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, 2000
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, 2000: 29,031,517.
<PAGE>
HSB GROUP, INC.
INDEX
PART I FINANCIAL STATEMENTS PAGE
Item 1 - Financial Statements
Consolidated Statements of Operations for the Quarters
ended June 30, 2000 and 1999 and the Six Months ended
June 30, 2000 and 1999 (unaudited)................................3
Consolidated Statements of Comprehensive Income for
the Quarters ended June 30, 2000 and 1999 and the Six Months
ended June 30, 2000 and 1999 (unaudited)..........................4
Consolidated Statements of Financial Position as of
June 30, 2000 (unaudited) and December 31, 1999...................5
Consolidated Statements of Cash Flows for the Six
Months ended June 30, 2000 and 1999 (unaudited) ..................6
Notes to Consolidated Financial Statements (unaudited)...............7
Item 2 - Management's Discussion and Analysis of
Consolidated Financial Condition and Results of Operations.......12
PART II OTHER INFORMATION
Item 1 - Legal Proceedings..........................................22
Item 4 - Submission of Matters to a Vote of Security Holders........22
Item 6 - Exhibits and Reports on Form 8-K...........................22
SIGNATURES................................................................23
2
<PAGE>
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,
-------------- --------------
2000 1999 2000 1999
-------------- ---------- ---------- --------
<S> <C> <C> <C> <C>
Revenues:
Gross earned premium $176.4 $206.8 $358.5 $415.7
Ceded premiums 77.0 113.1 167.8 225.5
------------- ---------- ---------- --------
Insurance premiums 99.4 93.7 190.7 190.2
Engineering services 40.2 27.8 77.2 55.4
Net investment income 15.6 16.6 30.5 32.3
Realized investment gains 10.2 10.2 23.5 17.3
-------------- ---------- ---------- --------
Total revenues 165.4 148.3 321.9 295.2
-------------- ---------- ---------- --------
Expenses:
Claims and adjustment 38.1 37.9 76.9 76.2
Policy acquisition 21.7 21.3 41.5 43.9
Underwriting and inspection 30.8 24.2 57.4 48.2
Engineering services 37.6 25.6 71.6 50.8
Interest 0.5 0.6 1.1 1.0
-------------- ---------- ---------- --------
Total expenses 128.7 109.6 248.5 220.1
-------------- ---------- ---------- --------
Income before income taxes and
distributions on capital securities $ 36.7 $ 38.7 $ 73.4 $ 75.1
Income taxes (benefit):
Current 13.5 11.1 29.6 19.3
Deferred (1.2) 0.3 (5.1) 3.0
-------------- ---------- ---------- --------
Total income taxes $ 12.3 $ 11.4 $ 24.5 $ 22.3
Distribution on capital securities
of subsidiary trust, net of income tax
benefits of $2.5, $2.4, $5.0 and $4.8 4.7 4.5 9.4 9.0
-------------- ---------- ---------- --------
Net income $ 19.7 $ 22.8 $ 39.5 $ 43.8
============== ========== ========== ========
Per share data:
Net income per common share-basic $ 0.68 $ 0.79 $ 1.36 $ 1.51
============== =========== ========== ========
Basic weighted-average common
shares outstanding 28.8 29.0 29.0 29.0
Net income per common share-assuming
dilution $ 0.67 $ 0.76 $ 1.35 $ 1.46
============== =========== ========== ========
Diluted weighted-average common
shares outstanding 34.1 34.8 34.3 34.6
Dividends declared per share $ 0.44 $ 0.42 $ 0.88 $ 0.84
</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, June 30,
--------------------------------- -----------------------------
2000 1999 2000 1999
--------------- ------------ -------------- ---------------
<S> <C> <C> <C> <C>
Net income $19.7 $22.8 $39.5 $43.8
Other comprehensive income, net of tax:
Unrealized gains (losses) on securities:
Unrealized holding gains (losses) arising during
the period, net of taxes (benefits) of $2.4;
($0.2); $4.7; and ($4.4) 9.8 (0.3) 13.7 (8.3)
Add : reclassification adjustments for gains
included in net income (5.6) (6.6) (14.2) (11.2)
--------------- ------------ -------------- ---------------
Total unrealized gains on securities 4.2 (6.9) (0.5) (19.5)
Foreign currency translation adjustments, net of
income taxes (0.5) 0.6 (0.8) 0.9
--------------- ------------ -------------- ---------------
Other comprehensive income 3.7 (6.3) (1.3) (18.6)
=============== ============ ============== ===============
Comprehensive income $23.4 $16.5 $38.2 $25.2
=============== ============ ============== ===============
</TABLE>
See Notes to Consolidated Financial Statements.
