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, 1997
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 Avenue, Houston, Texas 77042
- -------------------------------------- -------------------------
(Address of principal executive (Zip Code)
offices)
Registrant's telephone number, including area code (713) 952-9555
-------------
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, 1997 was 11,451,541
HIGHLANDS INSURANCE GROUP, INC.
TABLE OF CONTENTS
-----------------
Part I - Financial Information
Item 1. Financial Statements: Page No.
--------
Consolidated Balance Sheets
March 31, 1997 (Unaudited) and
December 31, 1996 3
Consolidated Statements of Income
(Unaudited) - Three Months Ended March 31,
1997 and 1996 5
Consolidated Statements of Stockholders' Equity
Three Months Ended March 31, 1997 (Unaudited)
and Year Ended December 31, 1996 6
Consolidated Statements of Cash Flows
(Unaudited) - Three Months Ended March 31,
1997 and 1996 7
Condensed Notes to Unaudited Consolidated
Financial Statements 9
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 16
Part II - Other Information
Item 1. Legal Proceedings 24
Item 6. Exhibits and Reports on Form 8-K 25
Signatures 26
<TABLE>
HIGHLANDS INSURANCE GROUP, INC.
CONSOLIDATED BALANCE SHEETS
(In Thousands)
<CAPTION>
March 31, December 31,
ASSETS 1997 1996
-------- ----------- -----------
(Unaudited)
<S> <C> <C>
Investments:
Fixed income securities
Available for sale, at fair value
(amortized cost of $315,539 at
3/31/97 and $320,909 at 12/31/96) $ 314,175 324,905
Held to maturity, at amortized cost
(fair value of $355,547 at 3/31/97 and
$367,446 at 12/31/96) 349,663 355,492
Equity securities, at fair value
(cost of $24,292 at 3/31/97 and
$26,293 at 12/31/96) 24,853 26,967
Other invested assets, at cost 3,423 3,770
--------- ---------
Total investments 692,114 711,134
Cash and cash equivalents 59,051 49,484
Premiums in course of collection 18,917 24,048
Premiums due under retrospective arrangements
119,097 121,276
Receivable from reinsurers 571,834 556,900
Funds on deposit with reinsurers 16,562 14,456
Deferred taxes 38,751 37,126
Accrued investment income 10,787 12,600
Deferred policy acquisition costs 5,842 6,436
Other assets 29,951 32,571
--------- ---------
Total assets $1,562,906 1,566,031
========== =========
See Condensed Notes to Unaudited Consolidated Financial Statements.
</TABLE>
<TABLE>
HIGHLANDS INSURANCE GROUP, INC.
CONSOLIDATED BALANCE SHEETS, Continued
(In Thousands)
<CAPTION>
March 31, December 31,
LIABILITIES AND STOCKHOLDERS' EQUITY 1997 1996
------------------------------------- ----------- -----------
(Unaudited)
<S> <C> <C>
Loss and loss adjustment expense $1,162,360 1,156,824
Unearned premiums 29,257 31,474
Convertible subordinated debentures 55,646 55,452
Funds held 19,712 16,475
Accounts payable and accrued liabilities 32,991 42,331
--------- ---------
Total liabilities 1,299,966 1,302,556
--------- ---------
Commitments and contingent liabilities
Stockholders' equity:
Common stock, $.01 par value; 50,000,000
shares authorized; 11,451,541 issued and
outstanding in 1997, 11,448,208 issued and
outstanding in 1996
114 114
Additional paid-in capital 192,339 192,273
Net unrealized (loss) gain on investments
(522) 3,036
Retained earnings 71,009 68,052
--------- ---------
Total stockholders' equity 262,940 263,475
--------- ---------
Total liabilities and stockholders'
equity $1,562,906 1,566,031
========== ==========
See Condensed Notes to Unaudited Consolidated Financial Statements.
</TABLE>
<TABLE>
HIGHLANDS INSURANCE GROUP, INC.
