-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, AQls2GrV4VZf71BogeVUeIofyRQiQVlICasx9RMbmdw5onK+uG1M54B5tdL9BdDh 5LWvR5HAYTzA/8yV+FmCnw== 0001034588-99-000022.txt : 19990817 0001034588-99-000022.hdr.sgml : 19990817 ACCESSION NUMBER: 0001034588-99-000022 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19990630 FILED AS OF DATE: 19990816 FILER: COMPANY DATA: COMPANY CONFORMED NAME: HSB GROUP INC CENTRAL INDEX KEY: 0001034588 STANDARD INDUSTRIAL CLASSIFICATION: FIRE, MARINE & CASUALTY INSURANCE [6331] IRS NUMBER: 061475343 STATE OF INCORPORATION: CT FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 001-13135 FILM NUMBER: 99690859 BUSINESS ADDRESS: STREET 1: ONE STATE ST STREET 2: P O BOX 5024 CITY: HARTFORD STATE: CT ZIP: 06102-5024 BUSINESS PHONE: 8607221866 MAIL ADDRESS: STREET 1: ONE STATE ST STREET 2: PO BOX 5024 CITY: HARTFORD STATE: CT ZIP: 06102 10-Q 1 10-Q FILING SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q /x/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 1999 OR / / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission File Number 001-13135 HSB GROUP, INC. (Exact name of registrant as specified in its charter) CONNECTICUT 06-1475343 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) P.O. BOX 5024, ONE STATE STREET, HARTFORD, CONNECTICUT 06102-5024 (Address of principal executive offices) (Zip Code) (860) 722-1866 (Registrant's telephone number, including area code) Not applicable (Former name, former address and former fiscal year, if changed since the last report) 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 The number of shares outstanding of the registrant's common stock without par value, as of July 31, 1999: 28,893,207. HSB GROUP, INC. INDEX PART I FINANCIAL STATEMENTS PAGE Item 1 - Financial Statements Consolidated Statements of Operations for the Quarters ended June 30, 1999 and 1998 and the Six Months ended June 30, 1999 and 1998 (unaudited)................................................ 3 Consolidated Statements of Comprehensive Income for the Quarters ended June 30, 1999 and 1998 and the Six Months ended June 30, 1999 and 1998 (unaudited)............................................. 4 Consolidated Statements of Financial Position as of June 30, 1999 (unaudited) and December 31, 1998 .......... 5 Consolidated Statements of Cash Flows for the Six Months ended June 30, 1999 and 1998 (unaudited) ............................................ 6 Notes to Consolidated Financial Statements (unaudited)....... 7 Item 2 - Management's Discussion and Analysis of Consolidated Financial Condition and Results of Operations................................................ 13 PART II OTHER INFORMATION Item 1 - Legal Proceedings................................... 26 Item 4 - Submission of Matters to a Vote of Security Holders.................................... 26 Item 6 - Exhibits and Reports on Form 8-K.................... 27 SIGNATURES......................................................... 28 2 Part I Item 1 - Financial Statements HSB GROUP, INC. Consolidated Statements of Operations Unaudited (in millions, except per share data)
Quarter Six Months Ended June 30 Ended June 30 1999 1998 1999 1998 ---------------------------------------------------------- Revenues: Gross earned premium $ 206.8 $ 175.7 $ 415.7 $ 355.4 Ceded premiums 113.1 85.3 225.5 165.6 ----------------------------------------------------------- Insurance premiums 93.7 90.4 190.2 189.8 Engineering services 27.8 22.7 55.4 42.4 Net investment income 16.6 15.9 32.3 31.1 Realized investment gains 10.2 7.3 17.3 10.5 ----------------------------------------------------------- Total revenues 148.3 136.3 295.2 273.8 ----------------------------------------------------------- Expenses: Claims and adjustment 37.9 40.4 76.2 85.0 Policy acquisition 21.3 12.8 43.9 27.4 Underwriting and inspection 24.2 27.5 48.2 57.2 Engineering services 25.6 20.7 50.8 38.6 Interest 0.6 0.1 1.0 0.2 ----------------------------------------------------------- Total expenses 109.6 101.5 220.1 208.4 ----------------------------------------------------------- Gain on sale of IRI - - - 39.0 Income from continuing operations before income taxes and distributions on capital securities $ 38.7 $ 34.8 $ 75.1 $ 104.4 Income taxes (benefit): Current 11.1 1.7 19.3 29.3 Deferred 0.3 7.6 3.0 2.5 ----------------------------------------------------------- Total income taxes $ 11.4 $ 9.3 $ 22.3 $ 31.8 Distribution on capital securities of subsidiary trust, net of income tax benefits of $2.4; $2.5; $4.8; and $4.9. 4.5 4.7 9.0 9.2 ----------------------------------------------------------- Income from continuing operations $ 22.8 $ 20.8 $ 43.8 $ 63.4 Discontinued operations: Loss from operations, net of income tax benefits of $3.2 - - - (6.6) Gain on disposal, net of income taxes of $23.7 - - - 36.9 ----------------------------------------------------------- Total discontinued operations $ - $ - $ - $ 30.3 ----------------------------------------------------------- Net income $ 22.8 $ 20.8 $ 43.8 $ 93.7 ----------------------------------------------------------- Per share data: Net income per common share-basic: Income from continuing operations $ 0.79 $ 0.71 $ 1.51 $ 2.16 Discontinued operations - - - 1.04 Net income $ 0.79 $ 0.71 $ 1.51 $ 3.20 Net income per common share-assuming dilution: Income from continuing operations $ 0.76 $ 0.68 $ 1.46 $ 1.99 Discontinued operations - - - 0.86 Net income $ 0.76 $ 0.68 $ 1.46 $ 2.85 Dividends declared per share $ 0.42 $ 0.40 $ 0.84 $ 0.80 Average shares outstanding and common stock equivalents 34.8 35.4 34.6 35.3
See Notes to Consolidated Financial Statements. 3 HSB GROUP, INC. Consolidated Statements of Comprehensive Income Unaudited (in millions)
Quarter Ended Six Months Ended June 30 Ended June 30 1999 1998 1999 1998 ----------------------------------------------------- Net income $22.8 $20.8 $43.8 $93.7 Other comprehensive income, net of tax: Unrealized gains (losses) on securities: Unrealized holding gains (losses) arising during the period (net of taxes (benefits) of ($0.2); $4.2; ($4.4); and $14.9) (0.3) 7.8 (8.3) 27.3 Add: reclassification adjustments for gains included in net income (6.6) (4.7) (11.2) (6.8) ----------------------------------------------------- Total unrealized gains (losses) on securities (6.9) 3.1 (19.5) 20.5 Foreign currency translation adjustments 0.6 (0.9) 0.9 (0.7) ----------------------------------------------------- Other comprehensive income (6.3) 2.2 (18.6) 19.8 ===================================================== Comprehensive income $16.5 $23.0 $25.2 $113.5 =====================================================
See Notes to Consolidated Financial Statements. 4 HSB GROUP, INC. Consolidated Statements of Financial Position (in millions, except per share data) June 30, December 31, 1999 1998 (Unaudited) ---------- ------------ Assets: Cash and cash equivalents $ 47.5 $ 18.3 Short-term investments, at cost 49.4 62.3 Fixed maturities, at fair value (cost - $561.5; $568.5) 544.9 577.1 Equity securities, at fair value (cost - $333.9; $326.3) 441.6 437.1 ------- ------- Total cash and invested assets 1,083.4 1,094.8 Reinsurance assets 660.8 630.4 Insurance premiums receivable 121.7 146.7 Engineering services receivable 29.4 26.1 Fixed assets 56.3 54.9 Prepaid acquisition costs 50.6 46.6 Capital lease 14.2 14.6 Other assets 146.4 129.9 -------- -------- Total assets $2,162.8 $2,144.0 ======== ======== Liabilities: Unearned insurance premiums $ 426.8 $ 477.9 Claims and adjustment expenses 592.2 550.3 Short-term borrowings 55.0 21.0 Long-term borrowings 25.1 25.1 Capital lease 27.8 27.9 Deferred income taxes 35.2 42.7 Dividends and distributions on capital securities 23.2 23.2 Ceded reinsurance payable 61.1 64.1 Other liabilities 84.7 83.6 ------- ------- Total liabilities 1,331.1 1,315.8 ------- ------- Company obligated mandatorily redeemable preferred exchange capital securities of subsidiary Trust I holding solely junior subordinated deferrable interest debentures of the Company, net of unamortized discount of $1.1 in 1999 and 1998 108.9 108.9 Company obligated mandatorily redeemable convertible capital securities of subsidiary Trust II holding solely junior subordinated deferrable interest debentures of the Company 300.0 300.0 Shareholders' equity: Common stock (stated value; shares authorized 50.0; shares issued and outstanding 29.1; 28.9) 10.0 10.0 Additional paid-in capital 35.8 33.5 Accumulated other comprehensive income 48.2 66.8 Retained earnings 335.3 311.2 Benefit plans (6.5) (2.2) -------- -------- Total shareholders' equity 422.8 419.3 -------- -------- Total $2,162.8 $2,144.0 ======== ======== Common shareholders' equity per common share $ 14.52 $ 14.53 See Notes to Consolidated Financial Statements. 5 HSB GROUP, INC. Consolidated Statements of Cash Flows Unaudited (in millions)