4
<PAGE>
HSB GROUP, INC.
Consolidated Statements of Financial Position
(In millions, except per share data)
<TABLE>
<CAPTION>
June 30,
2000 December 31,
(Unaudited) 1999
-------------------- -------------------
<S> <C> <C>
Assets:
Cash and cash equivalents $66.3 $73.0
Short-term investments, at cost 40.9 53.5
Fixed maturities, at fair value
(cost - $527.2; $545.7) 471.8 489.8
Equity securities, at fair value
(cost - $324.6; $316.6) 384.4 381.8
-------------------- -------------------
Total cash and invested assets 963.4 998.1
Reinsurance assets 605.2 850.3
Insurance premiums receivable 70.6 104.4
Engineering services receivable 45.8 39.1
Fixed assets 55.5 58.2
Prepaid acquisition costs 37.7 52.9
Capital lease 14.6 13.8
Deferred income taxes 6.9 -
Other assets 153.5 146.4
-------------------- -------------------
Total assets $1,953.2 $2,263.2
==================== ===================
Liabilities:
Unearned insurance premiums $272.2 $420.1
Claims and adjustment expenses 674.4 782.3
Short-term borrowings 30.8 41.5
Long-term borrowings - 25.1
Capital lease 28.9 27.8
Deferred income taxes - 2.8
Dividends and distributions on
capital securities 23.8 24.0
Ceded reinsurance payable 23.0 66.3
Other liabilities 110.8 87.8
-------------------- -------------------
Total liabilities 1,163.9 1,477.7
-------------------- -------------------
Company obligated mandatorily redeemable
capital securities of subsidiary Trust I
holding solely junior subordinated
deferrable interest debentures of the Company,
net of unamortized discount of $1.0
in 2000 and 1999 107.0 109.0
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 28.8; 29.1) 10.0 10.0
Additional paid-in capital 35.1 36.2
Accumulated other comprehensive income (3.2) (1.9)
Retained earnings 347.3 339.1
Benefit plans (6.9) (6.9)
-------------------- -------------------
Total shareholders' equity 382.3 376.5
-------------------- -------------------
Total $1,953.2 $2,263.2
==================== ===================
Shareholders' equity per common share $13.28 $12.95
</TABLE>
See Notes to Consolidated Financial Statements.
5
<PAGE>
HSB GROUP, INC.
Consolidated Statements of Cash Flows
Unaudited
(in millions)
Six Months
Ended June 30,
------------------------
2000 1999
-------------- ---------
Operating Activities:
Net income $ 39.5 $ 43.8
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization 10.4 10.2
Deferred income taxes (benefit) (5.1) 3.0
Realized investment gains, net (23.5) (17.3)
Distributions on capital securities 14.4 13.8
Change in balances
Insurance premiums receivable 33.8 25.0
Engineering services receivable (6.7) (3.3)
Prepaid acquisition costs 15.2 (4.0)
Reinsurance assets 245.1 (30.4)
Unearned insurance premiums (147.9) (51.1)
Claims and adjustment expenses (107.9) 41.9
Ceded reinsurance payable (43.3) (3.0)
Other 15.0 (18.4)
-------------- ---------
Cash provided by operating activities 39.0 10.2
-------------- ---------
Investing Activities:
Fixed asset additions, net (4.1) (7.4)
Investments:
Sale of short-term investments, net 12.6 12.9
Purchase of fixed maturities (63.4) (86.6)
Proceeds from sale of fixed maturities 64.0 84.6
Redemption of fixed maturities 14.6 8.3
Purchase of equity securities (107.6) (168.0)
Proceeds from sale of equity securities 125.3 180.3
-------------- ---------
Cash provided by investment activities 41.4 24.1
-------------- ---------
Financing Activities:
(Decrease) increase in short-term borrowings (10.7) 31.4
Repayment of long-term borrowings (25.1) -
Dividends and distributions on capital securities (40.0) (38.2)
Reacquisition of stock (9.6) (2.2)
Exercise of stock options 0.1 3.9
Reacquisition of Company obligated mandatorily
redeemable capital securities of
subsidiary Trust I (1.8) -
-------------- ---------
Cash used in financing activities (87.1) (5.1)
-------------- ---------
Net (decrease) increase in cash and
cash equivalents (6.7) 29.2
Cash and cash equivalents at beginning
of period 73.0 18.3
-------------- ---------
Cash and cash equivalents at end of period $ 66.3 $ 47.5
============== =========
Interest paid $ 2.5 $ 1.8
-------------- ---------
Federal income tax paid $ 18.1 $ 12.2
-------------- ---------
See Notes to Consolidated Financial Statements.
