<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 June 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 August 6, 1999, there were 48,713,545 shares of Common Stock, $1 par value
issued and outstanding.
<PAGE>
HCC INSURANCE HOLDINGS, INC.
INDEX
<TABLE>
<CAPTION>
PAGE NO.
<S> <C>
Part I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Balance Sheets
June 30, 1999 and December 31, 1998.........................................3
Condensed Consolidated Statements of Earnings
Six Months Ended June 30, 1999 and
Six Months Ended June 30, 1998..............................................4
Condensed Consolidated Statements of Earnings
Three Months Ended June 30, 1999 and
Three Months Ended June 30, 1998............................................5
Condensed Consolidated Statements of Changes in Shareholders' Equity
Six Months Ended June 30, 1999 and
Year Ended December 31, 1998................................................6
Condensed Consolidated Statements of Cash Flows
Six Months Ended June 30, 1999 and
Six Months Ended June 30, 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......................28
Part II. OTHER INFORMATION........................................................................29
</TABLE>
2
<PAGE>
HCC Insurance Holdings, Inc. and Subsidiaries
---------
Condensed Consolidated Balance Sheets
(Unaudited)
--------
<TABLE>
<CAPTION>
June 30, 1999 December 31, 1998
-------------- ------------------
ASSETS
<S> <C> <C>
Investments:
Fixed income securities, at market
(cost: 1999 $394,782,000; 1998 $375,107,000) $ 399,307,000 $ 393,238,000
Marketable equity securities, at market
(cost: 1999 $2,999,000; 1998 $1,750,000) 2,935,000 2,252,000
Short-term investments, at cost, which approximates market 183,022,000 129,084,000
Other investments, at cost, which approximates fair value 1,220,000 1,072,000
-------------- ------------------
Total investments 586,484,000 525,646,000
Cash 16,834,000 16,018,000
Restricted cash and cash investments 82,304,000 84,276,000
Reinsurance recoverables 505,708,000 372,672,000
Premium, claims and other receivables 407,929,000 382,630,000
Ceded unearned premium 167,711,000 149,568,000
Deferred policy acquisition costs 45,373,000 27,227,000
Property and equipment, net 37,052,000 32,983,000
Goodwill 161,429,000 88,043,000
Other assets 33,814,000 30,006,000
-------------- ------------------
TOTAL ASSETS $2,044,638,000 $ 1,709,069,000
-------------- ------------------
LIABILITIES
Loss and loss adjustment expense payable $ 610,985,000 $ 460,511,000
Reinsurance balances payable 112,852,000 90,983,000
Unearned premium 218,426,000 201,050,000
Deferred ceding commissions 48,575,000 30,842,000
Premium and claims payable 368,835,000 337,909,000
Notes payable 185,557,000 121,600,000
Accounts payable and accrued liabilities 38,269,000 26,311,000
-------------- ------------------
Total liabilities 1,583,499,000 1,269,206,000
SHAREHOLDERS' EQUITY
Common Stock, $1.00 par value; 250,000,000 shares authorized;
(issued and outstanding: 1999 48,693,832 shares;
1998 48,252,478 shares) 48,694,000 48,252,000
Additional paid-in capital 175,150,000 162,102,000
Retained earnings 235,945,000 219,804,000
Accumulated other comprehensive income 1,350,000 9,705,000
-------------- ------------------
Total shareholders' equity 461,139,000 439,863,000
-------------- ------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $2,044,638,000 $ 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 six months ended June 30,
1999 1998
------------- -------------
REVENUE
<S> <C> <C>
Net earned premium $ 62,084,000 $ 69,367,000
Management fees 47,573,000 34,751,000
Commission income 34,008,000 20,254,000
Net investment income 14,927,000 14,012,000
Net realized investment gain 91,000 125,000
Other operating income 15,787,000 8,819,000
------------- -------------
Total revenue 174,470,000 147,328,000
EXPENSE
Loss and loss adjustment expense 44,813,000 43,803,000
Operating expense:
Policy acquisition costs, net (654,000) 4,570,000
Compensation expense 37,642,000 26,523,000
Provision for reinsurance 29,500,000 --
Other operating expense 25,257,000 17,386,000
------------- -------------
Net operating expense 91,745,000 48,479,000
Interest expense 5,911,000 3,279,000
------------- -------------
Total expense 142,469,000 95,561,000
------------- -------------
Earnings before income tax provision 32,001,000 51,767,000
Income tax provision 11,005,000 17,046,000
------------- -------------
NET EARNINGS $ 20,996,000 $ 34,721,000
------------- -------------
BASIC EARNINGS PER SHARE DATA:
Earnings per share $ 0.43 $ 0.73
------------- -------------
Weighted average shares outstanding 48,858,000 47,824,000
------------- -------------
DILUTED EARNINGS PER SHARE DATA:
Earnings per share $ 0.42 $ 0.71
------------- -------------
Weighted average shares outstanding 49,757,000 48,917,000
------------- -------------
Cash dividends declared, per share $ 0.10 $ 0.08
------------- -------------
</TABLE>
See Notes to Condensed Consolidated Financial Statements
4
<PAGE>
HCC Insurance Holdings, Inc. and Subsidiaries
--------
Condensed Consolidated Statements of Earnings
(Unaudited)
--------
<TABLE>
<CAPTION>
For the three months ended June 30,
1999 1998
------------ ---------------
<S> <C> <C>
REVENUE
Net earned premium $ 28,105,000 $ 35,440,000
Management fees 24,138,000 18,643,000
Commission income 16,253,000 13,418,000
Net investment income 7,663,000 7,322,000
Net realized investment gain (loss) (79,000) 8,000
Other operating income 6,403,000 4,511,000
----------- -----------
Total revenue 82,483,000 79,342,000
EXPENSE
Loss and loss adjustment expense 21,049,000 26,613,000
Operating expense:
Policy acquisition costs, net (1,982,000) 2,335,000
Compensation expense 18,720,000 12,957,000
Provision for reinsurance 29,500,000 --
Other operating expense 12,232,000 9,479,000
----------- -----------
Net operating expense 58,470,000 24,771,000
Interest expense 2,602,000 1,658,000
----------- -----------
Total expense 82,121,000 53,042,000
----------- -----------
Earnings before income tax provision 362,000 26,300,000
Income tax provision 75,000 8,666,000
----------- -----------
NET EARNINGS $ 287,000 $17,634,000
----------- -----------
----------- -----------
BASIC EARNINGS PER SHARE DATA:
Earnings per share $ 0.01 $ 0.37
----------- -----------
----------- -----------
Weighted average shares outstanding 48,951,000 47,853,000
----------- -----------
----------- -----------
DILUTED EARNINGS PER SHARE DATA:
Earnings per share $ 0.01 $ 0.36
----------- -----------
----------- -----------
Weighted average shares outstanding 49,971,000 49,015,000
----------- -----------
----------- -----------
Cash dividends declared, per share $ 0.05 $ 0.04
----------- -----------
----------- -----------
</TABLE>
See Notes to Condensed Consolidated Financial Statements.
