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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.
/ / Transaction report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934.
For the fiscal year ended _______December 31, 1999_______________________
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. / /
The aggregate market value on March 10, 2000, of the voting stock held by
non-affiliates of the registrant was approximately $501.7 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 10, 2000 was 49,095,126.
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.................................................. 26
ITEM 3. Legal Proceedings........................................... 26
ITEM 4. Submission of Matters to a Vote of Security Holders......... 26
PART II.
ITEM 5. Market for the Registrant's Common Equity and Related
Stockholder Matters......................................... 27
ITEM 6. Selected Financial Data..................................... 28
ITEM 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 30
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 POTENTIAL YEAR 2000 INSURANCE COVERAGE 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 INCLUDE WORDS SUCH AS "ANTICIPATE",
"BELIEVE", "ESTIMATE", "EXPECT", "INTEND", "PLAN", "PROBABLY" 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 and life and health
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 directly 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 and
London, England; HCC Life Insurance Company ("HCCL") in Houston, Texas; 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 and New York City, New York; LDG Re (London), Ltd. ("LDG
Re-London") in London, England; HCC Aviation Insurance Group, Inc. ("HCCA") in
Dallas, Texas and Glendale, California; HCC Employer Services, Inc. ("HCCES") in
Northbrook, Illinois, Montgomery, Alabama and Dallas, Texas; and HCC Benefits
Corporation ("HCCB") in Atlanta, Georgia, Costa Mesa, California, Wakefield,
Massachusetts, Minneapolis, Minnesota and Dallas, Texas. 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.
Since its founding in 1974, the Company and its predecessor companies have
been consistently profitable on an annual basis, generally reporting annual
increases in gross written premium ("GWP"), management fees, brokerage income
and total revenue. During the period 1997 through 1999, the Company's insurance
company subsidiaries had an average combined ratio, before the effects of the
provision for reinsurance recorded in 1999, of 88.6% versus the less favorable
105.0% recorded by the U.S. property and casualty insurance industry overall.
During the same period, the Company's GWP increased from $346.4 million to
$568.3 million, an increase of 64%; management fees increased from
$51.0 million to $90.7 million, an increase of 78%; commission income increased
from $24.2 million to $54.6 million, an increase of 125%; and total revenue
increased from $280.3 million to $341.9 million, an increase of 22%.
The Company's insurance companies' underwriting activities are focused on
providing accident and health reinsurance, aviation, marine, offshore energy,
property, workers' compensation, group health and medical stop-loss insurance.
As an insurer in the United States, the Company operates on a surplus lines or a
non-admitted basis through HC and on an admitted basis through HCCL, AIC and
USSIC.
The Company's insurance company subsidiaries HC, AIC and USSIC 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"). HCCL, a life insurance
company, is rated "A-" (Excellent) by A.M. Best. 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
aviation, medical stop-loss, occupational accident and workers' compensation
insurance and a variety of accident and health related reinsurance products.
Beginning in 1996 with the acquisition of LDG Re, the Company commenced a
strategy of acquiring through merger or purchase, a number of companies whose
business was underwriting agency activities, primarily in the aviation, medical
stop-loss and workers' compensation insurance businesses. This was done in an
effort to further diversify the Company's operations and to enhance the
Company's ability to
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anticipate and capitalize on opportunities resulting from changing market
conditions in the insurance industry. The Company continued this expansion in
December, 1999, with the acquisition of The Centris Group, Inc. ("Centris") with
its underwriting agency subsidiary, USBenefits Insurance Services, Inc. ("USB"),
the operations of which have been integrated with HCCB. During 1999, the
Company's management fees from underwriting agencies were $90.7 million,
generated by $848.1 million in written premium. Management fees and written
premium are expected to increase in 2000 with the inclusion of USB's business.
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. In
recent years, the Company has significantly expanded its intermediary operations
internally and through acquisitions. The latest acquisition in this area, RML,
was consummated in January, 1999. During 1999, the Company's commission income
from its intermediary operations was $54.6 million.
Subsidiaries of the Company also provide insurance claims adjustment and
servicing to the Company's insurance company and agency subsidiaries and for
unrelated entities. Additionally, from time to time, the Company will make
strategic 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 protecting 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 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.
The property and casualty insurance underwriting business has historically
been cyclical and particular lines of business even 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 lead
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.
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
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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.
Additionally, claims adjusting and servicing subsidiaries provide 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 service provider, and the corollary ability
of such insurance underwriting agency, intermediary and service 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 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 protecting shareholders' equity. The Company expects
to continue to seek to acquire complementary businesses with established
managements and reputations 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 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 net loss exposure through the effective, prudent and
conservative use of reinsurance; and (iii) will continue to review the possible
acquisition of other specialty insurance companies and of other strategic
operational investments.
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.
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 companies,
underwriting agencies and insurance related service companies. Avemco, through
its insurance company subsidiaries, provided property and casualty insurance
principally in the general aviation line of business. Avemco's primary insurance
company subsidiaries were AIC and USSIC. The operations of USSIC were relocated
to Houston, Texas and it became a subsidiary of HC.
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
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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 Holdings, Limited ("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, primarily in the accident and health
marketplace.
On December 20, 1999, the Company acquired all of the outstanding shares of
Centris following a tender offer at a price of $12.50 per share. The total
consideration paid by the Company in connection with the Centris acquisition was
$149.5 million. Centris was the parent corporation of a group of insurance
companies and underwriting agencies principally operating in the medical
stop-loss line of business. Centris' primary insurance company subsidiary was
the entity now known as HCCL, whose operations are being relocated to Houston,
and it has become a subsidiary of HC. The medical stop-loss underwriting agency
operations of Centris have been combined with HCCB's operations.
The Company continues to evaluate possible acquisition candidates and may
complete one or more acquisitions during the remainder of 2000. 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.
DISPOSITIONS
In January, 1999, the Company sold its 21% interest in Underwriters
Indemnity Holdings, the parent of Underwriters Indemnity Company, to RLI
Corporation for $8.2 million. The Company realized a pre-tax gain of
$4.9 million in connection with the sale. The Company's investment in
Underwriters Indemnity Holdings was not material to the Company's' financial
position and results of operations.
In March, 2000, the Company sold Trafalgar Insurance Company ("TIC"), its
Oklahoma domiciled surplus lines insurance company subsidiary, for consideration
which approximated TIC's shareholders' equity determined on a GAAP basis. The
operations of TIC and the gain realized on the sale were not material to the
Company's revenue or net earnings.
INSURANCE COMPANY OPERATIONS
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, 1999 (dollars in thousands):
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1999 1998 1997
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Accident and health reinsurance............... $157,719 28% $114,787 23% $ 39,845 12%
Aviation...................................... 210,029 37 203,573 40 164,519 47
Marine........................................ 11,967 2 13,259 3 22,847 6
Medical stop-loss............................. 69,258 12 7,046 1 3,388 1
Offshore energy............................... 6,727 1 21,682 5 7,469 2
Property...................................... 63,309 11 106,515 21 85,379 25
Workers' compensation......................... 27,747 5 8,958 2 -- --
Other......................................... 21,575 4 22,456 5 22,952 7
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Total GWP................................... $568,331 100% $498,276 100% $346,399 100%
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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, 1999 (dollars in thousands):
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1999 1998 1997
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Accident and health reinsurance............... $ 37,725 27% $ 39,949 33% $ 24,777 17%
Aviation...................................... 68,513 49 53,030 44 75,280 53
Marine........................................ 5,483 4 5,654 5 17,271 12
Medical stop-loss............................. 20,332 15 3,415 3 3,388 2
Offshore energy............................... 1,133 1 2,324 2 1,416 1
Property...................................... 2,945 2 8,356 6 8,636 6
Workers' compensation......................... 673 -- 1,059 1 -- --
Other......................................... 3,120 2 8,096 6 12,085 9
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Total NWP................................... $139,924 100% $121,883 100% $142,853 100%
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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 ASSUMED--The Company's current reinsurance underwriting
activities are primarily in: 1) 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 2) facultative (individual account) reinsurance, particularly
in the aviation and property lines of business. Typically, the facultative
reinsurance 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 was the Company's largest overall line of
business in 1999 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 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. Insurance
claims related to general aviation business tend to be seasonal, with the bulk
of claims incurring during the spring and summer months.
The Company has been underwriting aviation risks since 1981 through HC. AIC
has been insuring aviation risks since 1959. GWP has risen consistently since
1997, increasing from a combined $164.5 million to $210.0 million in 1999. 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. 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 aviation underwriting
agency, HCCA. In 1997 and 1998, the Company experienced a decline in NWP due to
the implementation of the Company's reinsurance program at AIC following its
acquisition in 1997. Aviation NWP increased during 1999 as HCC increased its
retentions.
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.
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MARINE--The Company underwrites marine risks for ocean going vessels ("Blue
Water"), inland and coastal trading vessels ("Brown Water") and 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, primarily in HC.
Premium rates were adequate through 1995 but competition has created downward
pressure on these rates causing a reduction in the Company's GWP from
$22.8 million in 1997 to $12.0 million in 1999 and a corresponding decrease in
NWP from $17.3 million to $5.5 million for the same period. Underwriting
operations have been moved to HC's branch office in London, where a substantial
amount of the Company's business originates and experienced underwriters are
more available.
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, primarily in HC. 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
disproportionately high GWP and NWP during 1998 was the result of one large
policy that was substantially reinsured. Underwriting operations have been moved
to HC's branch office in London, where a substantial amount of the Company's
business originates and experienced underwriters are more available.
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 or a major platform explosion.
PROPERTY--The Company specializes in writing the property 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 and physical damage and catastrophe risks including flood
and earthquake.
The Company has written property business since 1986, primarily in HC.
During 1996, premium rates began to soften and this trend has continued through
1999 due in a large part to excess capacity and the absence of significant
catastrophe losses. GWP has declined from $85.4 million in 1997 to
$63.3 million in 1999 and is expected to decline further in 2000. NWP also
declined from $8.6 million to $2.9 million in the same period. Property NWP will
always be substantially less than GWP due to the amount of reinsurance purchased
in order to protect the Company from catastrophe exposure. Underwriting
operations have been moved to HC's branch office in London, where a substantial
amount of the Company's business originates and experienced underwriters are
more available.
Reinsurance is maintained on both a proportional and an excess of loss basis
to ensure adequate protection, particularly against catastrophic exposures. As
an example, through December 31, 1999, the Company had gross losses of
$60.8 million with respect to hurricanes Georges and Mitch both of which
occurred during 1998. The after-tax net loss, after reinsurance, with respect to
these hurricanes was $4.3 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 in HC during 1996. These risks are underwritten
primarily by LDG Re, 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
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truckers. The Company's GWP increased from $39.8 million in 1997 to
$157.7 million in 1999. This growth is from the Company's increased
participation in and the growth of the business underwritten by LDG Re. NWP has
not increased as dramatically as HC does not retain a large percentage of this
premium.
MEDICAL STOP-LOSS--Medical stop-loss business is written on an aggregate and
specific basis for employer sponsored self-insured health plans. This business
is underwritten by HCCB. The Company first began writing this business in 1996,
and GWP and NWP have increased as a result of greater participation in and the
growth of the business underwritten by HCCB. This growth is expected to continue
in the future.
WORKERS' COMPENSATION--The Company began writing statutory workers'
compensation business primarily in USSIC in 1998 by participating in the
business underwritten by HCCES. It is the intent of the Company to grow this
line of business in the future internally and possibly through acquisition. GWP
and NWP will rise in 2000, although substantial proportional reinsurance will
continue to be purchased. There is relatively no catastrophe exposure in this
line of business as there is very little business currently written in
California or Florida. Losses in this line of business generally take longer to
develop than in the Company's other lines of business.
INSURANCE COMPANY SUBSIDIARIES
HOUSTON CASUALTY COMPANY--HC, the Company's principal insurance company
subsidiary, is a Texas domiciled property and casualty insurer. HC 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, 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, 1999, HC had
statutory policyholders' surplus of $250.2 million.
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
established its London branch operation in order to more closely align its
underwriting operations with the London market, a historical focal point for
many of the markets in which HC operates. To this end, the Company has
transferred most of the underwriting responsibility for the lines of business HC
writes, except aviation and, to some extent, accident and health to this branch.
HCC LIFE INSURANCE COMPANY--HCCL is an Indiana domiciled life insurance
company and former subsidiary of Centris, which became a direct subsidiary of HC
in December, 1999 following the Centris acquisition. HCCL is rated "A-"
(Excellent) by A.M. Best and operates as an accident and health insurer on an
admitted basis in 41 states and the District of Columbia. The Company expects to
expand HCCL's operations through its utilization as an insurer of medical
stop-loss and related life insurance products underwritten by HCCB. At
December 31, 1999, HCCL had statutory policyholder's surplus of $70.5 million.
U.S. SPECIALTY INSURANCE COMPANY--USSIC is a Texas domiciled property and
casualty insurance company. It is a direct subsidiary of HC. USSIC is rated "A+,
VII" by A.M. Best and "AA" by Standard & Poor's. USSIC operates on an admitted
basis throughout the United States primarily writing general aviation, workers'
compensation and alternative workers' compensation insurance produced by
underwriting agency subsidiaries of the Company. As of December 31, 1999, USSIC
had statutory policyholders' surplus of $104.4 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+, VI" by A.M. Best and "AA" by Standard & Poor's and
operates primarily as a direct market underwriter of general aviation
9
<PAGE>
business on an admitted basis throughout the United States and Canada (except
Quebec). In addition, as a part of the Company's overall operations, AIC has
become an insurer of medical stop-loss products underwritten by HCCB. At
December 31, 1999, AIC had statutory policyholders' surplus of $62.5 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
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, 1999 (dollars in thousands):
<TABLE>
<CAPTION>
1999 1998 1997
------------------- ------------------- -------------------
<S> <C> <C> <C> <C> <C> <C>
Accident and health reinsurance................ $452,017 53% $356,530 50% $258,716 55%
Aviation....................................... 91,156 11 92,668 13 49,581 10
Medical stop-loss.............................. 184,302 22 182,528 26 93,435 20
Occupational accident.......................... 54,000 6 48,100 7 46,909 10
Workers' compensation.......................... 52,758 6 4,429 1 -- --
Other.......................................... 13,883 2 21,932 3 24,798 5
-------- --- -------- --- -------- ---
Total premium.............................. $848,116 100% $706,187 100% $473,439 100%
======== === ======== === ======== ===
</TABLE>
UNDERWRITING AGENCY SUBSIDIARIES
LDG REINSURANCE CORPORATION--LDG Re, with operations in Wakefield,
Massachusetts and New York City, New York, acts as an underwriting manager
writing accident and health, special risks and alternative workers' compensation
reinsurance. In 1999, LDG Re generated approximately $360.2 million of written
premium, the majority of which was written on behalf of non-affiliated insurance
companies.
LDG RE (LONDON), LTD.--LDG Re-London, located in London, England, is an
underwriting manager writing accident and health reinsurance business. During
1999, LDG Re-London generated approximately $90.1 million of written premium.
During 2000, LDG Re-London will underwrite primarily on behalf of HC-London.
HCC BENEFITS CORPORATION--HCCB, with its home office in Atlanta, Georgia and
regional offices in Costa Mesa, California, Wakefield, Massachusetts,
Minneapolis, Minnesota and Dallas, Texas, acts as an underwriting manager
writing medical stop-loss and excess medical insurance products to employer
sponsored self-insured health plans. In 1999, HCCB generated approximately
$184.3 million of medical stop-loss written premium and $6.7 million of other
written premium, the majority of which was underwritten on behalf of
non-affiliated insurance companies. In 1999, the acquired Centris agencies
generated approximately $214.2 million of written premium. It is expected that
in 2000 a substantial part of the overall written premium for HCCB will be
issued through HCCL and AIC.
HCC AVIATION GROUP, INC.--HCCA, with offices in Dallas, Texas and Glendale,
California, together with the Company's insurance company subsidiary AIC,
provides the base for the Company's presence in
10
<PAGE>
the domestic general aviation market. HCCA acts as an underwriting manager on
behalf of USSIC 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 1999, HCCA generated
approximately $91.1 million of written premium.
HCC EMPLOYER SERVICES, INC.--HCCES, with operations in Northbrook, Illinois,
Montgomery, Alabama and Dallas, Texas, acts as an underwriting manager on behalf
of affiliated and non-affiliated insurance companies, providing occupational
accident and health insurance to self-employed truckers and workers'
compensation insurance to small and medium size businesses. HCCES generated
approximately $101.6 million in premium in 1999.
Management fees generated by underwriting agency subsidiaries in 1999
amounted to $90.7 million, an increase of 23% over 1998.
COMBINED INSURANCE COMPANY AND UNDERWRITING AGENCY OPERATIONS
The Company's combined GWP was over $1.1 billion, after intercompany
eliminations, in 1999 with its insurance company operations writing
$568.3 million and its underwriting agency operations writing $848.1 million,
before intercompany eliminations.
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 who 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, based in Houston, Texas, is an intermediary
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 unaffiliated insurance and
reinsurance companies and underwriting agencies as well as the Company's
insurance company subsidiaries.
Commission income generated by intermediary subsidiaries in 1999 amounted to
$54.6 million, an increase of 42% over 1998.
11
<PAGE>
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 consist of fees, commissions or the sales price of
products sold. The subsidiaries currently operating in this segment provide
insurance claims adjusting services and the 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 $28.5 million in 1999, up 28% from 1998.
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 is also intended to protect 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
quality reinsurance at a reasonable price. The Company's reinsurance programs
renew throughout the year. Excess of loss programs that expired in 1999 have
been renewed with some increase in reinsurance costs. Additionally, the Company
retained higher percentages of its business in connection with certain lines of
business reinsured on a proportional basis. The Company plans to continue to
increase its retentions as underwriting conditions improve.
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 intends to continue to share its
business with these partners as underwriting profitability returns, to allow
them to recoup losses and build even stronger relationships for the future.
Management believes that increased retentions during profitable periods are 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 or severely curtail their writings. 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. The Company
places additional reinsurance on an excess of loss basis to cover individual
risk severity of loss and on a catastrophe basis to cover 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.
12
<PAGE>
The Company writes business in areas exposed to catastrophic losses and has
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. This 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
the Company to share with the reinsurers in 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 2000 treaty
reinsurance programs were placed with more than 92 domestic and foreign
reinsurers. As of December 31, 1999, the total amount recoverable from
reinsurers with respect to property and casualty insurance was approximately
$683.3 million, of which $91.3 million represents paid losses recoverable (in
the ordinary course of business) and $597.5 million represents outstanding
losses and estimated incurred but not reported loss recoverables, less a
$5.5 million reserve for potentially uncollectible reinsurance. In addition,
ceded unearned premium was $133.7 million. Of the $683.3 million,
$122.8 million was added as a result of the Centris acquisition in late
December, 1999. As of December 31, 1999, the Company held $154.1 million of
irrevocable letters of credit and $19.9 million in cash to collateralize a
portion of the total amount recoverable and had other payable balances due to
its reinsurers of $213.0 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 property and casualty reinsurance balances relating to
the reinsurers with net recoverable balances greater than $10.0 million as of
December 31, 1999. The total recoverables column includes paid loss recoverable,
outstanding loss recoverable, IBNR recoverable and ceded unearned premium.
<TABLE>
<CAPTION>
LETTERS OF CREDIT,
A.M. BEST TOTAL CASH DEPOSITS AND
REINSURER RATING LOCATION RECOVERABLES OTHER PAYABLES NET
- --------- ------------ --------------- ------------ ------------------ ------------
<S> <C> <C> <C> <C> <C>
December 31, 1999:
Underwriters at Lloyd's................... A United Kingdom $156,650,000 $22,805,000 $133,845,000
Underwriters Indemnity Company *.......... A- Texas 50,451,000 4,201,000 46,250,000
SCOR Reinsurance Company.................. A+ New York 41,137,000 1,740,000 39,397,000
AXA Reinsurance Company................... A+ Delaware 37,690,000 5,013,000 32,677,000
NAC Reinsurance Company **................ A+ New York 23,153,000 6,105,000 17,048,000
Transamerica Occidental Life Ins. Co...... A+ California 22,481,000 6,102,000 16,379,000
St. Paul Fire and Marine Insurance Co..... A+ Minnesota 17,577,000 1,721,000 15,856,000
Odyssey America Reinsurance Corp.......... A Connecticut 19,114,000 5,891,000 13,223,000
Sun Life Assurance Company of Canada...... A++ Canada 17,996,000 4,786,000 13,210,000
GE Reinsurance............................ A++ Illinois 16,535,000 4,869,000 11,666,000
Chartwell Reinsurance Company ***......... A Minnesota 12,736,000 2,074,000 10,662,000
</TABLE>
- ------------------------------
* Underwriters Indemnity Company was acquired by RLI Corporation in January,
1999.
** NAC Reinsurance Corporation was acquired by XL Capital, Ltd. in June, 1999.
*** Chartwell Reinsurance Company was acquired by Trenwick Group, Inc. in
October, 1999.
13
<PAGE>
Prior to our acquisition of Centris, its life insurance company subsidiary,
now HCCL, sold its entire block of life insurance and annuity business to Life
Reassurance Corporation of America in the form of an indemnity reinsurance
contract. Ceded life and annuity benefits amounted to $95.8 million as of
December 31, 1999.
In 1999, the Company recorded a $43.5 million provision for reinsurance to
reflect an estimated $29.5 million pre-tax loss for the insolvency of one of the
Company's reinsurers and an estimated $14.0 million pre-tax loss, the majority
of which represents the discount on ceded reserves, related to the commutation
of all liabilities with another reinsurer. This commutation, made at the
Company's request, was finalized and settled in February, 2000. In connection
with the commutation, the Company received cash and other amounts totaling
$56.5 million. Additionally, as of December 31, 1999 the Company has established
a reserve of $5.5 million which management believes is sufficient to absorb any
potential losses related to its reinsurance recoverables. However, the adverse
economic environment in the worldwide insurance industry has placed great
pressure on reinsurers and the results of their operations and these conditions
could, ultimately, affect reinsurers' solvency. Historically, there have been
insolvencies following 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 upon 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 will continue to take actions to protect shareholders'
equity.
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>
1999 1998 1997 1996 1995
-------- -------- -------- -------- --------
GWP....................................... $576,184 $500,962 $346,094 $340,367 $338,753
NWP....................................... 150,261 123,315 143,068 189,022 184,028
Policyholders' surplus.................... 315,474 369,401 331,922 288,863 251,125
GWP ratio................................. 182.6% 135.6% 104.3% 117.8% 134.9%
GWP industry average (1).................. * 147.9 154.7 179.9 194.0
NWP ratio................................. 47.6% 33.4% 43.1% 65.4% 73.3%
NWP industry average (1).................. * 84.3 89.7 105.2 113.0
</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. However, industry standards and rating agency criteria
place these ratios at 300% and 200%, respectively. 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 generally well below industry norms. These ratios
are expected to increase, however, as the Company's insurance company
subsidiaries continue to increase their participation as policy issuers for
business written by the Company's underwriting agency subsidiaries and their
retention of that business.
14
<PAGE>
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>
1999 1998 1997 1996 1995
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Loss ratio.......................................... 107.1% 67.2% 61.6% 64.4% 66.4%
Expense ratio....................................... 22.8 15.7 17.2 19.2 18.1
----- ----- ----- ----- -----
Combined ratio...................................... 129.9% 82.9% 78.8% 83.6% 84.5%
===== ===== ===== ===== =====
Combined ratio excluding the effects of the
provision for reinsurance in 1999................. 104.1%
=====
Industry average (1)................................ 107.7% 105.6% 101.6% 105.7% 106.3
</TABLE>
- ------------------------
(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 described 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.
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
the Company underwrites, such as most aviation, property and medical stop-loss,
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
15
<PAGE>
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, 1999, the difference between the latest
re-estimated liability and the reserves as originally estimated.
The following loss development triangle shows development in loss reserves
on a gross basis:
<TABLE>
<CAPTION>
1999 1998 1997 1996 1995 1994 1993 1992
-------- -------- -------- -------- -------- -------- -------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance sheet
reserves:.......... $871,104 $460,511 $275,008 $229,049 $200,756 $170,957 $144,178 $ 129,503
Cumulative paid as
of:
One year later..... 229,746 160,324 119,453 118,656 97,580 82,538 83,574
Two years later.... 209,724 179,117 167,459 143,114 126,290 130,379
Three years
later............ 193,872 207,191 166,541 157,509 158,973
Four years later... 214,046 192,540 176,472 182,193
Five years later... 195,930 195,269 192,512
Six years later.... 197,147 213,052
Seven years
later............ 215,280
Re-estimated
liability as of:
End of year........ 871,104 460,511 275,008 229,049 200,756 170,957 144,178 129,503
One year later..... 550,545 308,501 252,236 243,259 186,898 163,967 162,827
Two years later.... 316,250 249,013 248,372 207,511 183,015 176,817
Three years
later............ 250,817 247,053 214,738 203,137 194,419
Four years later... 248,687 220,695 211,546 215,531
Five years later... 217,892 218,182 222,746
Six years later.... 214,498 234,115
Seven years
later............ 231,269
Cumulative redundancy
(deficiency)....... $(90,034) $(41,242) $(21,768) $(47,931) $(46,935) $(70,320) $(101,766)
</TABLE>
16
<PAGE>
The gross deficiencies result from three principal conditions. The first is
the development of large claims on individual policies which were either
reported late by or for which reserves were increased as subsequent information
became available from the insurance companies that are responsible for adjusting
the claims. However, as these policies were substantially reinsured, there was
no material effect to the Company's net earnings. Secondly, during 1999 in
connection with the insolvency of one of the Company's reinsurers and with the
commutation, finalized subsequent to year-end, of all liabilities with another,
the Company re-evaluated all reserves and IBNR related to business placed with
these reinsurers to determine the ultimate losses it might conservatively
expect. These reserves were then used as the basis for the determination of the
provision for reinsurance recorded in 1999. Thirdly, for the years prior to
1997, the runoff of the retrocessional excess of loss business, which the
Company underwrote between 1988 and 1991, experienced gross development. This
development is due primarily to the delay in reporting of losses by the London
insurance market, coupled with the unprecedented number of catastrophe losses
during that period. This business is substantially reinsured, thereby not having
a material effect on the Company's net earnings.
17
<PAGE>
The following loss development triangle shows development in loss reserves
on a net basis:
<TABLE>
<CAPTION>
1999 1998 1997 1996 1995 1994 1993 1992
-------- -------- -------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Gross reserves for loss and LAE.... $871,104 $460,511 $275,008 $229,049 $200,756 $170,957 $144,178 $129,503
Less reinsurance recoverables...... 597,498 341,599 155,374 111,766 101,497 95,279 82,289 81,075
-------- -------- -------- -------- -------- -------- -------- --------
Reserves for loss and LAE, net of
reinsurance...................... 273,606 118,912 119,634 117,283 99,259 75,678 61,889 48,428
Effect on loss reserves of 1999
write off of ceded outstanding
and IBNR reinsurance
recoverables..................... -- 63,851 15,008 2,636 1,442 51 -- --
-------- -------- -------- -------- -------- -------- -------- --------
Reserves for loss and LAE net of
reinsurance and adjusted for
writeoff......................... 273,606 182,763 134,642 119,919 100,701 75,729 61,889 48,428
Cumulative paid, net of
reinsurance, as of:
One year later................... 56,052 48,775 47,874 41,947 36,500 29,258 18,978
Two years later.................. 64,213 66,030 56,803 49,283 41,207 32,733
Three years later................ 72,863 64,798 56,919 46,576 36,536
Four years later................. 67,355 60,441 51,536 38,480
Five years later................. 61,781 53,110 40,327
Six years later.................. 53,879 40,550
Seven years later................ 41,133
Eight years later................
Nine years later.................
Ten years later..................
Re-estimated liability, net of
reinsurance, as of:
End of year...................... 273,606 182,763 134,642 119,919 100,701 75,729 61,889 48,428
One year later................... 187,377 120,049 116,145 95,764 72,963 59,659 45,812
Two years later.................. 116,745 101,595 94,992 74,887 60,079 44,964
Three years later................ 97,353 85,484 76,474 62,224 46,129
Four years later................. 80,890 73,660 64,377 48,993
Five years later................. 69,528 64,103 50,785
Six years later.................. 59,408 50,585
Seven years later................ 46,071
Eight years later................
Nine years later.................
Ten years later..................
Cumulative redundancy
(deficiency)..................... $ (4,614) $ 17,897 $ 22,566 $ 19,811 $ 6,201 $ 2,481 $ 2,357
<CAPTION>
1991 1990 1989
-------- -------- --------
<S> <C> <C> <C>
Gross reserves for loss and LAE.... $123,248 $108,027 $96,477
Less reinsurance recoverables...... 83,727 60,194 45,160
-------- -------- -------
Reserves for loss and LAE, net of
reinsurance...................... 39,521 47,833 51,317
Effect on loss reserves of 1999
write off of ceded outstanding
and IBNR reinsurance
recoverables..................... -- -- --
-------- -------- -------
Reserves for loss and LAE net of
reinsurance and adjusted for
writeoff......................... 39,521 47,833 51,317
Cumulative paid, net of
reinsurance, as of:
One year later................... 18,416 23,450 22,660
Two years later.................. 23,057 33,815 34,300
Three years later................ 31,903 35,912 40,806
Four years later................. 33,875 42,465 41,878
Five years later................. 34,970 43,422 46,734
Six years later.................. 36,203 43,690 47,164
Seven years later................ 35,413 44,611 47,229
Eight years later................ 35,960 43,715 47,928
Nine years later................. 44,203 46,308
Ten years later.................. 46,646
Re-estimated liability, net of
reinsurance, as of:
End of year...................... 39,521 47,833 51,317
One year later................... 38,575 44,887 49,475
Two years later.................. 38,656 45,435 47,313
Three years later................ 39,176 44,689 48,085
Four years later................. 40,407 45,507 47,884
Five years later................. 43,418 46,805 47,933
Six years later.................. 45,142 48,932 48,086
Seven years later................ 43,924 50,190 49,392
Eight years later................ 39,858 49,732 50,324
Nine years later................. 47,422 50,101
Ten years later.................. 48,479
Cumulative redundancy
(deficiency)..................... $ (337) $ 411 $ 2,838
</TABLE>
18
<PAGE>
The Company believes that its loss reserves are adequate to provide for all
material 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, 1999 (dollars in
thousands):
<TABLE>
<CAPTION>
1999 1998 1997
-------- -------- --------
<S> <C> <C> <C>
Reserves for loss and LAE at beginning of year.............. $460,511 $275,008 $229,049
Reserves acquired with purchase of subsidiaries............. 146,233 3,877 1,919
Provision for loss and LAE for claims occurring in the
current year.............................................. 595,425 461,429 269,505
Increase in estimated loss and LAE for claims occurring in
prior years (1)........................................... 90,034 33,493 23,187
-------- -------- --------
Incurred loss and LAE....................................... 685,459 494,922 292,692
-------- -------- --------
Loss and LAE payments for claims occurring during:
Current year.............................................. 191,353 152,972 129,199
Prior years............................................... 229,746 160,324 119,453
-------- -------- --------
Loss and LAE payments....................................... 421,099 313,296 248,652
-------- -------- --------
Reserves for loss and LAE at end of the year................ $871,104 $460,511 $275,008
======== ======== ========
</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, 1999 (dollars in thousands):
<TABLE>
<CAPTION>
1999 1998 1997
-------- -------- --------
<S> <C> <C> <C>
Reserves for loss and LAE at beginning of year.............. $118,912 $119,634 $117,283
Reserves acquired with purchase of subsidiaries............. 55,523 3,877 1,919
Effect on loss reserves of write off of ceded outstanding
and IBNR reinsurance recoverables......................... 82,343 -- --
Provision for loss and LAE for claims occurring in the
current year.............................................. 105,036 105,895 100,288
Increase (decrease) in estimated loss and LAE for claims
occurring in prior years (2).............................. 4,614 (14,593) (3,774)
-------- -------- --------
Incurred loss and LAE....................................... 109,650 91,302 96,514
-------- -------- --------
Loss and LAE payments for claims occurring during:
Current year.............................................. 36,770 47,126 48,208
Prior years............................................... 56,052 48,775 47,874
-------- -------- --------
Loss and LAE payments....................................... 92,822 95,901 96,082
-------- -------- --------
Reserves for loss and LAE at end of the year................ $273,606 $118,912 $119,634
======== ======== ========
</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, 1999, 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.
19
<PAGE>
During 1999, the Company had net loss and LAE deficiency of $4.6 million
relating to prior year losses compared to redundancies of $14.6 million in 1998
and $3.8 million in 1997. The deficiencies and redundancies in the net reserves
result from the Company's and its actuaries' continued review of its loss
reserves and the increase or 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.
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 HCCL, AIC and USSIC, because of the types of risks
insured, are not considered to have significant environmental exposures.
Therefore, the Company does not expect to 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 and preferred and common equity securities. As of
December 31, 1999, the Company had $581.3 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 its Investment Committee 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 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 engaged a nationally prominent investment advisor, New England
Asset Management, a subsidiary of Berkshire Hathaway, Inc., in January, 2000 to
oversee the Company's investments, subject to the Company's investment policies.
Previously, the Company had managed its own investments. Therefore, it is
possible that the Company's investment policies may be changed based on the
advice of the investment advisor, although no material change is anticipated.
The insurance companies acquired in the Centris acquisition had portfolios
of preferred and common stocks which are recorded at market value for financial
reporting purposes. It has not been the Company's policy to invest in equity
securities. These equity securities were sold during the first quarter of 2000.
The Company's financial statements reflect an unrealized loss on fixed
income securities available for sale as of December 31, 1999, of $893,000. 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 losses of the Company's insureds. The underwriting agencies and
intermediaries typically have short-term investments, which are fiduciary funds
held on behalf of others. As of December 31, 1999, the Company had cash and
short-term
20
<PAGE>
investments of approximately $242.2 million, of which, $73.8 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, 1999:
<TABLE>
<CAPTION>
1999 1998 1997
-------- -------- --------
<S> <C> <C> <C>
Average investments......................................... $552,654 $522,209 $496,010
Net investment income....................................... 30,933 29,335 27,587
Average yield (1)........................................... 5.6% 5.6% 5.6%
Average tax equivalent yield (1)............................ 7.1% 7.3% 7.3%
</TABLE>
- ------------------------
(1) Excluding realized and unrealized capital gains and losses.
The table set forth below summarizes, by type, the investments of the
Company as of December 31, 1999:
<TABLE>
<CAPTION>
AMOUNT PERCENT OF TOTAL
-------- ----------------
<S> <C> <C>
Short-term investments...................................... $215,694 37%
U.S. Treasury securities.................................... 57,505 10
Obligations of states, municipalities and political
subdivisions.............................................. 99,459 17
Special revenue............................................. 163,644 28
Other fixed income securities............................... 22,033 4
Marketable equity securities................................ 19,970 3
Other investments........................................... 3,017 1
-------- ---
Total investments......................................... $581,322 100%
======== ===
</TABLE>
The table set forth below indicates the expected maturity distribution of
the Company's fixed income securities as of December 31, 1999:
<TABLE>
<CAPTION>
AMOUNT PERCENT OF TOTAL
-------- ----------------
<S> <C> <C>
One year or less............................................ $ 37,052 11%
One year to five years...................................... 107,647 32
Five years to ten years..................................... 97,250 28
Ten years to fifteen years.................................. 68,695 20
More than fifteen years..................................... 31,997 9
-------- ---
Total fixed income securities............................. $342,641 100%
======== ===
</TABLE>
The value of the Company's portfolio of fixed income securities is inversely
correlated to changes in market interest rates. In addition, some of the
Company's fixed income securities have call or prepayment options. This could
subject the Company to reinvestment risk should interest rates fall or issuers
call their securities and the Company invests the proceeds at lower interest
rates. The Company mitigates this risk by investing in securities with varied
maturity dates, so that only a portion of the portfolio will mature at any point
in time. The Company's fixed income securities have a weighted average maturity
of seven years and a weighted average duration of five years.
BANK LOAN
On December 17, 1999, the Company entered into a Loan Agreement (the
"Facility") with a group of banks. The Facility includes a $300.0 million
Revolving Loan Facility. Borrowing under the Facility may be made from time to
time by the Company for general corporate purposes until the Facility's
expiration on
21
<PAGE>
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 of HC, HCCL, AIC and USSIC and by the pledge of stock 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 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 $150.0 million Revolving Credit
Facility and $100.0 million Short-term Revolving Loan Facility entered into as
of March 8, 1999, which has been terminated, and to partially fund the Centris
acquisition. As of December 31, 1999, total debt outstanding under the Facility
was $235.0 million. Unrelated to the Facility, in December, 1999, the Company
entered into an $80 million bridge loan with a bank in connection with the
Centris acquisition. The full amount of the bridge loan was repaid prior to
December 31, 1999, immediately following the Centris acquisition.
FOREIGN EXCHANGE
The Company's balances denominated in foreign currency fluctuate as
transactions are recorded and settled. On a very limited basis in the past, the
Company has entered into foreign currency forward contracts as a hedge against
foreign currency fluctuations. RML, purchased by the Company during January,
1999, has a revenue stream in US Dollars but incurs expenses in British Pound
Sterling ("GBP"). To mitigate the foreign exchange risk, the Company entered
into foreign currency forward contracts expiring at staggered times through
December, 2000. As of December 31, 1999, the Company had forward contracts to
sell US $12.0 million for GBP at an average rate of 1.00 GBP equals US $1.60.
The foreign currency forward contracts are used to convert currency at a known
rate in an amount which approximates average monthly expenses. Thus, the effect
of these transactions is to limit the foreign currency exchange risk of the
recurring monthly expenses. In the future, the Company may continue to 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.
COMPETITION
The insurance business is generally highly competitive. The Company faces
competition from domestic and foreign insurers, underwriting agencies and
intermediaries. The Company's profitability is affected by many other factors,
including rate competition, severity and frequency of claims, interest rates,
state regulations, the judicial climate and general business conditions, all of
which are outside the control 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 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
22
<PAGE>
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 powers
to an insurance official. The regulation 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 reporting procedures and
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 the insurance holding company system regulatory requirements of the
states of California, Indiana, Maryland, Missouri, Pennsylvania and Texas. Under
such regulations, the Company is required to report information regarding its
capital structure, financial condition and management. 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 regulatory requirements.
