<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2000
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _________ to ________
HIGHLANDS INSURANCE GROUP, INC.
(Exact Name of Registrant as Specified in its Charter)
1-14028
(Commission File Number)
DELAWARE 75-2370945
(State or Other Jurisdiction (I.R.S. Employer
Of Incorporation Or Organization) Identification Number)
1000 LENOX DRIVE,
Lawrenceville, New Jersey 08648
(Address of Principal Executive Offices) (Zip Code)
(609) 896-1921
(Registrant's Telephone Number, Including Area Code)
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 reports), and (2) has been subject to 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 September 30, 2000 was 13,664,843.
1
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HIGHLANDS INSURANCE GROUP, INC.
TABLE OF CONTENTS
PART I - Financial Information
Item Page
---- ----
1. Financial Statements:
Consolidated Balance Sheets
September 30, 2000 (Unaudited) and
December 31, 1999 3
Consolidated Statements of Operations
(Unaudited) - Three and Nine Months Ended
September 30, 2000 and 1999 5
Consolidated Statements of Stockholders' Equity
Nine Months Ended September 30, 2000 (Unaudited)
and Year Ended December 31, 1999 6
Consolidated Statements of Comprehensive Income (Loss)
(Unaudited) - Three and Nine Months Ended
September 30, 2000 and 1999 7
Consolidated Statements of Cash Flows
(Unaudited) - Nine Months Ended September 30,
2000 and 1999 8
Condensed Notes to Unaudited Consolidated
Financial Statements 9
2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 12
3. Quantitative and Qualitative Disclosures About
Market Risk 14
PART II - Other Information
1. Legal Proceedings 15
4. Submission of Matters to a Vote of Security Holders 16
6. Exhibits and Reports on Form 8-K 16
Signatures 17
2
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PART 1 Financial Information
ITEM 1. Financial Statements
HIGHLANDS INSURANCE GROUP, INC.
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
<TABLE>
<CAPTION>
September 30, December 31,
ASSETS 2000 1999
------ ------------- ------------
(Unaudited)
<S> <C> <C>
Investments:
Fixed maturity securities - available-for-sale, at fair
value (amortized cost of $800,498 at 9/30/00 and
$802,594 at 12/31/99) $ 765,851 762,478
Equity securities, at fair value (cost of $30,686 at 9/30/00
and $31,376 at 12/31/99) 29,566 26,594
Other investments, at cost 2,299 3,100
---------- ---------
Total investments 797,716 792,172
Cash and cash equivalents 94,074 78,283
Premiums in course of collection, net 80,730 56,574
Premiums due under retrospectively rated policies 140,415 142,849
Receivable from reinsurers 651,787 684,525
Prepaid reinsurance premiums 10,619 3,777
Funds on deposit with reinsurers 14,253 17,534
Net deferred tax asset 76,967 82,536
Accrued investment income 11,237 11,396
Deferred policy acquisition costs 46,084 33,556
Other assets 51,278 58,085
---------- ---------
Total assets $1,975,160 1,961,287
========== =========
</TABLE>
See Condensed Notes to Unaudited Consolidated Financial Statements.
3
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HIGHLANDS INSURANCE GROUP, INC.
CONSOLIDATED BALANCE SHEETS, (Continued)
(Dollars in thousands)
<TABLE>
<CAPTION>
September 30, December 31,
LIABILITIES AND STOCKHOLDERS' EQUITY 2000 1999
------------------------------------ ------------- -----------
(Unaudited)
<S> <C> <C>
Loss and loss adjustment expense reserves $1,304,180 1,353,524
Unearned premiums 208,683 146,832
Senior bank debt 49,004 59,004
Convertible subordinated debentures 58,421 57,816
Accounts payable and accrued liabilities 71,124 75,069
---------- ---------
Total liabilities 1,691,412 1,692,245
---------- ---------
Mandatorily redeemable preferred stock 4,856 4,641
---------- ---------
Commitments and contingent liabilities
Stockholders' equity:
Common stock, $.01 par value; 50,000,000 shares authorized; 13,218,943
issued and outstanding in 2000 and 13,217,903 issued and outstanding in
1999 (excluding 739,400 shares held in the treasury or by subsidiaries
in 2000 and 1999) 140 140
Additional paid-in capital 231,495 231,515
Accumulated other comprehensive loss (23,249) (29,184)
Treasury stock, at cost (739,400 shares in 2000 and 1999) (9,459) (9,459)
Deferred compensation on restricted stock (3,097) (3,147)
Retained earnings 83,062 74,536
---------- ---------
Total stockholders' equity 278,892 264,401
---------- ---------
Total liabilities and stockholders' equity $1,975,160 1,961,287
========== =========
</TABLE>
See Condensed Notes to Unaudited Consolidated Financial Statements.
