<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the Quarter Ended September 30, 2000
------------------
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 from _______ to __________
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)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
--- ---
Indicate the number of shares outstanding of each of the issuer's classes of
common stock as of the latest practicable date.
On November 3, 2000, there were 49,634,790 shares of Common Stock, $1.00 par
value issued and outstanding.
<PAGE> 2
HCC INSURANCE HOLDINGS, INC.
INDEX
<TABLE>
<CAPTION>
PAGE NO.
--------
<S> <C>
Part I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Balance Sheets
September 30, 2000 and December 31, 1999...................................................3
Condensed Consolidated Statements of Earnings
For the nine months ended September 30, 2000 and 1999......................................4
Condensed Consolidated Statements of Earnings
For the three months ended September 30, 2000 and 1999.....................................5
Condensed Consolidated Statements of Changes in Shareholders' Equity
For the nine months ended September 30, 2000 and for the year ended December 31, 1999......6
Condensed Consolidated Statements of Cash Flows
For the nine months ended September 30, 2000 and 1999......................................8
Notes to Condensed Consolidated Financial Statements............................................9
Item 2. Management's Discussion and Analysis...........................................................21
Item 3. Quantitative and Qualitative Disclosures About Market Risk.....................................27
Part II. OTHER INFORMATION.......................................................................................29
</TABLE>
2
<PAGE> 3
HCC Insurance Holdings, Inc. and Subsidiaries
----------
Condensed Consolidated Balance Sheets
(Unaudited)
----------
<TABLE>
<CAPTION>
September 30, 2000 December 31, 1999
------------------ -----------------
<S> <C> <C>
ASSETS
Investments:
Fixed income securities, at market
(cost: 2000 $381,943,000; 1999 $343,534,000) $ 385,263,000 $ 342,641,000
Marketable equity securities, at market
(cost: 2000 $11,102,000; 1999 $22,493,000) 7,848,000 19,970,000
Short-term investments, at cost, which approximates market 266,865,000 215,694,000
Other investments, at cost, which approximates fair value 6,767,000 3,017,000
---------------- ----------------
Total investments 666,743,000 581,322,000
Cash 8,656,000 26,533,000
Restricted cash and cash investments 90,158,000 84,112,000
Premium, claims and other receivables 661,792,000 622,087,000
Reinsurance recoverables 758,653,000 736,485,000
Ceded unearned premium 121,083,000 133,657,000
Ceded life and annuity benefits 87,664,000 95,760,000
Deferred policy acquisition costs 40,300,000 40,450,000
Property and equipment, net 38,488,000 37,804,000
Goodwill 271,802,000 263,687,000
Other assets 25,537,000 42,827,000
---------------- ----------------
TOTAL ASSETS $ 2,770,876,000 $ 2,664,724,000
================ ================
LIABILITIES
Loss and loss adjustment expense payable $ 895,324,000 $ 871,104,000
Life and annuity policy benefits 87,664,000 95,760,000
Reinsurance balances payable 106,285,000 113,373,000
Unearned premium 189,204,000 188,524,000
Deferred ceding commissions 31,859,000 39,792,000
Premium and claims payable 686,958,000 598,638,000
Notes payable 229,171,000 242,546,000
Accounts payable and accrued liabilities 41,288,000 57,559,000
---------------- ----------------
Total liabilities 2,267,753,000 2,207,296,000
SHAREHOLDERS' EQUITY
Common Stock, $1.00 par value; 250,000,000 shares authorized;
(issued and outstanding: 2000 49,634,790 shares;
1999 48,839,027 shares) 49,635,000 48,839,000
Additional paid-in capital 185,025,000 176,359,000
Retained earnings 269,054,000 234,922,000
Accumulated other comprehensive income (loss) (591,000) (2,692,000)
---------------- ----------------
Total shareholders' equity 503,123,000 457,428,000
---------------- ----------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 2,770,876,000 $ 2,664,724,000
================ ================
</TABLE>
See Notes to Condensed Consolidated Financial Statements.
3
<PAGE> 4
HCC Insurance Holdings, Inc. and Subsidiaries
----------
Condensed Consolidated Statements of Earnings
(Unaudited)
----------
<TABLE>
<CAPTION>
For the nine months ended September 30,
2000 1999
-------------- --------------
<S> <C> <C>
REVENUE
Net earned premium $ 201,289,000 $ 99,576,000
Management fees 77,396,000 69,717,000
Commission income 31,749,000 44,742,000
Net investment income 28,538,000 22,866,000
Net realized investment loss (3,825,000) (266,000)
Other operating income 22,712,000 20,928,000
-------------- --------------
Total revenue 357,859,000 257,563,000
EXPENSE
Loss and loss adjustment expense 149,534,000 77,756,000
Operating expense:
Policy acquisition costs, net 21,673,000 3,490,000
Compensation expense 61,524,000 56,818,000
Provision for reinsurance -- 29,500,000
Other operating expense 39,146,000 36,212,000
-------------- --------------
Net operating expense 122,343,000 126,020,000
Interest expense 15,592,000 9,217,000
-------------- --------------
Total expense 287,469,000 212,993,000
-------------- --------------
Earnings before income tax provision 70,390,000 44,570,000
Income tax provision 28,350,000 14,456,000
-------------- --------------
NET EARNINGS $ 42,040,000 $ 30,114,000
============== ==============
BASIC EARNINGS PER SHARE DATA:
Earnings per share $ 0.85 $ 0.62
============== ==============
Weighted average shares outstanding 49,558,000 48,950,000
============== ==============
DILUTED EARNINGS PER SHARE DATA:
Earnings per share $ 0.84 $ 0.60
============== ==============
Weighted average shares outstanding 50,248,000 49,794,000
============== ==============
Cash dividends declared, per share $ 0.16 $ 0.15
============== ==============
</TABLE>
See Notes to Condensed Consolidated Financial Statements.
4
<PAGE> 5
HCC Insurance Holdings, Inc. and Subsidiaries
----------
Condensed Consolidated Statements of Earnings
(Unaudited)
----------
<TABLE>
<CAPTION>
For the three months ended September 30,
2000 1999
-------------- --------------
<S> <C> <C>
REVENUE
Net earned premium $ 66,279,000 $ 37,492,000
Management fees 23,587,000 22,144,000
Commission income 9,749,000 10,734,000
Net investment income 10,363,000 7,939,000
Net realized investment gain (loss) 547,000 (357,000)
Other operating income 8,156,000 5,141,000
-------------- --------------
Total revenue 118,681,000 83,093,000
EXPENSE
Loss and loss adjustment expense 47,593,000 32,943,000
Operating expense:
Policy acquisition costs, net 6,171,000 2,347,000
Compensation expense 19,947,000 19,176,000
Other operating expense 11,526,000 12,752,000
-------------- --------------
Net operating expense 37,644,000 34,275,000
Interest expense 5,256,000 3,306,000
-------------- --------------
Total expense 90,493,000 70,524,000
-------------- --------------
Earnings before income tax provision 28,188,000 12,569,000
Income tax provision 11,194,000 3,451,000
-------------- --------------
NET EARNINGS $ 16,994,000 $ 9,118,000
============== ==============
BASIC EARNINGS PER SHARE DATA:
Earnings per share $ 0.34 $ 0.19
============== ==============
Weighted average shares outstanding 49,742,000 49,130,000
============== ==============
DILUTED EARNINGS PER SHARE DATA:
Earnings per share $ 0.33 $ 0.18
============== ==============
Weighted average shares outstanding 51,040,000 49,866,000
============== ==============
Cash dividends declared, per share $ 0.06 $ 0.05
============== ==============
</TABLE>
See Notes to Condensed Consolidated Financial Statements.
