-----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, L0egyPkBHorRiylEDz6/9lEdPGWP2mQuMDL9Iq5FOmmx/qb0T/1sC1ePry9Wk8Jb /sVrb1VKBRo03p0KE2F2Wg== 0000950129-01-500785.txt : 20010516 0000950129-01-500785.hdr.sgml : 20010516 ACCESSION NUMBER: 0000950129-01-500785 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 20010331 FILED AS OF DATE: 20010515 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-Q SEC ACT: SEC FILE NUMBER: 001-13790 FILM NUMBER: 1636287 BUSINESS ADDRESS: STREET 1: 13403 NORTHWEST FRWY CITY: HOUSTON STATE: TX ZIP: 77040-6094 BUSINESS PHONE: 7136907300 10-Q 1 h87101e10-q.txt HCC INSURANCE HOLDINGS, INC. - 3/31/01 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 March 31, 2001. [ ] 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 May 4, 2001, there were 58,775,774 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 March 31, 2001 and December 31, 2000 (Restated)....................... 3 Condensed Consolidated Statements of Earnings For the three months ended March 31, 2001 and 2000 (Restated)......... 4 Condensed Consolidated Statements of Changes in Shareholders' Equity For the three months ended March 31, 2001 and for the year ended December 31, 2000 (Restated)........................... 5 Condensed Consolidated Statements of Cash Flows For the three months ended March 31, 2001 and 2000 (Restated)......... 7 Notes to Condensed Consolidated Financial Statements....................... 8 Item 2. Management's Discussion and Analysis....................................... 18 Item 3. Quantitative and Qualitative Disclosures About Market Risk................. 21 Part II. OTHER INFORMATION................................................................... 22
This report on Form 10-Q 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. 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 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 which are 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, any forward-looking events discussed in this report may not occur. 2 3 HCC Insurance Holdings, Inc. and Subsidiaries --------- Condensed Consolidated Balance Sheets (Unaudited) --------
March 31, 2001 December 31, 2000 ------------------ ----------------- (Restated) ASSETS Investments: Fixed income securities, at market (cost: 2001 $430,798,000; 2000 $422,821,000) $ 446,460,000 $ 433,844,000 Marketable equity securities, at market (cost: 2001 $10,249,000; 2000 $8,896,000) 9,179,000 6,282,000 Short-term investments, at cost, which approximates market 277,832,000 263,805,000 Other investments, at cost, which approximates fair value 7,180,000 7,182,000 ------------------ ----------------- Total investments 740,651,000 711,113,000 Cash 6,651,000 13,991,000 Restricted cash and cash investments 105,627,000 101,738,000 Premium, claims and other receivables 575,135,000 586,721,000 Reinsurance recoverables 833,956,000 789,412,000 Ceded unearned premium 95,189,000 114,469,000 Ceded life and annuity benefits 84,453,000 86,760,000 Deferred policy acquisition costs 35,594,000 39,108,000 Property and equipment, net 39,271,000 39,438,000 Goodwill 263,774,000 266,015,000 Other assets 11,398,000 18,995,000 ------------------ ----------------- TOTAL ASSETS $ 2,791,699,000 $ 2,767,760,000 ================== ================= LIABILITIES Loss and loss adjustment expense payable $ 990,722,000 $ 944,117,000 Life and annuity policy benefits 84,928,000 86,760,000 Reinsurance balances payable 102,689,000 130,746,000 Unearned premium 170,541,000 190,550,000 Deferred ceding commissions 24,360,000 30,013,000 Premium and claims payable 618,790,000 594,852,000 Notes payable 57,477,000 212,133,000 Accounts payable and accrued liabilities 37,513,000 47,659,000 ------------------ ----------------- Total liabilities 2,087,020,000 2,236,830,000 SHAREHOLDERS' EQUITY Common stock, $1.00 par value; 250,000,000 shares authorized; (shares issued and outstanding: 2001 58,678,954; 2000 51,342,006) 58,679,000 51,342,000 Additional paid-in capital 348,000,000 196,999,000 Retained earnings 289,533,000 277,876,000 Accumulated other comprehensive income 8,467,000 4,713,000 ------------------ ----------------- Total shareholders' equity 704,679,000 530,930,000 ------------------ ----------------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 2,791,699,000 $ 2,767,760,000 ================== =================
See Notes to Condensed Consolidated Financial Statements. 3 4 HCC Insurance Holdings, Inc. and Subsidiaries -------- Condensed Consolidated Statements of Earnings (Unaudited) --------
For the three months ended March 31, ------------------------------------ 2001 2000 --------------- -------------- (Restated) REVENUE Net earned premium $ 71,921,000 $ 63,356,000 Management fees 15,750,000 29,261,000 Commission income 14,641,000 14,833,000 Net investment income 10,632,000 8,249,000 Net realized investment loss (824,000) (403,000) Other operating income 2,972,000 6,651,000 --------------- -------------- Total revenue 115,092,000 121,947,000 EXPENSE Loss and loss adjustment expense 48,542,000 48,809,000 Operating expense: Policy acquisition costs, net 4,274,000 9,321,000 Compensation expense 18,619,000 22,284,000 Other operating expense 14,415,000 14,108,000 --------------- -------------- Net operating expense 37,308,000 45,713,000 Interest expense 3,347,000 5,021,000 --------------- -------------- Total expense 89,197,000 99,543,000 --------------- -------------- Earnings before income tax provision 25,895,000 22,404,000 Income tax provision 10,717,000 9,000,000 --------------- -------------- Earnings before cumulative effect of accounting change 15,178,000 13,404,000 Cumulative effect of accounting change, net of deferred tax effect of $1,335,000 -- (2,013,000) --------------- -------------- Net earnings $ 15,178,000 $ 11,391,000 =============== ============== BASIC EARNINGS PER SHARE DATA: Earnings before accounting change $ 0.28 $ 0.27 Cumulative effect of accounting change -- (0.04) --------------- -------------- Net earnings $ 0.28 $ 0.23 =============== ============== Weighted average shares outstanding 53,720,000 50,400,000 =============== ============== DILUTED EARNINGS PER SHARE DATA: Earnings before accounting change $ 0.28 $ 0.26 Cumulative effect of accounting change -- (0.04) --------------- -------------- Net earnings $ 0.28 $ 0.22 =============== ============== Weighted average shares outstanding 55,070,000 50,706,000 =============== ============== Cash dividends declared, per share $ 0.06 $ 0.05 =============== ==============
