Attached files
file | filename |
---|---|
8-K - FORM 8-K - HCC INSURANCE HOLDINGS INC/DE/ | h68221e8vk.htm |
EX-99.6 - EX-99.6 - HCC INSURANCE HOLDINGS INC/DE/ | h68221exv99w6.htm |
EX-99.3 - EX-99.3 - HCC INSURANCE HOLDINGS INC/DE/ | h68221exv99w3.htm |
EX-99.1 - EX-99.1 - HCC INSURANCE HOLDINGS INC/DE/ | h68221exv99w1.htm |
EX-99.5 - EX-99.5 - HCC INSURANCE HOLDINGS INC/DE/ | h68221exv99w5.htm |
EX-99.2 - EX-99.2 - HCC INSURANCE HOLDINGS INC/DE/ | h68221exv99w2.htm |
EX-23.1 - EX-23.1 - HCC INSURANCE HOLDINGS INC/DE/ | h68221exv23w1.htm |
Exhibit 99.4
Item 8. Financial Statements and
Supplementary Data
INDEX TO
CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES
Report of Independent Registered Public
Accounting Firm
|
F-1 | |||
Consolidated Balance Sheets at December 31,
2008 and 2007
|
F-2 | |||
Consolidated Statements of Earnings for the three
years ended December 31, 2008
|
F-3 | |||
Consolidated Statements of Comprehensive Income
for the three years ended December 31, 2008
|
F-4 | |||
Consolidated Statements of Changes in
Shareholders Equity for the three years ended
December 31, 2008
|
F-5 | |||
Consolidated Statements of Cash Flows for the
three years ended December 31, 2008 |
F-6 | |||
Notes to Consolidated Financial Statements |
F-7 | |||
Schedules: |
||||
Schedule 1 Summary of Investments other than Investments in Related Parties |
S-1 | |||
Schedule 2 Condensed Financial Information of Registrant |
S-2 | |||
Schedule 3
Supplementary Insurance Information |
S-6 | |||
Schedule 4
Reinsurance |
S-7 | |||
Schedule 5
Valuation and Qualifying Accounts |
S-8 |
Schedules
other than those listed above have been omitted because they are
either not required, not applicable, or the required information is
shown in the Consolidated Financial Statements and Notes thereto or
other Schedules.
REPORT OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders
HCC Insurance Holdings, Inc.
In our opinion, the consolidated financial statements listed in
the accompanying index present fairly, in all material respects,
the financial position of HCC Insurance Holdings, Inc. and its
subsidiaries at December 31, 2008 and 2007, and the results
of their operations and their cash flows for each of the three
years in the period ended December 31, 2008 in conformity
with accounting principles generally accepted in the United
States of America. In addition, in our opinion, the financial
statement schedules listed in the accompanying index present
fairly, in all material respects, the information set forth
therein when read in conjunction with the related consolidated
financial statements. Also in our opinion, the Company
maintained, in all material respects, effective internal control
over financial reporting as of December 31, 2008, based on
criteria established in Internal Control
Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO). The
Companys management is responsible for these financial
statements and financial statement schedules, for maintaining
effective internal control over financial reporting and for its
assessment of the effectiveness of internal control over
financial reporting, included in Managements Report on
Internal Control over Financial Reporting appearing under
Item 9A in the Companys annual report on Form
10-K for the year ended December 31, 2008. Our responsibility is to express opinions on these
financial statements, on the financial statement schedules, and
on the Companys internal control over financial reporting
based on our integrated audits. We conducted our audits in
accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we
plan and perform the audits to obtain reasonable assurance about
whether the financial statements are free of material
misstatement and whether effective internal control over
financial reporting was maintained in all material respects. Our
audits of the financial statements included examining, on a test
basis, evidence supporting the amounts and disclosures in the
financial statements, assessing the accounting principles used
and significant estimates made by management, and evaluating the
overall financial statement presentation. Our audit of internal
control over financial reporting included obtaining an
understanding of internal control over financial reporting,
assessing the risk that a material weakness exists, and testing
and evaluating the design and operating effectiveness of
internal control based on the assessed risk. Our audits also
included performing such other procedures as we considered
necessary in the circumstances. We believe that our audits
provide a reasonable basis for our opinions.
As discussed in Note 2 to the consolidated financial
statements, the Company changed the manner in which it accounts
for fair value measurements in 2008. As discussed in Note 1
to the consolidated financial statements, the Company changed
the manner in which it accounts for uncertain tax positions in
2007 and the manner in which it accounts for share-based
compensation in 2006.
A companys internal control over financial reporting is a
process designed to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with
generally accepted accounting principles. A companys
internal control over financial reporting includes those
policies and procedures that (i) pertain to the maintenance
of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the
company; (ii) provide reasonable assurance that
transactions are recorded as necessary to permit preparation of
financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the
company are being made only in accordance with authorizations of
management and directors of the company; and (iii) provide
reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use, or disposition of the
companys assets that could have a material effect on the
financial statements.
Because of its inherent limitations, internal control over
financial reporting may not prevent or detect misstatements.
Also, projections of any evaluation of effectiveness to future
periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree
of compliance with the policies or procedures may deteriorate.
/s/ PricewaterhouseCoopers
LLP
Houston, TX
March 2, 2009, except with respect to our opinion on the consolidated
financial statements insofar as it relates to the effects of the
changes in accounting for certain convertible debt instruments
discussed in Note 1 to the consolidated financial statements, as to
which the date is November 5, 2009
F-1
HCC
INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED
BALANCE SHEETS
(In
thousands, except per share data)
December 31, | ||||||||
2008 | 2007 | |||||||
(as adjusted) | (as adjusted) | |||||||
ASSETS
|
||||||||
Investments:
|
||||||||
Fixed income securities available for sale, at fair
value (amortized cost: 2008 $4,118,539;
2007 $3,641,667)
|
$ | 4,133,165 | $ | 3,666,705 | ||||
Fixed income securities held to maturity, at
amortized cost (fair value: $125,561)
|
123,553 | | ||||||
Short-term investments, at cost, which approximates fair value
|
497,477 | 783,650 | ||||||
Other investments
|
50,088 | 221,922 | ||||||
Total investments
|
4,804,283 | 4,672,277 | ||||||
Cash
|
27,347 | 39,135 | ||||||
Restricted cash and cash investments
|
174,905 | 193,151 | ||||||
Premium, claims and other receivables
|
770,823 | 763,401 | ||||||
Reinsurance recoverables
|
1,054,950 | 956,665 | ||||||
Ceded unearned premium
|
234,375 | 244,684 | ||||||
Ceded life and annuity benefits
|
64,235 | 66,199 | ||||||
Deferred policy acquisition costs
|
188,652 | 192,773 | ||||||
Goodwill
|
858,849 | 776,046 | ||||||
Other assets
|
153,581 | 170,189 | ||||||
Total assets
|
$ | 8,332,000 | $ | 8,074,520 | ||||
LIABILITIES | ||||||||
Loss and loss adjustment expense payable
|
$ | 3,415,230 | $ | 3,227,080 | ||||
Life and annuity policy benefits
|
64,235 | 66,199 | ||||||
Reinsurance balances payable
|
122,189 | 129,838 | ||||||
Unearned premium
|
977,426 | 943,946 | ||||||
Deferred ceding commissions
|
63,123 | 68,968 | ||||||
Premium and claims payable
|
405,287 | 497,974 | ||||||
Notes payable
|
343,649 | 319,471 | ||||||
Accounts payable and accrued liabilities
|
300,838 | 377,349 | ||||||
Total liabilities
|
5,691,977 | 5,630,825 | ||||||
SHAREHOLDERS EQUITY | ||||||||
Common stock, $1.00 par value; 250,000 shares
authorized (shares issued: 2008 116,457 and
2007 115,069; outstanding: 2008 113,444
and 2007 115,069)
|
116,457 | 115,069 | ||||||
Additional paid-in capital
|
881,534 | 851,086 | ||||||
Retained earnings
|
1,677,831 | 1,429,658 | ||||||
Accumulated other comprehensive income
|
27,536 | 47,882 | ||||||
Treasury stock, at cost (shares: 3,013)
|
(63,335 | ) | | |||||
Total shareholders equity
|
2,640,023 | 2,443,695 | ||||||
Total liabilities and shareholders equity
|
$ | 8,332,000 | $ | 8,074,520 | ||||
See Notes to Consolidated Financial Statements.
F-2
HCC
INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF EARNINGS
(In
thousands, except per share data)
Years Ended December 31, | ||||||||||||
2008 | 2007 | 2006 | ||||||||||
(as adjusted) | (as adjusted) | (as adjusted) | ||||||||||
REVENUE
|
||||||||||||
Net earned premium
|
$ | 2,007,774 | $ | 1,985,086 | $ | 1,709,189 | ||||||
Fee and commission income
|
125,201 | 140,092 | 137,131 | |||||||||
Net investment income
|
164,751 | 206,462 | 152,804 | |||||||||
Net realized investment gain (loss)
|
(27,941 | ) | 13,188 | (841 | ) | |||||||
Other operating income
|
9,638 | 43,545 | 77,012 | |||||||||
Total revenue
|
2,279,423 | 2,388,373 | 2,075,295 | |||||||||
EXPENSE
|
||||||||||||
Loss and loss adjustment expense, net
|
1,211,873 | 1,183,947 | 1,011,856 | |||||||||
Policy acquisition costs, net
|
381,441 | 366,610 | 319,885 | |||||||||
Other operating expense
|
233,509 | 241,642 | 222,324 | |||||||||
Interest expense
|
20,362 | 16,270 | 18,128 | |||||||||
Total expense
|
1,847,185 | 1,808,469 | 1,572,193 | |||||||||
Earnings before income tax expense
|
432,238 | 579,904 | 503,102 | |||||||||
Income tax expense
|
130,118 | 188,351 | 165,191 | |||||||||
Net earnings
|
$ | 302,120 | $ | 391,553 | $ | 337,911 | ||||||
|
||||||||||||
Earnings per common share:
|
||||||||||||
Basic
|
$ | 2.63 | $ | 3.47 | $ | 3.04 | ||||||
Diluted
|
$ | 2.61 | $ | 3.35 | $ | 2.89 | ||||||
|
||||||||||||
Weighted-average shares outstanding:
|
||||||||||||
Basic
|
114,848 | 112,873 | 111,309 | |||||||||
Diluted
|
115,463 | 116,997 | 116,736 |
See Notes to Consolidated Financial Statements.
F-3
HCC
INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF COMPREHENSIVE INCOME
(In
thousands)
Years Ended December 31, | ||||||||||||
2008 | 2007 | 2006 | ||||||||||
(as adjusted) | (as adjusted) | (as adjusted) | ||||||||||
Net earnings
|
$ | 302,120 | $ | 391,553 | $ | 337,911 | ||||||
Other comprehensive income (loss):
|
||||||||||||
Investment gains (losses):
|
||||||||||||
Investment gains (losses) during year
|
(37,290 | ) | 41,880 | 40,354 | ||||||||
Income tax charge (benefit)
|
(14,985 | ) | 14,416 | 14,212 | ||||||||
Investment gains (losses), net of tax
|
(22,305 | ) | 27,464 | 26,142 | ||||||||
Less reclassification adjustments for:
|
||||||||||||
Gains (losses) included in net earnings
|
(19,828 | ) | 37,461 | 38,527 | ||||||||
Income tax charge (benefit)
|
(6,940 | ) | 13,111 | 13,484 | ||||||||
Gains (losses) included in net earnings, net of tax
|
(12,888 | ) | 24,350 | 25,043 | ||||||||
Net investment gains (losses)
|
(9,417 | ) | 3,114 | 1,099 | ||||||||
Cash flow hedge loss
|
(5,543 | ) | (2,488 | ) | | |||||||
Income tax benefit
|
(1,940 | ) | (871 | ) | | |||||||
Cash flow hedge loss, net of tax
|
(3,603 | ) | (1,617 | ) | | |||||||
Foreign currency translation adjustment
|
(10,425 | ) | 13,276 | 17,048 | ||||||||
Income tax charge (benefit)
|
(3,099 | ) | 863 | 3,249 | ||||||||
Foreign currency translation adjustment, net of tax
|
(7,326 | ) | 12,413 | 13,799 | ||||||||
Other comprehensive income (loss)
|
(20,346 | ) | 13,910 | 14,898 | ||||||||
Comprehensive income
|
$ | 281,774 | $ | 405,463 | $ | 352,809 | ||||||
See Notes to Consolidated Financial Statements.
