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, 1998
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.)
1000 Lenox Drive,
Lawrenceville, New Jersey 08648
- -------------------------------------- -------------------------
(Address of principal executive (Zip Code)
offices)
Registrant's telephone number, including area code (609) 896-1921
-------------
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, 1998 was 13,195,431
HIGHLANDS INSURANCE GROUP, INC.
TABLE OF CONTENTS
-----------------
Part I - Financial Information
Item 1. Financial Statements: Page No.
--------
Consolidated Balance Sheets
March 31, 1998(Unaudited) and
December 31, 1997 3
Consolidated Statements of Operations
(Unaudited) - Three Months Ended
March 31, 1998 and 1997 5
Consolidated Statements of Stockholders' Equity
Three Months Ended March 31, 1998
(Unaudited) and Year Ended December 31, 1997 6
Consolidated Statements of Comprehensive
Income 7
Consolidated Statements of Cash Flows
(Unaudited) - Three Months Ended March 31,
1998 and 1997 8
Condensed Notes to Unaudited Consolidated
Financial Statements 10
Item 2.Management's Discussion and Analysis of
Financial Condition and Results of Operations 15
Part II - Other Information
Item 1. Legal Proceedings 23
Item 6. Exhibits and Reports on Form 8-K 23
Signatures 24
<TABLE>
HIGHLANDS INSURANCE GROUP, INC.
CONSOLIDATED BALANCE SHEETS
(In Thousands)
<CAPTION>
March 31, December 31,
ASSETS 1998 1997
-------- ------------ ------------
(Unaudited)
<S> <C> <C>
Investments:
Fixed income securities - available-for-
sale, at fair value (amortized cost of
$1,077,667 at 3/31/98 and $1,132,249
at 12/31/97) $1,107,263 1,166,585
Equity securities, at fair value
(cost of $2,405 at 3/31/98 and
$1,410 at 12/31/97) 2,541 1,554
Other invested assets, at cost 4,058 4,061
--------- ---------
Total investments 1,113,862 1,172,200
Cash and cash equivalents 61,408 60,717
Premiums in course of collection, net 86,819 84,977
Premiums due under retrospective policies 131,084 130,150
Receivable from reinsurers 734,961 723,114
Prepaid reinsurance premiums 13,942 24,451
Funds on deposit with reinsurers 20,009 20,172
Net deferred tax asset 66,535 64,043
Accrued investment income 14,226 16,459
Deferred policy acquisition costs 32,450 32,313
Other assets 50,543 38,060
--------- ---------
Total assets $2,325,839 2,366,656
========= =========
See Condensed Notes to Unaudited Consolidated Financial Statements.
</TABLE>
<TABLE>
CONSOLIDATED BALANCE SHEETS, Continued
(In Thousands)
<CAPTION>
March 31, December 31,
LIABILITIES AND STOCKHOLDERS' EQUITY 1998 1997
------------------------------------- ------------ -----------
(Unaudited)
<S> <C> <C>
Loss and loss adjustment expense
reserves $1,580,869 1,605,374
Unearned premiums 161,302 173,411
Senior bank debt 65,000 65,000
Convertible subordinated debenture s 56,425 56,229
Funds held 24,768 24,023
Accounts payable and accrued liabilities 104,867 113,326
--------- ---------
Total liabilities 1,993,231 2,037,363
--------- ---------
Stockholders' equity:
Common stock, $.01 par value; 50,000,000
shares authorized; 13,195,431 issued and
outstanding in 1998, 13,187,273 issued
and outstanding in 1997 132 132
Additional paid-in capital 223,474 223,460
Retained earnings 91,274 84,888
Accumulated other comprehensive income 17,728 20,813
--------- ---------
Total stockholders' equity 332,608 329,293
--------- ---------
Total liabilities and
stockholders' equity $2,325,839 2,366,656
========= =========
See Condensed Notes to Unaudited Consolidated Financial Statements.
