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 September 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 October 29, 1999: 29,114,959.
<PAGE>
HSB GROUP, INC.
INDEX
PART I FINANCIAL STATEMENTS PAGE
Item 1 - Financial Statements
Consolidated Statements of Operations for the
Quarters ended September 30, 1999
and 1998 and the Nine Months ended September 30,
1999 and 1998 (unaudited)........................................ 3
Consolidated Statements of Comprehensive Income
for the Quarters ended September 30, 1999 and 1998
and the Nine Months ended September 30, 1999 and
1998(unaudited).................................................. 4
Consolidated Statements of Financial Position
as of September 30, 1999 (unaudited)
and December 31, 1998 ........................................... 5
Consolidated Statements of Cash Flows for the
Nine Months ended September 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....................................... 25
Item 6 - Exhibits and Reports on Form 8-K........................ 25
SIGNATURES............................................................. 26
2
<PAGE>
HSB GROUP, INC.
Consolidated Statements of Operations
Unaudited
(in millions, except per share data)
<TABLE>
<CAPTION>
Quarter Nine Months
Ended September 30 Ended September 30
Revenues: 1999 1998 1999 1998
-------------------------------------------------------
<S> <C> <C> <C> <C>
Gross earned premium $200.6 $212.5 $616.3 $567.9
Ceded premiums 107.9 113.0 333.4 278.6
-------------------------------------------------------
Insurance premiums 92.7 99.5 282.9 289.3
Engineering services 30.6 25.3 86.0 67.7
Net investment income 16.5 15.5 48.8 46.6
Realized investment gains 13.5 7.9 30.8 18.4
-------------------------------------------------------
Total revenues 153.3 148.2 448.5 422.0
-------------------------------------------------------
Expenses:
Claims and adjustment 44.5 44.2 120.7 129.1
Policy acquisition 21.6 17.9 65.5 45.3
Underwriting and inspection 24.4 26.4 72.6 83.5
Engineering services 29.5 23.4 80.3 62.1
Interest 0.6 0.2 1.6 0.5
-------------------------------------------------------
Total expenses 120.6 112.1 340.7 320.5
-------------------------------------------------------
Gain on sale of IRI - - - 39.0
Income from continuing operations before income
taxes and distributions on capital securities $ 32.7 $ 36.1 $107.8 $140.5
Income taxes (benefit):
Current 11.7 9.8 31.0 39.1
Deferred (2.4) (0.5) 0.6 2.0
-------------------------------------------------------
Total income taxes $ 9.3 $ 9.3 $ 31.6 $ 41.1
Distribution on capital securities of subsidiary
trust, net of income tax benefits of $2.4;
$2.5; $7.2; and $7.4. 4.6 4.6 13.6 13.8
-------------------------------------------------------
Income from continuing operations $ 18.8 $ 22.2 $ 62.6 $ 85.6
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 $ 18.8 $ 22.2 $ 62.6 $115.9
-------------------------------------------------------
Per share data:
Net income per common share-basic:
Income from continuing operations $ 0.65 $ 0.75 $ 2.16 $ 2.91
Discontinued operations - - - 1.04
Net income $ 0.65 $ 0.75 $ 2.16 $ 3.95
Net income per common share-assuming dilution:
Income from continuing operations $ 0.64 $ 0.72 $ 2.10 $ 2.71
Discontinued operations - - - 0.86
Net income $ 0.64 $ 0.72 $ 2.10 $ 3.57
Dividends declared per share $ 0.44 $ 0.42 $ 1.28 $ 1.22
Average shares outstanding and common stock 34.7 35.3 34.6 35.3
equivalents
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
3
<PAGE>
HSB GROUP, INC.
Consolidated Statements of Comprehensive Income
Unaudited
(in millions)
<TABLE>
<CAPTION>
Quarter Nine Months
Ended September 30 Ended September 30
1999 1998 1999 1998
-------------------------------------------------------
<S> <C> <C> <C> <C>
Net income $ 18.8 $ 22.2 $ 62.6 $ 115.9
Other comprehensive income, net of tax:
Unrealized gains (losses) on securities:
Unrealized holding gains (losses) arising during the
period (net of taxes (benefits) of ($13.6); ($12.4);
($18.0); and $2.5) (24.9) (21.8) (33.2) 5.5
Add: reclassification adjustments for gains included in
net income (8.8) (5.2) (20.0) (12.0)
-------------------------------------------------------
Total unrealized gains (losses) on securities (33.7) (27.0) (53.2) (6.5)
Foreign currency translation adjustments 0.2 (1.1) 1.1 (1.8)
-------------------------------------------------------
Other comprehensive income (33.5) (28.1) (52.1) (8.3)
-------------------------------------------------------
Comprehensive income $ (14.7) $ (5.9) $ 10.5 $107.6
=======================================================
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
4
<PAGE>
HSB GROUP, INC.
