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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
/X/ Annual Report pursuant to Section 13 or 15(d)of the Securities Exchange Act
of 1934 (Fee required).
/ / Transaction report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 (No fee required).
For the fiscal year ended _______December 31, 1997________________________
Commission file number _______0-20766_____________________________________
HCC Insurance Holdings, Inc.
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(Exact name of registrant as specified in its charter)
Delaware 76-0336636
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(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
13403 Northwest Freeway, Houston, Texas 77040-6094
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(Address of principal executive offices) (Zip Code)
(713) 690-7300
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(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12 (b) of the Act:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE OF WHICH REGISTERED:
COMMON STOCK, $1.00 PAR VALUE New York Stock Exchange
Securities registered pursuant to Section 12 (g) of the Act: NONE
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes __X__ No _____
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K (Section229.405 of this chapter) is not contained herein, and
will not be contained, to the best of registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K. / /
The aggregate market value on March 13, 1998, of the voting stock held by
non-affiliates of the registrant was approximately $869.2 million. For purposes
of the determination of the above stated amount, only directors and executive
officers are presumed to be affiliates, but neither the registrant nor any such
person concede that they are affiliates of the registrant.
The number of shares outstanding of the registrant's Common Stock, $1.00 par
value, as of March 13, 1998 was 47,827,789.
Documents incorporated by reference: Information called for in Part III of this
Form 10-K is incorporated by reference to the Registrant's definitive Proxy
Statement to be filed within 120 days of the close of the Registrant's fiscal
year in connection with the Registrant's annual meeting of shareholders.
TABLE OF CONTENTS
HCC INSURANCE HOLDINGS, INC.
PAGE
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PART I.
ITEM 1. Business........................................................................ 3
ITEM 2. Properties...................................................................... 24
ITEM 3. Legal Proceedings............................................................... 24
ITEM 4. Submission of Matters to a Vote of Security Holders............................. 24
PART II.
ITEM 5. Market for the Registrant's Common Equity and Related Stockholder Matters....... 25
ITEM 6. Selected Financial Data......................................................... 26
ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of
Operations...................................................................... 28
ITEM 7A. Quantitative and Qualitative Disclosure About Market Risk....................... 35
ITEM 8. Financial Statements and Supplementary Data..................................... 35
ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial
Disclosures..................................................................... 35
PART III.
ITEM 10. Directors and Executive Officers of the Registrant.............................. 36
ITEM 11. Executive Compensation.......................................................... 36
ITEM 12. Security Ownership of Certain Beneficial Owners and Management.................. 36
ITEM 13. Certain Relationships and Related Transactions.................................. 36
PART IV.
ITEM 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K................. 36
SIGNATURES.............................................................................................. 37
This report on Form 10-K (this "Report") contains certain forward-looking
statements within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities Exchange Act of 1934, as amended,
which are intended to be covered by the safe harbors created thereby. Investors
are cautioned that all forward-looking statements necessarily involve risks and
uncertainty, including, without limitation, the risk of a significant natural
disaster, the inability of the Company to reinsure certain risks, the adequacy
of its loss reserves, the financial viability of reinsurers, the expansion or
contraction in its various lines of business, the impact of inflation, changing
licensing requirements and regulations in the United States and in foreign
countries, the ability of the Company to integrate its recently acquired
businesses, the effect of pending or future acquisitions as well as acquisitions
which have recently been consummated, general market conditions, competition,
licensing and pricing. All statements, other than statements of historical
facts, included or incorporated by reference in this Report that address
activities, events or developments that the Company expects or anticipates will
or may occur in the future, including, without limitation, such things as future
capital expenditures (including the amount and nature thereof), business
strategy and measures to implement such strategy, competitive strengths, goals,
expansion and growth of the Company's businesses and operations, plans,
references to future success, as well as other statements which includes words
such as "anticipate", "believe", "plan", "estimate", "expect", and "intend" and
other similar expressions, constitute forward-looking statements. Although the
Company believes that the assumptions underlying the forward-looking statements
contained herein are reasonable, any of the assumptions could over time prove to
be inaccurate and therefore, there can be no assurance that the forward-looking
statements included in this Report will themselves prove to be accurate. In
light of the significant uncertainties inherent in the forward-looking
statements included herein, the inclusion of such information should not be
regarded as a representation by the Company or any other person that the
objectives and plans of the Company will be achieved.
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PART I
In accordance with the pooling-of-interests method of accounting, the
financial information of HCC Insurance Holdings, Inc. and its subsidiaries set
forth in this Form 10-K has been restated to include the accounts and operations
of AVEMCO Corporation and LDG Management Company Incorporated.
ITEM 1. BUSINESS
GENERAL
HCC Insurance Holdings, Inc. ("HCC") is a Delaware corporation with
principal and executive offices located at 13403 Northwest Freeway, Houston,
Texas 77040. HCC and its consolidated subsidiaries are collectively referred to
herein as the "Company" unless the context otherwise requires. HCC, through its
subsidiaries, provides specialized property and casualty insurance coverages,
managing general agency services and insurance related services both to
commercial customers and individuals. The Company's insurance products are
underwritten on both a direct and reinsurance basis and are marketed by the
Company itself and through a network of independent and affiliated agents and
brokers. The Company's principal insurance company subsidiaries are Houston
Casualty Company ("HC"), U.S. Specialty Insurance Company ("USSIC") and
Trafalgar Insurance Company ("TIC") in Houston, Texas; and AVEMCO Insurance
Company ("AIC") in Frederick, Maryland. Until recently, the Company operated IMG
Insurance Company Ltd. ("IMG") as a separate company in Amman, Jordan and
London, England. The Company is in the process of consolidating IMG's operations
with those of HC and on a going forward basis, IMG will be operated as a branch
of HC in the same locations. The Company's principal agency subsidiaries are LDG
Management Company Incorporated ("LDG") in Wakefield, Massachusetts; HCC
Underwriters, A Texas Corporation ("HCCU") in Houston, Texas; The Kachler
Corporation ("Kachler") in Houston, Texas; North American Special Risk
Associates, Inc. ("NASRA") in Northbrook, Illinois; Aviation & Marine Insurance
Group, Inc. ("AMIG") in Dallas, Texas; and Guarantee Insurance Resources, Inc.
("GIR") in Marietta, Georgia.
Since its founding in 1974, the Company and its predecessor companies have
been consistently profitable, generally reporting annual increases in gross
written premium ("GWP"), net written premium ("NWP"), management fee and
commission income and total revenue. During the period 1995 through 1997, the
Company's insurance company subsidiaries had an average combined ratio of 82.3%
versus the less favorable 106.1% recorded by the U.S. property and casualty
insurance industry overall (1995-1996). During the same period, the Company's
GWP increased from $283.5 million to $346.4 million, an increase of 22%,
although growth has slowed recently; management fee and commission income
increased from $35.9 million to $75.9 million an increase of 112%; and net
earnings increased from $26.1 million to $49.8 million, an increase of 91%.
The Company's insurance companies' underwriting activities are focused on
providing aviation, marine, offshore energy, property, accident and health, and
lenders single interest insurance and reinsurance on a worldwide basis. As an
insurer, the Company operates on a surplus lines or a non-admitted basis through
HC and TIC and on an admitted basis through AIC and USSIC.
The Company's domestic insurance company subsidiaries are rated "A+"
(Superior) by A.M. Best Company ("A.M. Best"). HC is rated "Aq" and AIC is rated
"AAq" by Standard & Poor's Corporation ("S&P"). An A.M. Best or S&P rating is
intended to provide an independent opinion of an insurer's ability to meet its
obligations to policyholders and should not be considered as an investment
recommendation.
The Company also underwrites on behalf of non-affiliiated insurance
companies through its managing general agency operations. These agency
operations specialize in domestic general aviation insurance, medical stop-loss
coverage for employee sponsored self-insured health plans, occupational accident
coverage for self-insured truckers, and a variety of accident and health related
insurance and reinsurance products. Beginning in 1996, in an effort to further
diversify its operations to enhance the Company's
3
ability to anticipate and capitalize on opportunities resulting from changing
market conditions in the insurance industry, the Company commenced a strategy of
acquiring through merger or purchase, a number of privately held companies whose
business was managing general agency activities, primarily in the medical
stop-loss and domestic general aviation insurance businesses. As a result of
these acquisitions and internal growth, since 1995, the Company's management fee
and commission income has increased from $5.9 million (prior to both
poolings-of-interests restatements) to $75.9 million. The managing general
agency operations generated $518.2 million in premium during 1997, an increase
of 55% since 1995. The Company will continue to review possible acquisition
candidates in the insurance agency and services sectors in order to further the
Company's growth in this area.
STRATEGY
The Company's operating philosophy as an insurer is to maximize underwriting
profit while preserving the integrity of shareholders' equity. The Company
concentrates its writings in selected, narrowly defined lines of business in
which it believes there is a substantial opportunity to achieve underwriting
profits. The Company primarily underwrites first party coverages and lines of
business which have relatively short lead times between the occurrence of an
insured event and the reporting of claims to the Company. The Company's
insurance products are marketed both directly by the Company and through
independent and affiliated agents. With respect to the underwriting management,
marketing and related services, the Company seeks to offer quality underwriting,
decision-making, support and reinsurance capacity and financial and other
resources to take advantage of market opportunities for the development of new
products.
The property and casualty insurance underwriting business has historically
been cyclical (though not seasonal) and within the overall cycle of the
industry, particular lines of business experience their own cycles. These cycles
are characterized by periods of excess capital and significant competition in
policy pricing, terms and conditions, followed by periods of capital shortages,
typically resulting from adverse loss experience, which leads to decreased
competition, higher premium rates and stricter underwriting standards.
The position of a particular line of business in its respective underwriting
cycle depends on prevailing premium rates, availability and cost of reinsurance,
and other market conditions. The Company considers each of these factors in
determining when to increase or decrease premium volume in each line. With this
approach, the Company focuses on increasing net earnings rather than premium
volume or market share.
The Company purchases a substantial amount of reinsurance to limit its net
loss from both individual and catastrophic risks. The degree to which the
Company reinsures varies by, among other things, the particular risks inherent
in the policies underwritten, pricing of available reinsurance and competitive
conditions within the relevant line of business.