4
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HIGHLANDS INSURANCE GROUP, INC
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(Dollars in thousands, except per share data)
<TABLE>
<CAPTION>
Three Months Nine Months
Ended September 30, Ended September 30,
------------------------------ -------------------------------
2000 1999 2000 1999
-------- ------- ------- -------
<S> <C> <C> <C> <C>
Revenues:
Net premiums earned $102,912 78,091 274,820 237,954
Net investment income 15,639 16,821 46,721 51,762
Net realized investment gains (losses) (132) 1,030 826 2,824
-------- ------- ------- -------
Total revenues 118,419 95,942 322,367 292,540
-------- ------- ------- -------
Expenses:
Loss and loss adjustment expense incurred 77,869 65,753 204,605 182,423
Underwriting expenses 33,129 31,923 96,339 97,851
Debt interest and amortization expense 3,056 2,872 9,176 8,760
Other expenses, net 391 785 1,181 1,710
-------- ------- ------- -------
Total expenses 114,445 101,333 311,301 290,744
-------- ------- ------- -------
Income (loss) before income taxes 3,974 (5,391) 11,066 1,796
Income tax expense (benefit) 980 (2,068) 2,540 (432)
-------- ------- ------- -------
Net income (loss) $ 2,994 (3,323) 8,526 2,228
======== ======= ======= =======
Earnings (loss) per common share:
Basic $.23 (.25) .65 .17
Diluted $.23 (.25) .65 .16
======== ======= ======= =======
Weighted average number of common shares
outstanding:
Basic 13,219 13,218 13,217 12,867
Diluted 13,239 13,218 13,225 13,845
======== ======= ======= =======
</TABLE>
See Condensed Notes to Unaudited Consolidated Financial Statements.
5
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HIGHLANDS INSURANCE GROUP, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(Dollars in thousands)
<TABLE>
<CAPTION>
For the nine
months ended For the year ended
September 30, December 31,
2000 1999
------------- ------------------
(Unaudited)
<S> <C> <C>
Common stock:
Balance, beginning of year $ 140 132
Issuance of common stock, par value -- 8
-------- -------
Balance, end of period 140 140
-------- -------
Additional paid-in capital:
Balance, beginning of year 231,515 223,976
Net (retirement) issuance of common stock (20) 7,539
-------- -------
Balance, end of period 231,495 231,515
-------- -------
Accumulated other comprehensive income (loss):
Balance, beginning of year (29,184) 16,803
Changes in net unrealized gain or loss, net of tax 5,935 (46,138)
Net unrealized investment losses of written-off subsidiary, net of tax -- 151
-------- -------
Balance, end of period (23,249) (29,184)
-------- -------
Treasury stock, at cost:
Balance, beginning of year (9,459) (9,268)
Acquisition of treasury stock -- (191)
-------- -------
Balance, end of period (9,459) (9,459)
-------- -------
Deferred compensation on restricted stock:
Balance, beginning of year (3,147) (1,074)
Net retirement (issuance) of restricted stock 50 (2,073)
-------- -------
Balance, end of period (3,097) (3,147)
-------- -------
Retained earnings:
Balance, beginning of year 74,536 87,985
Net income (loss) 8,526 (13,449)
-------- -------
Balance, end of period 83,062 74,536
-------- -------
Total stockholders' equity $278,892 264,401
======== =======
</TABLE>
See Condensed Notes to Unaudited Consolidated Financial Statements.