F-4
HCC
INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS EQUITY
Years ended December 31, 2008, 2007 and 2006
(In thousands, except per share data)
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS EQUITY
Years ended December 31, 2008, 2007 and 2006
(In thousands, except per share data)
Accumulated |
||||||||||||||||||||||||
Additional |
Other |
Total |
||||||||||||||||||||||
Common |
Paid-In |
Retained |
Comprehensive |
Treasury |
Shareholders |
|||||||||||||||||||
Stock | Capital | Earnings | Income | Stock | Equity | |||||||||||||||||||
(as adjusted) | (as adjusted) | (as adjusted) | ||||||||||||||||||||||
Balance at December 31, 2005 (as previously reported)
|
$ | 110,803 | $ | 762,170 | $ | 798,388 | $ | 19,074 | $ | | $ | 1,690,435 | ||||||||||||
Cumulative effect of accounting change (adoption of FSP
APB 14-1)
|
| 19,667 | (8,087 | ) | | | 11,580 | |||||||||||||||||
Balance at December 31, 2005 (as adjusted)
|
110,803 | 781,837 | 790,301 | 19,074 | | 1,702,015 | ||||||||||||||||||
Net earnings
|
| | 337,911 | | | 337,911 | ||||||||||||||||||
Other comprehensive income
|
| | | 14,898 | | 14,898 | ||||||||||||||||||
Issuance of 928 shares for exercise of options, including
tax benefit of $3,396
|
928 | 18,071 | | | | 18,999 | ||||||||||||||||||
Stock-based compensation
|
| 14,022 | | | | 14,022 | ||||||||||||||||||
Reimbursement, net of income taxes of $2,127
|
| 3,950 | | | | 3,950 | ||||||||||||||||||
Cash dividends declared, $0.375 per share
|
| | (41,786 | ) | | | (41,786 | ) | ||||||||||||||||
Balance at December 31, 2006
|
111,731 | 817,880 | 1,086,426 | 33,972 | | 2,050,009 | ||||||||||||||||||
Cumulative effect of accounting change (adoption of FIN 48)
|
| | (678 | ) | | | (678 | ) | ||||||||||||||||
Net earnings
|
| | 391,553 | | | 391,553 | ||||||||||||||||||
Other comprehensive income
|
| | | 13,910 | | 13,910 | ||||||||||||||||||
Issuance of 1,101 shares for exercise of options, including
tax benefit of $3,352
|
1,101 | 23,432 | | | | 24,533 | ||||||||||||||||||
Issuance of 2,215 shares for debt conversions
|
2,215 | (2,215 | ) | | | | | |||||||||||||||||
Stock-based compensation
|
22 | 11,989 | | | | 12,011 | ||||||||||||||||||
Cash dividends declared, $0.42 per share
|
| | (47,643 | ) | | | (47,643 | ) | ||||||||||||||||
Balance at December 31, 2007
|
115,069 | 851,086 | 1,429,658 | 47,882 | | 2,443,695 | ||||||||||||||||||
Net earnings
|
| | 302,120 | | | 302,120 | ||||||||||||||||||
Other comprehensive loss
|
| | | (20,346 | ) | | (20,346 | ) | ||||||||||||||||
Issuance of 1,011 shares for exercise of options, including
tax benefit of $1,283
|
1,011 | 17,187 | | | | 18,198 | ||||||||||||||||||
Purchase of 3,013 common shares
|
| | | | (63,335 | ) | (63,335 | ) | ||||||||||||||||
Stock-based compensation
|
377 | 13,261 | | | | 13,638 | ||||||||||||||||||
Cash dividends declared, $0.47 per share
|
| | (53,947 | ) | | | (53,947 | ) | ||||||||||||||||
Balance at December 31, 2008
|
$ | 116,457 | $ | 881,534 | $ | 1,677,831 | $ | 27,536 | $ | (63,335 | ) | $ | 2,640,023 | |||||||||||
See Notes to Consolidated Financial Statements.
F-5
HCC
INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF CASH FLOWS
(In
thousands)
Years Ended December 31, | ||||||||||||
2008 | 2007 | 2006 | ||||||||||
(as adjusted) | (as adjusted) | (as adjusted) | ||||||||||
Operating activities:
|
||||||||||||
Net earnings
|
$ | 302,120 | $ | 391,553 | $ | 337,911 | ||||||
Adjustments to reconcile net earnings to cash provided by
operating activities:
|
||||||||||||
Change in premium, claims and other receivables
|
46,985 | 97,304 | 40,955 | |||||||||
Change in reinsurance recoverables
|
(98,354 | ) | 213,353 | 192,049 | ||||||||
Change in ceded unearned premium
|
10,309 | (18,436 | ) | 13,291 | ||||||||
Change in loss and loss adjustment expense payable
|
188,264 | 129,203 | 136,520 | |||||||||
Change in reinsurance balances payable
|
(8,014 | ) | 7,002 | (54,834 | ) | |||||||
Change in unearned premium
|
33,526 | 21,498 | 109,280 | |||||||||
Change in premium and claims payable, net of restricted cash
|
(80,219 | ) | (164,977 | ) | (126,027 | ) | ||||||
Change in trading portfolio
|
49,091 | 9,362 | (19,919 | ) | ||||||||
Stock-based compensation expense
|
13,638 | 12,011 | 13,126 | |||||||||
Depreciation and amortization expense
|
14,308 | 15,982 | 14,980 | |||||||||
(Gain) loss on investments
|
49,549 | (58,736 | ) | (52,688 | ) | |||||||
Other, net
|
(15,235 | ) | 71,317 | 48,744 | ||||||||
Cash provided by operating activities
|
505,968 | 726,436 | 653,388 | |||||||||
Investing activities:
|
||||||||||||
Sales of fixed income securities
|
583,211 | 438,057 | 338,927 | |||||||||
Maturity or call of fixed income securities
|
323,998 | 302,876 | 247,072 | |||||||||
Cost of securities acquired
|
(1,609,007 | ) | (1,377,750 | ) | (1,389,984 | ) | ||||||
Change in short-term investments
|
294,248 | (72,279 | ) | 129,919 | ||||||||
Proceeds from sales of strategic and other investments
|
77,097 | 46,612 | 63,285 | |||||||||
Payments for purchase of businesses, net of cash received
|
(103,153 | ) | (65,112 | ) | (45,722 | ) | ||||||
Other, net
|
(7,996 | ) | (9,741 | ) | (11,971 | ) | ||||||
Cash used by investing activities
|
(441,602 | ) | (737,337 | ) | (668,474 | ) | ||||||
Financing activities:
|
||||||||||||
Advances on line of credit
|
181,000 | 232,000 | 140,000 | |||||||||
Payments on line of credit and notes payable
|
(161,000 | ) | (205,763 | ) | (140,616 | ) | ||||||
Sale of common stock
|
18,198 | 24,533 | 18,999 | |||||||||
Purchase of common stock
|
(63,335 | ) | | | ||||||||
Dividends paid
|
(52,453 | ) | (46,158 | ) | (38,923 | ) | ||||||
Other, net
|
1,436 | (2,866 | ) | 9,981 | ||||||||
Cash provided (used) by financing activities
|
(76,154 | ) | 1,746 | (10,559 | ) | |||||||
Net decrease in cash
|
(11,788 | ) | (9,155 | ) | (25,645 | ) | ||||||
Cash at beginning of year
|
39,135 | 48,290 | 73,935 | |||||||||
Cash at end of year
|
$ | 27,347 | $ | 39,135 | $ | 48,290 | ||||||
See Notes to Consolidated Financial Statements.
F-6
HCC
INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
(tables in thousands, except per share data)
(1) | General Information and Significant Accounting and Reporting Policies |
HCC Insurance Holdings, Inc. and its subsidiaries (collectively,
we, us, or our) include domestic and foreign property and
casualty and life insurance companies, underwriting agencies and
brokers. We provide specialized property and casualty, surety,
and group life, accident and health insurance coverages and
related agency and reinsurance brokerage services to commercial
customers and individuals. We market our products both directly
to customers and through a network of independent and affiliated
brokers, producers, agents and third party administrators. Our
lines of business include diversified financial products (which
includes directors and officers liability,
professional indemnity, employment practices liability, surety,
credit, and fidelity); group life, accident and health;
aviation; our London market account (which includes energy,
marine, property, and accident and health); and other specialty
lines of insurance. We operate primarily in the United States,
the United Kingdom, Spain, Bermuda and Ireland, although some of
our operations have a broader international scope.
Our principal domestic insurance companies are Houston Casualty
Company and U.S. Specialty Insurance Company, HCC Life
Insurance Company, Avemco Insurance Company and American
Contractors Indemnity Company. These companies operate
throughout the United States with headquarters in Houston,
Texas; Atlanta, Georgia; Frederick, Maryland; and Los Angeles,
California, respectively. All of our principal domestic
insurance companies operate on an admitted basis, except Houston
Casualty Company, which also insures international risks. Our
foreign insurance companies are HCC International Insurance
Company, HCC Europe, HCC Reinsurance Company and the London
branch of Houston Casualty Company. These companies operate
principally from the United Kingdom, Spain and Bermuda. We also
participate in two Lloyds of London syndicates, which are
managed by our subsidiary, HCC Underwriting Agency, Ltd. (UK),
operating in London, England.
Our underwriting agencies provide underwriting management and
claims servicing for insurance and reinsurance companies in
specialized lines of business within the property and casualty
and group life, accident and health insurance sectors. Our
principal domestic agencies are Professional Indemnity Agency,
HCC Global Financial Products, Covenant Underwriters, HCC
Specialty Underwriters, HCC Indemnity Guaranty Agency,
RA&MCO Insurance Services, MultiNational Underwriters, LLC
and G.B. Kenrick & Associates. Our agencies operate
throughout the United States. Our principal foreign agency is
HCC Global Financial Products, with headquarters in Barcelona,
Spain.
Our reinsurance and insurance brokers provide brokerage,
consulting and other broker services to insurance and
reinsurance companies, commercial customers and individuals in
the same lines of business as the insurance companies and
underwriting agencies operate. Our reinsurance broker is Rattner
Mackenzie, which operates principally in the United Kingdom. Our
insurance broker is Continental Underwriters.
Basis
of Presentation
Our consolidated financial statements have been prepared in
conformity with accounting principles generally accepted in the
United States of America (generally accepted accounting
principles) and include the accounts of HCC Insurance Holdings,
Inc. and its subsidiaries. All significant intercompany balances
and transactions have been eliminated in consolidation.
Management must make estimates and assumptions that affect
amounts reported in our 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 2007 and 2006
consolidated financial statements to conform to the 2008
presentation. None of our reclassifications had an effect on our
consolidated net earnings, shareholders equity or cash
flows. We adopted FSP APB 14-1 and FSP EITF 03-6-1
on January 1, 2009. Our consolidated financial statements
have been adjusted for the retrospective application of these new accounting standards.
We have evaluated subsequent events through November 9, 2009,
which is the date these financial statements were issued.
F-7
HCC
INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
(continued,
tables in thousands, except per share data)
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
coverage in the period. Written premium, net of reinsurance, is
primarily recognized in earnings on a pro rata basis over the
term of the related policies. However, for certain policies,
written premium is recognized in earnings over the period of
risk in proportion to the amount of insurance risk 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.
We defer our direct costs to underwrite insurance policies, less
amounts reimbursed by reinsurers, and charge or credit the costs
to earnings proportionate with the premium earned. These policy
acquisition costs include underwriters salaries, bonuses,
commissions, taxes, fees, and other direct underwriting costs.
Historical and current loss adjustment expense experience and
anticipated investment income are considered in determining
premium deficiencies and the recoverability of deferred policy
acquisition costs.
Fee
and Commission Income
Fee and commission income in our consolidated statements of
earnings includes fee income from our underwriting agencies,
commission income from our brokers and proceeds from ceded
reinsurance (ceding commissions in excess of acquisition costs).
When there is no significant future servicing obligation, we
recognize fee and commission income from third parties on the
later of the effective date of the policy, the date when the
premium can be reasonably established, or the date when
substantially all services related to the insurance placement
have been rendered to the client. We record revenue from profit
commissions based on the profitability of business written,
calculated using the respective commission formula and actual
underwriting results through the date of calculation. Such
amounts are adjusted if and when experience changes. When
additional services are required, the service revenue is
deferred and recognized over the service period. We record an
allowance for estimated return commissions that we may be
required to pay on the early termination of policies. Proceeds
from ceded reinsurance are earned pro rata over the term of the
underlying policy.
When our underwriting agencies utilize one of our insurance
company subsidiaries as the policy issuing company and the
business is reinsured with a third-party reinsurer, we eliminate
in consolidation the fee and commission income against the
related insurance companys policy acquisition costs and
defer the policy acquisition costs of the underwriting agencies.
Premium,
Claims and Other Receivables
We use the gross method for reporting receivables and payables
on brokered transactions. We review the collectibility of our
receivables on a current basis and provide an allowance for
doubtful accounts if we deem that there are accounts that are
doubtful of collection. The allowance was $5.4 million and
$6.4 million at December 31, 2008 and 2007,
respectively. Our estimate of the level of the allowance could
change as conditions change in the future.
Loss
and Loss Adjustment Expense Payable
Loss and loss adjustment expense payable by our insurance
companies is based on estimates of payments to be made for
reported losses, incurred but not reported losses, and
anticipated receipts from salvage and subrogation. Reserves are
recorded on an undiscounted basis, except for reserves of
acquired companies. The
F-8
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INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
(continued,
tables in thousands, except per share data)
discount on those reserves is not material. Estimates for
reported losses are based on all available information,
including reports received from ceding companies on assumed
business. Estimates for incurred but not reported losses are
based both on our experience and the industrys experience.
While we believe that amounts included in our consolidated
financial statements are adequate, such estimates may be more or
less than the amounts ultimately paid when the claims are
settled. We continually review the estimates with our actuaries,
and any changes are reflected in loss and loss adjustment
expense in the period of the change.
Reinsurance
We record all reinsurance recoverables and ceded unearned
premium as assets, and deferred ceding commissions as
liabilities. All such amounts are recorded in a manner
consistent with the underlying reinsured contracts. We record a
reserve for uncollectible reinsurance based on our assessment of
reinsurers credit worthiness, reinsurance contract terms
and collectibility. Information utilized to calculate the
reserve is subject to change, which could affect the level of
the reserve in the future.
One assumed residential mortgage guaranty reinsurance contract,
which we determined does not transfer significant underwriting
risk, is accounted for using the deposit method of accounting.
In catastrophic or unforeseen circumstances, it is possible we
could incur financial losses on this contract. We record all
consideration received under the contract as a deposit
liability, rather than as net earned premium and loss and loss
adjustment expense. We use actuarial information to estimate
both our liability under the contract and the appropriate rates
to decrease the liability over the term of the contract. We
report income from this contract, net of any losses, as other
operating income in our consolidated statements of earnings.
Cash
and Short-term Investments
Cash consists of cash in banks, generally in operating accounts.
Short-term investments, including certificates of deposit and
money-market funds, are classified as investments in our
consolidated balance sheets as they relate principally to our
investment activities. We generally maintain our cash deposits
in major banks and invest our short-term funds in institutional
money-market funds and short-term financial instruments. These
securities typically mature within ninety days and, therefore,
bear minimal risk.
Certain fiduciary funds totaling $199.6 million and
$213.4 million were included in short-term investments and
fixed income securities at December 31, 2008 and 2007,
respectively. These funds are held by underwriting agencies,
brokers or surety companies for the benefit of insurance or
reinsurance clients. We earn interest, net of expenses, on these
funds.
Restricted
Cash and Cash Investments
Our agencies withhold premium funds for the payment of claims.
These funds are shown as restricted cash and cash investments in
our consolidated balance sheets. The corresponding liability is
included within premium and claims payable in our consolidated
balance sheets. These amounts are considered fiduciary funds,
and interest earned on these funds accrues to the benefit of the
insurance companies from whom the funds were withheld.
Therefore, we do not include these amounts as cash in our
consolidated statements of cash flows.
