<PAGE>
UNITED STATES
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 Quarter Ended September 30, 1999
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 from _______ to __________
Commission file number 0-20766
- ------------------------------------------------------------------------------
HCC Insurance Holdings, Inc.
- ------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 76-0336636
- ------------------------------------------------------------------------------
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
13403 Northwest Freeway, Houston, Texas 77040-6094
- ------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
(713) 690-7300
- ------------------------------------------------------------------------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
----- -----
Indicate the number of shares outstanding of each of the issuer's classes of
common stock as of the latest practicable date.
On November 5, 1999 there were 48,791,866 shares of Common Stock, $1 par value
issued and outstanding.
<PAGE>
HCC INSURANCE HOLDINGS, INC.
INDEX
<TABLE>
<CAPTION>
PAGE NO.
--------
<S> <C> <C>
Part I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Balance Sheets
September 30, 1999 and December 31, 1998.................................... 3
Condensed Consolidated Statements of Earnings
For the nine months ended September 30, 1999 and 1998....................... 4
Condensed Consolidated Statements of Earnings
For the three months ended September 30, 1999 and 1998...................... 5
Condensed Consolidated Statements of Changes in Shareholders'
Equity For the nine months ended September 30, 1999 and
year ended December 31, 1998................................................ 6
Condensed Consolidated Statements of Cash Flows
For the nine months ended September 30, 1999 and 1998....................... 8
Notes to Condensed Consolidated Financial Statements............................. 9
Item 2. Management's Discussion and Analysis.............................................21
Item 3. Quantitative and Qualitative Disclosures About Market Risk.......................29
Part II. OTHER INFORMATION.........................................................................30
</TABLE>
2
<PAGE>
HCC Insurance Holdings, Inc. and Subsidiaries
---------
Condensed Consolidated Balance Sheets
(Unaudited)
--------
<TABLE>
<CAPTION>
September 30, 1999 December 31, 1998
------------------ -----------------
<S> <C> <C>
ASSETS
Investments:
Fixed income securities, at market
(cost: 1999 $387,833,000 1998 $375,107,000) $ 390,832,000 $ 393,238,000
Marketable equity securities, at market
(cost: 1999 $1,674,000; 1998 $1,750,000) 1,140,000 2,252,000
Short-term investments, at cost, which approximates market 206,001,000 129,084,000
Other investments, at cost, which approximates fair value 1,724,000 1,072,000
--------------- ---------------
Total investments 599,697,000 525,646,000
Cash 10,677,000 16,018,000
Restricted cash and cash investments 82,611,000 84,276,000
Reinsurance recoverables 567,205,000 372,672,000
Premium, claims and other receivables 468,145,000 382,630,000
Ceded unearned premium 146,417,000 149,568,000
Deferred policy acquisition costs 41,819,000 27,227,000
Property and equipment, net 37,329,000 32,983,000
Goodwill 159,608,000 88,043,000
Other assets 40,503,000 30,006,000
--------------- ---------------
TOTAL ASSETS $ 2,154,011,000 $ 1,709,069,000
=============== ===============
LIABILITIES
Loss and loss adjustment expense payable $ 668,807,000 $ 460,511,000
Reinsurance balances payable 127,617,000 90,983,000
Unearned premium 198,199,000 201,050,000
Deferred ceding commissions 42,498,000 30,842,000
Premium and claims payable 431,895,000 337,909,000
Notes payable 189,559,000 121,600,000
Accounts payable and accrued liabilities 27,284,000 26,311,000
--------------- ---------------
Total liabilities 1,685,859,000 1,269,206,000
SHAREHOLDERS' EQUITY
Common Stock, $1.00 par value; 250,000,000 shares authorized;
(issued and outstanding: 1999 48,710,634 shares;
1998 48,252,478 shares) 48,711,000 48,252,000
Additional paid-in capital 175,564,000 162,102,000
Retained earnings 242,355,000 219,804,000
Accumulated other comprehensive income 1,522,000 9,705,000
--------------- ---------------
Total shareholders' equity 468,152,000 439,863,000
--------------- ---------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 2,154,011,000 $ 1,709,069,000
=============== ===============
</TABLE>
See Notes to Condensed Consolidated Financial Statements.
3
<PAGE>
HCC Insurance Holdings, Inc. and Subsidiaries
--------
Condensed Consolidated Statements of Earnings
(Unaudited)
--------
<TABLE>
<CAPTION>
For the nine months ended September 30,
1999 1998
--------------- ---------------
<S> <C> <C>
REVENUE
Net earned premium $ 99,576,000 $ 103,971,000
Management fees 69,717,000 53,548,000
Commission income 44,742,000 25,516,000
Net investment income 22,866,000 21,196,000
Net realized investment gain (loss) (266,000) 1,088,000
Other operating income 20,928,000 18,545,000
--------------- ---------------
Total revenue 257,563,000 223,864,000
EXPENSE
Loss and loss adjustment expense 77,756,000 62,358,000
Operating expense:
Policy acquisition costs, net 3,490,000 6,444,000
Compensation expense 56,818,000 41,102,000
Provision for reinsurance 29,500,000 --
Other operating expense 36,212,000 24,143,000
--------------- ---------------
Net operating expense 126,020,000 71,689,000
Interest expense 9,217,000 4,697,000
--------------- ---------------
Total expense 212,993,000 138,744,000
--------------- ---------------
Earnings before income tax provision 44,570,000 85,120,000
Income tax provision 14,456,000 28,324,000
--------------- ---------------
NET EARNINGS $ 30,114,000 $ 56,796,000
=============== ===============
BASIC EARNINGS PER SHARE DATA:
Earnings per share $ 0.62 $ 1.19
=============== ===============
Weighted average shares outstanding 48,950,000 47,839,000
=============== ===============
DILUTED EARNINGS PER SHARE DATA:
Earnings per share $ 0.60 $ 1.16
=============== ===============
Weighted average shares outstanding 49,794,000 48,917,000
=============== ===============
Cash dividends declared, per share $ 0.15 $ 0.12
=============== ===============
</TABLE>
See Notes to Condensed Consolidated Financial Statements.
4
<PAGE>
<TABLE>
<CAPTION>
HCC Insurance Holdings, Inc. and Subsidiaries
--------
Condensed Consolidated Statements of Earnings
(Unaudited)
--------
For the three months ended September 30,
1999 1998
----------------------- -----------------------
<S> <C> <C>
REVENUE
Net earned premium $ 37,492,000 $ 34,604,000
Management fees 22,144,000 18,797,000
Commission income 10,734,000 5,262,000
Net investment income 7,939,000 7,184,000
Net realized investment gain (loss) (357,000) 963,000
Other operating income 5,141,000 9,726,000
----------------------- -----------------------
Total revenue 83,093,000 76,536,000
EXPENSE
Loss and loss adjustment expense 32,943,000 18,555,000
Operating expense:
Policy acquisition costs, net 2,347,000 1,874,000
Compensation expense 19,176,000 14,579,000
Other operating expense 12,752,000 6,757,000
----------------------- -----------------------
Net operating expense 34,275,000 23,210,000
Interest expense 3,306,000 1,418,000
----------------------- -----------------------
Total expense 70,524,000 43,183,000
----------------------- -----------------------
Earnings before income tax provision 12,569,000 33,353,000
Income tax provision 3,451,000 11,278,000
----------------------- -----------------------
NET EARNINGS $ 9,118,000 $ 22,075,000
======================= =======================
BASIC EARNINGS PER SHARE DATA:
Earnings per share $ 0.19 $ 0.46
======================= =======================
Weighted average shares outstanding 49,130,000 47,870,000
======================= =======================
DILUTED EARNINGS PER SHARE DATA:
Earnings per share $ 0.18 $ 0.45
======================= =======================
Weighted average shares outstanding 49,866,000 48,919,000
======================= =======================
Cash dividends declared, per share $ 0.05 $ 0.04
======================= =======================
</TABLE>
See Notes to Condensed Consolidated Financial Statements.
