SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
/x/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1999
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 001-13135
HSB GROUP, INC.
(Exact name of registrant as specified in its charter)
CONNECTICUT 06-1475343
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
P.O. BOX 5024, ONE STATE STREET,
HARTFORD, CONNECTICUT 06102-5024
(Address of principal executive offices) (Zip Code)
(860) 722-1866
(Registrant's telephone number, including area code)
Not applicable
(Former name, former address and former fiscal year,
if changed since the last report)
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 outstanding of the registrant's common stock without par
value, as of July 31, 1999: 28,893,207.
<PAGE>
HSB GROUP, INC.
INDEX
PART I FINANCIAL STATEMENTS PAGE
Item 1 - Financial Statements
Consolidated Statements of Operations for the
Quarters ended June 30, 1999 and
1998 and the Six Months ended June 30, 1999 and 1998
(unaudited)................................................ 3
Consolidated Statements of Comprehensive Income for
the Quarters ended June 30, 1999 and 1998 and the
Six Months ended June 30, 1999 and
1998 (unaudited)............................................. 4
Consolidated Statements of Financial Position as
of June 30, 1999 (unaudited) and December 31, 1998 .......... 5
Consolidated Statements of Cash Flows for the
Six Months ended June 30, 1999 and
1998 (unaudited) ............................................ 6
Notes to Consolidated Financial Statements (unaudited)....... 7
Item 2 - Management's Discussion and Analysis
of Consolidated Financial Condition and Results
of Operations................................................ 13
PART II OTHER INFORMATION
Item 1 - Legal Proceedings................................... 26
Item 4 - Submission of Matters to a Vote of
Security Holders.................................... 26
Item 6 - Exhibits and Reports on Form 8-K.................... 27
SIGNATURES......................................................... 28
2
<PAGE>
Part I
Item 1 - Financial Statements
HSB GROUP, INC.
Consolidated Statements of Operations
Unaudited
(in millions, except per share data)
<TABLE>
<CAPTION>
Quarter Six Months
Ended June 30 Ended June 30
1999 1998 1999 1998
----------------------------------------------------------
<S> <C> <C> <C> <C>
Revenues:
Gross earned premium $ 206.8 $ 175.7 $ 415.7 $ 355.4
Ceded premiums 113.1 85.3 225.5 165.6
-----------------------------------------------------------
Insurance premiums 93.7 90.4 190.2 189.8
Engineering services 27.8 22.7 55.4 42.4
Net investment income 16.6 15.9 32.3 31.1
Realized investment gains 10.2 7.3 17.3 10.5
-----------------------------------------------------------
Total revenues 148.3 136.3 295.2 273.8
-----------------------------------------------------------
Expenses:
Claims and adjustment 37.9 40.4 76.2 85.0
Policy acquisition 21.3 12.8 43.9 27.4
Underwriting and inspection 24.2 27.5 48.2 57.2
Engineering services 25.6 20.7 50.8 38.6
Interest 0.6 0.1 1.0 0.2
-----------------------------------------------------------
Total expenses 109.6 101.5 220.1 208.4
-----------------------------------------------------------
Gain on sale of IRI - - - 39.0
Income from continuing operations before income taxes
and distributions on capital securities $ 38.7 $ 34.8 $ 75.1 $ 104.4
Income taxes (benefit):
Current 11.1 1.7 19.3 29.3
Deferred 0.3 7.6 3.0 2.5
-----------------------------------------------------------
Total income taxes $ 11.4 $ 9.3 $ 22.3 $ 31.8
Distribution on capital securities of subsidiary
trust, net of income tax benefits of $2.4; $2.5;
$4.8; and $4.9. 4.5 4.7 9.0 9.2
-----------------------------------------------------------
Income from continuing operations $ 22.8 $ 20.8 $ 43.8 $ 63.4
Discontinued operations:
Loss from operations, net of income tax benefits
of $3.2 - - - (6.6)
Gain on disposal, net of income taxes of $23.7 - - - 36.9
-----------------------------------------------------------
Total discontinued operations $ - $ - $ - $ 30.3
-----------------------------------------------------------
Net income $ 22.8 $ 20.8 $ 43.8 $ 93.7
-----------------------------------------------------------
Per share data:
Net income per common share-basic:
Income from continuing operations $ 0.79 $ 0.71 $ 1.51 $ 2.16
Discontinued operations - - - 1.04
Net income $ 0.79 $ 0.71 $ 1.51 $ 3.20
Net income per common share-assuming dilution:
Income from continuing operations $ 0.76 $ 0.68 $ 1.46 $ 1.99
Discontinued operations - - - 0.86
Net income $ 0.76 $ 0.68 $ 1.46 $ 2.85
Dividends declared per share $ 0.42 $ 0.40 $ 0.84 $ 0.80
Average shares outstanding and common stock equivalents 34.8 35.4 34.6 35.3
</TABLE>
See Notes to Consolidated Financial Statements.
3
<PAGE>
HSB GROUP, INC.
Consolidated Statements of Comprehensive Income
Unaudited
(in millions)
<TABLE>
<CAPTION>
Quarter Ended Six Months
Ended June 30 Ended June 30
1999 1998 1999 1998
-----------------------------------------------------
<S> <C> <C> <C> <C>
Net income $22.8 $20.8 $43.8 $93.7
Other comprehensive income, net of tax:
Unrealized gains (losses) on securities:
Unrealized holding gains (losses) arising during the
period (net of taxes (benefits) of ($0.2); $4.2;
($4.4); and $14.9) (0.3) 7.8 (8.3) 27.3
Add: reclassification adjustments for gains included in
net income (6.6) (4.7) (11.2) (6.8)
-----------------------------------------------------
Total unrealized gains (losses) on securities (6.9) 3.1 (19.5) 20.5
Foreign currency translation adjustments 0.6 (0.9) 0.9 (0.7)
-----------------------------------------------------
Other comprehensive income (6.3) 2.2 (18.6) 19.8
=====================================================
Comprehensive income $16.5 $23.0 $25.2 $113.5
=====================================================
</TABLE>
See Notes to Consolidated Financial Statements.
4
<PAGE>
HSB GROUP, INC.