5
<PAGE> 6
HCC Insurance Holdings, Inc. and Subsidiaries
----------
Condensed Consolidated Statements of Changes in Shareholders' Equity
For the nine months ended September 30, 2000 and
for the year ended December 31, 1999
(Unaudited)
----------
<TABLE>
<CAPTION>
Additional
Common paid-in Retained
Stock capital earnings
-------------- -------------- --------------
<S> <C> <C> <C>
BALANCE AS OF DECEMBER 31, 1998 $ 48,252,000 $ 162,102,000 $ 219,804,000
Net earnings -- -- 25,123,000
Other comprehensive income (loss) -- -- --
505,555 shares of Common Stock issued for exercise
of options, including tax benefit of $1,156,000 506,000 4,277,000 --
101,330 shares of Common Stock issued for
purchased companies 101,000 1,899,000 --
414,207 shares of Common Stock contractually
issuable in the future -- 8,271,000 --
Cash dividends declared, $0.20 per share -- -- (9,733,000)
Other (20,000) (190,000) (272,000)
-------------- -------------- --------------
BALANCE AS OF DECEMBER 31, 1999 $ 48,839,000 $ 176,359,000 $ 234,922,000
============== ============== ==============
<CAPTION>
Accumulated
other Total
comprehensive shareholders'
income (loss) equity
-------------- --------------
<S> <C> <C>
BALANCE AS OF DECEMBER 31, 1998 $ 9,705,000 $ 439,863,000
Net earnings -- 25,123,000
Other comprehensive income (loss) (12,397,000) (12,397,000)
505,555 shares of Common Stock issued for exercise
of options, including tax benefit of $1,156,000 -- 4,783,000
101,330 shares of Common Stock issued for
purchased companies -- 2,000,000
414,207 shares of Common Stock contractually
issuable in the future -- 8,271,000
Cash dividends declared, $0.20 per share -- (9,733,000)
Other -- (482,000)
-------------- --------------
BALANCE AS OF DECEMBER 31, 1999 $ (2,692,000) $ 457,428,000
============== ==============
</TABLE>
See Notes to Condensed Consolidated Financial Statements.
6
<PAGE> 7
HCC Insurance Holdings, Inc. and Subsidiaries
----------
Condensed Consolidated Statements of Changes in Shareholders' Equity
For the nine months ended September 30, 2000 and
for the year ended December 31, 1999
(Unaudited)
(continued)
----------
<TABLE>
<CAPTION>
Additional
Common paid-in Retained
stock capital earnings
-------------- -------------- --------------
<S> <C> <C> <C>
BALANCE AS OF DECEMBER 31, 1999 $ 48,839,000 $ 176,359,000 $ 234,922,000
Net earnings -- -- 42,040,000
Other comprehensive income -- -- --
556,290 shares of Common Stock issued for
exercise of options, including tax benefit of
$1,566,000 556,000 7,666,000 --
Issuance of 144,973 shares of
contractually issuable Common Stock 145,000 (145,000) --
Issuance of 94,500 shares of
contingently issuable Common Stock 95,000 1,145,000 --
Cash dividends declared, $0.16 per share -- -- (7,908,000)
-------------- -------------- --------------
BALANCE AS OF SEPTEMBER 30, 2000 $ 49,635,000 $ 185,025,000 $ 269,054,000
============== ============== ==============
<CAPTION>
Accumulated
other Total
comprehensive shareholders'
income (loss) equity
-------------- --------------
<S> <C> <C>
BALANCE AS OF DECEMBER 31, 1999 $ (2,692,000) $ 457,428,000
Net earnings -- 42,040,000
Other comprehensive income 2,101,000 2,101,000
556,290 shares of Common Stock issued for
exercise of options, including tax benefit of
$1,566,000 -- 8,222,000
Issuance of 144,973 shares of
contractually issuable Common Stock -- --
Issuance of 94,500 shares of
contingently issuable Common Stock -- 1,240,000
Cash dividends declared, $0.16 per share -- (7,908,000)
-------------- --------------
BALANCE AS OF SEPTEMBER 30, 2000 $ (591,000) $ 503,123,000
============== ==============
</TABLE>
See Notes to Condensed Consolidated Financial Statements.
7
<PAGE> 8
HCC Insurance Holdings, Inc. and Subsidiaries
----------
Condensed Consolidated Statements of Cash Flows
(Unaudited)
----------
<TABLE>
<CAPTION>
For the nine months ended September 30,
2000 1999
-------------- --------------
<S> <C> <C>
Cash flows from operating activities:
Net earnings $ 42,040,000 $ 30,114,000
Adjustments to reconcile net earnings to net
cash provided by operating activities:
Change in premium, claims and other receivables (46,126,000) (7,123,000)
Change in reinsurance recoverables (22,168,000) (224,033,000)
Change in ceded unearned premium 12,574,000 3,151,000
Change in loss and loss adjustment expense payable 24,220,000 208,296,000
Change in reinsurance balances payable (7,088,000) 36,634,000
Change in unearned premium 1,343,000 (3,082,000)
Change in premium and claims payable, net of restricted cash 82,959,000 (6,403,000)
Change in accounts payable and accrued liabilities (21,681,000) (4,601,000)
Net realized investment loss 3,825,000 266,000
Gains on dispositions of strategic and subsidiary investments (5,739,000) (5,523,000)
Provision for reinsurance -- 29,500,000
Depreciation and amortization expense 13,959,000 9,412,000
Deferred income taxes (1,513,000) (8,753,000)
Other, net 5,873,000 (4,871,000)
-------------- --------------
Cash provided by operating activities 82,478,000 52,984,000
Cash flows from investing activities:
Sales of fixed income securities 86,079,000 1,214,000
Maturity or call of fixed income securities 27,406,000 12,698,000
Sales of equity securities 7,437,000 2,800,000
Dispositions of strategic investments and non-core subsidiaries 27,803,000 15,905,000
Change in short-term investments (72,460,000) (47,362,000)
Cash paid for companies acquired, net of cash received (9,880,000) (57,863,000)
Cost of securities acquired (148,245,000) (35,417,000)
Purchases of property and equipment and other, net (6,203,000) (7,575,000)
-------------- --------------
Cash used by investing activities (88,063,000) (115,600,000)
Cash flows from financing activities:
Proceeds from notes payable 26,700,000 208,000,000
Sale of Common Stock 8,222,000 3,660,000
Payments on notes payable (39,842,000) (147,600,000)
Dividends paid (7,372,000) (6,785,000)
-------------- --------------
Cash provided by financing activities (12,292,000) 57,275,000
-------------- --------------
Net change in cash (17,877,000) (5,341,000)
Cash at beginning of period 26,533,000 16,018,000
-------------- --------------
CASH AT END OF PERIOD $ 8,656,000 $ 10,677,000
============== ==============
</TABLE>
See Notes to Condensed Consolidated Financial Statements.
8
<PAGE> 9
HCC Insurance Holdings, Inc. and Subsidiaries
----------
Notes to Condensed Consolidated Financial Statements
(Unaudited)
(1) GENERAL INFORMATION
HCC Insurance Holdings, Inc. ("the Company" or "HCC") and its subsidiaries
include domestic and foreign property and casualty and life insurance
companies, underwriting agencies, intermediaries and service companies.
HCC, through its subsidiaries, provides specialized property and casualty
and accident and health insurance to commercial customers in the areas of
accident and health reinsurance, aviation, marine, medical stop-loss,
property, offshore energy and workers' compensation insurance.
Basis of Presentation
The unaudited condensed consolidated financial statements have been
prepared in conformity with generally accepted accounting principles and
include all adjustments which are, in the opinion of management, necessary
for fair presentation of the results of the interim periods. All
adjustments made to the interim periods are of a normal recurring nature.
The condensed consolidated financial statements include the accounts of
the Company and its wholly-owned subsidiaries. All significant
intercompany balances and transactions have been eliminated. The condensed
consolidated financial statements for periods reported should be read in
conjunction with the annual consolidated financial statements and related
notes thereto. The condensed consolidated balance sheet as of December 31,
1999, and the condensed consolidated statement of changes in shareholders'
equity for the year then ended were derived from audited financial
statements, but do not include all disclosures required by generally
accepted accounting principles.