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(In Thousands)
<CAPTION>
Three Months
Ended March 31,
-------------------
1997 1996
-------- --------
<S> <C> <C>
Revenues:
Net premiums earned $ 29,715 46,836
Net investment income 12,857 12,670
Net realized investment gains 484 457
-------- --------
Total revenues 43,056 59,963
-------- --------
Expenses:
Losses and loss adjustment
expenses incurred 27,831 42,020
Underwriting expenses 9,524 15,398
Interest expense and debt amortization
1,798 1,430
Other expenses 354 851
-------- --------
Total expenses 39,507 59,699
-------- --------
Income before income tax 3,549 264
Income tax expense 592 50
-------- --------
Net income $ 2,957 214
======== ========
Net income per common share and common
stock equivalents - primary $ .21 .02
======== ========
Weighted average number of common
shares and common stock equivalents
outstanding 14,620 11,448
======== ========
See Condensed Notes to Unaudited Consolidated Financial Statements.
</TABLE>
<TABLE>
HIGHLANDS INSURANCE GROUP, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(In Thousands)
<CAPTION>
March 31, December 31,
1997 1996
-------- ---------
(Unaudited)
<S> <C> <C>
Common stock
Balance, beginning of year $ 114 1,000
Change in par value of common stock - (886)
-------- --------
Balance, end of period 114 114
-------- --------
Additional paid-in capital:
Balance, beginning of year 192,273 184,168
Addition resulting from issuance of
convertible subordinated debentures
with detachable common stock warrants 7,439
Change in par value of common stock 886
Contribution from former parent:
Net current tax asset 7,723
Net deferred tax asset (7,943)
Addition resulting from shares issued under
stock option plans 66 -
-------- --------
Balance, end of period 192,339 192,273
-------- --------
Net unrealized gain (loss) on investments:
3,036 8,547
Balance, beginning of year
Changes in net unrealized (loss) gain,
net of the applicable federal income
tax (3,558) (5,511)
-------- --------
Balance, end of period (522) 3,036
-------- --------
Retained earnings:
Balance, beginning of year 68,052 73,395
Net income (loss) 2,957 (5,343)
-------- --------
Balance, end of period 71,009 68,052
-------- --------
Total stockholders' equity $262,940 263,475
======== ========
See Condensed Notes to Unaudited Consolidated Financial Statements
</TABLE>
<TABLE>
HIGHLANDS INSURANCE GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In Thousands)
<CAPTION>
Three months ended
March 31,
-------------------
1997 1996
-------- --------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 2,957 214
-------- --------
Adjustment to reconcile net income to net
cash used in operating activities:
Depreciation and amortization 37 (4)
Change in deferred policy acquisition
costs 594 401
Gain on sale of investments (486) (350)
Decrease in premiums in course of
collection 5,131 3,559
(Increase) decrease in receivables from
reinsurers (14,934) 9,866
Increase (decrease) in loss and loss
adjustment expense reserves 5,536 (36,394)
(Increase) decrease in funds on deposit
with reinsurer (2,106) 944
Decrease in deferred taxes 592 -
Decrease (increase) in premiums due
under retrospective arrangements 2,179 (2,236)
Decrease in unearned premiums (2,217) (3,248)
Increase in funds held 3,237 1,636
Advances from former affiliates, net - 9,431
Change in other operating assets and
liabilities (4,974) (1,183)
-------- --------
Total adjustments (7,411) (17,578)
-------- --------
Net cash (used in) operating activities (4,454) (17,364)
-------- --------
Cash flows from investing activities:
Proceeds from sales
Equity securities 2,162 3,028
Other invested assets 621 -
Maturities or calls
Fixed maturity securities available for
sale 18,486 7,475
Fixed maturity securities held to
maturity 5,972 14,167
Investment purchases
Fixed maturity securities available for
sale (13,028) (44,950)
Fixed maturity securities held to
maturity - (1,894)
Equity securities - (2,014)
Net additions to property and
equipment (192) (139)
Proceeds from disposal of subsidiary, net - 22
Cash returned by former affiliates, net - 3,860
-------- --------
Net cash provided by (used in) investing
activities 14,021 (20,445)
-------- --------
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 in cash and cash equivalents 9,567 16,486
Cash and cash equivalents at beginning of period
49,484 85,176
-------- --------
Cash and cash equivalents at end of period $ 59,051 101,662
======== ========
See Condensed Notes to Unaudited Consolidated Financial Statements.