Consolidated Statements of Financial Position
(in millions, except per share data)
June 30, December 31,
1999 1998
(Unaudited)
---------- ------------
Assets:
Cash and cash equivalents $ 47.5 $ 18.3
Short-term investments, at cost 49.4 62.3
Fixed maturities, at fair value
(cost - $561.5; $568.5) 544.9 577.1
Equity securities, at fair value
(cost - $333.9; $326.3) 441.6 437.1
------- -------
Total cash and invested assets 1,083.4 1,094.8
Reinsurance assets 660.8 630.4
Insurance premiums receivable 121.7 146.7
Engineering services receivable 29.4 26.1
Fixed assets 56.3 54.9
Prepaid acquisition costs 50.6 46.6
Capital lease 14.2 14.6
Other assets 146.4 129.9
-------- --------
Total assets $2,162.8 $2,144.0
======== ========
Liabilities:
Unearned insurance premiums $ 426.8 $ 477.9
Claims and adjustment expenses 592.2 550.3
Short-term borrowings 55.0 21.0
Long-term borrowings 25.1 25.1
Capital lease 27.8 27.9
Deferred income taxes 35.2 42.7
Dividends and distributions on capital securities 23.2 23.2
Ceded reinsurance payable 61.1 64.1
Other liabilities 84.7 83.6
------- -------
Total liabilities 1,331.1 1,315.8
------- -------
Company obligated mandatorily redeemable
preferred exchange capital
securities of subsidiary Trust I
holding solely junior subordinated
deferrable interest debentures of the
Company, net of unamortized
discount of $1.1 in 1999 and 1998 108.9 108.9
Company obligated mandatorily redeemable
convertible capital securities
of subsidiary Trust II holding solely
junior subordinated deferrable
interest debentures of the Company 300.0 300.0
Shareholders' equity:
Common stock (stated value; shares authorized
50.0; shares issued and outstanding 29.1; 28.9) 10.0 10.0
Additional paid-in capital 35.8 33.5
Accumulated other comprehensive income 48.2 66.8
Retained earnings 335.3 311.2
Benefit plans (6.5) (2.2)
-------- --------
Total shareholders' equity 422.8 419.3
-------- --------
Total $2,162.8 $2,144.0
======== ========
Common shareholders' equity per common share $ 14.52 $ 14.53
See Notes to Consolidated Financial Statements.
5
<PAGE>
HSB GROUP, INC.
Consolidated Statements of Cash Flows
Unaudited
(in millions)
<TABLE>
<CAPTION>
Six Months Ended
June 30,
----------------------------------
1999 1998
-------------- -----------------
<S> <C> <C>
Operating Activities:
Net income $ 43.8 $ 93.7
Adjustments to reconcile net income to net
cash provided by operating
activities:
Depreciation and amortization 10.2 5.9
Deferred income taxes 3.0 2.5
Realized investment gains (17.3) (10.5)
Distributions on capital securities 13.8 14.1
Gain from the disposition of Radian,
net of income taxes - (30.3)
Gain from the disposition of IRI,
net of income taxes - (25.2)
Change in balances, net of effects from
purchases and sales of subsidiaries:
Insurance premiums receivable 25.0 (26.8)
Engineering services receivable (3.3) (10.2)
Prepaid acquisition costs (4.0) 16.0
Reinsurance assets (30.4) (278.5)
Unearned insurance premiums (51.1) 143.4
Claims and adjustment expenses 41.9 60.4
Ceded reinsurance payable (3.0) 94.7
Other (18.4) (39.7)
-------- --------
Cash provided by operating activities 10.2 9.5
-------- --------
Investing Activities:
Fixed asset additions, net (7.4) (7.6)
Investments:
Sale of short-term investments, net 12.9 71.6
Purchase of fixed maturities (86.6) (342.4)
Proceeds from sale of fixed maturities 84.6 23.5
Redemption of fixed maturities 8.3 17.9
Purchase of equity securities (168.0) (209.5)
Proceeds from disposition of Radian - 128.9
Proceeds from disposition of IRI - 49.1
Proceeds from sale of equity securities 180.3 109.0
Purchase of Solomon Associates,
net of cash acquired - (2.1)
--------- -------
Cash provided by (used in)
investment activities 24.1 (161.6)
--------- -------
Financing Activities:
Increase (decrease) in short-term borrowings 31.4 (35.3)
Dividends and distributions on capital securities (38.2) (27.9)
Reacquisition of stock (2.2) (24.1)
Exercise of stock options 3.9 8.4
---------- -------
Cash used in financing activities (5.1) (78.9)
---------- -------
Net increase (decrease) in cash and
cash equivalents 29.2 (231.0)
Cash and cash equivalents
at beginning of period 18.3 293.2
---------- --------
Cash and cash equivalents at end of period $ 47.5 62.2
========== ========
Interest paid $ 1.8 $ 1.1
---------- --------
Federal income tax paid $ 12.2 $ 25.5
---------- --------
</TABLE>
See Notes to Consolidated Financial Statements.
6
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. General
The interim consolidated financial statements in this report include
adjustments based on management's best estimates and judgments,
including estimates of future loss payments, which are necessary to
present a fair statement of the results for the interim periods
reported. These adjustments are of a normal, recurring nature. The
financial statements are prepared on the basis of generally accepted
accounting principles and should be read in conjunction with the
financial statements and related notes in the 1998 Annual Report.
Certain amounts for 1998 have been reclassified to conform with the
1999 presentation.
2. Discontinued Operations
On January 2, 1998, The Hartford Steam Boiler Inspection and Insurance
Company (HSBIIC) exercised its option to put its 40 percent share in
Radian International LLC (Radian LLC) to The Dow Chemical Company
(Dow), for approximately $129 million, net of expenses. Radian LLC was
formed in January 1996 as a joint venture with Dow to provide
environmental, engineering, information technology, remediation and
strategic chemical management services to industries and governments
world-wide. In connection with the formation of the new company, HSBIIC
contributed substantially all of the assets and liabilities of its
wholly-owned subsidiary, Radian Corporation at historical cost to
Radian LLC. No gain was recognized on the transfer. The results of
Radian LLC were classified as discontinued operations following
ratification on July 28, 1997 by the HSB's Board of Directors of
management's decision to exercise its put. The Company's share of
Radian LLC's losses incurred subsequent to such decision of
approximately $6.6 million after-tax was deferred and recognized at the
time the gain was recognized in 1998. This transaction resulted in an
after-tax gain of $36.9 million which was recorded in the first quarter
of 1998.
3. Industrial Risk Insurers
On January 6, 1998, HSBIIC sold its 23.5 percent share in Industrial
Risk Insurers (IRI) to Employers Reinsurance Corporation (ERC), one of
the world's largest reinsurance companies, in accordance with a
previously announced purchase and sale agreement between ERC and IRI's
twenty-three member insurers. The gain on the sale of IRI was $36.6
million pre-tax and $23.8 million after-tax, of which $39.0 million
pre-tax and $25.2 million after-tax was recognized in the first quarter
of 1998. In the fourth quarter of 1998, adjustments were made to the
costs associated with the sale. IRI is a voluntary, unincorporated
joint underwriting association, which provides property insurance for
the class of business known as "highly protected risks" (HPR) -- larger
manufacturing, processing, and industrial businesses which have
invested in protection against loss through the use of sprinklers and
other means. HSBIIC received gross proceeds of $49.1 million, prior to
transaction costs, for its 23.5 percent share in IRI. Because the sale
was structured in part as a reinsurance transaction, a portion of
HSBIIC's gross proceeds was utilized to reinsure in-force policies with
ERC.
Contemporaneous with the close of the sale, IRI was reconstituted with
ERC (with a 99.5 percent share) and HSBIIC (with a 0.5 percent share)
as the sole members. The new association has been renamed HSB
Industrial Risk Insurers. HSBIIC writes the business for HSB Industrial
Risk Insurers using its insurance licenses and provides certain other
management and technical services. In addition, through various quota
share reinsurance agreements with ERC and HSB Industrial Risk Insurers,
HSBIIC transferred its manufacturing book of business to HSB Industrial
Risk Insurers and retains 85 percent of the equipment breakdown
insurance and 15 percent of the property insurance of the combined
insurance portfolio. The agreements are of indefinite duration, but ERC
has an option to purchase HSB's interest in the business in the event
of a 50 percent or more change in the control of HSB.