See Notes to Condensed Consolidated Financial Statements. 4 5 HCC Insurance Holdings, Inc. and Subsidiaries Condensed Consolidated Statements of Changes in Shareholders' Equity For the three months ended March 31, 2001 and for the year ended December 31, 2000 (Restated) (Unaudited) ---------
Accumulated Additional other Total Common paid-in Retained comprehensive shareholders' stock capital earnings income (loss) equity ------------ ------------ ------------ ------------ ------------ BALANCE AS OF DECEMBER 31, 1999 $ 49,836,000 $175,363,000 $235,932,000 $ (2,692,000) $458,439,000 Net earnings -- -- 55,468,000 -- 55,468,000 Other comprehensive income -- -- -- 7,405,000 7,405,000 ------------ Comprehensive income 62,873,000 1,266,701 shares of common stock issued for exercise of options, including tax benefit of $3,627,000 1,266,000 19,596,000 -- -- 20,862,000 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 -- -- 1,240,000 Contractual grant of pooled company common stock by a shareholder prior to acquisition -- 1,040,000 -- -- 1,040,000 Dividends to shareholders of pooled company prior to acquisition -- -- (2,593,000) -- (2,593,000) Cash dividends declared, $0.22 per share -- -- (10,931,000) -- (10,931,000) ------------ ------------ ------------ ------------ ------------ BALANCE AS OF DECEMBER 31, 2000 $ 51,342,000 $196,999,000 $277,876,000 $ 4,713,000 $530,930,000 ============ ============ ============ ============ ============
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 three months ended March 31, 2001 and for the year ended December 31, 2000 (Restated) (Unaudited) (continued) ---------
Accumulated Additional other Total Common paid-in Retained comprehensive shareholders' stock capital earnings income (loss) equity ------------ ------------ ------------ ------------ ------------ BALANCE AS OF DECEMBER 31, 2000 $ 51,342,000 $196,999,000 $277,876,000 $ 4,713,000 $530,930,000 Net earnings -- -- 15,178,000 -- 15,178,000 Other comprehensive income -- -- -- 3,754,000 3,754,000 ------------ Comprehensive income 18,932,000 6,900,000 shares of common stock issued in public offering, net of costs 6,900,000 145,641,000 -- -- 152,541,000 284,010 shares of common stock issued for exercise of options, including tax benefit of $896,000 284,000 4,595,000 -- -- 4,879,000 Issuance of 113,906 shares of contractually issuable common stock 114,000 (114,000) -- -- -- Issuance of 39,032 shares of contingently issuable common stock 39,000 879,000 -- -- 918,000 Cash dividends declared, $0.06 per share -- -- (3,521,000) -- (3,521,000) ------------ ------------ ------------ ------------ ------------ BALANCE AS OF MARCH 31, 2001 $ 58,679,000 $348,000,000 $289,533,000 $ 8,467,000 $704,679,000 ============ ============ ============ ============ ============
See Notes to Condensed Consolidated Financial Statements. 6 7 HCC Insurance Holdings, Inc. and Subsidiaries -------- Condensed Consolidated Statements of Cash Flows (Unaudited) --------
For the three months ended March 31, ------------------------------------ 2001 2000 ------------------ ---------------- (Restated) Cash flows from operating activities: Net earnings $ 15,178,000 $ 11,391,000 Adjustments to reconcile net earnings to net cash provided by operating activities: Change in premium, claims and other receivables 11,586,000 71,428,000 Change in reinsurance recoverables (44,544,000) 46,146,000 Change in ceded unearned premium 19,280,000 3,832,000 Change in loss and loss adjustment expense payable 46,605,000 (17,783,000) Change in reinsurance balances payable (28,057,000) 1,060,000 Change in unearned premium (20,009,000) (6,478,000) Change in premium and claims payable, net of restricted cash 20,049,000 (44,508,000) Net realized investment loss 824,000 403,000 Gains on sales of other operating investments -- (1,144,000) Depreciation and amortization expense 4,521,000 4,447,000 Other, net (6,326,000) (7,158,000) ------------------ ---------------- Cash provided by operating activities 19,107,000 61,636,000 Cash flows from investing activities: Sales of fixed income securities 43,806,000 11,302,000 Maturity or call of fixed income securities 6,670,000 16,364,000 Sales of equity securities -- 6,547,000 Dispositions of other operating investments -- 16,145,000 Change in short-term investments (14,027,000) (120,823,000) Cash paid for companies acquired, net of cash received -- (9,901,000) Cost of securities acquired (60,598,000) (14,815,000) Purchases of property and equipment and other, net (1,299,000) (1,584,000) ------------------ ---------------- Cash used by investing activities (25,448,000) (96,765,000) Cash flows from financing activities: Proceeds from notes payable -- 24,000,000 Sale of common stock, net of costs 156,524,000 1,119,000 Payments on notes payable (154,500,000) (6,000,000) Dividends paid (3,023,000) (2,442,000) ------------------ ---------------- Cash provided (used) by financing activities (999,000) 16,677,000 ------------------ ---------------- Net change in cash (7,340,000) (18,452,000) Cash at beginning of period 13,991,000 26,825,000 ------------------ ---------------- CASH AT END OF PERIOD $ 6,651,000 $ 8,373,000 ================== ================