Six Months Ended June 30, ---------------------------------- 1999 1998 -------------- ----------------- Operating Activities: Net income $ 43.8 $ 93.7 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 10.2 5.9 Deferred income taxes 3.0 2.5 Realized investment gains (17.3) (10.5) Distributions on capital securities 13.8 14.1 Gain from the disposition of Radian, net of income taxes - (30.3) Gain from the disposition of IRI, net of income taxes - (25.2) Change in balances, net of effects from purchases and sales of subsidiaries: Insurance premiums receivable 25.0 (26.8) Engineering services receivable (3.3) (10.2) Prepaid acquisition costs (4.0) 16.0 Reinsurance assets (30.4) (278.5) Unearned insurance premiums (51.1) 143.4 Claims and adjustment expenses 41.9 60.4 Ceded reinsurance payable (3.0) 94.7 Other (18.4) (39.7) -------- -------- Cash provided by operating activities 10.2 9.5 -------- -------- Investing Activities: Fixed asset additions, net (7.4) (7.6) Investments: Sale of short-term investments, net 12.9 71.6 Purchase of fixed maturities (86.6) (342.4) Proceeds from sale of fixed maturities 84.6 23.5 Redemption of fixed maturities 8.3 17.9 Purchase of equity securities (168.0) (209.5) Proceeds from disposition of Radian - 128.9 Proceeds from disposition of IRI - 49.1 Proceeds from sale of equity securities 180.3 109.0 Purchase of Solomon Associates, net of cash acquired - (2.1) --------- ------- Cash provided by (used in) investment activities 24.1 (161.6) --------- ------- Financing Activities: Increase (decrease) in short-term borrowings 31.4 (35.3) Dividends and distributions on capital securities (38.2) (27.9) Reacquisition of stock (2.2) (24.1) Exercise of stock options 3.9 8.4 ---------- ------- Cash used in financing activities (5.1) (78.9) ---------- ------- Net increase (decrease) in cash and cash equivalents 29.2 (231.0) Cash and cash equivalents at beginning of period 18.3 293.2 ---------- -------- Cash and cash equivalents at end of period $ 47.5 62.2 ========== ======== Interest paid $ 1.8 $ 1.1 ---------- -------- Federal income tax paid $ 12.2 $ 25.5 ---------- --------
See Notes to Consolidated Financial Statements. 6 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 1. General The interim consolidated financial statements in this report include adjustments based on management's best estimates and judgments, including estimates of future loss payments, which are necessary to present a fair statement of the results for the interim periods reported. These adjustments are of a normal, recurring nature. The financial statements are prepared on the basis of generally accepted accounting principles and should be read in conjunction with the financial statements and related notes in the 1998 Annual Report. Certain amounts for 1998 have been reclassified to conform with the 1999 presentation. 2. Discontinued Operations On January 2, 1998, The Hartford Steam Boiler Inspection and Insurance Company (HSBIIC) exercised its option to put its 40 percent share in Radian International LLC (Radian LLC) to The Dow Chemical Company (Dow), for approximately $129 million, net of expenses. Radian LLC was formed in January 1996 as a joint venture with Dow to provide environmental, engineering, information technology, remediation and strategic chemical management services to industries and governments world-wide. In connection with the formation of the new company, HSBIIC contributed substantially all of the assets and liabilities of its wholly-owned subsidiary, Radian Corporation at historical cost to Radian LLC. No gain was recognized on the transfer. The results of Radian LLC were classified as discontinued operations following ratification on July 28, 1997 by the HSB's Board of Directors of management's decision to exercise its put. The Company's share of Radian LLC's losses incurred subsequent to such decision of approximately $6.6 million after-tax was deferred and recognized at the time the gain was recognized in 1998. This transaction resulted in an after-tax gain of $36.9 million which was recorded in the first quarter of 1998. 3. Industrial Risk Insurers On January 6, 1998, HSBIIC sold its 23.5 percent share in Industrial Risk Insurers (IRI) to Employers Reinsurance Corporation (ERC), one of the world's largest reinsurance companies, in accordance with a previously announced purchase and sale agreement between ERC and IRI's twenty-three member insurers. The gain on the sale of IRI was $36.6 million pre-tax and $23.8 million after-tax, of which $39.0 million pre-tax and $25.2 million after-tax was recognized in the first quarter of 1998. In the fourth quarter of 1998, adjustments were made to the costs associated with the sale. IRI is a voluntary, unincorporated joint underwriting association, which provides property insurance for the class of business known as "highly protected risks" (HPR) -- larger manufacturing, processing, and industrial businesses which have invested in protection against loss through the use of sprinklers and other means. HSBIIC received gross proceeds of $49.1 million, prior to transaction costs, for its 23.5 percent share in IRI. Because the sale was structured in part as a reinsurance transaction, a portion of HSBIIC's gross proceeds was utilized to reinsure in-force policies with ERC. Contemporaneous with the close of the sale, IRI was reconstituted with ERC (with a 99.5 percent share) and HSBIIC (with a 0.5 percent share) as the sole members. The new association has been renamed HSB Industrial Risk Insurers. HSBIIC writes the business for HSB Industrial Risk Insurers using its insurance licenses and provides certain other management and technical services. In addition, through various quota share reinsurance agreements with ERC and HSB Industrial Risk Insurers, HSBIIC transferred its manufacturing book of business to HSB Industrial Risk Insurers and retains 85 percent of the equipment breakdown insurance and 15 percent of the property insurance of the combined insurance portfolio. The agreements are of indefinite duration, but ERC has an option to purchase HSB's interest in the business in the event of a 50 percent or more change in the control of HSB. 7 4. Recent Accounting Developments The Accounting Standards Executive Committee of the American Institute of Certified Public Accountants (AcSEC) recently issued three Statements of Position (SOP) which became effective for fiscal years beginning after December 15, 1998; SOP 97-3, "Accounting by Insurance and Other Enterprises for Insurance-Related Assessments", SOP 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use", and SOP 98-5, "Reporting on the Costs of Start-Up Activities". Because the Company's accounting policies were in compliance with the provisions of the SOP's, the