-----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, KtMfnboMOx1CnCWub8IEJuhVfsHya4KQScgcRpUHr5blkN+rmDazof5nE7w0pbYf Ob4iSz37lFktdGAaPm/F0w== /in/edgar/work/0000950129-00-005494/0000950129-00-005494.txt : 20001115 0000950129-00-005494.hdr.sgml : 20001115 ACCESSION NUMBER: 0000950129-00-005494 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 20000930 FILED AS OF DATE: 20001114 FILER: COMPANY DATA: COMPANY CONFORMED NAME: HCC INSURANCE HOLDINGS INC/DE/ CENTRAL INDEX KEY: 0000888919 STANDARD INDUSTRIAL CLASSIFICATION: [6331 ] IRS NUMBER: 760336636 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 001-13790 FILM NUMBER: 764016 BUSINESS ADDRESS: STREET 1: 13403 NORTHWEST FRWY CITY: HOUSTON STATE: TX ZIP: 77040-6094 BUSINESS PHONE: 7136907300 10-Q 1 h81800e10-q.txt HCC INSURANCE HOLDINGS, INC. - DATED 09/30/2000 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the Quarter Ended September 30, 2000 ------------------ [ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 from _______ to __________ Commission file number 0-20766 ----------------------------------------------------- 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) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- Indicate the number of shares outstanding of each of the issuer's classes of common stock as of the latest practicable date. On November 3, 2000, there were 49,634,790 shares of Common Stock, $1.00 par value issued and outstanding. 2 HCC INSURANCE HOLDINGS, INC. INDEX
PAGE NO. -------- Part I. FINANCIAL INFORMATION Item 1. Condensed Consolidated Balance Sheets September 30, 2000 and December 31, 1999...................................................3 Condensed Consolidated Statements of Earnings For the nine months ended September 30, 2000 and 1999......................................4 Condensed Consolidated Statements of Earnings For the three months ended September 30, 2000 and 1999.....................................5 Condensed Consolidated Statements of Changes in Shareholders' Equity For the nine months ended September 30, 2000 and for the year ended December 31, 1999......6 Condensed Consolidated Statements of Cash Flows For the nine months ended September 30, 2000 and 1999......................................8 Notes to Condensed Consolidated Financial Statements............................................9 Item 2. Management's Discussion and Analysis...........................................................21 Item 3. Quantitative and Qualitative Disclosures About Market Risk.....................................27 Part II. OTHER INFORMATION.......................................................................................29
2 3 HCC Insurance Holdings, Inc. and Subsidiaries ---------- Condensed Consolidated Balance Sheets (Unaudited) ----------
September 30, 2000 December 31, 1999 ------------------ ----------------- ASSETS Investments: Fixed income securities, at market (cost: 2000 $381,943,000; 1999 $343,534,000) $ 385,263,000 $ 342,641,000 Marketable equity securities, at market (cost: 2000 $11,102,000; 1999 $22,493,000) 7,848,000 19,970,000 Short-term investments, at cost, which approximates market 266,865,000 215,694,000 Other investments, at cost, which approximates fair value 6,767,000 3,017,000 ---------------- ---------------- Total investments 666,743,000 581,322,000 Cash 8,656,000 26,533,000 Restricted cash and cash investments 90,158,000 84,112,000 Premium, claims and other receivables 661,792,000 622,087,000 Reinsurance recoverables 758,653,000 736,485,000 Ceded unearned premium 121,083,000 133,657,000 Ceded life and annuity benefits 87,664,000 95,760,000 Deferred policy acquisition costs 40,300,000 40,450,000 Property and equipment, net 38,488,000 37,804,000 Goodwill 271,802,000 263,687,000 Other assets 25,537,000 42,827,000 ---------------- ---------------- TOTAL ASSETS $ 2,770,876,000 $ 2,664,724,000 ================ ================ LIABILITIES Loss and loss adjustment expense payable $ 895,324,000 $ 871,104,000 Life and annuity policy benefits 87,664,000 95,760,000 Reinsurance balances payable 106,285,000 113,373,000 Unearned premium 189,204,000 188,524,000 Deferred ceding commissions 31,859,000 39,792,000 Premium and claims payable 686,958,000 598,638,000 Notes payable 229,171,000 242,546,000 Accounts payable and accrued liabilities 41,288,000 57,559,000 ---------------- ---------------- Total liabilities 2,267,753,000 2,207,296,000 SHAREHOLDERS' EQUITY Common Stock, $1.00 par value; 250,000,000 shares authorized; (issued and outstanding: 2000 49,634,790 shares; 1999 48,839,027 shares) 49,635,000 48,839,000 Additional paid-in capital 185,025,000 176,359,000 Retained earnings 269,054,000 234,922,000 Accumulated other comprehensive income (loss) (591,000) (2,692,000) ---------------- ---------------- Total shareholders' equity 503,123,000 457,428,000 ---------------- ---------------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 2,770,876,000 $ 2,664,724,000 ================ ================
See Notes to Condensed Consolidated Financial Statements. 3 4 HCC Insurance Holdings, Inc. and Subsidiaries ---------- Condensed Consolidated Statements of Earnings (Unaudited) ----------
For the nine months ended September 30, 2000 1999 -------------- -------------- REVENUE Net earned premium $ 201,289,000 $ 99,576,000 Management fees 77,396,000 69,717,000 Commission income 31,749,000 44,742,000 Net investment income 28,538,000 22,866,000 Net realized investment loss (3,825,000) (266,000) Other operating income 22,712,000 20,928,000 -------------- -------------- Total revenue 357,859,000 257,563,000 EXPENSE Loss and loss adjustment expense 149,534,000 77,756,000 Operating expense: Policy acquisition costs, net 21,673,000 3,490,000 Compensation expense 61,524,000 56,818,000 Provision for reinsurance -- 29,500,000 Other operating expense 39,146,000 36,212,000 -------------- -------------- Net operating expense 122,343,000 126,020,000 Interest expense 15,592,000 9,217,000 -------------- -------------- Total expense 287,469,000 212,993,000 -------------- -------------- Earnings before income tax provision 70,390,000 44,570,000 Income tax provision 28,350,000 14,456,000 -------------- -------------- NET EARNINGS $ 42,040,000 $ 30,114,000 ============== ============== BASIC EARNINGS PER SHARE DATA: Earnings per share $ 0.85 $ 0.62 ============== ============== Weighted average shares outstanding 49,558,000 48,950,000 ============== ============== DILUTED EARNINGS PER SHARE DATA: Earnings per share $ 0.84 $ 0.60 ============== ============== Weighted average shares outstanding 50,248,000 49,794,000 ============== ============== Cash dividends declared, per share $ 0.16 $ 0.15 ============== ==============
See Notes to Condensed Consolidated Financial Statements. 4 5 HCC Insurance Holdings, Inc. and Subsidiaries ---------- Condensed Consolidated Statements of Earnings (Unaudited) ----------
For the three months ended September 30, 2000 1999 -------------- -------------- REVENUE Net earned premium $ 66,279,000 $ 37,492,000 Management fees 23,587,000 22,144,000 Commission income 9,749,000 10,734,000 Net investment income 10,363,000 7,939,000 Net realized investment gain (loss) 547,000 (357,000) Other operating income 8,156,000 5,141,000 -------------- -------------- Total revenue 118,681,000 83,093,000 EXPENSE Loss and loss adjustment expense 47,593,000 32,943,000 Operating expense: Policy acquisition costs, net 6,171,000 2,347,000 Compensation expense 19,947,000 19,176,000 Other operating expense 11,526,000 12,752,000 -------------- -------------- Net operating expense 37,644,000 34,275,000 Interest expense 5,256,000 3,306,000 -------------- -------------- Total expense 90,493,000 70,524,000 -------------- -------------- Earnings before income tax provision 28,188,000 12,569,000 Income tax provision 11,194,000 3,451,000 -------------- -------------- NET EARNINGS $ 16,994,000 $ 9,118,000 ============== ============== BASIC EARNINGS PER SHARE DATA: Earnings per share $ 0.34 $ 0.19 ============== ============== Weighted average shares outstanding 49,742,000 49,130,000 ============== ============== DILUTED EARNINGS PER SHARE DATA: Earnings per share $ 0.33 $ 0.18 ============== ============== Weighted average shares outstanding 51,040,000 49,866,000 ============== ============== Cash dividends declared, per share $ 0.06 $ 0.05 ============== ==============
See Notes to Condensed Consolidated Financial Statements. 5 6 HCC Insurance Holdings, Inc. and Subsidiaries ---------- Condensed Consolidated Statements of Changes in Shareholders' Equity For the nine months ended September 30, 2000 and for the year ended December 31, 1999 (Unaudited) ----------