6
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In millions, except per share amounts)
(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 1999 Annual Report.
2. Industrial Risk Insurers
The joint underwriting association that was known as HSB Industrial
Risk Insurers is now known as Industrial Risk Insurers (IRI), effective
January 1, 2000. The reinsurance agreements effective January 1, 1998
between the Hartford Steam Boiler Inspection and Insurance Company
(HSBIIC), Employers Reinsurance Corporation (ERC) and Industrial Risk
Insurers were terminated with respect to loss or liabilities arising
out of occurrences taking place on or after January 1, 2000. As a
result, HSBIIC no longer retains 85 percent of the equipment breakdown
insurance and 15 percent of the property insurance of the combined
insurance portfolio for risks arising on or after January 1, 2000.
Concurrent with the termination of the reinsurance agreements, HSBIIC,
ERC and IRI also replaced the operating agreement dated January 1,
1998. The new agreement, effective January 1, 2000, calls for HSBIIC to
retain 0.5 percent membership share in IRI with the ability to increase
its total share up to a maximum of 10 percent, at no cost, at HSBIIC's
option. In addition, the new agreements also establish an arrangement
for HSB to perform equipment breakdown engineering and inspection
services for clients of IRI.
3. Recent Accounting Developments
In June 1998, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting
for Derivative Instruments and Hedging Activities" subsequently amended
by SFAS No. 137. 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. This statement is effective for the
Company for the first quarter of 2001. Based on the Company's current
investment policies and practices, the Company anticipates that the
adoption of the provisions of SFAS No. 133 will not have a significant
effect 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 (SOP 98-7)." SOP 98-7 identifies several methods of deposit
accounting and provides guidance on the application of each method.
This SOP became effective for financial statements for fiscal years
beginning after June 15, 1999.
7
<PAGE>
The adoption and impact of SOP 98-7 has not had a material impact on
the Company's results of operations, financial condition or cash
flows, as the Company is not party to any contracts that do not comply
with the risk transfer provisions of SFAS No. 113, "Accounting and
Reporting for Reinsurance of Short-Duration and Long-Duration
Contracts."
4. Legal Proceedings
The Company is involved in various 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 litigation, will
have a material adverse impact on the results of operations or the
financial position of the Company.
5. Earnings per Share
<TABLE>
<CAPTION>
Quarter Ended Six Months Ended
June 30, 2000 June 30, 2000
------------- ----------------
Income Shares Per Income Shares Per
Share Share
------ ------ ----- ------ ------ -----
<S> <C> <C> <C> <C> <C> <C>
Net Income $ 19.7 $ 39.5
Basic Earnings per Share:
Income available to common
shareholders $ 19.7 $ 39.5
Weighted average common
shares outstanding 28.8 29.0
Earnings per Share - basic $ 0.68 * $ 1.36 *
Effect of dilutive securities:
After-tax distributions on
convertible capital
securities $ 3.4 $ 6.8
Convertible capital securities 5.3 5.3
Diluted Earnings per Share:
Net Income available to
common shareholders and
assumed conversions $ 23.1 34.1 $ 46.3 34.3
Earnings per Share - assuming
dilution $0.67 * $ 1.35 *
</TABLE>
* Computation excludes rounding.
8
<PAGE>
<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>
Net Income $ 22.8 $ 43.8
Basic Earnings per Share:
Income available to common
shareholders $ 22.8 $ 43.8
Weighted average common
shares outstanding 29.0 29.0
Earnings per Share - basic $0.79 * $ 1.51 *
Effect of dilutive securities:
After-tax distributions on $ 3.5 $ 6.8
convertible capital
securities
Convertible capital securities 5.3 5.3
Stock options 0.5 0.3
Diluted Earnings per Share:
Net Income available to
common shareholders and
assumed conversions $ 26.3 34.8 $ 50.6 34.6
Earnings per Share -
assuming dilution $0.76 * $ 1.46 *
</TABLE>
* Computation excludes rounding.
6. 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.
