-----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, KovMSZxhwlctGdT+Q+k8iOJbNJi8H7+Y4aK/LSVhVrob+hQ/oVTIG9HwvMZ23OGz 0bCjqXi0RQt57UCoS5Qblg== 0000950129-01-501353.txt : 20010615 0000950129-01-501353.hdr.sgml : 20010615 ACCESSION NUMBER: 0000950129-01-501353 CONFORMED SUBMISSION TYPE: 8-K PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 20010614 ITEM INFORMATION: ITEM INFORMATION: FILED AS OF DATE: 20010614 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: 8-K SEC ACT: SEC FILE NUMBER: 001-13790 FILM NUMBER: 1660357 BUSINESS ADDRESS: STREET 1: 13403 NORTHWEST FRWY CITY: HOUSTON STATE: TX ZIP: 77040-6094 BUSINESS PHONE: 7136907300 8-K 1 h88344e8-k.txt HCC INSURANCE HOLDINGS, INC. - DATED 6/14/01 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ----------------------- FORM 8-K CURRENT REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 DATE OF REPORT (DATE OF EARLIEST EVENT REPORTED) JUNE 14, 2001 HCC INSURANCE HOLDINGS, INC. (EXACT NAME OR REGISTRANT SPECIFIED IN ITS CHARTER) STATE OR OTHER COMMISSION IRS EMPLOYER JURISDICTION FILE NUMBER: IDENTIFICATION OF INCORPORATION: NUMBER: DELAWARE 0-20766 76-0336636
13403 NORTHWEST FREEWAY HOUSTON, TEXAS 77040-6094 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE - (713) 690-7300 --------------------------------------------- 2 ITEM 5. OTHER EVENTS 1. On January 19, 2001, HCC Insurance Holdings, Inc. ("HCC") acquired all of the outstanding shares of Schanen Consulting Corporation and its operating subsidiary, Schanen Consulting Group, LLC, (collectively "Schanen") in exchange for 996,805 shares of HCC's Common Stock. This business combination has been recorded using the pooling-of-interests method of accounting. HCC's historical consolidated financial statements have been restated to include the accounts and operations of Schanen for all periods presented. 2. On June 6, 2001, HCC executed a Second Amendment to Loan Agreement (the "Facility") with a syndicate of financial institutions led by Wells Fargo Bank Texas, National Association ("Wells Fargo"), as administrative agent, lead arranger and lender, First Union National Bank, as syndication agent and lender, Bank of America, N.A., as documentation agent and lender, The Bank of New York, as senior managing agent and lender, Citicorp USA, as lender, and Southwest Bank of Texas, NA, as lender. Subsequent to the public offering of its Common Stock in March, 2001, HCC reviewed its anticipated capital needs and its ability to access the capital markets. HCC determined that it could afford to reduce its outstanding bank line of credit under the Facility and thereby lower its costs. Accordingly, HCC has reduced the size of the Facility from $300,000,000 to $200,000,000 and lowered the commitment fee from 25 basis points to 15 basis points on the unused portion of the Facility. HCC also changed the members of the syndicate of lenders, their respective commitment levels and revised certain covenants included in the Facility in order to provide increased operating flexibility. ITEM 7. FINANCIAL STATEMENTS AND EXHIBITS. (c) Exhibits. 99.1 Restated Consolidated Financial Statements of HCC Insurance Holdings, Inc. 99.2 Consent of PricewaterhouseCoopers LLP 99.3 Second Amendment to Loan Agreement dated as of June 6, 2001 among HCC Insurance Holdings, Inc. as borrower, Wells Fargo Bank Texas, National Association, as administrative agent, lead arranger and lender, First Union National Bank, as syndication agent and lender, Bank of America, N.A., as documentation agent and lender, The Bank of New York, as senior managing agent and lender, Citicorp USA, as lender, and Southwest Bank of Texas, N.A., as lender. 3 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 hereunto duly authorized. Dated: June 14, 2001 HCC INSURANCE HOLDINGS, INC. By: /s/ Christopher L. Martin ------------------------------------ Christopher L. Martin Vice President and General Counsel 4 EXHIBIT INDEX Exhibit No. Description - ----------- ----------- 99.1 Restated Consolidated Financial Statements of HCC Insurance Holdings, Inc. 99.1 Consent of PricewaterhouseCoopers LLP 99.3 Second Amendment to Loan Agreement dated as of June 6, 2001 among HCC Insurance Holdings, Inc. as borrower, Wells Fargo Bank Texas, National Association, as administrative agent, lead arranger and lender, First Union National Bank, as syndication agent and lender, Bank of America, N.A., as documentation agent and lender, The Bank of New York, as senior managing agent and lender, Citicorp USA, as lender, and Southwest Bank of Texas, N.A., as lender. EX-99.1 2 h88344ex99-1.txt RESTATED CONSOLIDATED FINANCIAL STATEMENTS 1 EXHIBIT 99.1 Report of Independent Accountants To the Board of Directors and Shareholders HCC Insurance Holdings, Inc. In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of earnings, comprehensive income, changes in shareholders' equity and cash flows present fairly, in all material respects, the financial position of HCC Insurance Holdings, Inc. and its subsidiaries at December 31, 2000 and 1999, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2000, in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. As discussed in Note 1, effective January 1, 2000 the Company changed its method of revenue recognition for certain contracts as prescribed by the Securities and Exchange Commission's Staff Accounting Bulletin No. 101 entitled "Revenue Recognition in Financial Statements". /s/ PricewaterhouseCoopers LLP Houston, Texas March 21, 2001 except for the second paragraph of Note 2, as to which the date is May 28, 2001. F-1 2 HCC Insurance Holdings, Inc. and Subsidiaries ---------- Consolidated Balance Sheets ----------
Pro forma ----------------- December 31, 2000 (Unaudited, December 31, See Note 2) 2000 1999 --------------- --------------- --------------- ASSETS Investments: Fixed income securities, at market (cost: 2000 $422,821,000; 1999 $343,534,000) $ 433,844,000 $ 433,844,000 $ 342,641,000 Marketable equity securities, at market (cost: 2000 $8,896,000; 1999 $22,493,000) 6,282,000 6,282,000 19,970,000 Short-term investments, at cost, which approximates market 264,141,000 263,805,000 215,694,000 Other investments, at cost, which approximates fair value 7,182,000 7,182,000 3,017,000 --------------- --------------- --------------- Total investments 711,449,000 711,113,000 581,322,000 Cash 13,991,000 13,991,000 26,825,000 Restricted cash and cash investments 101,738,000 101,738,000 84,112,000 Premium, claims and other receivables 586,721,000 586,721,000 622,910,000 Reinsurance recoverables 789,412,000 789,412,000 736,485,000 Ceded unearned premium 114,469,000 114,469,000 133,657,000 Ceded life and annuity benefits 86,760,000 86,760,000 95,760,000 Deferred policy acquisition costs 39,108,000 39,108,000 40,450,000 Property and equipment, net 39,438,000 39,438,000 37,924,000 Goodwill 266,015,000 266,015,000 263,687,000 Other assets 18,995,000 18,995,000 42,844,000 --------------- --------------- --------------- TOTAL ASSETS $ 2,768,096,000 $ 2,767,760,000 $ 2,665,976,000 =============== =============== =============== LIABILITIES Loss and loss adjustment expense payable $ 944,117,000 $ 944,117,000 $ 871,104,000 Life and annuity policy benefits 86,760,000 86,760,000 95,760,000 Reinsurance balances payable 130,746,000 130,746,000 113,373,000 Unearned premium 190,550,000 190,550,000 188,524,000 Deferred ceding commissions 30,013,000 30,013,000 39,792,000 Premium and claims payable 594,852,000 594,852,000 598,638,000 Notes payable 59,633,000 212,133,000 242,546,000 Accounts payable and accrued liabilities 47,659,000 47,659,000 57,800,000 --------------- --------------- --------------- Total liabilities 2,084,330,000 2,236,830,000 2,207,537,000 SHAREHOLDERS' EQUITY Common Stock, $1.00 par value; 250,000,000 shares authorized; (shares issued and outstanding: pro forma 58,242,006; 2000 51,342,006; 1999 49,835,832) 58,242,000 51,342,000 49,836,000 Additional paid-in capital 342,935,000 196,999,000 175,363,000 Retained earnings 277,876,000 277,876,000 235,932,000 Accumulated other comprehensive income (loss) 4,713,000 4,713,000 (2,692,000) --------------- --------------- --------------- Total shareholders' equity 683,766,000 530,930,000 458,439,000 --------------- --------------- --------------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 2,768,096,000 $ 2,767,760,000 $ 2,665,976,000 =============== =============== ===============
See Notes to Consolidated Financial Statements. F-2 3 HCC Insurance Holdings, Inc. and Subsidiaries ---------- Consolidated Statements of Earnings ----------
For the years ended December 31, 2000 1999 1998 ------------- ------------- ------------- REVENUE Net earned premium $ 267,647,000 $ 141,362,000 $ 143,100,000 Management fees 96,058,000 90,713,000 74,045,000 Commission income 49,886,000 58,233,000 40,804,000 Net investment income 39,836,000 30,946,000 29,342,000 Net realized investment gain (loss) (5,321,000) (4,164,000) 845,000 Other operating income 25,497,000 28,475,000 22,268,000 ------------- ------------- ------------- Total revenue 473,603,000 345,565,000 310,404,000 EXPENSE Loss and loss adjustment expense 198,470,000 109,650,000 91,302,000 Operating expense: Policy acquisition costs, net 23,743,000 8,177,000 10,978,000 Compensation expense 83,086,000 79,196,000 57,227,000 Provision for reinsurance -- 43,462,000 -- Other operating expense 53,274,000 53,273,000 36,558,000 ------------- ------------- ------------- Total operating expense 160,103,000 184,108,000 104,763,000 Interest expense 20,347,000 12,964,000 6,021,000 ------------- ------------- ------------- Total expense 378,920,000 306,722,000 202,086,000 ------------- ------------- ------------- Earnings before income tax provision 94,683,000 38,843,000 108,318,000 Income tax provision 37,202,000 12,271,000 35,208,000 ------------- ------------- ------------- Earnings before cumulative effect of accounting change 57,481,000 26,572,000 73,110,000 Cumulative effect of accounting change, net of deferred tax effect of $1,335,000 (2,013,000) -- -- ------------- ------------- ------------- NET EARNINGS $ 55,468,000 $ 26,572,000 $ 73,110,000 ============= ============= ============= BASIC EARNINGS PER SHARE DATA: Earnings before accounting change $ 1.13 $ 0.53 $ 1.49 Cumulative effect of accounting change (0.04) -- -- ------------- ------------- ------------- Net earnings $ 1.09 $ 0.53 $ 1.49 ============= ============= ============= Weighted average shares outstanding 50,742,000 50,058,000 48,917,000 ============= ============= ============= DILUTED EARNINGS PER SHARE DATA: Earnings before accounting change $ 1.11 $ 0.52 $ 1.46 Cumulative effect of accounting change (0.04) -- -- ------------- ------------- ------------- Net earnings $ 1.07 $ 0.52 $ 1.46 ============= ============= ============= Weighted average shares outstanding 51,619,000 50,646,000 49,933,000 ============= ============= =============
See Notes to Consolidated Financial Statements. F-3 4 HCC Insurance Holdings, Inc. and Subsidiaries ---------- Consolidated Statements of Comprehensive Income ----------
For the years ended December 31, 2000 1999 1998 ------------ ------------ ------------ Net earnings $ 55,468,000 $ 26,572,000 $ 73,110,000 Other comprehensive income net of tax: Foreign currency translation adjustment (172,000) 167,000 (344,000) Investment gains (losses): Investment gains (losses) during the year, net of income tax charge (benefit) of $2,386,000 in 2000, ($8,042,000) in 1999 and $1,283,000 in 1998 4,118,000 (15,271,000) 2,598,000 Less reclassification adjustment for (gains) losses included in net earnings, net of income tax (charge) benefit of $1,862,000 in 2000, $1,457,000 in 1999 and ($296,000) in 1998 3,459,000 2,707,000 (549,000) ------------ ------------ ------------ Other comprehensive income (loss) 7,405,000 (12,397,000) 1,705,000 ------------ ------------ ------------ COMPREHENSIVE INCOME $ 62,873,000 $ 14,175,000 $ 74,815,000 ============ ============ ============
See Notes to Consolidated Financial Statements. F-4 5 HCC Insurance Holdings, Inc. and Subsidiaries ---------- Consolidated Statements of Changes in Shareholders' Equity For the years ended December 31, 2000, 1999 and 1998 ----------
Additional Common paid-in Retained Stock capital earnings ------------- ------------- ------------- BALANCE AS OF DECEMBER 31, 1997 $ 48,756,000 $ 153,637,000 $ 155,386,000 Net earnings -- -- 73,110,000 Other comprehensive income -- -- -- 206,504 shares of Common Stock issued for exercise of options, including tax benefit of $925,000 206,000 1,997,000 -- 287,025 shares of Common Stock issued for purchased companies 287,000 5,472,000 -- Dividends to shareholders of pooled company prior to acquisition -- -- (443,000) Cash dividends declared, $0.16 per share -- -- (7,683,000) ------------- ------------- ------------- BALANCE AS OF DECEMBER 31, 1998 $ 49,249,000 $ 161,106,000 $ 220,370,000 ============= ============= =============
Accumulated other Total comprehensive shareholders' income (loss) equity ------------- ------------- BALANCE AS OF DECEMBER 31, 1997 $ 8,000,000 $ 365,779,000 Net earnings -- 73,110,000 Other comprehensive income 1,705,000 1,705,000 206,504 shares of Common Stock issued for exercise of options, including tax benefit of $925,000 -- 2,203,000 287,025 shares of Common Stock issued for purchased companies -- 5,759,000 Dividends to shareholders of pooled company prior to acquisition -- (443,000) Cash dividends declared, $0.16 per share -- (7,683,000) ------------- ------------- BALANCE AS OF DECEMBER 31, 1998 $ 9,705,000 $ 440,430,000 ============= =============
See Notes to Consolidated Financial Statements. F-5 6 HCC Insurance Holdings, Inc. and Subsidiaries ---------- Consolidated Statements of Changes in Shareholders' Equity For the years ended December 31, 2000, 1999 and 1998 (continued) ----------
Additional Common paid-in Retained Stock capital earnings ------------- ------------- ------------- BALANCE AS OF DECEMBER 31, 1998 $ 49,249,000 $ 161,106,000 $ 220,370,000 Net earnings -- -- 26,572,000 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 -- Dividends to shareholders of pooled company prior to acquisition -- -- (1,005,000) Cash dividends declared, $0.20 per share -- -- (9,733,000) Contractual adjustments to previous acquisitions (20,000) (190,000) (272,000) ------------- ------------- ------------- BALANCE AS OF DECEMBER 31, 1999 $ 49,836,000 $ 175,363,000 $ 235,932,000 ============= ============= =============
Accumulated other Total comprehensive shareholders' income (loss) equity ------------- ------------- BALANCE AS OF DECEMBER 31, 1998 $ 9,705,000 $ 440,430,000 Net earnings -- 26,572,000 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 Dividends to shareholders of pooled company prior to acquisition -- (1,005,000) Cash dividends declared, $0.20 per share -- (9,733,000) Contractual adjustments to previous acquisitions -- (482,000) ------------- ------------- BALANCE AS OF DECEMBER 31, 1999 $ (2,692,000) $ 458,439,000 ============= =============
See Notes to Consolidated Financial Statements. F-6 7 HCC Insurance Holdings, Inc. and Subsidiaries ---------- Consolidated Statements of Changes in Shareholders' Equity For the years ended December 31, 2000, 1999, and 1998 (continued) ----------