State insurance laws regulate the payment of dividends and other
distributions by insurance companies to their shareholders. Generally, insurance
companies are limited by such laws to the payment of dividends above a specified
level. Dividends in excess of those thresholds are "extraordinary dividends" and
subject to prior regulatory approval.
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 may have arrangements with residents or business entities
licensed to act in the state.
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 grant, renew and
revoke licenses and approvals, and to implement regulations, and licenses may be
denied or revoked for various reasons, including the violation of such
regulations. 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 requirements or
interpretations of regulatory authorities. There can be no assurance that the
Company has all such required licenses, approvals or complying contracts or that
such licenses, approvals or complying contracts can always be
23
<PAGE>
obtained or continued. 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 material adverse effect on the business and results of
operations of the Company.
HC is domiciled in Texas. It operates on an admitted basis in Texas and may
write reinsurance on all lines of business that it may write on a direct basis.
HC is an accredited reinsurer in 34 states 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 companies on risks which are not insured by
admitted companies. All surplus lines insurance is written through licensed
surplus lines insurance brokers, who are required to be knowledgeable of and
follow specific state laws prior to placing a risk with a surplus lines insurer.
Additionally, HC operates a branch office in London, England which is subject to
regulation by regulatory authorities in the United Kingdom. AIC is domiciled in
Maryland and operates as a licensed admitted insurer in all states, the District
of Columbia, and all Canadian provinces (except Quebec). USSIC is domiciled in
Texas and operates as a licensed admitted insurer in all states and the District
of Columbia. HCCL is domiciled in Indiana, and operates as a licensed admitted
insurer in 41 states and the District of Columbia.
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, 1999, each of the
Company's domestic insurance 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 state 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 likely 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
24
<PAGE>
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. A form of financial
services modernization legislation was enacted at the Federal level in 1999
through the Gramm-Leach-Bliley Act of 1999. Such legislation could have
significant implications on the banking, insurance and securities industries and
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 full extent to which such Federal or state legislative or regulatory
initiatives will or may affect the Company's operations, 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 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, 1999, the Company had 1,182 employees, including
employees of the acquired Centris entities. The Company is in the process of
reorganizing and combining Centris' operations with HCCB's operations. In
accordance with the restructuring and integration plans, the Company expects to
eliminate 86 employee positions. The employees who are expected to remain after
the Centris integration include five executive officers, 11 senior management,
111 management and 969 other personnel. Of this number, 168 are employed by the
Company's insurance subsidiaries, 585 are employed by the Company's underwriting
agency subsidiaries, 129 are employed by the Company's insurance intermediary
subsidiaries, 144 are employed by the Company's insurance services subsidiaries
and 70 are employed at the corporate headquarters. 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.
25
<PAGE>
ITEM 2. PROPERTIES
The Company's principal and executive offices are located in Houston, Texas,
in an approximately 51,000 square foot building owned by HC. HC also owns an
77,000 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 40 locations elsewhere in the United States and in England.
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>
SQUARE
SUBSIDIARY LOCATION FOOTAGE LEASE TERMINATION DATE
- ---------- ------------------------ --------- ----------------------
<S> <C> <C> <C>
LDG Re Wakefield, Massachusetts 34,000 October 31, 2001
AIC Frederick, Maryland 40,000 Owned
HCCB Costa Mesa, California 22,000 March 31, 2007
Atlanta, Georgia 21,000 January 31, 2006
HCCA Dallas, Texas 40,000 March 31, 2004
HCCEB Houston, Texas 27,000 August 31, 2001 and
October 31, 2002
HCCES Northbrook, Illinois 19,000 April 1, 2005
RML London, England 15,000 September 29, 2003
</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 such claims or 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 or claims 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 1999.
26
<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, 1998 through December 31, 1999, as reported by the NYSE were as
follows:
<TABLE>
<CAPTION>
1999 1998
----------------------------- -----------------------------
HIGH LOW HIGH LOW
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
First quarter.............................................. 21 7/16 16 23 15/16 15 5/8
Second quarter............................................. 22 11/16 17 15/16 23 11/16 19 5/8
Third quarter.............................................. 25 1/8 13 7/8 22 15/16 18 1/8
Fourth quarter............................................. 16 11/16 8 21 1/4 16 1/16
</TABLE>
On March 24, 2000, the closing sales price of the Company's Common Stock as
reported by the NYSE was $13 7/8.
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 10, 2000, there were
49,095,126 shares of issued and outstanding Common Stock held by 1,119
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 through the first
quarter of 1997. The Company increased the quarterly cash dividend to $0.03 per
share in April, 1997, to $0.04 per share beginning in April, 1998 and 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 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.
27
<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 31,
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)(3)
----------------------------------------------------
1999 1998 1997 1996 1995
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
STATEMENT OF EARNINGS DATA:
Revenue
Net earned premium...................... $141,362 $143,100 $162,571 $170,068 $158,632
Management fees......................... 90,713 74,045 51,039 28,651 25,373
Commission income....................... 54,552 38,441 24,209 21,477 21,053
Net investment income................... 30,933 29,335 27,587 23,593 21,757
Net realized investment gain (loss)..... (4,164) 845 (328) 8,341 1,636
Other operating income.................. 28,475 22,268 15,239 18,656 10,371
-------- -------- -------- -------- --------
Total revenue......................... 341,871 308,034 280,317 270,786 238,822
Expense
Loss and LAE............................ 109,650 91,302 96,514 114,464 105,374
Operating expense
Policy acquisition costs, net......... 8,177 10,978 13,580 8,218 10,634
Compensation expense.................. 77,488 56,077 51,458 42,102 48,162
Provision for reinsurance............. 43,462 -- -- -- --
Restructuring expense................. 5,489 -- -- -- --
Other operating expense............... 47,247 36,063 31,628 26,382 26,540
Merger expense........................ -- 107 8,069 26,160 --
-------- -------- -------- -------- --------
Total operating expense............. 181,863 103,225 104,735 102,862 85,336
Interest expense.......................... 12,964 6,021 6,004 4,993 6,471
-------- -------- -------- -------- --------
Total expense....................... 304,477 200,548 207,253 222,319 197,181
-------- -------- -------- -------- --------
Earnings before income tax provision...... 37,394 107,486 73,064 48,467 41,641
Income tax provision...................... 12,271 35,208 23,305 9,885 9,896
-------- -------- -------- -------- --------
Net earnings........................ $ 25,123 $ 72,278 $ 49,759 $ 38,582 $ 31,745
======== ======== ======== ======== ========
BASIC EARNINGS PER SHARE DATA:
Earnings per share (1).................... $ 0.51 $ 1.51 $ 1.06 $ 0.86 $ 0.75
======== ======== ======== ======== ========
Weighted average shares outstanding (1)... 49,061 47,920 46,995 44,795 42,577
======== ======== ======== ======== ========
DILUTED EARNINGS PER SHARE DATA:
Earnings per share (1).................... $ 0.51 $ 1.48 $ 1.03 $ 0.84 $ 0.74
======== ======== ======== ======== ========
Weighted average shares outstanding (1)... 49,649 48,936 48,209 46,043 43,113
======== ======== ======== ======== ========
Cash dividends declared, per share........ $ 0.20 $ 0.16 $ 0.12 $ 0.06
======== ======== ======== ========
</TABLE>
28
<PAGE>
<TABLE>
<CAPTION>
DECEMBER 31,
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)(3)
----------------------------------------------------------
1999 1998 1997 1996 1995
---------- ---------- ---------- -------- --------
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Total investments..................... $ 581,322 $ 525,646 $ 518,772 $468,725 $454,831
Premium, claims and other
receivables......................... 607,986 382,630 252,618 168,300 155,164
Reinsurance recoverables.............. 683,275 372,672 176,965 132,328 117,700
Ceded unearned premium................ 133,657 149,568 84,610 71,758 78,460
Goodwill.............................. 263,687 88,043 34,758 10,922 11,211
Total assets.......................... 2,650,623 1,709,069 1,198,132 965,793 896,476
Loss and LAE payable.................. 871,104 460,511 275,008 229,049 200,756
Unearned premium...................... 188,524 201,050 152,094 156,268 151,976
Total debt............................ 242,546 121,600 80,750 72,917 71,628
Shareholders' equity.................. 457,428 439,863 365,601 296,524 255,484
Book value per share (1) (2).......... 9.29 9.12 7.66 6.49 5.70
</TABLE>
- ------------------------
(1) These amounts have been adjusted to reflect the effects of the five-for-two
stock split payable as a 150% stock dividend to shareholders of record April
30, 1996.
(2) Book value per share is calculated by dividing the sum of shares outstanding
plus contractually issuable shares into total shareholders' equity.
(3) Certain amounts in the 1998, 1997, 1996 and 1995 selected consolidated
financial data have been reclassified to conform to the 1999 presentation.
Such reclassifications had no effect on the Company's net earnings,
shareholders' equity, or cash flows.
29
<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 POTENTIAL YEAR 2000 INSURANCE COVERAGE 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 INCLUDE WORDS SUCH AS "ANTICIPATE,",
"BELIEVE", "ESTIMATE", "EXPECT", "INTEND", "PLAN", "PROBABLY" 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 accident and health reinsurance,
aviation, marine, offshore energy, property, workers' compensation, group health
and medical stop-loss insurance, marketed directly by the Company and produced
by independent agents.
The Company has substantially increased its shareholders' equity through the
issuance of equity securities 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 aviation, medical
stop-loss, occupational accident and workers' compensation insurance and and a
variety of accident and health related reinsurance products.
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.
Since 1996, the Company has focused its acquisition activities on expanding
its underwriting agency and intermediary operations for three principal reasons.
The first reason is an attempt to increase the
30
<PAGE>
management fees and commission income components of the Company's total revenue,
which management believes has been a more predictable and stable source of
revenue than the potential underwriting profits from insurance company
operations. The second reason is an effort to insulate the Company from a
decline in its revenue growth rate as insurance premium rates become more
competitive in the lines of business in which the Company specializes and the
Company becomes more selective in its underwriting approach, resulting in
reduced earned premium. The third reason is to provide a future source of
premium revenue to the Company's insurance company subsidiaries and more control
of its distribution channels.
Operations whose revenue are included in other operating income consist of
insurance related service 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 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, 1999 (dollars in thousands):
<TABLE>
<CAPTION>
1999 1998 1997
--------- --------- ---------
<S> <C> <C> <C>
Direct...................................................... $ 291,513 $ 228,629 $ 177,728
Reinsurance assumed......................................... 276,818 269,647 168,671
--------- --------- ---------
Gross written premium..................................... 568,331 498,276 346,399
Reinsurance ceded........................................... (428,407) (376,393) (203,546)
--------- --------- ---------
Net written premium....................................... 139,924 121,883 142,853
Change in unearned premium.................................. 1,438 21,217 19,718
--------- --------- ---------
Net earned premium.......................................... $ 141,362 $ 143,100 $ 162,571
========= ========= =========
</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, 1999:
<TABLE>
<CAPTION>
1999 1998 1997
-------- -------- --------
<S> <C> <C> <C>
Net earned premium.......................................... 41.4% 46.5% 58.0%
Management fees............................................. 26.5 24.0 18.2
Commission income........................................... 16.0 12.5 8.7
Net investment income....................................... 9.0 9.5 9.8
Net realized investment gain (loss)......................... (1.2) 0.3 (0.1)
Other operating income...................................... 8.3 7.2 5.4
----- ----- -----
Total revenue............................................. 100.0 100.0 100.0
Loss and LAE................................................ 32.1 29.6 34.4
Net operating expense *..................................... 53.2 33.5 37.4
Interest expense............................................ 3.8 2.0 2.1
----- ----- -----
Earnings before income tax provision...................... 10.9 34.9 26.1
Income tax provision........................................ 3.6 11.4 8.3
----- ----- -----
Net earnings.............................................. 7.3% 23.5% 17.8%
===== ===== =====
</TABLE>
- ------------------------
* Includes restructuring expense, provision for reinsurance and merger
expense.
31
<PAGE>
YEAR END DECEMBER 31, 1999 VERSUS YEAR END DECEMBER 31, 1998
Total revenue increased 11% to $341.9 million in 1999, from $308.0 million
in 1998. The revenue increase was principally a result of increases in non-risk
bearing management fees and commission income. This growth is from new business
and acquisitions. It is anticipated that revenue from the insurance company
subsidiaries will begin to grow in 2000 as earned premium and investment income
begin to rise as a result of higher retentions and cash flow from increased
gross written premium.
Net investment income increased 5% to $30.9 million in 1999 from $29.3
million in 1998, reflecting a slightly higher level of investment assets and
increased interest rates earned on short-term investments. During 2000, the
Company will utilize its available cash flow to reduce its debt but,
nevertheless, it is anticipated that net investment income will continue to
grow.
Net realized investment losses from sales or write-downs of equity
securities were $3.9 million in 1999, compared to losses of $166,000 in 1998. In
1999, the Company recognized a $4.3 million realized loss from the write down of
one equity investment to its estimated fair market value based upon market
quotations and a sale expectation. Net realized investment losses from
disposition of fixed income securities were $164,000 in 1999, compared to gains
of $1.0 million in 1998. The losses in 1999 resulted from the sale of bonds by
HC in connection with the funding of the Centris acquisition.
Compensation expense increased to $77.5 million in 1999, from $56.1 million
in 1998. This increase reflects a normal progressional increase due to business
growth as well as the effect of acquisitions. Other operating expenses increased
$11.1 million to $47.2 million during the same period for similar reasons.
Currency conversion gains amounted to $442,000 in 1999, compared to gains of
$219,000 in 1998.
Interest expense was $13.0 million for 1999, an increase of $6.9 million
from 1998. The increase is a result of increased debt outstanding as a result of
fundings for acquisitions.
Income tax expense was $12.3 million in 1999 compared to $35.2 million in
1998. The decrease was due to the reduction in earnings before income tax. The
effective tax rates for both years were approximately the same. The effective
tax rate is expected to increase in 2000 as a result of increased goodwill
amortization which is not deductible for tax purposes, higher state income taxes
and foreign taxes for which credit against United States taxes may be limited.
The increased state income taxes result from expected increased income from
intermediaries and brokers subject to state income taxes as well as an expected
increase in income in states with higher income tax rates.
Net earnings in 1999 decreased to $25.1 million from $72.3 million in 1998,
due to the provision for reinsurance, which equated to $28.3 million after
income taxes, or $0.57 per diluted share, the higher net loss ratio and the
restructuring expense, which, after income taxes, amounted to $0.07 per diluted
share. Diluted earnings per share decreased to $0.51 per share from $1.48 per
share during the same period.
The Company's book value per share was $9.29 as of December 31, 1999, up
from $9.12 as of December 31, 1998.
32
<PAGE>
SEGMENTS
INSURANCE COMPANIES
GWP increased 14% to $568.3 million in 1999, from $498.3 million in 1998.
Accident and health reinsurance, medical stop-loss and workers' compensation
premium showed strong growth, as the insurance company subsidiaries continue to
participate in more of the business written by underwriting agency subsidiaries.
This growth was partially offset by reductions in property and offshore energy
premium as a result of the continuing extremely soft conditions in these
markets. NWP in 1999 increased 15% to $139.9 million from $121.9 million in
1998, as a result of increases in retained aviation and medical stop-loss
premium. Net earned premium in 1999 decreased slightly to $141.4 million from
$143.1 million in 1998 as changes in earned premium lag behind changes in
written premium. It is anticipated that NWP will rise during 2000, as the
insurance company subsidiaries begin to increase retentions as rates start to
improve.
Loss and LAE increased to $109.7 million in 1999, from $91.3 million in
1998, and the GAAP net loss ratio increased to 77.6% in 1999, from 63.8% in
1998. The GAAP gross loss ratio was 116.8% in 1999 compared to 109.2% in 1998.
The deterioration is primarily from poor results in the aviation, property and
medical stop-loss lines of business. The Company has taken steps to reduce these
gross loss ratios, primarily by increasing premium rates and more selective risk
selection. The statutory net combined ratio was 129.9% (104.1% excluding the
effects of the provision for reinsurance) in 1999 compared to 82.9% in 1998.
During 1999, the Company had net loss and LAE deficiency of $4.6 million
relating to prior year losses compared to a redundancy of $14.6 million in 1998.
During 1999, the Company had gross loss and LAE deficiency of $90.0 million
compared to a deficiency of $33.5 million in 1998. The gross deficiency results
from the development of large claims on individual policies which were either
reported late or reserves were increased as subsequent information became
available. However, as these policies were substantially reinsured, there is no
material effect to the Company's net earnings. The deficiencies and redundancies
in the net reserves result from the Company's and its actuaries' continued
review of its loss reserves and the increase or 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 material net incurred
losses.
In 1999, the insurance company subsidiaries recorded a $43.5 million
provision for reinsurance to reflect an estimated $29.5 million pre-tax loss for
the insolvency of one of the subsidiaries' reinsurers and an estimated $14.0
million pre-tax loss, the majority of which represents the discount on ceded
reserves, related to the commutation of all liabilities with another reinsurer.
This commutation, made at the Company's request, was finalized and settled in
February, 2000. In connection with the commutation, the subsidiaries received
cash and other amounts totaling $56.5 million. Additionally, as of December 31,
1999 the Company has a reserve of $5.5 million which management believes is
sufficient to absorb any potential losses related to its reinsurance
recoverables. However, the adverse economic environment in the worldwide
insurance industry has placed great pressure on reinsurers and the results of
their operations and these conditions could, ultimately, affect reinsurers'
solvency. Historically, there have been insolvencies following 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 upon 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 will continue to take
actions to protect shareholders' equity.
Policy acquisition costs, which are net of ceding commissions on reinsurance
ceded, decreased $2.8 million to $8.2 million in 1999, from $11.0 million in
1998, reflecting a greater amount of gross premium ceded and, therefore, a
higher level of ceding commissions.
33
<PAGE>
Net earnings of the insurance companies decreased to a loss of $10.7 million
in 1999, from a profit of $33.8 million in 1998, as a result of the provision
for reinsurance, the effect of restructuring and the higher net loss ratio.
Generally, underwriting profitability has deteriorated as the extremely
competitive market conditions continue to affect current results. These results
will probably continue to deteriorate even as there is a transition to a harder
market but, eventually, should become profitable as rates increase and
underwriting becomes more selective.
UNDERWRITING AGENCIES
Management fees increased 23% to $90.7 million in 1999, from $74.0 million
in 1998. Premium underwritten on behalf of affiliated and unaffiliated insurance
companies increased to $848.1 million in 1999, an increase of 20% from $706.2
million in 1998. Both increases resulted from acquisitions and internal growth
of existing operations. Management fees and premium underwritten are expected to
continue to increase in 2000 as a result of the Centris acquisition and
increased premium.
Net earnings of the underwriting agencies decreased to $17.2 million in
1999, from $19.4 million in 1998. Recent acquisitions have not yet had a
positive impact on net earnings due to licensing and other regulatory
requirements, which are in process. In addition, the underwriting agency segment
incurred a $1.4 million, net of income tax, restructuring expense in 1999.
Growth in underwriting agency premium has a positive impact on both the
insurance company segment and the intermediary segment.
INTERMEDIARIES
Commission income increased 42% to $54.6 million in 1999, from $38.4 million
in 1998, primarily as a result of the acquisition of RML, effective January 1,
1999. Net earnings of the intermediaries decreased to $13.6 million in 1999 from
$16.9 million in 1998. The increase in net earnings generated by RML was offset
by fewer large brokerage transactions in 1999 and other reductions, including a
$551,000 (net of income tax) restructuring expense in 1999.
OTHER OPERATIONS
Other operating revenue increased 28% to $28.5 million in 1999, from $22.3
million in 1998. There was a general increase in revenue of the service
operations, net of the decrease in revenue related to operations disposed of in
late 1998. Other operating net earnings increased to $7.6 million in 1999, from
$4.8 million in 1998 due principally to the higher earnings of the service
operations. Period to period comparisons may vary substantially depending on
activity in the purchase or disposition of strategic investments.
ACQUISITIONS
In connection with the Centris acquisition, a plan was formulated, approved
and implemented prior to December 31, 1999 to eliminate Centris' corporate
staff, combine the Centris medical stop-loss operations with those of HCCB and
combine certain Centris and HCCB production and underwriting facilities. In
accordance with the plan, certain Centris employees were terminated with
severance benefits to be paid in accordance with Centris' employment contracts
for executives or the HCC severance plan for Centris employees who did not have
employment contracts. These severance obligations were accrued as of the
acquisition date, included in the purchase price allocation and will not be
included in expense in the Company's statements of earnings. Additionally,
accruals of $848,000 were made at that date for future
34
<PAGE>
lease costs of office space made redundant by the plan. The following table
provides a detailed analysis of the accruals:
<TABLE>
<CAPTION>
ACCRUED AT ACCRUED AT
PURCHASE DECEMBER 31,
DATE PAID IN 1999 1999
---------- ------------ ------------
<S> <C> <C> <C>
Contractual executive severance accruals................. $6,744,000 $878,000 $5,866,000
Other severance accruals................................. 397,000 -- 397,000
Lease obligation accruals................................ 848,000 -- 848,000
---------- -------- ----------
Total.................................................. $7,989,000 $878,000 $7,111,000
========== ======== ==========
</TABLE>
It is expected that the significant portion of the severance accruals will
be paid prior to April 30, 2000, in accordance with the contractual terms of the
severance agreements. Management is still evaluating what additional actions, if
any, are necessary to finalize the integration of the Centris operations. Any
additional accruals will be recorded as an adjustment to the purchase price
allocation.
RESTRUCTURING
The Company recorded a restructuring charge and associated expenses of $5.5
million during the fourth quarter of 1999. Since its initial public offering in
1992, the Company has completed more than fifteen acquisitions for a total value
exceeding $750.0 million. During that time, total employees have grown from less
than 100 to more than 1,000. As a result of this rapid growth, management
believes certain operating inefficiencies occurred. At the beginning of the
fourth quarter of 1999, management made a review of its operations and
determined that they could be made more efficient, principally by reducing the
employee count in certain of its operations. Management believes that this
restructuring will strengthen the Company's corporate and management structure
and enhance future earnings by improving operating efficiency and therefore
profitability. The savings, principally in compensation expense, from the
restructuring is estimated to be approximately $10.0 million to $12.0 million in
the year 2000 and annually thereafter. The terminations that generated the
compensation savings took place in the fourth quarter.
A total of 92 employees were terminated in the fourth quarter as a result of
the Company's restructuring which affected all segments. The Company accrued
severance payments for 27 of these terminated employees at December 31, 1999,
substantially all of which was paid in January, 2000. The restructuring charge
also includes accruals of $911,000 related to future lease costs of office space
made redundant as a result of the restructuring plan and a write down of
$647,000 principally of leasehold improvements and other assets related to the
redundant space. The following table provides a detailed analysis of the charge:
<TABLE>
<CAPTION>
PAID IN ACCRUED EXPENSED
1999 AT 12/31/99 IN 1999
-------- ----------- ----------
<S> <C> <C> <C>
Severance.................................................. $691,000 $3,115,000 $3,806,000
Other...................................................... 125,000 911,000 1,036,000
-------- ---------- ----------
$816,000 $4,026,000 4,842,000
======== ==========
Write down of assets..................................... 647,000
----------
Total restructuring expense.............................. $5,489,000
==========
</TABLE>
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. The revenue growth resulted from increases in non-risk bearing management
fees, commission income, and other
35
<PAGE>
operating income as a result of internal growth and acquisitions. The decrease
in insurance company net earned premium offsets these increases.
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.
Net realized investment losses from sales of equity securities were $166,000
in 1998, compared to losses of $154,000 in 1997. Net realized investment gains
from disposition of fixed income securities were $1.0 million in 1998, compared
to losses of $174,000 in 1997. The gains in 1998 resulted principally from the
sale of bonds upon the liquidation of a subsidiary.
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 hired to oversee the
integration of the Company's many acquisitions.
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 $1.48 in 1998 from $1.03 in
1997.
SEGMENTS
INSURANCE COMPANIES
GWP increased 44% to $498.3 million in 1998 from $346.4 million in 1997, due
primarily to increased aviation, property, medical stop-loss and accident and
health reinsurance 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.
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.
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 expects the increase in AIC's loss reserves to be adequate to cover
any subsequent adverse development of AIC's prior losses.
36
<PAGE>
Loss and LAE decreased $5.2 million in 1998, to $91.3 million, reflecting
the increased use of reinsurance, despite the catastrophe loss in 1998 from the
hurricanes Georges and Mitch. Excluding the effect 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.
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 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.
Policy acquisition costs, which are net of ceding commissions on reinsurance
ceded, decreased $2.6 million to $11.0 million in 1998, from $13.6 million in
1997, reflecting a greater amount of gross premium ceded and, therefore, a
higher level of ceding commissions.
Net earnings of the insurance companies decreased to $33.8 million in 1998
from $40.6 million in 1997, as a result of a general deterioration in
underwriting results.
UNDERWRITING AGENCIES
Management fees in 1998 increased 45% to $74.0 million from $51.0 million in
1997. Premium underwritten on behalf of affiliated and unaffiliated insurance
companies increased to $706.2 million in 1998, an increase of 49% from $473.4
million in 1997. Both increases resulted from acquisitions and internal growth.
Net earnings of the underwriting agencies increased 46% to $19.4 million in
1998 from $13.3 million in 1997 due to acquisitions and internal growth.
INTERMEDIARIES
Commission income increased to $38.4 million in 1998 from $24.2 million in
1997 an increase of 59%. Net earnings of the intermediaries increased 139% to
$16.9 million in 1998 from $7.1 million in 1997. The increases result from
internal growth and a number of large brokerage transactions.
OTHER OPERATIONS
Other operating income increased 46% to $22.3 million in 1998, from $15.2
million in 1997, 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. Net earnings from other operations increased for
the same reasons.
LIQUIDITY AND CAPITAL RESOURCES
The Company receives substantial cash from premiums, reinsurance
recoverables, and management fee 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,
37
<PAGE>
payment of premiums to reinsurers, purchase of investments, debt service, policy
acquisition costs, operating expenses, income and other taxes and dividends.
As of December 31, 1999, 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 31, 2000. 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 (8.5% at December 31, 1999). At December 31, 1999, letters of credit
totaling $17.2 million had been issued to insurance companies by the bank on
behalf of the subsidiaries, with total securities collateralizing the line of
$21.5 million.
On December 17, 1999, the Company entered into a Loan Agreement (the
"Facility") with a group of banks. The Facility includes a $300.0 million
Revolving Loan Facility. Borrowing 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 of HC, HCCL, AIC and USSIC and by the pledge of stock 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 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 $150.0 million Revolving Credit
Facility and $100.0 million Short-term Revolving Loan Facility entered into as
of March 8, 1999 which has been terminated, and to partially fund the Centris
acquisition. As of December 31, 1999, total debt outstanding under the Facility
was $235.0 million. Unrelated to the Facility, in December, 1999, the Company
entered into an $80.0 million bridge loan with a bank in connection with the
Centris acquisition. The full amount of the bridge loan was repaid prior to
December 31, 1999, immediately following the Centris acquisition.
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, 1999, the Company had cash and short-term investments of
approximately $242.2 million. The Company's consolidated investment portfolio of
$581.3 million as of December 31, 1999, of which $216.3 million is short-term
investments, is available to provide additional liquidity.
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 and USSIC paid no dividends in 1999. During 2000, HC and USSIC's ordinary
dividend capacity is approximately $25.0 million and $10.4 million,
respectively.
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. Because AIC paid an extraordinary dividend of
$45.0 million during December, 1999, any dividends paid by AIC during 2000 will
need prior regulatory approval. No dividends from AIC are anticipated during
2000.
HCCL is limited by the State of Indiana in the amount of dividends it may
pay in any twelve month period, without prior regulatory approval, to the
greater of net gain from operations for the prior calendar
38
<PAGE>
year or ten percent (10%) of statutory capital and surplus as of the prior year
end. During 2000, HCCL's ordinary dividend capacity will be approximately
$7.0 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.
The value of the Company's portfolio of fixed income securities is inversely
correlated to changes in market interest rates. In addition, some of the
Company's fixed income securities have call or prepayment options. This could
subject the Company to reinvestment risk should interest rates fall or issuers
call their securities and the Company reinvests the proceeds at lower interest
rates. The Company mitigates this risk by investing in securities with varied
maturity dates, so that only a portion of the portfolio will mature at any point
in time.
As of December 31, 1999, the Company had a net deferred tax asset of $18.3
million compared to $3.4 million as of December 31, 1998. 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 and
the acquisition of Centris in late December, 1999 resulted in increases in gross
loss reserves, life and annuity policy benefits, gross unearned premiums and
deferred policy acquisition costs since 1997. Related amounts of reinsurance
recoverables, ceded life and policy benefits, ceded unearned premium and
deferred ceding commissions also increased. The Company continues to collect its
receivables and recoverables generally in the ordinary course of business 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 its liquidity exposure 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 sheets.
As of December 31, 1999, 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. However, industry standards and rating agency criteria
place these ratios at 300% and 200%, respectively. The Company's property and
casualty insurance company subsidiaries maintain a premium to surplus ratio
significantly lower than such guidelines, generally well below industry norms
and for the year ended December 31, 1999, their annual statutory GWP was 182.6%
of their statutory policyholders' surplus and their NWP was 47.6% 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.
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
39
<PAGE>
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 $300.0 million Facility's interest rate floats with that
of the market. Any significant increase in interest rates 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, 1999, 1998 and 1997, the gain (loss)
from currency conversion was $442,000, $219,000 and ($884,000), respectively.
On a very limited basis in the past, the Company has entered into foreign
currency forward contracts as a hedge against foreign currency fluctuations.
RML, purchased by the Company during January, 1999, has a revenue stream in US
Dollars but incurs expenses in GBP. To mitigate the foreign exchange risk, the
Company entered into foreign currency forward contracts expiring at staggered
times through December 2000. As of December 31, 1999, the Company had forward
contracts to sell US $12.0 million for GBP at an average rate of 1.00 GBP equals
US$1.60. The foreign currency forward contracts are used to convert currency at
a known rate in an amount which approximates average monthly expenses. Thus, the
effect of these transactions is to limit the foreign currency exchange risk of
the recurring monthly expenses. In the future, the Company may continue to 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 a form of speculative or trading investment.
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 is now effective for all fiscal quarters of fiscal years
beginning after June 15, 2000, with early adoption permitted. The Company has
utilized derivatives or hedging strategies only infrequently in the past and in
immaterial amounts, although it is currently using derivatives and hedging
strategies to a greater extent as it expands its foreign operations. The effects
of SFAS No. 133, as well as the timing of its adoption, are currently being
reviewed by management.
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 second 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
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 information as a result of the Year 2000 date
change. The Company's expenditures in
40
<PAGE>
connection with the Year 2000 issues associated with its own systems did not
have a material effect on the Company's results of operations. No additional
costs are anticipated.
Although the Company experienced no material system failures attributed to
the Year 2000 changeover, 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. As with other companies in the
insurance industry, the Company has evaluated and continues to evaluate the
potential Year 2000 insurance exposures. 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, insureds 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 such subsidiaries. The nature of the Company's response to
such attempted claims are 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.
EURO CONVERSION
On January 1, 1999, certain member countries of the European Union
irrevocably fixed the conversion rates between their national currencies and a
common currency, the "Euro", which became their common legal currency on that
date. The participating countries' former national currencies will continue to
serve as legal tender and denominations of the Euro between January 1, 1999 and
January 1, 2002. The conversion to the Euro is scheduled to be completed on
July 1, 2002, when the national currencies will cease to exist. The Company does
not expect the introduction of the Euro to have a material effect on the
Company's business, software plans, financial condition or results of
operations.
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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 rate 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
has not used 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 value of the Company's portfolio of fixed income securities is inversely
correlated to changes in the market interest rates. In addition, some of the
Company's fixed income securities have call or prepayment options. This could
subject the Company to reinvestment risk should interest rates fall or issuers
call their securities and the Company reinvests the proceeds at lower interest
rates. The Company mitigates this risk by investing in securities with varied
maturity dates, so that only a portion of the portfolio will mature at any point
in time. The fair value of the Company's fixed income securities as of December
31, 1999 and 1998 was $342.6 million and $393.2 million, respectively. If
interest rates were to change 1%, the fair value of the Company's fixed income
securities would change approximately $17.2 million as of December 31, 1999.
This compares to change in value of $21.9 million as of December 31, 1998 for
the same 1% change in interest rates. 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 December 31, 1999, the Company had $235.0 million in debt
outstanding under the Facility. At this debt level, a 1% change in market
interest rates would change the Company's annual interest expense by $2.4
million. As of December 31, 1998, the Company had $105.0 million in debt
outstanding under its previous facility. At that debt level, the 1% change in
market interest rates would have changed interest expense by $1.1 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, if any) as of December 31, 1999 was $20.0 million, compared to
$18.2 million as of December 31, 1998. If the market price of all marketable
equity securities were to change by 10% as of these dates, the fair value of the
Company's equity portfolio would have changed $2.0 million as of December 31,
1999 and $1.8 million as of December 31, 1998.
42
<PAGE>
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 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.
The table below shows the net amounts of significant foreign currency
balances at December 31, 1999 and 1998 converted to US Dollars. It also shows
the expected dollar change in fair value that would occur if exchange rates
changed 10% from exchange rates in effect at those times:
<TABLE>
<CAPTION>
1999 1998
----------------------------- -----------------------------
HYPOTHETICAL 10% HYPOTHETICAL 10%
US DOLLAR CHANGE IN US DOLLAR CHANGE IN
EQUIVALENT FAIR VALUE EQUIVALENT FAIR VALUE
---------- ---------------- ---------- ----------------
<S> <C> <C> <C> <C>
British Pound Sterling.................. $5,974,000 $597,000 $8,086,000 $809,000
Euro and 11 national currencies......... 1,054,000 105,000 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.
On a very limited basis in the past, the Company has entered into foreign
currency forward contracts as a hedge against foreign currency fluctuations.
RML, purchased by the Company during January, 1999, has a revenue stream in US
Dollars but incurs expenses in GBP. To mitigate the foreign exchange risk, the
Company entered into foreign currency forward contracts expiring at staggered
times through December, 2000. As of December 31, 1999, the Company had forward
contracts to sell US $12.0 million for GBP at an average rate of 1.00 GBP equals
US$1.60. The foreign currency forward contracts are used to convert currency at
a known rate in an amount which approximates average monthly expenses. Thus, the
effect of these transactions is to limit the foreign currency exchange risk of
the recurring monthly expenses. In the future, the Company may continue to 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 financial statements and financial statement schedules listed in the
accompanying index are filed as part 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, 1999, 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, 1999, 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, 1999, 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, 1999, 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
On December 20, 1999, the Company filed a report on Form 8-K/A related to
its acquisition of Centris. Such report, as amended, included financial
statements of Centris and certain required pro forma financial information.
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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.
<TABLE>
<S> <C> <C>
HCC INSURANCE HOLDINGS, INC.
(Registrant)
By: /s/ STEPHEN L. WAY
------------------------------------------
(Stephen L. Way)
CHAIRMAN OF THE BOARD
Dated: March 30, 2000 AND CHIEF EXECUTIVE OFFICER
</TABLE>
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 (Principal March 30, 2000
(Stephen L. Way) Executive Officer)
/s/ JAMES M. BERRY*
------------------------------------------- Director March 30, 2000
(James M. Berry)
/s/ MARVIN P. BUSH*
------------------------------------------- Director March 30, 2000
(Marvin P. Bush)
/s/ FRANK J. BRAMANTI*
------------------------------------------- Director and Executive Vice March 30, 2000
(Frank J. Bramanti) President
/s/ PATRICK B. COLLINS*
------------------------------------------- Director March 30, 2000
(Patrick B. Collins)
/s/ JAMES R. CRANE*
------------------------------------------- Director March 30, 2000
(James R. Crane)
/s/ J. ROBERT DICKERSON*
------------------------------------------- Director March 30, 2000
(J. Robert Dickerson)
/s/ EDWARD H. ELLIS, JR. Senior Vice President and
------------------------------------------- Chief Financial Officer March 30, 2000
(Edward H. Ellis, Jr.) (Chief Accounting Officer)
/s/ EDWIN H. FRANK, III*
------------------------------------------- Director March 30, 2000
(Edwin H. Frank, III)
/s/ ALAN W. FULKERSON*
------------------------------------------- Director March 30, 2000
(Alan W. Fulkerson)
/s/ WALTER J. LACK*
------------------------------------------- Director March 30, 2000
(Walter J. Lack)
</TABLE>
46
<PAGE>
<TABLE>
<C> <S> <C>
/s/ STEPHEN J. LOCKWOOD*
------------------------------------------- Director and Vice Chairman March 30, 2000
(Stephen J. Lockwood)
/s/ JOHN N. MOLBECK, JR.
------------------------------------------- Director, President and Chief March 30, 2000
(John N. Molbeck, Jr.) Operating Officer
</TABLE>
<TABLE>
<S> <C> <C> <C>
*By: /s/ JOHN N. MOLBECK, JR.
--------------------------------------
John N. Molbeck, Jr., March 30, 2000
ATTORNEY-IN-FACT
</TABLE>
47
<PAGE>
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES
<TABLE>
<S> <C>
Report of Independent Accountants........................... F-1
Consolidated Balance Sheets at December 31, 1999 and 1998... F-2
Consolidated Statements of Earnings for the three years
ended December 31, 1999................................... F-3
Consolidated Statements of Comprehensive Income for the
three years ended December 31, 1999....................... F-4
Consolidated Statements of Changes in Shareholders' Equity
for the three years ended December 31, 1999............... F-5
Consolidated Statements of Cash Flows for the three years
ended December 31, 1999................................... F-8
Notes to Consolidated Financial Statements.................. F-9
SCHEDULES:
Report of Independent Accountants on Financial
Statement Schedules..................................... S-1
Schedule 1 Summary of Investments other than Investments
in Related Parties...................................... S-2
Schedule 2 Condensed Financial Information of
Registrant.............................................. S-3
Schedule 3 Supplementary Insurance Information............ S-8
Schedule 4 Reinsurance.................................... S-9
Schedule 5 Valuation and Qualifying Accounts.............. 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 or other Schedules.
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)3.1 --Bylaws of HCC Insurance Holdings, Inc., as amended.
(B)3.2 --Restated Certificate of Incorporation of HCC Insurance
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.
(C)10.1 --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.