6
<PAGE>
HIGHLANDS INSURANCE GROUP, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Unaudited)
(Dollars in thousands)
<TABLE>
<CAPTION>
Three Months Nine Months
Ended September 30, Ended September 30,
--------------------------- -------------------------
2000 1999 2000 1999
------ ------ ------ ------
<S> <C> <C> <C> <C>
Net income (loss) $2,994 (3,323) 8,526 2,228
------ ------- ------ -------
Other comprehensive income (loss), net of taxes:
Increase (decrease) in unrealized gain or loss
on investments, net of taxes of $3,207 and
($4,589) for the three months and $3,485 and
($17,821) for the nine months ended
September 30, 2000 and 1999, respectively 5,956 (8,523) 6,472 (33,097)
Reclassification adjustments for realized
(gains) income, losses in net income, net of
taxes of $46 and $(360) for the three months and
$(289) and $(988) for the nine months ended
September 30, 2000 and 1999, respectively 86 (670) (537) (1,836)
------ ------- ------ -------
Other comprehensive income (loss), net of
taxes 6,042 (9,193) 5,935 (34,933)
------ ------- ------ -------
Comprehensive income (loss) $9,036 (12,516) 14,461 (32,705)
====== ======= ====== =======
</TABLE>
See Condensed Notes to Unaudited Consolidated Financial Statements.
7
<PAGE>
HIGHLANDS INSURANCE GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(Dollars in thousands)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
------------------------------
2000 1999
--------- ---------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 8,526 2,228
--------- ---------
Adjustments to reconcile net income to net cash used in operating activities:
Depreciation and amortization 3,831 1,359
Net realized investment gains (826) (2,824)
Deferred tax expense 2,416 (449)
Change in:
Premiums in course of collection (24,156) (10,556)
Premiums due under retrospectively rated policies 2,434 9,241
Receivable from reinsurers 32,738 (9,471)
Prepaid reinsurance premiums (6,842) 1,063
Funds on deposit with reinsurers 3,281 (997)
Deferred policy acquisition costs (12,528) (1,123)
Loss and loss adjustment expense reserves (49,344) (87,187)
Unearned premiums 61,851 3,660
Other operating assets and liabilities 1,224 (16,692)
--------- ---------
Total adjustments 14,079 (113,976)
--------- ---------
Net cash provided by (used in) operating activities 22,605 (111,748)
--------- ---------
Cash flows from investing activities:
Proceeds from sales:
Fixed maturity securities available-for-sale 81,591 137,848
Equity securities 1,721 8,311
Other invested assets 1,258 576
Maturities or calls:
Fixed maturity securities available-for-sale 38,973 132,459
Investment purchases:
Fixed maturity securities available-for-sale (117,870) (154,345)
Equity securities (1,000) (18,940)
Net additions to property and equipment (1,487) (3,731)
--------- ---------
Net cash provided by investing activities 3,186 102,178
--------- ---------
Cash flows from financing activities:
Repayment of senior bank debt (10,000) (5,996)
Issuance of common stock -- 5,474
Acquisition of treasury stock -- (191)
--------- ---------
Net cash used in financing activities (10,000) (713)
--------- ---------
Net increase (decrease) in cash and cash equivalents 15,791 (10,283)
Cash and cash equivalents at beginning of period 78,283 70,747
--------- ---------
Cash and cash equivalents at end of period $ 94,074 60,464
========= =========
Supplemental disclosure of cash flow information:
Interest paid $ 6,478 $ 6,161
========= =========
</TABLE>
See Condensed Notes to Unaudited Consolidated Financial Statements.
8
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HIGHLANDS INSURANCE GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2000
1. Basis of Presentation
The accompanying consolidated financial statements as of September 30, 2000
and for the three and nine months ended September 30, 2000 and 1999 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, 1999.
Highlands Group is an insurance holding company for Highlands Insurance
Company and its subsidiaries ("Highlands"), American Reliance, Inc. and its
subsidiaries ("American Reliance"), 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. For reporting
purposes, the Company considers all of its property and casualty insurance
operations as one segment. All material intercompany accounts and transactions
have been eliminated.