Additional Common paid-in Retained Stock capital earnings -------------- -------------- -------------- BALANCE AS OF DECEMBER 31, 1998 $ 48,252,000 $ 162,102,000 $ 219,804,000 Net earnings -- -- 25,123,000 Other comprehensive income (loss) -- -- -- 505,555 shares of Common Stock issued for exercise of options, including tax benefit of $1,156,000 506,000 4,277,000 -- 101,330 shares of Common Stock issued for purchased companies 101,000 1,899,000 -- 414,207 shares of Common Stock contractually issuable in the future -- 8,271,000 -- Cash dividends declared, $0.20 per share -- -- (9,733,000) Other (20,000) (190,000) (272,000) -------------- -------------- -------------- BALANCE AS OF DECEMBER 31, 1999 $ 48,839,000 $ 176,359,000 $ 234,922,000 ============== ============== ============== Accumulated other Total comprehensive shareholders' income (loss) equity -------------- -------------- BALANCE AS OF DECEMBER 31, 1998 $ 9,705,000 $ 439,863,000 Net earnings -- 25,123,000 Other comprehensive income (loss) (12,397,000) (12,397,000) 505,555 shares of Common Stock issued for exercise of options, including tax benefit of $1,156,000 -- 4,783,000 101,330 shares of Common Stock issued for purchased companies -- 2,000,000 414,207 shares of Common Stock contractually issuable in the future -- 8,271,000 Cash dividends declared, $0.20 per share -- (9,733,000) Other -- (482,000) -------------- -------------- BALANCE AS OF DECEMBER 31, 1999 $ (2,692,000) $ 457,428,000 ============== ==============
See Notes to Condensed Consolidated Financial Statements. 6 7 HCC Insurance Holdings, Inc. and Subsidiaries ---------- Condensed Consolidated Statements of Changes in Shareholders' Equity For the nine months ended September 30, 2000 and for the year ended December 31, 1999 (Unaudited) (continued) ----------
Additional Common paid-in Retained stock capital earnings -------------- -------------- -------------- BALANCE AS OF DECEMBER 31, 1999 $ 48,839,000 $ 176,359,000 $ 234,922,000 Net earnings -- -- 42,040,000 Other comprehensive income -- -- -- 556,290 shares of Common Stock issued for exercise of options, including tax benefit of $1,566,000 556,000 7,666,000 -- Issuance of 144,973 shares of contractually issuable Common Stock 145,000 (145,000) -- Issuance of 94,500 shares of contingently issuable Common Stock 95,000 1,145,000 -- Cash dividends declared, $0.16 per share -- -- (7,908,000) -------------- -------------- -------------- BALANCE AS OF SEPTEMBER 30, 2000 $ 49,635,000 $ 185,025,000 $ 269,054,000 ============== ============== ============== Accumulated other Total comprehensive shareholders' income (loss) equity -------------- -------------- BALANCE AS OF DECEMBER 31, 1999 $ (2,692,000) $ 457,428,000 Net earnings -- 42,040,000 Other comprehensive income 2,101,000 2,101,000 556,290 shares of Common Stock issued for exercise of options, including tax benefit of $1,566,000 -- 8,222,000 Issuance of 144,973 shares of contractually issuable Common Stock -- -- Issuance of 94,500 shares of contingently issuable Common Stock -- 1,240,000 Cash dividends declared, $0.16 per share -- (7,908,000) -------------- -------------- BALANCE AS OF SEPTEMBER 30, 2000 $ (591,000) $ 503,123,000 ============== ==============
See Notes to Condensed Consolidated Financial Statements. 7 8 HCC Insurance Holdings, Inc. and Subsidiaries ---------- Condensed Consolidated Statements of Cash Flows (Unaudited) ----------
For the nine months ended September 30, 2000 1999 -------------- -------------- Cash flows from operating activities: Net earnings $ 42,040,000 $ 30,114,000 Adjustments to reconcile net earnings to net cash provided by operating activities: Change in premium, claims and other receivables (46,126,000) (7,123,000) Change in reinsurance recoverables (22,168,000) (224,033,000) Change in ceded unearned premium 12,574,000 3,151,000 Change in loss and loss adjustment expense payable 24,220,000 208,296,000 Change in reinsurance balances payable (7,088,000) 36,634,000 Change in unearned premium 1,343,000 (3,082,000) Change in premium and claims payable, net of restricted cash 82,959,000 (6,403,000) Change in accounts payable and accrued liabilities (21,681,000) (4,601,000) Net realized investment loss 3,825,000 266,000 Gains on dispositions of strategic and subsidiary investments (5,739,000) (5,523,000) Provision for reinsurance -- 29,500,000 Depreciation and amortization expense 13,959,000 9,412,000 Deferred income taxes (1,513,000) (8,753,000) Other, net 5,873,000 (4,871,000) -------------- -------------- Cash provided by operating activities 82,478,000 52,984,000 Cash flows from investing activities: Sales of fixed income securities 86,079,000 1,214,000 Maturity or call of fixed income securities 27,406,000 12,698,000 Sales of equity securities 7,437,000 2,800,000 Dispositions of strategic investments and non-core subsidiaries 27,803,000 15,905,000 Change in short-term investments (72,460,000) (47,362,000) Cash paid for companies acquired, net of cash received (9,880,000) (57,863,000) Cost of securities acquired (148,245,000) (35,417,000) Purchases of property and equipment and other, net (6,203,000) (7,575,000) -------------- -------------- Cash used by investing activities (88,063,000) (115,600,000) Cash flows from financing activities: Proceeds from notes payable 26,700,000 208,000,000 Sale of Common Stock 8,222,000 3,660,000 Payments on notes payable (39,842,000) (147,600,000) Dividends paid (7,372,000) (6,785,000) -------------- -------------- Cash provided by financing activities (12,292,000) 57,275,000 -------------- -------------- Net change in cash (17,877,000) (5,341,000) Cash at beginning of period 26,533,000 16,018,000 -------------- -------------- CASH AT END OF PERIOD $ 8,656,000 $ 10,677,000 ============== ==============
See Notes to Condensed Consolidated Financial Statements. 8 9 HCC Insurance Holdings, Inc. and Subsidiaries ---------- Notes to Condensed Consolidated Financial Statements (Unaudited) (1) GENERAL INFORMATION HCC Insurance Holdings, Inc. ("the Company" or "HCC") and its subsidiaries include domestic and foreign property and casualty and life insurance companies, underwriting agencies, intermediaries and service companies. HCC, through its subsidiaries, provides specialized property and casualty and accident and health insurance to commercial customers in the areas of accident and health reinsurance, aviation, marine, medical stop-loss, property, offshore energy and workers' compensation insurance. Basis of Presentation The unaudited condensed consolidated financial statements have been prepared in conformity with generally accepted accounting principles and include all adjustments which are, in the opinion of management, necessary for fair presentation of the results of the interim periods. All adjustments made to the interim periods are of a normal recurring nature. The condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated. The condensed consolidated financial statements for periods reported should be read in conjunction with the annual consolidated financial statements and related notes thereto. The condensed consolidated balance sheet as of December 31, 1999, and the condensed consolidated statement of changes in shareholders' equity for the year then ended were derived from audited financial statements, but do not include all disclosures required by generally accepted accounting principles. During December, 1999, the Company acquired all of the outstanding shares of The Centris Group, Inc. ("Centris") in a transaction accounted for using the purchase method of accounting. Therefore, the results of operations and cash flows of the Centris companies are included in the 2000 condensed consolidated statement of earnings and cash flows but are not included in the 1999 condensed consolidated statements of earnings and cash flows. Income Tax For the nine months ended September 30, 2000 and 1999, the income tax provision has been calculated based on an estimated effective tax rate for each of the fiscal years. The difference between the Company's effective tax rate and the Federal statutory rate is the result of state income taxes, non-deductible goodwill amortization and tax exempt municipal bond interest. Effects of Recent Accounting Pronouncements Statement of Financial Accounting Standards ("SFAS") No. 133 entitled "Accounting for Derivative Instruments and Hedging Activities" was issued in June, 1998 and becomes effective for the Company January 1, 2001, with early adoption permitted. The Company has utilized derivative or hedging strategies only infrequently in the past and in immaterial amounts, although it is currently using derivatives and hedging strategies to a somewhat greater extent as it expands its foreign operations. The Company does not expect the adoption of SFAS No. 133 to have a material effect on the Company's financial position, results of operations or cash flows. 