(D)10.2 --Share Purchase Agreement dated January 29, 1999, among HCC
Insurance Holdings, Inc. and Gerald Axel, Barry J. Cook,
Gary J. Lockett, Christopher F.B. Mays, Mark E. Rattner,
Marshall Rattner, Inc., John Smith and Keith W. Steed.
(E)10.3 --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.
(F)10.4 --Loan Agreement ($300,000,000 Revolving Loan Facility)
dated as of December 17, 1999 among HCC Insurance
Holdings, Inc. as Borrower, Wells Fargo Bank (Texas),
National Association, as Agent, lead arranger and lender,
Bank of America, N.A. as documentation agent and lender,
Bank of New York as senior managing agent and lender, Bank
One, N.A. as co-agent and lender, First Union National
Bank as syndications agent and lender and Dresdner Bank
AG, New York and Grand Cayman Branches, as co-agent and a
lender.
(F)10.5 --$80,000,000 Note dated December 17, 1999 executed by HCC
Insurance Holdings, Inc. and payable to the order of Wells
Fargo Bank (Texas), National Association.
(G)10.6 --HCC Insurance Holdings, Inc. 1994 Nonemployee Director
Stock Option Plan.
10.7 --HCC Insurance Holdings, Inc. 1992 Incentive Stock Option
Plan, as amended and restated.
10.8 --HCC Insurance Holdings, Inc. 1995 Flexible Incentive Plan,
as amended and restated.
10.9 --HCC Insurance Holdings, Inc. 1997 Flexible Incentive Plan,
as amended and restated.
10.10 --HCC Insurance Holdings, Inc. 1996 Nonemployee Director
Stock Option Plan, as amended and restated.
(D)10.11 --Employment Agreement effective as of January 1, 1999,
between HCC Insurance Holdings, Inc. and Stephen L. Way.
(C)10.12 --Employment Agreement effective as of January 1, 1998,
between HCC Insurance Holdings, Inc. and John N. Molbeck.
Jr.
10.13 --Employment Agreement effective as of December 7, 1998,
between HCC Insurance Holdings, Inc. and Benjamin D.
Wilcox.
</TABLE>
49
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER
- -------
<C> <S>
(C)10.14 --Employment Agreement effective as of January 1, 1998,
between HCC Insurance Holdings, Inc. and Frank J.
Bramanti.
10.15 --Employment Agreement effective as of January 1, 1998,
between HCC Insurance Holdings, Inc. and Edward H. Ellis,
Jr.
(H)10.16 --Agreement and Plan of Merger dated as of October 11, 1999
among HCC Insurance Holdings, Inc., Merger Sub of
Delaware, Inc. and The Centris Group, Inc.
12 --Statement Regarding Computation of Ratios
21 --Subsidiaries of HCC Insurance Holdings, Inc.
23 --Consent of Independent Accountants--PricewaterhouseCoopers
LLP dated March 30, 2000
24 --Powers of Attorney
27 --EDGAR Financial Data Schedule--December 31, 1999
</TABLE>
- ------------------------
(A) Incorporated by reference to the Exhibits to HCC Insurance Holdings,
Inc.'s Registration Statement on Form S-1 (Registration No. 33-48737) filed
October 27, 1992.
(B) 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.
(C) Incorporated by reference to the Exhibits to HCC Insurance Holdings,
Inc.'s Form 10-K for the fiscal year ended December 31, 1998.
(D) Incorporated by reference to the Exhibits to HCC Insurance Holdings, Inc.'s
Form 10-Q for the fiscal quarter ended March 31, 1999.
(E) Incorporated by reference to the Exhibits to HCC Insurance Holdings,
Inc.'s Form 8-K filed March 15, 1999.
(F) Incorporated by reference to the Exhibits to HCC Insurance Holdings,
Inc.'s Form 8-K filed December 20, 1999.
(G) 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.
(H) Incorporated by reference to the Exhibits to HCC Insurance Holdings, Inc.'s
Schedule 14D-1 Tender Offer Statement in respect to shares of The Centris
Group, Inc. filed October 18, 1999.
50
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders
HCC Insurance Holdings, Inc.
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of earnings, of comprehensive income, of changes in
shareholders' equity and of cash flows present fairly, in all material respects,
the financial position of HCC Insurance Holdings, Inc. and its subsidiaries at
December 31, 1999 and 1998, and the results of their operations and their cash
flows for each of the three years in the period ended December 31, 1999, in
conformity with accounting principles generally accepted in the United States.
These financial statements are the responsibility of the Company's management;
our responsibility is to express an opinion on these financial statements based
on our audits. We conducted our audits of these statements in accordance with
auditing standards generally accepted in the United States, 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 provide a reasonable basis
for the opinion expressed above.
PricewaterhouseCoopers LLP
Houston, Texas
March 30, 2000
F-1
<PAGE>
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------------
1999 1998
-------------- --------------
<S> <C> <C>
ASSETS
Investments:
Fixed income securities, at market
(cost: 1999 $343,534,000; 1998 $375,107,000)............ $ 342,641,000 $ 393,238,000
Marketable equity securities, at market
(cost: 1999 $22,493,000; 1998 $1,750,000)............... 19,970,000 2,252,000
Short-term investments, at cost, which approximates
market.................................................. 215,694,000 129,084,000
Other investments, at cost, which approximates fair
value................................................... 3,017,000 1,072,000
-------------- --------------
Total investments..................................... 581,322,000 525,646,000
Cash........................................................ 26,533,000 16,018,000
Restricted cash and cash investments........................ 84,112,000 84,276,000
Commuted receivable......................................... 53,210,000 --
Premium, claims and other receivables....................... 607,986,000 382,630,000
Reinsurance recoverables.................................... 683,275,000 372,672,000
Ceded unearned premium...................................... 133,657,000 149,568,000
Ceded life and annuity benefits............................. 95,760,000 --
Deferred policy acquisition costs........................... 40,450,000 27,227,000
Property and equipment, net................................. 37,804,000 32,983,000
Goodwill.................................................... 263,687,000 88,043,000
Other assets................................................ 42,827,000 30,006,000
-------------- --------------
TOTAL ASSETS.......................................... $2,650,623,000 $1,709,069,000
============== ==============
LIABILITIES
Loss and loss adjustment expense payable.................... $ 871,104,000 $ 460,511,000
Life and annuity policy benefits............................ 95,760,000 --
Reinsurance balances payable................................ 113,373,000 90,983,000
Unearned premium............................................ 188,524,000 201,050,000
Deferred ceding commissions................................. 39,792,000 30,842,000
Premium and claims payable.................................. 584,537,000 337,909,000
Notes payable............................................... 242,546,000 121,600,000
Accounts payable and accrued liabilities.................... 57,559,000 26,311,000
-------------- --------------
Total liabilities..................................... 2,193,195,000 1,269,206,000
SHAREHOLDERS' EQUITY
Common Stock, $1.00 par value; 250,000,000 shares
authorized;
(issued: 1999 48,839,027 shares; 1998 48,252,478
shares)................................................... 48,839,000 48,252,000
Additional paid-in capital.................................. 176,359,000 162,102,000
Retained earnings........................................... 234,922,000 219,804,000
Accumulated other comprehensive income (loss)............... (2,692,000) 9,705,000
-------------- --------------
Total shareholders' equity............................ 457,428,000 439,863,000
-------------- --------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY............ $2,650,623,000 $1,709,069,000
============== ==============
</TABLE>
See Notes to Consolidated Financial Statements.
F-2
<PAGE>
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
------------------------------------------
1999 1998 1997
------------ ------------ ------------
<S> <C> <C> <C>
REVENUE
Net earned premium................................. $141,362,000 $143,100,000 $162,571,000
Management fees.................................... 90,713,000 74,045,000 51,039,000
Commission income.................................. 54,552,000 38,441,000 24,209,000
Net investment income.............................. 30,933,000 29,335,000 27,587,000
Net realized investment gain (loss)................ (4,164,000) 845,000 (328,000)
Other operating income............................. 28,475,000 22,268,000 15,239,000
------------ ------------ ------------
Total revenue................................ 341,871,000 308,034,000 280,317,000
EXPENSE
Loss and loss adjustment expense................... 109,650,000 91,302,000 96,514,000
Operating expense:
Policy acquisition costs, net.................... 8,177,000 10,978,000 13,580,000
Compensation expense............................. 77,488,000 56,077,000 51,458,000
Provision for reinsurance........................ 43,462,000 -- --
Restructuring expense............................ 5,489,000 -- --
Other operating expense.......................... 47,247,000 36,063,000 31,628,000
Merger expense................................... -- 107,000 8,069,000
------------ ------------ ------------
Total operating expense...................... 181,863,000 103,225,000 104,735,000
Interest expense................................... 12,964,000 6,021,000 6,004,000
------------ ------------ ------------
Total expense................................ 304,477,000 200,548,000 207,253,000
------------ ------------ ------------
Earnings before income tax provision......... 37,394,000 107,486,000 73,064,000
Income tax provision............................... 12,271,000 35,208,000 23,305,000
------------ ------------ ------------
NET EARNINGS................................. $ 25,123,000 $ 72,278,000 $ 49,759,000
============ ============ ============
BASIC EARNINGS PER SHARE DATA:
Earnings per share................................. $ 0.51 $ 1.51 $ 1.06
============ ============ ============
Weighted average shares outstanding................ 49,061,000 47,920,000 46,995,000
============ ============ ============
DILUTED EARNINGS PER SHARE DATA:
Earnings per share................................. $ 0.51 $ 1.48 $ 1.03
============ ============ ============
Weighted average shares outstanding................ 49,649,000 48,936,000 48,209,000
============ ============ ============
</TABLE>
See Notes to Consolidated Financial Statements
F-3
<PAGE>
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
----------------------------------------
1999 1998 1997
------------ ----------- -----------
<S> <C> <C> <C>
Net earnings.......................................... $ 25,123,000 $72,278,000 $49,759,000
Other comprehensive income net of tax:
Foreign currency translation adjustment............. 167,000 (344,000) (215,000)
Investment gains (losses):
Investment gains (losses) during the year, net of
deferred tax charge (benefit) of ($8,042,000) in
1999, $1,283,000 in 1998 and $2,373,000 in
1997............................................ (15,271,000) 2,598,000 4,470,000
Less reclassification adjustment for (gains)
losses included in net earnings, net of deferred
tax (charge) benefit of $1,457,000 in 1999,
($296,000) in 1998 and $115,000 in 1997......... 2,707,000 (549,000) 213,000
------------ ----------- -----------
Other comprehensive income (loss)................. (12,397,000) 1,705,000 4,468,000
------------ ----------- -----------
COMPREHENSIVE INCOME.............................. $ 12,726,000 $73,983,000 $54,227,000
============ =========== ===========
</TABLE>
See Notes to Consolidated Financial Statements.
F-4
<PAGE>
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
<TABLE>
<CAPTION>
ACCUMULATED
ADDITIONAL OTHER TOTAL
COMMON PAID-IN RETAINED COMPREHENSIVE TREASURY SHAREHOLDERS'
STOCK CAPITAL EARNINGS INCOME (LOSS) STOCK EQUITY
----------- ------------ ------------ ------------- ------------ -------------
<S> <C> <C> <C> <C> <C> <C>
BALANCE AS OF DECEMBER 31, 1996........ $49,017,000 $138,515,000 $162,132,000 $3,532,000 $(56,670,000) $296,526,000
Net earnings........................... -- -- 49,759,000 -- -- 49,759,000
Other comprehensive income............. -- -- -- 4,468,000 -- 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 -- -- -- 10,470,000
1,332,024 shares of Common Stock issued
for acquisitons....................... 1,332,000 9,805,000 (1,507,000) -- -- 9,630,000
Cash dividends declared, $0.12 per
share................................. -- -- (5,219,000) -- -- (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........................ (3,317,000) (3,430,000) (50,247,000) -- 56,994,000 --
Other.................................. -- -- 291,000 -- -- 291,000
----------- ------------ ------------ ---------- ------------ ------------
BALANCE AS OF DECEMBER 31, 1997.... $47,759,000 $154,633,000 $155,209,000 $8,000,000 $ -- $365,601,000
=========== ============ ============ ========== ============ ============
</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, 1999, 1998 AND 1997
(CONTINUED)
<TABLE>
<CAPTION>
ACCUMULATED
ADDITIONAL OTHER TOTAL
COMMON PAID-IN RETAINED COMPREHENSIVE SHAREHOLDERS'
STOCK CAPITAL EARNINGS INCOME (LOSS) EQUITY
----------- ------------ ------------ ------------- -------------
<S> <C> <C> <C> <C> <C>
BALANCE AS OF DECEMBER 31, 1997....................... $47,759,000 $154,633,000 $155,209,000 $8,000,000 $365,601,000
Net earnings.......................................... -- -- 72,278,000 -- 72,278,000
Other comprehensive income............................ -- -- -- 1,705,000 1,705,000
206,504 shares of Common Stock issued for exercise of
options, including tax benefit of $925,000........... 206,000 1,997,000 -- -- 2,203,000
287,025 shares of Common Stock issued for purchased
companies............................................ 287,000 5,472,000 -- -- 5,759,000
Cash dividends declared, $0.16 per share.............. -- -- (7,683,000) -- (7,683,000)
----------- ------------ ------------ ---------- ------------
BALANCE AS OF DECEMBER 31, 1998................... $48,252,000 $162,102,000 $219,804,000 $9,705,000 $439,863,000
=========== ============ ============ ========== ============
</TABLE>
See Notes to Consolidated Financial Statements.
F-6
<PAGE>
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
(CONTINUED)
<TABLE>
<CAPTION>
ACCUMULATED
ADDITIONAL OTHER TOTAL
COMMON PAID-IN RETAINED COMPREHENSIVE SHAREHOLDERS'
STOCK CAPITAL EARNINGS INCOME (LOSS) EQUITY
----------- ------------ ------------ ------------- -------------
<S> <C> <C> <C> <C> <C>
BALANCE AS OF DECEMBER 31, 1998....................... $48,252,000 $162,102,000 $219,804,000 $ 9,705,000 $439,863,000
Net earnings.......................................... -- -- 25,123,000 -- 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......... 506,000 4,277,000 -- -- 4,783,000
101,330 shares of Common Stock issued for purchased
companies............................................ 101,000 1,899,000 -- -- 2,000,000
414,207 shares of Common Stock contractually issuable
in the future........................................ -- 8,271,000 -- -- 8,271,000
Cash dividends declared, $0.20 per share.............. -- -- (9,733,000) -- (9,733,000)
Other................................................. (20,000) (190,000) (272,000) -- (482,000)
----------- ------------ ------------ ------------ ------------
BALANCE AS OF DECEMBER 31, 1999................... $48,839,000 $176,359,000 $234,922,000 $ (2,692,000) $457,428,000
=========== ============ ============ ============ ============
</TABLE>
See Notes to Consolidated Financial Statements.
F-7
<PAGE>
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
--------------------------------------------
1999 1998 1997
------------- ------------- ------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net earnings.................................... $ 25,123,000 $ 72,278,000 $ 49,759,000
Adjustments to reconcile net earnings to net
cash provided by operating activities:
Change in commuted receivable................. (53,210,000) -- --
Change in premium, claims and other
receivables................................. (92,206,000) (102,804,000) (84,309,000)
Change in reinsurance recoverables............ (231,294,000) (195,707,000) (70,972,000)
Change in ceded unearned premium.............. 31,408,000 (64,958,000) (12,852,000)
Change in deferred policy acquisition costs,
net......................................... (4,659,000) 5,666,000 5,857,000
Change in other assets........................ (12,081,000) 410,000 (4,501,000)
Change in loss and loss adjustment expense
payable..................................... 264,360,000 181,626,000 45,959,000
Change in reinsurance balances payable........ (15,098,000) 47,069,000 24,800,000
Change in unearned premium.................... (31,138,000) 46,074,000 (4,174,000)
Change in premium and claims payable, net of
restricted cash............................. 102,114,000 64,364,000 98,952,000
Change in accounts payable and accrued
liabilities................................. 4,707,000 (9,205,000) (2,794,000)
Net realized investment (gain) loss........... 4,164,000 (845,000) 328,000
Gains on sales of strategic investments....... (5,523,000) (4,694,000) --
Provision for reinsurance..................... 43,462,000 -- --
Depreciation and amortization expense......... 13,398,000 7,388,000 5,189,000
Other, net.................................... (2,630,000) 3,382,000 2,875,000
------------- ------------- ------------
Cash provided by operating activities....... 40,897,000 50,044,000 54,117,000
Cash flows from investing activities:
Sales of fixed income securities................ 131,485,000 18,212,000 27,090,000
Maturity or call of fixed income securities..... 17,050,000 30,202,000 19,173,000
Sales of equity securities...................... 2,886,000 4,160,000 17,656,000
Sales of strategic investments.................. 15,905,000 3,324,000 --
Change in short-term investments................ (14,935,000) (24,667,000) (26,562,000)
Cash paid for companies acquired, net of cash
received...................................... (186,923,000) (33,011,000) (12,948,000)
Cost of investments acquired.................... (70,736,000) (43,968,000) (87,084,000)
Purchase of property and equipment and other.... (9,076,000) (15,320,000) (6,718,000)
------------- ------------- ------------
Cash used by investing activities........... (114,344,000) (61,068,000) (69,393,000)
Cash flows from financing activities:
Proceeds from notes payable..................... 547,000,000 74,200,000 97,500,000
Sale of Common Stock............................ 4,783,000 2,203,000 10,470,000
Payments on notes payable....................... (458,600,000) (49,950,000) (89,667,000)
Dividends paid.................................. (9,221,000) (7,139,000) (4,550,000)
Repurchase of common stock...................... -- -- (324,000)
------------- ------------- ------------
Cash provided by financing activities....... 83,962,000 19,314,000 13,429,000
------------- ------------- ------------
Net change in cash.......................... 10,515,000 8,290,000 (1,847,000)
Cash as of beginning of year................ 16,018,000 7,728,000 9,575,000
------------- ------------- ------------
CASH AS OF END OF YEAR...................... $ 26,533,000 $ 16,018,000 $ 7,728,000
============= ============= ============
</TABLE>
See Notes to Consolidated Financial Statements
F-8
<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. ("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 life and health
insurance to commercial customers in the areas of accident and health
reinsurance, aviation, marine, property, offshore energy, workers' compensation,
group health and medical stop-loss insurance. The principal insurance company
subsidiaries are Houston Casualty Company ("HC") in Houston, Texas, and London,
England; HCC Life Insurance Company ("HCCL") in Houston, Texas; 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, specializing in aviation, medical stop-loss, occupational accident
and workers' compensation insurance and a variety of accident and health related
reinsurance products. The principal agency subsidiaries are LDG Reinsurance
Corporation ("LDG Re") in Wakefield, Massachusetts and New York City, New York;
LDG Re (London), Ltd. ("LDG Re-London") in London, England; HCC Aviation
Insurance Group, Inc. ("HCCA") in Dallas, Texas and Glendale, California; HCC
Employer Services, Inc. ("HCCES") in Northbrook, Illinois, Montgomery, Alabama
and Dallas, Texas; and HCC Benefits Corporation ("HCCB") in Atlanta, Georgia,
Costa Mesa, California, Wakefield, Massachusetts, Minneapolis, Minnesota and
Dallas, Texas. 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
companies 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. 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.
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 the related
deferred income tax effects, 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 maximize the Company's investment yield.
Short-term investments and restricted short-term investments are carried at
cost, which approximates market value.
F-9
<PAGE>
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(1) GENERAL INFORMATION AND SIGNIFICANT ACCOUNTING AND REPORTING POLICIES
(CONTINUED)
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 shorter of the
estimated useful life or 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, 1999 and 1998 is not material.
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
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)
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 also recorded a reserve for uncollectible reinsurance
based on current estimates of collectibility. These estimates could change and
affect the level of the reserve needed.
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 agency
operations which operate in existing lines of business and in the same country.
Goodwill related to acquired agency 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, 1999 and 1998, was $11.5 million and $5.2 million, respectively.
The Company's accounting policy regarding the assessment of the
recoverability of the carrying value of long-lived assets, including goodwill
and other intangibles and property, plant and equipment, is to review the
carrying value of the assets if the facts and circumstances suggest that they
may be impaired. If this review indicates that the carrying value will not be
recoverable, as determined based on the projected undiscounted future cash
flows, the carrying value is reduced to its estimated fair value. Amortization
of goodwill charged to income for the years ended December 31, 1999, 1998 and
1997 was $6.7 million, $3.0 million and $1.6 million, respectively.
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.
As of December 31, 1999 and 1998 the Company included $138.5 million and
$80.1 million, respectively, of certain fiduciary funds in short-term
investments. These are funds held by underwriting agency or intermediary
subsidiaries for the benefit of insurance or reinsurance clients. The Company
earns the interest on these funds.
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)
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
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. For the years ended
December 31, 1999, 1998 and 1997, the gain (loss) from currency conversion was
$442,000, $219,000 and ($884,000), 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.
On a very limited basis in the past, the Company has entered into foreign
currency forward contracts as a hedge against foreign currency fluctuations.
RML, purchased by the Company during January, 1999, has a revenue stream in US
Dollars but incurs expenses in GBP. To mitigate the foreign exchange risk, the
Company entered into foreign currency forward contracts expiring at staggered
times through December, 2000. The foreign currency forward contracts are used to
convert currency at a known rate in an amount which approximates average monthly
expenses. Thus, the effect of these transactions is to limit the foreign
currency exchange risk of the recurring monthly expenses. In the future, the
Company may continue to 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.
To the extent the fair value of the foreign exchange forward contracts
qualify for hedge accounting treatment the gain ($41,000 at December 31, 1999),
or loss due to changes in fair value is not recognized in the financial
statements until realized, at which time the gain or loss is recognized along
with the offsetting loss or gain on the hedged item. To the extent the fair
value of the foreign currency forward contracts do
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)
not qualify for hedge accounting treatment, the gain or loss due to changes in
fair value is recognized in the consolidated statements of earnings, but is
generally offset by changes in value of the underlying exposure.
COMPUTER PRODUCTS AND SERVICES
Revenue from software contracts is recognized when delivery has occurred,
other remaining vendor obligations are no longer significant and collectibility
is probable or in accordance with contract accounting rules when material
modification or customization is required. Revenue from the sale of computer
hardware is recognized when delivery has occurred. Maintenance support is
recognized 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 estimated 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.
EARNINGS PER SHARE
Basic earnings per share is based on the weighted average number of common
shares outstanding during the year 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 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 earnings per share
computation when the underlying conditions for issuance have been met.
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 is now effective for all fiscal quarters of fiscal years
beginning after June 15, 2000, with early adoption permitted. The Company has
utilized derivatives or hedging strategies only infrequently in the past and in
immaterial amounts, although it is currently using derivatives and hedging
strategies to a greater extent as it expands its foreign operations. The effects
of SFAS No. 133, as well as the timing of its adoption, are currently being
reviewed by management.
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
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)
Company during the second 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 shareholders' equity.
RECLASSIFICATIONS
Certain amounts in the 1998 and 1997 consolidated financial statements have
been reclassified to conform with the 1999 presentation. Such reclassifications
had no effect on the Company's shareholders' equity, net earnings or cash flows.
(2) ACQUISITIONS AND DISPOSITIONS
ACQUISITIONS
In 1999 and 1998, the Company acquired certain businesses in transactions
accounted for using the purchase method of accounting, as shown in the chart
below. The Company is still in the process of finalizing the purchase accounting
for The Centris Group, Inc. ("Centris") and the purchase price allocation may
change by amounts which are expected to be immaterial.
<TABLE>
<CAPTION>
CONSIDERATION
-----------------------
SHARES OF GOODWILL
COMPANY'S AMORTIZATION
EFFECTIVE COMMON GOODWILL PERIOD
DATE STOCK CASH RECOGNIZED IN YEARS
--------- --------- ----------- ------------ ------------
<S> <C> <C> <C> <C> <C>
1999
RML.................................... 01/01/99 414,207 $64,600,000 $ 70,800,000 30
Midwest Stop Loss Underwriting......... 01/28/99 110,330 3,000,000 4,800,000 20
Centris................................ 12/31/99 -- 149,500,000 101,900,000 20
1998
Guarantee Insurance Resources.......... 03/01/98 29,029 $21,400,000 $ 20,900,000 20
J.E. Stone and Associates, Inc......... 10/01/98 257,496 5,200,000 9,700,000 20
Sun Employer Services, Inc. ("Sun").... 11/01/98 500 17,600,000 21,300,000 30
North American Insurance
Management Corporation's occupational
accident operations................ 11/24/98 -- 4,000,000 4,000,000 20
</TABLE>
On a combined basis, the fair value of assets acquired was $549.5 million in
1999 and $44.9 million in 1998. The fair value of liabilities assumed was
$499.8 million in 1999 and $46.2 million in 1998. The total consideration was
$227.4 million in 1999 and $50.0 million in 1998. The results of operations of
the businesses acquired in transactions accounted for using the purchase method
of accounting have been included in the consolidated financial statements
beginning on the effective date of each transaction.
In connection with the Sun acquisition, the Company may 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 and the shares are issued. Of these shares, 49,000 are
issuable in 2000 because the contingency had been partially met as of December
31, 1999.
F-14
<PAGE>
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(2) ACQUISITIONS AND DISPOSITIONS (CONTINUED)
The following unaudited pro forma summary presents information as if the
1999 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 pro forma 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. Centris,
whose results of operations are included in the pro forma financial information
below, in 1999 experienced both a loss from discontinued operations of $13.2
million and significant underwriting losses.
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31,
---------------------------------
1999 1998
--------------- ---------------
<S> <C> <C>
UNAUDITED PROFORMA INFORMATION
Revenue..................................................... $447,239,000 $493,551,000
Earnings (loss) from continuing operations.................. (2,062,000) 69,905,000
Net earnings (loss)......................................... (15,293,000) 46,637,000
Basic earnings (loss) per share from continuing
operations................................................ (0.04) 1.46
Diluted earnings (loss) per share from continuing
operations................................................ (0.04) 1.43
Basic earnings (loss) per share............................. (0.31) 0.97
Diluted earnings (loss) per share........................... (0.31) 0.95
</TABLE>
In connection with the Centris acquisition, a plan was formulated, approved
and implemented prior to December 31, 1999 to eliminate Centris' corporate
staff, combine the Centris medical stop-loss operations with those of HCCB and
combine certain Centris and HCCB production and underwriting facilities. In
accordance with the plan, certain Centris employees were terminated with
severance benefits to be paid in accordance with Centris' employment contracts
for executives or the HCC severance plan for Centris employees who did not have
employment contracts. These severance obligations were accrued as of the
acquisition date, included in the purchase price allocation and will not be
included in expense in the Company's statements of earnings. Additionally,
accruals of $848,000 were made at that date for future lease costs of office
space made redundant by the plan. The following table provides a detailed
analysis of the accruals:
<TABLE>
<CAPTION>
ACCRUED AT
PURCHASE PAID IN ACCRUED AT
DATE 1999 12/31/99
---------- -------- ----------
<S> <C> <C> <C>
Contractual executive severance accruals................... $6,744,000 $878,000 $5,866,000
Other severance accruals................................... 397,000 -- 397,000
Lease obligation accruals.................................. 848,000 -- 848,000
---------- -------- ----------
Total.................................................. $7,989,000 $878,000 $7,111,000
========== ======== ==========
</TABLE>
It is expected that the significant portion of the severance accruals will
be paid prior to April 30, 2000 in accordance with the contractual terms of the
severance agreements. Management is still evaluating what additional actions, if
any, are necessary to finalize the integration of the Centris operations. Any
additional accruals will be recorded as an adjustment to the purchase price
allocation.
F-15
<PAGE>
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(2) ACQUISITIONS AND DISPOSITIONS (CONTINUED)
DISPOSITIONS
In January, 1999, the Company sold its 21% interest in Underwriters
Indemnity Holdings, the parent of Underwriters Indemnity Company, to RLI
Corporation for $8.2 million. The Company realized a pre-tax gain of $4.9
million, included in other operating income, in connection with the sale. The
Company's investment in Underwriters Indemnity Holdings, which was accounted for
by the equity method, was not material to the Company's financial position and
results of operations.
(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 cost or 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>
COST OR GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED MARKET
COST GAIN LOSS VALUE
------------- ----------- ----------- ------------
<S> <C> <C> <C> <C>
December 31, 1999:
Marketable equity securities........... $ 22,493,000 $ 8,000 $(2,531,000) $ 19,970,000
US Treasury securities................. 57,941,000 96,000 (532,000) 57,505,000
Obligations of states, municipalities
and political subdivisions........... 263,395,000 2,548,000 (2,839,000) 263,104,000
Other fixed income securities.......... 22,198,000 24,000 (190,000) 22,032,000
------------- ----------- ----------- ------------
Total securities................... $ 366,027,000 $ 2,676,000 $(6,092,000) $362,611,000
============= =========== =========== ============
December 31, 1998:
Marketable equity securities........... $ 1,750,000 $ 502,000 $ -- $ 2,252,000
Strategic operational investments...... 18,842,000 -- (2,900,000) 15,942,000
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................... $ 395,699,000 $19,437,000 $(3,704,000) $411,432,000
============= =========== =========== ============
</TABLE>
F-16
<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, 1999, 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....................................... $ 36,885,000 $ 37,052,000
Due after 1 year through 5 years............................ 107,135,000 107,647,000
Due after 5 years through 10 years.......................... 97,527,000 97,250,000
Due after 10 years through 15 years......................... 69,372,000 68,695,000
Due after 15 years.......................................... 32,615,000 31,997,000
------------ ------------
Total fixed income securities........................... $343,534,000 $342,641,000
============ ============
</TABLE>
As of December 31, 1999, the Company's insurance company subsidiaries had
deposited fixed income securities with an amortized cost of approximately
$40.0 million (market: $40.1 million) to meet the deposit requirements of
various insurance departments.
All investments in fixed income securities and other investments were income
producing for the twelve months preceding December 31, 1999. The sources of net
investment income for the three years ended December 31, 1999, are detailed
below:
<TABLE>
<CAPTION>
1999 1998 1997
----------- ----------- -----------
<S> <C> <C> <C>
Fixed income securities............................... $20,098,000 $20,711,000 $20,937,000
Short-term investments................................ 10,915,000 8,079,000 5,680,000
Equity securities..................................... 36,000 35,000 572,000
Other................................................. -- 607,000 445,000
----------- ----------- -----------
Total investment income............................. 31,049,000 29,432,000 27,634,000
Investment expense.................................... (116,000) (97,000) (47,000)
----------- ----------- -----------
Net investment income............................... $30,933,000 $29,335,000 $27,587,000
=========== =========== ===========
</TABLE>
F-17
<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, 1999:
Fixed income securities................................. $1,226,000 $(1,390,000) $ (164,000)
Marketable equity securities............................ 450,000 (4,391,000) (3,941,000)
Other investments....................................... 120,000 (179,000) (59,000)
---------- ----------- -----------
Realized gain (loss)................................ $1,796,000 $(5,960,000) $(4,164,000)
========== =========== ===========
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)
========== =========== ===========
</TABLE>
Unrealized pre-tax net investment gains (losses) on investments for three
years ended December 31, 1999 is as follows:
<TABLE>
<CAPTION>
1999 1998 1997
------------ ----------- -----------
<S> <C> <C> <C>
Fixed income securities............................... $(19,024,000) $ 3,551,000 $ 8,869,000
Marketable equity securities.......................... (3,025,000) 888,000 (201,000)
Strategic operational investments..................... 2,900,000 (1,403,000) (1,497,000)
------------ ----------- -----------
Net unrealized investment gain (loss)............. $(19,149,000) $ 3,036,000 $ 7,171,000
============ =========== ===========
</TABLE>
(4) PROPERTY AND EQUIPMENT
The following table summarizes property and equipment at December 31, 1999
and 1998:
<TABLE>
<CAPTION>
ESTIMATED
1999 1998 USEFUL LIFE
------------ ------------ --------------
<S> <C> <C> <C>
Buildings and improvements......................... $ 20,001,000 $ 18,995,000 30 to 45 years
Furniture, fixtures and equipment.................. 16,580,000 13,752,000 3 to 10 years
Management information systems..................... 27,769,000 20,615,000 3 to 7 years
------------ ------------
Total property and equipment................... 64,350,000 53,362,000
Less accumulated depreciation and amortization..... (26,546,000) (20,379,000)
------------ ------------
Property and equipment, net.................... $ 37,804,000 $ 32,983,000
============ ============
</TABLE>
Depreciation and amortization expense on property and equipment was
approximately $6.7 million, $4.4 million, and $3.5 million for the years ended
December 31, 1999, 1998 and 1997, respectively.
F-18
<PAGE>
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(5) NOTES PAYABLE
Notes payable as of December 31, 1999 and 1998 are shown in the table below.
The estimated fair value of the notes payable is based on current rates offered
to the Company for debt with similar terms and approximates the carrying value
at the balance sheet dates.
<TABLE>
<CAPTION>
1999 1998
------------ ------------
<S> <C> <C>
Acquisition notes........................................... $ 7,546,000 $ 16,600,000
Facility.................................................... 235,000,000 105,000,000
------------ ------------
Total notes payable..................................... $242,546,000 $121,600,000
============ ============
</TABLE>
Effective December 30, 1997, the Company executed a $120.0 million revolving
credit facility ("Previous Facility") with a group of banks. Borrowing under the
Previous Facility could be made by the Company until December 30, 1999, at which
time all principal was due. Outstanding advances under the Previous Facility
carried interest at the Company's option of either the prime rate or at the then
current London Interbank Offering Rate ("LIBOR") plus 1%.
On March 8, 1999, the Company entered into a Loan Agreement (the "Old
Facility") with a group of banks. The Old Facility included a $150.0 million
Revolving Loan Facility and $100.0 million Short Term Revolving Loan Facility.
Borrowings under the Old Facility could be made from time to time by the Company
for general corporate purposes through the Short Term Revolving Loan Facility
until it expired on March 7, 2000 and through the Revolving Loan Facility until
it expired on February 28, 2002. Outstanding loans under the Old Facility bore
interest at agreed upon rates.
On December 17, 1999, the Company entered into a Loan Agreement (the
"Facility") with a group of banks. The Facility includes a $300.0 million
Revolving Loan Facility. Borrowing 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 of HC, HCCL, AIC and USSIC and by the pledge of stock 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 financing arrangements comparable to
the Facility. The initial funding available under the Facility was used, among
other things, to refinance existing indebtedness under the Old Facility, and to
partially fund the Centris acquisition. As of December 31, 1999, total debt
outstanding under the Facility was $235.0 million and the weighted average
interest rate was 8.04%.
The acquisition note at December 31, 1998 was a note payable to the former
owner of Sun. The note carried interest at 6.4% and was due and paid January 5,
1999. The acquisition notes at December 31, 1999 are payable to former owners of
RML. The notes are payable in decreasing amounts in four annual installments
beginning January 31, 2000. The notes carry no stated interest, but were
discounted at 6.25% for financial reporting purposes when the acquisition of RML
was recorded. The interest rate used was based on current rates offered to the
Company as of RML's acquisition date.
F-19
<PAGE>
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(5) NOTES PAYABLE (CONTINUED)
At December 31, 1999, 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 31, 2000. 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 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 (8.5% at December 31,
1999). At December 31, 1999, letters of credit totaling $17.2 million had been
issued to insurance companies by the bank on behalf of the subsidiaries, with
total securities of $21.5 million collateralizing the line.
(6) INCOME TAX
As of December 31, 1999 and 1998, the Company had income taxes receivable of
$16.2 million and $2.9 million, respectively, included in other assets in the
consolidated balance sheets. In connection with the acquisition of Centris, the
Company acquired approximately $35.0 million in net operating loss carryforwards
for Federal income tax purposes which expire in varying amount through the year
2020. Future use of the net operating losses is subject to material statutory
limitations due to changes of ownership and entity. Therefore, a valuation
allowance was established to reduce the net deferred tax asset associated with
the carryforwards to zero. Any future tax benefit realized from the use of the
carryforwards will not be credited to future income but will reduce goodwill
recorded in connection with the purchase transaction. The components of the
income tax provision for the three years ended December 31, 1999, are as
follows:
<TABLE>
<CAPTION>
1999 1998 1997
----------- ----------- -----------
<S> <C> <C> <C>
Current............................................... $12,963,000 $32,498,000 $19,375,000
Deferred:
Change in net deferred tax at current enacted tax
rate................................................ (1,145,000) 2,758,000 4,074,000
Change in deferred tax valuation allowance.......... 453,000 (48,000) (144,000)
----------- ----------- -----------
Total deferred provision (benefit)................ (692,000) 2,710,000 3,930,000
----------- ----------- -----------
Total income tax provision........................ $12,271,000 $35,208,000 $23,305,000
=========== =========== ===========
</TABLE>
F-20
<PAGE>
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(6) INCOME TAX (CONTINUED)
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, 1999 and 1998, is as follows:
<TABLE>
<CAPTION>
1999 1998
------------ -----------
<S> <C> <C>
Tax net operating loss carryforwards........................ $ 12,155,000 $ 1,381,000
Excess of financial unearned premium over tax............... 2,512,000 4,408,000
Effect of loss reserve discounting and salvage and
subrogation accrual for tax............................... 9,585,000 5,187,000
Unrealizable loss on decrease in value of securities
available for sale (shareholders' equity)................. 1,611,000 --
Bad debt and accrued expenses, deducted for financial over
tax....................................................... 12,443,000 3,783,000
Valuation allowance......................................... (12,091,000) (50,000)
------------ -----------
Total assets............................................ 26,215,000 14,709,000
Unrealized gain on increase in value of securities available
for sale (shareholders' equity)........................... -- 5,522,000
Deferred policy acquisition costs, net of ceding
commissions, deductible for tax........................... 1,634,000 1,074,000
Amortizable goodwill........................................ 2,346,000 1,011,000
Property and equipment depreciation and other items......... 3,984,000 3,779,000
------------ -----------
Total liabilities....................................... 7,964,000 11,386,000
------------ -----------
Net deferred tax asset.................................. $ 18,251,000 $ 3,323,000
============ ===========
</TABLE>
Changes in the valuation allowance account applicable to the net deferred
tax asset for the three years ended December 31, 1999 are as follows:
<TABLE>
<CAPTION>
1999 1998 1997
----------- -------- ---------
<S> <C> <C> <C>
Balance, beginning of year................................. $ 50,000 $ 98,000 $ 54,000
Increase (decrease) charged (credited) to income........... 453,000 (48,000) (144,000)
Valuation allowance acquired, which in 1999 relates to net
operating loss carryforwards............................. 11,588,000 -- 188,000
----------- -------- ---------
Balance, end of year................................... $12,091,000 $ 50,000 $ 98,000
=========== ======== =========
</TABLE>
F-21
<PAGE>
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(6) INCOME TAX (CONTINUED)
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, 1999:
<TABLE>
<CAPTION>
1999 1998 1997
----------- ----------- -----------
<S> <C> <C> <C>
Statutory tax rate.................................... 35.0% 35.0% 35.0%
Federal tax at statutory rate......................... $13,088,000 $37,620,000 $25,572,000
Nontaxable municipal bond interest and dividends
received deduction.................................. (5,460,000) (5,753,000) (6,065,000)
Non deductible expenses............................... 1,097,000 450,000 2,198,000
State income taxes.................................... 3,011,000 3,521,000 2,242,000
Foreign income taxes.................................. 4,793,000 440,000 475,000
Foreign tax credit.................................... (4,354,000) (440,000) (475,000)
Other, net............................................ 96,000 (630,000) (642,000)
----------- ----------- -----------
Income tax provision.............................. $12,271,000 $35,208,000 $23,305,000
=========== =========== ===========
Effective tax rate................................ 32.8% 32.8% 31.9%
=========== =========== ===========
</TABLE>
(7) SEGMENT AND GEOGRAPHIC DATA
The Company classifies its activities into four operating business segments
based upon services provided: 1) 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. The subsidiaries currently operating in this segment provide
insurance claims adjusting services and the development and sale of insurance
industry related software. 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, amortization of goodwill, interest expense on debt incurred at the
purchase date and intercompany eliminations have been charged or credited to the
individual segments.