9
<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,
----------------------- -------------------------
2000 1999 2000 1999
--------- ----------- ----------- ------------
<S> <C> <C> <C> <C>
Revenues from continuing operations
Insurance premiums:
Commercial $93.0 $ 82.2 $ 181.0 $ 162.5
Global Special Risks 6.9 11.1 11.3 26.8
Engineering services 40.2 27.8 77.2 55.4
Net investment income and realized
investment gains 25.8 26.8 54.0 49.6
--------- ----------- ----------- ------------
Total revenues from reportable segments 165.9 147.9 323.5 294.3
Other segments (0.5) 0.4 (1.6) 0.9
--------- ----------- ----------- ------------
Total revenues $65.4 $ 148.3 $ 321.9 $ 295.2
========= =========== =========== ============
Net income (loss):
Commercial $5.8 $ 4.5 $ 10.2 $ 5.9
Global Special Risks (1.6) 2.7 (3.5) 7.9
Engineering services 1.2 1.2 2.5 2.5
Investment 17.2 18.6 36.3 34.6
--------- ----------- ----------- ------------
Total net income from reportable segments 22.6 27.0 45.5 50.9
Other segments (0.2) (1.5) (0.5) (1.5)
Corporate account 2.0 1.8 3.9 3.4
Distributions on capital securities (4.7) (4.5) (9.4) (9.0)
--------- ----------- ----------- -----------
Net income $19.7 $ 22.8 $ 39.5 $ 43.8
========= =========== =========== ============
</TABLE>
7. 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.
10
<PAGE>
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.
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.
During the second quarter of 2000, the Company purchased $2,000,000 in
face amount of Capital Securities.
11
<PAGE>
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS
OF CONSOLIDATED FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
JUNE 30, 2000
RESULTS OF OPERATIONS
---------------------
(dollar amounts in millions)
Consolidated Overview
---------------------
<TABLE>
<CAPTION>
Quarter Ended Six Months Ended
June 30, June 30,
--------------- ----------------
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenues:
Gross earned premiums $ 176.4 $ 206.8 $ 358.5 $ 415.7
Ceded premiums 77.0 113.1 167.8 225.5
--------- ------- ------- -------
Insurance premiums 99.4 93.7 190.7 190.2
Engineering services 40.2 27.8 77.2 55.4
Net investment income 15.6 16.6 30.5 32.3
Realized investment gains 10.2 10.2 23.5 17.3
------- ------- ------- -------
Total revenues $ 165.4 $ 148.3 $ 321.9 $ 295.2
------- ------- ------- -------
Pre-tax income $ 36.7 $ 38.7 $ 73.4 $ 75.1
Income taxes 12.3 11.4 24.5 22.3
Distributions on capital securities,
net of tax 4.7 4.5 9.4 9.0
------- ------- ------- -------
Net income $ 19.7 $ 22.8 $ 39.5 $ 43.8
------ ------- ------- -------
Net income per common share:
Basic $ 0.68 $ 0.79 $ 1.36 $ 1.51
Assuming dilution $ 0.67 $ 0.76 $ 1.35 $ 1.46
</TABLE>
12
<PAGE>
Overview of Results of Operations
---------------------------------
Total revenues for the second quarter and first six months of 2000 increased
11.5 and 9.0 percent from comparable periods in 1999. For these periods,
insurance premiums reflect growth in our Commercial business offset by declines
in our Global Special Risks business. The growth in Engineering Services
revenues of 44.6 percent for the second quarter and 39.4 percent year to date
reflects the impact of new business as well as continued growth in certain
engineering affiliates and subsidiaries. The year to date 2000 increase in
realized gains reflect the shift of a portion of investments out of common
stocks. A portion of such proceeds was utilized to fund share repurchases.
The Company's pre-tax earnings decreased 5.2 and 2.3 percent for the second
quarter and first six months of 2000 compared to 1999. The decrease in pre-tax
earnings for the second quarter and year to date 2000 was due primarily to
reduced underwriting profits in our Global Special Risks business and lower net
investment income.
The effective tax rates for the second quarter and year to date 2000 were 33.5
percent and 33.4 percent compared to 29.5 percent and 29.7 percent for the
comparable prior periods. The increases in the effective tax rates relate to
increases in non-deductible goodwill, fewer dividends received deductions and
reduced foreign tax credits. 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
------------------------------
In June 1998, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative
Instruments and Hedging Activities" subsequently amended by SFAS No. 137. 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. This statement is effective for the Company for
the first quarter of 2001. Based on the Company's current investment policies
and practices, the Company anticipates that the adoption of the provisions of
SFAS No. 133 will not have a significant effect 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 (SOP
98-7)." SOP 98-7 identifies several methods of deposit accounting and provides
guidance on the application of each method. This SOP became effective for
financial statements for fiscal years beginning after June 15, 1999. The
adoption and impact of SOP 98-7 has not had a material impact on the Company's
results of operations, financial condition or cash flows, as the Company is not
party to any contracts that do not comply with the risk transfer provisions of
SFAS No. 113, "Accounting and Reporting for Reinsurance of Short-Duration and
Long-Duration Contracts."