9 10 HCC Insurance Holdings, Inc. and Subsidiaries ---------- Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued) (1) GENERAL INFORMATION, CONTINUED During December, 1999 the Securities and Exchange Commission issued Staff Accounting Bulletin ("SAB") No. 101 entitled "Revenue Recognition in Financial Statements" which becomes effective for the Company during the fourth quarter of 2000. The Company does not expect the adoption of SAB No. 101 to have a material effect on the Company's financial position, results of operations or cash flows. The NAIC adopted Statements of Statutory Accounting Principles in March, 1998 as a product of its attempt to codify statutory accounting principles. Although subject to adoption by the individual states, an effective date of January 1, 2001 was established for implementation of the statements. Prior to the codification project, a comprehensive guide to statutory accounting principles did not exist. The codification is new and will evolve over time. The Company is in the process of reviewing the statutory accounting principles as currently published to determine the effect their adoption may have on the statutory policyholders' surplus and statutory net income of the Company's insurance company subsidiaries. Reclassifications Certain amounts in the 1999 condensed consolidated financial statements have been reclassified to conform to the 2000 presentation. Such reclassifications had no effect on the Company's net earnings, shareholders' equity or cash flows. (2) REINSURANCE In the normal course of business, the Company's insurance company subsidiaries cede a substantial portion of their premium to non-affiliated domestic and foreign reinsurers through quota share, surplus, excess of loss and facultative reinsurance agreements. Although the ceding of reinsurance does not discharge the primary insurer from liability to its policyholder, the subsidiaries participate in such agreements for the purposes of limiting their loss exposure, protecting against catastrophic loss and diversifying their business. The majority of assumed reinsurance was written by underwriting agency subsidiaries of the Company utilizing unaffiliated insurance companies as the primary writer. The following tables represent the effect of such reinsurance transactions on net premium and loss and loss adjustment expense:
Loss and Loss Written Earned Adjustment Premium Premium Expense -------------- -------------- -------------- For the nine months ended September 30, 2000: Direct business $ 478,210,000 $ 469,771,000 $ 332,707,000 Reinsurance assumed 235,272,000 246,953,000 212,657,000 Reinsurance ceded (498,728,000) (515,435,000) (395,830,000) -------------- -------------- -------------- NET AMOUNTS $ 214,754,000 $ 201,289,000 $ 149,534,000 ============== ============== ==============
10 11 HCC Insurance Holdings, Inc. and Subsidiaries ---------- Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued) (2) REINSURANCE, CONTINUED
Loss and Loss Written Earned Adjustment Premium Premium Expense -------------- -------------- -------------- For the nine months ended September 30, 1999: Direct business $ 213,556,000 $ 207,789,000 $ 198,559,000 Reinsurance assumed 208,527,000 208,971,000 304,732,000 Reinsurance ceded (323,067,000) (317,184,000) (425,535,000) -------------- -------------- -------------- NET AMOUNTS $ 99,016,000 $ 99,576,000 $ 77,756,000 ============== ============== ============== For the three months ended September 30, 2000: Direct business $ 178,835,000 $ 179,080,000 $ 124,184,000 Reinsurance assumed 63,369,000 71,559,000 51,815,000 Reinsurance ceded (170,030,000) (184,360,000) (128,406,000) -------------- -------------- -------------- NET AMOUNTS $ 72,174,000 $ 66,279,000 $ 47,593,000 ============== ============== ============== For the three months ended September 30, 1999: Direct business $ 74,728,000 $ 79,652,000 $ 73,629,000 Reinsurance assumed 60,626,000 59,696,000 95,299,000 Reinsurance ceded (97,477,000) (101,856,000) (135,985,000) -------------- -------------- -------------- NET AMOUNTS $ 37,877,000 $ 37,492,000 $ 32,943,000 ============== ============== ==============
11 12 HCC Insurance Holdings, Inc. and Subsidiaries ---------- Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued) (2) REINSURANCE, CONTINUED The table below represents the approximate composition of reinsurance recoverables in the accompanying condensed consolidated balance sheets:
September 30, 2000 December 31, 1999 ------------------ ----------------- Reinsurance recoverable on paid losses $ 122,634,000 $ 91,318,000 Commuted receivable -- 53,210,000 Reinsurance recoverable on outstanding losses 379,339,000 382,565,000 Reinsurance recoverable on IBNR 262,172,000 214,933,000 Reserve for uncollectible reinsurance (5,492,000) (5,541,000) -------------- -------------- TOTAL REINSURANCE RECOVERABLES $ 758,653,000 $ 736,485,000 ============== ==============
The insurance company subsidiaries require reinsurers not authorized by the subsidiaries' respective states of domicile to collateralize their reinsurance obligations to the Company. The table below shows amounts held by the Company as collateral plus other credits available for potential offset.
September 30, 2000 December 31, 1999 ------------------ ----------------- Payables to reinsurers $ 198,958,000 $ 212,962,000 Letters of credit 134,094,000 154,111,000 Cash deposits 23,232,000 19,882,000 -------------- -------------- TOTAL CREDITS $ 356,284,000 $ 386,955,000 ============== ==============
The Company has a reserve of $5.5 million as of September 30, 2000 for potential collectibility issues related to reinsurance recoverables. The adverse economic environment in the worldwide insurance industry has placed great pressure on reinsurers and the results of their operations. Ultimately, these conditions could affect reinsurers' solvency. Historically, there have been insolvencies following a period of competitive pricing in the industry, such as the marketplace has experienced for the last several years. Therefore, while management believes that the reserve is adequate based on current available information, conditions may change or additional information might be obtained that would affect management's estimate of the adequacy of the level of the reserve and which may result in a future increase or decrease in the reserve. Management continually reviews the Company's financial exposure to the reinsurance market and continues to take actions to protect shareholders' equity. During the current year, a number of reinsurers have delayed or suspended the payment of amounts recoverable under reinsurance contracts to which the Company's insurance company subsidiaries are a party. Such delays have affected, though not materially to date, the liquidity and investment income of the Company's insurance company subsidiaries. In addition, a number of reinsurers have claimed they are not liable for payment to the Company's insurance company subsidiaries, and in one case has sought arbitration. The Company believes these claims are without merit and expects to collect the full amount recoverable. The Company is currently in negotiations with most of these parties. If such negotiations do not result in a satisfactory resolution of the matters in question, the Company intends to seek a judicial or arbitral determination. 12 13 HCC Insurance Holdings, Inc. and Subsidiaries ---------- Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued) (3) SEGMENT AND GEOGRAPHIC INFORMATION The performance of each segment is evaluated by management based upon net earnings. Net earnings is calculated after tax and after all corporate expense allocations, purchase price allocations and intercompany eliminations have been charged or credited to the individual segments. The insurance company subsidiaries increased their policy issuance fees on certain 2000 contracts to reflect current market conditions, which had the effect of reducing the underwriting agencies' management fees by a like amount. This amounted to $7.3 million for the nine months ended September 30, 2000 and $3.3 million for the third quarter of 2000. The following tables show information by business segment and geographic location. Geographic location is determined by physical location of the Company's offices and does not represent the location of insureds or reinsureds from whom the business was generated.