</TABLE>
<TABLE>
HIGHLANDS INSURANCE GROUP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(In Thousands)
<CAPTION>
Three Months
Ended March 31,
------------------
1998 1997
------- -------
<S> <C> <C>
Revenues:
Net premiums earned $ 83,230 29,715
Net investment income 20,793 12,857
Net realized investment gains 3,030 484
-------- --------
Total revenues 107,053 43,056
-------- --------
Expenses:
Loss and loss adjustment expense incurred 59,029 27,831
Underwriting expenses 36,143 9,524
Debt interest and amortization expense 3,071 1,798
Other expenses 319 354
-------- --------
Total expenses 98,562 39,507
-------- --------
Income before income tax 8,491 3,549
Income tax expense 2,105 592
-------- --------
Net income $ 6,386 2,957
======== ========
Earnings per common share:
Basic $ .48 .26
Diluted $ .37 .22
======== ========
Weighted average number of
common shares outstanding:
Basic 13,195 11,452
Diluted 20,194 13,835
======== ========
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,
1998 1997
--------- ---------
(Unaudited)
<S> <C> <C>
Common stock:
Balance, beginning of year $ 132 114
Issuance of common stock, par value - 18
-------- --------
Balance, end of period 132 132
-------- --------
Additional paid-in capital:
Balance, beginning of year 223,460 192,273
Issuance of common stock 14 31,187
-------- --------
Balance, end of period 223,474 223,460
-------- --------
Retained earnings:
Balance, beginning of year 84,888 68,052
Net income 6,386 16,836
-------- --------
Balance, end of period 91,274 84,888
-------- --------
Net unrealized gain (loss) on
investments:
Balance, beginning of year 22,278 3,036
Change in net unrealized gain (loss),
net of applicable federal income tax (3,085) 19,242
-------- --------
Balance, end of period 19,193 22,278
-------- --------
Deferred compensation on restricted
stock:
Balance, beginning of year (1,465) -
Issuance of restricted sto ck - (1,465)
-------- -------
Balance, end of period (1,465) (1,465)
-------- --------
Total stockholders' equity $332,608 329,293
======== ========
See Condensed Notes to Unaudited Consolidated Financial Statements.
</TABLE>
<TABLE>
HIGHLANDS INSURANCE GROUP, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In Thousands)
<CAPTION>
Three Months
Ended Year Ended
March 31, December
1998 31, 1997
----------- -----------
<S> <C> <C>
Net income $ 6,386 16,836
-------- --------
Other comprehensive income net of taxes:
Change in unrealized gain on
investments (3,085) 19,242
Change in deferred compensation on
restricted stock - (1,465)
-------- --------
Other comprehensive income (3,085) 17,777
Comprehensive income $ 3,301 34,613
======== ========
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,
------------------
1998 1997
------- -------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 6,386 2,957
-------- --------
Adjustment to reconcile net income to net
cash used in operating activities:
Depreciation and amortization 881 37
Net realized investment gains (3,030) (484)
Change in:
Premiums in course of collection (1,842) 5,131
Premiums due under retrospective policies (934) 2,179
Receivables from reinsurers (11,847) (14,934)
Prepaid reinsurance premiums 10,509 652
Funds on deposit with reinsurers 163 (2,106)
Net deferred tax asset 2,105 592
Deferred policy acquisition costs (137) 594
Loss and loss adjustment expense reserves (24,505) 5,536
Unearned premiums (12,109) (2,217)
Funds held 745 3,237
Other operating assets and liabilities (21,507) (5,628)
-------- --------
Total adjustments (61,508) (7,411)
-------- --------
Net cash used in operating activities (55,122) (4,454)
-------- --------
Cash flows from investing activities:
Proceeds from sales:
Fixed maturity securities available for sale 71,710 -
Equity securities 986 2,162
Other invested assets (5) 621
Maturities or calls:
Fixed maturity securities available for sale 58,892 18,486
Fixed maturity securities held to maturity - 5,972
Investment purchases:
Fixed maturity securities available for sale (74,818) (13,028)
Net additions to property and equipment (966) (192)
-------- --------
Net cash provided by investing activities 55,799 14,021
-------- --------
Cash flows from financing activities:
Issuance of common stock 14 -
-------- --------
Net cash provided by financing activities 14 -
-------- --------
Net increase in cash and cash equivalents 691 9,567
Cash and cash equivalents at beginning of period 60,717 49,484
-------- --------
Cash and cash equivalents at end of period $ 61,408 59,051
======== ========
Supplemental disclosure of cash flow
information:
Interest paid $ 1,209 -
======== ========
See Condensed Notes to Unaudited Consolidated Financial Statements.