Consolidated Statements of Financial Position
(in millions, except per share data)
<TABLE>
<CAPTION>
September 30, December 31,
1999 1998
(Unaudited)
<S> <C> <C>
Assets:
Cash and cash equivalents $ 46.4 $ 18.3
Short-term investments, at cost 44.6 62.3
Fixed maturities, at fair value
(cost - $558.2; $568.5) 525.3 577.1
Equity securities, at fair value
(cost - $339.4; $326.3) 409.8 437.1
------------------------------
Total cash and invested assets 1,026.1 1,094.8
Reinsurance assets 826.3 630.4
Insurance premiums receivable 133.6 146.7
Engineering services receivable 35.0 26.1
Fixed assets 56.6 54.9
Prepaid acquisition costs 51.1 46.6
Capital lease 14.0 14.6
Other assets 146.3 129.9
------------------------------
Total assets $2,289.0 $2,144.0
==============================
Liabilities:
Unearned insurance premiums $ 440.9 $ 477.9
Claims and adjustment expenses 760.7 550.3
Short-term borrowings 44.4 21.0
Long-term borrowings 25.1 25.1
Capital lease 27.8 27.9
Deferred income taxes 14.4 42.7
Dividends and distributions on capital securities 18.6 23.2
Ceded reinsurance payable 60.5 64.1
Other liabilities 91.6 83.6
------------------------------
Total liabilities 1,484.0 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 $1.0 in 1999 and $1.1 in 1998 109.0 108.9
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 35.9 33.5
Accumulated other comprehensive income 14.7 66.8
Retained earnings 341.3 311.2
Benefit plans (5.9) (2.2)
------------------------------
Total shareholders' equity 396.0 419.3
------------------------------
Total $2,289.0 $2,144.0
==============================
Common shareholders' equity per common share $ 13.63 $ 14.53
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
5
<PAGE>
HSB GROUP, INC
Consolidated Statements of Cash Flows
Unaudited
(in millions)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
-----------------------------------
1999 1998
-----------------------------------
<S> <C> <C>
Operating Activities:
Net income $ 62.6 $ 115.9
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization 14.7 9.6
Deferred income taxes 0.6 2.0
Realized investment gains (30.8) (18.4)
Distributions on capital securities 20.8 21.2
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 13.1 (17.1)
Engineering services receivable (5.5) (12.1)
Prepaid acquisition costs (4.5) 3.7
Reinsurance assets (195.9) (471.1)
Unearned insurance premiums (37.0) 186.3
Claims and adjustment expenses 210.4 246.1
Ceded reinsurance payable (3.6) 84.2
Other (9.1) (51.8)
-----------------------------------
Cash provided by operating activities 35.8 43.0
-----------------------------------
Investing Activities:
Fixed asset additions, net (9.4) (12.6)
Investments:
Sale of short-term investments, net 17.7 70.5
Purchase of fixed maturities (123.8) (378.3)
Proceeds from sale of fixed maturities 113.6 44.1
Redemption of fixed maturities 13.6 29.8
Purchase of equity securities (254.8) (275.6)
Proceeds from sale of equity securities 279.2 191.4
Proceeds from disposition of Radian - 128.9
Proceeds from disposition of IRI - 49.1
Purchase of Solomon Associates, Inc., net of cash acquired - (2.1)
Purchase of Kemper books of business - (29.5)
Purchase of Structural Integrity Associates, Inc., net of cash
acquired (5.3) -
-----------------------------------
Cash provided by (used in) investment activities 30.8 (184.3)
-----------------------------------
Financing Activities:
Increase (decrease) in short-term borrowings 22.1 (38.0)
Dividends and distributions on capital securities (62.5) (52.0)
Reacquisition of stock (2.2) (27.8)
Exercise of stock options 4.1 9.3
-----------------------------------
Cash used in financing activities (38.5) (108.5)
-----------------------------------
Net increase (decrease) in cash and cash equivalents 28.1 (249.8)
Cash and cash equivalents at beginning of period 18.3 293.2
-----------------------------------
Cash and cash equivalents at end of period $ 46.4 $ 43.4
===================================
Interest paid $ 2.5 $ 1.9
-----------------------------------
Federal income tax paid $ 19.8 $ 41.7
-----------------------------------
</TABLE>
Non-cash investing and financing activities: Issuance of HSB common stock in
connection with the acquisition of Solomon Associates, Inc. in 1998.
