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EX-12 - EX-12 - HCC INSURANCE HOLDINGS INC/DE/ | h68417exv12.htm |
EX-31.2 - EX-31.2 - HCC INSURANCE HOLDINGS INC/DE/ | h68417exv31w2.htm |
EX-32.1 - EX-32.1 - HCC INSURANCE HOLDINGS INC/DE/ | h68417exv32w1.htm |
EX-31.1 - EX-31.1 - HCC INSURANCE HOLDINGS INC/DE/ | h68417exv31w1.htm |
Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
þ | Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
for the Quarterly Period Ended September 30, 2009. |
o | 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 incorporation or organization) |
(IRS Employer Identification No.) |
|
13403 Northwest Freeway, Houston, Texas | 77040-6094 | |
(Address of principal executive offices) | (Zip Code) |
(713) 690-7300
(Registrants 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 þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its
corporate Web site, if any, every Interactive Data File required to be submitted and posted
pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months
(or for such shorter period that the registrant was required to submit and post such files).
Yes o No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a
non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated
filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act.
(Check one):
Large accelerated filer þ | Accelerated filer o | Non-accelerated filer o | Smaller reporting company o | |||
(Do not check if a smaller reporting company) |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act).
Yes o No þ
Indicate the number of shares outstanding of each of the registrants classes of common stock as of
the latest practicable date.
On October 31, 2009, there were approximately 112.5 million shares of common stock
outstanding.
HCC INSURANCE HOLDINGS, INC.
TABLE OF CONTENTS
Page | ||||||||
Part I. FINANCIAL INFORMATION |
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Item 1. Financial Statements |
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5 | ||||||||
6 | ||||||||
7 | ||||||||
8 | ||||||||
9 | ||||||||
27 | ||||||||
46 | ||||||||
46 | ||||||||
47 | ||||||||
47 | ||||||||
47 | ||||||||
48 | ||||||||
EX-12 | ||||||||
EX-31.1 | ||||||||
EX-31.2 | ||||||||
EX-32.1 |
2
Table of Contents
FORWARD-LOOKING STATEMENTS
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 growth of our business and operations,
business strategy, competitive strengths, goals, plans, future capital expenditures 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 have an impact on the matters addressed in these forward-looking
statements, which could affect our future financial results and performance, including, among other
things:
| the effects of catastrophic losses, |
| the cyclical nature of the insurance business, |
| inherent uncertainties in the loss estimation process, which can adversely impact the adequacy of loss reserves, |
| the effects of emerging claim and coverage issues, |
| the effects of extensive governmental regulation of the insurance industry, |
| potential credit risk with brokers, |
| our assessment of underwriting risk, |
| our retention of risk, which could expose us to potential losses, |
| the adequacy of reinsurance protection, |
| the ability or willingness of reinsurers to pay balances due us, |
| the occurrence of terrorist activities, |
| our ability to maintain our competitive position, |
| changes in our assigned financial strength ratings, |
| our ability to raise capital and funds for liquidity in the future, |
| attraction and retention of qualified employees, |
| fluctuations in securities markets, which may reduce the value of our investment assets, reduce investment income or generate realized investment losses, |
| our ability to successfully expand our business through the acquisition of insurance-related companies, |
| impairment of goodwill, |
| the ability of our insurance company subsidiaries to pay dividends in needed amounts, |
| fluctuations in foreign exchange rates, |
3
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| failures of our information technology systems, | ||
| potential changes in the countrys health care delivery system, and |
| change of control. |
We describe these risks and uncertainties in greater detail in Item 1A, Risk Factors in our Annual
Report on Form 10-K for the year ended December 31, 2008.
These events or factors 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 that are included
in this report, our inclusion of this information is not a representation by us or any other person
that our objectives or plans will be achieved.
Our forward-looking statements speak only at 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.
4
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HCC Insurance Holdings, Inc. and Subsidiaries
Condensed Consolidated Balance Sheets
(unaudited, in thousands except per share data)
September 30, | December 31, | |||||||
2009 | 2008 | |||||||
(as adjusted) | ||||||||
ASSETS |
||||||||
Investments: |
||||||||
Fixed income
securities available for sale, at fair value (amortized cost: 2009
$4,575,847; 2008 $4,118,539) |
$ | 4,784,343 | $ | 4,133,165 | ||||
Fixed income
securities held to maturity, at amortized cost (fair value: 2009 $104,077;
2008 $125,561) |
103,286 | 123,553 | ||||||
Short-term investments, at cost, which approximates fair value |
559,907 | 497,477 | ||||||
Other investments |
4,691 | 50,088 | ||||||
Total investments |
5,452,227 | 4,804,283 | ||||||
Cash |
56,874 | 27,347 | ||||||
Restricted cash and cash investments |
183,769 | 174,905 | ||||||
Premium, claims and other receivables |
602,957 | 770,823 | ||||||
Reinsurance recoverables |
1,046,548 | 1,054,950 | ||||||
Ceded unearned premium |
261,346 | 234,375 | ||||||
Ceded life and annuity benefits |
62,645 | 64,235 | ||||||
Deferred policy acquisition costs |
203,031 | 188,652 | ||||||
Goodwill |
824,658 | 858,849 | ||||||
Other assets |
141,287 | 153,581 | ||||||
Assets held for sale |
205,684 | | ||||||
Total assets |
$ | 9,041,026 | $ | 8,332,000 | ||||
LIABILITIES |
||||||||
Loss and loss adjustment expense payable |
$ | 3,529,217 | $ | 3,415,230 | ||||
Life and annuity policy benefits |
62,645 | 64,235 | ||||||
Reinsurance balances payable |
147,313 | 122,189 | ||||||
Unearned premium |
1,035,476 | 977,426 | ||||||
Deferred ceding commissions |
69,553 | 63,123 | ||||||
Premium and claims payable |
190,347 | 405,287 | ||||||
Notes payable |
444,682 | 343,649 | ||||||
Accounts payable and accrued liabilities |
409,474 | 300,838 | ||||||
Liabilities related to assets held for sale |
164,898 | | ||||||
Total liabilities |
6,053,605 | 5,691,977 | ||||||
SHAREHOLDERS EQUITY |
||||||||
Common stock, $1.00 par value; 250.0 million shares authorized (shares issued: 2009 117,216
and 2008 116,457; outstanding: 2009 112,543 and 2008 113,444) |
117,216 | 116,457 | ||||||
Additional paid-in capital |
902,917 | 881,534 | ||||||
Retained earnings |
1,907,923 | 1,677,831 | ||||||
Accumulated other comprehensive income |
158,164 | 27,536 | ||||||
Treasury stock, at cost (shares: 2009 4,673 and 2008 3,013) |
(98,799 | ) | (63,335 | ) | ||||
Total shareholders equity |
2,987,421 | 2,640,023 | ||||||
Total liabilities and shareholders equity |
$ | 9,041,026 | $ | 8,332,000 | ||||
See Notes to Condensed Consolidated Financial Statements.
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HCC Insurance Holdings, Inc. and Subsidiaries
Condensed Consolidated Statements of Earnings
(unaudited, in thousands except per share data)
Nine months ended September 30, | Three months ended September 30, | |||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
(as adjusted) | (as adjusted) | |||||||||||||||
REVENUE |
||||||||||||||||
Net earned premium |
$ | 1,524,425 | $ | 1,505,128 | $ | 520,059 | $ | 504,972 | ||||||||
Fee and commission income |
88,113 | 99,558 | 31,687 | 37,795 | ||||||||||||
Net investment income |
141,740 | 130,832 | 48,111 | 35,962 | ||||||||||||
Other operating income |
29,824 | 10,829 | 1,405 | 4,828 | ||||||||||||
Net realized investment gain (loss) |
4,852 | (12,761 | ) | 864 | (12,808 | ) | ||||||||||
Other-than-temporary impairment loss: |
||||||||||||||||
Total loss |
(6,089 | ) | (6,029 | ) | (380 | ) | (4,430 | ) | ||||||||
Portion recognized in other comprehensive income |
810 | | 55 | | ||||||||||||
Net loss recognized in earnings |
(5,279 | ) | (6,029 | ) | (325 | ) | (4,430 | ) | ||||||||
Total revenue |
1,783,675 | 1,727,557 | 601,801 | 566,319 | ||||||||||||
EXPENSE |
||||||||||||||||
Loss and loss adjustment expense, net |
911,944 | 920,433 | 303,808 | 324,506 | ||||||||||||
Policy acquisition costs, net |
271,358 | 284,695 | 92,418 | 96,582 | ||||||||||||
Other operating expense |
195,509 | 174,420 | 64,985 | 57,702 | ||||||||||||
Interest expense |
11,816 | 14,547 | 3,549 | 4,768 | ||||||||||||
Total expense |
1,390,627 | 1,394,095 | 464,760 | 483,558 | ||||||||||||
Earnings before income tax expense |
393,048 | 333,462 | 137,041 | 82,761 | ||||||||||||
Income tax expense |
123,972 | 102,941 | 42,720 | 24,370 | ||||||||||||
Net earnings |
$ | 269,076 | $ | 230,521 | $ | 94,321 | $ | 58,391 | ||||||||
Net earnings per common share: |
||||||||||||||||
Basic |
$ | 2.39 | $ | 2.00 | $ | 0.84 | $ | 0.51 | ||||||||
Diluted |
$ | 2.37 | $ | 1.99 | $ | 0.83 | $ | 0.50 | ||||||||
See Notes to Condensed Consolidated Financial Statements.
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HCC Insurance Holdings, Inc. and Subsidiaries
Condensed Consolidated Statement of Changes in Shareholders Equity
(unaudited, in thousands except per share data)
Accumulated | ||||||||||||||||||||||||
Additional | other | Total | ||||||||||||||||||||||
Common | paid-in | Retained | comprehensive | Treasury | shareholders | |||||||||||||||||||
stock | capital | earnings | income | stock | equity | |||||||||||||||||||
Balance at December 31, 2008 (as
previously reported) |
$ | 116,457 | $ | 861,867 | $ | 1,696,816 | $ | 27,536 | $ | (63,335 | ) | $ | 2,639,341 | |||||||||||
Cumulative effect of accounting change
(convertible debt) |
| 19,667 | (18,985 | ) | | | 682 | |||||||||||||||||
Balance at December 31, 2008 (as adjusted) |
116,457 | 881,534 | 1,677,831 | 27,536 | (63,335 | ) | 2,640,023 | |||||||||||||||||
Cumulative effect of accounting change
(other-than-temporary impairments in
investments) |
| | 4,301 | (4,301 | ) | | | |||||||||||||||||
Comprehensive income: |
||||||||||||||||||||||||
Net earnings |
| | 269,076 | | | 269,076 | ||||||||||||||||||
Other comprehensive income: |
||||||||||||||||||||||||
Change in unrealized gain (loss)
on investments, net of tax |
| | | 125,604 | | 125,604 | ||||||||||||||||||
Other-than-temporary impairment
loss, net of tax |
| | | (527 | ) | | (527 | ) | ||||||||||||||||
Other, net of tax |
| | | 9,852 | | 9,852 | ||||||||||||||||||
Total other comprehensive income |
134,929 | |||||||||||||||||||||||
Comprehensive income |
404,005 | |||||||||||||||||||||||
Issuance of 528 shares for exercise of
options, including tax effect |
528 | 8,895 | | | | 9,423 | ||||||||||||||||||
Purchase of 1,660 common shares |
| | | | (35,464 | ) | (35,464 | ) | ||||||||||||||||
Stock-based compensation |
231 | 12,488 | | | | 12,719 | ||||||||||||||||||
Cash dividends declared, $0.385 per share |
| | (43,285 | ) | | | (43,285 | ) | ||||||||||||||||
Balance at September 30, 2009 |
$ | 117,216 | $ | 902,917 | $ | 1,907,923 | $ | 158,164 | $ | (98,799 | ) | $ | 2,987,421 | |||||||||||
See Notes to Condensed Consolidated Financial Statements.
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HCC Insurance Holdings, Inc. and Subsidiaries
Condensed Consolidated Statements of Cash Flows
(unaudited, in thousands)
Nine months ended September 30, | ||||||||
2009 | 2008 | |||||||
(as adjusted) | ||||||||
Operating activities: |
||||||||
Net earnings |
$ | 269,076 | $ | 230,521 | ||||
Adjustments to reconcile net earnings to net cash provided by operating activities: |
||||||||
Change in premium, claims and other receivables |
36,443 | 22,705 | ||||||
Change in reinsurance recoverables |
14,853 | (119,825 | ) | |||||
Change in ceded unearned premium |
(25,093 | ) | 6,121 | |||||
Change in loss and loss adjustment expense payable |
51,519 | 278,156 | ||||||
Change in reinsurance balances payable |
24,548 | (4,344 | ) | |||||
Change in unearned premium |
39,441 | 41,162 | ||||||
Change in premium and claims payable, net of restricted cash |
(63,727 | ) | (105,135 | ) | ||||
Change in accounts payable and accrued liabilities |
22,132 | (49,446 | ) | |||||
Change in trading securities |
| 49,091 | ||||||
Stock-based compensation expense |
12,472 | 9,990 | ||||||
Depreciation and amortization expense |
11,796 | 10,436 | ||||||
(Gain) loss on investments |
(3,152 | ) | 26,367 | |||||
Other, net |
27,238 | 5,376 | ||||||
Cash provided by operating activities |
417,546 | 401,175 | ||||||
Investing activities: |
||||||||
Sales of available for sale fixed income securities |
337,615 | 421,677 | ||||||
Maturity or call of available for sale fixed income securities |
260,839 | 255,439 | ||||||
Maturity or call of held to maturity fixed income securities |
86,190 | | ||||||
Cost of available for sale fixed income securities acquired |
(1,020,506 | ) | (1,088,234 | ) | ||||
Cost of held to maturity fixed income securities acquired |
(59,677 | ) | | |||||
Cost of other investments acquired |
| (36,735 | ) | |||||
Change in short-term investments |
(91,617 | ) | 33,665 | |||||
Proceeds from sales of strategic and other investments |
114,940 | 54,355 | ||||||
Payments for purchase of businesses, net of cash received |
(37,995 | ) | (73,996 | ) | ||||
Proceeds from sale of assets of business |
6,188 | | ||||||
Other, net |
(13,109 | ) | (3,203 | ) | ||||
Cash used by investing activities |
(417,132 | ) | (437,032 | ) | ||||
Financing activities: |
||||||||
Advances on line of credit |
115,000 | 106,000 | ||||||
Payments on line of credit and notes payable |
(15,032 | ) | (56,000 | ) | ||||
Sale of common stock |
9,423 | 13,884 | ||||||
Purchase of common stock |
(35,464 | ) | (21,870 | ) | ||||
Dividends paid |
(42,244 | ) | (38,061 | ) | ||||
Other, net |
(2,570 | ) | 13,013 | |||||
Cash provided by financing activities |
29,113 | 16,966 | ||||||
Net increase (decrease) in cash |
29,527 | (18,891 | ) | |||||
Cash at beginning of period |
27,347 | 39,135 | ||||||
Cash at end of period |
$ | 56,874 | $ | 20,244 | ||||
See Notes to Condensed Consolidated Financial Statements.
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HCC Insurance Holdings, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(unaudited, tables in thousands except per share data)
(1) | General Information |
HCC Insurance Holdings, Inc. and its subsidiaries (collectively, we, us or our) include domestic
and foreign property and casualty and life insurance companies and underwriting agencies. We
provide specialized property and casualty, surety, and group life, accident and health insurance
coverages and related agency services to commercial customers and individuals. We market our
products both directly to customers and through a network of independent brokers, producers,
agents and third party administrators. Our lines of business include diversified financial
products (which includes directors and officers liability, errors and omissions liability
(known as professional indemnity outside the U.S.), employment practices liability, surety,
credit, and fidelity coverages); group life, accident and health (which includes medical
stop-loss, short-term medical, occupational accident, and other coverages); aviation; our London
market account (which includes energy, property, marine, and accident and health coverages); and
other specialty lines of insurance (which includes public entity, U.K. liability, event
cancellation, contingency, and other coverages). We operate primarily in the United States, the
United Kingdom, Spain and Ireland, although some of our operations have a broader international
scope.
Basis of Presentation
Our unaudited condensed consolidated financial statements have been prepared in conformity with
accounting principles generally accepted in the United States of America (U.S. GAAP) and include
the accounts of HCC Insurance Holdings, Inc. and its subsidiaries. We have made all adjustments
that, in our opinion, are necessary for a fair statement of results of the interim periods, and
all such adjustments are of a normal recurring nature. All significant intercompany balances and
transactions have been eliminated in consolidation. The condensed consolidated financial
statements should be read in conjunction with our annual audited consolidated financial
statements and related notes. The condensed consolidated balance sheet at December 31, 2008 (as
adjusted) was derived from audited financial statements, but does not include all disclosures
required by generally accepted accounting principles.
Management must make estimates and assumptions that affect amounts reported in our condensed
consolidated financial statements and in disclosures of contingent assets and liabilities.
Ultimate results could differ from those estimates. We have reclassified certain amounts in our
2008 condensed consolidated financial statements to conform to the 2009 presentation. None of our
reclassifications had an effect on our consolidated net earnings, shareholders equity or cash
flows. Certain 2008 amounts have been adjusted to reflect our adoption of the new convertible
debt and earnings per share accounting standards as of January 1, 2009. See the Accounting
Guidance Adopted in 2009 section below for additional information.
We have evaluated subsequent events through November 5, 2009, which is the date these financial
statements were issued.
Accounting Guidance Adopted in 2009
Codification
Effective July 1, 2009, the Accounting Standards Codification (ASC or the Codification) issued by
the Financial Accounting Standards Board (FASB) became the single authoritative source of U.S.
GAAP. Rules and interpretive releases issued by the Securities and Exchange Commission (SEC) are
the only other source of U.S. GAAP for SEC registrants. Although the Codification renames and
renumbers all previous accounting literature, it does not change current U.S. GAAP. Our
accounting policies were not affected by our adoption and usage of the Codification.
Convertible Debt
A new accounting standard, originally issued as FSP APB 14-1, Accounting for Convertible Debt
Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement),
became effective January 1, 2009, required retrospective application to prior financial
statements and did not permit early adoption. This change to ASC Topic 470, Debt, clarifies that
convertible debt instruments that may be settled in cash upon conversion are not totally debt,
and requires issuers to bifurcate and separately account for the liability and equity components.
In our condensed consolidated financial statements, we bifurcated the debt and equity components
of our 1.30% Convertible Notes and 2.00% Convertible Notes and retrospectively adjusted our
consolidated financial statements for all periods prior to 2009. The effective interest rate on
our 1.30% and 2.00% Convertible Notes increased to 4.80% and 3.86%, respectively, which resulted
in the recognition of a $22.6 million and $8.3 million discount,
respectively, with the offsetting after-tax impact recorded in additional paid-in capital.