Investments
Substantially all of our fixed income securities are classified
as available for sale and reported at fair value, based on
quoted market prices of these securities or, when such prices
are not available in inactive markets, based on
managements internal assumptions about future cash flows
with risk-adjusted discount rates. The change in unrealized gain
or loss on available for sale securities is recorded as a
component of
F-9
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INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
(continued,
tables in thousands, except per share data)
other comprehensive income, net of the related deferred income
tax effect, within shareholders equity. For securities
denominated in currencies other than the U.S. dollar, the
foreign exchange gain/loss on available for sale securities is
recorded as a component of accumulated other comprehensive
income until the related securities mature or are sold. We
purchase the majority of our available for sale fixed income
securities with the intent to hold them to maturity, but they
may be sold prior to maturity if market conditions or
credit-related risk warrant or if our investment policies
dictate in order to maximize our investment yield.
Our available for sale fixed income portfolio includes
asset-backed and mortgage-backed securities for which we
recognize income using a constant effective yield based on
anticipated prepayments and the estimated economic life of the
securities. When actual prepayments differ significantly from
anticipated prepayments, the estimated economic life is
recalculated and the remaining unamortized premium or discount
is amortized prospectively over the remaining economic life.
A small portion of our fixed income securities are classified as
held to maturity and reported at amortized cost. This portfolio
includes foreign-denominated securities for which we have the
ability and intent to hold the securities to maturity or
redemption. We hold these securities to hedge the foreign
exchange risk associated with insurance claims that we will pay
in foreign currencies. Any foreign exchange gain/loss on these
securities is recorded through income and substantially offsets
any foreign exchange gain/loss on the related liabilities.
Short-term investments and restricted cash investments are
carried at cost, which approximates fair value. Other
investments include alternative investments, which are accounted
for using the equity method of accounting, and trading
securities, which are carried at fair value. The carrying value
of our alternative investments, the majority of which we
liquidated in 2008, was $46.0 million and
$172.8 million at December 31, 2008 and 2007,
respectively. The fair value of our trading securities, which
were liquidated during 2008, was $49.1 million at
December 31, 2007. Changes in carrying value are included
in the consolidated statements of earnings within net investment
income for other alternative investments and in other operating
income for trading securities.
Realized investment gains or losses are determined on an average
cost basis and included in earnings on the trade date. A
security is considered impaired when its cost exceeds its fair
value. We evaluate the securities in our fixed income securities
investment portfolio for possible
other-than-temporary
impairment losses at each quarter end, based on all relevant
facts and circumstances for each impaired security. Our
evaluation 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, | |
| stress testing of expected cash flows under various scenarios, | |
| whether the impairment is due to an issuer-specific event, credit issues or change in market interest rates, and | |
| Our ability and intent to hold the security for a period of time sufficient to allow full recovery or until maturity. |
When we conclude that a decline in a securitys fair value
is
other-than-temporary,
we recognize the impairment as a realized investment loss in our
consolidated statements of earnings. The impairment loss equals
the difference between the securitys fair value and cost
at the balance sheet date. We also establish a new cost basis
equal to the fair value, which is not adjusted for subsequent
recovery in fair value. If we do not expect to collect all of
the principal and interest through maturity, we accrete income
over the remaining life
F-10
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INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
(continued,
tables in thousands, except per share data)
of the security based on the interest rate necessary to discount
the expected future cash flows to the new basis. If we cannot
estimate the timing or amount of future cash flows or if the
security is non-income producing, we apply any cash proceeds as
a reduction of principal when received.
Derivative
Financial Instruments
We have reinsured interests in two long-term mortgage impairment
insurance contracts that are denominated in British pound
sterling. The exposure with respect to these two contracts is
measured based on movement in a specified United Kingdom housing
index. These insurance contracts qualify as derivative financial
instruments, are unhedged and are reported in other assets at
fair value, which was $16.1 million and $16.8 million
at December 31, 2008 and 2007, respectively. We determine
fair value based on our estimate of the present value of
expected future cash flows, modified to reflect specific
contract terms. We record changes in fair value and any foreign
exchange gain/loss on these contracts as a component of other
operating income in our consolidated statements of earnings.
We have interest rate swap agreements that effectively convert
outstanding borrowings on our Revolving Loan Facility from a
variable rate to a fixed rate. These agreements are recorded at
fair value and reported in accounts payable and accrued
expenses. For agreements that qualify for hedge accounting
treatment as cash flow hedges, the change in fair value is
recorded each period as a component of other comprehensive
income, net of the related deferred income tax effect. For all
other agreements, the change in fair value is recorded as a
component of other operating expense.
Strategic
Investments and Other Operating Income
Included in other assets are certain strategic investments in
insurance-related companies. For any strategic investment in
which we own a 20% to 50% equity interest, the investment and
income are recorded using the equity method of accounting. The
related income is reported in other operating income in the
consolidated statements of earnings. We record any interest,
dividends on investments not accounted for by the equity method
of accounting, and realized gains or losses in other operating
income and we record unrealized gains or losses in other
comprehensive income.
Goodwill
and Intangible Assets
When we complete a business combination, goodwill is either
allocated to the acquired business 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 agency segment, the reporting units are
individual subsidiaries. In our insurance company segment, the
reporting units are either individual subsidiaries or groups of
subsidiaries that share common licensing and other
characteristics.
We utilize the expected cash flow approach to determine the fair
value of a reporting unit. This approach utilizes 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 utilize 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.
We assess the impairment of goodwill 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. Our annual goodwill assessment was conducted as of
June 30, 2008, 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. Intangible assets not subject to
amortization are tested for impairment annually,
F-11
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INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
(continued,
tables in thousands, except per share data)
or sooner if an event occurs or circumstances change that
indicate that an intangible asset might be impaired. Other
intangible assets are amortized over their respective useful
lives.
Foreign
Currency
The functional currency of some of our foreign subsidiaries and
branches is the U.S. dollar. Assets and liabilities
recorded in foreign currencies are translated into
U.S. dollars at exchange rates in effect at the balance
sheet date. For available for sale securities, unrealized gains
and losses related to fluctuations in exchange rates are
recorded as a component of other comprehensive income, net of
the related deferred income tax effect, within
shareholders equity until the securities mature or are
sold. Similar exchange rate fluctuations related to held to
maturity securities are recorded through income. Transactions in
foreign currencies are translated at the rates of exchange in
effect on the date the transaction occurs. Transaction gains and
losses are recorded in earnings and included in other operating
expense in the consolidated statements of earnings. Our foreign
currency transactions are principally denominated in British
pound sterling and the Euro.
We utilize the British pound sterling and the Euro as the
functional currency in our other foreign operations. The
cumulative translation adjustment, representing the effect of
translating these subsidiaries assets and liabilities into
U.S. dollars, is included in the foreign currency
translation adjustment, net of the related deferred income tax
effect, within accumulated other comprehensive income is
shareholders equity. The effect of exchange rate changes
on cash balances held in foreign currencies was immaterial for
all periods presented and is not shown separately in the
consolidated statements of cash flows.
Income
Taxes
We file a consolidated Federal income tax return and include the
foreign subsidiaries income to the extent required by law.
Deferred income tax is accounted for using the liability method,
which reflects the tax impact of temporary differences between
the bases of assets and liabilities for financial reporting
purposes and such bases as measured by tax laws and regulations.
We provide a deferred tax liability for un-repatriated earnings
of our foreign subsidiaries at prevailing statutory rates when
required. Due to our history of earnings, expectations for
future earnings, and taxable income in carryback years, we
expect to be able to fully realize the benefit of any net
deferred tax asset on a consolidated basis.
In 2007, we adopted FIN No. 48, Accounting for
Uncertainty in Income Taxes. To adopt FIN 48, we
reduced beginning retained earnings by $0.7 million,
primarily for potential interest on previously recorded tax
liabilities related to uncertain tax positions. Effective
January 1, 2007, we recorded a liability for our uncertain
tax positions where we determined it is not more likely than not
the tax position will be sustained upon examination by the
appropriate tax authority. Changes in the liability for our
uncertain tax positions are reflected in income tax expense or
goodwill, if related to an acquisition, in the period when a new
uncertain tax position arises, we change our judgment about the
likelihood of uncertainty, the tax issue is settled, or the
statute of limitations expires. We report any potential net
interest income or expense and penalties related to changes in
our uncertain tax positions in our consolidated statements of
earnings as interest expense and other operating expense,
respectively.
Stock-Based
Compensation
We charge the fair value of stock-based compensation awards to
earnings in accordance with the requirements of Statement of
Financial Accounting Standards (SFAS) No. 123(R),
Share-Based Payment. Effective January 1, 2006, we
adopted SFAS 123(R) using the modified prospective method
and currently recognize compensation expense on a straight-line
basis for all unvested stock options as of that date. For stock
option awards, we use the Black-Scholes single option pricing
model to determine the fair value of the option on its grant
date and expense that value on a straight-line basis over the
options vesting period. For
F-12
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INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
(continued,
tables in thousands, except per share data)
grants of restricted stock and restricted stock units, we
measure fair value based on our closing stock price on the grant
date and expense that value on a straight-line basis over the
awards vesting period. For grants of unrestricted common
stock, we measure fair value based on our closing stock price on
the grant date and expense that value on the grant date.
Earnings
Per Share
Basic earnings per share is computed by dividing net earnings attributable to common stock by
the weighted-average common shares outstanding during the year.
Diluted earnings per share is computed by dividing net earnings attributable to common stock by the weighted-average common shares outstanding plus the
weighted-average potential common shares outstanding during the
year. Outstanding common stock options, when dilutive, are included in the weighted-average
potential common shares outstanding. Also included in the
weighted-average potential common shares outstanding are common
shares that would be issued for any premium in excess of the
principal amount of our convertible debt. We use the treasury
stock method to calculate the dilutive effect of potential
common shares outstanding.
Unvested restricted stock and unvested restricted stock units that contain non-forfeitable rights to dividends or dividend-equivalents are treated
as participating securities, which must be included in the earnings
allocation in calculating earnings per share under the two-class method.
Recent
Accounting Pronouncements
The Financial Accounting Standards Board (FASB) has issued FSP
FAS 157-2,
Effective Date of FASB Statement No. 157, to delay
the effective date of SFAS No. 157, Fair Value
Measurements, (discussed in Note 2) for nonfinancial
assets and nonfinancial liabilities measured at fair value on a
nonrecurring basis, such as goodwill. For these items,
FSP 157-2
is effective January 1, 2009. We will finalize our
assessment of the impact on our consolidated financial
statements from our adoption of FSP 157-2 as applicable
during 2009.
SFAS No. 159, The Fair Value Option for Financial
Assets and Financial Liabilities, issued by the FASB, was
effective January 1, 2008. SFAS 159 allows a company
to make an irrevocable election to measure eligible financial
assets and financial liabilities at fair value that are not
otherwise measured at fair value. Unrealized gains and losses
for those items are reported in current earnings at each
subsequent reporting date. As of December 31, 2008, we have
not elected to value any additional assets or liabilities at
fair value under the guidance of SFAS 159.
The FASB has issued SFAS No. 141 (revised 2007)
(SFAS 141(R)), Business Combinations, and
SFAS No. 160, Noncontrolling Interests in
Consolidated Financial Statements, an amendment of Accounting
Research Bulletin No. 51. SFAS 141(R) will
change the accounting treatment for business combinations and
will impact presentation of financial statements on the
acquisition date and accounting for acquisitions in subsequent
periods. SFAS 160 will change the accounting and reporting
for minority interests, which will be recharacterized as
noncontrolling interests and classified as a component of
shareholders equity. SFAS 141(R) and SFAS 160
are effective January 1, 2009, and early adoption is not
permitted. We will apply the guidelines of SFAS 141(R) to
future acquisitions. We do not expect the adoption of
SFAS 141(R) and SFAS 160 to have a material impact on
our future consolidated financial statements.
The FASB has issued SFAS No. 161, Disclosures about
Derivative Instruments and Hedging Activities an
amendment of FASB Statement No. 133, which expands the
required disclosures about a companys derivative and
hedging activities. SFAS 161 is effective January 1,
2009. We do not expect adoption to have a material impact on the
notes to our consolidated financial statements.
The FASB has issued SFAS No. 162, The Hierarchy of
Generally Accepted Accounting Principles. SFAS 162
identifies the sources of accounting principles and the
framework for selecting the principles to be used in the
preparation of financial statements in conformity with generally
accepted accounting principles in the United States.
SFAS 162 is effective 60 days after the Securities and
Exchange Commissions approval of the Public Company
Accounting Oversight Boards amendments to AU 411,
The Meaning of Present Fairly in
Conformity with Generally Accepted Accounting Principles.
Our usage of the hierarchical guidance provided by
SFAS 162 is not expected to have a material impact on our
consolidated financial statements.
F-13
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INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
(continued,
tables in thousands, except per share data)
Adoption of Recent Accounting Pronouncements
FSP No. 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. FSP EITF 03-6-1 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 SFAS No. 128, Earnings per Share. Under FSP EITF 03-6-1, unvested share-based
payments that contain non-forfeitable rights to dividends or dividend-equivalents are treated as
participating securities. Our adoption of FSP EITF 03-6-1 had
no impact on our consolidated
earnings per share in 2008 due to immateriality of our restricted stock awards that have such
terms. There were no restricted stock awards outstanding prior to 2008.