Insurance Underwriting Other Company Agency Intermediary Operations -------------- -------------- -------------- -------------- For the nine months ended September 30, 2000: Revenue: Domestic $ 210,756,000 $ 79,658,000 $ 17,108,000 $ 21,572,000 Foreign 7,404,000 3,631,000 17,059,000 -- Inter-segment -- 10,916,000 188,000 1,074,000 -------------- -------------- -------------- -------------- Total segment revenue $ 218,160,000 $ 94,205,000 $ 34,355,000 $ 22,646,000 ============== ============== ============== ============== Inter-segment revenue CONSOLIDATED TOTAL REVENUE Net earnings (loss): Domestic $ 17,810,000 $ 18,030,000 $ 5,962,000 $ 5,057,000 Foreign (2,519,000) 659,000 1,095,000 -- -------------- -------------- -------------- -------------- Total segment net earnings (loss) $ 15,291,000 $ 18,689,000 $ 7,057,000 $ 5,057,000 ============== ============== ============== ============== Inter-segment eliminations CONSOLIDATED NET EARNINGS Other items: Net investment income $ 19,902,000 $ 5,462,000 $ 2,434,000 $ 381,000 Depreciation and amortization 2,502,000 8,302,000 2,423,000 324,000 Interest expense 92,000 7,003,000 3,898,000 -- Capital expenditures 2,423,000 3,486,000 465,000 237,000 Income tax provision (benefit) 4,713,000 16,689,000 5,304,000 3,093,000 Inter-segment eliminations CONSOLIDATED INCOME TAX PROVISION Corporate Total -------------- -------------- For the nine months ended September 30, 2000: Revenue: Domestic $ 671,000 $ 329,765,000 Foreign -- 28,094,000 Inter-segment -- 12,178,000 -------------- -------------- Total segment revenue $ 671,000 370,037,000 ============== Inter-segment revenue (12,178,000) -------------- CONSOLIDATED TOTAL REVENUE $ 357,859,000 ============== Net earnings (loss): Domestic $ (3,489,000) $ 43,370,000 Foreign -- (765,000) -------------- -------------- Total segment net earnings (loss) $ (3,489,000) 42,605,000 ============== Inter-segment eliminations (565,000) -------------- CONSOLIDATED NET EARNINGS $ 42,040,000 ============== Other items: Net investment income $ 359,000 $ 28,538,000 Depreciation and amortization 408,000 13,959,000 Interest expense 4,599,000 15,592,000 Capital expenditures 207,000 6,818,000 Income tax provision (benefit) (1,104,000) 28,695,000 Inter-segment eliminations (345,000) -------------- CONSOLIDATED INCOME TAX PROVISION $ 28,350,000 ==============
13 14 HCC Insurance Holdings, Inc. and Subsidiaries ---------- Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued) (3) SEGMENT AND GEOGRAPHIC INFORMATION, CONTINUED
Insurance Underwriting Other Company Agency Intermediary Operations -------------- -------------- -------------- -------------- For the nine months ended September 30, 1999: Revenue: Domestic $ 108,932,000 $ 70,096,000 $ 26,633,000 $ 19,885,000 Foreign 9,080,000 2,951,000 19,846,000 -- Inter-segment -- 1,529,000 479,000 868,000 -------------- -------------- -------------- -------------- Total segment revenue $ 118,012,000 $ 74,576,000 $ 46,958,000 $ 20,753,000 ============== ============== ============== ============== Inter-segment revenue CONSOLIDATED TOTAL REVENUE Net earnings (loss): Domestic $ (1,456,000) $ 13,715,000 $ 9,185,000 $ 6,253,000 Foreign (1,209,000) 117,000 4,586,000 -- -------------- -------------- -------------- -------------- NET EARNINGS (LOSS) $ (2,665,000) $ 13,832,000 $ 13,771,000 $ 6,253,000 ============== ============== ============== ============== Other items: Net investment income $ 17,501,000 $ 3,051,000 $ 1,772,000 $ 275,000 Depreciation and amortization 1,886,000 4,304,000 2,633,000 191,000 Interest expense 8,000 2,819,000 3,039,000 -- Capital expenditures 1,991,000 4,219,000 583,000 438,000 Income tax provision (benefit) (7,850,000) 10,572,000 8,974,000 3,606,000 Corporate Total -------------- -------------- For the nine months ended September 30, 1999: Revenue: Domestic $ 140,000 $ 225,686,000 Foreign -- 31,877,000 Inter-segment -- 2,876,000 -------------- -------------- Total segment revenue $ 140,000 $ 260,439,000 ============== Inter-segment revenue (2,876,000) -------------- CONSOLIDATED TOTAL REVENUE $ 257,563,000 ============== Net earnings (loss): Domestic $ (1,077,000) $ 26,620,000 Foreign -- 3,494,000 -------------- -------------- NET EARNINGS (LOSS) $ (1,077,000) $ 30,114,000 ============== ============== Other items: Net investment income $ 267,000 $ 22,866,000 Depreciation and amortization 398,000 9,412,000 Interest expense 3,351,000 9,217,000 Capital expenditures 344,000 7,575,000 Income tax provision (benefit) (846,000) 14,456,000
The insurance company segment incurred a provision for reinsurance of $19.2 million, net of income tax, during the first nine months of 1999. 14 15 HCC Insurance Holdings, Inc. and Subsidiaries ---------- Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued) (3) SEGMENT AND GEOGRAPHIC INFORMATION, CONTINUED
Insurance Underwriting Other Company Agency Intermediary Operations -------------- -------------- -------------- -------------- For the three months ended September 30, 2000: Revenue: Domestic $ 69,225,000 $ 25,181,000 $ 4,870,000 $ 7,601,000 Foreign 5,025,000 856,000 5,697,000 -- Inter-segment -- 4,795,000 94,000 359,000 -------------- -------------- -------------- -------------- Total segment revenue $ 74,250,000 $ 30,832,000 $ 10,661,000 $ 7,960,000 ============== ============== ============== ============== Inter-segment revenue CONSOLIDATED TOTAL REVENUE Net earnings (loss): Domestic $ 7,810,000 $ 5,862,000 $ 1,427,000 $ 2,024,000 Foreign (159,000) 27,000 521,000 -- -------------- -------------- -------------- -------------- Total segment net earnings (loss) $ 7,651,000 $ 5,889,000 $ 1,948,000 $ 2,024,000 ============== ============== ============== ============== Inter-segment eliminations CONSOLIDATED NET EARNINGS Other items: Net investment income $ 7,223,000 $ 2,094,000 $ 831,000 $ 137,000 Depreciation and amortization 866,000 2,712,000 969,000 106,000 Interest expense 82,000 2,317,000 1,283,000 -- Capital expenditures 755,000 1,423,000 224,000 80,000 Income tax provision (benefit) 3,059,000 5,913,000 1,434,000 1,389,000 Inter-segment eliminations CONSOLIDATED INCOME TAX PROVISION Corporate Total -------------- -------------- For the three months ended September 30, 2000: Revenue: Domestic $ 226,000 $ 107,103,000 Foreign -- 11,578,000 Inter-segment -- 5,248,000 -------------- -------------- Total segment revenue $ 226,000 123,929,000 ============== Inter-segment revenue (5,248,000) -------------- CONSOLIDATED TOTAL REVENUE $ 118,681,000 ============== Net earnings (loss): Domestic $ (438,000) $ 16,685,000 Foreign -- 389,000 -------------- -------------- Total segment net earnings (loss) $ (438,000) 17,074,000 ============== Inter-segment eliminations (80,000) -------------- CONSOLIDATED NET EARNINGS $ 16,994,000 ============== Other items: Net investment income $ 78,000 $ 10,363,000 Depreciation and amortization 123,000 4,776,000 Interest expense 1,574,000 5,256,000 Capital expenditures 91,000 2,573,000 Income tax provision (benefit) (557,000) 11,238,000 Inter-segment eliminations (44,000) -------------- CONSOLIDATED INCOME TAX PROVISION $ 11,194,000 ==============
15 16 HCC Insurance Holdings, Inc. and Subsidiaries ---------- Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued) (3) SEGMENT AND GEOGRAPHIC INFORMATION, CONTINUED
Insurance Underwriting Other Companies Agencies Intermediaries Operations -------------- -------------- -------------- -------------- For the three months ended September 30, 1999: Revenue: Domestic $ 40,186,000 $ 22,458,000 $ 6,106,000 $ 4,579,000 Foreign 3,215,000 1,144,000 5,291,000 -- Inter-segment -- 676,000 134,000 304,000 -------------- -------------- -------------- -------------- Total segment revenue $ 43,401,000 $ 24,278,000 $ 11,531,000 $ 4,883,000 ============== ============== ============== ============== Inter-segment revenue CONSOLIDATED TOTAL REVENUE Net earnings (loss): Domestic $ 4,298,000 $ 4,062,000 $ 1,473,000 $ 729,000 Foreign (1,740,000) 152,000 631,000 -- -------------- -------------- -------------- -------------- TOTAL NET EARNINGS (LOSS) $ 2,558,000 $ 4,214,000 $ 2,104,000 $ 729,000 ============== ============== ============== ============== Other items: Net investment income $ 5,902,000 $ 1,134,000 $ 698,000 $ 98,000 Depreciation and amortization 615,000 1,483,000 851,000 (56,000) Interest expense (3,000) 936,000 1,163,000 -- Capital expenditures 421,000 666,000 20,000 48,000 Income tax provision (benefit) (896,000) 3,179,000 1,468,000 506,000 Corporate Total -------------- -------------- For the three months ended September 30, 1999: Revenue: Domestic $ 114,000 $ 73,443,000 Foreign -- 9,650,000 Inter-segment -- 1,114,000 -------------- -------------- Total segment revenue $ 114,000 84,207,000 ============== Inter-segment revenue (1,114,000) -------------- CONSOLIDATED TOTAL REVENUE $ 83,093,000 ============== Net earnings (loss): Domestic $ (487,000) $ 10,075,000 Foreign -- (957,000) -------------- -------------- TOTAL NET EARNINGS (LOSS) $ (487,000) $ 9,118,000 ============== ============== Other items: Net investment income $ 107,000 $ 7,939,000 Depreciation and amortization 122,000 3,015,000 Interest expense 1,210,000 3,306,000 Capital expenditures 44,000 1,199,000 Income tax provision (benefit) (806,000) 3,451,000