See Notes to Condensed Consolidated Financial Statements. 7 8 HCC Insurance Holdings, Inc. and Subsidiaries -------- Notes to Condensed Consolidated Financial Statements (Unaudited) (1) GENERAL INFORMATION As used in this report, unless otherwise required by the context, the terms "we," "us," "our" and the "Company" refer to HCC Insurance Holdings, Inc. and its consolidated subsidiaries, and the term "HCC" refers only to HCC Insurance Holdings, Inc. We provide specialized property and casualty and accident and health insurance coverages, underwriting agency and intermediary services and other insurance related services both to commercial customers and individuals. We operate primarily in the United States and in the United Kingdom, although some of our operations have a broader international scope. We underwrite insurance on both a direct basis, where we insure a risk in exchange for a premium, and a reinsurance basis, where we insure all or a portion of another insurance company's risk in exchange for all or portion of the premium. We market our products both directly to customers and through a network of independent and affiliated agents and brokers. Our lines of business include accident and health reinsurance, aviation, marine, medical stop-loss, offshore energy, property 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 our opinion, necessary for a 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 HCC and those of our 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. The condensed consolidated balance sheet as of December 31, 2000, and the condensed consolidated statement of changes in shareholders' equity for the year then ended were derived from audited financial statements, restated for the Schanen pooling-of-interests, but do not include all disclosures required by generally accepted accounting principles. On January 19, 2001, we acquired all of the outstanding shares of Schanen Consulting Corporation and its operating subsidiary, Schanen Consulting Group, L.L.C. (collectively "Schanen"), an insurance intermediary, in exchange for 996,805 shares of our common stock. This business combination has been recorded using the pooling-of-interests method of accounting and, accordingly, our condensed consolidated financial statements have been restated to include the accounts and operations of Schanen for all periods presented. Separate total revenue and net earnings of the combined entities for the three months ended March 31, 2000 are presented in the following table:
Revenue Net Earnings ------------------- ------------------- Amounts, as previously reported $ 120,089,000 $ 10,622,000 Schanen 1,858,000 769,000 ------------------ ------------------- AMOUNTS, AS RESTATED $ 121,947,000 $ 11,391,000 ================== ===================
8 9 HCC Insurance Holdings, Inc. and Subsidiaries -------- Notes to Condensed Consolidated Financial Statements (Unaudited) (1) GENERAL INFORMATION, CONTINUED Revenue Recognition Effective January 1, 2000, we changed certain of our revenue recognition methods for our underwriting agencies and intermediaries to agree with guidance contained in SEC Staff Accounting Bulletin Number 101 ("SAB 101") entitled "Revenue Recognition in Financial Statements." The after-tax cumulative non-cash charge resulting from the adoption of SAB 101 was $2.0 million. As required by this accounting guidance, we have restated the 2000 first quarter results for the cumulative effect of the change in accounting. The change did not have a material effect on earnings before cumulative effect of accounting change for any period presented. Income Tax For the three months ended March 31, 2001 and 2000, the income tax provision has been calculated based on an estimated effective tax rate for each of the fiscal years. The difference between our effective tax rate and the Federal statutory rate is primarily the result of state income taxes, non-deductible goodwill amortization and tax exempt municipal bond interest. Since its acquisition, Schanen has become part of our consolidated federal income tax return and is subject to certain state income taxes. However, prior to its acquisition by HCC, Schanen was not subject to income tax. Foreign Currency We underwrite risks which are denominated in a number of foreign currencies. As a result, we have receivables and payables in foreign currencies and we establish and maintain loss reserves with respect to our insurance policies in their respective currencies. Our net earnings could be impacted by exchange rate fluctuations affecting these balances. On a limited basis, we also enter into foreign currency forward contracts as a hedge against foreign currency fluctuations. Our subsidiaries operating in London have revenue streams primarily in U.S. Dollars and Canadian Dollars ("CAD") but their expenses are paid in British Pound Sterling ("GBP"). To mitigate our foreign exchange risk, we entered into foreign currency forward contracts expiring at staggered times through December 31, 2001. The foreign currency forward contracts are used to convert currency at a known rate in an amount which approximates average monthly expenses. This permits us to limit the foreign currency exchange risk of the recurring monthly expenses. In the future, we may continue to limit our exposure to currency fluctuations through the use of foreign currency forward contracts. We utilize these foreign currency forward contracts strictly as a hedge against existing exposure to foreign currency fluctuations rather than as a form of speculation or trading. We adopted Statement of Financial Accounting Standards ("SFAS") No. 133 entitled "Accounting for Derivative Instruments and Hedging Activities" effective for us January 1, 2001. To the extent the foreign exchange forward contracts qualify for hedge accounting treatment, the gain or loss due to changes in their fair value is recognized in accumulated other comprehensive income 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 foreign currency forward contracts do 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. The cumulative effect adjustment due to this change in accounting is not material to our financial position, results of operations or cash flows and, since we utilize derivatives or hedging strategies on a limited basis, we do not expect the adoption of SFAS No. 133 to be material on an ongoing basis. 