In its insurance company operations, the Company believes its operational
flexibility, experienced underwriting personnel, and access to and expertise in
the reinsurance marketplace allow the Company to implement its strategy of
emphasizing more profitable lines of business during periods of increased
premium rates and de-emphasizing less profitable lines of business during
periods of severe competition. In addition, through its acquisition and
ownership of insurance agency businesses, the Company believes that it has
demonstrated that those service based businesses can both complement the
Company's underwriting activities and serve as a source of revenue which may not
be subject to the same level of volatility as traditional underwriting revenues.
Many of the Company's insurance agency and services subsidiaries act as an agent
on behalf of, or provide services to, the Company's insurance company
subsidiaries as well as to non-affiliated insurers. The ability of the Company's
insurance company subsidiaries to utilize an affiliated insurance agency or
services provider, and the corollary ability of such insurance agency and
services subsidiaries to place business with, or provide other services to, an
affiliated
4
insurer, permits the Company to capture a greater portion of the total income
derived from generated premium.
The Company's business plan is to expand its underwriting activities and
continue the growth of its insurance agency and services operations. However,
the Company's business plan is shaped by its underlying operating philosophy,
which is to maximize underwriting profit opportunities, while preserving the
integrity of shareholders' equity. The Company expects to continue to seek to
acquire complementary businesses with established management and reputation in
the insurance industry, whose business, the Company believes, can be enhanced
through the synergism created by the Company's underwriting capabilities and its
other owned insurance related businesses. As a result, the Company's primary
interests are not necessarily in expanding market share or GWP, but rather in
increasing net earnings. To accomplish this objective, the Company: (i) has been
and is prepared to emphasize or reduce underwritings in certain lines of
business as premium rates, the availability and cost of reinsurance and other
market conditions warrant; (ii) will continue to attempt to limit its downside
net loss exposure through the effective, prudent and conservative use of
reinsurance; (iii) will, as conditions warrant, continue to emphasize the growth
of its insurance agency and services operations, which can be expected to result
in continuing growth of management fee and commission income as a portion of
total revenues; and (iv) will continue to review the possible acquisition of
other specialty insurance companies.
INDUSTRY SEGMENT INFORMATION
Financial information concerning the Company's operations by industry
segments is set forth in the Consolidated Financial Statements and the Notes
thereto.
RECENT ACQUISITIONS
On May 24, 1996, the Company issued 6,250,000 shares of its Common Stock to
acquire all of the outstanding shares of LDG. LDG underwrites on behalf of
insurance and reinsurance companies and conducts its business in two areas: (i)
insurance underwriting management and (ii) reinsurance underwriting management
and intermediary services. LDG underwrites insurance and/or reinsurance in the
following lines of business: medical stop-loss insurance for employer sponsored
self-insured health plans, accident and health special risks, workers'
compensation and alternative workers' compensation. LDG generally concentrates
on lines of business that have relatively short lead times between the
occurrence of an insured event and the reporting of claims.
On November 27, 1996, the Company issued 1,136,400 shares of its Common
Stock and paid $1.7 million in cash to acquire all of the outstanding shares of
NASRA. NASRA provides underwriting management and claims administration services
to insurance and reinsurance companies primarily for occupational accident
insurance for self-employed truckers and alternative workers' compensation
insurance.
On January 24, 1997, the Company issued 266,667 shares of its Common Stock
and paid $6.6 million in cash to acquire all of the occupational accident
business of TRM International, Inc. This acquired business was consolidated with
the operations of NASRA and effectively doubled NASRA's business.
On April 30, 1997, the Company issued 725,000 shares of its Common Stock to
acquire all of the outstanding shares of Interworld Corporation ("Interworld"),
the parent corporation of AMIG. AMIG provides underwriting management services
for general aviation risks, with special emphasis on private and corporate
aircraft and small to medium size airports and commercial operators.
On June 17, 1997, the Company issued 8,511,625 shares of its Common Stock
and 604,575 options to purchase its Common Stock in order to acquire all of the
outstanding shares and options to purchase shares of AVEMCO Corporation
("AVEMCO"), the parent corporation of a group of insurance and insurance
services companies. AVEMCO, through its insurance company subsidiaries, provides
property
5
and casualty insurance in the general aviation, lenders single interest,
short-term health and pleasure-craft marine lines of business. AVEMCO's primary
insurance company subsidiaries were AIC and USSIC. Following the acquisition,
the operations of USSIC have been relocated to Houston, Texas and it has become
a subsidiary of HC. AIC and USSIC operate on an admitted basis throughout the
United States and AIC also operates as an admitted insurer in Canada (except
Quebec).
AVEMCO's principal insurance agency and services operations are focused in
five areas: (i) underwriting management services for lenders single interest
coverage for banks and other financial institutions; (ii) underwriting
management services for short-term health and travel insurance marketed to
foreign students resident in the United States; (iii) claims management services
primarily on behalf of AIC; (iv) worldwide multilingual emergency assistance and
evacuation arrangement services for individuals traveling abroad; and (v)
insurance related computer products, software and services for property and
casualty insurance companies throughout the United States.
On June 26, 1997, the Company issued 98,003 shares of its Common Stock and
paid $3.6 million in cash to acquire all of the outstanding shares of Managed
Group Underwriting, Inc. ("MGU"). MGU provides underwriting management services
for medical stop-loss insurance for employer sponsored self-insured health
plans.
On July 31, 1997, the Company issued 17,354 shares of its Common Stock and
paid $2.8 million in cash to acquire all of the outstanding shares of
Continental Aviation Underwriters, Inc. ("Continental"). Continental provides
underwriting management services for general aviation risks, with special
emphasis on commercial agricultural operators.
On August 8, 1997, the Company issued 225,000 shares of its Common Stock to
acquire all of the outstanding shares of Southern Aviation Insurance
Underwriters, Inc. and Aviation Claims Administrators, Inc. (collectively,
"Southern"). Southern provides underwriting management and claims administration
services for general aviation risks, specializing in antique and vintage
military aircraft.
The operations of each of Continental and Southern have been consolidated
with those of AMIG in Dallas, Texas, which exercises overall responsibility for
underwriting management and claims administration services for the Company's
agency produced, domestic general aviation business.
On February 27, 1998, the Company issued 1,600,000 shares of its Common
Stock to acquire all of the outstanding shares of The Kachler Corporation
("Kachler"). Kachler is a retail insurance agency specializing in life, accident
and health insurance for employee benefit plans of large commercial customers
throughout the United States.
Effective as of February 28, 1998, the Company issued 29,029 shares of its
Common Stock and paid $21.4 million in cash to acquire all of the outstanding
shares of Insurance Alternatives, Inc. and the assets and liabilities of
Guarantee Insurance Resources, a general partnership (collectively, "GIR"). GIR
provides underwriting management services for medical stop-loss insurance for
employer sponsored self-insured health plans.
PENDING ACQUISITIONS
There are currently no acquisitions pending; however, the Company is
evaluating a number of possible acquisition candidates and expects to complete
one or more acquisitions during the remainder of 1998. The Company believes
these future acquisitions will expand and strengthen its existing lines of
business and perhaps provide access to additional specialty sectors, which
management expects will contribute to the growth of the Company.
6
INSURANCE COMPANY OPERATIONS
The Company's property and casualty insurance company businesses specialize
in the direct underwriting, including facultative (individual policy)
reinsurance of aviation, marine, offshore energy, property, accident and health,
and lenders single interest risks and to a lesser extent, treaty reinsurance
(contractual arrangements relating to specific types of risks) on both a
proportional (where the reinsurer shares proportionately in premiums and losses)
and an excess of loss (where only losses above a fixed point or percentage are
reinsured) basis in these same lines of business.
LINES OF BUSINESS
The following table sets forth the Company's insurance company subsidiaries'
GWP by line of business and the percent to total GWP for the periods indicated:
FOR THE YEARS ENDED DECEMBER 31,
(DOLLARS IN THOUSANDS)
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1997 1996 1995
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Aviation................................................. $ 164,519 47% $ 140,725 42% $ 132,690 39%
Property................................................. 85,379 25 118,154 35 124,336 37
Accident and health...................................... 43,232 12 13,004 4 10,897 3
Marine................................................... 22,847 7 32,433 10 37,321 11
Lenders single interest.................................. 21,878 7 22,870 7 16,646 5
Offshore energy.......................................... 7,469 2 8,496 2 14,893 4
Excess of loss........................................... 386 -- 734 -- 1,877 1
Miscellaneous............................................ 689 -- 862 -- 445 --
---------- --- ---------- --- ---------- ---
Total GWP.............................................. $ 346,399 100% $ 337,278 100% $ 339,105 100%
---------- --- ---------- --- ---------- ---
---------- --- ---------- --- ---------- ---
The following table sets forth the Company's insurance company subsidiaries'
NWP by line of business and the percent to total NWP for the periods indicated:
FOR THE YEARS ENDED DECEMBER 31,
(DOLLARS IN THOUSANDS)
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1997 1996 1995
----------------------- --------------------- ---------------------
Aviation................................................. $ 75,518 53% $ 104,964 56% $ 95,488 52%
Accident and health...................................... 28,165 20 12,851 7 10,794 6
Marine................................................... 17,271 12 25,918 14 32,855 18
Lenders single interest.................................. 11,097 8 19,726 10 14,600 8
Property................................................. 8,838 6 21,534 11 24,186 13
Offshore energy.......................................... 1,495 1 3,472 2 5,115 3
Excess of loss........................................... 300 -- (1,047) -- 833 --
Miscellaneous............................................ 688 -- 857 -- 454 --
---------- --- ---------- --- ---------- ---
Total NWP.............................................. $ 143,372 100% $ 188,275 100% $ 184,325 100%
---------- --- ---------- --- ---------- ---
---------- --- ---------- --- ---------- ---
UNDERWRITING
DIRECT--The Company underwrites direct business produced through independent
agents and brokers, affiliated intermediaries, and by direct marketing efforts,
particularly in small general aviation business.
REINSURANCE--The Company engages in reinsurance underwriting on a periodic
basis when market rates and other conditions make it profitable to do so, to
access business not readily available to the Company on a direct basis and to
provide reciprocity to non-affiliated insurance companies. The Company
7
began writing treaty reinsurance in 1984, but had dramatically reduced its book
of business by 1992, due to the deterioration in market conditions.