</TABLE>
HIGHLANDS INSURANCE GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1997
1. Basis of Presentation
---------------------
The accompanying consolidated financial statements as of March
31, 1997 and for the three-month period ended March 31, 1997 and
1996 are unaudited and include the accounts of Highlands
Insurance Group, Inc., (HIC) and its subsidiaries (the Company).
The Company is an insurance holding Company for Highlands
Insurance Company (Highlands) and its wholly-owned subsidiaries
including Highlands Lloyds, a controlled insurance affiliate,
Highlands Insurance Company (U.K.) Limited (Highlands UK) (a
foreign reinsurance company located in the United Kingdom) and
certain other insignificant companies (collectively, the
Insurance Subsidiaries). 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, 1996.
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
Statement Of Financial Accounting Standards No. 123, "Accounting
for Stock-Based Compensation" (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.
Pursuant to the Company's 1995 Stock Option Plan, HIC may grant
either incentive stock options (ISO) or non-qualified stock
options (NQSO). The exercise price for each share subject to an
option will be an amount that the Compensation Committee
determines, in its good faith judgment. In the case of ISOs,
however, the exercise price per share shall not be less than the
amount the 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. 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
of company common stock that are reserved for issuance under all
option plans is 750,000 at March 31, 1997. Subsequent to March
31, 1997 the maximum number of shares of company common stock
reserved for issuance under all option plans was increased to
1,200,000.
3. Income Tax
----------
The Company provides for income taxes on its statements of income
pursuant to Statement of Financial Accounting Standards 109,
"Accounting for Income Taxes" (SFAS 109). With respect to losses
for periods preceding the Distribution (January 23, 1996), no tax
benefit was recorded in the statements of income pursuant to SFAS
109 and the Company's tax-sharing arrangement with its former
parent, Halliburton Company. Tax receipts under its intercompany
tax-sharing arrangements with its former parent were recorded as
additions to stockholders' equity for the periods preceding the
Distribution.
4. Net Income Per Share
--------------------
Primary net income per share amounts are based upon the weighted
average number of common stock shares and common stock
equivalents, common stock warrants and options outstanding during
the period. Common stock warrants and stock options (common
stock equivalents) are antidilutive for primary net income per share
for the three months ended March 31, 1996. Fully diluted net
income per share is not presented as the effects of the
convertible subordinated debentures are antidilutive for all
periods presented.
5. Debt Outstanding
----------------
On January 23, 1996, HIC issued $62.85 million in principal
amount of 10% convertible subordinated debentures (Debentures)
due December 31, 2005, together with Series A and A-2
(collectively the "Series A Warrants") and Series B and B-2
(collective the "Series B Warrants") common stock purchase
warrants, to Insurance Partners, L.P., and Insurance Partners
Offshore (Bermuda), L.P. (collectively "IP") and to certain
members of the Company's management team (Management Investors).
The Company received $60 million in cash from IP and the
Management Investors and individual promissory notes (each, a
"Promissory Note" and, collectively, the "Promissory Notes") in
the aggregate principal amount of $2.85 million made by the
individual Management Investors without personal liability and
secured by a pledge of Debentures. The Debentures issued in
exchange for the Management Investors Promissory Note were issued
pursuant to a Purchase, Redemption and Bonus Agreement (the
"Purchase Agreement").
The carrying values of the Debentures, Series A Warrants and
Series B Warrants at the Distribution date were determined by
allocating the $62.85 million purchase price based upon estimated
relative fair value of such securities. The estimated fair value
of the Series A Warrants and Series B Warrants amounting to $8.2
million was recorded in paid-in capital, net of $.8 million of
Debenture's acquisition costs. The debt discount related to the
Series A Warrants and Series B Warrants is being amortized over
the ten-year life of the Debentures.
