SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------------------
FORM 10-Q
(Mark One)
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
X OF THE SECURITIES EXCHANGE ACT OF 1934
- -----
For the quarterly period ended March 31, 1996
or
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
- -----
For the transition period from to
------ ------
Commission File Number
1-14028
-------------------------------
HIGHLANDS INSURANCE GROUP, INC.
- -----------------------------------------------------------------
(Exact name of Registrant as specified in its charter)
Delaware 75-2370945
- -------------------------------------- -------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporated or organization) Identification No.)
10370 Richmond., Houston, Texas 77042
- -------------------------------------- -------------------------
(Address of principal executive (Zip Code)
offices)
Registrant's telephone number, including area code (713) 267-8567
-------------
Indicate by check mark whether the Registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months
(or for such shorter period that the Registrant was required to
file such filing requirements for the past 90 days.
Yes X No
---- ----
The number of shares of the Registrant's Common Stock, par value
$.01 per share, outstanding at March 31, 1996 was 11,448,430.
HIGHLANDS INSURANCE GROUP, INC.
TABLE OF CONTENTS
-----------------
Part I - Financial Information
Item 1. Financial Statements: Page No.
--------
Consolidated Balance Sheets
December 31, 1995 and March 31, 1996
(Unaudited) 3
Consolidated Statements of Income
(Unaudited) - Three Months Ended March 31,
1996 and 1995 5
Consolidated Statements of Changes in
Stockholders' Equity - Year Ended December 31,
1995 and Three Months Ended March 31, 1996
(Unaudited) 6
Consolidated Statements of Cash Flows
(Unaudited) - Three Months Ended March 31,
1996 and 1995 7
Condensed Notes to Consolidated Financial
Statements (Unaudited) 9
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 14
Part II - Other Information
Item 1. Legal Proceedings 20
Item 6. Exhibits and Reports on Form 8-K 21
Signatures 22
Part I. Financial Information
Item 1. Financial Statements
<TABLE>
HIGHLANDS INSURANCE GROUP, INC.
CONSOLIDATED BALANCE SHEETS
(In Thousands)
<CAPTION>
March 31, December 31,
ASSETS 1996 1995
-------- ----------- -----------
(Unaudited)
<S> <C> <C>
INVESTMENTS:
Fixed income securities
Available for sale, at fair value
(amortized cost of $253,648 at
3/31/96 and $216,093 at 12/31/95) $257,356 $227,509
Held to maturity, at amortized cost
(fair value of $375,081 at 3/31/96 and
$396,729 at 12/31/95) 362,601 374,364
Equity securities, at fair value
(cost of $30,900 at 3/31/96 and
$31,966 at 12/31/95) 31,510 33,697
---------- ----------
Total investments 651,467 635,570
CASH AND CASH EQUIVALENTS 101,662 85,176
PREMIUMS IN COURSE OF COLLECTION 37,400 40,959
PREMIUMS DUE FROM POLICYHOLDERS UNDER
RETROSPECTIVE ARRANGEMENTS 136,664 134,428
ACCRUED PREMIUMS 11,601 11,886
RECEIVABLE FROM REINSURERS 592,514 602,380
FUNDS ON DEPOSIT WITH REINSURERS 14,505 15,449
DEFERRED TAXES 32,574 29,534
RECEIVABLE FROM FORMER AFFILIATES 27,750 41,255
ACCRUED INVESTMENT INCOME 9,920 11,131
DEFERRED POLICY ACQUISITION COSTS 11,343 11,744
PROPERTY AND EQUIPMENT (Net of
accumulated depreciation of $7,268 at
3/31/96 and $7,111 at 12/31/95) 1,536 1,645
OTHER ASSETS 23,896 14,934
---------- ----------
Total assets $1,652,832 $1,636,091
========== ==========
See Condensed Notes to Consolidated Financial Statements.
</TABLE>
<TABLE>
HIGHLANDS INSURANCE GROUP, INC.
CONSOLIDATED BALANCE SHEETS, Continued
(In Thousands)
<CAPTION>
March 31, December 31,
LIABILITIES AND STOCKHOLDERS' EQUITY 1996 1995
------------------------------------- ----------- -----------
(Unaudited)
<S> <C> <C>
LOSS AND LOSS ADJUSTMENT EXPENSE $1,217,233 $1,253,627
UNEARNED PREMIUMS 49,323 52,571
CONVERTIBLE SUBORDINATED DEBENTURES 54,876 -
FUNDS HELD 24,338 22,702
PAYABLE TO FORMER AFFILIATES 484 676
ACCOUNTS PAYABLE AND ACCRUED LIABILITIES 37,556 39,405
---------- ----------
Total liabilities 1,383,810 1,368,981
---------- ----------
COMMITMENTS AND CONTINGENT LIABILITIES
STOCKHOLDERS' EQUITY
Common stock, $.01 par value; 50,000,000
shares authorized; 11,448,430 outstanding
in 1996 ($1,000 par value; 10,000 shares
authorized, 1,000 shares issued and
outstanding in 1995) 114 1,000
Additional paid-in capital 192,492 184,168
Net unrealized gain on investments 2,807 8,547
Retained earnings 73,609 73,395
---------- ----------
Total stockholders' equity 269,022 267,110
---------- ----------
Total liabilities and stockholders'
equity $1,652,832 $1,636,091
========== ==========
See Condensed Notes to Consolidated Financial Statements.