The accompanying notes are an integral part of the consolidated financial
statements.
6
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. General
The interim consolidated financial statements in this report present
the consolidated accounts of HSB Group, Inc. and its subsidiaries
(collectively, HSB or the Company). They 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.
7
<PAGE>
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.
4. Acquisitions
In July 1999 HSBIIC acquired Structural Integrity Associates, Inc.
(Structural) based in San Jose, California. Structural is an
engineering consulting firm which specializes in prevention, control
and repair of structural and mechanical failures. 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.
5. 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. Based on its current operations,
product designs and investment strategy, the Company does not
anticipate that the adoption of the provisions of SFAS No. 133 will
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
8
<PAGE>
not anticipate the adoption of SOP 98-7 will have a material impact on
results of operations, financial condition or cash flows.
6. 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, judgment has been entered in HSBIIC's
favor on remand from the Federal Court of Appeals for the Seventh
Circuit.
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 known litigation in
which the Company is a party, will have a material adverse impact on
the results of operations or the financial position of the Company.
7. Earnings per share
Computation of Earnings Per Share:
<TABLE>
<CAPTION>
Quarter Ended Nine Months Ended
September 30, 1999 September 30, 1999
------------------ ------------------
Income Shares Per Income Shares Per
Share Share
------ ------ ------ ------- ------- -----
<S> <C> <C> <C> <C> <C> <C>
Income from continuing
operations $ 18.8 $ 62.6
Basic EPS:
Income available to common
shareholders $ 18.8 $ 62.6
Weighted Average Common
Shares Outstanding 29.1 29.0
Income from continuing
operations per common
share - basic $ 0.65 $ 2.16
Effect of dilutive securities:
After-tax interest on
convertible capital
securities $ 3.4 $ 10.3
Convertible capital
securities 5.3 5.3
Stock options 0.3 0.3
Diluted EPS:
Income from continuing
operations available to
common and assumed
conversions $ 22.2 34.7 $ 72.9 34.6
Income from continuing
operations per common
share - assuming dilution $ 0.64 $ 2.10
</TABLE>
9
<PAGE>
<TABLE>
<CAPTION>
Quarter Ended Nine Months Ended
September 30, 1998 September 30, 1998
Income Shares Per Income Shares Per
Share Share
------ ------ ----- ------ ------ -----
<S> <C> <C> <C> <C> <C> <C>
Income from continuing
operations $ 22.2 $ 85.6
Basic EPS:
Income available to common
shareholders $ 22.2 $ 85.6
Weighted Average Common
Shares Outstanding 29.4 29.3
Income from continuing
operations per common
share - basic $ 0.75 $ 2.91
Effect of dilutive securities:
After-tax interest on
convertible capital
securities $ 3.4 $ 10.2
Convertible capital
securities 5.3 5.3
Stock options 0.6 0.7
Diluted EPS:
Income from continuing
operations available to
common and assumed
conversions $ 25.6 35.3 $ 95.8 35.3
Income from continuing
operations per common
share - assuming dilution $ 0.72 $ 2.71
</TABLE>
8. 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 worldwide. 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 Nine Months Ended
September 30 September 30
------------------------------- ------------------
1999 1998 1999 1998
-------------------------------------------- ----------- ---- ----------- -- ----------- -- ------------
<S> <C> <C> <C> <C>
Revenues from continuing operations
Insurance premiums:
Commercial $ 82.7 $ 83.5 $ 245.2 $ 220.5
Global Special Risks 10.1 14.5 36.9 63.8
Engineering services 30.6 25.3 86.0 67.7
Net investment income and realized
investment gains 30.0 23.4 79.6 65.0
----------- ----------- ----------- ------------
Total revenues from reportable segments 153.4 146.7 447.7 417.0
Other segments (0.1) 1.5 0.8 5.0
----------- ----------- ----------- ------------
Total revenues $ 153.3 $ 148.2 $ 448.5 $ 422.0
=========== =========== =========== ============
Net income (loss):
Commercial $ 4.2 $ 7.6 $ 10.1 $ 11.5
Global Special Risks (1.6) (2.2) 6.3 5.0
Engineering services 0.5 1.2 3.0 3.3
Investment 21.3 17.6 55.9 47.9
----------- ----------- ----------- ------------
Total net income from reportable segments 24.4 24.2 75.3 67.7
Other segments (2.2) 1.7 (3.7) 2.9
Corporate account 1.2 0.9 4.6 3.6
Distributions on capital securities (4.6) (4.6) (13.6) (13.8)
Discontinued operations - - - 30.3
Gain on sale of IRI, net of income taxes - - - 25.2