</TABLE>
HIGHLANDS INSURANCE GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1998
1. Basis of Presentation
---------------------
The accompanying consolidated financial statements as of
March 31, 1998 and for the three months ended March 31, 1998 and
1997 are unaudited and include the accounts of Highlands
Insurance Group, Inc., ("Highlands Group") and its subsidiaries
(the "Company"). 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, 1997.
Highlands Group is an insurance holding company for Highlands
Insurance Company and its subsidiaries ("Highlands"), American
Reliance, Inc. and its subsidiaries ("American Reliance")
beginning April 30, 1997, and Highlands Holdings (U.K.) Limited
and its subsidiary ("Highlands UK") (a foreign reinsurance
company located in the United Kingdom) and certain other
immaterial companies.
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.
2. Acquisition
-----------
On April 30, 1997, Highlands Group acquired Vik Brothers
Insurance, Inc. and its subsidiaries ("VBI"). Immediately after
the consummation of the acquisition, VBI was renamed American
Reliance, Inc. The acquisition was accounted for as a purchase
and, accordingly, the financial results of American Reliance are
included in these consolidated financial statements effective
April 30, 1997.
The acquisition was financed with a combination of common stock,
bank debt, preferred stock and cash. In connection with the
acquisition, Highlands Group paid approximately $55.4 million in
cash (including $35.6 million to repay American Reliance's
outstanding bank debt) and issued 1,656,700 shares of its common
stock (representing approximately 12.6% of Highlands Group's then
outstanding common stock) and 21,366 shares of newly issued
series one preferred stock to the holders of the common stock
warrants, preferred stockholders and creditors of American
Reliance. The closing price of Highlands Group's common stock
was $17.625 on April 30, 1997. The preferred stock is currently
owned by a subsidiary of American Reliance and has a preference
value of $1,000 per share. Simultaneously with the closing,
Highlands Group contributed approximately $41.5 million to the
capital of the insurance companies within the American Reliance
organization.
In connection with the acquisition, Highlands Group obtained a
$65 million senior revolving credit facility from a consortium of
banks led by The Chase Manhattan Bank (Credit Agreement).
Highlands Group funded the cash portion of the acquisition by
utilizing the credit facility and available working capital.
The acquired assets and liabilities of American Reliance were
reflected in the consolidated balance sheet as of April 30, 1997
on a fully consolidated basis at management's best estimate of
their fair values, based on information available at that time.
Evaluation and appraisal of assets and liabilities is continuing
and, therefore, allocation of the purchase price may be adjusted.
3. American Reliance Acquisition - Pro forma Results of
Operations
----------------------------------------------------
The following unaudited pro forma information presents the
results of operations of the Company and American Reliance for
the three months ended March 31, 1997 with pro forma adjustments
as if the acquisition and transactions related to the funding of
the acquisition had been consummated as of the beginning of the
period presented. This pro forma information is not necessarily
indicative of what would have occurred had the acquisition and
related transactions been made on the date indicated, or of
future results of the Company.
<TABLE>
<CAPTION>
Three
Months
Ended
March 31,
1997
(In thousands, except per share data) ------
<S> <C>
Revenues $ 128,887
Net income $ 1,485
Basic earnings per share $ .13
Diluted earnings per share $ .11
</TABLE>
4. Changes in Accounting Principles
--------------------------------
In June 1997, the Financial Accounting Standards Board (FASB)
issued Statement of Financial Accounting Standards No. 130,
"Comprehensive Income" (SFAS 130). SFAS 130 establishes
standards for the reporting and disclosure of comprehensive
income and its components (revenues, expenses, gains and losses).
SFAS 130 requires that all items that are required to be
recognized under accounting standards as components of
comprehensive income be reported in a financial statement that is
displayed with the same prominence as other financial statements.
SFAS 130 requires that an enterprise (a) classify items of other
comprehensive income by their nature in a financial statement and
(b) display the accumulated balance of other comprehensive income
separately from retained earnings and additional paid-in capital
in the equity section of the balance sheet. Comprehensive income
amounts have been presented to conform to the SFAS 130
requirements.