</TABLE>
<TABLE>
HIGHLANDS INSURANCE GROUP, INC.
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(In Thousands)
<CAPTION>
Three Months
Ended March 31,
------------------
1996 1995
-------- -------
<S> <C> <C>
REVENUES:
Net premiums earned $ 46,836 43,519
Net investment income 12,670 12,089
Net realized investment gains 457 165
-------- ------
Total revenues 59,963 55,773
-------- ------
EXPENSES:
Loss and loss adjustment
expense incurred 42,020 39,370
Underwriting expenses 15,398 14,663
Other expenses (income), net 2,281 (559)
-------- ------
Total expenses 59,699 53,474
-------- ------
INCOME BEFORE INCOME TAX 264 2,299
FEDERAL AND FOREIGN INCOME TAX 50 -
-------- ------
NET INCOME $ 214 2,299
======== ======
NET INCOME PER COMMON SHARE $ .02 .20
======== ======
See Condensed Notes to Consolidated Financial Statements.
</TABLE>
<TABLE>
HIGHLANDS INSURANCE GROUP, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(In Thousands)
<CAPTION>
March 31, December 31,
1996 1995
--------- ---------
(Unaudited)
<S> <C> <C>
COMMON STOCK
Balance, beginning of year $ 1,000 1,000
Change in par value of common stock (886) -
-------- --------
Balance, end of period 114 1,000
-------- --------
ADDITIONAL PAID-IN CAPITAL:
Balance, beginning of year 184,168 110,803
Addition resulting from issuance of
convertible subordinated debentures 7,438
Change in par value of common stock 886
Contribution from former parent for
net tax benefit 39,229
Contribution from former parent for
net deferred tax benefit 34,136
-------- --------
Balance, end of period 192,492 184,168
-------- --------
NET UNREALIZED GAIN (LOSS) ON INVESTMENTS:
Balance, beginning of year 8,547 (10,132)
Changes in net unrealized (loss) gain, net
of the applicable federal income tax (5,740) 18,679
-------- --------
Balance, end of period 2,807 8,547
-------- --------
RETAINED EARNINGS:
Balance, beginning of year 73,395 194,137
Net income (loss) 214 (120,742)
-------- --------
Balance, end of period 73,609 73,395
-------- --------
TOTAL STOCKHOLDERS' EQUITY $269,022 $267,110
======== ========
See Condensed Notes to Consolidated Financial Statements
</TABLE>
<TABLE>
HIGHLANDS INSURANCE GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In Thousands)
<CAPTION>
Three months ended
March 31,
-------------------
1996 1995
-------- -------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 214 2,299
-------- ------
Adjustment to reconcile net income to net
cash used in operating activities
Depreciation and amortization (4) 241
Change in deferred policy acquisition
costs 401 228
Gain on sale of investments (350) (51)
Decrease in premiums in course of collection 3,559 2,605
Decrease in receivables from reinsurers 9,866 356
Decrease in loss and loss adjustment expense
reserves (36,394) (23,835)
Decrease in funds on deposit with reinsurer 944 1,782
(Increase) decrease in premiums due from
policyholders and affiliated companies
under retrospective arrangements (2,236) 2,421
(Increase) decrease in unearned
premiums (3,248) 1,276
Increase in funds held 1,636 7,524
Advances from (payments to) former
affiliates, net 9,431 (1,774)
Change in other operating assets and
liabilities (1,183) 3,225
-------- ------
Total adjustments (17,578) (6,002)
-------- ------
Net cash used in operating activities (17,364) (3,703)
-------- ------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sales
Equity securities 3,028 26
Investment collections
Fixed income securities available for
sale 7,475 3,687
Fixed income securities held to maturity 14,167 10,625
Investment purchases
Fixed income securities available for
sale (44,950) (21,105)
Fixed income securities held to maturity (1,894) (411)
Equity securities (2,014) (1,000)
Purchases of property and equipment (139) (277)
Sales of property and equipment - 5
Proceeds from disposal of subsidiary, net 22 -
Cash returned by (invested by) former
affiliates, net 3,860 (35)
-------- -------
Net cash used in investing activities (20,445) (8,485)
-------- -------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuance of convertible
subordinated debentures 60,000 -
Payment of debt issuance expense (5,705) -
-------- -------
Net cash provided by financing
activities 54,295 -
-------- -------
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS 16,486 (12,188)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 85,176 52,789
-------- -------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $101,662 40,601
======== =======
See Condensed Notes to Consolidated Financial Statements.