5
<PAGE>
HCC Insurance Holdings, Inc. and Subsidiaries
--------
Condensed Consolidated Statements of Changes
in Shareholders' Equity For the six
months ended June 30, 1999 and
for the year ended December 31, 1998
(Unaudited)
--------
<TABLE>
<CAPTION>
Accumulated
Additional Other Total
Common Paid-in Retained Comprehensive Shareholders'
Stock Capital Earnings Income Equity
------------ ------------ ------------ ------------- -------------
<S> <C> <C> <C> <C> <C>
BALANCE AS OF DECEMBER 31, 1997 $ 47,759,000 $154,633,000 $155,209,000 $8,000,000 $365,601,000
Net earnings -- -- 72,278,000 -- 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 $925,000 206,000 1,997,000 -- -- 2,203,000
287,025 shares of Common Stock issued for
acquisitions 287,000 5,472,000 -- -- 5,759,000
Cash dividends declared, $0.16 per share -- -- (7,683,000) -- (7,683,000)
------------- ------------ ------------ ---------- ------------
BALANCE AS OF DECEMBER 31, 1998 $ 48,252,000 $162,102,000 $219,804,000 $9,705,000 $439,863,000
------------- ------------ ------------ ---------- ------------
------------- ------------ ------------ ---------- ------------
</TABLE>
See Notes to Condensed Consolidated Financial Statements
6
<PAGE>
HCC Insurance Holdings, Inc. and Subsidiaries
--------
Condensed Consolidated Statements of Changes
in Shareholders' Equity For the six
months ended June 30, 1999 and
for the year ended December 31, 1998
(Unaudited)
(continued)
--------
<TABLE>
<CAPTION>
Accumulated
Additional Other Total
Common Paid-in Retained Comprehensive Shareholders'
Stock Capital Earnings Income Equity
------------ ------------ ------------ ------------- -------------
<S> <C> <C> <C> <C> <C>
BALANCE AS OF DECEMBER 31, 1998 $ 48,252,000 $162,102,000 $219,804,000 $9,705,000 $439,863,000
Net earnings -- -- 20,996,000 -- 20,996,000
Other comprehensive income (loss) -- -- -- (8,355,000) (8,355,000)
340,024 shares of Common Stock issued for
exercise of options, including tax benefit of
$795,000 340,000 2,879,000 -- -- 3,219,000
101,330 shares of Common Stock issued for
acquisition 102,000 1,898,000 -- -- 2,000,000
414,207 shares of Common Stock contractually
issuable in the future -- 8,271,000 -- -- 8,271,000
Cash dividends declared, $0.10 per share -- -- (4,855,000) -- (4,855,000)
------------- ------------ ------------ ---------- ------------
BALANCE AS OF JUNE 30, 1999 $ 48,694,000 $175,150,000 $235,945,000 $1,350,000 $461,139,000
------------- ------------ ------------ ---------- ------------
------------- ------------ ------------ ---------- ------------
</TABLE>
See Notes to Condensed Consolidated Financial Statements.
7
<PAGE>
HCC Insurance Holdings, Inc. and Subsidiaries
--------
Condensed Consolidated Statements of Cash Flows
(Unaudited)
--------
<TABLE>
<CAPTION>
For the six months ended June 30,
1999 1998
------------- -------------
Cash flows from operating activities:
<S> <C> <C>
Net earnings $ 20,996,000 $ 34,721,000
Adjustments to reconcile net earnings to net
cash provided by operating activities:
Change in reinsurance recoverables (162,536,000) (49,101,000)
Change in premium, claims and other receivables 53,093,000 (62,636,000)
Change in ceded unearned premium (18,143,000) (56,359,000)
Change in loss and loss adjustment expense payable 150,474,000 43,553,000
Change in reinsurance balances payable 21,869,000 46,990,000
Change in unearned premium 17,145,000 53,618,000
Change in premium and claims payable, net of restricted cash (69,156,000) 38,055,000
Net realized investment gain (91,000) (125,000)
Gains on sales of strategic investments (5,523,000) --
Provision for reinsurance 29,500,000 --
Depreciation and amortization expense 6,397,000 3,349,000
Other, net (3,377,000) 895,000
------------- -------------
Cash provided by operating activities 40,648,000 52,960,000
Cash flows from investing activities:
Sales of fixed income securities 1,214,000 788,000
Maturity or call of fixed income securities 5,693,000 4,751,000
Sales of equity securities 1,520,000 3,406,000
Sales of strategic investments 15,905,000 --
Change in short-term investments (24,383,000) (25,901,000)
Cash paid for companies acquired, net of cash received (57,863,000) (19,172,000)
Cost of securities acquired (30,811,000) (14,461,000)
Purchases of property and equipment (6,376,000) (5,975,000)
------------- -------------
Cash used by investing activities (95,101,000) (56,564,000)
Cash flows from financing activities:
Proceeds from notes payable 204,000,000 21,200,000
Sale of Common Stock 3,219,000 1,006,000
Payments on notes payable (147,600,000) (13,950,000)
Dividends paid (4,350,000) (3,300,000)
------------- -------------
Cash provided by financing activities 55,269,000 4,956,000
------------- -------------
Net change in cash 816,000 1,352,000
Cash at beginning of period 16,018,000 7,728,000
------------- -------------
CASH AT END OF PERIOD $ 16,834,000 $ 9,080,000
------------- -------------
------------- -------------
</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
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 six months ended June 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.