During December, 1999, the Company acquired all of the outstanding shares
of The Centris Group, Inc. ("Centris") in a transaction accounted for
using the purchase method of accounting. Therefore, the results of
operations and cash flows of the Centris companies are included in the
2000 condensed consolidated statement of earnings and cash flows but are
not included in the 1999 condensed consolidated statements of earnings and
cash flows.
Income Tax
For the nine months ended September 30, 2000 and 1999, the income tax
provision has been calculated based on an estimated effective tax rate for
each of the fiscal years. The difference between the Company's effective
tax rate and the Federal statutory rate is the result of state income
taxes, non-deductible goodwill amortization and tax exempt municipal bond
interest.
Effects of Recent Accounting Pronouncements
Statement of Financial Accounting Standards ("SFAS") No. 133 entitled
"Accounting for Derivative Instruments and Hedging Activities" was issued
in June, 1998 and becomes effective for the Company January 1, 2001, with
early adoption permitted. The Company has utilized derivative or hedging
strategies only infrequently in the past and in immaterial amounts,
although it is currently using derivatives and hedging strategies to a
somewhat greater extent as it expands its foreign operations. The Company
does not expect the adoption of SFAS No. 133 to have a material effect on
the Company's financial position, results of operations or cash flows.
9
<PAGE> 10
HCC Insurance Holdings, Inc. and Subsidiaries
----------
Notes to Condensed Consolidated Financial Statements
(Unaudited)
(Continued)
(1) GENERAL INFORMATION, CONTINUED
During December, 1999 the Securities and Exchange Commission issued Staff
Accounting Bulletin ("SAB") No. 101 entitled "Revenue Recognition in
Financial Statements" which becomes effective for the Company during the
fourth quarter of 2000. The Company does not expect the adoption of SAB
No. 101 to have a material effect on the Company's financial position,
results of operations or cash flows.
The NAIC adopted Statements of Statutory Accounting Principles in March,
1998 as a product of its attempt to codify statutory accounting
principles. Although subject to adoption by the individual states, an
effective date of January 1, 2001 was established for implementation of
the statements. Prior to the codification project, a comprehensive guide
to statutory accounting principles did not exist. The codification is new
and will evolve over time. The Company is in the process of reviewing the
statutory accounting principles as currently published to determine the
effect their adoption may have on the statutory policyholders' surplus and
statutory net income of the Company's insurance company subsidiaries.
Reclassifications
Certain amounts in the 1999 condensed consolidated financial statements
have been reclassified to conform to the 2000 presentation. Such
reclassifications had no effect on the Company's net earnings,
shareholders' equity or cash flows.
(2) REINSURANCE
In the normal course of business, the Company's insurance company
subsidiaries cede a substantial portion of their premium to non-affiliated
domestic and foreign reinsurers through 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
purposes of limiting their loss exposure, protecting against catastrophic
loss and diversifying their business. The majority of assumed reinsurance
was written by underwriting agency subsidiaries of the Company utilizing
unaffiliated insurance companies as the primary writer. The following
tables represent the effect of such reinsurance transactions on net
premium and loss and loss adjustment expense:
<TABLE>
<CAPTION>
Loss and Loss
Written Earned Adjustment
Premium Premium Expense
-------------- -------------- --------------
<S> <C> <C> <C>
For the nine months ended September 30, 2000:
Direct business $ 478,210,000 $ 469,771,000 $ 332,707,000
Reinsurance assumed 235,272,000 246,953,000 212,657,000
Reinsurance ceded (498,728,000) (515,435,000) (395,830,000)
-------------- -------------- --------------
NET AMOUNTS $ 214,754,000 $ 201,289,000 $ 149,534,000
============== ============== ==============
</TABLE>
10
<PAGE> 11
HCC Insurance Holdings, Inc. and Subsidiaries
----------
Notes to Condensed Consolidated Financial Statements
(Unaudited)
(Continued)
(2) REINSURANCE, CONTINUED
<TABLE>
<CAPTION>
Loss and Loss
Written Earned Adjustment
Premium Premium Expense
-------------- -------------- --------------
<S> <C> <C> <C>
For the nine months ended September 30, 1999:
Direct business $ 213,556,000 $ 207,789,000 $ 198,559,000
Reinsurance assumed 208,527,000 208,971,000 304,732,000
Reinsurance ceded (323,067,000) (317,184,000) (425,535,000)
-------------- -------------- --------------
NET AMOUNTS $ 99,016,000 $ 99,576,000 $ 77,756,000
============== ============== ==============
For the three months ended September 30, 2000:
Direct business $ 178,835,000 $ 179,080,000 $ 124,184,000
Reinsurance assumed 63,369,000 71,559,000 51,815,000
Reinsurance ceded (170,030,000) (184,360,000) (128,406,000)
-------------- -------------- --------------
NET AMOUNTS $ 72,174,000 $ 66,279,000 $ 47,593,000
============== ============== ==============
For the three months ended September 30, 1999:
Direct business $ 74,728,000 $ 79,652,000 $ 73,629,000
Reinsurance assumed 60,626,000 59,696,000 95,299,000
Reinsurance ceded (97,477,000) (101,856,000) (135,985,000)
-------------- -------------- --------------
NET AMOUNTS $ 37,877,000 $ 37,492,000 $ 32,943,000
============== ============== ==============
</TABLE>
11
<PAGE> 12
HCC Insurance Holdings, Inc. and Subsidiaries
----------
Notes to Condensed Consolidated Financial Statements
(Unaudited)
(Continued)
(2) REINSURANCE, CONTINUED
The table below represents the approximate composition of reinsurance
recoverables in the accompanying condensed consolidated balance sheets:
<TABLE>
<CAPTION>
September 30, 2000 December 31, 1999
------------------ -----------------
<S> <C> <C>
Reinsurance recoverable on paid losses $ 122,634,000 $ 91,318,000
Commuted receivable -- 53,210,000
Reinsurance recoverable on outstanding losses 379,339,000 382,565,000
Reinsurance recoverable on IBNR 262,172,000 214,933,000
Reserve for uncollectible reinsurance (5,492,000) (5,541,000)
-------------- --------------
TOTAL REINSURANCE RECOVERABLES $ 758,653,000 $ 736,485,000
============== ==============
</TABLE>
The insurance company subsidiaries require reinsurers not authorized by
the subsidiaries' respective states of domicile to collateralize their
reinsurance obligations to the Company. The table below shows amounts held
by the Company as collateral plus other credits available for potential
offset.
<TABLE>
<CAPTION>
September 30, 2000 December 31, 1999
------------------ -----------------
<S> <C> <C>
Payables to reinsurers $ 198,958,000 $ 212,962,000
Letters of credit 134,094,000 154,111,000
Cash deposits 23,232,000 19,882,000
-------------- --------------
TOTAL CREDITS $ 356,284,000 $ 386,955,000
============== ==============
</TABLE>
The Company has a reserve of $5.5 million as of September 30, 2000 for
potential collectibility issues related to reinsurance recoverables. The
adverse economic environment in the worldwide insurance industry has
placed great pressure on reinsurers and the results of their operations.
Ultimately, these conditions could affect reinsurers' solvency.
Historically, there have been insolvencies following a period of
competitive pricing in the industry, such as the marketplace has
experienced for the last several years. Therefore, while management
believes that the reserve is adequate based on current available
information, conditions may change or additional information might be
obtained that would affect management's estimate of the adequacy of the
level of the reserve and which may result in a future increase or decrease
in the reserve. Management continually reviews the Company's financial
exposure to the reinsurance market and continues to take actions to
protect shareholders' equity.
During the current year, a number of reinsurers have delayed or suspended
the payment of amounts recoverable under reinsurance contracts to which
the Company's insurance company subsidiaries are a party. Such delays have
affected, though not materially to date, the liquidity and investment
income of the Company's insurance company subsidiaries. In addition, a
number of reinsurers have claimed they are not liable for payment to the
Company's insurance company subsidiaries, and in one case has sought
arbitration. The Company believes these claims are without merit and
expects to collect the full amount recoverable. The Company is currently
in negotiations with most of these parties. If such negotiations do not
result in a satisfactory resolution of the matters in question, the
Company intends to seek a judicial or arbitral determination.