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HCC Insurance Holdings, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(unaudited, tables in thousands except per share data)
The following line items in our 2008 condensed consolidated financial statements were affected by
this change in accounting principle:
Nine months ended September 30, 2008 | Three months ended September 30, 2008 | |||||||||||||||||||||||
As originally | As originally | |||||||||||||||||||||||
reported | As adjusted | Change | reported | As adjusted | Change | |||||||||||||||||||
Interest expense |
$ | 11,517 | $ | 14,547 | $ | 3,030 | $ | 3,750 | $ | 4,768 | $ | 1,018 | ||||||||||||
Earnings before income tax expense |
336,492 | 333,462 | (3,030 | ) | 83,779 | 82,761 | (1,018 | ) | ||||||||||||||||
Income tax expense |
104,001 | 102,941 | (1,060 | ) | 24,726 | 24,370 | (356 | ) | ||||||||||||||||
Net earnings |
232,491 | 230,521 | (1,970 | ) | 59,053 | 58,391 | (662 | ) | ||||||||||||||||
Diluted earnings per share |
$ | 2.01 | $ | 1.99 | $ | (0.02 | ) | $ | 0.51 | $ | 0.50 | $ | (0.01 | ) | ||||||||||
December 31, 2008 | ||||||||||||||||||||||||
As originally | ||||||||||||||||||||||||
reported | As adjusted | Change | ||||||||||||||||||||||
Other assets (debt issuance costs and deferred tax asset) |
$ | 153,964 | $ | 153,581 | $ | (383 | ) | |||||||||||||||||
Notes payable |
344,714 | 343,649 | (1,065 | ) | ||||||||||||||||||||
Additional paid-in capital |
861,867 | 881,534 | 19,667 | |||||||||||||||||||||
Retained earnings |
1,696,816 | 1,677,831 | (18,985 | ) | ||||||||||||||||||||
Total shareholders equity |
2,639,341 | 2,640,023 | 682 |
The reduction in retained earnings and the increase in additional paid-in capital resulted from
amortization of the implied discount as interest expense through the first contractual put date
of the 2.00% Convertible Notes at September 1, 2007 and the 1.30% Convertible Notes at April 1,
2009. The 2.00% Convertible Notes were submitted for conversion during September and October
2007. The implied discount on the 1.30% Convertible Notes was fully amortized in the first
quarter of 2009. At September 30, 2009, there was no remaining equity component and the liability
component was $124.7 million. At December 31, 2008, the 1.30% Convertible Notes had an equity
component of $1.1 million and a liability component of $123.6 million, consisting of a principal
amount of $124.7 million less a discount of $1.1 million. The effective interest rate on our
1.30% Convertible Notes was 2.47% for the nine months ended September 30, 2009 and 4.80% for the
nine months ended September 30, 2008. The contractual interest expense was $1.2 million in the
first nine months of 2009 and 2008. Interest expense resulting from amortization of the implied
discount was $1.1 million and $3.0 million in the nine months ended September 30, 2009 and 2008,
respectively. Our adoption of this guidance did not impact our past or current consolidated cash
flows.
Fair Value Measurements
A new accounting standard, originally issued as FSP FAS 157-2, Effective Date of FASB Statement
No. 157, became effective January 1, 2009. This guidance requires prospective application of ASC
Topic 820, Fair Value Measurement and Disclosure, to nonfinancial assets and nonfinancial
liabilities measured at fair value on a nonrecurring basis, such as goodwill. Our adoption of
this revised guidance had no impact on our condensed consolidated financial statements.
New accounting standards, originally issued as FSP FAS 157-4, Determining Fair Value When the
Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and
Identifying Transactions that Are Not Orderly; FSP FAS 107-1 and APB 28-1, Interim Disclosures
about Fair Value of Financial Instruments; and FSP FAS 115-2 and FAS 124-2, Recognition and
Presentation of Other-Than-Temporary Impairments, became effective prospectively on April 1,
2009. These changes to ASC Topic 820, Fair Value Measurements and Disclosures, and ASC Topic
320, Investments Debt and Equity Securities, modify the accounting guidance for determining
fair value of financial instruments under distressed market conditions, revise the recognition
and measurement requirements for other-than-temporary impairment losses on debt securities and
expand the related disclosures. Our adoption of this guidance did not have a material effect on
our 2009 condensed consolidated financial statements. See Note 3 for additional discussion of
these changes.
Earnings per Share
A new accounting standard, originally issued as FSP EITF 03-6-1, Determining Whether Instruments
Granted in Share-Based Payment Transactions are Participating Securities, became effective
January 1, 2009 and required retrospective application to
prior periods. This change to ASC Topic 260, Earnings Per Share, clarifies whether instruments
granted in share-based payments, such as restricted stock, are participating securities prior to
vesting and, therefore, must be included in the earnings allocation in
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HCC Insurance Holdings, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(unaudited, tables in thousands except per share data)
calculating earnings per
share under the two-class method described in ASC Topic 260-10-45-59A, Participating Securities
and the Two-Class Method. As revised, ASC Topic 260 requires that unvested share-based payments
that contain non-forfeitable rights to dividends or dividend-equivalents are treated as
participating securities. Our adoption of this guidance had no material impact on our
consolidated earnings per share in any prior period due to immateriality of our restricted stock
awards that have such terms.
Subsequent Events
A new accounting standard, originally issued as SFAS No. 165, Subsequent Events, provides
guidance to account for and disclose events that occur after the balance sheet date but before
financial statements are issued or available to be issued. We adopted this change to ASC Topic
855, Subsequent Events, as of June 30, 2009 and included the required disclosures in our
condensed consolidated financial statements.
Business Combinations
A new accounting standard, originally issued as SFAS No. 141 (revised 2007), Business
Combinations, became effective January 1, 2009. This change to ASC Topic 805, Business
Combinations, modifies certain accounting treatment for business combinations and impacts
presentation of financial statements on the acquisition date and accounting for acquisitions in
subsequent periods. Since January 1, 2009, we have recorded all new acquisitions in accordance
with this guidance.
Consolidation
A new accounting standard, originally issued as SFAS No. 160, Noncontrolling Interests in
Consolidated Financial Statements, an amendment of Accounting Research Bulletin No. 51, became
effective January 1, 2009. This change to ASC Topic 810, Consolidation, modifies the accounting
and reporting for minority interests, which are now recharacterized as noncontrolling interests
and classified as a component of shareholders equity. Our adoption of this guidance had no
impact on our condensed consolidated financial statements.
Derivatives
A new accounting standard, originally issued as SFAS No. 161, Disclosures about Derivative
Instruments and Hedging Activities an amendment of FASB Statement No. 133, became effective
January 1, 2009. This change to ASC Topic 815, Derivatives and Hedging, expands the required
disclosures about a companys derivative and hedging activities. Our adoption had no impact on
our condensed consolidated financial statements.
Recent Accounting Guidance
A new accounting standard, originally issued as SFAS No. 167, Amendments to FASB Interpretation
No. 46(R), was issued in June 2009. The guidance, which will be incorporated into ASC Topic 810,
Consolidation, changes various aspects of accounting for and disclosures of interests in variable
interest entities. We will adopt the guidance effective January 1, 2010. We do not expect our
adoption to have a material impact on our consolidated financial statements.
Net Earned Premium, Policy Acquisition Costs and Ceding Commissions
Substantially all of the property and casualty, surety, and accident and health policies written
by our insurance companies qualify as short-duration contracts. We recognize in current earned
income the portion of the premium that provides insurance protection in the period. For the
majority of our insurance policies, we recognize premium, net of reinsurance, on a pro rata basis
over the term of the related contract. For certain directors and officers liability tail
policies, surety bonds and energy construction contracts, we recognize premium, net of
reinsurance, over the period of risk in proportion to the amount of insurance protection
provided. Unearned premium represents the portion of premium written that relates to the
unexpired term of coverage. Premium for commercial title insurance and group life policies is
recognized in earnings when the premium is due. When the limit under a specific excess of loss
reinsurance layer has been exhausted, we effectively expense the remaining premium for that limit
and defer and amortize the reinstatement premium over the remaining period of risk.
Income Tax
For the nine months ended September 30, 2009 and 2008, the income tax provision was calculated
based on an estimated effective
tax rate for each fiscal year. Our effective tax rate differs from the United States Federal
statutory rate primarily due to tax-exempt municipal bond interest.
11
Table of Contents
HCC Insurance Holdings, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(unaudited, tables in thousands except per share data)
Notes Payable
Notes payable at September 30, 2009 and December 31, 2008 are shown in the table below. The
estimated fair value of our Convertible Notes ($156.8 million at September 30, 2009 and $149.8
million at December 31, 2008) is based on quoted market prices. The estimated fair value of our
Revolving Loan Facility is based on current borrowing rates offered to us and approximates the
carrying value at both balance sheet dates.
September 30, | December 31, | |||||||
2009 | 2008 | |||||||
1.30% Convertible Notes |
$ | 124,682 | $ | 123,649 | ||||
$575.0 million Revolving Loan Facility |
320,000 | 220,000 | ||||||
Total notes payable |
$ | 444,682 | $ | 343,649 | ||||
Our 1.30% Convertible Notes are due in 2023. We pay interest semi-annually on April 1 and October
1. Each one thousand dollar principal amount of notes is convertible into 44.1501 shares of our
common stock, which represents an initial conversion price of $22.65 per share. The initial
conversion price is subject to standard anti-dilution provisions designed to maintain the value
of the conversion option in the event we take certain actions with respect to our common stock,
such as stock splits, reverse stock splits, stock dividends and extraordinary dividends, that
affect all of the holders of our common stock equally and that could have a dilutive effect on
the value of the conversion rights of the holders of the notes or that confer a benefit upon our
current shareholders not otherwise available to the 1.30% Convertible Notes. Holders may
surrender notes for conversion if, as of the last day of the preceding calendar quarter, the
closing sale price of our common stock for at least 20 consecutive trading days during the period
of 30 consecutive trading days ending on the last trading day of that quarter is more than 130%
($29.45 per share) of the conversion price per share of our common stock. This condition was not
met at September 30, 2009. While the notes are not convertible during the fourth quarter of
2009, the convertible value of the notes, if converted, at September 30, 2009 was $150.6 million,
which exceeds the principal amount by $25.9 million. We must settle any conversions by paying
cash for the principal amount of the notes and issuing our common stock for the value of the
conversion premium. We can redeem the notes at any time. If we announce our intent to redeem the
notes, the notes will become immediately convertible, and the holders may surrender them for
conversion, payable on the same terms as described above, at any time until two business days
prior to the redemption date. Holders may require us to repurchase the notes on April 1, 2014 or
2019. The repurchase price to settle any such put by the holders will equal the principal amount
of the notes plus accrued and unpaid interest and will be paid in cash.
Stock-Based Compensation
In the first nine months of 2009, we granted the following shares of common stock, restricted
stock, restricted stock units and stock options for the purchase of shares of our common stock.
The fair value of the common stock was expensed on the grant date. The fair value of the
restricted stock, restricted stock units and stock options will be expensed over the vesting
period.
Weighted-average | ||||||||||||||||
Number of | grant date | Aggregate | Vesting | |||||||||||||
shares | fair value | fair value | period | |||||||||||||
Common stock |
75 | $ | 23.84 | $ | 1,778 | | ||||||||||
Restricted stock |
160 | 23.98 | 3,846 | 3-4 years | ||||||||||||
Restricted stock units |
21 | 23.90 | 509 | 4 years | ||||||||||||
Stock options |
335 | 5.41 | 1,814 | 3-5 years |
Acquisition, Dispositions and Assets Held for Sale
On February 27, 2009, we acquired Surety Company of the Pacific, which writes license and permit
bonds for California contractors. We included the results of operations of the acquired company
in our condensed consolidated financial statements
beginning on March 1, 2009. We valued all identifiable assets and liabilities at fair value and
allocated $5.6 million to goodwill. The goodwill is not deductible for United States Federal
income tax purposes.
12
Table of Contents
HCC Insurance Holdings, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(unaudited, tables in thousands except per share data)
On June 30, 2009, we sold the assets and licensed the intangibles related to our commercial
marine agency business. We entered into a five-year managing general underwriters agreement
that allows the purchaser to write that same business utilizing policies issued by one of our
insurance companies. We reduced goodwill by $18.0 million, the amount assigned to this reporting
unit, and recognized an immaterial gain on the transaction.
On October 3, 2009, we executed a contract to sell 100% of the stock of our reinsurance broker,
Rattner Mackenzie Limited (RML), to an affiliate of Marsh & McLennan Companies, Inc. (MMC) for
$42.5 million of MMC common stock. We also executed an agreement with MMC and its affiliates
whereby our insurance companies and agencies will continue to utilize MMC and its affiliates to
place certain of our reinsurance. The sale closed on October 8, 2009. At September 30, 2009, we
recorded RMLs assets and liabilities at fair value less the costs to sell and recognized a loss
on the transaction of $4.2 million, which was included in other operating income in our condensed
consolidated
statement of earnings for the third quarter of 2009. We also removed RMLs assets and
liabilities from the separate lines in our condensed consolidated balance sheet at September 30,
2009 and reported the applicable items as assets held for sale or liabilities related to assets
held for sale, as follows:
Assets: |
||||
Short-term investments |
$ | 33,083 | ||
Premium, claims and other receivables |
130,296 | |||
Goodwill |
41,926 | |||
Other assets |
379 | |||
Assets held for sale |
$ | 205,684 | ||
Liabilities: |
||||
Premium and claims payable |
$ | 160,447 | ||
Accounts payable and accrued liabilities |
4,451 | |||
Liabilities related to assets held for sale |
$ | 164,898 | ||
Goodwill
The above acquisition and dispositions impacted our goodwill in 2009. In addition, we
transferred $21.9 million of goodwill from two reporting units in our agency segment to a
reporting unit in our insurance company segment, based on a reorganization that created a
permanent change in cash flows. The changes in goodwill were as follows:
Insurance | Other | |||||||||||||||
Company | Agency | Operations | Total | |||||||||||||
Balance at December 31, 2008 |
$ | 646,527 | $ | 211,999 | $ | 323 | $ | 858,849 | ||||||||
Additions: |
||||||||||||||||
Acquisitions |
7,356 | 804 | | 8,160 | ||||||||||||
Earnouts on prior acquisitions |
15,265 | 2,478 | | 17,743 | ||||||||||||
Disposition |
| (18,048 | ) | | (18,048 | ) | ||||||||||
Classification as assets held for sale |
| (41,926 | ) | | (41,926 | ) | ||||||||||
Transfer and other |
21,821 | (21,941 | ) | | (120 | ) | ||||||||||
Balance at September 30, 2009 |
$ | 690,969 | $ | 133,366 | $ | 323 | $ | 824,658 | ||||||||
(2) | Fair Value |
We value financial assets and financial liabilities at fair value. In determining fair value, we
generally apply the market approach, which uses prices and other relevant data based on market
transactions involving identical or comparable assets and liabilities. We classify our financial
instruments into the following three-level hierarchy:
| Level 1 Inputs are based on quoted prices in active markets for identical instruments. | ||
| Level 2 Inputs are based on observable market data (other than quoted prices), or are derived from or corroborated by observable market data. | ||
| Level 3 Inputs are unobservable and not corroborated by market data. |
13
Table of Contents
HCC Insurance Holdings, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(unaudited, tables in thousands except per share data)
Our Level 1 investments are primarily U.S. Treasuries, for which we use quoted prices for
identical instruments to measure fair value.
Our Level 2 investments include most of our fixed income securities, which consist of U.S.
government agency securities, municipal bonds, certain corporate debt securities, and certain
mortgage-backed and asset-backed securities. Our Level 2 instruments also include our interest
rate swap agreements, which were reflected as liabilities in our condensed consolidated balance
sheet at September 30, 2009. We measure fair value for the majority of our Level 2 investments
using quoted prices of securities with similar characteristics. The remaining investments are
valued using pricing models or matrix pricing. The fair value measurements consider observable
assumptions, including benchmark yields, reported trades, broker/dealer quotes, issuer spreads,
two-sided markets, benchmark securities, bids, offers, default rates, loss severity and other
economic measures.
We use independent pricing services to assist us in determining fair value for over 99% of our
Level 1 and Level 2 investments. The pricing services provide a single price or quote per
security. We use data provided by our third party investment manager to value the remaining Level
2 investments. To validate that these quoted and modeled prices are reasonable estimates of fair
value, we perform various quantitative and qualitative procedures, including: 1) evaluation of
the underlying methodologies, 2) analysis of recent sales activity, 3) analytical review of our
fair values against current market prices, and 4) comparison of the pricing services fair value
to other pricing services fair value for the same investment. Based on these procedures, we did
not adjust the prices or quotes provided by our independent pricing services or third party
investment manager as of September 30, 2009 or December 31, 2008. In 2008 and 2009, the FASB
issued new accounting guidance related to determining the fair value of securities in inactive
markets. We did not apply the criteria of this guidance as of September 30, 2009 and December
31, 2008, since no markets for our investments were judged to be inactive as of those balance
sheet dates.
Our Level 3 financial instruments include certain fixed income securities and two insurance
contracts that we account for as derivatives. We determine fair value based on internally
developed models that use assumptions or other data that are not readily observable from
objective sources. Because we use the lowest level significant input to determine our hierarchy
classifications, a financial instrument may be classified in Level 3 even though there may be
significant readily-observable inputs.
We excluded from our fair value disclosures our $103.3 million held to maturity investment
portfolio and two investments valued at $4.1 million at September 30, 2009, which are measured at
amortized cost and at cost, respectively. Our held to maturity portfolio had a fair value of
$104.1 million at September 30, 2009.
The following table presents our assets and interest rate swap liabilities that were measured
at fair value.
Level 1 | Level 2 | Level 3 | Total | |||||||||||||
September 30, 2009 |
||||||||||||||||
Fixed income securities |
$ | 253,874 | $ | 4,521,894 | $ | 8,575 | $ | 4,784,343 | ||||||||
Other investments |
14 | | | 14 | ||||||||||||
Other assets |
| | 19,569 | 19,569 | ||||||||||||
Total assets measured at fair value |
$ | 253,888 | $ | 4,521,894 | $ | 28,144 | $ | 4,803,926 | ||||||||
Accounts payable and accrued liabilities |
$ | | $ | (3,778 | ) | $ | | $ | (3,778 | ) | ||||||
Total liabilities measured at fair value |
$ | | $ | (3,778 | ) | $ | | $ | (3,778 | ) | ||||||
December 31, 2008 |
||||||||||||||||
Fixed income securities |
$ | 87,678 | $ | 4,038,972 | $ | 6,515 | $ | 4,133,165 | ||||||||
Other investments |
16 | | | 16 | ||||||||||||
Other assets |
| 1,125 | 16,100 | 17,225 | ||||||||||||
Total assets measured at fair value |
$ | 87,694 | $ | 4,040,097 | $ | 22,615 | $ | 4,150,406 | ||||||||
Accounts payable and accrued liabilities |
$ | | $ | (8,031 | ) | $ | | $ | (8,031 | ) | ||||||
Total liabilities measured at fair value |
$ | | $ | (8,031 | ) | $ | | $ | (8,031 | ) | ||||||
14
Table of Contents
HCC Insurance Holdings, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(unaudited, tables in thousands except per share data)
The following table presents the changes in fair value of our Level 3 category during the
first nine months and the third quarter of 2009.