implementation of the SOP's had no impact upon the results of operations, financial condition or cash flows. In June 1998, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standard (SFAS) No. 133, "Accounting for Derivative Instruments and Hedging Activities". This statement establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. It requires that all derivatives be recognized as either assets or liabilities in the statement of financial position and that such instruments be measured at fair value. In addition, all hedging relationships must be designated, reassessed and documented pursuant to the provisions of SFAS No. 133. In June, 1999 SFAS No. 137 was issued. This statement defers the effective date of SFAS No. 133 to fiscal quarters of fiscal years beginning after June 15, 2000. The Company anticipates that the adoption of the provisions of SFAS No. 133 will not have a material impact on results of operations, financial condition or cash flows. In October 1998, AcSEC issued SOP 98-7, "Deposit Accounting: Accounting for Insurance and Reinsurance Contracts That Do Not Transfer Insurance Risk." The SOP identifies several methods of deposit accounting and provides guidance on the application of each method. This SOP is effective for financial statements for fiscal years beginning after June 15, 1999. Currently the Company is not party to any contracts which do not comply with the risk transfer provisions of SFAS No. 113, "Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts," and, therefore, does not anticipate the adoption of SOP 98-7 will have a material impact on results of operations, financial condition or cash flows. 5. Legal Proceedings HSBIIC has been involved in three significant claim-related disputes concerning the extent to which certain explosion events were insured under boiler and machinery coverages of HSBIIC. Information regarding these disputes has been provided in previous 10-K and 10-Q reports. Current rulings in all three cases confirm HSBIIC's long-standing position that HSBIIC policies do not cover the explosion events that occurred in those cases. In one case the parties settled their dispute following Summary Judgment rulings of the Federal District Court for the State of Illinois; in a second case, a decision of an arbitration panel has been confirmed by the Superior Court of the State of Connecticut; and in a third case, the Federal Court of Appeals for the Seventh Circuit has remanded the matter for entry of a judgment in HSBIIC's favor. The Company is also involved in various other legal proceedings as defendant or co-defendant that have arisen in the normal course of its business. In the judgment of management, after consultation with counsel, it is improbable that any liabilities which may arise from or with respect to the disputes above or any other litigation will have material adverse impact on the results of operations or the financial position of the Company. 8 6. Earnings per share Computation of Earnings Per Share:
Quarter Ended Six Months Ended June 30, 1999 June 30, 1999 ------------- ---------------- Income Shares Per Income Shares Per ------ ------ Share ------ ------ Share ----- ----- Income from continuing operations $ 22.8 $ 43.8 Basic EPS: Income available to common shareholders $ 22.8 $ 43.8 Weighted Average Common Shares Outstanding 29.0 29.0 Income from continuing operations per common share - basic $ 0.79 $ 1.51 Effect of dilutive securities: After-tax interest on convertible capital securities $ 3.5 $ 6.8 Convertible capital securities 5.3 5.3 Stock options 0.5 0.3 Diluted EPS: Income from continuing operations available to common and assumed conversions $ 26.3 34.8 $ 50.6 34.6 Income from continuing operations per common share - assuming dilution $ 0.76 $ 1.46
9
Quarter Ended Six Months Ended June 30, 1998 June 30, 1998 ------------- ---------------- Income Shares Per Income Shares Per ------ ------ Share ------ ------ Share ----- ----- Income from continuing operations $ 20.8 $ 63.4 Basic EPS: Income available to common shareholders $ 20.8 $ 63.4 Weighted Average Common Shares Outstanding 29.3 29.3 Income from continuing operations per common share - basic $ 0.71 $ 2.16 Effect of dilutive securities: After-tax interest on convertible capital securities $ 3.4 $ 6.8 Convertible capital securities 5.3 5.3 Stock options 0.8 0.7 Diluted EPS: Income from continuing operations available to common and assumed conversions $ 24.2 35.4 $ 70.2 35.3 Income from continuing operations per common share - assuming dilution $ 0.68 $ 1.99
7. Segment Information In 1998, HSB implemented the provisions of SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information". This standard requires companies to report financial and descriptive information about reportable operating segments utilizing the management approach to defining operating segments. It includes disclosure requirements relating to products and services, geographic areas and major customers. The adoption of SFAS No. 131 did not affect consolidated results of operations or financial position but did affect the disclosure of segment information. HSB has four reportable segments--Commercial insurance, Global Special Risk insurance, Engineering services and Investments. HSB is a multi-national company operating primarily in North American, European, and Asian markets. Through its Commercial segment operations, HSB provides risk modification services, equipment breakdown insurance and loss recovery services to commercial businesses. The Global Special Risk operating segment focuses on the needs of equipment-intensive industries by offering all risk coverage with customized engineering consulting and risk management. HSB's Engineering services operations offers professional scientific and technical consulting for industry and government on a worldwide basis. The Company's investment assets are managed by its Investment operating segment. The accounting policies of the segments are consistent with generally accepted accounting principles except for certain benefit charges which comprise the Corporate Account. HSB evaluates the performance of its segments and allocates resources to them based on net income (loss). Segment assets are not included in this evaluation process. Interest income and expense are included in the results of Investment operations. 10 The following presents revenue and net income from the Company's reportable segments and reconciles these amounts to the corresponding consolidated totals:
Quarter Ended Six Months Ended June 30 June 30 --------------- ---------------- 1999 1998 1999 1998 ------------------------------------------------------------------------------------------------------- Revenues from continuing operations Insurance premiums: Commercial $ 82.2 $ 68.9 $ 162.5 $ 137.0 Global Special Risks 11.1 19.3 26.8 49.3 Engineering services 27.8 22.7 55.4 42.4 Net investment income and realized investment gains 26.8 23.2 49.6 41.6 ----------- ----------- ----------- --------- Total revenues from reportable segments 147.9 134.1 294.3 270.3 Other segments 0.4 2.2 0.9 3.5 ----------- ----------- ----------- ---------- Total revenues $ 148.3 $ 136.3 $ 295.2 $ 273.8 ========== =========== =========== ========== Net income (loss): Commercial $ 4.5 $ 2.6 $ 5.9 $ 3.9 Global Special Risks 2.7 3.0 7.9 7.2 Engineering services 1.2 1.1 2.5 2.1 Investment 18.6 16.9 34.6 30.3 ----------- ----------- ----------- ---------- Total net income from reportable segments 27.0 23.6 50.9 43.5 Other segments (1.5) 0.5 (1.5) 1.2 Corporate account 1.8 1.4 3.4 2.7 Distributions on capital securities (4.5) (4.7) (9.0) (9.2) Discontinued operations - - - 30.3 Gain on sale of IRI, net of income taxes - - - 25.2 ----------- ----------- ----------- ---------- Net income $ 22.8 $ 20.8 $ 43.8 $ 93.7 =========== =========== =========== ==========
