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 June 30, 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 June 30, 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
June 30, 1996 (Unaudited) and
December 31, 1995 3
Consolidated Statements of Income
(Unaudited) - Three and Six Months Ended
June 30, 1996 and 1995 5
Consolidated Statements of Changes in
Stockholders' Equity - Six Months Ended
June 30, 1996 (Unaudited) and Year Ended
December 31,1995 6
Consolidated Statements of Cash Flows
(Unaudited) - Six Months Ended
June 30, 1996 and 1995 7
Condensed Notes to Unaudited Consolidated
Financial Statements 9
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 14
Part II - Other Information
Item 1. Legal Proceedings 21
Item 6. Exhibits and Reports on Form 8-K 23
Signatures 24
[/TABLE]
HIGHLANDS INSURANCE GROUP, INC.
CONSOLIDATED BALANCE SHEETS
(In Thousands)
[CAPTION]
June 30, December 31,
ASSETS 1996 1995
-------- ----------- -----------
(Unaudited)
[S] [C] [C]
INVESTMENTS:
Fixed income securities:
Available for sale, at fair value
(amortized cost of $256,037 at
6/30/96 and $216,093 at 12/31/95) $255,791 227,509
Held to maturity, at amortized cost
(fair value of $364,106 at 6/30/96 and
$396,729 at 12/31/95) 355,714 374,364
Equity securities, at fair value
(cost of $30,885 at 6/30/96 and
$31,966 at 12/31/95) 31,450 33,697
--------- ---------
Total investments 642,955 635,570
CASH AND CASH EQUIVALENTS 93,660 85,176
PREMIUMS IN COURSE OF COLLECTION 28,062 40,959
PREMIUMS DUE FROM POLICYHOLDERS UNDER
RETROSPIVE ARRANGEMENTS 141,116 134,428
RECEIVABLE FROM REINSURERS 581,700 602,380
DEFERRED TAXES 34,729 29,534
RECEIVABLE FROM FORMER AFFILIATES 27,719 41,255
OTHER ASSETS 60,590 66,789
---------- ---------
Total assets $1,610,531 1,636,091
========== =========
[/TABLE]
See Condensed Notes to Consolidated Financial Statements.
<TABLE>
HIGHLANDS INSURANCE GROUP, INC.
CONSOLIDATED BALANCE SHEETS, Continued
(In Thousands)
<CAPTION>
June 30, December 31,
LIABILITIES AND STOCKHOLDERS' EQUITY 1996 1995
------------------------------------- ----------- -----------
(Unaudited)
<S> <C> <C>
LOSS AND LOSS ADJUSTMENT EXPENSE $1,189,565 1,253,627
UNEARNED PREMIUMS 40,669 52,571
CONVERTIBLE SUBORDINATED DEBENTURES 55,068 -
FUNDS HELD 30,634 22,702
PAYABLE TO FORMER AFFILIATES 449 676
ACCOUNTS PAYABLE AND ACCRUED LIABILITIES 31,230 39,405
--------- ---------
Total liabilities 1,347,615 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 207 8,547
Retained earnings 70,103 73,395
--------- ---------
Total stockholders' equity 262,916 267,110
--------- ---------
Total liabilities and stockholders'
equity $1,610,531 1,636,091
========= =========
See Condensed Notes to Consolidated Financial Statements.
</TABLE>
<TABLE>
HIGHLANDS INSURANCE GROUP, INC.
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(In Thousands, except for per share amounts)
<CAPTION>
Three Months Six Months
Ended June 30, Ended June 30,
----------------- -----------------
1996 1995 1996 1995
-------- -------- ------- -------
<S> <C> <C> <C> <C>
REVENUES:
Net premiums earned $40,018 69,535 86,854 113,054
Net investment income 12,705 11,732 25,375 23,821
Net realized investment gains 209 270 666 435
------- ------- ------- -------
Total revenues 52,932 81,537 112,895 137,310
-------- ------- ------- -------
EXPENSES:
Loss and loss adjustment
expense incurred 40,223 65,194 82,243 104,564
Underwriting expenses 14,336 13,995 29,734 28,658
Other expenses (income), net 2,599 (531) 4,880 (1,090)
-------- -------- -------- --------
Total expenses 57,158 78,658 116,857 132,132
-------- -------- -------- --------
INCOME (LOSS) BEFORE INCOME TAX (4,226) 2,879 (3,962) 5,178
FEDERAL AND FOREIGN INCOME TAX
(BENEFIT) (720) - (670) -
-------- -------- -------- -------
NET INCOME (LOSS) $(3,506) 2,879 (3,292) 5,178
======== ======== ======== ========
NET INCOME (LOSS) PER COMMON $ (.31) .25 (.29) .45
SHARE ======== ======== ======== ========
</TABLE>
See Condensed Notes to Consolidated Financial Statements.