Additional Common paid-in Retained Stock capital earnings ------------- ------------- ------------- BALANCE AS OF DECEMBER 31, 1999 $ 49,836,000 $ 175,363,000 $ 235,932,000 Net earnings -- -- 55,468,000 Other comprehensive income -- -- -- 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 -- 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 -- Contractual grant of pooled company common stock by a shareholder prior to acquisition -- 1,040,000 -- Dividends to shareholders of pooled company prior to acquisition -- -- (2,593,000) Cash dividends declared, $0.22 per share -- -- (10,931,000) ------------- ------------- ------------- BALANCE AS OF DECEMBER 31, 2000 $ 51,342,000 $ 196,999,000 $ 277,876,000 ============= ============= =============
Accumulated other Total comprehensive shareholders' income (loss) equity ------------- ------------- BALANCE AS OF DECEMBER 31, 1999 $ (2,692,000) $ 458,439,000 Net earnings -- 55,468,000 Other comprehensive income 7,405,000 7,405,000 1,266,701 shares of Common Stock issued for exercise of options, including tax benefit of $3,627,000 -- 20,862,000 Issuance of 144,973 shares of contractually issuable Common Stock -- -- Issuance of 94,500 shares of contingently issuable Common Stock -- 1,240,000 Contractual grant of pooled company common stock by a shareholder prior to acquisition -- 1,040,000 Dividends to shareholders of pooled company prior to acquisition -- (2,593,000) Cash dividends declared, $0.22 per share -- (10,931,000) ------------- ------------- BALANCE AS OF DECEMBER 31, 2000 $ 4,713,000 $ 530,930,000 ============= =============
See Notes to Consolidated Financial Statements. F-7 8 HCC Insurance Holdings, Inc. and Subsidiaries ---------- Consolidated Statements of Cash Flows ----------
For the years ended December 31, 2000 1999 1998 ------------- ------------- ------------- Cash flows from operating activities: Net earnings $ 55,468,000 $ 26,572,000 $ 73,110,000 Adjustments to reconcile net earnings to net cash provided by operating activities: Change in premium, claims and other receivables 30,501,000 (92,206,000) (102,804,000) Change in reinsurance recoverables (52,007,000) (284,504,000) (195,707,000) Change in ceded unearned premium 19,188,000 31,408,000 (64,958,000) Change in deferred policy acquisition costs, net (8,664,000) (4,659,000) 5,666,000 Change in other assets 13,362,000 (12,081,000) 410,000 Change in loss and loss adjustment expense payable 72,311,000 264,360,000 181,626,000 Change in reinsurance balances payable 17,052,000 (15,098,000) 47,069,000 Change in unearned premium 2,689,000 (31,138,000) 46,074,000 Change in premium and claims payable, net of restricted cash (20,727,000) 102,114,000 64,364,000 Change in accounts payable and accrued liabilities (12,229,000) 4,707,000 (9,205,000) Net realized investment (gain) loss 5,321,000 4,164,000 (845,000) Gains on sales of other operating investments (5,739,000) (5,523,000) (4,694,000) Provision for reinsurance -- 43,462,000 -- Depreciation and amortization expense 19,908,000 13,420,000 7,405,000 Other, net 1,390,000 (1,824,000) 4,157,000 ------------- ------------- ------------- Cash provided by operating activities 137,824,000 43,174,000 51,668,000 Cash flows from investing activities: Sales of fixed income securities 137,175,000 131,485,000 18,212,000 Maturity or call of fixed income securities 34,341,000 17,050,000 30,202,000 Sales of equity securities 7,969,000 2,886,000 4,160,000 Dispositions of other operating investments 27,803,000 15,905,000 3,324,000 Change in short-term investments (69,400,000) (14,935,000) (24,667,000) Cash paid for companies acquired, net of cash received (8,909,000) (186,923,000) (33,011,000) Cost of investments acquired (244,586,000) (70,736,000) (43,968,000) Purchase of property and equipment and other (9,535,000) (9,114,000) (15,384,000) ------------- ------------- ------------- Cash used by investing activities (125,142,000) (114,382,000) (61,132,000) Cash flows from financing activities: Proceeds from notes payable 26,700,000 547,000,000 74,200,000 Sale of Common Stock 17,235,000 3,627,000 1,278,000 Payments on notes payable (57,042,000) (458,600,000) (49,950,000) Dividends paid (12,409,000) (10,226,000) (7,582,000) ------------- ------------- ------------- Cash provided (used) by financing activities (25,516,000) 81,801,000 17,946,000 ------------- ------------- ------------- Net change in cash (12,834,000) 10,593,000 8,482,000 Cash as of beginning of year 26,825,000 16,232,000 7,750,000 ------------- ------------- ------------- CASH AS OF END OF YEAR $ 13,991,000 $ 26,825,000 $ 16,232,000 ============= ============= =============
See Notes to Consolidated Financial Statements. F-8 9 HCC Insurance Holdings, Inc. and Subsidiaries ---------- Notes to Consolidated Financial Statements (1) GENERAL INFORMATION AND SIGNIFICANT ACCOUNTING AND REPORTING POLICIES HCC Insurance Holdings, Inc. ("the Company" or "HCC") and its subsidiaries, include domestic and foreign property and casualty and life insurance companies, underwriting agencies, intermediaries and service companies. HCC, through its subsidiaries, provides specialized property and casualty and life and health insurance to commercial customers in the areas of accident and health reinsurance and aviation, marine and offshore energy, medical stop-loss, property and workers' compensation insurance. The principal insurance company subsidiaries are Houston Casualty Company ("HC") in Houston, Texas, and London, England; HCC Life Insurance Company ("HCCL") in Houston, Texas; U.S. Specialty Insurance Company ("USSIC") in Houston, Texas; and Avemco Insurance Company ("AIC") in Frederick, Maryland. The underwriting agency subsidiaries provide underwriting management and claims servicing for insurance and reinsurance companies, specializing in aviation, medical stop-loss, occupational accident and workers' compensation insurance and a variety of accident and health related reinsurance products. The principal agency subsidiaries are LDG Reinsurance Corporation ("LDG Re") in Wakefield, Massachusetts and New York City, New York; and HCC Benefits Corporation ("HCCB") in Atlanta, Georgia, Costa Mesa, California, Wakefield, Massachusetts, Minneapolis, Minnesota and Dallas, Texas. We have recently consolidated the operations of other of the Company's agencies with certain of the Company's insurance companies. The intermediary subsidiaries provide brokerage, consulting and other intermediary services to insurance and reinsurance companies, commercial customers and individuals in the same lines of business as the insurance companies operate. The Company's principal intermediary subsidiaries are HCC Intermediaries, Inc. ("HCCI") in Houston, Texas; HCC Employee Benefits, Inc. ("HCCEB") in Houston, Texas and Atlanta, Georgia; and Rattner Mackenzie Limited ("RML") in London, England. The service company subsidiaries perform various insurance related services for insurance companies. The preparation of financial statements in conformity with generally accepted accounting principles in the United States ("GAAP") requires management to make estimates and assumptions. This affects amounts reported in the financial statements and the disclosure of contingent assets and liabilities. Actual results could differ from those estimates. A description of the significant accounting and reporting policies utilized by the Company in preparing the consolidated financial statements is as follows: Principles of Consolidation The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. The consolidated financial statements have been restated for all periods presented to include the accounts and operations of a group of companies acquired on January 19, 2001 in a transaction accounted for using the pooling-of-interests method of accounting. F-9 10 HCC Insurance Holdings, Inc. and Subsidiaries ---------- Notes to Consolidated Financial Statements (continued) (1) GENERAL INFORMATION AND SIGNIFICANT ACCOUNTING AND REPORTING POLICIES, CONTINUED Investments Fixed income securities and marketable equity securities are classified as available for sale and are carried at quoted market value, if readily marketable, or at management's estimated fair value, if not readily marketable. The change in unrealized gain or loss with respect to these securities is recorded as a component of other comprehensive income, net of the related deferred income tax effects, if any. Fixed income securities available for sale are purchased with the original intent to hold to maturity, but they may be available for sale if market conditions warrant, or if the Company's investment policies dictate, in order to maximize the Company's investment yield. Short-term investments and restricted short-term investments are carried at cost, which approximates market value. For the mortgage-backed securities portion of the fixed income portfolio, the Company recognizes income using a constant effective yield based on anticipated prepayments and the estimated economic life of the securities. When actual prepayments differ significantly from anticipated prepayments, the estimated economic life is recalculated and the remaining unamortized premium or discount is amortized prospectively over the remaining economic life. The realized gain or loss on investment transactions is determined on an average cost basis and included in earnings on the trade date. When impairment of the value of an investment is considered other than temporary, the decrease in value is reported in earnings as a realized investment loss and a new cost basis is established. Property and Equipment Property and equipment are carried at cost, net of accumulated depreciation. Depreciation expense is provided using the straight-line method over the estimated useful lives of the related assets. Amortization of leasehold improvements is provided using the straight-line method over the shorter of the estimated useful life or the term of the respective lease. Upon disposal of assets, the cost and related accumulated depreciation are removed from the accounts and the resulting gain or loss is included in earnings. Costs incurred in developing or purchasing management information systems are capitalized and included in property and equipment. These costs are amortized over their estimated useful lives from the dates the systems are placed in service. Earned Premium, Deferred Policy Acquisition Costs and Ceding Commissions of Insurance Company Subsidiaries All of the policies written by the Company are short-duration as defined by current accounting literature. Written premium, net of reinsurance, is primarily included in earnings on a pro rata basis over the lives of the related policies. However, for certain types of business, it is recognized over the period of risk in proportion to the amount of insurance risk provided. Policy acquisition costs, including commissions, taxes, fees and other direct costs of underwriting policies, less ceding commissions allowed by reinsurers, including expense allowances, are deferred and charged or credited to earnings proportionate to the premium earned. Historical and current loss and loss adjustment expense experience and anticipated investment income are considered in determining the recoverability of deferred policy acquisition costs. F-10 11 HCC Insurance Holdings, Inc. and Subsidiaries ---------- Notes to Consolidated Financial Statements (continued) (1) GENERAL INFORMATION AND SIGNIFICANT ACCOUNTING AND REPORTING POLICIES, CONTINUED Management Fees and Commission Income When there is no future servicing obligation, management fees and commission income are recognized on the revenue recognition date, which is the later of the effective date of policy, the date when the premium can be reasonably established, or the date when substantially all the services relating to the insurance placement have been rendered to the client. When additional services are required, the service revenue is deferred and recognized over the service period. The Company also records an allowance for estimated return commissions which the Company may be required to pay upon the early termination of policies. The Company changed certain of its revenue recognition methods for its agencies and intermediaries to agree with guidance contained in SEC Staff Accounting Bulletin Number 101 ("SAB 101") entitled "Revenue Recognition in Financial Statements." Previously, the Company's agencies and intermediaries recognized revenue in conformity with principles that historically had been considered generally accepted accounting principles for insurance agents and brokers. The Company had recognized return commissions when the event occurred that caused the return and accrued a liability for future servicing costs, when significant, instead of deferring revenue. The after-tax cumulative non-cash charge resulting from the adoption of SAB 101 was $2.0 million. As required by this new accounting guidance, the Company has restated the 2000 first quarter results for the cumulative effect of the change in accounting. The change was not material to earnings before cumulative effect of accounting change for the year ended December 31, 2000 or to net earnings for any prior year presented. Other Operating Revenue The Company has two primary sources of other operating revenue, which are included in the Company's other operations segment. The first source is a variety of insurance related services, principally claims adjusting services. These revenues are recorded when the service is performed. The second source is income from and gains or losses from the disposition of investments made in this segment. The income is recognized as earned and the gains or losses from the sale of investments are recognized upon consummation of the transaction or upon other-than-temporary impairments. Premium and Other Receivables The Company uses the gross method for reporting receivables and payables on brokered transactions. Management reviews the collectibility of its receivables on a current basis and provides an allowance for doubtful accounts if it deems that there are accounts which are doubtful of collection. The amount of the allowance as of December 31, 2000 and 1999 was $3.2 million and $1.7 million, respectively. Management's estimate of the level of the allowance could change as conditions change in the future. Loss and Loss Adjustment Expense Payable of Insurance Company Subsidiaries Loss and loss adjustment expense payable is based on estimates of payments to be made for reported and incurred but not reported ("IBNR") losses and anticipated salvage and subrogation receipts. Currently all reserves are recorded on an undiscounted basis. Estimates for reported losses are based on all available information, including reports received from ceding companies on business. Estimates for IBNR are based both on the Company's and the industry's experience. While management believes that amounts included in the accompanying financial F-11 12 HCC Insurance Holdings, Inc. and Subsidiaries ---------- Notes to Consolidated Financial Statements (continued) (1) GENERAL INFORMATION AND SIGNIFICANT ACCOUNTING AND REPORTING POLICIES, CONTINUED statements are adequate, such estimates may be more or less than the amounts ultimately paid when the claims are settled. The estimates are continually reviewed and any changes are reflected in current operations. Reinsurance The Company records all reinsurance recoverables and ceded unearned premiums as assets and deferred ceding commissions as a liability. All such amounts are recorded in a manner consistent with the underlying reinsured contracts. Management has also recorded a reserve for uncollectible reinsurance based on current estimates of collectibility. These estimates could change and affect the level of the reserve needed. Goodwill