5. Earnings Income Per Share
-------------------------
In 1997, FASB issued Statement of Financial Accounting Standards
No. 128, "Earnings Per Share" (SFAS 128). SFAS 128 replaced the
calculation of primary and fully diluted earnings per share with
basic and diluted earnings per share. Unlike primary earnings
per share, basic earnings per share excludes any dilutive effects
of options, warrants and convertible securities. All earnings
per share amounts for all periods have been presented and, where
appropriate, restated to conform to the SFAS 128 requirements.
The following table sets forth the computation of basic and
diluted earnings per share (in thousands, except per share data):
<TABLE>
<CAPTION>
Three Months Ended
March 31,
-----------------------
1998 1997
------- -------
<S> <C> <C>
NUMERATOR:
Net income, as reported $ 6,386 2,957
Effect of dilutive securities - after
tax debt expense applicable to
convertible subordinated debentures 1,157 -
------- -------
Numerator for diluted earnings per
common share - income available to
common stockholders after assumed
conversions $ 7,543 2,957
======= =======
DENOMINATOR:
Denominator for basic earnings
per share - weighted average shares 13,195 11,452
Effect of dilutive securities:
Common stock warrants and
outstanding stock options (based on
treasury stock method) 3,110 2,383
Convertible subordinated debentures 3,889 -
------- -------
Denominator for diluted earnings per
share - adjusted weighted average
shares and assumed conversions 20,194 13,835
======= =======
Basic earnings per share $ .48 .26
Diluted earnings per share $ .37 .22
</TABLE>
The convertible subordinated debentures, which are convertible
into approximately 3.9 million shares, were outstanding during
1997, but were not included in the computation of diluted
earnings per share because the assumed conversion would be
antidilutive.
6. Debt Outstanding
----------------
During the second quarter of 1997, the Company entered into a $65
million Credit Agreement, dated April 30, 1997. The Credit
Agreement, which contains customary terms and restrictions,
currently provides for an interest rate of LIBOR plus 75 to 150
basis points based upon a performance grid with the full
principal amount thereunder due on April 30, 2002. The Credit
Agreement was used to finance the purchase of American Reliance.
The average interest rate for the three months ended March 31,
1998 was 7.4%.
7. Comprehensive Income
--------------------
The following summaries present the components of comprehensive
income, other than net income, for the three months ended March
31, 1998 and the year ended December 31, 1997 (in thousands):
<TABLE>
Three months ended March 31, 1998
<CAPTION>
Income Tax
Pretax Effect After-tax
---------- ---------- ----------
<S> <C> <C> <C>
Unrealized gains (losses)
arising during period $ (1,715) (601) (1,115)
Less: reclassification
adjustment for realized gains
included in net income 3,030 1,060 1,970
------- ------- -------
Net change in unrealized gains
on investments $ (4,746) (1,661) (3,085)
Deferred compensation on
restricted stock - - -
------- ------- -------
Total other compensation income $ (4,746) (1,661) (3,085)
======= ======= =======
</TABLE>
<TABLE>
Year ended December 31, 1997
<CAPTION>
Income Tax
Pretax Effect After-tax
---------- ---------- ----------
<S> <C> <C> <C>
Unrealized gains (losses)
arising during period $ 35,189 12,317 22,872
Less: reclassification
adjustment for realized gains
included in net income 5,585 1,955 3,630
------- ------- -------
Net change in unrealized gains
on investments $ 29,604 10,362 19,242
Deferred compensation on
restricted stock (1,465) - (1,465)
------- ------- -------
Total other compensation income $ 28,139 10,362 17,777
======= ======= =======
</TABLE>
8. Warrant Price Adjustment
------------------------
The exercise price of the Series A, A-2, B and B-2 common stock
purchase warrants which were issued with the convertible
subordinated debentures are subject to adjustment for adverse
loss reserve and uncollectible reinsurance development,
commencing two years after issue and terminating after nine
years. No adjustment to the exercise price has been recorded
during the three months ended March 31, 1998.
9. Contingent Liabilities:
-----------------------
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 Operations reflect the consolidated results of
operations of the Company.