Fixed | ||||||||||||
income | Other | |||||||||||
securities | assets | Total | ||||||||||
Balance at December 31, 2008 |
$ | 6,515 | $ | 16,100 | $ | 22,615 | ||||||
Net redemptions |
(1,590 | ) | | (1,590 | ) | |||||||
Gains and
(losses) unrealized |
1,018 | 3,469 | 4,487 | |||||||||
Gains and
(losses) realized |
30 | | 30 | |||||||||
Transfers into Level 3 |
6,263 | | 6,263 | |||||||||
Transfers out of Level 3 |
(3,661 | ) | | (3,661 | ) | |||||||
Balance at September 30, 2009 |
$ | 8,575 | $ | 19,569 | $ | 28,144 | ||||||
Balance at June 30, 2009 |
$ | 5,982 | $ | 19,757 | $ | 25,739 | ||||||
Net redemptions |
(327 | ) | | (327 | ) | |||||||
Gains and
(losses) unrealized |
487 | (188 | ) | 299 | ||||||||
Transfers into Level 3 |
4,348 | | 4,348 | |||||||||
Transfers out of Level 3 |
(1,915 | ) | | (1,915 | ) | |||||||
Balance at September 30, 2009 |
$ | 8,575 | $ | 19,569 | $ | 28,144 | ||||||
Unrealized gains and losses on our Level 3 fixed income securities are reported in other comprehensive income within shareholders equity, and unrealized gains and losses on our Level 3 other assets are reported in other operating income. Transfers of investments into Level 3 occurred due to our inability to obtain a fair value using inputs based on observable market data. Transfers of investments out of Level 3 occurred because we were able to determine their fair value using inputs based on observable market data. |
(3) | Investments |
Substantially all of our fixed income securities are investment grade and 97% are rated A or
better. The cost or amortized cost, gross unrealized gain or loss, and fair value of investments
in fixed income securities that are classified as available for sale were as follows:
Cost or | Gross | Gross | ||||||||||||||
amortized | unrealized | unrealized | Fair | |||||||||||||
cost | gain | loss | value | |||||||||||||
September 30, 2009 |
||||||||||||||||
U.S. government and government agency securities |
$ | 455,025 | $ | 7,967 | $ | (9 | ) | $ | 462,983 | |||||||
Fixed income securities of states, municipalities
and political subdivisions |
1,012,861 | 67,462 | (209 | ) | 1,080,114 | |||||||||||
Special purpose revenue bonds of states,
municipalities and political subdivisions |
1,069,921 | 64,330 | (601 | ) | 1,133,650 | |||||||||||
Corporate fixed income securities |
542,098 | 24,875 | (349 | ) | 566,624 | |||||||||||
Residential mortgage-backed securities |
930,891 | 45,121 | (5,772 | ) | 970,240 | |||||||||||
Commercial mortgage-backed securities |
160,863 | 729 | (8,411 | ) | 153,181 | |||||||||||
Asset-backed securities |
27,783 | 721 | (1,623 | ) | 26,881 | |||||||||||
Foreign government securities |
254,627 | 8,758 | (773 | ) | 262,612 | |||||||||||
Foreign non-government securities |
121,778 | 6,280 | | 128,058 | ||||||||||||
Total available for sale fixed income securities |
$ | 4,575,847 | $ | 226,243 | $ | (17,747 | ) | $ | 4,784,343 | |||||||
15
Table of Contents
HCC Insurance Holdings, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(unaudited, tables in thousands except per share data)
Cost or | Gross | Gross | ||||||||||||||
amortized | unrealized | unrealized | Fair | |||||||||||||
cost | gain | loss | value | |||||||||||||
December 31, 2008 |
||||||||||||||||
U.S. government and government agency securities |
$ | 196,856 | $ | 9,447 | $ | (15 | ) | $ | 206,288 | |||||||
Fixed income securities of states, municipalities
and political subdivisions |
1,082,855 | 23,948 | (14,900 | ) | 1,091,903 | |||||||||||
Special purpose revenue bonds of states,
municipalities and political subdivisions |
899,466 | 16,249 | (16,083 | ) | 899,632 | |||||||||||
Corporate fixed income securities |
517,794 | 5,308 | (11,464 | ) | 511,638 | |||||||||||
Residential mortgage-backed securities |
796,522 | 40,229 | (13,673 | ) | 823,078 | |||||||||||
Commercial mortgage-backed securities |
179,479 | 42 | (27,685 | ) | 151,836 | |||||||||||
Asset-backed securities |
72,646 | 78 | (6,772 | ) | 65,952 | |||||||||||
Foreign government securities |
230,829 | 7,699 | (431 | ) | 238,097 | |||||||||||
Foreign non-government securities |
142,092 | 2,877 | (228 | ) | 144,741 | |||||||||||
Total available for sale fixed income securities |
$ | 4,118,539 | $ | 105,877 | $ | (91,251 | ) | $ | 4,133,165 | |||||||
The amortized cost and fair value of investments in fixed income securities that are
classified as held to maturity were as follows:
Amortized | Fair | |||||||
cost | value | |||||||
September 30, 2009 |
||||||||
U.S. government securities |
$ | 14,995 | $ | 15,018 | ||||
Foreign government securities |
80,683 | 81,396 | ||||||
Foreign non-government securities |
7,608 | 7,663 | ||||||
Total held to maturity fixed income securities |
$ | 103,286 | $ | 104,077 | ||||
December 31, 2008 |
||||||||
U.S. government securities |
$ | 21,319 | $ | 21,823 | ||||
Foreign government securities |
95,268 | 96,661 | ||||||
Foreign non-government securities |
6,966 | 7,077 | ||||||
Total held to maturity fixed income securities |
$ | 123,553 | $ | 125,561 | ||||
16
Table of Contents
HCC Insurance Holdings, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(unaudited, tables in thousands except per share data)
All fixed income securities were income producing in 2009. The following table displays the
gross unrealized losses and fair value of all available for sale fixed income securities
that were in a continuous unrealized loss position for the periods indicated:
Less than 12 Months | 12 Months or more | Total | ||||||||||||||||||||||
Unrealized | Unrealized | Unrealized | ||||||||||||||||||||||
Fair value | losses | Fair value | losses | Fair value | losses | |||||||||||||||||||
September 30, 2009 |
||||||||||||||||||||||||
U.S. government and government agency
securities |
$ | 28,650 | $ | (9 | ) | $ | | $ | | $ | 28,650 | $ | (9 | ) | ||||||||||
Fixed income securities of states,
municipalities and political
subdivisions |
| | 20,961 | (209 | ) | 20,961 | (209 | ) | ||||||||||||||||
Special purpose revenue bonds of
states, municipalities and political
subdivisions |
8,291 | (64 | ) | 30,862 | (537 | ) | 39,153 | (601 | ) | |||||||||||||||
Corporate fixed income securities |
4,237 | (188 | ) | 5,404 | (161 | ) | 9,641 | (349 | ) | |||||||||||||||
Residential mortgage-backed securities |
9,969 | (579 | ) | 45,575 | (5,194 | ) | 55,544 | (5,773 | ) | |||||||||||||||
Commercial mortgage-backed securities |
1,278 | (9 | ) | 100,751 | (8,402 | ) | 102,029 | (8,411 | ) | |||||||||||||||
Asset-backed securities |
2,641 | (636 | ) | 10,264 | (986 | ) | 12,905 | (1,622 | ) | |||||||||||||||
Foreign government securities |
17,372 | (634 | ) | 8,657 | (139 | ) | 26,029 | (773 | ) | |||||||||||||||
Total |
$ | 72,438 | $ | (2,119 | ) | $ | 222,474 | $ | (15,628 | ) | $ | 294,912 | $ | (17,747 | ) | |||||||||
December 31, 2008 |
||||||||||||||||||||||||
U.S. government and government agency
securities |
$ | 13,240 | $ | (10 | ) | $ | 590 | $ | (5 | ) | $ | 13,830 | $ | (15 | ) | |||||||||
Fixed income securities of states,
municipalities and political
subdivisions |
294,887 | (7,819 | ) | 98,682 | (7,081 | ) | 393,569 | (14,900 | ) | |||||||||||||||
Special purpose revenue bonds of
states, municipalities and political
subdivisions |
289,204 | (9,055 | ) | 98,743 | (7,028 | ) | 387,947 | (16,083 | ) | |||||||||||||||
Corporate fixed income securities |
298,464 | (7,217 | ) | 18,753 | (4,247 | ) | 317,217 | (11,464 | ) | |||||||||||||||
Residential mortgage-backed securities |
63,640 | (8,805 | ) | 16,409 | (4,868 | ) | 80,049 | (13,673 | ) | |||||||||||||||
Commercial mortgage-backed securities |
77,252 | (10,028 | ) | 72,642 | (17,657 | ) | 149,894 | (27,685 | ) | |||||||||||||||
Asset-backed securities |
54,798 | (4,062 | ) | 7,401 | (2,710 | ) | 62,199 | (6,772 | ) | |||||||||||||||
Foreign government securities |
| | 25,613 | (431 | ) | 25,613 | (431 | ) | ||||||||||||||||
Foreign non-government securities |
20,620 | (211 | ) | 6,381 | (17 | ) | 27,001 | (228 | ) | |||||||||||||||
Total |
$ | 1,112,105 | $ | (47,207 | ) | $ | 345,214 | $ | (44,044 | ) | $ | 1,457,319 | $ | (91,251 | ) | |||||||||
A security has an impairment loss when its fair value is less than its cost or amortized cost at
the balance sheet date. We evaluate the securities in our fixed income securities portfolio for
possible other-than-temporary impairment losses at each quarter end. We adopted a new accounting
standard, which specifies new criteria for identification and recognition of other-than-temporary
impairment losses, as of April 1, 2009. This standard requires us to determine, for each impaired
fixed income security, that (a) we do not intend to sell the security and (b) it is more likely
than not that we will not be required to sell the security before recovery of its amortized cost
basis. If we cannot assert either of these, the impairment is recorded as an other-than-temporary
loss through earnings in the current period. For all other impaired securities, the impairment is
considered an other-than-temporary loss if the net present value of the cash flows expected to be
collected from the security is less than its amortized cost basis. Such a shortfall in cash flows
is referred to as a credit loss. For any such security, the impairment loss is separated into
(a) the credit loss and (b) the amount related to all other factors, such as interest rate
changes, market conditions, etc. (the non-credit loss). The credit loss is charged to current
period earnings and the non-credit loss is charged to other comprehensive income, within
shareholders equity, on an after-tax basis. A securitys cost basis is permanently reduced by the
amount of an other-than-temporary loss recorded through earnings.
17
Table of Contents
HCC Insurance Holdings, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(unaudited, tables in thousands except per share data)
To adopt the new accounting standard, we reviewed all securities with a previous
other-than-temporary impairment loss that we still held at April 1, 2009. For each, we determined
the credit and non-credit component as of the adoption date. We calculated the net present value
of each security by discounting our best estimate of projected future cash flows at the effective
interest rate implicit in the security prior to impairment. For our mortgage-backed securities,
the estimated cash flows included prepayment assumptions and other assumptions regarding the
underlying collateral including default rates, recoveries and changes in value. We recorded a
cumulative adjustment of $4.3 million after-tax to reclassify the non-credit portion of the loss
from retained earnings to accumulated other comprehensive income as of the adoption date.
We review our impaired securities and assess whether any impairments are other-than-temporary at
each quarter end, based on all relevant facts and circumstances for each impaired security. During
2009 and 2008, our reviews covered all impaired securities where the loss exceeded $0.5 million
and the loss either exceeded 10% of cost or the security had been in a loss position for longer
than twelve consecutive months. Our review in the third quarter of 2009 covered 79% of the total
unrealized losses in the portfolio.
The determination that a security has incurred an other-than-temporary decline in value and the
amount of any current loss recognition requires management judgment and a continual review of
market conditions and our investment portfolio. In the second quarter of 2009, we changed our
criteria for determining if an impaired security has an other-than-temporary impairment to comply
with the new accounting standard. Our evaluation now considers various factors including:
| amount by which the securitys fair value is less than its cost, | ||
| length of time the security has been impaired, | ||
| the securitys credit rating and any recent downgrades, | ||
| whether the impairment is due to an issuer-specific event, | ||
| whether we intend to sell the security, | ||
| if it is more likely than not that we will have to sell the security before recovery of its amortized cost basis, and | ||
| stress testing of expected cash flows for mortgage-backed and asset-backed securities under various scenarios. |
To assist us in our evaluation, our outside investment advisors also perform detailed credit
evaluations of all of our fixed income securities on an ongoing basis.
The new accounting standard also changed the earnings recognition criteria for
other-than-temporary impairment losses. Prior to our adoption of this standard, when we concluded
that a decline in a securitys fair value was other-than-temporary, we recognized the impairment
as a realized investment loss in our consolidated statements of earnings. Beginning in the second
quarter of 2009, we recognize an other-than-temporary impairment loss in earnings in the period
that we determine: 1) we intend to sell the security, 2) it is more likely than not that we will
be required to sell the security before recovery of its amortized cost basis, or 3) the security
has a credit loss.
We identified and recognized pretax other-than-temporary impairment losses as follows:
Nine months ended September 30, | Three months ended September 30, | |||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
Total other-than-temporary impairment loss |
$ | (6,089 | ) | $ | (6,029 | ) | $ | (380 | ) | $ | (4,430 | ) | ||||
Portion recognized in other comprehensive income |
810 | | 55 | | ||||||||||||
Net other-than-temporary impairment loss
recognized in earnings |
$ | (5,279 | ) | $ | (6,029 | ) | $ | (325 | ) | $ | (4,430 | ) | ||||
At September 30, 2009, we had $4.8 million after-tax of other-than-temporary impairments,
primarily related to mortgage-backed and asset-backed securities, included in accumulated other
comprehensive income.
18
Table of Contents
HCC Insurance Holdings, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(unaudited, tables in thousands except per share data)
The roll forward of the credit-related portion of our pretax other-than-temporary impairment loss
recognized in earnings, for which a portion of the other-than-temporary loss was recognized in
other comprehensive income, beginning at the date of adoption of the new accounting standard, was
as follows:
Six months ended | Three months ended | |||||||
September 30, 2009 | September 30, 2009 | |||||||
Balance at beginning of period |
$ | | $ | 3,373 | ||||
Credit losses included in retained
earnings related to adoption of new
accounting standard |
2,723 | | ||||||
Credit losses recognized in earnings: |
||||||||
Securities previously impaired |
550 | 200 | ||||||
Securities not previously impaired |
425 | 125 | ||||||
Balance at September 30, 2009 |
$ | 3,698 | $ | 3,698 | ||||
Significant price deterioration in our fixed income securities occurred in the second half of
2008, principally due to the effects of the recent credit crisis, changes in market interest rates
and widening of credit spreads. We did not consider the $91.3 million of gross unrealized losses
in our available for sale fixed income securities at December 31, 2008 to be other-than-temporary
impairments as of that date because: 1) we received all contractual interest and principal
payments on these securities as of year-end 2008, 2) based on our fourth quarter 2008 review, we
believed it was probable that we would continue to collect all such cash payments due in the
future, and 3) as of December 31, 2008, we had the intent and ability to hold these securities
until maturity or for a period of time sufficient to allow recovery of the impaired securitys
fair value. Based on the guidance in the new accounting standard adopted on April 1, 2009, we do
not consider the $17.7 million of gross unrealized losses in our portfolio at September 30, 2009
to be other-than-temporary impairments as of that date because: 1) we received all contractual
interest and principal payments on these securities as of September 30, 2009, 2) we do not intend
to sell the securities, 3) it is more likely than not that we will not be required to sell the
securities before recovery of their amortized cost bases, and 4) for those securities with a
credit loss at September 30, 2009, the unrealized loss relates to non-credit factors, such as
interest rate changes and market conditions.
The change in our unrealized pretax net gains (losses) on investments during each period was as
follows:
Nine months ended September 30, | Three months ended September 30, | |||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
Available for sale fixed income securities |
$ | 193,870 | $ | (123,100 | ) | $ | 135,831 | $ | (63,985 | ) | ||||||
Strategic and other investments |
(2 | ) | 48 | | 1,285 | |||||||||||
Net unrealized investment gains (losses) |
$ | 193,868 | $ | (123,052 | ) | $ | 135,831 | $ | (62,700 | ) | ||||||
The amortized cost and fair value of our fixed income securities at September 30, 2009, 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 our mortgage-backed and asset-backed securities
at September 30, 2009 was 4.1 years.
Available for sale |
Held to maturity | |||||||||||||||
Cost or | ||||||||||||||||
amortized | Amortized | |||||||||||||||
cost | Fair value | cost | Fair value | |||||||||||||
Due in 1 year or less |
$ | 273,706 | $ | 277,613 | $ | 27,920 | $ | 28,127 | ||||||||
Due after 1 year through 5 years |
1,229,058 | 1,282,570 | 68,039 | 68,573 | ||||||||||||
Due after 5 years through 10 years |
824,271 | 874,968 | 7,327 | 7,377 | ||||||||||||
Due after 10 years through 15 years |
572,587 | 610,683 | | | ||||||||||||
Due after 15 years |
556,688 | 588,207 | | | ||||||||||||
Securities with fixed maturities |
3,456,310 | 3,634,041 | 103,286 | 104,077 | ||||||||||||
Residential mortgage-backed securities |
930,891 | 970,240 | | | ||||||||||||
Commercial mortgage-backed securities |
160,863 | 153,181 | | | ||||||||||||
Asset-backed securities |
27,783 | 26,881 | | | ||||||||||||
Total fixed income securities |
$ | 4,575,847 | $ | 4,784,343 | $ | 103,286 | $ | 104,077 | ||||||||
19
Table of Contents
HCC Insurance Holdings, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(unaudited, tables in thousands except per share data)
The sources of net investment income were as follows:
Nine months ended September 30, | Three months ended September 30, | |||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
Fixed income securities |
$ | 140,483 | $ | 129,511 | $ | 47,571 | $ | 44,215 | ||||||||
Short-term investments |
4,943 | 20,408 | 1,464 | 6,837 | ||||||||||||
Other investments |
(958 | ) | (16,160 | ) | | (14,244 | ) | |||||||||
Total investment income |
144,468 | 133,759 | 49,035 | 36,808 | ||||||||||||
Investment expense |
(2,728 | ) | (2,927 | ) | (924 | ) | (846 | ) | ||||||||
Net investment income |
$ | 141,740 | $ | 130,832 | $ | 48,111 | $ | 35,962 | ||||||||
Realized pretax gains (losses) on the sale of investments, which exclude other-than-temporary
impairment losses, were as follows:
Nine months ended September 30, | ||||||||||||||||||||||||
2009 | 2008 | |||||||||||||||||||||||
Gains | Losses | Net | Gains | Losses | Net | |||||||||||||||||||
Fixed income securities |
$ | 7,593 | $ | (3,289 | ) | $ | 4,304 | $ | 9,663 | $ | (14,076 | ) | $ | (4,413 | ) | |||||||||
Other investments |
710 | (162 | ) | 548 | 662 | (9,010 | ) | (8,348 | ) | |||||||||||||||
Realized gain (loss) |
$ | 8,303 | $ | (3,451 | ) | $ | 4,852 | $ | 10,325 | $ | (23,086 | ) | $ | (12,761 | ) | |||||||||
Three months ended September 30, | ||||||||||||||||||||||||
2009 | 2008 | |||||||||||||||||||||||
Gains | Losses | Net | Gains | Losses | Net | |||||||||||||||||||
Fixed income securities |
$ | 1,960 | $ | (1,122 | ) | $ | 838 | $ | 7,103 | $ | (11,769 | ) | $ | (4,666 | ) | |||||||||
Other investments |
27 | (1 | ) | 26 | 116 | (8,258 | ) | (8,142 | ) | |||||||||||||||
Realized gain (loss) |
$ | 1,987 | $ | (1,123 | ) | $ | 864 | $ | 7,219 | $ | (20,027 | ) | $ | (12,808 | ) | |||||||||
(4) | Earnings Per Share |
The following table details the numerator and denominator used in our earnings per share
calculations.