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
------------- ------------- -------------
For the six months ended June 30, 1999:
<S> <C> <C> <C>
Direct business $ 138,828,000 $ 128,137,000 $ 124,930,000
Reinsurance assumed 147,901,000 149,275,000 209,433,000
Reinsurance ceded (225,590,000) (215,328,000) (289,550,000)
------------- ------------- -------------
NET AMOUNTS $ 61,139,000 $ 62,084,000 $ 44,813,000
------------- ------------- -------------
------------- ------------- -------------
</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
------------- ------------- -------------
For the six months ended June 30, 1998:
<S> <C> <C> <C>
Direct business $ 118,499,000 $ 88,134,000 $ 72,431,000
Reinsurance assumed 143,347,000 118,731,000 112,309,000
Reinsurance ceded (195,271,000) (137,498,000) (140,937,000)
------------- ------------- -------------
NET AMOUNTS $ 66,575,000 $ 69,367,000 $ 43,803,000
------------- ------------- -------------
------------- ------------- -------------
For the three months ended June 30, 1999:
Direct business $ 88,790,000 $ 67,867,000 $ 78,193,000
Reinsurance assumed 56,296,000 63,928,000 118,921,000
Reinsurance ceded (114,366,000) (103,690,000) (176,065,000)
------------- ------------- -------------
NET AMOUNTS $ 30,720,000 $ 28,105,000 $ 21,049,000
------------- ------------- -------------
------------- ------------- -------------
For the three months ended June 30, 1998:
Direct business $ 80,108,000 $ 46,192,000 $ 40,766,000
Reinsurance assumed 68,307,000 61,800,000 63,871,000
Reinsurance ceded (107,657,000) (72,552,000) (78,024,000)
------------- ------------- -------------
NET AMOUNTS $ 40,758,000 $ 35,440,000 $ 26,613,000
------------- ------------- -------------
------------- ------------- -------------
</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>
June 30, 1999 December 31, 1998
-------------- -----------------
<S> <C> <C>
Reinsurance recoverable on paid losses $ 49,563,000 $ 33,572,000
Reinsurance recoverable on outstanding losses 345,842,000 279,086,000
Reinsurance recoverable on IBNR 140,407,000 62,513,000
Reserve for reinsurance recoverables (30,104,000) (2,499,000)
-------------- -----------------
TOTAL REINSURANCE RECOVERABLES $ 505,708,000 $ 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 financial condition of one of the
Company's reinsurers. Information was received from the administrator,
previously appointed to manage the affairs of the reinsurer, indicated
that the financial condition of the reinsurer had further deteriorated,
that the reinsurer was, in fact, insolvent and that the administrator
was recommending that the creditors vote to place the reinsurer into
liquidation. Primarily based upon the information contained in that
report, the Company has 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 June 30, 1999, the Company has a reserve for reinsurance
recoverables in the amount of $30.1 million which management believes
is sufficient to absorb any possible 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>
June 30, 1999 December 31, 1998
------------- -----------------
<S> <C> <C>
Payables to reinsurers $ 226,551,000 $ 227,613,000
Letters of credit 161,136,000 166,494,000
Cash deposits 15,405,000 8,077,000
------------- -----------------
TOTAL CREDITS $ 403,092,000 $ 402,184,000
------------- -----------------
------------- -----------------
</TABLE>
(3) ACQUISITIONS
During the first quarter of 1999, the Company acquired an underwriting
agency operation, Midwest Stop Loss Underwriters, Incorporated, 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
(pound)5.0 million in cash ($8.1 million at June 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 six months ended June 30, 1999 and
1998, respectively.