As discussed in Note 3, the Company wrote-off in December 1999 its remaining
investment in and deferred taxes associated with LMI Insurance Company (LMI).
The assets and liabilities of LMI were not included in the accompanying balance
sheet as of December 31, 1999. The September 30, 1999 consolidated financial
statements have not been restated.
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. Changes in Accounting Principles
Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for
Derivative Instruments and for Hedging Activities," requires companies to
recognize all derivatives as either assets or liabilities in the statement of
financial condition and to measure all derivatives at fair value. SFAS No. 133
requires that changes in fair value of a derivative be recognized currently in
earnings unless specific hedge accounting criteria are met. Upon implementation
of SFAS No. 133, hedging relationships may be redesignated, and securities held
to maturity may be transferred to available for sale or trading. SFAS No. 137,
"Accounting for Derivative Instruments and Hedging Activities - Deferral of the
Effective Date of FASB Statement No. 133," deferred the effective date of SFAS
No. 133 to fiscal years beginning after June 15, 2000. SFAS No. 138,
"Accounting for Certain Derivative Instruments and Certain Hedging Activities"
amended the accounting and reporting standards of SFAS No. 133 for certain
derivative instruments, hedging activities, and decisions made by the
Derivatives Implementation Group. The Company anticipates that the adoption of
the provisions of SFAS 133, SFAS 137, and SFAS 138 will not have a material
impact on the results of operations, financial condition or cash flows.
9
<PAGE>
3. Write-off of Subsidiary
In December 1999, the Company wrote-off its remaining investment in and
deferred taxes associated with LMI. Since 1997, the Company had supported LMI;
however, based upon an assessment of the value of LMI, the Company concluded
that continued support of LMI was no longer in the best interest of the Company
and its shareholders. In March 2000, the Court of Common Pleas in Franklin
County, Ohio, entered an order appointing the Superintendent of Insurance of the
State of Ohio as the Rehabilitator of LMI. As Rehabilitator, the Superintendent
is by operation of law vested with control of LMI, including title to all LMI
assets. On May 22, 2000, a Final Order of Liquidation and Appointment of
Liquidator was entered against LMI by the Court of Common Pleas in Franklin
County, Ohio. Management believes that the regulatory matters concerning LMI
will not have a material impact on the Company's ongoing operations. The
September 30, 1999 consolidated financial statements have not been restated to
reflect the write-off of LMI.
4. Earnings (Loss) Per Share
The following tables set forth the computation of basic and diluted earnings
(loss) per share (in thousands, except per share data):
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------- ----------------------
2000 1999 2000 1999
------- ------ ------ ------
<S> <C> <C> <C> <C>
NUMERATOR:
Net income (loss), as reported and for basic earnings
(loss) per share $ 2,994 (3,323) 8,526 2,228
Effect of dilutive securities - after tax debt expense
applicable to convertible subordinated debentures, if
appropriate -- -- -- --
------- ------ ------ ------
Numerator for diluted earnings per common share -
income available to common stockholders after
assumed conversions, if appropriate $ 2,994 (3,323) 8,526 2,228
======= ====== ====== ======
DENOMINATOR:
Denominator for basic earnings (loss) per share -
weighted average shares outstanding 13,219 13,218 13,217 12,867
Effect of dilutive securities:
Common stock warrants and outstanding stock
options (based on treasury stock method) 20 -- 8 978
Convertible subordinated debentures, if appropriate -- -- -- --
------- ------ ------ ------
Denominator for diluted earnings (loss) per share -
adjusted weighted average shares and assumed
conversions 13,239 13,218 13,225 13,845
======= ====== ====== ======
Basic earnings (loss) per share $ .23 (.25) .65 .17
Diluted earnings (loss) per share $ .23 (.25) .65 .16
======= ====== ====== ======
</TABLE>
The Debentures, which are convertible into approximately 3.9 million shares,
were outstanding during the nine months ended September 30, 2000 and 1999, but
were not included in the computation of diluted earnings (loss) per share
because the assumed conversion would be antidilutive.