Nine months ended September 30, | Three months ended September 30, | |||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
(as adjusted) | (as adjusted) | |||||||||||||||
Net earnings |
$ | 269,076 | $ | 230,521 | $ | 94,321 | $ | 58,391 | ||||||||
Less: net earnings attributable to
unvested
restricted stock and restricted stock units |
(1,436 | ) | (167 | ) | (537 | ) | (135 | ) | ||||||||
Net earnings attributable to common stock |
$ | 267,640 | $ | 230,354 | $ | 93,784 | $ | 58,256 | ||||||||
Weighted-average common shares outstanding |
112,154 | 115,164 | 111,892 | 114,812 | ||||||||||||
Dilutive effect of outstanding options
(determined using treasury stock method) |
283 | 408 | 371 | 312 | ||||||||||||
Dilutive effect of convertible debt
(determined using treasury stock method) |
478 | 368 | 683 | 287 | ||||||||||||
Weighted-average common shares and
potential common shares outstanding |
112,915 | 115,940 | 112,946 | 115,411 | ||||||||||||
Anti-dilutive stock options not included in
treasury stock method computation |
5,672 | 5,918 | 5,279 | 6,049 | ||||||||||||
20
Table of Contents
HCC Insurance Holdings, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(unaudited, tables in thousands except per share data)
(5) | Segment And Geographic Data |
The performance of each segment is evaluated by our management based on net earnings. Net
earnings is calculated after corporate expense allocations, interest expense on debt incurred for
acquired companies, and intercompany eliminations have been charged or credited to our individual
segments. All stock-based compensation is included in the corporate segment because it is not
included in managements evaluation of the other segments. All contractual and discretionary
bonuses are expensed in the respective employees segment in the year the bonuses are earned. Any
such bonuses that will be paid by restricted stock awards, which will be granted by the
Compensation Committee in the following year, are reversed in the corporate segment, which, in
turn, will record the appropriate stock-based compensation expense as the awards vest in future
years.
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.
Insurance | Other | |||||||||||||||||||
Company | Agency | Operations | Corporate | Total | ||||||||||||||||
Nine months ended September 30, 2009 |
||||||||||||||||||||
Revenue: |
||||||||||||||||||||
Domestic |
$ | 1,392,625 | $ | 42,264 | $ | 4,738 | $ | 2,321 | $ | 1,441,948 | ||||||||||
Foreign |
323,554 | 18,173 | | | 341,727 | |||||||||||||||
Inter-segment |
| 77,986 | 768 | | 78,754 | |||||||||||||||
Total segment revenue |
$ | 1,716,179 | $ | 138,423 | $ | 5,506 | $ | 2,321 | 1,862,429 | |||||||||||
Inter-segment eliminations |
(78,754 | ) | ||||||||||||||||||
Consolidated total revenue |
$ | 1,783,675 | ||||||||||||||||||
Net earnings (loss): |
||||||||||||||||||||
Domestic |
$ | 210,305 | $ | 11,597 | $ | 1,766 | $ | (23,728 | ) | $ | 199,940 | |||||||||
Foreign |
64,292 | 3,596 | | | 67,888 | |||||||||||||||
Total segment net earnings (loss) |
$ | 274,597 | $ | 15,193 | $ | 1,766 | $ | (23,728 | ) | 267,828 | ||||||||||
Inter-segment eliminations |
1,248 | |||||||||||||||||||
Consolidated net earnings |
$ | 269,076 | ||||||||||||||||||
Other items: |
||||||||||||||||||||
Net investment income |
$ | 138,903 | $ | 498 | $ | 13 | $ | 2,326 | $ | 141,740 | ||||||||||
Depreciation and amortization |
3,912 | 5,670 | 67 | 2,147 | 11,796 | |||||||||||||||
Interest expense (benefit) |
805 | 10,872 | (13 | ) | 152 | 11,816 | ||||||||||||||
Capital expenditures |
2,934 | 5,665 | 24 | 4,435 | 13,058 | |||||||||||||||
Tax expense: |
||||||||||||||||||||
Income tax expense (benefit) |
$ | 117,036 | $ | 9,196 | $ | 899 | $ | (3,819 | ) | $ | 123,312 | |||||||||
Inter-segment eliminations |
660 | |||||||||||||||||||
Consolidated income tax expense |
$ | 123,972 | ||||||||||||||||||
21
Table of Contents
HCC Insurance Holdings, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(unaudited, tables in thousands except per share data)
Insurance | Other | |||||||||||||||||||
Company | Agency | Operations | Corporate | Total | ||||||||||||||||
Nine months ended September 30, 2008 (as adjusted) |
||||||||||||||||||||
Revenue: |
||||||||||||||||||||
Domestic |
$ | 1,374,157 | $ | 37,578 | $ | 6,581 | $ | 645 | $ | 1,418,961 | ||||||||||
Foreign |
281,401 | 27,195 | | | 308,596 | |||||||||||||||
Inter-segment |
| 68,496 | | | 68,496 | |||||||||||||||
Total segment revenue |
$ | 1,655,558 | $ | 133,269 | $ | 6,581 | $ | 645 | 1,796,053 | |||||||||||
Inter-segment eliminations |
(68,496 | ) | ||||||||||||||||||
Consolidated total revenue |
$ | 1,727,557 | ||||||||||||||||||
Net earnings (loss): |
||||||||||||||||||||
Domestic |
$ | 177,820 | $ | 14,690 | $ | 2,011 | $ | (17,112 | ) | $ | 177,409 | |||||||||
Foreign |
53,360 | 1,283 | | | 54,643 | |||||||||||||||
Total segment net earnings (loss) |
$ | 231,180 | $ | 15,973 | $ | 2,011 | $ | (17,112 | ) | 232,052 | ||||||||||
Inter-segment eliminations |
(1,531 | ) | ||||||||||||||||||
Consolidated net earnings |
$ | 230,521 | ||||||||||||||||||
Other items: |
||||||||||||||||||||
Net investment income |
$ | 126,321 | $ | 3,911 | $ | 48 | $ | 552 | $ | 130,832 | ||||||||||
Depreciation and amortization |
3,588 | 4,671 | 94 | 2,083 | 10,436 | |||||||||||||||
Interest expense (benefit) |
667 | 11,798 | (73 | ) | 2,155 | 14,547 | ||||||||||||||
Capital expenditures |
2,403 | 3,282 | 111 | 2,071 | 7,867 | |||||||||||||||
Tax expense: |
||||||||||||||||||||
Income tax expense (benefit) |
$ | 97,796 | $ | 11,545 | $ | 248 | $ | (5,589 | ) | $ | 104,000 | |||||||||
Inter-segment eliminations |
(1,059 | ) | ||||||||||||||||||
Consolidated income tax expense |
$ | 102,941 | ||||||||||||||||||
22
Table of Contents
HCC Insurance Holdings, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(unaudited, tables in thousands except per share data)
Insurance | Other | |||||||||||||||||||
Company | Agency | Operations | Corporate | Total | ||||||||||||||||
Three months ended September 30, 2009 |
||||||||||||||||||||
Revenue: |
||||||||||||||||||||
Domestic |
$ | 468,072 | $ | 11,275 | $ | 1 | $ | 800 | $ | 480,148 | ||||||||||
Foreign |
115,754 | 5,899 | | | 121,653 | |||||||||||||||
Inter-segment |
| 27,183 | 281 | | 27,464 | |||||||||||||||
Total segment revenue |
$ | 583,826 | $ | 44,357 | $ | 282 | $ | 800 | 629,265 | |||||||||||
Inter-segment eliminations |
(27,464 | ) | ||||||||||||||||||
Consolidated total revenue |
$ | 601,801 | ||||||||||||||||||
Net earnings (loss): |
||||||||||||||||||||
Domestic |
$ | 71,380 | $ | 4,218 | $ | (395 | ) | $ | (10,064 | ) | $ | 65,139 | ||||||||
Foreign |
26,035 | 2,462 | | | 28,497 | |||||||||||||||
Total segment net earnings (loss) |
$ | 97,415 | $ | 6,680 | $ | (395 | ) | $ | (10,064 | ) | 93,636 | |||||||||
Inter-segment eliminations |
685 | |||||||||||||||||||
Consolidated net earnings |
$ | 94,321 | ||||||||||||||||||
Other items: |
||||||||||||||||||||
Net investment income |
$ | 47,176 | $ | 164 | $ | 6 | $ | 765 | $ | 48,111 | ||||||||||
Depreciation and amortization |
1,336 | 2,001 | 23 | 784 | 4,144 | |||||||||||||||
Interest expense (benefit) |
268 | 3,529 | | (248 | ) | 3,549 | ||||||||||||||
Capital expenditures |
778 | 1,979 | 11 | 1,374 | 4,142 | |||||||||||||||
Tax expense: |
||||||||||||||||||||
Income tax expense (benefit) |
$ | 39,422 | $ | 2,457 | $ | (249 | ) | $ | 635 | $ | 42,265 | |||||||||
Inter-segment eliminations |
455 | |||||||||||||||||||
Consolidated income tax expense |
$ | 42,720 | ||||||||||||||||||
23
Table of Contents
HCC Insurance Holdings, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(unaudited, tables in thousands except per share data)
Insurance | Other | |||||||||||||||||||
Company | Agency | Operations | Corporate | Total | ||||||||||||||||
Three months ended September 30, 2008 (as adjusted) |
||||||||||||||||||||
Revenue: |
||||||||||||||||||||
Domestic |
$ | 449,087 | $ | 11,304 | $ | 2,872 | $ | 192 | $ | 463,455 | ||||||||||
Foreign |
94,984 | 7,880 | | | 102,864 | |||||||||||||||
Inter-segment |
| 28,711 | | | 28,711 | |||||||||||||||
Total segment revenue |
$ | 544,071 | $ | 47,895 | $ | 2,872 | $ | 192 | 595,030 | |||||||||||
Inter-segment eliminations |
(28,711 | ) | ||||||||||||||||||
Consolidated total revenue |
$ | 566,319 | ||||||||||||||||||
Net earnings (loss): |
||||||||||||||||||||
Domestic |
$ | 50,035 | $ | 4,752 | $ | 1,062 | $ | (4,031 | ) | $ | 51,818 | |||||||||
Foreign |
6,831 | 1,057 | | | 7,888 | |||||||||||||||
Total segment net earnings (loss) |
$ | 56,866 | $ | 5,809 | $ | 1,062 | $ | (4,031 | ) | 59,706 | ||||||||||
Inter-segment eliminations |
(1,315 | ) | ||||||||||||||||||
Consolidated net earnings |
$ | 58,391 | ||||||||||||||||||
Other items: |
||||||||||||||||||||
Net investment income |
$ | 34,622 | $ | 1,153 | $ | 17 | $ | 170 | $ | 35,962 | ||||||||||
Depreciation and amortization |
1,221 | 1,675 | 29 | 687 | 3,612 | |||||||||||||||
Interest expense (benefit) |
263 | 4,069 | (22 | ) | 458 | 4,768 | ||||||||||||||
Capital expenditures |
614 | 911 | 42 | 625 | 2,192 | |||||||||||||||
Tax expense: |
||||||||||||||||||||
Income tax expense (benefit) |
$ | 21,211 | $ | 3,557 | $ | 740 | $ | (236 | ) | $ | 25,272 | |||||||||
Inter-segment eliminations |
(902 | ) | ||||||||||||||||||
Consolidated income tax expense |
$ | 24,370 | ||||||||||||||||||
The following tables present selected revenue items by line of business.
Nine months ended September 30, | Three months ended September 30, | |||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
Diversified financial products |
$ | 668,640 | $ | 593,378 | $ | 234,725 | $ | 203,295 | ||||||||
Group life, accident and health |
597,598 | 582,193 | 199,427 | 194,393 | ||||||||||||
Aviation |
98,514 | 105,125 | 33,053 | 35,413 | ||||||||||||
London market account |
75,587 | 80,824 | 26,208 | 27,429 | ||||||||||||
Other specialty lines |
84,109 | 138,846 | 26,659 | 44,420 | ||||||||||||
Discontinued lines |
(23 | ) | 4,762 | (13 | ) | 22 | ||||||||||
Net earned premium |
$ | 1,524,425 | $ | 1,505,128 | $ | 520,059 | $ | 504,972 | ||||||||
Property and casualty |
$ | 71,607 | $ | 83,483 | $ | 25,910 | $ | 32,761 | ||||||||
Accident and health |
16,506 | 16,075 | 5,777 | 5,034 | ||||||||||||
Fee and commission income |
$ | 88,113 | $ | 99,558 | $ | 31,687 | $ | 37,795 | ||||||||
24
Table of Contents
HCC Insurance Holdings, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(unaudited, tables in thousands except per share data)
(6) | Reinsurance |
In the normal course of business, our insurance companies cede a portion of their premium to
domestic and foreign reinsurers through treaty and facultative reinsurance agreements. Although
ceding for reinsurance purposes does not discharge the direct insurer from liability to its
policyholder, our insurance companies participate in such agreements in order to limit their loss
exposure, protect them against catastrophic loss and diversify their business. The following
table presents the effect of such reinsurance transactions on our premium and loss and loss
adjustment expense.
Loss and loss | ||||||||||||
Written | Earned | adjustment | ||||||||||
premium | premium | expense | ||||||||||
Nine months ended September 30, 2009 |
||||||||||||
Direct business |
$ | 1,709,613 | $ | 1,688,378 | $ | 1,026,184 | ||||||
Reinsurance assumed |
194,473 | 186,611 | 93,704 | |||||||||
Reinsurance ceded |
(376,197 | ) | (350,564 | ) | (207,944 | ) | ||||||
Net amounts |
$ | 1,527,889 | $ | 1,524,425 | $ | 911,944 | ||||||
Nine months ended September 30, 2008 |
||||||||||||
Direct business |
$ | 1,594,624 | $ | 1,550,461 | $ | 986,026 | ||||||
Reinsurance assumed |
292,932 | 291,490 | 272,220 | |||||||||
Reinsurance ceded |
(331,174 | ) | (336,823 | ) | (337,813 | ) | ||||||
Net amounts |
$ | 1,556,382 | $ | 1,505,128 | $ | 920,433 | ||||||
Three months ended September 30, 2009 |
||||||||||||
Direct business |
$ | 559,142 | $ | 583,130 | $ | 329,561 | ||||||
Reinsurance assumed |
61,240 | 61,648 | 28,701 | |||||||||
Reinsurance ceded |
(127,095 | ) | (124,719 | ) | (54,454 | ) | ||||||
Net amounts |
$ | 493,287 | $ | 520,059 | $ | 303,808 | ||||||
Three months ended September 30, 2008 |
||||||||||||
Direct business |
$ | 538,782 | $ | 521,777 | $ | 379,929 | ||||||
Reinsurance assumed |
74,182 | 95,247 | 85,930 | |||||||||
Reinsurance ceded |
(117,379 | ) | (112,052 | ) | (141,353 | ) | ||||||
Net amounts |
$ | 495,585 | $ | 504,972 | $ | 324,506 | ||||||
Ceding commissions netted against policy acquisition costs in the condensed consolidated
statements of earnings were $42.0 million and $36.7 million for the nine months ended September
30, 2009 and 2008, respectively. The comparable amounts were $16.6 million and $11.6 million for
the third quarter of 2009 and 2008, respectively.
The table below shows the components of reinsurance recoverables in our condensed consolidated
balance sheets.
September 30, | December 31, | |||||||
2009 | 2008 | |||||||
Reinsurance recoverable on paid losses |
$ | 75,628 | $ | 64,419 | ||||
Reinsurance recoverable on outstanding losses |
508,117 | 535,563 | ||||||
Reinsurance recoverable on incurred but not reported losses |
465,748 | 463,396 | ||||||
Reserve for uncollectible reinsurance |
(2,945 | ) | (8,428 | ) | ||||
Total reinsurance recoverables |
$ | 1,046,548 | $ | 1,054,950 | ||||
25
Table of Contents
HCC Insurance Holdings, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(unaudited, tables in thousands except per share data)
The tables below present the calculation of net reserves, net unearned premium and net deferred
policy acquisition costs.
September 30, | December 31, | |||||||
2009 | 2008 | |||||||
Loss and loss adjustment expense payable |
$ | 3,529,217 | $ | 3,415,230 | ||||
Reinsurance recoverable on outstanding losses |
(508,117 | ) | (535,563 | ) | ||||
Reinsurance recoverable on incurred but not reported losses |
(465,748 | ) | (463,396 | ) | ||||
Net reserves |
$ | 2,555,352 | $ | 2,416,271 | ||||
Unearned premium |
$ | 1,035,476 | $ | 977,426 | ||||
Ceded unearned premium |
(261,346 | ) | (234,375 | ) | ||||
Net unearned premium |
$ | 774,130 | $ | 743,051 | ||||
Deferred policy acquisition costs |
$ | 203,031 | $ | 188,652 | ||||
Deferred ceding commissions |
(69,553 | ) | (63,123 | ) | ||||
Net deferred policy acquisition costs |
$ | 133,478 | $ | 125,529 | ||||
(7) | Supplemental Information |
Supplemental information was as follows:
Nine months ended September 30, | Three months ended September 30, | |||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
(as adjusted) | (as adjusted) | |||||||||||||||
Income taxes paid |
$ | 121,572 | $ | 116,857 | $ | 32,756 | $ | 27,061 | ||||||||
Interest paid |
9,827 | 10,661 | 3,578 | 3,525 | ||||||||||||
Comprehensive income |
404,005 | 142,913 | 185,298 | 8,846 | ||||||||||||
Proceeds from sales of available for sale
fixed income securities |
337,615 | 421,677 | 137,871 | 184,799 |
(8) | Commitments and Contingencies |
Litigation
We are a 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 that relate to disputes with third parties, or that
involve alleged errors and omissions on the part of our subsidiaries. We have provided accruals
for these items to the extent we deem the losses probable and reasonably estimable. Although the
ultimate outcome of these matters cannot be determined at this time, based on present
information, the availability of insurance coverage and advice received from our outside legal
counsel, we believe the resolution of any such matters will not have a material adverse effect on
our consolidated financial position, results of operations or cash flows.