In connection with the Company's acquisitions of subsidiaries accounted for as purchases, the excess of cost over fair value of net assets acquired is being amortized using the straight-line method over twenty years for acquired agency operations which operate in existing lines of business and in the same country. Goodwill related to acquired agency operations which represent the Company's initial entry into new lines of business or new countries is amortized over thirty years. Goodwill related to acquired insurance company operations is amortized over forty years. Managements of the acquired businesses have successfully operated in their markets for a number of years and, with the additional capital provided by the Company, will be positioned to take advantage of increased opportunities. Accumulated amortization of goodwill as of December 31, 2000 and 1999, was $24.9 million and $11.9 million, respectively. The Company's accounting policy regarding the assessment of the recoverability of the carrying value of long-lived assets, including goodwill and other intangibles and property and equipment, is to review the carrying value of the assets if the facts and circumstances suggest that they may be impaired. If this review indicates that the carrying value will not be recoverable, as determined based on projected undiscounted future cash flows, the carrying value is reduced to its estimated fair value. Amortization of goodwill charged to income for the years ended December 31, 2000, 1999 and 1998 was $13.0 million, $6.7 million and $3.0 million, respectively. Cash and Short-term Investments Cash consists of cash in banks, generally in operating accounts. The Company classifies certificates of deposit, corporate demand notes receivable, commercial paper and money market funds as short-term investments. Short-term investments are classified as investments in the consolidated balance sheets as they relate principally to the Company's investment activities. As of December 31, 2000 and 1999 the Company included $158.3 million and $138.5 million, respectively, of certain fiduciary funds in short-term investments. These are funds held by underwriting agency or intermediary subsidiaries for the benefit of insurance or reinsurance clients. The Company earns the interest on these funds. F-12 13 HCC Insurance Holdings, Inc. and Subsidiaries ---------- Notes to Consolidated Financial Statements (continued) (1) GENERAL INFORMATION AND SIGNIFICANT ACCOUNTING AND REPORTING POLICIES, CONTINUED The Company generally maintains its cash deposits in major banks and invests its short-term investments with major banks and in investment grade commercial paper and repurchase agreements. These securities typically mature within 90 days and, therefore, bear minimal risk. The Company has not experienced any losses on its cash deposits or its short-term investments. Restricted Cash and Cash Investments In conjunction with the management of reinsurance pools, the Company's agency subsidiaries withhold premium funds for the payment of claims. These funds are shown as restricted cash and cash investments in the consolidated balance sheets. The corresponding liability is included within premium and claims payable in the consolidated balance sheets. These amounts are considered fiduciary funds, and interest earned on these funds accrues to the benefit of the members of the reinsurance pools. Therefore, the Company does not include these amounts as cash in the consolidated statements of cash flows. Foreign Currency The functional currency of most foreign subsidiaries and branches is the U.S. Dollar. Assets and liabilities recorded in foreign currencies are translated into U.S. Dollars at exchange rates in effect at the balance sheet date. Transactions in foreign currencies are translated at the rates of exchange in effect on the date the transaction occurs. Translation gains and losses are recorded in earnings and included in other operating expenses. The Company's foreign currency transactions are principally denominated in British Pound Sterling ("GBP") and other European currencies. For the years ended December 31, 2000, 1999 and 1998, the gain (loss) from currency conversion was $(330,000), $442,000 and $219,000, respectively. Some foreign subsidiaries or branches have a functional currency of either the GBP or the Canadian Dollar ("CAD"). The cumulative translation adjustment, representing the effect of translating these subsidiaries' or branches' assets and liabilities into U.S. Dollars, is included in the foreign currency translation adjustment within accumulated other comprehensive income. On a limited basis, the Company enters into foreign currency forward contracts as a hedge against foreign currency fluctuations. RML has revenue streams in U.S. Dollars and Canadian Dollars but its expenses are paid in GBP. To mitigate the foreign exchange risk, the Company entered into foreign currency forward contracts expiring at staggered times through December, 2001. The foreign currency forward contracts are used to convert currency at a known rate in an amount which approximates average monthly expenses. Thus, the effect of these transactions is to limit the foreign currency exchange risk of the recurring monthly expenses. The Company utilizes these foreign currency forward contracts strictly as a hedge against existing exposure to foreign currency fluctuations rather than as a form of speculative or trading investment. To the extent the foreign exchange forward contracts qualify for hedge accounting treatment, the gain ($4,000 as of December 31, 2000), or loss due to changes in fair value is not recognized in the financial statements until realized, at which time the gain or loss is recognized along with the offsetting loss or gain on the hedged item. To the extent the 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. F-13 14 HCC Insurance Holdings, Inc. and Subsidiaries ---------- Notes to Consolidated Financial Statements (continued) (1) GENERAL INFORMATION AND SIGNIFICANT ACCOUNTING AND REPORTING POLICIES, CONTINUED Income Tax The companies file a consolidated Federal income tax return and include the foreign subsidiaries' income to the extent required by law. Deferred income tax is accounted for using the liability method, which reflects the tax impact of temporary differences between the bases of assets and liabilities for financial reporting purposes and such bases as measured by tax laws and regulations. Earnings Per Share Basic earnings per share is based on the weighted average number of common shares outstanding during the year divided into net earnings. Diluted earnings per share is based on the weighted average number of common shares outstanding plus the potential common shares outstanding during the year divided into net earnings. Outstanding common stock options, when dilutive, are considered to be potential common stock for the purpose of the diluted calculation. The treasury stock method is used to calculate potential common stock outstanding due to options. Contingent shares to be issued are included in the earnings per share computation when the underlying conditions for issuance have been met. Effects of Recent Accounting Pronouncements Statement of Financial Accounting Standards ("SFAS") No. 133 entitled "Accounting for Derivative Instruments and Hedging Activities" was issued in June, 1998 and is effective for the Company January 1, 2001. The Company has utilized derivatives or hedging strategies on a limited basis. After adoption, hedge effectiveness will be measured by comparing RML's actual GBP expenses with proceeds from the forward currency forward contracts. The cumulative effect adjustment due to this change in accounting has been calculated by the Company and is not material to its financial position, results of operations or cash flows nor does the Company expect the adoption of SFAS No. 133 to be material on an ongoing basis due to its limited use of derivatives. In addition, 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 the Company accounts for and the structure of future acquisitions. Final rules implementing the announced standards are not expected until the second quarter of 2001 and no date has been established for adopting the final standards. Reclassifications Certain amounts in the 1999 and 1998 consolidated financial statements have been reclassified to conform with the 2000 presentation. Such reclassifications had no effect on the Company's shareholders' equity, net earnings or cash flows. F-14 15 HCC Insurance Holdings, Inc. and Subsidiaries ---------- Notes to Consolidated Financial Statements (continued) (2) ACQUISITIONS AND SUBSEQUENT EVENTS Public Offering of Common Stock During March 2001, the Company sold 6.9 million shares of the Company's Common Stock in a public offering at a price of $23.35 per share. Net proceeds from the offering amounted to approximately $152.8 million after deducting underwriting discounts and commissions and estimated offering expenses. Most of the proceeds, $152.5 million, were used to pay down the bank Facility. The unaudited pro forma consolidated balance sheet gives effect to the proceeds of the public offering as if it had occurred at December 31, 2000. Schanen Acquisition On January 19, 2001, the Company acquired all of the outstanding shares of Schanen Consulting Corporation and its operating subsidiary, Schanen Consulting Group, L.L.C., (collectively "Schanen") in exchange for 996,805 shares of the Company's Common Stock. This business combination has been recorded using the pooling-of-interests method of accounting. The Company's consolidated financial statements have been restated to include the accounts and operations of Schanen for all periods presented. The table below shows revenue and net earnings of the entities being combined for the three years ended December 31, 2000:
2000 1999 1998 ------------ ------------ ------------ Revenue: Amounts as previously reported $466,167,000 $341,871,000 $308,034,000 Schanen 7,436,000 3,694,000 2,370,000 ------------ ------------ ------------ Restated total revenue $473,603,000 $345,565,000 $310,404,000 ============ ============ ============ Net earnings: Amounts as previously reported $ 53,431,000 $ 25,123,000 $ 72,278,000 Schanen 2,037,000 1,449,000 832,000 ------------ ------------ ------------ Restated net earnings $ 55,468,000 $ 26,572,000 $ 73,110,000 ============ ============ ============
Purchase Acquisitions In 1999 and 1998, the Company acquired certain businesses in transactions accounted for using the purchase method of accounting. On a combined basis, the fair value of assets acquired was $549.5 million in 1999 and $44.9 million in 1998. The fair value of liabilities assumed was $499.8 million in 1999 and $46.2 million in 1998. The total consideration was $227.4 million in 1999 and $50.0 million in 1998. The results of operations of these businesses have been included in the consolidated financial statements beginning on the effective date of each transaction. The following table lists these transactions: F-15 16 HCC Insurance Holdings, Inc. and Subsidiaries ---------- Notes to Consolidated Financial Statements (continued) (2) ACQUISITIONS AND SUBSEQUENT EVENTS, CONTINUED
Consideration ------------------------ Shares of Goodwill Company's Amortization Effective Common Goodwill Period Date Stock Cash Recognized In Years --------- ------------ ---------- ---------- ----------- 1999 RML 01/01/99 414,207 $ 64,600,000 $ 70,800,000 30 Midwest Stop Loss Underwriting 01/28/99 101,330 3,000,000 4,800,000 20 Centris 12/31/99 -- 149,500,000 101,900,000 20 1998 Guarantee Insurance Resources 03/01/98 29,029 $ 21,400,000 $ 20,900,000 20 J.E. Stone and Associates, Inc. 10/01/98 257,496 5,200,000 9,700,000 20 Sun Employer Services, Inc. 11/01/98 500 17,600,000 21,300,000 30 North American Insurance Management Corporation's occupational accident operations 11/24/98 -- 4,000,000 4,000,000 20
The following unaudited pro forma summary presents information as if the 1999 purchase acquisitions had occurred at the beginning of each year after giving effect to certain adjustments including amortization of goodwill, increased interest expense from debt issued to fund the acquisitions and Federal income taxes. Similar information for the 1998 acquisitions is not included in this presentation as it is immaterial to the 1998 consolidated financial statements. The pro forma summary is for information purposes only, does not necessarily reflect the actual results that would have occurred, nor is it necessarily indicative of future results of the combined companies. Centris, whose results are included in the pro forma financial information below, in 1999 experienced both a loss from discontinued operations of $13.2 million and significant underwriting losses.
For the years ended December 31, Unaudited Proforma Information 1999 1998 ----------------- ----------------- Revenue $ 450,933,000 $ 495,921,000 Earnings (loss) from continuing operations (613,000) 70,737,000 Net earnings (loss) (13,844,000) 47,469,000 Basic earnings (loss) per share from continuing operations (0.01) 1.43 Diluted earnings (loss) per share from continuing operations (0.01) 1.40 Basic earnings (loss) per share (0.28) 0.96 Diluted earnings (loss) per share (0.28) 0.94
F-16 17 HCC Insurance Holdings, Inc. and Subsidiaries ---------- Notes to Consolidated Financial Statements (continued) (3) INVESTMENTS Substantially all of the Company's fixed income securities are investment grade; most are A rated or better. The cost or amortized cost, gross unrealized gain or loss and estimated market value of investments in fixed income and marketable equity securities, all of which are classified as available for sale, are as follows:
Cost or Gross Gross Estimated Amortized Unrealized Unrealized Market Cost Gain Loss Value ------------ ------------ ------------ ------------ December 31, 2000: Marketable equity securities $ 8,896,000 $ 264,000 $ (2,878,000) $ 6,282,000 US Treasury securities 71,155,000 1,482,000 (25,000) 72,612,000 Obligations of states, municipalities and political subdivisions 203,768,000 5,961,000 (414,000) 209,315,000 Corporate fixed income securities 100,881,000 3,008,000 (189,000) 103,700,000 Mortgage-backed securities 39,722,000 1,183,000 (113,000) 40,792,000 Foreign government securities 7,295,000 132,000 (2,000) 7,425,000 ------------ ------------ ------------ ------------ TOTAL SECURITIES $431,717,000 $ 12,030,000 $ (3,621,000) 440,126,000 ============ ============ ============ ============ December 31, 1999: Marketable equity securities $ 22,493,000 $ 8,000 $ (2,531,000) $ 19,970,000 US Treasury securities 57,941,000 96,000 (532,000) 57,505,000 Obligations of states, municipalities and political subdivisions 263,395,000 2,548,000 (2,839,000) 263,104,000 Corporate fixed income securities 14,459,000 -- (190,000) 14,269,000 Mortgage-backed securities 529,000 -- -- 529,000 Foreign government securities 7,210,000 24,000 -- 7,234,000 ------------ ------------ ------------ ------------ TOTAL SECURITIES $366,027,000 $ 2,676,000 $ (6,092,000) $362,611,000 ============ ============ ============ ============
F-17 18 HCC Insurance Holdings, Inc. and Subsidiaries ---------- Notes to Consolidated Financial Statements (continued) (3) INVESTMENTS, CONTINUED The amortized cost and estimated market value of fixed income securities at December 31, 2000, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. The weighted average life of the Company's mortgage-backed securities is four years.