5
<PAGE>
<TABLE>
<CAPTION>
HCC Insurance Holdings, Inc. and Subsidiaries
--------
Condensed Consolidated Statements of Changes in Shareholders' Equity
For the nine months ended September 30, 1999 and
for the year ended December 31, 1998
(Unaudited)
--------
Additional
Common Paid-in Retained
Stock Capital Earnings
-------------------- -------------------- --------------------
<S> <C> <C> <C>
BALANCE AS OF DECEMBER 31, 1997 $ 47,759,000 $ 154,633,000 $ 155,209,000
Net earnings -- -- 72,278,000
Other comprehensive income -- -- --
206,504 shares of Common Stock issued for
exercise of options, including tax benefit
of $925,000 206,000 1,997,000 --
287,025 shares of Common Stock issued for
acquisitions 287,000 5,472,000 --
Cash dividends declared, $0.16 per share -- -- (7,683,000)
-------------------- -------------------- --------------------
BALANCE AS OF DECEMBER 31, 1998 $ 48,252,000 $ 162,102,000 $ 219,804,000
==================== ==================== ====================
<CAPTION>
Accumulated
Other Total
Comprehensive Shareholders'
Income Equity
-------------------- -------------------
<S> <C> <C>
BALANCE AS OF DECEMBER 31, 1997 $ 8,000,000 $ 365,601,000
Net earnings -- 72,278,000
Other comprehensive income 1,705,000 1,705,000
206,504 shares of Common Stock issued for
exercise of options, including tax benefit
of $925,000 -- 2,203,000
287,025 shares of Common Stock issued for
acquisitions -- 5,759,000
Cash dividends declared, $0.16 per share -- (7,683,000)
-------------------- -------------------
BALANCE AS OF DECEMBER 31, 1998 $ 9,705,000 $ 439,863,000
==================== ===================
</TABLE>
See Notes to Condensed Consolidated Financial Statements
6
<PAGE>
<TABLE>
<CAPTION>
HCC Insurance Holdings, Inc. and Subsidiaries
--------
Condensed Consolidated Statements of Changes in Shareholders' Equity
For the nine months ended September 30, 1999 and
for the year ended December 31, 1998
(Unaudited)
(continued)
--------
Additional
Common Paid-in Retained
Stock Capital Earnings
-------------------- -------------------- -------------------
<S> <C> <C> <C>
BALANCE AS OF DECEMBER 31, 1998 $ 48,252,000 $ 162,102,000 $ 219,804,000
Net earnings -- -- 30,114,000
Other comprehensive income (loss) -- -- --
367,162 shares of Common Stock issued for
exercise of options, including tax benefit of
$858,000 367,000 3,293,000 --
101,330 shares of Common Stock issued for
acquisition 102,000 1,898,000 --
414,207 shares of Common Stock contractually
issuable in the future -- 8,271,000 --
Cash dividends declared, $0.15 per share -- -- (7,291,000)
Other (10,000) -- (272,000)
-------------------- -------------------- -------------------
BALANCE AS OF SEPTEMBER 30, 1999 $ 48,711,000 $ 175,564,000 $ 242,355,000
==================== ==================== ===================
<CAPTION>
Accumulated
Other Total
Comprehensive Shareholders'
Income Equity
------------------- -------------------
<S> <C> <C>
BALANCE AS OF DECEMBER 31, 1998 $ 9,705,000 $ 439,863,000
Net earnings -- 30,114,000
Other comprehensive income (loss) (8,183,000) (8,183,000)
367,162 shares of Common Stock issued for
exercise of options, including tax benefit of
$858,000 -- 3,660,000
101,330 shares of Common Stock issued for
acquisition -- 2,000,000
414,207 shares of Common Stock contractually
issuable in the future -- 8,271,000
Cash dividends declared, $0.15 per share -- (7,291,000)
Other -- (282,000)
------------------- -------------------
BALANCE AS OF SEPTEMBER 30, 1999 $ 1,522,000 $ 468,152,000
=================== ===================
</TABLE>
See Notes to Condensed Consolidated Financial Statements.
7
<PAGE>
<TABLE>
<CAPTION>
HCC Insurance Holdings, Inc. and Subsidiaries
--------
Condensed Consolidated Statements of Cash Flows
(Unaudited)
--------
For the nine months ended September 30,
1999 1998
----------------------- -----------------------
<S> <C> <C>
Cash flows from operating activities:
Net earnings $ 30,114,000 $ 56,796,000
Adjustments to reconcile net earnings to net cash provided by operating
activities:
Change in reinsurance recoverables (224,033,000) (141,167,000)
Change in premium, claims and other receivables (7,123,000) (72,408,000)
Change in ceded unearned premium 3,151,000 (50,769,000)
Change in loss and loss adjustment expense payable 208,296,000 123,942,000
Change in reinsurance balances payable 36,634,000 46,804,000
Change in unearned premium (3,082,000) 40,357,000
Change in premium and claims payable, net of restricted cash (6,403,000) 58,473,000
Gains on sales of strategic investments and subsidiary (5,523,000) (4,073,000)
Provision for reinsurance 29,500,000 --
Depreciation and amortization expense 9,412,000 4,978,000
Deferred income taxes (8,753,000) 4,207,000
Other, net (9,206,000) 1,702,000
----------------------- -----------------------
Cash provided by operating activities 52,984,000 68,842,000
Cash flows from investing activities:
Sales of fixed income securities 1,214,000 18,032,000
Maturity or call of fixed income securities 12,698,000 15,435,000
Sales of equity securities 2,800,000 3,406,000
Sales of strategic investments and subsidiary 15,905,000 1,794,000
Change in short-term investments (47,362,000) (30,328,000)
Cash paid for companies acquired, net of cash received (57,863,000) (24,232,000)
Cost of securities acquired (35,417,000) (26,541,000)
Purchases of property and equipment (7,575,000) (13,643,000)
----------------------- -----------------------
Cash used by investing activities (115,600,000) (56,077,000)
Cash flows from financing activities:
Proceeds from notes payable 208,000,000 27,200,000
Sale of Common Stock 3,660,000 1,139,000
Payments on notes payable (147,600,000) (34,950,000)
Dividends paid (6,785,000) (5,214,000)
----------------------- -----------------------
Cash provided by financing activities 57,275,000 (11,825,000)
----------------------- -----------------------
Net change in cash (5,341,000) 940,000
Cash at beginning of period 16,018,000 7,728,000
----------------------- -----------------------
CASH AT END OF PERIOD $ 10,677,000 $ 8,668,000
======================= =======================
</TABLE>
See Notes to Condensed Consolidated Financial Statement
8
<PAGE>
HCC Insurance Holdings, Inc. and Subsidiaries
--------
Notes to Condensed Consolidated Financial Statements
(Unaudited)
(1) GENERAL INFORMATION
-------------------
HCC Insurance Holdings, Inc. ("the Company" or "HCC") and its
subsidiaries include property and casualty insurance companies,
underwriting agencies, intermediaries and service companies. HCC, through
its subsidiaries, provides specialized property and casualty insurance
primarily to commercial customers, underwritten on both a direct and
reinsurance basis in the accident and health, aviation, lenders' single
interest, marine, medical stop-loss, offshore energy, property and
workers' compensation lines of business, both domestically and
internationally.
Basis of Presentation
---------------------
The unaudited condensed consolidated financial statements have been
prepared in conformity with generally accepted accounting principles and
include all adjustments which are, in the opinion of management,
necessary for fair presentation of the results of the interim periods.
All adjustments made to the interim periods are of a normal recurring
nature. The condensed consolidated financial statements include the
accounts of the Company and its wholly-owned subsidiaries. All
significant intercompany balances and transactions have been eliminated.
The condensed consolidated financial statements for periods reported
should be read in conjunction with the annual consolidated financial
statements and related notes thereto. The condensed consolidated balance
sheet as of December 31, 1998, and the condensed consolidated statement
of changes in shareholders' equity for the year then ended were derived
from audited financial statements, but do not include all disclosures
required by generally accepted accounting principles.
Income Tax
----------
For the nine months ended September 30, 1999 and 1998, the income tax
provision has been calculated based on an estimated effective tax rate
for each of the fiscal years. The difference between the Company's
effective tax rate and the Federal statutory rate is primarily the result
of nontaxable municipal bond interest included in pretax income, the
amortization of goodwill and state income taxes.
Effects of Recent Accounting Pronouncements
-------------------------------------------
Statement of Position ("SOP") 97-3 issued by the American Institute of
Certified Public Accountants' Accounting Standards Executive Committee
("AcSEC") is effective in the Company's fiscal quarter ended March 31,
1999. The adoption of the SOP, entitled "Accounting by Insurance and
Other Enterprises for Insurance-Related Assessments" did not have a
material effect on the Company's financial position, results of
operations or cash flows.
Statement of Financial Accounting Standards ("SFAS") No. 133 entitled
"Accounting for Derivative Instruments and Hedging Activities" was
issued in June, 1998 and had its initial effective date postponed in
June, 1999. The statement is now effective for all fiscal quarters of
all fiscal years beginning after June 15, 2000, with early adoption
permitted. The Company has utilized derivatives or hedging strategies
infrequently in the past and in immaterial amounts, although it is
currently using derivatives and hedging strategies to a greater extent
as it expands its foreign operations. The effect of the Statement as
well as the timing of its adoption are currently being reviewed by
management.