13
<PAGE>
Insurance Operations
--------------------
<TABLE>
<CAPTION>
Quarter Ended Six Months Ended
June 30, June 30,
------------- ----------------
2000 1999 2000 1999
----- ---- ---- ----
<S> <C> <C> <C> <C>
Gross earned premiums $ 176.4 $ 206.8 $ 358.5 $ 415.7
Ceded premiums 77.0 113.1 167.8 225.5
---------- -------- -------- --------
Insurance premiums 99.4 93.7 190.7 190.2
Claims and adjustment expenses 38.1 37.9 76.9 76.2
Underwriting, acquisition and other
expenses 52.5 45.5 98.9 92.1
---------- --------- -------- ---------
Underwriting gain $ 8.8 $ 10.3 $ 14.9 $ 21.9
========== ======== ======== =========
Loss ratio * 38.3% 40.5% 40.3% 40.1%
Expense ratio * 52.8% 48.6% 51.9% 48.4%
---------- -------- -------- ---------
Combined ratio * 91.1% 89.1% 92.2% 88.5%
========== ======== ======== =========
</TABLE>
* Computation excludes rounding.
Insurance operations include the underwriting 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., The Hartford Steam Boiler Inspection and
Insurance Company of Connecticut, The Hartford Steam Boiler Inspection and
Insurance Company of Texas, and HSBIIC's participation in Industrial Risk
Insurers (IRI) and various other pools.
Gross earned premiums in the second quarter and year to date 2000 decreased 14.7
and 13.8 percent from the comparable periods in 1999. The decrease in gross
earned premiums largely relates to declines in Global Special Risks gross earned
premiums of 38.2 and 34.5 percent for the quarter and year to date,
respectively. These declines primarily resulted from the Company's decision to
reduce its risk bearing position in IRI, effective January 1, 2000. The declines
in Global Special Risks were offset by increases in Commercial gross earned
premiums of 10.4 and 10.7 percent for the quarter and year to date,
respectively, which related primarily to increases in our domestic commercial
assumed equipment breakdown business.
Ceded premiums in the second quarter and year to date decreased 32.0 and 25.6
percent to comparable periods in 1999. This is consistent with declines in gross
earned premiums for the same periods and reflects changes in the structure of
some of the Company's reinsurance programs which now utilize less quota share
reinsurance on certain books of business as well as changes in the IRI
agreements.
14
<PAGE>
The loss ratio decreased from 40.5 percent in the second quarter of 1999 to 38.3
percent in the current quarter. On a year to date basis, the loss ratio was
essentially flat at 40.3 percent compared to 40.1 percent in 1999. The changes
in the loss ratio reflects improvement in the Commercial loss ratio, offset by
increased severity in equipment breakdown failures in the Global Special Risks
large risk business in the second quarter and year to date 2000.
The expense ratio increased from 48.6 percent in the second quarter of 1999 to
52.8 percent in the current quarter, and from 48.4 percent year to date in 1999
to 51.9 percent year to date in 2000. The increases in the expense ratio were
primarily attributed to increases in underwriting and inspection expenses, which
increased $6.6 million for the second quarter and $9.2 million year to date.
These increases were largely due to the reduced management fees related to the
Company's decision to reduce its risk bearing position in IRI, changes in the
Company's reinsurance programs which resulted in reduced ceding commissions, and
marketing incentive increases related to the growth in our Commercial business.
Policy acquisition costs were flat for the quarter and lower year to date
compared to 1999 amounts due primarily to the reduction in IRI net policy
acquisition costs. These changes were offset, however, by increased policy
acquisition costs in our Commercial business.
IRI management fees are reflected as expense reductions to underwriting and
inspection expenses and policy acquisition costs. The expense ratio would be
approximately 4 percent higher for the quarter and year to date, absent the IRI
arrangements.