F-22
<PAGE>
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(7) SEGMENT AND GEOGRAPHIC DATA (CONTINUED)
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, 1999:
Revenue:
Domestic................................ $151,044,000 $91,385,000 $31,778,000 $27,364,000 $ 681,000 $302,252,000
Foreign................................. 10,676,000 3,699,000 25,244,000 -- -- 39,619,000
Inter-segment........................... -- 3,170,000 594,000 1,133,000 -- 4,897,000
------------ ----------- ----------- ----------- ----------- ------------
TOTAL SEGMENT REVENUE................. $161,720,000 $98,254,000 $57,616,000 $28,497,000 $ 681,000 346,768,000
============ =========== =========== =========== ===========
Inter-segment revenue................... (4,897,000)
------------
CONSOLIDATED TOTAL REVENUE............ $341,871,000
============
Net earnings (loss):
Domestic................................ $ (8,631,000) $17,129,000 $ 9,042,000 $ 7,643,000 $(2,279,000) $ 22,904,000
Foreign................................. (2,078,000) 21,000 4,575,000 -- -- 2,518,000
------------ ----------- ----------- ----------- ----------- ------------
Total segment net earnings (loss)..... $(10,709,000) $17,150,000 $13,617,000 $ 7,643,000 $(2,279,000) 25,422,000
============ =========== =========== =========== ===========
Inter-segment eliminations.............. (299,000)
------------
CONSOLIDATED NET EARNINGS............. $ 25,123,000
============
Other items:
Net investment income................... $ 23,400,000 $ 4,186,000 $ 2,491,000 $ 424,000 $ 432,000 $ 30,933,000
Depreciation and amortization........... 2,880,000 5,898,000 3,776,000 264,000 580,000 13,398,000
Interest expense........................ 19,000 3,809,000 4,640,000 -- 4,496,000 12,964,000
Restructuring expense................... 687,000 3,278,000 1,453,000 -- 71,000 5,489,000
Capital expenditures.................... 2,405,000 5,339,000 110,000 585,000 637,000 9,076,000
Income tax provision (benefit).......... (13,324,000) 13,969,000 8,608,000 4,454,000 (1,242,000) 12,465,000
Inter-segment eliminations.............. (194,000)
------------
Consolidated income tax provision..... $ 12,271,000
============
</TABLE>
The insurance company segment incurred a provision for reinsurance totaling
$28.3 million, net of income tax, during 1999. Also during 1999, earnings before
income taxes was $32.3 million for domestic subsidiaries and $5.1 million for
foreign subsidiaries.
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, 1998:
Revenue:
Domestic................................ $156,715,000 $79,367,000 $33,086,000 $21,168,000 $ 2,121,000 $292,457,000
Foreign................................. 11,049,000 3,438,000 991,000 99,000 -- 15,577,000
Inter-segment........................... -- 1,975,000 1,876,000 1,252,000 -- 5,103,000
------------ ----------- ----------- ----------- ----------- ------------
TOTAL SEGMENT REVENUE................. $167,764,000 $84,780,000 $35,953,000 $22,519,000 $ 2,121,000 313,137,000
============ =========== =========== =========== ===========
Inter-segment revenue..................... (5,103,000)
------------
CONSOLIDATED TOTAL REVENUE............ $308,034,000
============
Net earnings (loss):
Domestic................................ $ 32,909,000 $19,283,000 $16,263,000 $ 5,210,000 $(2,676,000) $ 70,989,000
Foreign................................. 926,000 105,000 657,000 (399,000) -- 1,289,000
------------ ----------- ----------- ----------- ----------- ------------
NET EARNINGS (LOSS)................... $ 33,835,000 $19,388,000 $16,920,000 $ 4,811,000 $(2,676,000) $ 72,278,000
============ =========== =========== =========== =========== ============
Other items:
Net investment income................... $ 22,995,000 $ 3,949,000 $ 362,000 $ 536,000 $ 1,493,000 $ 29,335,000
Depreciation and amortization........... 2,011,000 4,094,000 406,000 422,000 455,000 7,388,000
Interest expense........................ (58,000) 1,963,000 91,000 -- 4,025,000 6,021,000
Capital expenditures.................... 10,405,000 2,685,000 660,000 205,000 1,365,000 15,320,000
Income tax provision (benefit).......... 9,485,000 13,025,000 10,702,000 2,885,000 (889,000) 35,208,000
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
============ =========== =========== =========== ===========
Inter-segment revenue..................... (7,363,000)
------------
CONSOLIDATED TOTAL REVENUE............ $280,317,000
============
Net earnings (loss):
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
------------ ----------- ----------- ----------- ----------- ------------
NET EARNINGS (LOSS)................... $ 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
Capital expenditures.................... 2,838,000 3,416,000 76,000 168,000 296,000 6,794,000
Income tax provision (benefit).......... 13,172,000 9,818,000 4,128,000 436,000 (4,249,000) 23,305,000
</TABLE>
The corporate net loss in 1997 included an after-tax charge of $7.2 million
with respect to merger expenses.
F-24
<PAGE>
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(7) SEGMENT AND GEOGRAPHIC DATA (CONTINUED)
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, 1999:
Domestic............................ $1,567,855,000 $520,122,000 $114,818,000 $16,984,000 $28,001,000 $2,247,780,000
Foreign............................. 83,882,000 28,756,000 290,205,000 -- -- 402,843,000
-------------- ------------ ------------ ----------- ----------- --------------
Total assets...................... $1,651,737,000 $548,878,000 $405,023,000 $16,984,000 $28,001,000 $2,650,623,000
============== ============ ============ =========== =========== ==============
December 31, 1998:
Domestic............................ $1,074,738,000 $431,619,000 $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 $458,703,000 $58,584,000 $30,519,000 $25,823,000 $1,709,069,000
============== ============ ============ =========== =========== ==============
</TABLE>
During the years ended December 31, 1998 and 1997, one broker in London,
England, produced gross written premium ("GWP") to the Company of approximately
$46.1 million and $42.8 million, respectively. This represents 10%, and 12% of
the Company's total GWP for those years. During 1999, no customer produced in
excess of 10% of the Company's total GWP.
(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, protect against catastrophic loss 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
F-25
<PAGE>
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(8) REINSURANCE (CONTINUED)
order to satisfy local licensing or other 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, 1999:
Direct business................................ $ 291,513,000 $ 294,130,000 $ 261,696,000
Reinsurance assumed............................ 276,818,000 294,103,000 423,763,000
Reinsurance ceded.............................. (428,407,000) (446,871,000) (575,809,000)
------------- ------------- -------------
Net amounts.................................. $ 139,924,000 $ 141,362,000 $ 109,650,000
============= ============= =============
For the year ended December 31, 1998:
Direct business................................ $ 228,629,000 $ 192,536,000 $ 202,858,000
Reinsurance assumed............................ 269,647,000 260,539,000 292,064,000
Reinsurance ceded.............................. (376,393,000) (309,975,000) (403,620,000)
------------- ------------- -------------
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
============= ============= =============
</TABLE>
Ceding commissions netted with policy acquisition costs in the consolidated
statements of earnings are $117.0 million, $59.1 million and $45.5 million for
the years ended December 31, 1999, 1998 and 1997, respectively.
The table below represents the composition of reinsurance recoverables in
the accompanying consolidated balance sheets:
<TABLE>
<CAPTION>
1999 1998
------------ ------------
<S> <C> <C>
Reinsurance recoverable on paid losses........... $ 91,318,000 $ 33,572,000
Reinsurance recoverable on outstanding losses.... 382,565,000 279,086,000
Reinsurance recoverable on IBNR.................. 214,933,000 62,513,000
Reserve for uncollectible reinsurance............ (5,541,000) (2,499,000)
------------ ------------
Total reinsurance recoverables............... $683,275,000 $372,672,000
============ ============
</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
F-26
<PAGE>
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(8) REINSURANCE (CONTINUED)
amounts held by the Company as collateral plus other credits available for
potential offset as of December 31, 1999 and 1998:
<TABLE>
<CAPTION>
1999 1998
------------ ------------
<S> <C> <C>
Payables to reinsurers........................... $212,962,000 $227,613,000
Letters of credit................................ 154,111,000 166,494,000
Cash deposits.................................... 19,882,000 8,077,000
------------ ------------
Total credits................................ $386,955,000 $402,184,000
============ ============
</TABLE>
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 net recoverable balance
greater than $10.0 million as of December 31, 1999 and 1998. The total
recoverables column included paid loss recoverable, outstanding loss
recoverable, IBNR recoverable and ceded unearned premium.
<TABLE>
<CAPTION>
LETTERS OF CREDIT,
A.M. BEST TOTAL CASH DEPOSITS AND
REINSURER RATING LOCATION RECOVERABLES OTHER PAYABLES NET
- --------- --------- --------------- ------------ ------------------ ------------
<S> <C> <C> <C> <C> <C>
December 31, 1999:
Underwriters at Lloyd's............. A United Kingdom $156,650,000 $22,805,000 $133,845,000
Underwriters Indemnity Company *.... A - Texas 50,451,000 4,201,000 46,250,000
SCOR Reinsurance Company............ A + New York 41,137,000 1,740,000 39,397,000
AXA Reinsurance Company............. A + Delaware 37,690,000 5,013,000 32,677,000
NAC Reinsurance Company **.......... A + New York 23,153,000 6,105,000 17,048,000
Transamerica Occidental Life Ins.
Co................................ A + California 22,481,000 6,102,000 16,379,000
St. Paul Fire and Marine Insurance
Co................................ A + Minnesota 17,577,000 1,721,000 15,856,000
Odyssey America Reinsurance Corp.... A Connecticut 19,114,000 5,891,000 13,223,000
Sun Life Assurance Company of
Canada............................ A ++ Canada 17,996,000 4,786,000 13,210,000
GE Reinsurance...................... A ++ Illinois 16,535,000 4,869,000 11,666,000
Chartwell Reinsurance Company ***... A Minnesota 12,736,000 2,074,000 10,662,000
December 31, 1998:
Underwriters at Lloyd's............. A United Kingdom $ 93,280,000 $37,040,000 $ 56,240,000
Underwriters Indemnity Company *.... A - Texas 51,576,000 11,039,000 40,537,000
SCOR Reinsurance Company............ A + New York 38,703,000 11,402,000 27,301,000
AXA Reinsurance Company............. A + Delaware 28,667,000 10,513,000 18,154,000
</TABLE>
* Underwriters Indemnity Company was acquired by RLI Corporation in January,
1999.
** NAC Reinsurance Corporation was acquired by XL Capital, Ltd. in June, 1999.
*** Chartwell Reinsurance Company was acquired by Trenwick Group, Inc. in
October, 1999.
Prior to the acquisition of Centris, its life insurance subsidiary, now
HCCL, sold its entire block of life insurance and annuity business to Life
Reassurance Corporation of America in the form of an indemnity reinsurance
contract. Ceded life and annuity benefits amounted to $95.8 million as of
December 31, 1999.
F-27
<PAGE>
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(8) REINSURANCE (CONTINUED)
In 1999, the Company recorded a $43.5 million provision for reinsurance to
reflect an estimated $29.5 million pre-tax loss for the insolvency of one of the
Company's reinsurers and an estimated $14.0 million pre-tax loss, the majority
of which represents the discount on ceded reserves, related to the commutation
of all liabilities with another reinsurer. This commutation, made at the
Company's request, was finalized and settled in February, 2000. In connection
with the commutation, the Company received cash and other amounts totaling
$56.5 million. Additionally, as of December 31, 1999 the Company has established
a reserve of $5.5 million which management believes is sufficient to absorb any
potential losses related to its reinsurance recoverables. However, the adverse
economic environment in the worldwide insurance industry has placed great
pressure on reinsurers and the results of their operations and these conditions
could, ultimately, affect reinsurers' solvency. Historically, there have been
insolvencies following 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 upon 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 will continue to take actions to protect shareholders'
equity.
(9) COMMITMENTS AND CONTINGENCIES
LITIGATION
The Company is a party to numerous claims and lawsuits which arise in the
normal course of its business. Many of such claims or 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 or claims will
not have a material adverse effect on its financial condition, results of
operations or cash flows.
FOREIGN CURRENCY FORWARD CONTRACTS
On a very limited basis in the past, the Company has entered into foreign
currency forward contracts as a hedge against foreign currency fluctuations.
There were no open foreign currency forward contracts at December 31, 1998. RML,
purchased by the Company during January, 1999, has a revenue stream in US
Dollars but incurs expenses in GBP. To mitigate the foreign exchange risk, the
Company entered into foreign currency forward contracts expiring at staggered
times through December, 2000. As of December 31, 1999, the Company had forward
contracts to sell US $12.0 million for GBP at an average rate of 1.00 GBP equals
US $1.60. The foreign currency forward contracts are used to convert currency at
a known rate in an amount which approximates average monthly expenses. Thus, the
effect of these transactions is to limit the foreign currency exchange risk of
the recurring monthly expenses. In the future, the Company may continue to 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. The fair value of
foreign currency forward contracts December 31, 1999 was $164,000.
F-28
<PAGE>
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(9) COMMITMENTS AND CONTINGENCIES (CONTINUED)
LEASES
The Company leases administrative office facilities under long-term
non-cancelable operating lease agreements expiring at various dates through
September, 2007. In addition to rent, 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 2004. Rent expense
under operating leases amounted to $5.7 million, $4.3 million, and $3.7 million
for the years ended December 31, 1999, 1998 and 1997, respectively.
At December 31, 1999, future minimum annual rental payments required under
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>
2000.............................................. $ 6,739,000
2001.............................................. 6,056,000
2002.............................................. 4,549,000
2003.............................................. 4,203,000
2004.............................................. 2,932,000
Thereafter........................................... 3,031,000
-----------
Total future minimum annual rental payments due............. $27,510,000
===========
</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. The Company maintains
reinsurance protection which it believes is sufficient to cover any foreseeable
event.
LOAN GUARANTEE
During 1999, the Company guaranteed the construction financing debt of a
partnership in which the company is a limited partner. The total amount of the
loan commitment is $11.5 million, of which $8.7 million was funded as of
December 31, 1999.
F-29
<PAGE>
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(10) RELATED PARTY TRANSACTIONS
Certain of the Company's Directors are officers, directors or owners of
business entities with which the Company transacts business. Balances with these
business entities and other related parties included in the accompanying
consolidated balance sheets are as follows:
<TABLE>
<CAPTION>
1999 1998
----------- -----------
<S> <C> <C>
Marketable equity securities................................ $ 5,051,000 $ --
Other investments........................................... 3,017,000 1,072,000
Reinsurance recoverables.................................... -- 42,974,000
Premiums, claims and other receivables...................... 3,347,000 4,986,000
Ceded unearned premium...................................... -- 8,601,000
Strategic investments, included in other assets............. -- 11,453,000
Loss and loss adjustment expense payable.................... -- 3,863,000
Reinsurance balances payable................................ -- 6,337,000
Premium payable............................................. -- 560,000
Notes payable............................................... 7,546,000 16,600,000
Accounts payable and accrued liabilities.................... -- 159,000
</TABLE>
Transactions with these business entities and other related parties included
in the accompanying consolidated statements of earnings are as follows:
<TABLE>
<CAPTION>
1999 1998 1997
----------- ----------- -----------
<S> <C> <C> <C>
Gross earned premium.................................. $ -- $ 1,716,000 $ 672,000
Ceded earned premium.................................. -- 14,543,000 16,041,000
Commission income..................................... -- 1,544,000 1,267,000
Investment income..................................... 206,000 64,000 397,000
Net realized investment gain (loss)................... (4,521,000) -- --
Other operating income................................ 5,221,000 968,000 8,000
Gross loss and loss adjustment expense................ -- 3,282,000 671,000
Ceded loss and loss adjustment expense................ -- 37,107,000 17,868,000
Other operating expense............................... 578,000 840,000 807,000
Interest expense...................................... 418,000 177,000 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 Corporation) 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, 1999, $2.3 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.
(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
employees residing in the United States who met
F-30
<PAGE>
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(11) EMPLOYEE BENEFIT PLANS (CONTINUED)
specified service requirements. All of these plans were combined into one plan
during 1998. The contributions are discretionary and are determined by
management as of the beginning of each calendar year. The Company currently
matches each employee's contribution to the 401(k) plan up to 6% of the
employee's salary. Employees of the Company who reside outside the United States
receive comparable benefits under different plans. The Company contributed $3.1
million, $1.7 million and $858,000 to the plans for the years ended December 31,
1999, 1998 and 1997, respectively, which is included in compensation expense in
the accompanying consolidated statements of earnings.
(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 2000, HC and USSIC's ordinary
dividend capacities is approximately $25.0 million and $10.4 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. Because AIC paid an extraordinary dividend of $45.0 million
during December, 1999, any dividends paid by AIC during 2000 will require prior
regulatory approval. No dividends from AIC are anticipated during 2000.
HCCL is limited by the State of Indiana in the amount of dividends it may
pay in any twelve month period, without prior regulatory approval, to the
greater of net gain from operations for the prior calendar year or ten percent
(10%) of statutory capital and surplus as of the prior year end. During 2000,
HCCL's ordinary dividend capacity will be approximately $7.0 million.
As of December 31, 1999, all of the domestic insurance company subsidiaries
total adjusted capital is significantly in excess of the NAIC authorized control
level risk-based capital.
The components of accumulated other comprehensive income (loss) are as
follows:
<TABLE>
<CAPTION>
UNREALIZED ACCUMULATED OTHER
FOREIGN CURRENCY INVESTMENT COMPREHENSIVE
TRANSLATION GAIN (LOSS) INCOME (LOSS)
---------------- ----------- -----------------
<S> <C> <C> <C>
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
Net change for year.............................. 167,000 (12,564,000) (12,397,000)
--------- ----------- -----------
Balance December 31, 1999........................ $(483,000) $(2,209,000) $(2,692,000)
========= =========== ===========
</TABLE>
F-31
<PAGE>
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(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, 1999, 7,487,054 shares
of Common Stock were reserved for the exercise of options, of which 5,470,008
shares were reserved for options previously granted and 2,017,046 shares were
reserved for future issuances of options.
Options vest over a zero to five year period and expire four 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. 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 $20.7 million, or $0.42 per share, for the year ended
December 31, 1999; $65.4 million, or $1.34 per share, for the year ended
December 31, 1998; and $43.8 million, or $0.91 per share, for the year ended
December 31, 1997. 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 5.7% for
1999, 5.3% for 1998 and 6.2% for 1997, b) expected volatility factor of .3, c)
dividend yield of 1.52% for 1999, .91% for 1998 and .56% for 1997, and d)
expected option life of four years for 1999 and five years for 1998 and 1997.
The following table provides an analysis of stock option activity during the
three years ended December 31, 1999:
<TABLE>
<CAPTION>
1999 1998 1997
-------------------------------- ------------------------------- -------------------------------
AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE
NUMBER OF EXERCISE FAIR NUMBER OF EXERCISE FAIR NUMBER OF EXERCISE FAIR
SHARES PRICE VALUE SHARES PRICE VALUE SHARES PRICE VALUE
---------- -------- -------- --------- -------- -------- --------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Outstanding, beginning
of year............... 5,459,766 $16.73 3,508,226 $16.22 3,124,793 $13.03
Granted at market
value................. 1,869,600 13.48 $4.16 2,779,500 17.01 $5.23 1,301,500 22.88 $ 7.98
Cancelled............... (1,327,243) 18.36 (192,462) 21.48 (125,075) 24.28
Exercised............... (532,115) 7.88 (635,498) 14.05 (792,992) 13.86
---------- ------ --------- ------ --------- ------
Outstanding, end of
year.................. 5,470,008 $16.08 5,459,766 $16.73 3,508,226 $16.22
========== ====== ========= ====== ========= ======
Exercisable, end of
year.................. 2,982,872 $16.84 2,792,707 $15.92 1,230,145 $11.60
========== ====== ========= ====== ========= ======
</TABLE>
F-32
<PAGE>
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(13) STOCK OPTIONS (CONTINUED)
Options outstanding and exerciseable as of December 31, 1999 are shown on
the following schedule:
<TABLE>
<CAPTION>
OPTIONS
OPTIONS OUTSTANDING EXERCISABLE
--------------------------------------- --------------------
AVERAGE AVERAGE AVERAGE
NUMBER OF REMAINING EXERCISE NUMBER OF EXERCISE
RANGE OF EXERCISE PRICES SHARES CONTRACTUAL LIFE PRICE SHARES PRICE
- ------------------------ --------- ---------------- -------- --------- --------
<S> <C> <C> <C> <C> <C>
Under $16.50................................... 2,712,041 5.08 years $12.36 1,184,515 $12.14
$16.50......................................... 1,063,000 4.06 16.50 607,849 16.50
$16.51 - $22.25................................ 675,600 5.23 19.42 406,348 18.91
Over $22.25.................................... 1,019,367 6.87 23.35 784,160 23.15
--------- ---------- ------ --------- ------
Total options................................ 5,470,008 5.23 years $16.08 2,982,872 $16.84
========= ========== ====== ========= ======
</TABLE>
(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, 1999:
<TABLE>
<CAPTION>
1999 1998 1997
----------- ----------- -----------
<S> <C> <C> <C>
Net earnings.......................................... $25,123,000 $72,278,000 $49,759,000
=========== =========== ===========
Reconciliation of number of shares outstanding:
Shares of Common Stock outstanding at year end........ 48,839,000 48,252,000 47,759,000
Changes in Common Stock due to issuance............... (241,000) (332,000) (764,000)
Contingent shares to be issued........................ 49,000 -- --
Common Stock contractually issuable in the future..... 414,000 -- --
----------- ----------- -----------
Weighted average Common Stock outstanding........... 49,061,000 47,920,000 46,995,000
Additional dilutive effect of outstanding options (as
determined by the application of the treasury stock
method)............................................. 588,000 1,016,000 1,214,000
----------- ----------- -----------
Weighted average Common Stock and potential common
stock outstanding................................. 49,649,000 48,936,000 48,209,000
=========== =========== ===========
</TABLE>
As of December 31, 1999, there were approximately 2.0 million options that
were not included in the computation of diluted earnings per share because to do
so would have been antidilutive. As part of the Sun purchase agreement (See Note
2), up to 378,000 shares of the Company's Common Stock are to be issued if
certain conditions are met as of December 31, 1999 or in subsequent years. Of
these shares, 49,000 are included in the 1999 computation because the
contingency had been partially met. The remainder of the contingent shares were
not included in the earnings per share computation because the conditions for
issuance of the remaining shares have not yet been met.
(15) STATUTORY INFORMATION
The Company's insurance company subsidiaries file financial statements
prepared in accordance with statutory accounting practices prescribed or
permitted by domestic or foreign insurance regulatory authorities. The
differences between statutory financial statements and financial statements
prepared in
F-33
<PAGE>
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(15) STATUTORY INFORMATION (CONTINUED)
accordance with GAAP vary between domestic and foreign jurisdictions. The
principal differences are that for statutory financial statements deferred
policy acquisition costs are not recognized, deferred income taxes are not
recorded, bonds are generally carried at amortized cost and insurance assets and
liabilities are presented net of reinsurance. The Company's use of permitted
statutory accounting practices does not have a significant impact on statutory
surplus. Statutory policyholders' surplus as of December 31, 1999, 1998, and
1997, and net income for the three years ended December 31, 1999, of the
Company's insurance company subsidiaries included in those companies' respective
filings with regulatory authorities are as follows:
<TABLE>
<CAPTION>
1999 1998 1997
------------ ------------ ------------
<S> <C> <C> <C>
Statutory policyholders' surplus................... $315,474,000 $369,401,000 $331,922,000
Statutory net income (loss)........................ (8,707,000) 53,162,000 56,626,000
</TABLE>
Statutory policyholders' surplus was adversely affected by adjustments for
reinsurance recoverables, which, although required statutorily, have no effect
on net earnings or shareholders' equity. Statutory net loss for 1999 includes a
$25.5 million loss, net of income tax, from the provision for reinsurance.
The National Association of Insurance Commissioners 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 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) OTHER INFORMATION
SUPPLEMENTAL CASH FLOW INFORMATION
Supplemental cash flow information for the three years ended December 31,
1999, is summarized below:
<TABLE>
<CAPTION>
1999 1998 1997
----------- ----------- -----------
<S> <C> <C> <C>
Interest paid......................................... $13,694,000 $ 5,409,000 $ 6,712,000
Income tax paid....................................... 23,116,000 30,662,000 24,132,000
Dividends declared but not paid at year end........... 2,442,000 1,930,000 1,386,000
</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-34
<PAGE>
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(16) OTHER INFORMATION (CONTINUED)
RESTRUCTURING
The Company recorded a restructuring charge and associated expenses of $5.5
million during the fourth quarter of 1999. Since its initial public offering in
1992, the Company has completed more than fifteen acquisitions for a total value
exceeding $750.0 million. During that time, total employees have grown from less
than 100 to more than 1,000. As a result of this rapid growth, management
believes certain operating inefficiencies occurred. At the beginning of the
fourth quarter of 1999, management made a review of its operations and
determined that they could be made more efficient, principally by reducing the
employee count in certain of its operations. The terminations that generated the
compensation savings took place in the fourth quarter.
A total of 92 employees were terminated in the fourth quarter as a result of
the Company's restructuring which affected all segments. The Company accrued
severance payments for 27 of these terminated employees at December 31, 1999,
substantially all of which was paid in January, 2000. The restructuring charge
also includes accruals of $911,000 related to future lease costs of office space
made redundant as a result of the restructuring plan and a write down of
$647,000, principally of leasehold improvements and other assets related to the
redundant space. The following table provides a detailed analysis of the charge:
<TABLE>
<CAPTION>
PAID ACCRUED EXPENSED
IN 1999 AT 12/31/99 IN 1999
-------- ----------- ----------
<S> <C> <C> <C>
Severance.................................................. $691,000 $3,115,000 $3,806,000
Other...................................................... 125,000 911,000 1,036,000
-------- ---------- ----------
$816,000 $4,026,000 4,842,000
======== ==========
Write down of assets..................................... 647,000
----------
Total restructuring expense.............................. $5,489,000
==========
</TABLE>
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, 1999:
<TABLE>
<CAPTION>
1999 1998 1997
------------ ------------ ------------
<S> <C> <C> <C>
Reserves for loss and LAE at beginning of the
year............................................. $460,511,000 $275,008,000 $229,049,000
Less reinsurance recoverables...................... 341,599,000 155,374,000 111,766,000
------------ ------------ ------------
Net reserves at beginning of the year.............. 118,912,000 119,634,000 117,283,000
Net reserves acquired with purchase of
subsidiaries..................................... 55,523,000 3,877,000 1,919,000
Effect on loss reserves of write off of ceded
outstanding and IBNR reinsurance recoverables.... 82,343,000 -- --
Provision for loss and LAE for claims occurring in
the current year................................. 105,036,000 105,895,000 100,288,000
Increase (decrease) in estimated loss and LAE for
claims occurring in prior years.................. 4,614,000 (14,593,000) (3,774,000)
------------ ------------ ------------
Incurred loss and LAE, net of reinsurance........ 109,650,000 91,302,000 96,514,000
------------ ------------ ------------
Loss and LAE payments for claims occurring during:
Current year..................................... 36,770,000 47,126,000 48,208,000
Prior years...................................... 56,052,000 48,775,000 47,874,000
------------ ------------ ------------
Loss and LAE payments, net of reinsurance.......... 92,822,000 95,901,000 96,082,000
------------ ------------ ------------
Net reserves at end of the year.................... 273,606,000 118,912,000 119,634,000
Plus reinsurance recoverables...................... 597,498,000 341,599,000 155,374,000
------------ ------------ ------------
Reserves for loss and LAE at end of the year... $871,104,000 $460,511,000 $275,008,000
============ ============ ============
</TABLE>
During 1999, the Company had net loss and LAE deficiency of $4.6 million
relating to prior year losses compared to redundancies of $14.6 million in 1998
and $3.7 million in 1997. The deficiencies and redundancies in the net reserves
result from the Company's and its actuaries' continued review of its loss
reserves and the increase or 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; AMOUNTS IN THOUSANDS, EXCEPT PER SHARE
DATA)
<TABLE>
<CAPTION>
FOURTH QUARTER THIRD QUARTER SECOND QUARTER FIRST QUARTER
------------------- ------------------- ------------------- -------------------
1999 1998 1999 1998 1999 1998 1999 1998
-------- -------- -------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Total revenue......................... $84,308 $84,170 $83,093 $76,536 $82,483 $79,342 $91,987 $67,986
Net earnings (loss)................... (4,991) 15,482 9,118 22,075 287 17,634 20,709 17,087
Basic earnings (loss) per share data:
Earnings (loss) per share............. $ (0.10) $ 0.32 $ 0.19 $ 0.46 $ 0.01 $ 0.37 $ 0.42 $ 0.36
======= ======= ======= ======= ======= ======= ======= =======
Weighted average shares outstanding... 49,193 48,159 49,130 47,870 48,951 47,853 48,764 47,794
======= ======= ======= ======= ======= ======= ======= =======
Diluted earnings (loss) per share
data:
Earnings (loss) per share............. $ (0.10) $ 0.32 $ 0.18 $ 0.45 $ 0.01 $ 0.36 $ 0.42 $ 0.35
======= ======= ======= ======= ======= ======= ======= =======
Weighted average shares outstanding... 49,193 48,970 49,866 48,919 49,971 49,015 49,544 48,809
======= ======= ======= ======= ======= ======= ======= =======
</TABLE>
During 1999, pre-tax provisions for reinsurance of $29.5 million and $14.0
million were recorded in the second quarter and fourth quarter, respectively.
Also, during the fourth quarter of 1999, the Company recorded a pre-tax
restructuring expense of $5.5 million and a $4.3 million writedown of one equity
investment to its estimated fair market value. The fourth quarter of 1998
includes a charge of $5.8 million (pre-tax) for catastrophe losses related to
hurricanes Georges and Mitch. The sum of the quarters earnings (loss) per share
may not equal the annual amounts due to rounding.
F-37
<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 30, 2000, 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. In our opinion, 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 30, 2000
S-1
<PAGE>
SCHEDULE 1
HCC INSURANCE HOLDINGS, INC.
SUMMARY OF INVESTMENTS
OTHER THAN INVESTMENTS IN RELATED PARTIES
DECEMBER 31, 1999
<TABLE>
<CAPTION>
COLUMN A COLUMN B COLUMN C COLUMN D
- --------------------------------------------------- ------------ ------------ ------------
AMOUNT AT
WHICH
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....................... $ 57,941,000 $ 57,505,000 $ 57,505,000
Bonds--states, municipalities and political
subdivisions..................................... 99,360,000 99,459,000 99,459,000
Bonds--special revenue........................... 164,035,000 163,644,000 163,644,000
Bonds--Canadian government....................... 6,189,000 6,213,000 6,213,000
Bonds--corporate................................. 15,480,000 15,291,000 15,291,000
Mortgage backed securities....................... 529,000 529,000 529,000
------------ ------------ ------------
Total fixed maturities....................... 343,534,000 $342,641,000 342,641,000
------------ ============ ------------
Equity securities:
Common stocks--banks, trusts and insurance
companies...................................... 7,863,000 $ 5,787,000 5,787,000
Common stocks--industrial........................ 10,141,000 9,694,000 9,694,000
Non-redeemable preferred stocks.................. 4,489,000 4,489,000 4,489,000
------------ ------------ ------------
Total equity securities...................... 22,493,000 $ 19,970,000 19,970,000
------------ ============ ------------
Short-term investments........................... 215,694,000 215,694,000
Other investments................................ 3,017,000 3,017,000
------------ ------------
TOTAL INVESTMENTS............................ $584,738,000 $581,322,000
============ ============
</TABLE>
S-2
<PAGE>
SCHEDULE 2
HCC INSURANCE HOLDINGS, INC.
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------
1999 1998
------------ ------------
<S> <C> <C>
ASSETS
Cash........................................................ $ 23,000 $ --
Short-term investments...................................... 395,000 4,539,000
Investment in subsidiaries.................................. 626,802,000 441,041,000
Intercompany loans to subsidiaries.......................... 76,260,000 103,426,000
Other assets................................................ 9,836,000 32,419,000
------------ ------------
TOTAL ASSETS............................................ $713,316,000 $581,425,000
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Notes payable............................................... $235,000,000 $105,000,000
Note payable to related party............................... 7,546,000 16,600,000
Payable to subsidiaries..................................... -- 14,558,000
Deferred Federal income tax................................. 948,000 261,000
Accounts payable and accrued liabilities.................... 12,394,000 5,143,000
------------ ------------
Total liabilities....................................... 255,888,000 141,562,000
Total shareholders' equity.............................. 457,428,000 439,863,000
------------ ------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY.............. $713,316,000 $581,425,000
============ ============
</TABLE>
See Note to Condensed Financial Information.
S-3
<PAGE>
SCHEDULE 2
HCC INSURANCE HOLDINGS, INC.
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
STATEMENTS OF EARNINGS
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
---------------------------------------
1999 1998 1997
----------- ----------- -----------
<S> <C> <C> <C>
Equity in earnings of subsidiaries.................... $30,948,000 $75,228,000 $56,024,000
Interest income from subsidiaries..................... 4,165,000 2,052,000 --
Interest income....................................... 146,000 285,000 24,000
Net realized investment gain.......................... -- 840,000 --
Other income.......................................... 73,000 -- --
----------- ----------- -----------
Total revenue..................................... 35,332,000 78,405,000 56,048,000
Interest expense...................................... 12,907,000 6,036,000 1,904,000
Merger related expenses............................... -- 107,000 3,326,000
Other operating expense............................... 266,000 1,623,000 2,032,000
----------- ----------- -----------
Total expense..................................... 13,173,000 7,766,000 7,262,000
----------- ----------- -----------
Earnings before income tax benefit.............. 22,159,000 70,639,000 48,786,000
Income tax benefit.................................... 2,964,000 1,639,000 973,000
----------- ----------- -----------
NET EARNINGS.................................... $25,123,000 $72,278,000 $49,759,000
=========== =========== ===========
</TABLE>
See Notes to Condensed Financial Information.
S-4
<PAGE>
SCHEDULE 2
HCC INSURANCE HOLDINGS, INC.
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
STATEMENTS OF COMPREHENSIVE INCOME
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
----------------------------------------
1999 1998 1997
------------ ----------- -----------
<S> <C> <C> <C>
Net earnings.......................................... $ 25,123,000 $72,278,000 $49,759,000
Other comprehensive income net of tax:
Foreign currency translation adjustment........... 167,000 (344,000) (215,000)
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 $(8,042,000) in
1999, $1,205,000 in 1998 and $2,373,000 in
1997........................................ (15,271,000) 2,454,000 4,470,000
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 $1,457,000
in 1999, ($218,000) in 1998 and $115,000 in
1997........................................ 2,707,000 (405,000) 213,000
------------ ----------- -----------
Other comprehensive income (loss)........... (12,397,000) 1,705,000 4,468,000
------------ ----------- -----------
COMPREHENSIVE INCOME........................ $ 12,726,000 $73,983,000 $54,227,000
============ =========== ===========
</TABLE>
See Notes to Condensed Financial Information.
S-5
<PAGE>
SCHEDULE 2
HCC INSURANCE HOLDINGS, INC.
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
-------------------------------------------
1999 1998 1997
------------- ------------ ------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net earnings..................................... $ 25,123,000 $ 72,278,000 $ 49,759,000
Adjustment to reconcile net earnings to net cash
provided (used) by operating activities:
Undistributed net income of subsidiaries......... (30,948,000) (75,228,000) (56,024,000)
Change in deferred Federal income tax, net of tax
effect of unrealized gain or loss.............. 687,000 3,934,000 197,000
Changes in other assets and other................ 12,336,000 -- --
Depreciation..................................... 29,000 29,000 30,000
Change in intercompany loan to subsidiaries...... (4,035,000) (2,052,000) --
Change in payable to subsidiary and other
payables....................................... (7,819,000) (3,932,000) (533,000)
Net realized investment gain..................... -- (840,000) --
------------- ------------ ------------
Cash used by operating activities.............. (4,627,000) (5,811,000) (6,571,000)
Cash flows from investing activities:
Sales of fixed income securities................. -- 16,680,000 --
Cash contributions to subsidiaries............... (36,030,000) (62,000) (62,442,000)
Purchase of subsidiaries......................... (201,947,000) (30,355,000) (6,483,000)
Change in short-term investments................. 4,144,000 (3,339,000) 2,790,000
Cost of investment acquired...................... (2,898,000) (2,525,000) --
Intercompany loan to subsidiaries................ (27,404,000) (34,530,000) (41,250,000)
Payments on intercompany loan to subsidiaries.... 66,595,000 15,986,000 --
Cash dividends from subsidiaries................. 93,228,000 24,450,000 43,526,000
------------- ------------ ------------
Cash used by investing activities................ (104,312,000) (13,695,000) (63,859,000)
Cash flows from financing activities:
Proceeds from note payable....................... 547,000,000 74,200,000 97,500,000
Payments on notes payable........................ (433,600,000) (49,950,000) (33,000,000)
Sale of Common Stock............................. 4,783,000 2,203,000 10,470,000
Dividends paid................................... (9,221,000) (7,139,000) (4,550,000)
------------- ------------ ------------
Cash provided by financing activities.......... 108,962,000 19,314,000 70,420,000
------------- ------------ ------------
Net change in cash............................. 23,000 (192,000) (10,000)
Cash as of beginning of year................... -- 192,000 202,000
------------- ------------ ------------
Cash as of end of year......................... $ 23,000 $ -- $ 192,000
============= ============ ============
</TABLE>
See Notes to Condensed Financial Information.