9 10 HCC Insurance Holdings, Inc. and Subsidiaries -------- Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued) (1) GENERAL INFORMATION, CONTINUED Effects of Recent Accounting Pronouncements The Financial Accounting Standards Board has recently announced that it proposes to change the accounting for certain acquisitions and goodwill. This pronouncement, if finally adopted, could affect the way we account for and the structure of future acquisitions. Rules implementing the announced standards are not final and no date has been established for adopting the final standards. Reclassifications Certain amounts in our 2000 condensed consolidated financial statements have been reclassified to conform to the 2001 presentation. Such reclassifications had no effect on our net earnings, shareholders' equity or cash flows. (2) PUBLIC OFFERING AND NOTES PAYABLE On March 6, 2001, we sold 6.9 million shares of our common stock in a public offering at a price of $23.35 per share. Net proceeds from the offering amounted to $152.5 million after deducting underwriting discounts, commissions and offering expenses and were used to pay down our bank facility. The table below shows the composition of our notes payable as shown in our condensed consolidated balance sheets:
March 31, 2001 December 31, 2000 ------------------ ------------------ Acquisition notes $ 4,477,000 $ 4,633,000 Bank facility 53,000,000 207,500,000 ------------------ ------------------ NET AMOUNTS $ 57,477,000 $ 212,133,000 ================== ==================
On December 17, 1999, we entered into a $300.0 million Revolving Loan Facility with a group of banks. We can borrow up to $300.0 million under the facility on a revolving basis until the facility expires 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 two of our principal insurance companies, Houston Casualty Company and Avemco Insurance Company, and by the stock of and guarantees entered into by our principal underwriting agency and intermediary subsidiaries. The facility agreement contains certain restrictive covenants, including minimum net worth requirements for us and certain of our subsidiaries, restrictions on certain extraordinary corporate actions, notice requirements for certain material occurrences and required maintenance of specified financial ratios. We believe that the restrictive covenants and our obligations that are contained in the facility agreement are typical for financing arrangements comparable to our facility. As of March 31, 2001, the weighted average interest rate on the facility debt outstanding was 6.5%. 10 11 HCC Insurance Holdings, Inc. and Subsidiaries -------- Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued) (3) REINSURANCE In the normal course of business, our insurance companies cede a substantial portion of their premium 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 them against catastrophic loss and diversifying their business. Most of the reinsurance assumed by our insurance companies was underwritten directly by one of our underwriting agencies, but was issued by other non-affiliated insurance companies in order to satisfy licensing, contractual or other requirements. 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 three months ended March 31, 2001: Direct business $ 181,952,000 $ 196,410,000 $ 130,066,000 Reinsurance assumed 47,262,000 51,479,000 100,204,000 Reinsurance ceded (156,709,000) (175,968,000) (181,728,000) ----------------- ----------------- ----------------- NET AMOUNTS $ 72,505,000 $ 71,921,000 $ 48,542,000 ================= ================= ================= For the three months ended March 31, 2000: Direct business $ 144,625,000 $ 138,417,000 $ 95,227,000 Reinsurance assumed 62,513,000 78,118,000 60,141,000 Reinsurance ceded (146,478,000) (153,179,000) (106,559,000) ----------------- ----------------- ----------------- NET AMOUNTS $ 60,660,000 $ 63,356,000 $ 48,809,000 ================= ================= =================
The table below represents the approximate composition of reinsurance recoverables in our condensed consolidated balance sheets:
March 31, 2001 December 31, 2000 ------------------- ------------------- Reinsurance recoverable on paid losses $ 95,595,000 $ 99,224,000 Reinsurance recoverable on outstanding losses 433,891,000 376,778,000 Reinsurance recoverable on IBNR 308,652,000 317,467,000 Reserve for uncollectible reinsurance (4,182,000) (4,057,000) ------------------- ------------------- TOTAL REINSURANCE RECOVERABLES $ 833,956,000 $ 789,412,000 =================== ===================
11 12 HCC Insurance Holdings, Inc. and Subsidiaries -------- Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued) (3) REINSURANCE, CONTINUED Our insurance companies require their reinsurers not authorized by the respective states of domicile of our insurance companies to collateralize the reinsurance obligations due to us. The table below shows amounts held by us as collateral plus other credits available for potential offset.