5. 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, for
the life of the stock purchase warrants, subject to
10
<PAGE>
adjustment due to adverse loss reserve and uncollectible reinsurance development
for years prior to 1996. No adjustment to the exercise price has been recorded
during the nine months ended September 30, 2000.
6. 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.
11
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RESULTS OF OPERATIONS
The results of the Company's consolidated operations for the periods indicated
are set forth below:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------------- ----------------------------
2000 1999 2000 1999
-------- ------- -------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Gross premiums written $136,607 92,768 368,520 264,534
Net premiums written $121,349 84,913 329,828 242,677
======== ======= ======== ========
Net premiums earned $102,912 78,091 274,820 237,954
Loss and loss adjustment expense incurred (77,869) (65,753) (204,605) (182,423)
Underwriting expenses (33,129) (31,923) (96,339) (97,851)
-------- ------- -------- --------
Underwriting loss (8,086) (19,585) (26,124) (42,320)
Net investment income 15,639 16,821 46,721 51,762
Net realized investment gains (losses) (132) 1,030 826 2,824
Debt interest and amortization expense (3,056) (2,872) (9,176) (8,760)
Other expenses, net (391) (785) (1,181) (1,710)
-------- ------- -------- --------
Income (loss) before income taxes 3,974 (5,391) 11,066 1,796
Income tax expense (benefit) 980 (2,068) 2,540 (432)
-------- ------- -------- --------
Net income (loss) $ 2,994 (3,323) 8,526 2,228
======== ======= ======== ========
Earnings (loss) per common share:
Basic $ .23 (.25) .65 .17
====== ===== ===== =====
Diluted $ .23 (.25) .65 .16
====== ===== ===== =====
Ratios:
Loss 75.7% 84.2% 74.5% 76.7%
Expense 32.2% 40.9% 35.1% 41.1%
------ ----- ----- -----
Combined 107.9% 125.1% 109.6% 117.8%
====== ===== ===== =====
</TABLE>
PERIOD TO PERIOD COMPARISONS
Gross Premiums Written. Gross premiums written for the three months and nine
months ended September 30, 2000 and 1999 were $136.6 million, $92.8 million,
$368.5 million and $264.5 million, respectively. The $43.8 million and $104.0
million or 47.3% and 39.3% increase for the three months and nine months ended
September 30, respectively, is due primarily to new business growth in the core
commercial lines and certain new programs. The Company continues to focus on
underwriting standards and adequate pricing during a period of competitive
pricing in both commercial and personal lines.
Net Premiums Written. Net premiums written for the three months and nine
months ended September 30, 2000 and 1999 were $121.3 million, $84.9 million,
$329.8 million and $242.7 million, respectively. The increase of $36.4 million
and $87.1 million or 42.9% and 35.9% in 2000 compared to 1999 is related to the
same issues affecting gross premiums written.
12
<PAGE>
Net Premiums Earned. Net premiums earned for the three months and nine months
ended September 30, 2000 and 1999 were $102.9 million, $78.1 million, $274.8
million and $238.0 million, respectively. The increase of $24.8 million and
$36.8 million or 31.8% and 15.5% in 2000 compared to 1999 is related to the
growth of gross and net premiums written as discussed above. Net premiums
written are initially deferred and earned based upon the terms of the underlying
policies which creates a lag in earnings during periods of increasing or
decreasing net premiums written.
Loss and Loss Adjustment Expense Incurred. Loss and loss adjustment expenses
incurred for the three months and nine months ended September 30, 2000 and 1999
were $77.9 million, $65.8 million, $204.6 million and $182.4 million,
respectively. The loss and loss adjustment expense ratio for the three months
and nine months ended September 30, 2000 and 1999 was 75.7%, 84.2%, 74.5% and
76.7%, respectively. Loss and loss adjustment expenses incurred for the three
months and nine months ended September 30, 2000 includes a charge of $3.5
million to increase Ocean Marine prior year loss reserves, a line of business
placed in run-off in early 2000. Loss and loss adjustment expenses for the three
months ended September 30, 2000 included weather related catastrophe losses of
approximately $1.0 million. Weather related catastrophe losses for the third
quarter of 1999 were approximately $6.3 million of which approximately $5.3
million related to Hurricane Floyd. For the nine months ended September 30, 2000
and 1999, weather related catastrophe losses were approximately $5.4 million and
$4.9 million (excluding Hurricane Floyd), respectively.