----------- ------------ ----------- ------------
Net income $ 18.8 $ 22.2 $ 62.6 $ 115.9
=========== =========== =========== ============
</TABLE>
9. 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 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>
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF CONSOLIDATED FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
SEPTEMBER 30,1999
RESULTS OF OPERATIONS
(dollar amounts in millions)
Consolidated Overview
<TABLE>
<CAPTION>
Quarter Ended Nine Months Ended
September 30 September 30
------------ ------------
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenues:
Gross earned premiums $ 200.6 $ 212.5 $ 616.3 $ 567.9
Ceded premiums 107.9 113.0 333.4 278.6
----------- --------- --------- --------
Insurance premiums 92.7 99.5 282.9 289.3
Engineering services 30.6 25.3 86.0 67.7
Net investment income 16.5 15.5 48.8 46.6
Realized investment gains 13.5 7.9 30.8 18.4
--------- --------- --------- --------
Total revenues $ 153.3 $ 148.2 $ 448.5 $ 422.0
========= ========= ========= ========
Pre-tax Income from Continuing Operations:
Pre-tax income excluding sale of IRI $ 32.7 $ 36.1 $ 107.8 $ 101.5
Pre-tax gain on sale of IRI - - - 39.0
-------------- -------------- -------------- --------
Pre-tax income 32.7 36.1 107.8 140.5
Income taxes on continuing operations 9.3 9.3 31.6 41.1
Distributions on capital securities 4.6 4.6 13.6 13.8
--------- --------- --------- --------
Income from continuing operations 18.8 22.2 62.6 85.6
Discontinued operations - - - 30.3
-------------- -------------- -------------- --------
Net income $ 18.8 $ 22.2 $ 62.6 $ 115.9
========= ========= ========= ========
Net income per common share:
Basic $ 0.65 $ 0.75 $ 2.16 $ 3.95
Assuming dilution $ 0.64 $ 0.72 $ 2.10 $ 3.57
</TABLE>
13
<PAGE>
Consolidated Overview
Absent the sales of Industrial Risk Insurers (IRI) and Radian International LLC
(Radian LLC) discussed below, the Company's third quarter 1999 after-tax
earnings decreased 15.3 percent from the third quarter of 1998 and increased 3.6
percent in the first nine months of 1999 compared to 1998. The results reflect a
decline in third quarter underwriting results impacted largely by $10 million in
losses from weather related events domestically and the Taiwan earthquake. These
results were offset in part by improvement in income from investment operations.
In addition, net income for the first nine 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 third quarter and year to date were 28 percent and 29 percent
compared to 26 percent and 27 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 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. Based on its
current operations, product designs and investment strategy, the Company does
not anticipate that the adoption of the provisions of SFAS No. 133 will 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
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<PAGE>
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 Nine Months Ended
September 30 September 30
------------ ------------
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Gross earned premiums $ 200.6 $ 212.5 $ 616.3 $ 567.9
Ceded premiums 107.9 113.0 333.4 278.6
----------- --------- --------- --------
Insurance premiums 92.7 99.5 282.9 289.3
Claims and adjustment expenses 44.5 44.2 120.7 129.1
Underwriting, acquisition and other expenses 46.0 44.3 138.1 128.8
----------- --------- --------- --------
Underwriting gain $ 2.2 $ 11.0 $ 24.1 $ 31.4
=========== ========= ========= ========
Loss ratio 48.1% 44.4% 42.7% 44.6%
Expense ratio 49.6% 44.5% 48.8% 44.6%
---------- --------- --------- --------
Combined ratio 97.7% 88.9% 91.5% 89.2%
========== ========= ========= ========
</TABLE>
Gross earned premiums in the third quarter of 1999 decreased 5.6 percent in
comparison to the third quarter of 1998. This was primarily attributable to a
decline in premiums from HSB Industrial Risk Insurers. Gross earned premiums
year to date increased 8.5 percent from the comparable period in 1998. This
reflects the impact of the acquisition of certain commercial books of business
acquired in mid 1998 as well as the impact of the timing of the Company's role
as direct writer of HSB Industrial Risk Insurers. These increases were offset in
part by decreases in Global Special Risk premiums. In certain areas of the
Company's direct businesses, the market is experiencing price erosion as the
number of insurers offering capacity has expanded. HSB will not write business
at rates which do not provide sufficient opportunity to earn a 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.