The Company is managed in two divisions - The Highlands Division
and the American Reliance Division. The Highlands Division
consists of business managed by the Company's Houston, Texas
office. In 1995, the Highlands Division classified three of its
product lines as discontinued (the "Discontinued Lines"):
business originated by its London operations; an umbrella/excess
liability policy program; and assumed casualty and property
reinsurance contracts. The Discontinued Lines are presented
separately due to their significance to the Company's total
underwriting loss which amounted to 5% and 21% of such loss for
the three months ended March 31, 1998 and 1997, respectively.
(Please refer to the Company's 1997 Annual Report Form 10-K for a
more complete description of the Discontinued Lines.) Results of
the Highlands Division exclude the Discontinued Lines which are
presented separately.
As discussed in Note 2 of the Condensed Notes to Unaudited
Consolidated Financial Statements, on April 30, 1997, Highlands
Group completed the acquisition of Vik Brothers Insurance, Inc.,
renamed American Reliance, Inc. The acquisition was accounted
for under the purchase method of accounting and, accordingly, the
consolidated financial statements include the results of American
Reliance's operations only from date of acquisition. The
American Reliance Division consists of business managed by the
Company's Lawrenceville, New Jersey office.
The results of the Company's consolidated operations for the
periods indicated are set forth below:
<TABLE>
<CAPTION>
Three Months Ended
March 31,
---------------------
1998 1997
------- -------
(Dollars in millions)
<S> <C> <C>
Consolidated Results:
Gross premiums written $ 92.3 31.0
Net premiums written $ 81.6 28.0
======= =======
Net premiums earned:
Highlands Division $ 20.5 29.5
American Reliance Division 62.6 -
Discontinued Lines .1 .2
------- -------
$ 83.2 29.7
------- -------
Underwriting (loss):
Highlands Division $ (2.6) (6.0)
American Reliance Division (8.7) -
Discontinued Lines (.6) (1.6)
------- -------
$ (11.9) (7.6)
Net investment income 20.8 12.9
Net realized investment gains 3.0 .5
Debt interest and amortization expense (3.1) (1.8)
Other (expenses), net (.3) (.4)
------- -------
Income before income taxes 8.5 3.6
Income tax expense 2.1 .6
------- -------
Net income $ 6.4 3.0
======= =======
Ratios:
Loss 70.9% 93.7%
Expense 43.4% 32.1%
-------- --------
Combined 114.3% 125.8%
======== ========
</TABLE>
Net premiums earned were $83.2 million and $29.7 million for the
three months ended March 31, 1998 and 1997, respectively. The
increase of $53.5 in 1998 is attributable to the inclusion of the
American Reliance Division.
Underwriting losses of $11.9 million in the three months ended
March 31, 1998 increased $4.3 million compared to the same 1997
period. The increase in underwriting losses for the period
includes reductions in the underwriting loss of the Highlands
Division of $3.4 million and the Discontinued Lines of $1 million
from 1997 which were offset by $8.7 million in underwriting
losses of the American Reliance Division. Also see "Highlands
Division," "American Reliance Division" and "Discontinued Lines"
for additional comments.
Net investment income for the three months ended March 31, 1998
and 1997 was $20.8 million and $12.9 million, respectively. Net
investment income increased $7.9 million from 1997 due to the
inclusion of the American Reliance Division. Net realized
investment gains increased $2.5 million to $3.0 million for the
three months ended March 31, 1998 compared to $.5 million for the
three months ended March 31, 1997.
Debt interest and amortization expense for the three months ended
March 31, 1998 compared with the same period for 1997 increased
$1.3 million as a result of the $65 million Credit Agreement used
to finance the purchase of American Reliance.
<TABLE>
Highlands Division
- ------------------
<CAPTION>
Three Months Ended
March 31,
------------------
1998 1997
------ ------
(Dollars in millions)
<S> <C> <C>
Gross premiums written $ 22.7 30.4
Net premiums written $ 20.1 27.9
======= =======
Net premiums earned $ 20.5 29.5
Loss and loss adjustment expense
incurred (15.4) (26.3)
Underwriting expenses (7.7) (9.2)
------- -------
Underwriting (loss) $ (2.6) (6.0)
======= =======
Ratios:
Loss 75.0% 89.2%
Expense 37.9% 31.2%
------- -------
Combined 112.9% 120.4%
======= =======
</TABLE>
The Highlands Division underwriting results primarily consist of
relatively large commercial accounts ("Special Accounts Unit"),
medium to small commercial accounts ("Commercial Insurance
Unit"), insurance for Halliburton Company, Highlands Group's
former parent, ("Insurance Services Unit"), commercial marine
products ("Marine Unit") and surety products ("Surety Unit").
