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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
/X/ Annual Report pursuant to Section 13 or 15(d)of the Securities Exchange Act
of 1934 (Fee required).
/ / Transaction report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 (No fee required).
For the fiscal year ended _______December 31, 1998_______________________
Commission file number _______0-20766____________________________________
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HCC Insurance Holdings, Inc.
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(Exact name of registrant as specified in its charter)
Delaware 76-0336636
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(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
13403 Northwest Freeway, Houston, Texas 77040-6094
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(Address of principal executive offices) (Zip Code)
(713) 690-7300
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(Registrant's telephone number, including area code)
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Securities registered pursuant to Section 12 (b) of the Act:
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TITLE OF EACH CLASS NAME OF EACH EXCHANGE OF WHICH REGISTERED:
COMMON STOCK, $1.00 PAR VALUE New York Stock Exchange
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Securities registered pursuant to Section 12 (g) of the Act: NONE
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 by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K (Section229.405 of this chapter) is not contained herein, and
will not be contained, to the best of registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K. /X/
The aggregate market value on March 19, 1999, of the voting stock held by
non-affiliates of the registrant was approximately $752.9 million. For purposes
of the determination of the above stated amount, only directors and executive
officers are presumed to be affiliates, but neither the registrant nor any such
person concede that they are affiliates of the registrant.
The number of shares outstanding of the registrant's Common Stock, $1.00 par
value, as of March 19, 1999 was 48,809,264.
Documents incorporated by reference: Information called for in Part III of this
Form 10-K is incorporated by reference to the Registrant's definitive Proxy
Statement to be filed within 120 days of the close of the Registrant's fiscal
year in connection with the Registrant's annual meeting of shareholders.
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TABLE OF CONTENTS
HCC INSURANCE HOLDINGS, INC.
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PART I.
ITEM 1. Business.......................................................................... 3
ITEM 2. Properties........................................................................ 27
ITEM 3. Legal Proceedings................................................................. 27
ITEM 4. Submission of Matters to a Vote of Security Holders............................... 27
PART II.
ITEM 5. Market for the Registrant's Common Equity and Related Stockholder Matters......... 28
ITEM 6. Selected Financial Data........................................................... 29
ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of
Operations........................................................................ 31
ITEM 7A. Quantitative and Qualitative Disclosure About Market Risk......................... 42
ITEM 8. Financial Statements and Supplementary Data....................................... 43
ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial
Disclosures....................................................................... 43
PART III.
ITEM 10. Directors and Executive Officers of the Registrant................................ 44
ITEM 11. Executive Compensation............................................................ 44
ITEM 12. Security Ownership of Certain Beneficial Owners and Management.................... 44
ITEM 13. Certain Relationships and Related Transactions.................................... 44
PART IV.
ITEM 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K................... 45
SIGNATURES.............................................................................................. 46
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THIS REPORT ON FORM 10-K (THIS "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, LICENSING 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.
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PART I
ITEM 1. BUSINESS
GENERAL
HCC Insurance Holdings, Inc. ("HCC") is a Delaware corporation with
principal and executive offices located at 13403 Northwest Freeway, Houston,
Texas 77040. HCC and its consolidated subsidiaries are collectively referred to
herein as the "Company" unless the context otherwise requires. HCC, through its
subsidiaries, provides specialized property and casualty insurance coverages,
underwriting agency and intermediary services and other insurance related
services both to commercial customers and individuals. The Company's insurance
products are underwritten on both a direct and reinsurance basis and are
marketed by the Company and through a network of independent and affiliated
agents and brokers. The Company's principal insurance company subsidiaries are
Houston Casualty Company ("HC") in Houston, Texas, London, England and Amman,
Jordan; U.S. Specialty Insurance Company ("USSIC") in Houston, Texas; and Avemco
Insurance Company ("AIC") in Frederick, Maryland. The principal underwriting
agency subsidiaries are LDG Reinsurance Corporation ("LDG Re") in Wakefield,
Massachusetts; HCC Aviation Insurance Group, Inc. ("HCCA") in Dallas, Texas and
Glendale, California; HCC Employer Services, Inc. ("HCCES") in Northbrook,
Illinois, Dallas, Texas and Montgomery, Alabama; and HCC Benefits Corporation
("HCCB") in Atlanta, Georgia, Wakefield, Massachusetts, Minneapolis, Minnesota
and Kansas City, Kansas. The Company's principal intermediary subsidiaries are
HCC Intermediaries, Inc. ("HCCI") in Houston, Texas; HCC Employee Benefits, Inc.
("HCCEB") in Houston, Texas; and, effective January 1, 1999, Rattner Mackenzie
Limited ("RML") in London, England and Amman, Jordan.
Since its founding in 1974, the Company and its predecessor companies have
been consistently profitable, generally reporting annual increases in gross
written premium ("GWP"), management fees, commission income and total revenue.
During the period 1996 through 1998, the Company's insurance company
subsidiaries had an average combined ratio of 81.8% versus the less favorable
103.7% recorded by the U.S. property and casualty insurance industry overall
(1996-1997). During the same period, the Company's GWP increased from $337.3
million to $498.3 million, an increase of 48%, management fees increased from
$28.7 million to $74.0 million an increase of 158%, commission income increased
from $21.5 million to $38.4 million, an increase of 79% and net earnings
increased from $38.6 million to $72.3 million, an increase of 87%.
The Company's insurance companies' underwriting activities are focused on
providing aviation, marine, offshore energy, property, medical stop-loss,
accident and health, workers' compensation and lenders' single interest
insurance and reinsurance on a worldwide basis. As an insurer in the USA, the
Company operates on a surplus lines or a non-admitted basis through HC and on an
admitted basis through AIC and USSIC.
The Company's domestic insurance company subsidiaries are rated "A+"
(Superior) by A.M. Best Company ("A.M. Best") and are rated "AA" (Very Strong)
by Standard & Poor's Corporation ("S&P"). An A.M. Best or S&P rating is intended
to provide an independent opinion of an insurer's ability to meet its
obligations to policyholders and should not be considered as an investment
recommendation.
The Company's underwriting agencies underwrite on behalf of affiliated and
non-affiliated insurance companies. These agency operations specialize in
domestic general aviation insurance, medical stop-loss coverage for employer
sponsored self-insured health plans, occupational accident coverage for
self-insured truckers, workers' compensation insurance and a variety of accident
and health related insurance and reinsurance products. Beginning in 1996 with
the acquisition of LDG Management Company, Incorporated ("LDG"), the Company
commenced a strategy of acquiring through merger or purchase, a number of
privately held companies whose business was underwriting agency activities,
primarily in the medical stop-loss, workers' compensation and domestic general
aviation insurance businesses. This was done in an effort to further diversify
the Company's operations and to enhance the Company's ability to anticipate
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and capitalize on opportunities resulting from changing market conditions in the
insurance industry. As a result of these acquisitions, the Company's management
fees from underwriting agencies have increased to $74.0 million. The Company's
underwriting agency operations generated $704.0 million in written premium
during 1998. Further acquisitions are likely in the area.
Brokerage operations are performed by the Company's intermediary
subsidiaries. The Company's intermediary operations consist of marketing,
placing, consulting on and servicing insurance risks for its clients, which
include insurance companies and other risk taking entities. The Company's
intermediary subsidiaries specialize in employee benefits on a retail basis and
reinsurance for both accident and health and property and casualty clients. The
Company significantly expanded its intermediary operations internally and
through acquisition in 1998 and continued this expansion in January, 1999 with
the acquisition of PEPYS Holdings Limited ("PEPYS") and its operating
subsidiary, RML. Since 1995, the Company's commission income from its
intermediary operations has increased from $5.9 million (prior to
pooling-of-interests restatements) to $38.4 million. Further acquisitions are
contemplated.
Two subsidiaries of the Company perform insurance related services for
customers of the Company's insurance and agency subsidiaries and for unrelated
entities. These services include insurance claims adjustment and servicing and
computer software development and sales.
From time to time the Company will make strategic operational investments,
generally in companies or operations in or related to the insurance industry.
Certain of these investments are intended to enhance the Company's operations
through strategic partnering in areas common to the investee and the Company.
The Company's revenue from these investments is comprised of equity in earnings
of the investee, dividends and gains on the sale of these investments.
STRATEGY
The Company's operating philosophy as an insurer is to maximize underwriting
profits while preserving shareholders' equity. The Company concentrates its
writings in selected, narrowly defined lines of business in which it believes
there is a substantial opportunity to achieve underwriting profits. The Company
primarily underwrites first party coverages and lines of business which have
relatively short lead times between the occurrence of an insured event and the
reporting of claims to the Company. The Company's insurance products are
marketed both directly and through independent and affiliated agents. With
respect to its underwriting management, marketing and related services, the
Company seeks to offer quality underwriting, decision-making, support,
reinsurance capacity and financial and other resources to take advantage of
market opportunities for the development of new products.
The property and casualty insurance underwriting business has historically
been cyclical (though mainly not seasonal) and within the overall cycle of the
industry, particular lines of business experience their own cycles. These cycles
are characterized by periods of excess capital and significant competition in
policy pricing, terms and conditions, followed by periods of capital shortages,
typically resulting from adverse loss experience, which leads to decreased
competition, higher premium rates and stricter underwriting standards.
The position of a particular line of business in its respective underwriting
cycle depends on prevailing premium rates, availability and cost of reinsurance,
and other market conditions. The Company considers each of these factors in
determining when to increase or decrease premium volume in each line. With this
approach, the Company focuses on increasing net earnings rather than premium
volume or market share.
The Company purchases a substantial amount of reinsurance to limit its net
loss from both individual and catastrophic risks. The degree to which the
Company reinsures varies by, among other things, the particular risks inherent
in the policies underwritten, pricing of available reinsurance and competitive
conditions within the relevant line of business.
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In its insurance company operations, the Company believes its operational
flexibility, experienced underwriting personnel and access to and expertise in
the reinsurance marketplace allow the Company to implement its strategy of
emphasizing more profitable lines of business during periods of increased
premium rates and de-emphasizing less profitable lines of business during
periods of severe competition. In addition, through its acquisition and
ownership of insurance underwriting agencies and intermediary businesses, the
Company believes that those service based businesses can both complement the
Company's underwriting activities and serve as a source of revenue which may not
be subject to the same level of volatility as traditional underwriting revenues.
Many of the Company's insurance underwriting agency and intermediary
subsidiaries act as agents or intermediaries on behalf of the Company's
insurance company subsidiaries as well as for non-affiliated insurers or other
risk taking entities. Additionally, a claims adjusting and servicing subsidiary
provides services for the insurance company subsidiaries and their customers.
The ability of the Company's insurance company subsidiaries to utilize an
affiliated insurance underwriting agency, intermediary or services provider, and
the corollary ability of such insurance underwriting agency, intermediary and
services subsidiaries to place business with or provide other services to an
affiliated insurer, permits the Company to earn a greater portion of the total
income derived from generated premium.
The Company's business plan is to expand its underwriting activities and
continue the growth of its insurance underwriting agency and intermediary
operations. The Company will also, from time to time, make strategic operational
investments in companies that present an opportunity for future profit from sale
or for enhancement of the Company's business. However, the Company's business
plan is shaped by its underlying operating philosophy, which is to maximize
underwriting profit opportunities, while preserving shareholders' equity. The
Company expects to continue to seek to acquire complementary businesses with
established management and reputation in the insurance industry, whose business,
the Company believes, can be enhanced through the synergism created by the
Company's underwriting capabilities and its other owned insurance related
businesses. As a result, the Company's primary interests are not necessarily in
expanding market share or GWP, but rather in increasing net earnings. To
accomplish this objective, the Company: (i) has been and is prepared to
emphasize or reduce underwritings in certain lines of business as premium rates,
the availability and cost of reinsurance and other market conditions warrant;
(ii) will continue to attempt to limit its downside net loss exposure through
the effective, prudent and conservative use of reinsurance; (iii) will, as
conditions warrant, emphasize the growth of its insurance underwriting agency
and intermediary operations, which can be expected to result in continuing
growth of management fees and commission income as a portion of total revenues;
and (iv) will continue to review the possible acquisition of other specialty
insurance companies and of other strategic operational investments that may,
after a period of growth, increase in value or that represent strong strategic
partners.
INDUSTRY SEGMENT INFORMATION
Financial information concerning the Company's operations by industry
segment is set forth in the Consolidated Financial Statements and the Notes
thereto.
MAJOR ACQUISITIONS
On May 24, 1996, the Company issued 6,250,000 shares of its Common Stock to
acquire all of the outstanding shares of LDG. LDG, now operating as LDG Re, acts
on behalf of insurance and reinsurance companies as a reinsurance underwriting
manager in the following lines of business: accident and health special risks
and alternative workers' compensation. LDG Re generally concentrates on lines of
business that have relatively short lead times between the occurrence of an
insured event and the reporting of claims.
On November 27, 1996, the Company issued 1,136,400 shares of its Common
Stock and paid $1.7 million in cash to acquire all of the outstanding shares of
North American Special Risks Associates, Inc. ("NASRA"). NASRA, now known as
HCCES, provides underwriting management and claims
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administration services to insurance and reinsurance companies primarily for
occupational accident insurance for self-employed truckers and alternative
workers' compensation insurance.
On June 17, 1997, the Company issued 8,511,625 shares of its Common Stock
and 604,575 options to purchase its Common Stock in order to acquire all of the
outstanding shares and options to purchase shares of Avemco Corporation
("Avemco"), the parent corporation of a group of insurance and insurance
services companies. Avemco, through its insurance company subsidiaries, provides
property and casualty insurance in the general aviation, lenders' single
interest and short-term health lines of business. Avemco's primary insurance
company subsidiaries were AIC and USSIC. Following the acquisition, the
operations of USSIC have been relocated to Houston, Texas and it has become a
subsidiary of HC. AIC and USSIC operate on an admitted basis throughout the
United States and AIC also operates as an admitted insurer in Canada (except
Quebec).
Avemco's principal insurance underwriting agency and services operations are
focused in three areas: (i) underwriting management services for lenders' single
interest coverage for banks and other financial institutions; (ii) underwriting
management services for short-term health and travel insurance marketed to
foreign students and others resident in the United States; and (iii) insurance
related computer products, software and services for property and casualty
insurance companies throughout the United States.
On February 27, 1998, the Company issued 1,600,000 shares of its Common
Stock to acquire all of the outstanding shares of The Kachler Corporation
("Kachler"), now known as HCCEB. Kachler was a retail insurance agency
specializing in life, accident and health insurance for employee benefit plans
of medium and large commercial customers throughout the United States.
On January 31, 1999, the Company acquired all of the outstanding stock of
PEPYS. PEPYS is the sole shareholder of RML. The total initial consideration was
$54.8 million in cash and deferred payments of $8.3 million in cash and 414,207
shares of the Company's Common Stock. Additional amounts may be paid in the
future based upon the attainment of certain earnings benchmarks over the next
four years. RML, the operating entity, provides intermediary services for
reinsurance business placed by the Company's insurance company subsidiaries as
well as unaffiliated insurance and reinsurance companies and underwriting
agencies.
PENDING ACQUISITIONS
There are currently no acquisitions pending; however, the Company is
evaluating a number of possible acquisition candidates and expects to complete
one or more acquisitions during the remainder of 1999. The Company believes
these future acquisitions will expand and strengthen its existing lines of
business and perhaps provide access to additional specialty sectors, which
management expects will contribute to the growth of the Company.
INSURANCE COMPANY OPERATIONS
The Company's property and casualty insurance company businesses specialize
in underwriting aviation, marine, offshore energy, property, medical stop-loss,
accident and health, workers' compensation and lenders' single interest risks.
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LINES OF BUSINESS
The following table sets forth the Company's insurance company subsidiaries'
GWP by line of business and the percent to total GWP for the three years ended
December 31, 1998 (dollars in thousands):
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1998 1997 1996
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Aviation................................................. $ 203,573 41% $ 164,519 47% $ 140,725 42%
Accident and health reinsurance.......................... 115,441 23 39,845 12 11,095 3
Property................................................. 106,515 21 85,379 25 118,154 35
Offshore energy.......................................... 21,682 5 7,469 2 8,496 2
Lenders' single interest................................. 17,944 4 21,877 6 22,870 7
Marine................................................... 13,259 3 22,847 7 32,433 10
Medical stop-loss........................................ 7,046 1 3,388 1 1,909 1
Workers' compensation.................................... 8,304 1 -- -- -- --
Other.................................................... 4,512 1 1,075 -- 1,596 --
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Total GWP................................................ $ 498,276 100% $ 346,399 100% $ 337,278 100%
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The following table sets forth the Company's insurance company subsidiaries'
net written premium ("NWP") by line of business and the percent to total NWP for
the three years ended December 31, 1998 (dollars in thousands):
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1998 1997 1996
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Aviation................................................. $ 53,030 44% $ 75,280 53% $ 104,815 57%
Accident and health reinsurance.......................... 40,519 33 24,777 17 10,942 6
Property................................................. 8,356 7 8,636 6 16,442 9
Lenders' single interest................................. 6,614 5 11,097 8 19,726 11
Marine................................................... 5,654 5 17,271 12 25,918 14
Medical stop-loss........................................ 3,415 3 3,388 2 1,909 1
Offshore energy.......................................... 2,324 2 1,416 1 3,472 2
Workers' compensation.................................... 1,482 -- -- -- -- --
Other.................................................... 489 1 988 1 (190) --
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Total NWP................................................ $ 121,883 100% $ 142,853 100% $ 183,034 100%
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UNDERWRITING
DIRECT--The Company underwrites direct business produced through independent
agents and brokers, affiliated intermediaries, and by direct marketing efforts,
primarily in small general aviation business.
REINSURANCE--The Company's current reinsurance underwriting activities are
primarily in the accident and health lines of business where the Company's
insurance company subsidiaries participate in various insurance and reinsurance
underwriting pools managed by its underwriting agency subsidiaries and
facultative (individual account) reinsurance, particularly in the aviation and
property lines of business.
The Company underwrites facultative reinsurance in most of its lines of
business. Typically, this is on international business in order to comply with
local licensing requirements or as reinsurance of captives, and usually can be
considered direct business, as the Company maintains underwriting and claims
control. However, all of this business is recorded under the caption of
"Reinsurance Assumed".
AVIATION--Aviation underwriting presently represents the Company's largest
overall line of business and in recent years the Company has grown into a market
leader in the aviation insurance industry. The Company insures general aviation
risks, including private aircraft owners and pilots, fixed base operations,
rotor wing aircraft, corporate aircraft, cargo operations, commuter airlines and
similar operations, both
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domestically and internationally. At this time, the Company does not generally
insure major airlines, major manufacturers or satellites. The coverages
underwritten include hull (including engines, avionics and other systems),
liabilities, war, cargo and various ancillary coverages.
The Company has been underwriting aviation risks since 1981 through HC. AIC
has been insuring aviation risks since 1959. GWP has risen consistently since
1996, increasing from a combined $140.7 million to $203.6 million in 1998. This
growth has occurred due to internal growth and acquisitions. Although, due to
market conditions, domestic risks had not been a focus for the Company since the
early 1990's, HC increased its writing of domestic general aviation risks late
in 1996 and with the acquisition of AIC and USSIC in mid-1997, the Company
achieved the position of a major participant in the domestic general aviation
insurance market. The Company's position is further enhanced by its subsidiary
aviation underwriting agency operations which underwrite on behalf of affiliated
and non-affiliated insurance companies. In 1998 and 1997, the Company
experienced a decline in NWP due to the implementation of the Company's
reinsurance program at AIC following its acquisition in 1997.
Reinsurance is maintained on both a proportional and an excess of loss basis
to protect the Company against individual risk severity of loss and catastrophe
exposure. Management believes that the aviation risks underwritten by the
Company carry a relatively low level of catastrophe exposure.
MARINE--The Company underwrites marine risks for ocean going vessels ("Blue
Water"), inland and coastal trading vessels ("Brown Water"), fishing vessels.
The coverages written include hull and machinery, liabilities (including
protection and indemnity), marine cargo and various ancillary coverages.
The Company has underwritten marine risks since 1984. Premium rates were
adequate during 1995 but competition has created downward pressure on these
rates causing a reduction in the Company's GWP from $32.4 million in 1996 to
$13.3 million in 1998 and a corresponding decrease in NWP from $25.9 million to
$5.7 million for the same period.
Reinsurance is maintained on an excess of loss basis to protect the Company
against individual risk severity of loss and catastrophe exposure. Management
believes that the marine risks underwritten by the Company carry a relatively
low level of catastrophe exposure.
OFFSHORE ENERGY--The Company has been underwriting offshore energy risks
since 1988. Offshore energy risks include drilling rigs, production and
gathering platforms, and pipelines. Coverages underwritten include physical
damage, liabilities, business interruption and various ancillary coverages.
Rates have declined significantly during the past few years to levels where
underwriting profitability is unlikely. Underwriting has been on a very
selective basis, striving for quality rather than quantity. The increase in GWP
and NWP during 1998 was the result of one large policy.
Reinsurance is maintained on both a proportional and an excess of loss basis
to protect the Company against individual risk severity of loss and the
catastrophic exposure that exists, for example, from a hurricane in the Gulf of
Mexico.
PROPERTY--The Company specializes in writing risks of large, often
multinational corporations, covering such commercial risks as hotels, office
buildings, retail locations, factories, industrial plants, utilities,
refineries, natural gas facilities and petrochemical plants. Coverage includes
business interruption, physical damage and catastrophe risks including flood and
earthquake.
The Company has written property business since 1986. GWP increased to
$118.2 million in 1996 as premium rates increased following the Northridge
earthquake in 1994. During 1996, premium rates began to soften and this trend
has continued through 1998 due in a large part to excess capacity and the
absence of significant catastrophe losses. GWP has declined from $118.2 million
in 1996 to $106.5 million in 1998. NWP also declined from $16.4 million to $8.4
million in the same period. Property NWP will always be substantially less than
GWP due to the amount of facultative reinsurance and reinsurance purchased in
order to protect the Company from catastrophe exposure.
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Reinsurance is maintained on both a proportional and an excess of loss basis
to ensure adequate protection, particularly against catastrophic exposures. As
an example, in 1998 the Company had gross losses of $53.7 million with respect
to hurricanes Georges and Mitch. The after-tax net loss, after reinsurance, with
respect to these hurricanes was $3.8 million. The Company conservatively
estimates its aggregate exposure in any individual catastrophe zone and
maintains catastrophe reinsurance to cover its exposure to any one occurrence.
ACCIDENT AND HEALTH REINSURANCE--The Company began underwriting accident and
health reinsurance risks through HC during 1996. These risks are produced
primarily by LDG Re, the underwriting agency which was acquired by the Company
during that year. The risks underwritten include reinsurance in the accident and
health special risks and alternative workers' compensation areas and
occupational accident insurance for self-employed truckers. The Company's GWP
increased from $11.1 million in 1996 to $115.4 million in 1998. This growth is
from the Company's increased participation in various insurance and reinsurance
pools managed by its underwriting agency subsidiaries.
Management believes that its accident and health reinsurance business
carries a relatively low level of catastrophe exposure.
MEDICAL STOP-LOSS--Medical stop-loss business is written on an aggregate and
specific basis for employer sponsored self-insured health plans. The business is
produced by an underwriting agency subsidiary of the Company. The Company first
began writing this business in 1996 and GWP has increased, as a result of
greater participation by an insurance company subsidiary in the business
underwritten by an underwriting agency subsidiary which produces this business.
LENDERS' SINGLE INTEREST--USSIC began writing lenders' single interest risks
in 1984. GWP decreased from $22.9 million in 1996 to $17.9 million in 1998 due
to a competitive market. Due to the implementation of a new reinsurance program
when USSIC was acquired in June, 1997, (part of the Avemco merger) NWP decreased
even further from $19.7 million in 1996 to $6.6 million in 1998. This coverage
is marketed to banks and other financial institutions and addresses risks of
physical loss or damage to the property collateralizing installment loans
(primarily automobiles). All of the lenders' single interest risks underwritten
by the Company are produced by the Company's subsidiary, Avemco Financial
Services, Inc. ("AFS").
Reinsurance is maintained on a proportional basis to protect against
frequency of loss. Management believes that its lenders' single interest
business carries a relatively low level of catastrophe exposure.
WORKERS' COMPENSATION--The Company began writing statutory workers'
compensation business in 1998 and expects to expand these writings significantly
through HCCES. It is the intent of the Company to grow this line of business in
the future internally and through acquisition. GWP will increase as an insurance
company subsidiary of HCC serves as a policy issuing company for HCCES's
business. The Company currently reinsures this business, except for a small
retention. Losses in this line of business generally take longer to develop than
in the Company's other lines of business, but, due to the Company's reinsurance,
management does not believe that the longer development period will adversely
affect the Company's underwriting results.
INSURANCE COMPANY SUBSIDIARIES
HOUSTON CASUALTY COMPANY--HC, the Company's principal insurance company
subsidiary, is rated A+, VIII by A.M. Best and AA by Standard & Poor's and
operates worldwide in most of the lines of business in which the Company
specializes. HC's business is produced by independent agents and brokers, the
group's underwriting agency and intermediary subsidiaries, AIC, USSIC, the
Company's subsidiary Trafalgar Insurance Company ("TIC"), and other insurance
and reinsurance companies worldwide. HC has a highly experienced staff of
underwriters trained to deal with the high value, complicated exposures
prevailing in many of the lines of business in which the Company specializes. As
of December 31, 1998, HC had statutory policyholders' surplus of $262.4 million.
9
<PAGE>
HOUSTON CASUALTY COMPANY--LONDON--HC was authorized by Her Majesty's
Treasury in 1998 to operate a full branch office in the United Kingdom. HC is in
the process of staffing this branch and expects it to become fully operational
towards the end of 1999. HC established the branch in London in order to be
closer to some of the markets in which HC operates and to have access to a
larger pool of insurance talent. The Company intends to transfer underwriting
responsibility for all lines of business HC writes, except aviation, to this
branch. HC-London initially began writing accident and health business in early
1999 through Feasey Slot Management, Ltd., an underwriting agency in which the
Company has a strategic investment.
HOUSTON CASUALTY COMPANY--JORDAN--HC also established a branch operation in
Amman, Jordan in 1998 with the assumption of all of the business of IMG
Insurance Company Ltd. ("IMG"). IMG, formerly a subsidiary of the Company, was
liquidated in 1998. Due to the similar nature of IMG's business to that written
by HC, management determined that an HC branch operation in Jordan rather than
an independently capitalized subsidiary would be a more productive and efficient
utilization of the Company's capital. Additionally, management believes that
this action can be expected to enhance the direct presence of HC in the Middle
Eastern, Asian and African markets and is expected to lead to increased
underwriting opportunities for the Company.
TRAFALGAR INSURANCE COMPANY--TIC, which was organized in 1993, is a wholly
owned subsidiary of HC. TIC, an Oklahoma domiciled property and casualty
insurance company, is rated A+, V by A.M. Best. TIC currently underwrites
primarily domestic property risks and was historically utilized by HC to offer
insurance on a surplus lines basis in certain jurisdictions where HC is not
otherwise permitted to do so. As of December 31, 1998, TIC had statutory
policyholders' surplus of $15.2 million, a decrease of $15.7 million from
December 31, 1997 due to a special dividend paid to HC. As a result of changes
in the operations of the Company's insurance company subsidiaries, including the
relocation and change in focus of USSIC's operations, management has determined
that TIC is no longer a necessary component of the Company's insurance company
operations and intends to effect the disposition of TIC during 1999. Its
business will be transferred to other insurance company subsidiaries of the
Company.
U.S. SPECIALTY INSURANCE COMPANY--USSIC is a Texas domiciled property and
casualty insurance company and former subsidiary of AIC, which became a direct
subsidiary of HC in December, 1997. The Company was re-domesticated from
Maryland to Texas in 1998. USSIC is rated A+, VII by A.M. Best and AA by
Standard & Poor's and has historically been an underwriter of general aviation
and lenders' single interest risks through a network of independent agents.
USSIC operates on an admitted basis throughout the United States. The Company
expects to continue USSIC's operation, primarily writing general aviation and
workers' compensation insurance produced by underwriting agency subsidiaries of
the Company. During December, 1998, the Company increased the policyholders'
surplus of USSIC by $32.5 million and as of December 31, 1998, USSIC had
statutory policyholders' surplus of $79.2 million.
AVEMCO INSURANCE COMPANY--AIC was organized in 1959 and became a subsidiary
of the Company in June, 1997. AIC is a Maryland domiciled property and casualty
insurer, is rated A+, VII by A.M. Best and AA by Standard & Poor's and operates
primarily as a direct market underwriter of general aviation business on an
admitted basis throughout the United States and Canada (except Quebec) and as an
insurer of lenders' single interest risks produced by AFS. In addition, as a
part of the Company's overall operations, AIC has become an insurer of medical
stop-loss products underwritten by an underwriting agency subsidiary of the
Company. At December 31, 1998, AIC had statutory policyholders' surplus of
$104.9 million.
UNDERWRITING AGENCY OPERATIONS
The Company's underwriting agency subsidiaries act on behalf of insurance
and reinsurance companies, conducting business in the areas of insurance
underwriting management and claims administration. The underwriting agency
subsidiaries do not assume any insurance or reinsurance risk themselves and the
10
<PAGE>
revenues generated are based entirely on management fees and profit commissions.
These subsidiaries are in a position to direct and control business that they
produce. In addition, certain of the business written by the underwriting
agencies is insured or reinsured by the Company's insurance company
subsidiaries. In some cases, the insurance company subsidiaries serve as policy
issuing companies for this business. The insurance company subsidiaries may
retain a portion of the risk and reinsure the remainder with other unaffiliated
insurance companies or reinsure all of the risk.
LINES OF BUSINESS
The following table sets forth the Company's underwriting agency
subsidiaries' premium by lines of business for the three years ended December
31, 1998 (dollars in thousands):
<TABLE>
<CAPTION>
1998 1997 1996
----------------------- --------------------- ---------------------
<S> <C> <C> <C> <C> <C> <C>
Accident and health reinsurance........................... $ 427,005 61% $ 305,625 64% $ 175,627 64%
Medical stop-loss......................................... 158,707 22 93,435 20 78,597 28
Aviation.................................................. 92,668 13 49,581 10 -- --
Lenders' single interest.................................. 18,325 3 21,848 5 22,871 8
Workers' compensation..................................... 4,429 1 -- -- -- --
Other..................................................... 2,890 -- 2,950 1 -- --
---------- --- ---------- --- ---------- ---
Total premium......................................... $ 704,024 100% $ 473,439 100% $ 277,095 100%
---------- --- ---------- --- ---------- ---
---------- --- ---------- --- ---------- ---
</TABLE>
UNDERWRITING AGENCY SUBSIDIARIES
LDG REINSURANCE CORPORATION--LDG Re, based in Wakefield, Massachusetts, acts
as an underwriting manager providing accident and health special risks and
alternative workers' compensation reinsurance. In 1998, LDG Re generated
approximately $378.9 million of written premium, the majority of which was
written on behalf of non-affiliated insurance companies.
HCC BENEFITS CORPORATION--HCCB, based in Atlanta, Georgia, acts as an
underwriting manager providing medical stop-loss and excess coverage insurance
products to employer sponsored self-insured health plans. In 1998, HCCB
generated approximately $158.7 million of written premium, the majority of which
was underwritten on behalf of non-affiliated insurance companies.
HCC AVIATION GROUP, INC.--HCCA, based in Dallas, Texas, provides the base,
along with the Company's insurance company subsidiary AIC, around which the
Company has rapidly developed a significant presence in the domestic general
aviation market. HCCA provides underwriting management services on behalf of
affiliated and non-affiliated insurance companies in the areas of private and
corporate aircraft, commercial agricultural aircraft, antique and vintage
military aircraft, small to medium sized airports, and commercial operators.
During 1998, HCCA generated approximately $95.6 million of written premium.
HCC EMPLOYER SERVICES, INC.--HCCES acts as an underwriting manager providing
occupational accident and health insurance to self-employed truckers from its
Northbrook, Illinois office and workers' compensation insurance to small and
medium size businesses from its Montgomery, Alabama office. HCCES generated
approximately $52.5 million in premium in 1998, the majority of which was
underwritten on behalf of non-affiliated insurance companies.
AVEMCO FINANCIAL SERVICES, INC.--AFS, based in Baltimore, Maryland, acts as
an underwriting manager providing lenders' single interest coverage to banks and
other financial institutions. During 1998, AFS generated approximately $18.3
million in written premium, all on behalf of affiliated insurance companies,
USSIC and AIC.
11
<PAGE>
Management fees generated by underwriting agency subsidiaries in 1998
amounted to $74.0 million, a substantial increase of 45% over 1997.
INTERMEDIARY OPERATIONS
The services performed by the Company's insurance intermediary subsidiaries
consist of marketing, placing, consulting on and servicing insurance risks for
their clients, which include medium to large corporations, insurance and
reinsurance companies or other risk taking entities. The intermediary
subsidiaries earn commission income and to a lesser extent fees for certain
services, generally from the underwriters with whom the business is placed.
Certain of these risks may be initially underwritten by the Company's insurance
company subsidiaries, which may retain a portion of the risk.
HCC EMPLOYEE BENEFITS, INC.,--HCCEB, based in Houston, Texas, is a retail
insurance agency and consulting firm specializing in life, accident and health
insurance for employee benefit plans of medium and large commercial customers
throughout the United States.
HCC INTERMEDIARIES, INC.--HCCI is an intermediary based in Houston, Texas
specializing in marketing and servicing large, complicated insurance and
reinsurance programs placed on behalf of multinational clients operating in the
same lines of business that the Company underwrites. This business is placed
with domestic and international insurance companies, including affiliated
insurance companies, on a direct basis and through other intermediaries. In
addition, HCCI acts as a reinsurance intermediary on behalf of affiliated and
non-affiliated insurance companies.
RATTNER MACKENZIE LIMITED--RML is an intermediary based in London, England.
RML is a Lloyd's broker specializing in accident and health reinsurance and
certain specialty property and casualty lines of business. Management believes
that RML is considered a market leader in its core businesses. RML serves as an
intermediary for reinsurance business placed by the Company's insurance company
subsidiaries as well as unaffiliated insurance and reinsurance companies and
underwriting agencies.
Commission income generated by intermediary subsidiaries in 1998 amounted to
$38.4 million, a substantial increase of 59% over 1997.
OTHER OPERATIONS
The Company's other operations consist of subsidiaries that are not
insurance companies, underwriting agencies or intermediaries. These operations
generally are insurance related services that may be performed for the Company's
subsidiaries, its reinsurers or unaffiliated entities. The revenue earned from
these services primarily consists of fees, commissions or the sales price of
product sold. The two subsidiaries currently operating in this segment provide
insurance claims adjusting services and development and sale of insurance
industry related software. Additionally, other operations include the returns
received from certain insurance related strategic operational investments which
the Company makes from time to time. Certain of these investments provide
strategic partnering opportunities. These returns may be in the form of equity
in the earnings of the investee, dividends or gains from the disposition of
these investments.
Other operating income was $22.3 million in 1998, up 46% from 1997.
COMBINED INSURANCE COMPANY AND UNDERWRITING AGENCY OPERATIONS
The Company's combined GWP was over $1.0 billion in 1998 with its insurance
company operations underwriting $498.3 million and its underwriting agency
operations underwriting $704.0 million.
12
<PAGE>
REINSURANCE CEDED
The Company principally utilizes reinsurance to reduce its net liability on
individual risks, to protect against catastrophic losses and to achieve a
desired ratio of NWP to policyholders' surplus. Various intermediaries,
including HCCI and RML, facilitate the placement of this reinsurance coverage on
behalf of the Company and are compensated, directly or indirectly, by the
reinsurers.
Reinsurance is ceded on both a proportional and an excess of loss basis.
Management believes that the Company reinsures its risks to a greater extent
than most of its competitors and most other insurance companies. This strategy
greatly reduces the likelihood of a significant net loss from insurance company
operations and protects the Company's shareholders' equity. Under its current
reinsurance protections, the Company has limited its net retained loss, across
any single line of business, to a maximum of approximately $1.0 million for any
one risk, but significantly less on most risks.
The type, cost and limits of reinsurance purchased can vary from year to
year based upon the Company's desired retention levels and the availability of
adequate reinsurance at a reasonable price. The Company's reinsurance programs
renew throughout the year. Programs that expired in 1998 have been renewed at
comparable costs.
The availability of reinsurance continues to be an important part of the
Company's business plan, protecting Shareholders equity from catastrophe losses
and the inconsistencies of the insurance cycle. Important relationships have
been built up over the years with many core Reinsurers who have supported the
Company in good and bad times. The Company will continue to share its business
with these partners when underwriting profitability returns, to allow them to
recoup losses and build even stronger relationships in the future. Increased
retentions during profitable periods is made possible not at the sacrifice of
core Reinsurers, but, through reduction of facultative reinsurance and the
natural attrition of certain Reinsurers who exit lines of business, severely
curtail their writings or become insolvent. This reduction in reinsurance market
capacity causes rates to rise but the increased rates historically have been
passed on to the primary market clients.
The Company structures a specific reinsurance program for each line of
business it underwrites. This reinsurance is placed in order to protect the
Company from exposure to foreseeable events. The Company places reinsurance
proportionally to cover loss frequency and catastrophe exposure on an excess of
loss basis to cover individual risk severity of loss and catastrophe exposure
from occurrences involving multiple risks, such as those resulting from a
hurricane or an earthquake. The Company does not intend to expose itself to any
net loss in excess of its reinsurance protection.
The Company writes business in areas exposed to catastrophic losses and has
significant exposures to this type of loss in California, the Atlantic Coast of
the United States, certain United States Gulf Coast states, particularly in
Florida and Texas, the Caribbean and Mexico. The Company carefully assesses its
overall exposures to a single catastrophic event and applies procedures that it
believes are more conservative than are typically used by the industry to
ascertain the Company's probable maximum loss ("PML") from any single event. The
Company maintains reinsurance protection which it believes is sufficient to
cover any foreseeable event.
The Company receives an overriding (ceding) commission on the premium ceded
to reinsurers which compensates the Company for the direct costs associated with
the production of the premium, the servicing of the business during the term of
the policies ceded and the costs associated with the placement of the related
reinsurance. In addition, certain of the Company's reinsurance treaties allow
for a sharing with the Company by the reinsurers of any net profits generated
under such treaties.
The ceding of reinsurance does not discharge the Company from liability to
its policyholders. The Company is required to pay losses even if the reinsurer
fails to meet its obligations under the reinsurance contract. To minimize its
exposure to reinsurance credit risk, the Company places its reinsurance with a
diverse group of financially sound reinsurers. The Company's 1999 treaty
reinsurance program was placed
13
<PAGE>
with more than 52 domestic and foreign reinsurers. As of December 31, 1998, the
total amount recoverable from reinsurers was approximately $372.7 million, of
which $33.6 million represents paid losses recoverable (in the ordinary course
of business) and $341.6 million represents outstanding losses recoverable, less
a $2.5 million reserve for uncollectible reinsurance. In addition, ceded
unearned premium was $149.6 million. At December 31, 1998, the Company held
$166.5 million of irrevocable letters of credit and $8.1 million in cash to
collateralize a portion of the total amount recoverable and had other payable
balances due to its reinsurers of $227.6 million as potential offsets against
reinsurance recoverables. The estimated duration for the Company's outstanding
losses is two years, as the majority of the Company's business has historically
had shorter lead times between the occurrence of an insured event and the final
settlements. The following table shows reinsurance balances relating to the
reinsurers with a total recoverable balance greater than $10.0 million and the
collateral and potential offsets held by the Company as of December 31, 1998:
<TABLE>
<CAPTION>
LETTERS OF
REINSURANCE CREDIT,
RECOVERABLES AND CASH DEPOSITS
CEDED UNEARNED AND OTHER
REINSURER LOCATION PREMIUM PAYABLES
- --------------------------------------------------------- ------------------- ---------------- ----------------
<S> <C> <C> <C>
Underwriters at Lloyd's.................................. United Kingdom $ 93,280,000 $ 37,040,000
Underwriters Indemnity Company*.......................... Texas 51,576,000 11,039,000
New Cap Reinsurance Corp. Ltd............................ Australia 49,924,000 40,764,000
Reinsurance Australia Corporation, Ltd................... Australia 41,606,000 44,411,000
SCOR Reinsurance Company................................. New York 38,703,000 11,402,000
AXA Reinsurance Company.................................. Delaware 28,667,000 10,513,000
GIO Insurance Limited.................................... Australia 24,011,000 25,158,000
Monegasque De Reassurances............................... Monaco 13,454,000 12,936,000
Overseas Partners Limited................................ Bermuda 12,718,000 10,919,000
TIG Reinsurance Company.................................. Connecticut 12,591,000 2,534,000
St. Paul Fire and Marine Insurance Co.................... Minnesota 12,278,000 4,349,000
</TABLE>
- ------------------------
* Underwriters Indemnity Company was acquired by RLI Corporation, an insurance
holding company, (NYSE: RLI) in January, 1999.
Prior to the Company's acquisition of Avemco, AIC retained a greater
percentage of overall premiums written than HC and TIC. Following the
acquisition, the Company implemented a program of reinsurance for AIC which is
more consistent with the reinsurance programs utilized by the Company's other
insurance company subsidiaries. The effect of this change was to limit the net
retained exposure of AIC, to reduce net earned premium and to reduce the effect
on net earnings of large losses and a high frequency of losses.
Due to the Company's financial analysis of active and potential reinsurers
and its conservative strategy of diversifying its reinsurers, the Company has
never incurred a significant loss on recoverables from reinsurers. The Company
has established a reserve of $2.5 million as of December 31, 1998, which is
intended to reduce the effects of any recoverable problem. However, the adverse
economic environment in the insurance industry has placed great pressure on
reinsurers and the results of their operations. These conditions could,
ultimately, affect reinsurers' solvency. Historically, there have been
insolvencies following a period of competitive pricing in the industry, such as
the marketplace is experiencing today. Therefore, while management believes that
the reserve is adequate, conditions can 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.
14
<PAGE>
OPERATING RATIOS
PREMIUM TO SURPLUS RATIO
The following table shows, for the periods indicated, the ratio of statutory
GWP and NWP to statutory policyholders' surplus for the Company's property and
casualty insurance company subsidiaries:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
(DOLLARS IN THOUSANDS)
----------------------------------------------------------
<S> <C> <C> <C> <C> <C>
1998 1997 1996 1995 1994
---------- ---------- ---------- ---------- ----------
GWP.................................................. $ 500,962 $ 346,094 $ 340,367 $ 338,753 $ 283,530
NWP.................................................. 123,315 143,068 189,022 184,028 133,143
Policyholders' surplus............................... 369,401 331,922 288,863 251,125 206,596
GWP ratio............................................ 135.6% 104.3% 117.8% 134.9% 137.2%
GWP industry average (1)............................. * 154.7 179.9 194.0 221.8
NWP ratio............................................ 33.4% 43.1% 65.4% 73.3% 64.4%
NWP industry average (1)............................. * 89.7 105.2 113.0 129.7
</TABLE>
- ------------------------
*--Not available
(1) Source: A.M. Best.
While there is no statutory requirement regarding a permissible premium to
surplus ratio, guidelines established by the National Association of Insurance
Commissioners ("NAIC") provide that a property and casualty insurer's annual
statutory GWP should not exceed 900% and NWP should not exceed 300% of its
policyholders' surplus. In keeping with its philosophy of protecting its
shareholders' equity and limiting its aggregate loss exposure, the Company
maintains premium to surplus ratios significantly lower than such guidelines,
and, as indicated above, below industry norms.
COMBINED RATIO
The underwriting experience of a property and casualty insurance company is
indicated by its combined ratio. The Company's insurance subsidiaries' loss
ratio, expense ratio and combined ratio, determined on the basis of statutory
accounting principles ("SAP"), are shown in the following table:
<TABLE>
<CAPTION>
1998 1997 1996 1995 1994
--------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
Loss ratio....................................................... 67.2% 61.6% 64.4% 66.4% 62.5%
Expense ratio.................................................... 15.7 17.2 19.2 18.1 20.4
--------- --------- --------- --------- ---------
Combined ratio................................................... 82.9% 78.8% 83.6% 84.5% 82.9%
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Industry average (1)............................................. * 101.6% 105.8% 106.4% 108.4%
</TABLE>
- ------------------------
* Not available
(1) Source: A.M. Best.
The SAP basis ratio data is not intended to be a substitute for results of
operations on the basis of generally accepted accounting principles ("GAAP").
The differences between SAP and GAAP are shown in Note (15) of the Company's
consolidated financial statements. Including this information on a SAP basis is
meaningful and useful to allow a comparison of the Company's operating results
with those of other companies in the insurance industry. A.M. Best reports on
insurer performance on a SAP basis to provide for more standardized comparisons
among individual companies, as well as overall industry performance.
15
<PAGE>
RESERVES
Applicable insurance laws and regulations require that reserves be
maintained for the payment of loss and loss adjustment expense ("LAE") with
respect to both reported and incurred but not reported ("IBNR") claims under
insurance and reinsurance policies issued by the Company's insurance company
subsidiaries. In most cases, the Company establishes reserves through an
evaluation of individual claims. In some types of aviation claims, an average
reserving method is utilized until more information becomes available which will
permit a more specific individual evaluation of claims. In the case of direct
and facultative reinsurance business, loss reserves are determined by evaluating
reported claims on the basis of the type of loss, jurisdiction of the
occurrence, knowledge of the circumstances surrounding the claim, severity of
injury or damage, potential for ultimate exposure, experience with the insured
and the line of business and policy provisions relating to the particular type
of claim. The Company establishes loss reserves for excess of loss and
proportional reinsurance claims based on information and reports received from
ceding companies. Loss reserves for IBNR losses are determined in part on the
basis of statistical information and in part on industry experience with respect
to the probable number and nature of claims arising from occurrences which have
not been reported. The Company does not discount any of its loss reserves.
With respect to some classes of risks, the period of time between the
occurrence of an insured event and the final settlement of a claim may be many
years, and during this period it often becomes necessary to adjust the claim
estimates either upward or downward. Certain classes of marine and offshore
energy insurance and workers' compensation insurance underwritten by the Company
have historically had longer lead times between the occurrence of an insured
event, reporting of the claim to the Company, and final settlement. In such
cases, the Company is forced to estimate reserves over long periods of time,
with the possibility of several adjustments to reserves. Other classes of
insurance, such as most aviation, property and accident and health business the
Company underwrites, historically have shorter lead times between the occurrence
of an insured event, reporting of the claim to the Company and final settlement.
The reserves with respect to such classes are, therefore, less likely to be
adjusted. The classes of insurance with shorter lead times currently represent
the majority of the risks underwritten by the Company's insurance company
operations.
The reserving process is intended to provide implicit recognition of the
impact of inflation and other factors affecting loss payments by taking into
account changes in historical payment patterns and perceived probable trends.
However, there is no precise method for the subsequent evaluation of the
adequacy of the consideration given to inflation, or to any other specific
factor, some of which are interdependent.
The Company underwrites, directly and through reinsurance, risks which are
denominated in a number of foreign currencies, and therefore establishes and
maintains loss reserves with respect to these policies in the respective
currencies. These reserves are subject to exchange rate fluctuations, which may
have an effect on the Company's earnings. From time to time, the Company may
attempt to limit its exposure to future currency fluctuations through the use of
foreign currency forward contracts.
The following loss development triangles show changes in reserves in
subsequent years from the prior loss estimates based on experience as of the end
of each succeeding year on the basis of GAAP. The estimate is increased or
decreased as more information becomes known about the frequency and severity of
losses for individual years. A redundancy means the original estimate was higher
than the current estimate; a deficiency means that the current estimate is
higher than the original estimate.
The first line of each loss development triangle presents, for each of the
years indicated, the gross reserve liability including the reserve for IBNR
losses. The first section of each table shows, by year, the cumulative amounts
of loss and LAE paid as of the end of each succeeding year. The second section
sets forth the re-estimates in later years of incurred losses, including
payments, for the years indicated. The "cumulative redundancy (deficiency)"
represents, as of December 31, 1998, the difference between the latest
re-estimated liability and the reserves as originally estimated.
16
<PAGE>
The following loss development triangle shows development in loss reserves
on a gross basis:
<TABLE>
<CAPTION>
1998 1997 1996 1995 1994 1993 1992
---------- ---------- ---------- ---------- ---------- ---------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance sheet reserves:.............. $ 460,511 $ 275,008 $ 229,049 $ 200,756 $ 170,957 $ 144,178 $ 129,503
Cumulative paid as of:
One year later..................... 160,324 119,453 118,656 97,580 82,538 83,574
Two years later.................... 179,117 167,459 143,114 126,290 130,379
Three years later.................. 207,191 166,541 157,509 158,973
Four years later................... 192,540 176,472 182,193
Five years later................... 195,269 192,512
Six years later.................... 213,052
Re-estimated liability as of:
End of year........................ 460,511 275,008 229,049 200,756 170,957 144,178 129,503
One year later..................... 308,501 252,236 243,259 186,898 163,967 162,827
Two years later.................... 249,013 248,372 207,511 183,015 176,817
Three years later.................. 247,053 214,738 203,137 194,419
Four years later................... 220,695 211,546 215,531
Five years later................... 218,182 222,746
Six years later.................... 234,115
Cumulative redundancy (deficiency)... $ (33,493) $ (19,964) $ (46,297) $ (49,738) $ (74,004) $ (104,612)
</TABLE>
During 1998 the Company had gross loss and LAE deficiency of $33.5 million
compared to deficiencies of $23.2 million in 1997 and $42.5 million in 1996. The
gross deficiency comes from two primary sources. Firstly, the development of
several large claims on individual policies which were either reported late or
reserves were increased as subsequent information became available. However, as
most of these policies were substantially reinsured, there was no material
effect to the Company's net earnings. Secondly, the run-off of the
retrocessional excess of loss business which the Company underwrote between 1988
and 1991. This development is due primarily to the delay in reporting of
catastrophe losses by the London insurance market, coupled with the
unprecedented number of catastrophes during the period in which the Company
underwrote this business. This business is also substantially reinsured, thereby
not having a material effect on the Company's net earnings.
[THE REMAINDER OF THIS PAGE LEFT INTENTIONALLY BLANK]
17
<PAGE>
The following loss development triangle shows development in loss reserves
on a net basis:
<TABLE>
<CAPTION>
1998 1997 1996 1995 1994 1993 1992
--------- --------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
Gross reserves for loss and LAE................. $ 460,511 $ 275,008 $ 229,049 $ 200,756 $ 170,957 $ 144,178 $ 129,503
Less reinsurance recoverables................... 341,599 155,374 111,766 101,497 95,279 82,289 81,075
--------- --------- --------- --------- --------- --------- ---------
Reserves for loss and LAE, net of reinsurance... 118,912 119,634 117,283 99,259 75,678 61,889 48,428
Cumulative paid, net of reinsurance as of
One year later................................ 48,775 47,874 41,947 36,500 29,258 18,978
Two years later............................... 66,030 56,803 49,283 41,207 32,733
Three years later............................. 64,798 56,919 46,576 36,536
Four years later.............................. 60,441 51,536 38,480
Five years later.............................. 53,110 40,327
Six years later............................... 40,550
Seven years later.............................
Eight years later.............................
Nine years later..............................
Ten years later...............................
Re-estimated liability, net of reinsurance as of
End of year................................... 118,912 119,634 117,283 99,259 75,678 61,889 48,428
One year later................................ 105,041 113,509 94,322 72,912 59,659 45,812
Two years later............................... 98,959 93,550 74,836 60,079 44,964
Three years later............................. 84,042 76,423 62,224 46,129
Four years later.............................. 73,609 64,377 48,993
Five years later.............................. 64,103 50,785
Six years later............................... 50,585
Seven years later.............................
Eight years later.............................
Nine years later..............................
Ten years later...............................
Cumulative redundancy (deficiency).............. $ 14,593 $ 18,324 $ 15,217 $ 2,069 $ (2,214) $ (2,157)
<CAPTION>
1991 1990 1989 1988
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Gross reserves for loss and LAE................. $ 123,248 $ 108,027 $ 96,477 $ 76,754
Less reinsurance recoverables................... 83,727 60,194 45,160 30,481
--------- --------- --------- ---------
Reserves for loss and LAE, net of reinsurance... 39,521 47,833 51,317 46,273
Cumulative paid, net of reinsurance as of
One year later................................ 18,416 23,450 22,660 18,414
Two years later............................... 23,057 33,815 34,300 27,698
Three years later............................. 31,903 35,912 40,806 33,601
Four years later.............................. 33,875 42,465 41,878 36,256
Five years later.............................. 34,970 43,422 46,734 36,045
Six years later............................... 36,203 43,690 47,164 37,718
Seven years later............................. 35,413 44,611 47,229 38,338
Eight years later............................. 43,715 47,928 38,415
Nine years later.............................. 46,308 39,006
Ten years later............................... 38,195
Re-estimated liability, net of reinsurance as of
End of year................................... 39,521 47,833 51,317 46,273
One year later................................ 38,575 44,887 49,475 43,362
Two years later............................... 38,656 45,435 47,313 42,463
Three years later............................. 39,176 44,689 48,085 40,352
Four years later.............................. 40,407 45,507 47,884 40,937
Five years later.............................. 43,418 46,805 47,933 40,384
Six years later............................... 45,142 48,932 48,086 40,071
Seven years later............................. 43,924 50,190 49,392 39,880
Eight years later............................. 49,732 50,324 40,587
Nine years later.............................. 50,101 41,014
Ten years later............................... 40,570
Cumulative redundancy (deficiency).............. $ (4,403) $ (1,899) $ 1,216 $ 5,703
</TABLE>
18
<PAGE>
The Company believes that its reserves are adequate to provide for all net
incurred losses.
The following table provides a reconciliation of the gross liability of loss
and LAE on a GAAP basis for the three years ended December 31, 1998 (dollars in
thousands):
<TABLE>
<CAPTION>
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
Reserves for loss and LAE at beginning of year............................... $ 275,008 $ 229,049 $ 200,756
Reserves acquired with purchase of subsidiary................................ 3,877 1,919 --
Provision for loss and LAE for claims occurring in the current year.......... 461,429 269,505 185,502
Increase in estimated loss and LAE for claims occurring in prior years (1)... 33,493 23,187 42,503
---------- ---------- ----------
Incurred loss and LAE........................................................ 494,922 292,692 228,005
---------- ---------- ----------
Loss and LAE payments for claims occurring during:
Current year............................................................... 152,972 129,199 81,056
Prior years................................................................ 160,324 119,453 118,656
---------- ---------- ----------
Loss and LAE payments........................................................ 313,296 248,652 199,712
---------- ---------- ----------
Reserves for loss and LAE at end of the year................................. $ 460,511 $ 275,008 $ 229,049
---------- ---------- ----------
---------- ---------- ----------
</TABLE>
- ------------------------
(1) Changes in loss and LAE reserves on a GAAP basis, for losses occurring in
prior years, reflect the gross effect of the resolution of losses for other
than the reserve value and the subsequent adjustments of loss reserves.
The following table provides a reconciliation of the liability for loss and
LAE, net of reinsurance ceded, on a GAAP basis for the three years ended
December 31, 1998 (dollars in thousands):
<TABLE>
<CAPTION>
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
Reserves for loss and LAE at beginning of year............................... $ 119,634 $ 117,283 $ 99,259
Reserves acquired with purchase of subsidiary................................ 3,877 1,919 --
Provision for loss and LAE for claims occurring in the current year.......... 105,895 100,288 119,401
Decrease in estimated loss and LAE for claims occurring in prior years (2)... (14,593) (3,774) (4,937)
---------- ---------- ----------
Incurred loss and LAE........................................................ 91,302 96,514 114,464
---------- ---------- ----------
Loss and LAE payments for claims occurring during:
Current year............................................................... 47,126 48,208 54,493
Prior years................................................................ 48,775 47,874 41,947
---------- ---------- ----------
Loss and LAE payments........................................................ 95,901 96,082 96,440
---------- ---------- ----------
Reserves for loss and LAE at end of the year................................. $ 118,912 $ 119,634 $ 117,283
---------- ---------- ----------
---------- ---------- ----------
</TABLE>
- ------------------------
(2) Changes in loss and LAE reserves on a GAAP basis, for losses occurring in
prior years, reflect the net effect of the resolution of losses for other
than the reserve value and the subsequent adjustments of loss reserves.
Although the Company experienced a gross loss deficiency during the three
years ended December 31, 1998, because the business is substantially reinsured
in the lines where adverse development has occurred, there is no material
adverse effect on a net loss basis.
During 1998, the Company had net loss and LAE redundancy of $14.6 million
relating to prior year losses compared to redundancies of $3.8 million in 1997
and $4.9 million in 1996. The redundancies in the net reserves result from the
Company's and its actuaries continued review of its loss reserves and the
reduction of such reserves as losses are finally settled and claims exposures
are reduced. The Company believes it has provided for all material net incurred
losses.
19
<PAGE>
AIC, acquired in June, 1997, recorded a $10.0 million increase in loss and
LAE reserves during December, 1997, predominately related to 1995 and 1996
claims incurred prior to the Company's acquisition of AIC. This deficiency is
included in the net redundancy recorded for 1997. This increase in reserves was
made in an effort to bring AIC's reserving practices consistent with the more
conservative method used by the Company's other insurance company operations.
The Company expects the increase in loss reserves to be adequate to cover any
subsequent adverse development of AIC's prior losses.
The Company has no material exposure to environmental pollution losses, as
HC only began writing business in 1981 and policies issued by HC normally
contain pollution exclusion clauses which limit pollution coverage to "sudden
and accidental" losses only, thus excluding intentional (dumping) and seepage
claims. Policies issued by AIC and USSIC, because of the types of risks insured,
principally general aviation, are not considered to have significant
environmental exposures. Therefore, the Company should not experience any
material development in reserves from environmental pollution claims.
INVESTMENTS
Insurance company investments must comply with applicable laws and
regulations which prescribe the type, quality and concentration of investments.
In general, these laws and regulations permit investments, within specified
limits and subject to certain qualifications, in Federal, state and municipal
obligations, corporate bonds, preferred and common equity securities. As of
December 31, 1998, the Company had $525.6 million of investment assets, the
majority of which were held by its insurance company subsidiaries.
The Company's investment policy is determined by the Company's Board of
Directors and is reviewed on a regular basis. Pursuant to its investment policy,
the Company concentrates its investments in obligations of states,
municipalities and political subdivisions, the interest income from which is
predominantly exempt from Federal income tax. The interest rates on these
securities are normally lower than rates on comparable taxable securities. The
Company's portfolio of fixed income securities available for sale principally
consists of intermediate term, tax-exempt securities. The Company generally
intends to hold such securities to maturity. However, the Company regularly
re-evaluates its position based upon market conditions, which may cause the
Company to restructure its portfolio and realize gains or losses in order to
maximize its total return on investments. Accordingly, all fixed income
securities are classified as available for sale and are recorded at market
value.
The Company's financial statements reflect an unrealized ("mark-to-market")
gain on fixed income securities available for sale as of December 31, 1998, of
$18.1 million. Since the Company's intention is to hold these securities until
maturity, it does not currently expect to realize any significant gain or loss
on these investments.
The Company has maintained a substantial level of cash and liquid short-term
instruments in its insurance company subsidiaries in order to maintain the
ability to fund large physical damage losses of the Company's insureds, should
they occur. As of December 31, 1998, the Company had cash and short-term
investments of approximately $145.1 million of which $70.6 million are in the
Company's insurance company subsidiaries.
The following tables reflect the investments of the Company (dollars are
expressed in thousands). The table set forth below reflects the average amount
of investments, income earned, and the yield thereon for the three years ended
December 31, 1998:
<TABLE>
<CAPTION>
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
Average investments.......................................................... $ 522,209 $ 496,010 $ 461,778
Net investment income........................................................ 29,335 27,587 23,593
Average yield (1)............................................................ 5.6% 5.6% 5.1%
Average tax equivalent yield (1)............................................. 7.3% 7.3% 6.9%
</TABLE>
- ------------------------
(1) Excluding realized and unrealized capital gains and losses.
20
<PAGE>
The table set forth below summarizes, by type, the investments of the
Company as of December 31, 1998:
<TABLE>
<CAPTION>
AMOUNT PERCENT OF TOTAL
---------- -----------------
<S> <C> <C>
Short-term investments................................................................ $ 129,084 25%
U.S. Treasury securities.............................................................. 19,773 4
Obligations of states, municipalities and political subdivisions...................... 163,798 31
Special revenue....................................................................... 208,355 40
Other fixed income securities......................................................... 1,312 --
Marketable equity securities.......................................................... 2,252 --
Other investments..................................................................... 1,072 --
---------- ---
Total investments................................................................... $ 525,646 100%
---------- ---
---------- ---
</TABLE>
The table set forth below indicates the expected maturity distribution of
the Company's fixed income securities as of December 31, 1998:
<TABLE>
<CAPTION>
AMOUNT PERCENT OF TOTAL
---------- -----------------
<S> <C> <C>
One year or less...................................................................... $ 7,828 2%
One year to five years................................................................ 151,878 39
Five years to ten years............................................................... 123,749 31
Ten years to fifteen years............................................................ 83,608 21
More than fifteen years............................................................... 26,175 7
---------- ---
Total fixed income securities....................................................... $ 393,238 100%
---------- ---
---------- ---
</TABLE>
BANK LOAN
On March 8, 1999, the Company entered into a Loan Agreement (the "Facility")
with a group of banks. The Facility includes a $150 million Revolving Loan
Facility and $100 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
HC, AIC, and USSIC and by the pledge of stock 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 March 13, 1999, total debt outstanding under the Facility was $176.0
million with $150.0 million due under the $150.0 million Revolving Loan Facility
and $26.0 million due under the $100.0 million Short Term Revolving Loan
Facility. The increase in debt subsequent to December 31, 1998 resulted from the
funding of the purchase price of acquisitions.
21
<PAGE>
FOREIGN EXCHANGE
The Company's balances denominated in foreign currency fluctuate as
transactions are recorded and settled. From time to time, the Company has
entered into foreign currency forward contracts as a hedge against foreign
currency fluctuations. Such activity has been on a very limited basis in the
past. The Company did not hedge this risk in 1998, and there were no open
foreign currency forward contracts as of December 31, 1998. In the future, the
Company may limit its exposure to currency fluctuations through the use of
foreign currency forward contracts. The Company utilizes these foreign currency
forward contracts strictly as a hedge against existing exposure to foreign
currency fluctuations and it does not do so as any form of speculative or
trading investment.
COMPETITION
The insurance business is generally highly competitive. The Company faces
competition from domestic and foreign insurers and underwriting agency and
intermediary operations, many of whom are larger and have greater financial,
marketing and management resources than the Company. The Company's profitability
is affected by many other factors, including rate competition, severity and
frequency of claims, interest rates, state regulations, court decisions, the
judicial climate and general business conditions, all of which are outside the
control of the Company. Although as an insurer, the Company's underwriting
strategy is to concentrate its writings in selected, narrowly defined lines of
business, the Company faces competition in these selected lines of business both
from other specialty insurance companies as well as larger, more diversified
insurance companies which underwrite multiple lines of business, including the
lines of business underwritten by the Company. The Company's medical stop-loss
business involves a diversified field of participants from small, start-up
operations to large, well-established organizations. Significant growth in the
number of medical stop-loss insurance underwriters and underwriting managers in
the past several years has increased the level of competition in this area of
the Company's business. The Company also faces intense and growing pressure in
this area from alternatives to employer sponsored self-insured health plans,
such as fully-insured plans, HMOs and Point of Service plans, as well as from
large well established direct insurers and competing underwriting managers
providing similar medical stop-loss products to those offered by the Company to
employer sponsored self-insured health plans.
Competition in the reinsurance marketplace is primarily due to an increase
in the number of reinsurers participating in the market as well as a tendency by
reinsureds to retain a greater percentage of their own risk. The Company
competes with other reinsurance underwriting managers and domestic and
international reinsurance companies. The Company's results of operations may
also be affected by the competition for reinsurance business between broker
reinsurance markets and direct marketing reinsurance companies. The Company also
competes with many reinsurance intermediaries in the broker reinsurance market,
some of which are affiliated with primary insurance brokers with substantial
financial resources. In its underwriting agency and services operations, the
Company competes with a large number of publicly traded and private firms which
operate as independent insurance agencies or insurance services providers as
well as with insurance companies which market insurance products directly
through their employees or affiliated insurance agencies. In each of the
business areas in which the Company is engaged, a significant number of the
Company's competitors have financial resources, employees, facilities, market
recognition, marketing, management, experience, and other resources
substantially greater than those of the Company. In addition to competition in
the operation of its business, the Company faces competition from a variety of
sources in attracting and retaining qualified employees.