Underwriting Expenses. Underwriting expenses for the three months and nine
months ended September 30, 2000 and 1999 were $33.1 million, $31.9 million,
$96.3 million and $97.9 million, respectively. The underwriting expense ratio
for the three months and nine months ended September 30, 2000 and 1999 was
32.2%, 40.9%, 35.1% and 41.1%, respectively. Expenses for the three months and
nine months benefited by $1.6 million of reduced expenses related to a true-up
of benefit accruals and additional earned fees. The three month and nine month
expense ratio was reduced by 1.6 points and .6 points, respectively.
Additionally, the decline in the underwriting expense ratio is the result of the
Company's expense saving initiatives regarding reduced system costs and salaries
and higher net premium earned in 2000.
Investment Results. Net investment income for the three months and nine
months ended September 30, 2000 and 1999 was $15.6 million, $16.8 million, $46.7
million and $51.8 million, respectively. Net investment income decreased $1.2
million and $5.1 million compared to 1999 due to the continued reduction in the
size of the investment portfolio due to payout of old reserves and the write-off
of a former subsidiary. Net realized investment gains (losses) for the Company
were $(.1) million, $1.0 million, $.8 million and $2.8 million for the three
months and nine months ended September 30, 2000 and 1999, respectively.
Debt Interest and Amortization Expense. Debt interest and amortization
expense for the three months and nine months ended September 30, 2000 and 1999
was $3.1 million, $2.9 million, $9.2 million and $8.8 million, respectively.
The increase is due to the underlying variable interest rate increases and
variable performance add-ons associated with the Company's senior bank debt.
Other Expenses. Other expenses consist of parent company expenses and
miscellaneous expenses of the insurance subsidiaries offset by miscellaneous
income.
Income Taxes. The Company provides for income taxes on its statements of
operations pursuant to Statement of Financial Accounting Standards No. 109,
"Accounting for Income Taxes" (SFAS 109). The total tax expense (benefit) for
the three months and nine months ended September 30, 2000 and 1999 was $1.0
million, $(2.1) million, $2.5 million and $(.4) million, respectively. The
Company's effective tax rate reflects the amount of net investment income from
tax advantaged fixed income securities and the magnitude of the underwriting
loss in relation to net taxable investment income.
LIQUIDITY AND CAPITAL RESOURCES
Highlands Group is a holding company, the principal assets of which at
September 30, 2000 are 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.
13
<PAGE>
Holding Company
As a 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 the
Company are not expected to be material. The annual cash interest requirements
relating to the Company's outstanding 10% convertible subordinated debentures
(the "Debentures") and the loan under the Credit Agreement are approximately
$10.0 million. Effective December 31, 1999, the Company and its lenders amended
the Credit Agreement to amend certain financial covenants and to provide for the
payment of $10.0 million in principal during 2000. The Company repaid $5.0
million of principal during the first quarter of 2000 and $5.0 million during
July 2000. The Company is in compliance with the amended covenants in the
Credit Agreement. Highlands Group does not currently intend to pay dividends on
its Common Stock.
Highlands Group's principal sources of funds are dividends and tax sharing
payments from its subsidiaries, 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 $30.9 million
in 2000 without prior regulatory approval. 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 interest of
the Debentures pursuant to the covenants contained in the Debentures.
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 loss payments
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 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.
YEAR 2000
As of the date of this filing, the Company has not experienced any Year 2000
problems that have materially affected its operations, the realization of
financial assets, or its results of operations. The Company will continue to
monitor its operations for non-compliant components. The Company is also
monitoring its open transactions with customers and vendors to ensure that there
are no undetected Year 2000 problems that could have a material adverse effect
on the Company or its operations.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There have been no material changes in the Company's investment strategies,
types of financial instruments held or the risks associated with such
instruments which would materially alter the market risk disclosures made in the
Company's Annual statement on Form 10-K for the year ended December 31, 1999.