</TABLE>
HIGHLANDS INSURANCE GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1996
1. BASIS OF PRESENTATION
---------------------
The accompanying condensed consolidated financial statements as
of March 31, 1996 and for the three-month period ended March 31,
1996 and 1995 are unaudited and include the accounts of Highlands
Insurance Group, Inc., (HIC) and its subsidiaries (the Company).
The Company is an insurance holding Company that through
Highlands Insurance Company (Highlands) and its other insurance
subsidiaries (collectively, the Insurance Subsidiaries), is
primarily engaged in the commercial property and casualty
insurance business. In the opinion of management, all
adjustments, consisting of normal recurring adjustments necessary
for a fair presentation, have been reflected. The results for
the period are not necessarily indicative of the results to be
expected for the entire year. The accompanying condensed
consolidated financial statements should be read in conjunction
with the consolidated financial statements and related notes
included in the Company's Form 10-K for the year ended December
31, 1995.
Certain financial information that is normally included in annual
financial statements prepared in accordance with generally
accepted accounting principles but is not required for interim
reporting purposes has been condensed or omitted.
Certain reclassifications have been made to the prior year's
financial statements to conform to the current year's
presentation.
HIC was wholly owned by Halliburton Company (Halliburton) until
January 23, 1996 when Halliburton distributed all of the
outstanding shares of common stock of HIC (the Distribution) to
holders of record of common stock of Halliburton on January 4,
1996. Holders of record received one share of common stock of
HIC for every ten shares of common stock of Halliburton held on
that date. Approximately 11.4 million common shares of HIC were
issued in conjunction with the Distribution.
2. ACCOUNTING STANDARDS
--------------------
In October 1995, the Financial Accounting Standards Board issued
FAS No. 123, "Accounting for Stock-Based Compensation to
Employees" (SFAS 123). SFAS 123 establishes accounting and
reporting standards for stock-based employee compensation plans.
SFAS 123 recommends but does not require entities to adopt the
fair value based method of accounting for all employee stock
compensation plans, under which compensation cost is measured
based on the fair value of the award at the grant date and
recognized over the vesting period. Entities may continue to
account for these plans using the intrinsic value based method of
accounting, under which compensation cost is measured as the
excess, if any, of the quoted market price of the stock at the
grant date over the amount an employee must pay to acquire the
stock. Entities not adopting the fair value based method must
present proforma disclosures of net income and earnings per share
as if the fair value method of accounting had been applied. The
Company has elected to use the intrinsic value based method of
accounting.
The Company's stock options are generally awarded at a value
that the Compensation Committee determines, in its good faith
judgment. However, in the case of incentive options they are
generally granted at the fair market value at the time of the grant.
The options are typically exercisable over or a period not in excess
of ten years. The options generally vest over three to four
years, or in full upon a change of control of the Company. The
maximum number of shares that may be granted under all option
plans is 750,000; at March 31, 1996, 507,000 shares, principally,
non-qualified options, were granted but not exercisable.
3. INCOME PER SHARE
----------------
The income per share amounts for the three months ended March 31,
1996 are based upon the weighted average number of common shares
outstanding during the period. The effect of convertible
subordinated debentures, common stock warrants and stock options
are considered to be antidilutive, therefore, the effects are not
reflected in either primary or fully diluted income per share
amounts. The income per share amounts for the three months ended
March 31, 1995 are based upon the 11,448,430 shares of common
stock that was distributed and outstanding immediately following
the Distribution.
4. DEBT
----
On January 23, 1996, HIC issued $62.85 million in principal
amount of HIC's 10% convertible subordinated debentures due
December 31, 2005, together with Series A and A-2 (collectively
the "Series A Warrants") and B and B-2 (collectively the
"Series B Warrants") common stock purchase warrants, to
Insurance Partners, L.P., Insurance Partners Offshore
(Bermuda), L.P. and to certain members of the Company's
management team.
The convertible subordinated debentures issued are convertible
into common stock of HIC after one year from issuance at the
option of the holders. Upon conversion, the holders would receive
approximately 3.9 million shares of HIC, or approximately 25%
ownership interest in HIC, if all of the debentures are converted into
common stock of HIC at a conversion price of $16.16 per share.
Interest on the debentures is payable semi-annually in cash at
10% per annum. HIC can redeem the debentures at any time after
December 3, 2002.
The detachable Series A Warrants enable the holders to purchase HIC common
stock at an exercise price of $14.69 per share, equal to an
additional ownership interest of approximately 21% after giving
effect to the assumed conversion of the debentures and the exercise
of the Series A Warrants. If all of the Series A Warrants were
exercised, the holders would receive approximately 4.0 million
shares of HIC. The exercise price and the number of shares of
HIC common stock into which the Series A Warrants are exercisable
will be subject to adjustment in certain circumstances. These
warrants expire on December 31, 2005.