FSP No. 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 and required
retrospective application to prior financial statements. FSP APB
14-1 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 consolidated financial statements, we adopted FSP APB 14-1 for
our 1.30% Convertible Notes and 2.00% Convertible Notes and retrospectively adjusted our
consolidated financial statements for all periods presented. 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. The
following line items in our consolidated financial statements were
affected by the adoption of FSP APB 14-1:
Twelve months ended December 31, 2008 | ||||||||||||
As originally | ||||||||||||
reported | As adjusted | Change | ||||||||||
Interest expense |
$ | 16,288 | $ | 20,362 | $ | 4,074 | ||||||
Earnings before income tax expense |
436,312 | 432,238 | (4,074 | ) | ||||||||
Income tax expense |
131,544 | 130,118 | (1,426 | ) | ||||||||
Net earnings |
304,768 | 302,120 | (2,648 | ) | ||||||||
Basic earnings per share |
$ | 2.65 | $ | 2.63 | $ | (0.02 | ) | |||||
Diluted earnings per share |
2.64 | 2.61 | (0.03 | ) | ||||||||
Twelve months ended December 31, 2007 | ||||||||||||
As originally | ||||||||||||
reported | As adjusted | Change | ||||||||||
Interest expense |
$ | 10,304 | $ | 16,270 | $ | 5,966 | ||||||
Earnings before income tax expense |
585,870 | 579,904 | (5,966 | ) | ||||||||
Income tax expense |
190,441 | 188,351 | (2,090 | ) | ||||||||
Net earnings |
395,429 | 391,553 | (3,876 | ) | ||||||||
Basic earnings per share |
$ | 3.50 | $ | 3.47 | $ | (0.03 | ) | |||||
Diluted earnings per share |
3.38 | 3.35 | (0.03 | ) | ||||||||
Twelve months ended December 31, 2006 | ||||||||||||
As originally | ||||||||||||
reported | As adjusted | Change | ||||||||||
Interest expense |
$ | 11,396 | $ | 18,128 | $ | 6,732 | ||||||
Earnings before income tax expense |
509,834 | 503,102 | (6,732 | ) | ||||||||
Income tax expense |
167,549 | 165,191 | (2,358 | ) | ||||||||
Net earnings |
342,285 | 337,911 | (4,374 | ) | ||||||||
Basic earnings per share |
$ | 3.08 | $ | 3.04 | $ | (0.04 | ) | |||||
Diluted earnings per share |
2.93 | 2.89 | (0.04 | ) | ||||||||
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 |
F-14
December 31, 2007 | ||||||||||||
As originally | ||||||||||||
reported | As adjusted | Change | ||||||||||
Other assets (debt issuance costs) |
$ | 170,314 | $ | 170,189 | $ | (125 | ) | |||||
Notes payable |
324,714 | 319,471 | (5,243 | ) | ||||||||
Accounts payable and accrued liabilities (deferred tax liability) |
375,561 | 377,349 | 1,788 | |||||||||
Additional paid-in capital |
831,419 | 851,086 | 19,667 | |||||||||
Retained earnings |
1,445,995 | 1,429,658 | (16,337 | ) | ||||||||
Total
shareholders equity |
2,440,365 | 2,443,695 | 3,330 |
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. 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. While the notes are not convertible during
the first quarter of 2009, the convertible value of the notes, if converted,
at December 31, 2008 was $147.3 million,
which exceeds the principal amount by $22.6 million. At December 31, 2007, the 1.30% Convertible Notes had an equity
component of $5.2 million and a liability component of $119.5 million, consisting of a principal
amount of $124.7 million less a discount of $5.2 million. The contractual interest expense was $1.6
million in 2008, 2007 and 2006. Interest expense resulting from amortization of the implied
discount was $4.1 million, $6.0 million and $6.7 million in 2008, 2007 and 2006, respectively. The
adoption of FSP APB 14-1 did not impact our past or current consolidated cash flows.
(2) | Fair Value Measurements |
Effective January 1, 2008, we adopted
SFAS No. 157, Fair Value Measurements, for
financial assets and financial liabilities measured at fair
value on a recurring basis (at least annually). SFAS 157
defines fair value, establishes a consistent framework for
measuring fair value and expands disclosure requirements about
fair value measurements. SFAS 157 also established a
hierarchy that prioritizes the input used to measure fair value
into three levels, as described below. Our adoption of
SFAS 157 did not impact our current or prior years
consolidated financial position, results of operations or cash
flows.
SFAS 157 applies to all financial instruments that are
measured and reported at fair value. SFAS 157 defines fair
value as the price that would be received to sell an asset or
would be paid to transfer a liability in an orderly transaction
between market participants at the measurement date. In 2008,
the FASB issued FSP
FAS 157-3,
Determining the Fair Value of a Financial Asset When the
Market for That Asset Is Not Active (FSP
FAS 157-3).
FSP
FAS 157-3
clarifies SFAS 157 with respect to the fair value
measurement of a security when the market for that security is
inactive. Our adoption of FSP
FAS 157-3
did not impact our consolidated financial position, results of
operations or cash flows.
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. The degree of judgment used to measure fair value
generally correlates to the type of pricing and other data used
as inputs, or assumptions, in the valuation process. Observable
inputs reflect market data obtained from independent sources,
while unobservable inputs reflect our own market assumptions
using the best information available to us. Based on the type of
inputs used to measure the fair value of our financial
instruments, we classify them into the three-level hierarchy
established by SFAS 157:
| 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. |
F-15
HCC
INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
(continued,
tables in thousands, except per share data)
Our Level 1 investments are primarily U.S. Treasuries
listed on stock exchanges. 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 and asset-backed securities. Our
Level 2 instruments also include our interest rate swap
agreements, which were reflected as liabilities in our
consolidated balance sheet at December 31, 2008. 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. We use data provided by our third party investment
managers to value the remaining Level 2 investments. We did
not apply the criteria of FSP
FAS 157-3,
since no markets for our investments were judged to be inactive.
To validate quoted and modeled prices, we perform various
procedures, including evaluation of the underlying
methodologies, analysis of recent sales activity, and analytical
review of our fair values against current market prices, other
pricing services and historical trends.
Our Level 3 securities include certain fixed income
securities and two insurance contracts that we account for as
derivatives. Fair value is based on internally developed models
that use our 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 SFAS 157 disclosures certain assets,
such as alternative investments and certain strategic
investments in insurance-related companies, since we account for
them using the equity method of accounting and have not elected
to measure them at fair value, pursuant to the guidance of
SFAS 159. These assets had a recorded value of
$63.0 million at December 31, 2008. We also excluded
our held to maturity investment portfolio valued at
$123.6 million and an investment valued at
$4.1 million at December 31, 2008, which are measured
at amortized cost and at cost, respectively.
The following table presents our assets and liabilities that
were measured at fair value as of December 31, 2008.
Level 1 | Level 2 | Level 3 | Total | |||||||||||||
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 | ) | ||||||
F-16
HCC
INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
(continued,
tables in thousands, except per share data)
The following table presents the changes in fair value of our
Level 3 category during 2008.
Fixed |
||||||||||||||||
Income |
Other |
Other |
||||||||||||||
Securities | Investments | Assets | Total | |||||||||||||
Balance at January 1, 2008
|
$ | 7,623 | $ | 5,492 | $ | 16,804 | $ | 29,919 | ||||||||
Net redemptions
|
(242 | ) | (5,261 | ) | | (5,503 | ) | |||||||||
Losses realized
|
| (299 | ) | | (299 | ) | ||||||||||
Other-than-temporary
impairment losses realized
|
(2,575 | ) | | | (2,575 | ) | ||||||||||
Gains and (losses) unrealized
|
(566 | ) | 68 | (704 | ) | (1,202 | ) | |||||||||
Net transfers in/out of Level 3
|
2,275 | | | 2,275 | ||||||||||||
Balance at December 31, 2008
|
$ | 6,515 | $ | | $ | 16,100 | $ | 22,615 | ||||||||
Unrealized gains and losses on our Level 3 fixed income
securities and other investments 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.
(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 | |||||||||||||
December 31, 2008
|
||||||||||||||||
U.S. government
|
$ | 196,856 | $ | 9,447 | $ | (15 | ) | $ | 206,288 | |||||||
States, municipalities and political subdivisions
|
1,982,321 | 40,197 | (30,983 | ) | 1,991,535 | |||||||||||
Corporate fixed income securities
|
517,794 | 5,308 | (11,464 | ) | 511,638 | |||||||||||
Asset-backed and mortgage-backed securities
|
1,048,647 | 40,349 | (48,130 | ) | 1,040,866 | |||||||||||
Foreign securities
|
372,921 | 10,576 | (659 | ) | 382,838 | |||||||||||
Total available for sale fixed income securities
|
$ | 4,118,539 | $ | 105,877 | $ | (91,251 | ) | $ | 4,133,165 | |||||||
December 31, 2007
|
||||||||||||||||
U.S. government
|
$ | 159,147 | $ | 4,445 | $ | (9 | ) | $ | 163,583 | |||||||
States, municipalities and political subdivisions
|
1,802,417 | 22,494 | (2,630 | ) | 1,822,281 | |||||||||||
Corporate fixed income securities
|
299,288 | 2,778 | (4,498 | ) | 297,568 | |||||||||||
Asset-backed and mortgage-backed securities
|
1,001,423 | 12,692 | (4,423 | ) | 1,009,692 | |||||||||||
Foreign securities
|
379,392 | 956 | (6,767 | ) | 373,581 | |||||||||||
Total available for sale fixed income securities
|
$ | 3,641,667 | $ | 43,365 | $ | (18,327 | ) | $ | 3,666,705 | |||||||
F-17
HCC
INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
(continued,
tables in thousands, except per share data)
The amortized cost and fair value of investments in fixed income
securities that are classified as held to maturity, all of which
had fair value in excess of cost, were as follows:
Amortized |
Fair |
|||||||
Cost | Value | |||||||
December 31, 2008
|
||||||||
U.S. government
|
$ | 21,319 | $ | 21,823 | ||||
Foreign securities
|
102,234 | 103,738 | ||||||
Total held to maturity fixed income securities
|
$ | 123,553 | $ | 125,561 | ||||
All fixed income securities were income producing during 2008,
except for one security valued at $0.1 million. 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 | |||||||||||||||||||
December 31, 2008
|
||||||||||||||||||||||||
U.S. government
|
$ | 13,240 | $ | (10 | ) | $ | 590 | $ | (5 | ) | $ | 13,830 | $ | (15 | ) | |||||||||
States, municipalities and political subdivisions
|
584,091 | (16,874 | ) | 197,425 | (14,109 | ) | 781,516 | (30,983 | ) | |||||||||||||||
Corporate fixed income securities
|
298,464 | (7,217 | ) | 18,753 | (4,247 | ) | 317,217 | (11,464 | ) | |||||||||||||||
Asset-backed and mortgage-backed securities
|
195,690 | (22,895 | ) | 96,452 | (25,235 | ) | 292,142 | (48,130 | ) | |||||||||||||||
Foreign securities
|
20,620 | (211 | ) | 31,994 | (448 | ) | 52,614 | (659 | ) | |||||||||||||||
Total
|
$ | 1,112,105 | $ | (47,207 | ) | $ | 345,214 | $ | (44,044 | ) | $ | 1,457,319 | $ | (91,251 | ) | |||||||||
December 31, 2007
|
||||||||||||||||||||||||
U.S. government
|
$ | 671 | $ | (2 | ) | $ | 2,234 | $ | (7 | ) | $ | 2,905 | $ | (9 | ) | |||||||||
States, municipalities and political subdivisions
|
236,494 | (1,535 | ) | 149,584 | (1,095 | ) | 386,078 | (2,630 | ) | |||||||||||||||
Corporate fixed income securities
|
34,577 | (2,316 | ) | 107,084 | (2,182 | ) | 141,661 | (4,498 | ) | |||||||||||||||
Asset-backed and mortgage-backed securities
|
89,112 | (1,205 | ) | 220,651 | (3,218 | ) | 309,763 | (4,423 | ) | |||||||||||||||
Foreign securities
|
82,971 | (861 | ) | 217,555 | (5,906 | ) | 300,526 | (6,767 | ) | |||||||||||||||
Total
|
$ | 443,825 | $ | (5,919 | ) | $ | 697,108 | $ | (12,408 | ) | $ | 1,140,933 | $ | (18,327 | ) | |||||||||
We review our investments for possible impairments and assess
whether any impairments are
other-than-temporary
at each quarter end. 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. During 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 12
consecutive months. At December 31, 2008, we had gross
unrealized losses on available for sale fixed income securities
of $91.3 million (2.2% of aggregate fair value of total
fixed income securities) compared to $18.3 million (0.5% of
aggregate fair value) at December 31, 2007. Our review in
the fourth quarter of 2008 covered 82% of the total unrealized
losses in the
F-18
HCC
INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
(continued,
tables in thousands, except per share data)
portfolio. We considered all of the unrealized losses at
year-end 2008 and 2007 to be temporary, based on the results of
our review. We recognized $11.1 million of
other-than-temporary realized losses on our fixed income
securities in 2008 and none in 2007 and 2006.
The amortized cost and fair value of our fixed income securities
at December 31, 2008, 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 asset-backed and
mortgage-backed securities at December 31, 2008 was
approximately 2.4 years.
Available for Sale | ||||||||||||||||
Cost |
Held to Maturity | |||||||||||||||
Amortized |
Amortized |
|||||||||||||||
Cost | Fair Value | Cost | Fair Value | |||||||||||||
Due in 1 year or less
|
$ | 137,466 | $ | 138,021 | $ | 87,262 | $ | 88,414 | ||||||||
Due after 1 year through 5 years
|
1,130,926 | 1,152,376 | 29,937 | 30,676 | ||||||||||||
Due after 5 years through 10 years
|
683,961 | 702,388 | 6,354 | 6,471 | ||||||||||||
Due after 10 years through 15 years
|
487,950 | 486,262 | | | ||||||||||||
Due after 15 years
|
629,589 | 613,252 | | | ||||||||||||
Securities with fixed maturities
|
3,069,892 | 3,092,299 | 123,553 | 125,561 | ||||||||||||
Asset-backed and mortgage-backed securities
|
1,048,647 | 1,040,866 | | | ||||||||||||
Total fixed income securities
|
$ | 4,118,539 | $ | 4,133,165 | $ | 123,553 | $ | 125,561 | ||||||||
At December 31, 2008, our domestic insurance companies had
deposited fixed income securities of $51.0 million
(amortized cost of $47.3 million) to meet the deposit
requirements of various insurance departments. In addition, we
had a deposit of fixed income securities of $13.9 million
(amortized cost of $12.6 million) at Lloyds of
London, which serves as security for our participation in two
Lloyds of London syndicates. There are withdrawal and
other restrictions on these deposits, but we direct how the
deposits are invested and we earn interest on the funds.