REGULATION
The activities of the Company are subject to licensing requirements and
extensive regulation under the laws of the United States and its various states,
territories and possessions, as well as the laws of other countries in which the
Company's subsidiaries operate. Currently, insurance companies are generally not
subject to any Federal regulation of their insurance business because of the
existence of a Federal law
22
<PAGE>
commonly known as the McCarran-Ferguson Act, which provides the insurance
industry with immunity from certain aspects of the Federal anti-trust law and
exempts the business of insurance from Federal regulation. Therefore, in the
United States, the Company's operations are regulated primarily at the state
level. The Company's business depends on the validity of, and continued good
standing under, the licenses and approvals pursuant to which it operates, as
well as compliance with pertinent regulations. The Company therefore devotes
significant efforts toward obtaining and maintaining its licenses and compliance
with a diverse and complex regulatory structure.
The Company's insurance subsidiaries, in common with other insurers, are
subject to regulation and supervision by the states and by other jurisdictions
in which they do business. Within the states, the method of such regulation
varies but generally has its source in statutes that delegate regulatory and
supervisory powers to an insurance official. The regulation and supervision
relates primarily to approval of policy forms and rates, the standards of
solvency that must be met and maintained, including risk based capital
measurements, the licensing of insurers and their agents, the nature of and
limitations of investments, restrictions of the size of risks which may be
insured under a single policy, deposits of securities for the benefit of
policyholders, methods of accounting, periodic examinations of the affairs of
insurance companies, the form and content of records of financial condition
required to be filed, and reserves for unearned premiums, losses and other
purposes. In general, such regulations are intended primarily for the protection
of policyholders rather than shareholders. Compliance is monitored by the state
insurance departments through periodic regulatory reporting procedures and
periodic examinations. The quarterly and annual financial reports to the
regulators in the United States utilize accounting principles which are
different from the GAAP used by the Company in its reports to shareholders. SAP,
in keeping with the intent to assure the protection of policyholders, is
generally based on a liquidation concept while GAAP is based on a going-concern
concept.
In addition to the regulatory supervision of the insurance company
subsidiaries of the Company, as an insurance holding company, the Company is
subject to regulation under the insurance holding company system regulatory acts
in the states of California, Maryland, Missouri, Oklahoma and Texas, which
contain certain reporting requirements including registration and the filing of
annual reports. In such registration and annual reports, the Company is required
to provide current information regarding its capital structure, general
financial condition, ownership, management, and the identity of each member of
its insurance holding company system. The Company is also required to provide
prior notice to insurance regulatory authorities of certain agreements and
transactions between the Company and its affiliates. These agreements and
transactions must satisfy certain standards set forth in the insurance laws and
regulations of such states. Insurance holding company laws also regulate the
payment of dividends and other distributions by insurance companies to their
shareholders.
Additionally, the underwriting agency, intermediary and services operations
of the Company are subject to state insurance laws and regulations which may
require the licensing of insurance agents, brokers, reinsurance intermediaries,
reinsurance underwriting managers, third party administrators and underwriting
agents and which regulate certain aspects of their business. These laws and
regulations may include requirements for certain provisions in contracts entered
into between the Company and various insurers or reinsurers, record keeping and
reporting requirements, limitations on authority, advertising and business
practice rules, and other matters. The manner of operating the Company's agency
activities in particular states may vary according to the licensing requirements
of the particular state, which may require, among other things, that a firm
operate in the state through a local corporation. In a few states, licenses are
issued only to individual residents or locally-owned business entities. In such
cases, the Company has arrangements with residents or business entities licensed
to act in the state.
There can be no assurance given that the Company has all such required
licenses, approvals or complying contracts or that such licenses, approvals or
complying contracts can always be obtained or continued. In all jurisdictions,
the applicable laws and regulations are subject to amendment or interpretation
by regulatory authorities. Generally, such authorities are vested with
relatively broad discretion to
23
<PAGE>
grant, renew and revoke licenses and approvals, and to implement regulations,
and licenses may be denied or revoked for various reasons, including the
violations of such regulations, conviction of crimes and the like. In some
instances, the Company follows practices based on its interpretations, or those
that it believes may be generally followed by the industry, of laws and
regulations, which may be different from the requirements or interpretations of
regulatory authorities. Accordingly, the possibility exists that the Company may
be precluded or temporarily suspended from carrying on some or all of its
activities or otherwise penalized in a given jurisdiction. Such preclusion or
suspension could have a materially adverse effect on the business and results of
operations of the Company.
HC is domiciled and licensed as an admitted insurer in Texas, is an
accredited reinsurer in 35 states (including Texas), and is an approved surplus
lines insurer or is otherwise permitted to write surplus lines insurance in 46
states, three U.S. territories and the District of Columbia. When a reinsurer
obtains accreditation from a particular state, insurers within that state are
permitted to obtain statutory credit for risks ceded to the reinsurer. Surplus
lines insurance is offered by non-admitted (unlicensed) companies on risks which
are not insured by admitted (licensed) companies. All surplus lines insurance is
written through licensed surplus lines insurance brokers, who are required to
ensure that no licensed admitted insurer will write a particular risk prior to
placing that risk with a surplus lines insurer. Additionally, HC through its
operations in Amman, Jordan (formerly IMG), is able under Jordanian law to
directly underwrite non-Jordanian risks and reinsure Jordanian risks. In
December, 1998, HC received regulatory approval to operate a full branch office
in the United Kingdom. Such approval will impose additional regulatory
requirements on HC, but management expects that such approval will also permit
HC to take advantage of increased opportunities in the London insurance market,
a historical focal point for specialty property and casualty risks. AIC is
domiciled and licensed as an admitted insurer in Maryland and operates as a
licensed admitted insurer in all other states, the District of Columbia, and all
Canadian provinces (except Quebec). USSIC is domiciled and licensed as an
admitted insurer in Texas and operates as a licensed admitted insurer in all
other states and the District of Columbia. TIC is domiciled and licensed as an
admitted insurer in Oklahoma, is an accredited reinsurer in three states
(including Oklahoma), and is an approved surplus lines insurer or is otherwise
permitted to write surplus lines insurance in 33 states and the District of
Columbia.
Under the laws of the State of Texas, HC and USSIC must maintain minimum
statutory capital of $1.0 million and minimum statutory surplus of $1.0 million
and may only pay dividends out of statutory earned surplus. The maximum amount
of dividends that HC and USSIC may pay without prior regulatory approval in any
12 month period is the greater of each of their statutory net income for the
prior year, or 10% of each of their statutory policyholders' surplus as of the
prior year end. The maximum amount each company could pay as dividends at
December 31, 1998, was $38.2 million and $7.9 million, respectively. Under the
laws of the State of Maryland, AIC may only pay dividends out of its statutory
earned surplus. The maximum amount of dividends that AIC may pay without prior
regulatory approval in any 12 month period is the greater of its statutory net
income (under certain conditions) or 10% of its statutory policyholders'
surplus. The maximum amount at December 31, 1998 was $10.5 million. Under the
laws of the State of Oklahoma, TIC may only pay dividends out of surplus funds.
The maximum amount TIC may pay HC without prior regulatory approval is the
greater of statutory net income excluding realized capital gains or 10% of
statutory capital and surplus. That amount at December 31, 1998 was $2.2
million. On December 31, 1998, TIC paid a special dividend of $15.3 million to
HC, as approved by state regulatory authorities. As a result of this
transaction, any dividends by TIC during the period ended December 31, 1999
would require the prior approval of the Oklahoma Department of Insurance.
The NAIC has developed a formula for analyzing insurance companies called
risk-based capital. The risk-based capital formula is intended to establish
"minimum" capital threshold levels that vary with the size and mix of a
company's business. It is designed to identify companies with the capital levels
that may require regulatory attention. As of December 31, 1998, each of the
Company's domestic insurance
24
<PAGE>
company subsidiaries' total adjusted capital is significantly in excess of the
NAIC authorized control level risk-based capital.
The NAIC has also developed a rating system, the Insurance Regulatory
Information System ("IRIS"), primarily intended to assist sate insurance
departments in overseeing the financial condition of all insurance companies
operating within their respective states. IRIS consists of eleven key financial
ratios that address various aspects of each insurer's financial condition and
stability. The Company's insurance company subsidiaries IRIS ratios generally
fall within the usual prescribed ranges except in satisfactorily explainable
circumstances such as when there is a large reinsurance transaction, capital
change or merger.
PENDING OR PROPOSED LEGISLATION
In recent years, state legislatures have considered or enacted laws that
modify and, in many cases, increase state authority to regulate insurance
companies and insurance holding company systems. The majority of state insurance
regulators are members of the NAIC, which seeks to promote uniformity of, and to
enhance the state regulation of, insurance. In addition, the NAIC and state
insurance regulators, as part of the NAIC's state insurance department
accreditation program, have re-examined existing laws and regulations,
specifically focusing on insurance company investments, issues relating to the
solvency of insurance companies, licensing and market conduct issues,
interpretations of existing laws, the development of new laws, and the
definition of extraordinary dividends. Also, Congress and certain Federal
agencies have conducted investigations of the current condition of the insurance
industry in the United States to determine whether to impose Federal regulation
of insurers and reinsurers. In the past several years there have been a number
of recommendations that the McCarran-Ferguson Act (which generally exempts the
insurance business from Federal regulation) be repealed entirely or modified to
remove the industry's anti-trust exemption and subject it to Federal regulation.
If the McCarran-Ferguson Act were to be repealed or modified, state regulation
of the insurance business would continue. This could result in an additional
layer of Federal regulation. In addition, in recent years, various measures have
been proposed at the Federal level to reform the current process of Federal and
state regulation of the financial services industries in the United States,
which are generally considered to include the banking, insurance and securities
industries. Such measures, which are often referred to as financial services
modernization, have as a principal objective the elimination or modification of
current regulatory impediments to cross-industry combinations involving banks,
securities firms and insurance companies. It is likely that some form of
financial services modernization legislation will eventually be enacted at the
Federal level which could have significant implications on the banking,
insurance and securities industries. If enacted, such legislation could result
in significant cross-industry consolidations among banks, insurance companies
and securities firms and increased competition in many of the areas of the
Company's operations. Also from time to time, Congress and certain states have
considered various legislative proposals which would provide for governmental
earthquake insurance coverage. The Company does not know at this time the extent
to which any or all such Federal or state legislative or regulatory initiatives
will or may be adopted, and no assurance can be given that they would not, if
adopted, have a material adverse effect on the Company or its results of
operations.
The NAIC adopted Statements of Statutory Accounting Principles ("SSAPs") in
March, 1998 as a product of its attempt to codify statutory accounting
principles. While subject to adoption by the individual states, the NAIC has
established an effective date of January 1, 2001 for the SSAPs. Prior to the
codification project, a comprehensive guide to statutory accounting principles
did not exist. Codification is new and will evolve over time. Based upon the
SSAPs as currently published, the Company does not expect their adoption to have
a material effect on the policyholders' surplus of its individual insurance
company subsidiaries. The only material effect on statutory net income is that
the statutory net income for HC will be decreased or increased by a change in
the method of recording equity in earnings or losses of subsidiaries. Currently
HC records the equity in earnings or losses of its subsidiaries as a component
of statutory net income. When codification becomes effective, the equity in
earnings or losses of subsidiaries
25
<PAGE>
will be recorded as an unrealized gain or loss which is a direct increase or
decrease to policyholders' surplus. Income will not be recognized until such
time (if any) that dividends are received from the subsidiaries and recorded in
statutory net income.
EMPLOYEES
As of December 31, 1998, the Company had 1,085 employees, which included
five executive officers, 51 senior management, 93 management and 936 other
personnel. Of this number, 241 were employed by the Company's insurance
subsidiaries, 587 were employed by the Company's underwriting agency
subsidiaries, 93 were employed by the Company's insurance intermediary
subsidiaries and 164 were employed by the Company's insurance services
subsidiaries. The Company is not a party to any collective bargaining agreement
and has not experienced work stoppages or strikes as a result of labor disputes.
The Company considers relations with its employees to be good.
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26
<PAGE>
ITEM 2. PROPERTIES
The Company's principal and executive offices are located in Houston, Texas,
in an approximately 52,000 square foot building owned by HC. HC also owns an
81,000 square foot building, acquired in 1998, adjacent to its home office
building. The Company also maintains sales and administration offices or other
facilities in over 30 locations elsewhere in the United States and in England,
Turkey and Jordan. The majority of these additional locations are in leased
facilities.
Principal office facilities of the Company, other than HC's owned
facilities, are as follows:
<TABLE>
<CAPTION>
SUBSIDIARY LOCATION SQUARE FOOT LEASE TERMINATION DATE
- ---------- ---------------------------- ----------- -----------------------
<S> <C> <C> <C>
LDG Re Wakefield, Massachusetts 34,000 October 31, 2001
AIC Frederick, Maryland 40,000 Owned
HCCA Dallas, Texas 36,000 February 28, 2004
HCCEB Houston, Texas 27,000 August 31, 2001 and
October 31, 2002
</TABLE>
ITEM 3. LEGAL PROCEEDINGS
The Company is a party to numerous claims and lawsuits which arise in the
normal course of its business. Many of the pending lawsuits involve claims under
policies underwritten or reinsured by the Company, the liabilities for which
management believes have been adequately included in its established loss
reserves. The Company believes the resolution of these lawsuits will not have a
material adverse effect on its financial condition, results of operations or
cash flows.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders during the
fourth quarter of 1998.
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27
<PAGE>
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
MARKET INFORMATION
The Company's Common Stock trades on the New York Stock Exchange ("NYSE")
under the ticker symbol "HCC".
The high and low sales prices for quarterly periods during the period
January 1, 1997 through December 31, 1998, as reported by the NYSE were as
follows:
<TABLE>
<CAPTION>
1998 1997
------------------ ------------------
<S> <C> <C> <C> <C>
HIGH LOW HIGH LOW
------- ------- ------- -------
First quarter............................................................. $23 15/16 $15 5/8 $29 1/2 $22 1/2
Second quarter............................................................ 23 11/16 19 5/8 28 5/8 21 1/2
Third quarter............................................................. 22 15/16 18 1/8 32 11/16 23 1/4
Fourth quarter............................................................ 21 1/4 16 1/16 29 3/8 18 1/8
</TABLE>
On March 19, 1999, the closing sales price of one share of the Company's
Common Stock as reported by the NYSE was $18 7/16.
SHAREHOLDERS
The Company has one class of authorized capital stock: 250,000,000 shares of
Common Stock, par value $1.00 per share. As of March 19, 1999, there were
48,809,264 shares of issued and outstanding Common Stock held by 1,629
shareholders of record; however, the Company believes there are in excess of
15,000 beneficial owners.
DIVIDENDS
Beginning in June, 1996, the Company announced a planned quarterly program
of paying cash dividends to shareholders. The Company paid a cash dividend in
July, 1996 of $0.02 per share and in each succeeding quarter until the first
quarter of 1997. The Company increased the quarterly cash dividend to $0.03 per
share in April, 1997 and to $0.04 per share beginning in April, 1998 and on
March 8, 1999 to $0.05 per share beginning in April, 1999. The Board of
Directors may review the Company's dividend policy from time to time, and any
determination with respect thereto will be made in light of regulatory and other
conditions then existing, including the Company's earnings, financial condition,
capital requirements, loan covenants, and other related factors. Under the terms
of the Company's March 8, 1999 Facility, the Company is prohibited from paying
dividends in excess of an agreed upon maximum amount in any fiscal year. Such
limitation will not affect the ability of the Company to pay dividends in a
manner consistent with its past practice and current expectations.
28
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA
The selected consolidated financial data set forth below has been derived
from the Consolidated Financial Statements. All information contained herein
should be read in conjunction with the Consolidated Financial Statements, the
related notes thereto and Management's Discussion and Analysis of Financial
Condition and Results of Operations included elsewhere in this Report.
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER,
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)(1)(4)
--------------------------------------------------------------
1998 1997 1996 1995 1994
------------ ------------ ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
STATEMENT OF EARNINGS DATA:
Revenue
Net earned premium............................. $ 143,100 $ 162,571 $ 170,068 $ 158,632 $ 121,422
Management fees................................ 74,045 51,039 28,651 25,373 21,208
Commission income.............................. 38,441 24,209 21,477 21,053 16,921
Net investment income.......................... 29,335 27,587 23,593 21,757 17,786
Net realized investment gain (loss)............ 845 (328) 8,341 1,636 434
Other operating income......................... 22,268 15,239 18,656 10,371 9,832
------------ ------------ ---------- ---------- ----------
Total revenue.............................. 308,034 280,317 270,786 238,822 187,603
Expense
Loss and LAE................................... 91,302 96,514 114,464 105,374 75,898
Operating expense
Policy acquisition costs..................... 10,978 13,580 8,218 10,634 9,470
Compensation expense......................... 56,077 51,458 42,102 48,162 41,728
Other operating expense...................... 36,063 31,628 26,382 26,540 21,429
Merger expense............................... 107 8,069 26,160 -- --
------------ ------------ ---------- ---------- ----------
Net operating expense...................... 103,225 104,735 102,862 85,336 72,627
Interest expense............................... 6,021 6,004 4,993 6,471 5,697
------------ ------------ ---------- ---------- ----------
Total expense.............................. 200,548 207,253 222,319 197,181 154,222
------------ ------------ ---------- ---------- ----------
Earnings before income tax provision........... 107,486 73,064 48,467 41,641 33,381
Income tax provision........................... 35,208 23,305 9,885 9,896 7,328
------------ ------------ ---------- ---------- ----------
Net earnings............................... $ 72,278 $ 49,759 $ 38,582 $ 31,745 $ 26,053
------------ ------------ ---------- ---------- ----------
------------ ------------ ---------- ---------- ----------
BASIC EARNINGS PER SHARE DATA:
Earnings per share (2)......................... $ 1.51 $ 1.06 $ 0.86 $ 0.75 $ 0.69
------------ ------------ ---------- ---------- ----------
------------ ------------ ---------- ---------- ----------
Weighted average shares outstanding (2)........ 47,920 46,995 44,795 42,577 37,970
------------ ------------ ---------- ---------- ----------
------------ ------------ ---------- ---------- ----------
DILUTED EARNINGS PER SHARE DATA:
Earnings per share (2)......................... $ 1.48 $ 1.03 $ 0.84 $ 0.74 $ 0.68
------------ ------------ ---------- ---------- ----------
------------ ------------ ---------- ---------- ----------
Weighted average shares outstanding (2)........ 48,936 48,209 46,043 43,113 38,529
------------ ------------ ---------- ---------- ----------
------------ ------------ ---------- ---------- ----------
Cash dividends declared, per share............... $ 0.16 $ 0.12 $ 0.06
------------ ------------ ----------
------------ ------------ ----------
</TABLE>
29
<PAGE>
<TABLE>
<CAPTION>
DECEMBER, 31
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)(1)(4)
--------------------------------------------------------------
1998 1997 1996 1995 1994
------------ ------------ ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Total investments................................ $ 525,646 $ 518,772 $ 468,725 $ 454,831 $ 348,259
Reinsurance recoverables......................... 372,672 176,965 132,328 117,700 116,365
Premium, claims and other receivables............ 382,630 252,618 168,300 155,164 133,822
Ceded unearned premium........................... 149,568 84,610 71,758 78,460 65,595
Total assets..................................... 1,709,069 1,198,132 965,793 896,476 752,798
Loss and LAE payable............................. 460,511 275,008 229,049 200,756 170,957
Unearned premium................................. 201,050 152,094 156,268 151,976 114,347
Total debt....................................... 121,600 80,750 72,917 71,628 99,508
Shareholders' equity............................. 439,863 365,601 296,524 255,484 168,760
Net tangible book value per share (2) (3)........ $ 7.29 $ 6.93 $ 6.20 $ 5.39 $ 3.88
Book value per share (2) (3)..................... $ 9.12 $ 7.66 $ 6.49 $ 5.70 $ 4.23
</TABLE>
- ------------------------
(1) On February 27, 1998, the Company acquired all of the outstanding stock of
Kachler. This business combination has been accounted for as
pooling-of-interests and, accordingly, the consolidated financial data shown
in this table has been restated to include the accounts and operations of
Kachler for all periods presented.
(2) These amounts have been adjusted to reflect the effects of the three-for-two
stock split payable as a 50% stock dividend to shareholders of record March
15, 1994, and the five-for-two stock split payable as a 150% stock dividend
to shareholders of record April 30, 1996.
(3) Book value per share is calculated by dividing shares outstanding into total
shareholders' equity. Net tangible book value per share uses total
shareholders' equity less goodwill as the numerator.
(4) Certain amounts in the 1997, 1996, 1995 and 1994 selected consolidated
financial data have been reclassified to conform to the 1998 presentation.
Such reclassifications had no effect on the Company's net earnings,
shareholders' equity, or cash flows.
30
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THIS REPORT ON FORM 10-K (THIS "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, LICENSING 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.
GENERAL
The Company's primary sources of revenue are earned premium and investment
income derived from its insurance company operations, management fees generated
from its underwriting agency operations, commission income produced by its
intermediary operations and other operating income. The Company's core
underwriting activities involve providing aviation, marine, offshore energy,
property, medical stop-loss, accident and health, workers' compensation and
lenders' single interest insurance, which is underwritten on both a direct and a
reinsurance basis, marketed directly by the Company and produced by independent
agents. Many of the Company's lines of business have relatively short lead times
between the occurrence of an insured event and the reporting of claims to the
Company.
During recent years, the Company has substantially increased its
shareholders' equity through the issuance of equity securities, incurrence of
debt, and earnings, thereby enabling it to increase the underwriting capacity of
its insurance company subsidiaries. The Company has utilized this additional
equity by increasing underwriting activity across many of its core lines of
business, emphasizing lines of business and individual opportunities with the
most favorable underwriting characteristics at a particular point in time. In
each line of business, as an insurer, the Company also cedes premium through the
purchase of reinsurance in types and amounts appropriate to the line of
business, market conditions and the Company's desired net risk retention
profile.
The Company's underwriting agency operations underwrite domestic general
aviation, medical stop-loss, occupational accident, workers' compensation,
accident and health insurance and reinsurance business.
The Company's intermediary operations also place insurance and reinsurance
for the Company's insurance company and underwriting agency operations and other
non-affiliated insurance companies and risk taking entities, as well as on
behalf of medium to large corporate clients.
31
<PAGE>
Since 1996, the Company has focused its acquisition activities on expanding
its underwriting agency and intermediary operations for three principal reasons.
Firstly is an attempt to increase the management fees and commission income
components of the Company's total revenue, which management believes to be a
more predictable and more stable source of revenue than the potential
underwriting gain from insurance company operations. Secondly, an effort to
insulate the Company from a decline in its net earnings growth rate as insurance
premium rates become more competitive in the lines of business in which the
Company specializes in and the Company becomes more selective in its
underwriting approach, resulting in reduced earned premium. Thirdly, to provide
a future source of premium revenue to the Company's insurance company
subsidiaries.
Operations whose revenue are included in other operating income consist of
insurance services operations which may support the Company's operations as well
as service unaffiliated customers. Additionally, this revenue includes revenue
from strategic operational investments and gains and losses from their
disposition. The Company may make such strategic operational investments from
time to time, generally in businesses that complement the Company's operations.
RESULTS OF OPERATIONS
The following table sets forth certain premium revenue information for the
three years ended December 31, 1998 (dollars in thousands):
<TABLE>
<CAPTION>
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
Direct..................................................................... $ 228,629 $ 177,728 $ 178,969
Reinsurance assumed........................................................ 269,647 168,671 158,309
----------- ----------- -----------
Gross written premium.................................................... 498,276 346,399 337,278
Reinsurance ceded.......................................................... (376,393) (203,546) (154,244)
----------- ----------- -----------
Net written premium...................................................... 121,883 142,853 183,034
Change in unearned premium................................................. 21,217 19,718 (12,966)
----------- ----------- -----------
Net earned premium......................................................... $ 143,100 $ 162,571 $ 170,068
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
The following table sets forth the relationships of certain income statement
items as a percent of total revenue for the three years ended December 31, 1998:
<TABLE>
<CAPTION>
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
Net earned premium................................................................ 46.5% 58.0% 62.8%
Management fees................................................................... 24.0 18.2 10.6
Commission income................................................................. 12.5 8.7 7.9
Net investment income............................................................. 9.5 9.8 8.7
Net realized investment gain (loss)............................................... 0.3 (0.1) 3.1
Other operating income............................................................ 7.2 5.4 6.9
----- ----- -----
Total revenue................................................................... 100.0 100.0 100.0
Loss and LAE...................................................................... 29.6 34.4 42.3
Net operating expense............................................................. 33.5 37.4 38.0
Interest expense.................................................................. 2.0 2.1 1.8
----- ----- -----
Earnings before income tax provision............................................ 34.9 26.1 17.9
Income tax provision.............................................................. 11.4 8.3 3.7
----- ----- -----
Net earnings.................................................................... 23.5% 17.8% 14.2%
----- ----- -----
----- ----- -----
</TABLE>
32
<PAGE>
YEAR ENDED DECEMBER 31, 1998 VERSUS YEAR ENDED DECEMBER 31, 1997
Total revenue increased 10% to $308.0 million in 1998 from $280.3 million in
1997. GWP increased 44% to $498.3 million in 1998 from $346.4 million in 1997,
due primarily to increased aviation, property and accident and health premium.
NWP for 1998 decreased to $121.9 million from $142.9 million in 1997, due to an
increase in the amount of ceded reinsurance. Net earned premium decreased to
$143.1 million in 1998 compared to $162.6 million in 1997 reflecting the
reduction in NWP and the reduced retentions of the Company. Management expects
GWP to increase significantly during 1999 primarily due to internal growth as
the Company's underwriting agency subsidiaries transfer business from
non-affiliated insurance companies to the Company's insurance company
subsidiaries. NWP will increase also, due to the increase in GWP, although at a
lower rate due to the continued low retention of risk. Net earned premium is
expected to decrease slightly in 1999, irrespective of the expected increase in
NWP, due to decreased retentions in 1998 which affect 1999 earned premium.
Management fees in 1998 increased 45% to $74.0 million from $51.0 million in
1997, reflecting internal growth and the acquisition of several underwriting
agencies during the period. The Company expects management fees to continue to
increase substantially during 1999 due to the effects of recent and future
acquisitions and internal growth.
Commission income increased to $38.4 million in 1998 from $24.2 million in
1997 an increase of 59%. The increase is a result of internal growth and a
number of large transactions. Commission income is expected to grow in 1999,
primarily as a result of the acquisition of RML in January, 1999.
Net investment income increased 6% to $29.3 million in 1998 from $27.6
million in 1997 reflecting a slightly higher level of investment assets. In
1998, the Company also utilized a substantial amount of its non-insurance
company subsidiary cash flow to reduce debt and therefore interest expense,
limiting the amount of cash subject to short-term investment. Management expects
to follow this strategy in 1999, which, together with expected lower interest
rates will produce investment income comparable to 1998.
Net realized investment losses from sales of equity securities were $166,000
during 1998, compared to losses of $154,000 in 1997. Net realized investment
gains from disposition of fixed income securities were $1.0 million during 1998,
compared to losses of $174,000 in 1997. The gains in 1998 resulted principally
from the sale of bonds upon the liquidation of IMG.
Other operating income increased from $15.2 million in 1997 to $22.3 million
in 1998, principally as a result of a $4.0 million pre-tax gain on the sale of
one of the Company's subsidiaries whose operations were not material to those of
the Company. Additionally, revenue of a service company subsidiary increased
$2.0 million in 1998.
Policy acquisition costs, which are net of ceding commissions on reinsurance
ceded, decreased $2.6 million or 19% between 1998 and 1997. The decrease
reflects a lower level of retained premium.
Operating earnings for 1998 were impacted by Hurricanes Georges and Mitch.
The gross loss from these hurricanes amounted to more than $50.0 million before
reinsurance, with Georges being the largest catastrophe loss ever incurred by
the Company. The net retained loss after reinsurance and taxes was $3.8 million,
or $0.08 per share. This catastrophe further demonstrates how the Company's
conservative reinsurance philosophy protects shareholders' equity and limits the
impact of a major catastrophe loss. To further mitigate against subsequent
catastrophes, the Company currently maintains lower retentions and anticipates
further reductions in overall catastrophe exposure in the future.
AIC, acquired in June, 1997, recorded a $10.0 million increase in loss and
LAE reserves during December, 1997, predominantly relating to 1995 and 1996
claims incurred prior to the Company's acquisition of AIC. This increase in
reserves was made to bring AIC's reserving practices consistent with the more
conservative method used by the Company's other insurance company operations.
Management
33
<PAGE>
expects the increase in AIC's loss reserves to be adequate to cover any
subsequent adverse development of AIC's prior losses.
Loss and LAE decreased $5.2 million in 1998, to $91.3 million, reflecting
the reduction in risk retention, despite the catastrophe loss in 1998 from the
Hurricanes Georges and Mitch. Excluding the effects of the catastrophe loss in
1998 and AIC's reserve strengthening in 1997, loss and LAE decreased $692,000
and the Company's GAAP loss ratio increased to 60.0% in 1998 from 53.2% in 1997.
Including these effects, the Company's GAAP loss ratio increased to 63.8% for
1998 from 59.4% in 1997. Both increases reflect the higher incurred losses and
LAE on substantially lower earned premium in 1998 when compared to 1997.
Additionally, the increased loss ratios reflect a general deterioration in
pricing in 1998 coupled with a higher frequency of attritional losses. The
Company's insurance company subsidiaries statutory combined ratio was 82.9% for
1998 compared to 78.8% for 1997. The Company's combined ratio remains
significantly better than the industry average.
During 1998, the Company had net loss and LAE redundancy of $14.6 million
relating to prior year losses compared to a redundancy of $3.8 million in 1997.
During 1998, the Company had gross loss and LAE deficiency of $33.5 million
compared to a deficiency of $23.2 million in 1997. The gross deficiency results
from the development of several large claims on individual policies which were
either reported late or reserves were increased as subsequent information became
available. However, as most of these policies were substantially reinsured,
there is no material effect to the Company's net earnings. The redundancies in
the net reserves result from the Company's and its actuaries' continued review
of its loss reserves and the reduction of such reserves as losses are finally
settled and claims exposures are reduced. The Company continues to believe it
has materially provided for all net incurred losses.
Compensation expense increased $4.6 million or 9% in 1998 to $56.1 million
due to the increase in personnel resulting from acquisitions completed during
1998, along with an increase in management personnel to oversee the operations
of the rapidly expanding group.
Other operating expense increased 14% to $36.1 million in 1998. These
expenses reflect increased expenditures required to meet the overall growth in
business and from acquisitions. Currency conversion gains amounted to $219,000
in 1998, compared to losses of $884,000 in 1997.
Merger expense represents non-recurring items incurred to consummate the
acquisitions and mergers which are accounted for as pooling-of-interests.
Income tax expense was $35.2 million in 1998, compared to $23.3 million in
1997. The Company's effective tax rate was 32.8% in 1998 compared to 31.9% in
1997. As net income from the underwriting agency and intermediary operations
grow, the Company's effective tax rate increases due to state income taxes and
the mitigation of the effect of tax exempt municipal bond income on the combined
effective tax rate.
Net earnings increased 45% to $72.3 million in 1998, from $49.8 million in
1997. Diluted earnings per share increased 44% to $1.48in 1998 from $1.03 in
1997.
YEAR ENDED DECEMBER 31, 1997 VERSUS YEAR ENDED DECEMBER 31, 1996
Total revenue increased to $280.3 million in 1997 from $270.8 million in
1996. GWP increased to $346.4 million in 1997 from $337.3 million in 1996, due
primarily to increased aviation and accident and health premium offset by
decreased property and marine premium. NWP for 1997 decreased to $142.9 million
from $183.0 million in 1996, due to an increase in the amount of ceded
reinsurance. Net earned premium decreased to $162.6 million in 1997 compared to
$170.1 million in 1996 reflecting the reduction in NWP and the reduced
retentions of the Company.
Management fees in 1997 increased 78% to $51.0 million from $28.7 million in
1996, reflecting internal growth and the acquisition of several underwriting
agencies in 1997. Commission income in 1997
34
<PAGE>
increased 13% to $24.2 million from $21.5 million in 1996, reflecting internal
growth. Net investment income increased 17% to $27.6 million in 1997 from $23.6
million in 1996 reflecting a higher level of investment assets.
Net realized investment losses from sales of equity securities were $154,000
during 1997, compared to gains of $8.3 million in 1996. During 1996, the Company
systematically liquidated the majority of its equity portfolio. Net realized
investment losses from disposition of fixed income securities were $174,000
during 1997, compared to gains of $29,000 in 1996.
During 1996, the Company sold one of its subsidiaries. This sale generated
an after tax gain of $2.2 million or $0.05 per share and is included in other
operating income.
Policy acquisitions costs, which are net of ceding commissions on
reinsurance ceded, increased $5.4 million or 65% between 1997 and 1996. The
increase reflects a higher average commission rate due to increase in the
accident and health line of business plus a $5.2 million ceded profit commission
in 1996 compared to $519,000 in 1997.
AIC, acquired in June, 1997, recorded a $10.0 million increase in loss and
LAE reserves during December, 1997, predominately relating to 1995 and 1996
claims incurred prior to the Company's acquisition of AIC. This increase in
reserves was made to bring AIC's reserving practices consistent with the more
conservative method used by the Company's other insurance company operations.
Management expects the increase in AIC's loss reserves to be adequate to cover
any subsequent adverse development of AIC's prior losses.
Loss and LAE decreased $18.0 million in 1997, to $96.5 million, reflecting
the increased use of reinsurance, despite the $10.0 million reserve
strengthening charge taken by AIC. During 1997, the Company had net loss and LAE
redundancy of $3.8 million relating to prior year losses compared to a
redundancy of $4.9 million in 1996. During 1997, the Company had gross loss and
LAE deficiency of $23.2 million compared to a deficiency of $42.5 million in
1996. The gross deficiency comes from two primary sources. Firstly, the
development of several large claims on individual policies which were either
reported late or reserves were increased as subsequent information became
available; however, as most of these policies were substantially reinsured,
there is no material effect to the Company's net earnings. Secondly, is the
run-off of the retrocessional excess of loss business which the Company
underwrote between 1988 and 1991. This development, $1.6 million in 1997
compared to $11.3 million in 1996, is primarily due to the delay in reporting of
catastrophe losses by the London insurance market, coupled with the
unprecedented number of catastrophes during the period in which the Company
underwrote this business. This business is also substantially reinsured, thereby
not having a material effect on the Company's net earnings.
Compensation expense increased $9.4 million or 22% in 1997, to $51.5 million
due to the increase in personnel resulting from acquisitions completed during
1997, along with an increase in management personnel to oversee the operations
of the rapidly expanding group.
Other operating expense increased 20% to $31.6 million in 1997. These
expenses reflect increased expenditures required to meet the overall growth in
business and from acquisitions. Currency conversion losses amounted to $884,000
in 1997, compared to losses of $181,000 in 1996.
Merger expense represents non-recurring items incurred to consummate the
acquisitions and mergers which are accounted for as pooling-of-interests. The
amounts incurred during 1996 were due to the combination with LDG and included a
compensatory stock grant of $24.0 million to certain key LDG employees
immediately prior to the merger.
Interest expense during 1997 increased 20% to $6.0 million from $5.0 million
during 1996 due to the increased level of indebtedness primarily to fund the
cash portion of acquisitions.
35
<PAGE>
Income tax expense was $23.3 million in 1997, compared to $9.9 million in
1996. The 1996 amount included a deferred tax benefit of $9.6 million which was
recorded in connection with the compensatory stock grant to certain key LDG
employees. The compensation expense was a non-cash item; however, $9.6 million
of actual cash tax savings will be recognized beginning from the grant date.
Most of the other merger expenses are not deductible for income tax purposes.
Also, as an S Corporation, LDG was exempt from Federal income taxes through May
21, 1996. Had LDG been subject to Federal income tax during the period January
1, 1996 to May 21, 1996, additional income tax expense of $2.3 million would
have been recorded in 1996.
Net earnings increased 29% to $49.8 million in 1997 from $38.5 million in
1996. Diluted earnings per share increased 23% to $1.03 in 1997 from $0.84 in
1996.
The Company's insurance company subsidiaries' statutory combined ratio was
78.8% for 1997 compared to 83.6% in 1996. The Company's combined ratio remains
significantly better than the industry average.
LIQUIDITY AND CAPITAL RESOURCES
The Company receives substantial cash from premiums, 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 LAE, payment of
premiums to reinsurers, purchase of investments, debt service, policy
acquisition costs, operating expenses, income and other taxes and dividends.
At December 31, 1998, several of the Company's subsidiaries maintained
revolving lines of credit with a bank in the combined maximum amount of $40.0
million available through December 30, 1999. Advances under the lines of credit
are primarily used to fund draws, if any, on letters of credit issued by the
bank on behalf of the subsidiaries. The lines of credit are collateralized by
securities having an aggregate market value of up to $50.0 million, the actual
amount of collateral at any one time being 125% of the aggregate amount
outstanding. Interest on the lines is payable at the bank's prime rate of
interest (7.75% at December 31, 1998). At December 31, 1998, letters of credit
totaling $19.8 million had been issued to insurance companies by the bank on
behalf of the subsidiaries, with total securities collateralizing the line of
$24.8 million.
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 $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
HC, AIC, and USSIC and by the pledge of stock 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 March 13, 1999, total debt outstanding under the Facility was $176.0
million with $150.0 million due under the $150.0 million Revolving Loan Facility
and $26.0 million due under the $100.0 million Short
36
<PAGE>
Term Revolving Loan Facility. The increase in debt subsequent to December 31,
1998 resulted from the funding of the purchase price of acquisitions.
The Company maintains a substantial level of cash and liquid short-term
investments which are used to meet anticipated payment obligations. As of
December 31, 1998, the Company had cash and short-term investments of
approximately $145.1 million. The Company's consolidated investment portfolio of
$525.6 million as of December 31, 1998 (of which $129.1 million is short-term
investments), is available to provide additional liquidity and cash for
operations.
Property and casualty insurance companies domiciled in the State of Texas
are limited in the payment of dividends to their shareholders in any 12 month
period, without the prior written consent of the Commissioner of Insurance, to
the greater of statutory net income or 10% of statutory policyholders' surplus.
HC paid no dividends to HCC in 1998. During 1999, HC's ordinary dividend
capacity will be approximately $38.2 million.
Under the laws of the State of Maryland, AIC may only pay dividends out of
statutory earned surplus. The maximum amount of dividends that AIC may pay
without prior regulatory approval in any 12 month period is the greater of its
statutory net income (under certain conditions) or 10% of its statutory
policyholders' surplus. The maximum amount at December 31, 1998 was $10.5
million.
The Company believes that its operating cash flows, short-term investments
and the Facility will provide sufficient sources of liquidity to meet its
anticipated needs for the foreseeable future.
At December 31, 1998, the Company had a net deferred tax asset of $3.4
million compared to $6.6 million at December 31, 1997. Due to the Company's
history of consistent earnings and expectations for the future, it is more
likely than not that the Company will be able to realize the benefit of its
deferred tax asset.
The overall increase in activities at the insurance company subsidiaries
resulted in increases in gross loss reserves, gross unearned premiums, deferred
policy acquisition costs and deferred ceding commissions since December 31,
1997. The Company continues to collect its receivables and recoverables
generally in the ordinary course and has not incurred and does not expect to
incur any significant liquidity difficulties as a result of the substantial
growth in gross amounts due. The Company limits any liquidity exposure it may
have by holding funds, letters of credit or other security such that net
balances due to it are significantly less than the gross balances shown in the
consolidated balance sheet.
As of December 31, 1998, each of the domestic insurance company
subsidiaries' total adjusted capital is significantly in excess of the NAIC
authorized control level risk-based capital.
Industry and regulatory guidelines suggest that a property and casualty
insurer's annual statutory GWP should not exceed 900% of its statutory
policyholders' surplus and NWP should not exceed 300% of its statutory
policyholders' surplus. The Company's insurance company subsidiaries maintain a
premium to surplus ratio significantly lower than such guidelines, and for the
year ended December 31, 1998, their annual statutory GWP was 135.6% of their
statutory policyholders' surplus and their NWP was 33.4% of their statutory
policyholders' surplus.
IMPACT OF INFLATION
The Company's operations, like those of other property and casualty
insurers, are susceptible to the effects of inflation, as premiums are
established before the ultimate amounts of loss and LAE are known. Although
management considers the potential effects of inflation when setting premium
rates, for competitive reasons, such premiums may not adequately compensate the
Company for the effects of inflation. However, as the majority of the Company's
business is comprised of lines which have short lead times between the
occurrence of an insured event, reporting of the claims to the Company and the
final settlement of the claims, the effects of inflation are minimized.
37
<PAGE>
A significant portion of the Company's revenue is related to healthcare
insurance and reinsurance products which are subject to the effects of the
underlying inflation of medical costs. Such inflation in the costs of healthcare
tends to generate increases in premiums for medical stop-loss coverage,
resulting in greater revenue, but also higher claim payments. Inflation may have
a negative impact on insurance and reinsurance operations by causing higher
claim settlements than may originally have been estimated without an immediate
increase in premiums to a level necessary to maintain profit margins. No express
provision for inflation is made, although trends are considered when setting
underwriting terms and claim reserves. Claim reserves are subject to a
continuing review process to assess their adequacy and are adjusted as deemed
appropriate. In addition, the market value of the investments held by the
Company varies depending on economic and market conditions and interest rates,
which are highly sensitive to the policies of governmental and regulatory
authorities. Any significant increase in interest rates could therefore have a
material adverse effect on the market value of the Company's investments. In
addition, the Company's $250.0 million Facility's interest rate floats with that
of the market. Any significant increase in interest rates could result in
increased interest costs under the Facility, which could have a material adverse
effect on earnings.
EXCHANGE RATE FLUCTUATIONS
The Company underwrites risks which are denominated in a number of foreign
currencies. It establishes and maintains loss reserves with respect to these
policies in their respective currencies. These reserves are subject to exchange
rate fluctuations which can have an effect on the Company's net earnings. The
Company's principal area of exposure is with respect to fluctuation in the
exchange rate between the major European currencies and the United States
Dollar. For the years ended December 31, 1998, 1997 and 1996, the gain (loss)
from currency conversion was $219,000, ($884,000) and ($181,000), respectively.
The Company's balances denominated in foreign currencies fluctuate as
transactions are recorded and settled. From time to time the Company has entered
into foreign currency forward contracts as a hedge against foreign currency
fluctuations. Such activity has been on a very limited basis in the past. The
Company did not hedge this risk in 1998 and there were no open foreign currency
forward contracts as of December 31, 1998. In the future, the Company may limit
its exposure to currency fluctuations through the use of foreign currency
forward contracts. The Company utilizes these foreign currency forward contracts
strictly as a hedge against existing exposure to foreign currency fluctuations
rather than as a form of speculative or trading investment.
EFFECTS OF RECENT ACCOUNTING PRONOUNCEMENTS
The Company adopted Statement of Financial Accounting Standards (SFAS") No.
130 entitled "Reporting Comprehensive Income" in 1998. This statement required
that all components of comprehensive income be reported in a full set of
financial statements and that the amount of total comprehensive income be
reported. Other comprehensive income includes gains and losses that are excluded
from net income, but are added to or deducted from net earnings in order to
calculate comprehensive income. Unrealized investment gains and losses of
investments and net unrealized gains and losses on foreign currency translation
are examples of such items.
The Company also adopted SFAS No. 131 entitled "Disclosures about Segments
of an Enterprise and Related Information" in 1998. This statement changed the
way the Company reports information about its operating segments. The agency
segment from prior years is now split into the underwriting agency and
intermediary segments. The corporate and other segment from prior years is now
split into two segments, other operations and corporate. Adoption of SFAS No.
131 had no effect on the Company's consolidated financial position, results of
operations or shareholders' equity.
SFAS No. 133 entitled "Accounting for Derivative Instruments and Hedging
Activities" was issued in June, 1998. The statement is effective for all fiscal
quarters and years beginning after June 15, 1999. The
38
<PAGE>
Company has utilized derivatives or hedging strategies only infrequently in the
past and in immaterial amounts, although it may do so more frequently in the
future as it expands its foreign operations. The Company is not a party to any
derivatives or hedging activities at December 31, 1998. The effect of the
Statement as well as the timing of its adoption are currently being reviewed by
management.
In December, 1997, the American Institute of Certified Public Accountants'
Accounting Executives Standards Committee ("AcSEC") issued Statement of Position
("SOP") 97-3, "Accounting by Insurance and Other Enterprises for
Insurance-Related Assessments," which provides guidance on accounting by all
entities that are subject to insurance-related assessments. It requires that
entities should recognize liabilities for insurance-related assessments when
certain specified criteria have been met. This SOP is effective for financial
statements for fiscal years beginning after December 15, 1998. 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 shareholders' equity.
In November, 1998, AcSEC issued SOP 98-7, "Deposit Accounting: Accounting
for Insurance and Reinsurance Contracts That Do Not Transfer Insurance Risk."
The SOP 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 shareholders' equity.
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 potential Year 2000 exposures. 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 discussion 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. Together with other companies in the insurance industry, the Company
has and continues to evaluate the potential insurance exposures arising from
Year 2000 problems or responses. 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 be 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.
39
<PAGE>
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.
During the two years ended December 31, 1998, the Company expensed $546,000
with respect to Year 2000 compliance and capitalized $6 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 $1.5 million which includes $1.2 million attributable
to the planned purchase and implementation of new systems. The cost of this new
software is being capitalized. The remaining estimated cost of $230,000 will be
expensed as incurred over the next twelve 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, where necessary, 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 a contingency plan for the remote possibility that there could be an
unforeseen Year 2000 failure. Such plan 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, and if the actual timing and
costs for the Company's Year 2000 remediation program differ materially from
those anticipated, the Company's financial results and financial condition 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,
results of operations, cash flows and financial condition.
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
40
<PAGE>
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.
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41
<PAGE>
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
The Company's principal assets and liabilities are financial instruments
which are subject to the market risk of potential losses from adverse changes in
market rates and prices. The Company's primary market risk exposures are:
interest rate risk on fixed income securities and interest expense on variable
rate debt, equity risk on marketable equity securities, credit risk on its
reinsurance recoverables and foreign currency exchange risk.
To manage its exposures of investment risks, the Company generally invests
in investment grade securities with characteristics of duration and liquidity to
reflect the underlying characteristics of its insurance liabilities. The Company
does not use derivatives to manage any of its investment related market risks.
Caution should be used in evaluating overall market risk from the
information below. Actual results could differ materially from estimates below
for a variety of reasons, including (but not limited to):
- Market changes could be different from market changes assumed below,
- Amounts and balances on which the estimates are based are likely to change
over time,
- Not all factors and balances are taken into account, and
- Assumptions used in the models may prove to be inaccurate.
INTEREST RATE RISK
The Company's portfolio of fixed income securities is inversely correlated
to changes in the market interest rates. In addition, some of the companies
fixed income securities have call or prepayment options, which could subject the
Company to reinvestment risk. Should interest rates fall, issuers call their
securities, and the Company reinvests the proceeds at lower interest rates. The
fair value of the Company's fixed income securities as of December 31, 1998 was
$393.2 million. If interest rates were to change 1%, the fair value of the
Company's fixed income securities would change approximately $21.9 million. The
change in fair value was determined using duration modeling assuming no
prepayments.
The Facility entered into by the Company is subject to variable interest
rates. Thus, the Company's interest expense is directly correlated to market
interest rates. As of March 31, 1999, the Company had $176.0 million in debt
outstanding. At this debt level, a 1% change in market interest rates would
change the Company's interest expense by $1.8 million.
EQUITY RISK
The Company's portfolio of marketable equity securities is subject to equity
price risk due to market changes. The fair value of the Company's marketable
equity securities (including those designated as strategic operational
investments) as of December 31, 1998 was $18.2 million. If the market price of
all marketable equity securities were to change by 10%, the fair value of the
Company's equity portfolio would change $1.8 million.
CREDIT RISK
See Reinsurance Ceded section contained in Item 1., Business, and Footnote
(8) in the Notes to Consolidated Financial Statements.
FOREIGN EXCHANGE RISK
The Company underwrites risks which are denominated in a number of foreign
currencies. It establishes and maintains loss reserves with respect to these
policies in their respective currencies, as well as having varying receivable
and payable balances at any point in time. These amounts are subject to
42
<PAGE>
exchange rate fluctuations which can have an effect on the Company's net
earnings. The Company's principal area of exposure is with respect to
fluctuation in the exchange rate between the major European currencies and the
United Sates Dollar.
The table below shows the net amounts of significant foreign currency
balances at December 31, 1998 converted to US Dollars. It also shows the
expected dollar change in fair value that would occur if exchange rates changed
10% from December 31, 1998 exchange rates.
<TABLE>
<CAPTION>
HYPOTHETICAL 10%
US DOLLAR CHANGE IN
EQUIVALENT FAIR VALUE
------------ ----------------
<S> <C> <C>
Great Britain Pound............................................................... $ 8,086,000 $ 809,000
11 Euro currencies................................................................ 2,296,000 230,000
</TABLE>
On a historical basis, the eleven national currencies which are now in the
process of being converted to the Euro have not always had their relative
exchange rates change together. However, with the fixing of exchange rates on
January 1, 1999, relative to the new Euro, these currencies will now behave as
one currency.
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. In the future, the Company may limit its exposure to currency
fluctuations through the use of foreign currency forward contracts. The Company
utilizes these foreign currency forward contracts strictly as a hedge against
existing exposure to foreign currency fluctuations rather than as a form of
speculative or trading investment.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated financial statements required in response to this section
are submitted as part of Item 14 of this report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURES
None.
43
<PAGE>
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
For information regarding Directors and Executive Officers of the
Registrant, reference is made to the Registrant's definitive proxy statement for
its Annual Meeting of Shareholders, which will be filed with the Securities and
Exchange Commission within 120 days after December 31, 1998, and which is
incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
For information regarding Executive Compensation, reference is made to the
Registrant's definitive proxy statement for its Annual Meeting of Shareholders,
which will be filed with the Securities and Exchange Commission within 120 days
after December 31, 1998, and which is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
For information regarding Security Ownership of Certain Beneficial Owners
and Management, reference is made to the Registrant's definitive proxy statement
for its Annual Meeting of Shareholders, which will be filed with the Securities
and Exchange Commission within 120 days after December 31, 1998, and which is
incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
For information regarding Certain Relationships and Related Transactions,
reference is made to the Registrant's definitive proxy statement for its Annual
Meeting of Shareholders, which will be filed with the Securities and Exchange
Commission within 120 days after December 31, 1998, and which is incorporated
herein by reference.
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44
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(A) EXHIBITS
The exhibits listed on the accompanying Index to Exhibits are filed as part
of this Report.
(B) FINANCIAL STATEMENT SCHEDULES
The financial statements and financial statement schedules listed in the
accompanying index are filed as part of this Report.
(C) REPORTS ON FORM 8-K
No reports on Form 8-K were filed by the Company during the fourth quarter
of 1998.
[THE REMAINDER OF THIS PAGE LEFT INTENTIONALLY BLANK]
45
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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)
By: /s/ STEPHEN L. WAY
------------------------------------------
(Stephen L. Way)
CHAIRMAN OF THE BOARD
Dated: March 31, 1999 AND CHIEF EXECUTIVE OFFICER
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
NAME TITLE DATE
- ------------------------------ --------------------------- -------------------
<C> <S> <C>
Chairman of the Board of
/s/ STEPHEN L. WAY Directors and Chief
- ------------------------------ Executive Officer March 31, 1999
(Stephen L. Way) (Principal Executive
Officer)
/s/ ARTHUR S. BERNER*
- ------------------------------ Director March 31, 1999
(Arthur S. Berner)
/s/ JAMES M. BERRY*
- ------------------------------ Director March 31, 1999
(James M. Berry)
/s/ FRANK J. BRAMANTI*
- ------------------------------ Director and Executive Vice March 31, 1999
(Frank J. Bramanti) President
/s/ PATRICK B. COLLINS*
- ------------------------------ Director March 31, 1999
(Patrick B. Collins)
/s/ J. ROBERT DICKERSON*
- ------------------------------ Director March 31, 1999
(J. Robert Dickerson)
Senior Vice President and
/s/ EDWARD H. ELLIS, JR. Chief Financial Officer
- ------------------------------ (Chief Accounting March 31, 1999
(Edward H. Ellis, Jr.) Officer)
/s/ EDWIN H. FRANK, III*
- ------------------------------ Director March 31, 1999
(Edwin H. Frank, III)
/s/ ALAN W. FULKERSON*
- ------------------------------ Director March 31, 1999
(Alan W. Fulkerson)
</TABLE>
46
<PAGE>
<TABLE>
<C> <S> <C>
/s/ WALTER J. LACK*
- ------------------------------ Director March 31, 1999
(Walter J. Lack)
/s/ STEPHEN J. LOCKWOOD*
- ------------------------------ Director and Vice Chairman March 31, 1999
(Stephen J. Lockwood)
/s/ JOHN N. MOLBECK, JR.
- ------------------------------ Director and President March 31, 1999
(John N. Molbeck, Jr.)
/s/ PETER B. SMITH, JR.*
- ------------------------------ Director and Executive Vice March 31, 1999
(Peter B. Smith, Jr.) President
</TABLE>
*By: /s/ JOHN N. MOLBECK,
JR.
------------------------- March 31, 1999
John N. Molbeck, Jr.,
ATTORNEY-IN-FACT
47
<PAGE>
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES
<TABLE>
<S> <C>
Reports of Independent Accountants................................................... F-1
Consolidated Balance Sheets at December 31, 1998 and 1997............................ F-3
Consolidated Statements of Earnings for the three years ended December 31, 1998...... F-4
Consolidated Statements of Comprehensive Income for the three years ended December
31, 1998........................................................................... F-5
Consolidated Statements of Changes in Shareholders' Equity for the three years ended
December 31, 1998.................................................................. F-6
Consolidated Statements of Cash Flows for the three years ended December 31, 1998.... F-9
Notes to Consolidated Financial Statements........................................... F-10
SCHEDULES:
Reports of Independent Accountants on Financial Statement Schedules....... S-1
Schedule 1 Summary of Investments other than Investments in Related Parties........ S-3
Schedule 2 Condensed Financial Information of Registrant........................... S-4
Schedule 3 Supplementary Insurance Information..................................... S-9
Schedule 4 Reinsurance............................................................. S-10
</TABLE>
Schedules other than those listed above have been omitted because they are
either not required, not applicable, or the required information is shown in the
Consolidated Financial Statements and related notes thereto.
48
<PAGE>
INDEX TO EXHIBITS
(ITEMS DENOTED BY A LETTER ARE INCORPORATED BY REFERENCE TO OTHER DOCUMENTS
PREVIOUSLY FILED WITH THE SECURITIES AND EXCHANGE COMMISSION AS SET FORTH AT THE
END OF THIS INDEX. ITEMS NOT DENOTED BY A LETTER ARE BEING FILED HEREWITH.)
<TABLE>
<CAPTION>
EXHIBIT
NUMBER
- ------------
<C> <S>
(A)3.4 --Bylaws of HCC Insurance Holdings, Inc., as amended.
(J)3.7 --Restated Certificate of Incorporation of HCC Holdings, Inc., filed with the Delaware Secretary of
State on July 23, 1996.
(A)4.1 --Specimen of Common Stock Certificate, $1.00 par value, of HCC Insurance Holdings, Inc.
(A)10.17 --Cost Allocation Agreement dated September 1, 1991, by and among HCC Holdings, A Texas Corporation,
Houston Casualty Company, Trafalgar Reinsurance Company Ltd., Houston Re Corporation and HCC
Underwriters, A Texas Corporation
(A)10.19 --Agreement for Allocation of Federal Income Tax dated November 29, 1991, by and among HCC Holdings,
Inc., Houston Casualty Company, SBS Insurance Holdings, Trafalgar Reinsurance Company, Ltd., HCC
Underwriters and Houston Re Corporation
(A)10.23 --HCC Insurance Holdings, Inc. 1992 Incentive Stock Option Plan
(A)10.24 --Program License Agreement dated April 29, 1992, by and between EPG America, Inc., and HCC Holdings,
Inc. pertaining to license for the computer services described therein
(B)10.227 --Loan Agreement dated August 24, 1993 in the original principal amount of $29,250,000 executed by HCC
Insurance Holdings, Inc., payable to First Interstate Bank of Texas, N.A. together with Promissory
Note and Commercial Pledge Agreement relating thereto.
(B)10.227.1 --Change in Loan Agreement dated February 7, 1994 between HCC Insurance Holdings, Inc. and First
Interstate Bank of Texas, N.A. relating to the $29,250,000 loan.
(B)10.228 --Promissory Note dated February 25, 1994 in the original principal amount of $12,000,000 executed by
Houston Casualty Company, payable to First Interstate Bank of Texas, N.A. together with Commercial
Pledge Agreement relating thereto.
(C)10.302 --Aircraft Dry Lease Agreement effective January 4, 1995 between SLW Aviation, Inc. and HCC Insurance
Holdings, Inc.
(C)10.303 --Stock Purchase Agreement effective January 1, 1994 between River Investments Limited and HCC
Underwriters, A Texas Corporation related to the acquisition of 25% of Middle East Insurance Brokers
Ltd.
(C)10.304 --Stock Purchase Agreement effective October 1, 1994 between various shareholders of Middle East
Insurance Brokers Ltd. and HCC Insurance Holdings, Inc. related to the acquisition of 75% of Middle
East Insurance Brokers Ltd.
(C)10.305 --Stock Purchase Agreement effective October 1, 1994 between various shareholders of International
Marine & General Insurance Company Ltd. and HCC Insurance Holdings, Inc. related to the acquisition
of 100% of International Marine & General Insurance Company Ltd.
(C)10.306 --Loan Agreement dated November 29, 1994 in the original principal amount of $20,000,000 executed by
HCC Insurance Holdings, Inc., payable to First Interstate Bank of Texas, N.A. together with the
Promissory Note.
</TABLE>
49
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER
- ------------
<C> <S>
(D)10.320 --Promissory note dated April 30, 1995, in the original principal amount of $12,000,000 executed by
Houston Casualty Company, payable to First Interstate Bank of Texas, N.A.
(E)10.324 --HCC Insurance Holdings, Inc. 1994 Non-employee Director Stock Option Plan.
(F)10.325 --HCC Insurance Holdings, Inc. 1995 Flexible Incentive Plan.
(H)10.326 --Agreement and Plan of Reorganization dated February 22, 1996 between various shareholders of LDG
Management Company Incorporated and affiliated companies and HCC Insurance Holdings, Inc. related to
the acquisition of 100% of the common stock of LDG Management Company Incorporated and affiliated
companies.
(I)10.327 --Agreement and Plan of Reorganization dated February 28, 1997 between Avemco Corporation and HCC
Insurance Holdings, Inc. related to the intent to merge in a stock for stock transaction.
(J)10.328 --HCC Insurance Holdings, Inc. 1996 Non-employee Director Stock Option Plan.
(K)10.329 --HCC Insurance Holdings, Inc. 1995 Flexible Incentive Plan.
(L)10.330 --Agreement and Plan of Reorganization dated November 27, 1996 between various shareholders of North
American Special Risk Associates and affiliated companies and HCC Insurance Holdings, Inc. related to
the acquisition of 100% of the common stock of North American Special Risk Associates, Inc. and
affiliated companies.
(L)10.331 --Agreement of Purchase and Sale dated January 23, 1997, between TRM International, Inc., Unicover
Manager, Inc., North American Special Risk Associates, Inc. and HCC Insurance Holdings, Inc.
(L)10.332 --Revolving Line of Credit Note dated October 7, 1996, in the original principal amount of $12,000,000
executed by Houston Casualty Company, payable to Wells Fargo Bank (Texas), National Association
together with Credit Agreement and General Pledge Agreement and Amendment relating thereto.
(L)10.333 --Revolving Line of Credit Note dated January 10, 1997, in the original principal amount of $10,000,000
executed by HCC Insurance Holdings, Inc., payable to Wells Fargo Bank (Texas), National Association
together with Credit Agreement and General Pledge Agreement relating thereto.
(N)10.334 --Agreement and Plan of Reorganization dated April 30, 1997 among Interworld Corporation, Aviation &
Marine Insurance Group, Inc., various shareholders of those companies and HCC Insurance Holdings,
Inc. related to the acquisition of 100% of the common stock of Interworld Corporation.
(O)10.335 --Stock Purchase Agreement dated June 27, 1997 between Sandra L. Ruder and HCC Insurance Holdings, Inc.
related to the purchase of 100% of the common stock of Managed Group Underwriting, Inc.
(P)10.336 --Stock Purchase Agreement dated July 31, 1997 between Continental Aviation Underwriters, Inc., the
shareholders thereof, and HCC Insurance Holdings, Inc. related to the purchase of 100% of the common
stock of Continental Aviation Underwriters, Inc.
(P)10.337 --Acquisition Agreement dated August 8, 1997 between Southern Aviation Insurance Underwriters, Inc.,
Aviation Claims Administrators, Inc., the shareholders thereof, and HCC Insurance Holdings, Inc.
related to the acquisition of 100% of the common stock of Southern Aviation Insurance Underwriters,
Inc. and Aviation Claims Administrators, Inc.
</TABLE>
50
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER
- ------------
<C> <S>
(P)10.338 --Line of Credit Agreements payable to Wells Fargo Bank (Texas), National Association executed by HCC
Insurance Holdings, Inc., Houston Casualty Company and IMG Insurance Company, Ltd. together with the
Credit Agreements and Security Agreements related thereto.
(Q)10.339 --Loan Agreement ($120,000,000 Revolving Loan Facility) dated as of December 19, 1997 among HCC
Insurance Holdings, Inc. as Borrower, Wells Fargo Bank (Texas), National Association, as Agent and as
a Lender, NationsBank of Texas, N.A. as Documentation Agent and as a Lender, and the Other Lenders'
Now or Hereafter Parties Thereto.
(R)10.340 --Agreement and Plan of Reorganization dated as of February 27, 1998 among HCC Insurance Holdings, Inc.
and various shareholders of The Kachler Corporation related to the acquisition of 100% of the common
stock of The Kachler Corporation.
(R)10.341 --Purchase Agreement dated as of February 28, 1998, among HCC Insurance Holdings, Inc., Bethany A.
Belanger, the partners of Guarantee Insurance Resources and others related to the acquisition of 100%
of the partnership assets and liabilities of Guarantee Insurance Resources and 100% of the common
stock of Insurance Alternatives, Inc.
(M)10.342 --HCC Insurance Holdings, Inc. 1997 Flexible Incentive Plan.
(S)10.343 --Agreement and Plan of Reorganization dated as of September 23, 1998 among HCC Insurance Holdings,
Inc.; The Kachler Corporation; J.E. Stone and Associates, Inc. and the shareholders of J.E. Stone and
Associates, Inc. related to the acquisition of 100% of the common stock of J.E. Stone and Associates,
Inc.
10.344 --Stock Purchase Agreement dated effective October 1, 1998 by and among HCC Insurance Holdings, Inc.,
and Sun Employer Services, Inc. and Howard V. Barton and Elizabeth A. Barton.
(T)10.345 --HCC Insurance Holdings, Inc. 1997 Flexible Incentive Plan, as amended.
(U)10.346 --HCC Insurance Holdings, Inc. 1996 Non-Employee Director Stock Option Plan, as restated and amended.
10.347 --Employment Agreement effective as of January 1, 1998, between HCC Insurance Holdings, Inc. and John
N. Molbeck, Jr..
10.348 --Employment Agreement effective as of January 1, 1998, between HCC Insurance Holdings, Inc. and
Stephen J. Lockwood.