The following information summarizes net earned premiums and net income by
reportable insurance segment:
Quarter Ended Six Months Ended
June 30, June 30,
------------- ----------------
2000 1999 2000 1999
---- ---- ---- ----
Commercial:
Net earned premiums $ 93.0 $ 82.2 $ 181.0 $ 162.5
Net income 5.8 4.5 10.2 5.9
Global Special Risks:
Net earned premiums $ 6.9 $ 11.1 $ 11.3 $ 26.8
Net (loss) income (1.6) 2.7 (3.5) 7.9
Net earned premiums in the Commercial segment rose $10.8 million or 13.1% in the
second quarter and $18.5 million or 11.4% for the first six months of 2000 due
primarily to continued growth in our domestic client company business through
our ReSource product. Net income for the second quarter and year to date 2000
was favorably impacted by reduced claim frequency and the absorption of fixed
costs on higher net earned premiums.
Global Special Risks net earned premiums for the second quarter and year to date
declined $4.2 million and $15.5 million from the comparable periods in 1999 due
primarily to the impact of changes in the IRI agreements. Global Special Risks
net income for the second quarter and year to date compared to the same periods
in 1999 was negatively impacted by increased loss severity at EIL as well as in
our domestic special risk business. Global Special Risks may continue to have an
adverse impact on underwriting results until such time as needed pricing
improvements are accepted in the marketplace. The Company is currently
evaluating various strategies regarding this business.
15
<PAGE>
Engineering Services Operations
-------------------------------
Quarter Ended Six Months Ended
June 30, June 30,
------------- ----------------
2000 1999 2000 1999
------- -------- --------- ---------
Engineering services revenues $ 40.2 $ 27.8 $ 77.2 $ 55.4
Engineering services expenses 37.6 25.6 71.6 50.8
------ --------- -------- --------
Operating gain $ 2.6 $ 2.2 $ 5.6 $ 4.6
========= ======== ======== =========
Net margin 6.6% 8.2% 7.3% 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 (IPT).
Engineering services revenues for the second quarter and first six months of
2000 increased $12.4 and $21.8 million compared to the same periods in 1999. The
growth in Engineering services revenues for the second quarter and year to date
was largely due to growth in license and service fees which resulted from the
Company's agreement with Enron Energy Services to provide energy services,
project management and other technical assistance. Engineering revenue growth
also reflected increased revenue generated by Structural (acquired in July
1999), HSBRT, the start up operations of IPT and new agreements with IRI that
became effective January 1, 2000.
Engineering services operating margin was 6.6 and 7.3 percent for the second
quarter and first six months of 2000, respectively, compared to 8.2 and 8.3
percent for comparable periods in 1999. The engineering services operating
margins continue to reflect increased investment of operating funds to develop
new products and establish start up operations, including IPT which had a
negative impact on the operating margin for the second quarter and year to date
2000. While the Company is exploring various strategic alternatives to limit
IPT's negative impact, there can be no assurance that such strategies will be
implemented in the near term. Therefore, IPT may continue to have an adverse
impact on engineering services operating margins during 2000 as the Company
continues to evaluate and develop this business.
16
<PAGE>
Investment Operations
---------------------
Quarter Ended Six Months Ended
June 30, June 30,
------------- ----------------
2000 1999 2000 1999
--------- --------- -------- ---------
Net investment income $ 15.6 $ 16.6 $ 30.5 $ 32.3
Realized investment gains 10.2 10.2 23.5 17.3
--------- --------- -------- ---------
Pretax income from
investment operations $ 25.8 $ 26.8 $ 54.0 $ 49.6
========= ========= ======== =========
Income from investment operations decreased $1.0 million for the second quarter
and increased $4.4 million for the first six months of 2000 compared to the same
periods in 1999. The decrease in net investment income for the second quarter
and year to date 2000, primarily related to reduced investable funds which
resulted from the repositioning of our investment portfolio in the first
quarter, a portion of the proceeds of which were used to repurchase stock and
repayment of long term debt. The year to date 2000 increase in realized
investment gains reflected the shift of some investments out of common stocks in
accordance with the investment portfolio's asset allocation targets. Realized
investment gains for the second quarter and year to date 2000 also include $2.8
and $5.4 million, respectively, of losses arising from declines in the
realizable value of certain venture capital investments considered to be other
than temporary. The Company continues to evaluate its investments for exposure
to declines in realizable value considered to be other than temporary. 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 macro
economic variables. Market risk generally encompasses systemic risks or risks
associated with macro factors relating to the economic impact of changes in the
fair value of a financial instrument. Market risk relates to the variability of
market prices and/or cash flows associated with changes in interest rates,
securities prices, market indices, yield curves or currency exchange rates and
is inherent to all financial instruments. The Company's investment strategy
continues to be to maximize total return on the investment portfolio through
investment income and capital appreciation and is based on such factors as
operational results, tax implications, regulatory requirements, interest rates,
dividends to stockholders, servicing requirements of capital securities and
market conditions.