The Debentures issued are convertible into common stock of HIC
after one year from issuance at the option of the holders. If
all of the debentures are converted into HIC common stock at a
conversion price of $16.16 per share, the holders would receive
approximately 3.9 million shares of HIC, or approximately 25%
ownership interest in HIC. 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 $12.71 per share, equal
to an additional ownership interest in HIC 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 related to
adverse loss reserve and uncollectible reinsurance development.
Such adjustment reduced the exercise price by $.18 and $1.80 per
share in 1997 and 1996, respectively. 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 $12.71 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 between January 1, 1999
and December 31, 2000. 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 related to
adverse loss reserve and uncollectible reinsurance development.
Such adjustment reduced the exercise price by $.18 and $1.80 per
share in 1997 and 1996, respectively. These warrants expire
on December 31, 2005.
The Purchase Agreement further provides for a bonus to be paid to
each Management Investor on the fifth anniversary of the Purchase
Agreement if the average closing price of the Company common
stock is equal to or greater than prices expressed as a
percentage of the exercise price of the Series A Warrants (as
adjusted from time to time) as specified in the Purchase
Agreement (the "Bonus Trigger Stock price"). The amount of the
bonus is stated as a percentage of a maximum bonus amount
separately determined for each Management Investor and equal to
the aggregate principal amount of each Management Investor's
Promissory Note. If the Bonus Trigger Stock Price is at least
1.40 times but less than 1.50 times the Series A Warrant exercise
price, the bonus is 25% of the maximum bonus amount, 50% if the
Bonus Trigger Stock price is at least 1.50 but less than 1.61
times the Series A Warrant exercise price and 100% if the Bonus
Trigger Stock price is 1.61 times the Series A Warrant exercise
price or higher.
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, IP and the Management Investors will have an
ownership interest in HIC of approximately 44%.
6. 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.
7. 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, 1996 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.
8. Subsequent Event
----------------
On April 30, 1997, HIC acquired Vik Brothers Insurance, Inc. and
its subsidiaries (VBII). The acquisition was financed with
a combination of common stock, bank debt, preferred stock and cash.
VBII is an insurance holding company that primarily writes commercial
property and casualty business for small to medium sized
companies and, to a lesser extent, personal lines business. The
acquisition was completed pursuant to a merger between HIC's
wholly-owned subsidiary, Highlands Acquisition Corp., and VBII
pursuant to an Amended and Restated Merger Agreement dated
February 13, 1997, as amended. In connection with the acquisition,
HIC paid approximately $55.4 million in cash (including $35.6
million to repay VBII's outstanding bank debt) and issued
1,656,780 shares of its common stock (representing approximately
12.6% of HIC's then outstanding common stock) and 21,366 shares
of newly issued preferred stock to the holders of the common
stock warrants, preferred stockholders and creditors of VBII.
The closing price of HIC's common stock was $17.625 on April 30,
1997. The preferred stock has a preference value of $1,000 per share.
Simultaneously with the closing, HIC contributed approximately
$41.5 million to the capital of the insurance companies within
the VBII organization. Upon consummation of the acquisition,
VBII was renamed American Reliance, Inc.
In connection with the acquisition, HIC obtained a $65
million senior credit facility from a consortium of banks led by
The Chase Manhattan Bank. HIC funded the cash portion of
the acquisition by utilizing the credit facility and available working
capital.
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations
For reporting purposes, the Company has three lines of business
which are considered discontinued (Discontinued Lines): (i)
business originated by the Company's London reinsurance
operations (Highlands (UK)), (ii) an umbrella/excess liability
policy program and (iii) 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 its Florida and Texas personal lines
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 1996 Form 10-K for a more complete
description of the Discontinued Lines.)