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
--------------------------------------------------------------------------------------
For the six months ended June 30, 1999:
Revenue:
<S> <C> <C> <C> <C> <C> <C>
Domestic $ 68,746,000 $47,638,000 $20,527,000 $15,306,000 $ 26,000 $ 152,243,000
Foreign 5,865,000 1,807,000 14,555,000 -- -- 22,227,000
Intersegment -- 853,000 345,000 564,000 -- 1,762,000
--------------------------------------------------------------------------------------
Total segment revenue $ 74,611,000 $50,298,000 $35,427,000 $15,870,000 $ 26,000 176,232,000
---------------------------------------------------------------------
---------------------------------------------------------------------
Intersegment revenue (1,762,000)
--------------
CONSOLIDATED TOTAL REVENUE $ 174,470,000
--------------
--------------
Net earnings (loss):
Domestic $ (5,754,000) $ 9,653,000 $ 7,712,000 $ 5,524,000 $ (590,000) $ 16,545,000
Foreign 531,000 (35,000) 3,955,000 -- -- 4,451,000
--------------------------------------------------------------------------------------
TOTAL NET EARNINGS (LOSS) $ (5,223,000) $ 9,618,000 $11,667,000 $ 5,524,000 $ (590,000) $ 20,996,000
--------------------------------------------------------------------------------------
--------------------------------------------------------------------------------------
Other items:
Net investment income $ 11,599,000 $ 1,917,000 $ 1,074,000 $ 177,000 $ 160,000 $ 14,927,000
Depreciation and amortization 1,271,000 2,821,000 1,782,000 247,000 276,000 6,397,000
Interest expense 11,000 1,883,000 1,876,000 -- 2,141,000 5,911,000
Income tax provision (benefit) (6,954,000) 7,393,000 7,506,000 3,100,000 (40,000) 11,005,000
Capital expenditures 1,570,000 3,553,000 563,000 390,000 300,000 6,376,000
</TABLE>
14
<PAGE>
HCC Insurance Holdings, Inc. and Subsidiaries
--------
Notes to Condensed Consolidated Financial Statements
(Unaudited)
(Continued)
<TABLE>
<CAPTION>
(4) SEGMENT AND GEOGRAPHIC INFORMATION, CONTINUED
Insurance Underwriting Other
Companies Agencies Intermediaries Operations Corporate Total
---------------------------------------------------------------------------------
---------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
For the six months ended June 30, 1998:
Revenue:
Domestic $75,403,000 $37,385,000 $17,001,000 $8,587,000 $ 975,000 $139,351,000
Foreign 5,419,000 1,621,000 871,000 66,000 -- 7,977,000
Intersegment -- 902,000 1,452,000 684,000 -- 3,038,000
---------------------------------------------------------------------------------
Total segment revenue $80,822,000 $39,908,000 $19,324,000 $9,337,000 $ 975,000 $150,366,000
------------------------------------------------------------------
------------------------------------------------------------------
Intersegment revenue (3,038,000)
-----------
CONSOLIDATED TOTAL REVENUE $147,328,000
------------
------------
Net earnings (loss):
Domestic $16,129,000 $ 9,366,000 $ 9,718,000 $1,151,000 $(1,986,000) $ 34,378,000
Foreign 175,000 (177,000) 611,000 (266,000) -- 343,000
---------------------------------------------------------------------------------
TOTAL NET EARNINGS (LOSS) $16,304,000 $ 9,189,000 $10,329,000 $ 885,000 $(1,986,000) $ 34,721,000
---------------------------------------------------------------------------------
---------------------------------------------------------------------------------
Other items:
Net investment income $10,964,000 $ 1,796,000 $ 194,000 $ 143,000 $ 915,000 $ 14,012,000
Depreciation and amortization 943,000 1,842,000 79,000 240,000 245,000 3,349,000
Interest expense 21,000 879,000 -- -- 2,379,000 3,279,000
Income tax provision (benefit) 4,541,000 6,791,000 6,201,000 486,000 (973,000) 17,046,000
Capital expenditures 3,973,000 1,299,000 4,000 134,000 565,000 5,975,000
</TABLE>
15
<PAGE>
HCC Insurance Holdings, Inc. and Subsidiaries
--------
Notes to Condensed Consolidated Financial Statements
(Unaudited)
(Continued)
<TABLE>
<CAPTION>
(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 June 30, 1999:
Revenue:
Domestic $ 31,458,000 $24,198,000 $10,008,000 $6,090,000 $ 59,000 $71,813,000
Foreign 2,841,000 935,000 6,894,000 -- -- 10,670,000
Intersegment -- 574,000 104,000 220,000 -- 898,000
------------------------------------------------------------------------------
Total segment revenue $ 34,299,000 $25,707,000 $17,006,000 $6,310,000 $ 59,000 $83,381,000
----------------------------------------------------------------
----------------------------------------------------------------
Intersegment revenue (898,000)
-----------
CONSOLIDATED TOTAL REVENUE $82,483,000
-----------
-----------
Net earnings (loss):
Domestic $(11,956,000) $ 5,194,000 $ 3,647,000 $1,263,000 $(196,000) $(2,048,000)
Foreign 463,000 75,000 1,797,000 -- -- 2,335,000
------------------------------------------------------------------------------
TOTAL NET EARNINGS (LOSS) $(11,493,000) $ 5,269,000 $ 5,444,000 $1,263,000 $(196,000) $ 287,000
------------------------------------------------------------------------------
------------------------------------------------------------------------------
Other items:
Net investment income $ 5,833,000 $ 1,008,000 $ 649,000 $ 96,000 $ 77,000 $ 7,663,000
Depreciation and amortization 646,000 1,458,000 902,000 184,000 127,000 3,317,000
Interest expense 2,000 734,000 957,000 -- 909,000 2,602,000
Income tax provision (benefit) (8,263,000) 4,026,000 3,578,000 794,000 (60,000) 75,000
Capital expenditures 788,000 2,211,000 164,000 359,000 25,000 3,547,000
</TABLE>
16
<PAGE>
HCC Insurance Holdings, Inc. and Subsidiaries
--------
Notes to Condensed Consolidated Financial Statements
(Unaudited)
(Continued)
<TABLE>
<CAPTION>
(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 June 30, 1998:
Revenue:
Domestic $38,865,000 $19,973,000 $11,764,000 $4,374,000 $ 802,000 $75,778,000
Foreign 2,122,000 998,000 411,000 33,000 -- 3,564,000
Intersegment -- 393,000 588,000 369,000 -- 1,350,000
-------------------------------------------------------------------------------
Total segment revenue $40,987,000 $21,364,000 $12,763,000 $4,776,000 $ 802,000 80,692,000