The focus of this disclosure is on one element of market risk - price risk. For
the Company, price risk relates to changes in the level of prices of financial
instruments due to changes in interest rates, equity prices or foreign exchange
rates. The primary price risk exposures of the Company relate to interest rates
and equity price risk.
For purposes of this disclosure market risk sensitive instruments are
categorized as instruments entered into for trading purposes and instruments
entered into for purposes other than trading. The Company does not hold any
financial instruments entered into for trading purposes and, therefore, market
risk sensitive instruments are classified as held for purposes other than
trading.
17
<PAGE>
Interest Rate Risk
------------------
Interest rate risk is the major price risk facing the Company's fixed income
portfolio and relates to the effect of changes in the level of interest rates on
the return on financial instruments. The Company attempts to mitigate this risk
by investing in high quality issues of various maturities using a buy and hold
approach and by structuring its portfolio such that the impact on regulatory
capital is moderated.
Equity Market Risk
------------------
Equity market risk is the possibility that market influences will adversely
affect the expected returns on equity investments. The Company attempts to
reduce this risk through diversification and focus on high quality, blue chip
investments.
Foreign Exchange Risk
---------------------
Foreign currency risk is the chance that fluctuations in foreign currency
exchange rates will impact the value of financial instruments. The Company has
foreign exchange exposure when it buys or sells foreign currencies or financial
instruments denominated in a foreign currency. The Company's foreign
transactions are primarily denominated in Canadian dollars.
Sensitivity Analysis
--------------------
The sensitivity analysis assumes an instantaneous shift in market interest
rates, with scenarios of interest rates increasing and decreasing 100 and 150
basis points from their levels at June 30, 2000, with all other variables held
constant. The analysis assumes the yield to worst methodology. A 100 and 150
basis point increase in the market interest rates would result in a pre-tax
decrease in the net financial instrument position of $47.2 million and $67.4,
respectively. Similarly, a 100 and 150 basis point decrease in market interest
rates would result in a pre-tax increase in the net financial instrument
position of $47.2 and $67.4 million, respectively.
Portfolio sensitivity to these variables tends to change over time due to
changes in portfolio composition and changes in market environment. For the
fixed maturity portfolio, sensitivity, as measured by duration, was 8.10 at June
30, 2000, essentially the same as at December 31, 1999.
The Company's convertible capital securities were issued at fixed rates, and as
such, interest expense would not be impacted by interest rate shifts. The effect
of 100 and 150 basis point increases in interest rates on the $300 million
convertible capital securities would result in an estimated market value of
$252.3 million and $ 241.2 million, respectively. This 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 impact of 100 and 150 basis
point increases in interest rates on the variable rate capital securities would
result in an additional annualized charge to pre-tax income of $1.1 million and
$ 1.6 million, respectively. A 100 and 150 basis point decrease in interest
rates would increase annualized pre-tax income by $1.1 million and $ 1.6
million, respectively, per year.
Equity price risk was measured assuming an instantaneous 10 percent and 25
percent change in the S&P 500 Index from its level at June 30, 2000 with all
other variables held constant. The Company's equity holdings (comprised of
common stocks and non-redeemable preferreds) were assumed to be 100 percent
correlated to this index. A 10 percent and 25 percent increase or decrease in
the S&P 500 Index would result in a $19.2 and $48.0 million increase or
decrease, respectively, in the net financial instrument position. The Company's
equity instruments' sensitivity to equity market risk, as measured by portfolio
beta, decreased from 0.98 at December 31, 1999 to 0.94 at June 30, 2000. This
change is generally attributed to portfolio repositioning during the period.
18
<PAGE>
The sensitivity analysis also assumes an instantaneous 10 percent and 20 percent
change in the foreign currency exchange rates versus the U.S. dollar from their
levels at June 30, 2000, with all other variables held constant. A 10 percent
and 20 percent strengthening of the U.S. dollar would result in decreases of
$5.1 and $10.2 million, respectively, in the net financial instrument position.
Weakening of the U.S. dollar versus all other currencies would result in like
increases in the net financial instrument position.
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 the S&P 500 Index and a decline of 10
percent in foreign currency exchange rates.