March 31, 2001 December 31, 2000 ---------------------- ------------------- Payables to reinsurers $ 177,113,000 $ 200,591,000 Letters of credit 141,727,000 142,494,000 Cash deposits 30,954,000 23,813,000 ---------------------- ------------------- TOTAL CREDITS $ 349,794,000 $ 366,898,000 ====================== ===================
We have a reserve of $4.2 million as of March 31, 2001 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 we believe that the reserve is adequate based on current available information, conditions may change or additional information might be obtained that would affect our estimate of the adequacy of the level of the reserve and which may result in a future increase or decrease in the reserve. We continually review our financial exposure to the reinsurance market and continue to take actions to protect our shareholders' equity. A number of reinsurers have delayed or suspended the payment of amounts recoverable under certain reinsurance contracts to which we are a party. Such delays have affected, though not materially to date, the investment income of our insurance companies, but not to any extent their liquidity. We limit our liquidity exposure by holding funds, letters of credit or other security such that net balances due are significantly less than the gross balances shown on our condensed consolidated balance sheets. In addition, a number of reinsurers have claimed they are not liable for payment to us and, in one or more cases, have sought arbitration of these matters. We believe these claims are without merit and expect to collect the full amount recoverable. We are currently in negotiations with most of these parties. If such negotiations do not result in a satisfactory resolution of the matters in question, we will seek a judicial or arbitral determination of these matters. 12 13 HCC Insurance Holdings, Inc. and Subsidiaries -------- Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued) (4) SEGMENT AND GEOGRAPHIC INFORMATION (AMOUNTS IN THOUSANDS) The performance of each segment is evaluated based upon net earnings before cumulative effect of accounting change and 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 following tables show information by business segment and geographic location. Geographic location is determined by physical location of our offices and does not represent the location of insureds or reinsureds from whom the business was generated. The segment information for the three months ended March 31, 2000 has been restated to include the accounts and operations of Schanen in the intermediary segment. Effective January 1, 2001, we consolidated the operations of three of our underwriting agencies into the operations of our insurance companies. Policies incepting on or after January 1, 2001, along with associated expenses, will be reported in the insurance company segment. The administration of policies incepting before January 1, 2001, which are now in run off, along with associated expenses, will continue to be reported in the underwriting agency segment. This consolidation will affect the comparability of segment information between periods. 13 14 HCC Insurance Holdings, Inc. and Subsidiaries -------- Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued) (4) SEGMENT AND GEOGRAPHIC INFORMATION, CONTINUED (AMOUNTS IN THOUSANDS)
Insurance Underwriting Other Company Agency Intermediary Operations Corporate Total ----------- --------- --------- --------- --------- --------- For the three months ended March 31, 2001: Revenue: Domestic $ 72,128 $ 17,030 $ 7,075 $ 2,432 $ 112 $ 98,777 Foreign 7,110 623 8,582 -- -- 16,315 Inter-segment -- 4,521 75 559 -- 5,155 ----------- --------- --------- --------- --------- --------- Total segment revenue $ 79,238 $ 22,174 $ 15,732 $ 2,991 $ 112 120,247 =========== ========= ========= ========= ========= Inter-segment revenue (5,155) --------- CONSOLIDATED TOTAL REVENUE $ 115,092 ========= Net earnings (loss): Domestic $ 7,102 $ 4,018 $ 1,975 $ 516 $ (55) $ 13,556 Foreign (654) 248 1,624 -- -- 1,218 ----------- --------- --------- --------- --------- --------- TOTAL SEGMENT NET EARNINGS (LOSS)$ 6,448 $ 4,266 $ 3,599 $ 516 $ (55) 14,774 =========== ========= ========= ========= ========= Inter-segment eliminations 404 --------- CONSOLIDATED NET EARNINGS $ 15,178 ========= Other items: Net investment income $ 7,694 $ 1,815 $ 1,015 $ 38 $ 70 $ 10,632 Depreciation and amortization 1,400 2,055 886 36 144 4,521 Interest expense 3 1,348 1,093 -- 903 3,347 Capital expenditures 685 311 141 48 114 1,299 Income tax provision 2,395 3,239 3,382 310 1,150 10,476 Inter-segment eliminations 241 --------- CONSOLIDATED INCOME TAX PROVISION $ 10,717 =========
14 15 HCC Insurance Holdings, Inc. and Subsidiaries -------- Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued) (4) SEGMENT AND GEOGRAPHIC INFORMATION, CONTINUED (AMOUNTS IN THOUSANDS)
Insurance Underwriting Other Company Agency Intermediary Operations Corporate Total ---------- ---------- ---------- ---------- ---------- ----------- For the three months ended March 31, 2000: Revenue: Domestic $ 67,640 $ 29,893 $ 9,289 $ 6,179 $ 254 $ 113,255 Foreign 1,447 938 6,307 -- -- 8,692 Inter-segment -- 2,184 38 351 -- 2,573 ---------- ---------- ---------- ---------- ---------- ----------- Total segment revenue $ 69,087 $ 33,015 $ 15,634 $ 6,530 $ 254 124,520 ========== ========== ========== ========== ========== Inter-segment revenue (2,573) ----------- CONSOLIDATED TOTAL REVENUE $ 121,947 =========== Net earnings (loss): Domestic $ 3,704 $ 6,882 $ 4,087 $ 966 $ (1,653) $ 13,986 Foreign (1,269) 187 767 -- -- (315) ---------- ---------- ---------- ---------- ---------- ----------- Total segment net earnings (loss) $ 2,435 $ 7,069 $ 4,854 $ 966 $ (1,653) 13,671 ========== ========== ========== ========== ========== Inter-segment eliminations (267) Cumulative effect of accounting change (2,013) ----------- CONSOLIDATED NET EARNINGS $ 11,391 =========== Other items: Net investment income $ 5,828 $ 1,440 $ 767 $ 113 $ 101 $ 8,249 Depreciation and amortization 789 2,829 617 107 105 4,447 Interest expense 5 2,282 1,285 -- 1,449 5,021 Capital expenditures 710 1,144 172 117 56 2,199 Income tax provision 274 5,677 2,733 470 20 9,174 Inter-segment eliminations (174) Cumulative effect of accounting change (1,335) ----------- CONSOLIDATED INCOME TAX PROVISION $ 7,665 ===========
