-----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, Rr7OhquL06iLken0dUlgHKgJdFF25Y99HVq6CiSFkTvMo+ZjrVrvCwPtyqv0gKyn VFA8QyaN1bNhTLXg2LYRXg== 0000912057-00-015148.txt : 20000331 0000912057-00-015148.hdr.sgml : 20000331 ACCESSION NUMBER: 0000912057-00-015148 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 12 CONFORMED PERIOD OF REPORT: 19991231 FILED AS OF DATE: 20000330 FILER: COMPANY DATA: COMPANY CONFORMED NAME: HCC INSURANCE HOLDINGS INC/DE/ CENTRAL INDEX KEY: 0000888919 STANDARD INDUSTRIAL CLASSIFICATION: FIRE, MARINE & CASUALTY INSURANCE [6331] IRS NUMBER: 760336636 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 001-13790 FILM NUMBER: 588461 BUSINESS ADDRESS: STREET 1: 13403 NORTHWEST FRWY CITY: HOUSTON STATE: TX ZIP: 77040-6094 BUSINESS PHONE: 7136907300 10-K 1 FORM 10-K 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____________________________________ HCC Insurance Holdings, Inc. - ----------------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) Delaware 76-0336636 - ----------------------------------------------------------------------------------------- (State or other jurisdiction of (IRS Employer incorporation or organization) Identification No.) 13403 Northwest Freeway, Houston, Texas 77040-6094 - ----------------------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) (713) 690-7300 - ----------------------------------------------------------------------------------------- (Registrant's telephone number, including area code)
Securities registered pursuant to Section 12 (b) of the Act: TITLE OF EACH CLASS NAME OF EACH EXCHANGE OF WHICH REGISTERED: COMMON STOCK, $1.00 PAR VALUE New York Stock Exchange
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. TABLE OF CONTENTS HCC INSURANCE HOLDINGS, INC.
PAGE -------- 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
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. 2 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 3 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 4 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 5 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):
1999 1998 1997 ------------------- ------------------- ------------------- 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 -------- --- -------- --- -------- --- Total GWP................................... $568,331 100% $498,276 100% $346,399 100% ======== === ======== === ======== ===
6 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):
1999 1998 1997 ------------------- ------------------- ------------------- 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 -------- --- -------- --- -------- --- Total NWP................................... $139,924 100% $121,883 100% $142,853 100% ======== === ======== === ======== ===
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. 7 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 8 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 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):
1999 1998 1997 ------------------- ------------------- ------------------- 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% ======== === ======== === ======== ===
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 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 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 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.
LETTERS OF CREDIT, A.M. BEST TOTAL CASH DEPOSITS AND REINSURER RATING LOCATION RECOVERABLES OTHER PAYABLES NET - --------- ------------ --------------- ------------ ------------------ ------------ 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
- ------------------------------ * 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 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:
FOR THE YEARS ENDED DECEMBER 31, (DOLLARS IN THOUSANDS) ---------------------------------------------------- 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
- ------------------------ * 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 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:
1999 1998 1997 1996 1995 -------- -------- -------- -------- -------- 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
- ------------------------ (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 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:
1999 1998 1997 1996 1995 1994 1993 1992 -------- -------- -------- -------- -------- -------- -------- --------- 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)
16 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 The following loss development triangle shows development in loss reserves on a net basis:
1999 1998 1997 1996 1995 1994 1993 1992 -------- -------- -------- -------- -------- -------- -------- -------- 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 1991 1990 1989 -------- -------- -------- 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
18 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):
1999 1998 1997 -------- -------- -------- 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 ======== ======== ========
- ------------------------ (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):
1999 1998 1997 -------- -------- -------- 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 ======== ======== ========
- ------------------------ (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 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 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:
1999 1998 1997 -------- -------- -------- 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%
- ------------------------ (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:
AMOUNT PERCENT OF TOTAL -------- ---------------- 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% ======== ===
The table set forth below indicates the expected maturity distribution of the Company's fixed income securities as of December 31, 1999:
AMOUNT PERCENT OF TOTAL -------- ---------------- 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% ======== ===
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 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 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 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 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 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:
SQUARE SUBSIDIARY LOCATION FOOTAGE LEASE TERMINATION DATE - ---------- ------------------------ --------- ---------------------- 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
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 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:
1999 1998 ----------------------------- ----------------------------- HIGH LOW HIGH LOW ------------- ------------- ------------- ------------- 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
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 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.