9
<PAGE>
HCC Insurance Holdings, Inc. and Subsidiaries
--------
Notes to Condensed Consolidated Financial Statements
(Unaudited)
(Continued)
(1) GENERAL INFORMATION, CONTINUED
------------------------------
In November, 1998, AcSEC issued SOP 98-7, "Deposit Accounting: Accounting
for Insurance and Reinsurance Contracts That Do Not Transfer Insurance
Risk" which provides guidance as to the use of deposit accounting for
insurance and reinsurance contracts that do not transfer insurance risk.
This SOP is effective for financial statements for fiscal years beginning
after June 15, 1999. The Company does not expect the adoption of this SOP
to have a material effect on the Company's financial position, results of
operations or cash flows.
Reclassifications
-----------------
Certain amounts in the 1998 condensed consolidated financial statements
have been reclassified to conform to the 1999 presentation. Such
reclassifications had no effect on the Company's financial position,
results of operations or cash flows.
(2) REINSURANCE
-----------
In the normal course of business the Company's insurance company
subsidiaries cede a substantial portion of their premium to
non-affiliated domestic and foreign reinsurers through proportional,
excess of loss and facultative reinsurance agreements. Although the
ceding of reinsurance does not discharge the primary insurer from
liability to its policyholder, the subsidiaries utilize such agreements
for the purpose of limiting their loss exposure and diversifying their
business. Some of the reinsurance assumed by the Company's insurance
company subsidiaries was actually underwritten directly by those
subsidiaries, but issued by other non-affiliated companies in order to
satisfy local licensing or other requirements. The majority of the
balance of assumed reinsurance was written by underwriting agency
subsidiaries of the Company, utilizing unaffiliated insurance companies
(which have given binding authority to the Company's underwriting agency
subsidiaries) as the primary writer. The following tables represent the
effect of such reinsurance transactions on net premium and loss and loss
adjustment expense:
<TABLE>
<CAPTION>
Loss and Loss
Written Earned Adjustment
Premium Premium Expense
------------------- -------------------- --------------------
<S> <C> <C> <C>
For the nine months ended September 30, 1999:
Direct business $ 213,556,000 $ 207,789,000 $ 198,559,000
Reinsurance assumed 208,527,000 208,971,000 304,732,000
Reinsurance ceded (323,067,000) (317,184,000) (425,535,000)
------------------- -------------------- --------------------
NET AMOUNTS $ 99,016,000 $ 99,576,000 $ 77,756,000
=================== ==================== ====================
</TABLE>
10
<PAGE>
HCC Insurance Holdings, Inc. and Subsidiaries
--------
Notes to Condensed Consolidated Financial Statements
(Unaudited)
(Continued)
(2) REINSURANCE, CONTINUED
----------------------
<TABLE>
<CAPTION>
Loss and Loss
Written Earned Adjustment
Premium Premium Expense
------------------- -------------------- --------------------
<S> <C> <C> <C>
For the nine months ended September 30, 1998:
Direct business $ 166,439,000 $ 138,936,000 $ 115,792,000
Reinsurance assumed 195,279,000 181,912,000 230,572,000
Reinsurance ceded (269,107,000) (216,877,000) (284,006,000)
------------------- -------------------- --------------------
NET AMOUNTS $ 92,611,000 $ 103,971,000 $ 62,358,000
=================== ==================== ====================
For the three months ended September 30, 1999:
Direct business $ 74,728,000 $ 79,652,000 $ 73,629,000
Reinsurance assumed 60,626,000 59,696,000 95,299,000
Reinsurance ceded (97,477,000) (101,856,000) (135,985,000)
------------------- -------------------- --------------------
NET AMOUNTS $ 37,877,000 $ 37,492,000 $ 32,943,000
=================== ==================== ====================
For the three months ended September 30, 1998:
Direct business $ 47,940,000 $ 50,802,000 $ 43,361,000
Reinsurance assumed 51,932,000 63,181,000 118,263,000
Reinsurance ceded (73,836,000) (79,379,000) (143,069,000)
------------------- -------------------- --------------------
NET AMOUNTS $ 26,036,000 $ 34,604,000 $ 18,555,000
=================== ==================== ====================
</TABLE>
11
<PAGE>
HCC Insurance Holdings, Inc. and Subsidiaries
--------
Notes to Condensed Consolidated Financial Statements
(Unaudited)
(Continued)
(2) REINSURANCE, CONTINUED
The table below represents the approximate composition of reinsurance
recoverables in the accompanying condensed consolidated balance sheets:
<TABLE>
<CAPTION>
September 30, 1999 December 31, 1998
----------------------- -----------------------
<S> <C> <C>
Reinsurance recoverable on paid losses $ 61,369,000 $ 33,572,000
Reinsurance recoverable on outstanding losses 388,130,000 279,086,000
Reinsurance recoverable on IBNR 147,960,000 62,513,000
Reserve for reinsurance recoverables (30,254,000) (2,499,000)
----------------------- -----------------------
TOTAL REINSURANCE RECOVERABLES $ 567,205,000 $ 372,672,000
======================= =======================
</TABLE>
The Company recorded a provision for reinsurance recoverables in the
amount of $29.5 million during the second quarter of 1999. The provision
was made primarily as a result of information received on July 29,
1999, relating to the insolvency of one of the Company's reinsurers.
Primarily based upon the information contained in that report, the
Company recorded a provision which, based upon management's estimate,
should be sufficient to absorb any possible losses that might result
from the insolvency of this reinsurer.
As of September 30, 1999, the Company has a reserve for reinsurance
recoverables in the amount of $30.3 million which management believes is
sufficient to absorb any anticipated potential losses related to its
reinsurance recoverables. However, the adverse economic environment in
the insurance industry has placed great pressure on reinsurers and the
results of their operations and these conditions could, ultimately,
affect reinsurers' solvency. Historically, there have been insolvencies
following an extended period of competitive pricing in the industry,
such as the marketplace has experienced for the past several years.
Therefore, while management believes that the reserve is adequate based
upon currently available information, conditions may change or
additional information might be obtained that would affect management's
estimate of the adequacy of the level of the reserve and which may
result in a future increase or decrease in the reserve.
12
<PAGE>
HCC Insurance Holdings, Inc. and Subsidiaries
--------
Notes to Condensed Consolidated Financial Statements
(Unaudited)
(Continued)
(2) REINSURANCE, CONTINUED
The insurance company subsidiaries require reinsurers not authorized by
the subsidiaries' respective states of domicile to collateralize their
reinsurance obligations to the Company. The table below shows amounts held
by the Company as collateral plus other credits available for potential
offset:
<TABLE>
<CAPTION>
September 30, 1999 December 31, 1998
----------------------- -----------------------
<S> <C> <C>
Payables to reinsurers $ 236,698,000 $ 227,613,000
Letters of credit 167,434,000 166,494,000
Cash deposits 19,593,000 8,077,000
----------------------- -----------------------
TOTAL CREDITS $ 423,725,000 $ 402,184,000
======================= =======================
</TABLE>
(3) ACQUISITIONS
During the first quarter of 1999, the Company acquired an underwriting
agency operation, Midwest Stop Loss Underwriters, Inc. ("MWU"), and a
London intermediary operation, Rattner Mackenzie Limited ("RML"), in
transactions accounted for under the purchase method of accounting. The
total consideration paid for the acquisitions was 101,330 shares of the
Company's Common Stock and $57.9 million in cash plus additional
consideration of 414,207 shares of the Company's Common Stock and
GBP 5.0 million in cash ($8.3 million at September 30, 1999 rate of
exchange), both to be paid over a four-year period. On a combined basis,
the fair value of assets acquired was $110.0 million and the fair value of
liabilities assumed was $108.3 million. Additional consideration may also
be paid during the next four years, dependent upon earnings levels
attained during those years by one of the acquired companies. Goodwill in
the aggregate amount of $75.9 million was recorded in connection with
these transactions. The goodwill is being amortized over periods of twenty
to thirty years. The results of operations of the businesses acquired in
purchase transactions have been included in the consolidated financial
statements beginning on the effective date of each transaction.
The pro forma information with respect to these acquisitions is not
presented as their effect on total revenue, net earnings and earning per
share is not material to the nine months ended September 30, 1999 and
1998, respectively.
On October 12, 1999, the Company announced that it had entered into a
definitive agreement with The Centris Group, Inc. (NYSE: CGE), to acquire
all of their outstanding shares in a transaction valued at approximately
$171.0 million. Pursuant to this agreement, a wholly owned subsidiary of
the Company will, through a cash tender, offer to purchase each Centris
share for $12.50 and will assume approximately $25.0 million of
outstanding bank debt. The cash tender commenced on October 18, 1999, and,
subject to customary conditions as well as certain regulatory approvals,
should be completed by year end 1999.