The detachable Series B Warrants enable the holders to purchase HIC common
stock at an exercise price of $14.69 per share, equal to an additional
ownership interest of 5% after giving effect to the assumed
conversion of the debentures and the exercise of the Series A and
B Warrants. The Series B Warrants become exercisable by the
holders in the event that the average closing market price of HIC
common stock exceeds 1.61 times the exercise price for any 30
consecutive trading days prior to December 31, 2000 but after
December 31, 1998. If all of the Series B Warrants were
exercised, the holders would receive approximately 1.0 million
additional shares of HIC common stock. The exercise price and
the number of shares of HIC common stock into which the Series B
Warrants are exercisable will be subject to adjustment in certain
circumstances. The detachable Series B Warrants expire on
December 31, 2005.
If the debentures are converted into common stock of HIC and the
Series A and B Warrants are utilized by the holders to purchase
common stock of HIC, the holders will own approximately 44% of
HIC.
5. RESTRUCTURING CHARGE
--------------------
The Company recorded a $1.3 million restructuring charge for
severance and lease costs in the first quarter of 1996. The
restructuring charge included the elimination of approximately
100 positions and the consolidation of office space.
Accordingly, such charge also included costs related to vacating
the excess leased office space.
6. CONTINGENT LIABILITIES:
-----------------------
Loss and Loss Adjustment Expense Reserves
-----------------------------------------
The Company establishes loss reserves which are estimates of
future payments of reported and unreported claims for losses and
the related expenses with respect to insured events that have
occurred. The process of establishing loss reserves is subject
to uncertainties that are normal, recurring and inherent in the
property and casualty business. The process requires reliance
upon estimates based on available data that reflect past
experience, current trends and other information and the exercise
of informed judgment. As information develops that varies from
experience, provides additional data or, in some cases, augments
data that previously was not considered sufficient for use in
determining reserves, changes in the Company's estimate of
ultimate liabilities may be required. The effect of these
changes, net of reinsurance, is charged or credited to income for
the periods in which they are determined.
Reserving for asbestos, environmental-related and certain other
long-term exposure claims is subject to significant additional
uncertainties that are not generally present for other types of
claims. Developed case law and adequate claim history do not
exist for such claims. Highlands and the insurance industry
dispute coverage for certain environmental, pollution and
asbestos liabilities of their policyholders. These claims differ
from almost all others in that it is not often clear that an
insurable event has occurred and which, if any, multiple policy
years and insurers will be liable. These uncertainties prevent
identification of applicable policy and policy limits until after
a claim is reported and substantial time is spent (many years in
some cases) resolving contract issues and determining facts
necessary to evaluate the claim. If the courts continue in the
future to expand the intent of the policies and the scope of the
coverage as they have in the past, additional liabilities could
emerge for amounts in excess of the current reserves held.
The Company uses methods and assumptions that are consistent with
prevailing actuarial practice and are modified periodically based
on changes in circumstances. However, estimation of loss
reserves for asbestos, environmental related and other long-term
exposure claims is one of the most difficult aspects of
establishing reserves, especially given the above uncertainties.
Reference is made to the Company's Form 10-K for the year ended
December 31, 1995 for a discussion of the Company's asbestos-
related and environmental pollution claims. Because of the
significant uncertainties involved and the likelihood that these
uncertainties will not be resolved in the near future, the
Company believes that no meaningful range of loss and loss
adjustment expense reserves beyond recorded reserves can be
established.
In management's judgment, information currently available has
been appropriately considered in estimating the Company's loss
reserves. However, future changes in estimates of the Company's
liability for insured events may adversely affect results in
future periods although such effects cannot be reasonably
estimated.
Other
- -----
The information set forth in Item 1 of Part II of this report is
incorporated herein by reference.
The Company is a party to various claims and legal actions
arising in the ordinary course of its insurance business which,
in the opinion of management, will not have a material effect on
the Company's financial position or results of operations.
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations
<TABLE>
Results of Operations
- ---------------------
The results of the Company's consolidated operations for
periods ended March 31, 1996 and 1995 are set forth below:
<CAPTION>
Period Ended March 31,
---------------------
1996 1995
------- -------
(Dollars in millions)
<S> <C> <C>
Consolidated Results:
Direct premiums written $ 49.9 58.0
Net premiums written 41.9 47.3
======= =======
Premiums earned:
Excluding Discontinued Lines $ 43.8 39.5
Discontinued Lines 3.0 4.0
------- -------
46.8 43.5
======= =======
Underwriting loss:
Excluding Discontinued Lines (9.1) (8.1)
Discontinued Lines (1.5) (2.4)
------- -------
(10.6) (10.5)
Net investment income 12.7 12.1
Net realized investment gains .5 .1
Other (expense) income (including
taxes) (2.4) .6
------- -------
Net income $ .2 2.3
======= =======
Ratios:
Loss 89.7% 90.4%
Expense 32.8 33.7
------- -------
Combined 122.5% 124.1%
======= =======
</TABLE>
The Company's consolidated results have been influenced by the
underwriting results of the Discontinued Lines (see Underwriting
Result of Discontinued Lines). In order to indicate the significance
of those influences, underwriting results exclusive of the
discontinued lines and with respect to the discontinued lines are
presented and discussed separately below.