The Company's current reinsurance underwriting activities are primarily in
accident and health lines of business where the Company's insurance company
subsidiaries participate in various insurance and reinsurance underwriting pools
managed by one of its subsidiaries and facultative reinsurance, particularly in
the aviation and property lines of business.
The Company previously wrote excess of loss reinsurance, typically aviation,
marine and non-marine catastrophe exposures. In 1992, due to a general market
contraction of available reinsurance for excess of loss business, the Company
was unable to purchase adequate protection at a reasonable cost and, therefore,
elected not to continue writing this class other than selectively on a net
basis. The run-off of this line of business continues profitably on a net basis.
The Company underwrites proportional treaty reinsurance on a selective
basis. The exposures reinsured are typically the same type of risks that the
Company underwrites on a direct basis.
The Company underwrites facultative reinsurance in most of its lines of
business. Typically, this is on international business in order to comply with
local licensing requirements or as reinsurance of captives, and usually can be
considered direct business, as the Company maintains underwriting and claims
control. However, all of this business is recorded under the caption of
"Reinsurance Assumed".
AVIATION--Aviation underwriting presently represents the Company's largest
overall line of business and in recent years the Company has grown into a market
leader in the aviation insurance industry. The Company insures, on both a direct
marketed and independent agency produced basis, general aviation risks,
including private aircraft owners and pilots, fixed base operations, rotor wing
aircraft, corporate aircraft, cargo operations, commuter airlines and similar
operations, many on both a domestic and international basis. At this time, the
Company does not generally insure major domestic trunk airlines, major
manufacturers or satellites. The coverages underwritten include hull (including
engines, avionics and other systems), liabilities, war, cargo and various
ancillary coverages.
The Company has been underwriting aviation risks since 1981 through HC. AIC
has been insuring aviation risks since 1959. GWP has risen consistently since
1995, increasing from $132.7 million to $164.5 million in 1997. This growth has
occurred due to internal growth, particularly internationally. Although, due to
market conditions, domestic risks had not been a focus for the Company since the
early 1990's, HC resumed writing domestic general aviation risks late in 1996
and with the acquisition of AIC and USSIC in mid-1997, the Company assumed the
role of a major participant in the domestic general aviation insurance market.
The Company's position in the domestic general aviation market is further
enhanced by its aviation managing general agency operations and the Company
estimates that it presently underwrites on behalf of affiliated and
non-affiliated insurance companies approximately 25% of the overall domestic
general aviation market. The Company expects that general aviation insurance
will continue to play a key role in the Company's near-term operations. In 1997,
the Company experienced a decline in NWP due to the implementation of the
Company's reinsurance program at AIC. The Company expects its overall increases
in GWP and NWP to slow during 1998 as a result of the Company's already
substantial market share and increased competition.
Treaty reinsurance is maintained on both a proportional and an excess of
loss basis to protect the Company against individual risk severity of loss and
catastrophe exposure. Management believes that the aviation risks underwritten
by the Company carry a relatively low level of catastrophe exposure.
MARINE--The Company underwrites marine risks for ocean going vessels ("Blue
Water"), inland and coastal trading vessels ("Brown Water"), fishing vessels and
to a limited extent, pleasure-crafts. The coverages written include hull and
machinery, liabilities (including protection and indemnity), marine cargo and
various ancillary coverages.
8
The Company has underwritten marine risks since 1984. Premium rates were
adequate during 1995 and 1996 but competition has created downward pressure on
these rates causing a reduction in the Company's GWP from $37.3 million in 1995
to $22.8 million in 1997 and a corresponding decrease in NWP from $32.9 million
to $17.3 million for the same period. The Company believes these rates will
remain soft during 1998.
Treaty reinsurance is maintained on an excess of loss basis to protect the
Company against individual risk severity of loss and catastrophe exposure.
Management believes that the marine risks underwritten by the Company carry a
relatively low level of catastrophe exposure.
OFFSHORE ENERGY--The Company has been underwriting offshore energy risks
since 1988. Offshore energy risks include drilling rigs, production and
gathering platforms, and pipelines. Coverages underwritten include physical
damage, liabilities, business interruption and various ancillary coverages.
Rates have declined significantly during the past few years to levels where
profitability is unlikely. Underwriting has been on a very selective basis,
striving for quality rather than quantity, which has resulted in a continued
reduction in GWP from $14.9 million in 1995 to $7.5 million in 1997. The Company
anticipates little growth in GWP and NWP during 1998 as severe competition is
expected to continue.
Treaty reinsurance is maintained on both a proportional and an excess of
loss basis to protect the Company against individual risk severity of loss and
the catastrophic exposure that exists, for example, from a hurricane in the Gulf
of Mexico.
PROPERTY--The Company specializes in writing catastrophe exposed risks in
general and the property risks of large multinational corporations, covering
such commercial risks as hotels, office buildings, retail locations, factories,
industrial plants, utilities, refineries, natural gas facilities and
petrochemical plants. Coverage includes business interruption and physical
damage, including flood and earthquake.
The Company has written property business since 1986. GWP grew to $124.3
million in 1995 as premium rates increased following the Northridge earthquake
in 1994. During 1996, premium rates began to soften and this trend has continued
throughout 1997 due in a large part to excess capacity and the absence of
significant catastrophe losses. GWP has declined from $124.3 million in 1995 to
$85.4 million in 1997. NWP also declined from $24.2 million to $8.8 million in
the same period. Property NWP will always be substantially less than GWP due to
the amount of reinsurance purchased to protect the Company's catastrophe
exposure. In the absence of a major catastrophe loss, which could be expected to
have a positive impact on pricing in the sector, the Company expects both GWP
and NWP to decline further during 1998 as premium rates continue to soften.
Considerable treaty reinsurance is maintained on both a proportional and an
excess of loss basis to ensure adequate protection, particularly against
catastrophic exposures. The Company conservatively estimates its aggregate
exposure in any individual catastrophe zone and maintains catastrophe
reinsurance to cover its exposure to any one occurrence.
ACCIDENT AND HEALTH--The Company began underwriting accident and health
risks through HC during 1996. These risks are produced primarily by the managing
general agencies which were acquired by the Company during that year. The risks
underwritten include medical stop-loss insurance for employer sponsored
self-insured health plans; reinsurance in the medical, accident and health
special risks, workers' compensation and alternative workers' compensation
areas; and occupational accident insurance for self-employed truckers. The
Company underwrites in this area on both a direct and reinsurance basis. The
Company's GWP increased from $13.0 million in 1996 to $43.2 million in 1997. The
Company expects its overall GWP and NWP to continue to increase significantly
during 1998, primarily due to the Company's anticipated utilization of AIC as a
primary insurer of medical stop-loss products underwritten by the Company's
accident and health agency operations.
9
Management believes that its accident and health business carries a
relatively low level of catastrophe exposure.
LENDERS SINGLE INTEREST--USSIC began writing lenders single interest risks
in 1984. GWP increased from $16.6 million in 1995 to $21.9 million in 1997,
however, due to the implementation of a reinsurance program when USSIC was
acquired in June, 1997, NWP decreased from $14.6 million in 1995 to $11.1
million in 1997. This coverage is marketed to banks and other financial
institutions and addresses risks of physical loss or damage to the property
securing installment loans (primarily automobiles). All of the lenders single
interest risks underwritten by the Company are produced by the Company's
subsidiary, Matterhorn Bank Programs, Inc. ("Matterhorn"). GWP is expected to
grow during 1998 but NWP will remain unchanged as the new reinsurance program
will be in effect for the entire year.
Treaty reinsurance is maintained on a proportional basis to protect against
frequency of loss. Management believes that its lenders single interest business
carries a relatively low level of catastrophe exposure.
INSURANCE COMPANY SUBSIDIARIES
HOUSTON CASUALTY COMPANY--HC, the Company's principal insurance company
subsidiary, is rated A+, VIII by A.M. Best and operates worldwide in all of the
lines of business in which the Company specializes (except lenders single
interest). HC's business is produced by independent agents and brokers, the
group's agency subsidiaries, AIC, USSIC, TIC, and other insurance and
reinsurance companies worldwide. HC has a highly experienced staff of
underwriters trained to deal with the high value, complicated exposures
prevailing in many of the lines of business in which the Company specializes. As
of December 31, 1997, HC had statutory policyholders' surplus of $233.0 million.
TRAFALGAR INSURANCE COMPANY--TIC, which was organized in 1993, is a wholly
owned subsidiary of HC. TIC is an Oklahoma domiciled property and casualty
insurance company, is rated A+, VI by A.M. Best and currently underwrites
domestic property risks and allows HC to offer insurance on a surplus lines
basis in certain jurisdictions where HC is not otherwise permitted to do so.
Applications for surplus lines approval are pending in many additional states
and TIC will expand its operations as approvals are received. As of December 31,
1997, TIC had statutory policyholders' surplus of $30.9 million.
U.S. SPECIALTY INSURANCE COMPANY--USSIC is a Maryland domiciled property and
casualty insurance company and former subsidiary of AIC which became a
subsidiary of HC in December, 1997. The Company is in the process of effecting
the re-domestication of USSIC from Maryland to Texas, which, pending regulatory
approval, is expected to be completed during the second quarter of 1998. USSIC
is rated A+, VII by A.M. Best and has historically been an underwriter of
general aviation, pleasure-craft marine and lenders single interest risks
through a network of independent agents. USSIC operates on an admitted basis
throughout the United States (except Hawaii). The Company expects to continue
USSIC's operation primarily as a general aviation and lenders single interest
underwriter. During December, 1997, the Company increased the policyholders'
surplus of USSIC by $38.4 million and as of December 31, 1997, USSIC had
statutory policyholders' surplus of $50.1 million.