The Highlands Division excludes the Discontinued Lines which are
presented separately below.
Period to Period Comparisons of the Highlands Division
Gross Premiums Written. Gross premiums written for the three
months ended March 31, 1998 and 1997 were $22.7 million and $30.4
million, respectively. The decrease of $7.7 million or 25% is
primarily attributable to decreases from retrospectively rated
policies in the Insurance Services Unit and production decreases
in the Commercial Insurance Unit. The Company continues to focus
on stricter underwriting standards and price increases, both of
which have contributed to declines in gross premiums written in
the Commercial Insurance Unit. The declines have been partially
offset by premium increases in the Marine Unit. Also
contributing to declines in gross premiums written is the
continued highly competitive pricing environment as insurers
compete to retain business.
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 and
net premiums earned 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 three months
ended March 31, 1998 and 1997 were $20.1 million and $27.9
million, respectively. The decrease of $7.8 million or 28% for
the three months ended March 31, 1998, is primarily related to
the same issues affecting gross premiums written.
Net Premiums Earned. Net premiums earned for the three months
ended March 31, 1998 and 1997 were $20.5 million and $29.5
million, respectively. The decrease of $9.0 million or 31% for
the three months ended March 31, 1998, is related to the same
issues affecting gross and net premiums written.
Loss and Loss Adjustment Expense Incurred. Loss and loss
adjustment expense incurred for the three months ended March 31,
1998 and 1997 were $15.4 million and $26.3 million, respectively.
The decrease for the three months ended March 31, 1998 is related
to lower incurred losses subject to retrospectively rated
policies and the overall declining premium volume and stricter
underwriting criteria. The decrease was partially offset by an
unusually large claim of $1.0 million in the Marine Unit.
Underwriting Expenses. Underwriting expenses for the three months
ended March 31, 1998 and 1997 were $7.7 million and $9.2 million,
respectively. The decline for the three months ended March 31,
1998 compared to the same 1997 period was primarily due to
declining premium related expenses and reduced operating costs.
<TABLE>
American Reliance Division
- --------------------------
<CAPTION>
Three Months
Ended
March 31, 1998
-----------------
(Dollars in millions)
<S> <C>
Gross premiums written $ 69.7
Net premiums written $ 61.4
=======
Net premiums earned $ 62.6
Loss and loss adjustment expense
incurred (43.4)
Underwriting expenses (27.9)
-------
Underwriting (loss) $ (8.7)
=======
Ratios:
Loss 69.3%
Expense 44.6%
-------
Combined 113.9%
=======
</TABLE>
American Reliance was acquired on April 30, 1997 and accounted
for as a purchase. Accordingly, the above results are for the
three months ended March 31, 1998 and are included in the
consolidated results of the Company.
Underwriting Results of the American Reliance Division
Gross Premiums Written. Gross premiums written for the three
months ended March 31, 1998 were $69.7 million. Although, prior
period gross premiums written are not presented, gross premiums
written have declined approximately 18.5% due to stricter
underwriting standards, increased price competition and servicing
problems associated with the implementation of a new policy
issuance system.
Net Premiums Written. Net premiums written for the three months
ended March 31, 1998 were $61.4 million. Net premiums written
have been impacted by the same issues affecting gross premiums
written.
Net Premiums Earned. Net premiums earned for the three months
ended March 31, 1998 were $62.6 million. Reductions in net
premiums earned are related to the same factors affecting gross
and net premiums written.
Loss and Loss Adjustment Expense Incurred. Loss and loss
adjustment expense incurred for the three months ended March 31,
1998 were $43.4 million. Although the prior period is not
presented, loss and loss adjustment expense incurred has declined
due to the decrease in premium volume.
Underwriting Expenses. Underwriting expenses for the three
months ended March 31, 1998 were $27.9 million. The expenses for
the period are higher than planned due to additional expenses
associated with implementation of the new policy issuance system.