13
<PAGE>
HCC Insurance Holdings, Inc. and Subsidiaries
--------
Notes to Condensed Consolidated Financial Statements
(Unaudited)
(Continued)
(4) SEGMENT AND GEOGRAPHIC INFORMATION
The performance of each segment is evaluated by management based upon net
earnings. Net earnings is calculated after tax and after all corporate
expense allocations, purchase price allocations and intercompany
eliminations have been charged or credited to the individual segments. The
following tables show information by business segment and geographic
location. Geographic location is determined by physical location of the
Company's offices and does not represent the location of insureds or
reinsureds from whom the business was generated.
<TABLE>
<CAPTION>
Insurance Underwriting Other
Companies Agencies Intermediaries Operations Corporate Total
--------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
For the nine months ended
September 30, 1999:
Revenue:
Domestic $108,932,000 $70,096,000 $26,633,000 $19,885,000 $ 140,000 $225,686,000
Foreign 9,080,000 2,951,000 19,846,000 -- -- 31,877,000
Intersegment -- 1,529,000 479,000 868,000 -- 2,876,000
--------------------------------------------------------------------------------------
Total segment revenue $118,012,000 $74,576,000 $46,958,000 $20,753,000 $ 140,000 $260,439,000
=====================================================================
Intersegment revenue (2,876,000)
------------
CONSOLIDATED TOTAL REVENUE $257,563,000
============
Net earnings (loss):
Domestic $(1,456,000) $13,715,000 $ 9,185,000 $6,253,000 $(1,077,000) $26,620,000
Foreign (1,209,000) 117,000 4,586,000 -- -- 3,494,000
--------------------------------------------------------------------------------------
TOTAL NET EARNINGS (LOSS) $(2,665,000) $13,832,000 $13,771,000 $6,253,000 $(1,077,000) $30,114,000
======================================================================================
Other items:
Net investment income $17,501,000 $ 3,051,000 $ 1,772,000 $ 275,000 $ 267,000 $22,866,000
Depreciation and amortization 1,886,000 4,304,000 2,633,000 191,000 398,000 9,412,000
Interest expense 8,000 2,819,000 3,039,000 -- 3,351,000 9,217,000
Income tax provision (benefit) (7,850,000) 10,572,000 8,974,000 3,606,000 (846,000) 14,456,000
Capital expenditures 1,991,000 4,219,000 583,000 438,000 344,000 7,575,000
</TABLE>
Net earnings of the insurance companies segment includes the provision for
reinsurance, which was $19.2 million, net of income taxes.
14
<PAGE>
HCC Insurance Holdings, Inc. and Subsidiaries
--------
Notes to Condensed Consolidated Financial Statements
(Unaudited)
(Continued)
(4) SEGMENT AND GEOGRAPHIC INFORMATION, CONTINUED
<TABLE>
<CAPTION>
Insurance Underwriting Other
Companies Agencies Intermediaries Operations Corporate Total
--------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
For the nine months ended
September 30, 1998:
Revenue:
Domestic $113,781,000 $57,186,000 $21,226,000 $17,854,000 $ 2,250,000 $212,297,000
Foreign 7,708,000 2,823,000 937,000 99,000 -- 11,567,000
Intersegment -- 2,013,000 1,684,000 1,057,000 -- 4,754,000
--------------------------------------------------------------------------------------
Total segment revenue $121,489,000 $62,022,000 $23,847,000 $19,010,000 $ 2,250,000 228,618,000
=======================================================================
Intersegment revenue (4,754,000)
------------
CONSOLIDATED TOTAL REVENUE $223,864,000
============
Net earnings (loss):
Domestic $ 27,145,000 $14,859,000 $11,609,000 $ 4,671,000 $(2,222,000) $ 56,062,000
Foreign 427,000 50,000 656,000 (399,000) -- 734,000
--------------------------------------------------------------------------------------
TOTAL NET EARNINGS (LOSS) $ 27,572,000 $14,909,000 $12,265,000 $ 4,272,000 $(2,222,000) $ 56,796,000
======================================================================================
Other items:
Net investment income $ 16,689,000 $ 2,888,000 $ 284,000 $ 223,000 $ 1,112,000 $ 21,196,000
Depreciation and amortization 1,441,000 2,739,000 122,000 356,000 320,000 4,978,000
Interest expense 35,000 1,422,000 -- -- 3,240,000 4,697,000
Income tax provision (benefit) 8,540,000 10,883,000 7,384,000 2,662,000 (1,145,000) 28,324,000
Capital expenditures 10,713,000 2,073,000 29,000 212,000 616,000 13,643,000
</TABLE>
15
<PAGE>
<TABLE>
<CAPTION>
HCC Insurance Holdings, Inc. and Subsidiaries
--------
Notes to Condensed Consolidated Financial Statements
(Unaudited)
(Continued)
(4) SEGMENT AND GEOGRAPHIC INFORMATION, CONTINUED
Insurance Underwriting Other
Companies Agencies Intermediaries Operations Corporate Total
-----------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
For the three months ended September 30, 1999:
Revenue:
Domestic $40,186,000 $22,458,000 $ 6,106,000 $ 4,579,000 $ 114,000 $73,443,000
Foreign 3,215,000 1,144,000 5,291,000 -- -- 9,650,000
Intersegment -- 676,000 134,000 304,000 -- 1,114,000
-----------------------------------------------------------------------------------
Total segment revenue $ 43,401,000 $24,278,000 $11,531,000 $ 4,883,000 $ 114,000 84,207,000
======================================================================
Intersegment revenue (1,114,000)
-------------
CONSOLIDATED TOTAL REVENUE $83,093,000
=============
Net earnings (loss):
Domestic $ 4,298,000 $ 4,062,000 $ 1,473,000 $ 729,000 $ (487,000) $10,075,000
Foreign (1,740,000) 152,000 631,000 -- -- (957,000)
-----------------------------------------------------------------------------------
TOTAL NET EARNINGS (LOSS) $ 2,558,000 $ 4,214,000 $ 2,104,000 $ 729,000 $ (487,000) $ 9,118,000
===================================================================================
Other items:
Net investment income $ 5,902,000 $ 1,134,000 $ 698,000 $ 98,000 $ 107,000 $ 7,939,000
Depreciation and amortization 615,000 1,483,000 851,000 (56,000) 122,000 3,015,000
Interest expense (benefit) (3,000) 936,000 1,163,000 -- 1,210,000 3,306,000
Income tax provision (benefit) (896,000) 3,179,000 1,468,000 506,000 (806,000) 3,451,000
Capital expenditures 421,000 666,000 20,000 48,000 44,000 1,199,000
</TABLE>
16
<PAGE>
<TABLE>
<CAPTION>
HCC Insurance Holdings, Inc. and Subsidiaries
--------
Notes to Condensed Consolidated Financial Statements
(Unaudited)
(Continued)
(4) SEGMENT AND GEOGRAPHIC INFORMATION, CONTINUED
Insurance Underwriting Other
Companies Agencies Intermediaries Operations Corporate Total
-----------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
For the three months ended September 30, 1998:
Revenue:
Domestic $38,378,000 $19,801,000 $ 4,225,000 $ 9,267,000 $ 1,275,000 $ 72,946,000
Foreign 2,289,000 1,202,000 66,000 33,000 -- 3,590,000
Intersegment -- 1,111,000 232,000 373,000 -- 1,716,000
-----------------------------------------------------------------------------------
Total segment revenue $ 40,667,000 $22,114,000 $ 4,523,000 $ 9,673,000 $ 1,275,000 $ 78,252,000
======================================================================
Intersegment revenue (1,716,000)
-------------
CONSOLIDATED TOTAL REVENUE $ 76,536,000
=============
Net earnings (loss):
Domestic $ 11,016,000 $ 5,493,000 $ 1,891,000 $ 3,520,000 $ (236,000) $ 21,684,000
Foreign 252,000 227,000 45,000 (133,000) -- 391,000
-----------------------------------------------------------------------------------
TOTAL NET EARNINGS (LOSS) $ 11,268,000 $ 5,720,000 $ 1,936,000 $ 3,387,000 $ (236,000) $ 22,075,000
===================================================================================
Other items:
Net investment income $ 5,725,000 $ 1,092,000 $ 90,000 $ 80,000 $ 197,000 $ 7,184,000
Depreciation and amortization 498,000 897,000 43,000 116,000 75,000 1,629,000
Interest expense 14,000 543,000 -- -- 861,000 1,418,000
Income tax provision (benefit) 3,999,000 4,092,000 1,183,000 2,176,000 (172,000) 11,278,000
Capital expenditures 6,740,000 774,000 25,000 78,000 51,000 7,668,000
</TABLE>
The increase in assets between December 31, 1998 and September 30, 1999
comes from two principal sources. First, the acquisition of RML increased
receivables, goodwill and short-term investments. Second, the increased
reinsurance activities of the insurance company subsidiaries caused
reinsurance recoverables to increase.