8. Global Floating Rate Capital Securities On July 15, 1997, a trust sponsored and wholly owned by the Company issued $110,000,000 aggregate liquidation amount of capital securities in a private placement and 3,403 shares of common securities to the Company, the proceeds of which were invested by the trust in $113,403,000 aggregate principal amount of the Company's debt securities. On November 5, 1997, an exchange offer was commenced, pursuant to which the capital securities originally issued in the private placement were exchanged for capital securities that were registered with the Securities and Exchange Commission (the "Capital Securities" ) and the debt securities were exchanged for debt securities that were registered with the Securities and Exchange Commission (the "Debt Securities" ). The Debt Securities represent all of the assets of the trust. The proceeds from the issuance of the Debt Securities were used by the Company for general corporate purposes. The Debt Securities and related income statement effects are eliminated in the Company's consolidated financial statements. The $113.4 million principal amount of Debt Securities accrue and pay cash distributions quarterly in arrears at a variable rate of LIBOR plus .91% of the stated liquidation amount of $1,000 per Debt Security, and are scheduled to mature on July 15, 2027. The Capital Securities accrue and pay cash distributions quarterly in arrears at a variable rate of LIBOR plus .91% of the stated liquidation amount of $1,000 per Capital Security. The terms of the Debt Securities, the guarantee of the Company with respect to the Capital Securities, the Indenture and the Trust Agreement together provide a full guarantee by HSB Group, Inc. of amounts due on the Capital Securities. 11 The Capital Securities are mandatorily redeemable upon the maturity of the Debt Securities on July 15, 2027, or earlier to the extent of any redemption by the Company of any Debt Securities. The redemption price in either such case will be $1,000 per share plus accrued and unpaid distributions to the date fixed for redemption. 12 ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION AND RESULTS OF OPERATIONS JUNE 30,1999 RESULTS OF OPERATIONS - --------------------- (dollar amounts in millions) Consolidated Overview - ---------------------
Quarter Ended Six Months Ended June 30 June 30 ------- ------- 1999 1998 1999 1998 ---- ---- ---- ---- Revenues: Gross earned premiums $206.8 $175.7 $415.7 $355.4 Ceded premiums 113.1 85.3 225.5 165.6 -------- --------- -------- ------- Insurance premiums 93.7 90.4 190.2 189.8 Engineering services 27.8 22.7 55.4 42.4 Net investment income 16.6 15.9 32.3 31.1 Realized investment gains 10.2 7.3 17.3 10.5 -------- --------- --------- ------- Total revenues $148.3 $136.3 $295.2 $273.8 ========== ========= ========= ======= Pre-tax Income from Continuing Operations: Pre-tax income excluding sale of IRI $ 38.7 $ 34.8 $ 75.1 $ 65.4 Pre-tax gain on sale of IRI - - - 39.0 ---------- --------- --------- ------- Pre-tax income 38.7 34.8 75.1 104.4 Income taxes on continuing operations 11.4 9.3 22.3 31.8 Distributions on capital securities 4.5 4.7 9.0 9.2 ------------- ----------- --------- ------- Income from continuing operations 22.8 20.8 43.8 63.4 Discontinued operations - - - 30.3 ------------- ----------- -------- ------- Net income $ 22.8 $ 20.8 $ 43.8 $ 93.7 ============= =========== ======== ======= Net income per common share: Basic $ 0.79 $ 0.71 $ 1.51 $ 3.20 Assuming dilution $ 0.76 $ 0.68 $ 1.46 $ 2.85
13 Absent the sales of Industrial Risk Insurers (IRI) and Radian International LLC (Radian LLC) discussed below, the Company's 1999 after-tax earnings increased 9.6 percent from the second quarter of 1998 and increased 14.7 percent in the first six months of 1999 compared to 1998 due to higher realized gains, improved underwriting results and higher engineering gains. Net income for the first six months of 1998 included after-tax gains on the sale of HSB's interest in IRI of $25.2 million and Radian LLC of $30.3 million. The Radian LLC gain is net of after-tax operating losses of $6.6 million that were deferred in 1997 when the decision was made to exercise HSB's option to put the Company's interest to The Dow Chemical Company (Dow). As a result, HSB's interest in Radian LLC was classified as a discontinued operation in 1997. The effective tax rate on income from continuing operations, excluding the sale of IRI, for the second quarter and the year to date were 29 percent and 30 percent compared to 27 percent and 28 percent for the comparable prior periods. Typically tax rate fluctuations occur as underwriting and engineering services results and realized gains change the mix of pre-tax income between fully taxable earnings and tax preferred earnings that can be obtained by investing in certain instruments. The taxes associated with the sale of IRI contributed to the higher taxes in the six month period of 1998 compared to 1999. The Company continues to manage its use of tax advantageous investments to maximize after tax earnings. Recent Accounting Developments - ------------------------------ The Accounting Standards Executive Committee of the American Institute of Certified Public Accountants (AcSEC) recently issued three Statements of Position (SOP) which became effective for fiscal years beginning after December 15, 1998; SOP 97-3, "Accounting by Insurance and Other Enterprises for Insurance-Related Assessments", SOP 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use", and SOP 98-5, "Reporting on the Costs of Start-Up Activities". Because the Company's accounting policies were in compliance with the provisions of the SOP's, the implementation of the SOP's had no impact upon the results of operations, financial condition or cash flows. In June 1998, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standard (SFAS) No. 133, "Accounting for Derivative Instruments and Hedging Activities". This statement establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. It requires that all derivatives be recognized as either assets or liabilities in the statement of financial position and that such instruments be measured at fair value. In addition, all hedging relationships must be designated, reassessed and documented pursuant to the provisions of SFAS No. 133. In June 1999, SFAS No. 137 was issued. This statement defers the effective date of SFAS No. 133 to fiscal quarters of fiscal years beginning after June 15, 2000. The Company anticipates that the adoption of the provisions of SFAS No. 133 will not have a material impact on results of operations, financial condition or cash flows. 14 In October 1998, AcSEC issued SOP 98-7, "Deposit Accounting: Accounting for Insurance and Reinsurance Contracts That Do Not Transfer Insurance Risk." The SOP identifies several methods of deposit accounting and provides guidance on the application of each method. This SOP is effective for financial statements for fiscal years beginning after June 15, 1999. Currently the Company is not party to any contracts which do not comply with the risk transfer provisions of SFAS No. 113, "Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts," and, therefore, does not anticipate the adoption of SOP 98-7 will have a material impact on results of operations, financial condition or cash flows. Insurance Operations - -------------------- Insurance operations include the insurance results of The Hartford Steam Boiler Inspection and Insurance Company (HSBIIC), HSB Engineering Insurance Limited (EIL), The Boiler Inspection and Insurance Company of Canada (BI&I), The Allen Insurance Company, Ltd., HSB of Connecticut, HSB of Texas, and HSBIIC's participation in HSB Industrial Risk Insurers and various other pools.