Ceded premiums decreased 4.5 percent in the current quarter consistent with the
decline in gross earned premiums for the same period. Ceded premiums increased
19.7 percent year to date resulting from the HSB Industrial Risk Insurers
arrangement and related reinsurance with ERC,
15
<PAGE>
as well as 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.
The loss ratio increased from 44.4 percent in the third quarter of 1998 to 48.1
percent in the current quarter. Year to date, the loss ratio decreased from 44.6
percent in 1998 to 42.7 percent in 1999. The third quarter variance was impacted
by $10 million in losses from weather-related events domestically and the Taiwan
earthquake. In the third quarter of 1998, weather-related loss events were $8.3
million less. Despite these events, the year to date loss ratio was favorable
due in part to the first quarter 1998 severe ice storms in Canada and third
quarter 1998 losses from Hurricane Georges.
Gross claims and adjustment expenses for the first nine months of 1999 and 1998
were $517.9 million and $478.5 million, respectively. This increase was the
result of weather-related events domestically, the Taiwan earthquake and large
losses in our Global Special Risk business which were largely reinsured. This
increase was partially offset by gross claims in 1998 from Hurricane Georges on
exposures written by HSB Industrial Risk Insurers. The significant increases in
claim reserves and reinsurance assets since December 31, 1998 largely relate to
these events.
The expense ratio increased from 44.5 percent in the third quarter of 1998 to
49.6 percent in the current quarter, and from 44.6 percent year to date in 1998
to 48.8 percent year to date in 1999. The increase in the expense ratio for both
the third quarter and year to date is primarily attributed to increases in
policy acquisition costs. These increases result from the impact of changes in
HSB's participation in HSB Industrial Risk Insurers reinsurance programs as well
as the timing of the Company's role as direct writer of that business. The year
to date expense ratio was also affected by the increased level of reinsurance
purchased and related ceding commissions. The year to date growth in gross
earned premiums and increases in commission rates which reflect changes in the
mix of business are also contributing factors. In addition, the expense ratio
has been impacted more heavily in 1999 by Year 2000 remediation costs.
The following information summarizes net earned premiums and net income by
reportable insurance segment:
Quarter Ended Nine Months Ended
September 30 September 30
------------ ------------
1999 1998 1999 1998
---- ---- ---- ----
Commercial:
Net earned premiums $ 82.7 $ 83.5 $ 245.2 $ 220.5
Net income 4.2 7.6 10.1 11.5
Global Special Risks:
Net earned premiums $ 10.1 $ 14.5 $ 36.9 $ 63.8
Net income (1.6) (2.2) 6.3 5.0
Net earned premiums in the Commercial segment declined $0.8 million in the third
quarter. Year to date net earned premiums rose $24.7 million over the comparable
period in 1998. The year to date increase is due primarily to the integration
of the Kemper portfolio and growth in our client company business, offset by
declines in direct billings. Profits for both the quarter and year to date were
adversely impacted by 1999 weather related losses, increased frequency of small
claims and expected higher systems costs related to the Year 2000 Program. 1998
year to date results were impacted by severe ice storms in Canada.
Global Special Risks net earned premiums declined $4.4 million in the third
quarter. Year to date, net earned premiums decreased $26.9 million. These
decreases relate to price erosion and the maintenance of strict underwriting
standards, coupled with changes in reinsurance programs. Global Special Risks
net income for third quarter of 1999 was negatively impacted due to losses
16
<PAGE>
from weather-related events domestically and the Taiwan earthquake. Despite
these events, 1999 Global Special Risks profitability improved over the same
period in the prior year, due to adherence to strict underwriting standards,
changes in reinsurance programs, and positive reserve development on pre-1998
IRI business. Results include 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 Nine Months Ended
September 30 September 30
------------ ------------
1999 1998 1999 1998
---- ---- ---- ----
Engineering services revenues $ 30.6 $ 25.3 $ 86.0 $ 67.7
Engineering services expenses 29.5 23.4 80.3 62.1
--------- -------- -------- ---------
Operating gain $ 1.1 $ 1.9 $ 5.7 $ 5.6
========= ======== ======== =========
Net margin 3.6% 7.4% 6.6% 8.3%
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),
Structural Integrity Associates, Inc. (Structural) and the Company's interest in
Integrated Process Technologies, LLC.