10.349 --Employment Agreement effective as of January 1, 1998, between HCC Insurance Holdings, Inc. and Frank
J. Bramanti.
10.350 --Employment Agreement effective as of January 1, 1998, between HCC Insurance Holdings, Inc. and Peter
B. Smith.
(V)10.351 --Loan Agreement ($150,000,000 Revolving Loan Facility and $100,000,000 Short Term Revolving Loan
Facility) dated as of March 8, 1999 among HCC Insurance Holdings, Inc. as Borrower, Wells Fargo Bank
(Texas), National Association, as Agent and as Lender, Nationsbank, N.A., as Documentation Agent and
as a Lender, and The Other Lenders Now or Hereafter Parties Thereto.
12 --Statement Regarding Computation of Ratios
21 --Subsidiaries of HCC Insurance Holdings, Inc.
</TABLE>
51
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER
- ------------
<C> <S>
23 --Consent of Independent Accountants--PricewaterhouseCoopers LLP dated March 26, 1999
23.1 --Consent of Independent Accountants--KPMG LLP dated March 26, 1999--included at page S-2
24 --Powers of Attorney
27 --EDGAR Financial Data Schedule--December 31, 1998
27.1 --EDGAR Financial Data Schedule--Restated December 31, 1997 and 1996
</TABLE>
- ------------------------
(A)Incorporated by reference to the Exhibits to HCC Insurance Holdings,
Inc.'s Registration Statement (Registration No. 33-48737) filed October
27, 1992.
(B)Incorporated by reference to the Exhibits to HCC Insurance Holdings,
Inc.'s Form 10-K for the fiscal year ended December 31, 1993.
(C)Incorporated by reference to the Exhibits to HCC Insurance Holdings,
Inc.'s Form 10-K for the fiscal year ended December 31, 1994.
(D)Incorporated by reference to the Exhibits to HCC Insurance Holdings,
Inc.'s Form 10-Q for the fiscal quarter ended March 31, 1995.
(E)Incorporated by reference to the Exhibits to HCC Insurance Holdings,
Inc.'s Registration Statement on Form S-8 (Registration No. 33-94472)
filed July 11, 1995.
(F)Incorporated by reference to the Exhibits to HCC Insurance Holdings,
Inc.'s Registration Statement on Form S-8 (Registration No. 33-94468)
filed July 11, 1995.
(G)Incorporated by reference to the Exhibits to HCC Insurance Holdings,
Inc.'s Form 10-K for fiscal year ended December 31, 1995.
(H)Incorporated by reference to the Exhibits to HCC Insurance Holdings,
Inc.'s Registration Statement (Registration No. 333-3652) filed April 15,
1996.
(I)Incorporated by reference to the Exhibits to HCC Insurance Holdings, Inc.
Preliminary Registration Statement filed March 7, 1997.
(J)Incorporated by reference to the Exhibits to HCC Insurance Holdings,
Inc.'s Registration Statement on Form S-8 (Registration No. 333-14479)
filed October 18, 1996.
(K)Incorporated by reference to the Exhibits to HCC Insurance Holdings,
Inc.'s Registration Statement on Form S-8 (Registration No. 333-14471)
filed October 18, 1996.
(L)Incorporated by reference to the Exhibits to HCC Insurance Holdings,
Inc.'s Form 10-K for fiscal year ended December 31, 1996.
(M)Incorporatedby reference to Exhibit A to the HCC Insurance Holdings,
Inc.'s Proxy Statement for the May 22, 1997 Annual Meeting of
Shareholders filed April 30, 1997.
(N)Incorporated by reference to the Exhibits to HCC Insurance Holdings,
Inc.'s Form 10-Q for the fiscal quarter ended March 31, 1997.
(O)Incorporated by reference to the Exhibits to HCC Insurance Holdings,
Inc.'s Form 10-Q for the fiscal quarter ended June 30, 1997.
(P)Incorporated by reference to the Exhibits to HCC Insurance Holdings,
Inc.'s Form 10-Q for the fiscal quarter ended September 30, 1997.
52
<PAGE>
(Q)Incorporated by reference to the Exhibits to HCC Insurance Holdings,
Inc.'s Form 8-K filed January 6, 1998.
(R)Incorporated by reference to Exhibits to HCC Insurance Holdings, Inc.'s
Form 10-K for the fiscal year ended December 31, 1998.
(S)Incorporated by reference to the Exhibits to HCC Insurance Holdings,
Inc.'s Form 10-Q for the fiscal quarter ended September 30, 1998.
(T)Incorporated by reference to the Exhibit A to the HCC Insurance Holdings,
Inc. Proxy Statement for the May 21, 1998 Annual Meeting of Shareholders
filed April 24, 1998.
(U)Incorporated by reference to the Exhibit B to the HCC Insurance Holdings,
Inc. Proxy Statement for the May 21, 1998 Annual Meeting of Shareholders
filed April 24, 1998.
(V)Incorporated by reference to the Exhibit 10.1 to the HCC Insurance
Holdings, Inc. Form 8-K filed March 15, 1999.
53
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders of
HCC Insurance Holdings, Inc.
In our opinion, based on our audits and the report of the other auditors, the
accompanying consolidated balance sheets and the related consolidated statements
of earnings, comprehensive income, changes in shareholders' equity and cash
flows present fairly, in all material respects, the financial position of HCC
Insurance Holdings, Inc. and its subsidiaries at December 31, 1998 and 1997, and
the results of their operations and their cash flows for each of the three years
in the period ended December 31, 1998, in conformity with generally accepted
accounting principles. These financial statements are the responsibility of the
HCC Insurance Holding Inc.'s management; our responsibility is to express an
opinion on these financial statements based on our audits. We did not audit the
1996 consolidated financial statements of Avemco Corporation, which statements
reflect total revenues constituting 43.7 percent and net earnings constituting
24.0 percent of the related consolidated financial statement totals for the year
ended December 31, 1996. Those statements were audited by other auditors whose
report dated January 31, 1997 except for Note 12, of which the date is February
28, 1997 and except for Note 14, of which the date is February 18, 1998, has
been furnished to us, and our opinion, insofar as it relates to data included
for 1996 is based solely on the report of the other auditors. We conducted our
audits of these statements in accordance with generally accepted auditing
standards which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits and the report of the other auditors provide a reasonable basis for the
opinion expressed above.
PRICEWATERHOUSECOOPERS LLP
Houston, Texas
March 26, 1999
F-1
<PAGE>
REPORT OF INDEPENDENT AUDITORS'
The Board of Directors and Shareholder
Avemco Corporation:
We have audited the consolidated statements of income, stockholders' equity and
cash flows of Avemco Corporation and subsidiaries for the year ended December
31, 1996 (not included separately herein). These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement
presentation.We believe that our audit provides a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated results of operations of
Avemco Corporation and subsidiaries and their cash flows for the year ended
December 31, 1996, in conformity with generally accepted accounting principles.
KPMG LLP
Washington, D.C.
January 31, 1997
(February 28, 1997, as to note 12
and February 18, 1998, as to note 14)
F-2
<PAGE>
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------------
1998 1997
---------------- ----------------
<S> <C> <C>
ASSETS
Investments:
Fixed income securities, at market
(cost: 1998 $375,107,000; 1997 $395,121,000)............................. $ 393,238,000 $ 409,701,000
Marketable equity securities, at market
(cost: 1998 $1,750,000; 1997 $4,202,000)................................. 2,252,000 3,816,000
Short-term investments, at cost, which approximates market................. 129,084,000 105,255,000
Other investments, at cost, which approximates fair value.................. 1,072,000 --
---------------- ----------------
Total investments...................................................... 525,646,000 518,772,000
Cash......................................................................... 16,018,000 7,728,000
Restricted cash and cash investments......................................... 84,276,000 60,063,000
Reinsurance recoverables..................................................... 372,672,000 176,965,000
Premium, claims and other receivables........................................ 382,630,000 252,618,000
Ceded unearned premium....................................................... 149,568,000 84,610,000
Deferred policy acquisition costs............................................ 27,227,000 21,604,000
Property and equipment, net.................................................. 32,983,000 19,926,000
Goodwill..................................................................... 88,043,000 34,758,000
Other assets................................................................. 30,006,000 21,088,000
---------------- ----------------
TOTAL ASSETS........................................................... $ 1,709,069,000 $ 1,198,132,000
---------------- ----------------
---------------- ----------------
LIABILITIES
Loss and loss adjustment expense payable..................................... $ 460,511,000 $ 275,008,000
Reinsurance balances payable................................................. 90,983,000 43,914,000
Unearned premium............................................................. 201,050,000 152,094,000
Deferred ceding commissions.................................................. 30,842,000 19,553,000
Premium and claims payable................................................... 337,909,000 237,770,000
Notes payable................................................................ 121,600,000 80,750,000
Accounts payable and accrued liabilities..................................... 26,311,000 23,442,000
---------------- ----------------
Total liabilities...................................................... 1,269,206,000 832,531,000
SHAREHOLDERS' EQUITY
Common Stock, $1.00 par value; 250,000,000 shares authorized;
(issued: 1998 48,252,478 shares; 1997 47,758,929 shares)................... 48,252,000 47,759,000
Additional paid-in capital................................................... 162,102,000 154,633,000
Retained earnings............................................................ 219,804,000 155,209,000
Accumulated other comprehensive income....................................... 9,705,000 8,000,000
---------------- ----------------
Total shareholders' equity............................................. 439,863,000 365,601,000
---------------- ----------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY............................. $ 1,709,069,000 $ 1,198,132,000
---------------- ----------------
---------------- ----------------
</TABLE>
See Notes to Consolidated Financial Statements.
F-3
<PAGE>
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
----------------------------------------------
<S> <C> <C> <C>
1998 1997 1996
-------------- -------------- --------------
REVENUE
Net earned premium.............................................. $ 143,100,000 $ 162,571,000 $ 170,068,000
Management fees................................................. 74,045,000 51,039,000 28,651,000
Commission income............................................... 38,441,000 24,209,000 21,477,000
Net investment income........................................... 29,335,000 27,587,000 23,593,000
Net realized investment gain (loss)............................. 845,000 (328,000) 8,341,000
Other operating income.......................................... 22,268,000 15,239,000 18,656,000
-------------- -------------- --------------
Total revenue............................................. 308,034,000 280,317,000 270,786,000
EXPENSE
Loss and loss adjustment expense................................ 91,302,000 96,514,000 114,464,000
Operating expense:
Policy acquisition costs, net................................. 10,978,000 13,580,000 8,218,000
Compensation expense.......................................... 56,077,000 51,458,000 42,102,000
Other operating expense....................................... 36,063,000 31,628,000 26,382,000
Merger expense................................................ 107,000 8,069,000 26,160,000
-------------- -------------- --------------
Net operating expense..................................... 103,225,000 104,735,000 102,862,000
Interest expense................................................ 6,021,000 6,004,000 4,993,000
-------------- -------------- --------------
Total expense............................................. 200,548,000 207,253,000 222,319,000
-------------- -------------- --------------
Earnings before income tax provision...................... 107,486,000 73,064,000 48,467,000
Income tax provision............................................ 35,208,000 23,305,000 9,885,000
-------------- -------------- --------------
NET EARNINGS.............................................. $ 72,278,000 $ 49,759,000 $ 38,582,000
-------------- -------------- --------------
-------------- -------------- --------------
BASIC EARNINGS PER SHARE DATA:
Earnings per share.............................................. $ 1.51 $ 1.06 $ 0.86
-------------- -------------- --------------
-------------- -------------- --------------
Weighted average shares outstanding............................. 47,920,000 46,995,000 44,795,000
-------------- -------------- --------------
-------------- -------------- --------------
DILUTED EARNINGS PER SHARE DATA:
Earnings per share.............................................. $ 1.48 $ 1.03 $ 0.84
-------------- -------------- --------------
-------------- -------------- --------------
Weighted average shares outstanding............................. 48,936,000 48,209,000 46,043,000
-------------- -------------- --------------
-------------- -------------- --------------
</TABLE>
See Notes to Consolidated Financial Statements.
F-4
<PAGE>
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
-------------------------------------------
<S> <C> <C> <C>
1998 1997 1996
------------- ------------- -------------
Net earnings........................................................ $ 72,278,000 $ 49,759,000 $ 38,582,000
Other comprehensive income net of tax:
Foreign currency translation adjustment........................... (344,000) (215,000) 95,000
Investment gains (losses):
Investment gains (losses) during the year, net of deferred tax
charge (benefit) of $1,283,000 in 1998, $2,373,000 in 1997 and
($82,000) in 1996............................................. 2,598,000 4,470,000 (251,000)
Less reclassification adjustment for (gains) losses included in
net earnings, net of deferred tax (charge) benefit of
($296,000) in 1998, $115,000 in 1997 and ($2,919,000) in
1996.......................................................... (549,000) 213,000 (5,422,000)
------------- ------------- -------------
Other comprehensive income (loss)............................... 1,705,000 4,468,000 (5,578,000)
------------- ------------- -------------
COMPREHENSIVE INCOME............................................ $ 73,983,000 $ 54,227,000 $ 33,004,000
------------- ------------- -------------
------------- ------------- -------------
</TABLE>
See Notes to Consolidated Financial Statements.
F-5
<PAGE>
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
<TABLE>
<CAPTION>
ACCUMULATED
ADDITIONAL OTHER
COMMON PAID-IN RETAINED COMPREHENSIVE
STOCK CAPITAL EARNINGS INCOME
------------- -------------- -------------- -------------
<S> <C> <C> <C> <C>
BALANCE AS OF DECEMBER 31, 1995......................... $ 19,100,000 $ 137,588,000 $ 140,258,000 $ 9,110,000
Net earnings............................................ -- -- 38,582,000 --
Other comprehensive income (loss)....................... -- -- -- (5,578,000)
28,648,869 shares of Common Stock issued for 150% stock
dividend............................................... 28,649,000 (28,649,000) -- --
132,108 shares of Common Stock issued for exercise of
options, including tax benefit of $366,000............. 132,000 837,000 -- --
Cash dividends declared, $0.06 per share................ -- -- (2,104,000)
Compensatory grant of pooled company stock prior to
merger................................................. -- 23,682,000 -- --
Dividends to shareholders of pooled companies prior to
merger................................................. -- -- (7,705,000) --
Capitalize undistributed earnings of pooled company upon
conversion from S Corporation.......................... -- 3,840,000 (3,840,000) --
1,136,400 shares of Common Stock issued for
acquisition............................................ 1,136,000 -- (1,452,000) --
Repurchase of 520,000 shares of common stock by pooled
company prior to merger................................ -- -- -- --
Other................................................... -- 1,217,000 (1,607,000) --
------------- -------------- -------------- -------------
BALANCE AS OF DECEMBER 31, 1996..................... $ 49,017,000 $ 138,515,000 $ 162,132,000 $ 3,532,000
------------- -------------- -------------- -------------
------------- -------------- -------------- -------------
<CAPTION>
TOTAL
TREASURY SHAREHOLDERS'
STOCK EQUITY
-------------- --------------
<S> <C> <C>
BALANCE AS OF DECEMBER 31, 1995......................... $ (50,570,000) $ 255,486,000
Net earnings............................................ -- 38,582,000
Other comprehensive income (loss)....................... -- (5,578,000)
28,648,869 shares of Common Stock issued for 150% stock
dividend............................................... -- --
132,108 shares of Common Stock issued for exercise of
options, including tax benefit of $366,000............. -- 969,000
Cash dividends declared, $0.06 per share................ (2,104,000)
Compensatory grant of pooled company stock prior to
merger................................................. -- 23,682,000
Dividends to shareholders of pooled companies prior to
merger................................................. -- (7,705,000)
Capitalize undistributed earnings of pooled company upon
conversion from S Corporation.......................... -- --
1,136,400 shares of Common Stock issued for
acquisition............................................ -- (316,000)
Repurchase of 520,000 shares of common stock by pooled
company prior to merger................................ (7,909,000) (7,909,000)
Other................................................... 1,809,000 1,419,000
-------------- --------------
BALANCE AS OF DECEMBER 31, 1996..................... $ (56,670,000) $ 296,526,000
-------------- --------------
-------------- --------------
</TABLE>
See Notes to Consolidated Financial Statements.
F-6
<PAGE>
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY--(CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
<TABLE>
<CAPTION>
ACCUMULATED
ADDITIONAL OTHER
COMMON PAID-IN RETAINED COMPREHENSIVE
STOCK CAPITAL EARNINGS INCOME
------------- -------------- -------------- -------------
<S> <C> <C> <C> <C>
BALANCE AS OF DECEMBER 31, 1996......................... $ 49,017,000 $ 138,515,000 $ 162,132,000 $ 3,532,000
Net earnings............................................ -- -- 49,759,000 --
Other comprehensive income.............................. -- -- -- 4,468,000
726,898 shares of Common Stock issued for exercise of
options, including tax benefit of $1,725,000........... 727,000 9,743,000 -- --
1,332,024 shares of Common Stock issued for
acquisitions........................................... 1,332,000 9,805,000 (1,507,000) --
Cash dividends declared, $0.12 per share................ -- -- (5,219,000) --
Repurchase of 14,895 shares of common stock by pooled
company prior to merger................................ -- -- -- --
Retirement of 3,316,636 shares of treasury stock........ (3,317,000) (3,430,000) (50,247,000) --
Other................................................... -- -- 291,000 --
------------- -------------- -------------- -------------
BALANCE AS OF DECEMBER 31, 1997..................... $ 47,759,000 $ 154,633,000 $ 155,209,000 $ 8,000,000
------------- -------------- -------------- -------------
------------- -------------- -------------- -------------
<CAPTION>
TOTAL
TREASURY SHAREHOLDERS'
STOCK EQUITY
-------------- --------------
<S> <C> <C>
BALANCE AS OF DECEMBER 31, 1996......................... $ (56,670,000) $ 296,526,000
Net earnings............................................ -- 49,759,000
Other comprehensive income.............................. -- 4,468,000
726,898 shares of Common Stock issued for exercise of
options, including tax benefit of $1,725,000........... -- 10,470,000
1,332,024 shares of Common Stock issued for
acquisitions........................................... -- 9,630,000
Cash dividends declared, $0.12 per share................ -- (5,219,000)
Repurchase of 14,895 shares of common stock by pooled
company prior to merger................................ (324,000) (324,000)
Retirement of 3,316,636 shares of treasury stock........ 56,994,000 --
Other................................................... -- 291,000
-------------- --------------
BALANCE AS OF DECEMBER 31, 1997..................... $ -- $ 365,601,000
-------------- --------------
-------------- --------------
</TABLE>
See Notes to Consolidated Financial Statements.
F-7
<PAGE>
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY--(CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
<TABLE>
<CAPTION>
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 Consolidated Financial Statements.
F-8
<PAGE>
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
-----------------------------------------------
<S> <C> <C> <C>
1998 1997 1996
--------------- -------------- --------------
Cash flows from operating activities:
Net earnings.................................................. $ 72,278,000 $ 49,759,000 $ 38,582,000
Adjustments to reconcile net earnings to net cash provided by
operating activities:
Change in reinsurance recoverables.......................... (195,707,000) (70,972,000) (14,628,000)
Change in premium, claims and other receivables............. (102,804,000) (84,309,000) (13,084,000)
Change in ceded unearned premium............................ (64,958,000) (12,852,000) 6,702,000
Change in deferred policy acquisition costs, net............ 5,666,000 5,857,000 (3,379,000)
Change in deferred income tax, net of tax effect of
unrealized gain or loss................................... 2,381,000 3,475,000 (7,430,000)
Change in loss and loss adjustment expense payable.......... 181,626,000 45,959,000 28,293,000
Change in reinsurance balances payable...................... 47,069,000 24,800,000 (28,061,000)
Change in unearned premium.................................. 46,074,000 (4,174,000) 4,292,000
Change in premium and claims payable, net of restricted
cash...................................................... 64,364,000 98,952,000 2,483,000
Change in accounts payable and accrued liabilities.......... (9,205,000) (2,794,000) 248,000
Net realized investment (gain) loss......................... (845,000) 328,000 (8,341,000)
Other gains................................................. (4,694,000) -- (3,307,000)
Non-cash compensation expense............................... -- -- 24,176,000
Depreciation and amortization expense....................... 7,388,000 5,189,000 4,045,000
Other, net.................................................. 1,411,000 (5,101,000) (1,128,000)
--------------- -------------- --------------
Cash provided by operating activities..................... 50,044,000 54,117,000 29,463,000
Cash flows from investing activities:
Sales of fixed income securities.............................. 18,212,000 27,090,000 24,399,000
Maturity or call of fixed income securities................... 30,202,000 19,173,000 17,573,000
Sales of equity securities.................................... 4,160,000 17,656,000 41,202,000
Other proceeds................................................ 3,324,000 -- 13,957,000
Change in short-term investments.............................. (24,667,000) (26,562,000) (7,296,000)
Cash paid for companies acquired, net of cash
received.................................................... (33,011,000) (12,948,000) (1,753,000)
Cost of investments acquired.................................. (43,968,000) (87,084,000) (97,909,000)
Purchase of property and equipment and other.................. (15,320,000) (6,718,000) (2,762,000)
--------------- -------------- --------------
Cash used by investing activities......................... (61,068,000) (69,393,000) (12,589,000)
Cash flows from financing activities:
Proceeds from notes payable................................... 74,200,000 97,500,000 44,000,000
Sale of Common Stock.......................................... 2,203,000 10,470,000 969,000
Payments on notes payable..................................... (49,950,000) (89,667,000) (42,711,000)
Dividends paid................................................ (7,139,000) (4,550,000) (9,092,000)
Repurchase common stock....................................... -- (324,000) (7,909,000)
--------------- -------------- --------------
Cash provided (used) by financing activities.............. 19,314,000 13,429,000 (14,743,000)
--------------- -------------- --------------
Net change in cash........................................ 8,290,000 (1,847,000) 2,131,000
Cash at beginning of year................................. 7,728,000 9,575,000 7,444,000
--------------- -------------- --------------
Cash at end of year....................................... $ 16,018,000 $ 7,728,000 $ 9,575,000
--------------- -------------- --------------
--------------- -------------- --------------
</TABLE>
See Notes to Consolidated Financial Statements.
F-9
<PAGE>
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) GENERAL INFORMATION AND SIGNIFICANT ACCOUNTING AND REPORTING POLICIES
HCC Insurance Holdings, Inc. and its subsidiaries (collectively, "the
Company" or "HCC"), include domestic and foreign 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 worldwide, underwritten on both a direct and
reinsurance basis, in the aviation, marine, property, offshore energy, medical
stop-loss, accident and health, workers' compensation and lenders' single
interest lines of business. The principal insurance company subsidiaries are
Houston Casualty Company ("HC") in Houston, Texas, London, England and Amman,
Jordan; U.S. Specialty Insurance Company ("USSIC") in Houston, Texas; and Avemco
Insurance Company ("AIC") in Frederick, Maryland. The underwriting agency
subsidiaries provide underwriting management and claims servicing for insurance
and reinsurance companies, primarily in the medical stop-loss, accident and
health, workers' compensation and aviation lines of business. The principal
agency subsidiaries are LDG Reinsurance Corporation ("LDG Re") in Wakefield,
Massachusetts; HCC Aviation Insurance Group, Inc. ("HCCA") in Dallas, Texas and
Glendale, California; HCC Employer Services, Inc. ("HCCES") in Northbrook,
Illinois, Dallas, Texas and Montgomery, Alabama; and HCC Benefits Corporation
("HCCB") in Atlanta, Georgia, Wakefield, Massachusetts, Minneapolis, Minnesota
and Kansas City, Kansas. The intermediary subsidiaries provide brokerage,
consulting and other intermediary services to insurance and reinsurance
companies, commercial customers and individuals in the same lines of business as
the insurance company subsidiaries operate. The Company's principal intermediary
subsidiaries are HCC Intermediaries, Inc. ("HCCI") in Houston, Texas; HCC
Employee Benefits, Inc. ("HCCEB") in Houston, Texas; and Rattner Mackenzie
Limited ("RML") in London, England and Amman, Jordan. The service company
subsidiaries perform various insurance related services for insurance companies.
The preparation of financial statements in conformity with generally
accepted accounting principles ("GAAP") requires management to make estimates
and assumptions. This affects amounts reported in the financial statements and
the disclosure of contingent assets and liabilities. Actual results could differ
from those estimates.
A description of the significant accounting and reporting policies utilized
by the Company in preparing the consolidated financial statements is as follows:
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiaries. All significant intercompany balances and
transactions have been eliminated in consolidation. During February 1998, the
Company acquired all of the outstanding common stock of The Kachler Corporation
("Kachler") in a transaction accounted for as a pooling-of-interests. (See Note
2) The Company's financial statements have been restated to include the accounts
and operations of Kachler for all periods presented.
INVESTMENTS
Fixed income securities and marketable equity securities are classified as
available for sale and are carried at quoted market value, if readily
marketable, or at management's estimated fair value, if not readily marketable.
The change in unrealized gain or loss with respect to these securities is
recorded as a component of other comprehensive income, net of related deferred
income tax, if any. Fixed income securities available for sale are purchased
with the original intent to hold to maturity, but they may be available for sale
if market conditions warrant, or if the Company's investment policies dictate,
in order to
F-10
<PAGE>
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(1) GENERAL INFORMATION AND SIGNIFICANT ACCOUNTING AND REPORTING POLICIES
(CONTINUED)
maximize the Company's investment yield. Short-term investments and restricted
short-term investments are carried at cost, which approximates market value.
The realized gain or loss on investment transactions is determined on an
average cost basis and included in earnings on the trade date. When impairment
of the value of an investment is considered other than temporary, the decrease
in value is reported in earnings as a realized investment loss and a new cost
basis is established.
PROPERTY AND EQUIPMENT
Property and equipment are carried at cost, net of accumulated depreciation.
Depreciation expense is provided using the straight-line method over the
estimated useful lives of the related assets. Amortization of leasehold
improvements is provided using the straight-line method over the term of the
respective lease. Upon disposal of assets, the cost and related accumulated
depreciation are removed from the accounts and the resulting gain or loss is
included in earnings.
Costs incurred in developing or purchasing management information systems
are capitalized and included in property and equipment. These costs are
amortized over their estimated useful lives from the dates the systems are
placed in service.
EARNED PREMIUM, DEFERRED POLICY ACQUISITION COSTS AND CEDING COMMISSIONS OF
INSURANCE COMPANY SUBSIDIARIES
Written premium, net of reinsurance, is primarily included in earnings on a
pro rata basis over the lives of the related policies. However, for certain
types of business, it is recognized over the period of risk in proportion to the
amount of insurance risk provided. Policy acquisition costs, including
commissions, taxes, fees and other direct costs of underwriting policies, less
ceding commissions allowed by reinsurers, including expense allowances, are
deferred and charged or credited to earnings proportionate to the premium
earned. Historical and current loss and loss adjustment expense experience and
anticipated investment income are considered in determining the recoverability
of deferred policy acquisition costs.
MANAGEMENT FEES AND COMMISSION INCOME
Management fees and commission income are recognized on the revenue
recognition date, which is the later of the effective date of the policy, the
date when the premium can be reasonably estimated, or the date when
substantially all required services relating to the insurance placement have
been rendered to the client. Management fees and commission income relating to
additional or return premiums or other policy adjustments are recognized when
the events occur and the amounts become known or can be estimated.
PREMIUM AND OTHER RECEIVABLES
The Company has adopted the gross method for reporting receivables and
payables on brokered transactions. Management reviews the collectibility of its
receivables on a current basis and provides an allowance for doubtful accounts
if it deems that there are accounts which are doubtful of collection. The amount
of the allowance at December 31, 1998 and 1997, is not material.
F-11
<PAGE>
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(1) GENERAL INFORMATION AND SIGNIFICANT ACCOUNTING AND REPORTING POLICIES
(CONTINUED)
LOSS AND LOSS ADJUSTMENT EXPENSE PAYABLE OF INSURANCE COMPANY SUBSIDIARIES
Loss and loss adjustment expense payable is based on undiscounted estimates
of payments to be made for reported and incurred but not reported ("IBNR")
losses and anticipated salvage and subrogation receipts. Estimates for reported
losses are based on all available information, including reports received from
ceding companies on assumed business. Estimates for IBNR are based both on the
Company's and the industry's experience. While management believes that amounts
included in the accompanying financial statements are adequate, such estimates
may be more or less than the amounts ultimately paid when the claims are
settled. The estimates are continually reviewed and any changes are reflected in
current operations.
REINSURANCE
The Company records all reinsurance recoverables and ceded unearned premiums
as assets and deferred ceding commissions as a liability. All such amounts are
estimated and recorded in a manner consistent with the underlying reinsured
contracts. Management has recorded a reserve for uncollectible reinsurance based
on estimates of collectibility. The adverse economic environment in the
insurance industry has placed great pressure on reinsurers and the results of
their operations. These conditions could, ultimately, affect reinsurers'
solvency. Historically, there have been insolvencies following a period of
competitive pricing in the industry, such as the marketplace is experiencing
today. Therefore, while management believes that the reserve is adequate,
conditions can 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.
GOODWILL
In connection with the Company's acquisitions of subsidiaries accounted for
as purchases, the excess of cost over fair value of net assets acquired is being
amortized using the straight-line method over twenty years for acquired
underwriting agency and intermediary operations which operate in existing lines
of business and in the same country as existing operations. Goodwill related to
such acquired operations which represent the Company's initial entry into new
lines of business or new countries is amortized over thirty years. Goodwill
related to acquired insurance company operations is amortized over forty years.
Managements of the acquired businesses have successfully operated in their
markets for a number of years and, with the additional capital provided by the
Company, will be positioned to take advantage of increased opportunities.
Accumulated amortization of goodwill as of December 31, 1998 and 1997, was $5.2
million and $2.8 million, respectively.
The Company has no reason to expect major changes in the business conditions
in which the acquired companies operate which might affect the recoverability of
the recorded goodwill. However, in the event business conditions change, the
recoverability will be re-evaluated based upon revised projections of future
undiscounted operating income and cash flows and, if impaired, the balances will
be adjusted accordingly. Amortization of goodwill charged to income for the
years ended December 31, 1998, 1997 and 1996, was $3.0 million, $1.6 million and
$684,000, respectively.
F-12
<PAGE>
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(1) GENERAL INFORMATION AND SIGNIFICANT ACCOUNTING AND REPORTING POLICIES
(CONTINUED)
CASH AND SHORT-TERM INVESTMENTS
Cash consists of cash in banks, generally in operating accounts. The Company
classifies certificates of deposit, corporate demand notes receivable,
commercial paper and money market funds as short-term investments. Short-term
investments are classified as investments in the consolidated balance sheets as
they relate principally to the Company's investment activities.
The Company generally maintains its cash deposits in major banks and invests
its short-term investments with major banks and in investment grade commercial
paper and repurchase agreements. These securities typically mature within 90
days and, therefore, bear minimal risk. The Company has not experienced any
losses on its cash deposits or its short-term investments.
RESTRICTED CASH AND CASH INVESTMENTS
In conjunction with the management of reinsurance pools, the Company's
agency subsidiaries withhold premium funds for the payment of claims. These
funds are shown as restricted cash and cash investments in the consolidated
balance sheets. The corresponding liability is included within premium and
claims payable in the consolidated balance sheets. These amounts are considered
fiduciary funds, and interest earned on these funds accrues to the benefit of
the members of the reinsurance pools. Therefore, the Company does not include
these amounts as cash in the consolidated statements of cash flows.
FOREIGN CURRENCY TRANSLATION
The functional currency of most foreign subsidiaries and branches is the
United States dollar. Assets and liabilities recorded in foreign currencies are
translated into United States dollars at exchange rates in effect at the balance
sheet date. Transactions in foreign currencies are translated at the rates of
exchange in effect on the date the transaction occurs. Translation gains and
losses are recorded in earnings and included in other operating expenses. The
Company's foreign currency transactions are principally denominated in British
Pound Sterling ("GBP") and other European currencies. From time to time the
Company enters into foreign currency forward contracts as a hedge against
foreign currency fluctuations. Gains or losses in the market value of foreign
currency forward contracts are recognized in the statements of earnings
concurrently with the gains and losses on the hedged balances. For the years
ended December 31, 1998, 1997 and 1996, the gain (loss) from currency conversion
was $219,000, ($884,000) and ($181,000), respectively.
Some foreign subsidiaries or branches have a functional currency of either
the GBP or the Canadian Dollar ("CAD"). The cumulative translation adjustment,
representing the effect of translating these subsidiaries' or branches' assets
and liabilities into United States dollars, is included in the foreign currency
translation adjustment within accumulated other comprehensive income.
COMPUTER PRODUCTS AND SERVICES
Revenue from custom software products is recognized using the percentage of
completion method of accounting. Revenue from other software contracts is
recognized when delivery has occurred, other remaining vendor obligations are no
longer significant, and collectibility is probable. Revenue from the sale of
computer hardware is recognized when delivery has occurred. Maintenance support
is recognized
F-13
<PAGE>
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(1) GENERAL INFORMATION AND SIGNIFICANT ACCOUNTING AND REPORTING POLICIES
(CONTINUED)
pro rata over the term of the maintenance agreement. Revenue from such products
and services is included in other operating income.
Software production costs are capitalized when the technological feasibility
of a new product has been established. The capitalized costs are amortized based
upon current and future revenue for each product with a minimum of straight-line
amortization over the remaining estimated economic life of the product. All
other software development costs are expenses as incurred.
INCOME TAX
The companies file a consolidated Federal income tax return and include the
foreign subsidiaries' income to the extent required by law. Deferred income tax
is accounted for using the liability method, which reflects the tax impact of
temporary differences between the bases of assets and liabilities for financial
reporting purposes and such bases as measured by tax laws and regulations. A
company acquired in a pooling-of-interests transaction was an S Corporation
prior to the pooling. Therefore, Federal income tax expense was not provided for
that company's earnings until the S Corporation election was terminated on May
22, 1996.
EARNINGS PER SHARE
Basic earnings per share are based on the weighted average number of common
shares outstanding during the year divided into net earnings. Diluted earnings
per share are based on the weighted average number of common shares outstanding
plus the potential common shares outstanding during the year 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 outstanding due to
options. Contingent shares to be issued are included in the diluted earnings per
share computation only when the underlying conditions for issuance have been
met.
COMPREHENSIVE INCOME
The Company adopted Statement of Financial Accounting Standards ("SFAS") No.
130 entitled "Reporting Comprehensive Income" in 1998. This statement required
that all components of comprehensive income be reported in a full set of
financial statements and that the amount of total comprehensive income be
reported. Other comprehensive income includes gains and losses that are excluded
from net income, but are added to or deducted from net earnings in order to
calculate comprehensive income. Unrealized investment gains and losses of
investments and net unrealized gains and losses on foreign currency translation
are examples of such items.
SEGMENT REPORTING
The Company also adopted SFAS No. 131 entitled "Disclosures about Segments
of an Enterprise and Related Information" in 1998. This statement changed the
way the Company reports information about its operating segments. The agency
segment from prior years is now split into the underwriting agency and
intermediary segments. The corporate and other segment from prior years is now
split into two segments,
F-14
<PAGE>
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(1) GENERAL INFORMATION AND SIGNIFICANT ACCOUNTING AND REPORTING POLICIES
(CONTINUED)
other operations and corporate. Adoption of SFAS No. 131 had no effect on the
Company's consolidated financial position, results of operations or
shareholders' equity.
EFFECTS OF RECENT ACCOUNTING PRONOUNCEMENTS
SFAS No. 133 entitled "Accounting for Derivative Instruments and Hedging
Activities" was issued in June, 1998. The statement is effective for all fiscal
quarters and years beginning after June 15, 1999. The Company has utilized
derivatives or hedging strategies only infrequently in the past and in
immaterial amounts, although it may do so more frequently in the future as it
expands its foreign operations. The Company is not a party to any derivatives or
hedging activities at December 31, 1998. The effect of the Statement as well as
the timing of its adoption are currently being reviewed by management.
In December, 1997, the American Institute of Certified Public Accountants'
Accounting Executives Standards Committee ("AcSEC") issued Statement of Position
("SOP") 97-3, "Accounting by Insurance and Other Enterprises for
Insurance-Related Assessments," which provides guidance on accounting by all
entities that are subject to insurance-related assessments. It required that
entities should recognize liabilities for insurance-related assessments when
certain specified criteria have been met. This SOP is effective for financial
statements for fiscal years beginning after December 15, 1998. 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 shareholders' equity.
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 year 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 shareholders' equity.
RECLASSIFICATIONS
Certain amounts in the 1997 and 1996 consolidated financial statements and
the quarterly financial data (See Note 18) have been reclassified to conform
with the 1998 presentation and to reflect application of SFAS No. 130 and SFAS
No. 131. Such reclassifications had no effect on the Company's shareholders'
equity, net earnings or cash flows.
(2) ACQUISITIONS AND DISPOSITIONS
ACQUISITIONS
On February 27, 1998, the Company acquired all of the outstanding common
stock of The Kachler Corporation ("Kachler") in exchange for 1,600,000 shares of
the Company's common stock. The acquisition was accounted for as a
pooling-of-interests and, accordingly, the Company's consolidated financial
statements have been restated to reflect the combination. Total revenue and net
earnings of Kachler prior to the acquisition are immaterial in relation to the
Company's revenue and net earnings.
During 1998 the Company acquired four underwriting agency operations in
transactions accounted for under the purchase method of accounting. The total
consideration paid was 287,025 shares of the
F-15
<PAGE>
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(2) ACQUISITIONS AND DISPOSITIONS (CONTINUED)
Company's Common Stock and $48.2 million in cash. On a combined basis, the fair
value of assets acquired was $44.9 million and the fair value of liabilities
assumed was $46.2 million. Goodwill in the aggregate amount of $55.9 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.
In connection with one of the acquisitions, the Company will also issue up
to 378,000 shares of its common stock on a contingent basis assuming certain
future financial benchmarks are met. Contingent shares issued will be recorded
as additional consideration at the current fair value if and when the financial
benchmarks are met.
The following unaudited proforma summary presents information as if the 1998
purchase acquisitions had occurred at the beginning of each year after giving
effect to certain adjustments including amortization of goodwill, increased
interest expense from debt issued to fund the acquisitions and Federal income
taxes. The proforma summary is for information purposes only, does not
necessarily reflect the actual results that would have occurred, nor is it
necessarily indicative of future results of the combined companies. The
unaudited proforma summary information for companies acquired in 1997 in
purchase transactions is not presented due to immateriality.
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER
31,
------------------------------
<S> <C> <C>
1998 1997
-------------- --------------
UNAUDITED PROFORMA INFORMATION
Revenue.......................................................................... $ 322,263,000 $ 303,351,000
Net earnings..................................................................... 71,965,000 48,029,000
Basic earnings per share......................................................... 1.50 1.02
Diluted earnings per share....................................................... 1.47 1.00
</TABLE>
ACQUISITION SUBSEQUENT TO DECEMBER 31, 1998
The Company acquired the outstanding common stock of PEPYS Holdings Limited
and its operating subsidiary, Rattner Mackenzie Limited, effective January 1,
1999. The consideration consisted of 414,207 shares of the Company's Common
Stock to be paid over a four year period and cash consideration of $54.8
million, $8.3 million of which is to be paid over a four year period. According
to the terms of the transaction, the Company will issue additional cash
consideration if certain earnings benchmarks are exceeded during the next four
years. This acquisition will be accounted for under the purchase method of
accounting.
DISPOSITION SUBSEQUENT TO DECEMBER 31, 1998
In January, 1999, the Company sold its 21% interest in Underwriters
Indemnity Holdings, Inc. ("UIH"), the parent of Underwriters Indemnity Company,
for $8.2 million. The Company realized a pre-tax gain of $4.9 million in
connection with UIH's acquisition by RLI Corporation, an insurance holding
company. The Company's investment in UIH, which was accounted for by the equity
method, was not material to the Company's financial position and results of
operations.
F-16
<PAGE>
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(3) INVESTMENTS
Substantially all of the Company's fixed income securities are investment
grade; most are A rated or better. No high-yield corporate bonds are owned or
contemplated. The amortized cost, gross unrealized gain or loss and estimated
market value of investments in fixed income and marketable equity securities,
all of which are classified as available for sale, are as follows:
<TABLE>
<CAPTION>
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED MARKET
COST GAIN LOSS VALUE
-------------- ------------- ------------- --------------
<S> <C> <C> <C> <C>
December 31, 1998:
Marketable equity securities.................... $ 1,750,000 $ 502,000 $ -- $ 2,252,000
US Treasury securities.......................... 19,183,000 627,000 (37,000) 19,773,000
Obligations of states, municipalities and
political subdivisions........................ 354,663,000 18,257,000 (767,000) 372,153,000
Other fixed income securities................... 1,261,000 51,000 -- 1,312,000
-------------- ------------- ------------- --------------
Total securities.............................. $ 376,857,000 $ 19,437,000 $ (804,000) $ 395,490,000
-------------- ------------- ------------- --------------
-------------- ------------- ------------- --------------
December 31, 1997:
Marketable equity securities.................... $ 4,202,000 $ 140,000 $ (526,000) $ 3,816,000
Redeemable preferred stock...................... 788,000 7,000 -- 795,000
US Treasury securities.......................... 11,807,000 410,000 (3,000) 12,214,000
Obligations of states, municipalities and
political subdivisions........................ 382,108,000 14,883,000 (704,000) 396,287,000
Other fixed income securities................... 418,000 -- (13,000) 405,000
-------------- ------------- ------------- --------------
Total securities.............................. $ 399,323,000 $ 15,440,000 $ (1,246,000) $ 413,517,000
-------------- ------------- ------------- --------------
-------------- ------------- ------------- --------------
</TABLE>
The Company also has strategic operational investments (included in other
assets) which were purchased to provide partnering and other opportunities. Such
investments are accounted for in the same manner as other equity investments.
The cost, gross unrealized loss, and estimated market value of marketable equity
securities designated as strategic operational investments as of December 31,
1998 and 1997 are as follows:
<TABLE>
<CAPTION>
1998 1997
------------- -------------
<S> <C> <C>
Cost................................................................................ $ 18,842,000 $ 6,019,000
Gross unrealized loss............................................................... (2,900,000) (1,497,000)
------------- -------------
Estimated market value............................................................ $ 15,942,000 $ 4,522,000
------------- -------------
------------- -------------
</TABLE>
F-17
<PAGE>
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(3) INVESTMENTS (CONTINUED)
The amortized cost and estimated market value of fixed income securities at
December 31, 1998, by contractual maturity, are shown below. Expected maturities
may differ from contractual maturities because borrowers may have the right to
call or prepay obligations with or without call or prepayment penalties.
<TABLE>
<CAPTION>
ESTIMATED
AMORTIZED MARKET
COST VALUE
-------------- --------------
<S> <C> <C>
Due in 1 year or less............................................................ $ 7,752,000 $ 7,828,000
Due after 1 year through 5 years................................................. 146,452,000 151,878,000
Due after 5 years through 10 years............................................... 116,921,000 123,749,000
Due after 10 years through 15 years.............................................. 79,566,000 83,608,000
Due after 15 years............................................................... 24,416,000 26,175,000
-------------- --------------
Total fixed income securities................................................ $ 375,107,000 $ 393,238,000
-------------- --------------
-------------- --------------
</TABLE>
As of December 31, 1998, the Company's insurance company subsidiaries had
deposited fixed income securities with an amortized cost of approximately $19.8
million (market: $20.9 million) to meet the deposit requirements of various
insurance departments.
The sources of net investment income for the three years ended December 31,
1998, are detailed below:
<TABLE>
<CAPTION>
1998 1997 1996
------------- ------------- -------------
<S> <C> <C> <C>
Fixed income securities............................................. $ 20,711,000 $ 20,937,000 $ 19,140,000
Short-term investments.............................................. 8,079,000 5,680,000 3,906,000
Equity securities................................................... 35,000 572,000 1,106,000
Other............................................................... 607,000 445,000 18,000
------------- ------------- -------------
Total investment income........................................... 29,432,000 27,634,000 24,170,000
Investment expense.................................................. (97,000) (47,000) (577,000)
------------- ------------- -------------
Net investment income............................................. $ 29,335,000 $ 27,587,000 $ 23,593,000
------------- ------------- -------------
------------- ------------- -------------
</TABLE>
All investments in fixed income securities and other investments were income
producing for the twelve months preceding December 31, 1998.
F-18
<PAGE>
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(3) INVESTMENTS (CONTINUED)
Realized pre-tax gain (loss) on the sale of investments is as follows:
<TABLE>
<CAPTION>
GAIN LOSS NET
------------- ------------- -------------
<S> <C> <C> <C>
For the year ended December 31, 1998:
Fixed income securities............................................ $ 1,132,000 $ (121,000) $ 1,011,000
Marketable equity securities....................................... 245,000 (411,000) (166,000)
------------- ------------- -------------
Realized gain (loss)............................................. $ 1,377,000 $ (532,000) $ 845,000
------------- ------------- -------------
------------- ------------- -------------
For the year ended December 31, 1997:
Fixed income securities............................................ $ 68,000 $ (242,000) $ (174,000)
Marketable equity securities....................................... 113,000 (267,000) (154,000)
------------- ------------- -------------
Realized gain (loss)............................................. $ 181,000 $ (509,000) $ (328,000)
------------- ------------- -------------
------------- ------------- -------------
For the year ended December 31, 1996:
Fixed income securities............................................ $ 543,000 $ (514,000) $ 29,000
Marketable equity securities....................................... 9,002,000 (690,000) 8,312,000
------------- ------------- -------------
Realized gain (loss)............................................. $ 9,545,000 $ (1,204,000) $ 8,341,000
------------- ------------- -------------
------------- ------------- -------------
</TABLE>
Unrealized pre-tax net investment gains (losses) on investments for three
years ended December 31, 1998 is as follows:
<TABLE>
<CAPTION>
1998 1997 1996
------------- ------------- -------------
<S> <C> <C> <C>
Fixed income securities............................................ $ 3,551,000 $ 8,869,000 $ (2,451,000)
Marketable equity securities....................................... 888,000 (201,000) (6,223,000)
Strategic operational investments.................................. (1,403,000) (1,497,000) --
------------- ------------- -------------
Net unrealized investment gain (loss)............................ $ 3,036,000 $ 7,171,000 $ (8,674,000)
------------- ------------- -------------
------------- ------------- -------------
</TABLE>
(4) OPERATIONAL PROPERTY AND EQUIPMENT
The following table summarizes property and equipment at December 31, 1998
and 1997:
<TABLE>
<CAPTION>
ESTIMATED
1998 1997 USEFUL LIFE
-------------- -------------- ----------------
<S> <C> <C> <C>
Buildings and improvements..................................... $ 18,995,000 $ 13,291,000 30 to 45 years
Furniture, fixtures and equipment.............................. 13,752,000 13,334,000 3 to 10 years
Management information systems................................. 20,615,000 13,799,000 3 to 7 years
-------------- --------------
Total property and equipment............................... 53,362,000 40,424,000
Less accumulated depreciation and amortization................. (20,379,000) (20,498,000)
-------------- --------------
Property and equipment, net................................ $ 32,983,000 $ 19,926,000
-------------- --------------
-------------- --------------
</TABLE>
Depreciation and amortization expense on property and equipment was
approximately $4.4 million, $3.5 million and $3.4 million for the years ended
December 31, 1998, 1997 and 1996, respectively.
F-19
<PAGE>
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(5) NOTES PAYABLE
Notes payable as of December 31, 1998 and 1997 are shown in the table below.
The estimated fair value of the notes payable as of December 31, 1998 and 1997,
which is based on current rates offered to the Company for debt with similar
terms, approximates the carrying value.
<TABLE>
<CAPTION>
1998 1997
-------------- -------------
<S> <C> <C>
Acquisition note.................................................................. $ 16,600,000 $ --
Facility.......................................................................... 105,000,000 80,750,000
-------------- -------------
Total notes payable........................................................... $ 121,600,000 $ 80,750,000
-------------- -------------
-------------- -------------
</TABLE>
Effective December 30, 1997, the Company executed a $120.0 million revolving
credit facility ("Facility") with a group of banks. Borrowing under the Facility
may be made by the Company until the expiration of the Facility on December 30,
1999, at which time all principal is due. Outstanding loans under the Facility
bear interest at the Company's option of either the prime rate (7.75% at
December 31, 1998) or at the current London Interbank Offering Rate ("LIBOR")
(5.1% at December 31, 1998) plus 1%. The loan is collateralized in part by the
common stock of HC and AIC. The agreement contains restrictive covenants,
including minimum net worth requirements for the Company and certain
subsidiaries, restrictions on certain extraordinary corporate actions, notice
requirements for certain material occurrences and the maintenance of required
financial ratios.
The acquisition note is a note payable to the former owner of Sun. The note
bears interest at 6.4% and is due January 5, 1999. It was paid subsequent to
year end utilizing funds received from a draw on the Facility.
On March 8, 1999, the Company entered into a Loan Agreement (the "New
Facility") with a group of banks. The New Facility includes a $150.0 million
Revolving Loan Facility and $100.0 million Short Term Revolving Loan Facility.
Borrowing under the New 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 New
Facility bear interest at agreed upon rates. The New Facility is collateralized
in part by the pledge of the stock of HC, AIC, and USSIC and by the pledge of
stock and guaranties entered into by the Company's principal underwriting agency
and intermediary subsidiaries. The New 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 New Facility agreement are typical for financing
arrangements comparable to the New Facility. The initial funding available under
the New 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.
At December 31, 1998, several of the Company's subsidiaries maintained
revolving lines of credit with a bank in the combined maximum amount of $40.0
million available through December 30, 1999. Advances under the lines of credit
are limited to amounts required to fund draws, if any, on letters of credit
issued by the bank on behalf of the subsidiaries and short-term direct cash
advances. The lines of credit are collateralized by securities having an
aggregate market value of up to $50.0 million, the actual amount of
F-20
<PAGE>
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(5) NOTES PAYABLE (CONTINUED)
collateral at any one time being 125% of the aggregate amount outstanding.
Interest on the lines is payable at the bank's prime rate of interest (7.75% at
December 31, 1998). At December 31, 1998, letters of credit totaling $19.8
million had been issued to insurance companies by the bank on behalf of the
subsidiaries, with total securities of $24.8 million collateralizing the line.
(6) INCOME TAX
Several of the Company's foreign subsidiaries are not subject to foreign
income taxes and no material foreign income tax expense was incurred for the
three years ended December 31, 1998. United States Federal income taxes are
provided on all foreign earnings. As of December 31, 1998 and 1997, the Company
had income taxes receivable of $2.9 million and $3.7 million, respectively,
included in other assets in the consolidated balance sheets. For Federal income
tax purposes, one subsidiary has approximately $3.2 million of net operating
loss carry forwards which will expire in the year 2010. The components of the
income tax provision for the three years ended December 31, 1998, are as
follows:
<TABLE>
<CAPTION>
1998 1997 1996
------------- ------------- -------------
<S> <C> <C> <C>
Current............................................................. $ 32,498,000 $ 19,375,000 $ 17,720,000
Deferred:
Change in net deferred tax at current enacted tax rate............ 2,758,000 4,074,000 (7,835,000)
Change in deferred tax valuation allowance........................ (48,000) (144,000) --
------------- ------------- -------------
Total income tax provision...................................... $ 35,208,000 $ 23,305,000 $ 9,885,000
------------- ------------- -------------
------------- ------------- -------------
</TABLE>
The net deferred tax asset is included in other assets in the consolidated
balance sheets. The composition of deferred tax assets and liabilities as of
December 31, 1998 and 1997, is as follows:
<TABLE>
<CAPTION>
1998 1997
------------- -------------
<S> <C> <C>
Tax net operating loss carry forward............................................... $ 1,381,000 $ 4,806,000
Excess of financial unearned premium over tax...................................... 4,408,000 4,944,000
Effect of loss reserve discounting and salvage and subrogation accrual for tax..... 5,187,000 4,398,000
Bad debt and accrued expenses, deducted for financial over tax..................... 3,783,000 3,258,000
------------- -------------
Total assets................................................................... 14,759,000 17,406,000
Excess of financial over currently taxable earnings from foreign subsidiaries...... -- 821,000
Unrealized gain on increase in value of securities available for sale
(shareholders' equity)........................................................... 5,522,000 4,455,000
Deferred policy acquisition costs, net of ceding commissions, deductible for tax... 1,074,000 3,136,000
Amortizable goodwill............................................................... 1,011,000 598,000
Property and equipment depreciation and other items................................ 3,779,000 1,757,000
------------- -------------
Total liabilities.............................................................. 11,386,000 10,767,000
------------- -------------
Net deferred tax asset......................................................... $ 3,373,000 $ 6,639,000
------------- -------------
------------- -------------
</TABLE>
F-21
<PAGE>
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(6) INCOME TAX (CONTINUED)
Changes in the valuation allowance account applicable to the net deferred
tax asset for the three years ended December 31, 1998 are as follows:
<TABLE>
<CAPTION>
1998 1997 1996
---------- ---------- ---------
<S> <C> <C> <C>
Balance, beginning of year..................................................... $ 98,000 $ 54,000 $ --
Decrease credited to income.................................................... (48,000) (144,000) --
Valuation allowance acquired................................................... -- 188,000 54,000
---------- ---------- ---------
Balance, end of year....................................................... $ 50,000 $ 98,000 $ 54,000
---------- ---------- ---------
---------- ---------- ---------
</TABLE>
The following table summarizes the differences between the Company's
effective tax rate for financial statement purposes and the Federal statutory
rate for the three years ended December 31, 1998:
<TABLE>
<CAPTION>
1998 1997 1996
------------- ------------- -------------
<S> <C> <C> <C>
Statutory tax rate.................................................. 35.0% 35.0% 35.0%
Federal tax at statutory rate....................................... $ 37,620,000 $ 25,572,000 $ 16,963,000
Nontaxable municipal bond interest and dividends received
deduction......................................................... (5,753,000) (6,065,000) (5,792,000)
State income taxes.................................................. 3,521,000 2,242,000 102,000
Other, net.......................................................... (180,000) 1,556,000 (1,388,000)
------------- ------------- -------------
Income tax provision............................................ $ 35,208,000 $ 23,305,000 $ 9,885,000
------------- ------------- -------------
------------- ------------- -------------
Effective tax rate.............................................. 32.8% 31.9% 20.4%
------------- ------------- -------------
------------- ------------- -------------
</TABLE>
F-22
<PAGE>
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(7) SEGMENT AND GEOGRAPHIC DATA
The Company classifies its activities into four operating business segments
based upon services provided: 1) property and casualty insurance company
operations, 2) underwriting agency operations, 3) intermediary operations, and
4) other operations. See Note 1 for a description of the services provided by
and the principal subsidiaries included in the insurance company, underwriting
agency and intermediary segments. The other operations perform various insurance
related services for insurance company subsidiaries and unaffiliated insurance
companies. Also included in other operations is income from strategic
operational investments. Corporate includes general corporate operations, and
those minor operations not included in an operating segment. Inter-segment
revenue consists primarily of management fees of the underwriting agency
segment, commission income of the intermediary segment and service revenue of
the other operations charged to the insurance company segment on business
retained by the Company's insurance company subsidiaries. Inter-segment pricing
(either flat rate fees or as a percentage premium) approximates what is charged
to unrelated parties for similar services.
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
COMPANY AGENCY INTERMEDIARY OPERATIONS CORPORATE TOTAL
----------- ------------ ------------ ---------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
For the year ended December 31, 1998:
Revenue:
Domestic................................. $157,019,000 $79,908,000 $33,086,000 $20,495,000 $ 1,795,000 $292,303,000
Foreign.................................. 11,203,000 3,438,000 991,000 99,000 -- 15,731,000
Inter-segment............................ 478,000 2,298,000 1,876,000 1,365,000 16,000 6,033,000
----------- ------------ ------------ ---------- ----------- -----------
Total segment revenue.................. $168,700,000 $85,644,000 $35,953,000 $21,959,000 $ 1,811,000 314,067,000
----------- ------------ ------------ ---------- -----------
----------- ------------ ------------ ---------- -----------
Intersegment revenue..................... (6,033,000)
-----------
CONSOLIDATED TOTAL REVENUE............. $308,034,000
-----------
-----------
Net earnings:
Domestic................................. $32,942,000 $19,367,000 $16,262,000 $4,439,000 $(2,155,000) $70,855,000
Foreign.................................. 1,232,000 (155,000) 745,000 (399,000) -- 1,423,000
----------- ------------ ------------ ---------- ----------- -----------
TOTAL NET EARNINGS..................... $34,174,000 $19,212,000 $17,007,000 $4,040,000 $(2,155,000) $72,278,000
----------- ------------ ------------ ---------- ----------- -----------
----------- ------------ ------------ ---------- ----------- -----------
Other items:
Net investment income.................... $23,578,000 $3,949,000 $ 362,000 $ 545,000 $ 901,000 $29,335,000
Depreciation and amortization............ 1,884,000 4,093,000 271,000 429,000 711,000 7,388,000
Interest expense......................... (58,000) 1,963,000 91,000 -- 4,025,000 6,021,000
Income tax provision..................... 9,733,000 14,002,000 10,749,000 2,108,000 (1,384,000) 35,208,000
Capital expenditures..................... 10,405,000 2,685,000 660,000 205,000 1,365,000 15,320,000
</TABLE>
F-23
<PAGE>
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(7) SEGMENT AND GEOGRAPHIC DATA (CONTINUED)
<TABLE>
<CAPTION>
INSURANCE UNDERWRITING OTHER
COMPANY AGENCY INTERMEDIARY OPERATIONS CORPORATE TOTAL
----------- ------------ ------------ ---------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
For the year ended December 31, 1997:
Revenue:
Domestic................................. $170,943,000 $55,838,000 $18,335,000 $15,343,000 $ 1,188,000 $261,647,000
Foreign.................................. 14,967,000 2,590,000 967,000 146,000 -- 18,670,000
Inter-segment............................ -- 3,067,000 1,213,000 1,812,000 1,271,000 7,363,000
----------- ------------ ------------ ---------- ----------- -----------
Total segment revenue.................. $185,910,000 $61,495,000 $20,515,000 $17,301,000 $ 2,459,000 287,680,000
----------- ------------ ------------ ---------- -----------
----------- ------------ ------------ ---------- -----------
Intersegment revenue..................... (7,363,000)
-----------
CONSOLIDATED TOTAL REVENUE............. $280,317,000
-----------
-----------
For the year ended December 31, 1997:
Net earnings:
Domestic................................. $34,274,000 $13,186,000 $6,104,000 $1,755,000 $(12,299,000) $43,020,000
Foreign.................................. 6,333,000 90,000 987,000 (671,000) -- 6,739,000
----------- ------------ ------------ ---------- ----------- -----------
TOTAL NET EARNINGS..................... $40,607,000 $13,276,000 $7,091,000 $1,084,000 $(12,299,000) $49,759,000
----------- ------------ ------------ ---------- ----------- -----------
----------- ------------ ------------ ---------- ----------- -----------
Other items:
Net investment income.................... $23,379,000 $2,620,000 $ 322,000 $ 128,000 $ 1,138,000 $27,587,000
Depreciation and amortization............ 1,453,000 2,490,000 173,000 492,000 581,000 5,189,000
Interest expense......................... 3,000 33,000 -- -- 5,968,000 6,004,000
Income tax provision..................... 13,172,000 9,818,000 4,128,000 436,000 (4,249,000) 23,305,000
Capital expenditures..................... 2,838,000 3,416,000 76,000 168,000 296,000 6,794,000
The corporate net loss in 1997 included an after tax charge of $7.2 million with respect to merger expenses.
For the year ended December 31, 1996:
Revenue:
Domestic................................. $177,739,000 $35,467,000 $12,532,000 $17,820,000 $ 2,776,000 $246,334,000
Foreign.................................. 20,730,000 2,224,000 1,219,000 279,000 -- 24,452,000
Inter-segment............................ -- 4,139,000 646,000 1,689,000 1,363,000 7,837,000
----------- ------------ ------------ ---------- ----------- -----------
Total segment revenue.................. $198,469,000 $41,830,000 $14,397,000 $19,788,000 $ 4,139,000 278,623,000
----------- ------------ ------------ ---------- -----------
----------- ------------ ------------ ---------- -----------
Intersegment revenue..................... (7,837,000)
-----------
CONSOLIDATED TOTAL REVENUE............. $270,786,000
-----------
-----------
Net earnings:
Domestic................................. $33,427,000 $(2,965,000) $3,166,000 $4,455,000 $(4,694,000) $33,389,000
Foreign.................................. 6,151,000 (1,551,000) 874,000 (281,000) -- 5,193,000
----------- ------------ ------------ ---------- ----------- -----------
TOTAL NET EARNINGS..................... $39,578,000 $(4,516,000) $4,040,000 $4,174,000 $(4,694,000) $38,582,000
----------- ------------ ------------ ---------- ----------- -----------
----------- ------------ ------------ ---------- ----------- -----------
Other items:
Net investment income.................... $20,146,000 $1,798,000 $ 179,000 $ 91,000 $ 1,379,000 $23,593,000
Depreciation and amortization............ 1,583,000 1,356,000 39,000 418,000 649,000 4,045,000
Interest expense......................... (25,000) 47,000 1,000 1,000 4,969,000 4,993,000
Income tax provision..................... 14,936,000 (6,710,000) 2,572,000 597,000 (1,510,000) 9,885,000
Capital expenditures..................... 617,000 1,786,000 62,000 253,000 215,000 2,933,000
</TABLE>
Non-recurring compensation expense of $14.4 million (after tax) of a company
prior to its acquisition in a pooling-of-interests transaction caused a net loss
for the underwriting agency segment during 1996.
F-24
<PAGE>
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(7) SEGMENT AND GEOGRAPHIC DATA (CONTINUED)
The corporate net loss in 1996 also included an after-tax charge of $2.1 million
with respect to other merger expenses.
Assets by business segment and geographic location are shown in the
following table:
<TABLE>
<CAPTION>
INSURANCE UNDERWRITING OTHER
COMPANY AGENCY INTERMEDIARY OPERATIONS CORPORATE TOTAL
------------- ------------ ------------ ---------- ---------- -------------
<S> <C> <C> <C> <C> <C> <C>
December 31, 1998:
Domestic................... $1,074,738,000 4$31,619,000 $52,940,000 $30,519,000 $25,823,000 $1,615,639,000
Foreign.................... 60,702,000 27,084,000 5,644,000 -- -- 93,430,000
------------- ------------ ------------ ---------- ---------- -------------
TOTAL ASSETS............. $1,135,440,000 4$58,703,000 $58,584,000 $30,519,000 $25,823,000 $1,709,069,000
------------- ------------ ------------ ---------- ---------- -------------
------------- ------------ ------------ ---------- ---------- -------------
December 31, 1997:
Domestic................... $ 777,666,000 2$65,619,000 $4,688,000 $22,107,000 $30,316,000 $1,100,396,000
Foreign.................... 66,572,000 25,680,000 5,374,000 110,000 -- 97,736,000
------------- ------------ ------------ ---------- ---------- -------------
TOTAL ASSETS............. $ 844,238,000 2$91,299,000 $10,062,000 $22,217,000 $30,316,000 $1,198,132,000
------------- ------------ ------------ ---------- ---------- -------------
------------- ------------ ------------ ---------- ---------- -------------
</TABLE>
During the years ended December 31, 1998, 1997 and 1996, one broker in
London, England, produced gross written premium ("GWP") to the Company of
approximately $46.1 million, $42.8 million and $25.7 million, respectively. This
represents 10%, 12% and 7% of the Company's total GWP for those years.