<TABLE>
HIGHLANDS INSURANCE GROUP, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(In Thousands)
<CAPTION>
June 30, 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
with attached common stock warrants 7,438 -
Change in par value of common stock 886 -
Contribution from former parent for:
net current tax benefit - 39,229
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 (8,340) 18,679
-------- --------
Balance, end of period 207 8,547
-------- --------
RETAINED EARNINGS:
Balance, beginning of year 73,395 194,137
Net loss (3,292) (120,742)
-------- --------
Balance, end of period 70,103 73,395
-------- --------
TOTAL STOCKHOLDERS' EQUITY $262,916 267,110
======== ========
</TABLE>
See Condensed Notes to Consolidated Financial Statements
<TABLE>
HIGHLANDS INSURANCE GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In Thousands)
<CAPTION>
Six months
ended June 30,
--------------------
1996 1995
-------- -------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $(3,292) 5,178
------- -------
Adjustment to reconcile net income (loss)to
net cash used in operating activities:
Depreciation and amortization (59) 259
Change in deferred policy
acquisition costs 2,431 187
Gain on sale of investments (607) (259)
Decrease in premiums in course of
collection 12,897 14,995
Decrease in receivables from reinsurers 20,680 13,550
Decrease in loss and loss adjustment
expense reserves (64,062) (39,750)
Decrease in funds on deposit with
reinsurer 4,280 2,730
Increase in premiums due from
policyholders under retrospective
arrangements (6,688) (24,341)
Decrease in unearned premiums (11,902) (509)
Increase in funds held 7,932 6,968
Advances from former affiliates, net 9,427 9,272
Change in other operating assets
and liabilities 1,775 10,326
-------- --------
Total adjustments (23,896) (6,572)
-------- --------
Net cash used in operating activities (27,188) (1,394)
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sales
Equity securities 3,539 999
Investment collections
Fixed income securities available
for sale 15,100 4,216
Fixed income securities held to
maturity 21,245 18,429
Investment purchases
Fixed income securities available
for sale (54,896) (26,601)
Fixed income securities held to
maturity (1,894) (1,879)
Equity securities (2,282) (1,300)
Purchases of property and equipment (818) (368)
Sales of property and equipment 121 41
Proceeds from disposal of subsidiary, net 22 -
Cash returned by (invested with)
former affiliates, net 3,860 (212)
-------- --------
Net cash used in investing activities (16,003) (6,675)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuance of convertible
subordinated debentures 60,000 -
Payment of debt issuance expense (5,705) -
Payment of interest expense on debt (2,620) -
-------- --------
Net cash provided by financing
activities 51,675 -
-------- --------
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS 8,484 (8,069)
CASH AND CASH EQUIVALENTS AT BEGINNING OF
PERIOD 85,176 52,789
-------- --------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $93,660 44,720
======== ========
</TABLE>
See Condensed Notes to Consolidated Financial Statements.
HIGHLANDS INSURANCE GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1996
1. BASIS OF PRESENTATION
---------------------
The accompanying condensed consolidated financial statements as
of June 30, 1996 and for both the three and six months periods
ended June 30, 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
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, to be not less than 100% of the fair value of
Company common stock on the date the option is granted.
However, in the case of incentive stock options, they are
generally granted at the fair market value at the time of the
grant. The options are typically exercisable over 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 June 30, 1996, 488,000 shares, principally
non-qualified options, were granted but not exercisable.