The results of the Company's consolidated operations for the
periods indicated are set forth below:
<TABLE>
<CAPTION>
Period Ended March 31,
---------------------
1997 1996
------- -------
(Dollars in millions)
<S> <C> <C>
Consolidated Results:
Gross premiums written $ 31.0 51.9
Net premiums written $ 28.0 44.1
======== ========
Net premiums earned:
Excluding Discontinued Lines $ 29.5 43.8
Discontinued Lines .2 3.0
-------- -------- ---
$ 29.7 46.8
======== ========
Underwriting loss:
Excluding Discontinued Lines $ (6.0) (9.1)
Discontinued Lines (1.6) (1.5)
-------- --------
$ (7.6) (10.6)
======== ========
Net investment income $ 12.9 12.7
======== ========
Net realized investment gains $ .5 .5
======== ========
Interest expense and debt
amortization $ 1.8 1.4
======== ========
Other expense $ .4 .9
======== ========
Net income $ 3.0 .2
======== ========
Ratios:
Loss 93.7% 89.7%
Expense 32.1% 32.9
-------- --------
Combined 125.8% 122.6%
======== ========
</TABLE>
The Company's consolidated results have been influenced by the
underwriting results of the Discontinued Lines (see Underwriting
Results of Discontinued Lines). In order to indicate the
magnitude 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, 1997 and
1996 amounted to $12.9 million and $12.7 million, respectively.
Net investment income for the first three months 1997 increased
$.2 million from 1996 primarily as a result of additional
investable funds from the issuance of the Debentures and tax
proceeds from the Company's former parent. Net realized
investment gains have not been a significant portion of revenue
for the Company.
Interest expense and debt amortization for the period ended March
31, 1997 compared with the same period for 1996 increased as a
result of the Debentures being outstanding for the full three
months in 1997.
Other expenses for the period ended March 31, 1997 compared to to
the same period in 1996 decreased by $.5 million due to a
decrease in incentive compensation accruals.
Gross premiums written and net premiums written have been
redefined for 1996 to include the effects of changes in premiums
due under retrospective policies. Such changes were previously
recorded only as net premiums earned.
<TABLE>
Underwriting Results Excluding Discontinued Lines
- -------------------------------------------------
<CAPTION>
Period Ended March 31,
---------------------
1997 1996
------ ------
(Dollars in millions)
<S> <C> <C>
Gross premiums written $ 30.4 48.8
Net premiums written $ 27.9 42.1
======= =======
Net premiums earned $ 29.5 43.8
Losses and loss adjustment expenses
incurred (26.3) (38.9)
Underwriting expense (9.2) (14.0)
------- -------
Underwriting loss $ (6.0) (9.1)
------- -------
Ratios:
Loss 89.2% 88.8%
Expense 31.2% 32.0
------- -------
Combined 120.4% 120.8%
======= =======
</TABLE>
The underwriting results excluding Discontinued Lines primarily
consist of relatively large commercial accounts (Special
Accounts), medium to small commercial accounts (Commercial
Insurance) insurance for Halliburton (Insurance Services),
commercial marine products (Marine Division) and surety products
(Surety Division).
Period to Period Comparisons of Underwriting Results Excluding
Discontinued Lines
Gross Premiums Written. Gross premiums written for the periods
ended March 31, 1997 and 1996 amounted to $30.4 million and $48.8
million, respectively. The decrease of $18.4 million or 38% in
1997 is attributable to several factors. The Company began its
underwriting initiatives in March 1996 and continues to focus on
stricter underwriting standards and price increases both of which
have contributed to declines in gross premiums written. Also
contributing to declines in gross premiums written is the
continued highly competitive market conditions for Special
Accounts customers. Special Accounts remains more selective in
its initial underwriting as well as renewal activity. Finally,
Special Accounts gross premium written decreased due to decreased
losses on retrospectively rated policies.
Gross premiums written for the three months ended March 31, 1996
were negatively impacted by $3.1 million of improperly classified
accrued premiums on retrospectively rated policies.