Net investment income for the period ended March 31, 1996 and
1995 amounted to $12.7 million and $12.1 million, respectively.
Net investment income for 1996 increased $.6 million from 1995 as
a result of additional investable funds from the issuance of the
convertible subordinated debentures. Net realized investment
gains have not been a significant portion of revenue for the
Company.
Other expenses for the period ended March 31, 1996 compared to
1995 increased by $3.0 million. The increase is the result of
the net interest expense and amortization of the debt discount
related to the convertible subordinated debentures and additional
expenses associated with being a separate public company.
<TABLE>
Underwriting Results Excluding Discontinued Lines
- -------------------------------------------------
<CAPTION>
Period Ended March 31,
---------------------
1996 1995
------ ------
(Dollars in millions)
<S> <C> <C>
Net premiums earned $ 43.8 39.5
Loss and loss adjustment expense incurred (38.9) (33.8)
Underwriting expense (14.0) (13.8)
------ -----
Underwriting results $ (9.1) (8.1)
------ -----
Ratios:
Loss 88.7% 85.6%
Expense 32.2 34.8
------ -----
Combined 120.9% 120.4%
====== =====
</TABLE>
The underwriting results excluding Discontinued Lines primarily
consist of relatively large third party and smaller complex
commercial accounts (Special Accounts), medium to small third
party commercial accounts (Commercial Insurance) and Halliburton
and its affiliates (Insurance Services).
Period to Period Comparisons of Underwriting Results Excluding
Discontinued Lines
Net Premiums Earned. Net premiums earned for the periods ended
March 31, 1996 and 1995 amounted to $43.8 million and $39.5
million, respectively. The increase of $4.3 million or 11% in
1996 was primarily the result of two items. Net premiums earned
increased as a result of an increase in incurred losses on
retrospectively rated policies. However, net premium earned in
1996 was negatively impacted by $3.1 million of improperly
classified accrued premiums on retrospectively rated policies.
Net premiums earned for retrospectively rated policies may be
adjusted up or down, subject to certain limitations contained in
the policy, based on the estimated loss experience of the insured
during the policy period. The Company estimates ultimate losses
for retrospectively rated policies and then adjusts net premiums
earned and premiums due from policyholders under retrospectively
rated policies for changes in the estimated ultimate loss and
loss adjustment expense from the date of the prior valuation.
These adjustments may cause net premiums earned to fluctuate
significantly from period to period. Experience rated contracts
reduce but do not eliminate risk to the insurer.
The 1996 net premiums earned continued to be impacted by
decisions regarding the Company's bonding and Texas personal
lines products. For the period ended March 31, 1996, $1.5
million of the Company's net premiums earned were produced by
Southern California Bonding Service, Incorporated. On March 15,
1996, the Company sold all of the common stock of Southern
California Bonding Service, Incorporated and ceded reinsurance of
100% of its inforce policies, subject to a profit sharing
arrangement. As a result of the sale, premiums from this probate
bonding business engaged in by Southern California Bonding
Service, Incorporated will be significantly reduced for the
remainder of 1996. The sale was not material for financial
reporting purposes. In addition, the Company ceased writing
Texas personal lines products which accounted for net premiums
earned of approximately $.7 million for the period ended March
31, 1995. Because of underwriting and agency management
initiatives begun in March 1996, Commercial Insurance premiums
are expected to decline during the remainder of 1996.
Loss and Loss Adjustment Expense Incurred. Loss and loss
adjustment expense incurred for the periods ended March 31, 1996
and 1995 amounted to $38.9 million and $33.8 million,
respectively. The increase in 1996 of $5.1 million or 15%
greater than 1995 was the result of adverse development on prior
year reserves and higher 1996 accident year loss ratios.
Underwriting Expense. Underwriting expense for the periods ended
March 31, 1996 and 1995 amounted to $14.0 million and $13.8
million, respectively. During the first quarter of 1996, the
Company implemented a plan under which it recorded a
restructuring charge as part of its strategic and financial
assessment of the Company's business. As a result, the Company
recorded a $1.3 million severance and lease charge to first
quarter 1996 earnings. The actions included the elimination of
approximately 100 positions and the consolidation of office
space. Accordingly, such charge also included costs related to
vacating the excess leased office space.