IMG INSURANCE COMPANY LTD.--Organized in September, 1991, as a Jordanian
Exempt Company ("JEC"), IMG conducts substantially all of its business outside
of Jordan and has been principally engaged in insuring and reinsuring large
commercial risks in substantially the same lines of business as HC. In
connection with IMG's business, the Company has agreed to unconditionally
guarantee certain of the insurance and reinsurance business of IMG. As of
December 31, 1997, IMG had policyholders' surplus of $28.5 million. During 1998,
the operations of IMG, through its Amman, Jordan and London, England offices,
were consolidated with the operations of HC and HC is in the process of assuming
all of IMG's existing insurance obligations. On a going forward basis, IMG will
operate as a branch of HC. Management believes that this action can be expected
to enhance the direct presence of HC in the Middle Eastern,
10
African and London insurance markets and is expected to lead to increased
underwriting opportunities for the Company in those and other international
markets.
AVEMCO INSURANCE COMPANY--AIC was organized in 1959 and became a subsidiary
of the Company in June, 1997. AIC is a Maryland domiciled property and casualty
insurer, is rated A+, VII by A.M. Best and operates primarily as a direct market
writer of general aviation and pleasure-craft marine business on an admitted
basis throughout the United States and Canada (except Quebec). In addition, as a
part of the Company's overall operations, it is anticipated that AIC will become
a primary insurer of medical stop-loss products underwritten by the Company's
accident and health managing general agency subsidiaries and of lenders single
interest risks underwritten by another subsidiary of the Company. At December
31, 1997, AIC had statutory policyholders' surplus of $67.9 million.
INSURANCE AGENCY AND SERVICES OPERATIONS
The Company's insurance agency subsidiaries act on behalf of insurance and
reinsurance companies, conducting business in the areas of insurance and
reinsurance underwriting management and claims administration. The insurance
services operations provide insurance related services including intermediary
services. The insurance agency and services subsidiaries do not assume any
insurance or reinsurance risk themselves and the revenues generated are based
entirely on management fees, commissions and profit commissions. As a result of
their operations, these subsidiaries are in a position to direct and control
such insurance premiums.
LDG, GIR and MGU act as underwriting managers providing medical stop-loss
and excess coverage insurance products principally to employer sponsored
self-insured health plans. Other areas of business include medical, accident and
health special risks, workers' compensation and alternative workers'
compensation insurance. In 1997, these operations generated approximately $442.0
million in premium, the majority of which was underwritten on behalf of
non-affiliated insurance companies.
AMIG, acquired by the Company in April, 1997, has provided the base, along
with the Company's insurance company subsidiary AIC, around which the Company
has rapidly developed a significant presence in the domestic general aviation
market. The underwriting management operations of AMIG have been consolidated
with those of Continental, acquired in July, 1997, Southern, acquired in August,
1997 and certain operations of USSIC, acquired in June, 1997. This combined
operation provides underwriting management services on behalf of affiliated and
non-affiliated insurance companies in the areas of private and corporate
aircraft, commercial agricultural aircraft, antique and vintage military
aircraft, small to medium sized airports, and commercial operators. During 1997,
the combined AMIG operation generated approximately $87.5 million in premium,
the majority of which was underwritten on behalf of non-affiliated insurance
companies.
NASRA acts as an underwriting manager providing occupational accident
(similar to workers' compensation) insurance to self-employed truckers and
generated approximately $46.9 million in premium in 1997, the majority of which
was underwritten on behalf of non-affiliated insurance companies.
Matterhorn acts as an underwriting manager providing lenders single interest
coverage to banks and other financial institutions. During 1997, Matterhorn
generated approximately $21.9 million in premium, all on behalf of affiliated
insurance companies, primarily USSIC.
Kachler, which was acquired in February, 1998, is a retail insurance agency
specializing in life, accident and health insurance for employee benefit plans
of large commercial customers throughout the United States. The Company intends
to increase Kachler's revenues substantially through the acquisition of similar
businesses during 1998 and 1999.
11
HCCU is an intermediary specializing in marketing and servicing large,
complicated insurance and reinsurance programs placed on behalf of multinational
clients operating in the same lines of business that the Company underwrites.
This business is placed with domestic and international insurance companies,
including affiliated insurance companies, on a direct basis and through other
intermediaries. In addition, HCCU acts as a reinsurance intermediary on behalf
of affiliated and non-affiliated insurance companies.
The Company's overall revenue from insurance agency and services operations
is composed of management fee and commission income which increased 77% to $75.9
million in 1997 from $42.8 million in 1995. The Company's premium from managing
general agency operations was $518.2 million in 1997 an increase of 55% from
$334.7 million in 1995. Management expects continued growth in management fee
and commission revenue in 1998, both from existing operations and additional
acquisitions in this sector.
COMBINED INSURANCE COMPANY AND INSURANCE AGENCY OPERATIONS
The Company's combined GWP was over $850.0 million in 1997, with its
insurance company operations underwriting $346.4 million and its managing
general agency operations underwriting $518.2 million, primarily on behalf of
non-affiliated insurance companies. The substantial premium base underwritten
and controlled by the Company's managing general agency operations is expected
to increase both internally and by acquisition during 1998 and will provide a
basis for significant growth for the Company's insurance company operations as
business is transferred from non-affiliated insurance companies.
REINSURANCE CEDED
The Company principally utilizes reinsurance to reduce its net liability on
individual risks, to protect against catastrophic losses and to achieve a
desired ratio of NWP to policyholders' surplus. Various intermediaries,
including HCCU, facilitate the placement of this reinsurance coverage on behalf
of the Company and are compensated, directly or indirectly, by the reinsurers.
Reinsurance is ceded under reinsurance treaties on both a proportional and
an excess of loss basis. The Company also reinsures large individual risks on a
facultative basis. Management believes that the Company reinsures its risks to a
greater extent than most of its competitors and most other insurance companies.
This strategy greatly reduces the likelihood of a significant net loss from
insurance company operations and protects the integrity of the Company's
shareholders' equity. Under its current reinsurance protections, the Company has
limited its net retained loss, across any single line of business, to a maximum
of approximately $500,000 for any one risk, but significantly less on most
risks.
The type, cost and limits of reinsurance purchased can vary from year to
year based upon the Company's desired retention levels and the availability of
adequate reinsurance at a reasonable price. The majority of the Company's
reinsurance programs are renewed on a calendar year basis. For 1998, the Company
has been successful in renewing its reinsurance protections at reduced costs to
1997.
The Company structures a specific reinsurance program for each line of
business it underwrites. This reinsurance is placed in order to protect the
Company from unreasonable exposure to foreseeable events. The Company places
reinsurance proportionally to cover loss frequency and for catastrophe coverage,
on an excess of loss basis to cover individual risk severity of loss and on a
catastrophe basis to cover losses involving multiple risks, such as those
resulting from a hurricane or an earthquake. The Company does not intend to
expose itself to a net loss from an individual risk in excess of its reinsurance
protection.
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
the United States, certain United States Gulf Coast states, particularly in
Florida and Texas, the Caribbean and Mexico. The Company carefully assesses its
overall exposures to a single catastrophic event and applies procedures that it
believes are more conservative than are typically used by the industry to
ascertain the Company's probable maximum loss ("PML") from any
12
single event. The Company maintains reinsurance protection which it believes is
sufficient to cover any foreseeable event.
The Company receives an overriding (ceding) commission on the premium ceded
to reinsurers which compensates the Company for the direct costs associated with
the production of the premium, the servicing of the business during the term of
the policies ceded, and the costs associated with the placement of the related
reinsurance. In addition, certain of the Company's reinsurance treaties allow
for a sharing with the Company, by the reinsurers, of the net profits generated
under such treaties.
The ceding of reinsurance does not discharge the Company from liability to
its policyholders. The Company is required to pay losses even if the reinsurer
fails to meet its obligations under the reinsurance contract. To minimize its
exposure to reinsurance credit risk, the Company places its reinsurance with a
diverse group of financially sound reinsurers. The Company's 1998 treaty
reinsurance program was placed with more than 57 domestic and foreign
reinsurers. As of December 31, 1997, the total amount recoverable from
reinsurers was approximately $203.3 million, of which $50.5 million represents
paid losses recoverable (in the ordinary course of business) and $155.4 million
represents outstanding losses recoverable, less a $2.5 million reserve for
uncollectible reinsurance. In addition, ceded unearned premium was $84.6
million. The Company held $93.9 million of irrevocable letters of credit and
$8.6 million in cash to collateralize a portion of the total amount recoverable
and had other payable balances due to its reinsurers of $116.6 million as
potential offsets against reinsurance recoverables. The estimated duration for
the Company's outstanding losses is 2 years, as the majority of the Company's
business has historically had shorter lead times between the occurrence of an
insured event and final settlements.
Prior to the Company's acquisition of AVEMCO, AIC retained a greater
percentage of overall premiums written than HC and TIC. Following the
acquisition, the Company implemented a program of reinsurance for AIC which is
more consistent with the reinsurance programs utilized by the Company's other
insurance company subsidiaries. The effect of this change was to limit the net
retained exposure of AIC and to reduce the effect on net earnings of large
losses and high frequency of losses.
Due to the Company's financial analysis of active and potential reinsurers
and its conservative strategy of diversifying its reinsurers, the Company has
never incurred a significant loss on recoverables from reinsurers. The Company
has established a reserve of $2.5 million as of December 31, 1997, to reduce the
effects of any recoverable problem.
OPERATING RATIOS
PREMIUM TO SURPLUS RATIO
The following table shows, for the periods indicated, the ratio of statutory
GWP and NWP to statutory policyholders' surplus for the Company's property and
casualty insurance company subsidiaries:
FOR THE YEARS ENDED DECEMBER 31,
(DOLLARS IN THOUSANDS)
----------------------------------------------------------
1997 1996 1995 1994 1993
---------- ---------- ---------- ---------- ----------
GWP.................................................. $ 346,094 $ 340,367 $ 338,753 $ 283,530 $ 205,905
NWP.................................................. 143,068 189,022 184,028 133,143 101,015
Policyholders' surplus............................... 331,922 288,863 251,125 206,596 175,637
GWP ratio............................................ 104.3% 117.8% 134.9% 137.2% 117.2%
GWP industry average (1)............................. * 179.9 194.0 221.8 224.4
NWP ratio............................................ 43.1% 65.4% 73.3% 64.4% 57.5%
NWP industry average (1)............................. * 105.2 113.0 129.7 132.6
- ------------------------
* Not available
(1) Source: A.M. Best.