Indemnifications
In conjunction with the sales of business assets and subsidiaries, we have provided
indemnifications to the buyers. Certain indemnifications cover typical representations and
warranties related to our responsibilities to perform under the sales contracts. Under other
indemnifications, we agree to reimburse the purchasers for taxes or ERISA-related amounts, if
any, assessed after the sale date but related to pre-sale activities. We cannot quantify the
maximum potential exposure covered by all of our indemnifications because the indemnifications
cover a variety of matters, operations and scenarios. Certain of these indemnifications have no
time limit. For those with a time limit, the longest such indemnification expires on June 30,
2015. We accrue a loss when a valid claim is made by a purchaser and we believe we have potential
exposure. At September 30, 2009, we have recorded a liability of $13.7 million and have provided
$6.7 million of letters of credit to cover our obligations or anticipated payments under these
indemnifications.
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Item 2. Managements Discussion and Analysis of Financial Condition and Results of
Operations
The following Managements Discussion and Analysis should be read in conjunction with the Condensed
Consolidated Financial Statements and the related Notes thereto.
Overview
We are a specialty insurance group with operations in the United States, the United Kingdom, Spain
and Ireland, transacting business in approximately 150 countries. Our group consists of insurance
companies, underwriting agencies and participation in two Lloyds of London syndicates that we
manage. Our shares trade on the New York Stock Exchange and closed at $27.35 on September 30, 2009
and $26.39 on October 31, 2009. We had a market capitalization of $3.0 billion at October 31, 2009.
We had shareholders equity of $3.0 billion at September 30, 2009. Our book value per share
increased 14% in the first nine months of 2009 to $26.54 at September 30, 2009, up from $23.27 at
December 31, 2008. We had net earnings of $269.1 million, or $2.37 per diluted share, and generated
$417.5 million of cash flow from operations in the first nine months of 2009. We declared dividends
of $0.385 per share in the first nine months of 2009, compared to $0.345 per share in the first
nine months of 2008, and paid $42.2 million of dividends in 2009. We repurchased 1.7 million shares
of our common stock for $35.5 million, at an average cost of $21.36 per share in 2009. We currently
have $4.9 billion of fixed income securities with an average rating of AA+ that are available to
fund claims and other liabilities. We maintain a $575.0 million Revolving Loan Facility that allows
us to borrow up to the maximum on a revolving basis, under which we have $240.0 million of
additional capacity at October 31, 2009. The facility expires in December 2011. We are rated AA
(Very Strong) by Standard & Poors Corporation and AA (Very Strong) by Fitch Ratings. Our major
domestic insurance companies are rated A+ (Superior) by A.M. Best Company, Inc.
We earned $269.1 million, or $2.37 per diluted share in the first nine months of 2009, compared to
$230.5 million, or $1.99 per diluted share, in the first nine months of 2008. Our third quarter net
earnings were $94.3 million, or $0.83 per diluted share in 2009, compared to $58.4 million, or
$0.50 per diluted share, in 2008. Our 2009 year-to-date earnings include $15.6 million of pretax
benefit due to a $25.0 million termination payment we received in the first quarter to commute a
reinsurance contract that had been accounted for using the deposit method of accounting. Our
year-to-date loss ratio for 2009 was 59.8%, compared to 61.2% for 2008. The 2008 loss ratio
included $24.5 million of losses related to the 2008 hurricanes. Profitability from our
underwriting operations remains at acceptable levels. Our year-to-date combined ratio was 84.6% for
2009, compared to 85.3% for 2008. Investment income increased $10.9 million year-over-year due to
the effect of $16.7 million of losses on alternative investments in 2008 and lower short-term
investment income in 2009. Realized investment gains offset the other-than-temporary credit losses
in 2009, compared to $18.8 million of losses realized in 2008, primarily in the third quarter,
related to the credit crisis. Our 2008 year-to-date results also included an $11.7 million loss
related to trading securities, which we sold in the third quarter of that year. See the Results
of Operations section below for additional discussion.
We underwrite a variety of specialty lines of business identified as diversified financial
products; group life, accident and health; aviation; London market account; and other specialty
lines of business. Products in each line are marketed by our insurance companies and agencies,
through a network of independent agents and brokers, directly to customers or through third party
administrators. The majority of our business is low limit or small premium business that has less
intense price competition, as well as lower catastrophe and volatility risk. We reinsure a
significant portion of our catastrophic exposure to hurricanes and earthquakes to minimize the
potential impact on our net earnings and shareholders equity.
We generate our revenue from six primary sources:
| risk-bearing earned premium produced by our insurance companies operations, | ||
| non-risk-bearing fee and commission income received by our underwriting agencies, | ||
| ceding commissions in excess of policy acquisition costs earned by our insurance companies, | ||
| investment income earned by all of our operations, | ||
| realized investment gains and losses, and other-than-temporary impairment losses, related to our fixed income securities portfolio, and |
| other operating income and losses, mainly from strategic investments and events that do not occur each year. |
27
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We produced $1.8 billion of revenue in the first nine months of 2009, which was $56.1 million or 3%
higher than in the first nine months of 2008. This increase principally resulted from: 1) higher
net earned premium, 2) $25.0 million related to the commutation of a reinsurance contract in 2009
that had been accounted for using the deposit method of accounting, and 3) losses in 2008 on fixed
income investments, alternative investments and trading securities, mainly due to the credit
crisis.
During the past several years, we substantially increased our shareholders equity by retaining
most of our earnings. With this additional equity, we increased the underwriting capacity of our
insurance companies and made strategic acquisitions, adding new lines of business or expanding
those with favorable underwriting characteristics. Since January 2008, we have acquired an
insurance business and five underwriting agencies for total consideration of $84.0 million. Net
earnings and cash flows from each acquired entity are included in our operations beginning on the
effective date of each transaction.
The following section discusses our key operating results. Amounts in the following tables are in
thousands, except for earnings per share, percentages, ratios and number of employees. Comparisons
refer to the first nine months of 2009 compared to the same period of 2008, unless otherwise noted.
Certain 2008 amounts have been adjusted to reflect our adoption of the new convertible debt and
earnings per share accounting standards as of January 1, 2009. See the Accounting Guidance
Adopted in 2009 section below for additional information.
Results of Operations
Net earnings were $269.1 million ($2.37 per diluted share) in the first nine months of 2009,
compared to $230.5 million ($1.99 per diluted share) in the same period of 2008 and $94.3 million
($0.83 per diluted share) in the third quarter of 2009, compared to $58.4 million ($0.50 per
diluted share) in the same period of 2008. The increase in year-to-date net earnings primarily
resulted from: 1) the 2009 commutation of a reinsurance contract that had been accounted for using
the deposit method of accounting, 2) catastrophic losses in 2008 from the 2008 hurricanes, and 3)
higher investment-related losses in 2008, as described more fully below. Net earnings were higher
quarter-over-quarter principally due to the lower investment-related losses in 2009 and
hurricane losses in 2008. Diluted earnings per share in both periods of
2009 benefited from the repurchase of 4.7 million shares of our common stock in 2008 and the first
quarter of 2009. The share repurchases reduced our diluted weighted-average shares outstanding,
which were 112.9 million and 115.9 million in the first nine months of 2009 and 2008, respectively,
and 112.9 million and 115.4 million in the third quarter of 2009 and 2008, respectively.
The following items affected pretax earnings in 2009 compared to 2008:
Nine months ended September 30, | Three months ended September 30, | |||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
Pretax earnings (loss) from: |
||||||||||||||||
Commutation of reinsurance contract, net of related costs |
$ | 15,600 | $ | | $ | | $ | | ||||||||
Prior years positive reserve development |
36,647 | 58,377 | 25,375 | 43,979 | ||||||||||||
2008 hurricanes |
| (24,534 | ) | | (24,534 | ) | ||||||||||
Other-than-temporary impairments |
(5,279 | ) | (6,029 | ) | (325 | ) | (4,430 | ) | ||||||||
Alternative investments |
(958 | ) | (16,735 | ) | | (14,321 | ) | |||||||||
Trading securities |
| (11,698 | ) | | 29 | |||||||||||
Sale of strategic investments and subsidiary, net |
(1,767 | ) | 9,158 | (1,767 | ) | |
| In 2009, we commuted, loss-free, all liability under a contract to provide reinsurance coverage for certain residential mortgage guaranty contracts. We had been recording revenue under this contract using the deposit method of accounting because we determined the contract did not transfer significant underwriting risk. We received a cash termination payment of $25.0 million in the first quarter. The termination increased other operating income by $20.5 million and fee and commission income by $5.0 million. This revenue was offset by $9.9 million of expenses for reinsurance and other direct costs, which were recorded in other operating expense. |
28
Table of Contents
| In 2009, we had favorable development of our prior years net loss reserves of $36.6 million, primarily from our U.K. professional indemnity business and the 2005 hurricanes. We had favorable development of $58.4 million in 2008 principally related to our directors and officers liability, property and U.K. professional indemnity businesses. |
| In 2008, we incurred losses of $89.9 million before reinsurance and $24.5 million after reinsurance related to hurricanes Gustav and Ike (referred to herein as the 2008 hurricanes). The losses are included in loss and loss adjustment expense. |
| We recognized, through earnings, other-than-temporary impairment losses of $5.3 million in 2009 and $6.0 million in 2008 on securities in our available for sale fixed income securities portfolio. |
| Our alternative investments generated $1.0 million of losses in 2009, compared to $16.7 million in 2008. These investments were fully liquidated by the second quarter of 2009. The income or loss on these investments is included in net investment income. |
| Our trading portfolio, which we liquidated during 2008, had losses of $11.7 million in 2008. These losses are reported in other operating income. |
| We sold strategic investments in insurance-related companies and realized a gain of $2.4 million in 2009 and $9.2 million in 2008. We also sold 100% of the stock of a subsidiary and realized a loss of $4.2 million in 2009. These net gains and losses are reported in other operating income. |
The following table sets forth the relationships of certain income statement items as a percent of
total revenue.
Nine months ended September 30, | Three months ended September 30, | |||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
(as adjusted) | (as adjusted) | |||||||||||||||
Net earned premium |
85.5 | % | 87.1 | % | 86.4 | % | 89.2 | % | ||||||||
Fee and commission income |
5.0 | 5.8 | 5.3 | 6.7 | ||||||||||||
Net investment income |
8.0 | 7.6 | 8.0 | 6.3 | ||||||||||||
Other operating income |
1.7 | 0.6 | 0.2 | 0.8 | ||||||||||||
Net realized investment and OTTI gain (loss) |
(0.2 | ) | (1.1 | ) | 0.1 | (3.0 | ) | |||||||||
Total revenue |
100.0 | 100.0 | 100.0 | 100.0 | ||||||||||||
Loss and loss adjustment expense, net |
51.1 | 53.3 | 50.5 | 57.3 | ||||||||||||
Policy acquisition costs, net |
15.2 | 16.4 | 15.4 | 17.0 | ||||||||||||
Other operating expense |
11.0 | 10.1 | 10.8 | 10.2 | ||||||||||||
Interest expense |
0.7 | 0.9 | 0.6 | 0.9 | ||||||||||||
Earnings before income tax expense |
22.0 | 19.3 | 22.7 | 14.6 | ||||||||||||
Income tax expense |
7.0 | 6.0 | 7.0 | 4.3 | ||||||||||||
Net earnings |
15.0 | % | 13.3 | % | 15.7 | % | 10.3 | % | ||||||||
Gross written premium, net written premium and net earned premium are detailed below. Written
premium reflects growth in our diversified financial products and London market account lines of
business and from our 2008 acquisitions. Written premium also reflects reductions due to the
discontinuance of an assumed quota share agreement and our U.K. motor business in 2008. See the
Insurance Company Segment section below for further discussion of the relationship and changes in
premium revenue.
Nine months ended September 30, | Three months ended September 30, | |||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
Gross written premium |
$ | 1,904,086 | $ | 1,887,556 | $ | 620,382 | $ | 612,964 | ||||||||
Net written premium |
1,527,889 | 1,556,382 | 493,287 | 495,585 | ||||||||||||
Net earned premium |
1,524,425 | 1,505,128 | 520,059 | 504,972 |
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The table below shows the source of our fee and commission income. Fee and commission income
decreased 11% year-over-year and 16% quarter-over-quarter. The decrease in 2009 primarily related
to lower third party agency and broker commissions, the sale of the operations of our commercial
marine agency business in the second quarter of 2009, and lower income from reinsurance overrides
and profit commissions on quota share treaties, partially offset by the $5.0 million termination
payment for commutation of a reinsurance contract that had been accounted for using the deposit
method of accounting in the first quarter of 2009.
Nine months ended September 30, | Three months ended September 30, | |||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
Agencies |
$ | 61,721 | $ | 62,750 | $ | 17,688 | $ | 18,932 | ||||||||
Insurance companies |
26,392 | 36,808 | 13,999 | 18,863 | ||||||||||||
Fee and commission income |
$ | 88,113 | $ | 99,558 | $ | 31,687 | $ | 37,795 | ||||||||
The sources of net investment income are detailed below.
Nine months ended September 30, | Three months ended September 30, | |||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
Fixed income securities |
||||||||||||||||
Taxable |
$ | 78,894 | $ | 72,716 | $ | 26,795 | $ | 25,394 | ||||||||
Exempt from U.S. income taxes |
61,589 | 56,795 | 20,776 | 18,821 | ||||||||||||
Total fixed income securities |
140,483 | 129,511 | 47,571 | 44,215 | ||||||||||||
Short-term investments |
4,943 | 20,408 | 1,464 | 6,837 | ||||||||||||
Alternative investments |
(958 | ) | (16,735 | ) | | (14,321 | ) | |||||||||
Other investments |
| 575 | | 77 | ||||||||||||
Total investment income |
144,468 | 133,759 | 49,035 | 36,808 | ||||||||||||
Investment expense |
(2,728 | ) | (2,927 | ) | (924 | ) | (846 | ) | ||||||||
Net investment income |
$ | 141,740 | $ | 130,832 | $ | 48,111 | $ | 35,962 | ||||||||
Net investment income increased 8% year-over-year and 34% quarter-over-quarter, primarily due to
the effect of losses on alternative investments in 2008 and higher income from fixed income
securities in 2009. This increase was partially offset by our earning significantly less income on
short-term investments due to lower market interest rates in 2009. Our fixed income securities
portfolio increased from $3.9 billion at September 30, 2008 to $4.9 billion at September 30, 2009.
The growth in fixed income securities resulted primarily from cash flow from operations and
liquidation of our alternative investments in late 2008 and early 2009. We reduced our exposure to
alternative investments, which were primarily fund-of-fund hedge fund investments, by redeeming
$52.6 million in the fourth quarter of 2008 and the remaining $44.3 million in 2009. We have
collected substantially all of these redeemed funds through September 30, 2009.
Other operating income was $29.8 million in the first nine months of 2009, compared to $10.8
million in the first nine months of 2008 and $1.4 million in the third quarter of 2009, compared to
$4.8 million in the third quarter of 2008. The 2009 income includes the $20.0 million termination
payment to commute a reinsurance contract that had been accounted for using the deposit method of
accounting. The 2009 year-to-date and third quarter income include a $2.4 million gain from the
sale of a strategic investment and a $4.2 million loss from sale of a subsidiary during the third
quarter of 2009. The 2008 nine-month period included a $9.2 million gain from the sale of a
strategic investment and losses related to our trading security portfolio that was sold in 2008.
Period to period comparisons in this category may vary substantially, depending on acquisition of
new investments, income or loss related to changes in the market values of certain investments, and
gains or losses related to dispositions. The following table details the components of our other
operating income.
Nine months ended September 30, | Three months ended September 30, | |||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
Contract using deposit accounting |
$ | 20,532 | $ | 774 | $ | | $ | 472 | ||||||||
Strategic investments |
4,714 | 13,074 | 2,859 | 910 | ||||||||||||
Trading securities |
| (11,698 | ) | | 29 | |||||||||||
Financial instruments |
3,469 | 2,275 | (188 | ) | (507 | ) | ||||||||||
Other |
1,109 | 6,404 | (1,266 | ) | 3,924 | |||||||||||
Other operating income |
$ | 29,824 | $ | 10,829 | $ | 1,405 | $ | 4,828 | ||||||||
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Table of Contents
We recognized, as a reduction of earnings, $5.3 million and $6.0 million of other-than-temporary
impairment losses in the first nine months of 2009 and 2008, respectively, and $0.3 million and
$4.4 million in the third quarter of 2009 and 2008, respectively. Gains on the sale of fixed
income securities substantially offset the impairment losses in the first nine months of 2009. In
the third quarter of 2008, we sold $26.6 million of bonds and preferred stock of certain issuers
with credit-related exposure, as a result of extreme credit market issues, and realized losses of
$19.4 million.
Loss and loss adjustment expense decreased year-over-year and quarter-over-quarter due to the 2008
hurricane losses in 2008, partially offset by losses recorded on increased net earned premium in
2009. Policy acquisition costs decreased year-over-year and quarter-over-quarter, principally due
to lower commission rates on certain lines of business and a change in the mix of business. See
the Insurance Company Segment section below for further discussion of the changes in loss and
loss adjustment expense and policy acquisition costs.
Other operating expense, which includes compensation expense, increased 12% in the first nine
months of 2009 and 13% in the third quarter of 2009, compared to the same 2008 periods. The 2009
increase included compensation and other operating expenses of businesses acquired in the fourth
quarter of 2008 and the first quarter of 2009. We had 1,916 employees at September 30, 2009
compared to 1,783 a year earlier, with the increase primarily due to acquisitions. In addition,
other operating expense for 2009 includes $9.9 million of expenses for costs directly related to
the first quarter commutation of a reinsurance contract that had been accounted for using the
deposit method of accounting.
Other operating expense includes $10.7 million and $9.2 million in the first nine months of 2009
and 2008, respectively, of stock-based compensation expense, after the effect of the deferral and
amortization of policy acquisition costs related to stock-based compensation for our underwriters.
At September 30, 2009, there was approximately $24.1 million of total unrecognized compensation
expense related to unvested options and restricted stock awards and units that is expected to be
recognized over a weighted-average period of 2.6 years.
Our effective income tax rate was 31.5% for the nine-month period of 2009, compared to 30.9% for
the nine-month period of 2008. The lower effective rate in 2008 related to the increased benefit
from tax-exempt investment income relative to a lower pretax income base.
At September 30, 2009, book value per share was $26.54, up from $23.27 at December 31, 2008. Total
assets were $9.0 billion and shareholders equity was $3.0 billion, compared to $8.3 billion and
$2.6 billion, respectively, at December 31, 2008. We repurchased 1.7 million shares of our common
stock in the first quarter of 2009, which increased book value per share by $0.07.