The Company has insureds and/or reinsureds in approximately 100 countries
world-wide. The following table shows the geographical distribution of GWP
written by the domestic insurance company subsidiaries based on location of the
insureds and reinsureds for the three years ended December 31, 1998:
<TABLE>
<CAPTION>
1998 1997 1996
------------------------- ------------------------- -------------------------
GWP % GWP % GWP %
-------------- --------- -------------- --------- -------------- ---------
<S> <C> <C> <C> <C> <C> <C>
United States............................ $ 371,720,000 77% $ 224,833,000 68% $ 194,546,000 62%
Asia..................................... 29,568,000 6 13,869,000 4 7,235,000 2
Europe................................... 29,553,000 6 24,581,000 7 39,135,000 13
Central America.......................... 18,770,000 4 15,109,000 5 19,253,000 6
South America............................ 16,406,000 4 24,492,000 7 26,033,000 8
Other.................................... 14,872,000 3 28,447,000 9 29,290,000 9
-------------- --------- -------------- --------- -------------- ---------
Total GWP............................ $ 480,889,000 100% $ 331,331,000 100% $ 315,492,000 100%
-------------- --------- -------------- --------- -------------- ---------
-------------- --------- -------------- --------- -------------- ---------
</TABLE>
(8) 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 quota share, surplus, 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 participate in such agreements for the purpose of limiting their
loss exposure and diversifying their business. Substantially all of the
reinsurance assumed by the Company's insurance company subsidiaries was
underwritten directly by the Company but issued by other non-affiliated
companies in order to satisfy local licensing or other
F-25
<PAGE>
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(8) REINSURANCE (CONTINUED)
requirements. The following table represents 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 year ended December 31, 1998:
Direct business............................................... $ 228,629,000 $ 192,536,000 $ 202,858,000
Reinsurance assumed........................................... 269,647,000 260,539,000 292,063,000
Reinsurance ceded............................................. (376,393,000) (309,975,000) (403,619,000)
-------------- -------------- --------------
Net amounts................................................. $ 121,883,000 $ 143,100,000 $ 91,302,000
-------------- -------------- --------------
-------------- -------------- --------------
For the year ended December 31, 1997:
Direct business............................................... $ 177,728,000 $ 174,533,000 $ 126,861,000
Reinsurance assumed........................................... 168,671,000 180,339,000 165,831,000
Reinsurance ceded............................................. (203,546,000) (192,301,000) (196,178,000)
-------------- -------------- --------------
Net amounts................................................. $ 142,853,000 $ 162,571,000 $ 96,514,000
-------------- -------------- --------------
-------------- -------------- --------------
For the year ended December 31, 1996:
Direct business............................................... $ 178,969,000 $ 186,417,000 $ 122,940,000
Reinsurance assumed........................................... 158,309,000 146,606,000 105,085,000
Reinsurance ceded............................................. (154,244,000) (162,955,000) (113,561,000)
-------------- -------------- --------------
Net amounts................................................. $ 183,034,000 $ 170,068,000 $ 114,464,000
-------------- -------------- --------------
-------------- -------------- --------------
</TABLE>
Ceding commissions netted with policy acquisition costs in the consolidated
statements of earnings are $59.1 million, $45.5 million and $39.3 million for
the years ended December 31, 1998, 1997 and 1996, respectively.
The table below represents the composition of reinsurance recoverables in
the accompanying consolidated balance sheets:
<TABLE>
<CAPTION>
1998 1997
-------------- --------------
<S> <C> <C>
Reinsurance recoverable on paid losses....................... $ 33,572,000 $ 24,126,000
Reinsurance recoverable on outstanding losses................ 279,086,000 140,516,000
Reinsurance recoverable on IBNR.............................. 62,513,000 14,858,000
Reserve for uncollectible reinsurance........................ (2,499,000) (2,535,000)
-------------- --------------
Total reinsurance recoverables........................... $ 372,672,000 $ 176,965,000
-------------- --------------
-------------- --------------
</TABLE>
The insurance company subsidiaries require reinsurers not authorized by
their respective states of domicile to collateralize their reinsurance
obligations to the Company with letters of credit or cash deposits. At December
31, 1998, the Company held letters of credit and cash deposits in the amounts of
$166.5 million and $8.1 million, respectively, to collateralize a portion of the
total amount recoverable and had other payable balances due to its reinsurers of
$227.6 million as potential offsets against reinsurance
F-26
<PAGE>
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(8) REINSURANCE (CONTINUED)
recoverables.. The Company has established a reserve of $2.5 million as of
December 31, 1998, to absorb the effects of any recoverable problem.
In order to minimize its exposure to reinsurance credit risk, the Company
evaluates the financial condition of its reinsurers and places its reinsurance
with a diverse group of financially sound companies. The following table shows
reinsurance balances relating to the reinsurers with a total recoverable balance
greater than $10.0 million and the collateral and potential offsets held by the
Company as of each year end:
<TABLE>
<CAPTION>
LETTERS OF
REINSURANCE CREDIT,
RECOVERABLES AND CASH DEPOSITS
CEDED UNEARNED AND OTHER
REINSURER LOCATION PREMIUM PAYABLES
- --------------------------------------------------------- ------------------- ---------------- ----------------
<S> <C> <C> <C>
December 31, 1998:
Underwriters at Lloyd's................................ United Kingdom $ 93,280,000 $ 37,040,000
Underwriters Indemnity Company*........................ Texas 51,576,000 11,039,000
New Cap Reinsurance Corp. Ltd.......................... Australia 49,924,000 40,764,000
Reinsurance Australia Corporation, Ltd................. Australia 41,606,000 44,411,000
SCOR Reinsurance Company............................... New York 38,703,000 11,402,000
AXA Reinsurance Company................................ Delaware 28,667,000 10,513,000
GIO Insurance Limited.................................. Australia 24,011,000 25,158,000
Monegasque De Reassurances............................. Monaco 13,454,000 12,936,000
Overseas Partners Limited.............................. Bermuda 12,718,000 10,919,000
TIG Reinsurance Company................................ Connecticut 12,591,000 2,534,000
St. Paul Fire and Marine Insurance Co.................. Minnesota 12,278,000 4,349,000
December 31, 1997:
Underwriters at Lloyd's................................ United Kingdom $ 31,687,000 $ 17,778,000
Underwriters Indemnity Company......................... Texas 28,925,000 6,825,000
Reinsurance Australia Corporation, Ltd................. Australia 28,921,000 31,965,000
SCOR Reinsurance Company............................... New York 23,625,000 10,707,000
AXA Reinsurance Company................................ Delaware 21,004,000 7,790,000
GIO Insurance Limited.................................. Australia 18,610,000 20,551,000
New Cap Reinsurance Corporation, Ltd................... Australia 18,496,000 16,295,000
Reliance Insurance Company............................. Pennsylvania 10,991,000 1,553,000
</TABLE>
* Underwriters Indemnity Company was acquired by RLI Corporation, an insurance
holding company, in January, 1999.
Approximately $2.1 million in recoverables is due from reinsurers that are
either under regulatory supervision or insolvent. The Company holds letters of
credit and cash deposits totaling $1.9 million to collateralize these balances
plus other credits of $1.1 million available for potential offset. The Company
is involved in a dispute with one reinsurer over coverage and other issues. The
Company believes the reinsurer's position is without merit and all amounts due
from the reinsurer will be recovered. The total amount in dispute is
approximately $2.3 million.
F-27
<PAGE>
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(9) COMMITMENTS AND CONTINGENCIES
LITIGATION
The Company is a party to numerous lawsuits arising in the normal course of
business. Many of the pending lawsuits involve claims under policies
underwritten or reinsured by the Company. Management believes that any liability
for such claims has been adequately included in its established loss reserves.
The Company believes the resolution of these lawsuits will not have a material
adverse effect on its financial condition, results of operations or cash flows.
FOREIGN CURRENCY FORWARD CONTRACTS
The Company had no open foreign currency forward contracts as of December
31, 1998 or 1997. The Company may, from time to time, limit its exposure to
currency fluctuations through the use of foreign currency forward contracts. The
Company utilizes these foreign currency forward contracts strictly as a hedge
against existing exposure to foreign currency fluctuations rather than as a form
of speculative or trading investment.
LEASES
The Company leases administrative office facilities under long-term
non-cancelable operating lease agreements expiring at various dates through
November, 2005. The agreements generally require the payment of utilities, real
estate taxes, insurance and repairs. The Company has recognized rent expense on
a straight-line basis over the terms of these leases. In addition, the Company
leases computer equipment and automobiles under operating leases expiring at
various dates through the year 2002. Rent expense under these leases amounted to
$4.3 million, $3.7 million and $2.5 million for the years ended December 31,
1998, 1997 and 1996, respectively.
At December 31, 1998, future minimum annual rental payments required under
the long-term non-cancelable operating leases, excluding certain expenses
payable by the Company, are as follows:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31, AMOUNT DUE
- --------------------------------------------------------------------------------------------------- -------------
<S> <C>
1999..................................................................................... $ 4,716,000
2000..................................................................................... 4,459,000
2001..................................................................................... 3,952,000
2002..................................................................................... 2,694,000
2003..................................................................................... 2,549,000
Thereafter.................................................................................. 1,321,000
-------------
Total future minimum annual rental payments due.................................................... $ 19,691,000
-------------
-------------
</TABLE>
CATASTROPHE EXPOSURE
The Company writes business in areas exposed to catastrophic losses and has
significant exposures to this type of loss in California, the Atlantic Coast of
United States, certain United States Gulf Coast states, particularly Florida and
Texas, the Caribbean and Mexico. The Company assesses its overall exposures to a
single catastrophic event and applies procedures that it believes are more
conservative than are typically used by the industry to ascertain the Company's
probable maximum loss ("PML") from any single event.
F-28
<PAGE>
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(9) COMMITMENTS AND CONTINGENCIES (CONTINUED)
The Company maintains reinsurance protection which it believes is sufficient to
cover any foreseeable event.
(10) RELATED PARTY TRANSACTIONS
Certain of the Company's directors are officers, directors or owners of
business entities with which the Company transacts business. The Company also
owns a 21% interest in one of the entities. Balances with these business
entities and other related parties included in the accompanying consolidated
balance sheets are as follows:
<TABLE>
<CAPTION>
1998 1997
------------- -------------
<S> <C> <C>
Other investments.................................................................. $ 1,072,000 $ --
Reinsurance recoverables........................................................... 42,974,000 21,191,000
Premiums, claims and other receivables............................................. 4,986,000 2,677,000
Ceded unearned premium............................................................. 8,601,000 7,734,000
Strategic operational investments, included in other assets........................ 11,453,000 2,892,000
Loss and loss adjustment expense payable........................................... 3,863,000 661,000
Reinsurance balances payable....................................................... 6,337,000 5,564,000
Premium payable.................................................................... 560,000 1,754,000
Notes payable...................................................................... 16,600,000 --
Accounts payable and accrued liabilities........................................... 159,000 325,000
</TABLE>
Transactions with these business entities and other related parties included
in the accompanying consolidated statements of earnings are as follows:
<TABLE>
<CAPTION>
1998 1997 1996
------------- ------------- -------------
<S> <C> <C> <C>
Gross earned premium................................................ $ 1,716,000 $ 672,000 $ 871,000
Ceded earned premium................................................ 14,543,000 16,041,000 12,050,000
Commission income................................................... 1,544,000 1,267,000 1,249,000
Investment income................................................... 64,000 397,000 --
Other operating income.............................................. 968,000 8,000 --
Gross loss and loss adjustment expense.............................. 3,282,000 671,000 661,000
Ceded loss and loss adjustment expense.............................. 37,107,000 17,868,000 5,852,000
Other operating expense............................................. 840,000 807,000 1,011,000
Interest expense.................................................... 177,000 14,000 --
</TABLE>
Substantially all of the insurance related amounts shown on the above tables
are due to balances and transactions with Underwriters Indemnity Company. Its
parent was majority owned by a Director and was 21% owned by the Company. Its
parent was sold to an unrelated party (RLI Insurance Company) in January, 1999.
During 1997, the Company committed to invest $5.0 million in an investment
partnership managed by a related party. At December 31, 1998, $1.1 million had
been invested under this commitment. In 1998, HC bought an office building to be
occupied by the Company from a partnership in which an officer and director was
a partner. The purchase price of $6.0 million was based upon independent
appraisal.
F-29
<PAGE>
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(11) EMPLOYEE BENEFIT PLANS
The Company had various defined contribution retirement plans under Section
401(k) of the Internal Revenue Code which covered substantially all of the
domestic employees who met specified service requirements. All of these plans
were combined into one plan during 1998. The Company's contributions to these
plans were based on varying percentages of the employees' contributions, up to
varying maximum levels. The Company's contributions to the new combined plan are
discretionary and are determined by management as of the beginning of each
calendar year. The Company contributed $1.7 million, $858,000 and $997,000 to
the plans for the years ended December 31, 1998, 1997 and 1996, respectively,
which is included in compensation expense in the accompanying consolidated
statements of earnings.
A company acquired in a pooling-of-interests transaction in 1997 had a
non-contributory defined benefit retirement plan covering substantially all of
its employees who met specified age and service requirements. This plan was
terminated in 1997, upon acquisition, at which time the participants' accounts
became fully vested. In accordance with applicable regulations, the plan's
assets were distributed to participants during 1998 and January 1999. Total
pension expense (credit) under the plan amounted to $(604,000), $0, and
($590,000), for the years ended December 31, 1998, 1997 and 1996, respectively.
A curtailment gain of $1.0 million was recognized in the 1996 pension credit as
a result of the acquired company's decision to eliminate certain future service
time credits.
(12) SHAREHOLDERS' EQUITY
Under the Texas Insurance Code, HC and USSIC must each maintain minimum
statutory capital of $1.0 million and minimum statutory surplus of $1.0 million,
and can only pay dividends out of statutory surplus funds. In addition, they are
limited in the amount of dividends which they may pay in any twelve month
period, without prior regulatory approval, to the greater of statutory net
income for the prior calendar year or ten percent (10%) of statutory capital and
surplus as of the prior calendar year end. During 1999, HC and USSIC's ordinary
dividend capacities will be approximately $38.2 million and $7.9 million,
respectively.
AIC is limited by the state of Maryland in the amount of dividends which it
may pay in any twelve month period, without prior regulatory approval, to the
greater of statutory net income (under certain conditions) for the prior
calendar year or ten percent (10%) of statutory capital and surplus as of the
prior year end. During 1999, AIC's ordinary dividend capacity will be
approximately $10.5 million.
As of December 31, 1998, all of the domestic insurance company subsidiaries
total adjusted capital greatly exceeded the NAIC authorized control level
risk-based capital.
F-30
<PAGE>
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(12) SHAREHOLDERS' EQUITY (CONTINUED)
The components of accumulated other comprehensive income are as follows:
<TABLE>
<CAPTION>
UNREALIZED ACCUMULATED
FOREIGN INVESTMENT OTHER
CURRENCY GAIN COMPREHENSIVE
TRANSLATION (LOSS) INCOME (LOSS)
------------- ---------- --------------
<S> <C> <C> <C>
Balance December 31, 1995........................ $ (186,000) $9,296,000 $ 9,110,000
Net change for year.............................. 95,000 (5,673,000) (5,578,000)
------------- ---------- --------------
Balance December 31, 1996........................ (91,000) 3,623,000 3,532,000
Net change for year.............................. (215,000) 4,683,000 4,468,000
------------- ---------- --------------
Balance December 31, 1997........................ (306,000) 8,306,000 8,000,000
Net change for year.............................. (344,000) 2,049,000 1,705,000
------------- ---------- --------------
Balance December 31, 1998........................ $ (650,000) $10,355,000 $ 9,705,000
------------- ---------- --------------
------------- ---------- --------------
</TABLE>
(13) STOCK OPTIONS
The Company has five option plans, the 1994 Non-employee Director Stock
Option Plan, the 1996 Non-employee Director Stock Option Plan, the 1992
Incentive Stock Option Plan, the 1995 Flexible Incentive Plan, and the 1997
Flexible Incentive Plan. All plans are administered by the Compensation
Committee of the Board of Directors. Each option may be used to purchase one
share of Common Stock of the Company. As of December 31, 1998, 7,529,103 shares
of Common Stock were reserved for the exercise of options, of which 5,459,766
shares were reserved for options previously granted and 2,069,337 shares were
reserved for future issuances of options.
Options vest over a zero to five year period and expire six to ten years
after grant date. All options have been granted at fixed exercise prices,
generally at the market price of the Company's Common Stock on the grant date.
Any excess of the market price on the grant date over the exercise price is
recognized as compensation expense in the accompanying consolidated financial
statements. During 1996, such compensation expense amounted to $494,000. If the
fair value method of valuing compensation related to options would have been
used, pro forma net earnings and pro forma diluted earnings per share would have
been $65.4 million, or $1.34 per share for the year ended December 31, 1998;
$43.8 million, or $0.91 per share, for the year ended December 31, 1997; and
$37.6 million, or $0.82 per share, for the year ended December 31, 1996. The
fair value of each option grant was estimated on the grant date using the Black-
Scholes single option pricing model with the following weighted average
assumptions:a) risk free interest rate of 5.3% for 1998, 6.2% for 1997 and 5.6%
for 1996, b) expected volatility factor of .3, c) dividend yield of .91% for
1998, .56% for 1997 and .3% for 1996, and d) expected option life of five years
for 1998 and 1997 and six years for 1996.
F-31
<PAGE>
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(13) STOCK OPTIONS (CONTINUED)
Stock option activity is shown below.
<TABLE>
<CAPTION>
1998 1997 1996
------------------------------------ ------------------------------------ -----------------------
AVERAGE AVERAGE AVERAGE
NUMBER OF EXERCISE AVERAGE NUMBER OF EXERCISE AVERAGE NUMBER OF EXERCISE
SHARES PRICE FAIR VALUE SHARES PRICE FAIR VALUE SHARES PRICE
---------- ----------- ----------- ---------- ----------- ----------- ---------- -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Outstanding, beginning of
year......................... 3,508,226 $ 16.22 3,124,793 $ 13.03 2,935,863 $ 11.71
Granted at market value........ 2,779,500 17.01 $ 5.23 1,301,500 22.88 $ 7.98 292,500 23.63
Granted below market value..... -- -- -- -- -- -- 60,000 13.01
Cancelled...................... (192,462) 21.48 (123,700) 24.37 (12,250) 11.51
Exercised...................... (635,498) 14.05 (530,542) 12.80 (120,420) 4.52
Pooled company option activity
prior to combination:
Granted at market value........ -- -- -- -- -- -- 45,600 15.25
Cancelled...................... -- -- (1,375) 15.84 (61,850) 20.02
Exercised...................... -- -- (262,450) 16.00 (14,650) 8.54
---------- ----------- ---------- ----------- ---------- -----------
Outstanding, end of year....... 5,459,766 $ 16.73 3,508,226 $ 16.22 3,124,793 $ 13.03
---------- ----------- ---------- ----------- ---------- -----------
---------- ----------- ---------- ----------- ---------- -----------
Exercisable, end of year....... 2,792,707 $ 15.92 1,230,145 $ 11.60 1,491,792 $ 12.72
---------- ----------- ---------- ----------- ---------- -----------
---------- ----------- ---------- ----------- ---------- -----------
<CAPTION>
AVERAGE
FAIR
VALUE
---------
<S> <C>
Outstanding, beginning of
year.........................
Granted at market value........ $ 9.87
Granted below market value..... 11.51
Cancelled......................
Exercised......................
Pooled company option activity
prior to combination:
Granted at market value........ 4.69
Cancelled......................
Exercised......................
Outstanding, end of year.......
Exercisable, end of year.......
</TABLE>
Options outstanding at December 31, 1998, are shown on the following
schedule:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
----------------------------------------
AVERAGE -----------------------
REMAINING AVERAGE AVERAGE
NUMBER OF CONTRACTUAL EXERCISE NUMBER OF EXERCISE
RANGE OF EXERCISE PRICES SHARES LIFE PRICE SHARES PRICE
- ---------------------------------------------------------- ---------- --------------- ----------- ---------- -----------
<S> <C> <C> <C> <C> <C>
Under $16.50.............................................. 1,498,691 5.30 years $ 9.73 1,197,163 $ 9.48
$16.50.................................................... 1,564,500 5.05 16.50 240,000 16.50
$16.51-$22.25............................................. 1,025,525 6.51 18.71 409,025 18.24
Over $22.25............................................... 1,371,050 7.85 23.17 946,519 22.90
---------- --------------- ----------- ---------- -----------
Total options............................................. 5,459,766 6.09 years $ 16.73 2,792,707 $ 15.92
---------- --------------- ----------- ---------- -----------
---------- --------------- ----------- ---------- -----------
</TABLE>
F-32
<PAGE>
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(14) EARNINGS PER SHARE
The following table provides reconciliation of the denominators used in the
earnings per share calculations for the three years ended December 31, 1998:
<TABLE>
<CAPTION>
1998 1997 1996
------------- ------------- -------------
<S> <C> <C> <C>
Net earnings........................................................ $ 72,278,000 $ 49,759,000 $ 38,582,000
------------- ------------- -------------
------------- ------------- -------------
Reconciliation of number of shares outstanding:
Shares of Common Stock outstanding at year end...................... 48,252,000 47,759,000 45,715,000
Changes in Common Stock due to issuance............................. (332,000) (764,000) (920,000)
------------- ------------- -------------
Weighted average Common Stock outstanding......................... 47,920,000 46,995,000 44,795,000
Additional dilutive effect of outstanding options (as determined by
the application of the treasury stock method)..................... 1,016,000 1,214,000 1,248,000
------------- ------------- -------------
Weighted average Common Stock and potential common stock
outstanding..................................................... 48,936,000 48,209,000 46,043,000
------------- ------------- -------------
------------- ------------- -------------
</TABLE>
As of December 31, 1998, 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 in connection with an acquisition accounted for under
the purchase method of accounting, 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.
F-33
<PAGE>
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(15) STATUTORY TO GAAP RECONCILIATIONS
Reconciliations of statutory policyholders' surplus as of December 31, 1998
and 1997, and net income for the three years ended December 31, 1998, of the
Company's insurance company subsidiaries included in those companies' respective
filings with regulatory authorities to the amounts shown in the accompanying
consolidated financial statements on the basis of GAAP are as follows:
<TABLE>
<CAPTION>
1998 1997
-------------- --------------
<S> <C> <C>
Statutory policyholders' surplus................................................. $ 369,401,000 $ 331,922,000
Difference in carrying value of fixed income securities.......................... 16,599,000 11,970,000
Difference in unearned premium................................................... 1,460,000 1,653,000
Assets non-admitted for statutory reporting...................................... 6,408,000 4,390,000
Deferred policy acquisition costs net of deferred ceding commissions capitalized
for GAAP....................................................................... (3,294,000) 2,713,000
Deferred income taxes recorded for GAAP.......................................... 3,769,000 3,899,000
Statutory provisions for reinsurance, net of GAAP reserve for uncollectible
reinsurance.................................................................... 17,657,000 5,838,000
Excess of statutory reserves over statement reserves............................. 954,000 --
Other............................................................................ 541,000 --
-------------- --------------
Shareholder's equity of insurance company subsidiaries on basis of GAAP........ 413,495,000 362,385,000
Equity attributable to non-insurance company parent and subsidiaries, net of
elimination entries in consolidation........................................... 26,368,000 3,216,000
-------------- --------------
Total shareholders' equity per accompanying consolidated financial
statements................................................................... $ 439,863,000 $ 365,601,000
-------------- --------------
-------------- --------------
</TABLE>
<TABLE>
<CAPTION>
1998 1997 1996
------------- ------------- -------------
<S> <C> <C> <C>
Statutory net income................................................ $ 53,162,000 $ 56,626,000 $ 45,079,000
Difference in unearned premium...................................... (193,000) 285,000 (4,175,000)
Deferred income tax benefit not recorded for statutory purposes..... 1,136,000 380,000 552,000
Change in deferred policy acquisition costs and deferred ceding
commissions capitalized for GAAP.................................. (6,395,000) (5,647,000) 3,279,000
Gain on transfer of subsidiary, eliminated for GAAP................. -- (4,663,000) --
Other, net.......................................................... 556,000 (30,000) 295,000
------------- ------------- -------------
Net income of insurance company subsidiaries on basis of GAAP..... 48,266,000 46,951,000 45,030,000
Net income (loss) attributable to non-insurance parent and
subsidiaries...................................................... 24,012,000 2,808,000 (6,448,000)
------------- ------------- -------------
Net earnings per accompanying consolidated financial statements... $ 72,278,000 $ 49,759,000 $ 38,582,000
------------- ------------- -------------
------------- ------------- -------------
</TABLE>
The NAIC adopted Statements of Statutory Accounting Principles ("SSAPs") in
March, 1998 as a product of its attempt to codify statutory accounting
principles. While subject to adoption by the individual states, the NAIC has
established an effective date of January 1, 2001 for the SSAPs. Prior to the
F-34
<PAGE>
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(15) STATUTORY TO GAAP RECONCILIATIONS (CONTINUED)
codification project, a comprehensive guide to statutory accounting principles
did not exist. Codification is new and will evolve over time. Based upon the
SSAPs as currently published, the Company does not expect their adoption to have
a material effect on the policyholders' surplus of its individual insurance
company subsidiaries. The only material effect on statutory net income is that
the statutory net income for HC will be decreased or increased by a change in
the method of recording equity in earnings or losses of subsidiaries. Currently
HC records the equity in earnings or losses of its subsidiaries as a component
of statutory net income. When codification becomes effective, the equity in
earnings or losses of subsidiaries will be recorded as an unrealized gain or
loss which is a direct increase or decrease to policyholders' surplus. Income
will not be recognized until such time (if any) that dividends are received from
the subsidiaries and recorded in statutory net income.
(16) SUPPLEMENTAL CASH FLOW INFORMATION
Supplemental cash flow information for the three years ended December 31,
1998, is summarized below:
<TABLE>
<CAPTION>
1998 1997 1996
------------- ------------- -------------
<S> <C> <C> <C>
Interest paid....................................................... $ 5,409,000 $ 6,712,000 $ 5,027,000
Income tax paid..................................................... 30,662,000 24,132,000 16,426,000
Dividends declared but not paid at year end......................... 1,930,000 1,386,000 717,000
</TABLE>
The unrealized gain or loss on securities available for sale, deferred taxes
related thereto, and the issuance of the Company's Common Stock for the purchase
of subsidiaries are non-cash transactions which have been included as direct
increases or decreases in shareholders' equity.
F-35
<PAGE>
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(17) LIABILITY FOR UNPAID LOSS AND LOSS ADJUSTMENT EXPENSE
The following table provides a reconciliation of the liability of loss and
loss adjustment expense ("LAE"), for the three years ended December 31, 1998:
<TABLE>
<CAPTION>
1998 1997 1996
-------------- -------------- --------------
<S> <C> <C> <C>
Reserves for loss and LAE at beginning of the year.............. $ 275,008,000 $ 229,049,000 $ 200,756,000
Less reinsurance recoverables................................... 155,374,000 111,766,000 101,497,000
-------------- -------------- --------------
Net reserves at beginning of the year....................... 119,634,000 117,283,000 99,259,000
Net reserves acquired with purchase of subsidiary............... 3,877,000 1,919,000 --
Provision for loss and LAE for claims occurring in the current
year.......................................................... 105,895,000 100,288,000 119,401,000
Decrease in estimated loss and LAE for claims occurring in prior
years......................................................... (14,593,000) (3,774,000) (4,937,000)
-------------- -------------- --------------
Incurred loss and LAE, net of reinsurance..................... 91,302,000 96,514,000 114,464,000
-------------- -------------- --------------
Loss and LAE payments for claims occurring during:
Current year.................................................... 47,126,000 48,208,000 54,493,000
Prior years..................................................... 48,775,000 47,874,000 41,947,000
-------------- -------------- --------------
Loss and LAE payments, net of reinsurance..................... 95,901,000 96,082,000 96,440,000
-------------- -------------- --------------
Net reserves at end of the year................................. 118,912,000 119,634,000 117,283,000
Plus reinsurance recoverables................................... 341,599,000 155,374,000 111,766,000
-------------- -------------- --------------
Reserves for loss and LAE at end of the year................ $ 460,511,000 $ 275,008,000 $ 229,049,000
-------------- -------------- --------------
-------------- -------------- --------------
</TABLE>
During 1998, the Company had net loss and LAE redundancy of $14.6 million
relating to prior year losses compared to redundancies of $3.8 million in 1997
and $4.9 million in 1996. The redundancies in the net reserves result from the
Company's and its advisors' continued review of its loss reserves and the
reduction of such reserves as losses are finally settled and claims exposures
are reduced. The Company believes it has provided for all material net incurred
losses.
The Company has no material exposure to environmental pollution losses, as
HC only began writing business in 1981 and policies issued by HC normally
contain pollution exclusion clauses which limit pollution coverage to "sudden
and accidental" losses only, thus excluding intentional (dumping) and seepage
claims. Policies issued by AIC and USSIC, because of the types of risks
incurred, principally general aviation, are not considered to have significant
environmental exposures. Therefore, the Company should not experience any
material development in reserves from environmental pollution claims.
F-36
<PAGE>
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(18) QUARTERLY FINANCIAL DATA (UNAUDITED)
<TABLE>
<CAPTION>
FOURTH QUARTER THIRD QUARTER SECOND QUARTER FIRST QUARTER
1998 1998 1998 1998
-------------- ------------- -------------- -------------
<S> <C> <C> <C> <C>
Net earned premium................................ $ 39,129,000 $34,604,000 $ 35,440,000 $ 33,927,000
Management fees................................... 20,947,000 18,797,000 18,643,000 16,108,000
Commission income................................. 12,925,000 5,262,000 13,418,000 6,836,000
Net investment income............................. 8,139,000 7,184,000 7,322,000 6,690,000
Other operating income............................ 3,723,000 9,726,000 4,511,000 4,308,000
Total revenue..................................... 84,170,000 76,536,000 79,342,000 67,986,000
Loss and loss adjustment expense.................. 28,944,000 18,555,000 26,613,000 17,190,000
Merger expense.................................... -- 1,000 79,000 27,000
Total expense..................................... 61,805,000 43,182,000 53,042,000 42,519,000
Earnings before income tax provision.............. 22,365,000 33,354,000 26,300,000 25,467,000
Income tax provision.............................. 6,883,000 11,279,000 8,666,000 8,380,000
-------------- ------------- -------------- -------------
Net earnings...................................... $ 15,482,000 $22,075,000 $ 17,634,000 $ 17,087,000
-------------- ------------- -------------- -------------
-------------- ------------- -------------- -------------
Basic earnings per share data:
Earnings per share................................ $ 0.32 $ 0.46 $ 0.37 $ 0.36
-------------- ------------- -------------- -------------
-------------- ------------- -------------- -------------
Weighted average shares outstanding............... 48,159,000 47,870,000 47,853,000 47,794,000
-------------- ------------- -------------- -------------
-------------- ------------- -------------- -------------
Diluted earnings per share data:
Earnings per share................................ $ 0.32 $ 0.45 $ 0.36 $ 0.35
-------------- ------------- -------------- -------------
-------------- ------------- -------------- -------------
Weighted average shares outstanding............... 48,970,000 48,919,000 49,015,000 48,809,000
-------------- ------------- -------------- -------------
-------------- ------------- -------------- -------------
</TABLE>
The fourth quarter of 1998 includes a charge of $3.8 million (after tax) for
catastrophe losses related to hurricanes Georges and Mitch.
F-37
<PAGE>
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(18) QUARTERLY FINANCIAL DATA (UNAUDITED) (CONTINUED)
<TABLE>
<CAPTION>
FOURTH QUARTER THIRD QUARTER SECOND QUARTER FIRST QUARTER
1997 1997 1997 1997
-------------- ------------- -------------- -------------
<S> <C> <C> <C> <C>
Net earned premium................................ $ 38,982,000 $31,437,000 $ 47,478,000 $ 44,674,000
Management fees................................... 18,371,000 13,142,000 9,919,000 9,607,000
Commission income................................. 6,662,000 4,880,000 5,991,000 6,676,000
Net investment income............................. 7,277,000 7,584,000 6,528,000 6,198,000
Other operating income............................ 3,699,000 4,028,000 3,974,000 3,538,000
Total revenue..................................... 74,921,000 61,107,000 73,652,000 70,637,000
Loss and loss adjustment expense.................. 25,977,000 14,467,000 29,452,000 26,618,000
Merger expense.................................... 487,000 305,000 5,404,000 1,873,000
Total expense..................................... 60,825,000 35,579,000 58,908,000 51,941,000
Earnings before income tax provision.............. 14,096,000 25,528,000 14,744,000 18,696,000
Income tax provision.............................. 3,474,000 8,408,000 5,760,000 5,663,000
-------------- ------------- -------------- -------------
Net earnings...................................... $ 10,622,000 $17,120,000 $ 8,984,000 $ 13,033,000
-------------- ------------- -------------- -------------
-------------- ------------- -------------- -------------
Basic earnings per share data:
Earnings per share................................ $ 0.22 $ 0.36 $ 0.19 $ 0.28
-------------- ------------- -------------- -------------
-------------- ------------- -------------- -------------
Weighted average shares outstanding............... 47,696,000 47,431,000 46,720,000 46,115,000
-------------- ------------- -------------- -------------
-------------- ------------- -------------- -------------
Diluted earnings per share data:
Earnings per share................................ $ 0.22 $ 0.35 $ 0.19 $ 0.27
-------------- ------------- -------------- -------------
-------------- ------------- -------------- -------------
Weighted average shares outstanding............... 48,636,000 48,722,000 47,983,000 47,448,000
-------------- ------------- -------------- -------------
-------------- ------------- -------------- -------------
</TABLE>
A charge of $6.5 million (after tax) for reserve strengthening was recorded
during the fourth quarter of 1997, predominantly relating to 1995 and 1996
claims incurred prior to the acquisition of AIC in 1997 in a
pooling-of-interests transaction.
F-38
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS ON
FINANCIAL STATEMENT SCHEDULES
To the Board of Directors of
HCC Insurance Holdings, Inc.:
Our audits of the consolidated financial statements referred to in our report
dated March 26, 1999, included on page F-1 of this Form 10-K also included an
audit of the financial statement schedules listed in Item 14(b) of this Form
10-K. Our report states that for the year ended December 31, 1996, our opinion,
insofar as it relates to data included for Avemco Corporation for 1996, is based
solely on the report of the other auditors. In our opinion, based on our audits
and the report of other auditors, these financial statement schedules present
fairly, in all material respects, the information set forth therein when read in
conjunction with the related consolidated financial statements.
PRICEWATERHOUSECOOPERS LLP
Houston, Texas
March 26, 1999
S-1
<PAGE>
INDEPENDENT AUDITORS' CONSENT AND REPORT ON SCHEDULES
The Board of Directors and Shareholder
Avemco Corporation:
The audit referred to in our report dated January 31, 1997 (February 28, 1997,
as to note 12 and February 18, 1998, as to note 14) includes the related
financial statement schedules for the year ended December 31, 1996, not included
separately herein. These financial statement schedules are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statement schedules based on our audit. In our opinion, such financial
statement schedules, when considered in relation to the basic consolidated
financial statements taken as a whole, present fairly in all material respects
the information set forth therein.
We consent to incorporation by reference in the registration statements (Nos.
333-14479, 333-14471, 333-61673, 333-61687 and 333-68771) on Form S-8 of HCC
Insurance Holdings, Inc. of our report dated January 31, 1997 (February 28,
1997, as to note 12 and February 18, 1998, as to note 14), relating to the
consolidated statements of income, stockholders' equity, and cash flows of
Avemco Corporation and subsidiaries for the year ended December 31, 1996, and
all related schedules, which report appears in the December 31, 1998 annual
report on Form 10-K of HCC Insurance Holdings, Inc.
KPMG LLP
Washington, D.C.
March 26, 1999
S-2
<PAGE>
SCHEDULE 1
HCC INSURANCE HOLDINGS, INC.
SUMMARY OF INVESTMENTS
OTHER THAN INVESTMENTS IN RELATED PARTIES
DECEMBER 31, 1998
<TABLE>
<CAPTION>
COLUMN D
--------------
AMOUNT AT
WHICH
COLUMN A COLUMN B COLUMN C SHOWN IN THE
- ---------------------------------------------------------------- -------------- -------------- BALANCE
TYPE OF INVESTMENT COST VALUE SHEET
- ---------------------------------------------------------------- -------------- -------------- --------------
<S> <C> <C> <C>
Fixed maturities:
Bonds--United States government and government agencies and
authorities................................................. $ 19,183,000 $ 19,773,000 $ 19,773,000
Bonds--states, municipalities and political subdivisions...... 154,281,000 163,798,000 163,798,000
Bonds--special revenue........................................ 200,382,000 208,355,000 208,355,000
Bonds--Canadian government.................................... 259,000 302,000 302,000
Bonds--corporate.............................................. 1,002,000 1,010,000 1,010,000
-------------- -------------- --------------
Total fixed maturities.................................... 375,107,000 393,238,000 393,238,000
-------------- -------------- --------------
--------------
Equity securities:
Common stocks--banks, trusts & insurance companies............ 1,259,000 $ 1,766,000 1,766,000
Common stocks--industrial..................................... 486,000 481,000 481,000
Non-redeemable preferred stocks............................... 5,000 5,000 5,000
-------------- -------------- --------------
Total equity securities................................... 1,750,000 $ 2,252,000 2,252,000
-------------- -------------- --------------
--------------
Short-term investments.......................................... 129,084,000 129,084,000
Other investments............................................... 1,072,000 1,072,000
-------------- --------------
Total investments......................................... $ 507,013,000 $ 525,646,000
-------------- --------------
-------------- --------------
</TABLE>
S-3
<PAGE>
SCHEDULE 2
HCC INSURANCE HOLDINGS, INC.
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------------
1998 1997
-------------- --------------
<S> <C> <C>
ASSETS
Cash............................................................................. $ -- $ 192,000
Short-term investments........................................................... 4,539,000 1,200,000
Investment in subsidiaries....................................................... 441,041,000 404,134,000
Intercompany loan to subsidiaries................................................ 103,426,000 41,250,000
Deferred Federal income tax...................................................... -- 5,174,000
Other assets..................................................................... 32,419,000 696,000
-------------- --------------
TOTAL ASSETS................................................................. $ 581,425,000 $ 452,646,000
-------------- --------------
-------------- --------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Notes payable.................................................................... $ 105,000,000 $ 80,750,000
Note payable to related party.................................................... 16,600,000 --
Payable to subsidiaries.......................................................... 14,558,000 4,755,000
Deferred Federal income tax...................................................... 261,000 --
Accounts payable and accrued liabilities......................................... 5,143,000 1,540,000
-------------- --------------
Total liabilities............................................................ 141,562,000 87,045,000
Total shareholders' equity................................................... 439,863,000 365,601,000
-------------- --------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY................................... $ 581,425,000 $ 452,646,000
-------------- --------------
-------------- --------------
</TABLE>
See Notes to Condensed Financial Information.
S-4
<PAGE>
SCHEDULE 2
HCC INSURANCE HOLDINGS, INC.
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
STATEMENTS OF EARNINGS
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
----------------------------------
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
Equity in earnings of subsidiaries.................... $75,228,000 $56,024,000 $41,905,000
Interest income from subsidiaries..................... 2,052,000 -- --
Interest income....................................... 285,000 24,000 41,000
Net realized investment gain.......................... 840,000 -- --
---------- ---------- ----------
Total revenue..................................... 78,405,000 56,048,000 41,946,000
Interest expense...................................... 6,036,000 1,904,000 1,110,000
Merger related expenses............................... 107,000 3,326,000 907,000
Other operating expense............................... 1,623,000 2,032,000 1,832,000
---------- ---------- ----------
Total expense......................................... 7,766,000 7,262,000 3,849,000
---------- ---------- ----------
Earnings before income tax benefit................ 70,639,000 48,786,000 38,097,000
Income tax benefit.................................... 1,639,000 973,000 485,000
---------- ---------- ----------
NET EARNINGS...................................... $72,278,000 $49,759,000 $38,582,000
---------- ---------- ----------
---------- ---------- ----------
</TABLE>
See Notes to Condensed Financial Information.
S-5
<PAGE>
SCHEDULE 2
HCC INSURANCE HOLDINGS, INC.
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
STATEMENTS OF COMPREHENSIVE INCOME
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
----------------------------------
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
Net earnings.......................................... $72,278,000 $49,759,000 $38,582,000
Other comprehensive income net of tax:
Foreign currency translation adjustment due to
consolidated subsidiaries....................... (344,000) (215,000) 95,000
Investment gains (losses):
Investment gains during the year, net of
deferred tax charge of $294,000 in 1998..... 546,000 -- --
Consolidated subsidiaries' investment gains
(losses) during the year, net of deferred
tax charge (benefit) of $1,205,000 in 1998,
$2,373,000 in 1997 and ($82,000) in 1996.... 2,454,000 4,470,000 (251,000)
Less reclassification adjustment for gains
included in net earnings, net of deferred
tax charge of $294,000 in 1998.............. (546,000) -- --
Less consolidated subsidiaries'
reclassification adjustments for (gains)
losses included in net earnings, net of
deferred tax (charge) benefit of ($218,000)
in 1998, $115,000 in 1997 and ($2,919,000)
in 1996..................................... (405,000) 213,000 (5,422,000)
---------- ---------- ----------
Other comprehensive income (loss)........... 1,705,000 4,468,000 (5,578,000)
---------- ---------- ----------
COMPREHENSIVE INCOME........................ $73,983,000 $54,227,000 $33,004,000
---------- ---------- ----------
---------- ---------- ----------
</TABLE>
See Notes to Condensed Financial Information.
S-6
<PAGE>
SCHEDULE 2
HCC INSURANCE HOLDINGS, INC.
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
----------------------------------------------
1998 1997 1996
-------------- -------------- --------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net earnings................................................... $ 72,278,000 $ 49,759,000 $ 38,582,000
Adjustment to reconcile net earnings to net cash provided
(used) by operating activities:
Undistributed net income of subsidiaries....................... (75,228,000) (56,024,000) (41,905,000)
Change in deferred Federal income tax, net of tax effect of
unrealized gain or loss...................................... 3,934,000 197,000 (5,423,000)
Depreciation................................................... 29,000 30,000 29,000
Change in intercompany loan to subsidiaries.................... (2,052,000) -- --
Change in payable to subsidiary and other...................... (3,932,000) (533,000) 8,971,000
Net realized investment gain................................... (840,000) -- --
-------------- -------------- --------------
Cash provided (used) by operating activities................. (5,811,000) (6,571,000) 254,000
Cash flows from investing activities:
Sales of fixed income securities............................... 16,680,000 -- --
Cash contributions to subsidiaries............................. (62,000) (62,442,000) --
Purchase of subsidiaries....................................... (30,355,000) (6,483,000) (1,753,000)
Change in short-term investments............................... (3,339,000) 2,790,000 (3,206,000)
Cost of investment acquired.................................... (2,525,000) -- --
Intercompany loan to subsidiaries.............................. (34,530,000) (41,250,000) --
Payments on intercompany loan to subsidiaries.................. 15,986,000 -- --
Cash dividends from subsidiaries............................... 24,450,000 43,526,000 5,180,000
-------------- -------------- --------------
Cash provided (used) by investing activities................. (13,695,000) (63,859,000) 221,000
Cash flows from financing activities:
Proceeds from note payable..................................... 74,200,000 97,500,000 --
Payments on notes payable...................................... (49,950,000) (33,000,000) --
Sale of Common Stock, net of costs............................. 2,203,000 10,470,000 843,000
Dividends paid................................................. (7,139,000) (4,550,000) (1,387,000)
-------------- -------------- --------------
Cash provided (used) by financing activities................. 19,314,000 70,420,000 (544,000)
-------------- -------------- --------------
Net decrease in cash......................................... (192,000) (10,000) (69,000)
Cash at beginning of year.................................... 192,000 202,000 271,000
-------------- -------------- --------------
Cash at end of year.......................................... $ -- $ 192,000 $ 202,000
-------------- -------------- --------------
-------------- -------------- --------------
</TABLE>
See Notes to Condensed Financial Information.
S-7
<PAGE>
HCC INSURANCE HOLDINGS, INC.
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
NOTE TO CONDENSED FINANCIAL INFORMATION
(1) The accompanying condensed financial information should be read in
conjunction with the consolidated financial statements and the related
notes thereto of HCC Insurance Holdings, Inc. and Subsidiaries. Investments
in subsidiaries are accounted for using the equity method.
(2) Intercompany loans to subsidiaries are demand notes issued primarily to
fund the cash portion of acquisitions. They bear interest at a rate set by
management, which approximates the interest rate charged to the Company for
similar debt. As of December 31, 1998, the interest rate on intercompany
loans was 6 1/2%.
S-8
<PAGE>
SCHEDULE 3
HCC INSURANCE HOLDINGS, INC.
SUPPLEMENTARY INSURANCE INFORMATION
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN F COLUMN G COLUMN H
------------ --------------- ------------- ----------- ----------- --------------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
(1) (1) (2)
<CAPTION>
DECEMBER 31,
------------------------------------------- FOR THE YEARS ENDED DECEMBER 31,
FUTURE POLICY -------------------------------------------
BENEFITS, BENEFITS,
LOSSES, CLAIMS,
DEFERRED POLICY CLAIMS LOSSES AND
ACQUISITION AND LOSS UNEARNED PREMIUM NET INVESTMENT SETTLEMENT
SEGMENTS COSTS EXPENSES PREMIUMS REVENUE INCOME EXPENSES
-------------------------- --------------- ------------- ----------- ----------- --------------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
1998 Insurance Company......... $ (3,615) $ 460,511 $ 201,050 $ 143,100 $ 23,578 $ 91,302
Underwriting Agency....... 3,949
Intermediary.............. 362
Other Operations 545
Corporate................. 901
--------------- ------------- ----------- ----------- ------- -------------
Total..................... $ (3,615) $ 460,511 $ 201,050 $ 143,100 $ 29,335 $ 91,302
--------------- ------------- ----------- ----------- ------- -------------
--------------- ------------- ----------- ----------- ------- -------------
1997 Insurance Company......... $ 2,051 $ 275,008 $ 152,094 $ 162,571 $ 23,379 $ 96,514
Underwriting Agency....... 2,620
Intermediary.............. 322
Other Operations.......... 128
Corporate................. 1,138
--------------- ------------- ----------- ----------- ------- -------------
Total..................... $ 2,051 $ 275,008 $ 152,094 $ 162,571 $ 27,587 $ 96,514
--------------- ------------- ----------- ----------- ------- -------------
--------------- ------------- ----------- ----------- ------- -------------
1996 Insurance Company......... $ 7,908 $ 229,049 $ 156,268 $ 170,068 $ 20,146 $ 114,464
Underwriting Agency....... 1,798
Intermediary.............. 179
Other Operations.......... 91
Corporate................. 1,379
--------------- ------------- ----------- ----------- ------- -------------
Total..................... $ 7,908 $ 229,049 $ 156,268 $ 170,068 $ 23,593 $ 114,464
--------------- ------------- ----------- ----------- ------- -------------
--------------- ------------- ----------- ----------- ------- -------------
<CAPTION>
COLUMN I COLUMN J COLUMN K
------------- --------------- -----------
<S> <C> <C> <C>
(2)
AMORTIZATION
OF DEFERRED
POLICY
ACQUISITION OTHER OPERATING PREMIUMS
COSTS EXPENSES WRITTEN
------------- --------------- -----------
<S> <C> <C> <C>
1998 $ 10,978 $ 17,365 $ 121,883
54,184
8,106
10,397
2,195
------------- ------- -----------
$ 10,978 $ 92,247 $ 121,883
------------- ------- -----------
------------- ------- -----------
1997 $ 13,580 $ 17,588 $ 142,853
45,274
9,294
14,401
4,598
------------- ------- -----------
$ 13,580 $ 91,155 $ 142,853
------------- ------- -----------
------------- ------- -----------
1996 $ 8,218 $ 17,186 $ 183,034
53,649
7,649
11,195
4,965
------------- ------- -----------
$ 8,218 $ 94,644 $ 183,034
------------- ------- -----------
------------- ------- -----------
</TABLE>
- ------------------------
(1) Columns C and D are shown ignoring the effects of reinsurance.
(2) Net investment income was allocated to the company, and therefore the
segment, on which the related investment asset was recorded. Other operating
expenses were allocated to the company, and therefore the corresponding
segment, which actually incurred those expenses.
Note: Column E is omitted because the Company has no other policy claims and
benefits payable.
S-9
<PAGE>
SCHEDULE 4
HCC INSURANCE HOLDINGS, INC.
REINSURANCE
<TABLE>
<CAPTION>
COLUMN D
-------------- COLUMN F
COLUMN C (1) --------------
COLUMN A COLUMN B -------------- ASSUMED FROM COLUMN E PERCENT OF
- --------------------------------------------- -------------- CEDED TO OTHER OTHER -------------- AMOUNT
EARNED PREMIUM GROSS AMOUNT COMPANIES COMPANIES NET AMOUNT ASSUMED TO NET
- --------------------------------------------- -------------- -------------- -------------- -------------- --------------
<S> <C> <C> <C> <C> <C>
For the year ended December 31, 1998:
Property and liability insurance............. $ 190,030,000 $ 233,549,000 $ 140,354,000 $ 96,835,000 145%
Accident and health insurance................ 2,506,000 76,426,000 120,185,000 46,265,000 260%
-------------- -------------- -------------- --------------
Total.................................... $ 192,536,000 $ 309,975,000 $ 260,539,000 $ 143,100,000 182%
-------------- -------------- -------------- -------------- -------
-------------- -------------- -------------- -------------- -------
For the year ended December 31, 1997:
Property and liability insurance............. $ 173,032,000 $ 177,371,000 $ 140,423,000 $ 136,084,000 103%
Accident and health insurance................ 1,501,000 14,930,000 39,916,000 26,487,000 151%
-------------- -------------- -------------- --------------
Total.................................... $ 174,533,000 $ 192,301,000 $ 180,339,000 $ 162,571,000 111%
-------------- -------------- -------------- -------------- -------
-------------- -------------- -------------- -------------- -------
For the year ended December 31, 1996:
Property and liability insurance............. $ 185,477,000 $ 162,829,000 $ 135,552,000 $ 158,200,000 86%
Accident and health insurance................ 940,000 126,000 11,054,000 11,868,000 93%
-------------- -------------- -------------- --------------
Total.................................... $ 186,417,000 $ 162,955,000 $ 146,606,000 $ 170,068,000 86%
-------------- -------------- -------------- -------------- -------
-------------- -------------- -------------- -------------- -------
</TABLE>
- ------------------------
(1) Substantially all of the reinsurance assumed by the Company's insurance
company subsidiaries was underwritten directly by the Company but issued by
other non-affiliated companies in order to satisfy local licensing or other
requirements.
S-10
<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
STOCK PURCHASE AGREEMENT
DATED EFFECTIVE AS OF
OCTOBER 1, 1998
BY AND AMONG
HCC INSURANCE HOLDINGS, INC.,
AND
SUN EMPLOYER SERVICES, INC.
AN ALABAMA CORPORATION
AND
HOWARD V. BARTON
AND
ELIZABETH A. BARTON
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
<S> <C> <C>
ARTICLE 1 SALE AND TRANSFER OF THE SUN COMMON STOCK. . . . . . . . . 2
Section 1.1 Sale of Sun Common Stock . . . . . . . . . . . . . . . . . 2
Section 1.2 Purchase Price . . . . . . . . . . . . . . . . . . . . . . 2
Section 1.3 Closing Deliveries . . . . . . . . . . . . . . . . . . . . 4
Section 1.4 Escrow Agreement . . . . . . . . . . . . . . . . . . . . . 4
Section 1.5 Additional Transfers . . . . . . . . . . . . . . . . . . . 4
ARTICLE 2 REPRESENTATIONS AND WARRANTIES
OF SUN AND SHAREHOLDER . . . . . . . . . . . . . . . . . . 5
Section 2.1 Corporate Existence and Power. . . . . . . . . . . . . . . 5
Section 2.2 Authorization. . . . . . . . . . . . . . . . . . . . . . . 5
Section 2.3 Governmental Authorization . . . . . . . . . . . . . . . . 5
Section 2.4 Non-Contravention. . . . . . . . . . . . . . . . . . . . . 6
Section 2.5 Capitalization . . . . . . . . . . . . . . . . . . . . . . 7
Section 2.6 Subsidiaries and Related Entities. . . . . . . . . . . . . 7
Section 2.7 Sun Financial Statements . . . . . . . . . . . . . . . . . 8
Section 2.8 Absence of Certain Changes . . . . . . . . . . . . . . . . 8
Section 2.9 No Undisclosed Liabilities . . . . . . . . . . . . . . . .10
Section 2.10 Litigation . . . . . . . . . . . . . . . . . . . . . . . .10
Section 2.11 Taxes. . . . . . . . . . . . . . . . . . . . . . . . . . .10
Section 2.12 Employee Benefit Plans, ERISA. . . . . . . . . . . . . . .11
Section 2.13 Material Agreements. . . . . . . . . . . . . . . . . . . .13
Section 2.14 Properties . . . . . . . . . . . . . . . . . . . . . . . .13
Section 2.15 Environmental Matters. . . . . . . . . . . . . . . . . . .14
Section 2.16 Labor Matters. . . . . . . . . . . . . . . . . . . . . . .15
Section 2.17 Compliance with Laws . . . . . . . . . . . . . . . . . . .15
Section 2.18 Trademarks, Trade Names, Etc.. . . . . . . . . . . . . . .15
Section 2.19 Sale of Sun. . . . . . . . . . . . . . . . . . . . . . . .15
Section 2.20 Broker's Fees. . . . . . . . . . . . . . . . . . . . . . .15
Section 2.21 Investment Representation. . . . . . . . . . . . . . . . .15
Section 2.22 Investments. . . . . . . . . . . . . . . . . . . . . . . .16
Section 2.23 Investment Company . . . . . . . . . . . . . . . . . . . .16
Section 2.24 Licenses . . . . . . . . . . . . . . . . . . . . . . . . .17
Section 2.25 Internal Controls. . . . . . . . . . . . . . . . . . . . .17
Section 2.26 Insurance. . . . . . . . . . . . . . . . . . . . . . . . .17
Section 2.27 Financial Solvency . . . . . . . . . . . . . . . . . . . .17
Section 2.28 Year 2000 Issue. . . . . . . . . . . . . . . . . . . . . .17
Section 2.29 North Bay Assets . . . . . . . . . . . . . . . . . . . . .18
</TABLE>
i
<PAGE>
TABLE OF CONTENTS (Cont.)
<TABLE>
<CAPTION>
PAGE
<S> <C> <C>
ARTICLE 3 REPRESENTATIONS AND WARRANTIES OF HCC . . . . . . . . . .18
Section 3.1 Corporate Existence and Power. . . . . . . . . . . . . . .18
Section 3.2 Corporate Authorization. . . . . . . . . . . . . . . . . .18
Section 3.3 Governmental Authorization . . . . . . . . . . . . . . . .19
Section 3.4 Shares of HCC Common Stock . . . . . . . . . . . . . . . .19
Section 3.5 SEC Filings. . . . . . . . . . . . . . . . . . . . . . . .19
Section 3.6 Non-Contravention. . . . . . . . . . . . . . . . . . . . .20
Section 3.7 Absence of Certain Changes . . . . . . . . . . . . . . . .20
Section 3.8 Compliance with Laws . . . . . . . . . . . . . . . . . . .20
Section 3.9 Broker's Fees. . . . . . . . . . . . . . . . . . . . . . .21
Section 3.10 Investment Company . . . . . . . . . . . . . . . . . . . .21
Section 3.11 Capitalization of HCC. . . . . . . . . . . . . . . . . . .21
Section 3.12 Investigation. . . . . . . . . . . . . . . . . . . . . . .21
Section 3.13 Investment Representation. . . . . . . . . . . . . . . . .21
ARTICLE 4 COVENANTS OF THE SHAREHOLDER AND SUN . . . . . . . . . . .22
Section 4.1 Conduct of Sun . . . . . . . . . . . . . . . . . . . . . .22
Section 4.2 Access to Financial and Operational Information. . . . . .24
Section 4.3 Other Offers . . . . . . . . . . . . . . . . . . . . . . .24
Section 4.4 Maintenance of Business. . . . . . . . . . . . . . . . . .24
Section 4.5 Compliance with Obligations. . . . . . . . . . . . . . . .25
Section 4.6 Notices of Certain Events. . . . . . . . . . . . . . . . .25
Section 4.7 Necessary Consents . . . . . . . . . . . . . . . . . . . .25
Section 4.8 Regulatory Approval. . . . . . . . . . . . . . . . . . . .25
Section 4.9 Satisfaction of Conditions Precedent . . . . . . . . . . .25
Section 4.10 Communications . . . . . . . . . . . . . . . . . . . . . .26
ARTICLE 5 COVENANTS OF HCC. . . . . . . . . . . . . . . . . . . . .26
Section 5.1 Conduct of HCC. . . . . . . . . . . . . . . . . . . . . .26
Section 5.2 Listing of HCC Common Stock . . . . . . . . . . . . . . .26
Section 5.3 Compliance with Obligations. . . . . . . . . . . . . . . .26
Section 5.4 Notices of Certain Events. . . . . . . . . . . . . . . . .27
Section 5.5 Rule 144 . . . . . . . . . . . . . . . . . . . . . . . . .27
ARTICLE 6 COVENANTS OF HCC, THE SHAREHOLDER AND SUN . . . . . . . .27
Section 6.1 Advice of Changes. . . . . . . . . . . . . . . . . . . . .27
Section 6.2 Regulatory Approvals. . . . . . . . . . . . . . . . . . .27
Section 6.3 Certain Filings. . . . . . . . . . . . . . . . . . . . . .28
Section 6.4 Satisfaction of Conditions Precedent . . . . . . . . . . .28
Section 6.5 Confidentiality. . . . . . . . . . . . . . . . . . . . . .28
</TABLE>
ii
<PAGE>
TABLE OF CONTENTS (Cont.)
<TABLE>
<CAPTION>
PAGE
<S> <C> <C>
Section 6.6 Tax Cooperation. . . . . . . . . . . . . . . . . . . . . .29
Section 6.7 Change of Name of Sun. . . . . . . . . . . . . . . . . . .29
Section 6.8 Public Disclosure of Transaction . . . . . . . . . . . . .29
ARTICLE 7 CONDITIONS TO CLOSING. . . . . . . . . . . . . . . . . . .29
Section 7.1 Conditions to Obligations of HCC. . . . . . . . . . . . .29
Section 7.2 Conditions to Obligations of the Shareholder . . . . . . .32
Section 7.3 Conditions to Obligations of Each Party. . . . . . . . . .33
ARTICLE 8 TERMINATION OF AGREEMENT . . . . . . . . . . . . . . . . .33
Section 8.1 Termination. . . . . . . . . . . . . . . . . . . . . . . .33
Section 8.2 Effect of Termination. . . . . . . . . . . . . . . . . . .34
ARTICLE 9 CLOSING MATTERS. . . . . . . . . . . . . . . . . . . . . .34
Section 9.1 The Closing. . . . . . . . . . . . . . . . . . . . . . . .34
ARTICLE 10 INDEMNIFICATION. . . . . . . . . . . . . . . . . . . . . .35
Section 10.1 Shareholder Agreement to Indemnify . . . . . . . . . . . .35
Section 10.2 Indemnification with Respect to Taxes and Licensing. . . .35
Section 10.3 Indemnification for Other Specified Claims . . . . . . . .35
Section 10.4 HCC Agreement to Indemnify . . . . . . . . . . . . . . . .36
Section 10.5 Indemnification of Claim by International Special
Risks, Ltd.. . . . . . . . . . . . . . . . . . . . . . . .36
Section 10.6 Survival of Representations. . . . . . . . . . . . . . . .36
Section 10.7 Procedure for Indemnification; Third Party Claims. . . . .37
ARTICLE 11 MISCELLANEOUS. . . . . . . . . . . . . . . . . . . . . . .37
Section 11.1 Further Assurances.. . . . . . . . . . . . . . . . . . . .37
Section 11.2 Fees and Expenses. . . . . . . . . . . . . . . . . . . . .38
Section 11.3 Notices. . . . . . . . . . . . . . . . . . . . . . . . . .38
Section 11.4 Governing Law. . . . . . . . . . . . . . . . . . . . . . .39
Section 11.5 Binding upon Successors and Assigns, Assignment. . . . . .39
Section 11.6 Severability . . . . . . . . . . . . . . . . . . . . . . .39
Section 11.7 Entire Agreement . . . . . . . . . . . . . . . . . . . . .39
Section 11.8 Amendment and Waivers. . . . . . . . . . . . . . . . . . .39
Section 11.9 No Waiver. . . . . . . . . . . . . . . . . . . . . . . . .39
Section 11.10 Construction of Agreement. . . . . . . . . . . . . . . . .39
Section 11.11 Counterparts . . . . . . . . . . . . . . . . . . . . . . .40
</TABLE>
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<PAGE>
STOCK PURCHASE AGREEMENT
THIS STOCK PURCHASE AGREEMENT (this "Agreement") is entered into
effective as of October 1, 1998 by and among HCC Insurance Holdings, Inc., a
Delaware corporation ("HCC"), Sun Employer Services, Inc., an Alabama
corporation ("Sun"), Howard V. Barton (the "Shareholder"), and Elizabeth A.
Barton ("Barton").
RECITALS:
A. The Shareholder owns all of the outstanding stock of Sun (the
"Sun Common Stock").
B. Barton owns all of the outstanding stock of Professional Audit
Service, Inc., an Alabama corporation ("PASI"), which prior to the Closing
Date, hereinafter defined, will be transferred to Sun.
C. HCC desires to purchase all of the outstanding stock of Sun
from Shareholder after the PASI Stock has been transferred to Sun by Barton,
and Shareholder desires to sell to HCC his shares in Sun (being all of the
outstanding stock of Sun) for the consideration and on the terms set forth in
this Agreement.
D. The Shareholder and Barton as tenants-in-common own of record
one Class F participating share (the "North Bay Share") in North Bay
Reinsurance, Ltd., a Cayman Islands Exempted Company ("North Bay"). Prior to
the Closing as defined herein, Sun will acquire such North Bay Share.
E. Sun, the Shareholder and Barton own all of the outstanding
membership interests in 7200 Copperfield Company, L.L.C., an Alabama limited
liability company (the "Copperfield Drive LLC"), which in turn owns certain
real property and a building located at 7200 Copperfield Drive, Montgomery,
Alabama. In connection with this Agreement, the Shareholder and Barton will
convey all of their membership interests in the Copperfield Drive LLC to Sun.
F. Sun owns 50% of the membership interests in KIMCO, LLC
("KIMCO") an Alabama limited liability company.
NOW, THEREFORE, in consideration of the foregoing and the mutual
representations, warranties, covenants and agreements set forth herein, the
parties hereto do hereby agree as follows:
<PAGE>
ARTICLE 1
SALE AND TRANSFER OF THE SUN COMMON STOCK
SECTION 1.1 SALE OF SUN COMMON STOCK.
(a) Subject to the terms and conditions of this Agreement,
Shareholder shall sell, transfer and deliver to HCC, and HCC shall purchase
from Shareholder, all of the outstanding Sun Common Stock at the Closing,
hereinafter defined.
SECTION 1.2 PURCHASE PRICE.
(a) The purchase price ("Purchase Price") shall be equal to
$24,660,000 and shall be paid by HCC to Shareholder as follows:
(i) $500,000 in cash (the "Cash Payment") shall be transferred
by wire transfer at the Closing to such account as Shareholder shall
specify, in immediately available funds; plus
(ii) at the Closing, HCC shall deliver to the Shareholder a
promissory note in the original principal amount of $16,600,000 due
January 5, 1998 (the "Note"); plus
(iii) 378,000 shares of common stock, par value $1.00 per share,
of HCC (the "HCC Common Stock") valued at the HCC Stock Value (the "Share
Payment"). As used herein, the HCC Stock Value means $20.00 per share.
The Share Payment shall be paid as follows:
(a) If the gross premium volume of Sun for 1999 equals
or exceeds $80,000,000, then the entire Share Payment shall be
made by March 1, 2000.
(b) If the gross premium volume of Sun for 1999 is less
than $80,000,000 but greater than the gross premium volume of Sun
for 1998, then a portion of the Share Payment equal to the
Achievement Percentage (defined below) multiplied by the full
Share Payment shall be made by March 1, 2000. As used herein, the
"Achievement Percentage" means the ratio (i) the gross premium
volume of Sun for 1999 less the gross premium volume of Sun for
1998 bears to (ii) $80,000,000 less the gross premium volume of
Sun for 1998.
(c) If the Shareholder has received less then the full
Share Payment, the Shareholder shall continue to be eligible to
receive the remaining Share Payment with respect to subsequent
years based on the respective Subsequent Year Achievement
Percentages (defined below) for such subsequent years until the
Share Payment has been made in full. As used herein, "Subsequent
Year Achievement
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<PAGE>
Percentage" means the ratio (i) the actual gross premium volume
of Sun for the particular year less the actual gross premium
volume of Sun for the prior year bears to (ii) the target premium
volume of Sun for the particular year as agreed to by the
Shareholder and HCC less the actual gross premium volume of
Sun for the prior year. The portion of the Share Payment made
with respect to any year subsequent to 1999 shall be equal to the
excess, if any, of (x) the Subsequent Year Achievement Percentage
with respect to such year multiplied by the full Share Payment,
over (y) the cumulative portion of the Share Payment made with
respect to all prior years. The portion of the Share Payment with
respect to any subsequent year shall be made by March 1 of the
following year.