3. INCOME PER SHARE
----------------
The income per share amounts for both the three and six months
ended June 30, 1996 are based upon the weighted average number of
common shares outstanding during the period. The effects 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 (loss) per share amounts. The income per share amounts
for both the three and six months ended June 30, 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
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 common stock 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 common stock 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
The results of the Company's consolidated operations for three
months and six months ended June 30, 1996 and 1995 are set forth
below:
<TABLE>
<CAPTION>
Three months Ended Six months Ended
June 30, June 30,
--------------------- ------------------
1996 1995 1996 1995
------- ------- ------- -------
(Dollars in millions)
<S> <C> <C> <C> <C>
Consolidated Results
Direct premiums written $ 27.5 47.7 77.4 105.6
Net premiums written 27.2 40.9 69.1 88.2
======== ======== ======== =======
Net premiums earned:
Excluding Discontinued Lines $ 37.1 66.5 81.0 106.0
Discontinued Lines 2.9 3.1 5.9 7.1
-------- -------- -------- --------
$ 40.0 69.6 86.9 113.1
======== ======== ======== ========
Underwriting loss:
Excluding Discontinued Lines (13.9) (6.1) (23.1) (14.2)
Discontinued Lines (.6) (3.5) (2.0) (6.0)
-------- -------- -------- --------
Net investment income (14.5) (9.6) (25.1) (20.2)
12.7 11.7 25.4 23.8
Net realized investment gains .2 .3 .6 .5
Other (expense) income
(including taxes) (1.9) .5 (4.2) 1.1
-------- -------- -------- --------
Net income (loss) $ (3.5) 2.9 (3.3) 5.2
======== ======== ======== ========
Ratios:
Loss
100.5% 93.8% 94.7% 92.5%
Expense 35.8 20.1 34.2 25.3
-------- -------- -------- --------
Combined 136.3% 113.9% 128.9% 117.8%
======== ======== ======== ========
</TABLE>
The Company's consolidated results prior to 1996 have been
significantly influenced by the underwriting results of the
Discontinued Lines (see Underwriting Results 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 six months ended June 30, 1996 and
1995 amounted to $25.4 million and $23.8 million, respectively.
Net investment income for 1996 increased $1.6 million from 1995
primarily 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 and amount to $.2 million and $.3 million
and $.7 million and $.4 million for the three months and six
months ended June 30, 1996 and 1995, respectively.
Other expenses for the six months ended June 30, 1996 compared to
1995 increased by $5.3 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.
Total tax benefits for the three months and six months ended June
30, 1996 amounted to $.7 million and $.6 million, respectively.
<TABLE>
Underwriting Results Excluding Discontinued Lines
- -------------------------------------------------
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
------------------- -------------------
1996 1995 1996 1995
------ ------ ------ ------
(Dollars in millions)
<S> <C> <C> <C> <C>
Direct premiums written $ 25.3 43.1 72.1 95.0
Net premiums written 25.1 39.1 65.0 82.6
======= ======= ======= =======
Net premiums earned $ 37.1 66.5 80.9 106.0
Loss and loss
adjustment expense
incurred (37.9) (60.3) (76.8) (94.2)
Underwriting (13.1) (12.3) (27.2) (26.0)
------- ------- ------- -------
Underwriting results $ (13.9) (6.1) (23.1) (14.2)
======= ======= ======= =======
Ratios:
Loss 102.2% 90.1% 94.9% 88.9%
Expense 34.6 18.5 33.7 24.4
------- ------- ------- -------
Combined 136.8% 108.6% 128.6% 113.3%
======= ======= ======= =======
</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) Halliburton and
its affiliates (Insurance Services) and a mix of commercial
marine products (Marine Division).
Period to Period Comparisons of Underwriting Results Excluding
Discontinued Lines - For the Quarters Ended June 30, 1996 and
1995
Net Premiums Earned. Net premiums earned for the quarters ended
June 30, 1996 and 1995 amounted to $37.1 million and $66.5
million, respectively. Net premiums earned for the second
quarter of 1996 were reduced by $2.6 million of accrued premium
adjustments while the like period for 1995 included additional
earned premiums from Insurance Services retro policies of $25
million which did not reoccur in 1996. In addition, net premiums
earned were impacted by underwriting initiatives begun in March
1996. Stricter underwriting standards, branch closings and price
increases have all contributed to decreases in net premiums
earned. The above actions will continue to reduce net premiums
earned during the remainder of 1996. The 1996 net premiums
earned also continued to be impacted by decisions to exit the
probate bonding business produced by Southern California Bonding
Service, Incorporated (SCB). On March 1, 1996, the Company sold
all of the common stock of SCB and ceded reinsurance of 100% of
its inforce policies, subject to a profit sharing arrangement.
The quarter ended June 30, 1995, included $1.9 million of SCB net
premiums earned.
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.