16 17 HCC Insurance Holdings, Inc. and Subsidiaries ---------- Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued) (4) EARNINGS PER SHARE Basic earnings per share is based on the weighted average number of common shares outstanding during the period divided into net earnings. Diluted earnings per share is based on the weighted average number of common shares outstanding plus the potential common shares outstanding during the period divided into net earnings. Outstanding common stock options, when dilutive, are considered to be potential common stock for the purpose of the diluted calculation. The treasury stock method is used to calculate potential common stock due to options. Contingent shares to be issued are included in the earnings per share computation only when the underlying conditions for issuance have been met. The following table provides a reconciliation of the denominators used in the earnings per share calculations:
For the nine months ended September 30, 2000 1999 -------------- -------------- Net earnings $ 42,040,000 $ 30,114,000 ============== ============== Reconciliation of number of shares outstanding: Shares of Common Stock outstanding at period end 49,635,000 48,711,000 Effect of Common Stock issued during the period (346,000) (175,000) Common Stock contractually issuable in the future 269,000 414,000 -------------- -------------- Weighted average Common Stock outstanding 49,558,000 48,950,000 Additional dilutive effect of outstanding options (as determined by the application of the treasury stock method) 690,000 844,000 -------------- -------------- Weighted average Common Stock and potential common stock outstanding 50,248,000 49,794,000 ============== ==============
17 18 HCC Insurance Holdings, Inc. and Subsidiaries ---------- Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued) (4) EARNINGS PER SHARE, CONTINUED
For the three months ended September 30, 2000 1999 -------------- -------------- Net earnings $ 16,994,000 $ 9,118,000 ============== ============== Reconciliation of number of shares outstanding: Shares of Common Stock outstanding at period end 49,635,000 48,711,000 Effect of Common Stock issued during the period (162,000) 5,000 Common Stock contractually issuable in the future 269,000 414,000 -------------- -------------- Weighted average Common Stock outstanding 49,742,000 49,130,000 Additional dilutive effect of outstanding options (as determined by the application of the treasury stock method) 1,298,000 736,000 -------------- -------------- Weighted average Common Stock and potential common stock outstanding 51,040,000 49,866,000 ============== ==============
As of September 30, 2000, there were approximately 3.3 million options that were not included in the computation of year-to-date diluted earnings per share (1.1 million shares for the third quarter) because to do so would have been antidilutive. There are 283,500 shares of the Company's Common Stock to be issued if certain conditions are met as of December 31, 2000, or in subsequent years. These shares were not included in the earnings per share computation because the conditions for issuance have not yet been met. 18 19 HCC Insurance Holdings, Inc. and Subsidiaries ---------- Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued) (5) OTHER INFORMATION Supplemental Information Supplemental information for the nine months ended September 30, 2000 and 1999, is summarized below:
2000 1999 ---------------- --------------- Interest paid $ 12,456,000 $ 8,346,000 Income tax paid 12,737,000 21,358,000 Comprehensive income 44,141,000 21,931,000 Ceding commissions netted with policy acquisition costs 155,958,000 84,869,000
Supplemental information for the three months ended September 30, 2000 and 1999, is summarized below:
2000 1999 ---------------- --------------- Comprehensive income $ 17,918,000 $ 9,290,000 Ceding commissions netted with policy acquisition costs 54,842,000 29,451,000
Restructuring As of December 31, 1999, the Company had accrued two separate restructuring liabilities, relating to HCC's ongoing operations ("HCC Internal") and to HCC's acquisition of Centris. Changes in the accruals between December 31, 1999 and September 30, 2000 are shown in the tables below: HCC Internal Restructuring
Accrued Paid 2000 Accrued at 12/31/99 in 2000 Adjustments at 9/30/00 ------------ ------------ ------------ ------------ Severance $ 3,115,000 $ 3,115,000 $ -- $ -- Other 911,000 213,000 (514,000) 184,000 ------------ ------------ ------------ ------------ TOTAL $ 4,026,000 $ 3,328,000 $ (514,000) $ 184,000 ============ ============ ============ ============
During 2000, the Company determined that one of the leased offices scheduled to be closed would be retained. Therefore, the Company reversed $789,000 (included as a credit in other operating expenses) of the restructuring expense recorded during the fourth quarter of 1999, of which $514,000 was the reversal of the accrual for the future lease payments and $275,000 was the reversal of the write down of certain assets. 19 20 HCC Insurance Holdings, Inc. and Subsidiaries ---------- Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued) (5) OTHER INFORMATION, CONTINUED Centris Restructuring
Accrued Paid 2000 Accrued at 12/31/99 in 2000 Adjustments at 9/30/00 ------------ ------------ ------------ ------------ Contractual executive severance accruals $ 5,866,000 $ 6,027,000 $ 166,000 $ 5,000 Other severance accruals 397,000 521,000 202,000 78,000 Lease obligation accruals 848,000 636,000 329,000 541,000 ------------ ------------ ------------ ------------ TOTAL $ 7,111,000 $ 7,184,000 $ 697,000 $ 624,000 ============ ============ ============ ============
The adjustments in 2000 were recorded as management decided to take additional steps to integrate parts of the Centris operations. Management continues to evaluate what additional actions, if any, are necessary to finalize the integration of the Centris operations. In addition, there are unresolved contingencies remaining from the acquisition. Any additional accruals for either the unresolved contingencies or the integration of operations will be recorded as an adjustment to the purchase price allocation within the allowable purchase allocation period. Legal Proceedings The Company is party to numerous claims and lawsuits that arise in the normal course of its business. Many of such claims or lawsuits involve claims under policies that the Company's insurance company subsidiaries underwrite as an insurer or reinsurer. The Company believes that the resolution of these lawsuits or claims will not have a material adverse effect on the Company's financial condition, results of operations or cash flows. 20 21 MANAGEMENT'S DISCUSSION AND ANALYSIS During December, 1999, the Company acquired all of the outstanding shares of The Centris Group, Inc. ("Centris") in a transaction accounted for using the purchase method of accounting. Therefore, the results of operations and cash flows of the Centris companies are included in the 2000 condensed consolidated statement of earnings and cash flows, but are not included in the 1999 condensed consolidated statement of earnings and cash flows. Three months ended September 30, 2000 versus three months ended September 30, 1999 Results of Operations Total revenue increased 43% to $118.7 million for the third quarter of 2000 from $83.1 million for the same period in 1999. This revenue increase resulted from increased retentions of premium underwritten by the Company's insurance company subsidiaries, particularly in the medical stop-loss line of business, and increased investment income. The upward trend in revenue is anticipated to continue. Net investment income increased 31% to $10.4 million for the third quarter of 2000 from $7.9 million for the same period in 1999. This was due to a higher level of invested assets and an increase in interest rates. The higher level of invested assets was due to greater retentions of premium underwritten by the Company's insurance company subsidiaries and the investment of cash received from a commuted reinsurance agreement during the first quarter of 2000. Net investment income is expected to continue to increase. Compensation expense increased $771,000 during the third quarter of 2000 from the same period in 1999. This increase reflects a normal progressional increase due to business growth plus the increase due to the Centris acquisition, offset by the savings resulting from the 1999 fourth quarter restructuring. Other operating expenses decreased $1.2 million during the same period due to the 1999 fourth quarter restructuring. Interest expense was $5.3 million for the third quarter of 2000 compared to $3.3 million for the same period in 1999. This increase is a result of higher interest rates and increased debt outstanding, principally as a result of funding for acquisitions. Income tax expense was $11.2 million for the third quarter of 2000 compared to $3.5 million for the same period in 1999. The Company's effective tax rate was 40% for the third quarter of 2000 compared to 27% in 1999. Most of the increase in the effective tax rate was due to non-deductible goodwill amortization relating to the Centris acquisition and increased underwriting agency income subject to state income taxes. Net earnings for the third quarter of 2000 increased 86% to $17.0 million or $0.33 per share from $9.1 million or $0.18 per share for the same period in 1999. These increases result from improved underwriting results and the increase in investment income. The Company's book value per share was $10.08 as of September 30, 2000, up from $9.75 as of June 30, 2000. 