15 16 HCC Insurance Holdings, Inc. and Subsidiaries -------- Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued) (5) 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 shares for the purpose of the diluted calculation. The treasury stock method is used to calculate potential common shares 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 three months ended March 31, 2001 2000 --------------- --------------- Net earnings $ 15,178,000 $ 11,391,000 =============== =============== Reconciliation of number of shares outstanding: Shares of common stock outstanding at period end 58,679,000 50,109,000 Effect of common shares issued during the period (5,114,000) (73,000) Contingent shares to be issued -- 95,000 Common shares contractually issuable in the future 155,000 269,000 --------------- --------------- Weighted average common shares outstanding 53,720,000 50,400,000 Additional dilutive effect of outstanding options (as determined by the application of the treasury stock method) 1,350,000 306,000 --------------- --------------- Weighted average common shares and potential common shares outstanding 55,070,000 50,706,000 =============== ===============
As of March 31, 2001, there were approximately 285,000 options that were not included in the computation of diluted earnings per share because to do so would have been antidilutive. There are 244,468 shares of the our common stock to be issued if certain conditions are met as of December 31, 2001, 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. 16 17 HCC Insurance Holdings, Inc. and Subsidiaries -------- Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued) (6) SUPPLEMENTAL INFORMATION Supplemental information for the three months ended March 31, 2001 and 2000, is summarized below:
2001 2000 ---------------- ---------------- Interest paid $ 6,001,000 $ 2,660,000 Income tax paid (received) 3,481,000 (6,896,000) Comprehensive income 18,932,000 12,536,000 Ceding commissions netted with policy acquisition costs 52,762,000 46,700,000
(7) COMMITMENTS AND CONTINGENCIES We are party to numerous lawsuits and other proceedings that arise in the normal course of our business. Many of such lawsuits and other proceedings involve claims under policies that we underwrite as an insurer or reinsurer, the liabilities for which, we believe, have been adequately included in our loss reserves. Also, from time to time we are a party to lawsuits and other proceedings which relate to disputes over contractual relationships with third parties, or which involve alleged errors and omissions on the part of our subsidiaries. We believe the resolution of such lawsuits will not have a material adverse effect on our financial condition, results of operations or cash flows. See also Note (3) concerning the collection of reinsurance recoverables. 17 18 MANAGEMENT'S DISCUSSION AND ANALYSIS Three months ended March 31, 2001 versus three months ended March 31, 2000 On January 19, 2001 we acquired all of the outstanding shares of Schanen Consulting Corporation and its operating subsidiary, Schanen Consulting Group, L.L.C. (collectively "Schanen"), an insurance intermediary, in a business combination recorded using the pooling-of-interests method of accounting and, accordingly, our historical condensed consolidated financial statements have been restated to include the accounts and operations of Schanen for all periods presented. Results of Operations Total revenue decreased to $115.1 million for the first quarter of 2001 from $121.9 million for the same period in 2000. The increase in the insurance company segment revenue resulting from higher retained premium and investment income was offset by reductions in the underwriting agency and other operations segments revenue as we consolidated the operations of three of our underwriting agencies into the operations of our insurance companies on January 1, 2001 and disposed of certain other operations during 2000. Net investment income increased 29% to $10.6 million for the first quarter of 2001 from $8.2 million for the same period in 2000. This increase was due to the higher level of invested assets which resulted from the strong operating cash flow in 2000, partially offset by the recent decrease in interest rates. We expect cash flow to continue to improve thereby increasing net investment income, but the increase could be substantially offset by the effect of falling interest rates. Compensation expense decreased to $18.6 million during the first quarter of 2001 from $22.3 million for the same period in 2000. The decrease is due principally to the sale of non-core subsidiaries and the closing or reduction of some operations of a purchased company subsequent to the end of the first quarter of 2000. Other operating expense in 2001 was also reduced for the same reasons but to a much lesser extent and were offset by a general increase in expense in our other operating subsidiaries as written premium continued to grow. Other operating expenses for the first quarter of 2000 also included a credit of $789,000 reflecting the reversal of some restructuring charges recorded during the previous year, whereas during the first quarter of 2001, we recorded $176,000 in non-recurring merger expense resulting from the acquisition of Schanen. Interest expense was $3.3 million for the first quarter of 2001, a decrease of $1.7 million from $5.0 million for the same period in 2000. The decrease is a result of decreased debt outstanding, as a result of using the proceeds from our March, 2001 public offering to substantially reduce our debt, and lower interest rates. We expect significantly reduced interest expense in future periods as a result of our debt reduction. Income tax expense on earnings before the change in accounting was $10.7 million for the first quarter of 2001 compared to $9.0 million for the same period in 2000. Our effective tax rate was 41% in the 2001 quarter compared to 40% in 2000, partly due to the fact that Schanen was not subject to income taxes prior to its acquisition. Net earnings before the change in accounting increased 13% to $15.2 million, or $0.28 per share, for the first quarter of 2001 from $13.4 million, or $0.26 per share, for the same period in 2000. The increase results from a much improved underwriting performance by the insurance company segment, which more than offset the reductions in the underwriting agency and intermediary segments. The Company's book value per share was $11.98 as of March 31, 2001, up from $10.29 as of December 31, 2000. 