7
<PAGE>
4. Recent Accounting Developments
The Accounting Standards Executive Committee of the American Institute
of Certified Public Accountants (AcSEC) recently issued three
Statements of Position (SOP) which became effective for fiscal years
beginning after December 15, 1998; SOP 97-3, "Accounting by Insurance
and Other Enterprises for Insurance-Related Assessments", SOP 98-1,
"Accounting for the Costs of Computer Software Developed or Obtained
for Internal Use", and SOP 98-5, "Reporting on the Costs of Start-Up
Activities". Because the Company's accounting policies were in
compliance with the provisions of the SOP's, the implementation of the
SOP's had no impact upon the results of operations, financial condition
or cash flows.
In June 1998, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standard (SFAS) No. 133, "Accounting
for Derivative Instruments and Hedging Activities". This statement
establishes accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts, and for hedging activities. It requires that all derivatives
be recognized as either assets or liabilities in the statement of
financial position and that such instruments be measured at fair value.
In addition, all hedging relationships must be designated, reassessed
and documented pursuant to the provisions of SFAS No. 133. In June,
1999 SFAS No. 137 was issued. This statement defers the effective date
of SFAS No. 133 to fiscal quarters of fiscal years beginning after June
15, 2000. The Company anticipates that the adoption of the provisions
of SFAS No. 133 will not have a material impact on results of
operations, financial condition or cash flows.
In October 1998, AcSEC issued SOP 98-7, "Deposit Accounting: Accounting
for Insurance and Reinsurance Contracts That Do Not Transfer Insurance
Risk." The SOP identifies several methods of deposit accounting and
provides guidance on the application of each method. This SOP is
effective for financial statements for fiscal years beginning after
June 15, 1999. Currently the Company is not party to any contracts
which do not comply with the risk transfer provisions of SFAS No. 113,
"Accounting and Reporting for Reinsurance of Short-Duration and
Long-Duration Contracts," and, therefore, does not anticipate the
adoption of SOP 98-7 will have a material impact on results of
operations, financial condition or cash flows.
5. Legal Proceedings
HSBIIC has been involved in three significant claim-related disputes
concerning the extent to which certain explosion events were insured
under boiler and machinery coverages of HSBIIC. Information regarding
these disputes has been provided in previous 10-K and 10-Q reports.
Current rulings in all three cases confirm HSBIIC's long-standing
position that HSBIIC policies do not cover the explosion events that
occurred in those cases. In one case the parties settled their dispute
following Summary Judgment rulings of the Federal District Court for
the State of Illinois; in a second case, a decision of an arbitration
panel has been confirmed by the Superior Court of the State of
Connecticut; and in a third case, the Federal Court of Appeals for the
Seventh Circuit has remanded the matter for entry of a judgment in
HSBIIC's favor.
The Company is also involved in various other legal proceedings as
defendant or co-defendant that have arisen in the normal course of its
business. In the judgment of management, after consultation with
counsel, it is improbable that any liabilities which may arise from or
with respect to the disputes above or any other litigation will have
material adverse impact on the results of operations or the financial
position of the Company.
8
<PAGE>
6. Earnings per share
Computation of Earnings Per Share:
<TABLE>
<CAPTION>
Quarter Ended Six Months Ended
June 30, 1999 June 30, 1999
------------- ----------------
Income Shares Per Income Shares Per
------ ------ Share ------ ------ Share
----- -----
<S> <C> <C> <C> <C> <C> <C>
Income from continuing
operations $ 22.8 $ 43.8
Basic EPS:
Income available to common
shareholders $ 22.8 $ 43.8
Weighted Average Common
Shares Outstanding 29.0 29.0
Income from continuing
operations per common
share - basic $ 0.79 $ 1.51
Effect of dilutive securities:
After-tax interest on
convertible capital
securities $ 3.5 $ 6.8
Convertible capital
securities 5.3 5.3
Stock options 0.5 0.3
Diluted EPS:
Income from continuing
operations available to
common and assumed
conversions $ 26.3 34.8 $ 50.6 34.6
Income from continuing
operations per common
share - assuming dilution $ 0.76 $ 1.46
</TABLE>
9
<PAGE>
<TABLE>
<CAPTION>
Quarter Ended Six Months Ended
June 30, 1998 June 30, 1998
------------- ----------------
Income Shares Per Income Shares Per
------ ------ Share ------ ------ Share
----- -----
<S> <C> <C> <C> <C> <C> <C>
Income from continuing
operations $ 20.8 $ 63.4
Basic EPS:
Income available to common
shareholders $ 20.8 $ 63.4
Weighted Average Common
Shares Outstanding 29.3 29.3
Income from continuing
operations per common
share - basic $ 0.71 $ 2.16
Effect of dilutive securities:
After-tax interest on
convertible capital
securities $ 3.4 $ 6.8
Convertible capital
securities 5.3 5.3
Stock options 0.8 0.7
Diluted EPS:
Income from continuing
operations available to
common and assumed
conversions $ 24.2 35.4 $ 70.2 35.3
Income from continuing
operations per common
share - assuming dilution $ 0.68 $ 1.99
</TABLE>
7. Segment Information
In 1998, HSB implemented the provisions of SFAS No. 131, "Disclosures
about Segments of an Enterprise and Related Information". This
standard requires companies to report financial and descriptive
information about reportable operating segments utilizing the
management approach to defining operating segments. It includes
disclosure requirements relating to products and services, geographic
areas and major customers. The adoption of SFAS No. 131 did not affect
consolidated results of operations or financial position but did
affect the disclosure of segment information.
HSB has four reportable segments--Commercial insurance, Global Special
Risk insurance, Engineering services and Investments. HSB is a
multi-national company operating primarily in North American, European,
and Asian markets. Through its Commercial segment operations, HSB
provides risk modification services, equipment breakdown insurance and
loss recovery services to commercial businesses. The Global Special
Risk operating segment focuses on the needs of equipment-intensive
industries by offering all risk coverage with customized engineering
consulting and risk management. HSB's Engineering services operations
offers professional scientific and technical consulting for industry
and government on a worldwide basis. The Company's investment assets
are managed by its Investment operating segment.
The accounting policies of the segments are consistent with generally
accepted accounting principles except for certain benefit charges which
comprise the Corporate Account. HSB evaluates the performance of its
segments and allocates resources to them based on net income (loss).
Segment assets are not included in this evaluation process. Interest
income and expense are included in the results of Investment
operations.