21 22 SEGMENTS Insurance Companies Gross written premium increased 79% to $ 242.2 million for the third quarter of 2000 from $135.4 million for the same period in 1999 due to new business, rate increases, increased participation by the Company's insurance company subsidiaries in the business underwritten by the Company's underwriting agency subsidiaries and the acquisition of Centris. Net written premium for the third quarter of 2000 increased 91% to $72.2 million from $37.9 million for the same period in 1999, as the Company's insurance company subsidiaries have increased retentions on many of their lines of business as underwriting results begin to improve. Net earned premium increased 77% to $66.3 million for the same reasons. Premium increases are expected to continue. Loss and loss adjustment expense increased to $47.6 million for the third quarter of 2000 from $32.9 million for the same period in 1999. The increase in net loss and loss adjustment expense is due to the higher level of net retained premium. The GAAP net loss ratio decreased to 71.8% for the third quarter of 2000 from 87.9% for the same period in 1999. The GAAP gross loss ratio was 70.2% in the third quarter of 2000 compared to 121.2% for the same period in 1999. The general improvement in the Company's loss ratios represents the effects of increased premium rates on certain lines of business, reduced writings on other unprofitable lines of business and a general improvement in market conditions, particularly in the medical stop-loss and aviation lines of business. The statutory net combined ratio was 98.4% in the third quarter of 2000 compared to 117.6% for the same period in 1999. Policy acquisition costs, which are net of commissions on ceded reinsurance, increased to $6.2 million during the third quarter of 2000 from $2.3 million for the same period in 1999. This increase in costs results from higher retained premium and the resulting reduced ceding commissions. Net earnings of the Company's insurance company subsidiaries increased to $7.7 million in the third quarter of 2000 from $2.6 million for the same period in 1999, principally as a result of the effect of the improved underwriting results and the increase in investment income. Underwriting Agencies Premiums underwritten by the Company's underwriting agencies increased 28% to $273.5 million for the third quarter of 2000 from $213.5 million for the same period in 1999. This increase resulted primarily from the increased premium volume in the medical stop-loss line of business, which was due to rate increases and the acquisition of Centris. Management fees increased to $23.6 million for the third quarter of 2000, compared to $22.1 million for the same period in 1999. The increase in management fees was disproportionate to the increase in written premium primarily due to increased retentions by the Company's insurance company subsidiaries. Net earnings of the Company's underwriting agency subsidiaries increased 40% to $5.9 million in the third quarter of 2000 from $4.2 million in 1999 due to increased revenue and higher pre-tax margins primarily as a result of the successful integration of the Centris acquisition. Intermediaries Commission income decreased to $9.7 million in the third quarter of 2000 from $10.7 million for the same period in 1999. Net earnings of the Company's intermediary subsidiaries decreased to $1.9 million in the third quarter of 2000 from $2.1 million for the same period in 1999. These decreases were due to a significant reduction in the amount of ceded reinsurance placed on behalf of the Company's insurance company subsidiaries as a result of their planned increase in retentions. 22 23 Other Operations Other operating revenue increased to $8.2 million during the third quarter of 2000 from $5.1 million for the same period in 1999 principally from the gain from the disposition of a subsidiary investment during the third quarter of 2000. There was no such gain for the same period in 1999. Net earnings from the Company's other operations increased to $2.0 million in 2000 from $729,000 in 1999 for the same reason. Quarter to quarter comparisons will vary substantially depending on income from subsidiary investments, or dispositions thereof, in any given period. Nine months ended September 30, 2000 versus nine months ended September 30, 1999 Results of Operations Total revenue increased 39% to $357.9 million for the first nine months of 2000 from $257.6 million for the same period in 1999. This revenue increase resulted from increased retentions of premium underwritten by the Company's insurance company subsidiaries, particularly in the medical stop-loss line of business, and increased investment income. The upward trend in revenue is anticipated to continue. Net investment income increased 25% to $28.5 million for the first nine months of 2000 from $22.9 million for the same period in 1999. This was due to a higher level of invested assets and an increase in interest rates. The higher level of invested assets was due to greater retentions of premium underwritten by the Company's insurance company subsidiaries and the investment of cash received from a commuted reinsurance agreement during the first quarter of 2000. In connection with the Company's hiring of new investment advisors in 2000, an in-depth review and restructuring of the Company's investment portfolio has been undertaken. The Company has not significantly changed the credit rating but has shortened the duration of its investment portfolio. The Company realized a $3.8 million loss on the sale of securities or write down of securities being sold in the first nine months of 2000, principally as a result of these actions. Net investment income is expected to continue to increase. Compensation expense increased $4.7 million during the first nine months of 2000 from the same period in 1999. This increase reflects a normal progressional increase due to business growth plus the increase due to the Centris acquisition, offset by the savings resulting from the 1999 fourth quarter restructuring. Other operating expenses increased $2.9 million during the same period for similar reasons. Interest expense was $15.6 million for the first nine months of 2000 compared to $9.2 million for the same period in 1999. This increase is a result of higher interest rates and increased debt outstanding, principally as a result of funding for acquisitions. Income tax expense was $28.4 million for the first nine months of 2000 compared to $14.5 million for the same period in 1999. The Company's effective tax rate was 40% in the 2000 period compared to 32% in 1999. Most of the increase in the effective tax rate was due to non-deductible goodwill amortization relating to the Centris acquisition and increased underwriting agency income subject to state income taxes. The Company recorded a provision for reinsurance recoverables in the amount of $29.5 million during the first nine months of 1999 relating to one of the Company's reinsurers that was subsequently placed into liquidation. The Company believes that the provision should be sufficient to absorb the losses resulting from this insolvency. Net earnings for the first nine months of 2000 increased 40% to $42.0 million or $0.84 per share from $30.1 million or $0.60 per share for the same period in 1999. These increases result from improved underwriting results, an increase in investment income and the effect of the provision for reinsurance recorded during 1999. The Company's book value per share was $10.08 as of September 30, 2000, up from $9.29 as of December 31, 1999. 