18 19 SEGMENTS Insurance Companies Gross written premium increased 11% to $229.2 million for the first quarter of 2001 from $207.1 million for the same period in 2000 due principally to an increase in medical stop-loss and accident and health reinsurance premium, offset by decreases in aviation and property premium. Net written premium for the first quarter of 2001 increased 20% to $72.5 million from $60.7 million for the same period in 2000, as our insurance companies have increased retentions on many of their lines of business as underwriting profit returns. Net earned premium increased 14% to $71.9 million for the same reason. The increase in net written premium and net earned premium is expected to continue. Loss and loss adjustment expense was $48.5 million for the first quarter of 2001 compared to $48.8 million for the same period in 2000. The GAAP net loss ratio decreased to 67% for the first quarter of 2001 from 77% for the same period in 2000. Improved underwriting results were experienced primarily in the medical stop-loss line of business. The GAAP gross loss ratio was 93% in the first quarter of 2001 compared to 72% for the same period in 2000. During the first quarter of 2001, we recorded a gross loss of approximately $55.7 million due to the Petrobras 36 oil production platform sinking. Excluding this one claim, our GAAP gross loss ratio would have been 70% for the first quarter of 2001. The Petrobras claim was substantially reinsured, and did not have a material effect on our net earnings. The GAAP combined ratio was 96.5% in the first quarter of 2001 compared to 104.1% for the same period in 2000. Policy acquisition costs, which are net of ceding commissions on reinsurance ceded, decreased to $4.3 million during the first quarter of 2001, compared to the same period in 2000. This is principally due to the higher policy issuance fees, which are recorded as ceding commissions, charged by our insurance companies on certain lines of business during 2001. These higher ceding commissions are partially offset by the increase in costs resulting from higher retained premium. Net earnings of our insurance companies increased to $6.4 million in the first quarter of 2001 from $2.4 million for the same period in 2000, primarily due to improved underwriting results. Underwriting Agencies Premiums underwritten decreased to $203.4 million for the first quarter of 2001 from $268.9 million for the same period in 2000. Most of the decrease is the result of our consolidation of the operations of three of our underwriting agencies into the operations of our insurance companies effective January 1, 2001. Additional decreases are due to lines of business either sold or discontinued. Management fees decreased to $15.8 million for the first quarter of 2001, compared to $29.3 million for the same period in 2000 for the same reasons and as a result of higher policy issuance fees charged by and increased retentions of our insurance companies. Net earnings of our underwriting agencies decreased to $4.3 million in the first quarter of 2001 from $7.1 million in 2000 for the same reasons. Intermediaries Commission income was $14.6 million for the first quarter of 2001, compared to $14.8 million for the same period in 2000. Net earnings of our intermediary segment decreased to $3.6 million for the first quarter of 2001 compared to $4.8 million for the same period of 2000. This difference is caused by the mix of business, which had a lower gross margin during the current quarter compared to the prior year quarter and the fact that Schanen was not subject to income taxes during 2000. 19 20 Other Operations The decrease in other operating revenue to $3.0 million during the first quarter of 2001 from $6.6 million for the same period in 2000 results principally from the sale or closure of certain operations during 2000. Also, a gain of $1.1 million from the sale of a unit was recorded during the first quarter of 2000 whereas there was no such gain in the first quarter 2001. Net earnings of other operations decreased to $516,000 in 2001 from $1.0 million in 2000 for the same reasons. Quarter to quarter comparisons may vary substantially depending on other operating investments or dispositions thereof in any given period. Liquidity and Capital Resources We receive substantial cash from premiums, collection of reinsurance recoverables, management fee and commission income and, to a lesser extent, investment income and proceeds from sales and redemptions of investments and other assets. Our principal cash outflows are for the payment of claims and loss adjustment expenses, payment of premiums to reinsurers, purchase of investments, debt service, policy acquisition costs, operating expenses, income and other taxes and dividends. 