Loss and Loss Adjustment Expense Incurred. Loss and loss
adjustment expense incurred for the quarters ended June 30, 1996
and 1995 amounted to $37.9 million and $60.3 million,
respectively. The decrease in 1996 of $22.4 million or 37% less
than 1995 can be attributed to lower incurred losses subject to
retrospectively rated policies and the declining premium volume.
The decline is offset slightly in the second quarter by a $2.0
million settlement of an unreserved environmental claim and loss
and loss adjustment expense strengthening for prior years
reserves.
Underwriting Expense. Underwriting expense for the quarters ended
June 30, 1996 and 1995 amounted to $13.1 million and $12.3
million, respectively. The increase in a period in which
premiums and losses are declining can be attributed to two items.
The first is a $1.1 million premium tax under-accrual that was
adjusted in the second quarter of 1996. The second item includes
a $1.2 million refund from the Texas Workers' Compensation
Insurance Facility (the "Insurance Facility")in 1995 which did
not reoccur in 1996.
Period to Period Comparisons of Underwriting Results Excluding
Discontinued Lines - For the Six Months Ended June 30, 1996
Net Premiums Earned. Net premiums earned for the six months ended
June 30, 1996 and 1995 amounted to $80.9 million and $106.0
million, respectively. The decrease of $25.1 million or 24% in
1996 is attributable to several factors including, as discussed
above, $2.6 million of accrued premium adjustments in 1996, $25
million net premiums earned increases in 1995 for Insurance Services
retrospectively rated policies and the recent underwriting
initiatives. Additionally, net premium earned in 1996 was
negatively impacted by $3.1 million of improperly classified
accrued premiums on retrospectively rated policies.
Loss and Loss Adjustment Expense Incurred. Loss and loss
adjustment expense incurred for the periods ended June 30, 1996
and 1995 amounted to $76.8 million and $94.2 million,
respectively. The decrease in 1996 of $17.4 million or 18% less
than 1995 reflects the lower incurred losses subject to
retrospectively rated policies and declining premium volume. The
decline is offset by adverse loss development on prior year
reserves.
Underwriting Expense. Underwriting expense for the periods ended
June 30, 1996 and 1995 amounted to $27.2 million and $26.0
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 plan 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. In the second quarter
of 1996, the Company recorded an adjustment of $1.1 million for
underaccrued premium taxes. Underwriting expense for 1995 also
included the benefit of a $1.2 million refund from the Insurance
Facility in 1995 which did not reoccur in 1996.
<TABLE>
Underwriting Results of Discontinued Lines
- ------------------------------------------
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
------------------- -----------------
1996 1995 1996 1995
-------- -------- -------- --------
(Dollars in millions)
<S> <C> <C> <C> <C>
Direct premiums written $ 2.2 $ 4.3 $ 5.3 $ 10.6
Net premiums written 2.1 1.8 4.1 5.6
======= ======== ======== ========
Net premiums earned $ 2.9 $ 3.1 $ 5.9 $ 7.1
Loss and loss adjustment expense
incurred (2.3) (4.9) (5.4) (10.4)
Underwriting expense (1.2) (1.7) (2.5) (2.7)
-------- -------- -------- --------
Underwriting results $ (0.6) $ (3.5) $ (2.0) $ (6.0)
======== ======== ======== ========
</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 (Highlands (UK)),
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 - For the Quarters and Six Months Ended June
30, 1996 and 1995
Net Premiums Earned. Net premiums earned were $2.9 million and
$3.1 million for the quarters and $5.9 and $7.1 for the six
months ended June 30, 1996 and 1995, respectively. The decline
for both periods 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 was $2.3 million and $4.9 million for the
quarters and $5.4 and $10.4 for the six months ended June 30,
1996 and 1995, respectively. The decline in loss and loss
adjustment expense for both the second quarter and the first six
months of 1996 reflects the decline in premium volume offset by
development on prior year loss reserves. In addition, the
Company's participation in an assumed reinsurance contract
resulted in a $.5 million loss from the ValuJet catastrophe in
the quarter ended June 30, 1996.
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 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 received $8
million of the tax benefit in February 1996 and the remaining $27
million 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. On June 28, 1996, Highlands paid a dividend to the
Company in the amount of $3 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 exceeded rates
then permitted under applicable Texas law and regulations. 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 was appropriate to reflect
the Company's estimate of the amount of the probable loss due.