The Share Payment shall be paid in full and shall become
non-forfeitable upon a "Change of Control," as defined herein, of HCC,
without regard to the provisions of clauses (a), (b), and (c) above. As used
in this Agreement, a Change of Control shall be deemed to have occurred if
(1) any "person" or "group" (within the meaning of Section 13(d) and 14(d)(2)
of the Securities Exchange Act of 1934) other than a trustee or other
fiduciary holding securities under an employee benefit plan of HCC becomes
the "beneficial owner" (as defined in Rule 13d-3 under the Securities
Exchange Act of 1934) directly or indirectly of 50% or more of HCC's then
outstanding voting common stock; (2) the shareholders of HCC approve a merger
or consolidation with any other corporation, other than a merger or
consolidation (a) in which a majority of the directors of the surviving
entity were directors of HCC prior to such consolidation or merger or (b)
which would result in the voting securities of HCC outstanding immediately
prior thereto continuing to represent (either by remaining outstanding or by
being changed into voting securities of the surviving entity) more than 50%
of the combined voting power of the voting securities of the surviving entity
outstanding immediately after such merger or consolidation; or (3) the
shareholders approve a plan of complete liquidation of HCC or an agreement
for the sale or disposition by HCC of all or substantially all of HCC's
assets.
(iv) All HCC Common Stock to be delivered pursuant to this
Agreement shall be restricted as to transfer and shall bear the following
legend:
"THE SHARES REPRESENTED BY THIS CERTIFICATE HAVE NOT BEEN
REGISTERED UNDER THE SECURITIES ACT OF 1933. THESE SHARES HAVE
BEEN ACQUIRED FOR INVESTMENT AND NOT WITH A VIEW TO DISTRIBUTION
OR RESALE, AND MAY NOT BE SOLD, MORTGAGED, PLEDGED, HYPOTHECATED
OR OTHERWISE TRANSFERRED WITHOUT AN EFFECTIVE REGISTRATION
STATEMENT FOR SUCH SHARES UNDER THE SECURITIES ACT OF 1933, OR AN
OPINION OF COUNSEL FOR THE CORPORATION THAT SUCH REGISTRATION IS
NOT REQUIRED UNDER SUCH ACT."
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<PAGE>
SECTION 1.3 CLOSING DELIVERIES.
At the Closing:
(a) Shareholder shall deliver to HCC
(i) certificates representing the Sun Common Stock, endorsed or
transferred to HCC, which shall transfer to HCC good and indefeasible
title to the Sun Common Stock, free and clear of all encumbrances; and
(ii) such other documents including officers' certificates and
opinions of counsel as may be required by this Agreement or reasonably
requested by HCC.
(b) HCC shall deliver to Shareholder
(i) the Cash Payment to be transferred to an account designated
by Shareholder in immediately available funds; and
(ii) such other documents, including officer certificates and
opinions of counsel as may be required by this Agreement or reasonably
requested by Shareholder.
SECTION 1.4 ESCROW AGREEMENT. Pursuant to an Escrow Agreement to be
entered into on or before the Closing Date (as hereinafter defined) in
substantially the form of Exhibit 1.5 (the "Escrow Agreement"), among HCC,
the Shareholder and Harris Trust Company of New York, or such other entity
mutually agreeable to HCC and the Shareholder, as Escrow Agent, HCC will
withhold $2,460,000 in cash from the amount due under the Note (the "Escrow
Payment"). On or before the due date of the Note, HCC will deposit, or cause
to be deposited in escrow pursuant to the Escrow Agreement, the Escrow
Payment which will be held as collateral for the indemnification obligations
of the Shareholder pursuant to Article 10 and to the Escrow Agreement pending
its release from escrow in accordance with the terms of the Escrow Agreement.
In accordance with, and subject to, the Escrow Agreement, such escrow will
be maintained for a period of two (2) years from the Closing Date.
SECTION 1.5 ADDITIONAL TRANSFERS. At or before the Effective Time,
and for the consideration provided for in Section 1.2 of this Agreement, (i)
Barton shall transfer to Sun all of the PASI Shares, (ii) the Shareholder and
Barton shall transfer to Sun their interest in the North Bay Share, and (iii)
the Shareholder and Barton shall transfer to Sun all of their membership
interests in the Copperfield Drive LLC, in each case free and clear of all
liens and encumbrances.
4
<PAGE>
ARTICLE 2
REPRESENTATIONS AND WARRANTIES
OF SUN AND SHAREHOLDER
Except as disclosed in a document referring specifically to this
Agreement (the "Sun Disclosure Schedule") which has been delivered to HCC on
or before the date hereof, Sun and the Shareholder (jointly and severally)
represent and warrant to HCC as set forth below.
SECTION 2.1 CORPORATE EXISTENCE AND POWER. Sun is a corporation
duly organized, validly existing and in good standing under the laws of the
state of its incorporation, and has all corporate powers and all material
governmental licenses, authorizations, consents and approvals (collectively,
"Governmental Authorizations") required to carry on its business as now
conducted, except such Governmental Authorizations the failure of which to
have obtained would not have a Material Adverse Effect, as hereinafter
defined, on Sun. Sun has delivered to HCC true and complete copies of Sun's
Articles of Incorporation and Bylaws as currently in effect. Sun is duly
qualified to do business as a foreign corporation and is in good standing in
each jurisdiction where the character of the property owned or leased by it
or the nature of its activities makes such qualification necessary, except
where the failure to be so qualified would not have a Material Adverse Effect
on Sun. For purposes of this Agreement, a "Material Adverse Effect," with
respect to any person or entity (including without limitation Sun and HCC),
means a material adverse effect on the condition (financial or otherwise),
business, properties, assets, liabilities (including contingent liabilities),
results of operations or prospects of such person or entity and its
affiliated companies and subsidiaries and/or parent corporation and/or
corporations under the same stock ownership, taken as a whole; and "Material
Adverse Change" means a change or a development involving a prospective
change which would result in a Material Adverse Effect.
SECTION 2.2 AUTHORIZATION. Each of the Shareholder, Sun, and Barton
has full right, power and authority to enter into this Agreement and each
other agreement to be entered into by it in connection with the transactions
contemplated hereby. This Agreement and such other agreements contemplated
hereby constitute, or upon execution will constitute, valid and binding
agreements of the Shareholder, Sun and Barton, enforceable against each of
them in accordance with their respective terms, except as such enforcement
may be limited by bankruptcy, insolvency or other similar laws effecting the
enforcement of creditors' rights generally or by general principles of equity.
SECTION 2.3 GOVERNMENTAL AUTHORIZATION. The execution, delivery and
performance by the Shareholder, Sun and Barton, of this Agreement, and the
consummation of the transactions contemplated hereunder require no action by
Sun, the Shareholder, or Barton or any filing by any of them with any
governmental body, agency, official or authority having authority over Sun,
other than in respect of:
(a) compliance with the applicable requirements of the
Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended (the "HSR
Act");
5
<PAGE>
(b) compliance with any applicable requirements of the Securities
Act of 1933, as amended (the "Securities Act") and the rules and regulations
promulgated thereunder;
(c) compliance with any applicable foreign or state securities or
"blue sky" laws;
(d) compliance with any requirements of any federal, state, foreign
or other insurance or reinsurance or intermediaries or managing general agent
laws, including licensing or other related laws; and
(e) such other filings or registrations with, or authorizations,
consents or approvals of, governmental bodies, agencies, officials or
authorities, the failure of which to make or obtain (i) would not reasonably
be expected to have a Material Adverse Effect on Sun, or (ii) would not
materially adversely affect the ability of any party to consummate the
transactions contemplated hereby and operate their businesses as heretofore
operated.
SECTION 2.4 NON-CONTRAVENTION. Except with HCC's knowledge and
written consent, the execution, delivery and performance by the Shareholder,
Sun and Barton of this Agreement and each other agreement to be entered into
in connection with this Agreement, and the consummation of the other
transactions contemplated hereby and thereby do not and will not:
(a) contravene or conflict with any of the organizational documents
of Sun, PASI, KIMCO, the Copperfield Drive LLC, or North Bay;
(b) assuming compliance with the matters referred to in Section 2.3,
contravene or conflict with or constitute a violation of any provision of any
law, regulation, judgment, injunction, order or decree binding upon or
applicable to Sun, the Shareholder, Barton, PASI, the Copperfield Drive LLC,
KIMCO or North Bay;
(c) conflict with or result in a breach or violation of, or
constitute a default under, or result in a contractual right to cause the
termination or cancellation of or loss of a material benefit under, or right
to accelerate, any material agreement, contract or other instrument binding
upon Sun or any material license, franchise, permit or other similar
authorization held by Sun, PASI, the Copperfield Drive LLC or KIMCO;
(d) result in the creation or imposition of any Lien (as
hereinafter defined) on any material asset of Sun, PASI, the Copperfield
Drive LLC, or KIMCO or on the North Bay Share by reason of the actions of the
Shareholder, Sun or Barton; or
(e) result in the loss of any material benefits relating to the
ownership of the North Bay Share,
except, with respect to clauses (b), (c) and (d) above, for contraventions,
defaults, losses, Liens and other matters referred to in such clauses that in
the aggregate would not be reasonably expected to
6
<PAGE>
have, individually or in the aggregate, a Material Adverse Effect on Sun.
For purposes of this Agreement, the term "Lien" means, with respect to any
asset, any mortgage, lien, pledge, charge, security interest or encumbrance
of any kind in respect of such asset.
SECTION 2.5 CAPITALIZATION.
(a) The entire authorized stock of Sun consists of 400 shares of
common stock, $1.00 par value per share, of which, subsequent to the
redemption referred to in Section 4.1(e) below, 94 shares are issued and
outstanding, and 306 shares are held as treasury stock. All of the issued
and outstanding shares of stock of Sun are owned by the Shareholder free of
any Liens or other encumbrances. The Shareholder and Barton own of record
the one share of common stock of Class F participating share of North Bay,
and such ownership is free of any Liens or other encumbrances which have not
been released. Such North Bay Share is the only issued and outstanding
Class F participating share of North Bay. Sun owns a 50% membership interest
in KIMCO. Sun owns such membership interest free of any Liens or other
encumbrances. The entire capitalization of the Copperfield Drive LLC
consists of a 50% membership interest owned by Shareholder and Barton and a
50% membership interest owned by Sun, in each case free of any Liens or other
encumbrances. The entire authorized stock of PASI consists of 100 shares of
Common Stock, $1.00 par value per share, of which 100 shares are issued and
outstanding, and no shares are held as treasury stock. All of the issued and
outstanding shares of stock of PASI are owned by Barton free of any Liens or
other encumbrances.
(b) All outstanding shares and membership interests set forth in
(a) above have been duly authorized and validly issued and are fully paid and
nonassessable, and the issuer complied with all applicable preemptive rights
in issuing such shares or membership interests. Except as set forth in (a)
above, there are outstanding (i) no shares of capital stock or other voting
securities or equity interests, (ii) no securities convertible into or
exchangeable for shares of its capital stock or voting securities or other
equity interests, (iii) no options or other rights to acquire from any party,
and no obligation to issue, any capital stock, voting securities or
securities convertible into or exchangeable for its capital stock or other
voting securities or equity interests (the items in clauses (i), (ii) and
(iii) being referred to collectively as the "Sun Securities"), (iv) no
obligations to repurchase, redeem or otherwise acquire any of Sun Securities
and (v) no contractual rights of any person or entity to include any such
securities in any registration statement proposed to be filed under the
Securities Act.
SECTION 2.6 SUBSIDIARIES AND RELATED ENTITIES.
(a) Except as set forth in this Section, Sun does not control
(whether directly or indirectly, and whether through the ownership of voting
securities or by contract or proxy, and whether alone or in combination with
others) any corporation, partnership, business organization or other similar
entity. KIMCO, PASI, and the Copperfield Drive LLC are collectively
sometimes hereinafter referred to as the "Sun Affiliated Entities".
7
<PAGE>
(b) Each Sun Affiliated Entity is duly organized, validly existing,
and in good standing under the laws of the state of Alabama, and has all
powers and all material Governmental Authorizations required to carry on its
business as now conducted, except such Governmental Authorizations the
failure of which to have obtained would not have a Material Adverse Effect on
it. Sun has delivered to HCC true and complete copies of the organizational
documents of each Sun Affiliated Entity as currently in effect. Each Sun
Affiliated Entity is duly qualified to do business as a foreign entity and is
in good standing in each jurisdiction where the character of the property
owned or leased by it or the nature of its activities makes such
qualification necessary, except where the failure to be so qualified would
not have a Material Adverse Effect on it.
SECTION 2.7 SUN FINANCIAL STATEMENTS. Sun has delivered to HCC
Sun's audited balance sheet (the "Audited Balance Sheet") as of June 30, 1998
(the "Balance Sheet Date") and an unaudited balance sheet as of June 30,
1997, Sun's audited income statements for the years ended June 30, 1998 and
Sun's unaudited balance sheets and income statements for the year ended June
30, 1997 (collectively, the "Sun Financial Statements"). The Sun Financial
Statements present fairly in all material respects, substantially in
conformity with generally accepted accounting principles consistently applied
(except as indicated in the notes thereto), the financial position of Sun as
of the dates thereof and results of operations and cash flows for the periods
therein indicated (subject to the absence of certain footnotes in the case of
unaudited financial statements). Sun has no material debt, liability or
obligation of any nature, whether accrued, absolute, contingent or otherwise,
and whether due or to become due, that is not reflected, reserved against or
disclosed in the Audited Balance sheet, including the notes thereto, except
for (i) those that are not required to be reported in accordance with the
aforesaid accounting principles; (ii) normal or recurring liabilities
incurred since June 30, 1998 in the ordinary course of business or (iii)
liabilities under this Agreement or as disclosed in the Sun Disclosure
Schedule.
SECTION 2.8 ABSENCE OF CERTAIN CHANGES. Since June 30, 1998, Sun
and each Sun Affiliated Entity has in all material respects conducted its
business in the ordinary course and there has not been:
(a) any Material Adverse Change with respect thereto or any event,
occurrence or development of a state of circumstances or facts known to Sun,
which as of the date hereof could reasonably be expected to have a Material
Adverse Effect on Sun;
(b) any declaration, setting aside or payment or any dividend or
other distribution in respect of any shares of capital stock of Sun other
than the declaration, setting aside or payment of dividends in accordance
with its existing dividend policy or practice, which policy or practice is
not inconsistent with Sun's past policy or practice;
(c) except as required by Section 4.1(e) hereof, any repurchase,
redemption or other acquisition by Sun of any outstanding shares of capital
stock or other securities of or other ownership interests in Sun;
8
<PAGE>
(d) any amendment of any term of any outstanding securities of Sun;
(e) any damage, destruction or other property or casualty loss
(whether or not covered by insurance) affecting the business, assets,
liabilities, earnings or prospects of Sun which, individually or in the
aggregate, has had or would reasonably be expected to have a Material Adverse
Effect on Sun or any Sun Affiliated Entity;
(f) any increase in indebtedness for borrowed money or capitalized
lease obligations of Sun or any Sun Affiliated Entity, except in the ordinary
course of business;
(g) any sale, assignment, transfer or other disposition of any
tangible or intangible asset material to the business of Sun, except in the
ordinary course of business and for a fair and adequate consideration;
(h) any amendment, termination or waiver by Sun or any Sun
Affiliated Entity of any right of substantial value under any agreement,
contract or other written commitment to which it is a party or by which it is
bound;
(i) any material reduction in the amounts of coverage provided by
existing casualty and liability insurance policies with respect to the
business or properties of Sun or any Sun Affiliated Entity;
(j) any (i) grant of any severance or termination pay to any
director, officer or employee of Sun or any Sun Affiliated Entity, (ii)
entering into of any employment, deferred compensation or other similar
agreement (or any amendment to any such existing agreement) with any
director, officer or employee of Sun, (iii) any increase in benefits payable
under any existing severance or termination pay policies or employment
agreements, or (iv) any increase in compensation, bonus or other benefits
payable to directors, officers or employees of Sun or any Sun Affiliated
Entity, in each case other than in the ordinary course of business consistent
with past practice;
(k) any new or amendment to or alteration of any existing bonus,
incentive, compensation, severance, stock option, stock appreciation right,
pension, matching gift, profit-sharing, employee stock ownership, retirement,
pension group insurance, death benefit, or other fringe benefit plan,
arrangement or trust agreement adopted or implemented by Sun or any Sun
Affiliated Entity which would result in a material increase in cost;
(l) any capital expenditures, capital additions or capital
improvements in excess of $10,000; or
(m) the entering into of any agreement by Sun or any Sun Affiliated
Entity or any person on behalf of Sun or any Sun Affiliated Entity to take
any of the foregoing actions.
9
<PAGE>
SECTION 2.9 NO UNDISCLOSED LIABILITIES. There are no existing
liabilities of Sun or any Sun Affiliated Entity of any kind whatsoever that
are, individually or in the aggregate, material to Sun, other than:
(a) liabilities disclosed, reserved against, or provided for in the
Audited Balance Sheet (including the notes thereto);
(b) liabilities incurred in the ordinary course of business
consistent with past practice since June 30, 1998; and
(c) liabilities under this Agreement or indicated in the Sun
Disclosure Schedule.
SECTION 2.10 LITIGATION. The Sun Disclosure Schedule sets forth all
actions, suits, proceedings, claims or investigations pending against Sun or
any Sun Affiliated Entity or relating to its business or the North Bay Share.
Neither Sun nor any Sun Affiliated Entity nor any Shareholder has received
written notice of a claim threatened against Sun or any Sun Affiliated Entity
or any of its assets or against or involving any of its officers, directors
or employees in connection with the business or affairs of Sun or any Sun
Affiliated Entity or the North Bay Share, including, without limitation, any
such claims for indemnification arising under any agreement to which Sun or
any Sun Affiliated Entity is a party. Neither Sun nor any Sun Affiliated
Entity has received written notice that it is subject, or in default with
respect, to any writ, order, judgment, injunction or decree which could,
individually or in the aggregate, have a Material Adverse Effect on Sun or
any Sun Affiliated Entity.
SECTION 2.11 TAXES.
(a) Sun and each Sun Affiliated Entity (i) has filed when due
(taking into account extensions) with the appropriate federal, state, local,
foreign and other governmental agencies, all material tax returns, estimates
and reports required to be filed by it, (ii) either paid when due and payable
or established adequate reserves or otherwise accrued on the Sun's Financial
Statements all material federal, state, local or foreign taxes, levies,
imposts, duties, licenses and registration fees and charges of any nature
whatsoever, and unemployment and social security taxes and income tax
withholding, including interest and penalties thereon ("Taxes") and there are
no tax deficiencies claimed in writing by any Taxing authority and received
by Sun or any Sun Affiliated Entity or the Shareholder that, in the
aggregate, would result in any tax liability in excess of the amount of the
reserves or accruals and (iii) has or will establish in accordance with its
normal accounting practices and procedures accruals and reserves that, in the
aggregate, are adequate for the payment of all Taxes not yet due and payable
and attributable to any period preceding the Effective Time. The Sun
Disclosure Schedule sets forth those tax returns for all periods that
currently are the subject of audit by any federal, state, local or foreign
taxing authority.
(b) There are no material taxes, interest, penalties, assessments
or deficiencies claimed in writing by any Taxing authority and received by
Sun or any Sun Affiliated Entity or the
10
<PAGE>
Shareholder to be due in respect of any tax returns filed by Sun or any Sun
Affiliated Entity (or any predecessor entity). Neither Sun nor any Sun
Affiliated Entity nor any predecessor entity, has executed or filed with the
Internal Revenue Service ("IRS") or any other Taxing authority any agreement
or other document extending, or having the effect of extending, the period of
assessment or collection of any Taxes.
(c) Neither Sun nor any Sun Affiliated Entity is a party to or
bound by (or will prior to the Effective Date become a party to or bound by)
any Tax indemnity, Tax sharing or Tax allocation agreement or other similar
arrangement. Neither Sun nor any Sun Affiliated Entity is a member of an
affiliated group or filed or been included in a combined, consolidated or
unitary Tax return.
SECTION 2.12 EMPLOYEE BENEFIT PLANS, ERISA.
(a) Neither Sun nor any Sun Affiliated Entity is a party to any
oral or written (i) employment, severance, or consulting agreement not
terminable on 60 days' or less notice, (ii) agreement with any executive
officer or other key employee (A) the benefits of which are contingent, or
the terms of which are materially altered, upon the occurrence of a
transaction involving Sun or a Sun Affiliated Entity of the nature of any of
the transactions contemplated by this Agreement, (B) providing any term of
employment or compensation guarantee extending for a period longer than one
year, or (C) providing severance benefits or other benefits after the
termination of employment of such executive officer or key employee
regardless of the reason for such termination of employment, or (iii)
agreement or plan, including, without limitation, any stock option plan,
stock appreciation right plan, restricted stock plan or stock purchase plan,
the benefits of which would be increased, or the vesting of benefits of which
will be accelerated, by the occurrence of any of the transactions
contemplated by this Agreement or the value of any of the benefits of which
will be calculated on the basis of any of the transactions contemplated by
this Agreement.
(b) Except as described in the Sun Disclosure Schedule, neither Sun
nor any corporation or other entity which under Section 4001(b) of the
Employee Retirement Income Security Act of 1974, as amended ("ERISA"), is
under common control with Sun (a "Sun ERISA Affiliate") maintains or within
the past five years has maintained, contributed to, or been obligated to
contribute to, any "Employee Pension Benefit Plan" ("Pension Plan") or any
"Employee Welfare Benefit Plan" ("Welfare Plan") as such terms are defined in
Sections 3(2) and 3(1) respectively of ERISA, which is subject to ERISA.
Each Pension Plan and Welfare Plan disclosed in the Sun Disclosure Schedule
(which Plans have been heretofore delivered to HCC) and maintained by Sun
has been maintained in all material respects in compliance with their terms
and all provisions of ERISA and the Code (including rules and regulations
thereunder) applicable thereto.
(c) No Pension Plan or Welfare Plan is currently subject to an
audit or other investigation by the IRS, the Department of Labor (the "DOL"),
the Pension Benefit Guaranty Corporation or any other governmental agency or
office nor are any such Plans subject to any lawsuits or legal proceedings of
any kind or to any material pending disputed claims by employees or
beneficiaries covered under any such Plan or by any other parties.
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(d) No "prohibited transaction," as defined in Section 406 of ERISA or
Section 4975 of the Code, resulting in liability to Sun or any Sun ERISA
Affiliate has occurred with respect to any Pension Plan or Welfare Plan.
Neither Sun nor the Shareholder has any knowledge of any breach of fiduciary
responsibility under Part 4 of Title I of ERISA which has resulted in liability
of Sun and Sun ERISA Affiliate, any trustee, administrator or fiduciary of any
Pension Plan or Welfare Plan.
(e) Neither Sun nor any Sun ERISA Affiliate, since January 1, 1986,
has maintained or contributed to, or been obligated or required to contribute
to, a "Multiemployer Plan," as such term is defined in Section 4001(a)(3) of
ERISA. Neither Sun nor any Sun ERISA Affiliate has either withdrawn, partially
or completely, or instituted steps to withdraw, partially or completely, from
any Multiemployer Plan nor has any event occurred which would enable a
Multiemployer Plan to give notice of and demand payment of any withdrawal
liability with respect to Sun or any Sun ERISA Affiliate.
(f) Except as described in the Sun Disclosure Schedule, there is no
contract, agreement, plan or arrangement covering any employee or former
employee of Sun or any Sun ERISA Affiliate that, individually or collectively,
could give rise to the payment of any amount that would not be deductible
pursuant to the terms of Sections 162(a)(I) or 280G of the Code.
(g) With respect to Sun and each Sun ERISA Affiliate, the Sun
Disclosure Schedule correctly identifies each material agreement, policy, plan
or other arrangement, whether written or oral, express or implied, fixed or
contingent, other than plans disclosed in the Sun Disclosure Schedule pursuant
to Section 2.12(b) above, to which Sun is a party or by which Sun is bound,
which is or relates to a pension, option, bonus, deferred compensation,
employment, retirement, stock purchase, profit-sharing, severance pay, health,
welfare, incentive, vacation, sick leave, medical disability, hospitalization,
life or other insurance or fringe benefit plan, policy, arrangement, or
agreement.
(h) Neither Sun nor any Sun ERISA Affiliate maintains or has
maintained or contributed to any Pension Plan that is or was subject to
Section 302 of Title IV of ERISA or Section 412 of the Code. Sun has made
available to HCC, for each Pension Plan which is intended to be "qualified"
within the meaning of Section 401(a) of the Code, a copy of the most recent
determination letter issued by the IRS to the effect that each such Plan is so
qualified and that each trust created thereunder is tax exempt under Section 501
of the Code, and Sun is unaware of any fact or circumstances that would
jeopardize the qualified status of each such Pension Plan or the tax exempt
status of each trust created thereunder.
SECTION 2.13 MATERIAL AGREEMENTS.
(a) The Sun Disclosure Schedule includes a complete and accurate list
of all contracts, agreements, leases (other than Sun Property Leases, as
hereinafter defined), and instruments to which Sun or any Sun Affiliated Entity
is a party or by which it or its properties or assets are bound which
individually involve net payments or receipts in excess of $25,000 per annum,
inclusive of contracts
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entered into with customers and suppliers in the ordinary course of business,
or that pertain to employment or severance benefits for any officer, director
or employee of Sun or any Sun Affiliated Entity, whether written or oral (the
"Material Sun Agreements").
(b) Neither Sun nor any Sun Affiliated Entity nor, to the knowledge of
Sun, any other party is in default under any Material Sun Agreement and no event
has occurred which (after notice or lapse of time or both) would become a breach
or default under, or would permit modification, cancellation, acceleration or
termination of any Material Sun Agreement or result in the creation of any
security interest upon, or any person obtaining any right to acquire, any
properties, assets or rights of Sun or any Sun Affiliated Entity, which, in any
such case, has had or would reasonably be expected to have a Material Adverse
Effect.
(c) To the knowledge of Sun, each such Material Sun Agreement is in
full force and effect and is valid and legally binding and there are no material
unresolved disputes involving or with respect to any Material Sun Agreement.
Except as described in the Sun Disclosure Schedule, no party to a Material Sun
Agreement has advised Sun or the Shareholder that it intends either to terminate
a Material Sun Agreement or to refuse to renew a Material Sun Agreement upon the
expiration of the term thereof. No representation or warranty is made that all
benefits contemplated in the Material Sun Agreements will be received.
(d) Neither Sun nor any Sun Affiliated Entity is in violation of, or
in default with respect to, any term of any of its organizational documents.
SECTION 2.14 PROPERTIES. Neither Sun nor any Sun Affiliated Entity owns
any real estate other than as described in the Sun Disclosure Schedule, and all
leases of real property to which Sun or an Sun Affiliated Entity is a party or
by which it is bound ("Sun Property Leases") are in full force and effect and
are set forth on the Sun Disclosure Schedule. There exists no default under
such Sun Property Leases, nor any event which with notice or lapse of time or
both would constitute a default thereunder, which default would have a Material
Adverse Effect. All of the properties and assets which are owned by Sun or an
Sun Affiliated Entity are owned free and clear of any Lien, except for Liens
described in the Sun Disclosure Schedule or Permitted Liens (as defined below).
Sun or such Sun Affiliated Entity has good and indefeasible title with respect
to such owned properties and assets subject to no Liens, other than those
described in the Sun Disclosure Schedule or Liens permitted under this
Section 2.14, and to all of the properties and assets necessary for the conduct
of their business other than to the extent that the failure to have such title
would not have a Material Adverse Effect. "PERMITTED LIENS" shall mean (i) any
lien, encumbrance or defect which does not materially detract from the fair
market value (free of such lien, encumbrance or defects) of the property or
assets subject thereto or materially interfere with the current use by Sun of
the property or assets subject thereto or affected thereby, (ii) any liens or
encumbrances for taxes not delinquent or which are being contested in good
faith, provided that adequate reserves for the same have been established in the
most recent financial statements of Sun to the extent required by GAAP applied
on a consistent basis, (iii) any liens or encumbrances for current taxes and
assessments not yet past due, and (iv) any inchoate mechanics and materialmen's
liens and encumbrances for construction in
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process, (iv) any workmen's, repairmen's, warehousemen's and carrier's liens
and encumbrances arising in the ordinary course of business which do not in
the aggregate materially detract from the value of Sun's business assets or
properties or materially impair the use thereof or which are being contested
in good faith by appropriate proceedings which have the effect of preventing
the forfeiture or sale of such business or property subject to any such lien
or encumbrance and for which adequate reserves have been established in
accordance with GAAP.
SECTION 2.15 ENVIRONMENTAL MATTERS.
(a) For the purposes of this Agreement, the following terms have the
following meanings:
"Environmental Laws" shall mean any and all federal, state, local
and foreign statutes, laws (including case law), regulations, ordinances,
rules, judgments, orders, decrees, codes, plans, injunctions, permits,
concessions, grants, franchises, licenses, agreements and governmental
restrictions relating to human health, the environment or to emissions,
discharges or releases of pollutants, contaminants, Hazardous Substances
(as hereinafter defined) or wastes into the environment or otherwise
relating to the manufacture, processing, distribution, use, treatment,
storage, disposal, transport or handling of pollutants, contaminants,
Hazardous Substances or wastes or the clean-up or other remediation
thereof.
"Environmental Liabilities" shall mean all liabilities, whether
vested or unvested, contingent or fixed, actual or potential, which
(i) arise under or relate to Environmental Laws and (ii) relate to
actions occurring or conditions existing on or prior to the Effective
Time.
"Hazardous Substances" shall mean any toxic, radioactive, caustic
or otherwise hazardous substance, including petroleum, its derivatives,
by-products and other hydrocarbons, or any substance having any
constituent elements displaying any of the foregoing characteristics.
"Regulated Activity" shall mean any generation, treatment,
storage, recycling, transportation, disposal or release of any Hazardous
Substances.
(b) No notice, notification, demand, request for information,
citation, summons, complaint or order has been received, no complaint has been
filed, no penalty has been assessed and no investigation or review is pending,
or to the knowledge of Sun or any Shareholder, has been threatened by any
governmental entity or other party with respect to any (i) alleged violation of
any Environmental Law, (ii) alleged failure to have any environmental permit,
certificate, license, approval, registration or authorization required in
connection with the conduct of its business or (iii) Regulated Activity.
(c) Neither Sun nor any Sun Affiliated Entity has any material
Environmental Liabilities and there has been no release of Hazardous Substances
into the environment by Sun or any Sun
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Affiliated Entity or with respect to any of its properties which has had, or
would reasonably be expected to have, a Material Adverse Effect.
SECTION 2.16 LABOR MATTERS. Neither Sun nor any Sun Affiliated Entity
is a party to any collective bargaining agreement or other labor union contract
applicable to persons employed by it, nor does it know of any activities or
proceedings of any labor union to organize any such employees.
SECTION 2.17 COMPLIANCE WITH LAWS. Except for violations which do not
have and would not reasonably be expected to have, individually or in the
aggregate, a Material Adverse Effect, neither Sun nor any Sun Affiliated Entity
has received any notice that it is in violation of, or has violated, any
applicable provisions of any laws, statutes, ordinances or regulations or any
term of any judgment, decree, injunction or order binding against it.
SECTION 2.18 TRADEMARKS, TRADE NAMES, ETC. Sun owns or possesses, or
holds a valid right or license to use, all intellectual property, patents,
trademarks, trade names, servicemarks, copyrights and licenses, and all rights
with respect to the foregoing, necessary for the conduct of its business as now
conducted, without any known conflict with the rights of others.
SECTION 2.19 SALE OF SUN. Except as contemplated by this Agreement,
there are currently no discussions to which Sun or the Shareholder is a party
relating to (a) the sale of any material portion of the assets of Sun, (b) any
merger, consolidation, share exchange, liquidation, dissolution or similar
transaction involving Sun, or (c) the transfer or issuance of any Sun
Securities.
SECTION 2.20 BROKER'S FEES. Neither Sun nor the Shareholder nor anyone
acting on the behalf or at the request thereof has any liability to any broker,
finder, investment banker or agent, or has agreed to pay any brokerage fees,
finder's fees or commissions, or to reimburse any expenses of any broker,
finder, investment banker or agent in connection with this Agreement.
SECTION 2.21 INVESTMENT REPRESENTATION. The shares of HCC Common Stock
to be acquired by the Shareholder pursuant to this Agreement will be acquired
solely for his individual account, for investment purposes only and not with a
view to the distribution thereof. The Shareholder is not participating,
directly or indirectly, in any distribution or transfer of such HCC Common
Stock, nor is the Shareholder participating, directly or indirectly, in
underwriting any such distribution of HCC Common Stock within the meaning of
the Securities Act. The Shareholder has such knowledge and experience in
business matters that he is capable of evaluating the merits and risks of an
investment in HCC and the acquisition of the shares of HCC Common Stock, and
he is making an informed investment decision with respect thereto. The
Shareholder has been informed by HCC that the shares of HCC Common Stock to be
issued pursuant to this Agreement and the documents to be executed in connection
herewith will not be registered under the Securities Act at the time of their
issuance and may not be transferred, assigned or otherwise disposed of absent
registration under the Securities Act or availability of an appropriate
exemption therefrom. The Shareholder has further been informed that HCC will
be under no obligation to register the shares of HCC Common Stock under the
Securities Act or to take any steps to assist the Shareholder to
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comply with any applicable exemption under the Securities Act with respect to
the shares of HCC Common Stock.
SECTION 2.22 INVESTMENTS. (a) The Sun Disclosure Schedule sets forth a
true and complete list of all bonds, stocks, mortgages and other investments of
any type owned by Sun as of the date hereof (collectively, the "Scheduled
Investments"). Sun has good and marketable title to each of the Scheduled
Investments.
(b) Except as set forth on the Sun Disclosure Schedule, none of the
Scheduled Investments is currently in default in the payment of principal or
interest, and, to the knowledge of the Shareholder, no event has occurred which
reasonably would be expected to result in a diminution of the value of any
nonpublicly traded security owned by Sun.
(c) There are no Liens on any of the Scheduled Investments, except for
(i) those Scheduled Investments deposited with governmental authorities, as
indicated on the Sun Disclosure Schedule, (ii) Liens which do not materially
detract from the value of the Scheduled Investments subject thereto, and (iii)
assets pledged to secure assumed reinsurance contract obligations which assets
are listed on the Sun Disclosure Schedule.
(d) Neither any of the Shareholder nor Sun has taken or omitted to
take, any action which would result in Sun being unable to enforce the terms of
any Scheduled Investment or which would cause any Scheduled Investment to be
subject to any valid offset, defense or counterclaim against the right of Sun to
enforce the terms of such Scheduled Investment.
(e) Since June 30, 1998, Sun has not (i) purchased or otherwise
invested in, or committed to purchase or otherwise invest in, any interest in
real property (including without limitation any extension of credit secured by a
mortgage or deed of trust), (ii) purchased or otherwise invested in, or
committed to purchase or otherwise invest in, bonds, notes, debentures or other
evidences of indebtedness rated lower than "Baa" by Moody's Investors Service
Inc. or "BBB" by Standard & Poor's Corporation at the time of purchase, (iii)
entered into any contract, agreement or arrangement with any affiliate with
respect to the purchase or other acquisition, sale or other disposition or
allocation of any Scheduled Investment or (iv) entered into any contract,
agreement or arrangement with respect to any foreign investments.
SECTION 2.23 INVESTMENT COMPANY. Sun is not an "investment company"
within the meaning of the Investment Company Act of 1940.
SECTION 2.24 LICENSES. Except as described in the Sun Disclosure
Schedule, Sun and the Sun Affiliated Entities and North Bay possess all material
licenses, certificates, authorizations and permits issued by, and have made all
declarations and filings with, the appropriate federal, state or foreign
regulatory agencies or bodies which are necessary or desirable for the ownership
of the properties of Sun, the Sun Affiliated Entities and the North Bay Share or
the conduct of the business of Sun, the Sun Affiliated Entities and North Bay
and neither Sun nor the Sun Affiliated Entities nor
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North Bay has received notification of any revocation or modification of any
such license, certificate, authorization or permit and neither Sun, the Sun
Affiliated Entities, nor North Bay, nor the Shareholder has any reason to
believe that any such license, certificate, authorization or permit will not
be renewed in the ordinary course.
SECTION 2.25 INTERNAL CONTROLS. Sun maintains a system of internal
accounting controls, which Sun reasonably believes is sufficient to provide
reasonable assurances that (i) transactions are executed in accordance with
management's general or specific authorization; (ii) transactions are recorded
as necessary to permit preparation of financial statements in conformity with
generally accepted accounting principles and to maintain asset accountability;
(iii) access to assets is permitted only in accordance with management's general
or specific authorization; and (iv) the recorded accountability for assets is
compared with the existing assets at reasonable intervals and appropriate
actions are taken with respect to any differences.
SECTION 2.26 INSURANCE. Sun has insurance covering its properties,
operations, personnel and businesses, which insurance is in amounts and insures
against such losses and risks as are adequate to protect Sun and its businesses.
Sun has not received notice from any insurer or agent of such insurer that
capital improvements or other expenditures are required and necessary to be made
in order to continue such insurance.
SECTION 2.27 FINANCIAL SOLVENCY. On and immediately after the Closing
Date, Sun will be "Solvent." As used in this paragraph, the term "Solvent"
means, with respect to a particular date, that on such date (i) the present fair
market value (or present fair salable value) of the assets of Sun is not less
than the total amount required to pay the probable liabilities of Sun on its
total existing debts and liabilities (including contingent liabilities) as they
become absolute and matured; (ii) Sun is able to realize upon its assets and pay
its debts and other liabilities, contingent obligations and commitments as they
mature and become due in the normal course of business; (iii) Sun has not
incurred debts or liabilities beyond its ability to pay such debts and
liabilities as they mature; and (iv) Sun does not engage in any business or
transaction and is not about to engage in any business or transaction for which
its property would constitute unreasonably small capital after giving due
consideration to the prevailing practice of the industry in which Sun is
engaged. In computing the amount of such contingent liabilities at any time, it
is intended that such liabilities will be computed at the amount that, in light
of all the facts and circumstances existing at such time, represents the amount
that can reasonably be expected to become an actual or matured liability.
SECTION 2.28 YEAR 2000 ISSUE. Sun is currently evaluating its
operations and systems to determine the risk of computer hardware and software
used by it becoming unable to recognize and properly execute date-sensitive
functions involving certain dates prior to and any dates after December 31, 1999
(the "Year 2000 Issue") and has determined that such risk will be remedied on a
timely basis without material expense and will not have a Material Adverse
Effect.
SECTION 2.29 NORTH BAY ASSETS. North Bay owns and controls, free of any
Liens or encumbrances, each of the assets set forth on Schedule 2.29 attached
hereto. North Bay began
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beneficially holding ceded insurance premiums allocable to the Class F
Participating share on January 1, 1997. Such assets have accumulated since
Shareholder and Barton have owned of record the North Bay Share and there
has never been a distribution of any cash or other assets to any of the
holders or owners of record of the North Bay Share.
ARTICLE 3
REPRESENTATIONS AND WARRANTIES
OF HCC
Except as disclosed in a document referring specifically to this
Agreement or in a document, exhibit, or appendix filed with the Securities and
Exchange Commission ("SEC") on or before the date hereof, (collectively referred
to herein as the "HCC Disclosure Schedule") which has been delivered or made
available to the Shareholder on or before the date hereof, HCC represents and
warrants to the Shareholder:
SECTION 3.1 CORPORATE EXISTENCE AND POWER. HCC is a corporation duly
incorporated, validly existing and in good standing under the laws of the state
of its incorporation. HCC has all corporate powers and all material
Governmental Authorizations required to carry on its business as now conducted,
except such Governmental Authorizations the failure of which to have obtained
would not have a Material Adverse Effect on HCC. HCC is duly qualified to do
business as a foreign corporation and is in good standing in each jurisdiction
where the character of the property owned or leased by it or the nature of its
activities makes such qualification necessary, except where the failure to be so
qualified would not have a Material Adverse Effect on HCC. HCC has made
available to Sun and the Shareholder true and complete copies of its
Certificate of Incorporation and Bylaws, as currently in effect.
SECTION 3.2 CORPORATE AUTHORIZATION. The execution, delivery and
performance by HCC of this Agreement and each other agreement entered into by
it in connection with the transactions contemplated hereby, and the consummation
by HCC of the transactions contemplated hereby and thereby are within the
corporate powers of HCC and have been duly authorized by all necessary
corporate action. This Agreement and each other agreement entered into by it in
connection with the transactions contemplated hereby constitutes, or upon
execution will constitute, valid and binding agreements of HCC enforceable in
each case in accordance with their respective terms, except as such enforcement
may be limited by bankruptcy, insolvency or other similar laws affecting the
enforcement of creditors' rights generally or by general principles of equity.
SECTION 3.3 GOVERNMENTAL AUTHORIZATION. The execution, delivery and
performance by HCC of this Agreement, require no action by or in respect of, or
filing with, any governmental body, agency, official or authority other than:
(a) compliance with the applicable requirements of the HSR Act;
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(b) compliance with any applicable requirements of the Securities
Exchange Act of 1934 (the "Exchange Act") and the rules and regulations
promulgated thereunder;
(c) compliance with any applicable requirements of the Securities Act
and the rules and regulations promulgated thereunder;
(d) compliance with any applicable foreign or state securities or
"blue sky" laws and the rules and regulations of the NYSE;
(e) compliance with any applicable requirements of any insurance
regulatory agency having authority over HCC; and
(f) such other filings or registrations with, or authorizations,
consents or approvals of, governmental bodies, agencies, officials or
authorities, the failure of which to make or obtain (i) would not reasonably be
expected to have a Material Adverse Effect on HCC or (ii) would not materially
adversely affect the ability of any party to consummate the transactions
contemplated hereby and operate their businesses as heretofore operated.
SECTION 3.4 SHARES OF HCC COMMON STOCK. Upon satisfaction of the
conditions for issuance pursuant to this Agreement, the shares of HCC Common
Stock to be issued to the Shareholder pursuant to this Agreement, and will be
duly authorized, validly issued, fully paid and nonassessable.
SECTION 3.5 SEC FILINGS.
(a) HCC has since January 1, 1996 filed all forms, proxy statements,
schedules, reports and other documents required to be filed by it with the SEC
pursuant to the Exchange Act.
(b) HCC has made available to Sun, the Shareholder and Barton or will
make available in the case of any of the following documents filed with the SEC
on or after the date hereof and prior to the Closing Date,
(i) its annual reports on Form 10-K for its fiscal years ended
December 31, 1997 and 1996;
(ii) any current reports on Form 8-K since January 1, 1998 and
its proxy or information statements relating to meetings of, or actions
taken without a meeting by, the shareholders of HCC held since
January 1, 1998; and
(iii) all of its other reports, statements, schedules and
registration statements filed with the SEC since December 31, 1997.
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(c) As of its filing date, no such report or statement filed pursuant
to the Exchange Act contained any untrue statement of a material fact or omitted
to state any material fact necessary in order to make the statements made
therein, in the light of the circumstances under which they were made, not
misleading.
(d) No registration statement filed pursuant to the Securities Act, if
declared effective by the SEC, as of the date such statement or amendment became
effective, contained any untrue statement of a material fact or omitted to state
any material fact required to be stated therein or necessary to make the
statements therein not misleading.
SECTION 3.6 NON-CONTRAVENTION. The execution, delivery and performance
by HCC of this Agreement and each other agreement to be entered into in
connection with this Agreement, and the consummation of the other transactions
contemplated hereby and thereby do not and will not:
(a) contravene or conflict with the organizational documents of HCC;
(b) assuming compliance with the matters referred to in Section 3.3,
contravene or conflict with or constitute a violation of any provision of any
law, regulation, judgment, injunction, order or decree binding upon or
applicable to HCC;
(c) conflict with or result in a breach or violation of, or constitute
a default under, or result in a contractual right to cause the termination or
cancellation of or loss of a material benefit under, or right to accelerate, any
material agreement, contract or other instrument binding upon HCC or any
material license, franchise, permit or other similar authorization held by HCC,
except, with respect to clauses (b) and (c) above, for contraventions, defaults,
losses, and other matters referred to in such clauses that in the aggregate
would not be reasonably expected to have, individually or in the aggregate, a
Material Adverse Effect on HCC.
SECTION 3.7 ABSENCE OF CERTAIN CHANGES. Since the date of filing with
the SEC of its most recent quarterly report on Form 10-Q, there has not been any
Material Adverse Change with respect to the business of HCC or any event,
occurrence, or development of a set of circumstances or facts known to HCC,
which as of the date hereof could reasonably be expected to have a Material
Adverse Effect on HCC.
SECTION 3.8 COMPLIANCE WITH LAWS. Except for violations which do not
have and would not reasonably be expected to have, individually or in the
aggregate, a Material Adverse Effect on HCC, HCC has received no notice that it
is in violation of, or has violated, any applicable provisions of any laws,
statutes, ordinances, or regulations or any term of any judgment, decree,
injunction, or order binding against it.
SECTION 3.9 BROKER'S FEES. Neither HCC nor anyone acting on behalf of
HCC or at the request of HCC has any liability to any broker, finder, investment
banker or agent, or has agree to
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pay any brokerage fees, finder's fees or commissions, or to reimburse any
expenses of any broker, finder, investment banker or agent in connection with
this Agreement.
SECTION 3.10 INVESTMENT COMPANY. HCC is not an "investment company"
within the meaning of the Investment Company Act of 1940.
SECTION 3.11 CAPITALIZATION OF HCC. The authorized capital stock of HCC
consists of 250,000,000 shares of HCC Common Stock. As of September 30, 1998,
there were 48,132,307 shares of HCC Common Stock issued and outstanding. All
outstanding shares of HCC Common Stock have been duly authorized and validly
issued and are fully paid and nonassessable and free from any preemptive rights.
Except as set forth in this Section and as otherwise contemplated by this
Agreement and except as disclosed in public filings made by HCC with the SEC
prior to the Closing Date or on the HCC Disclosure Schedule and except for
changes since September 30, 1998 resulting from the exercise of employee and
director stock options, or in connection with other acquisitions, mergers or
similar transactions there are outstanding (i) no shares of capital stock or
other voting securities of HCC, (ii) no securities of HCC convertible into or
exchangeable for shares of capital stock or voting securities of HCC and (iii)
no options or other rights to acquire from HCC, and no obligation of HCC to
issue, any capital stock, voting securities or securities convertible into or
exchangeable for capital stock or other voting securities of HCC (the items in
clauses (i), (ii) and (iii) being referred to collectively as the "HCC
Securities"). There are no outstanding obligations of HCC to repurchase, redeem
or otherwise acquire any HCC Securities.
SECTION 3.12 INVESTIGATION. To HCC's knowledge it has been afforded an
opportunity to conduct an investigation of Sun. HCC has been afforded an
opportunity to ask questions of Sun employees. Each of the parties hereto
represent and acknowledge that no investigation made by HCC shall in any way
affect any representation or warranty given by Sun, the Shareholder or Barton,
or any other party hereto, nor shall such investigation act as a waiver,
estoppel or create any equitable or legal defense to any action brought by HCC
in connection with the transactions contemplated hereunder or as a result of any
such investigation or affect the Shareholder's indemnification obligations set
forth in Article 10 hereof.
SECTION 3.13 INVESTMENT REPRESENTATION. The shares of Sun Common Stock
to be acquired by HCC pursuant to this Agreement will be acquired solely for
HCC's account, for investment purposes only and not with a view to the
distribution thereof. HCC is not participating, directly or indirectly, in any
distribution or transfer of such Sun Common Stock, nor is it participating,
directly or indirectly, in underwriting any such distribution of Sun Common
Stock within the meaning of the Securities Act. HCC has such knowledge and
experience in business matters that it is capable of evaluating the merits and
risks of an investment in Sun and the acquisition of the shares of Sun Common
Stock, and it is making an informed investment decision with respect thereto.
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ARTICLE 4
COVENANTS OF THE SHAREHOLDER AND SUN
From the date hereof until the occurrence of the earlier of (i) the
Effective Time or (ii) termination of this Agreement pursuant to Section 8.1
hereof (except that the covenants under Sections 4.8, 4.9, and 4.10 shall
continue in effect beyond Closing), Sun and the Shareholder agree that:
SECTION 4.1 CONDUCT OF SUN. Sun and the Sun Affiliated Entities each
shall in all material respects conduct its business in the ordinary course
except as specifically permitted in clause (e) below. Without limiting the
generality of the foregoing, from the date hereof until the Effective Time,
except as contemplated by this Agreement or as otherwise permitted with the
written consent of HCC:
(a) Neither Sun nor the Sun Affiliated Entities will adopt or propose
any change in its organizational documents;
(b) Neither Sun nor the Sun Affiliated Entities will enter into or
amend any employment agreements (oral or written) or increase the compensation
payable or to become payable by it to any of its officers, directors, or
consultants over the amount payable as of June 30, 1998, or increase the
compensation payable to any other employees (other than (i) increases in the
ordinary course of business which are not in the aggregate material, or
(ii) pursuant to plans disclosed in Sun Disclosure Schedule), or adopt or amend
any employee benefit plan or arrangement (oral or written), except that Sun
agrees, except as agreed to by HCC, to terminate each of Sun's Pension Plans,
Welfare Plan or any other retirement benefit plans on or before the Closing
Date;
(c) Neither Sun nor the Sun Affiliated Entities will issue any
securities;
(d) Sun and the Sun Affiliated Entities will each keep in full force
and effect any existing directors' and officers' liability insurance and will
not modify or reduce the coverage thereunder;
(e) Neither Sun nor the Sun Affiliated Entities will pay any dividend
or make any other distribution to holders of its capital stock nor redeem or
otherwise acquire any securities, except that prior to the Effective Time Sun
shall redeem six shares of the Sun Common Stock from the Shareholder in exchange
for the property described on Exhibit "B" attached hereto (the "Barton Ridge
Property", which for purposes hereof includes all interests in Plantation Gear,
LLC) and the 52' Hatteras yacht known as "Sundancer" (which for purposes hereof
includes all of the interests in Sun Harbor LLC), owned by Sun free and clear of
the liabilities secured thereby;
(f) Neither Sun nor the Sun Affiliated Entities will, directly or
indirectly, dispose of or acquire any material properties or assets except in
the ordinary course of business;
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(g) Neither Sun nor the Sun Affiliated Entities will incur any
additional indebtedness for borrowed money;
(h) Neither Sun nor the Sun Affiliated Entities will enter into any
extraordinary transaction outside of the ordinary course of its business as
presently conducted, make any capital expenditure in excess of $10,000, or incur
any non-budgeted expense over $5,000;
(i) Neither Sun nor the Sun Affiliated Entities will amend or change
the period of exercisability or accelerate the exercisability of any outstanding
options or warrants to acquire shares of capital stock, or accelerate, amend or
change the vesting period of any outstanding restricted stock;
(j) Neither Sun nor the Sun Affiliated Entities will (i) change
accounting methods except as necessitated by changes which Sun or the Sun
Affiliated Entities is required to make in order to prepare its federal, state
and local tax returns; (ii) amend or terminate any contract, agreement or
license to which it is a party (except pursuant to arrangements previously
disclosed in writing to HCC or disclosed in the Sun Disclosure Schedule) except
those amended or terminated in the ordinary course of business, consistent with
past practices, or involving changes which are not materially adverse in amount
or effect to Sun or the Sun Affiliated Entities individually or taken as a
whole; (iii) lend any amount to any person or entity, other than advances for
travel and expenses which are incurred in the ordinary course of business
consistent with past practices, and which are not material in amount to Sun or
the Sun Affiliated Entities taken as a whole, which travel and expenses shall
be documented by receipts for the claimed amounts; (iv) enter into any guarantee
or suretyship for any obligation except for the endorsements of checks and other
negotiable instruments in the ordinary course of business, consistent with past
practice; (v) waive or release any material right or claim except in the
ordinary course of business, consistent with past practice; (vi) issue or sell
any shares of its capital stock of any class or any other of its securities, or
issue or create any warrants, obligations, subscriptions, options, convertible
securities, stock appreciation rights or other commitments to issue shares of
capital stock, or take any action other than this transaction to accelerate the
vesting of any outstanding option or other security (except pursuant to existing
arrangements disclosed in writing to HCC before the date of this agreement);
(vii) merge, consolidate or reorganize with or acquire any entity; (viii) agree
to any audit assessment by any tax authority or file any federal or state income
or franchise tax return unless copies of such returns have been delivered to
HCC for its review prior to such agreement or filing; and (ix) terminate the
employment of any key executive employee;
(k) The Shareholder will maintain, and shall cause the Sun Affiliated
Entities to maintain, all insurance agency licenses or authorizations currently
held by the Shareholder or the Sun Affiliated Entities; and
(l) Neither Sun, the Sun Affiliated Entities, nor the Shareholder will
directly or indirectly, agree or commit to do any of the foregoing.
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SECTION 4.2 ACCESS TO FINANCIAL AND OPERATIONAL INFORMATION. Sun and
the Shareholder will give HCC, its counsel, financial advisors, auditors and
other authorized representatives reasonable access during normal business hours
to their offices, properties, books and records, will furnish to HCC, its
counsel, financial advisors, auditors and other authorized representatives such
financial and operating data as such persons may reasonably request and will
instruct its employees, counsel and financial advisors to cooperate with HCC in
its investigation of the business of Sun and the Sun Affiliated Entities and in
the planning for the combination of the businesses of Sun and the Sun Affiliated
Entities and HCC following the consummation of the transactions contemplated by
this Agreement; PROVIDED that no investigation pursuant to this Section shall
affect any representation or warranty given hereunder. In addition, following
the public announcement of this Agreement or the transactions contemplated
hereby, Sun will cooperate in arranging joint meetings among representatives of
Sun and HCC and persons with whom they maintain business relationships.
SECTION 4.3 OTHER OFFERS. Neither Sun nor the Shareholder will,
directly or indirectly, through representatives or otherwise, (i) solicit,
entertain, or negotiate with respect to, or in any manner encourage, discuss, or
consider, any Acquisition Proposal (as hereinafter defined), or (ii) disclose
any information relating to Sun, or afford access to the properties, books, or
records of Sun, directly or indirectly, in connection with any Acquisition
Proposal or possible or proposed Acquisition Proposal. To the extent that Sun
or the Shareholder or any of their respective officers, directors, employees or
other agents is currently involved in any discussions with respect to any
Acquisition Proposal or contemplated or proposed Acquisition Proposal, Sun and
the Shareholder shall terminate, and shall use their best efforts to cause,
where applicable, their respective officers, directors, employees or other
agents to terminate, such discussions immediately. Subject to their fiduciary
duties, the Board of Directors of Sun, and Shareholder, shall not (i) approve or
recommend, or propose to approve or recommend, any Acquisition Proposal (other
than an Acquisition Proposal made by HCC or an affiliate of HCC), or
(ii) approve or authorize the entering into any agreement with respect to any
Acquisition Proposal. The term "Acquisition Proposal" as used herein means any
offer or proposal for, or any indication of interest in, a merger or other
business combination involving Sun or the acquisition of any equity interest in,
or a substantial portion of the assets of, Sun or the Sun Affiliated Entities
other than the transactions contemplated by this Agreement.
SECTION 4.4 MAINTENANCE OF BUSINESS. Sun will, and the Shareholder
shall cause Sun and the Sun Affiliated Entities to, use commercially reasonable
efforts to carry on its business, keep available the services of its officers
and employees and preserve its relationships with those of its customers,
agents, suppliers, licensors and others having business relationships with it
that are material to its business in substantially the same manner as it has
prior to the date hereof. If Sun or the Shareholder becomes aware of a material
deterioration or facts which are likely to result in a material deterioration in
the relationship of Sun or the Sun Affiliated Entities with any customers,
supplier, licensor or others having business relationships with it, such party
will promptly in writing bring such information to the attention of the HCC.
SECTION 4.5 COMPLIANCE WITH OBLIGATIONS. Sun shall, and the
Shareholder shall cause Sun and the Sun Affiliated Entities to, use commercially
reasonable efforts to comply in all material
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respects with (i) all applicable federal, state, local and foreign laws,
rules and regulations, (ii) all material agreements and obligations,
including its respective charter and bylaws, by which it, its properties or
its assets may be bound, and (iii) all decrees, orders, writs, injunctions,
judgments, statutes, rules and regulations applicable to Sun or the Sun
Affiliated Entities or North Bay and its respective properties or assets.
SECTION 4.6 NOTICES OF CERTAIN EVENTS. Sun or the Shareholder shall,
upon obtaining knowledge of any of the following, promptly notify HCC of:
(a) any notice or other communication from any person alleging that
the consent of such person is or may be required in connection with this
Agreement,
(b) any notice or other communication from any governmental or
regulatory agency or authority in connection with this Agreement; and
(c) any actions, suits, claims, investigations or other judicial
proceedings commenced or threatened against Sun which, if pending on the date of
this Agreement, would have been required to have been disclosed pursuant hereto
or which relate to the consummation of transactions contemplated by this
Agreement.
SECTION 4.7 NECESSARY CONSENTS. After the Closing, the Shareholder
shall use commercially reasonable efforts to obtain such written consents and
take such other actions as may be necessary or appropriate to allow Sun or any
successor to carry on its business as a subsidiary of HCC after the Closing Date
(as defined in Section 9.1 hereof).
SECTION 4.8 REGULATORY APPROVAL. Sun and, where required pursuant to
the rules or regulations of any regulatory agency, the Shareholder will execute
and file, or join in the execution and filing of, any application or other
document that may be necessary in order to obtain the authorization, approval or
consent of any governmental body, federal, state, local or foreign which may be
reasonably required, or which HCC may reasonably request, in connection with
the consummation of the transaction provided for in this Agreement. Sun and the
Shareholder will use commercially reasonable efforts to obtain or assist HCC in
obtaining all such authorizations, approvals and consents.
SECTION 4.9 SATISFACTION OF CONDITIONS PRECEDENT. Sun and the
Shareholder shall use commercially reasonable efforts to cause the transactions
provided for in this Agreement to be consummated, and, without limiting the
generality of the foregoing to obtain all consents and authorizations of third
parties and to make all filings with, and give all notices to, third parties
that may be necessary or reasonably required on its part in order to effect the
transactions provided for herein.
SECTION 4.10 COMMUNICATIONS. Without the prior approval of HCC, neither
Sun nor any Shareholder will disclose any information relating to the
transactions contemplated by this
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Agreement, other than to HCC or an officer, director, attorney, or advisor of
Sun or the Shareholder who needs to know such information in connection with
the negotiation or consummation of the transactions contemplated hereby.
ARTICLE 5
COVENANTS OF HCC
SECTION 5.1 CONDUCT OF HCC. From the date hereof until the
occurrence of the earlier of (i) the Effective Time or (ii) the termination of
this Agreement pursuant to Section 8.1 hereof, HCC agrees that, except as
otherwise permitted with the written consent of the Shareholder, which consent
shall not be unreasonably withheld, HCC shall in all material respects conduct
its business in the ordinary course PROVIDED, HOWEVER, THAT nothing in this
Agreement shall be construed to prohibit or otherwise restrain HCC in any manner
from acquiring other businesses or substantially all of the assets thereof.
Without limiting the generality of the foregoing, from the date hereof until the
Effective Time, except as contemplated hereby or previously disclosed by HCC to
the Shareholder in writing:
(a) HCC will not adopt or propose any change in its Certificate of
Incorporation or Bylaws;
(b) HCC will not take any action that would result in a failure to
maintain the trading of HCC Common Stock on the NYSE; and
(c) HCC will not agree or commit to do any of the foregoing.
SECTION 5.2 LISTING OF HCC COMMON STOCK. HCC shall use reasonable
efforts to cause the shares of HCC Common Stock to be issued hereunder to be
approved for listing on the NYSE within 90 days following the Closing.
SECTION 5.3 COMPLIANCE WITH OBLIGATIONS. From the date hereof until
the occurrence of the earlier of (i) the Effective Time or (ii) the termination
of this Agreement pursuant to Section 8.1 hereof, HCC agrees that, except as
otherwise permitted with the written consent of the Shareholder, which consent
shall not be unreasonably withheld, HCC shall use its commercially reasonable
efforts to comply in all material respects with (i) all applicable federal,
state, local and foreign laws, rules and regulations, (ii) all material
agreements and obligations, including its respective charter and bylaws, by
which it, its properties or its assets may be bound, and (iii) all decrees,
orders, writs, injunctions, judgments, statutes, rules and regulations
applicable to HCC and its subsidiaries and their respective properties or
assets; except to the extent that the failure to comply with matters in clauses
(i), (ii) and (iii) would not have a Material Adverse Effect on HCC.
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SECTION 5.4 NOTICES OF CERTAIN EVENTS. From the date hereof until the
occurrence of the earlier of (i) the Effective Time or (ii) the termination of
this Agreement pursuant to Section 8.1 hereof, HCC shall, upon obtaining
knowledge of any of the following, promptly notify the Shareholder of:
(a) any notice or other communication from any person alleging that
the consent of such person is or may be required in connection with this
Agreement;
(b) any notice or other communication from any governmental or
regulatory agency or authority in connection with this Agreement; and
(c) any actions, suits, claims, investigations or other judicial
proceedings commenced or threatened against HCC which, if pending on the date
of this Agreement, would have been required to have been disclosed pursuant
hereto or which relate to the consummation of the transactions contemplated by
this Agreement.
SECTION 5.5 RULE 144. For so long as the shares of HCC Common Stock to
be issued by HCC to the Shareholder hereunder constitute restricted securities
within the meaning of Rule 144 promulgated under the Securities Act, but
paragraph (k) of Rule 144 does not apply to the resale of such shares, HCC
shall file such reports and take such further actions as may be required
pursuant to such Rule 144 to allow the continued sale of such HCC Common Stock
by the Shareholder thereunder.
ARTICLE 6
COVENANTS OF HCC,
THE SHAREHOLDER AND SUN
SECTION 6.1 ADVICE OF CHANGES. From the date hereof until the
occurrence of the earlier of (i) the Effective Time or (ii) termination of this
Agreement pursuant to Section 8.1 hereof, each party hereto agrees that such
party will promptly advise the others in writing (i) of any event known to any
of its executive officers or the Shareholder occurring subsequent to the date of
this Agreement that in its reasonable judgment renders any representation or
warranty of such party contained in this Agreement, if made on or as of the date
of such event or the Effective Date, untrue, inaccurate or misleading in any
material respect and (ii) of any Material Adverse Change in the business
condition of the party.
SECTION 6.2 REGULATORY APPROVALS. From the date hereof until the
occurrence of the earlier of (i) the Effective Time or (ii) termination of this
Agreement pursuant to Section 8.1 hereof, each party hereto agrees that such
party shall execute and file, or join in the execution and filing of, any
application or other document that may be necessary in order to obtain the
authorization, approval or consent of any governmental body, federal, state,
local or foreign, which may be
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requested in connection with the consummation of the transactions
contemplated by this Agreement. Each party shall use its commercially
reasonable efforts to obtain all such authorizations, approvals and consents.
SECTION 6.3 CERTAIN FILINGS. From the date hereof until the occurrence
of the earlier of (i) the Effective Time or (ii) termination of this Agreement
pursuant to Section 8.1 hereof, each party hereto agrees that such party will
cooperate with the other parties:
(a) in connection with the preparation of any filing required by the
HSR Act;
(b) in determining whether any action by or in respect of, or filing
with, any governmental body, agency or official, or authority is required, or
any actions, consents, approvals or waivers are required to be obtained from
parties to any material contracts, in connection with the consummation of the
transactions contemplated by this Agreement; and
(c) in seeking any such actions, consents, approvals or waivers or
making any such filings, furnishing information required in connection therewith
and seeking timely to obtain any such actions, consents, approvals or waivers.
SECTION 6.4 SATISFACTION OF CONDITIONS PRECEDENT. From the date
hereof until the occurrence of the earlier of (i) the Effective Time or
(ii) termination of this Agreement pursuant to Section 8.1 hereof, each party
hereto agrees that such party will use commercially reasonable efforts to
satisfy or cause to be satisfied all the conditions precedent that are
applicable to each of them, and to cause the transactions contemplated by this
Agreement to be consummated, and, without limiting the generality of the
foregoing, to obtain all material consents and authorizations of third parties
and to make filings with, and give all notices to, third parties that may be
necessary or reasonably required on its part in order to effect the transactions
contemplated hereby.