FOR THE YEARS ENDED DECEMBER 31, (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)(3) ---------------------------------------------------- 1999 1998 1997 1996 1995 -------- -------- -------- -------- -------- 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 ======== ======== ======== ========
28
DECEMBER 31, (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)(3) ---------------------------------------------------------- 1999 1998 1997 1996 1995 ---------- ---------- ---------- -------- -------- 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
- ------------------------ (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 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 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):
1999 1998 1997 --------- --------- --------- 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 ========= ========= =========
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:
1999 1998 1997 -------- -------- -------- 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% ===== ===== =====
- ------------------------ * Includes restructuring expense, provision for reinsurance and merger expense. 31 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 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 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 lease costs of office space made redundant by the plan. The following table provides a detailed analysis of the accruals:
ACCRUED AT ACCRUED AT PURCHASE DECEMBER 31, DATE PAID IN 1999 1999 ---------- ------------ ------------ 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 ========== ======== ==========
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:
PAID IN ACCRUED EXPENSED 1999 AT 12/31/99 IN 1999 -------- ----------- ---------- 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 ==========
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 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 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 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 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 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 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. [THE REMAINDER OF THIS PAGE LEFT INTENTIONALLY BLANK] 41 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 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:
1999 1998 ----------------------------- ----------------------------- HYPOTHETICAL 10% HYPOTHETICAL 10% US DOLLAR CHANGE IN US DOLLAR CHANGE IN EQUIVALENT FAIR VALUE EQUIVALENT FAIR VALUE ---------- ---------------- ---------- ---------------- 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
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 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. [THE REMAINDER OF THIS PAGE LEFT INTENTIONALLY BLANK] 44 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. [THE REMAINDER OF THIS PAGE LEFT INTENTIONALLY BLANK] 45 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. HCC INSURANCE HOLDINGS, INC. (Registrant) By: /s/ STEPHEN L. WAY ------------------------------------------ (Stephen L. Way) CHAIRMAN OF THE BOARD Dated: March 30, 2000 AND CHIEF EXECUTIVE OFFICER
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
NAME TITLE DATE ---- ----- ---- 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)
46 /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
*By: /s/ JOHN N. MOLBECK, JR. -------------------------------------- John N. Molbeck, Jr., March 30, 2000 ATTORNEY-IN-FACT
47 INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES 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
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 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.)
EXHIBIT NUMBER - ------- (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.
49
EXHIBIT NUMBER - ------- (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
- ------------------------ (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 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 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
DECEMBER 31, ------------------------------- 1999 1998 -------------- -------------- 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 ============== ==============
See Notes to Consolidated Financial Statements. F-2 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF EARNINGS
FOR THE YEARS ENDED DECEMBER 31, ------------------------------------------ 1999 1998 1997 ------------ ------------ ------------ 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 ============ ============ ============
See Notes to Consolidated Financial Statements F-3 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
FOR THE YEARS ENDED DECEMBER 31, ---------------------------------------- 1999 1998 1997 ------------ ----------- ----------- 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 ============ =========== ===========
See Notes to Consolidated Financial Statements. F-4 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
ACCUMULATED ADDITIONAL OTHER TOTAL COMMON PAID-IN RETAINED COMPREHENSIVE TREASURY SHAREHOLDERS' STOCK CAPITAL EARNINGS INCOME (LOSS) STOCK EQUITY ----------- ------------ ------------ ------------- ------------ ------------- 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 =========== ============ ============ ========== ============ ============
See Notes to Consolidated Financial Statements. F-5 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997 (CONTINUED)
ACCUMULATED ADDITIONAL OTHER TOTAL COMMON PAID-IN RETAINED COMPREHENSIVE SHAREHOLDERS' STOCK CAPITAL EARNINGS INCOME (LOSS) EQUITY ----------- ------------ ------------ ------------- ------------- 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 =========== ============ ============ ========== ============
See Notes to Consolidated Financial Statements. F-6 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997 (CONTINUED)
ACCUMULATED ADDITIONAL OTHER TOTAL COMMON PAID-IN RETAINED COMPREHENSIVE SHAREHOLDERS' STOCK CAPITAL EARNINGS INCOME (LOSS) EQUITY ----------- ------------ ------------ ------------- ------------- 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 =========== ============ ============ ============ ============
See Notes to Consolidated Financial Statements. F-7 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, -------------------------------------------- 1999 1998 1997 ------------- ------------- ------------ 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 ============= ============= ============
See Notes to Consolidated Financial Statements F-8 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 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 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 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 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 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.