Estimated Amortized Market Cost Value ------------ ------------ Due in 1 year or less $ 28,258,000 $ 28,366,000 Due after 1 year through 5 years 162,899,000 166,001,000 Due after 5 years through 10 years 82,861,000 85,391,000 Due after 10 years through 15 years 59,201,000 60,987,000 Due after 15 years 49,880,000 52,307,000 ------------ ------------ Securities with fixed maturities 383,099,000 393,052,000 Mortgage-backed securities 39,722,000 40,792,000 ------------ ------------ TOTAL FIXED INCOME SECURITIES $422,821,000 $433,844,000 ============ ============
As of December 31, 2000, the Company's insurance company subsidiaries had deposited fixed income securities with an amortized cost of approximately $32.8 million (market: $33.5 million) to meet the deposit requirements of various insurance departments. All investments in fixed income securities and other investments were income producing for the twelve months preceding December 31, 2000. The sources of net investment income for the three years ended December 31, 2000, are detailed below:
2000 1999 1998 ------------ ------------ ------------ Fixed income securities $ 22,074,000 $ 20,098,000 $ 20,711,000 Short-term investments 18,085,000 10,928,000 8,086,000 Equity securities 59,000 36,000 35,000 Other 4,000 -- 607,000 ------------ ------------ ------------ Total investment income 40,222,000 31,062,000 29,439,000 Investment expense (386,000) (116,000) (97,000) ------------ ------------ ------------ NET INVESTMENT INCOME $ 39,836,000 $ 30,946,000 $ 29,342,000 ============ ============ ============
F-18 19 HCC Insurance Holdings, Inc. and Subsidiaries ---------- Notes to Consolidated Financial Statements (continued) (3) INVESTMENTS, CONTINUED Realized pre-tax gain (loss) on the sale or write down of investments is as follows:
Gain Loss Net ----------- ----------- ----------- For the year ended December 31, 2000: Fixed income securities $ 1,173,000 $ (970,000) $ 203,000 Marketable equity securities 567,000 (6,195,000) (5,628,000) Other investments 104,000 -- 104,000 ----------- ----------- ----------- REALIZED GAIN (LOSS) $ 1,844,000 $(7,165,000) $(5,321,000) =========== =========== =========== For the year ended December 31, 1999: Fixed income securities $ 1,226,000 $(1,390,000) $ (164,000) Marketable equity securities 450,000 (4,391,000) (3,941,000) Other investments 120,000 (179,000) (59,000) ----------- ----------- ----------- REALIZED GAIN (LOSS) $ 1,796,000 $(5,960,000) $(4,164,000) =========== =========== =========== For the year ended December 31, 1998: Fixed income securities $ 1,132,000 $ (121,000) $ 1,011,000 Marketable equity securities 245,000 (411,000) (166,000) ----------- ----------- ----------- REALIZED GAIN (LOSS) $ 1,377,000 $ (532,000) $ 845,000 =========== =========== ===========
Unrealized pre-tax net investment gains (losses) on investments for three years ended December 31, 2000 are as follows:
2000 1999 1998 ------------ ------------ ------------ Fixed income securities $ 11,916,000 $(19,024,000) $ 3,551,000 Marketable equity securities (91,000) (3,025,000) 888,000 Strategic operational investments -- 2,900,000 (1,403,000) ------------ ------------ ------------ NET UNREALIZED INVESTMENT GAIN (LOSS) $ 11,825,000 $(19,149,000) $ 3,036,000 ============ ============ ============
F-19 20 HCC Insurance Holdings, Inc. and Subsidiaries ---------- Notes to Consolidated Financial Statements (continued) (4) PROPERTY AND EQUIPMENT The following table summarizes property and equipment at December 31, 2000 and 1999:
Estimated 2000 1999 Useful Life -------------- -------------- ---------------- Buildings and improvements $ 19,332,000 $ 20,001,000 30 to 45 years Furniture, fixtures and equipment 17,516,000 16,750,000 3 to 10 years Management information systems 34,078,000 27,769,000 3 to 10 years -------------- -------------- Total property and equipment 70,926,000 64,520,000 Less accumulated depreciation and amortization (31,488,000) (26,596,000) -------------- -------------- PROPERTY AND EQUIPMENT, NET $ 39,438,000 $ 37,924,000 ============== ==============
Depreciation and amortization expense on property and equipment was approximately $6.9 million, $6.7 million and $4.4 million for the years ended December 31, 2000, 1999 and 1998, respectively. (5) NOTES PAYABLE Notes payable as of December 31, 2000 and 1999 are shown in the table below. The estimated fair value of the notes payable is based on current rates offered to the Company for debt with similar terms and approximates the carrying value at the balance sheet dates.
Pro forma December 31, 2000 (Unaudited, See Note 2) 2000 1999 ----------------- -------------- -------------- Acquisition notes $ 4,633,000 $ 4,633,000 $ 7,546,000 Facility 55,000,000 207,500,000 235,000,000 -------------- -------------- -------------- TOTAL NOTES PAYABLE $ 59,633,000 $ 212,133,000 $ 242,546,000 ============== ============== ==============
F-20 21 HCC Insurance Holdings, Inc. and Subsidiaries ---------- Notes to Consolidated Financial Statements (continued) (5) NOTES PAYABLE, CONTINUED On December 17, 1999, the Company entered into a $300.0 million Revolving Loan Facility (the "Facility") with a group of banks. Borrowing under the Facility may be made from time to time on a revolving basis 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 stock of HC and AIC and by the stock and guarantees entered into by the Company's principal underwriting agency and intermediary subsidiaries. The Facility agreement contains certain restrictive covenants, including minimum net worth requirements for the Company and certain subsidiaries, restrictions on certain extraordinary corporate actions, notice requirements for certain material occurrences, and required maintenance of specified financial ratios. Management believes that the restrictive covenants and other obligations of the Company which are contained in the Facility agreement are typical for financing arrangements comparable to the Facility. As of December 31, 2000, total debt outstanding under the Facility was $207.5 million and the weighted average interest rate was 8.18%. During March 2001, the Company reduced the debt outstanding under the Facility to $55.0 million using the proceeds from its recent public stock offering (see Note 2). The acquisition notes are payable to former owners of RML. The notes are payable in decreasing amounts in four annual installments beginning January 31, 2000. The notes carry no stated interest, but were discounted at 6.25% for financial reporting purposes when the acquisition of RML was recorded. The interest rate used was based on current rates offered to the Company as of RML's acquisition date. At December 31, 2000, certain of the Company's subsidiaries maintained revolving lines of credit with a bank in the combined maximum amount of $55.0 million available through December 31, 2001. Advances under the lines of credit are limited to amounts required to fund draws, if any, on letters of credit issued by the bank on behalf of the subsidiaries and short-term direct cash advances. The lines of credit are collateralized by securities having an aggregate market value of up to $68.8 million, the actual amount of collateral at any one time being 125% of the aggregate amount outstanding. Interest on the lines is payable at the bank's prime rate of interest less 1% (8.5% at December 31, 2000). At December 31, 2000, letters of credit totaling $26.4 million had been issued to insurance companies by the bank on behalf of the subsidiaries, with total securities of $33.1 million collateralizing the lines. F-21 22 HCC Insurance Holdings, Inc. and Subsidiaries ---------- Notes to Consolidated Financial Statements (continued) (6) INCOME TAX As of December 31, 2000 and 1999, the Company had income taxes receivable of $13.2 million and $34.0 million, respectively, included in other assets in the consolidated balance sheets. The components of the income tax provision for the three years ended December 31, 2000 are as follows:
2000 1999 1998 ------------ ------------ ------------ Current $ 26,948,000 $ 12,963,000 $ 32,498,000 Deferred 8,919,000 (692,000) 2,710,000 ------------ ------------ ------------ TOTAL INCOME TAX PROVISION $ 35,867,000 $ 12,271,000 $ 35,208,000 ============ ============ ============
The net deferred tax asset is included in other assets in the consolidated balance sheets. The composition of deferred tax assets and liabilities as of December 31, 2000 and 1999, is as follows:
2000 1999 --------------- --------------- Tax net operating loss carryforwards $ 9,698,000 $ 11,692,000 Excess of financial unearned premium over tax 4,919,000 2,512,000 Effect of loss reserve discounting and salvage and subrogation accrual for tax 7,434,000 9,585,000 Unrealized loss on decrease in value of securities available for sale (shareholders' equity) -- 1,611,000 Excess of financial accrued expenses over tax 5,520,000 10,063,000 Allowance for bad debts, not deductible for tax 2,484,000 2,380,000 Foreign branch net operating loss carryforwards 1,912,000 463,000 Valuation allowance (9,666,000) (12,091,000) --------------- --------------- Total assets 22,301,000 26,215,000 Unrealized gain on increase in value of securities available for sale (shareholders' equity) 2,400,000 -- Deferred policy acquisition costs, net of ceding commissions, deductible for tax 5,237,000 1,634,000 Amortizable goodwill 3,816,000 2,346,000 Property and equipment depreciation and other items 4,183,000 3,984,000 --------------- --------------- Total liabilities 15,636,000 7,964,000 --------------- --------------- NET DEFERRED TAX ASSET $ 6,665,000 $ 18,251,000 =============== ===============
F-22 23 HCC Insurance Holdings, Inc. and Subsidiaries ---------- Notes to Consolidated Financial Statements (continued) (6) INCOME TAX, CONTINUED Changes in the valuation allowance account applicable to the net deferred tax asset for the three years ended December 31, 2000 are as follows:
2000 1999 1998 ------------ ------------ ------------ Balance, beginning of year $ 12,091,000 $ 50,000 $ 98,000 Increase (decrease) charged (credited) to income -- 453,000 (48,000) Valuation allowance related to acquired net operating loss carryforwards 3,262,000 11,588,000 -- Reduction in valuation allowance resulting from waiver of previously acquired net operating loss carryforwards (5,687,000) -- -- ------------ ------------ ------------ BALANCE, END OF YEAR $ 9,666,000 $ 12,091,000 $ 50,000 ============ ============ ============
In connection with the acquisition of Centris in 1999, the Company acquired approximately $35.0 million in net operating losses for Federal income tax purposes. As of December 31, 1999 a valuation allowance was established to reduce the acquired net operating loss deferred tax asset to zero. During 2000, under applicable Treasury regulations, the Company irrevocably waived (reduced) the level of the carryforwards to approximately $16.0 million. As a consequence of this waiver, the deferred tax asset and the related deferred tax valuation allowance applicable to the waived net operating losses were reduced by the same amount ($5.7 million) resulting in no change in net deferred tax assets. As of December 31, 2000, the Company has Federal net operating loss carryforwards of approximately $16.0 million which will expire in varying amounts through the year 2020. Future use of the carryforwards is subject to material statutory limitations due to prior changes of ownership. Any future tax benefit realized from the pre-acquisition loss carryforwards will not be credited to future income but will reduce goodwill recorded in connection with the applicable purchase transaction. As of December 31, 2000, the Company also has approximately $5.0 million of losses from foreign branches which are limited to use against future income of the respective foreign branches. F-23 24 HCC Insurance Holdings, Inc. and Subsidiaries ---------- Notes to Consolidated Financial Statements (continued) (6) INCOME TAX, CONTINUED The following table summarizes the differences between the Company's effective tax rate for financial statement purposes and the Federal statutory rate for the three years ended December 31, 2000:
2000 1999 1998 ------------ ------------ ------------ Statutory tax rate 35.0% 35.0% 35.0% Federal tax at statutory rate $ 31,967,000 $ 13,595,000 $ 37,911,000 Nontaxable municipal bond interest and dividends received deduction (3,545,000) (5,460,000) (5,753,000) Other non deductible expenses 620,000 622,000 312,000 Non deductible goodwill amortization 2,497,000 475,000 138,000 State income taxes 4,202,000 3,011,000 3,521,000 Foreign income taxes 1,537,000 4,793,000 440,000 Foreign tax credit (1,826,000) (4,354,000) (440,000) Other, net 415,000 (411,000) (921,000) ------------ ------------ ------------ INCOME TAX PROVISION $ 35,867,000 $ 12,271,000 $ 35,208,000 ============ ============ ============ EFFECTIVE TAX RATE 39.3% 31.6% 32.5% ============ ============ ============
(7) SEGMENT AND GEOGRAPHIC DATA The Company classifies its activities into four operating business segments based upon services provided: 1) insurance company operations, 2) underwriting agency operations, 3) intermediary operations, and 4) other operations. See Note 1 for a description of the services provided by and the principal subsidiaries included in the insurance company, underwriting agency and intermediary segments. The other operations segment performs various insurance related services and contains insurance related investments made from time to time. The primary operating entities in this segment principally provide insurance claims adjusting services. Also included in other operations is income from gains or losses from the disposition of the investments. Corporate includes general corporate operations, and those minor operations not included in an operating segment. Inter-segment revenue consists primarily of management fees of the underwriting agency segment, commission income of the intermediary segment and service revenue of the other operations charged to the insurance company segment on business retained by the Company's insurance company subsidiaries. Inter-segment pricing (either flat rate fees or as a percentage premium) approximates what is charged to unrelated parties for similar services. The performance of each segment is evaluated by management based upon net earnings. Net earnings is calculated after tax and after all corporate expense allocations, amortization of goodwill, interest expense on debt incurred at the purchase date and intercompany eliminations have been charged or credited to the individual segments. F-24 25 HCC Insurance Holdings, Inc. and Subsidiaries ---------- Notes to Consolidated Financial Statements (continued) (7) SEGMENT AND GEOGRAPHIC DATA, CONTINUED The following tables show information by business segment and geographic location. Geographic location is determined by physical location of the Company's offices and does not represent the location of insureds or reinsureds from whom the business was generated.