S-6
<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, 1999, the interest rate on intercompany
loans was 7 1/4%.
S-7
<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
-------- --------------- -------------- ----------- ----------- -------------- --------------
(1) (1) (2)
DECEMBER 31, FOR THE YEARS ENDED DECEMBER 31,
---------------------------------------------- ---------------------------------------------
FUTURE POLICY BENEFITS,
BENEFITS, CLAIMS, LOSSES
DEFERRED POLICY LOSSES, CLAIMS AND
ACQUISITION AND LOSS UNEARNED PREMIUM NET INVESTMENT SETTLEMENT
SEGMENTS COSTS EXPENSES PREMIUMS REVENUE INCOME EXPENSES
-------------------------- --------------- -------------- ----------- ----------- -------------- --------------
<S> <C> <C> <C> <C> <C> <C> <C>
1999 Insurance Company $ 658 $966,864 $188,524 $141,362 $23,400 $109,650
Underwriting Agency....... 4,186
Intermediary.............. 2,491
Other Operations 424
Corporate................. 432
-------- -------- -------- -------- ------- --------
Total $ 658 $966,864 $188,524 $141,362 $30,933 $109,650
======== ======== ======== ======== ======= ========
1998 Insurance Company......... $ (3,615) $460,511 $201,050 $143,100 $22,995 $ 91,302
Underwriting Agency....... 3,949
Intermediary.............. 362
Other Operations 536
Corporate................. 1,493
-------- -------- -------- -------- ------- --------
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
======== ======== ======== ======== ======= ========
<CAPTION>
COLUMN I COLUMN J COLUMN K
------------ --------------- ----------
(2)
FOR THE YEARS ENDED DECEMBER 31,
-------------------------------------------
AMORTIZATION
OF DEFERRED
POLICY
ACQUISITION OTHER OPERATING PREMIUM
COSTS EXPENSES WRITTEN
------------ --------------- ----------
<S> <C> <C> <C>
1999 $ 8,177 $ 63,963 $139,924
63,325
30,416
16,399
(417)
------- -------- --------
$ 8,177 $173,686 $139,924
======= ======== ========
1998 $10,978 $ 17,555 $121,883
50,325
8,241
14,936
1,190
------- -------- --------
$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
======= ======== ========
</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-8
<PAGE>
SCHEDULE 4
HCC INSURANCE HOLDINGS, INC.
REINSURANCE
<TABLE>
<CAPTION>
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E COLUMN F
-------- ------------- -------------- ------------ ------------ --------------
(1)
ASSUMED FROM PERCENT OF
CEDED TO OTHER OTHER AMOUNT
DIRECT AMOUNT COMPANIES COMPANIES NET AMOUNT ASSUMED TO NET
------------- -------------- ------------ ------------ --------------
<S> <C> <C> <C> <C> <C>
For the year ended December 31,
1999:
Life insurance in force............. $832,305,000 $799,573,000 $ 0 $ 32,732,000 0%
============ ============ ============ ============ =======
Earned premium:
Property and liability insurance.... $230,879,000 $277,089,000 $127,495,000 $ 81,285,000 157%
Accident and health insurance....... 63,251,000 169,782,000 166,608,000 60,077,000 277%
------------ ------------ ------------ ------------ -------
Total........................... $294,130,000 $446,871,000 $294,103,000 $141,362,000 208%
============ ============ ============ ============ =======
For the year ended December 31,
1998:
Earned premium:
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:
Earned premium:
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%
============ ============ ============ ============ =======
</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-9
<PAGE>
SCHEDULE 5
HCC INSURANCE HOLDINGS, INC.
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
VALUATION AND QUALIFYING ACCOUNTS
<TABLE>
<CAPTION>
1999 1998 1997
----------- ---------- ----------
<S> <C> <C> <C>
Reserve for uncollectible reinsurance:
Balance as of beginning of year....................... $ 2,499,000 $2,535,000 $2,415,000
Total provision charged to expense.................... 43,650,000 60,000 120,000
Total amounts written off............................. (40,608,000) (96,000) --
----------- ---------- ----------
Balance as of end of year............................. $ 5,541,000 $2,499,000 $2,535,000
=========== ========== ==========
</TABLE>
S-10
<PAGE>
HCC INSURANCE HOLDINGS, INC.
1992 INCENTIVE STOCK OPTION PLAN,
AS AMENDED AND RESTATED
1. PURPOSE
The purpose of the HCC Insurance Holdings, Inc. Amended and Restated 1992
Incentive Stock Option Plan is to provide a means through which HCC Insurance
Holdings, Inc., a Delaware corporation, and its Subsidiaries may attract able
persons to enter the employ of the Company and to provide a means whereby
those key employees upon whom the responsibilities of the successful
administration and management of the Company rest, and whose present and
potential contributions to the welfare of the Company are of importance, can
acquire and maintain stock ownership, thereby strengthening their concern for
the welfare of the Company and their desire to remain in its employ. A
further purpose of the Plan is to provide such key employees with additional
incentive and reward opportunities designed to enhance the profitable growth
of the Company.
2. DEFINITIONS
Whenever used herein, the following terms shall have the meanings
set forth below:
"Board" means the Board of Directors of HCC Insurance
Holdings, Inc.
"Code" means the Internal Revenue Code of 1986. Reference in
the Plan to any Code section includes any amendments or successor
provisions to such section and any regulations under such section.
"Committee" means not less than two members of the Board who
are selected by the Board as provided in Section 4(a).
"Common Stock" means the Company's Common Stock, $1.00
par value.
"Company" means HCC Insurance Holdings, Inc.
"Disability" means permanent and total disability within the
meaning of Code Section 22 (e) (3).
"Fair Market Value" of a share of Common Stock on any date
means the average of the high and low sales price of a share of Common
Stock as reflected in the report of consolidated trading of the
relevant exchange-listed securities for that date (or, if no such
shares were publicly traded on that date, the next preceding date that
such shares were so traded) published in The Wall Street Journal or in
any other publication selected by the Committee; provided, however,
that if shares of Common Stock shall not have been publicly traded for
more than ten (10) days immediately preceding such date, the Fair
Market Value of a share of Common Stock on any date means the value
determined by
<PAGE>
the Committee to be the value of the Common Stock on the day such
value is to be determined, in the Committee's sole discretion.
"Grantee" means an employee of the Company or one of its
Subsidiaries to whom an Incentive Stock Option is granted.
"Incentive Stock Option" means an Option described in Code
Section 422(b).
"1934 Act" means the Securities Exchange Act of 1934.
Reference in the Plan to any section or rule under the 1934 Act
includes any amendments or successor provisions to such section or
role.
"Option" means the right to purchase, at the price and for the
Term fixed by the Committee in accordance with the Plan and subject to
such other limitations and restrictions as the Plan and the Committee
may impose, the number of shares of Common Stock specified by the
Committee.
"Option Agreement" means a written agreement in a form
approved by the Committee to be entered into by the Company and the
Grantee of an Incentive Stock Option, as provided in Section 8 hereof.
"Plan" means the HCC Insurance Holdings, Inc. Amended and
Restated 1992 Incentive Stock Option Plan.
"Subsidiary" means any entity of which, at the time such
subsidiary status is to be determined, at least 50% of the total
combined voting power of all classes of stock of such entity is held by
the Company and its Subsidiaries (exclusive of ownership by the entity
whose subsidiary status is being determined).
"Successor" means the legal representative of the estate of a
deceased Grantee or the person or persons who shall acquire the right
to exercise an Incentive Stock Option by bequest or inheritance or by
reason of the death of the Grantee.
"Term" means the period during which a particular Incentive
Stock Option may be exercised.
3. EFFECTIVE DATE OF PLAN
The Plan shall become effective when approved at a meeting of the Company's
shareholders by the holders of a majority of the outstanding shares entitled to
vote. No Incentive Stock Options may be granted under the Plan after 2002,
although Option Agreements outstanding after that date may be amended at any
time prior to the end of their Term in accordance with the Plan and the Plan
shall remain in effect until all Incentive Stock Options granted under the Plan
have been exercised or have expired by reason of lapsed time.
<PAGE>
4. ADMINISTRATION OF THE PLAN
(a) The Plan shall be administered by the Committee which shall
consist of at least two directors of the Company selected and appointed by
the Board, each of whom shall be a "disinterested director" within the
meaning of Rule l6b-3 promulgated under the 1934 Act. Unless and until its
members are not qualified to serve on the Committee under the provisions of
the Plan, the Compensation Committee of the Board of Directors will function
as the Committee. The Committee shall have the power to construe and
interpret the Plan and the respective Option Agreements executed hereunder,
to establish and amend such rules and regulations as it deems necessary or
desirable for the proper administration of the Plan, and to determine the
terms, restrictions, and provisions of the respective Option Agreements
executed hereunder. The Committee may correct any defect, supply any
omission, or reconcile any inconsistency in the Plan or in any Option
Agreement executed hereunder in the manner and to the extent it shall deem
expedient to carry it into effect. A majority of the Committee shall
constitute a quorum. The Committee shall act by majority action at a meeting,
except that action permitted to be taken at a meeting may be taken without a
meeting if written consent thereto is given by all members of the Committee.
Any decision or action taken or to be taken by the Committee arising out of
or in connection with the construction, administration, interpretation, and
effect of the Plan and of its roles and regulations shall, to the extent
permitted by law, be within the Committee's absolute discretion (except as
otherwise specifically provided herein) and shall be conclusive and binding
upon all Grantees and any person claiming under or through any Grantee.
(b) The Committee shall have plenary authority, subject to the
provisions of the Plan, to grant Incentive Stock Options and to determine to
whom Incentive Stock Options shall be granted and the number of shares
subject to and the Term of each Incentive Stock Option, provided that no
Incentive Stock Option shall be granted which is exercisable after the
expiration of ten (10) years from the date it is granted.
5. GRANT OF OPTIONS; NUMBER AND SOURCE OF SHARES SUBJECT TO THE PLAN
(a) The Committee may from time to time grant Incentive Stock
Options under the Plan for not more than 528,500 shares of Common Stock
(subject to adjustment under Section 13), which shares will be provided from
Common Stock held in the Company's treasury which is not reserved for some
other purpose or from authorized and unissued Common Stock which is not
reserved for some other purpose.
(b) The date of grant of an Incentive Stock Option shall be the date
on which the Committee's action is final or such later date as specified by
the Committee.
(c) Shares as to which an Incentive Stock option previously granted
shall for any reason lapse, expire, or terminate shall be restored to the
total number available for grant of Incentive Stock Options under the Plan.
<PAGE>
(d) Shares shall be deemed to have been issued under the Plan only
to the extent actually issued and delivered pursuant to an Incentive Stock
Option.
6. EMPLOYEES ELIGIBLE TO RECEIVE OPTIONS
(a) Incentive Stock options may be granted under the Plan to key
employees of the Company or its Subsidiaries.
(b) Any person who, immediately before the grant of an Incentive
Stock Option, is the owner, directly or indirectly, of more than 10% of the
total combined voting power of all classes of stock of the Company or its
Subsidiaries shall not be eligible to receive an Incentive Stock Option;
provided that, such person shall be eligible to receive an Incentive Stock
Option if (i) the price to be paid by the Grantee to the Company upon
exercise of the Incentive Stock Option is not less than one hundred ten
percent (110%) of the Fair Market Value of the shares subject to the
Incentive Stock Option on the date the Incentive Stock Option is granted, and
(ii) such Incentive Stock Option shall not be exercisable after the
expiration of five (5) years from the date of grant.
7. LIMITATION ON ANNUAL AWARDS
The aggregate Fair Market Value (determined as of the date an Incentive Stock
Option is granted) of the shares with respect to which Incentive Stock
Options are exercisable for the first time by the Grantee during any calendar
year (under the Plan or any other stock option plans maintained by the
Company or its Subsidiaries) shall not exceed $100,000 (or such other
individual grant limit under the Code as may be in effect with respect to
Incentive Stock Options on the date of grant).
8. OPTION AGREEMENT
(a) The prospective Grantee of an Incentive Stock Option shall
execute an Option Agreement with the Company containing such terms and
conditions, not inconsistent with the Plan, as may be approved by the
Committee. The terms and conditions of Option Agreements may vary from
Grantee to Grantee.
(b) An Option Agreement may require the Grantee (or his Successor)
to give satisfactory assurance, upon exercise of the Incentive Stock Option,
that the shares to be delivered are being acquired for the purchaser's own
account for investment and not with a view to, or for sale in connection
with, any distribution of the shares so purchased or, in the case of
acquisition by an estate, that the shares are being acquired for resale in a
transaction which, in the opinion of counsel for the Company, would not
violate any Federal or State law.
(c) The Committee may amend an Option Agreement from time to time
and such amendment shall not be deemed to be a new grant of an incentive
Stock Option provided that such amendment does not materially increase the
value of the Incentive Stock Option to the Grantee.
<PAGE>
(d) Appropriate officers of the Company are hereby authorized to
execute (by facsimile or manually affixed signature) and deliver Option
Agreements, and amendments thereto, in the name of the Company as directed
from time to time by the Committee.
9. OPTION PRICE
The price to be paid by the Grantee to the Company upon exercise of an
Incentive Stock Option shall be determined by the Committee but, subject to
the provisions of Section 6(b) and to adjustment as provided in Section 13,
shall not be less than one hundred percent (100%) of the Fair Market Value of
the shares subject to the Incentive Stock Option on the date of grant.
Payment shall be made in cash or, with the consent of the Committee, in whole
or in part in Common Stock owned by the Grantee, which shall be valued at
Fair Market Value on the date the Incentive Stock Option is exercised. Any
payment in Common Stock shall be effected by delivery of shares to the
Company's Chief Financial Officer, endorsed in blank or accompanied by stock
powers executed in blank, together with any other documents as the Company
shall require.
10. TERMS AND INSTALLMENTS OF OPTIONS; EXERCISE OF OPTION DURING LIFE OF GRANTEE
(a) Each Incentive Stock Option granted under the Plan shall be
exercisable only during a Term commencing on the date the Incentive Stock
Option was granted and ending (unless the Incentive Stock Option shall have
terminated earlier under other provisions of the Plan) on a date to be fixed
by the Committee, but in no event to exceed ten (10) years from the date of
grant.
(b) The Committee shall have authority to grant Incentive Stock
Options exercisable in full at any time during their Term, or exercisable in
cumulative or noncumulative installments.
(c) Incentive Stock Options shall be exercised in whole or in part
in accordance with the terms set forth in the Grantee's Option Agreement.
(d) Upon compliance by the Grantee with such terms of exercise, the
Company shall promptly deliver to the Grantee a certificate or certificates
for the shares purchased, without charge to the Grantee for any issue or
transfer tax.
(e) The Committee may postpone any exercise of an Incentive Stock
Option for such time as the Committee in its discretion may deem necessary in
order to permit the Company with reasonable diligence (i) to effect or
maintain registration of the Plan or the shares issuable upon the exercise of
the Incentive Stock Option under the Securities Act of 1933, as amended, or
the securities laws of any applicable jurisdiction, or (ii) to determine that
such shares and Plan are exempt from such registration. The Company shall not
be obligated by virtue of any Option Agreement or any provision of the Plan
to recognize the exercise of an Incentive Stock Option to sell or issue
shares in violation of said Act or of the law of any government having
jurisdiction thereof. Any such postponement shall extend the Term of an
Incentive Stock Option with respect to any shares as to which the Incentive
Stock Option would have lapsed because of such postponement; provided,
however, that in no case will any such postponement serve to extend
<PAGE>
the Term of the Incentive Stock Option to a date exceeding ten years from the
date the Incentive Stock Option was granted.
(f) All Incentive Stock Options granted under the Plan shall be
nontransferable other than by will or by the law of descent and distribution.
An Incentive Stock Option may be exercised during the lifetime of the Grantee
only by the Grantee.
(g) Upon the exercise of an Incentive Stock Option by the Grantee,
the stock certificate or certificates may, at the request of the Grantee, be
issued in the Grantee's name and the name of another person as joint tenants
with right of survivorship.
(h) The Committee may provide in an option agreement that in the
event of a Change in Control (as hereinafter defined) of the Company, all or
a portion of the Options awarded to a Grantee shall become fully vested and
immediately exercisable. "Change in Control" shall mean (i) the occurrence of
an event of a nature that would be required to be reported in response to
Item 1 or Item 2 of a Form 8-K Current Report of the Company promulgated
pursuant to Sections 13 and 15(d) of the Securities Exchange Act of 1934, as
amended (the "Exchange Act"); provided that, without limitation, such a
Change in Control shall be deemed to have occurred if (a) any "person", as
such term is used in Sections 13(d) and 14(d) of the Exchange Act (other than
the Company, any trustee or other fiduciary holding securities under any
employee benefit plan of the Company, or any company owned, directly or
indirectly, by the shareholders of the Company in substantially the same
proportions as their ownership of stock of the Company), is or becomes the
"beneficial owner" (as defined in Rule 13d-3 under the Exchange Act),
directly or indirectly, of securities of the Company representing fifty
percent (50%) or more of the combined voting power of the Company's then
outstanding securities or (b) during any period of two consecutive years,
individuals who at the beginning of such period constitute the Board cease
for any reason to constitute at least a majority thereof, unless the election
by the Board or the nomination for election by the Company's shareholders was
approved by a vote of at least two-thirds (2/3) of the directors then still
in office who either were directors at the beginning of the two-year period
of whose election or nomination for election was previously so approved; (ii)
the shareholders of the Company approve a merger or consolidation of the
Company with any other corporation, other than a merger or consolidation of
the Company with any other corporation, other than a merger or consolidation
that would result in the voting securities of the Company outstanding
immediately prior thereto continuing to represent (either by remaining
outstanding or by being converted into voting securities of the surviving
entity) more than fifty-one percent (51%) of the combined voting power of the
voting securities of the surviving entity outstanding immediately after such
merger or consolidation; provided, however, that a merger or consolidation
effected to implement a reorganization or recapitalization of the Company, or
a similar transaction, in which no "person" acquires more than twenty percent
(20%) of the combined voting power of the Company's then outstanding
securities shall not constitute a Change in Control of the Company; or (iii)
the shareholders of the Company 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. If the Committee does not provide
for accelerated vesting in an option agreement pursuant to this Section
10(h), such Option shall vest, if at all, solely in accordance with the terms
of the agreement and the other terms of this Plan.
<PAGE>
11. EXERCISE OF OPTION BY GRANTEE ON CESSATION OF EMPLOYMENT
Incentive Stock Options shall terminate immediately upon the cessation of
employment of the Grantee unless the Committee has provided in the Grantee's
Option Agreement, subject to the limitations set forth below, for exercise of
Incentive Stock Options following cessation of employment. Employment for the
purposes of this section shall mean continuous full-time salaried employment
with the Company or a Subsidiary, except that vacations, sick leaves, and
other approved absences and severance pay periods shall be disregarded, but
only to the extent allowed by the Code. The following limitations shall apply
to any provisions the Committee shall make in an Option Agreement for
exercise of Incentive Stock Options following cessation of employment.
(a) If cessation of employment is the result of death or Disability
of the Grantee, no exercise may occur more than one (1) year following such
cessation of employment.
(b) If cessation of employment is for a reason other than death or
Disability of the Grantee, no exercise may occur more than three (3) months
following such cessation of employment; provided that, if the Grantee dies
during such three (3) month period, Incentive Stock Options may be exercised
within one (1) year after the date of death.
(c) Notwithstanding anything to the contrary contained in
Subsections (a) and (b) above, no exercise may occur after expiration of the
Term of the Incentive Stock Option.
(d) No installment which had not become exercisable at the time of
cessation of employment may be exercised thereafter.
(e) If the Grantee's employment has been terminated for deliberate
willful, or gross misconduct, as determined by the Committee, all Incentive
Stock Options shall terminate upon notice to Grantee of his termination.
12. SHAREHOLDERS' RIGHTS
No person shall have any rights of a shareholder by virtue of the grant of an
Incentive Stock Option except with respect to shares actually issued to that
person upon the exercise thereof, and for which certificates of stock have
been registered in that person's name.
13. ADJUSTMENT FOR CHANGES IN CAPITALIZATION
Any increase in the number of outstanding shares of Common Stock of the
Company occurring through stock splits or stock dividends after the adoption
of the Plan shall be reflected proportionately as an increase in the
aggregate number of shares of Common Stock then available for the grant of
Incentive Stock Options under the Plan and in the number of shares of Common
Stock subject to Incentive Stock Options then outstanding, and a
proportionate
<PAGE>
reduction shall be made in the per share price as to any outstanding
Incentive Stock Options. Any fractional shares resulting from such
adjustments shall be eliminated. If changes in capitalization other than
those considered above shall occur, the Committee shall make such adjustment
in the number and class of shares for which Incentive Stock Options may
thereafter be granted, in the number and class of shares remaining subject to
Incentive Stock Options then outstanding, and in the per share price as the
Committee in its discretion may consider appropriate, and all such
adjustments shall be conclusive upon all persons. No change shall be made in
the terms of an Incentive Stock Option which would cause such Incentive Stock
Option to fail to constitute an incentive stock option within the meaning of
Code Section 422.
14. CORPORATE MERGERS AND ACQUISITIONS
The Committee may grant Incentive Stock Options having terms and provisions
which vary from those specified in this Plan provided that any Incentive
Stock Options granted pursuant to this section are granted in substitution
for, or in connection with the assumption of, existing options granted by
another corporation and assumed or otherwise agreed to be provided for by the
Company pursuant to or by reason of a transaction involving a corporate
merger, consolidation, acquisition of property or stock, separation,
reorganization, or liquidation to which the Company or a Subsidiary is a
party.
15. TERMINATION, SUSPENSION, OR MODIFICATION OF PLAN
The Board may at any time terminate, suspend, or modify the Plan, except that
the Board shall not, without authorization of the holders of a majority of
the outstanding shares entitled to vote, effect any change (other than
through adjustment for changes in capitalization as hereinabove provided)
which: (a) increases the aggregate number of shares for which Incentive Stock
Options may be granted; (b) changes the class of employees eligible to be
granted Incentive Stock Options, (c) lowers the minimum per share price; (d)
extends the maximum Incentive Stock Option Term; (e) extends the maximum
period during which Incentive Stock Options may be granted under the Plan; or
(f) materially increases the benefits accruing to employees under the Plan.
No termination, suspension or modification of the Plan will adversely effect
any right acquired by any Grantee or any Successor under the terms of an
Incentive Stock Option granted before the date of such termination,
suspension or modification, unless such Grantee or Successor shall consent;
but it shall be conclusively presumed that any adjustment for changes in
capitalization as provided in Section 13 does not adversely affect any such
right.
16. APPLICATION OF PROCEEDS
The proceeds received by the Company, from the sale of its Shares under the
Plan will be used for general corporate purposes.
17. MISCELLANEOUS
(a) This Plan and all rights hereunder shall be construed in
accordance with and governed by the laws of the State of Texas.
<PAGE>
(b) Neither the adoption of this Plan nor any action of the Board or
the Committee shall be deemed to give a director or an employee any right to
be granted an Incentive Stock Option to purchase Common Stock except as may
be evidenced by an Option Agreement duly executed on behalf of the Company,
and then only to the extent and on the terms and conditions expressly set
forth therein.
(c) Nothing contained in the Plan shall (i) confer upon any employee
any right with respect to continuation of employment with the Company, or
(ii) interfere in any way with the right of the Company to terminate his or
her employment at any time.
(d) The terms of the Plan and of each related Option Agreement shall
be construed to qualify any Options granted under the Plan as Incentive Stock
Options.
(e) With respect to persons subject to Section 16 of the 1934 Act,
transactions under the Plan are intended to comply with all applicable
conditions of Rule 16b-3 or its successors under the 1934 Act. To the extent
any provision of the Plan or action by the Committee fails to so comply, it
will be void, to the extent permitted by law and deemed advisable by the
Committee.
(f) The Company shall not be obligated to issue any shares of Common
Stock until there has been compliance with such laws and regulations as the
Company may deem applicable. No fractional shares of Common Stock shall be
delivered. The Company shall have the right to deduct any tax required by law
to be withheld and to require any prepayments required to enable it to
satisfy its withholding obligations.
<PAGE>
HCC INSURANCE HOLDINGS, INC.
1995 FLEXIBLE INCENTIVE PLAN,
AS AMENDED AND RESTATED
1. PURPOSE OF THE PLAN
The purposes of HCC Insurance Holdings, Inc. 1995 Flexible Incentive
Plan (the "Plan") are to promote the interests of HCC Insurance Holdings,
Inc. and its subsidiaries (together with any successor thereto, the
"Company") and its Shareholders by enabling the Company to attract, motivate
and retain key employees by offering such key employees performance-based
stock incentives and other equity interests in the Company and other
incentive awards that recognize the creation of value for the Shareholders of
the Company and promote the Company's long-term growth and success. To
achieve these purposes, eligible persons may receive stock options, Stock
Appreciation Rights, Restricted Stock, Performance Awards, Performance Stock,
Dividend Equivalent Rights and any other Awards, or any combination thereof.
2. DEFINITIONS
As used in the Plan, the following terms shall have the meanings set
forth below unless the content otherwise requires:
2.1 "AWARD" shall mean the grant of a stock option, a Stock
Appreciation Right, a Restricted Stock, a Performance Award, performance
stock, a Dividend Equivalent Right or any other Award under the Plan.
2.2 "BOARD" shall mean the Board of Directors of the Company, as the
same may be constituted from time to time.
2.3 "CHANGE IN CONTROL" shall mean, after the effective date of the
Plan, (i) the occurrence of an event of a nature that would be required to be
reported in response to Item 1 or Item 2 of a Form 8-K Current Report of the
Company promulgated pursuant to Sections 13 and 15(d) of the Exchange Act;
provided that, without limitation, such a Change in Control shall be deemed
to have occurred if (a) any "person," as such term is used in Sections 13(d)
and 14(d) of the Exchange Act (other than the Company, any trustee or other
fiduciary holding securities under any employee benefit plan of the Company,
or any company owned, directly or indirectly, by the Shareholders of the
Company in substantially the same proportions as their ownership of stock of
the Company), is or becomes the "beneficial owner" (as defined in Rule 13d-3
under the Exchange Act), directly or indirectly, of securities of the Company
representing twenty-five percent (25%) or more of the combined voting power
of the Company's then outstanding securities or (b) during any period of two
consecutive years, individuals who at the beginning of such period constitute
the Board cease for any reason to constitute at least a majority thereof,
unless the election by the Board or the nomination for election by the
Company's Shareholders was approved by a vote of at least two-thirds (2/3) of
the Directors then still in office who either were Directors at the beginning
of the two-year period or whose election or nomination for election was
previously so approved; (ii) the Shareholders of the Company approve a merger
or consolidation of the Company with any other corporation, other than a
merger or consolidation that would result in the voting securities of the
Company outstanding immediately prior thereto continuing to represent (either
by remaining outstanding or by being converted into voting
<PAGE>
securities of the surviving entity) more than eighty percent (80%) of the
combined voting power of the voting securities of the surviving entity
outstanding immediately after such merger or consolidation; provided,
however, that a merger or consolidation effected to implement a
reorganization or recapitalization of the Company, or a similar transaction
(collectively, a "Reorganization"), in which no "person" acquires more than
twenty percent (20%) of the combined voting power of the Company's then
outstanding securities shall not constitute a Change in Control of the
Company; or (iii) the Shareholders of the Company 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.
2.4 "CODE" shall mean the Internal Revenue Code of 1986, as amended
from time to time.
2.5 "COMMITTEE" shall mean the Stock Option and Compensation
Committee, if such a separate committee is appointed by the Board, or, until
such time as a separate committee is appointed, it shall mean the Board. If a
separate committee is appointed, the Committee shall meet the applicable
requirements for "disinterested administration" within the requirements of
Rule 16b-3 promulgated under the Exchange Act and any successor thereunder
promulgated during the duration of the Plan. The Board may amend the Plan to
modify the definition of Committee within the limits of Rule 16b-3 to assure
that the Plan is administered in compliance with Rule 16b-3. Initially, the
Committee will consist of not less than three (3) members of the Board who
are appointed by, and serve at the pleasure of, the Board and who are (i)
"disinterested" within the meaning of Rule 16b-3 and (ii) "outside
directors," as required under Section 162(m) of the Code and such Treasury
Regulations as may be promulgated thereunder. The Board does not meet the
applicable requirements of Rule 16b-3.
2.6 "COMMON STOCK" shall mean the Common Stock, $1.00 par value per
share, of the Company.
2.7 "DESIGNATED BENEFICIARY" shall mean the beneficiary designated
by a Participant in a manner determined by the Committee, to exercise rights
of the Participant in the event of the Participant's death. In the absence of
an effective designation by a Participant the Designated Beneficiary shall be
the Participant's estate.
2.8 "DISABILITY" shall mean permanent and total inability to engage
in any substantial gainful activity 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 expected to last for a continuous period of not
less than twelve (12) months, as determined in the sole and absolute
discretion of the Committee.
2.9 "DIVIDEND EQUIVALENT RIGHT" shall mean the right of the holder
thereof to receive credits based on the cash dividends that would have been
paid on the Shares specified in an Award granting Dividend Equivalent Rights
if the Shares subject to such Award were held by the person to whom the Award
is made.
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<PAGE>
2.10 "EXCHANGE ACT" shall mean the Securities Exchange Act of 1934,
as amended from time to time.
2.11 "FAIR MARKET VALUE" shall mean with respect to the Shares, as
of any date, (i) the last reported sales price on any stock exchange on which
the Common Stock is traded or, if not reported on such exchange, on the
composite tape, or, in case no such sale takes place on such day, the average
of the reported closing bid and asked quotations on such exchange; (ii) if
the Common Stock is not listed on a stock exchange or no such quotations are
available, the closing price of the Common Stock as reported by the National
Market System of the National Association of Securities Dealers, Inc., or, if
no such quotations are available, the average of the high bid and low asked
quotations in the over-the-counter market as reported by the National
Quotation Bureau Incorporated, or similar organization; or (iii) in the event
that there shall be no public market for the Common Stock, the fair market
value of the Common Stock as determined (which determination shall be
conclusive) in good faith by the Committee, based upon the value of the
Company as a going concern, as if such Common Stock were publicly owned
stock, but without any discount with respect to minority ownership.
2.12 "INCENTIVE STOCK OPTION" shall mean any stock option awarded
under the Plan which qualifies as an "Incentive Stock Option" under Section
422 of the Code or any successor provision.
2.13 "NON-TANDEM STOCK APPRECIATION RIGHT" shall mean any Stock
Appreciation Right granted alone and not in connection with an Award which is
a stock option.
2.14 "NON-QUALIFIED STOCK OPTION" shall mean any stock option
awarded under the Plan that does not qualify as an Incentive Stock Option.
2.15 "OPTIONEE" shall mean any person who has been granted a stock
option under the Plan and who has executed a written stock option agreement
with the Company reflecting the terms of such grant.
2.16 "PERFORMANCE AWARD" shall mean any Award hereunder of Shares,
units or rights based upon, payable in, or otherwise related to, Shares
(including Restricted Stock), or cash of an equivalent value, as the
Committee may determine, at the end of a specified performance period
established by the Committee.
2.17 " PLAN" shall mean the HCC Insurance Holdings, Inc. Flexible
Incentive Plan set forth herein.
2.18 "RELOAD OPTION" shall mean a stock option as deemed in
subsection 6.6(b) herein.
2.19 "RESTRICTED STOCK" shall mean any Award of Shares under the
Plan that are subject to restrictions or risk of forfeiture.
2.20 "RETIREMENT" unless otherwise defined herein or as defined in
any other agreement regarding an Award, shall mean termination of employment
other than discharge for cause, after
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<PAGE>
age 65 or on or before age 65 if pursuant to the terms of any retirement plan
maintained by the Company or any of its Subsidiaries in which such person
participates.
2.21 "SHARES" shall mean shares of the Company's Common Stock and
any shares of capital stock or other securities of the Company hereafter
issued or issuable upon, in respect of or in substitution or exchange for
such Shares.
2.22 "STOCK APPRECIATION RIGHT" shall mean the right of the holder
thereof to receive an amount in cash or Shares equal to the excess of the
Fair Market Value of a Share on the date of exercise over the Fair Market
Value of a Share on the date of the grant (or such other value as may be
specified in the agreement granting the Stock Appreciation Right).
2.23 "SUBSIDIARY" shall mean a subsidiary corporation of the
Company, as defined in Section 424(f) of the Code.
2.24 "TANDEM STOCK APPRECIATION RIGHT" shall mean a Stock
Appreciation Right granted in connection with an Award which is a stock
option.
3. ADMINISTRATION OF THE PLAN
3.1 COMMITTEE. The Plan shall be administered and interpreted by the
Committee.
3.2 AWARDS. Subject to the provisions of the Plan and directions
from the Board, the Committee is authorized to:
(a) determine the persons to whom Awards are to be granted;
(b) determine the types and combinations of Awards to be granted,
the number of Shares to be covered by the Award, the pricing of the Award,
the time or times when the Award shall be granted and may be exercised, the
terms, performance criteria or other conditions, vesting periods or any
restrictions for an Award, any restrictions on Shares acquired pursuant to
the exercise of an Award and any other terms and conditions of an Award;
(c) conclusively interpret the provisions of the Plan;
(d) prescribe, amend and rescind the rules and regulations relating
to the Plan or make individual decisions as questions arise, or both;
(e) determine whether, to what extent and under what circumstances
to provide loans from the Company to participants to purchase Shares subject
to Awards under the Plan, and the terms and conditions of such loans;
(f) rely upon employees of the Company for such clerical and
recordkeeping duties as may be necessary in connection with the
administration of the Plan; and
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<PAGE>
(g) make all other determinations and take all other actions
necessary or advisable for the administration of the Plan.
3.3 PROCEDURES. A majority of the Committee members shall constitute
a quorum. All determinations of the Committee shall be made by a majority of
its members. All questions of interpretation and application of the Plan or
pertaining to any question of fact or Award granted hereunder shall be
decided by the Committee, whose decision shall be final, conclusive and
binding upon the Company and each other affected party.
4. SHARES SUBJECT TO PLAN
4.1 LIMITATIONS. The maximum number of Shares that may be issued
with respect to Awards under the Plan shall not exceed 450,000 unless such
maximum shall be increased or decreased by reason of changes in
capitalization of the Company as hereinafter provided. The Shares issued
pursuant to the Plan may be authorized but unissued Shares, or may be issued
Shares which have been reacquired by the Company.
4.2 CHANGES. To the extent that any Award under the Plan, or any
stock option or performance award granted under any prior incentive plan of
the Company shall be forfeited, shall expire or shall be canceled, in whole
or in part then the number of Shares covered by the Award or stock option so
forfeited, expired or canceled may again be awarded pursuant to the
provisions of the Plan. In the event that Shares are delivered to the Company
in full or partial payment of the exercise price for the exercise of a stock
option granted under the Plan or any prior incentive plan of the Company, the
number of Shares available for future Awards under the Plan shall be reduced
only by the net number of Shares issued upon the exercise of the option.
Awards that may be satisfied either by the issuance of Shares or by cash or
other consideration shall, until the form of consideration to be paid is
finally determined, be counted against the maximum number of Shares that may
be issued under the Plan. If the Award is ultimately satisfied by the payment
of consideration other than Shares, as, for example, a stock option granted
in tandem with a Stock Appreciation Right that is settled by a cash payment
of the stock appreciation, such Shares may again be made the subject of an
Award under the Plan. Awards will not reduce the number of Shares that may be
issued pursuant to the Plan if the settlement of the Award will not require
the issuance of Shares, as, for example, a Stock Appreciation Right that can
be satisfied only by the payment of cash.
5. ELIGIBILITY
Eligibility for participation in the Plan shall be confined to those
persons who are employed by the Company, and who are officers of the Company,
or who are in managerial or other key positions within the Company or are
otherwise valuable employees of the Company. In making any determination as
to persons to whom Awards shall be granted, the type of Award, and/or the
number of Shares to be covered by the Award, the Committee shall consider the
position and responsibilities of the person, his or her importance to the
Company, the duties of such person, his or her past, present and potential
contributions to the growth and success of the Company, and such other
factors as the Committee shall deem relevant in connection with accomplishing
the purposes of the Plan.
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<PAGE>
6. STOCK OPTIONS
6.1 GRANTS. The Committee may grant stock options alone or in
addition to other Awards granted under the Plan to any eligible officer,
director or other key employee. Each person so selected shall be offered an
option to purchase the number of Shares determined by the Committee. The
Committee shall specify whether such option is an Incentive Stock Option or
Non-Qualified Stock Option and any other terms and conditions relating to
such Award. To the extent that any stock option does not qualify as an
Incentive Stock Option (whether because of its provisions or the time or
manner of its exercise or otherwise), such stock option or the portion
thereof which does not qualify shall constitute a separate Non-Qualified
Stock Option. Each such person so selected shall have a reasonable period of
time within which to accept or reject the offered option. Failure to accept
within the period so fixed by the Committee may be treated as a rejection.
Each person who accepts an option shall enter into a written agreement with
the Company, in such form as the Committee may prescribe, setting forth the
terms and conditions of the option, consistent with the provisions of the
Plan. The Optionee and the Company shall enter into option agreements for
Incentive Stock Options and Non-Qualified Stock Options. At any time and from
time to time, the Optionee and the Company may agree to modify an option
agreement so that an Incentive Stock Option may be converted to a
Non-Qualified Stock Option.
The Committee may require that an Optionee meet certain conditions
before the option or a portion thereof may vest or be exercised, as, for
example, that the Optionee remain in the employ of the Company for a stated
period or periods of time before the option, or stated portions thereof, may
vest or be exercised.