Segments
Insurance Company Segment
Net earnings of our insurance company segment increased $43.4 million, or 19%, and $40.5 million,
or 71%, in the first nine months and third quarter of 2009 compared to the same periods in 2008.
The increases resulted from: 1) additional earned premium, 2) the net impact of the commutation in
2009 of a reinsurance contract that had been accounted for using the deposit method of accounting
and 3) higher investment income. Both the 2008 year-to-date and quarter-to-date periods were
negatively impacted by losses on alternative investments and losses from the 2008 hurricanes. Our
margins remain at an acceptable level of profitability in 2009 even though there is pricing
competition in certain of our markets.
Premium
Gross written premium was 1% higher in 2009, due to the effects of growth in our diversified
financial products and London market account lines of business and our recent acquisitions, offset
by lower aviation writings in the first half of 2009 and the discontinuance of an assumed quota
share contract and our U.K. motor business in 2008. The overall percentage of retained premium, as
measured by the percent of net written premium to gross written premium, decreased slightly to 80%
in 2009 from 82% in 2008.
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Table of Contents
The following tables provide premium information by line of business.
Gross | Net | NWP | Net | |||||||||||||
written | written | as % of | earned | |||||||||||||
premium | premium | GWP | premium | |||||||||||||
Nine months ended September 30, 2009 |
||||||||||||||||
Diversified financial products |
$ | 815,085 | $ | 661,129 | 81 | % | $ | 668,640 | ||||||||
Group life, accident and health |
636,018 | 592,438 | 93 | 597,598 | ||||||||||||
Aviation |
133,913 | 95,655 | 71 | 98,514 | ||||||||||||
London market account |
161,475 | 93,241 | 58 | 75,587 | ||||||||||||
Other specialty lines |
157,593 | 85,449 | 54 | 84,109 | ||||||||||||
Discontinued lines |
2 | (23 | ) | nm | (23 | ) | ||||||||||
Totals |
$ | 1,904,086 | $ | 1,527,889 | 80 | % | $ | 1,524,425 | ||||||||
Nine months ended September 30, 2008 |
||||||||||||||||
Diversified financial products |
$ | 744,920 | $ | 622,702 | 84 | % | $ | 593,378 | ||||||||
Group life, accident and health |
629,214 | 595,112 | 95 | 582,193 | ||||||||||||
Aviation |
147,268 | 106,996 | 73 | 105,125 | ||||||||||||
London market account |
154,028 | 97,142 | 63 | 80,824 | ||||||||||||
Other specialty lines |
207,361 | 129,667 | 63 | 138,846 | ||||||||||||
Discontinued lines |
4,765 | 4,763 | nm | 4,762 | ||||||||||||
Totals |
$ | 1,887,556 | $ | 1,556,382 | 82 | % | $ | 1,505,128 | ||||||||
Three months ended September 30, 2009 |
||||||||||||||||
Diversified financial products |
$ | 274,023 | $ | 220,267 | 80 | % | $ | 234,725 | ||||||||
Group life, accident and health |
210,689 | 197,767 | 94 | 199,427 | ||||||||||||
Aviation |
50,162 | 34,779 | 69 | 33,053 | ||||||||||||
London market account |
27,254 | 12,700 | 47 | 26,208 | ||||||||||||
Other specialty lines |
58,242 | 27,787 | 48 | 26,659 | ||||||||||||
Discontinued lines |
12 | (13 | ) | nm | (13 | ) | ||||||||||
Totals |
$ | 620,382 | $ | 493,287 | 80 | % | $ | 520,059 | ||||||||
Three months ended September 30, 2008 |
||||||||||||||||
Diversified financial products |
$ | 261,614 | $ | 215,556 | 82 | % | $ | 203,295 | ||||||||
Group life, accident and health |
210,930 | 195,283 | 93 | 194,393 | ||||||||||||
Aviation |
50,639 | 37,116 | 73 | 35,413 | ||||||||||||
London market account |
31,230 | 17,046 | 55 | 27,429 | ||||||||||||
Other specialty lines |
58,425 | 30,506 | 52 | 44,420 | ||||||||||||
Discontinued lines |
126 | 78 | nm | 22 | ||||||||||||
Totals |
$ | 612,964 | $ | 495,585 | 81 | % | $ | 504,972 | ||||||||
nm Not meaningful | |||
The changes in year-to-date premium volume and retention levels between periods resulted principally from the following factors: | |||
| Diversified financial products Gross and net written premium increased because we wrote more domestic directors and officers liability business at higher prices in 2009 and generated additional premium from residual value insurance and new lines of business. Premium volume in our other major products in this group was stable, although pricing for certain of these products is down slightly. Earned premium increased in 2009 primarily due to the higher volume of directors and officers liability business written in both 2009 and the last half of 2008. Our retention rate was lower in 2009 because we are reinsuring more directors and officers liability business. |
32
Table of Contents
| Group life, accident and health The year-to-date increase in gross written premium was due to writing more sports disability business, which is substantially reinsured. New premium in 2009 from a medical stop-loss company acquired in late 2008 was partially offset by lower premium in our organic lines of business. The increase in net earned premium was due to our acquisition of HCC Medical Insurance Services in the first quarter of 2008. | ||
| Aviation We wrote less aviation premium in the first half of 2009 compared to the same period of 2008, due to continuing competition on U.S. business and lack of growth in the aviation industry. Our writings were stable quarter-over-quarter due to an improved international market in 2009. Pricing on this line remains competitive, although we have seen price increases on the international portion of this business. | ||
| London market account Gross written premium increased year-over-year due to an increase in our energy business, which was concentrated in the second quarter of 2009. Net written premium was reduced due to increased spending on reinsurance. Net earned premium was lower in 2009 due to the reduction in net written premium. Written premium was lower quarter-over-quarter due to competitive pricing and reduced demand from insureds. | ||
| Other specialty lines Premium decreased year-over-year due to expiration of an assumed quota share contract in the second quarter of 2008 and discontinuance of our U.K. motor business in mid-2008 that was written through one of our Lloyds syndicates. The decrease in gross written, net written and net earned premium year-over-year was $49.1 million, $47.5 million and $57.1 million, respectively, and quarter-over-quarter was $3.0 million, $2.8 million and $19.3 million, respectively. Our premium from public risk increased in 2009 due to recent acquisitions in this line of business. The decrease in the retention rate was due to the change in mix of business in this line. |
Losses and Loss Adjustment Expenses
Our gross loss ratio was 59.7% and 68.3% in the first nine months of 2009 and 2008, respectively,
and 55.6% and 75.5% in the third quarter of 2009 and 2008, respectively. The higher gross loss
ratios in 2008 primarily related to losses in our London market account from the 2008 hurricanes
and our discontinued lines, both of which were substantially reinsured.
The table below shows the composition of net incurred loss and loss adjustment expense.
Nine months ended September 30, | Three months ended September 30, | |||||||||||||||||||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||||||||||||||||||
Loss | Loss | Loss | Loss | |||||||||||||||||||||||||||||
Amount | ratio | Amount | ratio | Amount | ratio | Amount | ratio | |||||||||||||||||||||||||
2008 hurricanes |
$ | | | % | $ | 24,534 | 1.7 | % | $ | | | % | $ | 24,534 | 4.9 | % | ||||||||||||||||
Net reserve
redundancies |
(36,647 | ) | (2.4 | ) | (58,377 | ) | (3.9 | ) | (25,375 | ) | (4.9 | ) | (43,979 | ) | (8.7 | ) | ||||||||||||||||
All other net
incurred loss and
loss adjustment
expense |
948,591 | 62.2 | 954,276 | 63.4 | 329,183 | 63.3 | 343,951 | 68.1 | ||||||||||||||||||||||||
Net incurred loss
and loss adjustment
expense |
$ | 911,944 | 59.8 | % | $ | 920,433 | 61.2 | % | $ | 303,808 | 58.4 | % | $ | 324,506 | 64.3 | % | ||||||||||||||||
During the third quarter of 2008, we recorded gross and net losses of $89.9 million and $24.5
million, respectively, for the 2008 hurricanes. Our net redundant development relating to prior
year losses included in net incurred loss and loss adjustment expense was $36.6 million in the
first nine months of 2009, compared to $58.4 million in the first nine months of 2008 and $25.4
million in the third quarter of 2009, compared to $44.0 million in the third quarter of 2008. The
redundant development in 2009 primarily resulted from our review and reduction of loss reserves for
the 2005 hurricanes and our U.K. professional indemnity business for the 2004-2006 underwriting
years. As part of our quarterly reserve review in the third quarter of 2009, we re-estimated our
net exposure in our diversified financial products line of business (principally related to our
directors and officers liability product), which resulted in redundant reserve development in the
2004-2006 underwriting years that was substantially offset by an increase in the reserves for the
2007 underwriting year. The redundant development in 2008 primarily resulted from reserve
reductions in our U.K. professional indemnity business for the 2004 and 2005 underwriting years, in
our diversified financial products line (primarily related to our directors and officers
liability product) in the 2005 and prior underwriting years, and in our London market account for
2005 and prior accident years. In the third quarter of 2008, we increased certain ultimate loss
ratios in the 2008 accident year due to the uncertainty in the financial markets, which caused us
to book $35.0 million of additional reserves. Deficiencies and
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redundancies in reserves occur in
the normal course of business
as we review our loss reserves with our actuaries, increasing or reducing loss
reserves as a result of such reviews and as losses are finally settled or claims exposures change.
We write directors and officers liability, errors and omissions liability and fiduciary liability
coverage for public and private companies and not-for-profit organizations and continue to closely
monitor our exposure to subprime and credit related issues. We provide coverage for certain
financial institutions, which have potential exposure to shareholders lawsuits. At September 30,
2009, we had 17 Side A only and 73 non-Side A only directors and officers liability, errors
and omissions liability and fiduciary liability claims related to subprime issues, compared to 15
and 57, respectively, at December 31, 2008. Based on our present knowledge, we believe our
ultimate losses from these coverages will be contained within our current overall loss reserves for
these lines of business.
We have no material exposure to environmental or asbestos losses.
We believe we have provided for all material net incurred losses as of September 30, 2009.
The following table provides comparative net loss ratios by line of business.
Nine months ended September 30, | Three months ended September 30, | |||||||||||||||||||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||||||||||||||||||
Net | Net | Net | Net | Net | Net | Net | Net | |||||||||||||||||||||||||
earned | loss | earned | loss | earned | loss | earned | loss | |||||||||||||||||||||||||
premium | ratio | premium | ratio | premium | ratio | premium | ratio | |||||||||||||||||||||||||
Diversified
financial products |
$ | 668,640 | 49.8 | % | $ | 593,378 | 46.2 | % | $ | 234,725 | 47.6 | % | $ | 203,295 | 47.1 | % | ||||||||||||||||
Group life, accident
and health |
597,598 | 73.3 | 582,193 | 73.7 | 199,427 | 72.3 | 194,393 | 72.6 | ||||||||||||||||||||||||
Aviation |
98,514 | 60.3 | 105,125 | 64.7 | 33,053 | 66.7 | 35,413 | 69.6 | ||||||||||||||||||||||||
London market account |
75,587 | 30.3 | 80,824 | 54.4 | 26,208 | 37.0 | 27,429 | 91.1 | ||||||||||||||||||||||||
Other specialty lines |
84,109 | 69.2 | 138,846 | 73.7 | 26,659 | 58.8 | 44,420 | 86.5 | ||||||||||||||||||||||||
Discontinued lines |
(23 | ) | nm | 4,762 | nm | (13 | ) | nm | 22 | nm | ||||||||||||||||||||||
Totals |
$ | 1,524,425 | 59.8 | % | $ | 1,505,128 | 61.2 | % | $ | 520,059 | 58.4 | % | $ | 504,972 | 64.3 | % | ||||||||||||||||
Expense ratio |
24.8 | 24.1 | 24.3 | 23.7 | ||||||||||||||||||||||||||||
Combined ratio |
84.6 | % | 85.3 | % | 82.7 | % | 88.0 | % | ||||||||||||||||||||||||
nm Not meaningful comparison | |||
The changes in net loss ratios between periods resulted principally from the following factors: | |||
| Diversified financial products The 2009 accident year losses for our surety businesses were higher than the 2008 accident year losses. The net loss ratios reflect redundant net reserve development of $21.8 million and $43.0 million in the nine months of 2009 and 2008, respectively. The redundancy in 2009 primarily related to our U.K. professional indemnity business. | ||
| Group life, accident and health While remaining relatively flat compared to 2008, the 2009 net loss ratios reflect lower losses on our medical stop-loss business, offset by adverse development and higher losses on short-term medical and other coverages. | ||
| Aviation The 2008 hurricanes increased the year-to-date 2008 loss ratio by 1.3 percentage points and the third quarter 2008 loss ratio by 4.0 percentage points. Redundant development in 2009 was higher than in 2008, but was offset by higher accident year losses in 2009. |
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| London market account The 2009 net loss ratios included redundant reserve development, primarily on the 2005 hurricanes, which reduced the year-to-date 2009 loss ratio by 14.2 percentage points. The 2008 hurricanes increased the 2008 year-to-date loss ratio by 21.4 percentage points and the third quarter 2008 loss ratio by 62.8 percentage points, partially offset by redundant reserve development, which decreased the 2008 year-to-date loss ratio by 18.1 percentage points. | ||
| Other specialty lines We incurred losses on our film completion and film production businesses in the first quarter of 2009. The 2008 hurricanes increased the 2008 year-to-date and third quarter ratios by 4.2 percentage points and 13.3 percentage points, respectively. |
The table below provides a reconciliation of our reserves for loss and loss adjustment expense
payable, net of reinsurance ceded, the amount of our paid claims and our net paid loss ratios.
Nine months ended September 30, | Three months ended September 30, | |||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
Net reserves for loss and loss adjustment expense
payable at beginning of period |
$ | 2,416,271 | $ | 2,342,800 | $ | 2,563,196 | $ | 2,476,251 | ||||||||
Net reserve additions from acquired businesses |
36,522 | 29,053 | 1,600 | | ||||||||||||
Foreign currency adjustment |
29,109 | (27,715 | ) | (247 | ) | (43,599 | ) | |||||||||
Incurred loss and loss adjustment expense |
911,944 | 920,433 | 303,808 | 324,506 | ||||||||||||
Loss and loss adjustment expense payments |
(838,494 | ) | (772,795 | ) | (313,005 | ) | (265,382 | ) | ||||||||
Net reserves for loss and loss adjustment expense
payable at end of period |
$ | 2,555,352 | $ | 2,491,776 | $ | 2,555,352 | $ | 2,491,776 | ||||||||
Net paid loss ratio |
55.0 | % | 51.3 | % | 60.2 | % | 52.6 | % | ||||||||
The net paid loss ratio is the percentage of losses paid, net of reinsurance, divided by net earned
premium for the period. The net paid loss ratio was higher in the first nine months of 2009,
primarily due to paying claims in our diversified financial products line of business and
completing a commutation in the third quarter of 2009. We commuted certain loss reserves related
to excess workers compensation business that is in runoff for $43.9 million. This commutation had
no material effect on net earnings but increased our net paid loss ratio by 2.9 and 8.5 percentage
points in the nine months and three months ended September 30, 2009, respectively.
Policy Acquisition Costs
Policy acquisition costs (which are reported net of the related portion of commissions on
reinsurance ceded) as a percentage of net earned premium decreased to 17.8% in the first nine
months of 2009 from 18.9% in the first nine months of 2008, principally due to lower commission
rates on certain lines of business and a change in the mix of business. The GAAP expense ratio of
24.8% in the first nine months of 2009 exceeded the ratio of 24.1% in the first nine months of
2008, as the lower policy acquisition costs were offset by the negative effect of lower income from
reinsurance overrides and profit commissions on quota share treaties.
Agency Segment
Revenue from our agency segment increased to $138.4 million in the first nine months of 2009 from
$133.3 million in the first nine months of 2008. The increase primarily was due to underwriting
agencies acquired in 2008 and $5.0 million of fee and commission income related to the 2009
commutation of a reinsurance contract that had been accounted for using the deposit method of
accounting, partially offset by lower revenue due to the 2009 sale of our commercial marine agency
business. Segment net earnings for the nine month period decreased to $15.2 million in 2009 from
$16.0 million in 2008. Operating expenses, including those resulting from the commutation of the
reinsurance contract, were higher in 2009, resulting in a decrease in the margin. In 2009, we sold
the operations of our commercial marine agency business and our reinsurance broker, which together
contributed 14% and 31% of our agency segment revenue and net earnings, respectively,
in the nine months ended
September 30, 2009.
Other Operations Segment
Revenue and net earnings from
our other operations segment were $5.5 million and $1.8 million,
respectively, in the first nine months of 2009 compared to $6.6 million and $2.0 million,
respectively, in the first nine months of 2008. The 2009 periods included a net $1.8 million loss
related to the sale of a strategic investment and sale of a subsidiary. The first nine months of
2008 included losses on trading securities, which we liquidated in late 2008. Results of this
segment may vary substantially period to period depending on our investment in or disposition of
strategic investments.