Gross premiums written 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 gross
premiums written and premiums due from policyholders under
retrospectively rated policies for changes in estimated ultimate
losses and loss adjustment expenses from the date of the prior
valuation. These adjustments may cause gross premiums written to
fluctuate significantly from period to period. Experience rated
contracts reduce but do not eliminate risk to the insurer.
Net Premiums Written. Net premiums written for the periods ended
March 31, 1997 and 1996 amounted to $27.9 million and $42.1
million, respectively. The decrease of $14.2 million or 34% in
1997 is primarily related to the same issues affecting gross
premiums written.
Net Premium Earned. Net premiums earned for the periods ended
March 31, 1997 and 1996 amounted to $29.5 million and $43.8
million, respectively. The decrease of $14.3 million or 33% in
1997 is also related to the same issues affecting gross premiums
written.
Losses and Loss Adjustment Expenses Incurred. Losses and loss
adjustment expenses incurred for the periods ended March 31, 1997
and 1996 amounted to $26.3 million and $38.9 million,
respectively. The decrease in 1997 of $12.6 million or 32% less
than 1996 is related to the declining premium volume.
Underwriting Expense. Underwriting expense for the periods ended
March 31, 1997 and 1996 amounted to $9.2 million and $14.0
million, respectively. The decrease in 1997 of $4.8 million is
related to declining premium volume and previous expense saving
initiatives. The period ended March 31, 1996 was negatively
impacted by the Company's implementation of a plan under which it
recorded a $1.3 million restructuring charge as part of its
strategic and financial assessment of the Company's business.
<TABLE>
Underwriting Results of Discontinued Lines
- ------------------------------------------
<CAPTION>
Period Ended March 31,
---------------------
1997 1996
-------- --------
(Dollars in millions)
<S> <C> <C>
Gross premiums written $ .6 3.1
Net premiums written $ .1 2.0
======= =======
Net premiums earned .2 3.0
Losses and loss adjustment expenses
incurred (1.5) (3.1)
Underwriting expense (.3) (1.4)
------- -------
Underwriting results $ (1.6) (1.5)
======= =======
</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 and canceled all remaining assumed casualty
and property reinsurance contracts during 1996.
Period to Period Comparisons of Underwriting Results of
Discontinued Lines
Net Premiums Earned. Net premiums earned were $.2 million and
$3.0 million for the periods ended March 31, 1997 and 1996,
respectively. The decline is due to the runoff of canceled
assumed reinsurance and the declining premiums from Highlands
(UK), which ceased writing new business in 1993. However, due to
the nature of the Company's policies and reinsurance contracts,
small premium adjustments can continue subsequent to
cancellation.
Loss and Loss Adjustment Expense Incurred. Loss and loss
adjustment expense for the period ended March 31, 1997 compared
to 1996 decreased by $1.6 million. The decline in loss and loss
adjustment expense for the first quarter 1997 reflects the
decline in premium volume offset by development on prior year
loss reserves.
Liquidity and Capital Resources
The Company is a holding company, the principal asset of which is
all of the capital stock of Highlands and $47.6 million of fixed
maturities and cash and cash equivalent investments at March 31,
1997. The Company's property and casualty insurance business is
conducted by Highlands and its wholly-owned insurance
subsidiaries. The liquidity and capital resource considerations
for the Company are different than those of its insurance
operations.
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 Highlands as a contribution to surplus,
paid approximately $5.7 million in transactions fees and
reimbursement of out-of-pocket expenses incurred in connection
with the issuance of the Debentures and Warrants 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 income 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. In 1996, the Company
received from Halliburton and forwarded to its subsidiaries
approximately $42.2 million in cash related to the tax benefit of
the significant tax losses incurred in 1995 which are utilizable
by Halliburton.
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 1997 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 are 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.
On April 30, 1997, HIC acquired Vik Brothers Insurance, Inc. and
its subsidiaries (VBII). The acquisition was financed with a
combination of common stock, bank debt, preferred stock and cash.
VBII is an insurance holding company that primarily writes
commercial property and casualty business for small to medium
sized companies and, to a lesser extent, personal lines business.