10
<PAGE>
The following presents revenue and net income from the Company's
reportable segments and reconciles these amounts to the corresponding
consolidated totals:
<TABLE>
<CAPTION>
Quarter Ended Six Months Ended
June 30 June 30
--------------- ----------------
1999 1998 1999 1998
-------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Revenues from continuing operations
Insurance premiums:
Commercial $ 82.2 $ 68.9 $ 162.5 $ 137.0
Global Special Risks 11.1 19.3 26.8 49.3
Engineering services 27.8 22.7 55.4 42.4
Net investment income and realized
investment gains 26.8 23.2 49.6 41.6
----------- ----------- ----------- ---------
Total revenues from reportable segments 147.9 134.1 294.3 270.3
Other segments 0.4 2.2 0.9 3.5
----------- ----------- ----------- ----------
Total revenues $ 148.3 $ 136.3 $ 295.2 $ 273.8
========== =========== =========== ==========
Net income (loss):
Commercial $ 4.5 $ 2.6 $ 5.9 $ 3.9
Global Special Risks 2.7 3.0 7.9 7.2
Engineering services 1.2 1.1 2.5 2.1
Investment 18.6 16.9 34.6 30.3
----------- ----------- ----------- ----------
Total net income from reportable segments 27.0 23.6 50.9 43.5
Other segments (1.5) 0.5 (1.5) 1.2
Corporate account 1.8 1.4 3.4 2.7
Distributions on capital securities (4.5) (4.7) (9.0) (9.2)
Discontinued operations - - - 30.3
Gain on sale of IRI, net of income taxes - - - 25.2
----------- ----------- ----------- ----------
Net income $ 22.8 $ 20.8 $ 43.8 $ 93.7
=========== =========== =========== ==========
</TABLE>
8. Global Floating Rate Capital Securities
On July 15, 1997, a trust sponsored and wholly owned by the Company
issued $110,000,000 aggregate liquidation amount of capital securities
in a private placement and 3,403 shares of common securities to the
Company, the proceeds of which were invested by the trust in
$113,403,000 aggregate principal amount of the Company's debt
securities. On November 5, 1997, an exchange offer was commenced,
pursuant to which the capital securities originally issued in the
private placement were exchanged for capital securities that were
registered with the Securities and Exchange Commission (the "Capital
Securities" ) and the debt securities were exchanged for debt
securities that were registered with the Securities and Exchange
Commission (the "Debt Securities" ).
The Debt Securities represent all of the assets of the trust. The
proceeds from the issuance of the Debt Securities were used by the
Company for general corporate purposes. The Debt Securities and related
income statement effects are eliminated in the Company's consolidated
financial statements. The $113.4 million principal amount of Debt
Securities accrue and pay cash distributions quarterly in arrears at a
variable rate of LIBOR plus .91% of the stated liquidation amount of
$1,000 per Debt Security, and are scheduled to mature on July 15, 2027.
The Capital Securities accrue and pay cash distributions quarterly in
arrears at a variable rate of LIBOR plus .91% of the stated
liquidation amount of $1,000 per Capital Security. The terms of the
Debt Securities, the guarantee of the Company with respect to the
Capital Securities, the Indenture and the Trust Agreement together
provide a full guarantee by HSB Group, Inc. of amounts due on the
Capital Securities.
11
<PAGE>
The Capital Securities are mandatorily redeemable upon the maturity of
the Debt Securities on July 15, 2027, or earlier to the extent of any
redemption by the Company of any Debt Securities. The redemption price
in either such case will be $1,000 per share plus accrued and unpaid
distributions to the date fixed for redemption.
12
<PAGE>
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS
OF CONSOLIDATED FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
JUNE 30,1999
RESULTS OF OPERATIONS
- ---------------------
(dollar amounts in millions)
Consolidated Overview
- ---------------------
<TABLE>
<CAPTION>
Quarter Ended Six Months Ended
June 30 June 30
------- -------
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenues:
Gross earned premiums $206.8 $175.7 $415.7 $355.4
Ceded premiums 113.1 85.3 225.5 165.6
-------- --------- -------- -------
Insurance premiums 93.7 90.4 190.2 189.8
Engineering services 27.8 22.7 55.4 42.4
Net investment income 16.6 15.9 32.3 31.1
Realized investment gains 10.2 7.3 17.3 10.5
-------- --------- --------- -------
Total revenues $148.3 $136.3 $295.2 $273.8
========== ========= ========= =======
Pre-tax Income from Continuing Operations:
Pre-tax income excluding sale of IRI $ 38.7 $ 34.8 $ 75.1 $ 65.4
Pre-tax gain on sale of IRI - - - 39.0
---------- --------- --------- -------
Pre-tax income 38.7 34.8 75.1 104.4
Income taxes on continuing operations 11.4 9.3 22.3 31.8
Distributions on capital securities 4.5 4.7 9.0 9.2
------------- ----------- --------- -------
Income from continuing operations 22.8 20.8 43.8 63.4
Discontinued operations - - - 30.3
------------- ----------- -------- -------
Net income $ 22.8 $ 20.8 $ 43.8 $ 93.7
============= =========== ======== =======
Net income per common share:
Basic $ 0.79 $ 0.71 $ 1.51 $ 3.20
Assuming dilution $ 0.76 $ 0.68 $ 1.46 $ 2.85
</TABLE>
13
<PAGE>
Absent the sales of Industrial Risk Insurers (IRI) and Radian International LLC
(Radian LLC) discussed below, the Company's 1999 after-tax earnings increased
9.6 percent from the second quarter of 1998 and increased 14.7 percent in the
first six months of 1999 compared to 1998 due to higher realized gains, improved
underwriting results and higher engineering gains. Net income for the first six
months of 1998 included after-tax gains on the sale of HSB's interest in IRI of
$25.2 million and Radian LLC of $30.3 million. The Radian LLC gain is net of
after-tax operating losses of $6.6 million that were deferred in 1997 when the
decision was made to exercise HSB's option to put the Company's interest to The
Dow Chemical Company (Dow). As a result, HSB's interest in Radian LLC was
classified as a discontinued operation in 1997.
The effective tax rate on income from continuing operations, excluding the sale
of IRI, for the second quarter and the year to date were 29 percent and 30
percent compared to 27 percent and 28 percent for the comparable prior periods.
Typically tax rate fluctuations occur as underwriting and engineering services
results and realized gains change the mix of pre-tax income between fully
taxable earnings and tax preferred earnings that can be obtained by investing in
certain instruments. The taxes associated with the sale of IRI contributed to
the higher taxes in the six month period of 1998 compared to 1999. The Company
continues to manage its use of tax advantageous investments to maximize after
tax earnings.
Recent Accounting Developments
- ------------------------------
The Accounting Standards Executive Committee of the American Institute of
Certified Public Accountants (AcSEC) recently issued three Statements of
Position (SOP) which became effective for fiscal years beginning after December
15, 1998; SOP 97-3, "Accounting by Insurance and Other Enterprises for
Insurance-Related Assessments", SOP 98-1, "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use", and SOP 98-5, "Reporting on
the Costs of Start-Up Activities". Because the Company's accounting policies
were in compliance with the provisions of the SOP's, the implementation of the
SOP's had no impact upon the results of operations, financial condition or cash
flows.
In June 1998, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standard (SFAS) No. 133, "Accounting for Derivative
Instruments and Hedging Activities". This statement establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities. It requires
that all derivatives be recognized as either assets or liabilities in the
statement of financial position and that such instruments be measured at fair
value. In addition, all hedging relationships must be designated, reassessed and
documented pursuant to the provisions of SFAS No. 133. In June 1999, SFAS No.
137 was issued. This statement defers the effective date of SFAS No. 133 to
fiscal quarters of fiscal years beginning after June 15, 2000. The Company
anticipates that the adoption of the provisions of SFAS No. 133 will not have a
material impact on results of operations, financial condition or cash flows.