<TABLE>
Discontinued Lines
- ------------------
<CAPTION>
Three Months Ended
March 31,
-----------------
1998 1997
------ ------
(Dollars in millions)
<S> <C> <C>
Gross premiums written $ (.1) .6
Net premiums written $ .1 .1
======= =======
Net premiums earned $ .1 .2
Loss and loss adjustment expense
incurred (.3) (1.5)
Underwriting expenses (.4) (.3)
------- -------
Underwriting (loss) $ (.6) (1.6)
======= =======
For reporting purposes, Highlands Group has three lines of
business which are considered Discontinued Lines, specifically
business originated by the Highlands Group'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
voluntary 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 $.1 million and $.2
million for the three months ended March 31, 1998 and 1997,
respectively. The decline is due to the cancellation of all
remaining voluntary assumed reinsurance contracts in 1996. Due
to the nature of the Company's reinsurance contracts, small
premium adjustments can continue long after cancellation of such
agreements.
Loss and Loss Adjustment Expense Incurred. Loss and loss
adjustment expense for the three months ended March 31, 1998
compared to 1997 decreased by $1.2 million. The decline in loss
and loss adjustment expense for the first quarter 1998 reflects
the absence of development on prior year loss reserves.
Liquidity and Capital Resources
Highlands Group is a holding company, the principal assets of
which at March 31, 1998 were all of the capital stock of
Highlands Insurance Company and American Reliance, Inc. The
Company's property and casualty insurance business is conducted
by its direct and indirect wholly-owned insurance subsidiaries.
The liquidity and capital resource considerations for the
Highlands Group are different than those of the Company's
insurance operations.
Holding Company
Highlands Group's principal requirements for funds are to pay
operating expenses, franchise and other taxes, debt service and
dividends. Operating expenses and franchise and other taxes
imposed on Highlands Group are not expected to be material. The
annual cash interest requirements relating to the convertible
subordinated debentures and the Credit Agreement are
approximately $11.0 million. Highlands Group does not currently
intend to pay dividends on its 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.
Highlands Group's principal sources of funds are dividend and tax
sharing payments from Highlands and American Reliance, 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 the insurance subsidiaries is subject to restrictions and
limitations imposed by the insurance regulatory authorities.
Dividend payments to Highlands Group from its insurance
subsidiaries are limited to $30.6 million in 1998 without prior
regulatory approval.
Management believes that Highlands Group's liquid assets and
access to the capital markets enable it to meet its liquidity
needs.
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 Highlands Group.
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.
Part II Other Information
-----------------
Item 1. Legal Proceedings
-----------------
None
Item 6: Exhibits and Reports on Form 8-K.
a) Exhibits
(27) Financial Data Schedule (Filed Electronically)
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, 1998 By /s/ Richard M. Haverland
--------------------
Richard M. Haverland
Chairman, President and Chief
Executive Officer
(Authorized Signatory)
Date: May 15, 1998 By /s/ Charles J. Bachand
------------------
Charles J. Bachand
Vice President, Treasurer and
Principal Accounting Officer
(Authorized Signatory)
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 7
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> MAR-31-1998
<DEBT-HELD-FOR-SALE> 0
<DEBT-CARRYING-VALUE> 1,107,263
<DEBT-MARKET-VALUE> 1,107,263
<EQUITIES> 2,541
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 1,113,862
<CASH> 61,408
<RECOVER-REINSURE> 734,961
<DEFERRED-ACQUISITION> 32,450
<TOTAL-ASSETS> 2,325,839
<POLICY-LOSSES> 1,580,869
<UNEARNED-PREMIUMS> 161,302
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 121,425
0
0
<COMMON> 132
<OTHER-SE> 332,476
<TOTAL-LIABILITY-AND-EQUITY> 2,325,839
83,230
<INVESTMENT-INCOME> 20,793
<INVESTMENT-GAINS> 3,030
<OTHER-INCOME> 0
<BENEFITS> 59,029
<UNDERWRITING-AMORTIZATION> 36,143
<UNDERWRITING-OTHER> 0
<INCOME-PRETAX> 8,491
<INCOME-TAX> 2,105
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 6,386
<EPS-PRIMARY> .48
<EPS-DILUTED> .37
<RESERVE-OPEN> 0
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 0
<PAYMENTS-PRIOR> 0
<RESERVE-CLOSE> 0
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