The acquisition was completed pursuant to a merger between HIC's
wholly-owned subsidiary, Highlands Acquisition Corp., and VBII
pursuant to an Amended and Restated Merger Agreement dated
February 13, 1997, as amended. In connection with the acquisition,
HIC paid approximately $55.4 million in cash (including $35.6 million
to repay VBII's outstanding debt) and issued 1,656,780 shares
of its common stock (representing approximately 12.6% of HIC's then
outstanding common stock) and 21,366 shares of its preferred
stock to the holders of the common stock warrants, preferred
stockholders and creditors of VBII. The closing price of
HIC's common stock was $17.625 on April 30, 1997. The
preferred stock has a preference value of $1,000 per share.
Simultaneously with the closing, HIC contributed
approximately $41.5 million to the capital of the insurance
companies within the VBII organization. Upon consummation of the
acquisition, VBII was renamed American Reliance, Inc.
In connection with the acquisition, HIC obtained a $65 million
senior credit facility from a consortium of banks led by
The Chase Manhattan Bank. HIC funded the cash portion of
the acquisition by utilizing the credit facility and available
working capital.
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.
Statutory Surplus. Maintenance of appropriate levels of
statutory surplus of the Company's U.S. Insurance Subsidiaries is
a primary objective of the Company and is also important to
regulatory authorities and U.S. insurance rating agencies. In
addition, increased public and regulatory concerns regarding the
financial stability of participants in the insurance industry
have caused greater emphasis to be placed by current and
potential customers upon the ratings assigned to property and
casualty insurance companies. Each of the U.S. Insurance
Subsidiaries and Highlands have been assigned as "A-" (Excellent)
rating by A.M. Best.
The National Association of Insurance Commissioners (NAIC) has
adopted risk based capital ("RBC") requirements that require
insurance companies to calculate and report information under a
risk-based formula which measures statutory capital and surplus
needs based on a regulatory definition of risk with respect to a
company's mix of products and its balance sheet. Highlands'
authorized control level RBC, as defined by the NAIC, was $56.6
million on December 31, 1996 which was substantially below
Highlands' existing capital of $187.0 million. The other U.S.
Insurance Subsidiaries have an RBC amount above the authorized
control level RBC as defined by the NAIC.
The NAIC's Insurance Regulatory Information System ("IRIS") was
developed by a committee of state insurance regulators primarily
to assist state insurance departments in executing their
statutory mandate to oversee the financial condition of insurance
companies operating in their respective states. IRIS helps to
identify those companies that merit the highest priority in the
allocation of the regulators' resources on the basis of eleven
financial ratios which are calculated annually from financial
information obtained from insurers' statutory annual statements.
A "usual range" of results for each ratio is used as a benchmark.
The ratios and benchmark comparisons are calculated within
defined parameters and are not intended to replace the Insurance
Commissioners' own in-depth financial analysis or on-site
examinations. Departure from the usual range on three or more of
the ratios could lead to inquiries from individual Commissioners.
An annual range of ratio results has been established from
studies of companies that have become insolvent or have
experienced financial difficulties. The analytical phase is a
review of annual statements and the financial ratios. Companies
that receive financial ratio values outside the usual range
generally are analyzed in order to identify those companies that
appear to require immediate regulatory attention. A more
comprehensive review of the ratio results in an insurer's annual
statement is performed later to confirm that an insurer's
situation in fact calls for increased and closer regulatory
attention. If the review confirms that the insurer's situation
should be accorded a higher priority in the Insurance
Commissioners' surveillance process, the insurer receives a
"second priority" designation. Highlands received "second
priority" designation as a result of the review of its financial
ratio results and statutory annual statements for 1996. The
primary reason Highlands received a "second priority" designation
was due to the large reserve increase it recorded in 1995.
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
-----------------
The following class action lawsuit was received by the Company in
April 1997 and involves Highlands' membership in the Texas
Workers Compensation Insurance Facility (Facility). The suit,
styled as Butler Weldments Corporation and Bryan Construction
Company, individually and on behalf of plaintiff class v. Liberty
Mutual Insurance Company et. al, individually and on behalf of
defendant class, was filed in District Court of Milam County, Texas.