14
<PAGE>
In October 1998, AcSEC issued SOP 98-7, "Deposit Accounting: Accounting for
Insurance and Reinsurance Contracts That Do Not Transfer Insurance Risk." The
SOP identifies several methods of deposit accounting and provides guidance on
the application of each method. This SOP is effective for financial statements
for fiscal years beginning after June 15, 1999. Currently the Company is not
party to any contracts which do not comply with the risk transfer provisions of
SFAS No. 113, "Accounting and Reporting for Reinsurance of Short-Duration and
Long-Duration Contracts," and, therefore, does not anticipate the adoption of
SOP 98-7 will have a material impact on results of operations, financial
condition or cash flows.
Insurance Operations
- --------------------
Insurance operations include the insurance results of The Hartford Steam Boiler
Inspection and Insurance Company (HSBIIC), HSB Engineering Insurance Limited
(EIL), The Boiler Inspection and Insurance Company of Canada (BI&I), The Allen
Insurance Company, Ltd., HSB of Connecticut, HSB of Texas, and HSBIIC's
participation in HSB Industrial Risk Insurers and various other pools.
<TABLE>
<CAPTION>
Quarter Ended Six Months Ended
June 30 June 30
------- -------
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Gross earned premiums $206.8 $ 175.7 $415.7 $355.4
Ceded premiums 113.1 85.3 225.5 165.6
----- ----- ----- -----
Insurance premiums 93.7 90.4 190.2 189.8
Claims and adjustment expenses 37.9 40.4 76.2 85.0
Underwriting, acquisition and
other expenses 45.5 40.3 92.1 84.6
---- ---- ---- ----
Underwriting gain $ 10.3 $ 9.7 $ 21.9 $ 20.2
===== ===== ===== =====
Loss ratio 40.5% 44.7% 40.1% 44.8%
Expense ratio 48.6% 44.6% 48.4% 44.5%
----- ------ ----- -----
Combined ratio 89.1% 89.3% 88.5% 89.3%
===== ====== ===== =====
</TABLE>
Gross earned premiums in the second quarter and year to date increased 17.7
percent and 17.0 percent from the comparable periods in 1998. This was primarily
attributable to an increase in premiums from HSB Industrial Risk Insurers of
$13.7 million and $26.7 million, respectively, for the quarter and year to date
reflecting the Company's role as
15
<PAGE>
direct writer of that business. Other growth includes the impact of certain
commercial books of business acquired in mid 1998. Gross earned premiums
representing coverage outside the U.S. for non HSB Industrial Risk Insurers
business decreased 5 percent in the first six months from the comparable period
in 1998. In certain areas of the Company's direct domestic and international
businesses, the market is experiencing price erosion as the number of insurers
offering capacity has expanded. HSB will not write business at rates which would
lessen our ability to maintain underwriting profit. As a result, premiums in the
Global Special Risk areas may continue to experience revenue declines until
pricing in these markets begins to improve.
Increases in ceded premium of 32.6 percent in the current quarter and 36.2
percent year to date were the result of both the HSB Industrial Risk Insurers
arrangement and related reinsurance with ERC, and the timing of instituting some
of the Company's reinsurance programs which now utilize significantly more quota
share reinsurance on certain of our books of business. We anticipate these new
reinsurance contracts and the HSB Industrial Risk Insurers arrangement, along
with growth in our commercial business, will likely continue to result in growth
in gross earned premium but lower growth in net earned premium.
The loss ratio decreased from 44.7 percent in the second quarter of 1998 to 40.5
percent in the current quarter. For the six months year to date, the loss ratio
decreased from 44.8 percent in 1998 to 40.1 percent in 1999. First quarter 1998
results were impacted by severe ice storms in Canada. Gross claims and
adjustment expenses for the first six months of 1999 and 1998 were $249.3
million and $220.7 million, respectively. This increase was primarily the result
of large losses in our Global Special Risk business which were largely
reinsured.
The expense ratio increased from 44.6 percent in the second quarter of 1998 to
48.6 percent in the current quarter, and from 44.5 percent year to date in 1998
to 48.4 percent year to date in 1999. Prepaid acquisition costs have grown
largely due to growth in gross premiums and different commission rates
reflecting changes in the mix of business. The expense ratio was also affected
by the increased level of reinsurance purchased and related ceding commissions.
In addition, the expense ratio has been impacted more heavily in 1999 by Year
2000 systems remediation costs.
16
<PAGE>
The following information summarizes net earned premiums and net income by
reportable insurance segment:
Quarter Ended Six Months Ended
June 30 June 30
------- -------
1999 1998 1999 1998
---- ---- ---- ----
Commercial:
Net earned premiums $ 82.2 $ 68.9 $ 162.5 $ 137.0
Net income 4.5 2.6 5.9 3.9
Global Special Risks:
Net earned premiums $ 11.1 $ 19.3 $ 26.8 $ 49.3
Net income 2.7 3.0 7.9 7.2
Net earned premiums in the Commercial segment rose $13.3 million in the second
quarter and $25.5 million for the first six months of 1999 over the comparable
periods in 1998 due to strong growth in client company billings and integration
of the Kemper portfolio. 1998 results were impacted by severe ice storms in
Canada during the first quarter. Profits in 1999 have been depressed by an
adjustment to commission expense, expected higher systems costs related to Year
2000 and increased frequency of small claims.
Global Special Risks net earned premiums declined $8.2 million and $22.5 million
for the quarter and year to date, respectively, in 1999 from the comparable
periods in 1998 due to price erosion and the maintenance of strict underwriting
standards, coupled with changes in reinsurance programs. Year to date net income
increased, however, due to favorable claims experience in comparison to 1998,
particularly in international business. In addition, current period results are
higher due to fees/expense reimbursement generated from managing the IRI
business. The level of fees/expense reimbursement in the future will be
dependent upon pricing in these markets and the volume of business which meets
our underwriting standards.
Engineering Services Operations
- -------------------------------
Quarter Ended Six Months Ended
June 30 June 30
------- ----------------
1999 1998 1999 1998
----- ----- ------ -----
Engineering services revenues $27.8 $22.7 $55.4 $42.4
Engineering services expenses 25.6 20.7 50.8 38.6
---- ---- ---- ----
Operating gain $ 2.2 $ 2.0 $ 4.6 $ 3.8
==== ==== ==== ====
Net margin 8.2% 8.9% 8.3% 8.9%
17
<PAGE>
Engineering services operations include the results of HSBIIC's, EIL's and
BI&I's engineering services, HSB Reliability Technologies (HSBRT), HSB
Professional Loss Control, HSB International, Solomon Associates, Inc. (SAI) and
the Company's interest in Integrated Process Technologies, LLC.
Engineering services revenues increased in 1999 by $5.1 million in the second
quarter and $13.0 million year to date compared to the same periods in 1998. The
growth in revenues was primarily due to SAI which was acquired in April 1998 and
EIL's engineering services revenues generated through recent acquisitions. The
decline in operating margin from the previous periods reflects operating costs
incurred to develop new products and in new start up operations, delays in
starting certain contracts and the closing of plants in the steel industry
serviced by a higher margin business unit.
The Company continues to focus on identifying and evaluating acquisition
candidates in the niche engineering management consulting service business,
primarily in process industries, in order to expand or complement its
engineering service capabilities.