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Liquidity and Capital Resources
During 2008, there were significant disruptions in the world-wide and U.S. financial markets. A
number of large financial institutions failed, received substantial capital infusions and loans
from the U.S. and various other governments, or were merged into other companies. The market
disruptions have resulted in a tightening of available sources of credit, increases in the cost of
credit and significant liquidity concerns for many companies. We believe we have sufficient
sources of liquidity at a reasonable cost at the present time, based on the following:
| We held $616.8 million of cash and liquid short-term investments at September 30, 2009 compared to $524.8 million at December 31, 2008. We generated an annual average $588.2 million in cash from our operating activities, excluding cash from commutations, in the three-year period ended December 31, 2008. During the first nine months of 2009, we generated $417.5 million of cash from operating activities. | ||
| Our available for sale bond portfolio had a fair value of $4.8 billion at September 30, 2009, compared to $4.1 billion at December 31, 2008, and has an average rating of AA+. We intend to hold these securities until their maturity, but we would be able to sell some of these securities to generate cash if the need arises; however, should we sell certain securities in the portfolio before their maturity to generate cash, given the current credit market volatility, it is possible we might not recoup the full reported fair value of the securities sold. | ||
| Our insurance companies have sufficient resources to pay potential claims in 2009, before consideration of expected cash flow from the insurance companies 2009 operations. As of December 31, 2008, we projected they will pay approximately $1.2 billion of claims and collect approximately $369.0 million of reinsurance in 2009. At December 31, 2008, our insurance companies had approximately $1.0 billion of cash, short-term investments, maturing bonds, and principal payments from mortgage-backed and asset-backed securities available in 2009 to pay these claims. There has been no significant change in our expectations of their ability to pay claims as of September 30, 2009. | ||
| We have a committed line of credit, led by Wells Fargo, through a syndicate group of large domestic banks and one large foreign bank. Our Revolving Loan Facility provides borrowing capacity to $575.0 million through December 2011. At October 31, 2009, we had $240.0 million of unused capacity, which we can draw against at any time at our request. We believe that the banks will be able and willing to perform on their commitments to us. The facility agreement contains two restrictive financial covenants, with which we were in compliance at September 30, 2009. | ||
| During 2009, there have been no significant changes in either our Standby Letter of Credit Facility or our Subsidiary Lines of Credit, both of which are more fully described in our Annual Report on Form 10-K for the year ended December 31, 2008. | ||
| We may redeem all $124.7 million of our 1.30% Convertible Notes at any time. The notes are subject to conversion by the note holders should our stock price exceed a set market price or if we announce a redemption of the notes. Our available capacity on the Revolving Loan Facility is sufficient to cover the $124.7 million of notes outstanding at September 30, 2009 that would be due if we redeem the notes or if they are converted. Holders may next require us to repurchase the notes on April 1, 2014. | ||
| Our domestic insurance subsidiaries have the ability to pay $199.2 million in dividends in 2009 to our holding company without obtaining special permission from state regulatory authorities. Our underwriting agencies have no restrictions on the amount of dividends that can be paid to our holding company. The holding company can utilize these dividends to pay down debt, pay dividends to shareholders, fund acquisitions, repurchase common stock and pay operating expenses. Cash flow available to the holding company in 2009 is expected to be more than ample to cover the holding companys required cash disbursements. | ||
| Our debt to total capital ratio was 13.0% at September 30, 2009 and 11.5% at December 31, 2008. We have a Universal Shelf registration statement, which was filed and became effective in March 2009 and expires in March 2012. The shelf registration statement provides for the issuance of an aggregate of $1.0 billion of securities. These securities may be debt securities, equity securities, trust preferred securities, or a combination thereof. The shelf registration statement provides us the means to access the debt and equity markets relatively quickly, if we are satisfied with the current pricing in the financial market. |
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Cash Flow
We receive substantial cash from premiums, reinsurance recoverables, outward commutations, fee and
commission income, proceeds from sales and redemptions of investments and investment income. Our
principal cash outflows are for the payment of claims and loss adjustment expenses, premium
payments to reinsurers, inward commutations, purchases of investments, debt service, policy
acquisition costs, operating expenses, taxes and dividends.
Cash provided by operating activities can fluctuate due to timing differences in the collection of
premiums and reinsurance recoverables and the payment of losses and premium and reinsurance
balances payable and the completion of commutations. Our operating cash flow also exceeds our net
earnings due to expansion of our diversified financial products line of business, where we retain
premium for a longer duration and pay claims later than for our short-tailed business.
Cash provided by operating activities was $417.5 million and $401.2 million in the first nine
months of 2009 and 2008, respectively. The components of our net operating cash flows are
summarized in the following table.
Nine months ended September 30, | ||||||||
2009 | 2008 | |||||||
(as adjusted) | ||||||||
Net earnings |
$ | 269,076 | $ | 230,521 | ||||
Change in premium, claims and other receivables, net of reinsurance, other
payables and restricted cash |
(2,736 | ) | (86,774 | ) | ||||
Change in unearned premium, net |
14,348 | 47,283 | ||||||
Change in loss and loss adjustment expense payable, net of reinsurance recoverables |
66,372 | 158,331 | ||||||
Change in trading securities |
| 49,091 | ||||||
(Gain) loss on investments |
(3,152 | ) | 26,367 | |||||
Other, net |
73,638 | (23,644 | ) | |||||
Cash provided by operating activities |
$ | 417,546 | $ | 401,175 | ||||
In the third quarter of 2009, we commuted certain loss reserves for $43.9 million of cash, which
reduced our cash provided by operating activities. Increased net loss payments, including the
commutation, were partially offset in 2009 by the $25.0 million we received to commute a
reinsurance contract that had been accounted for using the deposit method of accounting. During
2008, we had positive cash flow from the liquidation of our remaining trading portfolio.
In the third quarter of 2009, we received $17.5 million of cash from the sale of a strategic
investment, which we reinvested in fixed income securities. In October 2009, we received common
stock for the sale of a subsidiary and designated the stock as a trading security. We immediately
liquidated the stock for $43.3 million, which will increase our cash provided by operating
activities in the fourth quarter.
We maintain a substantial level of cash and liquid short-term investments to meet anticipated
payment obligations. Our combined cash and investment portfolio increased $667.0 million during
2009 to a total of $5.5 billion at September 30, 2009.
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Investments
At September 30, 2009, we had $5.5 billion of investment assets, an increase of $647.9 million from
December 31, 2008. This table summarizes our investments by type, substantially all of which are
reported at fair value, at September 30, 2009 and December 31, 2008.
September 30, 2009 | December 31, 2008 | |||||||||||||||
Amount | % | Amount | % | |||||||||||||
Short-term investments |
$ | 559,907 | 10 | % | $ | 497,477 | 10 | % | ||||||||
U.S. government and government agency securities |
477,978 | 9 | 227,607 | 5 | ||||||||||||
Fixed income securities of states, municipalities and political subdivisions |
1,080,114 | 20 | 1,091,903 | 23 | ||||||||||||
Special purpose revenue bonds of states, municipalities and political subdivisions |
1,133,650 | 21 | 899,632 | 19 | ||||||||||||
Corporate fixed income securities |
566,624 | 10 | 511,638 | 11 | ||||||||||||
Residential mortgage-backed securities |
970,240 | 18 | 823,078 | 17 | ||||||||||||
Commercial mortgage-backed securities |
153,181 | 3 | 151,836 | 3 | ||||||||||||
Asset-backed securities |
26,881 | 1 | 65,952 | 1 | ||||||||||||
Foreign government securities |
343,295 | 6 | 333,365 | 7 | ||||||||||||
Foreign non-government securities |
135,666 | 2 | 151,707 | 3 | ||||||||||||
Other investments |
4,691 | | 50,088 | 1 | ||||||||||||
Total investments |
$ | 5,452,227 | 100 | % | $ | 4,804,283 | 100 | % | ||||||||
The overall rating of our municipal bonds (consisting of our fixed income securities of states,
municipalities and political subdivisions and our special purpose revenue bonds of states,
municipalities and political subdivisions) was AA at September 30, 2009. Our portfolio of special
purpose revenue bonds at September 30, 2009 and December 31, 2008 included $139.3 million and
$150.9 million, respectively, of pre-refunded bonds that are supported by U.S. government debt
obligations. The remaining special purpose bonds are secured by revenue sources specific to each
security, such as water, sewer and utility fees; highway tolls; airport usage fees; property, sales
and fuel taxes; college tuition and services fees; and lease income.
The table below summarizes our special purpose revenue bonds by revenue source:
September 30, | December 31, | |||||||
2009 | 2009 | |||||||
Water and sewer |
28 | % | 26 | % | ||||
Transportation |
13 | 14 | ||||||
Education |
13 | 11 | ||||||
Pre-refunded |
12 | 17 | ||||||
Special tax |
12 | 13 | ||||||
Leasing |
8 | 9 | ||||||
Other |
14 | 10 | ||||||
Total |
100 | % | 100 | % | ||||
Many of our special purpose revenue bonds are insured by mono-line insurance companies or supported
by credit enhancement programs of various states and municipalities. We view bond insurance as
credit enhancement and not credit substitution. We base our investment decision on the strength of
the issuer. A credit review is performed on each issuer and on the sustainability of the revenue
source before we acquire a special purpose revenue bond and periodically on an ongoing basis
thereafter. The underlying average credit rating of our special purpose revenue bond issuers,
excluding any bond insurance, was AA at September 30, 2009. Although recent economic conditions in
the United States may reduce the source of revenue for certain of these securities, the majority
are supported by revenue from essential sources, such as water and sewer, education and
transportation fees, which we believe generate a stable source of revenue.
At September 30, 2009, we held a corporate bond portfolio with a fair value of $566.6 million, an
overall rating of A, and a weighted-average life of approximately 3.0 years. We also held a
portfolio of residential mortgage-backed securities (MBSs) and collateralized mortgage-obligations
(CMOs) with a fair value of $970.2 million. Within our residential MBS/CMO portfolio, $911.0
million of securities were issued by the Federal National Mortgage Association (Fannie Mae), the
Government National Mortgage Association (GNMA) and the Federal Home Loan Mortgage Corporation
(Freddie Mac), which are backed by the U.S. government.
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Within our residential mortgage-backed and asset-backed securities, we held $55.7 million, $4.8 million and $1.6 million of bonds that are collateralized by prime, Alt
A and subprime mortgages, respectively. All of these securities were current as to principal and
interest. The average rating and approximate weighted-average life of these securities at September
30, 2009 were as follows:
Average rating | Weighted-average life | |||||||
Prime |
BBB | 1.7 years | ||||||
Alt A |
BBB+ | 3.5 years | ||||||
Subprime |
A+ | 5.8 years |
At September 30, 2009, we held a commercial MBS securities portfolio with a fair value of $153.2
million, an average rating of AAA, an average loan-to-value ratio of 67%, and a weighted-average
life of approximately 4.7 years. We owned no collateralized debt obligations (CDOs) or
collateralized loan obligations (CLOs), and we have never been counterparty to any credit default
swap transactions.
This table shows a profile of our fixed income securities and short-term investments portfolio,
including the average amount of investments, income earned and the related yield.
Nine months ended September 30, | Three months ended September 30, | |||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
Average investments, at cost |
$ | 5,015,803 | $ | 4,599,463 | $ | 5,194,608 | $ | 4,706,770 | ||||||||
Net investment income * |
141,740 | 130,832 | 48,111 | 35,962 | ||||||||||||
Average short-term yield * |
1.1 | % | 3.5 | % | 1.0 | % | 4.3 | % | ||||||||
Average long-term yield * |
4.1 | % | 4.5 | % | 4.2 | % | 4.4 | % | ||||||||
Average long-term tax equivalent yield * |
4.9 | % | 5.2 | % | 5.0 | % | 5.2 | % | ||||||||
Weighted-average combined tax equivalent yield * |
4.6 | % | 5.0 | % | 4.4 | % | 5.1 | % | ||||||||
Weighted-average maturity of fixed income securities |
6.5 years | 6.9 years | ||||||||||||||
Weighted-average duration of fixed income securities |
4.7 years | 5.1 years | ||||||||||||||
Weighted-average combined duration |
4.3 years | 4.4 years | ||||||||||||||
Average rating |
AA+ | AA+ |
* | Excluding realized and unrealized gains and losses. |
This table summarizes, by rating, our investments in fixed income securities at September 30, 2009.
Available for sale | Held to maturity | |||||||||||||||
at fair value | at amortized cost | |||||||||||||||
Amount | % | Amount | % | |||||||||||||
AAA |
$ | 2,387,538 | 50 | % | $ | 103,286 | 100 | % | ||||||||
AA |
1,592,913 | 33 | | | ||||||||||||
A |
636,344 | 13 | | | ||||||||||||
BBB |
123,673 | 3 | | | ||||||||||||
BB and below |
43,875 | 1 | | | ||||||||||||
Total fixed income securities |
$ | 4,784,343 | 100 | % | $ | 103,286 | 100 | % | ||||||||
A security has an impairment loss when its fair value is less than its cost or amortized cost at
the balance sheet date. We evaluate the securities in our fixed income securities portfolio for
possible other-than-temporary impairment losses at each quarter end. We adopted a new accounting
standard, which specifies new criteria for identification and recognition of other-than-temporary
impairment losses, as of April 1, 2009. This standard requires us to determine, for each impaired
fixed income security, that (a) we do not intend to sell the security and (b) it is more likely
than not that we will not be required to sell the security before recovery of its amortized cost
basis. If we cannot assert either of these, the impairment is recorded as an other-than-temporary
loss through earnings in the current period. For all other impaired securities, the impairment is
considered an other-than-temporary loss if the net present value of the cash flows expected to be
collected from the security is less than its amortized cost basis. Such a shortfall in cash flows
is referred to as a credit loss. For any such security, the impairment loss is separated into
(a) the credit loss and (b) the amount related to all other factors, such as interest rate
changes, market conditions, etc. (the non-credit loss). The credit loss is charged to current
period earnings and the non-credit loss is charged to other comprehensive income, within
shareholders equity, on an after-tax basis. A securitys cost basis is permanently reduced by the
amount of an other-than-temporary loss recorded through earnings.
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To adopt the new accounting standard, we reviewed all securities with a previous
other-than-temporary impairment loss that we still held at April 1, 2009. For each, we determined
the credit and non-credit component as of the adoption date. We calculated the net present value
of each security by discounting our best estimate of projected future cash flows at the effective
interest rate implicit in the security prior to impairment. For our mortgage-backed securities,
the estimated cash flows included prepayment assumptions and other assumptions regarding the
underlying collateral including default rates, recoveries and changes in value. We recorded a
cumulative adjustment of $4.3 million after-tax to reclassify the non-credit portion of the loss
from retained earnings to accumulated other comprehensive income as of the adoption date.
We review our impaired securities and assess whether any impairments are other-than-temporary at
each quarter end, based on all relevant facts and circumstances for each impaired security. During
2009 and 2008, our reviews covered all impaired securities where the loss exceeded $0.5 million
and the loss either exceeded 10% of cost or the security had been in a loss position for longer
than twelve consecutive months. Our review in the third quarter of 2009 covered 79% of the total
gross unrealized losses in the portfolio.
The determination that a security has incurred an other-than-temporary decline in value and the
amount of any current loss recognition requires management judgment and a continual review of
market conditions and our investment portfolio. In the second quarter of 2009, we changed our
criteria for determining if an impaired security has an other-than-temporary impairment to comply
with the new accounting standard. Our evaluation now considers various factors including:
| amount by which the securitys fair value is less than its cost, | ||
| length of time the security has been impaired, | ||
| the securitys credit rating and any recent downgrades, | ||
| whether the impairment is due to an issuer-specific event, | ||
| whether we intend to sell the security, | ||
| if it is more likely than not that we will have to sell the security before recovery of its amortized cost basis, and | ||
| stress testing of expected cash flows for mortgage-backed and asset-backed securities under various scenarios. |
To assist us in our evaluation, our outside investment advisors also perform detailed credit
evaluations of all of our fixed income securities on an ongoing basis.
The new accounting standard also changed the earnings recognition criteria for
other-than-temporary impairment losses. Prior to our adoption of this standard, when we concluded
that a decline in a securitys fair value was other-than-temporary, we recognized the impairment
as a realized investment loss in our consolidated statements of earnings. Beginning in the second
quarter of 2009, we recognize an other-than-temporary impairment loss in earnings in the period
that we determine: 1) we intend to sell the security, 2) it is more likely than not that we will
be required to sell the security before recovery of its amortized cost basis, or 3) the security
has a credit loss.
We identified and recognized pretax other-than-temporary impairment losses as follows:
Nine months ended September 30, | Three months ended September 30, | |||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
Total other-than-temporary impairment loss |
$ | (6,089 | ) | $ | (6,029 | ) | $ | (380 | ) | $ | (4,430 | ) | ||||
Portion recognized in other comprehensive income |
810 | | 55 | | ||||||||||||
Net other-than-temporary impairment loss
recognized in earnings |
$ | (5,279 | ) | $ | (6,029 | ) | $ | (325 | ) | $ | (4,430 | ) | ||||
At September 30, 2009, we had $4.8 million after-tax of other-than-temporary impairments,
primarily related to mortgage-backed and asset-backed securities, included in accumulated other
comprehensive income.
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The roll forward of the credit-related portion of our pretax other-than-temporary impairment loss
recognized in earnings, for which a portion of the other-than-temporary loss was recognized in
other comprehensive income, beginning at the date of adoption of the new accounting standard, was
as follows:
Six months ended | Three months ended | |||||||
September 30, 2009 | September 30, 2009 | |||||||
Balance beginning of period |
$ | | $ | 3,373 | ||||
Credit losses in retained earnings related to adoption of new accounting standard |
2,723 | | ||||||
Credit losses recognized in earnings: |
||||||||
Securities previously impaired |
550 | 200 | ||||||
Securities not previously impaired |
425 | 125 | ||||||
Balance at September 30, 2009 |
$ | 3,698 | $ | 3,698 | ||||
At September 30, 2009, the net unrealized gain on our available for sale fixed income securities
portfolio was $208.5 million, compared to $72.7 million at June 30, 2009 and $14.6 million at
December 31, 2008. The change in the net unrealized gain or loss, net of the related income tax
effect, is recorded in other comprehensive income and fluctuates with changes in market interest
rates. Our general policy has been to hold our fixed income securities, which are classified as
available for sale, through periods of fluctuating interest rates and to not realize significant
gains or losses from their sale. The net unrealized gain on our fixed income securities portfolio
at October 31, 2009 was approximately $161.0 million.
Fair Value
We value financial assets and financial liabilities at fair value. In determining fair value, we
generally apply the market approach, which uses prices and other relevant data based on market
transactions involving identical or comparable assets and liabilities. We classify our financial
instruments into the following three-level hierarchy established:
| Level 1 Inputs are based on quoted prices in active markets for identical instruments. | ||
| Level 2 Inputs are based on observable market data (other than quoted prices), or are derived from or corroborated by observable market data. | ||
| Level 3 Inputs are unobservable and not corroborated by market data. |
Our Level 1 investments are primarily U.S. Treasuries, for which we use quoted prices for identical
instruments to measure fair value.
Our Level 2 investments include most of our fixed income securities, which consist of U.S.
government agency securities, municipal bonds, certain corporate debt securities, and certain
mortgage-backed and asset-backed securities. Our Level 2 instruments also include our interest rate
swap agreements, which were reflected as liabilities in our condensed consolidated balance sheet at
September 30, 2009. We measure fair value for the majority of our Level 2 investments using quoted
prices of securities with similar characteristics. The remaining investments are valued using
pricing models or matrix pricing. The fair value measurements consider observable assumptions,
including benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided
markets, benchmark securities, bids, offers, default rates, loss severity and other economic
measures.
We use independent pricing services to assist us in determining fair value for over 99% of our
Level 1 and Level 2 investments. The pricing services provide a single price or quote per security.
We use data provided by our third party investment manager to value the remaining Level 2
investments. To validate that these quoted and modeled prices are reasonable estimates of fair
value, we perform various quantitative and qualitative procedures, including: 1) evaluation of the
underlying methodologies, 2) analysis of recent sales activity, 3) analytical review of our fair
values against current market prices, and 4) comparison of the pricing services fair value to
other pricing services fair value for the same investment. Based on these procedures, we did not
adjust the prices or quotes provided by our independent pricing services or third party investment
manager as of September 30, 2009 or December 31, 2008. In 2008 and 2009, the FASB issued new
accounting guidance related to determining the fair value of securities in inactive markets. We
did not apply the criteria of this guidance as of September 30, 2009 and December 31, 2008, since
no markets for our investments were judged to be inactive as of those balance sheet dates.
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Our Level 3 financial instruments include certain fixed income securities and two insurance
contracts that we account for as derivatives. We determine fair value based on internally developed
models that use assumptions or other data that are not readily observable from objective sources.