SECTION 6.5 CONFIDENTIALITY.
(a) For a period of five (5) years from the date of this Agreement,
each such party will maintain in confidence, and cause its directors, officers,
employees, agents, and advisors to maintain in confidence, and not use to the
detriment of another party, any written or oral or other information obtained in
confidence from another party that in connection with this Agreement or the
transactions contemplated hereby unless such information is already known to
such party or to others not bound by a duty of confidentiality or unless such
information becomes publicly available through no fault of such party, unless
the use of such information is necessary or appropriate in making any filing or
obtaining any consent or approval required for the consummation of the
transaction contemplated hereby or unless the furnishing or use of such
information is required by or necessary or appropriate in connection with legal
proceedings. This Section 6.5(a) shall not apply to HCC following the Closing,
if the Closing occurs.
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(b) If the transactions contemplated by this Agreement are not
consummated, each party will return or destroy as much of such written
information as may be reasonably requested. Whether or not the Closing takes
place, the Shareholder waives, and will upon request cause Sun to waive, any
cause of action, right or claim arising out of the access of HCC or its
representatives to any trade secrets or other confidential information of Sun
except for the intentional competitive misuse by HCC of such trade secrets
or confidential information.
SECTION 6.6 TAX COOPERATION. HCC, Sun, and the Shareholder shall
cooperate in the preparation, execution, and filing of all returns,
questionnaires, applications, or other documents regarding any sales, use,
transfer, value, stock transfer, or stamp taxes, or any transfer, recording,
registration, or other fees, or any similar taxes or fees which become
payable in connection with the transactions contemplated by this Agreement.
SECTION 6.7 CHANGE OF NAME OF SUN. HCC reserves the right, at its
sole discretion, to change the name of Sun, or to change the structure,
organization or operations of Sun, or to move the business and operations of
Sun, as determined by HCC in its sole discretion. However, Sun shall grant
to Shareholder a non-exclusive, royalty-free license to use the name "Sun"
(but not the name "Sun Employer Services") in connection with any business
other than the insurance, benefits and related consulting businesses.
Without limiting the foregoing, the Shareholder shall have the right to
utilize the name "Sun" and the logo of Sun on his Hatteras boat (and any
successor boat or affiliated equipment) and with respect to any marina
business with which the Shareholder is associated.
SECTION 6.8 PUBLIC DISCLOSURE OF TRANSACTION. Subject to written
advice of counsel with respect to the legal requirements relating to a public
disclosure of the transactions contemplated hereby, the timing and content of
any announcements, press releases, or other public statements concerning the
transactions contemplated herein will be determined solely by HCC, with input
from Sun.
ARTICLE 7
CONDITIONS TO CLOSING
SECTION 7.1 CONDITIONS TO OBLIGATIONS OF HCC. The obligations of
HCC hereunder are subject to the fulfillment or satisfaction, on and as of
the Closing Date, of each of the following conditions (any one or more of
which may be waived by HCC, but only in a writing signed by HCC):
(a) The representations and warranties of Sun and the Shareholder
set forth herein remain true and accurate in all material respects on and as
of the Closing Date with the same force and effect as if they had been made
on the Closing Date (except to the extent a representation or warranty speaks
specifically as of an earlier date and except for changes contemplated by
this
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Agreement) and the Shareholder shall have provided HCC with a certificate
executed by the Shareholder dated as of the Closing Date, to such effect.
(b) Sun and the Shareholder shall have performed and complied in
all material respects with all of the covenants applicable to them contained
herein on or before the Closing Date, and HCC shall receive a certificate to
such effect signed by the Shareholder.
(c) Except as set forth in the Sun Disclosure Schedule or the Sun
Financial Statements, there shall have been no Material Adverse Change in Sun
since June 30, 1998.
(d) All written consents, assignments, waivers or authorizations,
other than Governmental Authorizations, that are required as a result of the
transaction contemplated by this Agreement for the continuation in full force
and effect of the Material Sun Agreements shall have been obtained.
(e) HCC shall have received the opinion of counsel to Sun and the
Shareholder in form and substance satisfactory to HCC.
(f) HCC shall have determined that all underwriting agreements and
related reinsurance agreements, agency agreements, and commission sharing
agreements of Sun in force on the date hereof, including, without limitation,
Sun's Agreement with Monumental General Casualty Company and Monumental Life
Insurance Company ("Monumental"), which includes a fronting fee of 6% to
Monumental, a 22% management fee to Sun, a 3% claims administration fee to
Sun, and the ceding of 100% of the employer liability premium (at a rate of
10% of the total gross written premium) to North Bay, will remain in full
force and effect, without restriction or modification as a result of the
transactions contemplated hereby, for a period of at least 12 months
following the Closing Date.
(g) The Shareholder shall be alive and not, in any way, Disabled.
For purposes of this Agreement, the Shareholder shall be deemed to be
"Disabled" if he is unable to engage in any substantial portion of his
regular duties for Sun by reason of any medically determinable physical or
mental impairment which can be expected to result in death or which has
lasted or can be reasonably expected to last for a continuous period of not
less than 12 months.
(h) Sun shall have received the unqualified opinion of independent
public accountants to Sun on their audited financial statements for the year
ended June 30, 1998.
(i) Sun shall have delivered to HCC its audited balance sheet and
its audited income statement for the year ended June 30, 1998.
(j) Sun is expected to earn, on a pro-forma basis, as reasonably
determined by HCC, at least $3,300,000 before income tax for the year ending
June 30, 1999.
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(k) The retained earnings, as calculated in accordance with GAAP,
applied on a basis consistent with the basis applied in the preparation of
the Audited Balance Sheet, of Sun immediately after the Effective Time will
equal or exceed $2,000,000.
(l) The Shareholder shall have tendered all the Sun Common Stock
for sale pursuant to this Agreement. No claim shall have been filed, made or
threatened by any other person or entity asserting that he, she or it is
entitled to any part of the Purchase Price.
(m) The Shareholder shall have executed and delivered to HCC a five
year worldwide Non-Competition Agreement covering all aspects of the
insurance business from the date of separation of employment from HCC and
Sun and their successors, in a form satisfactory to HCC.
(n) All plans, policies, arrangements, and agreements described in
Section 2.12 hereof shall have been terminated, except as approved in writing
by HCC.
(o) On or prior to the Closing Date, the Shareholder shall have
furnished HCC with evidence of such consents as the Shareholder shall know,
or HCC shall determine, to be required to enable HCC to continue to enjoy
the benefit of any lease, license, permit, contract or other agreement or
instrument to or of which Sun is a party or beneficiary and which can, by its
terms (with consent) and consistent with applicable law, be so enjoyed after
the transfer of the Sun Common Stock to HCC. If there is in existence any
lease, governmental license, permit or contract that by its terms or
applicable law, expires, terminates or is otherwise rendered invalid upon the
transfer of the Sun Common Stock to HCC, and such lease, license, permit, or
contract is required in order for the business of Sun to continue to be
conducted following the transfer of the Sun Common Stock in the same manner
as conducted previously, HCC shall have obtained, or been furnished by the
Shareholder an equivalent of, that lease, license, permit, or contract
effective as of and after the Closing Date.
(p) HCC shall have received resignations of all persons who are
officers or directors of Sun immediately prior to the Closing.
(q) HCC shall have received general releases in favor of Sun and
HCC executed by the Shareholder, Barton, and such other employees, officers,
or directors of Sun as HCC may designate. Those releases will not relate to
rights or obligations arising under this Agreement.
(r) HCC shall have received possession of all corporate,
accounting, business and tax records of Sun.
(s) The form and substance of all actions, proceedings, instruments
and documents required to consummate the transactions contemplated by this
Agreement shall have been satisfactory in all reasonable respects to HCC and
HCC's counsel.
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(t) HCC shall have determined that North Bay shall have adequately
reserved against all losses incurred by it and shall have a minimum IBNR
level for net retained business of at least $1,000,000.
(u) HCC or a subsidiary of HCC shall have entered into arrangements
reasonably satisfactory to HCC with each of Michael S. Hoover and Howard V.
Barton, II with respect to their continuing employment.
(v) The assets set forth on Schedule 2.29 shall be held of record
and beneficially by North Bay.
(w) Bobby G. Black and Joan Black shall each have executed a
Purchase Agreement, and an Employment Termination Agreement and Release and
Assignment in form and substance acceptable to HCC.
(x) Michael S. Hoover shall have executed a Purchase Agreement and
Assignment relating to the sale of his interest in KIMCO.
SECTION 7.2 CONDITIONS TO OBLIGATIONS OF THE SHAREHOLDER. The
obligations of the Shareholder hereunder are subject to the fulfillment or
satisfaction, on and as of the Closing Date, of each of the following
conditions (any one or more of which may be waived, but only in a writing
signed by such party):
(a) The representations and warranties of HCC set forth herein
shall be true and accurate in all material respects on and as of the Closing
Date with the same force and effect as if they had been made on the Closing
Date (except to the extent a representation or warranty speaks specifically
as of an earlier date and except for changes contemplated by this Agreement)
and HCC shall have provided the Shareholder with a certificate executed by
an authorized officer of each of HCC, dated as of the Closing Date, to such
effect. For the purposes of determining the accuracy of the representations
and warranties of HCC, any change or effect in the business of HCC that
results in substantial part as a consequence of the public announcement or
pendency of the intended acquisition of the Sun Common Stock by HCC shall
not be deemed a Material Adverse Change or Material Adverse Effect or other
breach of representation or warranty with respect to HCC.
(b) HCC shall have performed and complied with all of its
covenants contained herein in all material respects on or before the Closing
Date, and the Shareholder shall have received a certificate to such effect
signed by any authorized officer of HCC.
(c) Except as set forth in the HCC Disclosure Schedule, there shall
have been no Material Adverse Change in HCC since June 30, 1998.
(d) The Shareholder shall have received from Winstead Sechrest &
Minick P.C., counsel to HCC, an opinion in form and substance satisfactory
to the Shareholder.
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(e) The form and substance of all actions, proceedings, instruments
and documents required to consummate the transactions contemplated by this
Agreement shall have been satisfactory in all reasonable respects to the
Shareholder and his counsel.
SECTION 7.3 CONDITIONS TO OBLIGATIONS OF EACH PARTY. The respective
obligations of the parties hereunder at Closing are subject to the
fulfillment, on and as of the Closing Date, of each of the following
conditions (any one or more of which may be waived by such parties, but only
in a writing signed by such parties):
(a) No statute, rule, regulation, executive order, decree,
injunction or restraining order shall have been enacted, promulgated or
enforced (and not repealed, superseded or otherwise made inapplicable) by any
court or governmental authority which prohibits the consummation of the
transaction contemplated by this Agreement (each party agreeing to use its
commercially reasonable efforts to have any such order, decree or injunction
lifted).
(b) There shall have been obtained any and all Governmental
Authorizations, permits, approvals and consents of securities or "blue sky"
commissions of any jurisdiction and of any other governmental body or agency,
that may reasonably be deemed necessary so that the consummation of the
transaction contemplated by this Agreement will be in compliance with
applicable laws, the failure to comply with which would have a Material
Adverse Effect on HCC, Sun, or the Shareholder or would be reasonably likely
to subject any of HCC, Sun, or the Shareholder or any of their respective
directors or officers to penalties or criminal liability.
(c) The waiting period (and any extension thereof) applicable to
the consummation of the Merger under the HSR Act, if applicable, shall have
expired or been terminated.
ARTICLE 8
TERMINATION OF AGREEMENT
SECTION 8.1 TERMINATION. This Agreement may be terminated at any
time prior to the Closing Date:
(a) By the mutual consent of the Shareholder and the Board of
Directors of HCC.
(b) By the Board of Directors of HCC, if the Shareholder shall
have become Disabled or shall have died, or if there has been a material
breach by Sun or the Shareholder of any representation, warranty or covenant
contained in this Agreement which cannot be, or has not been, cured within 15
days after written notice of such breach is given to the Shareholder,
provided that the right to effect such cure shall not extend beyond the date
set forth in subparagraph (d) below.
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(c) By the Shareholder, if there has been a material breach by HCC
of any representation, warranty, or covenant contained in this Agreement
which cannot be, or has not been, cured within 15 days after written notice
of such breach is given to HCC, provided that the right to effect such cure
shall not extend beyond the date set forth in subparagraph (e) below.
(d) By the Board of Directors of HCC, if all conditions of Closing
set forth in Sections 7.1 and 7.3 of this Agreement have not been satisfied
or waived by November 15, 1998, provided, however, that HCC shall not be
entitled to terminate this Agreement pursuant to this subparagraph (d) if it
is in willful and material violation of any of its representations,
warranties, or covenants contained in this Agreement.
(e) By the Shareholder, if all conditions of Closing set forth in
Sections 7.2 and 7.3 of this Agreement have not been satisfied or waived by
November 15, 1998, provided, however, that the Shareholder shall not be
entitled to terminate this Agreement pursuant to this subparagraph (e) if the
Shareholder or Sun is in willful and material violation of any
representation, warranty, or covenant contained in this Agreement.
(f) If any governmental authority shall have issued an order,
decree or ruling or taken any other action permanently enjoining, restraining
or otherwise prohibiting the transactions contemplated by this Agreement and
such order, decree, ruling or other action shall have become final and
nonappealable.
SECTION 8.2 EFFECT OF TERMINATION. Upon termination of this
Agreement pursuant to this Article 8, this Agreement shall be void and of no
effect and shall result in no obligation of or liability to any party or
their respective directors, officers, employees, agents or Shareholder other
than the obligations under Section 6.5 hereof, unless such termination was
the result of an intentional breach of any representation, warranty or
covenant in this Agreement, in which case the party who breached the
representation, warranty or covenant shall be liable to the other parties for
damages, and all costs and expenses incurred in connection with the
preparation, negotiation, execution and performance of this Agreement.
ARTICLE 9
CLOSING MATTERS
SECTION 9.1 THE CLOSING. Subject to termination of this Agreement
as provided in Article 8 above, the closing of the transactions provided for
herein (the "Closing") will take place at the offices of Winstead Sechrest &
Minick P.C., 910 Travis Street, Suite 2400, Houston, Texas 77002 at 10:00
a.m., Houston Time on November 5, 1998, or, if all conditions to Closing have
not been satisfied or waived by such date, such other place, time and date as
the Shareholder and HCC may mutually select (herein sometimes called the
"Effective Time" or the "Closing Date").
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ARTICLE 10
INDEMNIFICATION
SECTION 10.1 SHAREHOLDER AGREEMENT TO INDEMNIFY. Subject to the
limitations set forth in this Article 10, from and after the Effective Time,
the Shareholder will indemnify and hold harmless HCC and its officers,
directors, agents, employees, successors, and assigns and each person, if
any, who controls or may control HCC within the meaning of the Securities
Act (hereinafter referred to individually as a "Sun Indemnified Person" and
collectively as "Sun Indemnified Persons") from and against any and all
claims, demands, actions, causes of action, losses, costs, damages,
liabilities and expenses including, without limitation, reasonable legal
fees, (net of: (i) any recoveries under insurance policies or any amounts
that would have been recoverable under insurance policies if the Surviving
Corporation had continued to maintain the same insurance coverage maintained
by Sun on the date of this Agreement; (ii) recoveries from third parties; and
(iii) tax savings known to Sun Indemnified Persons at the time of making of
claims hereunder) made against or incurred by Sun Indemnified Persons
(hereafter in this Section 10 referred to as "HCC Damages"), arising out of
any material misrepresentation or breach of or default under any of the
representations, warranties, covenants or agreements given or made in this
Agreement or any certificate or exhibit delivered by or on behalf of Sun or
the Shareholder pursuant hereto. The indemnification provided for in this
Section 10.1 will not apply unless and until the aggregate HCC Damages for
which one or more Sun Indemnified Persons seeks indemnification exceeds
$150,000 in the aggregate, in which event the indemnification provided for
will include all HCC Damages (a franchise deductible). The Sun Indemnified
Persons are only entitled to be reimbursed for the actual indemnified
expenditures or damages incurred by them for the above described losses.
Such Sun Indemnified Persons are not entitled to consequential, special, or
other speculative or punitive categories of damages. Notwithstanding the
foregoing, in no event shall the Shareholder have any obligation for
indemnification pursuant to this Section 10.1 in excess of an aggregate of
$15,000,000.
SECTION 10.2 INDEMNIFICATION WITH RESPECT TO TAXES AND LICENSING. In
addition to the indemnification provided in Section 10.1 above, the
Shareholder will indemnify and hold harmless the Sun Indemnified Persons from
and against all HCC Damages, whenever incurred, arising out of: (i) any
Taxes including, without limitation any Taxes accruing out of the redemption
of stock in exchange for the Barton Ridge Property and other property set
forth in Section 4.1(e) or (ii) from the failure to have obtained any license
including without limitation, any managing general agent's license, relating
to the business of Sun or any Sun Affiliated Entity or North Bay attributable
to any period preceding the Effective Time.
SECTION 10.3 INDEMNIFICATION FOR OTHER SPECIFIED CLAIMS. In addition
to the indemnification provided in Sections 10.1 and 10.2 above, the
Shareholder will indemnify and hold harmless the Sun Indemnified Persons from
and against all HCC Damages, whenever incurred, arising out of any liability
or claimed liability of Sun or any Sun Affiliated Entity or Shareholder or
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Barton to (i) William G. McKnight; (ii) Specialty Assistance Services, Inc.;
(iii) Bobby G. Black or Joan Black.
SECTION 10.4 HCC AGREEMENT TO INDEMNIFY. Subject to the limitations
set forth in this Article 10, from and after the Effective Time, HCC will
indemnify and hold harmless the Shareholder, Barton and each of their
administrators, heirs, personal representatives, successors and assigns
(hereinafter in this Section 10.4 referred to individually as an "HCC
Indemnified Person" and collectively as "HCC Indemnified Persons") from and
against any and all claims, demands, actions, causes of action, losses,
costs, damages, liabilities and expenses including, without limitation,
reasonable legal fees (net of: (i) any recoveries under insurance policies;
(ii) recoveries from third parties; and (iii) tax savings known to HCC
Indemnified Persons at the time of making a claim hereunder) (hereafter in
this Section 10.4 referred to as "Sun Damages") arising out of any
misrepresentation or breach of or default under any of the representations,
warranties, covenants and agreements given or made by HCC in this Agreement
or any certificate or exhibit delivered by or on behalf of HCC pursuant
hereto. The indemnification provided for in this Section 10.4 will not apply
unless and until the aggregate Sun Damages for which one or more HCC
Indemnified Person seeks indemnification exceeds $150,000 in the aggregate,
in which event the indemnification provided for will include all Sun Damages
(a franchise deductible). The HCC Indemnified Persons are only entitled to
be reimbursed for the actual indemnified expenditures or damages incurred by
them for the above described losses. Such HCC Indemnified Persons are not
entitled to consequential, special, or other speculative or punitive
categories of damages. Notwithstanding the foregoing, in no event shall HCC
have any obligation for indemnification pursuant to this Section 10.4 in
excess of an aggregate of $15,000,000.
SECTION 10.5 INDEMNIFICATION OF CLAIM BY INTERNATIONAL SPECIAL RISKS,
LTD. In addition to the indemnification provided in Section 10.4 above, HCC
will indemnify and hold harmless the HCC Indemnified Persons from and against
all Sun Damages, whenever incurred, arising out of any liability or claims of
liability of the Shareholder or any affiliate of the Shareholder regarding
the contract between Sun and International Special Risks, Ltd. and HCC will
not seek any indemnity from the Shareholder with respect to any such claim.
SECTION 10.6 SURVIVAL OF REPRESENTATIONS. Unless any representation,
warranty, covenant or agreement is required to terminate at an earlier time
in order to maintain the applicable pooling-of-interests accounting
treatment, each representation, warranty, covenant and agreement set forth in
this Agreement will remain operative and in full force and effect for a
period of one year after the Closing (the last date of such one year period
being herein called the "Final Date"), regardless of any investigation made
by or on behalf of the parties to this Agreement, upon which Final Date such
representations, warranties, covenants and agreements shall expire and be of
no further force and effect except for the covenants set forth in Section 6.5
hereof and except that the indemnification provided for in Sections 10.2 and
10.3 of this Agreement shall survive until a final resolution of all such
matters. Except as provided in the preceding sentence, any litigation or
other action of any kind arising out of or attributable to a breach of any
representation, warranty, covenant or agreement contained in this Agreement,
must be commenced prior to the Final Date. If not so commenced prior
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to the Final Date, any claims or indemnifications brought under this Article
10 (except for those relating to a breach of the covenants set forth in
Section 6.5 hereof or relating to indemnification under Sections 10.2 or 10.3
hereof) will thereafter conclusively be deemed to be waived regardless of
when such claim is or should have been discovered. Any such claim for
indemnification brought under this Article 10, brought before the Final Date,
shall survive until a final resolution of such claim is effective. As set
forth herein, no investigation by any party hereto into the business,
operations and conditions of the other party shall diminish in any way the
effect of any representation or warranty made by any such party in this
Agreement or shall relieve any party of any of its obligations under this
Agreement.
SECTION 10.7 PROCEDURE FOR INDEMNIFICATION; THIRD PARTY CLAIMS.
(a) Promptly after receipt by an indemnified party under this
Article 10 of notice of a claim against it for indemnification brought under
this Article 10 (a "Claim"), the indemnified party will, if a claim is to be
made against an indemnifying party, give prompt written notice to the
indemnifying party of the Claim, but the failure to promptly notify the
indemnifying party will not relieve the indemnifying party of any liability
that it may have to any indemnified party, except to the extent that the
indemnifying party demonstrates that the defense of such action is prejudiced
by the indemnified party's failure to give such prompt notice. Such notice
shall contain a description in reasonable detail of facts upon which such
Claim is based and, to the extent known, the amount thereof.
(b) If any Claim referred to in this Article 10 is made by a third
party against an indemnified party and such indemnified party gives written
notice to the indemnifying party of the Claim, the indemnifying party will be
entitled to participate in the defense of Claim and, to the extent that it
wishes to assume the defense of the Claim and, after written notice from the
indemnifying party to the indemnified party of its election to assume the
defense of the Claim, the indemnifying party shall assume such defense and
will not be liable to the indemnified party under this Article 10 for any
fees of other counsel or any other expenses with respect to the defense of
the Claim in each case subsequently incurred by the indemnified party in
connection with the defense of the Claim
ARTICLE 11
MISCELLANEOUS
SECTION 11.1 FURTHER ASSURANCES. Each party agrees to cooperate
fully with the other parties and to execute such further instruments,
documents and agreements and to give such further written assurances as
may be reasonably requested by any other party to better evidence and
reflect the transactions described herein and contemplated hereby and to
carry into effect the intents and purposes of this Agreement.
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SECTION 11.2 FEES AND EXPENSES. Until otherwise agreed by the
parties, each party shall bear its own fees and expenses, including counsel
fees and fees of brokers and investment bankers contracted by such party, in
connection with the transaction contemplated hereby, provided, however that
if the transaction contemplated by this Agreement is consummated, the
expenses of Shareholder and Barton shall be paid by Sun.
SECTION 11.3 NOTICES. Whenever any party hereto desires or is
required to give any notice, demand, or request with respect to this
Agreement, each such communication shall be in writing and shall be effective
only if it is delivered by personal service or mailed, United States
registered or certified mail, return receipt requested, postage prepaid, or
sent by prepaid overnight courier or confirmed telecopier, addressed as
follows:
HCC:
HCC Insurance Holdings, Inc.
13403 Northwest Freeway
Houston, Texas 77040-6094
Telecopy: (713) 462-2401
Attention: Frank J. Bramanti, Executive Vice President
With a copy (which shall not constitute notice) to:
Winstead Sechrest & Minick P.C.
910 Travis, Suite 2400
Houston, Texas 77002-5895
Telecopy: (713) 650-2400
Attention: Arthur S. Berner, Esq.
Shareholder, Barton or, prior to the Closing, Sun:
Mr. Howard V. Barton
8213 Marsh Pointe Drive
Montgomery, Alabama 36117
With a copy (which shall not constitute notice) to:
Capell, Howard, Knabe & Cobbs, P.A.
57 Adams Avenue
Montgomery, Alabama 36104-4045
Telecopy: (334) 323-8888
Attention: Henry H. Hutchinson, Esq.
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Such communications shall be effective when they are received by the
addressee thereof. Any party may change its address for such communications
by giving notice thereof to other parties in conformity with this Section.
SECTION 11.4 GOVERNING LAW. The internal laws of the State of Texas
(irrespective of its choice of law principles) will govern the validity of
this Agreement, the construction of its terms, and the interpretation and
enforcement of the rights and duties of the parties hereto.
SECTION 11.5 BINDING UPON SUCCESSORS AND ASSIGNS, ASSIGNMENT. This
Agreement and the provisions hereof shall be binding upon each of the
parties, their permitted successors and assigns. This Agreement may not be
assigned by any party without the prior consent of the other; provided,
however, that HCC shall be permitted at any time prior to the Effective Time
to cause the assignment of its rights and obligations under this Agreement to
a wholly owned (directly or indirectly) subsidiary of HCC (without in any way
relieving HCC of its obligations under this Agreement).
SECTION 11.6 SEVERABILITY. If any provision of this Agreement, or
the application thereof, shall for any reason or to any extent be invalid or
unenforceable, the remainder of this Agreement and application of such
provision to other persons or circumstances shall continue in full force and
effect and in no way be affected, impaired or invalidated.
SECTION 11.7 ENTIRE AGREEMENT. This Agreement, together with the
Confidentiality Agreement, and any other agreement and instrument referenced
herein constitute the entire understanding and agreement of the parties with
respect to the subject matter hereof and supersede all prior and
contemporaneous agreements or understandings, inducements or conditions,
express or implied, written or oral, between the parties with respect hereto.
SECTION 11.8 AMENDMENT AND WAIVERS. Any and all amendments and
modifications of this Agreement must be in writing and signed by HCC and the
Shareholder. No term, provision, or condition of this Agreement or any
breach thereof may be waived except in a writing signed by HCC (in the case
of a waiver by HCC) or by the Shareholder (in the case of a waiver by Sun or
the Shareholder). Any such waiver shall not be deemed to constitute a waiver
of any other term, provision, condition, or any succeeding breach thereof,
unless such waiver so expressly states.
SECTION 11.9 NO WAIVER. The failure of any party to enforce any of
the provisions hereof shall not be construed to be a waiver of the right of
such party thereafter to enforce such provisions.
SECTION 11.10 CONSTRUCTION OF AGREEMENT. A reference to an Article,
Section or an Exhibit shall mean an Article of, a Section in, or Exhibit to,
this Agreement unless otherwise explicitly set forth. The titles and
headings herein are for reference purposes only and shall not in any manner
limit the construction of this Agreement which shall be considered as a
whole. The words "include," "includes" and "including" when used herein
shall be deemed in each case to be followed by the words "without limitation."
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SECTION 11.11 COUNTERPARTS. This Agreement may be executed in any
number of counterparts, each of which shall be an original as against any
party whose signature appears thereon and all of which together shall
constitute one and the same instrument. This Agreement shall become binding
when one or more counterparts hereof, individually or taken together, shall
bear the signatures of all the parties reflected hereon as signatories.
IN WITNESS WHEREOF, the parties hereto have executed this Agreement as
of the date first above written.
[REMAINDER OF PAGE INTENTIONALLY LEFT BLANK]
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HCC INSURANCE HOLDINGS, INC.
By: /s/ Frank J. Bramanti
-----------------------------------
Name: Frank J. Bramanti,
Title: Executive Vice President
SIGNATURE PAGE OF STOCK PURCHASE AGREEMENT
<PAGE>
SUN EMPLOYER SERVICES, INC.,
an Alabama corporation
By: /s/ Howard V. Barton
-----------------------------------
Name: Howard V. Barton
Title: President
/s/ Howard V. Barton
--------------------------------------
Howard V. Barton, individually
/s/ Elizabeth A. Barton
--------------------------------------
Elizabeth A. Barton
SIGNATURE PAGE OF STOCK PURCHASE AGREEMENT
<PAGE>
EMPLOYMENT AGREEMENT
This Employment Agreement ("Agreement") is entered into as of the 1st
day of January, 1998 (the "Effective Date"), between HCC INSURANCE HOLDINGS,
INC. ("HCC" or "Company"), and JOHN N. MOLBECK, JR. ("Executive"), sometimes
collectively referred to herein as the "Parties."
R E C I T A L S:
WHEREAS, Executive is to be employed as President of HCC, and, as an
integral part of its management who participates in the decision-making
process relative to short and long-term planning and policy for the Company,
will serve on the Company's Executive Committee;
WHEREAS, it is the desire of the Board of Directors of HCC (the "Board")
to (i) directly engage Executive as an officer of HCC and its subsidiaries;
and (ii) directly engage, if elected, the services of Executive as a director
of HCC and its subsidiaries; and
WHEREAS, Executive is desirous of committing himself to serve HCC on the
terms herein provided.
NOW, THEREFORE, in consideration of the foregoing and of the respective
covenants and agreements set forth below, the Parties agree as follows:
2. TERM. The Company hereby agrees to employ Executive as its
President, and Executive hereby agrees to accept such employment, on the
terms and conditions set forth herein, for the period commencing on the
Effective Date and expiring as of 11:59 p.m. on December 31, 2002 (the "Basic
Term") (unless sooner terminated as hereinafter set forth). On or before
December 31, 1999, Executive shall assume the additional responsibilities of
Chief Executive Officer of HCC.
3. DUTIES.
(a) DUTIES AS EMPLOYEE OF THE COMPANY. Executive shall, subject
to the supervision of the Chief Executive Officer and Board (until such time
as Employee is elected Chief Executive Officer, at which time Employee shall
be subject to the supervision of the Chairman of the Board and Board), have
general management and control of HCC in the ordinary course of its business
with all such powers with respect to such management and control as may be
reasonably incident to such responsibilities. During normal business hours,
Executive shall devote his full time and attention to diligently attending to
the business of the Company during the Basic Term. During the Basic Term,
Executive shall not directly or indirectly render
EMPLOYMENT AGREEMENT - Page 1
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any services of a business, commercial, or professional nature to any other
person, firm, corporation, or organization, whether for compensation or
otherwise, without the prior written consent of the Chairman of the Board.
However, Executive shall have the right to engage in such activities as may
be appropriate in order to manage his personal investments so long as such
activities do not materially interfere or conflict with the performance of
his duties to the Company hereunder. The conduct of such activity shall not
be deemed to materially interfere or conflict with Executive's performance of
his duties until Executive has been notified in writing thereof and given a
reasonable period in which to cure the same.
(b) OTHER DUTIES. At all times during the Basic Term, the Company
shall use its best efforts to cause Executive to be elected a director and to
serve on the Executive Committee and Senior Management Committee of HCC. Any
such failure to use its best efforts prior to a Change of Control shall be a
material breach of this Agreement for purposes of Paragraph 4(a)(iv). If
elected, Executive agrees to serve as a director and on the Executive
Committee and Senior Management Committee of HCC and of any of its
subsidiaries and in one or more executive offices of any of HCC's
subsidiaries, provided Executive is indemnified for serving in any and all
such capacities in a manner acceptable to the Company and Executive. If
elected, Executive agrees that he shall not be entitled to receive any
compensation for serving as a director of HCC or in any capacities of HCC's
subsidiaries other than the compensation to be paid to Executive by the
Company pursuant to this Agreement.
4. COMPENSATION AND RELATED MATTERS.
(a) BASE SALARY. Executive shall receive a base salary paid by
the Company at the annual rate of $500,000, during the period beginning on
the Effective Date payable not less frequently than in substantially equal
monthly installments. The base salary shall be increased by $25,000 each
January 1, commencing January 1, 1999, until Executive's base salary reaches
$600,000. For purposes of this Agreement, "Base Salary" shall mean the
Executive's initial base salary and, when increased, the increased base
salary.
(b) BONUS PAYMENTS. Each year Executive shall be entitled to
receive, in addition to the Base Salary, an annual bonus payment based on
HCC's annual operating earnings per share ("OEPS") as set forth below:
$50,000 bonus if OEPS growth is 10% or more in any one year;
$100,000 bonus if OEPS growth is 15% or more in any one year
period; and
$200,000 bonus if OEPS growth is 20% or more in any one year
period.
For purposes of this Agreement, OEPS is defined as HCC's consolidated net
earnings less capital gains/losses, currency gains/losses, and any
nonrecurring merger and acquisition income or
EMPLOYMENT AGREEMENT - Page 2
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expenses as reported in HCC's Annual Report on Form 10-K.
(c) STOCK OPTIONS. In addition to stock options previously
granted to Executive, if any, in partial consideration for Executive's
non-competition agreement, set forth herein, Executive shall be provided with
additional options to purchase HCC shares as follows:
(1) On January 7, 1998, an option to acquire 200,000
shares, exercisable at a price of $16.50 per share and
vesting at 20% per year beginning on December 31, 1998
and on each of the four December 31st thereafter;
(2) For each year beginning with the year ending
December 31, 1999, of Executive's employment hereunder;
15,000 shares if, on such December 31, the price of the HCC
Common Stock has increased since the previous January 1, by
an amount that is greater than or equal to 10%, but less
than 15%;
20,000 shares if, on such December 31, the price of the HCC
Common Stock has increased since the previous January 1, by
an amount that is greater than or equal to 15%, but less
than 20%;
25,000 shares if, on such December 31, the price of the HCC
Common Stock has increased since the previous January 1, by
an amount that is greater than or equal to 20%, but less
than 25%; and
30,000 shares if, on such December 31, the price of the HCC
Common Stock has increased since the previous January 1, by
an amount that is greater than or equal to 25%; and
An additional option to acquire an additional 5,000 shares
for each additional 5% increase in the price of the HCC
Common Stock since the previous January 1.
Each of such options set forth in this Subparagraph (ii) shall be
priced at the average of the closing prices of HCC shares for the
month of December of the year of the grant and shall vest immediately.
For purposes of this Subparagraph, the granting of any option shall
not be pro-rated if the criteria set forth herein are not achieved in
full.
(d) EXPENSES. During the Basic Term, Executive shall be entitled
to receive prompt reimbursement for all reasonable expenses incurred by him
in accordance with the policies and procedures established by the
Compensation Committee for the Company's senior executive officers in
performing services hereunder, provided that Executive properly accounts
EMPLOYMENT AGREEMENT - Page 3
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therefor in accordance with Company policy.
(e) OTHER BENEFITS. Executive shall be entitled to participate in
or receive benefits under any compensatory employee benefit plan or other
arrangement made available by the Company now or in the future to its senior
executive officers and key management employees, subject to and on a basis
consistent with the terms, conditions, and overall administration of such
plan or arrangement. Nothing paid to Executive under any plan or arrangement
presently in effect or made available in the future shall be deemed to be in
lieu of the Base Salary payable to Executive pursuant to Paragraph (a) of
this Section. The Company shall not make any changes in any employee benefit
plans or other arrangements in effect on the date hereof or subsequently in
effect in which Executive currently or in the future participates (including,
without limitation, each pension and retirement plan, supplemental pension
and retirement plan, savings and profit sharing plan, stock or unit ownership
plan, stock or unit purchase plan, stock or unit option plan, life insurance
plan, medical insurance plan, disability plan, dental plan, health and
accident plan, or any other similar plan or arrangement) that would adversely
affect Executive's rights or benefits thereunder, unless such change occurs
pursuant to a program applicable to substantially all executives of the
Company and does not result in a proportionately greater reduction in the
rights of or benefits to Executive as compared with any other executive of
the Company.
(f) VACATIONS. Executive shall be entitled to twenty-five (25)
paid vacation days per year during the Basic Term. There shall be no
carryover of unused vacation from year to year. For purposes of this
Paragraph, weekends shall not count as vacation days, and Executive shall
also be entitled to all paid holidays and personal days given by the Company
to its senior executive officers.
(g) PERQUISITES. Executive shall be entitled to receive the
perquisites and fringe benefits appertaining to an executive officer of HCC
in accordance with any practice established by the Compensation Committee.
Notwithstanding, and in addition to, any perquisites to which Executive is
entitled pursuant to the preceding sentence, Executive shall: (i) have use of
a 1998 Mercedes 500 SEL automobile, and the Company shall pay all expenses
related to Executive's use of such car, including gasoline, insurance, and
maintenance; (ii) be allowed to travel on business utilizing first class
passage (whether domestic or international); (iii) receive an annual country
club dues allowance of up to $16,000; and (iv) receive a total of $1,000,000
term life insurance (which shall be in addition to the standard benefits
provided to Executive under the Company's group life insurance program that
covers officers).
(h) PRORATION. Any payments or benefits payable to Executive
hereunder in respect of any calendar year during which Executive is employed
by the Company for less than the entire year, unless otherwise provided in
the applicable plan or arrangement, shall be prorated in accordance with the
number of days in such calendar year during which he is so employed.
Notwithstanding the foregoing, any payments pursuant to Paragraphs 4(c) or
4(d) of this Agreement shall not be subject to proration.
EMPLOYMENT AGREEMENT - Page 4
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5. TERMINATION.
(a) DEFINITIONS.
(1) "CAUSE" shall mean:
(i) Material dishonesty which is not the result of an
inadvertent or innocent mistake of Executive with respect to the Company or
any of its subsidiaries;
(ii) Willful misfeasance or nonfeasance of duty by
Executive intended to injure or having the effect of injuring in some
material fashion the reputation, business, or business relationships of the
Company or any of its subsidiaries or any of their respective officers,
directors, or employees;
(iii) Material violation by Executive of any material term
of this Agreement; or
(iv) Conviction of Executive of any felony, any crime
involving moral turpitude or any crime other than a vehicular offense which
could reflect in some material fashion unfavorably upon the Company or any
of its subsidiaries.
Executive may not be terminated for Cause unless and until there has been
delivered to Executive written notice from the Board supplying the
particulars of Executive's acts or omissions that the Board believes
constitute Cause, a reasonable period of time (not less than 30 days) has
been given to Executive after such notice to either cure the same or to meet
with the Board, with his attorney if so desired by Executive, and following
which the Board by action of not less than two-thirds of its members
furnishes to Executive a written resolution specifying in detail its findings
that Executive has been terminated for Cause as of the date set forth in the
notice to Executive.
(2) A "CHANGE OF CONTROL" shall be deemed to have occurred if:
(i) Any "person" or "group" (within the meaning of
Sections 13(d) and 14(d)(2) of the Securities Exchange Act of 1934) other
than a trustee or other fiduciary holding securities under an employee
benefit plan of the Company becomes the "beneficial owner" (as defined in
Rule 13d-3 under the Securities Exchange Act of 1934), directly or
indirectly, of 50% or more of the Company's then outstanding voting common
stock; or
(ii) At any time during the period of three (3) consecutive
years (not including any period prior to the date hereof), individuals who
at the beginning of such period constituted the Board (and any new director
whose election by the Board or whose nomination for election by the
Company's shareholders were approved by a vote of at least two-thirds of
the directors then still in office who either were directors at the
EMPLOYMENT AGREEMENT - Page 5
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beginning of such period or whose election or nomination for election was
previously so approved) cease for any reason to constitute a majority
thereof; or
(iii) The shareholders of the Company approve a merger or
consolidation of the Company with any other corporation, other than a
merger or consolidation (a) in which a majority of the directors of the
surviving entity were directors of the Company prior to such consolidation
or merger, and (b) which would result in the voting securities of the
Company outstanding immediately prior thereto continuing to represent
(either by remaining outstanding or by being changed into voting securities
of the surviving entity) more than 50% of the combined voting power of the
voting securities of the surviving entity outstanding immediately after
such merger or consolidation; or
(iv) The shareholders approve a plan of complete
liquidation of the Company or an agreement for the sale or disposition by
the Company of all or substantially all of the Company's assets.
(3) A "DISABILITY" shall mean the absence of Executive from
Executive's duties with the Company on a full-time basis for 180 consecutive
days, or 180 days in a 365-day period, as a result of incapacity due to
mental or physical illness which results in the Executive being unable to
perform the essential functions of his position, with or without reasonable
accommodation.
(4) A "GOOD REASON" shall mean any of the following (without
Executive's express written consent):
(i) Following a Change of Control, a material alteration
in the nature or status of Executive's title, duties or responsibilities,
or the assignment of duties or responsibilities inconsistent with
Executive's status, title, duties and responsibilities;
(ii) A failure by the Company to continue in effect any
employee benefit plan in which Executive was participating, or the taking
of any action by the Company that would adversely affect Executive's
participation in, or materially reduce Executive's benefits under, any such
employee benefit plan, unless such failure or such taking of any action
adversely affects the senior members of corporate management of the Company
generally to the same extent;
(iii) A relocation of the Company's principal executive
offices, or Executive's relocation to any place other than the principal
executive offices, exceeding a distance of fifty (50) miles from the
Company's current executive office located in Houston, Texas, except for
reasonably required travel by Executive on the Company's business;
(iv) Any material breach by the Company of any provision of
EMPLOYMENT AGREEMENT - Page 6
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this Agreement including, without limitation, a failure to elect Executive
the Chief Executive Officer of the Company on or before December 31, 1999;
or
(v) Any failure by the Company to obtain the assumption
and performance of this Agreement by any successor (by merger,
consolidation, or otherwise) or assign of the Company.
However, Good Reason shall exist with respect to an above specified matter
only if such matter is not corrected by the Company within thirty (30) days
of its receipt of written notice of such matter from Executive, and in no
event shall a termination by Executive occurring more than ninety (90) days
following the date of the event described above be a termination for Good
Reason due to such event.
(5) "TERMINATION DATE" shall mean the date Executive is
terminated for any reason pursuant to this Agreement.
(b) TERMINATION WITHOUT CAUSE OR TERMINATION FOR GOOD REASON:
BENEFITS. In the event there is a termination by the Company without Cause,
or if Executive terminates for Good Reason (a "Termination Event"), this
Agreement shall terminate, except as provided in Paragraph 6, and Executive
shall be entitled to the following severance benefits:
(1) For a period of twelve (12) months after the Termination
Date (unless the remainder of the Basic Term is less than twelve
(12) months in which case, for an amount of time equal to the remainder of
the Basic Term), Base Salary (as defined in Paragraph 3(a)), at the rate,
and payable quarterly unless such termination is by the Company without
Cause, in which event such amount of Base Salary shall be paid in a lump
sum within ten (10) days of the Termination Event.
(2) If there is a Change of Control or if there is a termination
by the Company without Cause or by Executive for Good Reason, any stock
options and other stock-related grants ("Stock Awards") which Executive has
received under any of the HCC stock plans shall vest immediately; provided,
however, that the right to receive options referenced in Paragraph 3(c)(2)
above shall terminate upon termination from employment for any reason, and
further, if there is a termination for Good Reason or by the Company other
than for Cause, all options shall be exercisable for one year or the
remainder of their term, whichever is less.
(3) To the extent not theretofore paid or provided, the Company
shall timely pay or provide to Executive any other amounts or benefits
required to be paid or provided or which Executive is eligible to receive
under any plan, program, policy or practice, or contract or agreement of
the Company and its affiliated companies for the period of time equal to
the remainder of the Basic Term (such other amounts and benefits shall be
hereinafter referred to as the "Other Benefits"). Without limiting the
preceding sentence, through December 31, 2002 the Company, at its sole
expense, shall continue to
EMPLOYMENT AGREEMENT - Page 7
<PAGE>
provide (through its own plan and/or individual policies) Executive (and
Executive's dependents) with health benefits no less favorable than the
group health plan benefits provided during such period to any senior
executive officer of the Company or any affiliated company (to the extent
any such coverage or benefits are taxable to Executive by reason of being
provided under a self-insured health plan of the Company or an affiliate,
the Company shall make Executive "whole" for the same on an after-tax
basis). In any event, the Other Benefits provided for pursuant to this
Paragraph shall be secondary to any benefits and coverage Executive (or
his dependents) receive from another employer.
(4) If Executive receives any payments whether or not pursuant
to this Agreement which are subject to an excise tax imposed under
Section 4999 of the Internal Revenue Code of 1986, as amended, or any
similar tax imposed under federal, state, or local law (collectively,
"Excise Taxes"), the Company shall pay to Executive (on or before the date
on which the Company is required to withhold such Excise Taxes), 1) an
additional amount equal to all Excise Taxes then due and payable, and
2) the amount necessary to defray Executive's increased (federal, state,
and local) tax liability arising due to payment of the amount specified in
this Subsection (4) which shall include any costs and expenses, including
penalties and interest incurred by Executive in connection with any audit,
proceedings, etc. related to the payment of such Excise Taxes or this
payment. For purposes of calculating the amount payable to Executive under
this Paragraph, the federal and state income tax rates used shall be the
highest marginal federal and state rates applicable to ordinary income in
Executive's state of residence, taking into account any federal income tax
deductions or credits available to Executive for state income taxes. The
Company shall cause its independent auditors to calculate such amount and
provide Executive a copy of such calculation at least ten (10) days prior
to the date specified above for payment of such amount. It is the intent
of the Parties that this Subsection (4) shall place Executive in the same
net after-tax position Executive would have been in had no payment been
subject to an Excise Tax and, notwithstanding anything herein to the
contrary, it shall be construed to effectuate said result.
(5) All accrued compensation and unreimbursed expenses through
the Termination Date. Such amounts shall be paid to Executive in a lump
sum in cash within thirty (30) days after the Termination Date; and
(6) Executive shall be free to accept other employment during
such period, and there shall be no offset of any employment compensation
earned by Executive in such other employment during such period against
payments due Executive under this Paragraph (4), and there shall be not
offset in any compensation received from such other employment against the
Base Salary set forth above.
(c) TERMINATION IN EVENT OF DEATH: BENEFITS. If Executive's
employment is terminated by reason of Executive's death during the Basic
Term, this Agreement shall terminate, except as provided in Paragraph 6,
without further obligation to Executive's legal representatives
EMPLOYMENT AGREEMENT - Page 8
<PAGE>
under this Agreement, other than for payment of all accrued compensation,
unreimbursed expenses, the timely payment or provision of Other Benefits
through the date of death, and, if such death occurs on or after October 1 of
any year, such cash or stock bonus as Executive would otherwise have been
awarded in such year if Executive's death had not occurred. Such amounts
shall be paid to Executive's estate or beneficiary, as applicable, in a lump
sum in cash within ninety (90) days after the date of death. With respect to
the provision of Other Benefits, the term Other Benefits as used in this
Paragraph 4(c) shall include, without limitation, and Executive's estate
and/or beneficiaries shall be entitled to receive, benefits at least equal to
the most favorable benefits provided by the Company to the estates and
beneficiaries of other executive level employees of the Company under such
plans, programs, practices, and policies relating to death benefits, if any,
as in effect with respect to other executives and their beneficiaries at any
time during the 120-day period immediately preceding the date of death.
Additionally, all Stock Awards for which Executive would have been eligible
had he completed the Basic Term (except as set forth in Paragraph 4(b)(2)),
shall be accelerated, and Executive's estate or beneficiary shall be vested
in such Stock Awards as of the date of Executive's termination.
(d) TERMINATION IN EVENT OF DISABILITY: BENEFITS. If Executive's
employment is terminated by reason of Executive's Disability during the Basic
Term, this Agreement shall continue in full force for a period of one (1)
year following such Disability and if such Disability occurs on or after
October 1 of any year Executive shall be entitled to the same cash or stock
bonus in such year that Executive would have been awarded if such Disability
had not occurred. Following such one (1) year period, this Agreement shall
continue in full force except that (a) the Base Salary shall be reduced by
50% and (b) Executive shall not be entitled to any subsequent cash or stock
bonuses. In addition, all outstanding Stock Awards shall vest immediately
upon such termination due to Disability. If Executive's Disability occurs
prior to the commencement of the Consulting Period, defined below, in
addition to the amounts provided for herein, Executive shall receive the
Consulting Fee, defined below, at such time as it would have otherwise been
earned, whether or not Executive can perform Consulting Services, defined
below.
(e) VOLUNTARY TERMINATION BY EMPLOYEE AND TERMINATION FOR CAUSE:
BENEFITS. Executive may terminate his employment with the Company without
Good Reason by giving written notice of his intent and stating an effective
Termination Date at least ninety (90) days after the date of such notice;
provided, however, that the Company may accelerate such effective date by
paying Executive through the proposed Termination Date and also vesting
awards that would have vested but for this acceleration of the proposed
Termination Date. Upon such a termination by Executive except as provided in
Paragraph 6 or upon termination for Cause by the Company, this Agreement
shall terminate and the Company shall pay to Executive all accrued
compensation, unreimbursed expenses and the Other Benefits through the
Termination Date. Such amounts shall be paid to Executive in a lump sum in
cash within thirty (30) days after the date of termination.
(f) DIRECTOR POSITIONS. Executive agrees that upon termination of
employment, for any reason, at the request of the Chairman of the Board, he
will immediately
EMPLOYMENT AGREEMENT - Page 9
<PAGE>
tender his resignation from any and all Board positions held with the Company
and/or any of its subsidiaries and affiliates. If Executive remains as a
director, after such termination, Executive shall be compensated as an
outside director.
6. NON-COMPETITION, NON-SOLICITATION, AND CONFIDENTIALITY. Executive
recognizes and agrees that the benefit of not being employed at-will, is
provided in consideration for, among other things, the agreements contained
in this Section, as well as the Stock Options granted to Executive pursuant
to this Agreement. The Company agrees that while employed pursuant to this
Agreement, Executive will be provided with confidential information of
Company; specialized training on how to perform his duties; and contact with
the Company's customers and potential customers. Furthermore, in the event
Executive is terminated without Cause, or terminates for Good Reason, and
more than one (1) year remains on the existing Basic Term, then Executive
shall receive additional consideration in an amount equal to the quotient of
the Base Salary divided by 12, which shall thereupon be multiplied by the
number of months remaining in the Basic Term minus 12 months and which shall
be paid in one lump sum within ten (10) days of such termination.
In consideration of all of the foregoing, Executive agrees as follows:
(a) NON-COMPETITION DURING EMPLOYMENT. Executive agrees during
the Basic Term he will not compete with the Company by engaging in the
conception, design, development, production, marketing, or servicing of any
product or service that is substantially similar to the products or services
which the Company provides, and that he will not work for, in any capacity,
assist, or become affiliated with as an owner, partner, etc., either directly
or indirectly, any individual or business which offers or performs services,
or offers or provides products substantially similar to the services and
products provided by Company.
(b) CONFLICTS OF INTEREST. Executive agrees that during the Basis
Term, he will not engage, either directly or indirectly, in any activity (a
"Conflict of Interest") which might adversely affect the Company or its
affiliates, including ownership of a material interest in any supplier,
contractor, distributor, subcontractor, customer or other entity with which
the Company does business or accepting any material payment, service, loan,
gift, trip, entertainment, or other favor from a supplier, contractor,
distributor, subcontractor, customer or other entity with which the Company
does business, and that Executive will promptly inform the Chairman of the
Company as to each offer received by Executive to engage in any such
activity. Executive further agrees to disclose to the Company any other
facts of which Executive becomes aware which might in Executive's good faith
judgment reasonably be expected to involve or give rise to a Conflict of
Interest or potential Conflict of Interest.
(c) NON-COMPETITION AFTER TERMINATION. Executive agrees that
Executive shall not, at any time during the period of two (2) years after the
termination of the Basic Term, for any reason, within any of the markets in
which the Company has sold products or services or formulated a plan to sell
products or services into a market during the last twelve (12) months of
Executive's employ or which the Company enters into within three (3) months
thereafter, engage
EMPLOYMENT AGREEMENT - Page 10
<PAGE>
in or contribute Executive's knowledge to any work which is competitive with
or similar to a product, process, apparatus, service, or development on which
Executive worked or with respect to which Executive had access to
Confidential Information while employed by the Company; provided, however,
this Paragraph (c) shall not operate to prevent Executive from engaging in
retail insurance or re-insurance activities during such two-year period to
the extent such activities do not compete or permit any other person or
entity to compete with any business the Company or any of its subsidiaries or
affiliated companies were engaged in at the time of such termination or which
the Company enters into within three (3) months thereafter. Following the
expiration of said two (2) year period, Executive shall continue to be
obligated under the Confidential Information Paragraph of this Agreement not
to use or to disclose Confidential Information of the Company so long as it
shall not be publicly available. It is understood that the geographical area
set forth in this covenant is divisible so that if this clause is invalid or
unenforceable in an included geographic area, that area is severable and the
clause remains in effect for the remaining included geographic areas in which
the clause is valid.
(d) NON-SOLICITATION OF CUSTOMERS. Executive further agrees that
for a period of two (2) years after the termination of the Basic Term, he
will not solicit or accept any business from any customer or client or
prospective customer or client with whom Executive dealt or solicited while
employed by Company during the last twelve (12) months of his employment.
(e) NON-SOLICITATION OF EMPLOYEES. Executive agrees that for the
duration of the Basic Term, and for a period of two (2) years after the
termination of the Basic Term, he will not either directly or indirectly, on
his own behalf or on behalf of others, solicit, attempt to hire, or hire any
person employed by Company to work for Executive or for another entity, firm,
corporation, or individual.
(f) CONFIDENTIAL INFORMATION. Executive further agrees that he
will not, except as the Company may otherwise consent or direct in writing,
reveal or disclose, sell, use, lecture upon, publish or otherwise disclose to
any third party any Confidential Information or proprietary information of
the Company, or authorize anyone else to do these things at any time either
during or subsequent to his employment with the Company. This Section shall
continue in full force and effect after termination of Executive's employment
and after the termination of this Agreement. Executive's obligations under
this Paragraph with respect to any specific Confidential Information and
proprietary information shall cease when that specific portion of the
Confidential Information and proprietary information becomes publicly known,
in its entirety and without combining portions of such information obtained
separately. It is understood that such Confidential Information and
proprietary information of the Company include matters that Executive
conceives or develops, as well as matters Executive learns from other
employees of Company. Confidential Information is defined to include
information: (1) disclosed to or known by the Executive as a consequence of
or through his employment with the Company; (2) not generally known outside
the Company; and (3) which relates to any aspect of the Company or its
business, finances, operation plans, budgets, research, or strategic
development. "Confidential Information" includes, but is not limited to the
Company's trade secrets, proprietary information,
EMPLOYMENT AGREEMENT - Page 11
<PAGE>
financial documents, long range plans, customer lists, employer compensation,
marketing strategy, data bases, costing data, computer software developed by
the Company, investments made by the Company, and any information provided to
the Company by a third party under restrictions against disclosure or use by
the Company or others.
(g) RETURN OF DOCUMENTS, EQUIPMENT, ETC. All writings, records,
and other documents and things comprising, containing, describing,
discussing, explaining, or evidencing any Confidential Information, and all
equipment, components, parts, tools, and the like in Executive's custody or
possession that have been obtained or prepared in the course of Executive's
employment with the Company shall be the exclusive property of the Company,
shall not be copied and/or removed from the premises of the Company, except
in pursuit of the business of the Company, and shall be delivered to the
Company, without Executive retaining any copies, upon notification of the
termination of Executive's employment or at any other time requested by the
Company. The Company shall have the right to retain, access, and inspect all
property of Executive of any kind in the office, work area, and on the
premises of the Company upon termination of Executive's employment and at any
time during employment by the Company to ensure compliance with the terms of
this Agreement.
(h) REAFFIRM OBLIGATIONS. Upon termination of his employment with
the Company, Executive, if requested by Company, shall reaffirm in writing
Executive's recognition of the importance of maintaining the confidentiality
of the Company's Confidential Information and proprietary information, and
reaffirm any other obligations set forth in this Agreement.
(i) PRIOR DISCLOSURE. Executive represents and warrants that he
has not used or disclosed any Confidential Information he may have obtained
from Company prior to signing this Agreement, in any way inconsistent with
the provisions of this Agreement.
(j) CONFIDENTIAL INFORMATION OF PRIOR COMPANIES. Executive will
not disclose or use during the period of his employment with the Company any
proprietary or Confidential Information or Copyright Works which Executive
may have acquired because of employment with an employer other than the
Company or acquired from any other third party, whether such information is
in Executive's memory or embodied in a writing or other physical form.
(k) BREACH. Executive agrees that any breach of Paragraphs 5(a),
(c), (d), (e) or (f) above cannot be remedied solely by money damages, and
that in addition to any other remedies Company may have, Company is entitled
to obtain injunctive relief against Executive. Nothing herein, however,
shall be construed as limiting Company's right to pursue any other available
remedy at law or in equity, including recovery of damages and termination of
this Agreement and/or any payments that may be due pursuant to this Agreement.
(l) RIGHT TO ENTER AGREEMENT. Executive represents and covenants
to Company that he has full power and authority to enter into this Agreement
and that the execution of this Agreement will not breach or constitute a
default of any other agreement or contract to
EMPLOYMENT AGREEMENT - Page 12
<PAGE>
which he is a party or by which he is bound.
(m) EXTENSION OF POST-EMPLOYMENT RESTRICTIONS. In the event
Executive breaches Paragraphs 5(b), (d), or (e) above, the restrictive time
periods contained in those provisions will be extended by the period of time
Executive was in violation of such provisions.
(n) ENFORCEABILITY. The agreements contained in Section 5 are
independent of the other agreements contained herein. Accordingly, failure
of the Company to comply with any of its obligations outside of this
Paragraph do not excuse Executive from complying with the agreements
contained herein.
(o) SURVIVABILITY. The agreements contained in Paragraphs
5(c)-(g) shall survive the termination of this Agreement for any reason.
7. CONSULTING AGREEMENT. Effective upon Executive's termination of
employment for any reason other than Executive's termination prior to the end
of the Basic Term by the Company for Cause, HCC hereby retains Executive as a
consultant (an independent contractor and not as an employee) for a period of
ten (10) years (the "Consulting Period"). Termination of the Basic Term
shall not effect the Parties' rights and obligations under this Paragraph 6.
Subject to the following, Executive agrees to provide, if requested, a
minimum of 200 hours of service per year, or, as requested by the Company, up
to a total of 600 hours during any one year of the Consulting Period;
provided, however, that the total number of hours to be worked over the
duration of the Consulting Period shall not exceed 2,000 (the "Consulting
Services"). The Consulting Services to be provided shall be commensurate
with Executive's training, background, experience and prior duties with the
Company. Executive agrees to make himself reasonably available to provide
such Consulting Services during the Consulting Period; provided, however, the
Company agrees that it shall provide reasonable advance notice to Executive
of its expected consulting needs and any request for Consulting Services
hereunder shall not unreasonably interfere with Executive's other business
activities and personal affairs as determined in good faith by Executive. In
addition, Executive shall not be required to perform any requested Consulting
Services which, in Executive's good faith opinion, would cause Executive to
breach any fiduciary duty or contractual obligation Executive may have to
another employer. Further, during the Consulting Period, Executive shall not
be subject to any non-competition provisions except for the two-year period
provided for in Paragraph 5(c). Unless waived by Executive, Executive shall
not be required to perform Consulting Services for more than four (4) days
during any week or for more than eight (8) hours during any day. Executive's
travel time shall constitute hours of Consulting Services for purposes of
this Paragraph 6. The Parties contemplate that, when appropriate, the
Consulting Services shall be performed at Executive's office, residence or at
the Company's executive offices in Houston, Texas and may be performed at
such other locations only as they may mutually agree upon. Executive shall
be properly reimbursed for all travel and other expenses reasonably incurred
by Executive in rendering the Consulting Services. HCC shall pay Executive
$100,000 per year (the "Consulting Fee") during the Consulting Period,
payable monthly in arrears. Executive may elect to delay payment for services
but not the services themselves. Except as set forth below
EMPLOYMENT AGREEMENT - Page 13
<PAGE>
and in Paragraphs 4(c) or 4(d) hereof, if Executive fails to provide the
hours requested by the Company in any 24-month period, Executive's rights to
receive any further Consulting Fee shall immediately terminate. During the
Consulting Period, Executive shall receive no employment benefits from HCC.
If Executive dies or becomes Disabled during the Basic Term (or as an
employee of the Company following the Basic Term) or during the Consulting
Period he (or, on his death, his beneficiary or estate) shall receive or
continue to receive as the case may be the Consulting Fee during the
remainder of the Consulting Period as if such death or Disability had not
occurred.
8. ASSIGNMENT. This Agreement cannot be assigned by Executive. The
Company may assign this Agreement only to a successor (whether direct or
indirect, by purchase, merger, consolidation or otherwise) to all or
substantially all of the business and assets of the Company provided such
successor expressly agrees in writing reasonably satisfactory to Executive to
assume and perform this Agreement in the same manner and to the same extent
that the Company would be required to perform it if no such succession and
assignment had taken place. Failure of the Company to obtain such written
agreement prior to the effectiveness of any such succession shall be a
material breach of this Agreement.
9. BINDING AGREEMENT. Executive understands that his obligations
under this Agreement are binding upon Executive's heirs, successors, personal
representatives, and legal representatives.
10. NOTICES. All notices pursuant to this Agreement shall be in
writing and sent certified mail, return receipt requested, addressed as set
forth below, or by delivering the same in person to such party, or by
transmission by facsimile to the number set forth below. Notice deposited in
the United States Mail, mailed in the manner described hereinabove, shall be
effective upon deposit. Notice given in any other manner shall be effective
only if and when received:
If to Executive: John N. Molbeck, Jr.
3424 Ella Lee Lane
Houston, Texas 77027
If to Company: HCC Insurance Holdings, Inc.
13403 Northwest Freeway
Houston, Texas 77040
Fax: (713) 462-2401
with a copy (which shall Arthur S. Berner, Esq.
not constitute notice) to: Winstead Sechrest & Minick P.C.
Suite 2400
910 Travis Street
Houston, Texas 77002-5895
Fax: (713) 650-2400
EMPLOYMENT AGREEMENT - Page 14
<PAGE>
11. WAIVER. No waiver by either party to this Agreement of any right
to enforce any term or condition of this Agreement, or of any breach hereof,
shall be deemed a waiver of such right in the future or of any other right or
remedy available under this Agreement.
12. SEVERABILITY. If any provision of this Agreement is determined to
be void, invalid, unenforceable, or against public policy, such provisions
shall be deemed severable from the Agreement, and the remaining provisions of
the Agreement will remain unaffected and in full force and effect.
13. ARBITRATION. In the event any dispute arises out of Executive's
employment with or by the Company, or separation/termination therefrom,
whether as an employee or as a consultant, which cannot be resolved by the
Parties to this Agreement, such dispute shall be submitted to final and
binding arbitration. The arbitration shall be conducted in accordance with
the National Rules for the Resolution of Employment Disputes of the American
Arbitration Association ("AAA"). If the Parties cannot agree on an
arbitrator, a list of seven (7) arbitrators will be requested from AAA, and
the arbitrator will be selected using alternate strikes with Executive
striking first. The cost of the arbitration will be shared equally by
Executive and Company; provided, however, the Company shall promptly
reimburse Executive for all costs and expenses incurred in connection with
any dispute in an amount up to, but not exceeding 20 percent of Executive's
Base Salary (or, if the dispute arises during the Consulting Period,
Executive's Base Salary as in effect immediately prior to the beginning of
the Consulting Period) unless such termination was for Cause in which event
Executive shall not be entitled to reimbursement unless and until it is
determined he was terminated other than for Cause. Arbitration of such
disputes is mandatory and in lieu of any and all civil causes of action and
lawsuits either party may have against the other arising out of Executive's
employment with Company, or separation therefrom. Such arbitration shall be
held in Houston, Texas.
14. ENTIRE AGREEMENT. The terms and provisions contained herein shall
constitute the entire agreement between the parties with respect to
Executive's employment with Company during the time period covered by this
Agreement. This Agreement replaces and supersedes any and all existing
Agreements entered into between Executive and the Company relating generally
to the same subject matter, if any, and shall be binding upon Executive's
heirs, executors, administrators, or other legal representatives or assigns.
15. MODIFICATION OF AGREEMENT. This Agreement may not be changed or
modified or released or discharged or abandoned or otherwise terminated, in
whole or in part, except by an instrument in writing signed by the Executive
and an officer or other authorized executive of Company.
16. UNDERSTAND AGREEMENT. Executive represents and warrants that he
has read and understood each and every provision of this Agreement, and
Executive understands that he has the right to obtain advice from legal
counsel of choice, if necessary and desired, in order to interpret any and
all provisions of this Agreement, and that Executive has freely and
voluntarily entered into this Agreement.