Investment Operations
- ---------------------
Quarter Ended Six Months Ended
June 30 June 30
------- -------
1999 1998 1999 1998
---- ---- ---- ----
Net investment income $16.6 $15.9 $32.3 $31.1
Realized investment gains 10.2 7.3 17.3 10.5
---- --- ---- ----
Pretax income from
investment operations $26.8 $23.2 $49.6 $41.6
===== ===== ===== =====
Income from investment operations for the second quarter and year to date
increased $3.6 million and $8.0 million, respectively, primarily due to realized
investment gains resulting from repositioning the investment portfolio due to
market fluctuations.
The Company's investment strategy continues to be to maximize total return on
the investment portfolio through investment income and capital appreciation.
Investment strategies for any given year are developed based on many factors
including operational results, tax implications, regulatory requirements,
interest rates, dividends to stockholders and market conditions. The investment
portfolio includes a wide variety of high quality equity securities and both
domestic and foreign fixed maturities. The Company continues to manage its use
of tax advantageous investments to maximize after-tax investment earnings. The
Company does not engage in cash flow underwriting; it seeks to have underwriting
profit each year.
Market Risk
- -----------
The value of the Company's financial instruments reacts to changes in various
macro variables. These changes are thought of as systemic risks or market risks
and are quantified as equity market risk, interest rate risk and foreign
currency risk. Equity
18
<PAGE>
market risk is the chance that market influences will affect the expected
returns on equity investments. Interest rate risk relates the effect that
changes in the level of interest rates will have on the return on financial
instruments, fixed income investments in particular. Foreign currency risk is
the chance that fluctuations in foreign currency exchange rates will impact the
value of financial instruments.
Portfolio sensitivity to these variables tends to change over time due to
changes in portfolio composition and changes in market environment. During the
first half of 1999 the Company's equity instruments sensitivity to equity market
risk, as measured by portfolio beta, decreased from 1.02 to 0.97. This change is
generally attributed to portfolio repositioning during the period.
For the fixed maturity portfolio, sensitivity, as measured by duration,
increased from 5.48 to 7.85 during the first half of 1999. The increase in
duration is due to the interest rate environment that occurred during the
period. The Company uses a yield to worst call methodology to calculate
duration. This assumes that an issuer, given the current rate environment, will
call higher coupon debt if appropriate. Given that interest rates increased
during the year, the call feature on many issues became non-applicable. This
caused the portfolio to show an increase in duration and correspondingly an
increase in sensitivity to interest rates.
The following analysis illustrates the sensitivity of the market value of the
financial instruments to selected changes in market rates and prices. The range
reflects the Company's view of reasonably possible market movements over a one
year period. The range of values selected should not be interpreted as the
Company's prediction of future market events, but rather an illustration of the
impact of such events. The computations do not contemplate any actions the
Company would undertake in response to changes in interest rates.
The sensitivity analysis assumes an instantaneous shift in market interest
rates, with scenarios of interest rates increasing 100 and 150 basis points from
their levels at June 30, 1999, and all other variables held constant. Currency
risk assumes an instantaneous 10 percent and 20 percent change in the foreign
currency exchange rates versus the US dollar from their levels at June 30, 1999
with all other variables held constant. Equity price risk is measured assuming
an instantaneous 10 percent and 25 percent change in the S & P 500 Index from
its level at June 30, 1999 with all other variables held constant.
The Company's convertible capital securities have been issued at fixed rates,
and as such interest expense would not be impacted by interest rate shifts. The
impact of 100 and 150 basis point increases in interest rates on the convertible
capital securities would be an estimated decrease in market value of $27.3
million and $39.4 million and is calculated without giving any effect to the
relationship of the conversion price to the current market price of HSB Group,
Inc. common stock.
The following table reflects the estimated effects on the market value of the
Company's financial instruments due to an increase in interest rates of 100
basis points, a 10 percent
19
<PAGE>
decline in foreign currency exchange rates, and a decline of 10 percent in the S
& P 500 Index.
Held For Other Than Trading Purposes
Market Interest Currency Equity
At June 30, 1999 Value Rate Risk Risk Risk
- --------------------------------------------------------------------------------
Fixed maturity securities $ 544.9 $(35.7) $(2.3) $ -
Equity securities 441.6 (12.8) (1.8) (23.0)
Short term investments 49.4 (0.6) (2.2) -
------------------------------------------------
Total all securities $1,035.9 $(49.1) $(6.3) $(23.0)
------------------------------------------------
The following table reflects the estimated effects on the market value of the
Company's financial instruments due to an increase in interest rates of 150
basis points, a 20 percent decline in foreign currency exchange rates, and a
decline of 25 percent in the S& P 500 Index.
Held For Other Than Trading Purposes
Market Interest Currency Equity
At June 30, 1999 Value Rate Risk Risk Risk
- --------------------------------------------------------------------------------
Fixed maturity securities $ 544.9 $(51.1) $ (4.5) $ -
Equity securities 441.6 (18.2) (3.7) (57.5)
Short term investments 49.4 (0.9) (4.1) -
------------------------------- -----------------------
Total all securities $1,035.9 $(70.2) $(12.3) $(57.5)
------------------------------- -----------------------
Statement of Comprehensive Income
- ---------------------------------
In addition to the impact of HSB's results of operations, the Consolidated
Statements of Comprehensive Income displays the effects of price movements on
HSB's invested assets. As a result of the market corrections and subsequent
rebounds, cumulative holding gains, net of taxes, for the first six months of
1999 decreased $18.6 million as compared to the increase of $19.8 million in the
same period in 1998. Exclusive of realized gains, the decrease in 1999 is mainly
in fixed maturities due to rising interest rates.
20
<PAGE>
Liquidity and Capital Resources
- -------------------------------
Balances at
June 30 December 31
1999 1998
-------- -------------
Total assets $ 2,162.8 $ 2,144.0
Short-term investments 49.4 62.3
Cash and cash equivalents 47.5 18.3
Short-term borrowings 55.0 21.0
Capital securities of subsidiary Trust I 108.9 108.9
Capital securities of subsidiary Trust II 300.0 300.0
Common shareholder's equity 422.8 419.3
Liquidity refers to the Company's ability to generate sufficient funds to meet
the cash requirements of its business operations. HSB is a holding company whose
principal subsidiary is HSBIIC. HSB relies on investment income, primarily in
the form of dividends from HSBIIC, in order to meet its short and long-term
liquidity requirements including the service requirements for its capital
securities. The Company receives a regular inflow of cash from maturing
investments, engineering services and insurance operations. The mix of the
investment portfolio is managed to respond to expected claim pay-out patterns
and the service requirements of the Company's capital securities. HSB also
maintains a highly liquid short-term portfolio to provide for immediate cash
needs and to offset a portion of interest rate risk relating to the Capital
Securities of subsidiary Trust I.
Cash provided from operations was $10.2 million in the first six months of 1999
compared to $9.5 million for the same period in 1998. Overall cash flows in 1998
were significantly impacted by the investment of proceeds from the convertible
capital securities issued in late December 1997 and the sales of Radian and IRI
in 1998.
Capital resources consist of shareholders' equity, capital securities and debt
outstanding, and represent those funds deployed or available to be deployed to
support business operations. Common shareholders' equity of $422.8 million at
June 30, 1999, increased by $3.5 million since December 31, 1998. The increase
primarily reflects comprehensive income of $25.2 million and option exercises of
$3.9 million, less dividends of $24.4 million and share repurchases of $2.2
million.