-----------------------------------------------------------------
-----------------------------------------------------------------
Intersegment revenue (1,350,000)
-----------
CONSOLIDATED TOTAL REVENUE $79,342,000
-----------
-----------
Net earnings (loss):
Domestic $ 6,385,000 $ 4,956,000 $ 6,727,000 $ 610,000 $ (644,000) $18,034,000
Foreign (575,000) 22,000 286,000 (133,000) -- (400,000)
-------------------------------------------------------------------------------
TOTAL NET EARNINGS (LOSS) $ 5,810,000 $ 4,978,000 $ 7,013,000 $ 477,000 $ (644,000) $17,634,000
-------------------------------------------------------------------------------
-------------------------------------------------------------------------------
Other items:
Net investment income $ 5,257,000 $ 1,108,000 $ 108,000 $ 74,000 $ 775,000 $ 7,322,000
Depreciation and amortization 485,000 994,000 39,000 121,000 125,000 1,764,000
Interest expense 15,000 549,000 -- -- 1,094,000 1,658,000
Income tax provision (benefit) 918,000 3,640,000 4,236,000 224,000 (352,000) 8,666,000
Capital expenditures 1,398,000 161,000 4,000 119,000 160,000 1,842,000
</TABLE>
The increase in assets between December 31, 1998 and June 30, 1999 comes
from two principle 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 six months ended June 30,
1999 1998
------------ ------------
<S> <C> <C>
Net earnings $ 20,996,000 $ 34,721,000
------------ ------------
------------ ------------
Reconciliation of number of shares outstanding:
Shares of Common Stock outstanding at period end 48,694,000 47,861,000
Changes in Common Stock due to issuance (250,000) (37,000)
Common Stock contractually issuable in the future 414,000 --
------------ ------------
Weighted average Common Stock outstanding 48,858,000 47,824,000
Additional dilutive effect of outstanding options
(as determined by the application of the
treasury stock method) 899,000 1,093,000
------------ ------------
Weighted average Common Stock and potential
common stock outstanding 49,757,000 48,917,000
------------ ------------
------------ ------------
</TABLE>
18
<PAGE>
HCC Insurance Holdings, Inc. and Subsidiaries
--------
Notes to Condensed Consolidated Financial Statements
(Unaudited)
(Continued)
(5) EARNINGS PER SHARE, CONTINUED
<TABLE>
<CAPTION>
For the three months ended June 30,
1999 1998
--------------- ------------
<S> <C> <C>
Net earnings $ 287,000 $ 17,634,000
--------------- ------------
--------------- ------------
Reconciliation of number of shares outstanding:
Shares of Common Stock outstanding at period end 48,694,000 47,861,000
Changes in Common Stock due to issuance (157,000) (8,000)
Common stock contractually issuable in the future 414,000 --
--------------- ------------
Weighted average Common Stock outstanding 48,951,000 47,853,000
Additional dilutive effect of outstanding options
(as determined by the application of the
treasury stock method) 1,020,000 1,162,000
--------------- ------------
Weighted average Common Stock and potential
common stock outstanding 49,971,000 49,015,000
--------------- ------------
--------------- ------------
</TABLE>
As of June 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 six months ended June 30, 1999 and 1998,
is summarized below:
<TABLE>
<CAPTION>
1999 1998
------------------- ------------------
<S> <C> <C>
Interest paid $ 5,301,000 $ 2,437,000
Income tax paid 17,288,000 10,786,000
Comprehensive income 12,641,000 32,925,000
Ceding commissions 55,418,000 26,847,000
Supplemental information for the three months ended June 30, 1999 and
1998, is summarized below:
1999 1998
------------------- ------------------
Comprehensive income (loss) $ (7,437,000) $ 16,193,000
Ceding commissions 32,280,000 13,307,000
</TABLE>
20
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
THREE MONTHS ENDED JUNE 30, 1999 VERSUS THREE MONTHS ENDED JUNE 30, 1998
RESULTS OF OPERATIONS
Total revenue increased to $82.5 million for the second quarter of 1999 from
$79.3 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 and acquisitions made
during the last twelve months and is expected to continue. Additionally,
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 increasing retentions.
Compensation expense of $18.7 million for the second quarter of 1999
increased from $13.0 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 $2.7 million
to $12.2 million during the same period for similar reasons.
Interest expense was $2.6 million for the second quarter of 1999, an increase
of $944,000 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 $75,000 for the second quarter of 1999 compared to
$8.7 million for the same period in 1998. The decrease was due to the small
amount of earnings before income tax provision in the second quarter of 1999.
Generally, as net income from the underwriting agencies and intermediary
operations grows and goodwill amortization increases, the Company's effective
tax rate will increase due to state income taxes, the non-deductibility of
certain goodwill amortization and the mitigation of the effect of tax exempt
municipal bond income on the combined effective tax rate.
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 financial condition of one of the Company's reinsurers. Information
received from the administrator, previously appointed to manage the affairs
of the reinsurer, indicated that the financial condition of the reinsurer had
further deteriorated, that the reinsurer was, in fact, insolvent and that the
administrator was recommending that the creditors vote to place the reinsurer
into liquidation. Primarily based upon the information contained in that
report, the Company has 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
has been 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
will be settled in the normal course of business, which is anticipated to be
five years or more.
As of June 30, 1999, the Company has a reserve for reinsurance recoverables
in the amount of $30.1 million which management believes is sufficient to
absorb any possible 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.