Some of the plaintiffs in this suit are retrospective policyholders
that were insured by defendants and are alleging damages due to
the failure by the defendants, including Highlands, to rebate
excess premiums returned to defendants by the Facility as
specified as in the Texas Insurance Code. Because this
litigation is in its early stages and because the Texas
Insurance Department has not adopted regulations establishing
a method for determining the amount of premiums to be rebated
to policyholders, Highlands is currently unable to determine
its ultimate liability, if any, with respect to this litigation
or with respect to such anticipated regulations. Management,
however, does not believe that this matter will have a material
adverse effect on the financial position of the Company although
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 such matter is resolved.
On February 3, 1997, litigation between Highlands and Highlands
Underwriters and the California Insurance Department converning
Proposition 103 was settled for $5.7 million and such amount is
not in excess of current legal reserves and is not expected to
have a material adverse effect on the financial condition of the
Company. The settlement has been submitted to the Administrative
Law Judge and the Commissioner of Insurance for their approval,
and the Company has no reason to believe at this time that the
settlement will not be approved. In the event the settlement is
not approved, the Company will continue to defend this matter
vigorously.
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
February 25, 1997, pertaining to the Registrant's press
release reporting the results of operations for the
three months and twelve months ended December 31, 1996,
and certain other selected financial data.
The Registrant filed a Form 8-K Current Report, dated
March 31, 1997, pertaining to the Registrant's press
release on the status of the Registrant's acquisition of
Vik Brothers Insurance Inc.
The Registrant filed a Form 8-K Current Report, dated
April 30, 1997, pertaining to the Registrant's press
release of the Registrant's completion of the
acquisition of Vik Brothers Insurance, Inc.
The Registrant filed a Form 8-K Current Report, dated
May 7, 1997, pertaining to the Registrant's press
release reporting the results of operations for the
three months ended March 31, 1997, and certain other
selected financial data.
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, 1997 By /s/ Richard M. Haverland
--------------------
Richard M. Haverland
Chairman, President and Chief
Executive Officer
(Authorized Signatory)
Date: May 15, 1997 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,
---------------------
1997 1996
-------- --------
<S> <C> <C>
EARNINGS:
Primary:
Net income, as reported $ 2,957 214
After tax interest income on excess
stock warrant and option proceeds 168 -
------- -------
Net income, as adjusted 3,125 214
======= =======
Fully diluted:
Net income, as reported - -
After tax interest income on excess
stock warrant and option proceeds
After tax interest expense applicable to
Convertible Subordinated Debentures - -
------- -------
Net income, as adjusted - -
======= =======
SHARES:
Primary:
Number of common shares outstanding, per
consolidated financial statements 11,452 11,448
Additional dilutive effect of
outstanding stock warrants and options
(based on treasury stock method using
average market price) 3,168 -
------- -------
Weighted average, as adjusted 14,620 11,448
======= =======
Fully diluted:
Weighted average number of common shares
outstanding, per consolidated financial
statements - -
Additional dilutive effect of:
Stock warrants and options - -
Outstanding stock options (based on
treasury stock method using market
price at end of period) - -
------- -------
Weighted average, as adjusted - -
======= =======
EARNINGS PER COMMON SHARE:
Primary $ .21 .02
Fully diluted - -
</TABLE>
Common stock warrants and stock options are antidilutive for the
period ended March 31, 1996. Fully diluted earnings per share is
not presented as the effects of the convertible subordinated
debentures are antidilutive for all periods presented.
[ARTICLE]
[LEGEND]
HIGHLANDS INSURANCE GROUP, INC.
FINANCIAL DATA SCHEDULE
This schedule contains summary financial information extracted
from the financial statements contained in the Form 10-Q for the
quarterly period ended March 31, 1997 for Highlands Insurance
Group, Inc. and its qualified in its entirety by reference to
such statements.