<TABLE>
Underwriting Results of Discontinued Lines
- ------------------------------------------
<CAPTION>
Period Ended March 31,
---------------------
1996 1995
------- ------
(Dollars in millions)
<S> <C> <C>
Net premiums earned $ 3.0 4.0
Loss and loss adjustment expense
incurred (3.1) (5.5)
Underwriting expense (1.4) (.9)
------ -----
Underwriting results $ (1.5) (2.4)
====== =====
</TABLE>
For reporting purposes, the Company has three lines of business
which are considered Discontinued Lines, specifically business
originated by the Company's London operations, an umbrella/excess
liability policy program and assumed casualty and property
reinsurance contracts. The Company has ceased to write these
Discontinued Lines. Although the Company has discontinued other
lines of business, primarily personal and probate bonding
business, the Company has included the financial results of those
lines in underwriting results excluding Discontinued Lines for
consistency purposes.(Please refer to the Company's 1995 Form
10-K for a more complete description of the Discontinued Lines.)
Period to Period Comparisons of Underwriting Results of
Discontinued Lines
Net Premiums Earned. Net premiums earned were $3.0 million and
$4.0 million for the periods ended March 31, 1996 and 1995,
respectively. The decline is due to reduced writings of assumed
reinsurance and the declining premiums from Highlands (UK), which
ceased writing new business in 1993.
Loss and Loss Adjustment Expense Incurred. Loss and loss
adjustment expense for the period ended March 31, 1996 compared
to 1995 decreased by $2.4 million. The decline in loss and loss
adjustment expense for the first quarter 1996 reflects the
decline in premium volume offset by minor development on prior
year loss reserve.
Liquidity and Capital Resources
The Company is a holding company, the principal asset of which is
all of the capital stock of Highlands. The Company's property and
casualty insurance business is conducted by Highlands and the
other Insurance Subsidiaries. The liquidity and capital resource
considerations for the Company and its Insurance Subsidiaries are
different.
Holding Company
Immediately following the Distribution, the Company issued $62.85
million in principal amount of Debentures for $60.0 million in
cash and $2.85 million of notes. Of such proceeds, the Company
invested $10.0 million in the U.S. Insurance subsidiaries as a
contribution to surplus, paid approximately $5.6 million in
transactions fees and for reimbursement of out-of-pocket expenses
incurred in connection with the issuance of the Debentures and
retained the remaining approximately $44.4 million for general
corporate purposes.
Prior to the Distribution, the Company was included in the
Halliburton consolidated U.S. federal tax return. An intercompany
tax-sharing arrangement between the Company and Halliburton
resulted in the Company receiving from or paying to Halliburton a
cash payment for U.S. federal income taxes based on financial
reporting (book) income rates that were determined by
Halliburton. The Company was not charged more U.S. federal income
tax than it would have paid on a separate return basis. Pursuant
to SFAS 109, the Company provided for income taxes on its
statements of operations as if it had filed separate tax returns
in each taxing jurisdiction (separate return method). Differences
between income tax provisions calculated using the separate
return method and amounts calculated under the intercompany tax-
sharing arrangements were reflected as additions or reductions to
stockholders' equity, as appropriate. The Company will receive
approximately $35 million in cash from Halliburton related to the
tax benefit of the significant tax losses incurred in 1995 which
are utilizable by Halliburton. Under the agreement, $8 million
of the tax benefit was paid in February 1996 and the remainder
will be paid in September 1996.
The tax-sharing agreement resulted in Halliburton acquiring the
domestic deferred tax assets and liabilities from its U.S.
subsidiaries. In contemplation of Halliburton's distribution of
the Company's shares, Halliburton contributed to the Company the
net deferred tax assets attributable to the Company which the
Company recorded as a contribution to capital. Based on the tax-
free nature of the spin-off, the deferred tax asset attributes
are available to the Company.
The Company's other principal sources of funds are dividend and
tax sharing payments from Highlands, if any, and funds that may
be raised from time to time from the issuance of additional debt
or equity securities. The payment of dividends by Highlands is
subject to restrictions and limitations imposed by the insurance
laws of the State of Texas. The maximum dividend payable by
Highlands for 1996 without approval is approximately $18.0
million. Both the issuance of additional debt and the issuance
of additional equity securities at a price less than current
market price would require the consent of the holders of a
majority in interest of the Debentures pursuant to the covenants
contained in the Debentures.
As a holding company, the Company's principal requirements for
funds are to pay operating expenses, to pay franchise and other
taxes, to pay debt service and to pay dividends. Operating
expenses and franchise and other taxes imposed on the Company are
not expected to be material. Initially, the annual cash interest
requirements relating to the Debentures will be approximately
$6.3 million. The Company does not currently intend to pay
dividends on the Company Common Stock. In light of the Company's
corporate strategy, an additional use of funds may be to invest
in other insurance companies or other insurance operations.