13
While there is no statutory requirement regarding a permissible premium to
surplus ratio, guidelines established by the National Association of Insurance
Commissioners ("NAIC") provide that a property and casualty insurer's annual
statutory GWP should not exceed 900% and NWP should not exceed 300% of its
policyholders' surplus. In keeping with its philosophy of protecting its
shareholders' equity and limiting its aggregate loss exposure, the Company
maintains premium to surplus ratios significantly lower than such guidelines,
and, as indicated above, below industry norms.
COMBINED RATIO
The underwriting experience of a property and casualty insurance company is
indicated by its combined ratio. The Company's insurance subsidiaries' loss
ratio, expense ratio and combined ratio, determined on the basis of statutory
accounting principles ("SAP"), are shown in the following table:
1997 1996 1995 1994 1993
--------- --------- --------- --------- ---------
Loss ratio............................................................. 61.6% 64.4% 66.4% 62.5% 66.3%
Expense ratio.......................................................... 17.2 19.2 18.1 20.4 23.7
--------- --------- --------- --------- ---------
Combined ratio......................................................... 78.8% 83.6% 84.5% 82.9% 90.0%
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Industry average (1)................................................... * 105.8% 106.4% 108.4% 106.9%
- ------------------------
* Not available
(1) Source: A.M. Best.
The SAP basis ratio data is not intended to be a substitute for results of
operations on the basis of generally accepted accounting principles ("GAAP").
The difference between SAP and GAAP are shown in Note (15) of the Company's
consolidated financial statements. Including this information on a SAP basis is
meaningful and useful to allow a comparison of the Company's operating results
with those of other companies in the insurance industry. A.M. Best reports on
insurer performance on a SAP basis to provide for more standardized comparisons
among individual companies, as well as overall industry performance.
RESERVES
Applicable insurance laws and regulations require that reserves be
maintained for the payment of loss and loss adjustment expense ("LAE") with
respect to both reported and incurred but not reported ("IBNR") claims under
insurance and reinsurance policies issued by the Company. In most cases, the
Company establishes reserves through an evaluation of individual claims. In some
types of aviation claims, an average reserving method is utilized until more
information becomes available which will permit a more specific individual
evaluation of claims. In the case of direct and facultative reinsurance
business, loss reserves are determined by evaluating reported claims on the
basis of the type of loss, jurisdiction of the occurrence, knowledge of the
circumstances surrounding the claim, severity of injury or damage, potential for
ultimate exposure, experience with the insured and the line of business and
policy provisions relating to the particular type of claim. The Company
establishes loss reserves for excess of loss and proportional reinsurance claims
based on information and reports received from ceding companies. Loss reserves
for IBNR losses are determined in part on the basis of statistical information
and in part on industry experience with respect to the probable number and
nature of claims arising from occurrences which have not been reported. The
Company does not discount any of its loss reserves.
With respect to some classes of risks, the period of time between the
occurrence of an insured event and the final settlement of a claim may be many
years, and during this period it often becomes necessary to adjust the claim
estimates either upward or downward. Certain classes of marine and offshore
energy insurance underwritten by the Company have historically had longer lead
times between the occurrence of an insured event, reporting of the claim to the
Company, and final settlement. In such cases, the Company is forced to estimate
reserves over long periods of time, with the possibility of several adjustments
to
14
reserves. Other classes of insurance, such as most aviation, property and
accident and health business the Company underwrites, historically have shorter
lead times between the occurrence of an insured event, reporting of the claim to
the Company, and final settlement. The reserves with respect to such classes
are, therefore, less likely to be adjusted. The classes of insurance with
shorter lead times currently represent the majority of the risks underwritten by
the Company's insurance company operations.
The reserving process is intended to provide implicit recognition of the
impact of inflation and other factors affecting loss payments by taking into
account changes in historical payment patterns and perceived probable trends.
However, there is no precise method for the subsequent evaluation of the
adequacy of the consideration given to inflation, or to any other specific
factor, some of which are interdependent.
The Company underwrites, directly and through reinsurance, risks which are
denominated in a number of foreign currencies, and therefore establishes and
maintains loss reserves with respect to these policies in the respective
currencies. These reserves are subject to exchange rate fluctuations, which may
have an effect on the Company's earnings. From time to time, the Company may
attempt to limit its exposure to future currency fluctuations through the use of
foreign currency forward contracts.
The following loss development triangles show changes in reserves in
subsequent years from the prior loss estimates based on experience as of the end
of each succeeding year on the basis of GAAP. The estimate is increased or
decreased as more information becomes known about the frequency and severity of
losses for individual years. A redundancy means the original estimate was higher
than the current estimate; a deficiency means that the current estimate is
higher than the original estimate.
The first line of each loss development triangle presents, for each of the
years indicated, the gross reserve liability including the reserve for IBNR
losses. The first section of each table shows, by year, the cumulative amounts
of loss and LAE paid as of the end of each succeeding year. The second section
sets forth the re-estimates in later years of incurred losses, including
payments, for the years indicated. The "cumulative redundancy (deficiency)"
represents, as of December 31, 1997, the difference between the latest
re-estimated liability and the reserves as originally estimated.
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15
The following loss development triangle shows development in loss reserves
on a gross basis:
FOR THE YEARS ENDED DECEMBER 31,
(DOLLARS IN THOUSANDS)
----------------------------------------------------------------------
1997 1996 1995 1994 1993 1992
---------- ---------- ---------- ---------- ---------- ----------
Balance sheet reserves:.......................... $ 275,008 $ 229,049 $ 200,756 $ 170,957 $ 144,178 $ 129,503
Cumulative paid as of:
One year later................................. 119,453 118,656 97,580 82,538 83,574
Two years later................................ 167,459 143,114 126,290 130,379
Three years later.............................. 166,541 157,509 158,973
Four years later............................... 176,472 182,193
Five years later............................... 192,512
Re-estimated liability as of:
End of year.................................... 275,008 229,049 200,756 170,957 144,178 129,503
One year later................................. 252,236 243,259 186,898 163,967 162,827
Two years later................................ 248,372 207,511 183,015 176,817
Three years later.............................. 214,738 203,137 194,419
Four years later............................... 211,546 215,531
Five years later............................... 222,746
Cumulative redundancy (deficiency)............... $ (23,187) $ (47,616) $ (43,781) $ (67,368) $ (93,243)
During 1997, the Company had gross loss and LAE deficiency of $23.2 million
compared to deficiencies of $42.5 million in 1996 and $15.9 million in 1995. The
gross deficiency comes from two primary sources. Firstly, the development of
several large claims on individual policies which were either reported late or
reserves were increased as subsequent information became available, however, as
most of these policies were substantially reinsured, there was no material
effect to the Company's net earnings. Secondly, the run-off of the
retrocessional excess of loss business which the Company underwrote between 1988
and 1991. This development, $1.6 million in 1997 compared to $11.3 million in
1996 and $9.8 million in 1995, is due primarily to the delay in reporting of
catastrophe losses by the London insurance market, coupled with the
unprecedented number of catastrophes during the period in which the Company
underwrote this business. This business is also substantially reinsured, thereby
not having a material effect on the Company's net earnings.
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16
The following loss development triangle shows development in loss reserves
on a net basis:
FOR THE YEARS ENDED DECEMBER 31,
(DOLLARS IN THOUSANDS)
---------------------------------------------------------------------------
1997 1996 1995 1994 1993 1992 1991
--------- --------- --------- --------- --------- --------- ---------
Gross reserves for loss and LAE.................. $ 275,008 $ 229,049 $ 200,756 $ 170,957 $ 144,178 $ 129,503 $ 123,248
Less reinsurance recoverables.................... 155,374 111,766 101,497 95,279 82,289 81,075 83,727
--------- --------- --------- --------- --------- --------- ---------
Reserves for loss and LAE, net of reinsurance.... 119,634 117,283 99,259 75,678 61,889 48,428 39,521
Cumulative paid, net of reinsurance as of
One year later................................. 47,874 41,947 36,500 29,258 18,978 18,416
Two years later................................ 56,803 49,283 41,207 32,733 23,057
Three years later.............................. 56,919 46,576 36,536 31,903
Four years later............................... 51,536 38,480 33,875
Five years later............................... 40,327 34,970
Six years later................................ 36,203
Seven years later..............................
Eight years later..............................
Nine years later...............................
Ten years later................................
Re-estimated liability, net of reinsurance as of
End of year.................................... 119,634 117,283 99,259 75,678 61,889 48,428 39,521
One year later................................. 113,509 94,322 72,912 59,659 45,812 38,575
Two years later................................ 93,550 74,836 60,079 44,964 38,656
Three years later.............................. 76,423 62,224 46,129 39,176
Four years later............................... 64,377 48,993 40,407
Five years later............................... 50,785 43,418
Six years later................................ 45,142
Seven years later..............................
Eight years later..............................
Nine years later...............................
Ten years later................................