Quarter Ended Six Months Ended June 30 June 30 ------- ------- 1999 1998 1999 1998 ---- ---- ---- ---- Gross earned premiums $206.8 $ 175.7 $415.7 $355.4 Ceded premiums 113.1 85.3 225.5 165.6 ----- ----- ----- ----- Insurance premiums 93.7 90.4 190.2 189.8 Claims and adjustment expenses 37.9 40.4 76.2 85.0 Underwriting, acquisition and other expenses 45.5 40.3 92.1 84.6 ---- ---- ---- ---- Underwriting gain $ 10.3 $ 9.7 $ 21.9 $ 20.2 ===== ===== ===== ===== Loss ratio 40.5% 44.7% 40.1% 44.8% Expense ratio 48.6% 44.6% 48.4% 44.5% ----- ------ ----- ----- Combined ratio 89.1% 89.3% 88.5% 89.3% ===== ====== ===== =====
Gross earned premiums in the second quarter and year to date increased 17.7 percent and 17.0 percent from the comparable periods in 1998. This was primarily attributable to an increase in premiums from HSB Industrial Risk Insurers of $13.7 million and $26.7 million, respectively, for the quarter and year to date reflecting the Company's role as 15 direct writer of that business. Other growth includes the impact of certain commercial books of business acquired in mid 1998. Gross earned premiums representing coverage outside the U.S. for non HSB Industrial Risk Insurers business decreased 5 percent in the first six months from the comparable period in 1998. In certain areas of the Company's direct domestic and international businesses, the market is experiencing price erosion as the number of insurers offering capacity has expanded. HSB will not write business at rates which would lessen our ability to maintain underwriting profit. As a result, premiums in the Global Special Risk areas may continue to experience revenue declines until pricing in these markets begins to improve. Increases in ceded premium of 32.6 percent in the current quarter and 36.2 percent year to date were the result of both the HSB Industrial Risk Insurers arrangement and related reinsurance with ERC, and the timing of instituting some of the Company's reinsurance programs which now utilize significantly more quota share reinsurance on certain of our books of business. We anticipate these new reinsurance contracts and the HSB Industrial Risk Insurers arrangement, along with growth in our commercial business, will likely continue to result in growth in gross earned premium but lower growth in net earned premium. The loss ratio decreased from 44.7 percent in the second quarter of 1998 to 40.5 percent in the current quarter. For the six months year to date, the loss ratio decreased from 44.8 percent in 1998 to 40.1 percent in 1999. First quarter 1998 results were impacted by severe ice storms in Canada. Gross claims and adjustment expenses for the first six months of 1999 and 1998 were $249.3 million and $220.7 million, respectively. This increase was primarily the result of large losses in our Global Special Risk business which were largely reinsured. The expense ratio increased from 44.6 percent in the second quarter of 1998 to 48.6 percent in the current quarter, and from 44.5 percent year to date in 1998 to 48.4 percent year to date in 1999. Prepaid acquisition costs have grown largely due to growth in gross premiums and different commission rates reflecting changes in the mix of business. The expense ratio was also affected by the increased level of reinsurance purchased and related ceding commissions. In addition, the expense ratio has been impacted more heavily in 1999 by Year 2000 systems remediation costs. 16 The following information summarizes net earned premiums and net income by reportable insurance segment: Quarter Ended Six Months Ended June 30 June 30 ------- ------- 1999 1998 1999 1998 ---- ---- ---- ---- Commercial: Net earned premiums $ 82.2 $ 68.9 $ 162.5 $ 137.0 Net income 4.5 2.6 5.9 3.9 Global Special Risks: Net earned premiums $ 11.1 $ 19.3 $ 26.8 $ 49.3 Net income 2.7 3.0 7.9 7.2 Net earned premiums in the Commercial segment rose $13.3 million in the second quarter and $25.5 million for the first six months of 1999 over the comparable periods in 1998 due to strong growth in client company billings and integration of the Kemper portfolio. 1998 results were impacted by severe ice storms in Canada during the first quarter. Profits in 1999 have been depressed by an adjustment to commission expense, expected higher systems costs related to Year 2000 and increased frequency of small claims. Global Special Risks net earned premiums declined $8.2 million and $22.5 million for the quarter and year to date, respectively, in 1999 from the comparable periods in 1998 due to price erosion and the maintenance of strict underwriting standards, coupled with changes in reinsurance programs. Year to date net income increased, however, due to favorable claims experience in comparison to 1998, particularly in international business. In addition, current period results are higher due to fees/expense reimbursement generated from managing the IRI business. The level of fees/expense reimbursement in the future will be dependent upon pricing in these markets and the volume of business which meets our underwriting standards. Engineering Services Operations - ------------------------------- Quarter Ended Six Months Ended June 30 June 30 ------- ---------------- 1999 1998 1999 1998 ----- ----- ------ ----- Engineering services revenues $27.8 $22.7 $55.4 $42.4 Engineering services expenses 25.6 20.7 50.8 38.6 ---- ---- ---- ---- Operating gain $ 2.2 $ 2.0 $ 4.6 $ 3.8 ==== ==== ==== ==== Net margin 8.2% 8.9% 8.3% 8.9% 17 Engineering services operations include the results of HSBIIC's, EIL's and BI&I's engineering services, HSB Reliability Technologies (HSBRT), HSB Professional Loss Control, HSB International, Solomon Associates, Inc. (SAI) and the Company's interest in Integrated Process Technologies, LLC. Engineering services revenues increased in 1999 by $5.1 million in the second quarter and $13.0 million year to date compared to the same periods in 1998. The growth in revenues was primarily due to SAI which was acquired in April 1998 and EIL's engineering services revenues generated through recent acquisitions. The decline in operating margin from the previous periods reflects operating costs incurred to develop new products and in new start up operations, delays in starting certain contracts and the closing of plants in the steel industry serviced by a higher margin business unit. The Company continues to focus on identifying and evaluating acquisition candidates in the niche engineering management consulting service business, primarily in process industries, in order to expand or complement its engineering service capabilities. Investment Operations - --------------------- Quarter Ended Six Months Ended June 30 June 30 ------- ------- 1999 1998 1999 1998 ---- ---- ---- ---- Net investment income $16.6 $15.9 $32.3 $31.1 Realized investment gains 10.2 7.3 17.3 10.5 ---- --- ---- ---- Pretax income from investment operations $26.8 $23.2 $49.6 $41.6 ===== ===== ===== ===== Income from investment operations for the second quarter and year to date increased $3.6 million and $8.0 million, respectively, primarily due to realized investment gains resulting from repositioning the investment portfolio due to market fluctuations. The Company's investment strategy continues to be to maximize total return on the investment portfolio through investment income and capital appreciation. Investment strategies for any given year are developed based on many factors including operational results, tax implications, regulatory requirements, interest rates, dividends to stockholders and market conditions. The investment portfolio includes a wide variety of high quality equity securities and both domestic and foreign fixed maturities. The Company continues to manage its use of tax advantageous investments to maximize after-tax investment earnings. The Company does not engage in cash flow underwriting; it seeks to have underwriting profit each year. Market Risk - ----------- The value of the Company's financial instruments reacts to changes in various macro variables. These