On July 2, 1996, the named plaintiffs and a group of 14 insurance
company defendants, including the Company, entered into a
settlement agreement (the "Settlement Agreement"), and said
agreement has received preliminary approval of the court.
Pursuant to the terms of the Settlement Agreement, in July of
1996 notification of the settlement was published in several
Texas newspapers and mailed to all insureds within the settlement
class. If there are no appeals or opt-outs that would terminate
the Settlement Agreement, final approval of the agreement and the
distribution of the settlement fund should occur in the last
quarter of 1996. The Company's liability, pursuant to the terms
of the Settlement Agreement, is not in excess of current legal
reserves and is not expected to have a material adverse effect on
the financial position of the Company. In the event that the
Court does not approve the Settlement Agreement due to an appeal,
opt-outs or any other reason, the Company would continue to
defend this matter and its resolution 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 Commissioner on July 18, 1995. On
August 22, 1995 the 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 accordingly
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 insurance 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. There was a hearing pursuant to the above-referenced
Notice of Hearing during May 1996. The Company continues to
believe that it has meritorious defenses to a rollback liability.
Item 6: Exhibits and Reports on Form 8-K.
a) Exhibits
(12) Computation of Earnings Per Share
(27) Financial Data Schedule (Filed Electronically)
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 reporting the results of operations for the
three months and twelve months ended December 31, 1995,
and certain other selected financial data.
The Registrant filed a Form 8-K Current Report, dated
May 14, 1996 pertaining to the Registrants' press
release reporting the results of operations for the
three months ended March 31, 1996, and certain other
selected financial data.
The Registrant filed a Form 8-K Current Report, dated
June 21, 1996 pertaining to the Registrant's press
release of its agreement to acquire VIK Brothers
Insurance Inc.
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: August ___, 1996 By /s/ Richard M. Haverland
--------------------
Richard M. Haverland
Chairman, President and Chief
Executive Officer
(Authorized Signatory)Date:
August ___, 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 thousands, except for per share amounts)
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
------------------ ----------------
1996 1995 1996 1995
-------- ------- ------- -------
<S> <C> <C> <C> <C>
EARNINGS:
Primary (1):
Net income (loss), as reported $(3,506) 2,879 (3,292) 5,178
======= ======= ======= =======
Fully diluted (1)(2):
Net income (loss), as reported (3,506) 2,879 (3,292) 5,178
======= ======= ======= =======
SHARES:
Primary(1):
Number of common shares
outstanding, per consolidated
financial statements 11,448 11,448 11,448 11,448
======= ======= ======= =======
Fully diluted(1)(2):
Weighted average number of
common shares outstanding,
per consolidated financial
statements 11,448 11,448 11,448 11,448
======= ======= ======= =======
EARNINGS PER COMMON SHARE:
Primary $ (.31) .25 (.29) .45
Fully diluted (.31) .25 (.29) .45
1. Common stock purchase warrants and stock options are
antidilutive for the periods presented.
2. Common stock issuable upon conversion of the convertible
subordinated debt is antidilutive for all periods presented.
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 7
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-END> JUN-30-1996
<DEBT-HELD-FOR-SALE> 355,714
<DEBT-CARRYING-VALUE> 255,791
<DEBT-MARKET-VALUE> 256,037
<EQUITIES> 31,450
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 642,955
<CASH> 93,660
<RECOVER-REINSURE> 581,700
<DEFERRED-ACQUISITION> 9,313
<TOTAL-ASSETS> 1,610,531
<POLICY-LOSSES> 1,189,565
<UNEARNED-PREMIUMS> 40,669
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 55,068
0
0
<COMMON> 114
<OTHER-SE> 262,916
<TOTAL-LIABILITY-AND-EQUITY> 1,610,531
86,854
<INVESTMENT-INCOME> 25,375
<INVESTMENT-GAINS> 660
<OTHER-INCOME> (4,880)
<BENEFITS> 82,243
<UNDERWRITING-AMORTIZATION> 16,223
<UNDERWRITING-OTHER> 13,511
<INCOME-PRETAX> (3,962)
<INCOME-TAX> (670)
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (3,292)
<EPS-PRIMARY> (.31)
<EPS-DILUTED> (.31)
<RESERVE-OPEN> 0
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 0
<PAYMENTS-PRIOR> 0
<RESERVE-CLOSE> 0
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