EMPLOYMENT AGREEMENT - Page 15
<PAGE>
17. GOVERNING LAW. This Agreement shall be governed by and construed
in accordance with the laws of the State of Texas.
18. JURISDICTION AND VENUE. With respect to any litigation regarding
this Agreement, Executive agrees to venue in the state or federal courts in
Harris County, Texas, and agrees to waive and does hereby waive any defenses
and/or arguments based upon improper venue and/or lack of personal
jurisdiction. By entering into this Agreement, Executive agrees to personal
jurisdiction in the state and federal courts in Harris County, Texas.
IN WITNESS WHEREOF, the Parties have executed this Agreement in multiple
copies, effective as of the date first written above.
EXECUTIVE COMPANY
HCC INSURANCE HOLDINGS, INC.
/s/ John N. Molbeck, Jr. By: /s/ Stephen L. Way
- -------------------------------- ------------------------------------
JOHN N. MOLBECK, JR. STEPHEN L. WAY
Chief Executive Officer and
Chairman of the Board
Dated: 1/23/98 Dated: 1/23/98
-------------------------- --------------------------------------
EMPLOYMENT AGREEMENT - Page 16
<PAGE>
EMPLOYMENT AGREEMENT
This Employment Agreement ("Agreement") is entered into effective as of
the 1st day of January, 1998 (the "Effective Date"), between HCC INSURANCE
HOLDINGS, INC. ("HCC" or the "Company"), and STEPHEN J. LOCKWOOD
("Executive"), sometimes collectively referred to herein as the "Parties".
R E C I T A L S:
WHEREAS, Executive is to be employed as Vice Chairman of the Board of
Directors of HCC and Chairman and Chief Executive Officer of LDG Reinsurance
Corporation ("LDG"); and
WHEREAS, it is the desire of the Board of Directors of HCC (the "Board")
to directly engage Executive in the capacities set forth above; and
WHEREAS, Executive is desirous of committing himself to serve HCC on the
terms herein provided.
NOW, THEREFORE, in consideration of the foregoing and of the respective
covenants and agreements set forth below, the Parties agree as follows:
2. TERM. The Company hereby agrees to employ Executive as its Vice
Chairman of the Board of Directors, as the Chairman and Chief Executive
Officer of LDG and as a director of HCC Benefits, Inc. ("Benefits"), and
Executive hereby agrees to accept such employment, on the terms and
conditions set forth herein, for the period commencing on the Effective Date
and expiring as of 11:59 p.m. on December 31, 2002 (the "Basic Term") (unless
sooner terminated as hereinafter set forth). At any time on or after January
1, 2000, and prior to December 31, 2002, Executive may, at his option, cease
to be a full time employee and elect to begin the Consulting Period as
defined in Section 6 hereof. (The period of time beginning as of the date
Executive commences the Consulting Period, if before December 31, 2002, and
ending on December 31, 2002 is hereinafter called the "Early Consulting
Period").
3. DUTIES.
(a) DUTIES AS EMPLOYEE OF THE COMPANY. Executive shall, subject
to the supervision of the Board act as Vice Chairman of the Board of HCC,
Chairman and Chief Executive Officer of LDG, and a director of Benefits in
the ordinary course of its business with all such powers as may be reasonably
incident to such responsibilities. Executive shall report to the Chairman of
the Board or the President of HCC. During normal business hours Executive
shall devote his full time and attention to diligently attending to the
business of the Company and its subsidiaries during his term of employment
hereunder. During his term of employment, Executive shall not directly or
indirectly render any services of a business, commercial, or
EMPLOYMENT AGREEMENT - Page 1
<PAGE>
professional nature to any other person, firm, corporation, or organization,
whether for compensation or otherwise, without the prior written consent of
the Board. However, Executive shall have the right to engage in such
activities as may be appropriate in order to manage his personal investments
so long as such activities do not interfere or conflict with the performance
of his duties to the Company and its subsidiaries as set forth hereunder.
The conduct of such activity shall not be deemed to materially interfere or
conflict with Executive's performance of his duties until Executive has been
notified in writing thereof and given a reasonable period in which to cure
the same.
(b) OTHER DUTIES. At all times during the Basic Term, the Company
shall use its best efforts to cause Executive to be elected director and to
serve on the Senior Management Committee of HCC. If elected, Executive
agrees that he shall not be entitled to receive any compensation for serving
as a Director of HCC or any of HCC's subsidiaries other than the compensation
to be paid to Executive by the Company pursuant to this Agreement.
4. COMPENSATION AND RELATED MATTERS.
(a) BASE SALARY. Executive shall receive an initial base salary
paid by the Company at the annual rate of $450,000, during 1998 and 1999.
Subject to Executive's right to begin the Consulting Period, as set forth in
Section 6, if Executive no longer acts as the Chief Executive Officer of LDG
such base salary shall be reduced to $100,000 beginning January 1, 2000 or
such later date as Executive ceases to act as Chief Executive Officer of LDG
and shall remain at $100,000 during the remainder of the Basic Term. All
base salary payments shall be payable in substantially equal monthly
installments. For purposes of this Agreement, "Base Salary" shall mean the
Executive's initial base salary and, when changed, the changed base salary.
(b) BONUS PAYMENTS. Executive shall be eligible to receive, in
addition to the Base Salary, an annual cash bonus payment in an amount, which
may be zero, to be determined in the sole discretion of the Company's
Compensation Committee.
(c) STOCK OPTIONS. In addition to stock options previously
granted to Executive, in partial consideration for Executive's
non-competition agreements, set forth herein, Executive shall be provided
with additional options to purchase HCC shares as follows:
(1) 150,000 shares to be granted effective as of January 7,
1998, at an exercise price of $16.50 per share vesting in
two equal installments of 75,000 shares on December 31, 1998
and December 31, 1999;
(2) 50,000 shares on December 31 of each year during the Basic
Term if, but only if, Executive is maintaining the position
of Chief Executive Officer of LDG and if not maintaining
such position on such date such option shall be reduced to
25,000 options if, but only if, Executive is acting as
Chairman of LDG. Such options
EMPLOYMENT AGREEMENT - Page 2
<PAGE>
shall be priced at the average closing price of HCC shares
for the month of December of the year of the grant. Any option
so granted shall vest immediately.
(d) EXPENSES. During the Basic Term Executive shall be entitled
to receive prompt reimbursement for all reasonable expenses incurred by him
(in accordance with the policies and procedures established by the Board for
its senior executive officers) in performing services hereunder, provided
that Executive properly accounts therefor in accordance with Company policy
and such expenses are approved by the Chairman of the Board or President of
HCC.
(e) OTHER BENEFITS. Executive shall be entitled to participate in
or receive benefits under any employee benefit plan or other arrangement made
available by the Company now or in the future to its senior executive
officers and key management employees, subject to and on a basis consistent
with the terms, conditions, and overall administration of such plan or
arrangement. Nothing paid to Executive under any plan or arrangement
presently in effect or made available in the future shall be deemed to be in
lieu of the Base Salary payable to Executive pursuant to subsection (a) of
this Section. The Company shall not make any changes in any employee benefit
plans or other arrangements in effect on the date hereof or subsequently in
effect in which Executive currently or in the future participates (including,
without limitation, each pension and retirement plan, supplemental pension
and retirement plan, savings and profit sharing plan, stock or unit ownership
plan, stock or unit purchase plan, stock or unit option plan, life insurance
plan, medical insurance plan, disability plan, dental plan, health and
accident plan, or any other similar plan or arrangement) that would adversely
affect Executive's rights or benefits thereunder, unless such change occurs
pursuant to a program applicable to substantially all executives of the
Company and does not result in a proportionately greater reduction in the
rights of or benefits to Executive as compared with any other executive of
the Company.
(f) VACATIONS. Executive shall be entitled to fifty (50) paid
vacation days per year for each of the calendar years ended December 31 of
the Basic Term while Executive is a full-time Employee. There shall be no
carryover of unused vacation from year to year. For purposes of this
Section, weekends shall not count as vacation days, and Executive shall also
be entitled to all paid holidays given by the Company to its senior executive
officers.
(g) PERQUISITES. Executive shall be entitled to receive the
perquisites and fringe benefits appertaining to an executive officer of HCC
in accordance with any practice established by the Company's Compensation
Committee. Notwithstanding, and in addition to, any perquisites to which
Executive is entitled pursuant to the preceding sentence, Executive shall:
(i) have use of a Mercedes 500 SEL automobile, and the Company shall pay all
expenses related to Executive's use of such car, including gasoline,
insurance, and maintenance; and (ii) be allowed to travel on business
utilizing: (x) First Class Domestic and International passage plus (y) for so
long as Executive remains as Chief Executive Officer or Chairman of the Board
of LDG, up to $3,000,000 of corporate aircraft expense (not to exceed
$650,000 in each of the calendar years ending December 31, 1998 and 1999 and
$575,000 in each of the calendar years
EMPLOYMENT AGREEMENT - Page 3
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ending December 31, 2000 and 2001 and $550,000 in the calendar year ending
December 31, 2002). To avoid confusion, Executive's use of the corporate
aircraft shall terminate if Executive ceases to be both Chief Executive
Officer and the Chairman of the Board of LDG but not if he ceases to hold
only one of such positions while retaining the other. In addition,
Executive's right to use corporate aircraft shall immediately terminate upon
Executive's death or termination for Cause, whether during the Basic Term,
the Early Consulting Period, or the Consulting Period. From and after the
Effective Date, Executive shall be entitled to utilization of an office and
employees (whose compensation will not exceed $75,000 per year).
(h) PRORATION. Any payments or benefits payable to Executive
hereunder in respect of any calendar year during which Executive is employed
by the Company for less than the entire year, unless otherwise provided in
the applicable plan or arrangement, shall be prorated in accordance with the
number of days in such calendar year during which he is so employed.
5. TERMINATION.
(a) DEFINITIONS.
(1) "CAUSE" shall mean:
(i) Material dishonesty which is not the result of an
inadvertent or innocent mistake of Executive with respect to the Company or
any of its subsidiaries;
(ii) Willful misfeasance or nonfeasance of duty by
Executive intended to injure or having the effect of injuring in some
material fashion the reputation, business, or business relationships of the
Company or any of its subsidiaries or any of their respective officers,
directors, or employees;
(iii) Material violation by Executive of any term of this
Agreement; or
(iv) Conviction of Executive of any felony, any crime
involving moral turpitude or any crime other than a vehicular offense which
could reflect in some material fashion unfavorably upon the Company or any
of its subsidiaries.
Executive may not be terminated for Cause unless and until there has
been delivered to Executive written notice from the Board supplying the
particulars of Executive's acts or omissions that the Board believes
constitutes Cause, a reasonable period of time (not less than 30 days) has
been given to Executive after such notice to either cure the same or to meet
with Board with his attorney if so desired by Executive, and following which
the Board by action of not less than two-thirds (2/3rd) of its members
furnishes to Executive a written resolution specifying in detail with
findings that Executive has been terminated for Cause as of the date set
forth in the notice to Executive.
(2) A "CHANGE OF CONTROL" shall be deemed to have occurred if:
EMPLOYMENT AGREEMENT - Page 4
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(i) Any "person" or "group" (within the meaning of
Sections 13(d) and 14(d)(2) of the Securities Exchange Act of 1934) other
than a trustee or other fiduciary holding securities under an employee
benefit plan of the Company becomes the "beneficial owner" (as defined in
Rule 13d-3 under the Securities Exchange Act of 1934), directly or
indirectly, of 50% or more of the Company's then outstanding voting common
stock; or
(ii) At any time during the period of three (3) consecutive
years (not including any period prior to the date hereof), individuals who
at the beginning of such period constituted the Board (and any new director
whose election by the Board or whose nomination for election by the
Company's shareholders were approved by a vote of at least two-thirds of
the directors then still in office who either were directors at the
beginning of such period or whose election or nomination for election was
previously so approved) cease for any reason to constitute a majority
thereof; or
(iii) The shareholders of the Company approve a merger or
consolidation of the Company with any other corporation, other than a
merger or consolidation (a) in which a majority of the directors of the
surviving entity were directors of the Company prior to such consolidation
or merger, and (b) which would result in the voting securities of the
Company outstanding immediately prior thereto continuing to represent
(either by remaining outstanding or by being changed into voting securities
of the surviving entity) more than 50% of the combined voting power of the
voting securities of the surviving entity outstanding immediately after
such merger or consolidation; or
(iv) The shareholders approve a plan of complete
liquidation of the Company or an agreement for the sale or disposition by
the Company of all or substantially all of the Company's assets.
(3) A "DISABILITY" shall mean the absence of Executive from
Executive's duties with the Company on a full-time basis for 180 consecutive
days, or 180 days in a 365-day period, as a result of incapacity due to
mental or physical illness which results in the Executive being unable to
perform the essential functions of his position, with or without reasonable
accommodation.
(4) A "GOOD REASON" shall mean any of the following (without
Executive's express written consent):
(i) Following a Change of Control, a material alteration
in the nature or status of Executive's title, duties or responsibilities,
or the assignment of duties inconsistent with, or a substantial and
material alteration in the nature or status of, Executive's duties and
responsibilities;
EMPLOYMENT AGREEMENT - Page 5
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(ii) A failure by the Company to continue in effect any
employee benefit plan in which Executive was participating, or the taking
of any action by the Company that would adversely affect Executive's
participation in, or materially reduce Executive's benefits under, any such
employee benefit plan, unless such failure or such taking of any action
adversely affects the senior members of corporate management of the Company
generally to the same extent;
(iii) Executive's required relocation to any place other
than his current office exceeding a distance of one hundred (100) miles
from Wakefield, Massachusetts, except for reasonably required travel by
Executive on the Company's business;
(iv) Any material breach by the Company of any provision of
this Agreement if such material breach has not been cured within thirty
(30) days following written notice of such breach by Executive to the
Company setting forth with reasonable specificity the nature of the breach;
or
(v) Any failure by the Company to obtain the assumption
and performance of this Agreement by any successor (by merger,
consolidation, or otherwise) or assign of the Company.
However, Good Reason shall exist with respect to an above-specified
matter only if such matter is not corrected by the Company within thirty (30)
days of its receipt of written notice of such matter from Executive, and in
no event shall a termination by Executive occurring more than ninety (90)
days following the date of the event described above be a termination for
Good Reason due to such event.
(5) "TERMINATION DATE" shall mean the date Executive is
terminated for any reason pursuant to this Agreement.
(b) TERMINATION WITHOUT CAUSE OR TERMINATION FOR GOOD REASON:
BENEFITS. In the event there is a termination without Cause or if Executive
terminates for Good Reason (a "Termination Event"), this Agreement shall
terminate and Executive shall be entitled to the following severance benefits:
(1) For a period of twelve (12) months after the Termination
Event (unless the remainder of the Basic Term is less than 12 months in
which case, for an amount of time equal to the remainder of the Basic
Term), Base Salary (as defined in Section 3(a), at the rate in effect
immediately prior to the Termination Event, payable quarterly, in arrears.
(2) Subject to any contrary provisions of any stock option grant
or plan that might provide for acceleration of vesting of options at an
earlier date than set forth herein, if there is a Change of Control or if
there is a termination without Cause, any
EMPLOYMENT AGREEMENT - Page 6
<PAGE>
stock options which Executive has received under the HCC Stock Option Plans
shall vest immediately; provided, however, that the right to receive
options referenced in Section 3(c)(2) above shall terminate upon
termination from employment for any reason, and further, if there is a
termination for Good Reason, all unvested options shall be void.
(3) To the extent not theretofore paid or provided, the Company
shall timely pay or provide to Executive any other amounts or benefits
required to be paid or provided or which Executive is eligible to receive
under any plan, program, policy or practice, or contract or agreement of
the Company and its affiliated companies (such other amounts and benefits
shall be hereinafter referred to as the "Other Benefits"). Without
limiting the preceding sentence, through December 31, 2002, the Company, at
its sole expense, shall continue to provide (through its own plan and/or
individual policies) Executive (and Executive's dependents) with health
benefits no less favorable than the group health plan benefits provided
during such period to any senior executive officer in the Company or any
affiliated company (to the extent any such coverage or benefits are taxable
to Executive by reason of being provided under a self-insured health plan
of the Company or an affiliate, the Company shall make Executive "whole"
for the same on an after-tax basis.) In any event the Other Benefits
provided for pursuant to this Section shall be secondary to any benefits
and coverage Executive (or his dependents) receive from another employer.
(4) If Executive receives any payments whether or not pursuant
to this Agreement which are subject to an excise tax imposed under
Section 4999 of the Internal Revenue Code of 1986, as amended, or any
similar tax imposed under federal, state, or local law (collectively,
"Excise Taxes"), the Company shall pay to Executive (on or before the date
on which the Company is required to withhold such Excise Taxes), 1) an
additional amount equal to all Excise Taxes then due and payable, and
2) the amount necessary to defray Executive's increased (federal, state,
and local) tax liability arising due to payment of the amount specified in
this subsection (b)(4) which shall include any costs and expenses,
including penalties and interest incurred by Executive in connection with
any audit, proceedings, etc. related to the payment of such Excise Taxes or
this payment. For purposes of calculating the amount payable to Executive
under this Section, the federal and state income tax rates used shall be
the highest marginal federal and state rates applicable to ordinary income
in Executive's state of residence, taking into account any federal income
tax deductions or credits available to Executive for state income taxes.
The Company shall cause its independent auditors to calculate such amount
and provide Executive a copy of such calculation at least ten (10) days
prior to the date specified above for payment of such amount. It is the
intent of the Parties that this subsection (b)(4) shall place Executive in
the same net after-tax position Executive would have been in had no payment
been subject to an Excise Tax and, notwithstanding anything herein to the
contrary, it shall be construed to effectuate said result;
(5) All accrued compensation and unreimbursed expenses through
the Termination Date. Such amounts shall be paid to Executive in a lump
sum in cash within
EMPLOYMENT AGREEMENT - Page 7
<PAGE>
thirty (30) days after the Termination Date; and
(6) Executive shall be free to accept other employment during
such period, and there shall be no offset of any employment compensation
earned by Executive in such other employment during such period against
payments due Executive hereunder, and there shall be not offset in any
compensation received from such other employment against the Base Salary
set forth above; provided, however, that such compensation may terminate if
acceptance of such employment would violate any of the provisions of
Section 5, below
If Executive's employment is terminated pursuant to this subsection (b)
on or after October 1 of any year, any cash or stock bonus which Executive
would otherwise have been awarded in such year shall be awarded as if
termination had not taken place.
(c) TERMINATION IN EVENT OF DEATH: BENEFITS. If Executive's
employment is terminated by reason of Executive's death during the Basic
Term, this Agreement shall terminate without further obligation to
Executive's legal representatives under this Agreement, other than for
payment of all accrued compensation, unreimbursed expenses, the timely
payment or provision of Other Benefits through the date of death, and, if
such death occurs on or after October 1 of any year, such cash or stock bonus
as Executive would otherwise have been awarded in such year if Executive's
death had not occurred. Such amounts shall be paid to Executive's estate or
beneficiary, as applicable, in a lump sum in cash within ninety (90) days
after the date of death. With respect to the provision of Other Benefits,
the term Other Benefits as used in this Section 4(c) shall include, without
limitation, and Executive's estate and/or beneficiaries shall be entitled to
receive, benefits at least equal to the most favorable benefits provided by
the Company to the estates and beneficiaries of other executive level
employees of the Company under such plans, programs, practices, and policies
relating to death benefits, if any, as in effect with respect to other
executives and their beneficiaries at any time during the 120-day period
immediately preceding the date of death. Additionally, all stock options for
which Executive would have been eligible had he completed the Basic Term
(except as set forth in Section 4(b)(2), shall be accelerated, and
Executive's estate or beneficiary shall be vested in such options as of the
date of Executive's termination.
(d) TERMINATION IN EVENT OF DISABILITY: BENEFITS. If Executive's
employment is terminated by reason of Executive's Disability during the Basic
Term, this Agreement shall continue in full force for a period of one (1)
year following such Disability and if such Disability occurs on or after
October 1 of any year Executive shall be entitled to the same cash or stock
bonus in such year that Executive would have been awarded if such Disability
had not occurred. Following such one (1) year period, this Agreement shall
continue in full force for the remainder of the Basic Term except that (a)
the Base Salary shall be reduced by 50% and (b) Executive shall, not be
entitled to any subsequent cash or stock bonuses. In addition, all
outstanding options shall vest immediately upon the date of such Disability.
(e) VOLUNTARY TERMINATION BY EXECUTIVE AND TERMINATION FOR CAUSE:
BENEFITS. Executive may terminate his employment with the Company by giving
written notice
EMPLOYMENT AGREEMENT - Page 8
<PAGE>
of his intent and stating an effective Termination Date at least ninety (90)
days after the date of such notice; provided, however, that the Company may
accelerate such effective date by paying Executive through the proposed
Termination Date. The Company may terminate Executive's employment with
Cause at any time. Upon such a termination by Executive or upon termination
for Cause by the Company, this Agreement shall terminate and the Company
shall pay to Executive all accrued compensation, unreimbursed expenses and
the Other Benefits through the Termination Date. Such amounts shall be paid
to Executive in a lump sum in cash within thirty (30) days after the later of
the date of termination or the date of the Board's decision as set forth
herein. Upon a voluntary termination by employee or termination for Cause,
Executive shall be entitled to receive no further salary nor consulting
payments as set forth herein. Upon such termination, all unvested options
shall terminate and be of no further force or effect.
(f) DIRECTOR POSITIONS. Executive agrees that upon termination of
employment, for any reason, at the request of the Chairman of the Board, and
if Executive owns less than 2,000,000 shares of HCC Common Stock or if
Executive has been terminated for Cause, he will immediately tender his
resignation from any and all Board positions held with the Company and/or any
of its subsidiaries and affiliates, including without limitation, as Vice
Chairman of the Company, Chairman of LDG, and a Director of Benefits. If
Executive remains as a Director, after such termination, Executive shall be
compensated as an outside director. While an outside Director, Executive
shall be entitled to First Class Business Travel but shall no longer be
entitled to use of corporate aircraft.
(g) SEVERANCE PAYMENT. In addition to all other payments due
hereunder in the event of Executive's termination other than for Cause, as
both Chief Executive Officer and Chairman of the Board of LDG, Executive
shall receive a severance payment in the amount of $1.3 million reduced by
the corporate aircraft expense previously utilized by Executive since January
1, 1998 in excess of $300,000 in each calendar year beginning January 1,
1998. At the Company's sole election, such severance may be paid in cash or
by permitting the Executive to incur additional corporate aircraft expense.
6. NON-COMPETITION, NON-SOLICITATION, AND CONFIDENTIALITY. Executive
recognizes and agrees that the benefit of not being employed at-will, is
provided in consideration for, among other things, the agreements contained
in this Section, as well as the Stock Options granted to Executive pursuant
to this Agreement. The Company agrees that while employed pursuant to this
Agreement, Executive will be provided with confidential information of
Company; specialized training on how to perform his duties; and contact with
the Company's customers and potential customers. Furthermore, in the event
Executive is terminated without Cause, or terminates for Good Reason, and
more than one (1) year remains on the existing Basic Term, then Executive
shall receive additional consideration in an amount equal to the quotient of
the Base Salary divided by 12, which shall thereupon be multiplied by the
number of months remaining in the Basic Term minus 12 months and which shall
be paid in one lump sum within ten (10) days of such termination.
In consideration of all of the foregoing, Executive agrees as follows:
EMPLOYMENT AGREEMENT - Page 9
<PAGE>
(a) NON-COMPETITION DURING EMPLOYMENT. Executive agrees during
the Basic Term he will not compete with the Company by engaging in the
conception, design, development, production, marketing, or servicing of any
product or service that is substantially similar to the products or services
which the Company provides, and that he will not work for, in any capacity,
assist, or become affiliated with as an owner, partner, etc., either directly
or indirectly, any individual or business which offers or performs services,
or offers or provides products substantially similar to the services and
products provided by Company.
(b) CONFLICTS OF INTEREST. Executive agrees that during the Basic
Term, he will not engage, either directly or indirectly, in any activity (a
"Conflict of Interest") which might adversely affect the Company or its
affiliates, including ownership of a material interest in any supplier,
contractor, distributor, subcontractor, customer or other entity with which
the Company does business or accepting any material payment, service, loan,
gift, trip, entertainment, or other favor from a supplier, contractor,
distributor, subcontractor, customer or other entity with which the Company
does business, and that Executive will promptly inform the Chairman of the
Company as to each offer received by Executive to engage in any such
activity. Executive further agrees to disclose to the Company any other
facts of which Executive becomes aware which might in Executive's good faith
judgment reasonably be expected to involve or give rise to a Conflict of
Interest or potential Conflict of Interest.
(c) NON-COMPETITION AFTER TERMINATION. Executive agrees that
Executive shall not, at any time during the period of three (3) years (the
"Non-Competition Period"; unless there shall be a Change of Control of HCC,
in which case the Non-Competition Period shall be reduced to 18 months) after
the termination of the Basic Term, for any reason, within any of the markets
in which the Company has sold products or services or formulated a plan to
sell products or services into a market during the last twelve (12) months of
Executive's employ or which the Company enters into within three (3) months
thereafter, engage in or contribute Executive's knowledge to any work which
is competitive with or similar to a product, process, apparatus, service, or
development on which Executive worked or with respect to which Executive had
access to Confidential Information while employed by the Company; provided,
however, this subsection (c) shall not operate to prevent Executive from
engaging in retail insurance or re-insurance activities during such
three-year period to the extent such activities do not compete or permit any
other person or entity to compete with any business the Company or any of its
subsidiaries or affiliated companies were engaged in at the time of such
termination or which the Company enters into within three (3) months
thereafter. Following the expiration of said three (3) year period,
Executive shall continue to be obligated under the Confidential Information
Section of this Agreement not to use or to disclose Confidential Information
of the Company so long as it shall not be publicly available. It is
understood that the geographical area set forth in this covenant is divisible
so that if this clause is invalid or unenforceable in an included geographic
area, that area is severable and the clause remains in effect for the
remaining included geographic areas in which the clause is valid.
(d) NON-SOLICITATION OF CUSTOMERS. Executive further agrees that
for a period of three (3) years after the termination of the Basic Term
(unless there shall be a Change
EMPLOYMENT AGREEMENT - Page 10
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of Control of HCC in which case such period shall be reduced to 18 months),
he will not solicit or accept any business from any customer or client or
prospective customer or client with whom Executive dealt or solicited while
employed by Company during the last twelve (12) months of his employment.
(e) NON-SOLICITATION OF EMPLOYEES. Executive agrees that for the
duration of the Basic Term, and for a period of three (3) years after the
termination of the Basic Term, he will not either directly or indirectly, on
his own behalf or on behalf of others, solicit, attempt to hire, or hire any
person employed by Company to work for Executive or for another entity, firm,
corporation, or individual.
(f) CONFIDENTIAL INFORMATION. Executive further agrees that he
will not, except as the Company may otherwise consent or direct in writing,
reveal or disclose, sell, use, lecture upon, publish or otherwise disclose to
any third party any Confidential Information or proprietary information of
the Company, or authorize anyone else to do these things at any time either
during or subsequent to his employment with the Company. This Section shall
continue in full force and effect after termination of Executive's employment
and after the termination of this Agreement. Executive's obligations under
this Section with respect to any specific Confidential Information and
proprietary information shall cease when that specific portion of the
Confidential Information and proprietary information becomes publicly known,
in its entirety and without combining portions of such information obtained
separately. It is understood that such Confidential Information and
proprietary information of the Company include matters that Executive
conceives or develops, as well as matters Executive learns from other
employees of Company. Confidential Information is defined to include
information: (1) disclosed to or known by the Executive as a consequence of
or through his employment with the Company; (2) not generally known outside
the Company; and (3) which relates to any aspect of the Company or its
business, finances, operation plans, budgets, research, or strategic
development. Confidential Information includes, but is not limited to the
Company's trade secrets, proprietary information, financial documents, long
range plans, customer lists, employer compensation, marketing strategy, data
bases, costing data, computer software developed by the Company, investments
made by the Company, and any information provided to the Company by a third
party under restrictions against disclosure or use by the Company or others.
(g) RETURN OF DOCUMENTS, EQUIPMENT, ETC. All writings, records,
and other documents and things comprising, containing, describing,
discussing, explaining, or evidencing any Confidential Information, and all
equipment, components, parts, tools, and the like in Executive's custody or
possession that have been obtained or prepared in the course of Executive's
employment with the Company shall be the exclusive property of the Company,
shall not be copied and/or removed from the premises of the Company, except
in pursuit of the business of the Company, and shall be delivered to the
Company, without Executive retaining any copies, upon notification of the
termination of Executive's employment or at any other time requested by the
Company. The Company shall have the right to retain, access, and inspect all
property of Executive of any kind in the office, work area, and on the
premises of the Company upon termination of Executive's employment and at any
time during employment by the
EMPLOYMENT AGREEMENT - Page 11
<PAGE>
Company to ensure compliance with the terms of this Agreement.
(h) REAFFIRM OBLIGATIONS. Upon termination of his employment with
the Company, Executive, if requested by Company, shall reaffirm in writing
Executive's recognition of the importance of maintaining the confidentiality
of the Company's Confidential Information and proprietary information, and
reaffirm any other obligations set forth in this Agreement.
(i) PRIOR DISCLOSURE. Executive represents and warrants that he
has not used or disclosed any Confidential Information he may have obtained
from the Company prior to signing this Agreement, in any way inconsistent
with the provisions of this Agreement.
(j) CONFIDENTIAL INFORMATION OF PRIOR COMPANIES. Executive will
not disclose or use during the period of his employment with the Company any
proprietary or Confidential Information or copyright works which Executive
may have acquired because of employment with an employer other than the
Company or acquired from any other third party, whether such information is
in Executive's memory or embodied in a writing or other physical form.
(k) BREACH. Executive agrees that any breach of Sections 5(a),
(b), (c), (d), (e) or (f) above cannot be remedied solely by money damages,
and that in addition to any other remedies Company may have, Company is
entitled to obtain injunctive relief against Executive. Nothing herein,
however, shall be construed as limiting the Company's right to pursue any
other available remedy at law or in equity, including recovery of damages and
termination of this Agreement and/or any payments that may be due pursuant to
this Agreement.
(l) RIGHT TO ENTER AGREEMENT. Executive represents and covenants
to Company that he has full power and authority to enter into this Agreement
and that the execution of this Agreement will not breach or constitute a
default of any other agreement or contract to which he is a party or by which
he is bound.
(m) EXTENSION OF POST-EMPLOYMENT RESTRICTIONS. In the event
Executive breaches Sections 5(b), (c), (d), or (e) or (f) above, the
restrictive time periods contained in those provisions will be extended by
the period of time Executive was in violation of such provisions.
(n) ENFORCEABILITY. The agreements contained in this Section 5
are independent of the other agreements contained herein. Accordingly,
failure of the Company to comply with any of its obligations outside of this
Section do not excuse Executive from complying with the agreements contained
herein.
(o) SURVIVABILITY. The agreements contained in Sections 5(c)
through (g) shall survive the termination of this Agreement for any reason.
7. CONSULTING AGREEMENT. (a) Effective upon Executive's termination of
employment for any reason other than Executive's termination prior to the end of
the Basic Term
EMPLOYMENT AGREEMENT - Page 12
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by the Company for Cause, HCC hereby retains Executive as a consultant (an
independent contractor and not as an employee) for a period of five (5) years
(the "Consulting Period"). Termination of the Basic Term shall not effect
the Parties' rights and obligations under this Section 6. Subject to the
following, Executive agrees to provide, if requested, a minimum of 100 hours
of service per year, or, as requested by the Company, up to a total of 500
hours during any one year of the Consulting Period; provided, however, that
the total number of hours to be worked over the duration of the Consulting
Period shall not exceed 500 (the "Consulting Services"). The Consulting
Services to be provided shall be commensurate with Executive's training,
background, experience and prior duties with the Company. Executive agrees
to make himself reasonably available to provide such Consulting Services
during the Consulting Period; provided, however, the Company agrees that it
shall provide reasonable advance notice to Executive of its expected
consulting needs and any request for Consulting Services hereunder shall not
unreasonably interfere with Executive's other business activities and
personal affairs as determined in good faith by Executive. In addition,
Executive shall not be required to perform any requested Consulting Services
which, in Executive's good faith opinion, would cause Executive to breach any
fiduciary duty or contractual obligation Executive may have to another
employer. Further, during the Consulting Period, Executive shall not be
subject to any non-competition provisions except for the three-year period
provided for in Section 5(c). Unless waived by Executive, Executive shall
not be required to perform Consulting Services for more than four (4) days
during any week or for more than eight (8) hours during any day. Executive's
travel time shall constitute hours of Consulting Services for purposes of
this Section 6. The Parties contemplate that, when appropriate, the
Consulting Services shall be performed at Executive's office, residence or at
LDG's executive offices in Wakefield, Massachusetts, and may be performed at
such other locations only as they may mutually agree upon. Executive shall
be properly reimbursed for all travel and other expenses reasonably incurred
by Executive in rendering the Consulting Services but Executive shall not be
entitled to utilize corporate aircraft during the Consulting Period. HCC
shall pay Executive $100,000 per year (the "Yearly Consulting Fee") and a
total of $500,000 (the "Total Consulting Fee") during the Consulting Period,
payable monthly in arrears, provided, however, if Executive works in excess
of 100 hours in any calendar year, such calendar year's Yearly Consulting Fee
shall be increased by multiplying the number of hours in excess of 100 by
$1,000 and such excess amount shall be reduced from the final Yearly
Consulting Fee paid to Executive as set forth in this Section 6 and shall not
increase the Total Consulting Fee. Executive may elect to delay payment for
services but not the services themselves. Except as set forth below and in
Sections 4(c) or 4(d) hereof, if Executive fails to provide the hours
requested by the Company in any 12-month period, Executive's rights to
receive any further Consulting Fee shall immediately terminate. During the
Consulting Period, Executive shall receive no employment benefits from HCC.
If Executive dies or becomes Disabled during the Consulting Period neither he
nor, on his death, his beneficiary or estate, shall receive or continue to
receive as the case may be the Consulting Fee during the remainder of the
Consulting Period.
(b) If Executive has elected to begin the Early Consulting Period,
during such Early Consulting Period Executive shall be required to provide
Consulting Services in any amount of, at least, 500 hours per each calendar
year. During such Early Consulting Period,
EMPLOYMENT AGREEMENT - Page 13
<PAGE>
Executive shall: (a) receive the Consulting Fee of $100,000 per year; (b)
receive stock options in an amount equal to 25,000 shares per year
(exercisable at a price as set forth in Section 3(c)(2) hereof); and (c)
shall be entitled to the use of corporate aircraft in a manner determined in
accordance with Section 3(g) hereof. During such Early Consulting Period,
Executive shall receive no employment benefits from HCC. If Executive dies
or becomes Disabled during the Early Consulting Period, for the remainder of
such Early Consulting Period (but not for the Consulting Period) Executive
(or, on his death, his beneficiary or estate) shall continue to receive as
the case may be the Consulting Fee for the remainder of the Early Consulting
Period.
8. ASSIGNMENT. This Agreement may be assigned by Company, but cannot
be assigned by Executive.
9. BINDING AGREEMENT. Executive understands that his obligations
under this Agreement are binding upon Executive's heirs, successors, personal
representatives, and legal representatives.
If to Executive: Stephen J. Lockwood
29 Bradlee Road
Marblehead, MA 01945
Fax: _______________
If to Company: HCC Insurance Holdings, Inc.
13403 Northwest Freeway
Houston, TX 77040
Att.: Chairman of the Board
Fax: (713) 462-2401
with a copy (which shall Arthur S. Berner, Esq.
not constitute notice) to: Winstead Sechrest & Minick P.C.
Suite 2400
910 Travis Street
Houston, TX 77002-5895
Fax: (713) 650-2400
10. WAIVER. No waiver by either party to this Agreement of any right
to enforce any term or condition of this Agreement, or of any breach hereof,
shall be deemed a waiver of such right in the future or of any other right or
remedy available under this Agreement.
11. SEVERABILITY. If any provision of this Agreement is determined to
be void, invalid, unenforceable, or against public policy, such provisions
shall be deemed severable from the Agreement, and the remaining provisions of
the Agreement will remain unaffected and in full force and effect.
12. ARBITRATION. In the event any dispute arises out of Executive's
employment with the Company, or separation therefrom, which cannot be
resolved by the Parties, such dispute
EMPLOYMENT AGREEMENT - Page 14
<PAGE>
shall be submitted to final and binding arbitration. The arbitration shall
be conducted in accordance with the National Rules for the Resolution of
Employment Disputes of the American Arbitration Association ("AAA"). If the
Parties cannot agree on an arbitrator, a list of seven (7) arbitrators will
be requested from AAA, and the arbitrator will be selected using alternate
strikes with Executive striking first. The cost of the arbitration will be
shared equally by Executive and the Company. Arbitration of such disputes is
mandatory and in lieu of any and all civil causes of action and lawsuits
either Party may have against the other arising out of Executive's employment
with Company, or separation therefrom. Such arbitration shall be held in
Houston, Texas.
13. ENTIRE AGREEMENT. The terms and provisions contained herein shall
constitute the entire agreement between the Parties with respect to
Executive's employment with Company during the time period covered by this
Agreement. This Agreement replaces and supersedes any and all existing
Agreements entered into between Executive and the Company relating generally
to the same subject matter, if any, and shall be binding upon Executive's
heirs, executors, administrators, or other legal representatives or assigns.
14. MODIFICATION OF AGREEMENT. This Agreement may not be changed or
modified or released or discharged or abandoned or otherwise terminated, in
whole or in part, except by an instrument in writing signed by the Executive
and an officer or other authorized executive of the Company.
15. UNDERSTAND AGREEMENT. Executive represents and warrants that he
has read and understood each and every provision of this Agreement, and
Executive understands that he has the right to obtain advice from legal
counsel of his choice, if necessary and desired, in order to interpret any
and all provisions of this Agreement, and that Executive has freely and
voluntarily entered into this Agreement.
16. GOVERNING LAW. This Agreement shall be governed by and construed
in accordance with the laws of the State of Texas.
17 JURISDICTION AND VENUE. With respect to any litigation regarding
this Agreement, Executive agrees to venue in the state or federal courts in
Harris County, Texas, and agrees to waive and does hereby waive any defenses
and/or arguments based upon improper venue and/or lack of personal
jurisdiction. By entering into this Agreement, Executive agrees to personal
jurisdiction in the state and federal courts in Harris County, Texas.
IN WITNESS WHEREOF, the parties have executed this Agreement as of the
date first written above.
EXECUTIVE COMPANY
HCC INSURANCE HOLDINGS, INC.
EMPLOYMENT AGREEMENT - Page 15
<PAGE>
/s/ Stephen J. Lockwood By: /s/ Stephen L. Way
- -------------------------------- ------------------------------
STEPHEN J. LOCKWOOD STEPHEN L. WAY
Chief Executive Officer and
Chairman of the Board
Dated: 3/3/99 Dated: 3/3/99
-------------------------- ---------------------------
EMPLOYMENT AGREEMENT - Page 16
<PAGE>
EMPLOYMENT AGREEMENT
This Employment Agreement ("Agreement") is entered into effective as of
the 1st day of January, 1998 (the "Effective Date"), between HCC INSURANCE
HOLDINGS, INC. ("HCC" or "Company"), and FRANK J. BRAMANTI ("Executive"),
sometimes collectively referred to herein as the "Parties."
R E C I T A L S:
WHEREAS, Executive is to be employed as Executive Vice President of HCC,
and as an integral part of its management who participates in the
decision-making process relative to short and long-term planning and policy
for the Company, will serve on the Company's Executive Committee;
WHEREAS, it is the desire to the Board of Directors of HCC (the "Board")
to (i) directly engage Executive as an officer of HCC and its subsidiaries;
and (ii) directly engage, if elected, the services of Executive as a director
of HCC and its subsidiaries; and
WHEREAS, Executive is desirous of committing himself to serve HCC on the
terms herein provided.
NOW, THEREFORE, in consideration of the foregoing and of the respective
covenants and agreements set forth below, the Parties agree as follows:
1. TERM. The Company hereby agrees to employ Executive as an
Executive Vice President, and Executive hereby agrees to accept such
employment, on the terms and conditions set forth herein, for the period
commencing on the Effective Date and expiring as of 11:59 p.m. on December
31, 2002 (the "Basic Term") (unless sooner terminated as hereinafter set
forth).
2. DUTIES.
(a) DUTIES AS EMPLOYEE OF THE COMPANY. Executive shall, subject
to the supervision of the Chief Executive Officer, the President, and the
Board, have general management responsibilities in the ordinary course of
HCC's business with all such powers with respect to such management as may be
reasonably incident to such responsibilities. During normal business hours,
Executive shall devote his full time and attention to diligently attending to
the business of the Company during the Basic Term. During the Basic Term,
Executive shall not directly or indirectly render any services of a business,
commercial, or professional nature to any other person, firm, corporation, or
organization, whether for compensation or otherwise, without the prior
written consent of the Chairman of the Board. However, Executive shall have
the right to engage in such activities as may be appropriate in order to
manage his personal investments so long as such activities do not interfere
or conflict with the performance of his duties to the Company hereunder. The
conduct of such activity shall not be deemed to materially interfere or
conflict with Executive's performance of his duties until Executive has been
notified
EMPLOYMENT AGREEMENT - Page 1
<PAGE>
in writing thereof and given a reasonable period in which to cure the same.
(b) OTHER DUTIES. At all times during the Basic Term, the Company
shall use its best efforts to cause Executive to be elected a director and to
serve on the Executive Committee and Senior Management Committee of HCC. Any
such failure to use its best efforts prior to a Change of Control shall be a
material breach of this Agreement for purposes of Paragraph (4)(a)(iv). If
elected, Executive agrees to serve as a director and on the Executive
Committee and Senior Management Committee of HCC and of any of its
subsidiaries and in one or more executive offices of any of HCC's
subsidiaries, provided Executive is indemnified for serving in any and all
such capacities in a manner acceptable to the Company and Executive. If
elected, Executive agrees that he shall not be entitled to receive any
compensation for serving as a director of HCC or in any capacities of HCC's
subsidiaries other than the compensation to be paid to Executive by the
Company pursuant to this Agreement.
3. COMPENSATION AND RELATED MATTERS.
(a) BASE SALARY. Executive shall receive a base salary (the "Base
Salary") paid by the Company at the annual rate of $325,000, during the
period beginning on the Effective Date hereof and ending December 31, 2002,
payable not less frequently than in substantially equal monthly installments.
In such event, Executive will be entitled to paid vacation as set forth in
Subparagraph 3(f)(i). At any time on or after January 1, 2000, Executive
may, at his option, remain as a full-time employee with increased vacation,
in which case his Base Salary shall be reduced to $275,000 annually (the
"Reduced Salary). In such event, Executive will be entitled to paid vacation
as set forth in Subparagraph 3(f)(ii) and shall be entitled to continued
benefits from the Company. Alternatively, at Executive's sole discretion and
election, on or before January 1, 2000, Executive may voluntarily terminate
his employment with the Company and elect to become a consultant to the
Company for the remainder of the Basic Term (the "Consulting Period") at an
annual consulting fee of $150,000. In such event, Executive shall be
required to perform 300 hours of service per annum on behalf of the Company
as directed by the President or Chairman of the Board (the "Consulting
Services"). The Consulting Services to be provided shall be commensurate
with Executive's training, background, experience and prior duties with the
Company. Executive agrees to make himself reasonably available to provide
such Consulting Services during the Consulting Period; provided, however, the
Company agrees that it shall provide reasonable advance notice to Executive
of its expected consulting needs and any request for Consulting Services
hereunder shall not unreasonably interfere with Executive's other business
activities and personal affairs, as determined in good faith by Executive.
In addition, Executive shall not be required to perform any requested
Consulting Services which, in Executive's good faith opinion, would cause
Executive to breach any fiduciary duty or contractual obligation Executive
may have to another employer. Further, during the Consulting Period,
Executive shall not be subject to any non-competition provisions except for
the two-year period provided for in Paragraph 5(c). Executive's travel time
shall constitute hours of Consulting Services for purposes of this Paragraph
3(a). The Parties contemplate that, when appropriate, the Consulting
Services shall be performed at Executive's office, residence or at the
Company's executive offices in Houston, Texas and may be performed at such
other locations only as they may mutually agree upon. Executive shall be
promptly reimbursed for all travel and other expenses reasonably incurred by
Executive in rendering the Consulting Services.
EMPLOYMENT AGREEMENT - Page 2
<PAGE>
Executive's annual consulting fee shall be paid quarterly in advance. In such
event, Executive, acting as a consultant, shall be entitled to no further
benefits from the Company.
(b) BONUS PAYMENTS. Executive shall be entitled to receive, in
addition to the Base Salary, an annual cash bonus payment in an amount, which
may be zero, to be determined at the sole discretion of the Compensation
Committee. If Executive elects to become a Consultant, he shall receive no
bonus.
(c) STOCK OPTIONS. In addition to stock options previously
granted to Executive, in partial consideration for Executive's
non-competition agreements, set forth herein, Executive shall be provided
with additional options to purchase HCC shares as follows:
(1) 100,000 shares to be granted effective as of January 7,
1998, at an exercise price of $16.50 per share vesting in
two equal installments of 50,000 each on December 31, 1998
and December 31, 1999; and
(2) 25,000 shares on December 31, of each year this Agreement is
in effect and Executive is a full time employee on such
date. Such options shall be priced at the average closing
price of HCC shares for the month of December of the year of
the grant. Any options so granted shall vest immediately.
Executive shall receive no options if he is acting as a
consultant.
(d) EXPENSES. During the Basic Term, Executive shall be entitled
to receive reimbursement for all reasonable expenses incurred by him in
accordance with the policies and procedures established by the Board for the
Company's senior executive officers in performing services hereunder,
provided that Executive properly accounts therefor in accordance with Company
policy.
(e) OTHER BENEFITS. Except if Executive elects to become a
consultant, as set forth above, Executive shall be entitled to participate in
or receive benefits under any compensatory employee benefit plan or other
arrangement made available by the Company now or in the future to its senior
executive officers and key management employees, subject to and on a basis
consistent with the terms, conditions, and overall administration of such
plan or arrangement. Nothing paid to Executive under any plan or arrangement
presently in effect or made available in the future shall be deemed to be in
lieu of the Base Salary payable to Executive pursuant to Paragraph (a) of
this Section. The Company shall not make any changes in any employee benefit
plans or other arrangements in effect on the date hereof or subsequently in
effect in which Executive currently or in the future participates (including,
without limitation, each pension and retirement plan, supplemental pension
and retirement plan, savings and profit sharing plan, stock or unit ownership
plan, stock or unit purchase plan, stock or unit option plan, life insurance
plan, medical insurance plan, disability plan, dental plan, health and
accident plan, or any other similar plan or arrangement) that would adversely
affect Executive's rights or benefits thereunder, unless such change occurs
pursuant to a program applicable to substantially all executives of the
Company and does not result in a proportionately greater reduction in the
rights of or benefits to Executive as compared with any other executive of
the Company.
EMPLOYMENT AGREEMENT - Page 3
<PAGE>
(f) VACATIONS. (i) Executive shall be entitled to thirty (30)
paid vacation days per year during the Basic Term, provided however, (ii) if
Executive should elect to remain a full-time employee and not a consultant
after January 1, 2000 at the Reduced Salary, Executive shall be entitled to
sixty (60) paid vacation days per year from such date. There shall be no
carryover of unused vacation from year to year. For purposes of this
Paragraph, weekends shall not count as vacation days, and Executive shall
also be entitled to all paid holidays and personal days given by the Company
to its senior executive officers.
(g) PERQUISITES. Executive shall be entitled to receive the
perquisites and fringe benefits appertaining to an executive officer of HCC
in accordance with any practice established by the Compensation Committee.
Notwithstanding, and in addition to, any perquisites to which Executive is
entitled pursuant to the preceding sentence, Executive shall, whether acting
as an employee or as a consultant: (i) have use of a 1998 Mercedes 500 SEL
automobile, and the Company shall pay all expenses related to Executive's use
of such car, including gasoline, insurance, and maintenance; (ii) be allowed
to travel on business utilizing first class passage (whether domestic or
international); (iii) be reimbursed for annual club dues for Lakeside Country
Club; and (iv) receive a total of $1,000,000 term life insurance (which shall
be in addition to the standard benefits provided to Executive under the
Company's group life insurance program that covers officers).
(h) PRORATION. Any payments or benefits payable to Executive
hereunder in respect of any calendar year during which Executive is employed
by the Company for less than the entire year, unless otherwise provided in
the applicable plan or arrangement, shall be prorated in accordance with the
number of days in such calendar year during which he is so employed.
Notwithstanding the foregoing, any payments pursuant to Paragraphs 4(b)(4),
4(c) or 4(d) of this Agreement shall not be subject to proration.
4. TERMINATION.
(a) DEFINITIONS.
(1) "CAUSE" shall mean:
(i) Material dishonesty which is not the result of an
inadvertent or innocent mistake of Executive with respect to the Company or
any of its subsidiaries;
(ii) Willful misfeasance or nonfeasance of duty by
Executive intended to injure or having the effect of injuring in some
material fashion the reputation, business, or business relationships of the
Company or any of its subsidiaries or any of their respective officers,
directors, or employees;
(iii) Material violation by Executive of any material term
of this Agreement; or
(iv) Conviction of Executive of any felony, any crime
involving
EMPLOYMENT AGREEMENT - Page 4
<PAGE>
moral turpitude or any crime other than a vehicular offense which could
reflect in some material fashion unfavorably upon the Company or any of
its subsidiaries.
Executive may not be terminated for Cause unless and until there has been
delivered to Executive written notice from the Board supplying the
particulars of Executive's acts or omissions that the Board believes
constitute Cause, a reasonable period of time (not less than 30 days) has
been given to Executive after such notice to either cure the same or to meet
with the Board, with his attorney if so desired by Executive, and following
which the Board by action of not less than two-thirds of its members
furnishes to Executive a written resolution specifying in detail its findings
that Executive has been terminated for Cause as of the date set forth in the
notice to Executive.
(2) A "CHANGE OF CONTROL" shall be deemed to have occurred if:
(i) Any "person" or "group" (within the meaning of
Sections 13(d) and 14(d)(2) of the Securities Exchange Act of 1934) other
than a trustee or other fiduciary holding securities under an employee
benefit plan of the Company becomes the "beneficial owner" (as defined in
Rule 13d-3 under the Securities Exchange Act of 1934), directly or
indirectly, of 50% or more of the Company's then outstanding voting common
stock; or
(ii) At any time during the period of three (3) consecutive
years (not including any period prior to the date hereof), individuals who
at the beginning of such period constituted the Board (and any new director
whose election by the Board or whose nomination for election by the
Company's shareholders were approved by a vote of at least two-thirds of
the directors then still in office who either were directors at the
beginning of such period or whose election or nomination for election was
previously so approved) cease for any reason to constitute a majority
thereof; or
(iii) The shareholders of the Company approve a merger or
consolidation of the Company with any other corporation, other than a
merger or consolidation (a) in which a majority of the directors of the
surviving entity were directors of the Company prior to such consolidation
or merger, and (b) which would result in the voting securities of the
Company outstanding immediately prior thereto continuing to represent
(either by remaining outstanding or by being changed into voting securities
of the surviving entity) more than 50% of the combined voting power of the
voting securities of the surviving entity outstanding immediately after
such merger or consolidation; or
(iv) The shareholders approve a plan of complete
liquidation of the Company or an agreement for the sale or disposition by
the Company of all or substantially all of the Company's assets.
(3) A "DISABILITY" shall mean the absence of Executive from
Executive's duties with the Company on a full-time basis for 180 consecutive
days, or 180 days in a 365-day period, as a result of incapacity due to
mental or physical illness which results in the
EMPLOYMENT AGREEMENT - Page 5
<PAGE>
Executive being unable to perform the essential functions of his position,
with or without reasonable accommodation.
(4) A "GOOD REASON" shall mean any of the following (without
Executive's express written consent):
(i) Following a Change of Control, a material alteration
in the nature or status of Executive's title, duties or responsibilities,
or the assignment of duties or responsibilities inconsistent with
Executive's status, title, duties and responsibilities;
(ii) A failure by the Company to continue in effect any
employee benefit plan in which Executive was participating, or the taking
of any action by the Company that would adversely affect Executive's
participation in, or materially reduce Executive's benefits under, any such
employee benefit plan, unless such failure or such taking of any action
adversely affects the senior members of corporate management of the Company
generally to the same extent;
(iii) A relocation of the Company's principal executive
offices, or Executive's relocation to any place other than the principal
executive offices, exceeding a distance of fifty (50) miles from the
Company's current executive office located in Houston, Texas, except for
reasonably required travel by Executive on the Company's business;
(iv) Any material breach by the Company of any provision of
this Agreement; or
(v) Any failure by the Company to obtain the assumption
and performance of this Agreement by any successor (by merger,
consolidation, or otherwise) or assign of the Company.
However, Good Reason shall exist with respect to an above specified matter only
if such matter is not corrected by the Company within thirty (30) days of its
receipt of written notice of such matter from Executive, and in no event shall a
termination by Executive occurring more than ninety (90) days following the date
of the event described above be a termination for Good Reason due to such event.
(5) "TERMINATION DATE" shall mean the date Executive is
terminated for any reason pursuant to this Agreement.
(b) TERMINATION WITHOUT CAUSE, OR TERMINATION FOR GOOD REASON:
BENEFITS. In the event there is a termination by the Company without Cause,
or if Executive terminates for Good Reason (a "Termination Event"), this
Agreement shall terminate and Executive shall be entitled to the following
severance benefits:
(1) For a period of twelve (12) months after the Termination
Date (unless the remainder of the Basic Term is less than twelve
(12) months, in which case,
EMPLOYMENT AGREEMENT - Page 6
<PAGE>
for an amount of time equal to the remainder of the Basic Term), Base
Salary (as defined in Paragraph 3(a)), at the rate and payable quarterly
unless such termination is by the Company without Cause, in which event
such amount of Base Salary shall be paid in a lump sum within ten
(10) days of the Termination Event.
(2) If there is a Change of Control or termination by the
Company without Cause or by Executive for Good Reason any stock options
and other stock-related grants ("Stock Awards") which Executive has
received under any of the HCC stock plans shall vest immediately; provided,
however, that the options provided for in Paragraph 3(c)(2) shall be
granted as of the Termination Date and shall be priced at the closing price
of HCC shares as of such date. If there is a termination for Good Reason
or by the Company other than for Cause, all options shall be exercisable
for one year or the remainder of their term, whichever is less.
(3) To the extent not theretofore paid or provided, the Company
shall timely pay or provide to Executive any other amounts or benefits
required to be paid or provided or which Executive is eligible to receive
under any plan, program, policy or practice, or contract or agreement of
the Company and its affiliated companies for the period of time equal to
the remainder of the Basic Term (such other amounts and benefits shall be
hereinafter referred to as the "Other Benefits"). Without limiting the
preceding sentence, through December 31, 2002 the Company, at its sole
expense, shall continue to provide (through its own plan and/or individual
policies) Executive (and Executive's dependents) with health benefits no
less favorable than the group health plan benefits provided during such
period to any senior executive officer of the Company or any affiliated
company (to the extent any such coverage or benefits are taxable to
Executive by reason of being provided under a self-insured health plan of
the Company or an affiliate, the Company shall make Executive "whole" for
the same on an after-tax basis). In any event, the Other Benefits provided
for pursuant to this Paragraph shall be secondary to any benefits and
coverage Executive (or his dependents) receive from another employer.
(4) If any such Termination occurs on or after October 1 of any
year, such cash and/or stock bonus that Executive otherwise would have
received if such Termination had not taken place.
(5) If Executive receives any payments whether or not pursuant
to this Agreement which are subject to an excise tax imposed under
Section 4999 of the Internal Revenue Code of 1986, as amended, or any
similar tax imposed under federal, state, or local law (collectively,
"Excise Taxes"), the Company shall pay to Executive (on or before the date
on which the Company is required to withhold such Excise Taxes), 1) an
additional amount equal to all Excise Taxes then due and payable, and
2) the amount necessary to defray Executive's increased (federal, state,
and local) tax liability arising due to payment of the amount specified in
this Subsection (5) which shall include any costs and expenses, including
penalties and interest incurred by Executive in connection with any audit,
proceedings, etc. related to the payment of such Excise Taxes or this
payment. For purposes of calculating the amount payable to Executive under
this
EMPLOYMENT AGREEMENT - Page 7
<PAGE>
Paragraph, the federal and state income tax rates used shall be the
highest marginal federal and state rates applicable to ordinary income in
Executive's state of residence, taking into account any federal income tax
deductions or credits available to Executive for state income taxes. The
Company shall cause its independent auditors to calculate such amount and
provide Executive a copy of such calculation at least ten (10) days prior
to the date specified above for payment of such amount. It is the intent
of the Parties that this Subsection (5) shall place Executive in the same
net after-tax position Executive would have been in had no payment been
subject to an Excise Tax and, notwithstanding anything herein to the
contrary, it shall be construed to effectuate said result.
(6) All accrued compensation and unreimbursed expenses through
the Termination Date. Such amounts shall be paid to Executive in a lump
sum in cash within thirty (30) days after the Termination Date; and
(7) Executive shall be free to accept other employment during
such period, and there shall be no offset of any employment compensation
earned by Executive in such other employment during such period against
payments due Executive under this Paragraph (4), and there shall be no
offset in any compensation received from such other employment against the
Base Salary set forth above.
(c) TERMINATION IN EVENT OF DEATH: BENEFITS. If Executive's
employment is terminated by reason of Executive's death during the Basic
Term, this Agreement shall terminate without further obligation to
Executive's legal representatives under this Agreement, other than for
payment of all accrued compensation, unreimbursed expenses, the timely
payment or provision of Other Benefits through the date of death, and, if
such death occurs on or after October 1 of any year, such cash or stock bonus
as Executive would otherwise have been awarded in such year if Executive's
death had not occurred. Such amounts shall be paid to Executive's estate or
beneficiary, as applicable, in a lump sum in cash within ninety (90) days
after the date of death. With respect to the provision of Other Benefits,
the term Other Benefits as used in this Paragraph 4(c) shall include, without
limitation, and Executive's estate and/or beneficiaries shall be entitled to
receive, benefits at least equal to the most favorable benefits provided by
the Company to the estates and beneficiaries of other executive level
employees of the Company under such plans, programs, practices, and policies
relating to death benefits, if any, as in effect with respect to other
executives and their beneficiaries at any time during the 120-day period
immediately preceding the date of death. Additionally, all Stock Awards for
which Executive would have been eligible had he completed the Basic Term
(except as set forth in Paragraph 4(b)(2)), shall be accelerated, and
Executive's estate or beneficiary shall be vested in such Stock Awards as of
the date of Executive's termination.
(d) TERMINATION IN EVENT OF DISABILITY: BENEFITS. If Executive's
employment is terminated by reason of Executive's Disability during the Basic
Term, this Agreement shall continue in full force for a period of one (1)
year following such Disability and if such Disability occurs on or after
October 1 of any year Executive shall be entitled to the same cash or stock
bonus in such year that Executive would have been awarded if such Disability
had not occurred. Following such one (1) year period, this Agreement shall
continue in full force except that (a) the Base Salary shall be reduced by
50% and (b) Executive shall not be entitled to
EMPLOYMENT AGREEMENT - Page 8
<PAGE>
any subsequent cash or stock bonuses. In addition, all outstanding Stock
Awards shall vest immediately upon such termination due to Disability.
(e) VOLUNTARY TERMINATION BY EMPLOYEE AND TERMINATION FOR CAUSE:
BENEFITS. Executive may terminate his employment with the Company without
Good Reason by giving written notice of his intent and stating an effective
Termination Date at least ninety (90) days after the date of such notice;
provided, however, that the Company may accelerate such effective date by
paying Executive through the proposed Termination Date and also vesting
awards that would have vested but for this acceleration of the proposed
Termination Date. Upon such a termination by Executive, except as provided in
Paragraph 3(a), or upon termination for Cause by the Company, this Agreement
shall terminate, and the Company shall pay to Executive all accrued
compensation, unreimbursed expenses and the Other Benefits through the
Termination Date. Such amounts shall be paid to Executive in a lump sum in
cash within thirty (30) days after the date of termination.
(f) DIRECTOR POSITIONS. Executive agrees that upon termination of
employment, for any reason, at the request of the Chairman of the Board,
Executive will immediately tender his resignation from any and all Board
positions held with the Company and/or any of its subsidiaries and
affiliates. If Executive remains as a director, after such termination,
Executive shall be compensated as an outside director.
5. NON-COMPETITION, NON-SOLICITATION, AND CONFIDENTIALITY. Executive
recognizes and agrees that the benefit of not being employed at-will, is
provided in consideration for, among other things, the agreements contained
in this Section as well as the Stock Options granted to Executive pursuant to
this Agreement. The Company agrees that while employed pursuant to this
Agreement, Executive will be provided with confidential information of
Company; specialized training on how to perform his duties; and contact with
the Company's customers and potential customers. Furthermore, in the event
Executive is terminated without Cause, or terminates for Good Reason; and
more than one (1) year remains on the existing Basic Term, then Executive
shall receive additional consideration in an amount equal to the quotient of
the Base Salary divided by 12, which shall thereupon be multiplied by the
number of months remaining in the Basic Term minus 12 months, and which shall
be paid in one lump sum within ten (10) days of such termination.
In consideration of all of the foregoing, Executive agrees as follows:
(a) NON-COMPETITION DURING EMPLOYMENT. Executive agrees during
the Basic Term he will not compete with the Company by engaging in the
conception, design, development, production, marketing, or servicing of any
product or service that is substantially similar to the products or services
which the Company provides, and that he will not work for, in any capacity,
assist, or become affiliated with as an owner, partner, etc., either directly
or indirectly, any individual or business which offers or performs services,
or offers or provides products substantially similar to the services and
products provided by Company, provided, Executive shall not be prevented from
owning no more than 2% of any Company whose stock is publicly traded.
EMPLOYMENT AGREEMENT - Page 9
<PAGE>
(b) CONFLICTS OF INTEREST. Executive agrees that during the Basic
Term, he will not engage, either directly or indirectly, in any activity (a
"Conflict of Interest") which might adversely affect the Company or its
affiliates, including ownership of a material interest in any supplier,
contractor, distributor, subcontractor, customer or other entity with which
the Company does business or accepting any material payment, service, loan,
gift, trip, entertainment, or other favor from a supplier, contractor,
distributor, subcontractor, customer or other entity with which the Company
does business, and that Executive will promptly inform the Chairman of the
Company as to each offer received by Executive to engage in any such
activity. Executive further agrees to disclose to the Company any other
facts of which Executive becomes aware which might in Executive's good faith
judgment reasonably be expected to involve or give rise to a Conflict of
Interest or potential Conflict of Interest.
(c) NON-COMPETITION AFTER TERMINATION. Executive agrees that
Executive shall not, at any time during the period of two (2) years after the
termination of the Basic Term for any reason, within any of the markets in
which the Company has sold products or services or formulated a plan to sell
products or services into a market during the last twelve (12) months of
Executive's employ or which the Company enters into within three (3) months
thereafter, engage in or contribute Executive's knowledge to any work which
is competitive with or similar to a product, process, apparatus, service, or
development on which Executive worked or with respect to which Executive had
access to Confidential Information while employed by the Company; provided,
however, this Paragraph (c) shall not operate to prevent Executive from
engaging in retail insurance or re-insurance activities during such two-year
period to the extent such activities do not compete or permit any other
person or entity to compete with any business the Company or any of its
subsidiaries or affiliated companies were engaged in at the time of such
termination or which the Company enters into within three (3) months
thereafter. Following the expiration of said two (2) year period, Executive
shall continue to be obligated under the Confidential Information Paragraph
of this Agreement not to use or to disclose Confidential Information of the
Company so long as it shall not be publicly available. It is understood that
the geographical area set forth in this covenant is divisible so that if this
clause is invalid or unenforceable in an included geographic area, that area
is severable and the clause remains in effect for the remaining included
geographic areas in which the clause is valid.