The sources of net investment income were as follows:
2008 | 2007 | 2006 | ||||||||||
Fixed income securities
|
$ | 174,710 | $ | 150,594 | $ | 112,878 | ||||||
Short-term investments
|
24,173 | 37,764 | 30,921 | |||||||||
Other investments
|
(30,191 | ) | 23,930 | 14,178 | ||||||||
Total investment income
|
168,692 | 212,288 | 157,977 | |||||||||
Investment expense
|
(3,941 | ) | (5,826 | ) | (5,173 | ) | ||||||
Net investment income
|
$ | 164,751 | $ | 206,462 | $ | 152,804 | ||||||
Realized pretax gains (losses) on the sale of investments, which
exclude
other-than-temporary
impairment losses, were as follows:
Gains | Losses | Net | ||||||||||
Year ended December 31, 2008
|
||||||||||||
Fixed income securities
|
$ | 12,088 | $ | (20,127 | ) | $ | (8,039 | ) | ||||
Other investments
|
663 | (9,433 | ) | (8,770 | ) | |||||||
Realized gain (loss)
|
$ | 12,751 | $ | (29,560 | ) | $ | (16,809 | ) | ||||
F-19
HCC
INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
(continued,
tables in thousands, except per share data)
Gains | Losses | Net | ||||||||||
Year ended December 31, 2007
|
||||||||||||
Fixed income securities
|
$ | 14,728 | $ | (1,266 | ) | $ | 13,462 | |||||
Other investments
|
305 | (579 | ) | (274 | ) | |||||||
Realized gain (loss)
|
$ | 15,033 | $ | (1,845 | ) | $ | 13,188 | |||||
Year ended December 31, 2006
|
||||||||||||
Fixed income securities
|
$ | 886 | $ | (1,771 | ) | $ | (885 | ) | ||||
Other investments
|
93 | (49 | ) | 44 | ||||||||
Realized gain (loss)
|
$ | 979 | $ | (1,820 | ) | $ | (841 | ) | ||||
Since 2005, we used certain available for sale fixed income
securities, denominated in British pound sterling, to
economically hedge foreign currency exposure on certain
insurance reserves and other liabilities, denominated in the
same currency. We incorrectly recorded the unrealized exchange
rate fluctuations on these securities through earnings as an
offset to the opposite fluctuations in the liabilities they
hedged, rather than through other comprehensive income within
shareholders equity. In 2007, to correct our accounting,
we reversed $13.4 million of cumulative unrealized exchange
rate gains. We recorded this reversal as a charge to our gain or
loss from currency conversion account, with an offsetting credit
to other comprehensive income. We reported our net loss from
currency conversion, which included this $13.4 million
charge, as a component of other operating expense in the
consolidated statements of earnings. In 2007, we sold these
available for sale securities and realized the
$13.4 million of embedded cumulative currency conversion
gains. This gain was included in the net realized investment
gain (loss) line of our consolidated statements of earnings. The
offsetting effect of these transactions had no impact on our
2007 consolidated net earnings. Our gain (loss) from currency
conversion, excluding the $13.4 million charge, was
$1.9 million, ($1.8) million and zero in 2008, 2007
and 2006, respectively.
Unrealized pretax net gains (losses) on investments during each
year were as follows:
2008 | 2007 | 2006 | ||||||||||
Available for sale fixed income securities
|
$ | (10,412 | ) | $ | 26,663 | $ | 6,890 | |||||
Strategic and other investments
|
(7,050 | ) | (22,244 | ) | (5,063 | ) | ||||||
Net unrealized investment gains (losses)
|
$ | (17,462 | ) | $ | 4,419 | $ | 1,827 | |||||
(4) | Acquisitions and Goodwill |
Acquisitions
During the past three years, we completed ten business
acquisitions, ranging between $4.1 million and
$140.0 million. We acquired these businesses to grow
existing lines of business, such as medical stop-loss and
surety, and to diversify into new specialty lines of business,
such as medical excess, short-term medical and public entity
insurance. Our largest acquisition in 2008 was MultiNational
Underwriters, LLC for $42.7 million. The results of
operations of the acquired businesses were included in our
consolidated financial statements
F-20
HCC
INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
(continued,
tables in thousands, except per share data)
beginning on the effective date of each transaction. The
following table provides aggregate information on these
acquisitions (in millions):
Total Cash |
Goodwill |
|||||||||||||
Consideration Paid |
Recognized through |
|||||||||||||
Number of |
through December 31, |
December 31, |
Tax Deductible |
|||||||||||
Acquisitions | 2008 | 2008 | Goodwill | |||||||||||
2008
|
Five | $ | 72.6 | $ | 62.6 | $ | 51.4 | |||||||
2007
|
Two | 16.3 | 4.8 | | ||||||||||
2006
|
Three | 163.5 | 158.3 | 136.2 |
The business combinations were recorded using the purchase
method of accounting under SFAS No. 141, Business
Combinations. We valued all identifiable assets and
liabilities at fair value and allocated any remaining
consideration to goodwill in our purchase price allocations. The
majority of the goodwill related to the value of unique
synergies derived from our $140.0 million acquisition of
the Health Products Division in 2006 and the value of the
assembled workforce, which is subsumed into goodwill in
accordance with SFAS 141, for the Health Products Division
and certain of the other acquisitions. We adopted
SFAS 141(R) on January 1, 2009. Any future adjustments
to finalize our pre-2009 purchase price allocations, other than
for tax-related items, will be recorded as an adjustment to
goodwill, in accordance with SFAS 141. All tax-related
items will be recorded through earnings in the period when the
adjustment is determined, in accordance with SFAS 141(R).
Our acquisition of MultiNational Underwriters, LLC includes a
possible additional earnout depending upon achievement of
certain underwriting profit levels. At December 31, 2008,
we accrued $4.2 million for this earnout, with an
offsetting increase to goodwill, which will be paid in 2009. Our
prior acquisition of HCC Global Financial Products, LLC on
October 1, 2002 for $6.9 million of initial
consideration includes a contingency for future earnout
payments, as defined in the purchase agreement, as amended. The
earnout is based on HCC Globals pretax earnings from the
acquisition date through September 30, 2007. Pretax
earnings include underwriting results on longer-duration
business until all future losses are paid. When the conditions
for accrual have been satisfied under the purchase agreement, we
record a liability to the former owners with an offsetting
increase to goodwill. At December 31, 2008, unpaid accrued
earnout totaled $20.2 million, of which $18.8 million
will be paid in 2009. The total earnout and the related goodwill
recognized from the acquisition date through December 31,
2008 was $187.5 million.
On February 28, 2009, we acquired Surety Company of the
Pacific, which writes license and permit bonds for California
contractors. We will record this business combination in
accordance with SFAS 141(R).
Goodwill
When we complete a business combination, goodwill is either
allocated to the acquired business 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. During 2008, we transferred $27.3 million of
goodwill from our agency segment to our insurance company
segment, based on a reorganization that shifted cash flows from
a reporting unit in our agency segment to reporting units in our
insurance company segment. In 2007, we
F-21
HCC
INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
(continued,
tables in thousands, except per share data)
transferred $3.3 million of goodwill associated with a
strategic investment to the carrying cost of that investment.
The changes in goodwill were as follows:
Insurance |
Other |
|||||||||||||||||||
Company | Agency | Operations | Corporate | Total | ||||||||||||||||
Balance at December 31, 2006
|
$ | 532,820 | $ | 206,534 | $ | | $ | 3,323 | $ | 742,677 | ||||||||||
Additions:
|
||||||||||||||||||||
Acquisitions
|
3,503 | | | | 3,503 | |||||||||||||||
Earnouts
|
27,984 | 5,205 | | | 33,189 | |||||||||||||||
Transfer and other
|
(323 | ) | | 323 | (3,323 | ) | (3,323 | ) | ||||||||||||
Balance at December 31, 2007
|
563,984 | 211,739 | 323 | | 776,046 | |||||||||||||||
Additions:
|
||||||||||||||||||||
Acquisitions
|
36,207 | 22,243 | | | 58,450 | |||||||||||||||
Earnouts
|
20,225 | 5,336 | | | 25,561 | |||||||||||||||
Transfer and other
|
26,111 | (27,319 | ) | | | (1,208 | ) | |||||||||||||
Balance at December 31, 2008
|
$ | 646,527 | $ | 211,999 | $ | 323 | $ | | $ | 858,849 | ||||||||||
(5) | 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 | ||||||||||
Year ended December 31, 2008
|
||||||||||||
Direct business
|
$ | 2,156,613 | $ | 2,091,212 | $ | 1,327,932 | ||||||
Reinsurance assumed
|
342,150 | 363,389 | 307,562 | |||||||||
Reinsurance ceded
|
(438,145 | ) | (446,827 | ) | (423,621 | ) | ||||||
Net amounts
|
$ | 2,060,618 | $ | 2,007,774 | $ | 1,211,873 | ||||||
Year ended December 31, 2007
|
||||||||||||
Direct business
|
$ | 2,000,552 | $ | 2,001,329 | $ | 1,119,384 | ||||||
Reinsurance assumed
|
450,627 | 433,951 | 233,026 | |||||||||
Reinsurance ceded
|
(465,570 | ) | (450,194 | ) | (168,463 | ) | ||||||
Net amounts
|
$ | 1,985,609 | $ | 1,985,086 | $ | 1,183,947 | ||||||
Year ended December 31, 2006
|
||||||||||||
Direct business
|
$ | 1,867,908 | $ | 1,790,636 | $ | 990,800 | ||||||
Reinsurance assumed
|
367,740 | 357,799 | 228,038 | |||||||||
Reinsurance ceded
|
(423,096 | ) | (439,246 | ) | (206,982 | ) | ||||||
Net amounts
|
$ | 1,812,552 | $ | 1,709,189 | $ | 1,011,856 | ||||||
F-22
HCC
INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
(continued,
tables in thousands, except per share data)
Ceding commissions that are netted with policy acquisition costs
in the consolidated statements of earnings were
$47.8 million in 2008, $45.8 million in 2007 and
$45.8 million in 2006.
The table below shows the components of reinsurance recoverables
reported in our consolidated balance sheets.
2008 | 2007 | |||||||
Reinsurance recoverable on paid losses
|
$ | 64,419 | $ | 80,915 | ||||
Reinsurance recoverable on outstanding losses
|
535,563 | 458,190 | ||||||
Reinsurance recoverable on incurred but not reported losses
|
463,396 | 426,090 | ||||||
Reserve for uncollectible reinsurance
|
(8,428 | ) | (8,530 | ) | ||||
Total reinsurance recoverables
|
$ | 1,054,950 | $ | 956,665 | ||||
Reinsurers not authorized by the respective states of domicile
of our U.S. domiciled insurance companies are required to
collateralize reinsurance obligations due to us. The table below
shows the amounts of letters of credit and cash deposits held by
us as collateral, plus other credits available for potential
offset at December 31, 2008 and 2007.
2008 | 2007 | |||||||
Payables to reinsurers
|
$ | 252,198 | $ | 246,745 | ||||
Letters of credit
|
184,314 | 188,400 | ||||||
Cash deposits
|
110,153 | 114,549 | ||||||
Total credits
|
$ | 546,665 | $ | 549,694 | ||||
The tables below present the calculation of net reserves, net
unearned premium and net deferred policy acquisition costs at
December 31, 2008 and 2007.
2008 | 2007 | |||||||
Loss and loss adjustment expense payable
|
$ | 3,415,230 | $ | 3,227,080 | ||||
Reinsurance recoverable on outstanding losses
|
(535,563 | ) | (458,190 | ) | ||||
Reinsurance recoverable on incurred but not reported losses
|
(463,396 | ) | (426,090 | ) | ||||
Net reserves
|
$ | 2,416,271 | $ | 2,342,800 | ||||
Unearned premium
|
$ | 977,426 | $ | 943,946 | ||||
Ceded unearned premium
|
(234,375 | ) | (244,684 | ) | ||||
Net unearned premium
|
$ | 743,051 | $ | 699,262 | ||||
Deferred policy acquisition costs
|
$ | 188,652 | $ | 192,773 | ||||
Deferred ceding commissions
|
(63,123 | ) | (68,968 | ) | ||||
Net deferred policy acquisition costs
|
$ | 125,529 | $ | 123,805 | ||||
F-23
HCC
INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
(continued,
tables in thousands, except per share data)
In order to reduce our exposure to reinsurance credit risk, we
evaluate the financial condition of our reinsurers and place our
reinsurance with a diverse group of companies and syndicates,
which we believe to be financially sound. The following table
shows reinsurance balances with our reinsurers that had a net
recoverable balance greater than $25.0 million at
December 31, 2008 and 2007. The total recoverables column
includes paid losses recoverable, outstanding losses
recoverable, incurred but not reported losses recoverable, and
ceded unearned premium. The total credits column includes
letters of credit, cash deposits and other payables.
Total |
Total |
Net |
||||||||||||||||||
Reinsurer
|
Rating |
Location
|
Recoverables | Credits | Recoverables | |||||||||||||||
December 31, 2008
|
||||||||||||||||||||
Hannover Rueckversicherungs AG
|
A | Germany | $ | 98,037 | $ | 20,090 | $ | 77,947 | ||||||||||||
Transatlantic Reinsurance Company
|
A | New York | 88,549 | 21,122 | 67,427 | |||||||||||||||
Swiss Reinsurance America Corporation
|
A+ | New York | 56,377 | 6,827 | 49,550 | |||||||||||||||
Harco National Insurance Company
|
A− | Illinois | 48,201 | 354 | 47,847 | |||||||||||||||
ACE Property & Casualty Insurance Co.
|
A+ | Pennsylvania | 50,927 | 3,521 | 47,406 | |||||||||||||||
Arch Reinsurance Company
|
A | Bermuda | 42,354 | 4,919 | 37,435 | |||||||||||||||
December 31, 2007
|
||||||||||||||||||||
Hannover Rueckversicherungs AG
|
A | Germany | $ | 97,224 | $ | 26,195 | $ | 71,029 | ||||||||||||
Swiss Reinsurance America Corporation
|
A+ | New York | 61,147 | 3,133 | 58,014 | |||||||||||||||
Harco National Insurance Company
|
A− | Illinois | 57,679 | 4,259 | 53,420 | |||||||||||||||
Arch Reinsurance Company
|
A | Bermuda | 45,283 | 2,816 | 42,467 | |||||||||||||||
ACE Property & Casualty Insurance Co.
|
A+ | Pennsylvania | 45,450 | 6,385 | 39,065 | |||||||||||||||
Transatlantic Reinsurance Company
|
A+ | New York | 44,175 | 9,061 | 35,114 | |||||||||||||||
Everest Reinsurance Company
|
A+ | Delaware | 27,674 | 70 | 27,604 | |||||||||||||||
Lloyds Syndicate Number 2791
|
A | United Kingdom | 28,518 | 1,990 | 26,528 |
The companies ratings are the latest published by
A.M. Best Company, Inc. Lloyds of London is an
insurance and reinsurance marketplace composed of many
independent underwriting syndicates financially supported by a
central trust fund. Lloyds of London is rated
A by A.M. Best Company, Inc.