Held For Other Than Trading Purposes
Market Interest Currency Equity
At June 30, 2000 Value Rate Risk Risk Risk
------------------------------------------------------------------------------
Fixed maturity securities $ 471.8 $ (33.4) $ (3.5) $ -
Equity securities 384.4 (13.5) (1.0) (19.2)
Short term investments 40.9 (0.3) (0.6) -
-------------------------------------------------
Total all securities $ 897.1 $ (47.2) $ (5.1) $ (19.2)
-------------------------------------------------
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, 2000 Value Rate Risk Risk Risk
------------------------------------------------------------------------------
Fixed maturity securities $ 471.8 $ (47.9) $ (6.9) $ -
Equity securities 384.4 (19.0) (2.1) (48.0)
Short term investments 40.9 (0.5) (1.2) -
-------------------------------------------------
Total all securities $ 897.1 $ (67.4) $ (10.2) $ (48.0)
-------------------------------------------------
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 six months of 2000 decreased $1.3 million as
compared to the decrease of $18.6 million in the same period in 1999. Exclusive
of realized gains, the change in 2000 when compared to the first six months of
1999 is mainly due to rising interest rates.
19
<PAGE>
Liquidity and Capital Resources
Balances at
------------------------
June 30, December 31,
2000 1999
---------- ------------
Total assets $ 1,953.2 $ 2,263.2
Short-term investments 40.9 53.5
Cash and cash equivalents 66.3 73.0
Short-term borrowings 30.8 41.5
Long-term borrowings - 25.1
Capital securities of subsidiary Trust I 107.0 109.0
Capital securities of subsidiary Trust II 300.0 300.0
Common shareholder's equity 382.3 376.5
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 $39.0 million in the first six months of 2000
compared to $10.2 million for the same period in 1999. The decreases in
reinsurance assets, insurance premiums receivable, prepaid acquisition costs,
unearned insurance premiums and claims and adjustments expenses on the
Consolidated Statement of Position from December 31, 1999 to June 30, 2000
largely relate to changes in the IRI arrangement, which became effective January
1, 2000. This trend is expected to continue during 2000. Cash used in financing
activities was $87.1 million in the first six months of 2000 compared to $5.1
million for the same period in 1999. This increase is largely due to the
decrease in short-term borrowings and the settlement of $25.1 million of senior
notes that matured during the second quarter of 2000. Cash used in financing
activities for the first six months of 2000 also includes the repurchase of $2
million in face amount of capital securities of subsidiary Trust I at a
discount.
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 increased by
approximately $5.8 million since December 31, 1999. The increase primarily
reflects comprehensive income of $38.2 million less dividends of $25.3 million
and stock repurchases of $9.6 million. Shareholders' equity as a percent of
assets was 19.6% up from 16.6% at December 31, 1999 as changes in the balance
sheet reflects the Company's decision to reduce its risk bearing position in
Industrial Risk Insurers effective January 1, 2000. During the first six months
of 2000, the Company repurchased approximately 365,000 shares of its outstanding
shares.
At June 30, 2000, HSBIIC had significant short-term and long-term borrowing
capacity. HSBIIC is currently authorized to issue up to $100 million of
commercial paper, an increase of $25 million since December 31,
20
<PAGE>
1999. Commercial paper outstanding at June 30, 2000 was approximately $27
million. The weighted-average interest rate was 6.5 percent at June 30, 2000.
Standard & Poor's and Duff & Phelps credit rating services have assigned their
highest ratings for the commercial paper.
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 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.
21
<PAGE>
PART II - OTHER INFORMATION
Item 1 - Legal Proceedings
See Note 4 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 18, 2000.
(b) Three 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
------- ---------- --------------
Ellis 24,241,373 363,061
Ferland 24,260,314 344,120
Fore 24,258,398 346,036
2. Appointment of PricewaterhouseCoopers L.L.P. as Independent
Public Accountants
Votes for Against Abstain
--------- ------- -------
24,364,253 192,732 47,449
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 18, 2000 reporting on the first quarter earnings, the
declaration of a dividend, and the Annual Meeting of Shareholders.
Form 8-K dated June 16, 2000 reporting on the unification of the Company's
insurance operations under the newly appointed Chief Global Insurance
Officer.
22
<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 11, 2000 By: /s/ Saul L. Basch
Saul L. Basch
Senior Vice President,
Treasurer and Chief
Financial Officer
Date: August 11, 2000 By: /s/ Robert C. Walker
Robert C. Walker
Senior Vice President
and General Counsel
23