Cumulative redundancy (deficiency)............... $ 3,774 $ 5,709 $ (745) $ (2,488) $ (2,357) $ (5,621)
1990 1989 1988 1987
--------- --------- --------- ---------
Gross reserves for loss and LAE.................. $ 108,027 $ 96,477 $ 76,754 $ 86,101
Less reinsurance recoverables.................... 60,194 45,160 30,481 37,971
--------- --------- --------- ---------
Reserves for loss and LAE, net of reinsurance.... 47,833 51,317 46,273 48,130
Cumulative paid, net of reinsurance as of
One year later................................. 23,450 22,660 18,414 23,476
Two years later................................ 33,815 34,300 27,698 29,440
Three years later.............................. 35,912 40,806 33,601 32,820
Four years later............................... 42,465 41,878 36,256 35,713
Five years later............................... 43,422 46,734 36,045 36,992
Six years later................................ 43,690 47,164 37,718 36,490
Seven years later.............................. 44,611 47,229 38,338 37,567
Eight years later.............................. 47,928 38,415 38,074
Nine years later............................... 39,006 38,180
Ten years later................................ 38,750
Re-estimated liability, net of reinsurance as of
End of year.................................... 47,833 51,317 46,273 48,130
One year later................................. 44,887 49,475 43,362 45,267
Two years later................................ 45,435 47,313 42,463 42,526
Three years later.............................. 44,689 48,085 40,352 40,699
Four years later............................... 45,507 47,884 40,937 39,688
Five years later............................... 46,805 47,933 40,384 40,207
Six years later................................ 48,932 48,086 40,071 39,737
Seven years later.............................. 50,190 49,392 39,880 39,341
Eight years later.............................. 50,324 40,587 39,217
Nine years later............................... 41,014 39,983
Ten years later................................ 40,360
Cumulative redundancy (deficiency)............... $ (2,357) $ 993 $ 5,259 $ 7,770
17
The following table provides a reconciliation of the gross liability of loss
and LAE on a GAAP basis for the three years ended December 31, 1997 (dollars in
thousands):
1997 1996 1995
---------- ---------- ----------
Reserves for loss and LAE at beginning of year............................... $ 229,049 $ 200,756 $ 170,957
Reserves acquired with purchase of subsidiary................................ 1,919 -- --
Provision for loss and LAE for claims occurring in the current year.......... 269,505 185,502 195,019
Increase in estimated loss and LAE for claims occurring in prior years (1)... 23,187 42,503 15,941
---------- ---------- ----------
Incurred loss and LAE........................................................ 292,692 228,005 210,960
---------- ---------- ----------
Loss and LAE payments for claims occurring during:
Current year............................................................... 129,199 81,056 83,579
Prior years................................................................ 119,453 118,656 97,582
---------- ---------- ----------
Loss and LAE payments........................................................ 248,652 199,712 181,161
---------- ---------- ----------
Reserves for loss and LAE at end of the year................................. $ 275,008 $ 229,049 $ 200,756
---------- ---------- ----------
---------- ---------- ----------
- ------------------------
(1) Changes in loss and LAE reserves on a GAAP basis, for losses occurring in
prior years, reflect the gross effect of the resolution of losses for other
than the reserve value and the subsequent adjustments of loss reserves.
The following table provides a reconciliation of the liability for loss and
LAE, net of reinsurance ceded, on a GAAP basis for the three years ended
December 31, 1997 (dollars in thousands):
1997 1996 1995
---------- ---------- ---------
Reserves for loss and LAE at beginning of year................................. $ 117,283 $ 99,259 $ 75,678
Reserves acquired with purchase of subsidiary.................................. 1,919 -- --
Provision for loss and LAE for claims occurring in the current year............ 100,288 119,401 108,140
Decrease in estimated loss and LAE for claims occurring in prior years (2)..... (3,774) (4,937) (2,766)
---------- ---------- ---------
Incurred loss and LAE.......................................................... 96,514 114,464 105,374
---------- ---------- ---------
Loss and LAE payments for claims occurring during:
Current year................................................................... 48,208 54,493 45,291
Prior years.................................................................... 47,874 41,947 36,502
---------- ---------- ---------
Loss and LAE payments.......................................................... 96,082 96,440 81,793
---------- ---------- ---------
Reserves for loss and LAE at end of the year................................... $ 119,634 $ 117,283 $ 99,259
---------- ---------- ---------
---------- ---------- ---------
- ------------------------
(2) Changes in loss and LAE reserves on a GAAP basis, for losses occurring in
prior years, reflect the net effect of the resolution of losses for other
than the reserve value and the subsequent adjustments of loss reserves.
Although the Company experienced a gross loss deficiency during 1997, 1996
and 1995, because the business is substantially reinsured in the lines where
adverse development has occurred, there is no material adverse effect on a net
loss basis.
During 1997, the Company had net loss and LAE redundancy of $3.8 million
relating to prior year losses compared to redundancies of $4.9 million in 1996
and $2.8 million in 1995. The Company believes it has materially provided for
all net incurred losses.
18
AIC, acquired in June, 1997, recorded a $10.0 million increase in loss and
LAE reserves during December, 1997, predominately related to 1995 and 1996
claims incurred prior to the Company's acquisition of AIC. This deficiency is
included in the net redundancy recorded for 1997. This increase in reserves was
made in an effort to bring AIC's reserving practices consistent with the more
conservative method used by the Company's other insurance company operations.
The Company expects the increase in loss reserves to be adequate to cover any
subsequent adverse development of AIC's prior losses.
The Company has no material exposure to environmental pollution losses, as
HC only began writing business in 1981 and policies issued by HC normally
contain pollution exclusion clauses which limit pollution coverage to "sudden
and accidental" losses only, thus excluding intentional (dumping) and seepage
claims. Policies issued by AIC and USSIC, because of the types of risks insured,
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.
INVESTMENTS
Insurance company investments must comply with applicable laws and
regulations which prescribe the type, quality and concentration of investments.
In general, these laws and regulations permit investments, within specified
limits and subject to certain qualifications, in Federal, state and municipal
obligations, corporate bonds, preferred and common equity securities. As of
December 31, 1997, the Company had $523.3 million of investment assets, the
majority of which were held by insurance company subsidiaries.
The Company's investment policy is determined by the Company's Board of
Directors and is reviewed on a regular basis. Pursuant to its investment policy,
the Company concentrates its investments in obligations of states,
municipalities and political subdivisions, the interest income from which is
predomi-
nantly exempt from Federal income tax. The interest rates on these securities
are normally lower than rates on comparable taxable securities. The Company's
portfolio of fixed income securities available for sale principally consists of
intermediate term, tax-exempt securities. The Company generally intends to hold
such securities to maturity. However, the Company regularly re-evaluates its
position based upon market conditions, which may cause the Company to
restructure its portfolio and realize gains or losses in order to maximize its
total return on investments. Accordingly, all fixed income securities are
classified as available for sale and are recorded at market value.
The Company's financial statements reflect an unrealized ("mark-to-market")
gain on fixed income securities available for sale as of December 31, 1997, of
$14.6 million. Since the Company's intention is to hold these securities until
maturity, it does not currently expect to realize any significant gain or loss
on these investments.
The Company has maintained a substantial level of cash and liquid short-term
instruments in order to maintain the ability to fund large physical damage
losses of the Company's insureds, should they occur. As of December 31, 1997,
the Company had cash and short-term investments of approximately $112.6 million.
The following tables reflect the investments of the Company (dollars are
expressed in thousands). The table set forth below reflects the average amount
of investments, income earned, and the yield thereon for the three years ended
December 31, 1997:
1997 1996 1995
---------- ---------- ----------
Average investments.......................................................... $ 496,010 $ 461,778 $ 401,545
Net investment income........................................................ 27,718 23,595 21,748
Average yield (1)............................................................ 5.6% 5.1% 5.4%
Average tax equivalent yield (1)............................................. 7.3 6.9 7.1
- ------------------------
(1) Excluding realized and unrealized capital gains and losses.
19
The table set forth below summarizes, by type, the investments of the
Company as of December 31, 1997:
AMOUNT PERCENT OF TOTAL
---------- -----------------
Short-term investments................................................................ $ 105,255 20%
U.S. Treasury securities.............................................................. 12,214 2
Obligations of states, municipalities and political subdivisions...................... 180,028 35
Special revenue....................................................................... 216,259 41
Other fixed income securities......................................................... 1,200 --
Marketable equity securities.......................................................... 8,339 2
---------- ---
Total investments................................................................... $ 523,295 100%
---------- ---
---------- ---
The table set forth below indicates the expected maturity distribution of
the Company's fixed income securities as of December 31, 1997:
AMOUNT PERCENT OF TOTAL
---------- -----------------
One year or less...................................................................... $ 13,151 3%
One year to five years................................................................ 126,691 31
Five years to ten years............................................................... 132,278 32
Ten years to fifteen years............................................................ 102,064 25
More than fifteen years............................................................... 35,517 9
---------- ---
Total fixed income securities....................................................... $ 409,701 100%
---------- ---
---------- ---
BANK LOAN
Effective as of December 30, 1997, the Company entered into a $120.0 million
revolving credit facility (the "Facility") with a group of banks. Borrowings
under the Facility may be made by the Company until the expiration of the
Facility on December 30, 1999, at which time all principal is due. The Facility
is collateralized by the stock of HC and AIC. The Facility agreement contains
certain restrictive covenants, including, without limitation, minimum net worth
requirements for the Company and certain subsidiaries, restrictions on certain
extraordinary corporate actions, notice requirements for certain material
occurrences, and required maintenance of specified financial ratios. Management
believes that the restrictive covenants and other obligations of the Company
which are contained in the Facility agreement are typical for financing
arrangements comparable to the Facility. The initial funding was used, among
other things, to refinance existing indebtedness of the Company. As of March 13,
1998, the Company had outstanding indebtedness under the Facility in the amount
of $102.0 million.
FOREIGN EXCHANGE
From time to time, the Company enters into foreign currency forward
contracts as a hedge against foreign currency fluctuations, primarily British
Pound Sterling ("GBP"). The Company's balances denominated in foreign currency
fluctuate as transactions are recorded and settled. During 1997, the average GBP
liability, for subsidiaries whose functional currency was the United States
dollar, was approximately L793,000 ($1.3 million at December 31, 1997, rate of
exchange) which was hedged by an average open forward contract balance of
approximately L125,000 ($206,000 at the December 31, 1997, rate of exchange).
There are no open foreign currency forward contracts as of December 31, 1997.
The Company may continue to limit its exposure to currency fluctuations through
the use of foreign currency forward contracts.
The Company utilizes these foreign currency forward contracts strictly as a
hedge against existing exposure to foreign currency fluctuations and it does not
do so as any form of speculative or trading investment.
20
COMPETITION
The insurance business is generally highly competitive. The Company faces
competition from domestic and foreign insurers and agency operations, many of
whom are larger and have greater financial, marketing and management resources
than the Company. The Company's profitability is affected by many other factors,
including rate competition, severity and frequency of claims, interest rates,
state regulations, court decisions, the judicial climate and general business
conditions, all of which are outside the control of the Company. Although as an
insurer, the Company's underwriting strategy is to concentrate its writings in
selected, narrowly defined lines of business, the Company faces competition in
these selected lines of business both from other specialty insurance companies
as well as larger, more diversified insurance companies which underwrite
multiple lines of business, including the lines of business underwritten by the
Company. The Company's medical stop-loss business involves a diversified field
of participants from small, start-up operations to large, well-established
organizations. Significant growth in the number of medical stop-loss insurance
underwriters and underwriting managers in the past several years has increased
the level of competition in this area of the Company's business. The Company
also faces intense and growing pressure in this area from alternatives to
employer sponsored self-insured health plans, such as fully-insured plans, HMOs
and Point of Service plans, as well as from large well established direct
insurers and competing underwriting managers providing similar medical stop-loss
products to those offered by the Company to employer sponsored self-insured
health plans.