changes are thought of as systemic risks or market risks and are quantified as equity market risk, interest rate risk and foreign currency risk. Equity 18 market risk is the chance that market influences will affect the expected returns on equity investments. Interest rate risk relates the effect that changes in the level of interest rates will have on the return on financial instruments, fixed income investments in particular. Foreign currency risk is the chance that fluctuations in foreign currency exchange rates will impact the value of financial instruments. Portfolio sensitivity to these variables tends to change over time due to changes in portfolio composition and changes in market environment. During the first half of 1999 the Company's equity instruments sensitivity to equity market risk, as measured by portfolio beta, decreased from 1.02 to 0.97. This change is generally attributed to portfolio repositioning during the period. For the fixed maturity portfolio, sensitivity, as measured by duration, increased from 5.48 to 7.85 during the first half of 1999. The increase in duration is due to the interest rate environment that occurred during the period. The Company uses a yield to worst call methodology to calculate duration. This assumes that an issuer, given the current rate environment, will call higher coupon debt if appropriate. Given that interest rates increased during the year, the call feature on many issues became non-applicable. This caused the portfolio to show an increase in duration and correspondingly an increase in sensitivity to interest rates. The following analysis illustrates the sensitivity of the market value of the financial instruments to selected changes in market rates and prices. The range reflects the Company's view of reasonably possible market movements over a one year period. The range of values selected should not be interpreted as the Company's prediction of future market events, but rather an illustration of the impact of such events. The computations do not contemplate any actions the Company would undertake in response to changes in interest rates. The sensitivity analysis assumes an instantaneous shift in market interest rates, with scenarios of interest rates increasing 100 and 150 basis points from their levels at June 30, 1999, and all other variables held constant. Currency risk assumes an instantaneous 10 percent and 20 percent change in the foreign currency exchange rates versus the US dollar from their levels at June 30, 1999 with all other variables held constant. Equity price risk is measured assuming an instantaneous 10 percent and 25 percent change in the S & P 500 Index from its level at June 30, 1999 with all other variables held constant. The Company's convertible capital securities have been issued at fixed rates, and as such interest expense would not be impacted by interest rate shifts. The impact of 100 and 150 basis point increases in interest rates on the convertible capital securities would be an estimated decrease in market value of $27.3 million and $39.4 million and is calculated without giving any effect to the relationship of the conversion price to the current market price of HSB Group, Inc. common stock. The following table reflects the estimated effects on the market value of the Company's financial instruments due to an increase in interest rates of 100 basis points, a 10 percent 19 decline in foreign currency exchange rates, and a decline of 10 percent in the S & P 500 Index. Held For Other Than Trading Purposes Market Interest Currency Equity At June 30, 1999 Value Rate Risk Risk Risk - -------------------------------------------------------------------------------- Fixed maturity securities $ 544.9 $(35.7) $(2.3) $ - Equity securities 441.6 (12.8) (1.8) (23.0) Short term investments 49.4 (0.6) (2.2) - ------------------------------------------------ Total all securities $1,035.9 $(49.1) $(6.3) $(23.0) ------------------------------------------------ The following table reflects the estimated effects on the market value of the Company's financial instruments due to an increase in interest rates of 150 basis points, a 20 percent decline in foreign currency exchange rates, and a decline of 25 percent in the S& P 500 Index. Held For Other Than Trading Purposes Market Interest Currency Equity At June 30, 1999 Value Rate Risk Risk Risk - -------------------------------------------------------------------------------- Fixed maturity securities $ 544.9 $(51.1) $ (4.5) $ - Equity securities 441.6 (18.2) (3.7) (57.5) Short term investments 49.4 (0.9) (4.1) - ------------------------------- ----------------------- Total all securities $1,035.9 $(70.2) $(12.3) $(57.5) ------------------------------- ----------------------- Statement of Comprehensive Income - --------------------------------- In addition to the impact of HSB's results of operations, the Consolidated Statements of Comprehensive Income displays the effects of price movements on HSB's invested assets. As a result of the market corrections and subsequent rebounds, cumulative holding gains, net of taxes, for the first six months of 1999 decreased $18.6 million as compared to the increase of $19.8 million in the same period in 1998. Exclusive of realized gains, the decrease in 1999 is mainly in fixed maturities due to rising interest rates. 20 Liquidity and Capital Resources - ------------------------------- Balances at June 30 December 31 1999 1998 -------- ------------- Total assets $ 2,162.8 $ 2,144.0 Short-term investments 49.4 62.3 Cash and cash equivalents 47.5 18.3 Short-term borrowings 55.0 21.0 Capital securities of subsidiary Trust I 108.9 108.9 Capital securities of subsidiary Trust II 300.0 300.0 Common shareholder's equity 422.8 419.3 Liquidity refers to the Company's ability to generate sufficient funds to meet the cash requirements of its business operations. HSB is a holding company whose principal subsidiary is HSBIIC. HSB relies on investment income, primarily in the form of dividends from HSBIIC, in order to meet its short and long-term liquidity requirements including the service requirements for its capital securities. The Company receives a regular inflow of cash from maturing investments, engineering services and insurance operations. The mix of the investment portfolio is managed to respond to expected claim pay-out patterns and the service requirements of the Company's capital securities. HSB also maintains a highly liquid short-term portfolio to provide for immediate cash needs and to offset a portion of interest rate risk relating to the Capital Securities of subsidiary Trust I. Cash provided from operations was $10.2 million in the first six months of 1999 compared to $9.5 million for the same period in 1998. Overall cash flows in 1998 were significantly impacted by the investment of proceeds from the convertible capital securities issued in late December 1997 and the sales of Radian and IRI in 1998. Capital resources consist of shareholders' equity, capital securities and debt outstanding, and represent those funds deployed or available to be deployed to support business operations. Common shareholders' equity of $422.8 million at June 30, 1999, increased by $3.5 million since December 31, 1998. The increase primarily reflects comprehensive income of $25.2 million and option exercises of $3.9 million, less dividends of $24.4 million and share repurchases of $2.2 million. At June 30, 1999, HSBIIC had significant short-term and long-term borrowing capacity. HSBIIC is currently authorized to issue up to $75 million of commercial paper. Commercial paper outstanding at June 30, 1999 was approximately $50 million. HSBIIC has been involved in three significant claim-related disputes concerning the extent to which certain explosion events were insured under boiler and machinery coverages of HSBIIC. Information regarding these disputes has been provided in previous 10-K and 10-Q reports. Current rulings in all three cases confirm HSBIIC's 21 long-standing position that