17
<PAGE>
HCC Insurance Holdings, Inc. and Subsidiaries
--------
Notes to Condensed Consolidated Financial Statements
(Unaudited)
(Continued)
(5) EARNINGS PER SHARE
Basic earnings per share is based on the weighted average number of common
shares outstanding during the period divided into net earnings. Diluted
earnings per share is based on the weighted average number of common
shares outstanding plus the potential common shares outstanding during the
period divided into net earnings. Outstanding common stock options, when
dilutive, are considered to be potential common stock for the purpose of
the diluted calculation. The treasury stock method is used to calculate
potential common stock due to options. Contingent shares to be issued are
included in the diluted earnings per share computations only when the
underlying conditions for issuance have been met.
The following table provides a reconciliation of the denominators used in
the earnings per share calculations:
<TABLE>
<CAPTION>
For the nine months ended September 30,
1999 1998
---------------------- --------------------
<S> <C> <C>
Net earnings $ 30,114,000 $ 56,796,000
====================== ====================
Reconciliation of number of shares outstanding:
Shares of Common Stock outstanding at period end 48,711,000 48,132,000
Changes in Common Stock due to issuance (175,000) (293,000)
Common Stock contractually issuable in the future 414,000 --
---------------------- --------------------
Weighted average Common Stock outstanding 48,950,000 47,839,000
Additional dilutive effect of outstanding options
(as determined by the application of the treasury
stock method) 844,000 1,078,000
---------------------- --------------------
Weighted average Common Stock and potential
common stock outstanding 49,794,000 48,917,000
====================== ====================
</TABLE>
18
<PAGE>
<TABLE>
<CAPTION>
HCC Insurance Holdings, Inc. and Subsidiaries
--------
Notes to Condensed Consolidated Financial Statements
(Unaudited)
(Continued)
(5) EARNINGS PER SHARE, CONTINUED
For the three months ended September 30,
1999 1998
---------------------- --------------------
<S> <C> <C>
Net earnings $ 9,118,000 $ 22,075,000
====================== ====================
Reconciliation of number of shares outstanding:
Shares of Common Stock outstanding at period end 48,711,000 48,132,000
Changes in Common Stock due to issuance 5,000 (262,000)
Common stock contractually issuable in the future 414,000 --
---------------------- --------------------
Weighted average Common Stock outstanding 49,130,000 47,870,000
Additional dilutive effect of outstanding options
(as determined by the application of the
treasury stock method) 736,000 1,049,000
---------------------- --------------------
Weighted average Common Stock and potential
common stock outstanding 49,866,000 48,919,000
====================== ====================
</TABLE>
As of September 30, 1999, there were approximately 1.7 million options
that were not included in the computation of diluted earnings per share
because to do so would have been antidilutive. There are 378,000 shares of
the Company's Common Stock to be issued if certain conditions are met as
of December 31, 1999, or in subsequent years. These shares were not
included in the diluted earnings per share computation, because the
conditions for issuance have not yet been met.
19
<PAGE>
HCC Insurance Holdings, Inc. and Subsidiaries
--------
Notes to Condensed Consolidated Financial Statements
(Unaudited)
(Continued)
(6) SUPPLEMENTAL INFORMATION
Supplemental information for the nine months ended September 30, 1999 and
1998, is summarized below:
<TABLE>
<CAPTION>
1999 1998
------------------ ----------------
<S> <C> <C>
Interest paid $ 8,346,000 $ 4,082,000
Income tax paid 21,358,000 11,454,000
Comprehensive income 21,931,000 57,564,000
Ceding commissions 84,869,000 41,777,000
</TABLE>
Supplemental information for the three months ended September 30, 1999 and
1998, is summarized below:
<TABLE>
<CAPTION>
1999 1998
------------------ ----------------
<S> <C> <C>
Comprehensive income $ 9,290,000 $ 24,639,000
Ceding commissions 29,451,000 14,930,000
</TABLE>
20
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
THREE MONTHS ENDED SEPTEMBER 30, 1999 VERSUS THREE MONTHS ENDED SEPTEMBER 30,
1998
RESULTS OF OPERATIONS
Total revenue increased 9% to $83.1 million for the third quarter of 1999, from
$76.5 million for the same period in 1998. The revenue increase was principally
a result of increases in non-risk bearing management fees and commission income.
This growth is from new business, rate increases and acquisitions made during
the last twelve months, and is expected to continue. It is anticipated that
revenue from the insurance company subsidiaries will begin to grow rapidly
through 2000 as earned premium and investment income begin to rise as a result
of higher retentions and cash flow from increased gross written premium.
Compensation expense increased to $19.2 million for the third quarter of 1999,
from $14.6 million for the same period in 1998. This increase reflects a normal
progressional increase due to business growth as well as the effect of
acquisitions. Other operating expenses increased $6.0 million to $12.8 million
during the same period for similar reasons.
Interest expense was $3.3 million for the third quarter of 1999, an increase of
$1.9 million from the same period in 1998. The increase is a result of increased
debt outstanding as a result of fundings for acquisitions.
Income tax expense was $3.5 million for the third quarter of 1999 compared to
$11.3 million for the same period in 1998. The decrease was due to the reduction
in earnings as a result of the increased net loss ratio.
Net earnings for the third quarter of 1999 decreased to $9.1 million from $22.1
million for the same period in 1998 as a result of the increased net loss ratio.
Diluted earnings per share decreased to $0.18 per share from $0.45 per share
during the same period.
The Company's book value per share was $9.53 as of September 30, 1999, up from
$9.39 as of June 30, 1999.
SEGMENTS
INSURANCE COMPANIES
Gross written premium increased 36% to $135.4 million for the third quarter
of 1999, from $99.9 million for the same period in 1998. Medical stop-loss,
and accident and health premium showed strong growth, primarily as our
insurance company subsidiaries continue to participate in more of the
business written by our underwriting agencies. Net written premium for the
third quarter of 1999 increased 45% to $37.9 million from $26.0 million for
the same period in 1998, from increases in retained aviation, medical
stop-loss, and accident and health premium. Net earned premium for the third
quarter of 1999 increased to $37.5 million from $34.6 million for the same
period in 1998, for the same reasons. It is anticipated that retained premium
will continue to rise in the remainder of this year and through 2000, as the
insurance company subsidiaries begin to increase retentions and rates start
to improve, particularly in the accident and health reinsurance, aviation and
medical stop-loss lines of business.
Loss and loss adjustment expense increased to $32.9 million for the third
quarter of 1999, from $18.6 million for the same period in 1998, and the GAAP
net loss ratio increased to 87.9% for the third quarter of 1999 compared to
53.6% for the same period in 1998. The GAAP gross loss ratio improved to
121.2% in the third quarter of 1999 compared to 141.8% for the same period in
1998. The deterioration in the net loss ratio is primarily from very poor
results in the aviation and medical stop-loss lines of business. The aviation
loss ratio is seasonally higher during the third quarter, but the 1999 third
quarter was much higher than usual. The Company has taken steps to reduce
these loss ratios, primarily by increasing premium rates and more selective
risk selection.
21
<PAGE>
The statutory net combined ratio was 117.6% for the third quarter of 1999
compared to 68.0% for the same period in 1998.
Policy acquisition costs, which are net of ceding commissions on reinsurance
ceded, increased $473,000 during the third quarter of 1999, from the same period
in 1998, reflecting the increase in net earned premium.
Net earnings of the insurance companies decreased to $2.6 million for the third
quarter of 1999 from $11.3 million for the same period in 1998, as a result of
the increased net loss ratio.
Generally, underwriting profitability has deteriorated as the extremely
competitive market conditions of 1998 continue to affect current results.
These results will probably continue to deteriorate even as there is a
transition to a harder market but, eventually, should turn more profitable as
rates increase and underwriting becomes more selective.
UNDERWRITING AGENCIES
Management fees increased 18% to $22.1 million for the third quarter of 1999,
from $18.8 million for the same period in 1998. Premium underwritten on behalf
of affiliated and unaffiliated insurance companies increased to $213.5 million
during the same period, also an increase of 18% from 1998. Both increases
resulted from acquisitions and internal growth of existing operations.
Net earnings of the underwriting agencies decreased to $4.2 million in the third
quarter of 1999 from $5.7 million for the same period in 1998. Recent
acquisitions have not yet had a positive impact on net earnings due to licensing
and other regulatory requirements, which are in process. Growth in underwriting
agency premium has a positive impact on both the insurance company segment and
the intermediary segment.
INTERMEDIARIES
Commission income increased 104% to $10.7 million in the third quarter of
1999, from $5.3 million for the same period in 1998, primarily as a result of
the acquisition of Rattner Mackenzie Limited, acquired effective January 1,
1999. Net earnings of the intermediaries increased 9% to $2.1 million in the
third quarter of 1999 compared to $1.9 million for the same period in 1998.
The increase in net earnings from RML was partially offset by other
reductions.