Net earnings for the second quarter of 1999 decreased to $287,000 from $17.6
million for the same period in 1998, due to the provision for reinsurance,
which equated to $19.2 million after income taxes, or $0.38 per diluted
share. Diluted earnings per share decreased to $0.01 per share from $0.36 per
share during the same period. Improved performances by the underwriting
agency and other operations segments were offset by declines in the insurance
company segment, which included the provision for reinsurance, and the
intermediary segment.
The Company's book value per share was $9.39 as of June 30, 1999, compared to
$9.59 as of March 31, 1999.
21
<PAGE>
SEGMENTS
INSURANCE COMPANIES
Gross written premium decreased to $145.1 million for the second quarter of
1999 from $148.4 million for the same period in 1998. Medical stop-loss,
workers' compensation and accident and health reinsurance premium showed
strong growth, primarily as our insurance company subsidiaries continue to
participate in more of the business written by our underwriting agencies.
This growth was offset by a reduction in property and onshore and offshore
energy premium as a result of the continuing extremely soft conditions in
these markets. Net written premium for the second quarter of 1999 decreased
to $30.7 million from $40.8 million for the same period in 1998, as decreases
in retained property, onshore and offshore energy and aviation premium offset
the increases in retained medical stop-loss and accident and health
reinsurance premium. Net earned premium for the second quarter of 1999
decreased to $28.1 million from $35.4 million for the same period in 1998,
for the same reasons. It is anticipated that retained premium will begin to
rise in the second half of this year and through 2000, as the insurance
company subsidiaries begin to increase their 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 decreased to $21.0 million for the second
quarter of 1999, from $26.6 million for the same period in 1998, and the GAAP
net loss ratio remained relatively constant at 74.9% for the second quarter
of 1999, compared to 75.1% for the same period in 1998. The GAAP gross loss
ratio was 149.6% in the second quarter of 1999, compared to 96.9% for the
same period in 1998. The increase resulted primarily from very poor results
in the property and onshore and offshore energy lines of business. The
Company has taken steps to reduce the gross loss ratio, primarily by
increasing premium rates and more selective risk selection. The statutory net
combined ratio was 97.5% for the second quarter of 1999, compared to 89.0%
for the same period in 1998.
Policy acquisition costs, which are net of ceding commissions on reinsurance
ceded, decreased $4.3 million during the second quarter 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 $11.5 million
for the second quarter of 1999 from a profit of $5.8 million for the same
period in 1998, primarily as a result of the provision for reinsurance.
Generally, underwriting profitability continues to deteriorate as the
extremely competitive market conditions of 1997 and 1998 continue to affect
current results, despite our relatively low retentions. These results will
probably continue to deteriorate even as there is a transition to a harder
market but, eventually, should turn more profitable as reinsurance capacity
diminishes, rates increase and underwriting becomes more selective.
UNDERWRITING AGENCIES
Management fees increased 29% to $24.1 million for the second quarter of
1999, compared to the same period in 1998. Premium underwritten on behalf of
affiliated and unaffiliated insurance companies increased to $213.3 million
during the same period, an increase of 17%. Both increases resulted from
acquisitions and internal growth of existing operations.
Net earnings of the underwriting agencies increased to $5.3 million in the
second quarter of 1999, from $5.0 million for the same period in 1998. Recent
acquisitions have not yet had a significant impact due to licensing and other
regulatory requirements, which are in process, and some system delays which
have been subsequently corrected. Growth in underwriting agency premium has a
positive impact on both the insurance company segment and the intermediary
segment.
INTERMEDIARIES
Commission income increased 21% to $16.3 million in the second quarter of
1999, compared to the same period in 1998. Rattner Mackenzie Limited ("RML"),
acquired effective January 1, 1999, had $6.4 million of revenue in the second
quarter of 1999. The effect of RML's acquisition was partially offset by a
decrease in commission income from existing business. Net earnings of the
intermediaries decreased to $5.4 million in the second quarter of 1999, from
$7.0 million for the same period in 1998. The increase in net earnings due to
the RML acquisition was offset by a reduction in higher margin commission
income.
22
<PAGE>
OTHER OPERATIONS
The increase in other operating revenue of $1.9 million for the second
quarter of 1999, compared to the same period in 1998, is due to a general
increase in revenue, net of the decrease in revenue related to operations
disposed of in late 1998. Net earnings of other operations increased $786,000
for the same reasons. Quarter to quarter 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.
SIX MONTHS ENDED JUNE 30, 1999 VERSUS SIX MONTHS ENDED JUNE 30, 1998
RESULTS OF OPERATIONS
Total revenue increased to $174.5 million for the first six months of 1999,
an increase of 18% from 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 and acquisitions made
during the last twelve months and is expected to continue. Additionally,
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 increasing retentions.
Compensation expense of $37.6 million for the first six months of 1999
increased from $26.5 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 $7.9 million
to $25.3 million during the same period for similar reasons.
Interest expense was $5.9 million for the first six months of 1999, an
increase of $2.6 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 $11.0 million for the first six months of 1999
compared to $17.0 million the same period in 1998. The decrease was due to
the reduction in earnings before income tax provision due to the provision
for reinsurance recorded in 1999. The Company's effective tax rate was 34%
for the first six months of 1999, compared to 33% for the same period in
1998. As net income from the underwriting agencies and intermediary
operations grows and goodwill amortization increases, the Company's effective
tax rate will increase due to state income taxes, the non-deductibility of
certain goodwill amortization and the mitigation of the effect of tax exempt
municipal bond income on the combined effective tax rate.