HSBIIC policies do not cover the explosion events that occurred in those cases. In one case the parties settled their dispute following Summary Judgment rulings of the Federal District Court for the State of Illinois; in a second case, a decision of an arbitration panel has been confirmed by the Superior Court of the State of Connecticut; and in a third case, the Federal Court of Appeals for the Seventh Circuit has remanded the matter for entry of a judgment in HSBIIC's favor. The Company writes business in European markets primarily through its U.K. subsidiary, EIL. The adoption of a common currency (the euro) by eleven of the fifteen member countries of the European Union on January 1, 1999 is not expected to result in a substantial change in the business or a significant increase in costs in the short term. In part, this is due to the fact that much of the business is U.S. dollar denominated. The U.K. is not a first wave euro country and as such the impact is primarily limited to the small overseas offices located in Spain and the Irish Republic. Over time, if the U.K. adopts the euro as its currency, there may be more of an impact, however, the number of affected transactions are such that a manual backup system is practicable. The Company will continue to monitor developments and assess impacts on markets, pricing, and reporting. Year 2000 - --------- The following Year 2000 statements constitute a Year 2000 Readiness Disclosure within the meaning of the Year 2000 Information and Readiness Disclosure Act of 1998. Year 2000 Plan and State of Readiness - ------------------------------------- In 1996, the Company began a comprehensive effort to assess and address issues affecting the Company, which related to the inability of computer equipment and embedded computer chips to distinguish between the year 1900 and the year 2000. As has been well publicized, many computer systems and date controlled equipment may cease to function or may function in a different manner when the year 2000 arrives because they are programmed to recognize only the last two digits of the year. As a part of this effort, the Company established a Year 2000 Program to address four key areas: (i) applications software, primarily consisting of the Company's policy management, claims, financial recording and reporting, human resource systems, and engineering databases and systems; (ii) infrastructures, such as mainframe and corporate servers, workstations and networking components; (iii) embedded technology in facilities in which the Company conducts its operations and in testing equipment used by the Company's engineering staff; and (iv) key business partners and suppliers. In addition, the Company is evaluating potential coverage exposures arising out of the Year 2000 and its impact on insured equipment. The Company's Year 2000 Program consists of six partially overlapping stages for the key areas listed above: (i) assessment and analysis; (ii) development, renovation and replacement; (iii) implementation; (iv) testing and certification; (v) contingency planning; and (vi) audit and review. The Company is using members of its internal information technology staff as well as external consultants and 22 programmers to complete various tasks in connection with its Year 2000 Program and is currently on schedule. The Company has completed the assessment and analysis phase for its policy management, claims, financial recording and reporting, human resource systems and engineering databases and systems. The development, renovation, replacement and implementation phases are largely complete for these systems. We have substantially completed Year 2000 testing for our current policy management, financial application and engineering systems. We will continue to Year 2000 test our claims, human resource systems and other supporting applications throughout the third quarter of 1999. The Company has completed the assessment and analysis phase with respect to infrastructure items. The mainframe is Year 2000 compliant and the Company expects to complete the migration to Year 2000 compliant servers and supporting hardware and software by September 1999. Replacement of the various components of non-compliant workstations and peripheral equipment also is expected to be completed by September 1999. Many of the third-party software applications utilized by the Company in its desktop environment are already Year 2000 compliant. The Company expects to complete the installation of such compliant programs on virtually all of its workstations by September 1999. In the area of embedded chip technology, the Company's principal exposure relates to the prevalence of such technology in office buildings in which the Company leases space for conducting its business operations. The Company has sent questionnaires to the leasing vendors for all of its principal facilities with respect to Year 2000 readiness and has received assurances of readiness from most of its vendors. The Company has identified and is currently in the process of contacting key suppliers of services and business partners, such as client companies, agents and brokers, with whom the Company has significant business relations and who may either electronically provide to, or receive from, the Company certain financial and other information. As the Company receives responses from its suppliers and business partners, it will update its assessment of the potential impact on the Company of such parties' Year 2000 state of readiness and remediation plans and conduct renovations and/or replacement and compliance testing, as appropriate. The Company is relying upon Year 2000 readiness statements of other entities and has not independently verified the accuracy of such statements. Costs - ----- It is currently estimated that the Company's aggregate spending in connection with the Year 2000 Program will be in the range of $27 million of which approximately $24.6 million has been expended through June 30, 1999. Certain of these costs are being expensed as they are incurred and are being funded through operating cash flow. The 23 Company has expensed $5.1 million, $1.5 million and $0.2 million in 1998, 1997 and 1996, respectively, and $4.2 million for the first six months of 1999. It is estimated that expenditures of $2.4 million for the remainder of 1999 will be expensed as incurred. The remainder of the $27 million estimate which has not been expensed relates to systems that the Company anticipated replacing in the normal course of information technology development but the timetable for which was accelerated in contemplation of the Year 2000 event. Costs of replacement and renovation of information systems and infrastructure that would have occurred in the normal course of business without the advent of the Year 2000 event are excluded from these amounts. The current estimate also does not include any costs associated with the implementation of contingency plans that are in the process of being developed. The Company does not expect the costs relating to its Year 2000 Program to have a material effect on its results of operations, liquidity or financial condition. However, the Year 2000 Program is an ongoing process and the estimated costs, as well as the estimated completion dates for various phases of the program, are subject to change. Risks - ----- The failure of one or more critical software applications or components of the Company's infrastructure to be Year 2000 compliant could cause a material disruption in the normal business operations of the Company. Such disruptions could include the inability to process policies, register and collect premiums and engineering receivables, process claims or schedule inspections and engineering services. Due to the difficulty in estimating the scope and duration of such failures, the Company is unable to determine at this time whether the consequences of such failures will have a material impact on the Company's results of operations, liquidity, or financial condition. Moreover, the