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PART II Other Information
ITEM 1. LEGAL PROCEEDINGS
From 1958 to 1986, the Company issued fixed premium, guaranteed cost (not
retrospectively rated) insurance policies to Brown & Root Company ("Brown &
Root"), a subsidiary of Halliburton Company ("Halliburton"), formerly the
Company's parent and largest customer. Beginning in 1987, the Company's
insurance policies with Halliburton (including Brown & Root) were written on a
retrospectively rated or high-deductible basis. Since the mid-1990's,
approximately 23,000 third party asbestos claims have been made against Brown &
Root. Through September 30, 2000, the Company paid $1.1 million on behalf of
Brown & Root under the fixed premium policies on asbestos claims, and billed
Brown & Root $8.5 million under the retrospectively rated and high-deductible
policies on asbestos claims. Brown & Root has not paid this billed amount and
has questioned the proper allocation of the asbestos claims between the fixed
premium and the retrospectively rated and high-deductible policies.
On April 5, 2000, the Company filed an action in the Delaware Court of
Chancery ("Delaware Action") asserting that indemnification obligations exist
pursuant to the Distribution Agreement dated October 10, 1995 between the
Company and Halliburton, which was executed as part of the distribution by
Halliburton of the shares of the Company's common stock to Halliburton's
stockholders and the public. The action is seeking (i) a declaratory judgment
that Halliburton is responsible for indemnifying the Company for losses and
expenses incurred on the Halliburton/Brown & Root policies; (ii) an injunction
ordering Halliburton to assume responsibility for such losses and expenses;
(iii) a judgment against Halliburton for non-payment of the amounts billed under
the retrospectively rated and high-deductible policies; and (iv) a declaration
estopping Brown & Root from invoking insurance under the fixed premium policies.
On April 24, 2000, Halliburton filed an action in the District Court of Harris
County, Texas ("Texas Action") seeking (i) a declaratory judgment that the
Company is liable for costs and expenses under the fixed premium policies; (ii)
a declaratory judgment that Halliburton has the right to select the policy under
which such coverage is to be paid; and (iii) damages.
On July 13, 2000, the Company amended its complaint in the Delaware Action,
adding a count seeking a declaratory judgment that the Company is not liable
under the fixed premium policies because those policies were terminated pursuant
to the Investment Agreement dated October 10, 1995 among the Company,
Halliburton, Insurance Partners, L.P. and Insurance Partners Offshore (Bermuda)
L.P. The Company also filed a motion for a preliminary injunction enjoining
Halliburton from instituting, continuing or prosecuting any action in any other
jurisdiction arising out of or related to the subject matter of the Delaware
Action. On July 26, 2000, Halliburton filed motions to dismiss the Delaware
Action on the grounds of forum non conveniens and failure to state a claim upon
which relief can be granted.
The Company filed its answer in the Texas Action on July 26, 2000 denying the
allegations in Halliburton's complaint. On July 27, 2000, Halliburton filed an
amended petition in the Texas Action adding Brown & Root as a plaintiff.
Discovery in the Delaware Action and the Texas Action has commenced.
On September 8, 2000, the Company filed a motion for judgment on the pleadings
in the Delaware Action.
On November 6, 2000, Halliburton filed a second amended petition in the Texas
Action adding Highlands Insurance Group, Inc., as a defendant.
Oral argument on the motions pending in the Delaware Action is scheduled for
November 30, 2000.
If the Company is not successful in the litigation described above, it could
have a material adverse impact on the Company. The Company believes, however,
that the positions it has taken in the Delaware Action and Texas Action are
meritorious, and that, ultimately, the Company will not be responsible for a
material amount, if any, of Brown & Root's asbestos liability.
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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
(27) Financial Data Schedule (Filed Electronically)
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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: November 14, 2000 By /s/ Willis T. King, Jr.
-----------------------
Willis T. King, Jr.
Chairman and Chief
Executive Officer
(Authorized Signatory)
Date: November 14, 2000 By /s/ Charles J. Bachand
----------------------
Charles J. Bachand
Vice President, Treasurer and
Principal Accounting Officer
(Authorized Signatory)
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