CONSIDERATION ----------------------- SHARES OF GOODWILL COMPANY'S AMORTIZATION EFFECTIVE COMMON GOODWILL PERIOD DATE STOCK CASH RECOGNIZED IN YEARS --------- --------- ----------- ------------ ------------ 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
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 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.
FOR THE YEAR ENDED DECEMBER 31, --------------------------------- 1999 1998 --------------- --------------- 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
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:
ACCRUED AT PURCHASE PAID IN ACCRUED AT DATE 1999 12/31/99 ---------- -------- ---------- 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 ========== ======== ==========
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 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:
COST OR GROSS GROSS ESTIMATED AMORTIZED UNREALIZED UNREALIZED MARKET COST GAIN LOSS VALUE ------------- ----------- ----------- ------------ 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 ============= =========== =========== ============
F-16 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.
ESTIMATED AMORTIZED MARKET COST VALUE ------------ ------------ 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 ============ ============
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:
1999 1998 1997 ----------- ----------- ----------- 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 =========== =========== ===========
F-17 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:
GAIN LOSS NET ---------- ----------- ----------- 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) ========== =========== ===========
Unrealized pre-tax net investment gains (losses) on investments for three years ended December 31, 1999 is as follows:
1999 1998 1997 ------------ ----------- ----------- 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 ============ =========== ===========
(4) PROPERTY AND EQUIPMENT The following table summarizes property and equipment at December 31, 1999 and 1998:
ESTIMATED 1999 1998 USEFUL LIFE ------------ ------------ -------------- 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 ============ ============
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 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.
1999 1998 ------------ ------------ Acquisition notes........................................... $ 7,546,000 $ 16,600,000 Facility.................................................... 235,000,000 105,000,000 ------------ ------------ Total notes payable..................................... $242,546,000 $121,600,000 ============ ============
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 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:
1999 1998 1997 ----------- ----------- ----------- 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 =========== =========== ===========
F-20 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:
1999 1998 ------------ ----------- 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 ============ ===========
Changes in the valuation allowance account applicable to the net deferred tax asset for the three years ended December 31, 1999 are as follows:
1999 1998 1997 ----------- -------- --------- 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 =========== ======== =========
F-21 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:
1999 1998 1997 ----------- ----------- ----------- 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% =========== =========== ===========
(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 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.
INSURANCE UNDERWRITING OTHER COMPANY AGENCY INTERMEDIARY OPERATIONS CORPORATE TOTAL ------------ ------------ ------------ ----------- ----------- ------------ 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 ============
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 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (7) SEGMENT AND GEOGRAPHIC DATA (CONTINUED)
INSURANCE UNDERWRITING OTHER COMPANY AGENCY INTERMEDIARY OPERATIONS CORPORATE TOTAL ------------ ------------ ------------ ----------- ----------- ------------ 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
The corporate net loss in 1997 included an after-tax charge of $7.2 million with respect to merger expenses. F-24 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:
INSURANCE UNDERWRITING OTHER COMPANY AGENCY INTERMEDIARY OPERATIONS CORPORATE TOTAL -------------- ------------ ------------ ----------- ----------- -------------- 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 ============== ============ ============ =========== =========== ==============
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 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:
LOSS AND LOSS WRITTEN EARNED ADJUSTMENT PREMIUM PREMIUM EXPENSE ------------- ------------- ------------- 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 ============= ============= =============
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:
1999 1998 ------------ ------------ 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 ============ ============
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 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:
1999 1998 ------------ ------------ 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 ============ ============
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.