23 24 SEGMENTS Insurance Companies Gross written premium increased 69% to $713.5 million for the first nine months of 2000, from $422.1 million for the same period in 1999 due to new business, rate increases, increased participation by the Company's insurance company subsidiaries in the business underwritten by the Company's underwriting agency subsidiaries and the acquisition of Centris. Net written premium for the first nine months of 2000 increased 117% to $214.8 million from $99.0 million for the same period in 1999, as the Company's insurance company subsidiaries have increased retentions on many of their lines of business as underwriting results begin to improve. Net earned premium increased 102% to $201.3 million for the same reasons. Premium increases are expected to continue. Loss and loss adjustment expense increased to $149.5 million for the first nine months of 2000 from $77.8 million for the same period in 1999. The increase in net loss and loss adjustment expense is due to the higher level of net retained premium. The GAAP net loss ratio decreased to 74.3% for the first nine months of 2000 from 78.1% for the same period in 1999. The GAAP gross loss ratio was 76.1% in the first nine months of 2000 compared to 120.8% for the same period in 1999. The general improvement in the Company's loss ratios represents the effects of increased premium rates on certain lines of business, reduced writings on other unprofitable lines of business and a general improvement in market conditions, particularly in the medical stop-loss and domestic aviation lines of business. The statutory net combined ratio was 100.1% in the first nine months of 2000 compared to 103.2% for the same period in 1999. Policy acquisition costs, which are net of commissions on ceded reinsurance, increased to $21.7 million during the first nine months of 2000 from $3.5 million for the same period in 1999. This increase in costs results from higher retained premium and the resulting reduced ceding commissions. Net earnings of the Company's insurance company subsidiaries increased to $15.3 million in the first nine months of 2000 from a loss of $2.7 million for the same period in 1999, primarily as a result of improved underwriting results, the effect of the provision for reinsurance recorded in 1999 and the increase in investment income. Underwriting Agencies Premiums underwritten increased 30% to $829.8 million for the first nine months of 2000 from $637.7 million for the same period in 1999. Management fees increased 11% to $77.4 million for the first nine months of 2000, compared to $69.7 million for the same period in 1999. These increases resulted primarily from the increased premium volume in the medical stop-loss line of business, which was due to rate increases and the acquisition of Centris. The increase in management fees was disproportionate to the increase in written premium primarily due to increased retentions by the Company's insurance company subsidiaries. Net earnings of the Company's underwriting agency subsidiaries increased 35% to $18.7 million in the first nine months of 2000 from $13.8 million in 1999 due to increased revenue and higher pretax margins primarily as a result of the successful integration of the Centris acquisition. Intermediaries Commission income decreased to $31.7 million in the first nine months of 2000 from $44.7 million for the same period in 1999. Net earnings of the Company's intermediary subsidiaries decreased to $7.1 million in the first nine months of 2000 from $13.8 million for the same period in 1999. These decreases were due to a significant reduction in the amount of ceded reinsurance placed on behalf of the Company's insurance company subsidiaries as a result of their planned increase in retentions. 24 25 Other Operations Other operating revenue increased to $22.7 million during the first nine months of 2000 from $20.9 million for the same period in 1999. Net earnings of the Company's other operations decreased to $5.1 million in 2000 from $6.3 million in 1999. Period to period comparisons will vary substantially depending on income from subsidiary investments, or dispositions thereof, in any given period. Restructuring As of December 31, 1999, the Company had accrued two separate restructuring liabilities, relating to HCC's ongoing operations ("HCC Internal") and to HCC's acquisition of Centris. Changes in the accruals between December 31, 1999 and June 30, 2000 are shown in the tables below: HCC Internal Restructuring
Accrued Paid 2000 Accrued at 12/31/99 in 2000 Adjustments at 9/30/00 ------------ ------------ ------------ ------------ Severance $ 3,115,000 $ 3,115,000 $ -- $ -- Other 911,000 213,000 (514,000) 184,000 ------------ ------------ ------------ ------------ TOTAL $ 4,026,000 $ 3,328,000 $ (514,000) $ 184,000 ============ ============ ============ ============
During 2000, the Company determined that one of the leased offices scheduled to be closed would be retained. Therefore, the Company reversed $789,000 (included as a credit in other operating expenses) of the restructuring expense recorded during the fourth quarter of 1999, of which $514,000 was the reversal of the accrual for future lease payments and $275,000 was the reversal of the write down of certain assets. Centris Restructuring
Accrued Paid 2000 Accrued at 12/31/99 in 2000 Adjustments at 9/30/00 ------------ ------------ ------------ ------------ Contractual executive severance accruals $ 5,866,000 $ 6,027,000 $ 166,000 $ 5,000 Other severance accruals 397,000 521,000 202,000 78,000 Lease obligation accruals 848,000 636,000 329,000 541,000 ------------ ------------ ------------ ------------ TOTAL $ 7,111,000 $ 7,184,000 $ 697,000 $ 624,000 ============ ============ ============ ============
The adjustments in 2000 were recorded as management decided to take additional steps to integrate parts of the Centris operations. Management continues to evaluate what additional actions, if any, are necessary to finalize the integration of the Centris operations. In addition, there are unresolved contingencies remaining from the acquisition. Any additional accruals for either the unresolved contingencies or the integration of operations will be recorded as an adjustment to the purchase price allocation within the allowable purchase allocation period. Liquidity and Capital Resources The Company receives substantial cash from premiums, reinsurance recoverables, management fees and commission income and, to a lesser extent, investment income and proceeds from sales and redemptions of investment and other assets. The principal cash outflows are for the payment of claims and loss adjustment expenses ("LAE"), payment of premiums to reinsurers, purchase of investments, debt service, policy acquisition costs, operating expenses, income and other taxes and dividends. Quarter to quarter variations in operating cash flows can occur due to timing differences in either the payment of claims and the collection of related recoverables or the collection of receivables and the payment of related payable amounts. The Company 25 26 continues to collect its receivables and recoverables generally in the ordinary course and has not incurred and does not expect to incur any significant liquidity difficulties. The Company limits its liquidity exposure by holding funds, letters of credit and other security such that net exposures are less than the gross balances shown in the condensed consolidated balance sheet. During the current year, a number of reinsurers have delayed or suspended the payment of amounts recoverable under reinsurance contracts to which the Company's insurance company subsidiaries are a party. Such delays have affected, though not materially to date, the liquidity and investment income of the Company's insurance company subsidiaries. The Company's consolidated cash and investment portfolio increased $67.2 million, or 11% since December 31, 1999, and totaled $675.4 million as of September 30, 2000, of which $275.5 million was cash and short-term investments. The increase in investments resulted primarily from the collection of the commutation receivable. Total assets increased slightly to $2.8 billion as of September 30, 2000. On December 17, 1999, the Company entered into a $300.0 million Revolving Loan Facility (the "Facility") with a group of banks. Borrowings under the Facility may be made from time to time by the Company for general corporate purposes until the Facility's expiration on December 18, 2004. Outstanding advances under the Facility bear interest at agreed upon rates. The Facility is collateralized in part by the pledge of the stock the Company's principal insurance company subsidiaries and by the pledge of stock of and guarantees entered into by the Company's principal underwriting agency and intermediary subsidiaries. The Facility agreement contains certain restrictive covenants, including, without limitation, minimum net worth requirements for the Company and