Insurance Subsidiaries
Insurance Operations. The principal sources of funds for the
Insurance Subsidiaries are premiums and amounts earned from the
investment of such premiums. The principal uses of funds by these
subsidiaries are the payment of losses and related expenses,
underwriting expenses, other operating expenses and dividends and
tax sharing payments to the Company.
In the insurance industry, liquidity refers to the ability of an
enterprise to generate adequate amounts of cash from its
operations, including from its investment portfolio, in order to
meet its financial commitments, which are principally obligations
under the insurance policies it has written. Liquidity
requirements of insurance companies are influenced significantly
by product mix. Future catastrophe claims, the timing and amount
of which are inherently unpredictable, may create increased
liquidity requirements for the Insurance Subsidiaries. The
liquidity requirements of the Insurance Subsidiaries are met by
that portion of the investment portfolio that is held in cash and
highly liquid securities.
Various regulatory and legal actions are currently pending
involving the Insurance Subsidiaries and specific aspects of the
conduct of their business. See Part II: "Other Information".
While the aggregate dollar amounts involved in such regulatory
and legal matters cannot be determined with certainty, the
amounts at issue could have a significant effect on the Company's
consolidated results of operations. In the opinion of management,
however, the ultimate liability in one or more of these actions
in excess of amounts currently reserved is not expected to have a
material effect on liquidity or capital resources.
Reinsurance Receivables. The Company monitors the financial
condition of the reinsurance companies with which it places
significant reinsurance coverage and strives to place current
reinsurance coverages with financially sound reinsurance
companies. In the past, the Company has placed reinsurance
coverage with several hundred reinsurance companies. It monitors
the financial condition of many of such companies only on a
periodic basis. A number of such companies are in run-off or have
ceased writing reinsurance and some have become insolvent. The
Company's ability to monitor the financial condition of some
reinsurance companies is limited because of the difficulty of
acquiring accurate information.
Part II Other Information
-----------------
Item 1. Legal Proceedings
-----------------
On May 15, 1991, Weatherford Roofing Company and other plaintiffs
commenced an action against Employers National Insurance Company
in the 116th Texas State District Court in Dallas County, Texas,
alleging that they had been overcharged for workers' compensation
insurance. On April 23, 1992, the plaintiffs amended their
petition purporting to allege a class action on behalf of all
employers who purchased workers' compensation insurance covering
Texas employees between 1987 and 1992 and who had been
overcharged premiums for that insurance. On April 18, 1994,
Highlands and Highlands Underwriters Insurance Company were added
to the action as named defendants. The lawsuit, styled
Weatherford Roofing Company, et. al. v. Employers National
Insurance Company, (Case No. 91-05637), alleges, among other
things, that the defendants conspired to charge rates of premium
for retrospectively rated insurance policies that were in excess
of the rates then permitted under applicable Texas law and
regulations. The Company intends to defend this litigation
vigorously and, based on the advice of its counsel, believes it
has meritorious defenses, but there can be no assurances
regarding the ultimate resolution of the litigation. Even though
the Company believes it has meritorious defenses, it has been
engaged in extensive discussions involving the settlement of this
matter and increased legal reserves in the third quarter of 1995
due to this matter. In view of the status of the litigation and
global settlement discussions which occurred in the fourth
quarter of 1995, the Company determined that an additional
increase of its legal reserves in the fourth quarter of 1995 due
to this matter was appropriate to reflect the Company's estimate
of the amount of the probable loss. In the opinion of the
Company, its ultimate liability, if any, for Weatherford Roofing
in excess of amounts currently reserved is not expected to have a
material adverse effect on the financial position of the Company.
In light of the inherent uncertainty in any litigation, however,
it is possible that a resolution of the matter could have a
material adverse effect on results of operations of the Company
in the period in which the matter is resolved.
In November 1988, the State of California adopted by ballot
initiative Proposition 103, a comprehensive system of regulation
applicable to all property and casualty insurance written in
California. Proposition 103 does not apply to workers'
compensation insurance or reinsurance. Proposition 103 provided,
among other things, that rates for automobile and certain other
insurance policies issued or renewed on or after November 8, 1988
be rolled back to levels of November 8, 1987 and then reduced by
an additional 20%. The State of California has notified the
Company that it believes the Company has a premium rollback
obligation to policyholders under Proposition 103 in the amount
of $2.7 million, plus interest. On April 18, 1995, the
Department of Insurance of the State of California issued a
Notice of Hearing Re Proposition 103 Rollback Exemption
Application In the Matter of the Rate Rollback Liability of
Highlands and Highlands Underwriters Insurance Company.