12
<PAGE> 13
HCC Insurance Holdings, Inc. and Subsidiaries
----------
Notes to Condensed Consolidated Financial Statements
(Unaudited)
(Continued)
(3) SEGMENT AND GEOGRAPHIC INFORMATION
The performance of each segment is evaluated by management based upon net
earnings. Net earnings is calculated after tax and after all corporate
expense allocations, purchase price allocations and intercompany
eliminations have been charged or credited to the individual segments. The
insurance company subsidiaries increased their policy issuance fees on
certain 2000 contracts to reflect current market conditions, which had the
effect of reducing the underwriting agencies' management fees by a like
amount. This amounted to $7.3 million for the nine months ended September
30, 2000 and $3.3 million for the third quarter of 2000. 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
-------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
For the nine months ended September 30, 2000:
Revenue:
Domestic $ 210,756,000 $ 79,658,000 $ 17,108,000 $ 21,572,000
Foreign 7,404,000 3,631,000 17,059,000 --
Inter-segment -- 10,916,000 188,000 1,074,000
-------------- -------------- -------------- --------------
Total segment revenue $ 218,160,000 $ 94,205,000 $ 34,355,000 $ 22,646,000
============== ============== ============== ==============
Inter-segment revenue
CONSOLIDATED TOTAL REVENUE
Net earnings (loss):
Domestic $ 17,810,000 $ 18,030,000 $ 5,962,000 $ 5,057,000
Foreign (2,519,000) 659,000 1,095,000 --
-------------- -------------- -------------- --------------
Total segment net earnings (loss) $ 15,291,000 $ 18,689,000 $ 7,057,000 $ 5,057,000
============== ============== ============== ==============
Inter-segment eliminations
CONSOLIDATED NET EARNINGS
Other items:
Net investment income $ 19,902,000 $ 5,462,000 $ 2,434,000 $ 381,000
Depreciation and amortization 2,502,000 8,302,000 2,423,000 324,000
Interest expense 92,000 7,003,000 3,898,000 --
Capital expenditures 2,423,000 3,486,000 465,000 237,000
Income tax provision (benefit) 4,713,000 16,689,000 5,304,000 3,093,000
Inter-segment eliminations
CONSOLIDATED INCOME TAX PROVISION
<CAPTION>
Corporate Total
-------------- --------------
<S> <C> <C>
For the nine months ended September 30, 2000:
Revenue:
Domestic $ 671,000 $ 329,765,000
Foreign -- 28,094,000
Inter-segment -- 12,178,000
-------------- --------------
Total segment revenue $ 671,000 370,037,000
==============
Inter-segment revenue (12,178,000)
--------------
CONSOLIDATED TOTAL REVENUE $ 357,859,000
==============
Net earnings (loss):
Domestic $ (3,489,000) $ 43,370,000
Foreign -- (765,000)
-------------- --------------
Total segment net earnings (loss) $ (3,489,000) 42,605,000
==============
Inter-segment eliminations (565,000)
--------------
CONSOLIDATED NET EARNINGS $ 42,040,000
==============
Other items:
Net investment income $ 359,000 $ 28,538,000
Depreciation and amortization 408,000 13,959,000
Interest expense 4,599,000 15,592,000
Capital expenditures 207,000 6,818,000
Income tax provision (benefit) (1,104,000) 28,695,000
Inter-segment eliminations (345,000)
--------------
CONSOLIDATED INCOME TAX PROVISION $ 28,350,000
==============
</TABLE>
13
<PAGE> 14
HCC Insurance Holdings, Inc. and Subsidiaries
----------
Notes to Condensed Consolidated Financial Statements
(Unaudited)
(Continued)
(3) SEGMENT AND GEOGRAPHIC INFORMATION, CONTINUED
<TABLE>
<CAPTION>
Insurance Underwriting Other
Company Agency Intermediary Operations
-------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
For the nine months ended September 30, 1999:
Revenue:
Domestic $ 108,932,000 $ 70,096,000 $ 26,633,000 $ 19,885,000
Foreign 9,080,000 2,951,000 19,846,000 --
Inter-segment -- 1,529,000 479,000 868,000
-------------- -------------- -------------- --------------
Total segment revenue $ 118,012,000 $ 74,576,000 $ 46,958,000 $ 20,753,000
============== ============== ============== ==============
Inter-segment revenue
CONSOLIDATED TOTAL REVENUE
Net earnings (loss):
Domestic $ (1,456,000) $ 13,715,000 $ 9,185,000 $ 6,253,000
Foreign (1,209,000) 117,000 4,586,000 --
-------------- -------------- -------------- --------------
NET EARNINGS (LOSS) $ (2,665,000) $ 13,832,000 $ 13,771,000 $ 6,253,000
============== ============== ============== ==============
Other items:
Net investment income $ 17,501,000 $ 3,051,000 $ 1,772,000 $ 275,000
Depreciation and amortization 1,886,000 4,304,000 2,633,000 191,000
Interest expense 8,000 2,819,000 3,039,000 --
Capital expenditures 1,991,000 4,219,000 583,000 438,000
Income tax provision (benefit) (7,850,000) 10,572,000 8,974,000 3,606,000
<CAPTION>
Corporate Total
-------------- --------------
<S> <C> <C>
For the nine months ended September 30, 1999:
Revenue:
Domestic $ 140,000 $ 225,686,000
Foreign -- 31,877,000
Inter-segment -- 2,876,000
-------------- --------------
Total segment revenue $ 140,000 $ 260,439,000
==============
Inter-segment revenue (2,876,000)
--------------
CONSOLIDATED TOTAL REVENUE $ 257,563,000
==============
Net earnings (loss):
Domestic $ (1,077,000) $ 26,620,000
Foreign -- 3,494,000
-------------- --------------
NET EARNINGS (LOSS) $ (1,077,000) $ 30,114,000
============== ==============
Other items:
Net investment income $ 267,000 $ 22,866,000
Depreciation and amortization 398,000 9,412,000
Interest expense 3,351,000 9,217,000
Capital expenditures 344,000 7,575,000
Income tax provision (benefit) (846,000) 14,456,000
</TABLE>
The insurance company segment incurred a provision for reinsurance of $19.2
million, net of income tax, during the first nine months of 1999.