At June 30, 1999, HSBIIC had significant short-term and long-term borrowing
capacity. HSBIIC is currently authorized to issue up to $75 million of
commercial paper. Commercial paper outstanding at June 30, 1999 was
approximately $50 million.
HSBIIC has been involved in three significant claim-related disputes concerning
the extent to which certain explosion events were insured under boiler and
machinery coverages of HSBIIC. Information regarding these disputes has been
provided in previous 10-K and 10-Q reports. Current rulings in all three cases
confirm HSBIIC's
21
<PAGE>
long-standing position that HSBIIC policies do not cover the explosion events
that occurred in those cases. In one case the parties settled their dispute
following Summary Judgment rulings of the Federal District Court for the State
of Illinois; in a second case, a decision of an arbitration panel has been
confirmed by the Superior Court of the State of Connecticut; and in a third
case, the Federal Court of Appeals for the Seventh Circuit has remanded the
matter for entry of a judgment in HSBIIC's favor.
The Company writes business in European markets primarily through its U.K.
subsidiary, EIL. The adoption of a common currency (the euro) by eleven of the
fifteen member countries of the European Union on January 1, 1999 is not
expected to result in a substantial change in the business or a significant
increase in costs in the short term. In part, this is due to the fact that much
of the business is U.S. dollar denominated. The U.K. is not a first wave euro
country and as such the impact is primarily limited to the small overseas
offices located in Spain and the Irish Republic. Over time, if the U.K. adopts
the euro as its currency, there may be more of an impact, however, the number of
affected transactions are such that a manual backup system is practicable. The
Company will continue to monitor developments and assess impacts on markets,
pricing, and reporting.
Year 2000
- ---------
The following Year 2000 statements constitute a Year 2000 Readiness Disclosure
within the meaning of the Year 2000 Information and Readiness Disclosure Act of
1998.
Year 2000 Plan and State of Readiness
- -------------------------------------
In 1996, the Company began a comprehensive effort to assess and address issues
affecting the Company, which related to the inability of computer equipment and
embedded computer chips to distinguish between the year 1900 and the year 2000.
As has been well publicized, many computer systems and date controlled equipment
may cease to function or may function in a different manner when the year 2000
arrives because they are programmed to recognize only the last two digits of the
year.
As a part of this effort, the Company established a Year 2000 Program to address
four key areas: (i) applications software, primarily consisting of the Company's
policy management, claims, financial recording and reporting, human resource
systems, and engineering databases and systems; (ii) infrastructures, such as
mainframe and corporate servers, workstations and networking components; (iii)
embedded technology in facilities in which the Company conducts its operations
and in testing equipment used by the Company's engineering staff; and (iv) key
business partners and suppliers. In addition, the Company is evaluating
potential coverage exposures arising out of the Year 2000 and its impact on
insured equipment. The Company's Year 2000 Program consists of six partially
overlapping stages for the key areas listed above: (i) assessment and analysis;
(ii) development, renovation and replacement; (iii) implementation; (iv) testing
and certification; (v) contingency planning; and (vi) audit and review. The
Company is using members of its internal information technology staff as well as
external consultants and
22
<PAGE>
programmers to complete various tasks in connection with its Year 2000 Program
and is currently on schedule.
The Company has completed the assessment and analysis phase for its policy
management, claims, financial recording and reporting, human resource systems
and engineering databases and systems. The development, renovation, replacement
and implementation phases are largely complete for these systems. We have
substantially completed Year 2000 testing for our current policy management,
financial application and engineering systems. We will continue to Year 2000
test our claims, human resource systems and other supporting applications
throughout the third quarter of 1999.
The Company has completed the assessment and analysis phase with respect to
infrastructure items. The mainframe is Year 2000 compliant and the Company
expects to complete the migration to Year 2000 compliant servers and supporting
hardware and software by September 1999. Replacement of the various components
of non-compliant workstations and peripheral equipment also is expected to be
completed by September 1999. Many of the third-party software applications
utilized by the Company in its desktop environment are already Year 2000
compliant. The Company expects to complete the installation of such compliant
programs on virtually all of its workstations by September 1999.
In the area of embedded chip technology, the Company's principal exposure
relates to the prevalence of such technology in office buildings in which the
Company leases space for conducting its business operations. The Company has
sent questionnaires to the leasing vendors for all of its principal facilities
with respect to Year 2000 readiness and has received assurances of readiness
from most of its vendors.
The Company has identified and is currently in the process of contacting key
suppliers of services and business partners, such as client companies, agents
and brokers, with whom the Company has significant business relations and who
may either electronically provide to, or receive from, the Company certain
financial and other information. As the Company receives responses from its
suppliers and business partners, it will update its assessment of the potential
impact on the Company of such parties' Year 2000 state of readiness and
remediation plans and conduct renovations and/or replacement and compliance
testing, as appropriate.
The Company is relying upon Year 2000 readiness statements of other entities and
has not independently verified the accuracy of such statements.
Costs
- -----
It is currently estimated that the Company's aggregate spending in connection
with the Year 2000 Program will be in the range of $27 million of which
approximately $24.6 million has been expended through June 30, 1999. Certain of
these costs are being expensed as they are incurred and are being funded through
operating cash flow. The
23
<PAGE>
Company has expensed $5.1 million, $1.5 million and $0.2 million in 1998, 1997
and 1996, respectively, and $4.2 million for the first six months of 1999. It is
estimated that expenditures of $2.4 million for the remainder of 1999 will be
expensed as incurred. The remainder of the $27 million estimate which has not
been expensed relates to systems that the Company anticipated replacing in the
normal course of information technology development but the timetable for which
was accelerated in contemplation of the Year 2000 event. Costs of replacement
and renovation of information systems and infrastructure that would have
occurred in the normal course of business without the advent of the Year 2000
event are excluded from these amounts. The current estimate also does not
include any costs associated with the implementation of contingency plans that
are in the process of being developed.
The Company does not expect the costs relating to its Year 2000 Program to have
a material effect on its results of operations, liquidity or financial
condition. However, the Year 2000 Program is an ongoing process and the
estimated costs, as well as the estimated completion dates for various phases of
the program, are subject to change.
Risks
- -----
The failure of one or more critical software applications or components of the
Company's infrastructure to be Year 2000 compliant could cause a material
disruption in the normal business operations of the Company. Such disruptions
could include the inability to process policies, register and collect premiums
and engineering receivables, process claims or schedule inspections and
engineering services. Due to the difficulty in estimating the scope and duration
of such failures, the Company is unable to determine at this time whether the
consequences of such failures will have a material impact on the Company's
results of operations, liquidity, or financial condition. Moreover, the
Company's operations are interdependent with systems of business partners and
service providers, such as financial institutions, communication service
providers and utilities, over which the Company has no control. The failure of
one or more of such business partners or service providers to be Year 2000
compliant could have a material adverse impact on the Company. However, the
Company believes that with the implementation of its Year 2000 Program as
scheduled, including the contingency plans discussed below, the risk of material
disruptions to its normal business operations should be significantly reduced.
As an insurance company, the Company maintains a significant portfolio of
investments in cash, short-term fixed income, and equity securities. Inasmuch as
the advent of the Year 2000 may cause events, business interruptions and altered
economic facts and circumstances, the value of the Company's investments may be
affected favorably or unfavorably. The Company is selectively monitoring the
Year 2000 compliant status of the corporate issuers of the securities in its
investment portfolio primarily through reviewing public disclosure documents.