Insurance Underwriting Other Company Agency Intermediary Operations Corporate Total ------------- ------------- ------------- ------------- ------------- ------------- For the year ended December 31, 2000: Revenue: Domestic $ 276,240,000 $ 99,808,000 $ 31,525,000 $ 23,826,000 $ 1,035,000 $ 432,434,000 Foreign 15,054,000 4,446,000 21,669,000 -- -- 41,169,000 Inter-segment -- 16,404,000 345,000 1,468,000 -- 18,217,000 ------------- ------------- ------------- ------------- ------------- ------------- Total segment revenue $ 291,294,000 $ 120,658,000 $ 53,539,000 $ 25,294,000 $ 1,035,000 491,820,000 ============= ============= ============= ============= ============= Inter-segment revenue (18,217,000) ------------- CONSOLIDATED TOTAL REVENUE $ 473,603,000 ============= Net earnings (loss): Domestic $ 27,289,000 $ 18,758,000 $ 9,846,000 $ 5,960,000 $ (4,710,000) $ 57,143,000 Foreign (3,094,000) 672,000 1,366,000 -- -- (1,056,000) ------------- ------------- ------------- ------------- ------------- ------------- Total segment net earnings (loss) $ 24,195,000 $ 19,430,000 $ 11,212,000 $ 5,960,000 $ (4,710,000) 56,087,000 ============= ============= ============= ============= ============= Inter-segment eliminations (619,000) ------------- CONSOLIDATED NET EARNINGS $ 55,468,000 ============= Other items: Net investment income $ 27,948,000 $ 7,547,000 $ 3,335,000 $ 476,000 $ 530,000 $ 39,836,000 Depreciation and amortization 3,662,000 11,926,000 3,567,000 385,000 368,000 19,908,000 Interest expense 103,000 9,222,000 4,846,000 2,000 6,174,000 20,347,000 Restructuring expense 749,000 798,000 (789,000) 3,000 -- 761,000 Capital expenditures 3,124,000 4,651,000 1,082,000 219,000 1,074,000 10,150,000 Income tax provision (benefit) 8,308,000 19,565,000 6,402,000 3,578,000 (1,604,000) 36,249,000 Inter-segment eliminations (382,000) ------------- Consolidated income tax provision $ 35,867,000 =============
The agency segment incurred the $2.0 million reduction in net income resulting from the cumulative effect of the Company's adoption of SAB 101 effective January 1, 2000. For 2000, earnings before income taxes were $92.7 million for domestic subsidiaries and a loss before income taxes of $1.4 million for foreign subsidiaries. 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 $11.4 million for the year ended December 31, 2000, but as the insurance company segment reduced its net policy acquisition costs by a like amount, there was no effect to consolidated net income. F-25 26 HCC Insurance Holdings, Inc. and Subsidiaries ---------- Notes to Consolidated Financial Statements (continued) (7) SEGMENT AND GEOGRAPHIC DATA, CONTINUED
Insurance Underwriting Other Company Agency Intermediary Operations Corporate Total ------------- ------------- ------------- ------------- ------------- ------------- For the year ended December 31, 1999: Revenue: Domestic $ 151,044,000 $ 91,385,000 $ 35,472,000 $ 27,364,000 $ 681,000 $ 305,946,000 Foreign 10,676,000 3,699,000 25,244,000 -- -- 39,619,000 Inter-segment -- 3,170,000 594,000 1,133,000 -- 4,897,000 ------------- ------------- ------------- ------------- ------------- ------------- Total segment revenue $ 161,720,000 $ 98,254,000 $ 61,310,000 $ 28,497,000 $ 681,000 350,462,000 ============= ============ ============= ============= ============= Inter-segment revenue (4,897,000) ------------- CONSOLIDATED TOTAL REVENUE $ 345,565,000 ============= Net earnings (loss): Domestic $ (8,631,000) $ 17,129,000 $ 10,491,000 $ 7,643,000 $ (2,279,000) $ 24,353,000 Foreign (2,078,000) 21,000 4,575,000 -- -- 2,518,000 ------------- ------------- ------------- ------------- ------------- ------------- Total segment net earnings (loss) $ (10,709,000) $ 17,150,000 $ 15,066,000 $ 7,643,000 $ (2,279,000) 26,871,000 ============= ============= ============= ============= ============= Inter-segment eliminations (299,000) ------------- CONSOLIDATED NET EARNINGS $ 26,572,000 ============= Other items: Net investment income $ 23,400,000 $ 4,186,000 $ 2,504,000 $ 424,000 $ 432,000 $ 30,946,000 Depreciation and amortization 2,880,000 5,898,000 3,798,000 264,000 580,000 13,420,000 Interest expense 19,000 3,809,000 4,640,000 -- 4,496,000 12,964,000 Restructuring expense 687,000 3,278,000 1,453,000 -- 71,000 5,489,000 Capital expenditures 2,405,000 5,339,000 148,000 585,000 637,000 9,114,000 Income tax provision (benefit) (13,324,000) 13,969,000 8,608,000 4,454,000 (1,242,000) 12,465,000 Inter-segment eliminations (194,000) ------------- Consolidated income tax provision $ 12,271,000 =============
The insurance company segment incurred a provision for reinsurance totaling $28.3 million, net of income tax, during 1999. Also during 1999, earnings before income taxes was $33.7 million for domestic subsidiaries and $5.1 million for foreign subsidiaries. F-26 27 HCC Insurance Holdings, Inc. and Subsidiaries ---------- Notes to Consolidated Financial Statements (continued) (7) SEGMENT AND GEOGRAPHIC DATA, CONTINUED
Insurance Underwriting Other Company Agency Intermediary Operations Corporate Total ------------- ------------- ------------- ------------- ------------- ------------- For the year ended December 31, 1998: Revenue: Domestic $ 156,715,000 $ 79,367,000 $ 35,456,000 $ 21,168,000 $ 2,121,000 $ 294,827,000 Foreign 11,049,000 3,438,000 991,000 99,000 -- 15,577,000 Inter-segment -- 1,975,000 1,876,000 1,252,000 -- 5,103,000 ------------- ------------- ------------- ------------- ------------- ------------- Total segment revenue $ 167,764,000 $ 84,780,000 $ 38,323,000 $ 22,519,000 $ 2,121,000 315,507,000 ============= ============= ============= ============= ============= Inter-segment revenue (5,103,000) ------------- CONSOLIDATED TOTAL REVENUE $ 310,404,000 ============= Net earnings (loss): Domestic $ 32,909,000 $ 19,283,000 $ 17,095,000 $ 5,210,000 $ (2,676,000) $ 71,821,000 Foreign 926,000 105,000 657,000 (399,000) -- 1,289,000 ------------- ------------- ------------- ------------- ------------- ------------- NET EARNINGS (LOSS) $ 33,835,000 $ 19,388,000 $ 17,752,000 $ 4,811,000 $ (2,676,000) $ 73,110,000 ============= ============= ============= ============= ============= ============= Other items: Net investment income $ 22,995,000 $ 3,949,000 $ 369,000 $ 536,000 $ 1,493,000 $ 29,342,000 Depreciation and amortization 2,011,000 4,094,000 423,000 422,000 455,000 7,405,000 Interest expense (58,000) 1,963,000 91,000 -- 4,025,000 6,021,000 Capital expenditures 10,405,000 2,685,000 724,000 205,000 1,365,000 15,384,000 Income tax provision (benefit) 9,485,000 13,025,000 10,702,000 2,885,000 (889,000) 35,208,000
F-27 28 HCC Insurance Holdings, Inc. and Subsidiaries ---------- Notes to Consolidated Financial Statements (continued) (7) SEGMENT AND GEOGRAPHIC DATA, CONTINUED Assets by business segment and geographic location are shown in the following table:
Insurance Underwriting Other Company Agency Intermediary Operations Corporate Total -------------- -------------- -------------- -------------- -------------- -------------- December 31, 2000: Domestic $1,613,412,000 $ 559,649,000 $ 89,836,000 $ 6,908,000 $ 34,299,000 $2,304,104,000 Foreign 146,825,000 37,729,000 279,102,000 -- -- 463,656,000 -------------- -------------- -------------- -------------- -------------- -------------- Total assets $1,760,237,000 $ 597,378,000 $ 368,938,000 $ 6,908,000 $ 34,299,000 $2,767,760,000 ============== ============== ============== ============== ============== ============== December 31, 1999: Domestic $1,567,855,000 $ 520,122,000 $ 116,070,000 $ 16,984,000 $ 42,102,000 $2,263,133,000 Foreign 83,882,000 28,756,000 290,205,000 -- -- 402,843,000 -------------- -------------- -------------- -------------- -------------- -------------- Total assets $1,651,737,000 $ 548,878,000 $ 406,275,000 $ 16,984,000 $ 42,102,000 $2,665,976,000 ============== ============== ============== ============== ============== ==============
During the year ended December 31, 1998, one broker in London, England, produced gross written premium ("GWP") to the Company of approximately $46.1 million. This represents 10% of the Company's total GWP for that year. During 2000 and 1999, no customer produced in excess of 10% of the Company's total GWP. F-28 29 HCC Insurance Holdings, Inc. and Subsidiaries ---------- Notes to Consolidated Financial Statements (continued) (8) REINSURANCE In the normal course of business, the Company's insurance company subsidiaries cede a substantial portion of their premium to non-affiliated domestic and foreign reinsurers through quota share, surplus, excess of loss and facultative reinsurance agreements. Although the ceding of reinsurance does not discharge the primary insurer from liability to its policyholder, the subsidiaries participate in such agreements for the purpose of limiting their loss exposure, protect against catastrophic loss and diversifying their business. Most of the reinsurance assumed by the Company's insurance company subsidiaries was underwritten directly by one of the Company's underwriting agency subsidiaries, but issued by other non-affiliated companies in order to satisfy local licensing, contractual or other requirements. The following table represents the effect of such reinsurance transactions on net premium and loss and loss adjustment expense:
Loss and Loss Written Earned Adjustment Premium Premium Expense --------------- --------------- --------------- For the year ended December 31, 2000: Direct business $ 676,730,000 $ 663,458,000 $ 493,647,000 Reinsurance assumed 290,727,000 311,137,000 279,999,000 Reinsurance ceded (683,669,000) (706,948,000) (575,176,000) --------------- --------------- --------------- NET AMOUNTS $ 283,788,000 $ 267,647,000 $ 198,470,000 =============== =============== =============== For the year ended December 31, 1999: Direct business $ 291,513,000 $ 294,130,000 $ 261,696,000 Reinsurance assumed 276,818,000 294,103,000 423,763,000 Reinsurance ceded (428,407,000) (446,871,000) (575,809,000) --------------- --------------- --------------- NET AMOUNTS $ 139,924,000 $ 141,362,000 $ 109,650,000 =============== =============== =============== For the year ended December 31, 1998: Direct business $ 228,629,000 $ 192,536,000 $ 202,858,000 Reinsurance assumed 269,647,000 260,539,000 292,064,000 Reinsurance ceded (376,393,000) (309,975,000) (403,620,000) --------------- --------------- --------------- NET AMOUNTS $ 121,883,000 $ 143,100,000 $ 91,302,000 =============== =============== ===============
Ceding commissions netted with policy acquisition costs in the consolidated statements of earnings are $214.7 million, $117.0 million and $59.1 million for the years ended December 31, 2000, 1999 and 1998, respectively. F-29 30 HCC Insurance Holdings, Inc. and Subsidiaries ---------- Notes to Consolidated Financial Statements (continued) (8) REINSURANCE The table below represents the composition of reinsurance recoverables in the accompanying consolidated balance sheets:
2000 1999 -------------- -------------- Reinsurance recoverable on paid losses $ 99,224,000 $ 91,318,000 Commuted receivable -- 53,210,000 Reinsurance recoverable on outstanding losses 376,778,000 382,565,000 Reinsurance recoverable on IBNR 317,467,000 214,933,000 Reserve for uncollectible reinsurance (4,057,000) (5,541,000) -------------- -------------- TOTAL REINSURANCE RECOVERABLES $ 789,412,000 $ 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 as of December 31, 2000 and 1999:
2000 1999 -------------- -------------- Payables to reinsurers $ 200,591,000 $ 212,962,000 Letters of credit 142,494,000 154,111,000 Cash deposits 23,813,000 19,882,000 -------------- -------------- TOTAL CREDITS $ 366,898,000 $ 386,955,000 ============== ==============
F-30 31 HCC Insurance Holdings, Inc. and Subsidiaries ---------- Notes to Consolidated Financial Statements (continued) (8) REINSURANCE CONTINUED In order to minimize its exposure to reinsurance credit risk, the Company evaluates the financial condition of its reinsurers and places its reinsurance with a diverse group of financially sound companies. The following table shows reinsurance balances relating to the reinsurers with a net recoverable balance greater than $10.0 million as of December 31, 2000 and 1999. The total recoverables column includes paid loss recoverable, outstanding loss recoverable, IBNR recoverable and ceded unearned premium.