14
<PAGE> 15
HCC Insurance Holdings, Inc. and Subsidiaries
----------
Notes to Condensed Consolidated Financial Statements
(Unaudited)
(Continued)
(3) SEGMENT AND GEOGRAPHIC INFORMATION, CONTINUED
<TABLE>
<CAPTION>
Insurance Underwriting Other
Company Agency Intermediary Operations
-------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
For the three months ended September 30, 2000:
Revenue:
Domestic $ 69,225,000 $ 25,181,000 $ 4,870,000 $ 7,601,000
Foreign 5,025,000 856,000 5,697,000 --
Inter-segment -- 4,795,000 94,000 359,000
-------------- -------------- -------------- --------------
Total segment revenue $ 74,250,000 $ 30,832,000 $ 10,661,000 $ 7,960,000
============== ============== ============== ==============
Inter-segment revenue
CONSOLIDATED TOTAL REVENUE
Net earnings (loss):
Domestic $ 7,810,000 $ 5,862,000 $ 1,427,000 $ 2,024,000
Foreign (159,000) 27,000 521,000 --
-------------- -------------- -------------- --------------
Total segment net earnings (loss) $ 7,651,000 $ 5,889,000 $ 1,948,000 $ 2,024,000
============== ============== ============== ==============
Inter-segment eliminations
CONSOLIDATED NET EARNINGS
Other items:
Net investment income $ 7,223,000 $ 2,094,000 $ 831,000 $ 137,000
Depreciation and amortization 866,000 2,712,000 969,000 106,000
Interest expense 82,000 2,317,000 1,283,000 --
Capital expenditures 755,000 1,423,000 224,000 80,000
Income tax provision (benefit) 3,059,000 5,913,000 1,434,000 1,389,000
Inter-segment eliminations
CONSOLIDATED INCOME TAX PROVISION
<CAPTION>
Corporate Total
-------------- --------------
<S> <C> <C>
For the three months ended September 30, 2000:
Revenue:
Domestic $ 226,000 $ 107,103,000
Foreign -- 11,578,000
Inter-segment -- 5,248,000
-------------- --------------
Total segment revenue $ 226,000 123,929,000
==============
Inter-segment revenue (5,248,000)
--------------
CONSOLIDATED TOTAL REVENUE $ 118,681,000
==============
Net earnings (loss):
Domestic $ (438,000) $ 16,685,000
Foreign -- 389,000
-------------- --------------
Total segment net earnings (loss) $ (438,000) 17,074,000
==============
Inter-segment eliminations (80,000)
--------------
CONSOLIDATED NET EARNINGS $ 16,994,000
==============
Other items:
Net investment income $ 78,000 $ 10,363,000
Depreciation and amortization 123,000 4,776,000
Interest expense 1,574,000 5,256,000
Capital expenditures 91,000 2,573,000
Income tax provision (benefit) (557,000) 11,238,000
Inter-segment eliminations (44,000)
--------------
CONSOLIDATED INCOME TAX PROVISION $ 11,194,000
==============
</TABLE>
15
<PAGE> 16
HCC Insurance Holdings, Inc. and Subsidiaries
----------
Notes to Condensed Consolidated Financial Statements
(Unaudited)
(Continued)
(3) SEGMENT AND GEOGRAPHIC INFORMATION, CONTINUED
<TABLE>
<CAPTION>
Insurance Underwriting Other
Companies Agencies Intermediaries Operations
-------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
For the three months ended September 30, 1999:
Revenue:
Domestic $ 40,186,000 $ 22,458,000 $ 6,106,000 $ 4,579,000
Foreign 3,215,000 1,144,000 5,291,000 --
Inter-segment -- 676,000 134,000 304,000
-------------- -------------- -------------- --------------
Total segment revenue $ 43,401,000 $ 24,278,000 $ 11,531,000 $ 4,883,000
============== ============== ============== ==============
Inter-segment revenue
CONSOLIDATED TOTAL REVENUE
Net earnings (loss):
Domestic $ 4,298,000 $ 4,062,000 $ 1,473,000 $ 729,000
Foreign (1,740,000) 152,000 631,000 --
-------------- -------------- -------------- --------------
TOTAL NET EARNINGS (LOSS) $ 2,558,000 $ 4,214,000 $ 2,104,000 $ 729,000
============== ============== ============== ==============
Other items:
Net investment income $ 5,902,000 $ 1,134,000 $ 698,000 $ 98,000
Depreciation and amortization 615,000 1,483,000 851,000 (56,000)
Interest expense (3,000) 936,000 1,163,000 --
Capital expenditures 421,000 666,000 20,000 48,000
Income tax provision (benefit) (896,000) 3,179,000 1,468,000 506,000
<CAPTION>
Corporate Total
-------------- --------------
<S> <C> <C>
For the three months ended September 30, 1999:
Revenue:
Domestic $ 114,000 $ 73,443,000
Foreign -- 9,650,000
Inter-segment -- 1,114,000
-------------- --------------
Total segment revenue $ 114,000 84,207,000
==============
Inter-segment revenue (1,114,000)
--------------
CONSOLIDATED TOTAL REVENUE $ 83,093,000
==============
Net earnings (loss):
Domestic $ (487,000) $ 10,075,000
Foreign -- (957,000)
-------------- --------------
TOTAL NET EARNINGS (LOSS) $ (487,000) $ 9,118,000
============== ==============
Other items:
Net investment income $ 107,000 $ 7,939,000
Depreciation and amortization 122,000 3,015,000
Interest expense 1,210,000 3,306,000
Capital expenditures 44,000 1,199,000
Income tax provision (benefit) (806,000) 3,451,000
</TABLE>
16
<PAGE> 17
HCC Insurance Holdings, Inc. and Subsidiaries
----------
Notes to Condensed Consolidated Financial Statements
(Unaudited)
(Continued)
(4) EARNINGS PER SHARE
Basic earnings per share is based on the weighted average number of common
shares outstanding during the period divided into net earnings. Diluted
earnings per share is based on the weighted average number of common
shares outstanding plus the potential common shares outstanding during the
period divided into net earnings. Outstanding common stock options, when
dilutive, are considered to be potential common stock for the purpose of
the diluted calculation. The treasury stock method is used to calculate
potential common stock due to options. Contingent shares to be issued are
included in the earnings per share computation only when the underlying
conditions for issuance have been met.
The following table provides a reconciliation of the denominators used in
the earnings per share calculations:
<TABLE>
<CAPTION>
For the nine months ended September 30,
2000 1999
-------------- --------------
<S> <C> <C>
Net earnings $ 42,040,000 $ 30,114,000
============== ==============
Reconciliation of number of shares outstanding:
Shares of Common Stock outstanding at period end 49,635,000 48,711,000
Effect of Common Stock issued during the period (346,000) (175,000)
Common Stock contractually issuable in the future 269,000 414,000
-------------- --------------
Weighted average Common Stock outstanding 49,558,000 48,950,000
Additional dilutive effect of outstanding options
(as determined by the application of the
treasury stock method) 690,000 844,000
-------------- --------------
Weighted average Common Stock and potential
common stock outstanding 50,248,000 49,794,000
============== ==============
</TABLE>
17
<PAGE> 18
HCC Insurance Holdings, Inc. and Subsidiaries
----------
Notes to Condensed Consolidated Financial Statements
(Unaudited)
(Continued)
(4) EARNINGS PER SHARE, CONTINUED
<TABLE>
<CAPTION>
For the three months ended September 30,
2000 1999
-------------- --------------
<S> <C> <C>
Net earnings $ 16,994,000 $ 9,118,000
============== ==============
Reconciliation of number of shares outstanding:
Shares of Common Stock outstanding at period end 49,635,000 48,711,000
Effect of Common Stock issued during the period (162,000) 5,000
Common Stock contractually issuable in the future 269,000 414,000
-------------- --------------
Weighted average Common Stock outstanding 49,742,000 49,130,000
Additional dilutive effect of outstanding options
(as determined by the application of the
treasury stock method) 1,298,000 736,000
-------------- --------------
Weighted average Common Stock and potential
common stock outstanding 51,040,000 49,866,000
============== ==============
</TABLE>
As of September 30, 2000, there were approximately 3.3 million options
that were not included in the computation of year-to-date diluted earnings
per share (1.1 million shares for the third quarter) because to do so
would have been antidilutive. There are 283,500 shares of the Company's
Common Stock to be issued if certain conditions are met as of December 31,
2000, or in subsequent years. These shares were not included in the
earnings per share computation because the conditions for issuance have
not yet been met.
18
<PAGE> 19
HCC Insurance Holdings, Inc. and Subsidiaries
----------
Notes to Condensed Consolidated Financial Statements
(Unaudited)
(Continued)
(5) OTHER INFORMATION
Supplemental Information
Supplemental information for the nine months ended September 30, 2000 and
1999, is summarized below:
<TABLE>
<CAPTION>
2000 1999
---------------- ---------------
<S> <C> <C>
Interest paid $ 12,456,000 $ 8,346,000
Income tax paid 12,737,000 21,358,000
Comprehensive income 44,141,000 21,931,000
Ceding commissions netted with policy acquisition costs 155,958,000 84,869,000
</TABLE>
Supplemental information for the three months ended September 30, 2000 and
1999, is summarized below:
<TABLE>
<CAPTION>
2000 1999
---------------- ---------------
<S> <C> <C>
Comprehensive income $ 17,918,000 $ 9,290,000
Ceding commissions netted with policy acquisition costs 54,842,000 29,451,000
</TABLE>
Restructuring
As of December 31, 1999, the Company had accrued two separate
restructuring liabilities, relating to HCC's ongoing operations ("HCC
Internal") and to HCC's acquisition of Centris. Changes in the accruals
between December 31, 1999 and September 30, 2000 are shown in the tables
below:
HCC Internal Restructuring
<TABLE>
<CAPTION>
Accrued Paid 2000 Accrued
at 12/31/99 in 2000 Adjustments at 9/30/00
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Severance $ 3,115,000 $ 3,115,000 $ -- $ --
Other 911,000 213,000 (514,000) 184,000
------------ ------------ ------------ ------------
TOTAL $ 4,026,000 $ 3,328,000 $ (514,000) $ 184,000
============ ============ ============ ============
</TABLE>
During 2000, the Company determined that one of the leased offices
scheduled to be closed would be retained. Therefore, the Company reversed
$789,000 (included as a credit in other operating expenses) of the
restructuring expense recorded during the fourth quarter of 1999, of which
$514,000 was the reversal of the accrual for the future lease payments and
$275,000 was the reversal of the write down of certain assets.