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. We limit our liquidity exposure by holding funds, letters of credit and other security such that net balances due to us are generally less than the gross balances shown in our condensed consolidated balance sheets. We maintain a substantial level of cash and liquid short-term investments which are used to meet anticipated payment obligations. Our consolidated cash and investment portfolio increased $22.2 million, or 3% since December 31, 2000, and totaled $747.3 million as of March 31, 2001, of which $284.5 million was cash and short-term investments. The increase in investments resulted from operating cash flows which continue to be strong. The operating cash flow for the first quarter of 2000 was exceptionally high in relation to 2001 because of the receipt of $53.2 million from a reinsurance commutation and a net income tax refund of $6.9 million. On March 6, 2001, we sold 6.9 million shares of our common stock in a public offering at a price of $23.35 per share. Net proceeds from the offering amounted to $152.5 million after deducting underwriting discounts, commissions and estimated offering expenses and were used to pay down our bank facility. On December 17, 1999, we entered into a $300.0 million Revolving Loan Facility with a group of banks. We can borrow up to $300.0 million under the facility on a revolving basis until the facility expires 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 two of our principal insurance companies, Houston Casualty Company and Avemco Insurance Company, and by the stock of and guarantees entered into by our principal underwriting agency and intermediary subsidiaries. The facility agreement contains certain restrictive covenants, including minimum net worth requirements for us and certain of our subsidiaries, restrictions on certain extraordinary corporate actions, notice requirements for certain material occurrences and required maintenance of specified financial ratios. We believe that the restrictive covenants and our obligations that are contained in the facility agreement are typical for financing arrangements comparable to our facility. As of March 31, 2001, total debt outstanding under the facility was $53.0 million with a weighted average interest rate of 6.5%. We continue to collect our receivables and recoverables generally in the ordinary course of business and we have not incurred and do not expect to incur any significant liquidity difficulties as a result of the level of gross amounts due. However, a number of reinsurers have delayed or suspended the payment of amounts recoverable under certain reinsurance contracts to which we are a party. Such delays have affected, though not materially to date, the investment income of our insurance companies, but not to any extent their liquidity. We limit our liquidity exposure by holding funds, letters of credit or other security such that net balances due are significantly less than the gross balances shown in our condensed consolidated balance sheets. In addition, a number of reinsurers have claimed they are not liable for payment to us and, in one or more cases, have sought arbitration of these matters. We believe these claims are without merit and expect to collect the full amount recoverable. We 20 21 are currently in negotiations with most of these parties. If such negotiations do not result in a satisfactory resolution of the matters in question, we will seek a judicial or arbitral determination of these matters. Loss and loss adjustment expense payable increased $46.6 million between December 31, 2000 and March 31, 2001 primarily due to the Petrobras loss. Because the Petrobras loss is substantially reinsured, reinsurance recoverables also increased during the first quarter of 2001. We expect the Petrobras claim to be paid and the related reinsurance recoverables collected during the next 60 days. We believe that our operating cash flows, short-term investments and bank facility will provide sufficient sources of liquidity to meet our operating needs for the foreseeable future. Effects of Recent Accounting Pronouncements We adopted Statement of Financial Accounting Standards ("SFAS") No. 133 entitled "Accounting for Derivative Instruments and Hedging Activities" effective January 1, 2001. The cumulative effect adjustment due to this change in accounting is not material to our financial position, results of operations or cash flows and, since we utilize derivatives or hedging strategies on a limited basis, we do not expect the adoption of SFAS No. 133 to be material on an ongoing basis. The Financial Accounting Standards Board has recently announced that it proposes to change the accounting for certain acquisitions and goodwill. This pronouncement, if finally adopted, could affect the way we account for and the structure of future acquisitions. Rules implementing the announced standards are not final and no date has been established for adopting the final standards. 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 our Annual Report on Form 10-K for the year ended December 31, 2000. 21 22 PART II - OTHER INFORMATION Item 1. Legal Proceedings We are party to numerous lawsuits and other proceedings that arise in the normal course of our business. Many of such lawsuits and other proceedings involve claims under policies that we underwrite as an insurer or reinsurer, the liabilities for which, we believe, have been adequately included in our loss reserves. Also, from time to time we are a party to lawsuits and other proceedings which relate to disputes over contractual relationships with third parties, or which involve alleged errors and omissions on the part of our subsidiaries. We believe the resolution of such lawsuits will not have a material adverse effect on our financial condition, results of operations or cash flows. See also Note (3) concerning the collection of reinsurance recoverables. Item 6. Exhibits and Reports on Form 8-K (a) Exhibits None. (b) Reports on Form 8-K On February 23, 2001, we filed a report on Form 8-K related to our announcement of financial results for the fourth quarter and full year 2000. On March 2, 2001, we filed a report on Form 8-K related to our announcement that we had priced a public offering of 6.9 million shares of our common stock at $23.35 per share. 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) May 14, 2000 /s/ Stephen L. Way - --------------------------- ----------------------------------------------- (Date) Stephen L. Way, Chairman of the Board and Chief Executive Officer May 14, 2000 /s/ Edward H. Ellis, Jr. - --------------------------- ----------------------------------------------- (Date) Edward H. Ellis, Jr., Senior Vice President and Chief Financial Officer 22 -----END PRIVACY-ENHANCED MESSAGE-----