Subsequent to the issuance of the Notice of Hearing, there was a
Prehearing Conference Order and several motions regarding the
extent and nature of discovery. On June 30, 1995, Highlands and
Highlands Underwriters Insurance Company mailed a settlement
offer to the Insurance Commissioner of the State of California,
which was rejected by the Insurance Commissioner on July 18,
1995. On August 22, 1995 the Insurance Commissioner issued a
Notice of Intent to Set Hearing Re: Rollback Liability for
virtually all open cases with insurance companies that had not
settled with the California Department of Insurance with respect
to their respective Proposition 103 rollback liabilities. At that
time, the Company determined that it was probable that there
would be an unfavorable outcome with respect to this matter in
excess of established reserves and legal reserves were increased.
In December of 1995, a decision was entered in the matter of
Amwest Surety Insurance Company v. Pete Wilson, et. al. In that
case, the Supreme Court of the State of California determined
that surety would be subject to Proposition 103. In light of
that court decision, the Company determined that an additional
increase of its legal reserves in the fourth quarter of 1995 due
to this matter was appropriate in order to reflect the Company's
estimate of the amount of the probable loss. This matter is
currently scheduled for hearing during May, 1996. The Company
continues to believe that it has meritorious defenses to a
rollback liability pursuant to its corrected constitutional
percentage and constitutional variance calculations.
Item 6: Exhibits and Reports on Form 8-K.
a) Exhibits
(12) Computation of Earnings Per Share
(27) Financial Data Schedule
b) The Registrant filed a Form 8-K Current Report, dated
January 23, 1996, pertaining to the Registrant's press
release of the Registrant's spin-off from Halliburton
Company.
The Registrant filed a Form 8-K Current Report, dated
March 8, 1996 pertaining to the Registrant's press
release of fourth quarter 1995 and year ended December
31, 1995 financial results.
SIGNATURES
Pursuant to the requirements of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be
signed on its behalf by the undersigned thereunto duly
authorized.
HIGHLANDS INSURANCE GROUP, INC.
(Registrant)
Date: May 15, 1996 By /s/ Richard M. Haverland
--------------------
Richard M. Haverland
Chairman, President and Chief Executive Officer
(Authorized Signatory)
Date: May 15, 1996 By /s/ Charles J. Bachand
------------------
Charles J. Bachand
Vice President, Treasurer and Principal
Accounting Officer
(Authorized Signatory)
<TABLE>
HIGHLANDS INSURANCE GROUP, INC. AND SUBSIDIARIES
COMPUTATION OF EARNINGS PER SHARE
(In millions, except for per share amounts)
<CAPTION>
Three Months Ended
March 31,
---------------------
1996 1995
--------- ---------
<S> <C> <C>
EARNINGS:
Primary:
Net income, as reported $ 214 2,299
======= =======
Fully diluted:
Net income, as reported 214 2,299
After tax interest expense applicable to
Convertible Subordinated Debentures - -
------- -------
Net income, as adjusted $ 214 2,299
======= =======
SHARES:
Primary:
Number of common shares outstanding, per
consolidated financial statements 11,448 11,448
Additional dilutive effect of
outstanding stock options (based on
treasury stock method using average
market price) - -
------- -------
Weighted average, as adjusted 11,448 11,448
======= =======
Fully diluted:
Weighted average number of common shares
outstanding, per consolidated financial
statements 11,448 11,448
Additional dilutive effect of:
Stock warrants - -
Outstanding stock options (based on
treasury stock method using market
price at end of period) - -
------- -------
Weighted average, as adjusted 11,448 11,448
======= =======
EARNINGS PER COMMON SHARE:
Primary $ .02 .20
Fully diluted .02 .20
Common stock warrants and stock options are considered to be
antidilutive for the period ended March 31, 1996. Earnings per
share for 1995 has been computed based upon 11,448,430 shares of
Company common stock distributed on January 23, 1996.
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 7
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-END> MAR-31-1996
<DEBT-HELD-FOR-SALE> 362,601
<DEBT-CARRYING-VALUE> 257,356
<DEBT-MARKET-VALUE> 253,648
<EQUITIES> 31,510
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 651,467
<CASH> 101,662
<RECOVER-REINSURE> 592,514
<DEFERRED-ACQUISITION> 11,343
<TOTAL-ASSETS> 1,652,832
<POLICY-LOSSES> 1,217,233
<UNEARNED-PREMIUMS> 49,323
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 54,876
0
0
<COMMON> 114
<OTHER-SE> 268,908
<TOTAL-LIABILITY-AND-EQUITY> 1,652,832
46,836
<INVESTMENT-INCOME> 12,670
<INVESTMENT-GAINS> 457
<OTHER-INCOME> (2,281)
<BENEFITS> 42,020
<UNDERWRITING-AMORTIZATION> 7,894
<UNDERWRITING-OTHER> 7,504
<INCOME-PRETAX> 264
<INCOME-TAX> 50
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 214
<EPS-PRIMARY> .02
<EPS-DILUTED> .02
<RESERVE-OPEN> 0
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 0
<PAYMENTS-PRIOR> 0
<RESERVE-CLOSE> 0
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