OTHER OPERATIONS
Other operating revenue decreased to $5.1 million for the third quarter of
1999, from $9.7 million for the same period in 1998. During the 1998 third
quarter there were $4.8 million in gains from dispositions of strategic
investments, whereas there were no gains in the 1999 third quarter. However,
there was a general increase in revenue of the service operations, net of the
decrease in revenue related to operations disposed of in late 1998. Other
operating net earnings decreased for the same reasons. Quarter to quarter
comparisons may vary substantially depending on activity in the purchase or
disposition of strategic investments.
NINE MONTHS ENDED SEPTEMBER 30, 1999 VERSUS NINE MONTHS ENDED SEPTEMBER 30, 1998
RESULTS OF OPERATIONS
Total revenue increased 15% to $257.6 million for the first nine months of
1999, from $223.9 million for the same period in 1998. The revenue increase
was principally a result of increases in non-risk bearing management fees and
commission income. This growth is from new business, rate increases and
acquisitions made during the last twelve months and is expected to continue. It
is anticipated that revenue from the insurance company subsidiaries will begin
to grow rapidly through 2000 as earned premium and investment income begin to
rise as a result of higher retentions and cash flow from increased gross written
premium.
Compensation expense increased to $56.8 million for the first nine months of
1999, from $41.1 million for the
22
<PAGE>
same period in 1998. This increase reflects a normal progressional increase
due to business growth as well as the effect of acquisitions. Other operating
expenses increased $12.1 million to $36.2 million during the same period for
similar reasons.
Interest expense was $9.2 million for the first nine months of 1999, an increase
of $4.5 million from the same period in 1998. The increase is a result of
increased debt outstanding as a result of fundings for acquisitions.
The Company recorded a provision for reinsurance recoverables in the amount of
$29.5 million during the second quarter of 1999. The provision was made
primarily as a result of information received on July 29, 1999, relating to the
insolvency of one of the Company's reinsurers. Primarily based upon the
information contained in that report, the Company recorded a provision which,
based upon management's estimate, should be sufficient to absorb any possible
losses that might result from the insolvency of this reinsurer.
Although this non-recurring charge has substantially affected earnings, it
was contained within the earnings for second quarter of 1999 and should have
no adverse effect on future earnings. This is not a cash item and losses over
will be settled in the normal course of business, which is anticipated to be
over five years.
As of September 30, 1999, the Company has a reserve for reinsurance recoverables
in the amount of $30.3 million which management believes is sufficient to absorb
any anticipated potential losses related to its reinsurance recoverables.
However, the adverse economic environment in the insurance industry has
placed great pressure on reinsurers and the results of their operations and
these conditions could, ultimately, affect reinsurers' solvency.
Historically, there have been insolvencies following an extended period of
competitive pricing in the industry, such as the marketplace has experienced
for the past several years. Therefore, while management believes that the
reserve is adequate based upon currently available information, conditions
may change or additional information might be obtained that would affect
management's estimate of the adequacy of the level of the reserve and which
may result in a future increase or decrease in the reserve.
Income tax expense was $14.5 million for the first nine months of 1999 compared
to $28.3 million for the same period in 1998. The decrease was due to the
reduction in earnings before income tax due to the provision for reinsurance
recorded in the second quarter 1999 and the higher net loss ratio.
Net earnings for the first nine months of 1999 decreased to $30.1 million from
$56.8 million for the same period in 1998, due to the provision for reinsurance,
which equated to $19.2 million after income taxes, or $0.39 per diluted share
and the higher net loss ratio. Diluted earnings per share decreased to $0.60 per
share from $1.16 per share during the same period.
The Company's book value per share was $9.53 as of September 30, 1999, up from
$9.12 as of December 31, 1998.
SEGMENTS
INSURANCE COMPANIES
Gross written premium increased 17% to $422.1 million for the first nine months
of 1999, from $361.8 million for the same period in 1998. Medical stop-loss, and
accident and health premium showed strong growth, as our insurance company
subsidiaries continue to participate in more of the business written by our
underwriting agencies. This growth was partially offset by reductions in
property and offshore energy premium as a result of the continuing extremely
soft conditions in these markets. Net written premium for the first nine
months of 1999 increased to $99.0 million from $92.6 million for the same
period in 1998, from increases in retained aviation and medical stop-loss
premium. Net earned premium for the first nine months of 1999 decreased to
$99.6 million from $104.0 million as changes in earned premium lag behind
changes in written
23
<PAGE>
premium. It is anticipated that retained premium will continue to rise during
the remainder of this year and through 2000, as the insurance company
subsidiaries begin to increase retentions and rates start to improve,
particularly in the accident and health, aviation and medical stop-loss lines of
business.
Loss and loss adjustment expense increased to $77.8 million for the first
nine months of 1999, from $62.4 million for the same period in 1998, and the
GAAP net loss ratio increased to 78.1% for the first nine months of 1999,
from 60.0% for the same period in 1998. The GAAP gross loss ratio was 120.8%
in the first nine months of 1999 compared to 108.0% for the same period in
1998. The deterioration is primarily from poor results in the aviation and
medical stop-loss lines of business. The Company has taken steps to reduce
these gross loss ratios, primarily by increasing premium rates and more
selective risk selection. The statutory net combined ratio was 103.2% for the
first nine months of 1999 compared to 77.0% for the same period in 1998.
Policy acquisition costs, which are net of ceding commissions on reinsurance
ceded, decreased $3.0 million during the first nine months of 1999, from the
same period in 1998, reflecting a greater amount of gross premium ceded and,
therefore, a higher level of ceding commissions.
Net earnings of the insurance companies decreased to a loss of $2.7 million
for the first nine months of 1999, from a profit of $27.6 million for the
same period in 1998, as a result of the second quarter 1999 provision for
reinsurance and the higher net loss ratio.
Generally, underwriting profitability has deteriorated as the extremely
competitive market conditions of 1998 continue to affect current results.
These results will probably continue to deteriorate even as there is a
transition to a harder market but, eventually, should turn more profitable as
rates increase and underwriting becomes more selective.
UNDERWRITING AGENCIES
Management fees increased 30% to $69.7 million for the first nine months of
1999, from $53.5 million for the same period in 1998. Premium underwritten on
behalf of affiliated and unaffiliated insurance companies increased to $637.7
million during the same period, an increase of 26% from 1998. Both increases
resulted from acquisitions and internal growth of existing operations.
Net earnings of the underwriting agencies decreased to $13.8 million for the
first nine months of 1999, from $14.9 million for the same period in 1998.
Recent acquisitions have not yet had a positive impact on net earnings due to
licensing and other regulatory requirements, which are in process. Growth in
underwriting agency premium has a positive impact on both the insurance
company segment and the intermediary segment.
INTERMEDIARIES
Commission income increased 75% to $44.7 million in the first nine months of
1999, from $25.5 million for the same period in 1998, primarily as a result of
the acquisition of RML, effective January 1, 1999. Net earnings of the
intermediaries increased 12% to $13.8 million in the first nine months of 1999
compared to $12.3 million for the same period in 1998. The increase in net
earnings from RML was partially offset by other reductions.
OTHER OPERATIONS
Other operating revenue increased to $20.9 million for the first nine months of
1999, from $18.5 million for the same period in 1998. There was a general
increase in revenue of the service operations, net of the decrease in revenue
related to operations disposed of in late 1998. Other operating net earnings
increased to $6.3 million for the first nine months of 1999, from $4.3 million
for the same period in 1998 for the same reasons. Period to period comparisons
may vary substantially depending on activity in the purchase or disposition of
strategic investments, but it is anticipated that growth in this area will
continue.
24
<PAGE>
ACQUISITIONS
The Company acquired an underwriting agency, MWU, and a London intermediary,
RML, during the quarter ended March 31, 1999. These acquisitions were
accounted for using the purchase method of accounting. The total
consideration to be paid is 515,537 shares of the Company's Common Stock,
$66.2 million in cash and notes, plus additional consideration based upon
future levels of earnings.
On October 12, 1999, the Company announced that it had entered into a
definitive agreement with The Centris Group, Inc. (NYSE: CGE), to acquire all
of their outstanding shares in a transaction valued at approximately $171.0
million. Pursuant to this agreement, a wholly owned subsidiary of the Company
will, through a cash tender, offer to purchase each Centris share for $12.50
and will assume approximately $25.0 million of outstanding bank debt. The
cash tender commenced on October 18, 1999, and, subject to customary
conditions as well as certain regulatory approvals, should be completed by
year end 1999.
RESTRUCTURING
The Company expects to record a restructuring/reorganization charge and
associated expenses of approximately $5.0 million during the fourth quarter
of 1999. Since its initial public offering in 1992, the Company has completed
more than fifteen acquisitions for a total value exceeding $500 million.