LETTERS OF CREDIT, A.M. BEST TOTAL CASH DEPOSITS AND REINSURER RATING LOCATION RECOVERABLES OTHER PAYABLES NET - --------- --------- --------------- ------------ ------------------ ------------ 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
* 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 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 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:
FOR THE YEARS ENDED DECEMBER 31, AMOUNT DUE - -------------------------------- ----------- 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 ===========
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 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:
1999 1998 ----------- ----------- 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
Transactions with these business entities and other related parties included in the accompanying consolidated statements of earnings are as follows:
1999 1998 1997 ----------- ----------- ----------- 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
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 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:
UNREALIZED ACCUMULATED OTHER FOREIGN CURRENCY INVESTMENT COMPREHENSIVE TRANSLATION GAIN (LOSS) INCOME (LOSS) ---------------- ----------- ----------------- 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) ========= =========== ===========
F-31 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:
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 ---------- -------- -------- --------- -------- -------- --------- -------- -------- 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 ========== ====== ========= ====== ========= ======
F-32 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:
OPTIONS OPTIONS OUTSTANDING EXERCISABLE --------------------------------------- -------------------- AVERAGE AVERAGE AVERAGE NUMBER OF REMAINING EXERCISE NUMBER OF EXERCISE RANGE OF EXERCISE PRICES SHARES CONTRACTUAL LIFE PRICE SHARES PRICE - ------------------------ --------- ---------------- -------- --------- -------- 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 ========= ========== ====== ========= ======
(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:
1999 1998 1997 ----------- ----------- ----------- 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 =========== =========== ===========
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 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:
1999 1998 1997 ------------ ------------ ------------ 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
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:
1999 1998 1997 ----------- ----------- ----------- 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
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 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:
PAID ACCRUED EXPENSED IN 1999 AT 12/31/99 IN 1999 -------- ----------- ---------- 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 ==========
F-35 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:
1999 1998 1997 ------------ ------------ ------------ 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 ============ ============ ============
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 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (18) QUARTERLY FINANCIAL DATA (UNAUDITED; AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
FOURTH QUARTER THIRD QUARTER SECOND QUARTER FIRST QUARTER ------------------- ------------------- ------------------- ------------------- 1999 1998 1999 1998 1999 1998 1999 1998 -------- -------- -------- -------- -------- -------- -------- -------- 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 ======= ======= ======= ======= ======= ======= ======= =======
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 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 SCHEDULE 1 HCC INSURANCE HOLDINGS, INC. SUMMARY OF INVESTMENTS OTHER THAN INVESTMENTS IN RELATED PARTIES DECEMBER 31, 1999
COLUMN A COLUMN B COLUMN C COLUMN D - --------------------------------------------------- ------------ ------------ ------------ AMOUNT AT WHICH SHOWN IN THE BALANCE TYPE OF INVESTMENT COST VALUE SHEET - --------------------------------------------------- ------------ ------------ ------------ 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 ============ ============
S-2 SCHEDULE 2 HCC INSURANCE HOLDINGS, INC. CONDENSED FINANCIAL INFORMATION OF REGISTRANT BALANCE SHEETS
DECEMBER 31, --------------------------- 1999 1998 ------------ ------------ 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 ============ ============
See Note to Condensed Financial Information. S-3 SCHEDULE 2 HCC INSURANCE HOLDINGS, INC. CONDENSED FINANCIAL INFORMATION OF REGISTRANT STATEMENTS OF EARNINGS
FOR THE YEARS ENDED DECEMBER 31, --------------------------------------- 1999 1998 1997 ----------- ----------- ----------- 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 =========== =========== ===========
See Notes to Condensed Financial Information. S-4 SCHEDULE 2 HCC INSURANCE HOLDINGS, INC. CONDENSED FINANCIAL INFORMATION OF REGISTRANT STATEMENTS OF COMPREHENSIVE INCOME
FOR THE YEARS ENDED DECEMBER 31, ---------------------------------------- 1999 1998 1997 ------------ ----------- ----------- 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 ============ =========== ===========
See Notes to Condensed Financial Information. S-5 SCHEDULE 2 HCC INSURANCE HOLDINGS, INC. CONDENSED FINANCIAL INFORMATION OF REGISTRANT STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, ------------------------------------------- 1999 1998 1997 ------------- ------------ ------------ 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 ============= ============ ============
See Notes to Condensed Financial Information. S-6 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 SCHEDULE 3 HCC INSURANCE HOLDINGS, INC. SUPPLEMENTARY INSURANCE INFORMATION (DOLLARS IN THOUSANDS)
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 -------------------------- --------------- -------------- ----------- ----------- -------------- -------------- 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 ======== ======== ======== ======== ======= ======== COLUMN I COLUMN J COLUMN K ------------ --------------- ---------- (2) FOR THE YEARS ENDED DECEMBER 31, ------------------------------------------- AMORTIZATION OF DEFERRED POLICY ACQUISITION OTHER OPERATING PREMIUM COSTS EXPENSES WRITTEN ------------ --------------- ---------- 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 ======= ======== ========
- ------------------------ (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 SCHEDULE 4 HCC INSURANCE HOLDINGS, INC. REINSURANCE
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 ------------- -------------- ------------ ------------ -------------- 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% ============ ============ ============ ============ =======