Engineering services revenues increased $5.3 million in the third quarter and
$18.3 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, Structural
which was acquired in July 1999 and EIL's engineering services revenues
generated through other 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, systems costs related to the Year 2000 Program and
the closing of plants in the steel industry serviced by a higher margin business
unit.
In July 1999 HSBIIC acquired Structural based in San Jose, California.
Structural is an engineering consulting firm which specializes in prevention,
control and repair of structural and mechanical failures. 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.
17
<PAGE>
Investment Operations
Quarter Ended Nine Months Ended
September 30 September 30
------------ ------------
1999 1998 1999 1998
---- ---- ---- ----
Net investment income $ 16.5 $ 15.5 $ 48.8 $ 46.6
Realized investment gains 13.5 7.9 30.8 18.4
------- ------- ------ ------
Pretax income from
investment operations $ 30.0 $ 23.4 $ 79.6 $ 65.0
======= ======= ====== ======
Income from investment operations for the third quarter and year to date
increased $6.6 million and $14.6 million, respectively, primarily due to
realized investment gains 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
macroeconomic variables. These changes are considered systemic risks or market
risks and are quantified as equity market risk, interest rate risk and foreign
currency risk. Equity market risk is the possibility that market influences will
adversely affect the expected returns on equity investments. Interest rate risk
relates to the effect of changes in the level of interest rates on the return on
financial instruments, in particular fixed income investments. 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 nine months 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 8.62 during the first nine months of 1999. The increase
in duration is due primarily to changes that occurred in the interest rate
environment 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. As
interest rates increased during the year, the call feature on many issues became
non-applicable. This change in the environment caused portfolio duration to
increase and a corresponding 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
18
<PAGE>
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 September 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
September 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 September 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 $26.0
million and $37.4 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 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 September 30, 1999 Value Rate Risk Risk Risk
- --------------------------------------------------------------------------------
Fixed maturity securities $ 525.3 $ (38.1) $ (2.2) $ -
Equity securities 409.8 (14.3) (1.9) (21.4)
Short term investments 44.5 (0.3) (1.3) -
----------------------------------------------------
Total all securities $ 979.6 $ (52.7) $ (5.4) $ (21.4)
----------------------------------------------------
19
<PAGE>
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 September 30, 1999 Value Rate Risk Risk Risk
- --------------------------------------------------------------------------------
Fixed maturity securities $ 525.3 $ (54.3) $ (4.4) $ -
Equity securities 409.8 (20.1) (3.7) (53.4)
Short term investments 44.5 (0.5) (2.5) -
---------------------------------------------------
Total all securities $ 979.6 $ (74.9) $ (10.6) $ (53.4)
---------------------------------------------------
Statement of Comprehensive Income
In addition to the impact of HSB's results of operations, the Consolidated
Statements of Comprehensive Income display the effects of price movements on
HSB's invested assets. As a result of market fluctuations, cumulative holding
gains, net of taxes, for the first nine months of 1999 decreased $52.1 million
as compared to the decrease of $8.3 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.
Liquidity and Capital Resources
Balances at
September 30 December 31
1999 1998
---------- ---------------
Total assets $ 2,289.0 $ 2,144.0
Short-term investments 44.6 62.3
Cash and cash equivalents 46.4 18.3
Short-term borrowings 44.4 21.0
Capital securities of subsidiary Trust I 109.0 108.9
Capital securities of subsidiary Trust II 300.0 300.0
Common shareholder's equity 396.0 419.3
Liquidity refers to the Company's ability to generate sufficient funds to meet
the cash requirements of its business operations. HSB Group, Inc. (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 $35.8 million in the first nine months of 1999
compared to $43.0 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 $396.0 million at
September 30, 1999, decreased by $23.3 million since December 31, 1998. The
reduction in shareholders' equity was caused by the impact of rising interest
rate levels on our fixed income investments. The components of the decrease
primarily reflect comprehensive income of $10.5 million and option exercises of
$4.1 million, less dividends of $37.2 million and share repurchases of $2.2
million.