19
<PAGE> 20
HCC Insurance Holdings, Inc. and Subsidiaries
----------
Notes to Condensed Consolidated Financial Statements
(Unaudited)
(Continued)
(5) OTHER INFORMATION, CONTINUED
Centris Restructuring
<TABLE>
<CAPTION>
Accrued Paid 2000 Accrued
at 12/31/99 in 2000 Adjustments at 9/30/00
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Contractual executive severance
accruals $ 5,866,000 $ 6,027,000 $ 166,000 $ 5,000
Other severance accruals 397,000 521,000 202,000 78,000
Lease obligation accruals 848,000 636,000 329,000 541,000
------------ ------------ ------------ ------------
TOTAL $ 7,111,000 $ 7,184,000 $ 697,000 $ 624,000
============ ============ ============ ============
</TABLE>
The adjustments in 2000 were recorded as management decided to take
additional steps to integrate parts of the Centris operations. Management
continues to evaluate what additional actions, if any, are necessary to
finalize the integration of the Centris operations. In addition, there are
unresolved contingencies remaining from the acquisition. Any additional
accruals for either the unresolved contingencies or the integration of
operations will be recorded as an adjustment to the purchase price
allocation within the allowable purchase allocation period.
Legal Proceedings
The Company is party to numerous claims and lawsuits that arise in the
normal course of its business. Many of such claims or lawsuits involve
claims under policies that the Company's insurance company subsidiaries
underwrite as an insurer or reinsurer. The Company believes that the
resolution of these lawsuits or claims will not have a material adverse
effect on the Company's financial condition, results of operations or cash
flows.
20
<PAGE> 21
MANAGEMENT'S DISCUSSION AND ANALYSIS
During December, 1999, the Company acquired all of the outstanding shares of The
Centris Group, Inc. ("Centris") in a transaction accounted for using the
purchase method of accounting. Therefore, the results of operations and cash
flows of the Centris companies are included in the 2000 condensed consolidated
statement of earnings and cash flows, but are not included in the 1999 condensed
consolidated statement of earnings and cash flows.
Three months ended September 30, 2000 versus three months ended September 30,
1999
Results of Operations
Total revenue increased 43% to $118.7 million for the third quarter of 2000 from
$83.1 million for the same period in 1999. This revenue increase resulted from
increased retentions of premium underwritten by the Company's insurance company
subsidiaries, particularly in the medical stop-loss line of business, and
increased investment income. The upward trend in revenue is anticipated to
continue.
Net investment income increased 31% to $10.4 million for the third quarter of
2000 from $7.9 million for the same period in 1999. This was due to a higher
level of invested assets and an increase in interest rates. The higher level of
invested assets was due to greater retentions of premium underwritten by the
Company's insurance company subsidiaries and the investment of cash received
from a commuted reinsurance agreement during the first quarter of 2000. Net
investment income is expected to continue to increase.
Compensation expense increased $771,000 during the third quarter of 2000 from
the same period in 1999. This increase reflects a normal progressional increase
due to business growth plus the increase due to the Centris acquisition, offset
by the savings resulting from the 1999 fourth quarter restructuring. Other
operating expenses decreased $1.2 million during the same period due to the 1999
fourth quarter restructuring.
Interest expense was $5.3 million for the third quarter of 2000 compared to $3.3
million for the same period in 1999. This increase is a result of higher
interest rates and increased debt outstanding, principally as a result of
funding for acquisitions.
Income tax expense was $11.2 million for the third quarter of 2000 compared to
$3.5 million for the same period in 1999. The Company's effective tax rate was
40% for the third quarter of 2000 compared to 27% in 1999. Most of the increase
in the effective tax rate was due to non-deductible goodwill amortization
relating to the Centris acquisition and increased underwriting agency income
subject to state income taxes.
Net earnings for the third quarter of 2000 increased 86% to $17.0 million or
$0.33 per share from $9.1 million or $0.18 per share for the same period in
1999. These increases result from improved underwriting results and the increase
in investment income.
The Company's book value per share was $10.08 as of September 30, 2000, up from
$9.75 as of June 30, 2000.
21
<PAGE> 22
SEGMENTS
Insurance Companies
Gross written premium increased 79% to $ 242.2 million for the third quarter of
2000 from $135.4 million for the same period in 1999 due to new business, rate
increases, increased participation by the Company's insurance company
subsidiaries in the business underwritten by the Company's underwriting agency
subsidiaries and the acquisition of Centris. Net written premium for the third
quarter of 2000 increased 91% to $72.2 million from $37.9 million for the same
period in 1999, as the Company's insurance company subsidiaries have increased
retentions on many of their lines of business as underwriting results begin to
improve. Net earned premium increased 77% to $66.3 million for the same reasons.
Premium increases are expected to continue.
Loss and loss adjustment expense increased to $47.6 million for the third
quarter of 2000 from $32.9 million for the same period in 1999. The increase in
net loss and loss adjustment expense is due to the higher level of net retained
premium. The GAAP net loss ratio decreased to 71.8% for the third quarter of
2000 from 87.9% for the same period in 1999. The GAAP gross loss ratio was 70.2%
in the third quarter of 2000 compared to 121.2% for the same period in 1999. The
general improvement in the Company's loss ratios represents the effects of
increased premium rates on certain lines of business, reduced writings on other
unprofitable lines of business and a general improvement in market conditions,
particularly in the medical stop-loss and aviation lines of business. The
statutory net combined ratio was 98.4% in the third quarter of 2000 compared
to 117.6% for the same period in 1999.
Policy acquisition costs, which are net of commissions on ceded reinsurance,
increased to $6.2 million during the third quarter of 2000 from $2.3 million for
the same period in 1999. This increase in costs results from higher retained
premium and the resulting reduced ceding commissions.
Net earnings of the Company's insurance company subsidiaries increased to $7.7
million in the third quarter of 2000 from $2.6 million for the same period in
1999, principally as a result of the effect of the improved underwriting results
and the increase in investment income.
Underwriting Agencies
Premiums underwritten by the Company's underwriting agencies increased 28% to
$273.5 million for the third quarter of 2000 from $213.5 million for the same
period in 1999. This increase resulted primarily from the increased premium
volume in the medical stop-loss line of business, which was due to rate
increases and the acquisition of Centris. Management fees increased to $23.6
million for the third quarter of 2000, compared to $22.1 million for the same
period in 1999. The increase in management fees was disproportionate to the
increase in written premium primarily due to increased retentions by the
Company's insurance company subsidiaries. Net earnings of the Company's
underwriting agency subsidiaries increased 40% to $5.9 million in the third
quarter of 2000 from $4.2 million in 1999 due to increased revenue and higher
pre-tax margins primarily as a result of the successful integration of the
Centris acquisition.
Intermediaries
Commission income decreased to $9.7 million in the third quarter of 2000 from
$10.7 million for the same period in 1999. Net earnings of the Company's
intermediary subsidiaries decreased to $1.9 million in the third quarter of 2000
from $2.1 million for the same period in 1999. These decreases were due to a
significant reduction in the amount of ceded reinsurance placed on behalf of the
Company's insurance company subsidiaries as a result of their planned increase
in retentions.