certain subsidiaries, restrictions on certain extraordinary corporate actions, notice requirements for certain material occurrences, and required maintenance of specified financial ratios. Management believes that the restrictive covenants and other obligations of the Company which are contained in the Facility agreement are typical for comparable financing arrangements. The initial funding available under the Facility was used, among other things, to refinance existing indebtedness and to partially fund the Centris acquisition. As of September 30, 2000, total debt outstanding under the Facility was $224.7 million and the weighted average interest rate was 8.09%. The Company believes that its operating cash flows, short-term investments and the Facility will provide sufficient sources of liquidity to meet its operating needs for the foreseeable future. Effects of Recent Accounting Pronouncements Statement of Financial Accounting Standards ("SFAS") No. 133 entitled "Accounting for Derivative Instruments and Hedging Activities" was issued in June, 1998 and becomes effective for the Company January 1, 2001, with early adoption permitted. The Company has utilized derivative or hedging strategies only infrequently in the past and in immaterial amounts, although it is currently using derivatives and hedging strategies to a somewhat greater extent as it expands its foreign operations. The Company does not expect the adoption of SFAS No. 133 to have a material effect on the Company's financial position, results of operations or cash flows. During December, 1999 the Securities and Exchange Commission issued Staff Accounting Bulletin ("SAB") No. 101 entitled "Revenue Recognition in Financial Statements" which becomes effective for the Company during the fourth quarter of 2000. The Company does not expect the adoption of SAB No. 101 to have a material effect on the Company's financial position, results of operations or cash flows. 26 27 The NAIC adopted Statements of Statutory Accounting Principles in March, 1998 as a product of its attempt to codify statutory accounting principles. Although subject to adoption by the individual states, an effective date of January 1, 2001 was established for implementation of the statements. Prior to the codification project, a comprehensive guide to statutory accounting principles did not exist. The codification is new and will evolve over time. The Company is in the process of reviewing the statutory accounting principles as currently published to determine the effect their adoption may have on the statutory policyholders' surplus and statutory net income of the Company's insurance company subsidiaries. Year 2000 The Year 2000 issue is the result of date coding within computer programs that were written using just two digits rather than four digits to define the applicable year. If not corrected, these date codes could cause computers to fail to calculate dates beyond 1999 and, as a result, computer applications could have failed or created erroneous information as a result of the Year 2000 date change. Although the Company experienced no material system failures attributed to the year 2000 change-over, the Company may have exposure in the property and casualty operations of its insurance company subsidiaries to claims asserted under certain insurance policies for damages caused by an insured's failure to address its own Year 2000 computer problems. The Company's insurance company subsidiaries did not generally offer policies of insurance marketed as Year 2000 liability coverage. However, due to the nature of certain of the policies, such as policies of property insurance, an insured may submit purported claims for coverage under such policies, which may result from Year 2000 related causes. In this regard, the Company continues to assess appropriate responses to such attempted claims in light of Year 2000 coverage issues under the insurance coverages offered by the insurance company subsidiaries. The nature of the Company's response to such attempted claims is generally dependent on the particular facts and circumstances of the underlying claims and coverage. Management does not believe that Year 2000 coverage issues associated with the insurance coverages offered by the Company's insurance company subsidiaries will have a material adverse effect on the Company's results of operations or cash flows. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK There have been no material changes in market risk from the information provided in Item 7A. "Quantitative and Qualitative Disclosures About Market Risk" of the Company's Annual Report on Form 10-K for the year ended December 31, 1999. 27 28 This report on Form 10-Q (the "Report") contains certain "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, and Section 21E of the Securities Exchange Act of 1934, which are intended to be covered by the safe harbors created by those laws. We have based these forward-looking statements on our current expectations and projections about future events. These forward-looking statements include information about possible or assumed future results of our operations. All statements, other than statements of historical facts, included or incorporated by reference in this Report that address activities, events or developments that we expect or anticipate may occur in the future, including such things as future capital expenditures, business strategies, competitive strengths, goals, growth of our businesses and operations, plans and references to future successes may be considered forward-looking statements. Also, when we use words such as "anticipate", "believe", "estimate", "expect", "intend", "plan", "probably" or similar expressions, we are making forward-looking statements. Many risks and uncertainties may impact the matters addressed in these forward-looking statements. Many possible events or factors could affect our future financial results and performance. These could cause our results or performance to differ materially from those we express in our forward-looking statements. Although we believe that the assumptions underlying our forward-looking statements are reasonable, any of these assumptions, and therefore also the forward-looking statements based on these assumptions, could themselves prove to be inaccurate. In light of the significant uncertainties inherent in the forward-looking statements included in this Report, our inclusion of this information is not a representation by us or any other person that our objectives and plans will be achieved. Our forward-looking statements speak only as of the date made and we will not update these forward-looking statements unless the securities laws require us to do so. In light of these risks, uncertainties and assumptions, the forward-looking events discussed in this Report may not occur. 28 29 PART II - OTHER INFORMATION Item 1. Legal Proceedings The Company is party to numerous claims and lawsuits that arise in the normal course of its business. Many of such claims or lawsuits involve claims under policies that the Company's insurance company subsidiaries underwrite as an insurer or reinsurer. The Company believes that the resolution of these lawsuits or claims will not have a material adverse effect on the Company's financial condition, results of operations or cash flows. Item 6. Exhibits and reports on Form 8-K: (a) Exhibits: 27 EDGAR Financial Data Schedule - September 30, 2000 (b) Reports on Form 8-K: None. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. HCC Insurance Holdings, Inc. ----------------------------------------------- (Registrant) November 14, 2000 /s/ Stephen L. Way - ---------------------- ----------------------------------------------- (Date) Stephen L. Way, Chairman of the Board and Chief Executive Officer November 14, 2000 /s/ Edward H. Ellis, Jr. - ---------------------- ----------------------------------------------- (Date) Edward H. Ellis, Jr., Senior Vice President and Chief Financial Officer 29 30 INDEX TO EXHIBITS
EXHIBIT NUMBER DESCRIPTION - ------- ----------- 27 EDGAR Financial Data Schedule - September 30, 2000
EX-27.1 2 h81800ex27-1.txt FINANCIAL DATA SCHEDULE
7 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION FROM THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS FOUND IN THE COMPANY'S FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 2000, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 9-MOS DEC-31-2000 JAN-01-2000 SEP-30-2000 385,263,000 0 0 7,848,000 0 0 666,743,000 8,656,000 758,653,000 8,441,000 2,770,876,000 985,439,000 189,204,000 0 0 229,171,000 0 0 49,635,000 453,488,000 2,770,876,000 201,289,000 28,538,000 (3,825,000) 131,857,000 149,534,000 21,673,000 100,670,000 70,390,000 28,350,000 42,040,000 0 0 0 42,040,000 0.85 0.84 273,606,000 0 0 0 0 253,813,000 0
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