During that time, total employees have grown from less than 100 to more than
1,000. Management believes that this restruturing will strengthen the
Company's corporate and management structure and enhance future earnings. The
savings in the year 2000 and beyond from this restructuring should far exceed
the charge and result in the Company improving its efficiency and
profitability.
LIQUIDITY AND CAPITAL RESOURCES
The Company receives substantial cash from premium, reinsurance recoverables,
management fees and commission income and, to a lesser extent, investment
income and proceeds from sales and redemptions of investment assets. The
principal cash outflows are for the payment of claims and loss adjustment
expenses ("LAE"), payment of premium to reinsurers, purchase of investments,
debt service, policy acquisition costs, operating expenses, income and other
taxes, and dividends.
The overall increase in activities at the insurance company subsidiaries
resulted in increases in gross loss reserves, gross unearned premium,
deferred policy acquisition costs and related reinsurance balances since
December 31, 1998. Changes in these balances affect operating cash flows on a
period to period basis. The Company does not expect to incur any significant
liquidity difficulties as a result of the growth in reinsurance recoverables
or as a result of the insolvency of any of its reinsurers. The Company
attempts to limit any liquidity exposure it may have by holding funds,
letters of credit or other security such that net balances due to the Company
are significantly less than the gross balances shown in the condensed
consolidated balance sheet.
The Company's consolidated cash and investment portfolio increased $68.7
million, or 13%, since December 31, 1998, and totaled $610.4 million as of
September 30, 1999, of which $216.7 million was cash and short-term
investments. During 1999, the Company's unrealized pre-tax gain on fixed
income securities was reduced $15.1 million due to an increase in market
interest rates. Since the Company's intention is to generally hold these
securities to maturity, it does not currently expect to realize any
significant gain or loss on these investments. Total assets increased to over
$2.1 billion as of September 30, 1999, from $1.7 billion as of December 31,
1998.
On March 8, 1999, the Company entered into a Loan Agreement (the "Facility")
with a group of banks. The Facility includes a $150.0 million Revolving Loan
Facility and a $100.0 million Short Term Revolving Loan Facility. Borrowing
under the Facility may be made from time to time by the Company for general
corporate purposes through the Short Term Revolving Loan Facility until its
expiration on March 7, 2000, and through the Revolving Loan Facility until
its expiration on February 28, 2002. Outstanding loans under the Facility bear
25
<PAGE>
interest at agreed upon rates. The Facility is collateralized in part by
the pledge of the stock of the Company's principal insurance company
subsidiaries and by the pledge of stock of and guaranties entered into by the
Company's principal underwriting agency and intermediary subsidiaries. The
Facility agreement contains certain restrictive covenants, including, without
limitation, minimum net worth requirements for the Company and certain
subsidiaries, restrictions on certain extraordinary corporate actions, notice
requirements for certain material occurrences and required maintenance of
specified financial ratios. Management believes that the restrictive
covenants and other obligations of the Company which are contained in the
Facility agreement are typical for financing arrangements comparable to the
Facility. The initial funding available under the Facility was used, among
other things, to refinance existing indebtedness of the Company including all
outstanding indebtedness under the Company's $120.0 million revolving credit
facility entered into as of December 30, 1997, which has been terminated. As
of September 30, 1999, total debt outstanding under the Facility was $182.0
million with $150.0 million due under the $150.0 million Revolving Loan
Facility and $32.0 million due under the $100.0 million Short Term Revolving
Loan Facility and the weighted average interest rate was 6.6%.
The Company has received a commitment from its bank for an $80.0 million
Bridge Loan to be used in connection with the acquisition of The Centris
Group, Inc. The Company plans on repaying this Bridge Loan immediately after
closing the Centris acquisition with internally generated funds from one of
its insurance company subsidiaries. In addition, the Company is negotiating
with its bank group for a new five year, $300.0 million revolving credit
facility to replace its existing bank facilities. The Company expects to
complete these financings before the end of 1999.
The Company believes that its operating cash flows, short-term investments,
the Facility and Bridge Loan will provide sufficient sources of liquidity to
meet its operating needs for the foreseeable future.
EFFECTS OF RECENT ACCOUNTING PRONOUNCEMENTS
Statement of Position ("SOP") 97-3 issued by the American Institute of
Certified Public Accountants' Accounting Standards Executive Committee
("AcSEC") is first effective in the Company's fiscal quarter ended March 31,
1999. The adoption of the SOP entitled "Accounting by Insurance and Other
Enterprises for Insurance-Related Assessments" did not have a material effect
on the Company's financial position, results of operations or cash flows.
SFAS No. 133 entitled "Accounting for Derivative Instruments and Hedging
Activities" was issued in June, 1998 and had its initial effective date
postponed in June, 1999. The statement is now effective for all fiscal
quarters of fiscal years beginning after June 15, 2000, with early adoption
permitted. The Company has utilized derivatives or hedging strategies
infrequently in the past and in immaterial amounts, although it is currently
using derivatives and hedging strategies to a greater extent as it expands
its foreign operations. The effects of the Statement, as well as the timing
of its adoption, are currently being reviewed by management.
In November, 1998, AcSEC issued SOP 98-7, "Deposit Accounting: Accounting for
Insurance and Reinsurance Contracts That Do Not Transfer Insurance Risk"
which provides guidance as to the use of deposit accounting for insurance and
reinsurance contracts that do not transfer insurance risk. This SOP is
effective for financial statements for fiscal years beginning after June 15,
1999. The Company does not expect the adoption of this SOP to have a material
effect on the Company's financial position, results of operations or cash
flows.
YEAR 2000
The Year 2000 issue is the result of date coding within computer programs
that were written using just two digits rather than four digits to define the
applicable year. If not corrected, these date codes could cause computers to
fail to calculate dates beyond 1999 and, as a result, computer applications
could fail or create erroneous results by or at the Year 2000.
The Company, together with outside vendors engaged by the Company, has made
assessments of the Company's potential Year 2000 exposure related to its
computerized information systems and has substantially completed its
26
<PAGE>
efforts to test and remediate these systems for compliance. The Company has
also made assessments of the potential Year 2000 exposure associated with its
embedded technology systems, such as telephone systems, environmental control
systems and elevators, and does not believe that it has significant Year 2000
exposure in this area.
The Company has had discussions with important suppliers, business partners,
customers and other third parties to determine the extent to which the
Company may be vulnerable to the failure of these parties to identify and
correct their own Year 2000 issues. Based upon information received from
these third parties, management does not believe that the Company has any
significant Year 2000 exposures related to its third party relationships.
In addition to its own systems and third-party relationships, the Company may
also have exposure in the property and casualty operations of its insurance
company subsidiaries to claims asserted under certain insurance policies for
damages caused by an insured's failure to address its own Year 2000 computer
problems. As with other companies in the insurance industry, the Company has
evaluated and continues to evaluate the potential insurance exposures arising
from Year 2000 problems. The Company's insurance company subsidiaries do not
offer policies of insurance marketed as Year 2000 liability coverage.
However, due to the nature of certain of the policies insureds may attempt to
submit claims for coverage under such policies which may result from Year
2000 related causes. In this regard, the Company continues to assess and
modify insurance coverages currently offered by such subsidiaries in light of
coverage issues associated with the Year 2000 problem. Due to the difficulty
in accurately assessing potential Year 2000 losses, if any, related to Year
2000 coverage issues, it is not possible to reasonably estimate their
potential effects on the Company's financial position and results of
operations.
The Company's own software vendor subsidiary has completed its Year 2000
compliance plan, and, based upon the results, management believes that the
subsidiary's products are Year 2000 compliant.
The Company continues to evaluate and mitigate its Year 2000 exposures in
advance of respective critical dates. Further, in the ongoing acquisition of
technology and business equipment, the Company generally requires that its
vendors certify the Year 2000 compliance of acquired products. The Company
relies upon such certifications.
From January 1, 1997 through September 30, 1999, the Company expensed
$788,000 with respect to Year 2000 compliance and capitalized $7.0 million
with respect to new software purchases and installations which are Year 2000
compliant. The total estimated remaining cost is expected to be under
$150,000 and will be incurred over the next six months. The Company does not
track internal costs with respect to the expenses related to Year 2000
remediation. The level of expense anticipated in connection with the Year
2000 issues is not expected to have a material effect on the Company's
results of operations. The costs of the Company's Year 2000 compliance
efforts are expected to be funded out of operating cash flow, which is
sufficient to provide funding. To date, no material information technology
projects of the Company have been delayed as a result of the Company's Year
2000 compliance efforts.