We have a reserve of $8.4 million at December 31, 2008
for potential collectibility issues related to reinsurance
recoverables, including disputed amounts and associated
expenses. While we believe the reserve is adequate based on
information currently available, market conditions may change or
additional information might be obtained that may require us to
change the reserve in the future. We periodically review our
financial exposure to the reinsurance market and the level of
our reserve and continue to take actions in an attempt to
mitigate our exposure to possible loss.
HCC Life Insurance Company previously sold its entire block of
individual life insurance and annuity business to Swiss Re
Life & Health America, Inc. (rated A+ by
A.M. Best Company, Inc.) in the form of an indemnity
reinsurance contract. Ceded life and annuity benefits amounted
to $64.2 million and $66.2 million at
December 31, 2008 and 2007, respectively.
F-24
HCC
INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
(continued,
tables in thousands, except per share data)
(6) | Liability for Unpaid Loss and Loss Adjustment Expense |
The following table provides a reconciliation of the liability
for unpaid loss and loss adjustment expense payable.
2008 | 2007 | 2006 | ||||||||||
Reserves for loss and loss adjustment expense payable at
beginning of year
|
$ | 3,227,080 | $ | 3,097,051 | $ | 2,813,720 | ||||||
Less reinsurance recoverables on reserves
|
884,280 | 988,090 | 1,280,287 | |||||||||
Net reserves at beginning of year
|
2,342,800 | 2,108,961 | 1,533,433 | |||||||||
Net reserve addition from acquired businesses
|
29,053 | 742 | 146,811 | |||||||||
Foreign currency adjustment
|
(82,677 | ) | 27,304 | 36,957 | ||||||||
Incurred loss and loss adjustment expense:
|
||||||||||||
Provision for loss and loss adjustment expense for claims
occurring in current year
|
1,294,244 | 1,210,344 | 1,018,382 | |||||||||
Decrease in estimated loss and loss adjustment expense for
claims occurring in prior years
|
(82,371 | ) | (26,397 | ) | (6,526 | ) | ||||||
Incurred loss and loss adjustment expense
|
1,211,873 | 1,183,947 | 1,011,856 | |||||||||
Loss and loss adjustment expense payments for claims occurring
during:
|
||||||||||||
Current year
|
397,103 | 422,058 | 397,760 | |||||||||
Prior years
|
687,675 | 556,096 | 222,336 | |||||||||
Loss and loss adjustment expense payments
|
1,084,778 | 978,154 | 620,096 | |||||||||
Net reserves at end of year
|
2,416,271 | 2,342,800 | 2,108,961 | |||||||||
Plus reinsurance recoverables on reserves
|
998,959 | 884,280 | 988,090 | |||||||||
Reserves for loss and loss adjustment expense at end of
year
|
$ | 3,415,230 | $ | 3,227,080 | $ | 3,097,051 | ||||||
Our net loss and loss adjustment expense was reduced by
redundant reserve development relating to prior years
losses of $82.4 million in 2008, $26.4 million in 2007
and $6.5 million in 2006. The redundant development for
2008 resulted primarily from the re-estimation of our net
exposure in our diversified financial products line of business
(principally related to our directors and officers
liability product) on the 2005 and prior underwriting years, our
London market account for the 2005 and prior accident years, and
an assumed quota share program reported in our other specialty
lines for the 2005 and prior accident years. We increased
certain ultimate loss ratios in accident year 2008 due to
increased claims activity, primarily from financial
institutions. The largest portion of this increase was in our
directors and officers liability business, primarily
for policies written in 2007 and 2008. The redundant development
for 2007 related primarily to reserve reductions in our
diversified financial products line of business from the 2003
and 2004 underwriting years. The redundant development for 2006
related to reductions in our 2005 hurricane and aviation
reserves, mostly offset by a $20.2 million commutation
charge on certain assumed run-off accident and health business
reported in our discontinued lines.
We write directors and officers liability,
professional indemnity 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 market related issues. We also write trade
credit business and provide coverage for certain financial
institutions, which have potential exposure to shareholder
lawsuits as a result of the current economic
F-25
HCC
INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
(continued,
tables in thousands, except per share data)
environment. Based on our present knowledge, we believe our
ultimate losses from these coverages will be contained within
our current overall loss reserves for this business.
We have no material exposure to asbestos claims or environmental
pollution losses. Our largest insurance company subsidiary began
writing business in 1981, and its policies normally contain
pollution exclusion clauses that limit pollution coverage to
sudden and accidental losses only, thus excluding
intentional dumping and seepage claims. Policies issued by our
other insurance company subsidiaries do not have significant
environmental exposure because of the types of risks covered.
(7) | Notes Payable |
Notes payable at December 31, 2008 and 2007 are shown in
the table below. The estimated fair value of our Convertible
Notes ($149.8 million and $162.4 million at
December 31, 2008 and 2007, respectively) 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.
2008 | 2007 | |||||||
(as adjusted) | (as adjusted) | |||||||
1.30% Convertible Notes
|
$ | 123,649 | $ | 119,471 | ||||
$575.0 million Revolving Loan Facility
|
220,000 | 200,000 | ||||||
Total notes payable
|
$ | 343,649 | $ | 319,471 | ||||
Convertible
Notes
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 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 December 31, 2008. 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 for cash at any time on or
after April 4, 2009. Holders may require us to repurchase
the notes on April 1, 2009, 2014 or 2019, or if a change in
control of HCC Insurance Holdings, Inc. occurs on or before
April 1, 2009. The repurchase price to settle any such put
or change in control provisions will equal the principal amount
of the notes plus accrued and unpaid interest and will be paid
in cash.
Revolving
Loan Facility
Our $575.0 million Revolving Loan Facility allows us to
borrow up to the maximum allowed by the facility on a revolving
basis until the facility expires on December 19, 2011. The
interest rate is 30-day LIBOR plus a margin of 15 to
50 basis points, depending on our debt rating. At
December 31, 2008, the contractual interest rate on the
outstanding balance was 30-day LIBOR plus 25 basis points
(0.69%), but the effective interest rate on $200.0 million
of the facility was 4.60% due to the fixed interest rate swaps
discussed below. The facility is collateralized by guarantees
entered into by our domestic underwriting agencies. The
F-26
HCC
INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
(continued,
tables in thousands, except per share data)
facility agreement contains two restrictive financial covenants,
with which we were in compliance at December 31, 2008. Our
debt to capital ratio, including the Standby Letter of Credit
Facility discussed below, cannot exceed 35% and our combined
ratio, calculated under statutory accounting principles on a
trailing four-quarter average, cannot be greater than 105%. At
December 31, 2008, our actual ratios under these covenants
were 13.9% and 85.2%, respectively.
In 2007, we entered into three interest rate swap agreements to
exchange
30-day LIBOR
(0.44% at December 31, 2008) for a 4.60% fixed rate on
$200.0 million of our Revolving Loan Facility. The swaps
qualify for cash flow hedge accounting treatment. The three
swaps expire in November 2009. As of December 31, 2008, we
had entered into two additional swaps for $105.0 million,
which will begin when the original swaps expire in November 2009
and will expire in November 2010. The fixed rate on the new
swaps is 2.94%. All of our swaps were in a total unrealized loss
position of $8.0 million at December 31, 2008.
Standby
Letter of Credit Facility
We have an $82.0 million Standby Letter of Credit Facility
that is used to guarantee our performance in two Lloyds of
London syndicates. Letters of credit issued under the Standby
Letter of Credit Facility are unsecured commitments of HCC
Insurance Holdings, Inc. The Standby Letter of Credit Facility
contains the same two restrictive financial covenants similar as
our Revolving Loan Facility, with which we were in compliance at
December 31, 2008.
Subsidiary
Lines of Credit
At December 31, 2008, certain of our subsidiaries
maintained revolving lines of credit with banks in the combined
maximum amount of $50.1 million available through
November 30, 2009. Advances under the lines of credit are
limited to amounts required to fund draws, if any, on letters of
credit issued by the bank on behalf of the subsidiaries and
short-term direct cash advances. The lines of credit are
collateralized by securities having an aggregate market value of
up to $62.8 million, the actual amount of collateral at any
one time being 125% of the aggregate amount outstanding.
Interest on the lines is payable at the banks prime rate
of interest (3.25% at December 31, 2008) for draws on
the letters of credit and either prime or prime less 1% on
short-term cash advances. At December 31, 2008, letters of
credit totaling $20.1 million had been issued to insurance
companies by the bank on behalf of our subsidiaries, with total
securities of $25.2 million collateralizing the lines.
(8) | Income Taxes |
At December 31, 2008 and 2007, we had current income taxes
payable (receivable) of $(1.2) million and
$17.3 million, respectively, included in accounts payable
and accrued liabilities in the consolidated balance sheets.
F-27
HCC
INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
(continued,
tables in thousands, except per share data)
The following table summarizes the differences between our
effective tax rate for financial statement purposes and the
Federal statutory rate:
2008 | 2007 | 2006 | ||||||||||
(as adjusted) | (as adjusted) | (as adjusted) | ||||||||||
Statutory tax rate
|
35 | % | 35 | % | 35 | % | ||||||
Federal tax at statutory rate
|
$ | 151,283 | $ | 202,966 | $ | 176,086 | ||||||
Nontaxable municipal bond interest and dividends received
deduction
|
(22,614 | ) | (18,215 | ) | (15,291 | ) | ||||||
Non-deductible expenses
|
456 | 1,233 | 781 | |||||||||
State income taxes, net of federal tax benefit
|
1,553 | 3,855 | 3,820 | |||||||||
Foreign income taxes
|
31,036 | 37,406 | 22,548 | |||||||||
Foreign tax credit
|
(30,868 | ) | (37,396 | ) | (22,405 | ) | ||||||
Uncertain tax positions (net of federal tax benefit on state
positions of $303 in 2008 and $232 in 2007)
|
(1,647 | ) | (1,561 | ) | | |||||||
Other, net
|
919 | 63 | (348 | ) | ||||||||
Income tax expense
|
$ | 130,118 | $ | 188,351 | $ | 165,191 | ||||||
Effective tax rate
|
30.1 | % | 32.5 | % | 32.8 | % | ||||||
The components of income tax expense were as follows:
2008 | 2007 | 2006 | ||||||||||
(as adjusted) | (as adjusted) | (as adjusted) | ||||||||||
Federal current
|
$ | 107,193 | $ | 113,950 | $ | 128,167 | ||||||
Federal deferred
|
(8,550 | ) | 32,858 | 8,599 | ||||||||
Total federal
|
98,643 | 146,808 | 136,766 | |||||||||
State current
|
2,948 | 2,795 | 3,842 | |||||||||
State deferred
|
(559 | ) | 3,135 | 2,035 | ||||||||
Total state
|
2,389 | 5,930 | 5,877 | |||||||||
Foreign current
|
30,556 | 38,043 | 24,665 | |||||||||
Foreign deferred
|
480 | (637 | ) | (2,117 | ) | |||||||
Total foreign
|
31,036 | 37,406 | 22,548 | |||||||||
Uncertain tax positions
|
(1,950 | ) | (1,793 | ) | | |||||||
Income tax expense
|
$ | 130,118 | $ | 188,351 | $ | 165,191 | ||||||
F-28
HCC
INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
(continued,
tables in thousands, except per share data)
The net deferred tax asset (liability) is included in other assets or accounts payable and accrued liabilities, respectively, in our
consolidated balance sheets. The composition of deferred tax
assets and liabilities at December 31, 2008 and 2007 was as
follows:
2008 | 2007 | |||||||
(as adjusted) | (as adjusted) | |||||||
Excess of financial unearned premium over tax
|
$ | 18,705 | $ | 24,801 | ||||
Discounting of loss reserves, net of salvage and subrogation
|
60,758 | 58,591 | ||||||
Excess of financial accrued expenses over tax
|
15,187 | 8,896 | ||||||
Allowance for bad debts, not deductible for tax
|
10,172 | 12,156 | ||||||
Stock-based compensation under SFAS 123(R) in excess of
deduction for tax
|
9,457 | 6,716 | ||||||
Federal tax net operating loss carryforwards
|
214 | 650 | ||||||
State tax net operating loss carryforwards
|
3,053 | 2,996 | ||||||
Federal benefit of state uncertain tax positions
|
352 | 655 | ||||||
Valuation allowance
|
(4,698 | ) | (6,521 | ) | ||||
Total deferred tax assets
|
113,200 | 108,940 | ||||||
Unrealized gain on increase in value of securities
|
13,811 | 22,340 | ||||||
Deferred policy acquisition costs, net of ceding commissions,
deductible for tax
|
21,073 | 23,025 | ||||||
Amortizable goodwill for tax
|
50,184 | 37,281 | ||||||
Book basis in net assets of foreign subsidiaries in excess of tax
|
10,499 | 15,148 | ||||||
Property and equipment depreciation and other items
|
2,999 | 12,154 | ||||||
Total deferred tax liabilities
|
98,566 | 109,948 | ||||||
Net deferred tax asset (liability)
|
$ | 14,634 | $ | (1,008 | ) | |||
Changes in the valuation allowance account applicable to
deferred tax assets result primarily from the acquisition and
expiration of net operating losses and other tax attributes
related to acquired businesses. Changes in the valuation
allowance were as follows:
2008 | 2007 | 2006 | ||||||||||
Balance at beginning of year
|
$ | 6,521 | $ | 7,822 | $ | 10,293 | ||||||
State tax rates
|
(1,603 | ) | | | ||||||||
Acquisitions
|
(1,108 | ) | | | ||||||||
Net operating loss carryforwards
|
892 | (1,240 | ) | (1,746 | ) | |||||||
Other
|
(4 | ) | (61 | ) | (725 | ) | ||||||
Balance at end of year
|
$ | 4,698 | $ | 6,521 | $ | 7,822 | ||||||
At December 31, 2008, we had Federal, state and foreign tax
net operating loss carryforwards of approximately
$0.6 million, $41.8 million and $2.1 million,
respectively, which will expire in varying amounts through 2028.
Future use of certain carryforwards is subject to statutory
limitations due to prior changes of ownership. We have recorded
valuation allowances of $2.7 million and $0.9 million
against our state and foreign loss carryforwards, respectively.
Based on our history of taxable income in our domestic insurance
and other operations and our projections of future taxable
income in our domestic and foreign insurance operations, we
believe it is more likely than not that the deferred tax assets
related to our loss carryforwards, for which there are no
valuation allowances, will be realized.