Letters of Credit, A.M. Best Total Cash Deposits and Reinsurer Rating Location Recoverables Other Payables Net - -------------------------------------- ---------- ---------------- -------------------- -------------------- -------------------- December 31, 2000: Underwriters at Lloyd's A United Kingdom $ 220,849,000 $ 28,602,000 $ 192,247,000 GE Reinsurance Corporation A++ Illinois 38,152,000 4,881,000 33,271,000 AXA Reinsurance Company A+ Delaware 40,886,000 9,131,000 31,755,000 Underwriters Indemnity Company A- Texas 33,912,000 2,416,000 31,496,000 SCOR Reinsurance Company A+ New York 28,419,000 734,000 27,685,000 American Re-Insurance Company A++ Delaware 23,487,000 2,249,000 21,238,000 Transamerica Occidental Life Ins. Co. A+ California 17,056,000 151,000 16,905,000 Federal Insurance Company A++ Indiana 21,185,000 6,708,000 14,477,000 St. Paul Fire and Marine Insurance Co. A+ Minnesota 14,290,000 -- 14,290,000 Odyssey America Reinsurance Corp. A Connecticut 24,602,000 11,741,000 12,861,000 American Fidelity Assurance Corp. A+ Oklahoma 21,745,000 10,680,000 11,065,000 NAC Reinsurance Corporation A+ New York 10,972,000 94,000 10,878,000 Chartwell Insurance Company A Minnesota 11,308,000 677,000 10,631,000 December 31, 1999: Underwriters at Lloyd's A United Kingdom $ 156,650,000 $ 22,805,000 $ 133,845,000 Underwriters Indemnity Company A- Texas 50,451,000 4,201,000 46,250,000 SCOR Reinsurance Company A+ New York 41,137,000 1,740,000 39,397,000 AXA Reinsurance Company A+ Delaware 37,690,000 5,013,000 32,677,000 NAC Reinsurance Company A+ New York 23,153,000 6,105,000 17,048,000 Transamerica Occidental Life Ins. Co. A+ California 22,481,000 6,102,000 16,379,000 St. Paul Fire and Marine Insurance Co. A+ Minnesota 17,577,000 1,721,000 15,856,000 Odyssey America Reinsurance Corp. A Connecticut 19,114,000 5,891,000 13,223,000 Sun Life Assurance Company of Canada A++ Canada 17,996,000 4,786,000 13,210,000 GE Reinsurance A++ Illinois 16,535,000 4,869,000 11,666,000 Chartwell Insurance Company A Minnesota 12,736,000 2,074,000 10,662,000
F-31 32 HCC Insurance Holdings, Inc. and Subsidiaries ---------- Notes to Consolidated Financial Statements (continued) (8) REINSURANCE CONTINUED Lloyds of London is an insurance and reinsurance marketplace composed of many independent underwriting syndicates financially supported by a central trust fund. As of December 31, 2000, the net recoverable due from underwriters at Lloyd's, aggregating $192.2 million, represented balances due from over 140 different syndicates, five of which each had a net recoverable balance in excess of $10.0 million. The largest net recoverable balance from an individual Lloyd's syndicate as of December 31, 2000 was $26.5 million. HCCL previously sold its entire block of life insurance and annuity business to Life Reassurance Corporation of America (rated A++ by A.M. Best) in the form of an indemnity reinsurance contract. Ceded life and annuity benefits amounted to $86.8 million and $95.8 million as of December 31, 2000 and 1999, respectively. The Company has a reserve of $4.1 million as of December 31, 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 2000, a number of reinsurers have delayed or suspended the payment of amounts recoverable under certain reinsurance contracts to which the Company is a party. Such delays have affected, though not materially to date, the investment income of the Company's insurance company subsidiaries, but not to any extent their liquidity. The Company limits its 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 the Company's 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. 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 will seek a judicial or arbitral determination of these matters. During 1999, the Company recorded a provision for reinsurance totaling $29.5 million in connection with the insolvency of a reinsurer. The Company expects this provision to be sufficient. The Company also recorded a $14.0 million provision following a commutation (the contractual settlement of outstanding and future liabilities) with another reinsurer, the majority of which represents the present value discount of ceded losses. F-32 33 HCC Insurance Holdings, Inc. and Subsidiaries ---------- Notes to Consolidated Financial Statements (continued) (9) COMMITMENTS AND CONTINGENCIES Litigation The Company is party to numerous lawsuits and other proceedings that arise in the normal course of its business. Many of such lawsuits and other proceedings involve claims under policies that the Company's insurance company subsidiaries underwrite as an insurer or reinsurer, the liabilities for which management believes have been adequately included in the Company's loss reserves. Also, from time to time, the Company is 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 its subsidiaries. Management believes the resolution of any such lawsuits will not have a material adverse effect on the Company's financial condition, results of operations or cash flows. Foreign Currency Forward Contracts On a limited basis, the Company enters into foreign currency forward contracts as a hedge against foreign currency fluctuations. RML has revenue streams in U.S. Dollars and Canadian Dollars but incurs expenses in GBP. To mitigate the foreign exchange risk, the Company entered into foreign currency forward contracts expiring at staggered times through December, 2001. As of December 31, 2000, the Company had forward contracts to sell US $7.5 million for GBP at an average rate of 1.00 GBP equals US $1.50 and to sell CAD $600,000 for GBP at an average rate of 1.00 GBP equals CAD $2.18. The foreign currency forward contracts are used to convert currency at a known rate in an amount which approximates average monthly expenses. Thus, the effect of these transactions is to limit the foreign currency exchange risk of the recurring monthly expenses. The Company utilizes these foreign currency forward contracts strictly as a hedge against existing exposure to foreign currency fluctuations rather than as a form of speculative or trading investment. The fair value of foreign currency forward contracts December 31, 2000 was $14,000. Leases The Company leases administrative office facilities under long-term non-cancelable operating lease agreements expiring at various dates through September, 2007. In addition to rent, the agreements generally require the payment of utilities, real estate taxes, insurance and repairs. The Company has recognized rent expense on a straight-line basis over the terms of these leases. In addition, the Company leases computer equipment and automobiles under operating leases expiring at various dates through the year 2004. Rent expense under operating leases amounted to $7.3 million, $5.9 million, and $4.5 million, for the years ended December 31, 2000, 1999 and 1998, respectively. F-33 34 HCC Insurance Holdings, Inc. and Subsidiaries ---------- Notes to Consolidated Financial Statements (continued) (9) COMMITMENTS AND CONTINGENCIES, CONTINUED At December 31, 2000, future minimum annual rental payments required under long-term, non-cancelable operating leases, excluding certain expenses payable by the Company, are as follows:
For the Years Ended December 31, Amount Due -------------------------------- ------------------- 2001 $ 6,214,000 2002 5,174,000 2003 4,543,000 2004 3,163,000 2005 2,172,000 Thereafter 2,059,000 -------------- TOTAL FUTURE MINIMUM ANNUAL RENTAL PAYMENTS DUE $ 23,325,000 ==============
Catastrophe Exposure The Company writes business in areas exposed to catastrophic losses and has significant exposures to this type of loss in California, the Atlantic Coast of United States, certain United States Gulf Coast states, particularly Florida and Texas, the Caribbean and Mexico. The Company assesses its overall exposures to a single catastrophic event and applies procedures that it believes are more conservative than are typically used by the industry to ascertain the Company's probable maximum loss ("PML") from any single event. The Company maintains reinsurance protection which it believes is sufficient to cover any foreseeable event. Loan Guarantee During 1999, the Company guaranteed the construction financing debt of a partnership in which the company is a limited partner. The total amount of the loan commitment is $11.5 million, of which $11.1 million was funded as of December 31, 2000. (10) RELATED PARTY TRANSACTIONS Certain of the Company's Directors are officers, directors or owners of business entities with which the Company transacts business. Balances with these business entities and other related parties included in the accompanying consolidated balance sheets are as follows:
2000 1999 ---------- ---------- Marketable equity securities $2,725,000 $5,051,000 Other investments 7,182,000 3,017,000 Premiums, claims and other receivables 435,000 3,347,000 Notes payable 4,633,000 7,546,000
F-34 35 HCC Insurance Holdings, Inc. and Subsidiaries ---------- Notes to Consolidated Financial Statements (continued) (10) RELATED PARTY TRANSACTIONS, CONTINUED Transactions with these business entities and other related parties included in the accompanying consolidated statements of earnings are as follows:
2000 1999 1998 -------------------- -------------------- -------------------- Gross earned premium $ -- $ -- $ 1,716,000 Ceded earned premium -- -- 14,543,000 Commission income -- -- 1,544,000 Investment income 112,000 206,000 64,000 Net realized investment loss (5,067,000) (4,521,000) -- Other operating income 89,000 5,221,000 968,000 Gross loss and loss adjustment expense -- -- 3,282,000 Ceded loss and loss adjustment expense -- -- 37,107,000 Other operating expense 757,000 578,000 840,000 Interest expense 74,000 418,000 177,000
The Company has committed to invest $5.0 million in an investment partnership managed by a related party. As of December 31, 2000, $3.4 million had been invested under this commitment. In 1998, HC bought an office building to be occupied by the Company from a partnership in which an officer and Director was a partner. The purchase price of $6.0 million was based upon independent appraisal. F-35 36 HCC Insurance Holdings, Inc. and Subsidiaries ---------- Notes to Consolidated Financial Statements (continued) (11) EMPLOYEE BENEFIT PLANS The Company has a defined contribution retirement plan under Section 401(k) of the Internal Revenue Code which covers substantially all of the employees residing in the United States who meet specified service requirements. The contributions are discretionary and are determined by management as of the beginning of each calendar year. The Company currently matches each employee's contribution to the 401(k) plan up to 6% of the employee's salary. Employees of the Company who reside outside the United States receive comparable benefits under different plans. The Company contributed $3.2 million, $3.1 million, and $1.7 million to the plans for the years ended December 31, 2000, 1999 and 1998, respectively, which is included in compensation expense in the accompanying consolidated statements of earnings. (12) SHAREHOLDERS' EQUITY Under the Texas Insurance Code, HC and USSIC must each maintain minimum statutory capital of $1.0 million and minimum statutory surplus of $1.0 million, and can only pay dividends out of statutory surplus funds. In addition, they are limited in the amount of dividends which they may pay in any twelve-month period, without prior regulatory approval, to the greater of statutory net income for the prior calendar year or ten percent (10%) of statutory policyholders' surplus as of the prior calendar year end. During 2001, HC's and USSIC's ordinary dividend capacities will be approximately $23.1 million and $10.6 million, respectively. AIC is limited by the State of Maryland in the amount of dividends which it may pay in any twelve-month period, without prior regulatory approval, to the lesser of statutory net income for the prior calendar year or ten percent (10%) of statutory policyholders' surplus as of the prior year end. During 2001, AIC's ordinary dividend capacity will be approximately $8.6 million. HCCL is limited by the laws of the State of Indiana in the amount of dividends it may pay in any twelve-month period, without prior regulatory approval, to the greater of net gain from operations for the prior calendar year or ten percent (10%) of statutory capital and surplus as of the prior year end. During 2001, HCCL's ordinary dividend capacity will be approximately $6.3 million. As of December 31, 2000, all of the domestic insurance company subsidiaries total adjusted capital is significantly in excess of the NAIC authorized control level risk-based capital. F-36 37 HCC Insurance Holdings, Inc. and Subsidiaries ---------- Notes to Consolidated Financial Statements (continued) (12) SHAREHOLDERS' EQUITY, CONTINUED The components of accumulated other comprehensive income (loss) are as follows:
Accumulated Unrealized Other Foreign Currency Investment Comprehensive Translation Gain (Loss) Income (Loss) ---------------- ------------ ------------ Balance December 31, 1997 $ (306,000) $ 8,306,000 $ 8,000,000 Net change for year (344,000) 2,049,000 1,705,000 ------------ ------------ ------------ Balance December 31, 1998 (650,000) 10,355,000 9,705,000 Net change for year 167,000 (12,564,000) (12,397,000) ------------ ------------ ------------ Balance December 31, 1999 (483,000) (2,209,000) (2,692,000) Net change for year (172,000) 7,577,000 7,405,000 ------------ ------------ ------------ Balance December 31, 2000 $ (655,000) $ 5,368,000 $ 4,713,000 ============ ============ ============
(13) STOCK OPTIONS The Company has five option plans, the 1994 Non-employee Director Stock Option Plan, the 1996 Non-employee Director Stock Option Plan, the 1992 Incentive Stock Option Plan, the 1995 Flexible Incentive Plan, and the 1997 Flexible Incentive Plan. All plans are administered by the Compensation Committee of the Board of Directors. Each option may be used to purchase one share of Common Stock of the Company. As of December 31, 2000, 6,149,243 shares of Common Stock were reserved for the exercise of options, of which 5,494,229 shares were reserved for options previously granted and 655,014 shares were reserved for future issuances of options. Options vest over a zero to five year period and expire four to ten years after grant date. All options have been granted at fixed exercise prices, generally at the market price of the Company's Common Stock on the grant date. Any excess of the market price on the grant date over the exercise price is recognized as compensation expense in the accompanying consolidated financial statements. If the fair value method of valuing compensation related to options would have been used, pro forma net earnings and pro forma diluted earnings per share would have been $50.8 million, or $0.98 per share, for the year ended December 31, 2000; $22.2 million, or $0.44 per share, for the year ended December 31, 1999; and $66.2 million, or $1.33 per share, for the year ended December 31, 1998. The fair value of each option grant was estimated on the grant date using the Black-Scholes single option pricing model with the following weighted average assumptions: a) risk free interest rate of 6.4% for 2000, 5.7% for 1999 and 5.3% for 1998, b) expected volatility factor of .3, c) dividend yield of 0.89% for 2000, 1.52% for 1999 and 0.91% for 1998, and d) expected option life of four years for 2000 and 1999, and five years for 1998. The average fair value of options granted during the years ended December 31, 2000, 1999 and 1998 was $4.51, $4.16 and $5.23, respectively. F-37 38 HCC Insurance Holdings, Inc. and Subsidiaries ---------- Notes to Consolidated Financial Statements (continued) (13) STOCK OPTIONS, CONTINUED The following table provides an analysis of stock option activity during the three years ended December 31, 2000:
2000 1999 1998 ----------------------------- -------------------------- ---------------------------- Average Average Average Number Exercise Number Exercise Number Exercise of Shares Price of Shares Price of Shares Price ------------- ------------- ----------- ------------- ----------- ------------- Outstanding, beginning of year 5,470,008 $ 16.08 5,459,766 $ 16.73 3,508,226 $ 16.22 Granted at market value 1,745,000 13.59 1,869,600 2,779,500 17.01 Forfeitures and expirations (434,242) 18.32 (1,327,243) 18.36 (192,462) 21.48 Exercised (1,286,537) 14.34 (532,115) 7.88 (635,498) 14.05 ------------ ------------- ---------- ------------- ---------- ------------- OUTSTANDING, END OF YEAR 5,494,229 $ 15.54 5,470,008 $ 16.08 5,459,766 $ 16.73 ============ ============= ========== ============= ========== ============= EXERCISABLE, END OF YEAR 2,716,705 $ 16.59 2,982,872 $ 16.84 2,792,707 $ 15.92 ============ ============= ========== ============= ========== =============