The Company recorded a provision for reinsurance recoverables in the amount
of $29.5 million during the first six months of 1999. The provision was made
primarily as a result of information received on July 29, 1999, relating to
the financial condition of one of the Company's reinsurers. Information
received from the administrator, previously appointed to manage the affairs
of the reinsurer, indicated that the financial condition of the reinsurer had
further deteriorated, that the reinsurer was, in fact, insolvent and that the
administrator was recommending that the creditors vote to place the reinsurer
into liquidation. Primarily based upon the information contained in that
report, the Company has 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
has been 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
will be settled in the normal course of business, which is anticipated to be
five years or more.
As of June 30, 1999, the Company has a reserve for reinsurance recoverables
in the amount of $30.1 million which management believes is sufficient to
absorb any possible 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.
Net earnings for the first six months of 1999 decreased to $21.0 million from
$34.7 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. Diluted earnings per share decreased to $0.42 per share from
$0.71 per share during the same period. Improved performances by all
operations of the Company were offset by a decline in the insurance company
segment, which included the provision for reinsurance.
The Company's book value per share was $9.39 as of June 30, 1999, up from
$9.12 as of December 31, 1998.
23
<PAGE>
SEGMENTS
INSURANCE COMPANIES
Gross written premium increased 10% to $286.7 million for the first six
months of 1999, from $261.8 million for the same period in 1998. Medical
stop-loss, workers' compensation and accident and health reinsurance premium
showed strong growth, primarily as our insurance company subsidiaries continue
to participate in more of the business written by our underwriting agencies.
This growth was partially offset by a reduction in property and onshore and
offshore energy premium as a result of the continuing extemely soft
conditions in these markets. Net written premium for the first six months of
1999 decreased to $61.1 million from $66.6 million for the same period in
1998, as decreases in retained property, onshore and offshore energy and
accident and health reinsurance premium offset the increase in retained
medical stop-loss premium. Net earned premium for the first six months of
1999 decreased to $62.1 million from $69.4 for the same period in 1998, for
the same reasons. It is anticipated that retained premium will begin to rise
in the second half of this year and through 2000, as the insurance company
subsidiaries begin to increase their 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 $44.8 million for the first six
months of 1999, from $43.8 million for the same period in 1998, and the GAAP
net loss ratio increased to 72.2% for the first six months of 1999, from
63.1% for the same period in 1998. The GAAP gross loss ratio was 120.5% in the
first six months of 1999, compared to 89.3% for the same period in 1998. The
increase resulted primarily from very poor results in the property and
onshore and offshore energy lines of business. The Company has taken steps to
reduce the gross loss ratio, primarily by increasing premium rates and more
selective risk selection. The statutory net combined ratio was 95.3% for the
first six months of 1999 compared to 81.2% for the same period in 1998.
Policy acquisition costs, which are net of ceding commissions on reinsurance
ceded, decreased $5.2 million during the first six 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 $5.2 million
for the first six months of 1999 from a profit of $16.3 million for the same
period in 1998, as a result of the provision for reinsurance, the higher loss
ratio due to reduced premium rates and deteriorating loss experience.
Generally, underwriting profitability continues to deteriorate as the
extremely competitive market conditions of 1997 and 1998 continue to affect
current results, despite our relatively low retentions. These results will
probably continue to deteriorate even as there is a transition to a harder
market but, eventually, should turn more profitable as reinsurance capacity
diminishes, rates increase and underwriting becomes more selective.
UNDERWRITING AGENCIES
Management fees increased 37% to $47.6 million for the first six months of
1999, compared to the same period in 1998. Premium underwritten on behalf of
affiliated and unaffiliated insurance companies increased to $424.1 million
during the same period, an increase of 30%. Both increases resulted from
acquisitions and internal growth of existing operations.
Net earnings of the underwriting agencies increased to $9.6 million for the
first six months of 1999, from $9.2 million for the same period in 1998.
Recent acquisitions have not yet had a significant impact due to licensing
and other regulatory requirements, which are in process, and some system
delays which have been subsequently corrected. Growth in underwriting agency
premium has a positive impact on both the insurance company segment and the
intermediary segment.
INTERMEDIARIES
Commission income increased 68% to $34.0 million in the first six months of
1999, compared to the same period in 1998. The acquisition of RML, effective
January 1, 1999, accounts for this increase. Net earnings of the
intermediaries increased 13% to $11.7 million in the first six months of 1999
from the same period in 1998, principally as a result of the RML acquisition.
24
<PAGE>
OTHER OPERATIONS
The increase in other operating revenue of $7.0 million for the first six
months of 1999, compared to the same period in 1998, is principally from a
gain of $4.9 million from the sale of the Company's 21% interest in
Underwriters Indemnity Holdings, Inc. ("UIH") during the first quarter of
1999. There was also a general increase in revenue, net of the decrease in
revenue related to operations disposed of in late 1998.
Net earnings of other operations increased to $5.5 million for the first six
months of 1999 from $885,000 for the same period in 1998, which is
principally attributable to the gains on sales of strategic investments.
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.
ACQUISITIONS
The Company acquired an underwriting agency and 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.
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 $61.7
million, or 11%, since December 31, 1998, and totaled $603.3 million as of
June 30, 1999, of which $199.9 million was cash and short-term investments.
During 1999, the Company's unrealized pre-tax gain on fixed income securities
was reduced $13.6 million due to an increase in market interest rates. Since
the Company's intention is to 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 $2.0 billion as of June 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 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
25
<PAGE>
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 June 30, 1999, total debt outstanding under the
Facility was $178.0 million with $150.0 million due under the $150.0 million
Revolving Loan Facility and $28.0 million due under the $100.0 million Short
Term Revolving Loan Facility and the weighted average interest rate was 6.14%.