F-29
HCC
INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
(continued,
tables in thousands, except per share data)
At December 31, 2008 and 2007, we had recorded tax
liabilities for unrecognized gross tax benefits related to
uncertain tax positions under FIN 48 of $5.0 million
and $7.6 million, respectively. Of the total amount of our
unrecognized tax benefits at December 31, 2008,
$4.8 million would reduce our annual effective tax rate if
the uncertain tax benefits were recognized as a reduction of
income tax expense currently. At December 31, 2008, it is
reasonably possible that liabilities for unrecognized tax
benefits could decrease $1.5 million (including
$0.3 million in interest) in the next twelve months, due to
the expiration of statutes of limitation. A reconciliation of
our liability for unrecognized gross tax benefits was as follows:
2008 | 2007 | |||||||
Balance at beginning of year
|
$ | 7,622 | $ | 9,869 | ||||
Gross increases:
|
||||||||
Tax positions of current year
|
597 | 953 | ||||||
Tax positions of prior years
|
188 | 248 | ||||||
Acquisitions
|
| 72 | ||||||
Gross decreases:
|
||||||||
Statute expirations
|
(352 | ) | (1,468 | ) | ||||
Settlements
|
(2,383 | ) | (1,327 | ) | ||||
Tax positions of prior years
|
(670 | ) | (305 | ) | ||||
Acquisitions
|
| (183 | ) | |||||
Other
|
| (237 | ) | |||||
Balance at end of year
|
$ | 5,002 | $ | 7,622 | ||||
We report any potential net interest income and expense and
penalties related to changes in our uncertain tax positions in
our consolidated statement of earnings as interest expense and
other operating expense, respectively. We recognized a net
$0.2 million of interest income in 2008 and
$0.4 million in 2007 and no penalties in either year. At
December 31, 2008, we had $0.8 million and
$0.2 million accrued for interest expense and penalties,
respectively.
We file income tax returns in the U.S. Federal
jurisdiction, and various states and foreign jurisdictions. With
a few exceptions, we are no longer subject to U.S. Federal,
state and local, or foreign income tax examinations by tax
authorities for years before 2003. In 2008, the Internal Revenue
Service concluded an examination of our 2004 and 2005
U.S. Federal income tax returns. The results of this
examination did not have a material effect on our consolidated
financial position, results of operations or cash flows.
(9) | Shareholders Equity |
Treasury
Stock
On June 20, 2008, our Board of Directors approved the
repurchase of up to $100.0 million of our common stock, as
part of our philosophy of building long-term shareholder value.
The share repurchase plan authorizes repurchases to be made in
the open market or in privately negotiated transactions from
time-to-time.
Repurchases under the plan will be subject to market and
business conditions, as well as the level of cash generated from
our operations, cash required for acquisitions, debt covenant
compliance, trading price of our stock being at or below book
value, and other relevant factors. The repurchase plan does not
obligate us to purchase any particular number of shares and may
be suspended or discontinued at any time at our discretion. In
2008, we repurchased 3.0 million shares of our common stock
in the open market for a total cost of $63.3 million and a
weighted-average cost of $21.02 per share.
F-30
HCC
INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
(continued,
tables in thousands, except per share data)
Other
Comprehensive Income
The components of accumulated other comprehensive income in our
consolidated balance sheets were as follows:
Accumulated |
||||||||||||||||
Unrealized |
Cash Flow |
Foreign |
Other |
|||||||||||||
Investment |
Hedge |
Currency |
Comprehensive |
|||||||||||||
Gains | Loss | Translation | Income | |||||||||||||
Balance at December 31, 2005
|
$ | 16,919 | $ | | $ | 2,155 | $ | 19,074 | ||||||||
Net change for year
|
1,099 | | 13,799 | 14,898 | ||||||||||||
Balance at December 31, 2006
|
18,018 | | 15,954 | 33,972 | ||||||||||||
Net change for year
|
3,114 | (1,617 | ) | 12,413 | 13,910 | |||||||||||
Balance at December 31, 2007
|
21,132 | (1,617 | ) | 28,367 | 47,882 | |||||||||||
Net change for year
|
(9,417 | ) | (3,603 | ) | (7,326 | ) | (20,346 | ) | ||||||||
Balance at December 31, 2008
|
$ | 11,715 | $ | (5,220 | ) | $ | 21,041 | $ | 27,536 | |||||||
Reimbursement
In 2006, certain executives agreed to reimburse us for
contractual obligations related to our stock option
investigation. We recorded a $6.1 million receivable
related to these contractual reimbursements and a corresponding
$4.0 million increase to additional paid-in capital, net of
$2.1 million of taxes payable on these reimbursements, in
2006. The receivable was collected in 2007.
Dividends
U.S. insurance companies are limited to the amount of
dividends they can pay to their parent by the laws of their
state of domicile. The maximum dividends that our direct
domestic subsidiaries can pay in 2009 without special permission
is $199.2 million.
(10) | Earnings Per Share |
The following table details the numerator and denominator used
in the earnings per share calculations.
2008 | 2007 | 2006 | ||||||||||
(as adjusted) | (as adjusted) | (as adjusted) | ||||||||||
Net earnings
|
$ | 302,120 | $ | 391,553 | $ | 337,911 | ||||||
Less: Net earnings attributable to unvested restricted stock and
restricted stock units
|
(498 | ) | | | ||||||||
Net earnings available to common stock
|
$ | 301,622 | $ | 391,553 | $ | 337,911 | ||||||
Weighted-average common shares outstanding
|
114,848 | 112,873 | 111,309 | |||||||||
Dilutive effect of outstanding
options (determined using treasury stock method)
|
333 | 760 | 1,177 | |||||||||
Dilutive effect of convertible debt (determined using treasury
stock method)
|
282 | 3,364 | 4,250 | |||||||||
Weighted-average common shares and potential common shares
outstanding
|
115,463 | 116,997 | 116,736 | |||||||||
Anti-dilutive stock options not included in treasury stock
method computation
|
6,080 | 4,714 | 1,588 | |||||||||
F-31
HCC
INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
(continued,
tables in thousands, except per share data)
(11) | Stock-Based Compensation |
Our stock-based compensation plan, the 2008 Flexible Incentive
Plan, is administered by the Compensation Committee of the Board
of Directors. We currently have stock options, restricted stock
awards and restricted stock units outstanding under this plan.
Each option granted under the plan may be used to purchase one
share of our common stock. Outstanding options vest over a
period of up to seven years, which is the requisite service
period, and expire four to eight years after the grant date.
Each restricted stock award and unit entitles the recipient to
one share or equivalent unit of our common stock. Outstanding
restricted stock awards and units vest over a period of up to
four years, which is the requisite service period.
The consolidated statements of earnings reflect stock-based
compensation expense of $13.7 million, $12.0 million
and $13.1 million in 2008, 2007 and 2006, respectively,
after the effect of the deferral and amortization of policy
acquisition costs related to stock-based compensation for our
underwriters. The total tax benefit recognized in earnings from
stock-based compensation arrangements was $4.4 million,
$4.2 million and $3.7 million, in 2008, 2007 and 2006,
respectively. At December 31, 2008, there was approximately
$31.8 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 2.8 years. In 2009, we expect to recognize
$13.2 million of expense, including the amortization of
deferred policy acquisition costs, for all stock-based awards
currently outstanding. At December 31, 2008,
13.1 million shares of our common stock were authorized and
reserved for the exercise of options and release of restricted
stock grants, of which 8.4 million shares were reserved for
awards previously granted and 4.7 million shares were
reserved for future issuance.
Common
Stock Grants to Directors
In 2008 and 2007, we granted fully-vested common stock valued at
$80,000 to each non-management director as part of their annual
compensation for serving on our Board of Directors. The number
of shares granted to each director was based on our closing
stock price on the grant date, which was either the day of the
Annual Meeting of Shareholders or the day the director joined
the Board, if later.
Stock
Options
The table below shows the weighted-average fair value of options
granted and the related weighted-average assumptions used in the
Black-Scholes model, which we use to determine the fair value of
an option on its grant date. The risk-free interest rate is
based on the U.S. Treasury rate that most closely
approximates each options expected term. We based our
expected volatility on the historical volatility of our stock
over a period matching each options expected term. Our
dividend yield is based on an average of our historical dividend
payments divided by the stock price. We used historical exercise
patterns by grant type to estimate the expected option life.
2008 | 2007 | 2006 | ||||||||||
Fair value of options granted
|
$ | 4.15 | $ | 6.59 | $ | 7.20 | ||||||
Risk free interest rate
|
2.6 | % | 4.4 | % | 4.7 | % | ||||||
Expected volatility
|
24.9 | % | 21.0 | % | 22.0 | % | ||||||
Expected dividend yield
|
1.9 | % | 1.3 | % | 1.1 | % | ||||||
Expected option life
|
3.8 years | 4.3 years | 3.8 years |
F-32
HCC
INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
(continued,
tables in thousands, except per share data)
The following table details our stock option activity during
2008.
Weighted- |
Weighted- |
|||||||||||||||
Average |
Average |
Aggregate |
||||||||||||||
Number |
Exercise |
Contractual |
Intrinsic |
|||||||||||||
of Shares | Price | Life | Value | |||||||||||||
Outstanding, beginning of year
|
8,565 | $ | 25.79 | |||||||||||||
Granted
|
938 | 22.20 | ||||||||||||||
Exercised
|
(1,012 | ) | 16.73 | |||||||||||||
Forfeited and expired
|
(242 | ) | 28.52 | |||||||||||||
Outstanding, end of year
|
8,249 | 26.41 | 3.1 years | $ | 19,171 | |||||||||||
Vested or expected to vest, end of year
|
7,725 | 26.33 | 3.1 years | 18,365 | ||||||||||||
Exercisable, end of year
|
3,648 | 25.19 | 2.3 years | 11,516 | ||||||||||||
The aggregate intrinsic value (the amount by which the fair
value of the underlying stock exceeds the exercise price) of
options exercised during 2008, 2007 and 2006 was
$7.2 million, $12.5 million and $13.8 million,
respectively.
Exercise of options during 2008, 2007 and 2006 resulted in cash
receipts of $16.9 million, $21.1 million and
$15.6 million, respectively. We generally recognize a tax
benefit when our employees exercise options. We recorded a
benefit of $1.3 million, $3.4 million and
$3.4 million as financing cash flow in our consolidated
statements of cash flows in 2008, 2007 and 2006, respectively.
Restricted
Stock
We measure the fair value of our restricted stock awards and
units based on the closing price of our common stock on the
grant date. All outstanding restricted stock awards and units
earn dividends or dividend equivalent units during the vesting
period. The following table details the 2008 activity for our
restricted stock awards and units.
Weighted- |
||||||||||||||||
Number |
Weighted-Average |
Average |
Aggregate |
|||||||||||||
of |
Grant Date |
Contractual |
Intrinsic |
|||||||||||||
Shares | Fair Value | Life | Value | |||||||||||||
Restricted Stock Awards
|
||||||||||||||||
Outstanding, beginning of year
|
| |||||||||||||||
Awarded
|
344 | $ | 23.48 | |||||||||||||
Outstanding, end of year
|
344 | 23.48 | 3.6 years | $ | 9,202 | |||||||||||
Expected to vest, end of year
|
275 | 23.48 | 3.6 years | 7,362 | ||||||||||||
Restricted Stock Units
|
||||||||||||||||
Outstanding, beginning of year
|
| |||||||||||||||
Awarded
|
133 | $ | 23.74 | |||||||||||||
Outstanding, end of year
|
133 | 23.74 | 3.7 years | $ | 3,556 | |||||||||||
Expected to vest, end of year
|
107 | 23.74 | 3.7 years | 2,853 | ||||||||||||
F-33
HCC
INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
(continued,
tables in thousands, except per share data)
(12) | Segment and Geographic Data |
We classify our activities into the following three operating
business segments based on services provided: 1) insurance
company, 2) agency and 3) other operations. See
Note 1 for a description of the principal subsidiaries
included in and the services provided by our insurance company
and agency segments. Our other operations segment includes
insurance-related investments, which we make periodically, and
our trading portfolio, which we liquidated in 2008. Corporate
includes general corporate operations and those minor operations
not included in a segment. Inter-segment revenue consists
primarily of fee and commission income of our agency segment
charged to our insurance company segment. Inter-segment pricing
(either flat rate fees or as a percentage of premium)
approximates what is charged to unrelated parties for similar
services.
The performance of each segment is evaluated by our management
based on net earnings. Net earnings is calculated, and tax after
corporate expense allocations, interest expense on debt incurred
for acquired companies, 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 on
the corporate segment, which will record the appropriate
stock-based compensation expense as the awards vest in future
years.
No one customer comprised 10% or more of our consolidated
revenues in 2008.
F-34
HCC
INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
(continued,
tables in thousands, except per share data)
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 | ||||||||||||||||
(as adjusted) | (as adjusted) | |||||||||||||||||||
Year ended December 31, 2008
|
||||||||||||||||||||
Revenue:
|
||||||||||||||||||||
Domestic
|
$ | 1,805,989 | $ | 51,020 | $ | 6,017 | $ | 808 | $ | 1,863,834 | ||||||||||
Foreign
|
383,476 | 32,113 | | | 415,589 | |||||||||||||||
Inter-segment
|
| 105,311 | 1,309 | | 106,620 | |||||||||||||||
Total segment revenue
|
$ | 2,189,465 | $ | 188,444 | $ | 7,326 | $ | 808 | 2,386,043 | |||||||||||
Inter-segment eliminations
|
(106,620 | ) | ||||||||||||||||||
Consolidated total revenue
|
$ | 2,279,423 | ||||||||||||||||||
Net earnings (loss):
|
||||||||||||||||||||
Domestic
|
$ | 236,939 | $ | 24,307 | $ | 2,178 | $ | (24,500 | ) | $ | 238,924 | |||||||||
Foreign
|
64,782 | 4,062 | | | 68,844 | |||||||||||||||
Total segment net earnings (loss)
|
$ | 301,721 | $ | 28,369 | $ | 2,178 | $ | (24,500 | ) | 307,768 | ||||||||||
Inter-segment eliminations
|
(5,648 | ) | ||||||||||||||||||
Consolidated net earnings
|
$ | 302,120 | ||||||||||||||||||
Other items:
|
||||||||||||||||||||
Net investment income
|
$ | 159,452 | $ | 4,529 | $ | 55 | $ | 715 | $ | 164,751 | ||||||||||
Depreciation and amortization
|
4,711 | 6,719 | 119 | 2,759 | 14,308 | |||||||||||||||
Interest expense (benefit)
|
1,174 | 15,590 | (103 | ) | 3,701 | 20,362 | ||||||||||||||
Capital expenditures
|
2,652 | 6,978 | 127 | 2,903 | 12,660 | |||||||||||||||
Income tax expense (benefit)
|
$ | 123,000 | $ | 17,664 | $ | (310 | ) | $ | (6,572 | ) | $ | 133,782 | ||||||||
Inter-segment eliminations
|
(3,664 | ) | ||||||||||||||||||
Consolidated income tax expense
|
$ | 130,118 | ||||||||||||||||||
For 2008, earnings before income taxes were $330.1 million
for our domestic subsidiaries and $102.1 million for our
foreign subsidiaries and branches.