Company's operations are interdependent with systems of business partners and service providers, such as financial institutions, communication service providers and utilities, over which the Company has no control. The failure of one or more of such business partners or service providers to be Year 2000 compliant could have a material adverse impact on the Company. However, the Company believes that with the implementation of its Year 2000 Program as scheduled, including the contingency plans discussed below, the risk of material disruptions to its normal business operations should be significantly reduced. As an insurance company, the Company maintains a significant portfolio of investments in cash, short-term fixed income, and equity securities. Inasmuch as the advent of the Year 2000 may cause events, business interruptions and altered economic facts and circumstances, the value of the Company's investments may be affected favorably or unfavorably. The Company is selectively monitoring the Year 2000 compliant status of the corporate issuers of the securities in its investment portfolio primarily through reviewing public disclosure documents. State government and municipal bonds held by the Company are general obligations and/or are credit-enhanced and therefore the Company does not perceive there to be a significant credit risk with these securities in the absence of a severe Year 2000 disruption affecting governments and businesses generally. A portion of the Company's portfolio is invested in non-public issues where 24 public disclosure documents are unavailable. Due to the difficulty in estimating the scope and duration of such events, the Company is unable to determine at this time whether the consequences of such developments will have a material impact on the Company's investment portfolio and therefore, on the Company's results of operations, liquidity or financial condition. Contingency Plans - ----------------- As a component of the Year 2000 Program, the Company is concurrently developing contingency plans intended to mitigate the possible disruption of business operations arising out of the Year 2000 event. These plans will be continuously refined during 1999 as the Company completes compliance testing on its internal applications software and infrastructure and further assesses the Year 2000 readiness status of its business partners. Contingency plans may include securing back-up power for the Company's data center, manual processing, short-term fixes to non-compliant programs or business partner interfaces and modifying the Company's asset selection criteria for its investment activities. Insurance Coverage Issues - ------------------------- The Company continues to evaluate the potential coverage exposures arising out of the Year 2000 event and its impact on insured equipment. The Company has prepared an endorsement to its equipment breakdown and all-risk forms which reiterates that coverage is not provided for the inherent inability of computers and computerized equipment to properly recognize a particular date or time, such as the year 2000. It is Company policy to include the endorsement on new and renewal equipment breakdown and all-risk policies. In addition, a notice reiterating the Company's coverage intent with respect to Year 2000 exposures has been sent to all new and renewal equipment breakdown policyholders. Most of the insurers that the Company reinsures for equipment breakdown coverage are issuing similar endorsements to their policies. The Company is conducting an on-going communications program with its client company insurers and agents to disseminate to the ultimate policyholders its Year 2000 loss control suggestions and policy coverage position. Quantification of the Company's exposure to Year 2000 losses and loss adjustment expenses are not reasonably estimable at this time as applicable policy and reinsurance contract wordings have not been legally tested in the context of such losses. Forward-Looking Statements - -------------------------- Certain statements contained in this report are forward-looking and are based on management's current expectations. Actual results may differ materially from such expectations depending on the outcome of certain factors described with such forward-looking statements and other factors including: significant natural disasters and severe weather conditions; changes in interest rates and the performance of the financial markets; changes in the availability, cost and collectibility of reinsurance; changes in domestic and foreign laws, regulations and taxes; the entry of new or stronger 25 competitors and the intensification of pricing competition; the loss of current customers or the inability to obtain new customers; changes in the coverage terms selected by insurance customers, including higher deductibles and lower limits; the adequacy of loss reserves; changes in asset valuations; consolidation and restructuring in the insurance industry; changes in the Company's participation in joint underwriting associations, and in particular its arrangement with HSB Industrial Risk Insurers; changes in the demand and customer base for engineering and inspection services offered by the Company, whether resulting from changes in the law or otherwise, and other general market conditions. PART II - OTHER INFORMATION Item 1 - Legal Proceedings See Note 5 to Consolidated Financial Statements, Part I, Item 1. Item 4 - Submission of Matters to a Vote of Security Holders (a) The Annual Meeting of Shareholders was held on April 20, 1999. (b) Four directors were nominated for election at the Annual Meeting. Proxies for such meeting were solicited by Registrant's management pursuant to Regulation 14A under the Securities Exchange Act of 1934; there was no solicitation in opposition to management's nominees as listed in the proxy statement; and all of such nominees were elected for a three-year term. (c) The following matters were voted upon at the Annual Meeting with the voting results indicated. 1. Election of directors Nominee Votes for Votes Withheld Joel B. Alvord 24,872,065 528,203 Richard G. Dooley 25,109,084 291,184 Gordon W. Kreh 25,153,132 247,136 Lois D. Rice 25,091,709 308,559 2. Proposal to amend and restate the 1995 Stock Option Plan Votes for Against Abstain 22,719,558 2,422,700 258,010 26 3. Appointment of PricewaterhouseCoopers L.L.P. as Independent Public Accountants Votes for Against Abstain 25,105,358 97,076 197,835 Item 6 - Exhibits and Reports on Form 8-K (a) Exhibits Exhibit 27 - Financial Data Schedule (b) Reports on Form 8-K Form 8-K dated April 20, 1999 reporting on the first quarter results, the declaration of a dividend and the Company's Annual Meeting. (See Consolidated Statements of Operations for corrected 1999 year-to-date Net Income per share - assuming dilution.) 27 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. HSB GROUP, INC. Date: August 16, 1999 By: /s/ Saul L. Basch Saul L. Basch Senior Vice President, Treasurer and Chief Financial Officer Date: August 16, 1999 By: /s/ Robert C. Walker Robert C. Walker Senior Vice President and General Counsel 28 EX-27 2 FINANCIAL DATA SCHEDULE
7 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE FINANCIAL STATEMENTS FILED HEREWITH AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000,000 6-MOS DEC-31-1999 JUN-30-1999 534 0 0 442 11 0 987 97 661 51 2163 592 427 0 0 80 409 0 10 412 2163 190 32 17 55 76 44 100 66 22 44 0 0 0 44 1.51 1.46 550 0 0 0 0 592 0 Cash includes short-term investments. Company obligated mandatorily redeemable capital securities and convertible capital securities classified at mezzanine level on Consolidated Statements of Financial Position. Includes engineering services, underwriting and inspection and interest expense. Per SFAS No. 128 "Earnings per Share", this item represents EPS-Basic. Per SFAS No. 128 "Earnings per Share", this item represents EPS-Assuming Dilution. Not calculated at interim periods.
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