Because we use the lowest level significant input to determine our hierarchy classifications, a
financial instrument may be classified in Level 3 even though there may be significant
readily-observable inputs.
We excluded from our fair value disclosures our $103.3 million held to maturity investment
portfolio and two investments valued at $4.1 million at September 30, 2009, which are measured at
amortized cost and at cost, respectively. Our held to maturity portfolio had a fair value of
$104.1 million at September 30, 2009.
The following table presents our assets and interest rate swap liabilities that were measured at
fair value.
Level 1 | Level 2 | Level 3 | Total | |||||||||||||
September 30, 2009 |
||||||||||||||||
Fixed income securities |
$ | 253,874 | $ | 4,521,894 | $ | 8,575 | $ | 4,784,343 | ||||||||
Other investments |
14 | | | 14 | ||||||||||||
Other assets |
| | 19,569 | 19,569 | ||||||||||||
Total assets measured at fair value |
$ | 253,888 | $ | 4,521,894 | $ | 28,144 | $ | 4,803,926 | ||||||||
Accounts payable and accrued liabilities |
$ | | $ | (3,778 | ) | $ | | $ | (3,778 | ) | ||||||
Total liabilities measured at fair value |
$ | | $ | (3,778 | ) | $ | | $ | (3,778 | ) | ||||||
December 31, 2008 |
||||||||||||||||
Fixed income securities |
$ | 87,678 | $ | 4,038,972 | $ | 6,515 | $ | 4,133,165 | ||||||||
Other investments |
16 | | | 16 | ||||||||||||
Other assets |
| 1,125 | 16,100 | 17,225 | ||||||||||||
Total assets measured at fair value |
$ | 87,694 | $ | 4,040,097 | $ | 22,615 | $ | 4,150,406 | ||||||||
Accounts payable and accrued liabilities |
$ | | $ | (8,031 | ) | $ | | $ | (8,031 | ) | ||||||
Total liabilities measured at fair value |
$ | | $ | (8,031 | ) | $ | | $ | (8,031 | ) | ||||||
The following table presents the changes in fair value of our Level 3 category during the first
nine months and the third quarter of 2009.
Fixed | ||||||||||||
income | Other | |||||||||||
securities | assets | Total | ||||||||||
Balance at December 31, 2008 |
$ | 6,515 | $ | 16,100 | $ | 22,615 | ||||||
Net redemptions |
(1,590 | ) | | (1,590 | ) | |||||||
Gains and
(losses) unrealized |
1,018 | 3,469 | 4,487 | |||||||||
Gains and
(losses) realized |
30 | | 30 | |||||||||
Transfers into Level 3 |
6,263 | 6,263 | ||||||||||
Transfers out of Level 3 |
(3,661 | ) | | (3,661 | ) | |||||||
Balance at September 30, 2009 |
$ | 8,575 | $ | 19,569 | $ | 28,144 | ||||||
Balance at June 30, 2009 |
$ | 5,982 | $ | 19,757 | $ | 25,739 | ||||||
Net redemptions |
(327 | ) | | (327 | ) | |||||||
Gains and
(losses) unrealized |
487 | (188 | ) | 299 | ||||||||
Transfers into Level 3 |
4,348 | 4,348 | ||||||||||
Transfers out of Level 3 |
(1,915 | ) | | (1,915 | ) | |||||||
Balance at September 30, 2009 |
$ | 8,575 | $ | 19,569 | $ | 28,144 | ||||||
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Unrealized gains and losses on our Level 3 fixed income securities are reported in other
comprehensive income within shareholders equity, and unrealized gains and losses on our Level 3
other assets are reported in other operating income. Transfers of investments into Level 3
occurred due to our inability to obtain a fair value using inputs based on observable market data.
Transfers of investments out of Level 3 occurred because we were able to determine their fair value
using inputs based on observable market data.
Notes Payable
Notes payable at September 30, 2009 and December 31, 2008 are shown in the table below. The
estimated fair value of our Convertible Notes ($156.8 million at September 30, 2009 and $149.8
million at December 31, 2008) is based on quoted market prices. The estimated fair value of our
Revolving Loan Facility is based on current borrowing rates offered to us and approximates the
carrying value at both balance sheet dates.
September 30, | December 31, | |||||||
2009 | 2008 | |||||||
1.30% Convertible Notes |
$ | 124,682 | $ | 123,649 | ||||
$575.0 million Revolving Loan Facility |
320,000 | 220,000 | ||||||
Total notes payable |
$ | 444,682 | $ | 343,649 | ||||
Our 1.30% Convertible Notes are due in 2023. We pay interest semi-annually on April 1 and October
1. Each one thousand dollar principal amount of notes is convertible into 44.1501 shares of our
common stock, which represents an initial conversion price of $22.65 per share. The initial
conversion price is subject to standard anti-dilution provisions designed to maintain the value of
the conversion option in the event we take certain actions with respect to our common stock, such
as stock splits, reverse stock splits, stock dividends and extraordinary dividends, that affect all
of the holders of our common stock equally and that could have a dilutive effect on the value of
the conversion rights of the holders of the notes or that confer a benefit upon our current
shareholders not otherwise available to the 1.30% Convertible Notes. Holders may surrender notes
for conversion if, as of the last day of the preceding calendar quarter, the closing sale price of
our common stock for at least 20 consecutive trading days during the period of 30 consecutive
trading days ending on the last trading day of that quarter is more than 130% ($29.45 per share) of
the conversion price per share of our common stock. This condition was not met at September 30,
2009. While the notes are not convertible during the fourth quarter of 2009, the convertible value
of the notes, if converted, at September 30, 2009 was $150.6 million, which exceeds the principal
amount by $25.9 million. We must settle any conversions by paying cash for the principal amount of
the notes and issuing our common stock for the value of the conversion premium. We can redeem the
notes at any time. If we announce our intent to redeem the notes, the notes will become
immediately convertible, and the holders may surrender them for conversion, payable on the same
terms as described above, at any time until two business days prior to the redemption date.
Holders may require us to repurchase the notes on April 1, 2014 or 2019. The repurchase price to
settle any such put by the holders will equal the principal amount of the notes plus accrued and
unpaid interest and will be paid in cash.
Accounting Guidance Adopted in 2009
Codification
Effective July 1, 2009, the Accounting Standards Codification (ASC or the Codification) issued by
the Financial Accounting Standards Board (FASB) became the single authoritative source of U.S.
GAAP. Rules and interpretive releases issued by the Securities and Exchange Commission (SEC) are
the only other source of U.S. GAAP for SEC registrants. Although the Codification renames and
renumbers all previous accounting literature, it does not change current U.S. GAAP. Our accounting
policies were not affected by our adoption and usage of the Codification.
Convertible
Debt
A new accounting standard, originally issued as FSP APB 14-1, Accounting for Convertible Debt
Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement), became
effective January 1, 2009, required retrospective application to prior financial statements and did
not permit early adoption. This change to ASC Topic 470, Debt, clarifies that convertible debt
instruments that may be settled in cash upon conversion are not totally debt, and requires issuers
to bifurcate and separately account for the liability and equity components. In our condensed
consolidated financial statements, we bifurcated the debt and equity components of our 1.30%
Convertible Notes and 2.00% Convertible Notes and retrospectively adjusted our consolidated
financial statements for all periods prior to 2009. The effective interest rate on our 1.30% and
2.00% Convertible Notes increased to 4.80% and
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3.86%, respectively, which resulted in the recognition of a $22.6 million and $8.3 million
discount, respectively, with the offsetting after-tax impact recorded in additional paid-in
capital. The following line items in our 2008 condensed consolidated financial statements were
affected by this change in accounting principle:
Nine months ended September 30, 2008 | Three months ended September 30, 2008 | |||||||||||||||||||||||
As originally | As originally | |||||||||||||||||||||||
reported | As adjusted | Change | reported | As adjusted | Change | |||||||||||||||||||
Interest expense |
$ | 11,517 | $ | 14,547 | $ | 3,030 | $ | 3,750 | $ | 4,768 | $ | 1,018 | ||||||||||||
Earnings before income tax expense |
336,492 | 333,462 | (3,030 | ) | 83,779 | 82,761 | (1,018 | ) | ||||||||||||||||
Income tax expense |
104,001 | 102,941 | (1,060 | ) | 24,726 | 24,370 | (356 | ) | ||||||||||||||||
Net earnings |
232,491 | 230,521 | (1,970 | ) | 59,053 | 58,391 | (662 | ) | ||||||||||||||||
Diluted earnings per share |
$ | 2.01 | $ | 1.99 | $ | (0.02 | ) | $ | 0.51 | $ | 0.50 | $ | (0.01 | ) | ||||||||||
December 31, 2008 | ||||||||||||||||||||||||
As originally | ||||||||||||||||||||||||
reported | As adjusted | Change | ||||||||||||||||||||||
Other assets (debt issuance costs and deferred tax asset) |
$ | 153,964 | $ | 153,581 | $ | (383 | ) | |||||||||||||||||
Notes payable |
344,714 | 343,649 | (1,065 | ) | ||||||||||||||||||||
Additional paid-in capital |
861,867 | 881,534 | 19,667 | |||||||||||||||||||||
Retained earnings |
1,696,816 | 1,677,831 | (18,985 | ) | ||||||||||||||||||||
Total shareholders equity |
2,639,341 | 2,640,023 | 682 |
The reduction in retained earnings and the increase in additional paid-in capital resulted from
amortization of the implied discount as interest expense through the first contractual put date of
the 2.00% Convertible Notes at September 1, 2007 and the 1.30% Convertible Notes at April 1, 2009.
The 2.00% Convertible Notes were submitted for conversion during September and October 2007. The
implied discount on the 1.30% Convertible Notes was fully amortized in the first quarter of 2009.
At September 30, 2009, there was no remaining equity component and the liability component was
$124.7 million. At December 31, 2008, the 1.30% Convertible Notes had an equity component of $1.1
million and a liability component of $123.6 million, consisting of a principal amount of $124.7
million less a discount of $1.1 million. The effective interest rate on our 1.30% Convertible
Notes was 2.47% for the nine months ended September 30, 2009 and 4.80% for the nine months ended
September 30, 2008. The contractual interest expense was $1.2 million in the first nine months of
2009 and 2008. Interest expense resulting from amortization of the implied discount was $1.1
million and $3.0 million in the nine months ended September 30, 2009 and 2008, respectively. Our
adoption of this guidance did not impact our past or current consolidated cash flows.
Fair Value Measurements
A new accounting standard, originally issued as FSP FAS 157-2, Effective Date of FASB Statement No.
157, became effective January 1, 2009. This guidance requires prospective application of ASC Topic
820, Fair Value Measurement and Disclosure, to nonfinancial assets and nonfinancial liabilities
measured at fair value on a nonrecurring basis, such as goodwill. Our adoption of this revised
guidance had no impact on our condensed consolidated financial statements.
New accounting standards, originally issued as FSP FAS 157-4, Determining Fair Value When the
Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and
Identifying Transactions that Are Not Orderly; FSP FAS 107-1 and APB 28-1, Interim Disclosures
about Fair Value of Financial Instruments; and FSP FAS 115-2 and FAS 124-2, Recognition and
Presentation of Other-Than-Temporary Impairments, became effective prospectively on April 1, 2009.
These changes to ASC Topic 820, Fair Value Measurements and Disclosures, and ASC Topic 320,
Investments Debt and Equity Securities, modify the accounting guidance for determining fair value
of financial instruments under distressed market conditions, revise the recognition and measurement
requirements for other-than-temporary impairment losses on debt securities and expand the related
disclosures. Our adoption of this guidance did not have a material effect on our 2009 condensed
consolidated financial statements. See the Investments section above for additional discussion of
these changes.
Earnings per Share
A new accounting standard, originally issued as FSP EITF 03-6-1, Determining Whether Instruments
Granted in Share-Based Payment Transactions are Participating Securities, became effective January
1, 2009 and required retrospective application to prior periods. This change to ASC Topic 260,
Earnings Per Share, clarifies whether instruments granted in share-based payments, such as
restricted stock, are participating securities prior to vesting and, therefore, must be included in
the earnings allocation in calculating earnings per share under the two-class method described in
ASC Topic 260-10-45-59A, Participating Securities and the Two-Class Method. As revised, ASC Topic
260 requires that unvested share-based payments that contain non-forfeitable rights to dividends or
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dividend-equivalents are treated as participating securities. Our adoption of this guidance had no
material impact on our consolidated earnings per share in any prior period due to immateriality of
our restricted stock awards that have such terms.
Subsequent Events
A new accounting standard, originally issued as SFAS No. 165, Subsequent Events, provides guidance
to account for and disclose events that occur after the balance sheet date but before financial
statements are issued or available to be issued. We adopted this change to ASC Topic 855,
Subsequent Events, as of June 30, 2009 and included the required disclosures in our condensed
consolidated financial statements.
Business Combinations
A new accounting standard, originally issued as SFAS No. 141 (revised 2007), Business Combinations,
became effective January 1, 2009. This change to ASC Topic 805, Business Combinations, modifies
certain accounting treatment for business combinations and impacts presentation of financial
statements on the acquisition date and accounting for acquisitions in subsequent periods. Since
January 1, 2009, we have recorded all new acquisitions in accordance with this guidance.
Consolidation
A new accounting standard, originally issued as SFAS No. 160, Noncontrolling Interests in
Consolidated Financial Statements, an amendment of Accounting Research Bulletin No. 51, became
effective January 1, 2009. This change to ASC Topic 810, Consolidation, modifies the accounting
and reporting for minority interests, which are now recharacterized as noncontrolling interests and
classified as a component of shareholders equity. Our adoption of this guidance had no impact on
our condensed consolidated financial statements.
Derivatives
A new accounting standard, originally issued as SFAS No. 161, Disclosures about Derivative
Instruments and Hedging Activities an amendment of FASB Statement No. 133, became effective
January 1, 2009. This change to ASC Topic 815, Derivatives and Hedging, expands the required
disclosures about a companys derivative and hedging activities. Our adoption had no impact on our
condensed consolidated financial statements.
Recent Accounting Guidance
A new accounting standard, originally issued as SFAS No. 167, Amendments to FASB Interpretation No.
46(R), was issued in June 2009. The guidance, which will be incorporated into ASC Topic 810,
Consolidation, changes various aspects of accounting for and disclosures of interests in variable
interest entities. We will adopt the guidance effective January 1, 2010. We do not expect our
adoption to have a material impact on our consolidated financial statements.
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, 2008, except
as described above in the sections Investments and Accounting
Guidance Adopted in 2009 as
they relate to other-than-temporary impairments on investments, and the section Accounting
Guidance Adopted in 2009 and the following paragraphs as they relate to the valuation of
goodwill.
When we complete a business combination, goodwill is either allocated to the reporting unit in
which the acquired business is included or, if there are synergies with our other businesses,
allocated to the different reporting units based on their respective share of the estimated future
cash flows. In our insurance company segment, we have five reporting units, which are either
individual subsidiaries or groups of subsidiaries that share common licensing and other
characteristics. In our agency segment, we have six reporting units, which are individual
subsidiaries.
An indicator of impairment of goodwill exists when the fair value of a reporting unit is less than
its carrying amount. We assess our goodwill for impairment annually, or sooner if an event occurs
or circumstances change that would more likely than not reduce the fair value of a reporting unit
below its carrying amount. We conducted our 2009 goodwill impairment test as of June 30, 2009,
which is consistent with the timeframe for our annual assessment in prior years. Based on our
latest impairment test, the fair value of each of our reporting units exceeded its carrying amount.
No events have occurred that indicate there is an impairment in our goodwill as of September 30,
2009.
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For our 2009 impairment test, we incorporated new accounting guidance, which required us to
consider three valuation approaches (market, income and cost) to determine the fair value of each
reporting unit. We utilized the market and income approaches, and based our assumptions and inputs
on market participant data, rather than our own data. For the income approach, we estimated the
present value of expected cash flows to determine the fair value of each reporting unit. We
utilized estimated future cash flows, probabilities as to occurrence of these cash flows, a
risk-free rate of interest, and a risk premium for uncertainty in the cash flows. We weighted the
results of the market and income approaches to determine the calculated fair value of each
reporting unit. Prior to 2009, we used the expected cash flow approach with assumptions and inputs
based on our own internal data to determine the fair value of each reporting unit. In all years, we
utilized our budgets and projection of future operations based on historical and expected industry
trends to estimate our future cash flows and their probability of occurring as projected.
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, 2008.
Item 4. Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under
the Securities Exchange Act of 1934, as amended (the Act)) that are designed to ensure that
required information is recorded, processed, summarized and reported within the required timeframe,
as specified in rules set forth by the Securities and Exchange Commission. Our disclosure controls
and procedures are also designed to ensure that information required to be disclosed is accumulated
and communicated to management, including our Chief Executive Officer (CEO) and Chief Financial
Officer (CFO), to allow timely decisions regarding required disclosures.
Our management, with the participation of our CEO and CFO, evaluated the effectiveness of the
design and operation of our disclosure controls and procedures as of September 30, 2009. Based on
this evaluation, our CEO and CFO concluded that our disclosure controls and procedures were
effective as of September 30, 2009.
(b) Changes in Internal Control over Financial Reporting
During the third quarter of 2009, there were no changes in our internal control over financial
reporting that have materially affected, or are reasonably likely to materially affect, our
internal control over financial reporting.
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Part II Other Information
Item 1. Legal Proceedings
We are a 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 that relate to disputes with third parties, or that involve
alleged errors and omissions on the part of our subsidiaries. We have provided accruals for these
items to the extent we deem the losses probable and reasonably estimable. Although the ultimate
outcome of these matters cannot be determined at this time, based on present information, the
availability of insurance coverage and advice received from our outside legal counsel, we believe
the resolution of any such matters will not have a material adverse effect on our consolidated
financial position, results of operations or cash flows.
Item 1A. Risk Factors
There have been no material changes in our risk factors described in our Annual Report on Form 10-K
for the year ended December 31, 2008.
Item 6. Exhibits
a. Exhibits
A3.1
|
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. | |
B3.2
|
Amended and Restated Bylaws of HCC Insurance Holdings, Inc., as amended. | |
C10.1
|
First Amendment to Employment Agreement of Craig J. Kelbel effective as of September 1, 2009. | |
12
|
Statement of Ratio of Earnings to Fixed Charges. | |
31.1
|
Certification by Chief Executive Officer. | |
31.2
|
Certification by Chief Financial Officer. | |
32
|
Certification with Respect to Quarterly Report. |
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 Form 8-K filed April 3, 2008. | |
C | Incorporated by reference to the Exhibits to HCC Insurance Holdings, Inc.s Form 8-K filed August 28, 2009. |
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused
this report to be signed on its behalf by the undersigned, thereunto duly authorized.
HCC Insurance Holdings, Inc.
|
||||
November 5, 2009
|
/s/ John N. Molbeck, Jr.
|
|||
November 5, 2009
|
/s/ Pamela J. Penny
and Chief Accounting Officer |
48