22
<PAGE> 23
Other Operations
Other operating revenue increased to $8.2 million during the third quarter of
2000 from $5.1 million for the same period in 1999 principally from the gain
from the disposition of a subsidiary investment during the third quarter of
2000. There was no such gain for the same period in 1999. Net earnings from the
Company's other operations increased to $2.0 million in 2000 from $729,000 in
1999 for the same reason. Quarter to quarter comparisons will vary substantially
depending on income from subsidiary investments, or dispositions thereof, in any
given period.
Nine months ended September 30, 2000 versus nine months ended September 30, 1999
Results of Operations
Total revenue increased 39% to $357.9 million for the first nine months of 2000
from $257.6 million for the same period in 1999. This revenue increase resulted
from increased retentions of premium underwritten by the Company's insurance
company subsidiaries, particularly in the medical stop-loss line of business,
and increased investment income. The upward trend in revenue is anticipated to
continue.
Net investment income increased 25% to $28.5 million for the first nine months
of 2000 from $22.9 million for the same period in 1999. This was due to a higher
level of invested assets and an increase in interest rates. The higher level of
invested assets was due to greater retentions of premium underwritten by the
Company's insurance company subsidiaries and the investment of cash received
from a commuted reinsurance agreement during the first quarter of 2000. In
connection with the Company's hiring of new investment advisors in 2000, an
in-depth review and restructuring of the Company's investment portfolio has been
undertaken. The Company has not significantly changed the credit rating but has
shortened the duration of its investment portfolio. The Company realized a $3.8
million loss on the sale of securities or write down of securities being sold in
the first nine months of 2000, principally as a result of these actions. Net
investment income is expected to continue to increase.
Compensation expense increased $4.7 million during the first nine months of 2000
from the same period in 1999. This increase reflects a normal progressional
increase due to business growth plus the increase due to the Centris
acquisition, offset by the savings resulting from the 1999 fourth quarter
restructuring. Other operating expenses increased $2.9 million during the same
period for similar reasons.
Interest expense was $15.6 million for the first nine months of 2000 compared to
$9.2 million for the same period in 1999. This increase is a result of higher
interest rates and increased debt outstanding, principally as a result of
funding for acquisitions.
Income tax expense was $28.4 million for the first nine months of 2000 compared
to $14.5 million for the same period in 1999. The Company's effective tax rate
was 40% in the 2000 period compared to 32% in 1999. Most of the increase in the
effective tax rate was due to non-deductible goodwill amortization relating to
the Centris acquisition and increased underwriting agency income subject to
state income taxes.
The Company recorded a provision for reinsurance recoverables in the amount of
$29.5 million during the first nine months of 1999 relating to one of the
Company's reinsurers that was subsequently placed into liquidation. The Company
believes that the provision should be sufficient to absorb the losses resulting
from this insolvency.
Net earnings for the first nine months of 2000 increased 40% to $42.0 million or
$0.84 per share from $30.1 million or $0.60 per share for the same period in
1999. These increases result from improved underwriting results, an increase in
investment income and the effect of the provision for reinsurance recorded
during 1999.
The Company's book value per share was $10.08 as of September 30, 2000, up from
$9.29 as of December 31, 1999.
23
<PAGE> 24
SEGMENTS
Insurance Companies
Gross written premium increased 69% to $713.5 million for the first nine months
of 2000, from $422.1 million for the same period in 1999 due to new business,
rate increases, increased participation by the Company's insurance company
subsidiaries in the business underwritten by the Company's underwriting agency
subsidiaries and the acquisition of Centris. Net written premium for the first
nine months of 2000 increased 117% to $214.8 million from $99.0 million for the
same period in 1999, as the Company's insurance company subsidiaries have
increased retentions on many of their lines of business as underwriting results
begin to improve. Net earned premium increased 102% to $201.3 million for the
same reasons. Premium increases are expected to continue.
Loss and loss adjustment expense increased to $149.5 million for the first nine
months of 2000 from $77.8 million for the same period in 1999. The increase in
net loss and loss adjustment expense is due to the higher level of net retained
premium. The GAAP net loss ratio decreased to 74.3% for the first nine months of
2000 from 78.1% for the same period in 1999. The GAAP gross loss ratio was 76.1%
in the first nine months of 2000 compared to 120.8% for the same period in 1999.
The general improvement in the Company's loss ratios represents the effects of
increased premium rates on certain lines of business, reduced writings on other
unprofitable lines of business and a general improvement in market conditions,
particularly in the medical stop-loss and domestic aviation lines of business.
The statutory net combined ratio was 100.1% in the first nine months of 2000
compared to 103.2% for the same period in 1999.
Policy acquisition costs, which are net of commissions on ceded reinsurance,
increased to $21.7 million during the first nine months of 2000 from $3.5
million for the same period in 1999. This increase in costs results from higher
retained premium and the resulting reduced ceding commissions.
Net earnings of the Company's insurance company subsidiaries increased to $15.3
million in the first nine months of 2000 from a loss of $2.7 million for the
same period in 1999, primarily as a result of improved underwriting results, the
effect of the provision for reinsurance recorded in 1999 and the increase in
investment income.
Underwriting Agencies
Premiums underwritten increased 30% to $829.8 million for the first nine months
of 2000 from $637.7 million for the same period in 1999. Management fees
increased 11% to $77.4 million for the first nine months of 2000, compared to
$69.7 million for the same period in 1999. These increases resulted primarily
from the increased premium volume in the medical stop-loss line of business,
which was due to rate increases and the acquisition of Centris. The increase in
management fees was disproportionate to the increase in written premium
primarily due to increased retentions by the Company's insurance company
subsidiaries. Net earnings of the Company's underwriting agency subsidiaries
increased 35% to $18.7 million in the first nine months of 2000 from $13.8
million in 1999 due to increased revenue and higher pretax margins primarily as
a result of the successful integration of the Centris acquisition.
Intermediaries
Commission income decreased to $31.7 million in the first nine months of 2000
from $44.7 million for the same period in 1999. Net earnings of the Company's
intermediary subsidiaries decreased to $7.1 million in the first nine months of
2000 from $13.8 million for the same period in 1999. These decreases were due to
a significant reduction in the amount of ceded reinsurance placed on behalf of
the Company's insurance company subsidiaries as a result of their planned
increase in retentions.
24
<PAGE> 25
Other Operations
Other operating revenue increased to $22.7 million during the first nine months
of 2000 from $20.9 million for the same period in 1999. Net earnings of the
Company's other operations decreased to $5.1 million in 2000 from $6.3 million
in 1999. Period to period comparisons will vary substantially depending on
income from subsidiary investments, or dispositions thereof, in any given
period.
Restructuring
As of December 31, 1999, the Company had accrued two separate restructuring
liabilities, relating to HCC's ongoing operations ("HCC Internal") and to HCC's
acquisition of Centris. Changes in the accruals between December 31, 1999 and
June 30, 2000 are shown in the tables below:
HCC Internal Restructuring
<TABLE>
<CAPTION>
Accrued Paid 2000 Accrued
at 12/31/99 in 2000 Adjustments at 9/30/00
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Severance $ 3,115,000 $ 3,115,000 $ -- $ --
Other 911,000 213,000 (514,000) 184,000
------------ ------------ ------------ ------------
TOTAL $ 4,026,000 $ 3,328,000 $ (514,000) $ 184,000
============ ============ ============ ============
</TABLE>
During 2000, the Company determined that one of the leased offices scheduled to
be closed would be retained. Therefore, the Company reversed $789,000 (included
as a credit in other operating expenses) of the restructuring expense recorded
during the fourth quarter of 1999, of which $514,000 was the reversal of the
accrual for future lease payments and $275,000 was the reversal of the write
down of certain assets.