Competition in the reinsurance marketplace is primarily due to an increase
in the number of reinsurers participating in the market as well as a tendency by
reinsureds to retain a greater percentage of their own risk. The Company
competes with other reinsurance underwriting managers and domestic and
international reinsurance companies. The Company's results of operations may
also be affected by the competition for reinsurance business between broker
reinsurance markets and direct marketing reinsurance companies. The Company also
competes with many reinsurance intermediaries in the broker reinsurance market,
some of which are affiliated with primary insurance brokers with substantial
financial resources. In its insurance agency and services operations, the
Company competes with a large number of publicly traded and private firms which
operate as independent insurance agencies or insurance services providers as
well as with insurance companies which market insurance products directly
through their employees or affiliated insurance agencies. In each of the
business areas in which the Company is engaged, a significant number of the
Company's competitors have financial resources, employees, facilities, market
recognition, marketing, management, experience, and other resources
substantially greater than those of the Company. In addition to competition in
the operation of its business, the Company faces competition from a variety of
sources in attracting and retaining qualified employees.
REGULATION
The activities of the Company are subject to licensing requirements and
extensive regulation under the laws of the United States and its various states,
territories and possessions, as well as the laws of other countries in which the
Company's subsidiaries operate. Currently insurance companies are generally not
subject to any Federal regulation of their insurance business because of the
existence of a Federal law commonly known as the McCarran-Ferguson Act, which
provides the insurance industry with immunity from certain aspects of the
Federal anti-trust law and exempts the business of insurance from Federal
regulation. Therefore, in the United States, the Company's operations are
regulated primarily at the state level. The Company's business depends on the
validity of, and continued good standing under, the licenses and approvals
pursuant to which it operates, as well as compliance with pertinent regulations.
The Company therefore devotes significant efforts toward obtaining and
maintaining its licenses and compliance with a diverse and complex regulatory
structure.
The Company's insurance subsidiaries, in common with other insurers, are
subject to regulation and supervision by the states and by other jurisdictions
in which they do business. Within the states, the method of such regulation
varies but generally has its source in statutes that delegate regulatory and
supervisory
21
powers to an insurance official. The regulation and supervision relates
primarily to approval of policy forms and rates, the standards of solvency that
must be met and maintained, including risk based capital measurements, the
licensing of insurers and their agents, the nature of and limitations of
investments, restrictions of the size of risks which may be insured under a
single policy, deposits of securities for the benefit of policyholders, methods
of accounting, periodic examinations of the affairs of insurance companies, the
form and content of records of financial condition required to be filed, and
reserves for unearned premiums, losses and other purposes. In general, such
regulations are intended primarily for the protection of policyholders rather
than shareholders. Compliance is monitored by the state insurance departments
through periodic regulatory reporting procedures and periodic examinations. The
quarterly and annual financial reports to the regulators in the United States
utilize accounting principles which are different from the GAAP used by the
Company in its reports to shareholders. The SAP, in keeping with the intent to
assure the protection of policyholders, are generally based on a liquidation
concept while GAAP is based on a going-concern concept.
In addition to the regulatory supervision of the insurance company
subsidiaries of the Company, as an insurance holding company, the Company is
subject to regulation under the insurance holding company system regulatory acts
in the states of California, Maryland, Missouri, Oklahoma and Texas, which
contain certain reporting requirements including registration and the filing of
annual reports. In such registration and annual reports, the Company is required
to provide current information regarding its capital structure, general
financial condition, ownership, management, and the identity of each member of
its insurance holding company system. The Company is also required to provide
prior notice to insurance regulatory authorities of certain agreements and
transactions between the Company and its affiliates. These agreements and
transactions must satisfy certain standards set forth in the insurance laws and
regulations of such states. Insurance holding company laws also regulate the
payment of dividends and other distributions by insurance companies to their
shareholders.
Additionally, the insurance agency and services operations of the Company
are subject to state insurance laws and regulations which require the licensing
of insurance agents, brokers, reinsurance intermediaries, reinsurance
underwriting managers, third party administrators and managing general agents
and which regulate certain aspects of their business. These laws and regulations
may include requirements for certain provisions in contracts entered into
between the Company and various insurers or reinsurers, record keeping and
reporting requirements, limitations on authority, advertising and business
practice rules, and other matters. The manner of operating the Company's agency
activities in particular states may vary according to the licensing requirements
of the particular state, which may require, among other things, that a firm
operate in the state through a local corporation. In a few states, licenses are
issued only to individual residents or locally-owned business entities. In such
cases, the Company has arrangements with residents or business entities licensed
to act in the state.
There can be no assurance given that the Company has all such required
licenses, approvals or complying contracts or that such licenses, approvals or
complying contracts can always be obtained or continued. In all jurisdictions,
the applicable laws and regulations are subject to amendment or interpretation
by regulatory authorities. Generally, such authorities are vested with
relatively broad discretion to grant, renew and revoke licenses and approvals,
and to implement regulations, and licenses may be denied or revoked for various
reasons, including the violations of such regulations, conviction of crimes and
the like. In some instances, the Company follows practices based on its
interpretations, or those that it believes may be generally followed by the
industry, of laws and regulations, which may be different from the requirements
or interpretations of regulatory authorities. Accordingly, the possibility
exists that the Company may be precluded or temporarily suspended from carrying
on some or all of its activities or otherwise penalized in a given jurisdiction.
Such preclusion or suspension could have a materially adverse effect on the
business and results of operations of the Company.
HC is domiciled and licensed as an admitted insurer in Texas, is an
accredited reinsurer in 30 states (including Texas), and is an approved surplus
lines insurer or is otherwise permitted to write surplus lines
22
insurance in 46 states, three U.S. territories and the District of Columbia.
When a reinsurer obtains accreditation from a particular state, insurers within
that state are permitted to obtain statutory credit for risks ceded to the
reinsurer. Surplus lines insurance is offered by non-admitted (unlicensed)
companies on risks which are not insured by admitted (licensed) companies. All
surplus lines insurance is written through licensed surplus lines insurance
brokers, who are required to ensure that no licensed admitted insurer will write
a particular risk prior to placing that risk with a surplus lines insurer.
Additionally, HC through its operations in Amman, Jordan (formerly IMG), is able
under Jordanian law to directly underwrite non-Jordanian risks and reinsure
Jordanian risks. HC is in the process of seeking regulatory approval with the
appropriate English authorities to operate a formal branch office in London,
England. Such approval, if granted, will impose additional regulatory
requirements on HC, but management expects that such approval will also permit
HC to take advantage of increased opportunities in the London insurance market,
a historical focal point for specialty property and casualty risks. TIC is
domiciled and licensed as an admitted insurer in Oklahoma, is an accredited
reinsurer in three states (including Oklahoma), and is an approved surplus lines
insurer or is otherwise permitted to write surplus lines insurance in 28 states
and the District of Columbia. AIC is domiciled and licensed as an admitted
insurer in Maryland and operates as a licensed admitted insurer in 49 other
states, the District of Columbia, and all Canadian provinces (except Quebec).
USSIC is domiciled and licensed as an admitted insurer in Maryland and operates
as a licensed admitted insurer in 48 other states and the District of Columbia.
The Company expects, pending regulatory approval, to re-domesticate USSIC from
Maryland to Texas in 1998.
Under the laws of the State of Texas, HC must maintain minimum statutory
capital of $1.0 million and minimum statutory surplus of $1.0 million and may
only pay dividends out of its statutory earned surplus. The maximum amount of
dividends that HC may pay without prior regulatory approval in any 12 month
period is the greater of its statutory net investment income for the prior year,
or 10% of its statutory policyholders' surplus as of the prior year end, which
at December 31, 1997, was $23.3 million. Under the laws of the State of
Maryland, AIC and USSIC may only pay dividends out of its statutory earned
surplus. The maximum amount of dividends that AIC and USSIC may pay without
prior regulatory approval in any 12 month period is the greater of its statutory
net income or 10% of its statutory policyholders' surplus, which at December 31,
1997 was $6.8 million for AIC. However, on December 30, 1997, AIC paid an
extraordinary dividend of $13.7 million, which was approved by the Maryland
Insurance Administration and which represented a dividend of USSIC to AIC's
parent, the result of which is that USSIC has become a wholly owned subsidiary
of HC. As a result of this transaction, any dividends by AIC during the period
ending December 30, 1998 would require the prior approval of the Maryland
Insurance Administration. The maximum amount of dividends USSIC may pay HC
during 1998 is $5.0 million. Under the laws of the State of Oklahoma, TIC may
only pay dividends out of surplus funds. The maximum amount TIC may pay HC
without prior regulatory approval is the greater of statutory net income
excluding realized capital gains or 10% of statutory capital and surplus, which
at December 31, 1997 was $3.1 million.
The NAIC has developed a formula for analyzing insurance companies called
risk-based capital. The risk-based capital formula is intended to establish
"minimum" capital threshold levels that vary with the size and mix of a
company's business. It is designed to identify companies with the capital levels
that may require regulatory attention. As of December 31, 1997, each of the
Company's domestic insurance company subsidiaries' total adjusted capital is
significantly in excess of the NAIC authorized control level risk-based capital.
PENDING LEGISLATION
In recent years, state legislatures have considered or enacted laws that
modify and, in many cases, increase state authority to regulate insurance
companies and insurance holding company systems. The majority of state insurance
regulators are members of the NAIC, which seeks to promote uniformity of, and to
enhance the state regulation of, insurance. In addition, the NAIC and state
insurance regulators, as part of the NAIC's state insurance department
accreditation program, have re-examined existing laws and
23
regulations, specifically focusing on insurance company investments, issues
relating to the solvency of insurance companies, licensing and market conduct
issues, interpretations of existing laws, the development of new laws, and the
definition of extraordinary dividends. Also, Congress and certain Federal
agencies have conducted investigations of the current condition of the insurance
industry in the United States to determine whether to impose Federal regulation
of insurers and reinsurers. In the past several years there have been a number
of recommendations that the McCarran-Ferguson Act (which generally exempts the
insurance business from Federal regulation) be repealed entirely or modified to
remove the industry's anti-trust exemption and subject it to Federal regulation.