Options outstanding and exerciseable as of December 31, 2000 are shown on the following schedule:
Options Outstanding Options Exercisable ------------------------------------- --------------------- Average Average Remaining Average Range of Number of Remaining Exercise Number of Exercise Exercise Prices Shares Contractual Life Price Shares Price - --------------- ----------- ---------------- ---------- ---------- --------- Under $16.00 2,614,400 4.80 years $ 11.53 952,454 $ 11.41 $16.00-$16.99 1,434,546 3.51 16.45 821,319 16.46 Over $16.99 1,445,283 5.30 21.88 942,932 21.94 --------- --------------- --------- --------- --------- TOTAL OPTIONS 5,494,229 4.59 years $ 15.54 2,716,705 $ 16.59 ========= =============== ========= ========= =========
F-38 39 HCC Insurance Holdings, Inc. and Subsidiaries ---------- Notes to Consolidated Financial Statements (continued) (14) EARNINGS PER SHARE The following table provides reconciliation of the denominators used in the earnings per share calculations for the three years ended December 31, 2000:
2000 1999 1998 ------------ ------------ ------------ NET EARNINGS $ 55,468,000 $ 26,572,000 $ 73,110,000 ============ ============ ============ Reconciliation of number of shares outstanding: Shares of Common Stock outstanding at year end 51,342,000 49,836,000 49,249,000 Changes in Common Stock due to issuance (908,000) (241,000) (332,000) Contingent shares to be issued 39,000 49,000 -- Common Stock contractually issuable in the future 269,000 414,000 -- ------------ ------------ ------------ Weighted average Common Stock outstanding 50,742,000 50,058,000 48,917,000 Additional dilutive effect of outstanding options (as determined by the application of the treasury stock method) 877,000 588,000 1,016,000 ------------ ------------ ------------ WEIGHTED AVERAGE COMMON STOCK AND POTENTIAL COMMON STOCK OUTSTANDING 51,619,000 50,646,000 49,933,000 ============ ============ ============
As of December 31, 2000, there were approximately 1.5 million options that were not included in the computation of diluted earnings per share because to do so would have been antidilutive. As part of a 1999 purchase agreement, up to 378,000 shares of the Company's Common Stock are to be issued if certain conditions are met. Of these shares, 94,500 have been issued and 39,000 are included in the 2000 computation because the contingency had been partially met. The remainder of the contingent shares were not included in the earnings per share computation because the conditions for issuance of the remaining shares have not yet been met. F-39 40 HCC Insurance Holdings, Inc. and Subsidiaries ---------- Notes to Consolidated Financial Statements (continued) (15) STATUTORY INFORMATION The Company's insurance company subsidiaries file financial statements prepared in accordance with statutory accounting practices prescribed or permitted by domestic or foreign insurance regulatory authorities. The differences between statutory financial statements and financial statements prepared in accordance with GAAP vary between domestic and foreign jurisdictions. The principal differences are that for statutory financial statements deferred policy acquisition costs are not recognized, deferred income taxes are not recorded, bonds are generally carried at amortized cost, certain assets are non-admitted and charged directly to surplus, a liability for a provision for reinsurance is recorded and charged directly to surplus and insurance assets and liabilities are presented net of reinsurance. The Company's use of permitted statutory accounting practices does not have a significant impact on statutory surplus. Statutory policyholders' surplus, and net income for the three years ended December 31, 2000, after intercompany eliminations, of the Company's insurance company subsidiaries included in those companies' respective filings with regulatory authorities are as follows:
2000 1999 1998 ---- ---- ---- Statutory policyholders' surplus $326,249,000 $315,474,000 $369,401,000 Statutory net income (loss) 13,749,000 (8,707,000) 53,162,000
Statutory policyholders' surplus has been adversely affected by statutory adjustments for reinsurance recoverables which, although required statutorily, have no effect on net earnings or shareholders' equity. The statutory net loss for 1999 includes a $25.5 million loss, net of income tax, from the provision for reinsurance. The National Association of Insurance Commissioners adopted Statements of Statutory Accounting Principles 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. Codification is new and will evolve over time. The cumulative effect of codification is expected to increase statutory policyholders' surplus of the Company's insurance company subsidiaries by approximately $6.0 million. The Company expects that the statutory surplus of its insurance company subsidiaries after adoption will continue to be in excess of their regulatory risk-based capital requirements. F-40 41 HCC Insurance Holdings, Inc. and Subsidiaries ---------- Notes to Consolidated Financial Statements (continued) (16) OTHER INFORMATION Supplemental Cash Flow Information Supplemental cash flow information for the three years ended December 31, 2000, is summarized below:
2000 1999 1998 ----------- ----------- ----------- Interest paid $17,418,000 $13,694,000 $ 5,409,000 Income tax paid 11,859,000 23,116,000 30,662,000 Dividends declared but not paid at year end 3,557,000 2,442,000 1,930,000
The unrealized gain or loss on securities available for sale, deferred taxes related thereto and the issuance of the Company's Common Stock for the purchase of subsidiaries are non-cash transactions which have been included as direct increases or decreases in shareholders' equity. The cumulative effect of accounting change due to the Company's adoption of SAB 101 is a non-cash charge to earnings. Restructuring As of December 31, 1999, the Company had accrued two separate restructuring liabilities, one relating to HCC's ongoing operations ("HCC Internal") and another relating to HCC's acquisition of Centris. Changes in the accruals between December 31, 1999 and December 31, 2000 are shown in the tables below: HCC Internal Restructuring
Accrued Paid 2000 Accrued at 12/31/99 in 2000 Adjustments at 12/31/00 ----------- ---------- ----------- ----------- Severance $3,115,000 $3,115,000 $ -- $ -- Other 911,000 292,000 (514,000) 105,000 ---------- ---------- ---------- ---------- TOTAL $4,026,000 $3,407,000 $ (514,000) $ 105,000 ========== ========== ========== ==========
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. Centris Restructuring
Accrued Paid 2000 Accrued at 12/31/99 in 2000 Adjustments at 12/31/00 ----------- ---------- ----------- ---------- Contractual executive severance accruals $5,866,000 $6,027,000 $ 166,000 $ 5,000 Other severance accruals 397,000 541,000 258,000 114,000 Lease obligation accruals 848,000 1,004,000 1,196,000 1,040,000 ---------- ---------- ---------- ---------- TOTAL $7,111,000 $7,572,000 $1,620,000 $1,159,000 ========== ========== ========== ==========
F-41 42 HCC Insurance Holdings, Inc. and Subsidiaries ---------- Notes to Consolidated Financial Statements (continued) (16) OTHER INFORMATION, CONTINUED The adjustments in 2000 were recorded as management decided to take additional steps to integrate parts of the Centris operations. During the fourth quarter of 2000, the Company also recorded a restructuring charge and associated expenses of $1.5 million. A total of 26 employees were or will be terminated as a result of the Company's restructuring of certain underwriting agency operations and their integration into the Company's insurance company operations. The charges affected both segments and consisted of $557,000 accrued severance pay to be paid at various times throughout 2001 and $992,000 for the write down or write off of various impaired assets, primarily redundant computer software. Restructuring charges of $761,000 in 2000 and $5.5 million in 1999 are included in other operating expenses in the consolidated statements of earnings. F-42 43 HCC Insurance Holdings, Inc. and Subsidiaries ---------- Notes to Consolidated Financial Statements (continued) (17) LIABILITY FOR UNPAID LOSS AND LOSS ADJUSTMENT EXPENSE The following table provides a reconciliation of the liability of loss and loss adjustment expense ("LAE"), for the three years ended December 31, 2000:
2000 1999 1998 ------------- ------------- ------------- Reserves for loss and LAE at beginning of the year $ 871,104,000 $ 460,511,000 $ 275,008,000 Less reinsurance recoverables 597,498,000 341,599,000 155,374,000 ------------- ------------- ------------- Net reserves at beginning of the year 273,606,000 118,912,000 119,634,000 Net reserve adjustments from acquisition and disposition of subsidiaries 514,000 55,523,000 3,877,000 Effect on loss reserves of write off of ceded outstanding and IBNR reinsurance recoverables -- 82,343,000 -- Provision for loss and LAE for claims occurring in the current year 208,055,000 105,036,000 105,895,000 Increase (decrease) in estimated loss and LAE for claims occurring in prior years (9,585,000) 4,614,000 (14,593,000) ------------- ------------- ------------- Incurred loss and LAE, net of reinsurance 198,470,000 109,650,000 91,302,000 ------------- ------------- ------------- Loss and LAE payments for claims occurring during: Current year 76,725,000 36,770,000 47,126,000 Prior years 145,993,000 56,052,000 48,775,000 ------------- ------------- ------------- Loss and LAE payments, net of reinsurance 222,718,000 92,822,000 95,901,000 ------------- ------------- ------------- Net reserves at end of the year 249,872,000 273,606,000 118,912,000 Plus reinsurance recoverables 694,245,000 597,498,000 341,599,000 ------------- ------------- ------------- RESERVES FOR LOSS AND LAE AT END OF THE YEAR $ 944,117,000 $ 871,104,000 $ 460,511,000 ============= ============= =============
F-43 44 HCC Insurance Holdings, Inc. and Subsidiaries ---------- Notes to Consolidated Financial Statements (continued) (17) LIABILITY FOR UNPAID LOSS AND LOSS ADJUSTMENT EXPENSE, CONTINUED During 2000, the Company had net loss and LAE redundancy of $9.6 million relating to prior year losses compared to a deficiency of $4.6 million in 1999 and a redundancy of $14.6 million in 1998. The deficiencies and redundancies in the reserves result from the Company's and its actuaries' continued review of its loss reserves and the increase or reduction of such reserves as losses are finally settled and claims exposures are reduced. The Company believes it has provided for all material net incurred losses. The Company has no material exposure to environmental pollution losses, as HC only began writing business in 1981 and policies issued by HC normally contain pollution exclusion clauses which limit pollution coverage to "sudden and accidental" losses only, thus excluding intentional (dumping) and seepage claims. Policies issued by AIC and USSIC, because of the types of risks incurred, principally general aviation, are not considered to have significant environmental exposures. Therefore, the Company should not experience any material development in reserves from environmental pollution claims. F-44 45 HCC Insurance Holdings, Inc. and Subsidiaries ---------- Notes to Consolidated Financial Statements (continued) (18) QUARTERLY FINANCIAL DATA (UNAUDITED; AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
Fourth Quarter Third Quarter Second Quarter First Quarter ------------------- ------------------- ------------------- ----------------------- 2000 1999 2000 1999 2000 1999 2000 1999 -------- -------- -------- -------- -------- -------- ----------- -------- Total revenue $110,170 $ 85,233 $120,539 $ 84,016 $120,947 $ 83,406 $ 121,947 $ 92,910 Earnings (loss) before 13,135 (4,628) 17,762 9,480 13,180 649 13,404 21,071 accounting change Cumulative effect of accounting change -- -- -- -- -- -- (2,013) -- -------- -------- -------- -------- -------- -------- ------------ -------- Net earnings (loss) $ 13,135 $ (4,628) $ 17,762 $ 9,480 $ 13,180 $ 649 $ 11,391 $ 21,071 ======== ======== ======== ======== ======== ======== ============ ======== BASIC EARNINGS (LOSS) PER SHARE DATA: Earnings (loss) before accounting change $ 0.26 $ (0.09) $ 0.35 $ 0.19 $ 0.26 $ 0.01 $ 0.27 $ 0.42 Cumulative effect of accounting change -- -- -- -- -- -- (0.04) -- -------- -------- -------- -------- -------- -------- ------------ -------- Earnings (loss) per share $ 0.26 $ (0.09) $ 0.35 $ 0.19 $ 0.26 $ 0.01 $ 0.23 $ 0.42 ======== ======== ======== ======== ======== ======== ============ ======== Weighted average shares outstanding 51,181 50,190 50,739 50,127 50,525 49,948 50,400 49,761 ======== ======== ======== ======== ======== ======== ============ ======== DILUTED EARNINGS (LOSS) PER SHARE DATA: Earnings (loss) before accounting change $ 0.25 $ (0.09) $ 0.34 $ 0.19 $ 0.26 $ 0.01 $ 0.26 $ 0.42 Cumulative effect of accounting change -- -- -- -- -- -- (0.04) -- -------- -------- -------- -------- -------- -------- ------------ -------- Earnings (loss) per share $ 0.25 $ (0.09) $ 0.34 $ 0.19 $ 0.26 $ 0.01 $ 0.22 $ 0.42 ======== ======== ======== ======== ======== ======== ============ ======== Weighted average shares outstanding 52,530 50,190 52,037 50,863 51,083 50,968 50,706 50,541 ======== ======== ======== ======== ======== ======== ============ ========
During 1999, pre-tax provisions for reinsurance of $29.5 million and $14.0 million were recorded in the second quarter and fourth quarter, respectively. Also, during the fourth quarter of 1999, the Company recorded a pre-tax restructuring expense of $5.5 million. During the fourth quarter of 2000, the Company recorded a $4.4 million pre-tax increase in reserves of discontinued lines of business that were part of the 1999 Centris acquisition and a $1.5 million in pre-tax restructuring expense. The sum of the quarters earnings (loss) per share may not equal the annual amounts due to rounding. F-45 EX-99.2 3 h88344ex99-2.txt CONSENT OF PRICEWATERHOUSECOOPERS LLP 1 Exhibit 99.2 CONSENT OF INDEPENDENT ACCOUNTANTS We hereby consent to the incorporation by reference in the registration statements on Forms S-8 (Nos. 333-14471, 333-14479, 333-61673, 333-61687, 333-68771 and 333-89905) and Forms S-3 (Nos. 333-58350, 333-46432, 333-46432-01, 333-46432-02) of HCC Insurance Holdings, Inc. of our report, which include an emphasis paragraph related to a change in the Company's method of revenue recognition for certain contracts, dated March 21, 2001, except for the second paragraph of Note 2, as to which the date is May 28, 2001, relating to the financial statements, which appear in the accompanying HCC Insurance Holdings, Inc.'s Form 8-K. /s/ PricewaterhouseCoopers LLP - ------------------------------ PricewaterhouseCoopers LLP Houston, Texas June 14, 2001 EX-99.3 4 h88344ex99-3.txt SECOND AMENDMENT TO LOAN AGREEMENT DATED 6/6/01 1 Exhibit 99.3 SECOND AMENDMENT TO LOAN AGREEMENT THIS SECOND AMENDMENT TO LOAN AGREEMENT (this "Amendment") is made and entered into as of June 6, 2001 by and among HCC INSURANCE HOLDINGS, INC., a Delaware corporation (the "Borrower"); each of the Lenders which is a party to the Loan Agreement (as defined below) (individually, a "Lender" and, collectively, the "Lenders"), WELLS FARGO BANK TEXAS, NATIONAL ASSOCIATION, Administrative Agent for the Lenders and Lead Arranger (in such capacity, together with its successors in such capacity, the "Agent"), FIRST UNION NATIONAL BANK, as Syndication Agent, BANK OF AMERICA, N.A., as Documentation Agent, and THE BANK OF NEW YORK, as Senior Managing Agent. RECITALS A. The Borrower, the Lenders and the Agent executed and delivered that certain Loan Agreement dated as of December 17, 1999. Said Loan Agreement, as heretofore amended, is herein called the "Loan Agreement". Any capitalized term used in this Amendment and not otherwise defined shall have the meaning ascribed to it in the Loan Agreement. B. The Borrower, the Lenders and the Agent desire to amend the Loan Agreement in certain respects. NOW, THEREFORE, in consideration of the premises and the mutual agreements, representations and warranties