(d) NON-SOLICITATION OF CUSTOMERS. Executive further agrees that
for a period of two (2) years after the termination of the Basic Term, he
will not solicit or accept any business from any customer or client or
prospective customer or client with whom Executive dealt or solicited while
employed by Company during the last twelve (12) months of his employment.
(e) NON-SOLICITATION OF EMPLOYEES. Executive agrees that for the
duration of the Basic Term, and for a period of two (2) years after the
termination of the Basic Term, he will not either directly or indirectly, on
his own behalf or on behalf of others, solicit, attempt to hire, or hire any
person employed by Company to work for Executive or for another entity, firm,
corporation, or individual.
(f) CONFIDENTIAL INFORMATION. Executive further agrees that he
will not, except as the Company may otherwise consent or direct in writing,
reveal or disclose, sell, use,
EMPLOYMENT AGREEMENT - Page 10
<PAGE>
lecture upon, publish or otherwise disclose to any third party any
Confidential Information or proprietary information of the Company, or
authorize anyone else to do these things at any time either during or
subsequent to his employment with the Company. This Section shall continue
in full force and effect after termination of Executive's employment and
after the termination of this Agreement. Executive's obligations under this
Paragraph with respect to any specific Confidential Information and
proprietary information shall cease when that specific portion of the
Confidential Information and proprietary information becomes publicly known,
in its entirety and without combining portions of such information obtained
separately. It is understood that such Confidential Information and
proprietary information of the Company include matters that Executive
conceives or develops, as well as matters Executive learns from other
employees of Company. Confidential Information is defined to include
information: (1) disclosed to or known by the Executive as a consequence of
or through his employment with the Company; (2) not generally known outside
the Company; and (3) which relates to any aspect of the Company or its
business, finances, operation plans, budgets, research, or strategic
development. "Confidential Information" includes, but is not limited to the
Company's trade secrets, proprietary information, financial documents, long
range plans, customer lists, employer compensation, marketing strategy, data
bases, costing data, computer software developed by the Company, investments
made by the Company, and any information provided to the Company by a third
party under restrictions against disclosure or use by the Company or others.
(g) RETURN OF DOCUMENTS, EQUIPMENT, ETC. All writings, records,
and other documents and things comprising, containing, describing,
discussing, explaining, or evidencing any Confidential Information, and all
equipment, components, parts, tools, and the like in Executive's custody or
possession that have been obtained or prepared in the course of Executive's
employment with the Company shall be the exclusive property of the Company,
shall not be copied and/or removed from the premises of the Company, except
in pursuit of the business of the Company, and shall be delivered to the
Company, without Executive retaining any copies, upon notification of the
termination of Executive's employment or at any other time requested by the
Company. The Company shall have the right to retain, access, and inspect all
property of Executive of any kind in the office, work area, and on the
premises of the Company upon termination of Executive's employment and at any
time during employment by the Company to ensure compliance with the terms of
this Agreement.
(h) REAFFIRM OBLIGATIONS. Upon termination of his employment with
the Company, Executive, if requested by Company, shall reaffirm in writing
Executive's recognition of the importance of maintaining the confidentiality
of the Company's Confidential Information and proprietary information, and
reaffirm any other obligations set forth in this Agreement.
(i) PRIOR DISCLOSURE. Executive represents and warrants that he
has not used or disclosed any Confidential Information he may have obtained
from Company prior to signing this Agreement, in any way inconsistent with
the provisions of this Agreement.
(j) CONFIDENTIAL INFORMATION OF PRIOR COMPANIES. Executive will
not disclose or use during the period of his employment with the Company any
proprietary or Confidential Information or Copyright Works which Executive
may have acquired because of employment with an employer other than the
Company or acquired from any other third party,
EMPLOYMENT AGREEMENT - Page 11
<PAGE>
whether such information is in Executive's memory or embodied in a writing or
other physical form.
(k) BREACH. Executive agrees that any breach of Paragraphs 5(a),
(c), (d), (e) or (f) above cannot be remedied solely by money damages, and
that in addition to any other remedies Company may have, Company is entitled
to obtain injunctive relief against Executive. Nothing herein, however,
shall be construed as limiting Company's right to pursue any other available
remedy at law or in equity, including recovery of damages and termination of
this Agreement and/or any payments that may be due pursuant to this Agreement.
(l) RIGHT TO ENTER AGREEMENT. Executive represents and covenants
to Company that he has full power and authority to enter into this Agreement
and that the execution of this Agreement will not breach or constitute a
default of any other agreement or contract to which he is a party or by which
he is bound.
(m) EXTENSION OF POST-EMPLOYMENT RESTRICTIONS. In the event
Executive breaches Paragraphs 5(b), (d), or (e) above, the restrictive time
periods contained in those provisions will be extended by the period of time
Executive was in violation of such provisions.
(n) ENFORCEABILITY. The agreements contained in Section 5 are
independent of the other agreements contained herein. Accordingly, failure
of the Company to comply with any of its obligations outside of this
Paragraph do not excuse Executive from complying with the agreements
contained herein.
(o) SURVIVABILITY. The agreements contained in Paragraphs
5(c)-(g) shall survive the termination of this Agreement for any reason.
6. ASSIGNMENT. This Agreement cannot be assigned by Executive. The
Company may assign this Agreement only to a successor (whether direct or
indirect, by purchase, merger, consolidation or otherwise) to all or
substantially all of the business and assets of the Company provided such
successor expressly agrees in writing reasonably satisfactory to Executive to
assume and perform this Agreement in the same manner and to the same extent
that the Company would be required to perform it if no such succession and
assignment had taken place. Failure of the Company to obtain such written
agreement prior to the effectiveness of any such succession shall be a
material breach of this Agreement.
7. BINDING AGREEMENT. Executive understands that his obligations
under this Agreement are binding upon Executive's heirs, successors, personal
representatives, and legal representatives.
8. NOTICES. All notices pursuant to this Agreement shall be in
writing and sent certified mail, return receipt requested, addressed as set
forth below, or by delivering the same in person to such party, or by
transmission by facsimile to the number set forth below (which shall not
constitute notice). Notice deposited in the United States Mail, mailed in the
manner described hereinabove, shall be effective upon deposit. Notice given
in any other manner shall be effective only if and when received:
EMPLOYMENT AGREEMENT - Page 12
<PAGE>
If to Executive: Frank J. Bramanti
13707 Cottrell Court
Houston, TX 77077
Fax: (281) 558-5461
If to Company: HCC Insurance Holdings, Inc.
13403 Northwest Freeway
Houston, Texas 77040
Fax: (713) 462-2401
with a copy (which shall Arthur S. Berner, Esq.
not constitute notice) to: Winstead Sechrest & Minick P.C.
Suite 2400
910 Travis Street
Houston, Texas 77002-5895
Fax: (713) 650-2400
9. WAIVER. No waiver by either party to this Agreement of any right
to enforce any term or condition of this Agreement, or of any breach hereof,
shall be deemed a waiver of such right in the future or of any other right or
remedy available under this Agreement.
10. SEVERABILITY. If any provision of this Agreement is determined to
be void, invalid, unenforceable, or against public policy, such provisions
shall be deemed severable from the Agreement, and the remaining provisions of
the Agreement will remain unaffected and in full force and effect.
11. ARBITRATION. In the event any dispute arises out of Executive's
employment with or by the Company, or separation/termination therefrom,
whether as an employee or as a consultant which cannot be resolved by the
Parties to this Agreement, such dispute shall be submitted to final and
binding arbitration. The arbitration shall be conducted in accordance with
the National Rules for the resolution of Employment Disputes of the American
Arbitration Association ("AAA"). If the Parties cannot agree on an
arbitrator, a list of seven (7) arbitrators will be requested from AAA, and
the arbitrator will be selected using alternate strikes with Executive
striking first. The cost of the arbitration will be shared equally by
Executive and Company; provided, however, the Company shall promptly
reimburse Executive for all costs and expenses incurred in connection with
any dispute in an amount up to, but not exceeding twenty percent (20%) of
Executive's Base Salary (or, if the dispute arises during the Consulting
Period, Executive's Base Salary as in effect immediately prior to the
beginning of the Consulting Period) unless such termination was for Cause in
which event Executive shall not be entitled to reimbursement unless and until
it is determined he was terminated other than for Cause. Arbitration of such
disputes is mandatory and in lieu of any and all civil causes of action and
lawsuits either party may have against the other arising out of Executive's
employment with Company, or separation therefrom. Such arbitration shall be
held in Houston, Texas.
12. ENTIRE AGREEMENT. The terms and provisions contained herein shall
constitute
EMPLOYMENT AGREEMENT - Page 13
<PAGE>
the entire agreement between the parties with respect to Executive's
employment with Company during the time period covered by this Agreement.
This Agreement replaces and supersedes any and all existing Agreements
entered into between Executive and the Company relating generally to the same
subject matter, if any, and shall be binding upon Executive's heirs,
executors, administrators, or other legal representatives or assigns.
13. MODIFICATION OF AGREEMENT. This Agreement may not be changed or
modified or released or discharged or abandoned or otherwise terminated, in
whole or in part, except by an instrument in writing signed by the Executive
and an officer or other authorized executive of Company.
14. UNDERSTAND AGREEMENT. Executive represents and warrants that he
has read and understood each and every provision of this Agreement, and
Executive understands that he has the right to obtain advice from legal
counsel of choice, if necessary and desired, in order to interpret any and
all provisions of this Agreement, and that Executive has freely and
voluntarily entered into this Agreement.
15. GOVERNING LAW. This Agreement shall be governed by and construed
in accordance with the laws of the State of Texas.
16. JURISDICTION AND VENUE. With respect to any litigation regarding
this Agreement, Executive agrees to venue in the state or federal courts in
Harris County, Texas, and agrees to waive and does hereby waive any defenses
and/or arguments based upon improper venue and/or lack of personal
jurisdiction. By entering into this Agreement, Executive agrees to personal
jurisdiction in the state and federal courts in Harris County, Texas.
IN WITNESS WHEREOF, the Parties have executed this Agreement in multiple
copies, effective as of the date first written above.
EXECUTIVE COMPANY
HCC INSURANCE HOLDINGS, INC.
/s/ Frank J. Bramanti By: /s/ Stephen L. Way
- ------------------------------- ------------------------------------
FRANK J. BRAMANTI STEPHEN L. WAY
Chief Executive Officer and
Chairman of the Board
Dated: 1/23/98 Dated: 1/23/98
------------------------- ---------------------------------
EMPLOYMENT AGREEMENT - Page 14
<PAGE>
EMPLOYMENT AGREEMENT
This Employment Agreement ("Agreement") is entered into effective as of
the 1st day of January, 1998 (the "Effective Date"), between HCC INSURANCE
HOLDINGS, INC. ("HCC" or "Company"), and PETER B. SMITH, JR. ("Executive"),
sometimes collectively referred to herein as the "Parties."
R E C I T A L S:
WHEREAS, Executive is to be employed as Executive Vice President of HCC,
and as an integral part of its management who participates in the
decision-making process relative to short and long term planning and policy
for the Company, will serve on the Company's Executive Committee;
WHEREAS, it is the desire of the Board of Directors of HCC (the "Board")
to (i) directly engage Executive as an officer of HCC and its subsidiaries;
and (ii) directly engage, if elected, the services of Executive as a director
of HCC and its subsidiaries; and
WHEREAS, Executive is desirous of committing himself to serve HCC on the
terms herein provided.
NOW, THEREFORE, in consideration of the foregoing and of the respective
covenants and agreements set forth below, the Parties agree as follows:
1. TERM. The Company hereby agrees to employ Executive as an
Executive Vice President, and Executive hereby agrees to accept such
employment, on the terms and conditions set forth herein, for the period
commencing on the Effective Date and expiring as of 11:59 p.m. on December
31, 2002 (the "Basic Term") (unless sooner terminated as hereinafter set
forth).
2. DUTIES.
(a) Duties as Employee of the Company. Executive shall, subject
to the supervision of the Chief Executive Officer, President, and Board, have
general management responsibilities in the ordinary course of HCC's business
with all such powers with respect to such management as may be reasonably
incident to such responsibilities. During normal business hours, Executive
shall devote his full time and attention to diligently attending to the
business of the Company during the Basic Term. During the Basic Term,
Executive shall not directly or indirectly render any services of a business,
commercial, or professional nature to any other person, firm, corporation, or
organization, whether for compensation or otherwise, without the prior
written consent of the Chairman of the Board. However, Executive shall have
the right
EMPLOYMENT AGREEMENT - Page 1
<PAGE>
to engage in such activities as may be appropriate in order to manage his
personal investments so long as such activities do not materially interfere
or conflict with the performance of his duties to the Company hereunder. The
conduct of such activity shall not be deemed to materially interfere or
conflict with Executive's performance of his duties until Executive has been
notified in writing thereof and given a reasonable period in which to cure
the same.
(b) OTHER DUTIES. At all times during the Basic Term the Company
shall use its best efforts to cause Executive to be elected a director and to
serve on the Executive Committee and Senior Management Committee of HCC. Any
such failure to use its best efforts prior to a Change of Control shall be a
material breach of this Agreement for purposes of Paragraph 4(a)(iv). If
elected, Executive agrees to serve as a director, member of the Executive
Committee and member of the Senior Management Committee of HCC and of any of
its subsidiaries and in one or more executive offices of any of HCC's
subsidiaries, provided Executive is indemnified for serving in any and all
such capacities in a manner acceptable to the Company and Executive.
Executive will serve as President and Chief Executive Officer of Houston
Casualty Company, U.S. Specialty Insurance Company and Trafalgar Insurance
Company and as Chairman of Avemco Insurance Company. If elected, Executive
agrees that he shall not be entitled to receive any compensation for serving
as a director of HCC or in any capacities of HCC's subsidiaries other than
the compensation to be paid to Executive by the Company pursuant to this
Agreement.
3. COMPENSATION AND RELATED MATTERS.
(a) BASE SALARY. Executive shall receive a base salary paid by
the Company at the annual rate of $325,000, during the period beginning on
the Effective Date payable not less frequently than in substantially equal
monthly installments. Such Base Salary shall increase $25,000 each January 1,
commencing January 1, 1999 until Executive's base salary reaches $425,000.
For purposes of this Agreement, "Base Salary" shall mean the Executive's
initial base salary and, when increased, the increased base salary.
(b) BONUS PAYMENTS. Each year, Executive shall be entitled to
receive, in addition to the Base Salary, an annual bonus payment based on
HCC's annual operating earnings per share ("OEPS"), as set forth below:
$37,500 bonus if OEPS growth is 10% or more in any one year period;
$75,000 bonus if OEPS growth is 15% or more in any one year period;
and
$150,000 bonus if OEPS growth is 20% or more in any one year period.
For purposes of this Agreement, OEPS is defined as HCC's consolidated net
earnings less capital
EMPLOYMENT AGREEMENT - Page 2
<PAGE>
gains/losses, currency gains/losses, and any nonrecurring merger and
acquisition income or expenses as reported in HCC's Annual Report on Form
10-K.
(c) STOCK OPTIONS. In addition to stock options previously
granted to Executive, in partial consideration for Executive's
non-competition agreements, set forth herein, effective December 31, 1998,
Executive shall be provided with additional options to purchase HCC shares as
follows:
(1) On January 7, 1998, an option to acquire 100,000 shares,
exercisable at a price of $16.50 per share and vesting at 20% per year
beginning on December 31, 1998 and for each of the four years thereafter;
(2) For each year beginning with the year ending December 31,
1999, of Executive's employment hereunder;
10,000 shares if, on such December 31, the price of the HCC Common
Stock has increased since the previous January 1, by an amount that
is greater than or equal to 10%, but less than 15%;
15,000 shares if, on such December 31, the price of the HCC Common
Stock has increased since the previous January 1, by an amount that
is greater than or equal to 15%, but less than 20%;
20,000 shares if, on such December 31, the price of the HCC Common
Stock has increased since the previous January 1, by an amount that
is greater than or equal to 20%, but less than 25%; and
25,000 shares if, on such December 31, the price of the HCC Common
Stock has increased since the previous January 1, by an amount that
is greater than or equal to 25%.
Each of such options set forth in this subparagraph (ii) shall be
priced at the average of the closing prices of HCC shares for the
month of December of the year of the grant and shall vest
immediately. For purposes of this Subparagraph, the granting of
any option shall not be pro-rated if the criteria set forth herein
are not achieved in full.
(d) EXPENSES. During the Basic Term, Executive shall be
entitled to receive prompt reimbursement for all reasonable expenses incurred
by him in accordance with the policies and procedures established by the
Compensation Committee for the Company's senior executive officers in
performing services hereunder, provided that Executive properly accounts
therefor in accordance with Company policy.
(e) OTHER BENEFITS. Executive shall be entitled to participate
in or receive
EMPLOYMENT AGREEMENT - Page 3
<PAGE>
benefits under any compensatory employee benefit plan or other arrangement
made available by the Company now or in the future to its senior executive
officers, subject to and on a basis consistent with the terms, conditions,
and overall administration of such plan or arrangement. Nothing paid to
Executive under any plan or arrangement presently in effect or made available
in the future shall be deemed to be in lieu of the Base Salary payable to
Executive pursuant to Paragraph (a) of this Section. The Company shall not
make any changes in any employee benefit plans or other arrangements in
effect on the date hereof or subsequently in effect in which Executive
currently or in the future participates (including, without limitation, each
pension and retirement plan, supplemental pension and retirement plan,
savings and profit sharing plan, stock or unit ownership plan, stock or unit
purchase plan, stock or unit option plan, life insurance plan, medical
insurance plan, disability plan, dental plan, health and accident plan, or
any other similar plan or arrangement) that would adversely affect
Executive's rights or benefits thereunder, unless such change occurs pursuant
to a program applicable to substantially all executives of the Company and
does not result in a proportionately greater reduction in the rights of or
benefits to Executive as compared with any other executive of the Company.
(f) VACATIONS. Executive shall be entitled to twenty five (25)
paid vacation days per year during the Basic Term. There shall be no
carryover of unused vacation from year to year. For purposes of this
Paragraph, weekends shall not count as vacation days, and Executive shall
also be entitled to all paid holidays and personal days given by the Company
to its senior executive officers.
(g) PERQUISITES. Executive shall be entitled to receive the
perquisites and fringe benefits appertaining to an executive officer of HCC
in accordance with any practice established by the Compensation Committee.
Notwithstanding, and in addition to, any perquisites to which Executive is
entitled pursuant to the preceding sentence, Executive shall: (i) have use
of a 1998 Mercedes SEL automobile, and the Company shall pay all expenses
related to Executive's use of such car, including gasoline, insurance, and
maintenance; (ii) be allowed to travel on business utilizing first class
passage (whether domestic or international); (iii) receive annual club dues
for the Houston City Club, the Country Club of Fairfield, and Lochinvar Golf
Club; and (iv) receive a total of $1,000,000 term life insurance (which shall
be an addition to the standard benefits provided to Executive under the
Company's group life insurance program that covers officers).
(h) PRORATION. Any payments or benefits payable to Executive
hereunder in respect of any calendar year during which Executive is employed
by the Company for less than the entire year, unless otherwise provided in
the applicable plan or arrangement, shall be prorated in accordance with the
number of days in such calendar year during which he is so employed.
Notwithstanding the foregoing, any payments pursuant to Paragraphs 4(c) or
4(d) of this Agreement shall not be subject to proration.
5. TERMINATION.
(a) DEFINITIONS.
EMPLOYMENT AGREEMENT - Page 4
<PAGE>
(1) "CAUSE" shall mean:
(i) Material dishonesty which is not the result of an
inadvertent or innocent mistake of Executive with respect to the Company or
any of its subsidiaries;
(ii) Willful misfeasance or nonfeasance of material duty
by Executive intended to injure or having the effect of injuring in some
material fashion the reputation, business, or business relationships of the
Company or any of its subsidiaries or any of their respective officers,
directors, or employees;
(iii) Material violation by Executive of any material term
of this Agreement; or
(iv) Conviction of Executive of any felony, any crime
involving moral turpitude or any crime other than a vehicular offense which
could reflect in some material fashion unfavorably upon the Company or any of
its subsidiaries.
Executive may not be terminated for Cause unless and until there has been
delivered to Executive written notice from the Board supplying the
particulars of Executive's acts or omissions that the Board believes
constitute Cause, a reasonable period of time (not less than 30 days) has
been given to Executive after such notice to either cure the same or to meet
with the Board, with his attorney if so desired by Executive, and following
which the Board by action of not less than two-thirds of its members
furnishes to Executive a written resolution specifying in detail its findings
that Executive has been terminated for Cause as of the date set forth in the
notice to Executive.
(2) A "CHANGE OF CONTROL" shall be deemed to have occurred if:
(i) Any "person" or "group" (within the meaning of
Sections 13(d) and 14(d)(2) of the Securities Exchange Act of 1934) other
than a trustee or other fiduciary holding securities under an employee
benefit plan of the Company becomes the "beneficial owner" (as defined in
Rule 13d-3 under the Securities Exchange Act of 1934), directly or
indirectly, of 50% or more of the Company's then outstanding voting common
stock; or
(ii) At any time during the period of three (3)
consecutive years (not including any period prior to the date hereof),
individuals who at the beginning of such period constituted the Board (and
any new director whose election by the Board or whose nomination for election
by the Company's shareholders were approved by a vote of at least two-thirds
of the directors then still in office who either were directors at the
beginning of such period or whose election or nomination for election was
previously so approved) cease for any reason to constitute a majority
thereof; or
EMPLOYMENT AGREEMENT - Page 5
<PAGE>
(iii) The shareholders of the Company approve a merger or
consolidation of the Company with any other corporation, other than a merger
or consolidation (a) in which a majority of the directors of the surviving
entity were directors of the Company prior to such consolidation or merger,
and (b) which would result in the voting securities of the Company
outstanding immediately prior thereto continuing to represent (either by
remaining outstanding or by being changed into voting securities of the
surviving entity) more than 50% of the combined voting power of the voting
securities of the surviving entity outstanding immediately after such merger
or consolidation; or
(iv) The shareholders approve a plan of complete
liquidation of the Company or an agreement for the sale or disposition by the
Company of all or substantially all of the Company's assets.
(3) A "DISABILITY" shall mean the absence of Executive from
Executive's duties with the Company on a full-time basis for 180 consecutive
days, or 180 days in a 365 day period, as a result of incapacity due to
mental or physical illness which results in the Executive being unable to
perform the essential functions of his position, with or without reasonable
accommodation.
(4) A "GOOD REASON" shall mean any of the following (without
Executive's express written consent):
(i) Following a Change of Control, a material alteration
in the nature or status of Executive's title, duties or responsibilities,
or the assignment of duties or responsibilities inconsistent with
Executive's status, title, duties and responsibilities;
(ii) A failure by the Company to continue in effect any
employee benefit plan in which Executive was participating, or the taking
of any action by the Company that would adversely affect Executive's
participation in, or materially reduce Executive's benefits under, any such
employee benefit plan, unless such failure or such taking of any action
adversely affects the senior members of corporate management of the Company
generally to the same extent;
(iii) A relocation of the Company's principal executive
offices, or Executive's relocation to any place other than the principal
executive offices, exceeding a distance of fifty (50) miles from the
Company's current executive office located in Houston, Texas, except for
reasonably required travel by Executive on the Company's business;
(iv) Any material breach by the Company of any provision
of this Agreement; or
(v) Any failure by the Company to obtain the assumption
and
EMPLOYMENT AGREEMENT - Page 6
<PAGE>
performance of this Agreement by any successor (by merger, consolidation,
or otherwise) or assign of the Company.
However, Good Reason shall exist with respect to an above specified matter
only if such matter is not corrected by the Company within thirty (30) days
of its receipt of written notice of such matter from Executive, and in no
event shall a termination by Executive occurring more than ninety (90) days
following the date of the event described above be a termination for Good
Reason due to such event.
(5) "TERMINATION DATE" shall mean the date Executive is
terminated for any reason pursuant to this Agreement.
(b) TERMINATION WITHOUT CAUSE OR FOR GOOD REASON: BENEFITS. In
the event there is a termination by the Company without Cause, or if
Executive terminates for Good Reason (a "Termination Event"), this Agreement
shall terminate and Executive shall be entitled to the following severance
benefits:
(1) For a period of twelve (12) months after the Termination
Date (unless the remainder of the Basic Term is less than twelve (12)
months, in which case, for an amount of time equal to the remainder of the
Basic Term), Base Salary (as defined in Paragraph 3(a), at the rate, and
payable quarterly unless such termination is by the Company without Cause,
in which event such amount of Base Salary shall be paid in a lump sum
within ten (10) days of the Termination Event.
(2) If there is a Change of Control or if there is a
termination by the Company without Cause or by Executive for Good Reason,
any stock options and other stock-related grants ("Stock Awards") which
Executive has received under any of the HCC stock plans shall vest
immediately; provided, however, that the right to receive options
referenced in Paragraph 3(c)(2) above shall terminate upon termination from
employment for any reason, and further, if there is a termination for Good
Reason, or by the Company other than for Cause, all options shall be
exercisable for one year or the remainder of their term, whichever is less.
(3) To the extent not theretofore paid or provided, the
Company shall timely pay or provide to Executive any other amounts or
benefits required to be paid or provided or which Executive is eligible to
receive under any plan, program, policy or practice, or contract or
agreement of the Company and its affiliated companies for the period of time
equal to the remainder of the Basic Term (such other amounts and benefits
shall be hereinafter referred to as the "Other Benefits"). Without
limiting the preceding sentence, through December 31, 2002 the Company, at
its sole expense, shall continue to provide (through its own plan and/or
individual policies) Executive (and Executive's dependents) with health
benefits no less favorable than the group health plan benefits provided
during such period to any senior executive officer of the Company or any
affiliated company (to the extent any such coverage or benefits are taxable
to Executive
EMPLOYMENT AGREEMENT - Page 7
<PAGE>
by reason of being provided under a self-insured health plan of the Company
or an affiliate, the Company shall make Executive "whole" for the same on
an after-tax basis). In any event the Other Benefits provided for pursuant
to this Paragraph shall be secondary to any benefits and coverage Executive
(or his dependents) receive from another employer.
(4) If Executive receives any payments whether or not pursuant
to this Agreement which are subject to an excise tax imposed under Section
4999 of the Internal Revenue Code of 1986, as amended, or any similar tax
imposed under federal, state, or local law (collectively, "Excise Taxes"),
the Company shall pay to Executive (on or before the date on which the
Company is required to withhold such Excise Taxes), 1) an additional amount
equal to all Excise Taxes then due and payable, and 2) the amount necessary
to defray Executive's increased (federal, state, and local) tax liability
arising due to payment of the amount specified in this Subsection (4) which
shall include any costs and expenses, including penalties and interest
incurred by Executive in connection with any audit, proceedings, etc.
related to the payment of such Excise Taxes or this payment. For purposes
of calculating the amount payable to Executive under this Paragraph, the
federal and state income tax rates used shall be the highest marginal
federal and state rates applicable to ordinary income in Executive's state
of residence, taking into account any federal income tax deductions or
credits available to Executive for state income taxes. The Company shall
cause its independent auditors to calculate such amount and provide
Executive a copy of such calculation at least ten (10) days prior to the
date specified above for payment of such amount. It is the intent of the
Parties that this Subsection (4) shall place Executive in the same net
after-tax position Executive would have been in had no payment been subject
to an Excise Tax and, notwithstanding anything herein to the contrary, it
shall be construed to effectuate said result;
(5) All accrued compensation and unreimbursed expenses through
the Termination Date. Such amounts shall be paid to Executive in a lump
sum in cash within thirty (30) days after the Termination Date; and
(6) Executive shall be free to accept other employment during
such period, and there shall be no offset of any employment compensation
earned by Executive in such other employment during such period against
payments due Executive under this Paragraph (4) and there shall be not
offset in any compensation received from such other employment against the
Base Salary set forth above.
(c) TERMINATION IN EVENT OF DEATH: BENEFITS. If Executive's
employment is terminated by reason of Executive's death during the Basic
Term, this Agreement shall terminate without further obligation to
Executive's legal representatives under this Agreement, other than for
payment of all accrued compensation, unreimbursed expenses, the timely
payment or provision of Other Benefits through the date of death, and, if
such death occurs on or after October 1 of any year, such cash or stock bonus
as Executive would otherwise have been awarded in such year if Executive's
death had not occurred. Such amounts shall be paid to
EMPLOYMENT AGREEMENT - Page 8
<PAGE>
Executive's estate or beneficiary, as applicable, in a lump sum in cash
within ninety (90) days after the date of death. With respect to the
provision of Other Benefits, the term Other Benefits as used in this
Paragraph 4(c) shall include, without limitation, and Executive's estate
and/or beneficiaries shall be entitled to receive, benefits at least equal to
the most favorable benefits provided by the Company to the estates and
beneficiaries of other executive level employees of the Company under such
plans, programs, practices, and policies relating to death benefits, if any,
as in effect with respect to other executives and their beneficiaries at any
time during the 120-day period immediately preceding the date of death.
Additionally, all Stock Awards for which Executive would have been eligible
had he completed the Basic Term (except as set forth in Paragraph 4(b)(2)),
shall be accelerated, and Executive's estate or beneficiary shall be vested
in such Stock Awards as of the date of Executive's termination.
(d) TERMINATION IN EVENT OF DISABILITY: BENEFITS. If
Executive's employment is terminated by reason of Executive's Disability
during the Basic Term, this Agreement shall continue in full force for a
period of one (1) year following such Disability and if such Disability
occurs on or after October 1 of any year Executive shall be entitled to the
same cash or stock bonus in such year that Executive would have been awarded
if such Disability had not occurred. Following such one (1) year period, this
Agreement shall continue in full force except that (a) the Base Salary shall
be reduced by 50% and (b) Executive shall not be entitled to any subsequent
cash or stock bonuses. In addition, all outstanding Stock Awards shall vest
immediately upon such termination due to Disability.
(e) VOLUNTARY TERMINATION BY EMPLOYEE AND TERMINATION FOR CAUSE:
BENEFITS. Executive may terminate his employment with the Company without
Good Reason by giving written notice of his intent and stating an effective
Termination Date at least ninety (90) days after the date of such notice;
provided, however, that the Company may accelerate such effective date by
paying Executive through the proposed Termination Date and also vesting
awards that would have vested but for this acceleration of the proposed
Termination Date. Upon such a termination by Executive or upon termination
for Cause by the Company, this Agreement shall terminate, and the Company
shall pay to Executive all accrued compensation, unreimbursed expenses and
the Other Benefits through the Termination Date. Such amounts shall be paid
to Executive in a lump sum in cash within thirty (30) days after the date of
termination.
(f) DIRECTOR POSITIONS. Executive agrees that upon termination
of employment, for any reason, at the request of the Chairman of the Board,
he will immediately tender his resignation from any and all Board positions
held with the Company and/or any of its subsidiaries and affiliates.
6. NON-COMPETITION, NON-SOLICITATION, AND CONFIDENTIALITY. Executive
recognizes and agrees that the benefit of not being employed at-will, is
provided in consideration for, among other things, the agreements contained
in this Section as well as the Stock Options granted to Executive pursuant to
this Agreement. The Company agrees that while employed pursuant to this
Agreement, Executive will be provided with confidential information of
Company; specialized training on how to perform his duties; and contact with
the Company's customers and
EMPLOYMENT AGREEMENTS - Page 9
<PAGE>
potential customers. Furthermore, in the event Executive is terminated
without Cause, or terminates for Good Reason, and more than one (1) year
remains on the existing Basic Term, then Executive shall receive additional
consideration in an amount equal to the quotient of the Base Salary divided
by 12, which shall thereupon be multiplied by the number of months remaining
in the Basic Term minus 12 months, and which shall be paid in one lump sum
within ten (10) days of such termination.
In consideration of all of the foregoing, Executive agrees as follows:
(a) NON-COMPETITION DURING EMPLOYMENT. Executive agrees during
the Basic Term he will not compete with the Company by engaging in the
conception, design, development, production, marketing, or servicing of any
product or service that is substantially similar to the products or services
which the Company provides, and that he will not work for, in any capacity,
assist, or become affiliated with as an owner, partner, etc., either directly
or indirectly, any individual or business which offers or performs services,
or offers or provides products substantially similar to the services and
products provided by Company.
(b) CONFLICTS OF INTEREST. Executive agrees that during the
Basic Term, he will not engage, either directly or indirectly, in any
activity (a "Conflict of Interest") which might adversely affect the Company
or its affiliates, including ownership of a material interest in any
supplier, contractor, distributor, subcontractor, customer or other entity
with which the Company does business or accepting any material payment,
service, loan, gift, trip, entertainment, or other favor from a supplier,
contractor, distributor, subcontractor, customer or other entity with which
the Company does business, and that Executive will promptly inform the
Chairman of the Company as to each offer received by Executive to engage in
any such activity. Executive further agrees to disclose to the Company any
other facts of which Executive becomes aware which might in Executive's good
faith judgment reasonably be expected to involve or give rise to a Conflict
of Interest or potential Conflict of Interest.
(c) NON-COMPETITION AFTER TERMINATION. Executive agrees that
Executive shall not, at any time during the period of two (2) years after the
termination of the Basic Term, for any reason, within any of the markets in
which the Company has sold products or services or formulated a plan to sell
products or services into a market during the last twelve (12) months of
Executive's employ or which the Company enters into within three (3) months
thereafter, engage in or contribute Executive's knowledge to any work which
is competitive with or similar to a product, process, apparatus, service, or
development on which Executive worked or with respect to which Executive had
access to Confidential Information while employed by the Company; provided,
however, this Paragraph (c) shall not operate to prevent Executive from
engaging in retail insurance or re-insurance activities during such two-year
period to the extent such activities do not compete or permit any other
person or entity to compete with any business the Company or any of its
subsidiaries or affiliated companies were engaged in at the time of such
termination or which the Company enters into within three (3) months
thereafter. Following the expiration of said two (2) year period, Executive
shall continue to be obligated under the Confidential Information Paragraph
of this Agreement not to use or to disclose Confidential Information of
EMPLOYMENT AGREEMENT - Page 10
<PAGE>
the Company so long as it shall not be publicly available. It is understood
that the geographical area set forth in this covenant is divisible so that if
this clause is invalid or unenforceable in an included geographic area, that
area is severable and the clause remains in effect for the remaining included
geographic areas in which the clause is valid.
(d) NON-SOLICITATION OF CUSTOMERS. Executive further agrees
that for a period of two (2) years after the termination of the Basic Term,
he will not solicit or accept any business from any customer or client or
prospective customer or client with whom Executive dealt or solicited while
employed by Company during the last twelve (12) months of his employment.
(e) NON-SOLICITATION OF EMPLOYEES. Executive agrees that for
the duration of the Basic Term, and for a period of two (2) years after the
termination of the Basic Term, he will not either directly or indirectly, on
his own behalf or on behalf of others, solicit, attempt to hire, or hire any
person employed by Company to work for Executive or for another entity, firm,
corporation, or individual.
(f) CONFIDENTIAL INFORMATION. Executive further agrees that he
will not, except as the Company may otherwise consent or direct in writing,
reveal or disclose, sell, use, lecture upon, publish or otherwise disclose to
any third party any Confidential Information or proprietary information of
the Company, or authorize anyone else to do these things at any time either
during or subsequent to his employment with the Company. This Section shall
continue in full force and effect after termination of Executive's employment
and after the termination of this Agreement. Executive's obligations under
this Paragraph with respect to any specific Confidential Information and
proprietary information shall cease when that specific portion of the
Confidential Information and proprietary information becomes publicly known,
in its entirety and without combining portions of such information obtained
separately. It is understood that such Confidential Information and
proprietary information of the Company include matters that Executive
conceives or develops, as well as matters Executive learns from other
employees of Company. Confidential Information is defined to include
information: (1) disclosed to or known by the Executive as a consequence of
or through his employment with the Company; (2) not generally known outside
the Company; and (3) which relates to any aspect of the Company or its
business, finances, operation plans, budgets, research, or strategic
development. "Confidential Information" includes, but is not limited to the
Company's trade secrets, proprietary information, financial documents, long
range plans, customer lists, employer compensation, marketing strategy, data
bases, costing data, computer software developed by the Company, investments
made by the Company, and any information provided to the Company by a third
party under restrictions against disclosure or use by the Company or others.
(g) RETURN OF DOCUMENTS, EQUIPMENT, ETC. All writings, records,
and other documents and things comprising, containing, describing,
discussing, explaining, or evidencing any Confidential Information, and all
equipment, components, parts, tools, and the like in Executive's custody or
possession that have been obtained or prepared in the course of Executive's
employment with the Company shall be the exclusive property of the Company,
shall
EMPLOYMENT AGREEMENT - Page 11
<PAGE>
not be copied and/or removed from the premises of the Company, except in
pursuit of the business of the Company, and shall be delivered to the
Company, without Executive retaining any copies, upon notification of the
termination of Executive's employment or at any other time requested by the
Company. The Company shall have the right to retain, access, and inspect all
property of Executive of any kind in the office, work area, and on the
premises of the Company upon termination of Executive's employment and at any
time during employment by the Company to ensure compliance with the terms of
this Agreement.
(h) REAFFIRM OBLIGATIONS. Upon termination of his employment
with the Company, Executive, if requested by Company, shall reaffirm in
writing Executive's recognition of the importance of maintaining the
confidentiality of the Company's Confidential Information and proprietary
information, and reaffirm any other obligations set forth in this Agreement.
(i) PRIOR DISCLOSURE. Executive represents and warrants that he
has not used or disclosed any Confidential Information he may have obtained
from Company prior to signing this Agreement, in any way inconsistent with
the provisions of this Agreement.
(j) CONFIDENTIAL INFORMATION OF PRIOR COMPANIES. Executive will
not disclose or use during the period of his employment with the Company any
proprietary or Confidential Information or Copyright Works which Executive
may have acquired because of employment with an employer other than the
Company or acquired from any other third party, whether such information is
in Executive's memory or embodied in a writing or other physical form.
(k) BREACH. Executive agrees that any breach of Paragraphs
5(a), (c), (d), (e) or (f) above cannot be remedied solely by money damages,
and that in addition to any other remedies Company may have, Company is
entitled to obtain injunctive relief against Executive. Nothing herein,
however, shall be construed as limiting Company's right to pursue any other
available remedy at law or in equity, including recovery of damages and
termination of this Agreement and/or any payments that may be due pursuant to
this Agreement.
(l) RIGHT TO ENTER AGREEMENT. Executive represents and
covenants to Company that he has full power and authority to enter into this
Agreement and that the execution of this Agreement will not breach or
constitute a default of any other agreement or contract to which he is a
party or by which he is bound.
(m) EXTENSION OF POST EMPLOYMENT RESTRICTIONS. In the event
Executive breaches Paragraphs 5(b), (d), or (e) above, the restrictive time
periods contained in those provisions will be extended by the period of time
Executive was in violation of such provisions.
(n) ENFORCEABILITY. The agreements contained in Section 5 are
independent of the other agreements contained herein. Accordingly, failure
of the Company to comply with any of its obligations outside of this
Paragraph do not excuse Executive from complying with the agreements
contained herein.
EMPLOYMENT AGREEMENT - Page 12
<PAGE>
(o) SURVIVABILITY. The agreements contained in Paragraph
5(c)-(g) shall survive the termination of this Agreement for any reason.
7. ASSIGNMENT. The Company may assign this Agreement only to a
successor (whether direct or indirect, by purchase, merger, consolidation or
otherwise) to all or substantially all of the business and assets of the
Company provided such successor expressly agrees in writing reasonably
satisfactory to Executive to assume and perform this Agreement in the same
manner and to the same extent that the Company would be required to perform
it if no such succession and assignment had taken place. Failure of the
Company to obtain such written agreement prior to the effectiveness of any
such succession shall be a material breach of this Agreement.
8. BINDING AGREEMENT. Executive understands that his obligations
under this Agreement are binding upon Executive's heirs, successors, personal
representatives, and legal representatives.
9. NOTICES. All notices pursuant to this Agreement shall be in
writing and sent certified mail, return receipt requested, addressed as set
forth below, or by delivering the same in person to such party, or by
transmission by facsimile to the number set forth below (which shall not
constitute notice). Notice deposited in the United States Mail, mailed in
the manner described hereinabove, shall be effective upon deposit. Notice
given in any other manner shall be effective only if and when received:
If to Executive: Peter B. Smith, Jr.
2150 Brentwood
Houston, Texas 77019
If to Company: HCC Insurance Holdings, Inc.
13403 Northwest Freeway
Houston, Texas 77040
Fax: (713) 462-2401
with a copy (which shall Arthur S. Berner, Esq.
not constitute notice) to: Winstead Sechrest & Minick P.C.
Suite 2400
910 Travis Street
Houston, Texas 77002-5895
Fax: (713) 650-2400
10. WAIVER. No waiver by either party to this Agreement of any right
to enforce any term or condition of this Agreement, or of any breach hereof,
shall be deemed a waiver of such right in the future or of any other right or
remedy available under this Agreement.
EMPLOYMENT AGREEMENT - Page 13
<PAGE>
11. SEVERABILITY. If any provision of this Agreement is determined to
be void, invalid, unenforceable, or against public policy, such provisions
shall be deemed severable from the Agreement, and the remaining provisions of
the Agreement will remain unaffected and in full force and effect.
12. ARBITRATION. In the event any dispute arises out of Executive's
employment with the Company, or separation therefrom, which cannot be
resolved by the Parties to this Agreement, such dispute shall be submitted to
final and binding arbitration. The arbitration shall be conducted in
accordance with the National Rules for the Resolution of Employment Disputes
of the American Arbitration Association ("AAA"). If the Parties cannot agree
on an arbitrator, a list of seven (7) arbitrators will be requested from AAA,
and the arbitrator will be selected using alternate strikes with Executive
striking first. The cost of the arbitration will be shared equally by
Executive and Company; provided, however, the Company shall promptly
reimburse Executive for all costs and expenses incurred in connection with
any dispute in an amount up to, but not exceeding 20 percent of Executive's
Base Salary unless such termination was for Cause in which event Executive
shall not be entitled to reimbursement unless and until it is determined he
was terminated other than for Cause. Arbitration of such disputes is
mandatory and in lieu of any and all civil causes of action and lawsuits
either party may have against the other arising out of Executive's employment
with Company, or separation therefrom. Such arbitration shall be held in
Houston, Texas.
13. ENTIRE AGREEMENT. The terms and provisions contained herein shall
constitute the entire agreement between the parties with respect to
Executive's employment with Company during the time period covered by this
Agreement. This Agreement replaces and supersedes any and all existing
Agreements entered into between Executive and the Company relating generally
to the same subject matter, if any, and shall be binding upon Executive's
heirs, executors, administrators, or other legal representatives or assigns.
14. MODIFICATION OF AGREEMENT. This Agreement may not be changed or
modified or released or discharged or abandoned or otherwise terminated, in
whole or in part, except by an instrument in writing signed by the Executive
and an officer or other authorized executive of Company.
15. UNDERSTAND AGREEMENT. Executive represents and warrants that he
has read and understood each and every provision of this Agreement, and
Executive understands that he has the right to obtain advice from legal
counsel of choice, if necessary and desired, in order to interpret any and
all provisions of this Agreement, and that Executive has freely and
voluntarily entered into this Agreement.
16. GOVERNING LAW. This Agreement shall be governed by and construed
in accordance with the laws of the State of Texas.
17. JURISDICTION AND VENUE. With respect to any litigation regarding
this Agreement, Executive agrees to venue in the state or federal courts in
Harris County, Texas, and
EMPLOYMENT AGREEMENT - Page 14
<PAGE>
agrees to waive and does hereby waive any defenses and/or arguments based
upon improper venue and/or lack of personal jurisdiction. By entering into
this Agreement, Executive agrees to personal jurisdiction in the state and
federal courts in Harris County, Texas.
IN WITNESS WHEREOF, the Parties have executed this Agreement in multiple
copies, effective as of the date first written above.
EXECUTIVE COMPANY
HCC INSURANCE HOLDINGS, INC.
/s/ Peter B. Smith, Jr. By: /s/ Stephen L. Way
- -------------------------------- ----------------------------------
PETER B. SMITH, JR. STEPHEN L. WAY
Chief Executive Officer and
Chairman of the Board
Dated: 1/23/98 Dated: 1/23/98
-------------------------- -------------------------------
EMPLOYMENT AGREEMENT - Page 15
<PAGE>
EXHIBIT 12
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
STATEMENT OF RATIOS
<TABLE>
<CAPTION>
=======================================================================================================================
FOR THE YEARS ENDED DECEMBER 31,
(DOLLARS IN THOUSANDS)
1998 1997 1996 1995 1994
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Gross premium to surplus ratio:
Gross written premium $ 500,962 $ 346,094 $ 340,367 $ 338,753 $ 283,530
Policyholders' surplus 369,401 331,922 288,863 251,125 206,596
Premium to surplus ratio (1) 135.6% 104.3% 117.8% 134.9% 137.2%
(Gross premium to surplus ratio = gross written premium divided by policyholders' surplus)
Net premium to surplus ratio:
Net written premium $ 123,315 $ 143,068 $ 189,022 $ 184,028 $ 133,143
Policyholders' surplus 369,401 331,922 288,863 251,125 206,596
Premium to surplus ratio (1) 33.4% 43.1% 65.4% 73.3% 64.4%
(Net premium to surplus ratio = net written premium divided by policyholders' surplus)
Loss ratio:
Incurred loss and LAE $ 95,435 $ 100,158 $ 115,521 $ 106,346 $ 76,494
Net earned premium 142,108 162,626 179,490 160,145 122,393
Loss ratio (1) 67.2% 61.6% 64.4% 66.4% 62.5%
(Loss ratio = incurred loss and LAE divided by net earned premium)
Expense ratio:
Underwriting expense $ 19,417 $ 24,627 $ 36,379 $ 33,239 $ 27,137
Net written premium 123,315 143,068 189,022 184,028 133,143
Expense ratio (1) 15.7% 17.2% 19.2% 18.1% 20.4%
(Expense ratio = underwriting expense divided by net written premium)
Combined ratio (1) 82.9% 78.8% 83.6% 84.5% 82.9%
(Combined ratio = loss ratio plus expense ratio)
</TABLE>
(1) Calculated for the Company's insurance company subsidiaries on the basis
of statutory accounting principles.
<PAGE>
EXHIBIT 21
HCC INSURANCE HOLDINGS, INC.
SUBSIDIARIES
<TABLE>
<CAPTION>
STATE OR COUNTRY
NAME OF INCORPORATION
---- ----------------
<S> <C> <C>
1. 7200 Copperfield Company, LLC Alabama
2. Airway Underwriters of Michigan Michigan
3. Avemco Corporation Delaware
4. Avemco Financial Services Inc. Maryland
5. Avemco Insurance Company Maryland
6. Aviation & Marine Premium Acceptance Corporation Texas
7. Continental Aviation Underwriters, Inc. Tennessee
8. Eagle Aerobatic Flight Team, Inc. Wisconsin
9. Eastern Aviation & Marine Underwriters, Inc. Maryland
10. Guarantee Insurance Resources, Inc. Georgia
11. HCC Aviation Insurance Group Texas
12. HCC Benefits Corporation Delaware
13. HCC Employee Benefits, Inc. Delaware
14. HCC Employer Services of Oklahoma, Inc. Oklahoma
15. HCC Employer Services, Inc. Alabama
16. HCC Intermediaries, Inc. Texas
17. HCC Intermediate Holdings, Inc. Delaware
18. HCC Reinsurance Company Limited Bermuda
19. HCC Service Corporation Delaware
20. HCC U.K. Acquisition Limited U.K.
21. HCC Underwriters, a Texas Corporation Texas
22. Hinchcliff International Group Services, Inc. Maryland
23. Houston Casualty Company Texas
24. Insurance Alternatives, Inc. Georgia
25. International Aviation Underwriters, Inc. Texas
26. KIMCO, LLC Alabama
27. LDG Insurance Agency Incorporated Massachusetts
28. LDG Management Company Incorporated Massachusetts
29. LDG Reinsurance Corporation Delaware
30. Loss Management Services, Inc. Maryland
31. Managed Group Underwriting, Inc. Kansas
32. Matterhorn Bank Programs, Inc. Maryland
33. MEDEKS International Saglik Ve Sigorta Destek Idari Hizmetleri A.S. (Turkey) Turkey
34. Medical Reinsurance Underwriters Incorporated Massachusetts
35. Middle East Insurance Brokers, Limited (Jordan) Jordan
36. Midwest Stop Loss Underwriters, Incorporated Minnesota
37. NASRA TPA, Inc. Illinois
38. NEWECC, Inc. Nevada
39. North American Special Risk Associates, Inc. Illinois
40. PEPYS Holdings Limited (U.K.) U.K.
41. PEPYS Management Services Limited (U.K.) U.K.
42. Professional Audit Service, Inc. Alabama
43. Rattner Mackenzie Limited (U.K.) U.K.
44. SBS Insurance Holdings, a Texas Corporation Texas
45. Signal Aviation Insurance Services, Inc. Nevada
46. Southern Aviation Insurance Underwriters, Inc. Alabama
47. Specialty Insurance Underwriters, Inc. Missouri
48. SRRF Management Incorporated Massachusetts
49. The Wheatley Group, Ltd. New York
50. Trafalgar Insurance Company Oklahoma
51. U.S. Specialty Insurance Company Texas
52. Universal Loss Management, Inc. Delaware
</TABLE>
<PAGE>
EXHIBIT 23
CONSENT OF INDEPENDENT ACCOUNTANTS
We consent to the incorporation by reference in the registration statements of
HCC Insurance Holdings, Inc. on Forms S-8 (File Nos. 333-14479, 333-14471,
333-61673, 333-61687, and 333-68771) of our reports dated March 26, 1999, on our
audits of the consolidated financial statements and financial statement
schedules of HCC Insurance Holdings, Inc. as of December 31, 1998 and 1997, and
for the three year period ended December 31, 1998, which reports are included in
this Annual Report on Form 10-K. Our reports state that they are based on the
reports of KPMG LLP, independent certified public accountants with respect to
their audit of the 1996 consolidated financial statements of Avemco Corporation.
PRICEWATERHOUSECOOPERS LLP
Houston, Texas
March 26, 1999
<PAGE>
EXHIBIT 24
POWERS OF ATTORNEY
<PAGE>
POWER OF ATTORNEY
Know all men by these presents, that the undersigned constitutes and
appoints Stephen L. Way and John N. Molbeck, Jr., and each of them, his true and
lawful attorney-in-fact and agent, with full power of substitution and
re-substitution, for him and in his name, place and stead, in any and all
capacities, to sign this Annual Report on Form 10-K and any and all amendments
thereto, and to file same, with all exhibits thereto, and other documents in
connection therewith, with the Securities and Exchange Commission, granting unto
such attorneys-in-fact and agents, and each of them, full power and authority to
do and perform each and every act and thing requisite and necessary to be done
in and about the premises, as fully to all intents and purposes as he might or
could do in person, hereby ratifying and confirming all that such
attorneys-in-fact and agents or any of the, or their or his substitute or
substitutes, may lawfully do or cause to be done by virtue hereof.
/s/ ARTHUR S. BERNER
--------------------
Arthur S. Berner
Date: March 22, 1999
<PAGE>
POWER OF ATTORNEY
Know all men by these presents, that the undersigned constitutes and
appoints Stephen L. Way and John N. Molbeck, Jr., and each of them, his true and
lawful attorney-in-fact and agent, with full power of substitution and
re-substitution, for him and in his name, place and stead, in any and all
capacities, to sign this Annual Report on Form 10-K and any and all amendments
thereto, and to file same, with all exhibits thereto, and other documents in
connection therewith, with the Securities and Exchange Commission, granting unto
such attorneys-in-fact and agents, and each of them, full power and authority to
do and perform each and every act and thing requisite and necessary to be done
in and about the premises, as fully to all intents and purposes as he might or
could do in person, hereby ratifying and confirming all that such
attorneys-in-fact and agents or any of the, or their or his substitute or
substitutes, may lawfully do or cause to be done by virtue hereof.
/s/ JAMES M. BERRY
--------------------
James M. Berry
Date: March 22, 1999
<PAGE>
POWER OF ATTORNEY
Know all men by these presents, that the undersigned constitutes and
appoints Stephen L. Way and John N. Molbeck, Jr., and each of them, his true and
lawful attorney-in-fact and agent, with full power of substitution and
re-substitution, for him and in his name, place and stead, in any and all
capacities, to sign this Annual Report on Form 10-K and any and all amendments
thereto, and to file same, with all exhibits thereto, and other documents in
connection therewith, with the Securities and Exchange Commission, granting unto
such attorneys-in-fact and agents, and each of them, full power and authority to
do and perform each and every act and thing requisite and necessary to be done
in and about the premises, as fully to all intents and purposes as he might or
could do in person, hereby ratifying and confirming all that such
attorneys-in-fact and agents or any of the, or their or his substitute or
substitutes, may lawfully do or cause to be done by virtue hereof.
/s/ FRANK J. BRAMANTI
---------------------
Frank J. Bramanti
Date: March 22, 1999
<PAGE>
POWER OF ATTORNEY
Know all men by these presents, that the undersigned constitutes and
appoints Stephen L. Way and. John N. Molbeck, Jr., and each of them, his true
and lawful attorney-in-fact and agent, with full power of substitution and
re-substitution, for him and in his name, place and stead, in any and all
capacities, to sign this Annual Report on Form 10-K and any and all amendments
thereto, and to file same, with all exhibits thereto, and other documents in
connection therewith, with the Securities and Exchange Commission, granting unto
such attorneys-in-fact and agents, and each of them, full power and authority to
do and perform each and every act and thing requisite and necessary to be done
in and about the premises, as fully to all intents and purposes as he might or
could do in person, hereby ratifying and confirming all that such
attorneys-in-fact and agents or any of the, or their or his substitute or
substitutes, may lawfully do or cause to be done by virtue hereof.
/s/ PATRICK B. COLLINS
----------------------
Patrick B. Collins
Date: March 22, 1999
<PAGE>
POWER OF ATTORNEY
Know all men by these presents, that the undersigned constitutes and
appoints Stephen L. Way and John N. Molbeck, Jr., and each of them, his true and
lawful attorney-in-fact and agent, with full power of substitution and
re-substitution, for him and in his name, place and stead, in any and all
capacities, to sign this Annual Report on Form 10-K and any and all amendments
thereto, and to file same, with all exhibits thereto, and other documents in
connection therewith, with the Securities and Exchange Commission, granting unto
such attorneys-in-fact and agents, and each of them, full power and authority to
do and perform each and every act and thing requisite and necessary to be done
in and about the premises, as fully to all intents and purposes as he might or
could do in person, hereby ratifying and confirming all that such
attorneys-in-fact and agents or any of the, or their or his substitute or
substitutes, may lawfully do or cause to be done by virtue hereof.
/s/ J. ROBERT DICKERSON
-----------------------
J. Robert Dickerson
Date: March 22, 1999
<PAGE>
POWER OF ATTORNEY
Know all men by these presents, that the undersigned constitutes and
appoints Stephen L. Way and. John N. Molbeck, Jr., and each of them, his true
and lawful attorney-in-fact and agent, with full power of substitution and
re-substitution, for him and in his name, place and stead, in any and all
capacities, to sign this Annual Report on Form 10-K and any and all amendments
thereto, and to file same, with all exhibits thereto, and other documents in
connection therewith, with the Securities and Exchange Commission, granting unto
such attorneys-in-fact and agents, and each of them, full power and authority to
do and perform each and every act and thing requisite and necessary to be done
in and about the premises, as fully to all intents and purposes as he might or
could do in person, hereby ratifying and confirming all that such
attorneys-in-fact and agents or any of the, or their or his substitute or
substitutes, may lawfully do or cause to be done by virtue hereof.
/s/ EDWIN H. FRANK, III
-----------------------
Edwin H. Frank, III
Date: March 22, 1999
<PAGE>
POWER OF ATTORNEY
Know all men by these presents, that the undersigned constitutes and
appoints Stephen L. Way and John N. Molbeck, Jr., and each of them, his true and
lawful attorney-in-fact and agent, with full power of substitution and
re-substitution, for him and in his name, place and stead, in any and all
capacities, to sign this Annual Report on Form 10-K and any and all amendments
thereto, and to file same, with all exhibits thereto, and other documents in
connection therewith, with the Securities and Exchange Commission, granting unto
such attorneys-in-fact and agents, and each of them, full power and authority to
do and perform each and every act and thing requisite and necessary to be done
in and about the premises, as fully to all intents and purposes as he might or
could do in person, hereby ratifying and confirming all that such
attorneys-in-fact and agents or any of the, or their or his substitute or
substitutes, may lawfully do or cause to be done by virtue hereof.
/s/ ALLAN W. FULKERSON
----------------------
Allan W. Fulkerson
Date: March 22, 1999
<PAGE>
POWER OF ATTORNEY
Know all men by these presents, that the undersigned constitutes and
appoints Stephen L. Way and John N. Molbeck, Jr., and each of them, his true and
lawful attorney-in-fact and agent, with full power of substitution and
re-substitution, for him and in his name, place and stead, in any and all
capacities, to sign this Annual Report on Form 10-K and any and all amendments
thereto, and to file same, with all exhibits thereto, and other documents in
connection therewith, with the Securities and Exchange Commission, granting unto
such attorneys-in-fact and agents, and each of them, full power and authority to
do and perform each and every act and thing requisite and necessary to be done
in and about the premises, as fully to all intents and purposes as he might or
could do in person, hereby ratifying and confirming all that such
attorneys-in-fact and agents or any of the, or their or his substitute or
substitutes, may lawfully do or cause to be done by virtue hereof.
/s/ WALTER J. LACK
------------------
Walter J. Lack
Date: March 22, 1999
<PAGE>
POWER OF ATTORNEY
Know all men by these presents, that the undersigned constitutes and
appoints Stephen L. Way and John N. Molbeck, Jr., and each of them, his true and
lawful attorney-in-fact and agent, with full power of substitution and
re-substitution, for him and in his name, place and stead, in any and all
capacities, to sign this Annual Report on Form 10-K and any and all amendments
thereto, and to file same, with all exhibits thereto, and other documents in
connection therewith, with the Securities and Exchange Commission, granting unto
such attorneys-in-fact and agents, and each of them, full power and authority to
do and perform each and every act and thing requisite and necessary to be done
in and about the premises, as fully to all intents and purposes as he might or
could do in person, hereby ratifying and confirming all that such
attorneys-in-fact and agents or any of the, or their or his substitute or
substitutes, may lawfully do or cause to be done by virtue hereof.
/s/ STEPHEN J. LOCKWOOD
-----------------------
Stephen J. Lockwood
Date: March 22, 1999
<PAGE>
POWER OF ATTORNEY
Know all men by these presents, that the undersigned constitutes and
appoints Stephen L. Way and John N. Molbeck, Jr., and each of them, his true and
lawful attorney-in-fact and agent, with full power of substitution and
re-substitution, for him and in his name, place and stead, in any and all
capacities, to sign this Annual Report on Form 10-K and any and all amendments
thereto, and to file same, with all exhibits thereto, and other documents in
connection therewith, with the Securities and Exchange Commission, granting unto
such attorneys-in-fact and agents, and each of them, full power and authority to
do and perform each and every act and thing requisite and necessary to be done
in and about the premises, as fully to all intents and purposes as he might or
could do in person, hereby ratifying and confirming all that such
attorneys-in-fact and agents or any of the, or their or his substitute or
substitutes, may lawfully do or cause to be done by virtue hereof.
/s/ PETER B. SMITH, JR.
-----------------------
Peter B. Smith, Jr.
Date: March 22, 1999
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 7
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION FROM THE CONSOLIDATED
FINANCIAL STATEMENTS FOUND IN THE COMPANY'S FORM 10-K FOR THE YEAR ENDED
DECEMBER 31, 1998, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<DEBT-HELD-FOR-SALE> 393,238,000
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 2,252,000
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 525,646,000
<CASH> 16,018,000
<RECOVER-REINSURE> 372,672,000
<DEFERRED-ACQUISITION> (3,615,000)
<TOTAL-ASSETS> 1,709,069,000
<POLICY-LOSSES> 460,511,000
<UNEARNED-PREMIUMS> 201,050,000
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 121,600,000
0
0
<COMMON> 48,252,000
<OTHER-SE> 391,611,000
<TOTAL-LIABILITY-AND-EQUITY> 1,709,069,000
143,100,000
<INVESTMENT-INCOME> 29,335,000
<INVESTMENT-GAINS> 845,000
<OTHER-INCOME> 134,754,000
<BENEFITS> 91,302,000
<UNDERWRITING-AMORTIZATION> 10,978,000
<UNDERWRITING-OTHER> 92,247,000
<INCOME-PRETAX> 107,486,000
<INCOME-TAX> 35,208,000
<INCOME-CONTINUING> 72,278,000
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 72,278,000
<EPS-PRIMARY> 1.51
<EPS-DILUTED> 1.48
<RESERVE-OPEN> 119,634,000
<PROVISION-CURRENT> 105,895,000
<PROVISION-PRIOR> (14,593,000)
<PAYMENTS-CURRENT> 47,126,000
<PAYMENTS-PRIOR> 48,775,000
<RESERVE-CLOSE> 118,912,000
<CUMULATIVE-DEFICIENCY> (14,593,000)
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 7
<LEGEND>
THIS SCHEDULE HAS BEEN RESTATED DUE TO THE COMPANY'S MERGER WITH KACHLER, WHICH
WAS COUNTED FOR AS A POOLING-OF-INTERESTS. SEE NOTES 1 AND 2 TO THE CONSOLIDATED
FINANCIAL STATEMENTS FOUND IN THE COMPANY'S FORM 10-K FOR THE YEAR ENDED
DECEMBER 31, 1998. THIS SCHEDULE IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO
SUCH FINANCIAL STATEMENTS.
</LEGEND>
<RESTATED>
<S> <C> <C>
<PERIOD-TYPE> YEAR YEAR
<FISCAL-YEAR-END> DEC-31-1997 DEC-31-1996
<PERIOD-START> JAN-01-1997 JAN-01-1996
<PERIOD-END> DEC-31-1997 DEC-31-1996
<DEBT-HELD-FOR-SALE> 409,701,000 377,555,000
<DEBT-CARRYING-VALUE> 0 0
<DEBT-MARKET-VALUE> 0 0
<EQUITIES> 3,816,000 12,477,000
<MORTGAGE> 0 0
<REAL-ESTATE> 0 0
<TOTAL-INVEST> 518,772,000 468,725,000
<CASH> 7,728,000 9,575,000
<RECOVER-REINSURE> 176,965,000 132,328,000
<DEFERRED-ACQUISITION> 2,051,000 7,908,000
<TOTAL-ASSETS> 1,198,132,000 965,793,000
<POLICY-LOSSES> 275,008,000 229,049,000
<UNEARNED-PREMIUMS> 152,094,000 156,268,000
<POLICY-OTHER> 0 0
<POLICY-HOLDER-FUNDS> 0 0
<NOTES-PAYABLE> 80,750,000 72,917,000
0 0
0 0
<COMMON> 47,759,000 49,017,000
<OTHER-SE> 317,842,000 247,509,000
<TOTAL-LIABILITY-AND-EQUITY> 1,198,132,000 965,793,000
162,571,000 170,068,000
<INVESTMENT-INCOME> 27,587,000 23,593,000
<INVESTMENT-GAINS> (328,000) 8,341,000
<OTHER-INCOME> 90,487,000 68,784,000
<BENEFITS> 96,514,000 114,464,000
<UNDERWRITING-AMORTIZATION> 13,580,000 8,218,000
<UNDERWRITING-OTHER> 91,155,000 94,644,000
<INCOME-PRETAX> 73,064,000 48,467,000
<INCOME-TAX> 23,305,000 9,885,000
<INCOME-CONTINUING> 49,759,000 38,582,000
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> 49,759,000 38,582,000
<EPS-PRIMARY> 1.06 0.86
<EPS-DILUTED> 1.03 0.84
<RESERVE-OPEN> 117,283,000 99,259,000
<PROVISION-CURRENT> 100,288,000 119,401,000
<PROVISION-PRIOR> (3,774,000) (4,937,000)
<PAYMENTS-CURRENT> 48,208,000 54,493,000
<PAYMENTS-PRIOR> 47,874,000 41,947,000
<RESERVE-CLOSE> 119,634,000 117,283,000
<CUMULATIVE-DEFICIENCY> (3,774,000) (4,937,000)
</TABLE>