The Company is not aware of any such legislation that is currently pending. If
the McCarran-Ferguson Act were to be repealed or modified, state regulation of
the insurance business would continue. This could result in an additional layer
of Federal regulation. Also from time to time, Congress and certain states have
considered various legislative proposals which would provide for governmental
earthquake insurance coverage. The Company does not know at this time the extent
to which any or all such Federal or state legislative or regulatory initiatives
will or may be adopted, and no assurance can be given that they would not, if
adopted, have a material adverse effect on the Company.
EMPLOYEES
As of December 31, 1997, the Company had 929 employees, which included five
executive officers, 46 senior management, 94 management and 784 other personnel.
Of this number, 306 were employed by the Company's insurance subsidiaries, 499
were employed by the Company's insurance agency subsidiaries and 124 were
employed by the Company's insurance services subsidiaries. The Company is not a
party to any collective bargaining agreement and has not experienced work
stoppages or strikes as a result of labor disputes. The Company considers
relations with its employees to be good.
ITEM 2. PROPERTIES
The Company's principal and executive offices are located in Houston, Texas,
in an approximately 54,000 square foot building owned by HC. LDG's principal
facility is leased office space in Wakefield, Massachusetts consisting of
approximately 34,000 square feet, which lease terminates on October 31, 2001.
AIC's principal facility is an approximately 40,000 square foot office building
owned by an AVEMCO subsidiary and located in Frederick, Maryland. AMIG's
principal facility is leased office space in Dallas, Texas consisting of
approximately 36,000 square feet, which lease terminates on August 31, 2002. The
Company owns a 48,200 square foot office building and storage complex in St.
Peters, Missouri. The Company also maintains sales and administration offices or
other facilities in over 30 locations elsewhere in the United States and in
England, Turkey and China. The majority of these additional locations are in
leased facilities.
ITEM 3. LEGAL PROCEEDINGS
The Company is a party to numerous claims and lawsuits which arise in the
normal course of its business. Many of the pending lawsuits involve claims under
policies underwritten or reinsured by the Company, the liabilities for which
management believes have been adequately included in its established loss
reserves. The Company believes the resolution of these lawsuits will not have a
material adverse effect on its financial condition, results of operations or
cash flows.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders during the
fourth quarter of 1997.
[THE REMAINDER OF THIS PAGE LEFT INTENTIONALLY BLANK]
24
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS
MARKET INFORMATION
The Company's Common Stock trades on the New York Stock Exchange ("NYSE")
under the symbol "HCC".
The high and low closing sales prices for quarterly periods during the
period January 1, 1996 through December 31, 1997, as reported by the NYSE were
as follows:
1997 1996(1)
--------------------- --------------------
HIGH LOW HIGH LOW
---------- --------- --------- ---------
First quarter......................................................... $ 29 1/2 $ 22 1/2 $ 23 1/4 $ 14 1/2
Second quarter........................................................ 28 5/8 21 1/2 25 1/2 19 1/8
Third quarter......................................................... 32 11/16 23 1/4 32 3/4 22 1/8
Fourth quarter........................................................ 29 3/8 18 1/8 29 1/4 23 1/8
- ------------------------
(1) The above prices have been retroactively adjusted to reflect the effects of
the five-for-two stock split, payable as a 150% stock dividend to
shareholders of record April 30, 1996. On March 13, 1998, the closing sales
price of one share of the Company's Common Stock as reported by the NYSE was
$22 1/8.
SHAREHOLDERS
The Company has one class of authorized capital stock: 100,000,000 shares of
Common Stock, par value $1.00 per share. As of March 13, 1998, there were
47,827,789 shares of issued and outstanding Common Stock held by 1,158
shareholders of record; however, the Company believes there are in excess of
15,000 beneficial owners.
DIVIDENDS
On April 19, 1996, the Company announced that the Board of Directors had
declared a five-for-two stock split in the form of a 150% stock dividend,
payable to shareholders of record as of April 30, 1996 and that it would
purchase, for cash, any fractional shares issued in connection with this split.
Beginning in June, 1996, the Company announced a planned quarterly program
of paying cash dividends to shareholders. The Company paid a cash dividend in
July, 1996 of $0.02 per share and in each succeeding quarter until the first
quarter of 1997. The Company increased the cash dividend to $0.03 per share in
April, 1997 and to $0.04 per share beginning in April, 1998. The Company
presently plans to continue to pay a $0.04 per share dividend in future
quarters. The Board of Directors may review the Company's dividend policy from
time to time, and any determination with respect thereto will be made in light
of regulatory and other conditions then existing, including the Company's
earnings, financial condition, capital requirements, loan covenants, and other
related factors. Under the terms of the Company's December 30, 1997 Facility,
the Company is prohibited from paying dividends in excess of an agreed upon
maximum amount in any fiscal year. Such limitation will not affect the ability
of the Company to pay dividends in a manner consistent with its past practice
and current expectations.
25
ITEM 6. SELECTED FINANCIAL DATA
The selected consolidated financial data set forth below has been derived
from the Consolidated Financial Statements. All information contained herein
should be read in conjunction with the Consolidated Financial Statements, the
related notes thereto and Management's Discussion and Analysis of Financial
Condition and Results of Operations included elsewhere in this Report.
FOR THE YEARS ENDED DECEMBER 31,
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)(1)(2)
----------------------------------------------------------
1997 1996 1995 1994 1993
---------- ---------- ---------- ---------- ----------
STATEMENT OF EARNINGS DATA
Revenue
Net earned premium................................ $ 163,090 $ 175,309 $ 159,588 $ 122,352 $ 95,365
Management fee and commission income.............. 75,867 51,356 42,786 35,722 30,900
Net investment income............................. 27,718 23,595 21,748 17,778 14,458
Computer products and services.................... 7,064 8,471 8,227 8,153 7,453
Net realized investment gain (loss)............... (329) 8,341 1,636 434 10,583
Gain on sale of subsidiary........................ -- 3,307 -- -- --
---------- ---------- ---------- ---------- ----------
Total revenue................................. 273,410 270,379 233,985 184,439 158,759
Expense
Loss and LAE...................................... 96,514 114,464 105,374 75,898 62,712
Operating expense
Policy acquisition costs........................ 59,110 47,512 42,357 35,234 24,056
Compensation expense............................ 44,634 37,102 43,110 38,142 29,823
Other operating expense......................... 31,042 25,797 25,868 20,922 19,944
Merger expense.................................. 8,069 26,160 -- -- --
Ceding commissions.............................. (45,011) (34,053) (30,767) (24,834) (15,771)
---------- ---------- ---------- ---------- ----------
Net operating expense......................... 97,844 102,518 80,568 69,464 58,052
Interest expense.................................. 6,004 4,993 6,471 5,697 3,513
---------- ---------- ---------- ---------- ----------
Total expense................................. 200,362 221,975 192,413 151,059 124,277
---------- ---------- ---------- ---------- ----------
Earnings before income tax provision.............. 73,048 48,404 41,572 33,380 34,482
Income tax provision.............................. 23,297 9,874 9,884 7,328 6,269
---------- ---------- ---------- ---------- ----------
Net earnings.................................. $ 49,751 $ 38,530 $ 31,688 $ 26,052 $ 28,213
---------- ---------- ---------- ---------- ----------
---------- ---------- ---------- ---------- ----------
BASIC EARNINGS PER SHARE DATA:
Earnings per share (3)............................ $ 1.10 $ 0.89 $ 0.77 $ 0.72 $ 0.83
---------- ---------- ---------- ---------- ----------
---------- ---------- ---------- ---------- ----------
Weighted average shares outstanding (3)........... 45,395 43,195 40,977 36,370 34,138
---------- ---------- ---------- ---------- ----------
---------- ---------- ---------- ---------- ----------
DILUTED EARNINGS PER SHARE DATA:
Earnings per share (3)............................ $ 1.07 $ 0.87 $ 0.76 $ 0.71 $ 0.81
---------- ---------- ---------- ---------- ----------
---------- ---------- ---------- ---------- ----------
Weighted average shares outstanding (3)........... 46,609 44,443 41,513 36,929 35,040
---------- ---------- ---------- ---------- ----------
---------- ---------- ---------- ---------- ----------
Cash dividends declared, per share.................. $ 0.12 $ 0.06
---------- ----------
---------- ----------
26
FOR THE YEARS ENDED DECEMBER 31,
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)(1)(2)
----------------------------------------------------------
1997 1996 1995 1994 1993
---------- ---------- ---------- ---------- ----------
BALANCE SHEET DATA:
Total investments................................... $ 523,295 $ 468,725 $ 454,831 $ 348,259 $ 312,297
Reinsurance recoverables............................ 203,300 132,328 117,700 116,365 96,944
Premium, claims and other receivables............... 251,477 167,168 154,084 132,799 76,063
Ceded unearned premium.............................. 84,610 71,758 78,460 65,595 32,727
Total assets........................................ 1,222,763 964,099 894,834 751,213 563,819
Loss and LAE payable................................ 275,008 229,049 200,756 170,957 144,178
Unearned premium.................................... 152,094 156,268 151,976 114,347 68,120
Total debt.......................................... 80,750 72,917 71,628 99,508 83,444
Shareholders' equity................................ 365,480 296,413 255,425 168,758 146,204
Net tangible book value per share (3) (4)........... $ 7.16 $ 6.43 $ 5.59 $ 4.04 $ 4.05
Book value per share (3) (4)........................ $ 7.92 $ 6.72 $ 5.91 $ 4.41 $ 4.08
- ------------------------
(1) On May 24, 1996, the Company acquired 100% of the outstanding common stock
of LDG and on June 17, 1997 the Company acquired 100% of the outstanding
common stock and options of AVEMCO. These business combinations have been
accounted for as poolings-of-interests and, accordingly, the consolidated
financial data shown in this table has been restated to include the accounts
and operations of LDG and AVEMCO for all periods presented.
On November 27, 1996, the Company acquired 100% of the outstanding shares of
NASRA, on April 30, 1997, the Company acquired 10