The Company believes that its Year 2000 compliance plan will be successful
based upon its progress to date. Many of the Company's major systems have
been replaced or remediated and are currently successfully processing
business and information that contain the Year 2000 or later years. No new
information has come to management's attention that would indicate that the
plan should be altered significantly or that the plan will not be successful
in the time frame prescribed by the plan. Nevertheless, the Company is
finalizing its contingency plans for the remote possibility that there could
be an unforeseen Year 2000 failure. Such plans document procedures to address
any material Year 2000 failures until remediation of the related systems
could be performed.
The dates of expected completion and the costs of the Company's Year 2000
remediation efforts are based on management's estimates, which were derived
utilizing assumptions of future events, including the availability of certain
resources, third party remediation plans and other factors. There can be no
guarantee that these estimates will be achieved. If the actual timing and
costs for the Company's Year 2000 remediation program differ materially from
those anticipated, the Company's financial condition and results of
operations could be significantly affected. Additionally, despite testing by
the Company, the Company's systems may contain undetected errors or defects
associated with Year 2000 date functions. The inability of the Company to
correctly identify significant Year 2000 issues for remediation or to
complete its Year 2000 testing and remediation efforts prior to respective
critical dates,
27
<PAGE>
the failure of its contingency planning, the failure of third parties with
whom the Company has an important relationship to identify, test and
remediate their own Year 2000 issues and the resulting disruption which could
occur in the Company's systems, the impact of future acquisitions in which
Year 2000 issues in the acquired systems have not been tested or remediated
and the inability of the Company to adequately address coverage issues
related to its insurance company subsidiaries, could have material adverse
effects on the Company's business, and its financial condition, results of
operations and cash flows.
EURO CONVERSION
On January 1, 1999, certain member countries of the European Union
irrevocably fixed the conversion rates between their national currencies and
a common currency, the "Euro", which became their common legal currency on
that date. The participating countries' former national currencies will
continue to serve as legal tender and denominations of the Euro between
January 1, 1999, and January 1, 2002. The conversion to the Euro is scheduled
to be completed on July 1, 2002, when the national currencies will cease to
exist. The introduction of the Euro has not had a material effect on the
Company's business, software plans, financial condition or results of
operations.
28
<PAGE>
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
- -------------------------------------------------------------------
From time to time, the Company enters into foreign currency forward contracts
as a hedge against foreign currency fluctuations. The Company did not hedge
this risk in 1998 and there were no open foreign currency forward contracts
as of December 31, 1998. RML, purchased by the Company during January, 1999,
has a revenue stream in US Dollars but expenses in Great British Pounds. To
mitigate the foreign exchange risk, the Company enters into foreign currency
forward contracts expiring at staggered times through December 2000. As of
September 30, 1999, the Company had forward contracts to sell US$ 15.0
million for Pounds at an average rate of 1 GBP = US$1.60. The foreign
currency forward contracts are used to convert currency at a known rate in an
amount which approximates average monthly expenses. Thus, the effect of these
transactions is to limit the foreign currency exchange risk of the recurring
monthly expenses.
THIS REPORT ON FORM 10-Q (THE "REPORT") CONTAINS CERTAIN FORWARD-LOOKING
STATEMENTS WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933,
AS AMENDED, AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934, AS
AMENDED, WHICH ARE INTENDED TO BE COVERED BY THE SAFE HARBORS CREATED
THEREBY. INVESTORS ARE CAUTIONED THAT ALL FORWARD-LOOKING STATEMENTS
NECESSARILY INVOLVE RISKS AND UNCERTAINTY, INCLUDING, WITHOUT LIMITATION, THE
RISK OF A SIGNIFICANT NATURAL DISASTER, THE INABILITY OF THE COMPANY TO
REINSURE CERTAIN RISKS, THE ADEQUACY OF ITS LOSS RESERVES, THE FINANCIAL
VIABILITY OF REINSURERS, THE EXPANSION OR CONTRACTION IN ITS VARIOUS LINES OF
BUSINESS, THE IMPACT OF INFLATION, THE IMPACT OF YEAR 2000 ISSUES, CHANGING
LICENSING REQUIREMENTS AND REGULATIONS IN THE UNITED STATES AND IN FOREIGN
COUNTRIES, THE ABILITY OF THE COMPANY TO INTEGRATE ITS RECENTLY ACQUIRED
BUSINESSES, THE EFFECT OF PENDING OR FUTURE ACQUISITIONS AS WELL AS
ACQUISITIONS WHICH HAVE RECENTLY BEEN CONSUMMATED, GENERAL MARKET CONDITIONS,
COMPETITION AND PRICING. ALL STATEMENTS, OTHER THAN STATEMENTS OF HISTORICAL
FACTS, INCLUDED OR INCORPORATED BY REFERENCE IN THIS REPORT THAT ADDRESS
ACTIVITIES, EVENTS OR DEVELOPMENTS THAT THE COMPANY EXPECTS OR ANTICIPATES
WILL OR MAY OCCUR IN THE FUTURE, INCLUDING, WITHOUT LIMITATION, SUCH THINGS
AS FUTURE CAPITAL EXPENDITURES (INCLUDING THE AMOUNT AND NATURE THEREOF),
BUSINESS STRATEGY AND MEASURES TO IMPLEMENT SUCH STRATEGY, COMPETITIVE
STRENGTHS, GOALS, EXPANSION AND GROWTH OF THE COMPANY'S BUSINESSES AND
OPERATIONS, PLANS, REFERENCES TO FUTURE SUCCESS, AS WELL AS OTHER STATEMENTS
WHICH INCLUDES WORDS SUCH AS "ANTICIPATE," "BELIEVE," "PROBABLY," "PLAN,"
"ESTIMATE," "EXPECT," AND "INTEND" AND OTHER SIMILAR EXPRESSIONS, CONSTITUTE
FORWARD-LOOKING STATEMENTS. ALTHOUGH THE COMPANY BELIEVES THAT THE
ASSUMPTIONS UNDERLYING THE FORWARD-LOOKING STATEMENTS CONTAINED HEREIN ARE
REASONABLE, ANY OF THE ASSUMPTIONS COULD OVER TIME PROVE TO BE INACCURATE
AND, THEREFORE, THERE CAN BE NO ASSURANCE THAT THE FORWARD-LOOKING STATEMENTS
INCLUDED IN THIS REPORT WILL THEMSELVES PROVE TO BE ACCURATE. IN LIGHT OF THE
SIGNIFICANT UNCERTAINTIES INHERENT IN THE FORWARD-LOOKING STATEMENTS INCLUDED
HEREIN, THE INCLUSION OF SUCH INFORMATION SHOULD NOT BE REGARDED AS A
REPRESENTATION BY THE COMPANY OR ANY OTHER PERSON THAT THE OBJECTIVES AND
PLANS OF THE COMPANY WILL BE ACHIEVED.
29
<PAGE>
PART II - OTHER INFORMATION
---------------------------
Item 6. Exhibits and Reports on Form 8-K:
---------------------------------
(a) Exhibits:
27 EDGAR Financial Data Schedule - September 30, 1999
(b) Reports on Form 8-K:
None
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.
HCC Insurance Holdings, Inc.
-----------------------------------------------
(Registrant)
November 15, 1999 /s/ Stephen L. Way
- ---------------------------- -----------------------------------------------
(Date) Stephen L. Way, Chairman of the Board
and Chief Executive Officer
November 15, 1999 /s/ Edward H. Ellis, Jr.
- ---------------------------- -----------------------------------------------
(Date) Edward H. Ellis, Jr., Senior Vice President and
Chief Financial Officer
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 7
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION FROM THE CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS FOUND IN THE COMPANY'S FORM 10-Q FOR THE
QUARTER ENDED SEPTEMBER 30, 1999, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE
TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> SEP-30-1999
<DEBT-HELD-FOR-SALE> 390,832,000
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 1,140,000
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 599,697,000
<CASH> 93,288,000
<RECOVER-REINSURE> 567,205,000
<DEFERRED-ACQUISITION> (697,000)
<TOTAL-ASSETS> 2,154,011,000
<POLICY-LOSSES> 668,807,000
<UNEARNED-PREMIUMS> 198,199,000
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 189,599,000
0
0
<COMMON> 48,711,000
<OTHER-SE> 419,441,000
<TOTAL-LIABILITY-AND-EQUITY> 2,154,011,000
99,576,000
<INVESTMENT-INCOME> 22,866,000
<INVESTMENT-GAINS> (266,000)
<OTHER-INCOME> 135,387,000
<BENEFITS> 77,756,000
<UNDERWRITING-AMORTIZATION> 3,490,000
<UNDERWRITING-OTHER> 122,530,000
<INCOME-PRETAX> 44,570,000
<INCOME-TAX> 14,456,000
<INCOME-CONTINUING> 30,114,000
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 30,114,000
<EPS-BASIC> 0.62
<EPS-DILUTED> 0.60
<RESERVE-OPEN> 118,912,000
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
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<RESERVE-CLOSE> 132,717,000
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</TABLE>