F-35
HCC
INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
(continued,
tables in thousands, except per share data)
Insurance |
Other |
|||||||||||||||||||
Company | Agency | Operations | Corporate | Total | ||||||||||||||||
(as adjusted) | (as adjusted) | |||||||||||||||||||
Year ended December 31, 2007
|
||||||||||||||||||||
Revenue:
|
||||||||||||||||||||
Domestic
|
$ | 1,849,620 | $ | 62,246 | $ | 38,904 | $ | 4,553 | $ | 1,955,323 | ||||||||||
Foreign
|
395,495 | 37,555 | | | 433,050 | |||||||||||||||
Inter-segment
|
| 78,836 | | | 78,836 | |||||||||||||||
Total segment revenue
|
$ | 2,245,115 | $ | 178,637 | $ | 38,904 | $ | 4,553 | 2,467,209 | |||||||||||
Inter-segment eliminations
|
(78,836 | ) | ||||||||||||||||||
Consolidated total revenue
|
$ | 2,388,373 | ||||||||||||||||||
Net earnings (loss):
|
||||||||||||||||||||
Domestic
|
$ | 277,331 | $ | 29,043 | $ | 22,801 | $ | (24,044 | ) | $ | 305,131 | |||||||||
Foreign
|
80,502 | 4,810 | | | 85,312 | |||||||||||||||
Total segment net earnings (loss)
|
$ | 357,833 | $ | 33,853 | $ | 22,801 | $ | (24,044 | ) | 390,443 | ||||||||||
Inter-segment eliminations
|
1,110 | |||||||||||||||||||
Consolidated net earnings
|
$ | 391,553 | ||||||||||||||||||
Other items:
|
||||||||||||||||||||
Net investment income
|
$ | 192,486 | $ | 9,520 | $ | 2,498 | $ | 1,958 | $ | 206,462 | ||||||||||
Depreciation and amortization
|
4,921 | 8,030 | 219 | 2,812 | 15,982 | |||||||||||||||
Interest expense (benefit)
|
1,579 | 11,606 | (51 | ) | 3,136 | 16,270 | ||||||||||||||
Capital expenditures
|
5,462 | 3,416 | 412 | 2,780 | 12,070 | |||||||||||||||
Income tax expense (benefit)
|
$ | 162,058 | $ | 25,853 | $ | 13,211 | $ | (13,621 | ) | $ | 187,501 | |||||||||
Inter-segment eliminations
|
850 | |||||||||||||||||||
Consolidated income tax expense
|
$ | 188,351 | ||||||||||||||||||
For 2007, earnings before income taxes were $447.2 million
for our domestic subsidiaries and $132.7 million for our
foreign subsidiaries and branches.
F-36
HCC
INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
(continued,
tables in thousands, except per share data)
Insurance |
Other |
|||||||||||||||||||
Company | Agency | Operations | Corporate | Total | ||||||||||||||||
(as adjusted) | (as adjusted) | |||||||||||||||||||
Year ended December 31, 2006
|
||||||||||||||||||||
Revenue:
|
||||||||||||||||||||
Domestic
|
$ | 1,536,675 | $ | 65,866 | $ | 75,077 | $ | 6,198 | $ | 1,683,816 | ||||||||||
Foreign
|
357,092 | 34,387 | | | 391,479 | |||||||||||||||
Inter-segment
|
25 | 79,795 | | | 79,820 | |||||||||||||||
Total segment revenue
|
$ | 1,893,792 | $ | 180,048 | $ | 75,077 | $ | 6,198 | 2,155,115 | |||||||||||
Inter-segment eliminations
|
(79,820 | ) | ||||||||||||||||||
Consolidated total revenue
|
$ | 2,075,295 | ||||||||||||||||||
Net earnings (loss):
|
||||||||||||||||||||
Domestic
|
$ | 205,024 | $ | 32,281 | $ | 48,844 | $ | (25,274 | ) | $ | 260,875 | |||||||||
Foreign
|
66,991 | 10,038 | | | 77,029 | |||||||||||||||
Total segment net earnings (loss)
|
$ | 272,015 | $ | 42,319 | $ | 48,844 | $ | (25,274 | ) | 337,904 | ||||||||||
Inter-segment eliminations
|
7 | |||||||||||||||||||
Consolidated net earnings
|
$ | 337,911 | ||||||||||||||||||
Other items:
|
||||||||||||||||||||
Net investment income
|
$ | 137,896 | $ | 9,484 | $ | 2,610 | $ | 2,814 | $ | 152,804 | ||||||||||
Depreciation and amortization
|
4,603 | 7,593 | 509 | 2,275 | 14,980 | |||||||||||||||
Interest expense (benefit)
|
1,887 | 11,552 | 517 | 4,172 | 18,128 | |||||||||||||||
Capital expenditures
|
4,199 | 2,317 | 757 | 5,731 | 13,004 | |||||||||||||||
Income tax expense (benefit)
|
$ | 129,857 | $ | 25,483 | $ | 23,645 | $ | (13,620 | ) | $ | 165,365 | |||||||||
Inter-segment eliminations
|
(174 | ) | ||||||||||||||||||
Consolidated income tax expense
|
$ | 165,191 | ||||||||||||||||||
For 2006, earnings before income taxes were $386.4 million
for our domestic subsidiaries and $116.7 million for our
foreign subsidiaries and branches.
F-37
HCC
INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
(continued,
tables in thousands, except per share data)
The following tables present selected revenue items by line of
business:
2008 | 2007 | 2006 | ||||||||||
Diversified financial products
|
$ | 805,604 | $ | 777,414 | $ | 728,861 | ||||||
Group life, accident and health
|
777,268 | 758,516 | 591,070 | |||||||||
Aviation
|
139,838 | 153,121 | 152,886 | |||||||||
London market account
|
106,857 | 124,609 | 112,362 | |||||||||
Other specialty lines
|
173,449 | 171,824 | 123,981 | |||||||||
Discontinued lines
|
4,758 | (398 | ) | 29 | ||||||||
Net earned premium
|
$ | 2,007,774 | $ | 1,985,086 | $ | 1,709,189 | ||||||
Property and casualty
|
$ | 105,137 | $ | 121,307 | $ | 114,400 | ||||||
Accident and health
|
20,064 | 18,785 | 22,731 | |||||||||
Fee and commission income
|
$ | 125,201 | $ | 140,092 | $ | 137,131 | ||||||
Assets by business segment and geographic location are shown in
the following tables:
Insurance |
Other |
|||||||||||||||||||
Company | Agency | Operations | Corporate | Total | ||||||||||||||||
(as adjusted) | (as adjusted) | |||||||||||||||||||
December 31, 2008
|
||||||||||||||||||||
Domestic
|
$ | 5,486,898 | $ | 402,093 | $ | 24,715 | $ | 278,366 | $ | 6,192,072 | ||||||||||
Foreign
|
1,803,872 | 336,056 | | | 2,139,928 | |||||||||||||||
Total assets
|
$ | 7,290,770 | $ | 738,149 | $ | 24,715 | $ | 278,366 | $ | 8,332,000 | ||||||||||
December 31, 2007
|
||||||||||||||||||||
Domestic
|
$ | 5,131,724 | $ | 438,779 | $ | 78,527 | $ | 298,032 | $ | 5,947,062 | ||||||||||
Foreign
|
1,730,569 | 396,889 | | | 2,127,458 | |||||||||||||||
Total assets
|
$ | 6,862,293 | $ | 835,668 | $ | 78,527 | $ | 298,032 | $ | 8,074,520 | ||||||||||
(13) | 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.
Catastrophe
Exposure
We have exposure to catastrophic losses caused by natural perils
(such as hurricanes and earthquakes), as well as from man-made
events (such as terrorist attacks). The incidence and severity
of catastrophic losses is
F-38
HCC
INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
(continued,
tables in thousands, except per share data)
unpredictable. We assess our exposures in areas most vulnerable
to natural catastrophes and apply procedures to ascertain our
probable maximum loss from any single event. We maintain
reinsurance protection that we believe is sufficient to limit
our exposure to a foreseeable event.
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. Other indemnifications 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
December 31, 2009. We accrue a loss when a valid claim is
made by a purchaser and we believe we have potential exposure.
At December 31, 2008, we have recorded a liability of
$15.8 million and have provided $6.7 million of
letters of credit to cover our obligations or anticipated
payments under these indemnifications.
Terrorist
Exposure
Under the Terrorism Risk Insurance Program Reauthorization Act
of 2007, we are required to offer terrorism coverage to our
commercial policyholders in certain lines of business, for which
we may, when warranted, charge an additional premium. The
policyholders may or may not accept such coverage. This law
establishes a deductible that each insurer would have to meet
before U.S. Federal reimbursement would occur. For 2009,
our deductible is approximately $100.7 million. The Federal
government would provide reimbursement for 85% of any additional
covered losses in 2009 up to the maximum amount set out in the
Act. Currently, the Act expires on December 31, 2014.
Leases
We lease administrative office facilities and transportation
equipment under operating leases that expire at various dates
through 2025. The agreements generally require us to pay rent,
utilities, real estate taxes, insurance and repairs. We
recognize rent expense on a straight-line basis over the term of
the lease, including free-rent periods. Rent expense under
operating leases totaled $12.6 million in 2008,
$11.1 million in 2007 and $10.3 million in 2006.
At December 31, 2008, future minimum rental payments
required under long-term, non-cancelable operating leases,
excluding certain expenses payable by us, were as follows:
2009
|
$ | 12,361 | ||
2010
|
12,168 | |||
2011
|
10,838 | |||
2012
|
8,310 | |||
2013
|
6,508 | |||
Thereafter
|
22,354 | |||
Total future minimum rental payments
|
$ | 72,539 | ||
(14) | Related Party Transactions |
At December 31, 2008, 2007 and 2006, we had accruals of
$24.4 million, $31.7 million and $47.7 million,
respectively, for amounts owed to former owners of businesses we
acquired, who now are officers of certain of
F-39
HCC
INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
(continued,
tables in thousands, except per share data)
our subsidiaries. These accruals represent amounts due under the
terms of various acquisition agreements. We paid
$30.9 million in 2008, $49.0 million in 2007 and
$32.3 million in 2006 related to such agreements.
We own equity interests in three companies for which we use the
equity method of accounting. We recorded gross written premium
from business originating at the three companies of
$16.5 million in 2008, $15.7 million in 2007, and
$16.9 million in 2006. During 2008, 2007 and 2006, we also
ceded written premium of $0.4 million, $3.7 million
and $9.3 million, respectively, to one of these companies
under a quota share reinsurance agreement.
(15) | Statutory Information |
Our insurance companies file financial statements prepared in
accordance with statutory accounting principles prescribed or
permitted by domestic or foreign insurance regulatory
authorities. The differences between statutory financial
statements and financial statements prepared in accordance with
generally accepted accounting principles vary between domestic
and foreign jurisdictions.
Statutory policyholders surplus and net income, after
intercompany eliminations, included in those companies
respective filings with regulatory authorities were as follows:
2008 | 2007 | 2006 | ||||||||||
Statutory policyholders surplus
|
$ | 1,852,684 | $ | 1,744,889 | $ | 1,342,054 | ||||||
Statutory net income
|
308,717 | 365,308 | 303,758 |
The statutory surplus of each of our insurance companies is
significantly in excess of regulatory risk-based capital
requirements.
(16) | Supplemental Information |
Supplemental cash flow information was as follows:
2008 | 2007 | 2006 | ||||||||||
Cash received from commutations
|
$ | 7,500 | $ | 101,040 | $ | 12,750 | ||||||
Income taxes paid
|
154,415 | 146,829 | 167,086 | |||||||||
Interest paid
|
14,611 | 8,618 | 9,387 | |||||||||
Dividends declared but not paid at year end
|
14,152 | 12,658 | 11,173 |
The unrealized gain or loss on securities available for sale and
the related deferred taxes are non-cash transactions that have
been included as direct increases or decreases in our
consolidated shareholders equity.
(17) | Quarterly Financial Data (Unaudited) |
Fourth Quarter | Third Quarter | Second Quarter | First Quarter | |||||||||||||||||||||||||||||
2008 | 2007 | 2008 | 2007 | 2008 | 2007 | 2008 | 2007 | |||||||||||||||||||||||||
Total revenue
|
$ | 551,866 | $ | 614,407 | $ | 566,319 | $ | 582,494 | $ | 593,850 | $ | 594,250 | $ | 567,388 | $ | 597,222 | ||||||||||||||||
Net earnings (as adjusted)
|
$ | 71,599 | $ | 98,996 | $ | 58,391 | $ | 96,955 | $ | 91,675 | $ | 100,031 | $ | 80,455 | $ | 95,571 | ||||||||||||||||
Earnings per share: (as adjusted)
|
||||||||||||||||||||||||||||||||
Basic
|
$ | 0.63 | $ | 0.86 | $ | 0.51 | $ | 0.86 | $ | 0.79 | $ | 0.89 | $ | 0.70 | $ | 0.85 | ||||||||||||||||
Diluted
|
0.63 | 0.85 | 0.50 | 0.83 | 0.79 | 0.85 | 0.69 | 0.82 | ||||||||||||||||||||||||
Weighted average shares outstanding:
|
||||||||||||||||||||||||||||||||
Basic
|
113,895 | 114,641 | 114,812 | 112,652 | 115,457 | 112,273 | 115,232 | 111,959 | ||||||||||||||||||||||||
Diluted
|
114,093 | 117,085 | 115,411 | 116,323 | 116,040 | 117,728 | 116,369 | 117,009 |
The sum of earnings per share for the quarters may not equal the
annual amounts due to rounding.
F-40