- ------------------------ (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 SCHEDULE 5 HCC INSURANCE HOLDINGS, INC. CONDENSED FINANCIAL INFORMATION OF REGISTRANT VALUATION AND QUALIFYING ACCOUNTS
1999 1998 1997 ----------- ---------- ---------- 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 =========== ========== ==========
S-10 EX-10.7 2 EXHIBIT 10.7 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 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. 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. (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. (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 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. 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 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. (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. EX-10.8 3 EXHIBIT 10.8 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 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. 2 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 3 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 4 (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. 5 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. 6 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 7 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- 8 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 9 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 10 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. 11 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. 12 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. 13 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 14 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. 15 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 16 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; 17 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 18 100,000 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. 19 EX-10.9 4 EXHIBIT 10.9 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 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 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. 3 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. 4 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. 5 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 6 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); 7 (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. 8 (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 9 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. 10 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. 11 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 12 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. 13 (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 14 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. 15 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 16 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 17 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. 18 EX-10.10 5 EXHIBIT 10.10 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 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. -2- 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. -3- (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: -4- (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 -5- (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. -6- (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. -7- (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. -8- EX-10.13 6 EXHIBIT 10.13 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 Page 1 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 Page 2 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. Page 3 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 Page 4 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. Page 5 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. Page 6 (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 Page 7 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; Page 8 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 Page 9 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 Page 10 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 Page 11 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. Page 12 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. Page 13 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 Page 14 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 ----------------- --------------------- Page 15 EX-10.15 7 EXHIBIT 10.15 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 Page 1 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 Page 2 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 Page 3 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 Page 4 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 Page 5 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 Page 6 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 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 (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 (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 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 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 EX-12 8 EXHIBIT 12 EXHIBIT 12 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES STATEMENT OF RATIOS ================================================================================
FOR THE YEARS ENDED DECEMBER 31, (DOLLARS IN THOUSANDS) ADJUSTED 1999(2) 1999 1998 1997 1996 1995 - ---------------------------------------------------------------------------------------------------------------------------------- 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)
(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. EX-21 9 EXHIBIT 21 EXHIBIT 21 HCC INSURANCE HOLDINGS, INC. SUBSIDIARIES
STATE OR COUNTRY NAME OF INCORPORATION ---- ---------------- 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 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
EX-23 10 EXHIBIT 23 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 EX-24 11 EXHIBIT 24 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 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 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 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 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 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 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 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 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 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 EX-27 12 EXHIBIT 27
7 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. YEAR DEC-31-1999 JAN-01-1999 DEC-31-1999 342,641,000 0 0 19,970,000 0 0 581,322,000 26,533,000 779,035,000 658,000 2,650,623,000 966,864,000 188,524,000 0 0 242,546,000 0 0 48,839,000 408,589,000 2,650,623,000 141,362,000 30,933,000 (4,164,000) 173,740,000 109,650,000 8,177,000 173,686,000 37,394,000 12,271,000 25,123,000 0 0 0 25,123,000 0.51 0.51 118,912,000 105,036,000 4,614,000 36,770,000 56,052,000 273,606,000 4,614,000
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