6.2 OPTION PRICE. The option exercise price of the Shares covered by
each stock option shall be determined by the Committee; provided, however,
that the option exercise price of an Incentive Stock Option shall not be less
than one hundred percent (100%) of the Fair Market Value of Shares on the
date of the grant of such Incentive Stock Option.
6.3 INCENTIVE STOCK OPTIONS LIMITATIONS.
(a) In no event shall any person be granted Incentive Stock Options
to the extent that the Shares covered by any Incentive Stock Options (and any
Incentive Stock Options granted under any other plans of the Company and its
Subsidiaries) that may be exercised for the first time by such person in any
calendar year have an aggregate Fair Market Value in excess of $100,000. For
this purpose, the Fair Market Value of the Shares shall be determined as of
the dates on which the Incentive Stock Options are granted. It is intended
that the limitation on Incentive Stock Options provided in this subsection
6.3(a) be the maximum limitation on options which may be considered Incentive
Stock Options under the Code.
(b) Notwithstanding anything herein to the contrary, in no event
shall any employee owning more than ten percent (10%) of the total combined
voting power of the Company or any Subsidiary be granted an Incentive Stock
Option hereunder unless the option exercise price shall be at least one
hundred ten percent (110%) of the Fair Market Value of the Shares subject to
such Incentive Stock Option at the time that the Incentive Stock Option is
granted and the term of such Incentive Stock Option shall not exceed five (5)
years.
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<PAGE>
6.4 OPTION TERM. Subject to subsection 6.3(b) hereof, the term of a
stock option shall be for such period of months or years from the date of its
grant as may be determined by the Committee; provided, however, that no
Incentive Stock Option shall be exercisable later than ten (10) years from
the date of its grant. Furthermore, no stock option may be exercised unless,
at the time of such exercise, the Optionee is; and has been continuously
since the date of grant of his or her Incentive Stock Option, employed by the
Company, except that:
(a) A stock option may, to the extent vested, be exercised within
the period of ninety (90) days after the date the Optionee ceases to be an
employee of the Company and the Subsidiaries for any reason other than as set
forth below (or within such lesser period as may be specified in the
applicable option agreement), provided that the option agreement may
designate a longer exercise period and that the exercise after such ninety
(90)-day period shall be treated as the exercise of a Non-Qualified Stock
Option under the Plan;
(b) In the event of the death of the Optionee while in the employ of
the Company or the Subsidiaries or within ninety (90) days after the date the
Optionee ceases to be an employee of the Company or the Subsidiaries (or
within such lesser period as may be specified in the applicable option
agreement, whichever is shorter), the stock option may, to the extent vested
and previously unexercised, be exercised by the Optionee's Designated
Beneficiary within the one-year period immediately following such date of
death (or within such lesser period as may be specified in the applicable
option agreement, whichever is shorter);
(c) If the Optionee ceases to be an employee of the Company by
reason of the Optionee's Disability, the Incentive Stock Option may be
exercised within the period of one year after the date of Disability (or
within such lesser period as may be specified in the applicable option
agreement);
(d) If the Optionee voluntarily terminates employment with the
Company without good reason (which determination shall be made in the sole
and absolute discretion of the Committee), the stock option may, to the
extent vested and previously unexercised, be exercised by the Optionee within
the period of ten (10) days after the termination of employment of the
Optionee (or within such lesser period as may be specified in the applicable
option agreement, whichever is shorter);
(e) If the employment of the Optionee is terminated for cause (which
determination shall be made in the sole and absolute discretion of the
Committee) the stock option may, to the extent vested and previously
unexercised, be exercised by the Optionee within the period of ten (10) days
after the termination of employment of the Optionee (or within such lesser
period as may be specified in the applicable option agreement, whichever is
shorter);
(f) In the event of the termination of the Optionee's employment on
or after the attainment of age 65 (or such other age as is permitted for the
Optionee by the Committee in its sole discretion) and provided Optionee does
not engage in full time employment with any other entity ("Retirement"), the
stock option may, to the extent vested and previously unexercised, be
exercised by the Optionee within the period of one (1) year after the
termination of employment
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<PAGE>
by the Optionee (or within such lesser period as may be specified in the
applicable option agreement, whichever is shorter), provided that the
exercise of the option more than ninety (90) days after the Optionee's
termination of employment shall be treated as the exercise of a Non-Qualified
Option under the Plan.
6.5 VESTING OF STOCK OPTIONS.
(a) Each stock option granted hereunder may only be exercised to the
extent that the Optionee is vested in such option. Each stock option shall
vest separately in accordance with the option vesting schedule, if any,
determined by the Committee in its sole discretion, which will be
incorporated in the stock option agreement entered into between the Company
and each Optionee and only to the extent that the Optionee remains in the
continuous employ of the Company or a Subsidiary. The option vesting schedule
will be accelerated if, in the sole discretion of the Committee, the
Committee determines that acceleration of the option vesting schedule would
be desirable for the Company.
(b) In the event of the dissolution or liquidation of the Company,
each stock option granted under the Plan shall terminate as of a date to be
fixed by the Board; provided, however, that not less than thirty (30) days
written notice of the date so fixed shall be given to each Optionee and each
such Optionee shall be fully vested in and shall have the right during such
period to exercise the option, even though such option would not otherwise be
exercisable under the option vesting schedule. At the end of such period, any
unexercised option shall terminate and be of no other effect.
(c) In the event of a Reorganization (as defined in Section 2.3
hereof):
(1) If there is no plan or agreement respecting the
Reorganization, or if such plan or agreement does not specifically
provide for the change, conversion or exchange of the Shares under
outstanding and unexercised stock options for other securities then
the provisions of subsection 6.5(b) shall apply as if the Company had
dissolved or been liquidated on the effective date of the
Reorganization; or
(2) If there is a plan or agreement respecting the
Reorganization, and if such plan or agreement specifically provides for
the change, conversion or exchange of the Shares under outstanding and
unexercised stock options for securities of another corporation, then
the Board shall adjust the Shares under such outstanding and
unexercised stock options (and shall adjust the Shares remaining under
the Plan which are then available to be awarded under the Plan, if such
plan or agreement makes no specific provision therefore) in a manner
not inconsistent with the provisions of such plan or agreement for the
adjustment, change, conversion or exchange of such Shares and such
options.
(d) The Committee may provide in an option agreement and/or Stock
Appreciation Rights agreement that in the event of a Change in Control of the
Company, (1) all or a portion of the stock options and any associated Stock
Appreciation Rights awarded under such agreement shall become fully vested and
immediately exercisable and/or (2) the vesting of all performance-
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<PAGE>
based stock options shall be determined as if the performance period or cycle
applicable to such options had ended immediately upon such Change in Control;
provided, however, that if in the opinion of counsel to the Company the
immediate exercisability of options when taken into consideration with all
other "parachute payments" as defined in Section 280G of the Code, as
amended, would result in an "excess parachute payment" as defined in such
section as well as an excise tax imposed by Section 4999 of the Code, such
options and any associated Stock Appreciation Rights shall become fully
vested and immediately exercisable, except as and to the extent the Committee
in its sole discretion, shall otherwise determine, which determination by the
Committee shall be based solely upon maximizing the after-tax benefits to be
received by any such Optionee. If the Committee does not provide for
accelerated vesting in an option or Stock Appreciation Rights agreement
pursuant to this Subsection 6.5(d), such option and/or Stock Appreciation
Right shall vest, if at all, solely in accordance with the terms of the
agreement and the other terms of this Plan.
6.6 EXERCISE OF STOCK OPTIONS.
(a) Stock options may be exercised as to Shares only in amounts and
at intervals of time specified in the written option agreement between the
Company and the Optionee. Each exercise of a stock option, or any part
thereof, shall be evidenced by a notice in writing to the Company. The
purchase price of the Shares as to which an option shall be exercised shall
be paid in full at the time of exercise, and may be paid to the Company
either:
(1) in cash (including check, bank draft or money order); or
(2) by the delivery of Shares having a Fair Market Value equal
to the aggregate option rate;
(3) by a combination of cash and Shares; or
(4) by other consideration deemed acceptable by the Committee
in its sole discretion.
(b) If an Optionee delivers Shares (including Shares of Restricted
Stock) already owned by him or her in full or partial payment of the exercise
price for any stock option granted under the Plan or any prior incentive plan
of the Company, or if the Optionee elects to have the Company reflect that
number of Shares out of the Shares being acquired through the exercise of the
option having a Fair Market Value equal to the exercise price of the stock
option being exercised, the Committee may authorize the automatic grant of a
new option (a "Reload Option") for that number of Shares as shall equal the
number of already owned Shares surrendered (including Shares of Restricted
Stock) or newly acquired Shares being retained in payment of the option
exercise price of the underlying stock option being exercised. The grant of a
Reload Option will become effective upon the exercise of the underlying stock
option. The option exercise price of the Reload Option shall be the Fair
Market Value of a Share on the effective date of the grant of the Reload
Option. Each Reload Option shall be exercisable no earlier than six (6)
months from the date of its grant and no later than the time when the
underlying stock option being exercised could be last exercised. The
Committee may also specify additional
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terms, conditions and restrictions for the Reload Option and the Shares to be
acquired upon the exercise thereof.
(c) The amount, as determined by the Committee, of any federal,
state or local tax required to be withheld by the Company due to the exercise
of a stock option shall be satisfied by payment by the Optionee to the
Company of the amount of such withholding obligation in cash or other
consideration acceptable to the Committee in its sole discretion.
(d) An Optionee shall not have any of the rights of a Shareholder of
the Company with respect to the Shares covered by a stock option except to
the extent that one or more certificates representing such Shares shall have
been delivered to the Optionee, or the Optionee has been determined to be a
Shareholder of record by the Company's transfer agent, upon due exercise of
the option.
6.7 DATE OF A STOCK OPTION GRANT. The granting of a stock option
shall take place only upon the execution and delivery by the Company and an
optionee of an option agreement. Neither any action taken by the Board nor
anything contained in the Plan or in any resolution adopted or to be adopted
by the Board or the Shareholders of the Company shall constitute the granting
of a stock option under the Plan.
7. STOCK APPRECIATION RIGHTS
7.1 GRANTS. The Committee may grant to any eligible employee either
Non-Tandem Stock Appreciation Rights or Tandem Stock Appreciation Rights.
Stock Appreciation Rights shall be subject to such terms and conditions as
the Committee shall impose. The grant of the Stock Appreciation Right may
provide that the holder may be paid for the value of the Stock Appreciation
Right either in cash or in Shares, or a combination thereof, at the
discretion of the Committee. In the event of the exercise of a Stock
Appreciation Right payable in Shares, the holder of the Stock Appreciation
Right shall receive that number of whole Shares of stock of the Company
having an aggregate Fair Market Value on the date of exercise equal to the
value obtained by multiplying (i) either (a) in the case of a Tandem Stock
Appreciation Right, the difference between the Fair Market Value of a Share
on the date of exercise over the per share exercise price of the related
option, or (b) in the case of a Non-Tandem Stock Appreciation Right the
difference between the Fair Market Value of a Share on the date of exercise
over the Fair Market Value on the date of the grant by (ii) the number of
Shares as to which the Stock Appreciation Right is exercised. However,
notwithstanding the foregoing, the Committee, in its sole discretion, may
place a ceiling on the amount payable upon exercise of a Stock Appreciation
Right but any such limitation shall be specified at the time that the Stock
Appreciation Right is granted.
7.2 EXERCISABILITY. A Tandem Stock Appreciation Right may be granted
at the time of the grant of the related stock option or, if the related stock
option is a Non-Qualified Stock Option, at any time thereafter during the
term of the stock option. A Tandem Stock Appreciation Right granted in
connection with an Incentive Stock Option (i) may be exercised at, and only
at, the times and to the extent the related Incentive Plan Stock Option is
exercisable, (ii) expires upon the termination of the related Incentive Stock
Option, (iii) may not exceed 100% of the
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difference between the exercise price of the related Incentive Stock Option
and the market price of the Shares subject to the related Incentive Stock
Option at the time the Tandem Stock Appreciation Right is exercised and (iv)
may be exercised at, and only at, such times as the market price of the
Shares subject to the related Incentive Stock Option exceeds the exercise
price of the related Incentive Stock Option. The Tandem Stock Appreciation
Right may be transferred at, and only at, the times and to the extent the
related stock option is transferable. If a Tandem Stock Appreciation Right is
granted, there shall be surrendered and canceled from the related option at
the time of exercise of the Tandem Stock Appreciation Right, in lieu of
exercise under the related option, that number of Shares as shall equal the
number of Shares as to which the Tandem Stock Appreciation Right shall have
been exercised.
7.3 CERTAIN LIMITATIONS ON NON-TANDEM STOCK, APPRECIATION RIGHTS. A
Non-Tandem Stock Appreciation Right will be exercisable as provided by the
Committee and will have such other terms and conditions as the Committee may
determine. A Non-Tandem Stock Appreciation Right is subject to acceleration
of vesting or immediate termination in certain circumstances in the same
manner as stock options pursuant to subsections 6.4 and 6.5 of the Plan.
7.4 LIMITED STOCK APPRECIATION RIGHTS. The Committee is also
authorized to grant "limited stock appreciation rights," either as Tandem
Stock Appreciation Rights or Non-Tandem Stock Appreciation Rights. Limited
stock appreciation rights would become exercisable only upon the occurrence
of a Change in Control or such other event as the Committee may designate at
the time of grant or thereafter.
8. RESTRICTED STOCK
8.1 GRANTS. The Committee may grant Awards of Restricted Stock for
no cash consideration, for such minimum consideration as may be required by
applicable law, or for such other consideration as may be specified by the
grant. The terms and conditions of the Restricted Stock shall be specified by
the grant agreement. The Committee, in its sole discretion, may specify any
particular rights which the person to whom an Award of Restricted Stock is
made shall have in the Restricted Stock during the restriction period and the
restrictions applicable to the particular Award, the vesting schedule (which
may be based on service, performance or other factors) and rights to
acceleration of vesting (including, without limitation, whether non-vested
Shares are forfeited or vested upon termination of employment). Further, the
Committee may award performance-based Restricted Stock by conditioning the
grant, or vesting or such other factors, such as the release, expiration or
lapse of restrictions upon any such Award (including the acceleration of any
such conditions or terms) of such Restricted Stock upon the attainment of
specified performance goals or such other factors as the Committee may
determine. The Committee shall also determine when the restrictions shall
lapse or expire and the conditions, if any, under which the Restricted Stock
will be forfeited or sold back to the Company. Each Award of Restricted Stock
may have different restrictions and conditions. The Committee, in its
discretion, may prospectively change the restriction period and the
restrictions applicable to any particular Award of Restricted Stock. Unless
otherwise set forth in the Plan, Restricted Stock may not be disposed of by
the recipient until the restrictions specified in the Award expire.
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8.2 AWARDS AND CERTIFICATES. Any Restricted Stock issued hereunder
may be evidenced such manner as the Committee, in its sole discretion, shall
deem appropriate including, without limitation, book-entry registration or
issuance of a stock certificate or certificates. In the event any stock
certificate is issued in respect of Shares of Restricted Stock awarded
hereunder, such certificate shall bear an appropriate legend with respect to
the restrictions applicable to such Award. The Company may retain, at its
option, the physical custody of any stock certificate representing any awards
of Restricted Stock during the restriction period or require that the
Restricted Stock be placed in escrow or trust, along with a stock power
endorsed in blank, until all restrictions are removed or expire.
9. PERFORMANCE AWARDS
9.1 GRANTS. A Performance Award may consist of either or both, as
the Committee may determine, of (i) "Performance Shares" or the right to
receive Shares, Restricted Stock or cash of an equivalent value, or any
combination thereof as the Committee may determine, or (ii) "Performance
Units," or the right to receive a fixed dollar amount payable in cash, Common
Stock, Restricted Stock or any combination thereof, as the Committee may
determine. The Committee may grant Performance Awards to any eligible
employee, for no cash consideration, for such minimum consideration as may be
required by applicable law or for such other consideration as may be
specified at the time of the grant. The terms and conditions of Performance
Awards shall be specified at the time of the grant and may include provisions
establishing the performance period, the performance criteria to be achieved
during a performance period the criteria used to determine vesting (including
the acceleration thereof), whether Performance Awards are forfeited or vest
upon termination of employment during a performance period and the maximum or
minimum settlement values. Each Performance Award shall have its own terms
and conditions, which shall be determined at the discretion of the Committee.
If the Committee determines, in its sole discretion, that the established
performance measures or objectives are no longer suitable because of a change
in the Company's business, operations, corporate structure or for other
reasons that the Committee deems satisfactory, the Committee may modify the
performance measures or objectives and/or the performance period.
9.2 TERMS AND CONDITIONS. Performance Awards may be valued by
reference to the Fair Market Value of a Share or according to any formula or
method deemed appropriate by the Committee, in its sole discretion,
including, but not limited to, achievement of specific financial, production,
sales, cost or earnings performance objectives that the Committee believes to
be relevant to the Company's business and for remaining in the employ of the
Company for a specified period of time, or the Company's performance or the
performance of its Common Stock measured against the performance of the
market, the Company's industry segment or its direct competitors. Performance
Awards may be paid in cash, Shares (including Restricted Stock) or other
consideration, or any combination thereof. If payable in Shares, the
consideration for the issuance of the Shares may be the achievement of the
performance objective established at the time of the grant of the Performance
Award. Performance Awards may be payable in a single payment or in
installments and may be payable at a specified date or dates or upon
attaining the performance objective, all at the Committee's discretion. The
extent to which any applicable performance objective has been achieved shall
be conclusively determined by the Committee.
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10. DIVIDEND EQUIVALENT RIGHTS
The Committee may grant a Dividend Equivalent Right either as a
component of another Award or as a separate Award, and, in general, each such
holder of a Dividend Equivalent Right that is outstanding on a dividend
record date for the Company's Common Stock shall be credited with an amount
equal to the cash or stock dividends or other distributions that would have
been received had the Shares covered by the Award been issued and outstanding
on the dividend record date. The terms and conditions of the Dividend
Equivalent Right shall be specified by the grant. Dividend equivalents
credited to the holder of a Dividend Equivalent Right may be paid currently
or may be deemed to be reinvested in additional Shares (which may thereafter
accrue additional Dividend Equivalent Rights). Any such reinvestment shall be
at the Fair Market Value at the time thereof. Dividend Equivalent Rights may
be settled in cash or Shares, or a combination thereof, in a single payment
or in installments. A Dividend Equivalent Right granted as a component of
another Award may provide that such Dividend Equivalent Right shall be
settled upon exercise, settlement or payment for or lapse of restrictions on
such other Award, and that such Dividend Equivalent Right shall expire or be
forfeited or annulled under the same conditions as such other Award. A
Dividend Equivalent Right granted as a component of another Award may also
contain terms and conditions different from such other Award.
11. OTHER AWARDS
The Committee may grant to any eligible employee other forms of
Awards based upon, payable in, or otherwise related to, in whole or in part,
Shares, if the Committee, in its sole discretion, determines that such other
form of Award is consistent with the purposes and restrictions of the Plan.
The terms and conditions of such other form of Award shall be specified by
the grant including, but not limited to, the price, if any, and the vesting
schedule, if any. Such Awards may be granted for no cash consideration, for
such minimum consideration as may be required by applicable law, or for such
other consideration as may be specified by the grant.
12. COMPLIANCE WITH SECURITIES AND OTHER LAWS
In no event shall the Company be required to sell or issue Shares
under any Award if the sale or issuance thereof would constitute a violation
of applicable Federal or state securities laws or regulations or a violation
of any other law or regulation of any governmental or regulatory agency or
authority or any national securities exchange. As a condition to any sale or
issuance of Shares, the Company may place legends on Shares, issue stop
transfer orders and require such agreements or undertakings as the Company
may deem necessary or advisable to assure compliance with any such laws or
regulations, including, if the Company or its counsel deems it appropriate,
representations from the person to whom an Award is granted that he or she is
acquiring the Shares solely for investment and not with a view to
distribution and that no distribution of the Shares will be made unless
registered pursuant to applicable Federal and state securities laws, or in
the opinion of counsel of the Company, such registration is unnecessary.
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13. ADJUSTMENTS UPON CHANGES IN CAPITALIZATION OR REORGANIZATION
The value of an Award in Shares shall be adjusted from time to time
as follows:
(a) Subject to any required action by Shareholders, the number of
Shares covered by each outstanding Award, and the exercise price, shall be
proportionately adjusted for any increase or decrease in the number of issued
Shares of the Company resulting from a subdivision or consolidation of Shares
or the payment of a stock dividend (but only in Shares) or any other increase
or decrease in the number of Shares affected without receipt of consideration
by the Company.
(b) Subject to any required action by Shareholders, if the Company
shall be the surviving corporation in any Reorganization, merger or
consolidation, each outstanding Award shall pertain to and apply to the
securities to which a holder of the number of Shares subject to the Award
would have been entitled, and if a plan or agreement reflecting any such
event is in effect that specifically provides for the change, conversion or
exchange of Shares, then any adjustment to Shares relating to an Award
hereunder shall not be inconsistent with the terms of any such plan or
agreement.
(c) In the event of a change in the Shares of the Company as
presently constituted, which is limited to a change of par value into the
same number of Shares with a different par value or without par value, the
Shares resulting from any such change shall be deemed to be the Shares within
the meaning of the Plan.
To the extent that the foregoing adjustments relate to stock or
securities of the Company, such adjustments shall be made by the Board, whose
determination shall be final, binding and conclusive.
Except as hereinbefore expressly provided in the Plan, any person to
whom an Award is granted shall have no rights by reason of any subdivision or
consolidation of stock of any class or the payment of any stock dividend or
any other increase or decrease in the number of shares of stock of any class
or by reason of any dissolution, liquidation, reorganization, merger or
consolidation or spin-off of assets or stock of another corporation, and any
issue by the Company of shares of stock of any class, or securities
convertible into shares of stock of any class, shall not affect and no
adjustment by reason thereof shall be made with respect to, the number or
exercise price of Shares subject to an Award.
The grant of an Award pursuant to the Plan shall not affect in any
way the right or power of the Company to make adjustments, reclassifications,
Reorganizations or changes of its capital or business structure or to merge
or to consolidate or to dissolve, liquidate or sell or transfer all or any
part of its business or assets.
14. AMENDMENT OR TERMINATION OF THE PLAN
14.1 AMENDMENT OF THE PLAN. Notwithstanding anything contained in
the Plan to the contrary, all provisions of the Plan may at any time or from
time to time be modified or amended
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by the Board; provided, however, that no Award at any time outstanding under
the Plan may be modified, unpaired or canceled adversely to the holder of the
Award without the consent of such holder; and provided, further, that the
Plan may not be amended without approval by the holders of a majority of the
Shares of the Company represented and voted at a meeting of the Shareholders
(a) to increase the maximum number of Shares subject to the Plan, (b) to
materially modify the requirements as to eligibility for participation in the
Plan, (c) to decrease the minimum exercise price for options, (d) to
otherwise materially increase the benefits accruing to persons to whom Awards
may be made under the Plan, as amended, or (e) if such approval is otherwise
necessary, to comply with Rule 16b-3 promulgated under the Exchange Act as
amended, or to comply with any other applicable laws, regulations or listing
requirements, or to qualify for an exemption or characterization that is
deemed desirable by the Board.
14.2 TERMINATION OF THE PLAN. The Board may suspend or terminate the
Plan at any time, and such suspension or termination may be retroactive or
prospective. However, no Award may be granted on or after the tenth
anniversary of the adoption of the Plan. Termination of the Plan shall not
impair or affect any Award previously granted hereunder and the rights of the
holder of the Award shall remain in effect until the Award has been exercised
in its entirety or has expired or otherwise has been terminated by the terms
of such Award.
15. AMENDMENTS AND ADJUSTMENTS TO AWARDS
The Committee may amend, modify or terminate any outstanding Award
with the Participants consent at any time prior to payment or exercise in any
manner not inconsistent with the terms of the Plan, including, without
limitation, (i) to change the date or dates as of which (A) an option becomes
exercisable or (B) a performance-based Award is deemed earned, (ii) to amend
the terms of any outstanding Award to provide an exercise price per share
which is higher or lower than the then current exercise price per share of
such outstanding Award or (iii) to cancel an Award and grant a new Award in
substitution, therefore under such different terms and conditions as it
determines in its sole and complete discretion to be appropriate including,
but not limited to, having an exercise price per share which may be higher or
lower than the exercise price per share of the canceled Award. The Committee
is also authorized to make adjustments in the terms and conditions of, and
the criteria included in, Awards in recognition of unusual or non-recurring
events (including, without limitation, the events described in Section 13
hereof) affecting the Company, or the financial statements of the Company or
any Affiliate, or of changes in applicable laws, regulations or accounting
principles, whenever the Committee determines that such adjustments are
appropriate in order to prevent reduction or enlargement of the benefits or
potential benefits intended to be made available under the Plan. Any
provision of the Plan or any agreement regarding an Award to the contrary
notwithstanding, the Committee may cause any Award granted to be canceled in
consideration of a cash payment or alternative Award made to the holder of
such canceled Award equal in value to the Fair Market Value of such canceled
Award. The determinations of value under this Section 15 shall be made by the
Committee in its sole discretion.
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16. GENERAL PROVISIONS
16.1 NO LIMIT ON OTHER COMPENSATION ARRANGEMENTS. Nothing contained
in the Plan shall prevent the Company from adopting or continuing in effect
other compensation arrangements, and such arrangements may be either
generally applicable or applicable only in specific cases.
16.2 NO RIGHT TO EMPLOYMENT. Nothing in the Plan or in any Award,
nor the grant of any Award, shall confer upon or be construed as giving any
recipient of an Award any right to remain in the employ of the Company.
Further, the Company may at any time dismiss a Participant in the Plan from
employment, free from any liability or any claim under the Plan, unless
otherwise expressly provided in the Plan or in any Award agreement. No
employee, Participant or other person shall have any claim to be granted any
Award, and there is no obligation for uniformity or treatment of employees,
participants or holders or beneficiaries of Awards.
16.3 GOVERNING LAW. THE VALIDITY, CONSTRUCTION AND EFFECT OF THE
PLAN AND ANY RULES AND REGULATIONS RELATING TO THE PLAN SHALL BE DETERMINED
IN ACCORDANCE WITH THE LAWS OF THE STATE OF TEXAS.
16.4 SEVERABILITY. If any provision of the Plan or any Award is or
becomes or is deemed to be invalid, illegal or unenforceable in any
jurisdiction or as to any person or Award, or would disqualify the Plan or
any Award under any law deemed applicable by the Committee, such provision
shall be construed or deemed amended to conform to applicable laws, or if it
cannot be construed or deemed amended without in the sole determination of
the Committee, materially altering the intent of the Plan or the Award, such
provision shall be stricken as to such jurisdiction, person or Award and the
remainder of the Plan and any such Award shall remain in full force and
effect.
16.5 NO FRACTIONAL SHARES. No fractional Shares shall be issued or
delivered pursuant to the Plan or any Award, and the Committee shall
determine whether cash, other securities or other property shall be paid or
transferred in lieu of any fractional Shares or whether such fractional
Shares or any rights thereto shall be canceled, terminated or otherwise
eliminated.
16.6 HEADINGS. Headings are given to the subsections of the Plan
solely as a convenience to facilitate reference. Such headings shall not be
deemed in any way material or relevant to the construction or interpretation
of the Plan or any provision thereof.
16.7 EFFECTIVE DATE. The Plan shall be effective as of the date of
its approval by the holders of a majority of the Shares of the Company
represented and voting at the next Annual Meeting of Shareholders. If the
Plan is not approved by the Shareholders at the 1995 Annual Meeting, after
such date, the Plan and all Awards granted thereunder, if any, shall be null
and void.
16.8 NON-TRANSFERABILITY OF AWARDS. Awards shall be nontransferable
other than by will or the laws of descent and distribution, and Awards may be
exercised, during the lifetime of
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the holder, only by the holder (or the holder's duly appointed guardian or
personal representative); provided, however, that Awards other than Incentive
Stock Options may be transferred (i) by the holder to a family member, trust,
charity, or similar organization for estate planning purposes or (ii) with
the approval of the Committee, as directed under a qualified domestic
relations order.
17. NAMED EXECUTIVE OFFICERS
17.1 APPLICABILITY OF SECTION 17. The provisions of this Section 17
shall apply only to those Executive Officers (i) whose compensation is
required to be reported in the Company's proxy statement pursuant to Item
402(a)(3)(i) and (ii) of Regulation S-K under the general rules and
regulations under the Exchange Act, as amended, and (ii) whose total
compensation, including estimated Awards, is determined by the Committee to
possibly be subject to the limitations on deductions imposed by Section
162(m) of the Code ("Named Executive Officers"). In the event of any
inconsistencies between this Section 17 and the other Plan provisions as they
pertain to Named Executive Officers, the provisions of this Section 17 shall
control.
17.2 ESTABLISHMENT OF PERFORMANCE GOALS. Awards for Named Executive
Officers, other than stock options and Stock Appreciation Rights, shall be
based on the attainment of certain performance goals. No later than the
earlier of (i) ninety (90) days after the commencement of the applicable
fiscal year or such other award period as may be established by the Committee
("Award Period") and (ii) the completion of twenty-five percent (25%) of such
Award Period, the Committee shall establish, in writing, the performance
goals applicable to each such Award for Named Executive Officers. At the time
the performance goals are established by the Committee, their outcome must be
substantially uncertain. In addition, the performance goal must state, in
terms of an objective formula or standard, the method for computing the
amount of compensation payable to the Named Executive Officer if the goal is
obtained. Such formula or standard shall be sufficiently objective so that a
third party with knowledge of the relevant performance results could
calculate the amount to be paid to the subject Named Executive Officer. The
material terms of the performance goals for Named Executive Officers and the
compensation payable thereunder shall be submitted to the Shareholders of the
Company for their review and approval. Shareholder approval shall be obtained
for such performance goals prior to any Award being paid to such Named
Executive Officer. If the Shareholders do not approve such performance goals,
no amount shall be paid to such Named Executive Officer for such applicable
Award Period under the Plan. The disclosure of the "material terms" of a
performance goal and the compensation payable thereunder shall be determined
under the guidelines set forth under Section 162(m) of the Code, and the
Treasury Regulations thereunder.
17.3 COMPONENTS OF AWARDS. Each Award to a Named Executive Officer,
other than stock options and Stock Appreciation Rights, shall be based on
performance goals which are sufficiently objective so that a third party
having knowledge of the relevant facts could determine whether the goal was
met. Except as provided in subsection 17.8 herein, performance measures which
may serve as determinants of Named Executive Officers Awards shall be limited
to the following measures: earnings per share; return on assets; return on
equity; return on capital; net profit after taxes; net profit before taxes;
economic value added; operating profits; stock price;
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<PAGE>
market share; and sales or expenses. Within ninety (90) days following the
end of each Award Period, the Committee shall certify in writing that the
performance goals, and any other material terms were satisfied. Thereafter,
Awards shall be made for each Named Executive Officer as determined by the
Committee. The Awards may not vary from the pre-established amount based on
the level of achievement.
17.4 NO MID-YEAR CHANGE IN AWARDS. Except as provided in subsections
17.8 and 17.9 herein, each Named Executive Officers Awards shall be based
exclusively on the performance measures established by the Committee pursuant
to subsection 17.2.
17.5 NO PARTIAL AWARD PERIOD PARTICIPATION. A Named Executive
Officer who becomes eligible to participate in the Plan after performance
goals have been established in an Award Period pursuant to subsection 17.2
may not participate in the Plan prior to the next succeeding Award Period,
except with respect to Awards which are stock options or Stock Appreciation
Rights.
17.6 PERFORMANCE GOALS. Except as provided in subsection 17.8
herein, performance goals shall not be changed following their establishment,
and Named Executive Officers shall not receive any payout, except with
respect to Awards which are stock options or Stock Appreciation Rights, when
the minimum performance goals are not met or exceeded.
17.7 INDIVIDUAL PERFORMANCE AND DISCRETIONARY ADJUSTMENTS. Except as
provided in subsection 17.8 herein, subjective evaluations of individual
performance of Named Executive Officers shall not be reflected in their
Awards, other than Awards which are stock options or Stock Appreciation
Rights. The payment of such Awards shall be entirely dependent upon the
attainment of the pre-established performance goals.
17.8 AMENDMENTS. No amendment of the Plan with respect to any Named
Executive Officer may be made which would (i) increase the maximum amount
that can be paid to any one Participant under the Plan, (ii) change the
specified performance goal for payment of Awards, or (iii) modify the
requirements as to eligibility for participation in the Plan, unless the
Company's Shareholders have first approved such amendment in a manner which
would permit the deduction under Section 162(m) of the Code of such payment
in the fiscal year it is paid. The Committee shall amend this Section 17 and
such other provisions as it deems appropriate, to cause amounts payable to
Named Executive Officers to satisfy the requirements of Section 162(m) and
the Treasury Regulations promulgated thereunder.
17.9 STOCK OPTIONS AND STOCK APPRECIATION RIGHTS. Notwithstanding
any provision of the Plan (including the provisions of this Section 17) to
the contrary, the amount of compensation which a Named Executive Officer may
receive with respect to stock options and Stock Appreciation Rights which are
granted hereunder is based solely on an increase in the value of the
applicable Shares after the date of grant of such Award. Thus, no stock
option may be granted hereunder to a Named Executive Officer with an exercise
price less than the Fair Market Value of Shares on the date of grant.
Furthermore, the maximum number of Shares (or cash equivalent value) with
respect to which stock options or Stock Appreciation Rights may be granted
hereunder to any Named Executive Officer during any calendar year may not
exceed
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100,000 Shares, subject to adjustment as provided in Section 13 hereunder.
17.10 MAXIMUM AMOUNT OF COMPENSATION. The maximum amount of
compensation payable as an Award (other than an Award which is a stock option
or Stock Appreciation Right) to any Named Executive Officer during any
calendar year may not exceed $1,000,000.
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HCC INSURANCE HOLDINGS, INC.
1997 FLEXIBLE INCENTIVE PLAN,
AS AMENDED AND RESTATED
1. PURPOSE
The purposes of HCC Insurance Holdings, Inc. 1997 Flexible Incentive
Plan (the "1997 Flexible Plan") are to promote the interests of HCC Insurance
Holdings, Inc. and its subsidiaries (together with any successor thereto, the
"Company") and its Shareholders by enabling the Company to attract, motivate
and retain key employees by offering such key employees performance-based
stock incentives and other equity interests in the Company and other
incentive awards that recognize the creation of value for the Shareholders of
the Company and promote the Company's long-term growth and success. To
achieve these purposes, eligible persons may receive stock options, Stock
Appreciation Rights, Restricted Stock. Performance Awards, performance stock,
Dividend Equivalent Rights and any other Awards, or any combination thereof.
2. DEFINITIONS
As used in the 1997 Flexible Plan, the following terms shall have
the meanings set forth below unless the content otherwise requires:
2.1 "AWARD" shall mean the grant of a stock option, a Stock
Appreciation Right, a Restricted Stock, a Performance Award, performance
stock, a Dividend Equivalent Right or any other Award under the 1997 Flexible
Plan.
2.2 "BOARD" shall mean the Board of Directors of the Company, as the
same may be constituted from time to time.
2.3 "CHANGE IN CONTROL" shall mean, after the effective date of the
1997 Flexible Plan, (i) the occurrence of an event of a nature that would be
required to be reported in response to Item 1 or Item 2 of a Form 8-K Current
Report of the Company promulgated pursuant to Sections 13 and 15(d) of the
Exchange Act; provided that, without limitation, such a Change in Control
shall be deemed to have occurred if (a) any "person," as such term is used in
Sections 13(d) and 14(d) of the Exchange Act (other than the Company, any
trustee or other fiduciary holding securities under any employee benefit plan
of the Company, or any company owned, directly or indirectly, by the
Shareholders of the Company in substantially the same proportions as their
ownership of stock of the Company), is or becomes the "beneficial owner" (as
defined in Rule 13d-3 under the Exchange Act), directly or indirectly, of
securities of the Company representing fifty percent (50%) or more of the
combined voting power of the Company's then outstanding securities or (b)
during any period of two consecutive years, individuals who at the beginning
of such period constitute the Board cease for any reason to constitute at
least a majority thereof, unless the election by the Board or the nomination
for election by the Company's Shareholders was approved by a vote of at least
two-thirds (2/3) of the Directors then still in office who either were
Directors at the beginning of the two-year period or whose election or
nomination for election was previously so approved; (ii) the Shareholders of
the Company approve a merger or consolidation of the Company with any other
corporation, other than a merger or consolidation that would result in the
voting securities of the Company
<PAGE>
outstanding immediately prior thereto continuing to represent (either by
remaining outstanding or by being converted into voting securities of the
surviving entity) more than fifty-one percent (51%) of the combined voting
power of the voting securities of the surviving entity outstanding
immediately after such merger or consolidation; provided, however, that a
merger or consolidation effected to implement a reorganization or
recapitalization of the Company, or a similar transaction (collectively, a
"Reorganization"), in which no "person" acquires more than twenty percent
(20%) of the combined voting power of the Company's then outstanding
securities shall not constitute a Change in Control of the Company; or (iii)
the Shareholders of the Company 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.
2.4 "CODE" shall mean the Internal Revenue Code of 1986, as amended
from time to time.
2.5 "COMMITTEE" shall mean the Stock Option or Compensation
Committee, if such a separate committee is appointed by the Board, or, until
such time as a separate committee is appointed, it shall mean the Board. If a
separate committee is appointed, the Committee shall meet the applicable
requirements for "disinterested administration" within the requirements of
Rule 16b-3 promulgated under the Exchange Act and any successor thereunder
promulgated during the duration of the 1997 Flexible Plan. The Board may
amend the 1997 Flexible Plan to modify the definition of Committee within the
limits of Rule 16b-3 to assure that the 1997 Flexible Plan is administered in
compliance with Rule 16b-3. Initially, the Committee will consist of not less
than three (3) members of the Board who are appointed by, and serve at the
pleasure of, the Board and who are (i) "disinterested" within the meaning of
Rule 16b-3 and (ii) "outside directors," as required under Section 162(m) of
the Code and such Treasury Regulations as may be promulgated thereunder.
2.6 "COMMON STOCK" shall mean the Common Stock, $1.00 par value per
share, of the Company.
2.7 "DESIGNATED BENEFICIARY" shall mean the beneficiary designated
by an Optionee in a manner determined by the Committee, to exercise rights of
the Optionee in the event of the Optionee's death. In the absence of an
effective designation by an Optionee the Designated Beneficiary shall be the
Optionee's estate.