The Company believes that its operating cash flows, short-term investments
and the Facility 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 is currently engaged in efforts to
remediate and test 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 is currently involved in 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
26
<PAGE>
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
and continues to evaluate the potential insurance exposures arising from Year
2000 problems. The Company's insurance company subsidiaries do not generally
offer policies of insurance marketed as Year 2000 liability coverage.
However, due to the nature of certain of the policies, such as policies of
property insurance, insureds may attempt to submit claims for coverage under
such policies which may result from Year 2000 related causes. In this regard,
the Company is currently assessing what modifications or responses may be
appropriate related to the 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 is utilizing and will continue to utilize both internal and
external resources 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 June 30, 1999, the Company expensed $730,000
with respect to Year 2000 compliance and capitalized $6.8 million with
respect to new software purchases and installations which are Year 2000
compliant. The total estimated remaining cost of modification of existing
software and new Year 2000 compliant systems is $700,000 which includes
$450,000 attributable to the planned purchase and implementation of new
systems. The cost of this new software is being capitalized. The remaining
estimated cost of $250,000 will be expensed as 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, including that of a major insurance company
subsidiary, 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 in the process of
developing contingency plans for the remote possibility that there could be
an unforeseen Year 2000 failure. Such plans will develop and 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 remediation and testing efforts prior to respective
critical dates, the failure of its contingency planning, the failure of third
parties with whom the Company has an important relationship to identify,
remediate and test 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 remediated or
tested 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.
27
<PAGE>
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 Company does not expect the introduction of the Euro to have a
material effect on the Company's business, software plans, financial
condition or results of operations.
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 April 2000. As of June
30, 1999, the Company had forward contracts to sell US$ 10.0 million for
Pounds at an average rate of 1 GBP = US$ 1.6163. 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,"
"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.
28
<PAGE>
PART II - OTHER INFORMATION
Item 4. SUBMISSIONS OF MATTERS TO A VOTE OF SECURITY HOLDERS
On May 20, 1999, the Company held its 1999 Annual Meeting
of Shareholders. At such time the following items were
submitted to a vote of shareholders through the solicitation
of proxies:
(a) Election of Directors.
The following persons were elected to serve on the
Board of Directors until the 2000 Annual Meeting of
Shareholders or until their successors have been
duly elected and qualified. The Directors received
the votes set forth opposite their respective names:
<TABLE>
<CAPTION>
NAME FOR AGAINST ABSTAINED
<S> <C> <C> <C>
Stephen L. Way 37,372,522 0 953,080
James M. Berry 37,453,347 0 872,255
Frank J. Bramanti 37,372,522 0 953,080
Marvin P. Bush 37,452,837 0 872,765
Patrick B. Collins 37,453,347 0 872,255
James R. Crane 37,453,290 0 872,312
J. Robert Dickerson 37,453,347 0 872,255
Edwin H. Frank, III 37,372,522 0 953,080
Allan W. Fulkerson 37,372,447 0 953,155
Walter J. Lack 37,372,522 0 953,080
Stephen J. Lockwood 37,372,522 0 953,080
John N. Molbeck, Jr. 37,372,522 0 953,080
Peter B. Smith, Jr. 37,372,522 0 953,080
</TABLE>
(b) Shareholders of the Company were requested to
ratify the appointment of PricewaterhouseCoopers
LLP, as independent auditors for the Company and
its subsidiaries to audit the accounts of the
Company and its subsidiaries for the year ended
December 31, 1999. Such appointment was approved
by the shareholders, who voted 37,304,792 shares
in favor, 989,660 shares against, and 31,150
shares abstained.
Item 6. EXHIBITS AND REPORTS ON FORM 8-K:
(a) Exhibits:
27 EDGAR Financial Data Schedule - June 30, 1999
(b) Reports on Form 8-K:
None
29
<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.
HCC Insurance Holdings, Inc.
--------------------------------------
(Registrant)
August 16, 1999 /s/ Stephen L. Way
- --------------- --------------------------------------
(Date) Stephen L. Way, Chairman of the Board
and Chief Executive Officer
August 16, 1999 /s/ Edward H. Ellis, Jr.
- --------------- --------------------------------------
(Date) Edward H. Ellis, Jr., Senior Vice
President and Chief Financial Officer
30
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 7
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS FOUND IN THE COMPANY'S FORM 10-Q FOR
THE QUARTER ENDED JUNE 30, 1999, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE
TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> JUN-30-1999
<DEBT-HELD-FOR-SALE> 399,307,000
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 2,935,000
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 586,484,000
<CASH> 99,138,000
<RECOVER-REINSURE> 505,708,000
<DEFERRED-ACQUISITION> (3,202,000)
<TOTAL-ASSETS> 2,044,638,000
<POLICY-LOSSES> 610,985,000
<UNEARNED-PREMIUMS> 218,426,000
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 185,557,000
0
0
<COMMON> 48,694,000
<OTHER-SE> 412,445,000
<TOTAL-LIABILITY-AND-EQUITY> 2,044,638,000
62,084,000
<INVESTMENT-INCOME> 14,927,000
<INVESTMENT-GAINS> 91,000
<OTHER-INCOME> 97,368,000
<BENEFITS> 44,813,000
<UNDERWRITING-AMORTIZATION> (654,000)
<UNDERWRITING-OTHER> 92,399,000
<INCOME-PRETAX> 32,001,000
<INCOME-TAX> 11,080,000
<INCOME-CONTINUING> 20,921,000
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 20,921,000
<EPS-BASIC> 0.43
<EPS-DILUTED> 0.42
<RESERVE-OPEN> 118,912,000
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 0
<PAYMENTS-PRIOR> 0
<RESERVE-CLOSE> 124,736,000
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