herein set forth, and further good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the Borrower, the Lenders and the Agent do hereby agree as follows: SECTION 1. Amendments to Loan Agreement. Effective as of the date hereof, the Loan Agreement is hereby amended as follows: (a) The definition of "Margin Percentage" set forth in Section 1.1 of the Loan Agreement is hereby amended to read in its entirety as follows: Margin Percentage means (i) on any day prior to July 1, 2001, 0.750% and (ii) on and after July 1, 2001, the applicable per annum percentage set forth at the appropriate intersection in the table shown below, based on the Debt to Capitalization Ratio as of the last day of the most recently ended fiscal quarter of Borrower calculated by Agent as soon as practicable after receipt by Agent of all financial reports required under this Agreement with respect to such fiscal quarter (including a Compliance Certificate) (provided, however, that if the Margin Percentage is increased as a result of the reported Debt to Capitalization Ratio, such increase shall be retroactive to the date that Borrower was obligated to deliver such financial reports to Agent pursuant to the terms of this Agreement and provided further, however, that if the Margin Percentage is decreased as a result of the reported Debt to Capitalization Ratio, and such financial reports are delivered to Agent not more than ten (10) calendar days after the date required to be delivered pursuant to the terms of this Agreement, such decrease shall be retroactive to the date that Borrower was obligated to deliver such financial reports to Agent pursuant to the terms of this Agreement): 2 Debt to Capitalization Ratio Margin Percentage Greater than or equal to 0.250 to 1.000 1.150 Greater than or equal to 0.175 to 1.00 but less than 0.250 to 1.000 0.950 Less than 0.175 to 1.000 0.750 (b) The definition of "Permitted Dividends" set forth in Section 1.1 of the Loan Agreement is hereby amended to read in its entirety as follows: Permitted Dividends means (i) dividends or distributions by a Subsidiary of Borrower to Borrower (or to another Subsidiary of Borrower) or redemption by a Subsidiary of any of its stock held by Borrower (or by another Subsidiary of Borrower), (ii) dividends paid in stock and stock splits and (iii) so long as no Default or Event of Default shall have occurred and be continuing (or would result therefrom), dividends or distributions by Borrower not exceeding, in the aggregate in any applicable fiscal year, $35,000,000. The dividends and distributions otherwise permitted under this definition shall be subject to the provisions of Section 8.15 hereof. (c) Section 2.2(a) of the Loan Agreement is hereby amended to read in its entirety as follows: (a) [INTENTIONALLY LEFT BLANK] (d) Section 2.3(a) of the Loan Agreement is hereby amended to read in its entirety as follows: (a) Borrower shall pay to Agent for the account of each Revolving Loan Lender revolving loan commitment fees for the period from June 6, 2001 to and including the Revolving Loan Termination Date at 0.15% per annum. Such revolving loan commitment fees shall be computed (on the basis of the actual number of days elapsed in a year composed of 365 or 366 days, as the case may be) on each day and shall be based on the excess of (x) the aggregate amount of each Revolving Loan Lender's Commitment for such day over (y) the aggregate unpaid principal balance of such Lender's Note on such day. Accrued revolving loan commitment fees under this provision shall be payable in arrears on the Quarterly Dates prior to the Revolving Loan Termination Date and on the Revolving Loan Termination Date. (e) Section 7.2(h) of the Loan Agreement is hereby amended to read in its entirety as follows: (h) within sixty (60) days after the end of each fiscal year, projections of the consolidated financial statements of Borrower and its Subsidiaries for the following fiscal year 2 3 (f) Section 7.3(a)(ii) of the Loan Agreement is hereby amended to read in its entirety as follows: (ii) Debt to Capitalization Ratio - a Debt to Capitalization Ratio of not greater than 30% at all times. (g) Section 7.3(b) of the Loan Agreement is hereby amended to read in its entirety as follows: (b) Borrower will cause each of its Insurance Company Subsidiaries to maintain a Risk Based Capital Ratio of not less than 200% as of the last day of each fiscal year. In addition, Borrower will cause the Insurance Company Subsidiaries to maintain, on a consolidated basis, a statutory surplus of not less than $300,000,000 at all times. (h) Section 8.1(vii) of the Loan Agreement is hereby amended to read in its entirety as follows: (vii) any unsecured Indebtedness of Borrower not to exceed, in the aggregate at any one time outstanding, $100,000,000 (to be increased on a dollar-for-dollar basis by any decrease of the Commitments from time to time from the levels in effect as of May 1, 2001); provided, however, that $100,000,000 of such availability for borrowings shall be restricted to public debt offerings by Borrower; and (i) A new subsection (viii) is hereby added to Section 8.1, such new subsection to read in its entirety as follows: (viii) any unsecured Indebtedness owing by a Subsidiary of Borrower to Borrower. (j) Section 8.5 of the Loan Agreement is hereby amended to read in its entirety as follows: 8.5 Disposition of Assets. Sell, convey or lease all or any part of its assets, except as permitted by Section 8.4 hereof and except for (a) sales of Inventory in the ordinary course of business, (b) transfers resulting from casualty or condemnation of property, (c) intercompany sales or transfers of goods, (d) any sale or other transfer of any property or assets not otherwise permitted hereunder provided that the net proceeds of all such sales and transfers shall not exceed, in the aggregate during any fiscal year of Borrower, five percent (5%) of the tangible assets of Borrower and its Subsidiaries, on a consolidated basis and determined in accordance with GAAP, (e) licenses or sublicenses of intellectual property and general intangibles and licenses, leases or subleases of other Property in the ordinary course of business and which do not materially interfere with the business or operation of any Obligor and which does not otherwise have a Material Adverse Effect, (f) sales/leaseback transactions (provided that Borrower and its Subsidiaries shall not, in the aggregate, consummate more than three (3) sales/leasebacks with respect to Property owned by Borrower or its Subsidiaries as of the Effective Date), and (g) sales of any investment assets (including, without limitation, stocks, bonds, cash equivalents, etc.) in the ordinary course of business. Prior to consummation of any single 3 4 disposition providing for aggregate consideration in excess of $25,000,000, Borrower shall certify to Agent that no Default can reasonably be expected to arise by reason of such transaction. This Section shall be subject to the limitations set forth in Section 8.15 hereof. (k) Section 8.6 of the Loan Agreement is hereby amended to read in its entirety as follows: 8.6 Redemption, Dividends and Distributions. At any time: (a) redeem, retire or otherwise acquire, directly or indirectly, any equity interest in Borrower other than stock repurchases not exceeding, in the aggregate and on a cumulative basis from and after the Effective Date, $100,000,000 or (b) make any distributions of any Property or cash to the owner of any of the equity interests in Borrower or any of its Subsidiaries other than Permitted Dividends. (l) Section 8.12 of the Loan Agreement is hereby amended to read in its entirety as follows: 8.12 Acquisitions. Without the prior written consent of the Majority Lenders, acquire any real Property or any material personal Property (including any acquisition of equity interests in another Person other than an Obligor or, subject to the provisions of Section 8.15 hereof, any other Subsidiary of Borrower as of the Effective Date) after the Effective Date from any Person other than an Obligor if the aggregate cash consideration for transactions would exceed twelve and one-half percent (12-1/2%) of the tangible assets of Borrower and its Subsidiaries, on a consolidated basis and determined in accordance with GAAP, in any fiscal year or if the aggregate consideration (cash or otherwise) for transactions would exceed twenty-five percent (25%) of the tangible assets of Borrower and its Subsidiaries, on a consolidated basis and determined in accordance with GAAP, in any fiscal year. Each such acquisition shall be subject to the provisions of Section 8.7 hereof. Notwithstanding anything to the contrary set forth in this Section, neither the Borrower nor any of its Subsidiaries may acquire any additional equity interests in and to the Second Tier Insurance Company Subsidiaries without the prior written consent of the Majority Lenders. SECTION 2. Reduction of Commitments. The Commitments of the respective Lenders are hereby reduced to the amounts set forth on Exhibit A hereto. SECTION 3. Amendment Fee. No part of this Amendment shall become effective until the Borrower shall have delivered to the Agent payment to each Lender of a fee equal to 0.075% of such Lender's Commitment, as amended hereby. SECTION 4. Ratification. Except as expressly amended by this Amendment, the Loan Agreement and the other Loan Documents shall remain in full force and effect. None of the rights, title and interests existing and to exist under the Loan Agreement are hereby released, diminished or impaired, and the Borrower hereby reaffirms all covenants, representations and warranties in the Loan Agreement (except such representations and warranties which are, by their express terms, limited to a prior date). 4 5 SECTION 5. Expenses. The Borrower shall pay to the Agent all reasonable fees and expenses of its respective legal counsel (pursuant to Section 11.3 of the Loan Agreement) incurred in connection with the execution of this Amendment. SECTION 6. New Lenders. From and after the date hereof, Citicorp USA and Southwest Bank of Texas, N.A. shall constitute "Lenders" under the Loan Agreement and, by their execution hereof, Citicorp USA and Southwest Bank of Texas, N.A. acknowledge and agree to the obligations arising therefrom. SECTION 7. Certifications. The Borrower hereby certifies that (a) no material adverse change in the assets, liabilities, financial condition, business or affairs of the Borrower has occurred since December 31, 2000 and (b) no uncured Default or uncured Event of Default has occurred and is continuing or will occur as a result of this Amendment. SECTION 8. Waiver/Consent. The Agent and the Lenders hereby waive any Default or Event of Default which may exist as a result of the Borrower's failure to comply with Section 8.1(vii) of the Loan Agreement for all periods prior to the date of this Amendment. The waiver granted herein is given solely for the express purpose stated herein and is not a waiver of any other provision of the Loan Agreement or for any other period. SECTION 9. Miscellaneous. This Amendment (a) shall be binding upon and inure to the benefit of the Borrower, the Lenders and the Agent and their respective successors, assigns, receivers and trustees; (b) may be modified or amended only by a writing signed by the required parties; (c) shall be governed by and construed in accordance with the laws of the State of Texas and the United States of America; (d) may be executed in several counterparts by the parties hereto on separate counterparts, and each counterpart, when so executed and delivered, shall constitute an original agreement, and all such separate counterparts shall constitute but one and the same agreement and (e) together with the other Loan Documents, embodies the entire agreement and understanding between the parties with respect to the subject matter hereof and supersedes all prior agreements, consents and understandings relating to such subject matter. The headings herein shall be accorded no significance in interpreting this Amendment. NOTICE PURSUANT TO TEX. BUS. & COMM. CODE SECTION 26.02 THE LOAN AGREEMENT, AS AMENDED BY THIS AMENDMENT, AND ALL OTHER LOAN DOCUMENTS EXECUTED BY ANY OF THE PARTIES PRIOR HERETO OR SUBSTANTIALLY CONCURRENTLY HEREWITH CONSTITUTE A WRITTEN LOAN AGREEMENT WHICH REPRESENTS THE FINAL AGREEMENT BETWEEN THE PARTIES AND MAY NOT BE CONTRADICTED BY EVIDENCE OF PRIOR, CONTEMPORANEOUS OR SUBSEQUENT ORAL AGREEMENTS OF THE PARTIES. THERE ARE NO UNWRITTEN ORAL AGREEMENTS BETWEEN THE PARTIES. 5 6 IN WITNESS WHEREOF, the Borrower, the Lenders and the Agent have caused this Amendment to be signed by their respective duly authorized officers, effective as of the date first above written. Exhibit A -- Reduced Commitments HCC INSURANCE HOLDINGS, INC., a Delaware corporation By: /s/ Edward H. Ellis, Jr. ----------------------------------------- Edward H. Ellis, Jr., Senior Vice President and Chief Financial Officer 6 7 WELLS FARGO BANK TEXAS, NATIONAL ASSOCIATION, as Administrative Agent and Lead Arranger and as a Lender By: /s/ Jonathan C. Homeyer --------------------------- Name: Jonathan C. Homeyer -------------------------------------- Title: Vice President ------------------------------------- 7 8 FIRST UNION NATIONAL BANK, as Syndication Agent and as a Lender By: /s/ Daniel J. Norton ----------------------------------------- Name: Daniel J. Norton ---------------------------------------- Title: Director --------------------------------------- 8 9 BANK OF AMERICA, N.A., as Documentation Agent and as a Lender By: /s/ Leslie E. Reed ----------------------------------------- Name: Leslie E. Reed --------------------------------------- Title: Vice President -------------------------------------- 9 10 THE BANK OF NEW YORK, as Senior Managing Agent and as a Lender By: /s/ Benjamin L. Balkind ----------------------------------------- Name: Benjamin L. Balkind --------------------------------------- Title: Vice President -------------------------------------- 10 11 CITICORP USA By: /s/ William J. Cavanagh ---------------------------------------- Name: William J. Cavanagh -------------------------------------- Title: Vice President ------------------------------------- 11 12 SOUTHWEST BANK OF TEXAS, N.A. By: /s/ Bennett D. Douglas ---------------------------------------- Name: Bennett D. Douglas -------------------------------------- Title: Senior Vice President ------------------------------------- 12 13 The undersigned hereby join in this Amendment to evidence their consent to execution by Borrower of this Amendment, to confirm that each Loan Document now or previously executed by the undersigned applies and shall continue to apply to the Loan Agreement, as amended hereby, to acknowledge that without such consent and confirmation, Lenders would not execute this Amendment and to join in the notice pursuant to Tex. Bus. & Comm. Code Section 26.02 set forth above. AVEMCO CORPORATION, a Delaware corporation, NORTH AMERICAN SPECIAL RISK ASSOCIATES, INC., an Illinois corporation, LDG REINSURANCE CORPORATION, a Massachusetts corporation, HCC EMPLOYER SERVICES, INC., an Alabama corporation, HCC EMPLOYEE BENEFITS, INC., a Delaware corporation, HCC AVIATION INSURANCE GROUP, INC., a Texas corporation, HCC BENEFITS CORPORATION, a Delaware corporation, HCC INTERMEDIARIES, INC., a Texas corporation, HCC INTERMEDIATE HOLDINGS, INC., a Delaware corporation, THE CENTRIS GROUP, INC., a Delaware corporation, U.S. BENEFITS INSURANCE SERVICES, INC., a California corporation, and U.S. HOLDINGS, INC., a Delaware corporation By: /s/ Edward H. Ellis, Jr. ---------------------------------------- Name: Edward H. Ellis, Jr. -------------------------------------- Title: Senior Vice President ------------------------------------- 13 14 Wells Fargo Bank Texas, National Association.....................................................$45,000,000 First Union National Bank........................................................................$40,000,000 Bank of America, N.A.............................................................................$40,000,000 The Bank of New York.............................................................................$35,000,000 Citicorp USA.....................................................................................$25,000,000 Southwest Bank of Texas, N.A.....................................................................$15,000,000
EXHIBIT A -----END PRIVACY-ENHANCED MESSAGE-----