2.8 "DISABILITY" shall mean permanent and total inability to engage
in any substantial gainful activity 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 expected to last for a continuous period of not
less than twelve (12) months, as determined in the sole and absolute
discretion of the Committee.
2.9 "DIVIDEND EQUIVALENT RIGHT" shall mean the right of the holder
thereof to receive credits based on the cash dividends that would have been
paid on the Shares specified in an Award granting Dividend Equivalent Rights
if the Shares subject to such Award were held by the person to whom the Award
is made.
2
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2.10 "EXCHANGE ACT" shall mean the Securities Exchange Act of 1934,
as amended from time to time.
2.11 "FAIR MARKET VALUE" shall mean with respect to the Shares, as
of any date, (i) the last reported sales price on any stock exchange on which
the Common Stock is traded or, if not reported on such exchange, on the
composite tape, or, in case no such sale takes place on such day, the average
of the reported closing bid and asked quotations on such exchange; (ii) if
the Common Stock is not listed on a stock exchange or no such quotations are
available, the closing price of the Common Stock as reported by the National
Market System of the National Association of Securities Dealers, Inc., or, if
no such quotations are available, the average of the high bid and low asked
quotations in the over-the-counter market as reported by the National
Quotation Bureau Incorporated, or similar organization; or (iii) in the event
that there shall be no public market for the Common Stock, the fair market
value of the Common Stock as determined (which determination shall be
conclusive) in good faith by the Committee, based upon the value of the
Company as a going concern, as if such Common Stock were publicly owned
stock, but without any discount with respect to minority ownership.
2.12 "INCENTIVE STOCK OPTION" shall mean any stock option awarded
under the 1997 Flexible Plan which qualifies as an "Incentive Stock Option"
under Section 422 of the Code or any successor provision.
2.13 "NON-TANDEM STOCK APPRECIATION RIGHT" shall mean any Stock
Appreciation Right granted alone and not in connection with an Award which is
a stock option.
2.14 "NON-QUALIFIED STOCK OPTION" shall mean any stock option
awarded under the 1997 Flexible Plan that does not qualify as an Incentive
Stock Option.
2.15 "OPTIONEE" shall mean any person who has been granted a stock
option under the 1997 Flexible Plan and who has executed a written stock
option agreement with the Company reflecting the terms of such grant.
2.16 "PERFORMANCE AWARD" shall mean any Award hereunder of Shares,
units or rights based upon, payable in, or otherwise related to, Shares
(including Restricted Stock), or cash of an equivalent value, as the
Committee may determine, at the end of a specified performance period
established by the Committee.
2.17 "1997 FLEXIBLE PLAN" shall mean the HCC Insurance Holdings,
Inc. 1997 Flexible Incentive Plan set forth herein.
2.18 "RESTRICTED STOCK" shall mean any Award of Shares under the
1997 Flexible Plan that are subject to restrictions or risk of forfeiture.
2.19 "RETIREMENT" unless otherwise defined herein or in any other
agreement regarding an Award, shall mean termination of employment other than
discharge for cause, after age 65 or on or before age 65 if pursuant to the
terms of any retirement plan maintained by the Company or any of its
Subsidiaries in which such person participates.
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2.20 "SHARES" shall mean shares of the Company's Common Stock and
any shares of capital stock or other securities of the Company hereafter
issued or issuable upon, in respect of or in substitution or exchange for
such Shares.
2.21 "STOCK APPRECIATION RIGHT" shall mean the right of the holder
thereof to receive an amount in cash or Shares equal to the excess of the
Fair Market Value of a Share on the date of exercise over the Fair Market
Value of a Share on the date of the grant (or such other value as may be
specified in the agreement granting the Stock Appreciation Right).
2.22 "SUBSIDIARY" shall mean a subsidiary corporation of the
Company, as defined in Section 424(f) of the Code.
2.23 "TANDEM STOCK APPRECIATION RIGHT" shall mean a Stock
Appreciation Right granted in connection with an Award which is a stock
option.
3. ADMINISTRATION OF THE 1997 FLEXIBLE PLAN
3.1 COMMITTEE. The 1997 Flexible Plan shall be administered and
interpreted by the Committee.
3.2 AWARDS. Subject to the provisions of the 1997 Flexible Plan and
directions from the Board, the Committee is authorized to:
(a) determine the persons to whom Awards are to be granted;
(b) determine the types and combinations of Awards to be granted,
the number of Shares to be covered by the Award, the pricing of the Award,
the time or times when the Award shall be granted and may be exercised, the
terms, performance criteria or other conditions, vesting periods or any
restrictions for an Award, any restrictions on Shares acquired pursuant to
the exercise of an Award and any other terms and conditions of an Award;
(c) conclusively interpret the provisions of the 1997 Flexible Plan;
(d) prescribe, amend and rescind the rules and regulations relating
to the 1997 Flexible Plan or make individual decisions as questions arise, or
both;
(e) determine whether, to what extent and under what circumstances
to provide loans from the Company to participants to purchase Shares subject
to Awards under the 1997 Flexible Plan, and the terms and conditions of such
loans;
(f) rely upon employees of the Company for such clerical and record
keeping duties as may be necessary in connection with the administration of
the 1997 Flexible Plan; and
(g) make all other determinations and take all other actions
necessary or advisable for the administration of the 1997 Flexible Plan.
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3.3 PROCEDURES. A majority of the Committee members shall constitute
a quorum. All determinations of the Committee shall be made by a majority of
its members. All questions of interpretation and application of the 1997
Flexible Plan or pertaining to any question of fact or Award granted
hereunder shall be decided by the Committee, whose decision shall be final,
conclusive and binding upon the Company and each other affected party.
4. SHARES SUBJECT TO 1997 FLEXIBLE PLAN
4.1 LIMITATIONS. The maximum number of Shares that may be issued
with respect to Awards under the 1997 Flexible Plan shall not exceed
4,000,000 unless such maximum shall be increased or decreased by reason of
changes in capitalization of the Company as hereinafter provided. The Shares
issued pursuant to the 1997 Flexible Plan may be authorized but unissued
Shares, or may be issued Shares which have been reacquired by the Company.
4.2 CHANGES. To the extent that any Award under the 1997 Flexible
Plan, shall be forfeited, shall expire or shall be canceled, in whole or in
part, then the number of Shares covered by the Award or stock option so
forfeited, expired or canceled may again be awarded pursuant to the
provisions of the 1997 Flexible Plan. In the event that Shares are delivered
to the Company in full or partial payment of the exercise price for the
exercise of a stock option granted under the 1997 Flexible Plan, the number
of Shares available for future Awards under the 1997 Flexible Plan shall be
reduced only by the net number of Shares issued upon the exercise of the
option. Awards that may be satisfied either by the issuance of Shares or by
cash or other consideration shall, until the form of consideration to be paid
is finally determined, be counted against the maximum number of Shares that
may be issued under the 1997 Flexible Plan. If the Award is ultimately
satisfied by the payment of consideration other than Shares, as, for example,
a stock option granted in tandem with a Stock Appreciation Right that is
settled by a cash payment of the stock appreciation, such Shares may again be
made the subject of an Award under the 1997 Flexible Plan. Awards will not
reduce the number of Shares that may be issued pursuant to the 1997 Flexible
Plan if the settlement of the Award will not require the issuance of Shares,
as, for example, a Stock Appreciation Right that can be satisfied only by the
payment of cash.
5. ELIGIBILITY
Eligibility for participation in the 1997 Flexible Plan shall be
confined to those persons who are employed by the Company, and who are
officers of the Company, or who are in managerial or other key positions
within the Company or are otherwise valuable employees of the Company. In
making any determination as to persons to whom Awards shall be granted, the
type of Award, and/or the number of Shares to be covered by the Award, the
Committee shall consider the position and responsibilities of the person, his
or her importance to the Company, the duties of such person, his or her past,
present and potential contributions to the growth and success of the Company,
and such other factors as the Committee shall deem relevant in connection
with accomplishing the purposes of the 1997 Flexible Plan.
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6. STOCK OPTIONS
6.1 GRANTS. The Committee may grant stock options alone or in
addition to other Awards granted under the 1997 Flexible Plan to any eligible
officer or other key employee. Each person so selected shall be offered an
option to purchase the number of Shares determined by the Committee. The
Committee shall specify whether such option is an Incentive Stock Option or
Non-Qualified Stock Option and any other terms and conditions relating to
such Award. To the extent that any stock option does not qualify as an
Incentive Stock Option (whether because of its provisions or the time or
manner of its exercise or otherwise), such stock option or the portion
thereof which does not qualify shall constitute a separate Non-Qualified
Stock Option. Each such person so selected shall have a reasonable period of
time within which to accept or reject the offered option. Failure to accept
within the period so fixed by the Committee may be treated as a rejection.
Each person who accepts an option shall enter into a written agreement with
the Company, in such form as the Committee may prescribe, setting forth the
terms and conditions of the option, consistent with the provisions of the
1997 Flexible Plan. The Optionee and the Company shall enter into option
agreements for Incentive Stock Options and Non-Qualified Stock Options. At
any time and from time to time, the Optionee and the Company may agree to
modify an option agreement so that an Incentive Stock Option may be converted
to a Non-Qualified Stock Option.
The Committee may require that an Optionee meet certain conditions
before the option or a portion thereof may vest or be exercised, as, for
example, that the Optionee remain in the employ of the Company for a stated
period or periods of time before the option, or stated portions thereof, may
vest or be exercised.
6.2 OPTION PRICE. The option exercise price of the Shares covered by
each stock option shall be determined by the Committee; provided, however,
that the option exercise price of an Incentive Stock Option shall not be less
than one hundred percent (100%) of the Fair Market Value of Shares on the
date of the grant of such Incentive Stock Option.
6.3 INCENTIVE STOCK OPTIONS LIMITATIONS.
(a) In no event shall any person be granted Incentive Stock Options
to the extent that the Shares covered by any Incentive Stock Options (and any
Incentive Stock Options granted under any other plans of the Company and its
Subsidiaries) that may be exercised for the first time by such person in any
calendar year have an aggregate Fair Market Value in excess of $100,000. For
this purpose, the Fair Market Value of the Shares shall be determined as of
the dates on which the Incentive Stock Options are granted. It is intended
that the limitation on Incentive Stock Options provided in this subsection
6.3(a) be the maximum limitation on options which may be considered Incentive
Stock Options under the Code.
(b) Notwithstanding anything herein to the contrary, in no event
shall any employee owning more than ten percent (10%) of the total combined
voting power of the Company or any Subsidiary be granted an Incentive Stock
Option hereunder unless the option exercise price shall
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be at least one hundred ten percent (110%) of the Fair Market Value of the
Shares subject to such Incentive Stock Option at the time that the Incentive
Stock Option is granted and the term of such Incentive Stock Option shall not
exceed five (5) years.
6.4 OPTION TERM. Subject to subsection 6.3(b) hereof, the term of a
stock option shall be for such period of months or years from the date of its
grant as may be determined by the Committee; provided, however, that no stock
option shall be exercisable later than ten (10) years from the date of its
grant. Furthermore, no stock option may be exercised unless, at the time of
such exercise, the Optionee is, and has been continuously since the date of
grant of his or her stock option, employed by the Company, except that:
(a) A stock option may, to the extent vested, be exercised within
the period of ninety (90) days after the date the Optionee ceases to be an
employee of the Company and the Subsidiaries for any reason other than as set
forth below (or within such lesser period as may be specified in the
applicable option agreement), provided that the option agreement may
designate a longer exercise period and that the exercise after such ninety
(90)-day period shall be treated as the exercise of a Non-Qualified Stock
Option under the 1997 Flexible Plan.
(b) In the event of the death of the Optionee while in the employ of
the Company or the Subsidiaries or within ninety (90) days after the date the
Optionee ceases to be an employee of the Company or the Subsidiaries (or
within such lesser period as may be specified in the applicable option
agreement, whichever is shorter), the stock option may, to the extent vested
and previously unexercised, be exercised by the Optionee's Designated
Beneficiary within the one-year period immediately following such date of
death (or within such lesser period as may be specified in the applicable
option agreement, whichever is shorter);
(c) If the Optionee voluntarily terminates employment with the
Company without good reason (which determination shall be made in the sole
and absolute discretion of the Committee), the stock option may, to the
extent vested and previously unexercised by the Optionee within the period of
ten (10) days after the termination of employment of the Optionee (or within
such lesser period as may be specified in the applicable option agreement,
whichever is shorter);
(d) If the Optionee ceases to be an employee of the Company by
reason of the Optionee's Disability, the stock option may be exercised by the
Optionee for the full number of shares or any portion thereof except as to
the issuance of fractional shares, to the full extent of this option less any
previously exercised shares at any time within the period of one year after
the date of Disability of the Optionee (or within such lesser period as may
be specified in the applicable option agreement, whichever is shorter);
(e) If the employment of the Optionee is terminated for cause (which
determination shall be made in the sole and absolute discretion of the
Committee) the stock option may, to the extent vested and previously
unexercised, be exercised by the Optionee within the period of ten (10) days
after the termination of employment of the Optionee (or within such lesser
period as may be specified in the applicable option agreement, whichever is
shorter);
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(f) In the event of the termination of the Optionee's employment on
or after the attainment of age 65 (or such other age as is permitted for the
Optionee by the Committee in its sole discretion) and provided Optionee does
not engage in full time employment with any other entity ("Retirement"), the
stock option may, to the extent vested and previously unexercised, be
exercised by the Optionee within the period of one (1) year after the
termination of employment by the Optionee (or within such lesser period as
may be specified in the applicable option agreement, whichever is shorter),
provided that the exercise of the option more than ninety (90) days after the
Optionee's termination of employment shall be treated as the exercise of a
Non-Qualified Option under the 1997 Flexible Plan.
6.5 VESTING OF STOCK OPTIONS.
(a) Each stock option granted hereunder may only be exercised to the
extent that the Optionee is vested in such option. Each stock option shall
vest separately in accordance with the option vesting schedule, if any,
determined by the Committee in its sole discretion, which will be
incorporated in the stock option agreement entered into between the Company
and each Optionee and only to the extent that the Optionee remains in the
continuous employ of the Company or a Subsidiary. The option vesting schedule
will be accelerated if, in the sole discretion of the Committee, the
Committee determines that acceleration of the option vesting schedule would
be desirable for the Company.
(b) In the event of the dissolution or liquidation of the Company,
each stock option granted under the 1997 Flexible Plan shall terminate as of
a date to be fixed by the Board; provided, however, that not less than thirty
(30) days' written notice of the date so fixed shall be given to each
Optionee and each such Optionee shall be fully vested in and shall have the
right during such period to exercise the option, even though such option
would not otherwise be exercisable under the option vesting schedule. At the
end of such period, any unexercised option shall terminate and be of no other
effect.
(c) In the event of a Reorganization (as defined in Section 2.3
hereof):
(1) If there is no plan or agreement respecting the
Reorganization, or if such plan or agreement does not specifically
provide for the change, conversion or exchange of the Shares under
outstanding and unexercised stock options for other securities then the
provisions of subsection 6.5(b) shall apply as if the Company had
dissolved or been liquidated on the effective date of the
Reorganization; or
(2) If there is a plan or agreement respecting the
Reorganization, and if such plan or agreement specifically provides for
the change, conversion or exchange of the Shares under outstanding and
unexercised stock options for securities of another corporation, then
the Board shall adjust the Shares under such outstanding and
unexercised stock options (and shall adjust the Shares remaining under
the 1997 Flexible Plan which are then available to be awarded under the
1997 Flexible Plan, if such plan or agreement makes no specific
provision therefore) in a manner not inconsistent with the provisions
of such plan or agreement for the adjustment, change, conversion or
exchange of such Shares and such options.
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(3) The Committee may provide in an option agreement and/or
Stock Appreciation Rights agreement that in the event of a Change in
Control of the Company, (i) all or a portion of the stock options and
any associated Stock Appreciation Rights awarded under such agreement
shall become fully vested and immediately exercisable and/or (ii) the
vesting of all performance-based stock options shall be determined as
if the performance period or cycle applicable to such stock options had
ended immediately upon such Change in Control; provided, however, that
if in the opinion of counsel to the Company the immediate
exercisability of options when taken into consideration with all other
"parachute payments" as defined in Section 280G of the Code, as
amended, would result in an "excess parachute payment" as defined in
such section as well as an excise tax imposed by Section 4999 of the
Code, such options and any associated Stock Appreciation Rights shall
become fully vested and immediately exercisable, except as and to the
extent the Committee in its sole discretion, shall otherwise determine,
which determination by the Committee shall be based solely upon
maximizing the after-tax benefits to be received by any such Optionee.
If the Committee does not provide for accelerated vesting in an option
or Stock Appreciation Rights agreement pursuant to this Subsection
6.5(c)(3), such option and/or Stock Appreciation Right shall vest, if
at all, solely in accordance with the terms of the agreement and the
other terms of this Plan.
6.6 EXERCISE OF STOCK OPTIONS.
(a) Stock options may be exercised as to Shares only in amounts and
at intervals of time specified in the written option agreement between the
Company and the Optionee. Each exercise of a stock option, or any part
thereof, shall be evidenced by a notice in writing to the Company. The
purchase price of the Shares as to which an option shall be exercised shall
be paid in full at the time of exercise, and may be paid to the Company
either:
(1) in cash (including check, bank draft or money order); or
(2) by the delivery of Shares having a Fair Market Value equal
to the aggregate option rate;
(3) by a combination of cash and Shares; or
(4) by other consideration deemed acceptable by the Committee
in its sole discretion.
(b) The amount, as determined by the Committee, of any Federal, state
or local tax required to be withheld by the Company due to the exercise of a
stock option shall be satisfied by payment by the Optionee to the Company of the
amount of such withholding obligation in cash or other consideration acceptable
to the Committee in its sole discretion.
(c) An Optionee shall not have any of the rights of a Shareholder of
the Company with respect to the Shares covered by a stock option except to
the extent that one or more certificates representing such Shares shall have
been delivered to the Optionee, or the Optionee
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has been determined to be a Shareholder of record by the Company's transfer
agent, upon due exercise of the option.
6.7 DATE OF A STOCK OPTION GRANT. The granting of a stock option
shall take place only upon the execution and delivery by the Company and an
Optionee of an option agreement. Neither any action taken by the Board nor
anything contained in the 1997 Flexible Plan or in any resolution adopted or
to be adopted by the Board or the Shareholders of the Company shall
constitute the granting of a stock option under the 1997 Flexible Plan.
7. STOCK APPRECIATION RIGHTS
7.1 GRANTS. The Committee may grant to any eligible employee either
Non-Tandem Stock Appreciation Rights or Tandem Stock Appreciation Rights.
Stock Appreciation Rights shall be subject to such terms and conditions as
the Committee shall impose. The grant of the Stock Appreciation Right may
provide that the holder may be paid for the value of the Stock Appreciation
Right either in cash or in Shares, or a combination thereof, at the
discretion of the Committee. In the event of the exercise of a Stock
Appreciation Right payable in Shares, the holder of the Stock Appreciation
Right shall receive that number of whole Shares of stock of the Company
having an aggregate Fair Market Value on the date of exercise equal to the
value obtained by multiplying (i) either (a) in the case of a Tandem Stock
Appreciation Right, the difference between the Fair Market Value of a Share
on the date of exercise over the per share exercise price of the related
option, or (b) in the case of a Non-Tandem Stock Appreciation Right the
difference between the Fair Market Value of a Share on the date of exercise
over the Fair Market Value on the date of the grant by (ii) the number of
Shares as to which the Stock Appreciation Right is exercised. However,
notwithstanding the foregoing, the Committee, in its sole discretion, may
place a ceiling on the amount payable upon exercise of a Stock Appreciation
Right but any such limitation shall be specified at the time that the Stock
Appreciation Right is granted.
7.2 EXERCISABILITY. A Tandem Stock Appreciation Right may be granted
at the time of the grant of the related stock option or, if the related stock
option is a Non-Qualified Stock Option, at any time thereafter during the
term of the stock option. A Tandem Stock Appreciation Right granted in
connection with an Incentive Stock Option (i) may be exercised at, and only
at, the times and to the extent the related Incentive Plan Stock Option is
exercisable, (ii) expires upon the termination of the related Incentive Stock
Option, (iii) may not exceed 100% of the difference between the exercise
price of the related Incentive Stock Option and the market price of the
Shares subject to the related Incentive Stock Option at the time the Tandem
Stock Appreciation Right is exercised and (iv) may be exercised at, and only
at, such times as the market price of the Shares subject to the related
Incentive Stock Option exceeds the exercise price of the related Incentive
Stock Option. The Tandem Stock Appreciation Right may be transferred at, and
only at, the times and to the extent the related stock option is
transferable. If a Tandem Stock Appreciation Right is granted, there shall be
surrendered and canceled from the related option at the time of exercise of
the Tandem Stock Appreciation Right, in lieu of exercise under the related
option, that number of Shares as shall equal the number of Shares as to which
the Tandem Stock Appreciation Right shall have been exercised.
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7.3 CERTAIN LIMITATIONS ON NON-TANDEM STOCK, APPRECIATION RIGHTS. A
Non-Tandem Stock Appreciation Right will be exercisable as provided by the
Committee and will have such other terms and conditions as the Committee may
determine. A Non-Tandem Stock Appreciation Right is subject to acceleration
of vesting or immediate termination in certain circumstances in the same
manner as stock options pursuant to subsections 6.4 and 6.5 of the 1997
Flexible Plan.
7.4 LIMITED STOCK APPRECIATION RIGHTS. The Committee is also
authorized to grant "Limited Stock Appreciation Rights," either as Tandem
Stock Appreciation Rights or Non-Tandem Stock Appreciation Rights. Limited
Stock Appreciation Rights would become exercisable only upon the occurrence
of a Change in Control or such other event as the Committee may designate at
the time of grant or thereafter.
8. RESTRICTED STOCK
8.1 GRANTS. The Committee may grant Awards of Restricted Stock for
no cash consideration, for such minimum consideration as may be required by
applicable law, or for such other consideration as may be specified by the
grant. The terms and conditions of the Restricted Stock shall be specified by
the grant agreement. The Committee, in its sole discretion, may specify any
particular rights which the person to whom an Award of Restricted Stock is
made shall have in the Restricted Stock during the restriction period and the
restrictions applicable to the particular Award, the vesting schedule (which
may be based on service, performance or other factors) and rights to
acceleration of vesting (including, without limitation, whether non-vested
Shares are forfeited or vested upon termination of employment). Further, the
Committee may award performance-based Restricted Stock by conditioning the
grant, or vesting or such other factors, such as the release, expiration or
lapse of restrictions upon any such Award (including the acceleration of any
such conditions or terms) of such Restricted Stock upon the attainment of
specified performance goals or such other factors as the Committee may
determine. The Committee shall also determine when the restrictions shall
lapse or expire and the conditions, if any, under which the Restricted Stock
will be forfeited or sold back to the Company. Each Award of Restricted Stock
may have different restrictions and conditions. The Committee, in its
discretion, may prospectively change the restriction period and the
restrictions applicable to any particular Award of Restricted Stock. Unless
otherwise set forth in the 1997 Flexible Plan, Restricted Stock may not be
disposed of by the recipient until the restrictions specified in the Award
expire.
8.2 AWARDS AND CERTIFICATES. Any Restricted Stock issued hereunder
may be evidenced in such manner as the Committee, in its sole discretion, shall
deem appropriate including, without limitation, book-entry registration or
issuance of a stock certificate or certificates. In the event any stock
certificate is issued in respect of Shares of Restricted Stock awarded
hereunder, such certificate shall bear an appropriate legend with respect to
the restrictions applicable to such Award. The Company may retain, at its
option, the physical custody of any stock certificate representing any awards
of Restricted Stock during the restriction period or require that the
Restricted Stock be placed in escrow or trust, along with a stock power
endorsed in blank, until all restrictions are removed or expire.
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9. PERFORMANCE AWARDS
9.1 GRANTS. A Performance Award may consist of either or both, as
the Committee may determine, of (i) "Performance Shares" or the right to
receive Shares, Restricted Stock or cash of an equivalent value, or any
combination thereof as the Committee may determine, or (ii) "Performance
Units," or the right to receive a fixed dollar amount payable in cash, Common
Stock, Restricted Stock or any combination thereof, as the Committee may
determine. The Committee may grant Performance Awards to any eligible
employee, for no cash consideration, for such minimum consideration as may be
required by applicable law or for such other consideration as may be
specified at the time of the grant. The terms and conditions of Performance
Awards shall be specified at the time of the grant and may include provisions
establishing the performance period, the performance criteria to be achieved
during a performance period the criteria used to determine vesting (including
the acceleration thereof), whether Performance Awards are forfeited or vest
upon termination of employment during a performance period and the maximum or
minimum settlement values. Each Performance Award shall have its own terms
and conditions, which shall be determined at the discretion of the Committee.
If the Committee determines, in its sole discretion, that the established
performance measures or objectives are no longer suitable because of a change
in the Company's business, operations, corporate structure or for other
reasons that the Committee deems satisfactory, the Committee may modify the
performance measures or objectives and/or the performance period.
9.2 TERMS AND CONDITIONS. Performance Awards may be valued by
reference to the Fair Market Value of a Share or according to any formula or
method deemed appropriate by the Committee, in its sole discretion,
including, but not limited to, achievement of specific financial, production,
sales, cost or earnings performance objectives that the Committee believes to
be relevant to the Company's business and for remaining in the employ of the
Company for a specified period of time, or the Company's performance or the
performance of its Common Stock measured against the performance of the
market, the Company's industry segment or its direct competitors. Performance
Awards may be paid in cash, Shares (including Restricted Stock) or other
consideration, or any combination thereof. If payable in Shares, the
consideration for the issuance of the Shares may be the achievement of the
performance objective established at the time of the grant of the Performance
Award. Performance Awards may be payable in a single payment or in
installments and may be payable at a specified date or dates or upon
attaining the performance objective, all at the Committee's discretion. The
extent to which any applicable performance objective has been achieved shall
be conclusively determined by the Committee.
10. DIVIDEND EQUIVALENT RIGHTS
The Committee may grant a Dividend Equivalent Right either as a
component of another Award or as a separate Award, and, in general, each such
holder of a Dividend Equivalent Right that is outstanding on a dividend
record date for the Company's Common Stock shall be credited with an amount
equal to the cash or stock dividends or other distributions that would have
been received had the Shares covered by the Award been issued and outstanding
on the dividend record date. The terms and conditions of the Dividend
Equivalent Right shall be specified by the grant. Dividend equivalents
credited to the holder of a Dividend Equivalent Right may be paid currently
or may be deemed to be reinvested in additional Shares (which may thereafter
accrue
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additional Dividend Equivalent Rights). Any such reinvestment shall be at the
Fair Market Value at the time thereof. Dividend Equivalent Rights may be
settled in cash or Shares, or a combination thereof, in a single payment or
in installments. A Dividend Equivalent Right granted as a component of
another Award may provide that such Dividend Equivalent Right shall be
settled upon exercise, settlement or payment for or lapse of restrictions on
such other Award, and that such Dividend Equivalent Right shall expire or be
forfeited or annulled under the same conditions as such other Award. A
Dividend Equivalent Right granted as a component of another Award may also
contain terms and conditions different from such other Award.
11. OTHER AWARDS
The Committee may grant to any eligible employee other forms of
Awards based upon, payable in or otherwise related to, in whole or in part,
Shares, if the Committee, in its sole discretion, determines that such other
form of Award is consistent with the purposes and restrictions of the 1997
Flexible Plan. The terms and conditions of such other form of Award shall be
specified by the grant including, but not limited to, the price, if any, and
the vesting schedule, if any. Such Awards may be granted for no cash
consideration, for such minimum consideration as may be required by
applicable law or for such other consideration as may be specified by the
grant.
12. COMPLIANCE WITH SECURITIES AND OTHER LAWS
In no event shall the Company be required to sell or issue Shares
under any Award if the sale or issuance thereof would constitute a violation
of applicable Federal or state securities laws or regulations or a violation
of any other law or regulation of any governmental or regulatory agency or
authority or any national securities exchange. As a condition to any sale or
issuance of Shares, the Company may place legends on Shares, issue stop
transfer orders and require such agreements or undertakings as the Company
may deem necessary or advisable to assure compliance with any such laws or
regulations, including, if the Company or its counsel deems it appropriate,
representations from the person to whom an Award is granted that he or she is
acquiring the Shares solely for investment and not with a view to
distribution and that no distribution of the Shares will be made unless
registered pursuant to applicable Federal and state securities laws, or in
the opinion of counsel of the Company, such registration is unnecessary.
13. ADJUSTMENTS UPON CHANGES IN CAPITALIZATION OR REORGANIZATION
The value of an Award in Shares shall be adjusted from time to time
as follows:
(a) Subject to any required action by Shareholders, the number of
Shares covered by each outstanding Award, and the exercise price, shall be
proportionately adjusted for any increase or decrease in the number of issued
Shares of the Company resulting from a subdivision or consolidation of Shares
or the payment of a stock dividend (but only in Shares) or any other increase
or decrease in the number of Shares affected without receipt of consideration
by the Company.
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(b) Subject to any required action by Shareholders, if the Company
shall be the surviving corporation in any Reorganization, merger or
consolidation, each outstanding Award shall pertain to and apply to the
securities to which a holder of the number of Shares subject to the Award
would have been entitled, and if a plan or agreement reflecting any such
event is in effect that specifically provides for the change, conversion or
exchange of Shares, then any adjustment to Shares relating to an Award
hereunder shall not be inconsistent with the terms of any such plan or
agreement.
(c) In the event of a change in the Shares of the Company as
presently constituted, which is limited to a change of par value into the
same number of Shares with a different par value or without par value, the
Shares resulting from any such change shall be deemed to be the Shares within
the meaning of the 1997 Flexible Plan.
To the extent that the foregoing adjustments relate to stock or
securities of the Company, such adjustments shall be made by the Board, whose
determination shall be final, binding and conclusive.
Except as hereinbefore expressly provided in the 1997 Flexible Plan,
any person to whom an Award is granted shall have no rights by reason of any
subdivision or consolidation of stock of any class or the payment of any
stock dividend or any other increase or decrease in the number of shares of
stock of any class or by reason of any dissolution, liquidation,
reorganization, merger or consolidation or spin-off of assets or stock of
another corporation, and any issue by the Company of shares of stock of any
class, or securities convertible into shares of stock of any class, shall not
affect and no adjustment by reason thereof shall be made with respect to, the
number or exercise price of Shares subject to an Award.
The grant of an Award pursuant to the 1997 Flexible Plan shall not
affect in any way the right or power of the Company to make adjustments,
reclassifications, reorganizations or changes of its capital or business
structure or to merge or to consolidate or to dissolve, liquidate or sell or
transfer all or any part of its business or assets.
14. AMENDMENT OR TERMINATION OF THE 1997 FLEXIBLE PLAN
14.1 AMENDMENT OF THE 1997 FLEXIBLE PLAN. Notwithstanding anything
contained in the 1997 Flexible Plan to the contrary, all provisions of the
1997 Flexible Plan may at any time or from time to time be modified or
amended by the Board; provided, however, that no Award at any time
outstanding under the 1997 Flexible Plan may be modified, impaired or
canceled adversely to the holder of the Award without the consent of such
holder; and provided, further, that the 1997 Flexible Plan may not be amended
without approval by the holders of a majority of the Shares of the Company
represented and voted at a meeting of the Shareholders (a) to increase the
maximum number of Shares subject to the 1997 Flexible Plan, (b) to materially
modify the requirements as to eligibility for participation in the 1997
Flexible Plan, (c) to decrease the minimum exercise price for options, (d) to
otherwise materially increase the benefits accruing to persons to whom Awards
may be made under the 1997 Flexible Plan, as amended, or (e) if such
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approval is otherwise necessary, to comply with Rule 16b-3 promulgated under
the Exchange Act as amended, or to comply with any other applicable laws,
regulations or listing requirements, or to qualify for an exemption or
characterization that is deemed desirable by the Board.
14.2 TERMINATION OF THE 1997 FLEXIBLE PLAN. The Board may suspend or
terminate the 1997 Flexible Plan at any time, and such suspension or
termination may be retroactive or prospective. However, no Award may be
granted on or after the tenth anniversary of the adoption of the 1997
Flexible Plan. Termination of the 1997 Flexible Plan shall not impair or
affect any Award previously granted hereunder and the rights of the holder of
the Award shall remain in effect until the Award has been exercised in its
entirety or has expired or otherwise has been terminated by the terms of such
Award.
15. AMENDMENTS AND ADJUSTMENTS TO AWARDS
The Committee may amend, modify or terminate any outstanding Award
with the Participant's consent at any time prior to payment or exercise in
any manner not inconsistent with the terms of the 1997 Flexible Plan,
including, without limitation to change the date or dates as of which (a) an
option becomes exercisable or (b) a performance-based Award is deemed earned.
The Committee is also authorized to make adjustments in the terms and
conditions of, and the criteria included in, Awards in recognition of unusual
or non-recurring events (including, without limitation, the events described
in Section 13 hereof) affecting the Company, or the financial statements of
the Company or any Affiliate, or of changes in applicable laws, regulations
or accounting principles, whenever the Committee determines that such
adjustments are appropriate in order to prevent reduction or enlargement of
the benefits or potential benefits intended to be made available under the
1997 Flexible Plan. Any provision of the 1997 Flexible Plan or any agreement
regarding an Award to the contrary notwithstanding, the Committee may cause
any Award granted to be canceled in consideration of a cash payment or
alternative Award made to the holder of such canceled Award equal in value to
the Fair Market Value of such canceled Award. The determinations of value
under this Section 15 shall be made by the Committee in its sole discretion.
16. GENERAL PROVISIONS
16.1 NO LIMIT ON OTHER COMPENSATION ARRANGEMENTS. Nothing contained
in the 1997 Flexible Plan shall prevent the Company from adopting or
continuing in effect other compensation arrangements, and such arrangements
may be either generally applicable or applicable only in specific cases.
16.2 NO RIGHT TO EMPLOYMENT. Nothing in the 1997 Flexible Plan or in
any Award, nor the grant of any Award, shall confer upon or be construed as
giving any recipient of an Award any right to remain in the employ of the
Company. Further, the Company may at any time dismiss an Optionee in the 1997
Flexible Plan from employment, free from any liability or any claim under the
1997 Flexible Plan, unless otherwise expressly provided in the 1997 Flexible
Plan or in any Award agreement. No employee, Optionee or other person shall
have any claim to be granted any Award, and there is no obligation for
uniformity or treatment of employees, participants or holders or
beneficiaries of Awards.
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16.3 GOVERNING LAW. THE VALIDITY, CONSTRUCTION AND EFFECT OF THE
1997 FLEXIBLE PLAN AND ANY RULES AND REGULATIONS RELATING TO THE 1997
FLEXIBLE PLAN SHALL BE DETERMINED IN ACCORDANCE WITH THE LAWS OF THE STATE OF
TEXAS.
16.4 SEVERABILITY. If any provision of the 1997 Flexible Plan or any
Award is or becomes or is deemed to be invalid, illegal or unenforceable in
any jurisdiction or as to any person or Award, or would disqualify the 1997
Flexible Plan or any Award under any law deemed applicable by the Committee,
such provision shall be construed or deemed amended to conform to applicable
laws, or if it cannot be construed or deemed amended without, in the sole
determination of the Committee, materially altering the intent of the 1997
Flexible Plan or the Award, such provision shall be stricken as to such
jurisdiction, person or Award and the remainder of the 1997 Flexible Plan and
any such Award shall remain in full force and effect.
16.5 NO FRACTIONAL SHARES. No fractional Shares shall be issued or
delivered pursuant to the 1997 Flexible Plan or any Award, and the Committee
shall determine whether cash, other securities or other property shall be
paid or transferred in lieu of any fractional Shares or whether such
fractional Shares or any rights thereto shall be canceled, terminated or
otherwise eliminated.
16.6 HEADINGS. Headings are given to the subsections of the 1997
Flexible Plan solely as a convenience to facilitate reference. Such headings
shall not be deemed in any way material or relevant to the construction or
interpretation of the 1997 Flexible Plan or any provision thereof.
16.7 EFFECTIVE DATE. The 1997 Flexible Plan shall be effective as of
June 1, 1997 after its approval by the holders of a majority of the Shares of
the Company represented and voting at the Annual Meeting of Shareholders to
be held May 22, 1997. If the 1997 Flexible Plan is not approved by the
Shareholders at the 1997 Annual Meeting, the 1997 Flexible Plan shall be null
and void.
16.8 NON-TRANSFERABILITY OF AWARDS. Awards shall be nontransferable
other than by will or the laws of descent and distribution, and Awards may be
exercised, during the lifetime of the holder, only by the holder (or the
holder's duly appointed guardian or personal representative); provided,
however, that Awards other than Incentive Stock Options may be transferred
(i) by the holder to a family member, trust, charity, or similar organization
for estate planning purposes or (ii) with the approval of the Committee, as
directed under a qualified domestic relations order.
17. NAMED EXECUTIVE OFFICERS
17.1 APPLICABILITY OF SECTION 17. The provisions of this Section 17
shall apply only to those Executive Officers (i) whose compensation is
required to be reported in the Company's proxy statement pursuant to Item
402(a)(3)(i) and (ii) of Regulation S-K under the general rules and
regulations under the Exchange Act, as amended, and (ii) whose total
compensation, including estimated Awards, is determined by the Committee to
possibly be subject to the
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limitations on deductions imposed by Section 162(m) of the Code ("Named
Executive Officers"). In the event of any inconsistencies between this
Section 17 and the other 1997 Flexible Plan provisions as they pertain to
Named Executive Officers, the provisions of this Section 17 shall control.