Centris Restructuring
<TABLE>
<CAPTION>
Accrued Paid 2000 Accrued
at 12/31/99 in 2000 Adjustments at 9/30/00
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Contractual executive severance
accruals $ 5,866,000 $ 6,027,000 $ 166,000 $ 5,000
Other severance accruals 397,000 521,000 202,000 78,000
Lease obligation accruals 848,000 636,000 329,000 541,000
------------ ------------ ------------ ------------
TOTAL $ 7,111,000 $ 7,184,000 $ 697,000 $ 624,000
============ ============ ============ ============
</TABLE>
The adjustments in 2000 were recorded as management decided to take additional
steps to integrate parts of the Centris operations. Management continues to
evaluate what additional actions, if any, are necessary to finalize the
integration of the Centris operations. In addition, there are unresolved
contingencies remaining from the acquisition. Any additional accruals for either
the unresolved contingencies or the integration of operations will be recorded
as an adjustment to the purchase price allocation within the allowable purchase
allocation period.
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 and other assets. The
principal cash outflows are for the payment of claims and loss adjustment
expenses ("LAE"), payment of premiums to reinsurers, purchase of investments,
debt service, policy acquisition costs, operating expenses, income and other
taxes and dividends. Quarter to quarter variations in operating cash flows can
occur due to timing differences in either the payment of claims and the
collection of related recoverables or the collection of receivables and the
payment of related payable amounts. The Company
25
<PAGE> 26
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. The Company limits its liquidity exposure by holding
funds, letters of credit and other security such that net exposures are less
than the gross balances shown in the condensed consolidated balance sheet.
During the current year, a number of reinsurers have delayed or suspended the
payment of amounts recoverable under reinsurance contracts to which the
Company's insurance company subsidiaries are a party. Such delays have affected,
though not materially to date, the liquidity and investment income of the
Company's insurance company subsidiaries.
The Company's consolidated cash and investment portfolio increased $67.2
million, or 11% since December 31, 1999, and totaled $675.4 million as of
September 30, 2000, of which $275.5 million was cash and short-term investments.
The increase in investments resulted primarily from the collection of the
commutation receivable. Total assets increased slightly to $2.8 billion as of
September 30, 2000.
On December 17, 1999, the Company entered into a $300.0 million Revolving Loan
Facility (the "Facility") with a group of banks. Borrowings under the Facility
may be made from time to time by the Company for general corporate purposes
until the Facility's expiration on December 18, 2004. Outstanding advances under
the Facility bear interest at agreed upon rates. The Facility is collateralized
in part by the pledge of the stock the Company's principal insurance company
subsidiaries and by the pledge of stock of and guarantees 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 comparable financing arrangements. The initial funding
available under the Facility was used, among other things, to refinance existing
indebtedness and to partially fund the Centris acquisition. As of September 30,
2000, total debt outstanding under the Facility was $224.7 million and the
weighted average interest rate was 8.09%.
The Company believes that its operating cash flows, short-term investments and
the Facility will provide sufficient sources of liquidity to meet its operating
needs for the foreseeable future.
Effects of Recent Accounting Pronouncements
Statement of Financial Accounting Standards ("SFAS") No. 133 entitled
"Accounting for Derivative Instruments and Hedging Activities" was issued in
June, 1998 and becomes effective for the Company January 1, 2001, with early
adoption permitted. The Company has utilized derivative or hedging strategies
only infrequently in the past and in immaterial amounts, although it is
currently using derivatives and hedging strategies to a somewhat greater extent
as it expands its foreign operations. The Company does not expect the adoption
of SFAS No. 133 to have a material effect on the Company's financial position,
results of operations or cash flows.
During December, 1999 the Securities and Exchange Commission issued Staff
Accounting Bulletin ("SAB") No. 101 entitled "Revenue Recognition in Financial
Statements" which becomes effective for the Company during the fourth quarter of
2000. The Company does not expect the adoption of SAB No. 101 to have a material
effect on the Company's financial position, results of operations or cash flows.
26
<PAGE> 27
The NAIC adopted Statements of Statutory Accounting Principles in March, 1998 as
a product of its attempt to codify statutory accounting principles. Although
subject to adoption by the individual states, an effective date of January 1,
2001 was established for implementation of the statements. Prior to the
codification project, a comprehensive guide to statutory accounting principles
did not exist. The codification is new and will evolve over time. The Company is
in the process of reviewing the statutory accounting principles as currently
published to determine the effect their adoption may have on the statutory
policyholders' surplus and statutory net income of the Company's insurance
company subsidiaries.
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 have failed or created erroneous information as a result of the Year 2000
date change. Although the Company experienced no material system failures
attributed to the year 2000 change-over, the Company may 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. The Company's insurance
company subsidiaries did 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, an insured may submit
purported claims for coverage under such policies, which may result from Year
2000 related causes. In this regard, the Company continues to assess appropriate
responses to such attempted claims in light of Year 2000 coverage issues under
the insurance coverages offered by the insurance company subsidiaries. The
nature of the Company's response to such attempted claims is generally dependent
on the particular facts and circumstances of the underlying claims and coverage.
Management does not believe that Year 2000 coverage issues associated with the
insurance coverages offered by the Company's insurance company subsidiaries will
have a material adverse effect on the Company's results of operations or cash
flows.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There have been no material changes in market risk from the information provided
in Item 7A. "Quantitative and Qualitative Disclosures About Market Risk" of the
Company's Annual Report on Form 10-K for the year ended December 31, 1999.
27
<PAGE> 28
This report on Form 10-Q (the "Report") contains certain "forward-looking
statements" within the meaning of Section 27A of the Securities Act of 1933, and
Section 21E of the Securities Exchange Act of 1934, which are intended to be
covered by the safe harbors created by those laws. We have based these
forward-looking statements on our current expectations and projections about
future events. These forward-looking statements include information about
possible or assumed future results of our operations. All statements, other than
statements of historical facts, included or incorporated by reference in this
Report that address activities, events or developments that we expect or
anticipate may occur in the future, including such things as future capital
expenditures, business strategies, competitive strengths, goals, growth of our
businesses and operations, plans and references to future successes may be
considered forward-looking statements. Also, when we use words such as
"anticipate", "believe", "estimate", "expect", "intend", "plan", "probably" or
similar expressions, we are making forward-looking statements.
Many risks and uncertainties may impact the matters addressed in these
forward-looking statements. Many possible events or factors could affect our
future financial results and performance. These could cause our results or
performance to differ materially from those we express in our forward-looking
statements. Although we believe that the assumptions underlying our
forward-looking statements are reasonable, any of these assumptions, and
therefore also the forward-looking statements based on these assumptions, could
themselves prove to be inaccurate. In light of the significant uncertainties
inherent in the forward-looking statements included in this Report, our
inclusion of this information is not a representation by us or any other person
that our objectives and plans will be achieved.
Our forward-looking statements speak only as of the date made and we will not
update these forward-looking statements unless the securities laws require us to
do so. In light of these risks, uncertainties and assumptions, the
forward-looking events discussed in this Report may not occur.
28
<PAGE> 29
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
The Company is party to numerous claims and lawsuits that arise in
the normal course of its business. Many of such claims or lawsuits
involve claims under policies that the Company's insurance company
subsidiaries underwrite as an insurer or reinsurer. The Company
believes that the resolution of these lawsuits or claims will not
have a material adverse effect on the Company's financial condition,
results of operations or cash flows.
Item 6. Exhibits and reports on Form 8-K:
(a) Exhibits:
27 EDGAR Financial Data Schedule - September 30, 2000
(b) Reports on Form 8-K:
None.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HCC Insurance Holdings, Inc.
-----------------------------------------------
(Registrant)
November 14, 2000 /s/ Stephen L. Way
---------------------- -----------------------------------------------
(Date) Stephen L. Way, Chairman of the Board
and Chief Executive Officer
November 14, 2000 /s/ Edward H. Ellis, Jr.
---------------------- -----------------------------------------------
(Date) Edward H. Ellis, Jr., Senior Vice President and
Chief Financial Officer
29
<PAGE> 30
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<S> <C>
27 EDGAR Financial Data Schedule - September 30, 2000
</TABLE>