At September 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 September 30, 1999 was
approximately $40 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.
20
<PAGE>
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, judgment has
been entered in HSBIIC's favor on remand from the Federal Court of Appeals for
the Seventh Circuit.
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 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 virtually complete for these systems as well. We
have substantially completed Year 2000 testing for our current policy
management, claims, human resources and engineering systems. The Company has
recently implemented new financial applications and Year 2000 testing for these
applications
21
<PAGE>
is expected to be substantially completed by December 1, 1999. We will continue
to Year 2000 test other supporting applications through December 1999. We are
currently limiting changes to our production environment, and will continue to
do so through the first few months of the year 2000.
With respect to infrastructure items, the mainframe is Year 2000 compliant and
the Company has largely completed the migration to Year 2000 compliant servers
and supporting hardware and software. Replacement of the various components of
non-compliant workstations and peripheral equipment has also been mostly
completed. Many of the third-party software applications utilized by the Company
in its desktop environment are already Year 2000 compliant. The Company has
substantially completed the installation of such compliant programs on virtually
all of its workstations.
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 continues to be in contact with its key suppliers of service and
business partners, such as client companies, agents and brokers, with whom the
Company has significant business relations, as to their Year 2000 readiness
status. As the Company receives responses and updated information from its
suppliers and business partners, it is reassessing the potential impact on the
Company of such parties' Year 2000 state of readiness and remediation plans and
conducts 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 $27.8 million of which
approximately $26.5 million has been expended through September 30, 1999.
Certain of these costs are being expensed as they are incurred and are being
funded through operating cash flow. The Company has expensed $5.1 million, $1.5
million and $0.2 million in 1998, 1997 and 1996, respectively, and $5.7 million
for the first nine months of 1999. It is estimated that expenditures of $1.0
million for the remainder of 1999 will be expensed as incurred. The remainder of
the $27.8 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.
22
<PAGE>
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 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. During the remainder of 1999, the
Company will be completing, reviewing and updating Year 2000 business
contingency plans to prepare for the crossover into the next year. 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. The endorsement is being included on all 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
23
<PAGE>
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 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.
24
<PAGE>
PART II - OTHER INFORMATION
Item 1 - Legal Proceedings
See Note 6 to Consolidated Financial Statements, Part I, Item 1.
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 July 26, 1999 reporting on the second quarter results and
announcing the declaration of a dividend.
25
<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: November 15, 1999 By: /s/ Saul L. Basch
Saul L. Basch
Senior Vice President, Treasurer
and Chief Financial Officer
Date: November 15, 1999 By: /s/ Robert C. Walker
Robert C. Walker
Senior Vice President and
General Counsel
26
<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> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> SEP-30-1999
<DEBT-HELD-FOR-SALE> 514
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 410
<MORTGAGE> 11
<REAL-ESTATE> 0
<TOTAL-INVEST> 935
<CASH> 91 <F1>
<RECOVER-REINSURE> 826
<DEFERRED-ACQUISITION> 51
<TOTAL-ASSETS> 2289
<POLICY-LOSSES> 761
<UNEARNED-PREMIUMS> 441
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 70
409 <F2>
0
<COMMON> 10
<OTHER-SE> 386
<TOTAL-LIABILITY-AND-EQUITY> 2289
283
<INVESTMENT-INCOME> 49
<INVESTMENT-GAINS> 31
<OTHER-INCOME> 86
<BENEFITS> 121
<UNDERWRITING-AMORTIZATION> 66
<UNDERWRITING-OTHER> 154 <F3>
<INCOME-PRETAX> 87
<INCOME-TAX> 24
<INCOME-CONTINUING> 63
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 63
<EPS-BASIC> 2.16<F4>
<EPS-DILUTED> 2.10<F5>
<RESERVE-OPEN> 550
<PROVISION-CURRENT> 0 <F6>
<PROVISION-PRIOR> 0 <F6>
<PAYMENTS-CURRENT> 0 <F6>
<PAYMENTS-PRIOR> 0 <F6>
<RESERVE-CLOSE> 761
<CUMULATIVE-DEFICIENCY> 0
<FN>
<F1>Cash includes cash equivalents and 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>