State government and municipal bonds held by the Company are general obligations
and/or are credit-enhanced and therefore the Company does not perceive there to
be a significant credit risk with these securities in the absence of a severe
Year 2000 disruption affecting governments and businesses generally. A portion
of the Company's portfolio is invested in non-public issues where
24
<PAGE>
public disclosure documents are unavailable. Due to the difficulty in estimating
the scope and duration of such events, the Company is unable to determine at
this time whether the consequences of such developments will have a material
impact on the Company's investment portfolio and therefore, on the Company's
results of operations, liquidity or financial condition.
Contingency Plans
- -----------------
As a component of the Year 2000 Program, the Company is concurrently developing
contingency plans intended to mitigate the possible disruption of business
operations arising out of the Year 2000 event. These plans will be continuously
refined during 1999 as the Company completes compliance testing on its internal
applications software and infrastructure and further assesses the Year 2000
readiness status of its business partners. Contingency plans may include
securing back-up power for the Company's data center, manual processing,
short-term fixes to non-compliant programs or business partner interfaces and
modifying the Company's asset selection criteria for its investment activities.
Insurance Coverage Issues
- -------------------------
The Company continues to evaluate the potential coverage exposures arising out
of the Year 2000 event and its impact on insured equipment. The Company has
prepared an endorsement to its equipment breakdown and all-risk forms which
reiterates that coverage is not provided for the inherent inability of computers
and computerized equipment to properly recognize a particular date or time, such
as the year 2000. It is Company policy to include the endorsement on new and
renewal equipment breakdown and all-risk policies. In addition, a notice
reiterating the Company's coverage intent with respect to Year 2000 exposures
has been sent to all new and renewal equipment breakdown policyholders. Most of
the insurers that the Company reinsures for equipment breakdown coverage are
issuing similar endorsements to their policies. The Company is conducting an
on-going communications program with its client company insurers and agents to
disseminate to the ultimate policyholders its Year 2000 loss control suggestions
and policy coverage position.
Quantification of the Company's exposure to Year 2000 losses and loss adjustment
expenses are not reasonably estimable at this time as applicable policy and
reinsurance contract wordings have not been legally tested in the context of
such losses.
Forward-Looking Statements
- --------------------------
Certain statements contained in this report are forward-looking and are based on
management's current expectations. Actual results may differ materially from
such expectations depending on the outcome of certain factors described with
such forward-looking statements and other factors including: significant natural
disasters and severe weather conditions; changes in interest rates and the
performance of the financial markets; changes in the availability, cost and
collectibility of reinsurance; changes in domestic and foreign laws, regulations
and taxes; the entry of new or stronger
25
<PAGE>
competitors and the intensification of pricing competition; the loss of current
customers or the inability to obtain new customers; changes in the coverage
terms selected by insurance customers, including higher deductibles and lower
limits; the adequacy of loss reserves; changes in asset valuations;
consolidation and restructuring in the insurance industry; changes in the
Company's participation in joint underwriting associations, and in particular
its arrangement with HSB Industrial Risk Insurers; changes in the demand and
customer base for engineering and inspection services offered by the Company,
whether resulting from changes in the law or otherwise, and other general market
conditions.
PART II - OTHER INFORMATION
Item 1 - Legal Proceedings
See Note 5 to Consolidated Financial Statements, Part I, Item 1.
Item 4 - Submission of Matters to a Vote of Security Holders
(a) The Annual Meeting of Shareholders was held on April 20, 1999.
(b) Four directors were nominated for election at the Annual
Meeting. Proxies for such meeting were solicited by
Registrant's management pursuant to Regulation 14A under the
Securities Exchange Act of 1934; there was no solicitation in
opposition to management's nominees as listed in the proxy
statement; and all of such nominees were elected for a
three-year term.
(c) The following matters were voted upon at the Annual Meeting with
the voting results indicated.
1. Election of directors
Nominee Votes for Votes Withheld
Joel B. Alvord 24,872,065 528,203
Richard G. Dooley 25,109,084 291,184
Gordon W. Kreh 25,153,132 247,136
Lois D. Rice 25,091,709 308,559
2. Proposal to amend and restate the 1995 Stock Option
Plan
Votes for Against Abstain
22,719,558 2,422,700 258,010
26
<PAGE>
3. Appointment of PricewaterhouseCoopers L.L.P. as
Independent Public Accountants
Votes for Against Abstain
25,105,358 97,076 197,835
Item 6 - Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit 27 - Financial Data Schedule
(b) Reports on Form 8-K
Form 8-K dated April 20, 1999 reporting on the first quarter results, the
declaration of a dividend and the Company's Annual Meeting. (See Consolidated
Statements of Operations for corrected 1999 year-to-date Net Income per share -
assuming dilution.)
27
<PAGE>
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.
HSB GROUP, INC.
Date: August 16, 1999 By: /s/ Saul L. Basch
Saul L. Basch
Senior Vice President,
Treasurer and Chief
Financial Officer
Date: August 16, 1999 By: /s/ Robert C. Walker
Robert C. Walker
Senior Vice President and
General Counsel
28
<TABLE> <S> <C>
<ARTICLE> 7
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
FINANCIAL STATEMENTS FILED HEREWITH AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> JUN-30-1999
<DEBT-HELD-FOR-SALE> 534
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 442
<MORTGAGE> 11
<REAL-ESTATE> 0
<TOTAL-INVEST> 987
<CASH> 97 <F1>
<RECOVER-REINSURE> 661
<DEFERRED-ACQUISITION> 51
<TOTAL-ASSETS> 2163
<POLICY-LOSSES> 592
<UNEARNED-PREMIUMS> 427
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 80
409 <F2>
0
<COMMON> 10
<OTHER-SE> 412
<TOTAL-LIABILITY-AND-EQUITY> 2163
190
<INVESTMENT-INCOME> 32
<INVESTMENT-GAINS> 17
<OTHER-INCOME> 55
<BENEFITS> 76
<UNDERWRITING-AMORTIZATION> 44
<UNDERWRITING-OTHER> 100 <F3>
<INCOME-PRETAX> 66
<INCOME-TAX> 22
<INCOME-CONTINUING> 44
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 44
<EPS-BASIC> 1.51<F4>
<EPS-DILUTED> 1.46<F5>
<RESERVE-OPEN> 550
<PROVISION-CURRENT> 0 <F6>
<PROVISION-PRIOR> 0 <F6>
<PAYMENTS-CURRENT> 0 <F6>
<PAYMENTS-PRIOR> 0 <F6>
<RESERVE-CLOSE> 592
<CUMULATIVE-DEFICIENCY> 0
<FN>
<F1>Cash includes short-term investments.
<F2>Company obligated mandatorily redeemable capital securities and convertible
capital securities classified at mezzanine level on Consolidated Statements of
Financial Position.
<F3>Includes engineering services, underwriting and inspection and interest
expense.
<F4>Per SFAS No. 128 "Earnings per Share", this item represents EPS-Basic.
<F5>Per SFAS No. 128 "Earnings per Share", this item represents EPS-Assuming
Dilution.
<F6>Not calculated at interim periods.
</FN>
</TABLE>