17.2 ESTABLISHMENT OF PERFORMANCE GOALS. Awards for Named Executive
Officers, other than stock options and Stock Appreciation Rights, shall be
based on the attainment of certain performance goals. No later than the
earlier of (i) ninety (90) days after the commencement of the applicable
fiscal year or such other award period as may be established by the Committee
("Award Period") and (ii) the completion of twenty-five percent (25%) of such
Award Period, the Committee shall establish, in writing, the performance
goals applicable to each such Award for Named Executive Officers. At the time
the performance goals are established by the Committee, their outcome must be
substantially uncertain. In addition, the performance goal must state, in
terms of an objective formula or standard, the method for computing the
amount of compensation payable to the Named Executive Officer if the goal is
obtained. Such formula or standard shall be sufficiently objective so that a
third party with knowledge of the relevant performance results could
calculate the amount to be paid to the subject Named Executive Officer. The
material terms of the performance goals for Named Executive Officers and the
compensation payable thereunder shall be submitted to the Shareholders of the
Company for their review and approval. Shareholder approval shall be obtained
for such performance goals prior to any Award being paid to such Named
Executive Officer. If the Shareholders do not approve such performance goals,
no amount shall be paid to such Named Executive Officer for such applicable
Award Period under the 1997 Flexible Plan. The disclosure of the "material
terms" of a performance goal and the compensation payable thereunder shall be
determined under the guidelines set forth under Section 162(m) of the Code,
and the Treasury Regulations thereunder.
17.3 COMPONENTS OF AWARDS. Each Award to a Named Executive Officer,
other than stock options and Stock Appreciation Rights, shall be based on
performance goals which are sufficiently objective so that a third party
having knowledge of the relevant facts could determine whether the goal was
met. Except as provided in subsection 17.8 herein, performance measures which
may serve as determinants of Named Executive Officers Awards shall be limited
to the following measures: earnings per share; return on assets; return on
equity; return on capital; net profit after taxes; net profit before taxes;
economic value added; operating profits; stock price; market share; and sales
or expenses. Within ninety (90) days following the end of each Award Period,
the Committee shall certify in writing that the performance goals, and any
other material terms were satisfied. Thereafter, Awards shall be made for
each Named Executive Officer as determined by the Committee. The Awards may
not vary from the pre-established amount based on the level of achievement.
17.4 NO MID-YEAR CHANGE IN AWARDS. Except as provided in subsections
17.8 and 17.9 herein, each Named Executive Officers Awards shall be based
exclusively on the performance measures established by the Committee pursuant
to subsection 17.2.
17.5 NO PARTIAL AWARD PERIOD PARTICIPATION. A Named Executive
Officer who becomes eligible to participate in the 1997 Flexible Plan after
performance goals have been
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established in an Award Period pursuant to subsection 17.2 may not
participation in the 1997 Flexible Plan prior to the next succeeding Award
Period, except with respect to Awards which are stock options or Stock
Appreciation Rights.
17.6 PERFORMANCE GOALS. Except as provided in subsection 17.8
herein, performance goals shall not be changed following their establishment,
and Named Executive Officers shall not receive any payout, except with
respect to Awards which are stock options or Stock Appreciation Rights, when
the minimum performance goals are not met or exceeded.
17.7 INDIVIDUAL PERFORMANCE AND DISCRETIONARY ADJUSTMENTS. Except as
provided in subsection 17.8 herein, subjective evaluations of individual
performance of Named Executive Officers shall not be reflected in their
Awards, other than Awards which are stock options or Stock Appreciation
Rights. The payment of such Awards shall be entirely dependent upon the
attainment of the pre-established performance goals.
17.8 AMENDMENTS. No amendment of the 1997 Flexible Plan with respect
to any Named Executive Officer may be made which would (i) increase the
maximum amount that can be paid to any one Optionee under the 1997 Flexible
Plan, (ii) change the specified performance goal for payment of Awards, or
(iii) modify the requirements as to eligibility for participation in the 1997
Flexible Plan, unless the Company's Shareholders have first approved such
amendment in a manner which would permit the deduction under Section 162(m)
of the Code of such payment in the fiscal year it is paid. The Committee
shall amend this Section 17 and such other provisions as it deems
appropriate, to cause amounts payable to Named Executive Officers to satisfy
the requirements of Section 162(m) and the Treasury Regulations promulgated
thereunder. The maximum number of Shares (or cash equivalent value) with
respect to which stock options or Stock Appreciation Rights may be granted
hereunder to any Named Executive Officer during any calendar year may not
exceed 4,000,000 shares, subject to adjustment as provided in Section 13
hereunder.
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HCC INSURANCE HOLDINGS, INC.
1996 NONEMPLOYEE DIRECTOR STOCK OPTION PLAN,
AS AMENDED AND RESTATED
1. PURPOSE
The HCC INSURANCE HOLDINGS, INC. 1996 NONEMPLOYEE DIRECTOR STOCK
OPTION PLAN (the "1996 Directors' Plan") is intended to promote the interest
of HCC Insurance Holdings, Inc., a Delaware corporation (the "Company"), and
its Shareholders by helping to award and retain highly-qualified independent
directors, and allowing them to develop a sense of proprietorship and
personal involvement in the development and financial success of the Company.
Accordingly, the Company shall grant to members of the Board of Directors
(the "Board") of the Company who are not employees of the Company or any of
its subsidiaries ("Nonemployee Directors") the option ("Option") to purchase
shares of the common stock of the Company ("Stock"), as hereinafter set
forth. Options granted under the 1996 Directors' Plan shall be options which
do not constitute incentive stock options, within the meaning of Section
422(b) of the Internal Revenue Code of 1986, as amended.
2. OPTION AGREEMENTS
Each Option shall be evidenced by a written agreement in the form
attached to the 1996 Directors' Plan.
3. ELIGIBILITY OF OPTIONEE
Options may be granted only to individuals who are Nonemployee
Directors of the Company. Each Nonemployee Director who was serving on the
Board of Directors of the Company on December 14, 1995, shall receive, as of
such date and without the exercise of the discretion of any person or
persons, an Option exercisable for 5,000 shares of Stock. Each individual
becoming a Nonemployee Director (a "New Member") after April 1, 1997, shall
on the date of his first election receive an option exercisable for 12,500
shares of Stock (the "New Member Grant"). Such new Member Grant shall be
provided from this 1996 Directors' Plan or from such other stock option plan
which the Company has in effect. Each individual who is a Nonemployee
Director as of the January 1 immediately following the date of the last
regularly scheduled Board of Directors meeting to be held in each calendar
year and without the exercise of the discretion of any person or persons,
will be granted an additional Option exercisable for 10,000 shares of Stock
(subject to adjustment in the same manner as provided in Paragraph VII hereof
with respect to shares of Stock subject to Options then outstanding). Such
Option shall be granted on the date determined by the Compensation Committee
of the Board, which date shall be within the period beginning ten (10)
trading days before such January 1 (or the immediately preceding December 31)
and ending ten (10) trading days after such January 1 (or the immediately
preceding December 31) (the date on which such Option is granted shall be
referred to herein as the "Date of Grant"). Such Option shall be granted on
the date determined by the Compensation Committee of the Board, which date
shall be within the period beginning ten (10) trading days before such
January 1 (or the immediately preceding December 31) and ending ten (10)
trading days after such January 1 (or the immediately preceding December 31)
(the date on which such Option is granted shall be referred to herein as the
"Date of Grant") If, as of any date that the 1996 Directors' Plan is in
effect, there are not sufficient shares of Stock available under the 1996
Directors' Plan to allow for the grant to each Nonemployee Director of an
Option for the number of shares provided herein, each Nonemployee Director
shall receive an Option for a prorata
<PAGE>
share of the total number of shares of Stock then available under the 1996
Directors' Plan. All Options granted under the 1996 Directors' Plan shall be
at the Option price set forth in Paragraph 5 hereof and shall be subject to
adjustment as provided in Paragraph 7 hereof.
4. SHARES SUBJECT TO THE 1996 DIRECTORS' PLAN
The aggregate number of shares which may be issued under Options
granted under the 1996 Directors' Plan shall not exceed 450,000 shares of
Stock. Such shares may consist of authorized but unissued shares of Stock or
previously issued shares of Stock reacquired by the Company. Any of such
shares which remain unissued and which are not subject to outstanding Options
at the termination of the 1996 Directors' Plan shall cease to be subject to
the 1996 Directors' Plan, but, until termination of the 1996 Directors' Plan,
the Company shall at all times make available a sufficient number of shares
to meet the requirements of the 1996 Directors' Plan. Should any Option
hereunder expire or terminate prior to its exercise in full, the shares
theretofore subject to such Option may again be subject to an Option granted
under the 1996 Directors' Plan. The aggregate number of shares which may be
issued under the 1996 Directors' Plan shall be subject to adjustment in the
same manner as provided in Paragraph 7 hereof with respect to shares of
Stock subject to Options then outstanding. Exercise of an Option shall result
in a decrease in the number of shares of Stock which may thereafter be
available, both for purposes of the 1996 Directors' Plan and for sale to any
one individual, by the number of shares as to which the Option is exercised.
5. OPTION PRICE AND PERIOD
The purchase price of Stock issued under each Option shall be the
closing trading price of the Company's Common Stock on the New York Stock
Exchange ("NYSE") or, if not traded on the NYSE, any other securities
exchange on which the Stock is traded, for, other than for a new Member
Grant, the Date of Grant (or the immediately preceding trading day if the
Date of Grant is not a trading day) and for a New Member Grant, the trading
day immediate preceding the New Member's election to the Board of Directors.
In the event the Stock is not publicly traded at the time a determination of
the purchase price is required to be made hereunder, the determination of the
purchase price shall be made by the Board in such manner as it deems
appropriate."
Except as otherwise provided herein, each option and all rights or
obligations thereunder shall expire on the tenth anniversary of the grant
date (the "Expiration Date"), and shall be subject to earlier termination as
hereinafter provided.
6. TERM OF 1996 DIRECTORS' PLAN
The 1996 Directors' Plan shall be effective on the date the 1996
Directors' Plan is approved by the Shareholders of the Company. Except with
respect to Options then outstanding, if not sooner terminated under the
provisions of Paragraph 7, the 1996 Directors' Plan shall terminate upon and
no further Options shall be granted after December 31, 2001.
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7. RECAPITALIZATION OR REORGANIZATION
(a) The existence of the 1996 Directors' Plan and the Options
granted hereunder shall not affect in any way the right or power of the Board
or the Shareholders of the Company to make or authorize any adjustment,
recapitalization, reorganization or other change in the Company's capital
structure or its business, any merger or consolidation of the Company, any
issue of debt or equity securities, the dissolution or liquidation of the
Company or any sale, lease, exchange or other disposition of all or any part
of its assets or business or any other corporate act or proceeding.
(b) The shares with respect to which Options may be granted are
shares of Stock as presently constituted, but if, and whenever, prior to the
expiration of an Option theretofore granted, the Company shall effect a
subdivision or consolidation of shares of Stock or the payment of a stock
dividend on Stock without receipt of consideration by the Company, the number
of shares of Stock with respect to which such Option may thereafter be
exercised (i) in the event of an increase in the number of outstanding shares
shall be proportionately increased, and the purchase price per share shall be
proportionately reduced, and (ii) in the event of a reduction in the number
of outstanding shares shall be proportionately reduced, and the purchase
price per share shall be proportionately increased.
(c) If the Company merges or consolidates with one or more
corporations and the Company shall be the surviving corporation, thereafter
upon any exercise of this Option the Grantee shall be entitled to purchase
under this Option, in lieu of the number of shares of Stock as to which
Option shall then be exercisable, the number and class of shares of stock and
securities to which the Grantee would have been entitled pursuant to the
terms of the agreement of merger or consolidation if, immediately prior to
such merger or consolidation, the Grantee had been the holder of record of
the number of shares of Stock as to which this Option is then exercisable. If
the Company shall not be the surviving corporation in any merger of
consolidation, or if the Company is dissolved or liquidated, this Option
shall expire on the effective date of such merger or consolidation or such
dissolution or liquidation; provided, that nothing herein shall preclude a
surviving corporation or other corporation into which stock of the Company
may be converted from assuming or substituting new options for the Option
granted hereunder, which assumption or substitution may be made without the
consent of the holder of this Option to such assumption, substitution, merger
or consolidation, and further provided that immediately prior to such
expiration, the entire number of shares of Stock for which this Option may be
exercised shall be accelerated so that Grantee shall have the opportunity to
exercise the entire unexpired portion of this Option prior to its expiration.
The Company agrees to give at least 30 days prior notice to Grantee of the
effective date of any such merger, consolidation, dissolution or liquidation.
If the Company is acquired by another entity, in any manner, so that
following such acquisition the Company is a subsidiary of another entity, the
Company shall be deemed to be not the surviving corporation for purposes of
this subparagraph (c).
(d) If the Company recapitalizes or otherwise changes its capital
structure, thereafter upon any exercise of an Option theretofore granted the
optionee shall be entitled to purchase under such Option, in lieu of the
number and class of shares of Stock then covered by such Option, the number
and class of shares of stock and securities to which the optionee would have
been entitled pursuant to the terms of the recapitalization if, immediately
prior to such recapitalization, the optionee had been the holder of record of
the number of shares of Stock then covered by such Option.
(e) Any adjustment provided for in Subparagraphs (b), (c) or (d)
above shall be subject to any required Shareholder action.
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(f) Except as hereinbefore expressly provided, the issuance by the
Company of shares of stock of any class or securities convertible into shares
of stock of any class, for cash, property, labor or services, upon direct
sale, upon the exercise of rights or warrants to subscribe therefor, or upon
conversion of share or obligations of the Company convertible into such
shares or other securities, and in any case whether or not for fair value,
shall not affect, and no adjustment by reason thereof shall be made with
respect to, the number of shares of Stock subject to Options theretofore
granted or the purchase price per share.
8. AMENDMENT OR TERMINATION OF THE 1996 DIRECTORS' PLAN
The Board in its discretion may terminate the 1996 Directors' Plan
at any time with respect to any shares for which Options have not theretofore
been granted. The Board shall have the right to alter or amend the 1996
Directors' Plan or any part thereof from time to time; provided, that no
change in any Option theretofore granted may be made which would impair the
rights of the optionee without the consent of such optionee; and provided,
further, that the Board may not make any alteration or amendment which would
materially increase the benefits accruing to participants under the 1996
Directors' Plan, increase the aggregate number of shares which may be issued
pursuant to the provisions of the 1996 Directors' Plan, change the class of
individuals eligible to receive Options under the 1996 Directors' Plan or
extend the term of the 1996 Directors' Plan, without the approval of the
Shareholders of the Company.
9. SECURITIES LAWS
(a) The Company shall not be obligated to issue any Stock pursuant
to any Option granted under the 1996 Directors' Plan at any time when the
offering of the shares covered by such Option have not been registered under
the Securities Act of 1933, as amended, (the "Act") and such other state and
federal laws, rules or regulations as the Company deems applicable and, in
the opinion of legal counsel for the Company, there is no exemption from the
registration requirements of such laws, rules or regulations available for
the offering and sale of such shares.
(b) It is intended that the 1996 Directors' Plan and any grant of an
Option made to a person subject to Section 16 of the Securities Exchange Act
of 1934, as amended (the "1934 Act"), meet all of the requirements of Rule
16b-3, as currently in effect or as hereinafter modified or amended ("Rule
16b-3"), promulgated under the 1934 Act. If any provision of the 1996
Directors' Plan or any such Option would disqualify the 1996 Directors' Plan
or such Option under, or would otherwise not comply with, Rule 16b-3, such
provision or Option shall be construed or deemed amended to conform to Rule
16b-3.
10. VESTING AND EXERCISE OF OPTIONS
(a) (i) Except as set forth herein, any Option granted hereunder
shall be fully exercisable on the first anniversary of the Date of Grant.
(ii) A New Member Grant shall also be fully exercisable on the
first anniversary of the Date of Grant in the year such New Member is
elected to the Board of Directors (without regard to the date a New
Member was first elected to the Board of Directors).
(b) The purchase price of the Stock purchased upon exercise of an
option shall be paid in full at the time of each exercise of an option and may
be paid to the Company, either:
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(1) in cash (including a check, bank draft or money order); or
(2) by the delivery of Stock having a fair market value equal to the
aggregate Option price; or
(3) by a combination of cash and Stock.
No options shall be exercisable except in respect of whole shares of Stock. Upon
exercise of an option, the person exercising the option shall be entitled to one
(1) stock certificate evidencing the shares acquired upon such exercise.
(c) An option granted under the 1996 Directors' Plan shall, by its
terms, be nontransferable by the Nonemployee Director other than by will or
the laws of descent and distribution; provided that an option may be
transferred by the Nonemployee Director to a family member, trust, charity,
or similar organization for estate planning purposes. During the Nonemployee
Director's lifetime, the option shall be exercisable only by the Nonemployee
Director or by the Nonemployee Director's duly appointed guardian or personal
representative.
(d) If the directorship of the Nonemployee Director is terminated
for any reason other than (i) Disability (as hereinafter defined) of the
Nonemployee Director, (ii) death of the Nonemployee Director, (iii)
Retirement (as hereinafter defined) of the Nonemployee Director, or (iv) on
account of any act of fraud or intentional misrepresentation or embezzlement,
misappropriation or conversion of assets or opportunities of the Company, or
cause as determined by the Board of Directors, an Option (to the extent
otherwise exercisable by the Nonemployee Director on the date of such
termination) shall be exercisable by the Nonemployee Director at any time
prior to the Expiration Date of the Option or within two (2) months after the
date of such termination of the directorship, whichever is the shorter period.
(e) If the Nonemployee Director's directorship is terminated by
reason of Disability, an Option (whether or not exercisable on the date of
the Nonemployee Director's termination of directorship by reason of
Disability) shall be exercisable by the Nonemployee Director at any time
prior to the Expiration Date of the Option or within twelve (12) months after
the date of such termination, whichever is the shorter period. As used
herein, the term "Disability" shall mean the inability to engage in any
substantial gainful activity by reason of any medically determinable physical
or mental impairment which can be expected to last for a continuous period of
not less than twelve (12) months. The determination of whether or not a
Nonemployee Director's directorship is terminated by reason of Disability
shall be in the sole and absolute discretion of the Board. An individual
shall not be considered Disabled unless he furnishes proof of the existence
thereof in such form and manner, and at such times, as the Board may require.
(f) If a Nonemployee Director dies while serving as a member of the
Board or during the twelve (12)-month period described in Subparagraph (e)
above, the Option shall be exercisable (whether or not exercisable on the
date of the death of such Nonemployee Director) by the person or persons
entitled to do so under the Nonemployee Director's will, or, if the
Nonemployee Director shall fail to make testamentary disposition of said
Option or shall die intestate, by the Nonemployee Director's legal
representative or representatives, at any time prior to the Expiration Date
of the Option or within twelve
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(12) months after the date of such death, whichever is the shorter period. If
a Nonemployee Director dies during the two-month period described in
subsection (d) above, the option shall be exercisable as described above.
(g) The option of a Nonemployee Director shall automatically
terminate as of the date his directorship is terminated, if the directorship
is terminated on account of any act of (i) fraud or intentional
misrepresentation, or (ii) embezzlement, misappropriation or conversion of
assets or opportunities of the Company or (iii) cause as determined by the
Board of Directors.
(h) If the directorship of the Nonemployee Director is terminated by
reason of Retirement (as hereinafter defined), an Option (to the extent
otherwise exercisable by the Nonemployee Director on the date of exercise)
shall be exercisable by the Nonemployee Director at any time prior to the
Expiration Date of the Option or within twelve (12) months after the date of
such termination of the directorship, whichever is the shorter period. As
used herein, the term `Retirement' shall mean a voluntary election by the
Nonemployee Director to resign as a director or to cease to stand for
election as a director.
11. MISCELLANEOUS
(a) Nothing contained in this 1996 Directors' Plan (nor in any
option granted pursuant to this 1996 Directors' Plan) shall confer upon any
Nonemployee Director any right to continue as a member of the Board or
constitute any contract or agreement or interfere in any way with the right
of the Company to remove such Nonemployee Director from the Board. Nothing
contained herein or in any Option Agreement shall affect any other
contractual rights of a Nonemployee Director.
(b) An option shall be deemed to be exercised when the Secretary of
the Company receives written notice of such exercise from the person entitled
to exercise the option together with payment of the purchase price made in
accordance with this 1996 Directors' Plan.
(c) The holder of an option shall not be entitled to the privilege
of stock ownership as to any shares of Stock not actually issued and
delivered to the holder. Subject to the provisions of Paragraph 9. above,
upon exercise of an option for Stock at a time when there is not in effect
under the Act a registration statement relating to the Stock issuable upon
exercise thereof or not available for delivery a prospectus meeting the
requirements of Section 10 of the Act, the holder of the option shall
represent and warrant in writing to the Company that, inter alia, the shares
of Stock purchased are being acquired for investment and not with a view to
the resale or distribution thereof. No shares of Stock shall be issued upon
the exercise of any option unless and until there shall have been compliance
with any then applicable requirements of the Securities and Exchange
Commission, other regulatory agencies having jurisdiction and any exchanges
upon which securities subject to the option may be listed.
(d) The 1996 Directors' Plan and the options issued hereunder shall
be governed by, and construed and enforced in accordance with, the laws of
the State of Delaware applicable to contracts made and performed within that
State.
(e) The proceeds received by the Company from the sale of shares
pursuant to options shall be used for general corporate purposes.
(f) The members of the Board shall not be liable for any act,
omission or determination taken or made in good faith with respect to the
1996 Directors' Plan or any option granted under it.
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(g) Any payment or any issuance or transfer of shares of Stock to
the Nonemployee Director, or to his legal representative, heir, legatee or
distributee, in accordance with the provisions hereof, shall, to the extent
thereof, be in full satisfaction of all claims of such persons hereunder. The
Board may require any Nonemployee Director, legal representative, heir,
legatee or distributee, as a condition precedent to such payment, to execute
a release and receipt therefor in such form as it shall determine.
(h) Neither the Board nor the Company guarantees the Stock of the
Company from loss or depreciation.
(i) All expenses incident to the administration or termination of
the 1996 Directors' Plan, including, but not limited to, legal and accounting
fees, shall be paid by the Company.
(j) Records of the Company regarding the Nonemployee Director's
period of service, termination or service and the reason therefor, leaves of
absence, and other matters shall be conclusive for all purposes hereunder,
unless determined by the Board to be incorrect.
(k) The Company shall, upon request or as may be specifically
required hereunder, furnish or cause to be furnished all of the information
or documentation which is necessary or required by the Board to perform its
duties and functions under the 1996 Directors' Plan.
(l) The Company assumes no obligation or responsibility to the
Nonemployee Director or his or her personal representatives, heirs, legatees
or distributees for any act of, or failure to act on the part of the Board.
(m) Any action required of the Company shall be by resolution of the
Board or by a person authorized to act by Board resolution.
(n) If any provision of this 1996 Directors' Plan shall be held to
be illegal or invalid for any reason, the illegality or invalidity shall not
affect the remaining provisions hereof, but shall be fully severable and the
1996 Directors' Plan shall be construed and enforced as if the illegal or
invalid provision had never been included herein.
(o) Whenever any notice is required or permitted hereunder, such
notice must be in writing and personally delivered or sent by mail. Any
notice required or permitted to be delivered hereunder shall be deemed to be
delivered on the date on which it is personally delivered in accordance
herewith. The Company or a Nonemployee Director may change, at any time and
from time to time, by written notice to the other, the address which it or he
had theretofore specified for receiving notices. Until it is changed in
accordance herewith, the Company and each Nonemployee Director shall specify
as its and his address for receiving notices the address set forth in the
Option Agreement pertaining to the shares to which such notice relates.
(p) Any person entitled to notice hereunder may waive such notice.
(q) The 1996 Directors' Plan shall be binding upon the Nonemployee
Director, his or her heirs, legatees and legal representatives, upon the
Company, its successors and assigns and upon the Board and its successors.
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(r) The titles and headings of sections and paragraphs are included
for convenience of reference only and are not to be considered in
construction of the provisions hereof.
(s) Words used in the masculine shall apply to the feminine where
applicable and, wherever the context of this 1996 Directors' Plan dictates,
the plural shall be read as the singular and the singular as the plural.
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EMPLOYMENT AGREEMENT
This Employment Agreement ("Agreement") is entered into as of the
7th day of December, 1998 (the "Effective Date"), between HOUSTON CASUALTY
COMPANY ("HC" or "Company"), and BENJAMIN D. WILCOX ("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 and Chief
Operating Officer of HC, U.S. Specialty Insurance Company ("USSIC") and
Trafalgar Insurance Company ("TIC");
WHEREAS, it is the desire of the Board of Directors of HC (the
"Board") to (i) directly engage Executive as an officer of HC and its
subsidiaries; and (ii) directly engage, if elected, the services of Executive
as a director of HC and its subsidiaries; and
WHEREAS, Executive is desirous of committing himself to serve HC 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 its
President and Chief Operating Officer and President and Chief Operating
Officer of USSIC and TIC, 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, 2003 (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 and Board, have
general management and control of HC, USSIC and TIC 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 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
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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. Executive agrees to serve on the Senior
Management Committee of HCC Insurance Holdings, Inc. ("HCC") and as a
Director of HC, USSIC, TIC, and Avemco Insurance Company ("AIC"), 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 additional compensation for
serving as a director 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 $300,000, 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 $15,000 each
January 1, commencing January 1, 2000. 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 effective
as of December 7, 1999, of not less than $50,000 at the discretion of the
Board of Directors and the Executive Committee of HCC based on Executive's
personal performance, Executive's group operating earnings per share ("OEPS")
and the price of HCC's Common Stock. For purposes of this Agreement, OEPS is
defined as HC's consolidated net earnings less capital gains/losses, currency
gains/losses, and any nonrecurring merger and acquisition income or expenses.
(c) STOCK OPTIONS. On the Effective Date, Executive shall
be provided with options to purchase 100,000 shares of HCC Common Stock at a
price per share equal to $16 15/16. Such shares will vest at 20% per year
beginning on the first anniversary of the Effective Date and 20% on each of
the four anniversaries thereafter. Such option will expire on the sixth
anniversary of the Effective Date.
(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 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
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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 (20)
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 HC 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 a car
allowance of $1,250 per month; (ii) be allowed to travel on business
utilizing first class domestic passage and business class international
passage (and, upon approval of the Chief Executive Officer, will be entitled
to travel with Executive's spouse); (iii) receive annual country club dues at
the Lochinvar Golf and the Bayou Clubs; and (iv) receive a total of
$1,000,000 life insurance (either term or "split dollar" in HC's discretion),
which shall be in addition to the standard benefits provided to the Executive
under the Company's or HCC's group life insurance programs 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.
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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 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
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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 performance of this Agreement by any
successor (by merger, consolidation, or otherwise) or assign of the
Company.
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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; and further, if there is a termination for Good
Reason or by the Company other than for Cause, all vested 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, 2003 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.
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(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 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, except as provided in Paragraph 6, 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 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
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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 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. All unvested options shall be void. 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. 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;
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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
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 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
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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, 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
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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 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
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agreements contained herein.
(o) SURVIVABILITY. The agreements contained in Paragraphs
5(c)-(g) shall survive the termination of this Agreement for any reason.
6. 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, HC hereby
retains Executive as a consultant (an independent contractor and not as an
employee) for a period of three (3) 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 166 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 hours (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 not 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
$200,000 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 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.
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7. 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.
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. 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: Benjamin D. Wilcox
2904 Ferndale
Houston, Texas 77009
Fax: (713) 610-1974
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.
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.
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12. 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.
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 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
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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
HOUSTON CASUALTY COMPANY
/s/ Benjamin D. Wilcox By: /s/ Stephen L. Way
- ----------------------- --------------------------
BENJAMIN D. WILCOX STEPHEN L. WAY
Chairman of the Board
Dated: January 4, 1999 Dated: January 4, 1999
----------------- ---------------------
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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 EDWARD HARDIN ELLIS, 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 Senior Vice President and
Chief Financial Officer ("CFO") until June 30, 2001, 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 Senior Management 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
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 a Senior
Vice President and CFO, 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 September
30, 2001 (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 Board of Directors, act as Chief Financial Officer
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 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 Board of Directors of HCC. However, Executive shall have the right to
engage in such activities
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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. If elected, Executive agrees to serve as a
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. 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 $225,000, during each calendar year of the
Basic Term, payable in substantially equal monthly installments. For purposes
of this Agreement, "Base Salary" shall mean the Executive's initial base
salary or, if increased, then the increased base salary.
(b) BONUS PAYMENTS. Executive shall be eligible to receive, in
addition to the Base Salary, an annual cash and/or stock bonus payment in
amount, which may be zero, to be determined at the sole discretion of the
Compensation Committee.
(c) STOCK OPTIONS. In addition to stock options previously
granted to Executive, Executive shall be entitled to receive, in addition to
the Base Salary, options to purchase HCC shares, which may be zero, to be
determined at the sole discretion of the Board of Directors or the HCC
Compensation Committee.
(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
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 benefits under any compensation 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
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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 (20) 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 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 Board.
(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 Paragraph 4(c) or
4(d) 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;
(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
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material fashion unfavorably upon the Company or any of its
subsidiaries.
(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.
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 his 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.
(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
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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;
(iii) A relocation of the Company's executive offices,
or Executive's relocation to any place other than the 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.
(6) "TERMINATION FOLLOWING A CHANGE OF CONTROL" shall
mean failure of any successor/surviving company to adopt 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
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Reason (a "Termination Event"), this Agreement shall terminate and Executive
shall be entitled to the following severance benefits:
(1) For the remainder of the Basic Term after the
Termination Date, Base Salary (as defined in Paragraph 3(a)), at the
rate in effect immediately prior to the Termination Event, payable in a
lump sum;
(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 Option
Plans shall vest immediately provided, however, 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 that
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 and through
December 31, 2001 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), provided, however, such coverage shall
be secondary to any group health plan coverage Executive (or his
dependents) receive from another employer, (such other amounts and
benefits shall be hereinafter referred to as the "Other Benefits");
(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 amounts specified in this Subsections (4) of this
Paragraph 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
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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. 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 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. 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:
Page 7
<PAGE>
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,
Executive will immediately tender his resignation from any and all Board
positions held with the Company and/or any of its subsidiaries and affiliates.
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. 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.
(a) NON-COMPETITION DURING EMPLOYMENT. Executive agrees that
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.
(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
President 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 in Executive's good faith
judgment could reasonably be expected to involve or give rise to a Conflict
of Interest or potential Conflict of Interest.
Page 8
<PAGE>
(c) 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.
(d) 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.
(e) 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.
(f) 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.
Page 9
<PAGE>
(g) 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.
(h) BREACH. Executive agrees that any breach of Paragraphs
5(a) or (c) 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.
(i) 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.
(j) 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.
(k) SURVIVABILITY. The agreements contained in Paragraphs
5(c)-(d) 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
Page 10
<PAGE>
described hereinabove, shall be effective upon deposit. Notice given in any
other manner shall be effective only if and when received:
If to Executive: Edward Hardin Ellis, Jr.
1826 Castlerock
Houston Texas 77090
--------------------
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, 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.
Page 11
<PAGE>
12. 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.
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/ Edward H. Ellis, Jr. By: /s/ Stephen L. Way
- ------------------------ --------------------------------
EDWARD HARDIN ELLIS, JR. STEPHEN L. WAY
Chief Executive Officer and
Chairman of the Board
Dated: 1/23/98 Dated: 1/23/98
------------------ -----------------------------
Page 12
<PAGE>
EXHIBIT 12
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
STATEMENT OF RATIOS
================================================================================
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
(DOLLARS IN THOUSANDS)
ADJUSTED
1999(2) 1999 1998 1997 1996 1995
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Gross premium to surplus ratio:
Gross written premium $ 576,184 $ 500,962 $ 346,094 $ 340,367 $ 338,753
Policyholders' surplus 315,474 369,401 331,922 288,863 251,125
Premium to surplus ratio (1) 182.6% 135.6% 104.3% 117.8% 134.9%
(Gross premium to surplus ratio = gross written premium divided by policyholders' surplus)
Net premium to surplus ratio:
Net written premium $ 150,261 $ 123,315 $ 143,068 $ 189,022 $ 184,028
Policyholders' surplus 315,474 369,401 331,922 288,863 251,125
Premium to surplus ratio (1) 47.6% 33.4% 43.1% 65.4% 73.3%
(Net premium to surplus ratio = net written premium divided by policyholders' surplus)
Loss ratio:
Incurred loss and LAE $ 119,093 $ 160,908 $ 95,435 $ 100,158 $ 115,521 $ 106,346
Net earned premium 146,850 150,304 142,108 162,626 179,490 160,145
Loss ratio (1) 81.1% 107.1% 67.2% 61.6% 64.4% 66.4%
(Loss ratio = incurred loss and LAE divided by net earned premium)
Expense ratio:
Underwriting expense $ 33,427 $ 34,220 $ 19,417 $ 24,627 $ 36,379 $ 33,239
Net written premium 145,200 150,261 123,315 143,068 189,022 184,028
Expense ratio (1) 23.0% 22.8% 15.7% 17.2% 19.2% 18.1%
(Expense ratio = underwriting expense divided by net written premium)
Combined ratio (1) $ 104.1% 129.9% 82.9% 78.8% 83.6% 84.5%
(Combined ratio = loss ratio plus expense ratio)
</TABLE>
(1) Calculated for the Company's insurance company subsidiaries on the basis of
statutory accounting principles.
(2) Excluding the effects of the provision for reinsurance in 1999.
<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. Avemco Corporation Delaware
3. Avemco Financial Services Inc. Maryland
4. Avemco Insurance Company Maryland
5. Aviation & Marine Premium Acceptance Corporation Texas
6. Centris Insurance Company Indiana
7. Centris Underwriting Agencies Indiana
8. Eagle Aerobatic Flight Team, Inc. Wisconsin
9. Eastern Aviation & Marine Underwriters, Inc. Maryland
10. Guarantee Insurance Resources, Inc. Georgia
11. HCC Acquisitions (U.K.) Limited United Kingdom
12. HCC Administrators, Inc. Illinois
13. HCC Aviation Insurance Group Texas
14. HCC Benefits Corporation Delaware
15. HCC Employee Benefits, Inc. Delaware
16. HCC Employer Services, Inc. Alabama
17. HCC Employer Services, Inc. Illinois
18. HCC Intermediaries, Inc. Texas
19. HCC Intermediate Holdings, Inc. Delaware
20. HCC Life Insurance Company Indiana
21. HCC Reinsurance Company Limited Bermuda
22. HCC Risk Management, Inc. Indiana
23. HCC Service Company, GP Texas
24. HCC Corporation Delaware
25. HCC Service Delaware, LLC Delaware
26. HCC Underwriters, a Texas Corporation Texas
27. Houston Casualty Company Texas
28. Interra, Inc. Indiana
29. Interra Reinsurance Group, Inc. Indiana
30. KFA, Inc. Oklahoma
31. KIMCO, LLC Alabama
32. LDG Insurance Agency Incorporated Massachusetts
33. LDG Reinsurance Corporation (London) Limited Delaware
34. LDG Reinsurance Corporation Massachusetts
35. Loss Management Services, Inc. Maryland
36. Managed Group Underwriting, Inc. Kansas
37. Matterhorn Bank Programs, Inc. Maryland
38. MEDEKS International Saglik Ve Sigorta Destek Idari Hizmetleri A.S. (Turkey) Turkey
39. Merger Sub, Inc. Texas
40. Merger Sub of Alabama, Inc. Alabama
41. Middle East Insurance Brokers, Limited (Jordan) Jordan
42. Midwest Stop Loss Underwriters, Incorporated Minnesota
43. PEPYS Holdings Limited (U.K.) United Kingdom
44. PEPYS Management Services Limited (U.K.) United Kingdom
45. Professional Audit Service, Inc. Alabama
46. Rattner Mackenzie Limited (U.K.) United Kingdom
47. SBS Insurance Holdings, a Texas Corporation Texas
48. Select Benefits, Inc. Indiana
49. Signal Aviation Insurance Services, Inc. Nevada
50. Specialty Insurance Underwriters, Inc. Missouri
51. The Centris Group, Inc. Delaware
52. The Wheatley Group, Ltd. New York
<PAGE>
53. Trafalgar Insurance Company Oklahoma
54. USBenefits Insurance Services, Inc. California
55. US Holdings, Inc. Delaware
56. US Medcare Review, Inc. Illinois
57. U.S. Specialty Insurance Company Texas
58. Universal Loss Management, Inc. Delaware
59. VASA Brougher, Inc. Indiana
60. VASA Insurance Group, Inc. Indiana
61. VASA North America, Inc. Indiana
</TABLE>
<PAGE>
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the incorporation by reference in the registration
statements on Forms S-8 (File Nos. 333-14471, 333-14479, 333-61673, 333-61687,
333-68771 and 333-89905) of HCC Insurance Holdings, Inc. of our reports dated
March 30, 2000, relating to the financial statements and financial statement
schedules, which appear in HCC Insurance Holdings, Inc.'s Annual Report on Form
10-K for the year ended December 31, 1999.
/s/ PricewaterhouseCoopers LLP
Houston, Texas
March 30, 2000
<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 30, 2000
<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/ MARVIN P. BUSH
------------------
Marvin P. Bush
Date: March 30, 2000
<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 30, 2000
<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 30, 2000
<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 R. CRANE
------------------
James R. Crane
Date: March 30, 2000
<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 30, 2000
<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 30, 2000
<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 30, 2000
<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 30, 2000
<PAGE>
POWERS 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 30, 2000
<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, 1999, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> DEC-31-1999
<DEBT-HELD-FOR-SALE> 342,641,000
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 19,970,000
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 581,322,000
<CASH> 26,533,000
<RECOVER-REINSURE> 779,035,000
<DEFERRED-ACQUISITION> 658,000
<TOTAL-ASSETS> 2,650,623,000
<POLICY-LOSSES> 966,864,000
<UNEARNED-PREMIUMS> 188,524,000
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 242,546,000
0
0
<COMMON> 48,839,000
<OTHER-SE> 408,589,000
<TOTAL-LIABILITY-AND-EQUITY> 2,650,623,000
141,362,000
<INVESTMENT-INCOME> 30,933,000
<INVESTMENT-GAINS> (4,164,000)
<OTHER-INCOME> 173,740,000
<BENEFITS> 109,650,000
<UNDERWRITING-AMORTIZATION> 8,177,000
<UNDERWRITING-OTHER> 173,686,000
<INCOME-PRETAX> 37,394,000
<INCOME-TAX> 12,271,000
<INCOME-CONTINUING> 25,123,000
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 25,123,000
<EPS-BASIC> 0.51
<EPS-DILUTED> 0.51
<RESERVE-OPEN> 118,912,000
<PROVISION-CURRENT> 105,036,000
<PROVISION-PRIOR> 4,614,000
<PAYMENTS-CURRENT> 36,770,000
<PAYMENTS-PRIOR> 56,052,000
<RESERVE-CLOSE> 273,606,000
<CUMULATIVE-DEFICIENCY> 4,614,000
</TABLE>
