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EX-12 - EX-12 - HCC INSURANCE HOLDINGS INC/DE/ | h72709exv12.htm |
EX-31.2 - EX-31.2 - HCC INSURANCE HOLDINGS INC/DE/ | h72709exv31w2.htm |
EX-31.1 - EX-31.1 - HCC INSURANCE HOLDINGS INC/DE/ | h72709exv31w1.htm |
EX-32.1 - EX-32.1 - HCC INSURANCE HOLDINGS INC/DE/ | h72709exv32w1.htm |
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
þ | Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
for the Quarterly Period Ended March 31, 2010. |
o | Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
from to |
Commission file number 001-13790
HCC Insurance Holdings, Inc.
(Exact name of registrant as specified in its charter)
Delaware | 76-0336636 | |
(State or other jurisdiction of incorporation or organization) |
(IRS Employer Identification No.) |
|
13403 Northwest Freeway, Houston, Texas | 77040-6094 | |
(Address of principal executive offices) | (Zip Code) |
(713) 690-7300
(Registrants telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the registrant was required to file such reports) and (2) has been subject
to such filing requirements for the past 90 days.
Yes þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its
corporate Web site, if any, every Interactive Data File required to be submitted and posted
pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months
(or for such shorter period that the registrant was required to submit and post such files).
Yes o No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a
non-accelerated filer or a smaller reporting company. See definition of large accelerated filer,
accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer þ | Accelerated filer o | Non-accelerated filer o (Do not check if a smaller reporting company) | Smaller reporting company o |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act).
Yes o No þ
Indicate the number of shares outstanding of each of the registrants classes of common stock as of
the latest practicable date.
On April 30, 2010, there were approximately 115.0 million shares of common stock
outstanding.
HCC INSURANCE HOLDINGS, INC.
TABLE OF CONTENTS
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39 |
2
FORWARD-LOOKING STATEMENTS
This report on Form 10-Q contains certain forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934,
which are intended to be covered by the safe harbors created by those laws. We have based these
forward-looking statements on our current expectations and projections about future events. These
forward-looking statements include information about possible or assumed future results of our
operations. All statements, other than statements of historical facts, included or incorporated by
reference in this report that address activities, events or developments that we expect or
anticipate may occur in the future, including such things as growth of our business and operations,
business strategy, competitive strengths, goals, plans, future capital expenditures and references
to future successes may be considered forward-looking statements. Also, when we use words such as
anticipate, believe, estimate, expect, intend, plan, probably or similar expressions,
we are making forward-looking statements.
Many risks and uncertainties may have an impact on the matters addressed in these forward-looking
statements, which could affect our future financial results and performance, including, among other
things:
| the effects of catastrophic losses, | ||
| the cyclical nature of the insurance business, | ||
| inherent uncertainties in the loss estimation process, which can adversely impact the adequacy of loss reserves, | ||
| the impact of the credit market downturn and subprime market exposures, | ||
| the effects of emerging claim and coverage issues, | ||
| the effects of extensive governmental regulation of the insurance industry, | ||
| potential credit risk with brokers, | ||
| the effects of industry consolidations, | ||
| our assessment of underwriting risk, | ||
| our retention of risk, which could expose us to potential losses, | ||
| the adequacy of reinsurance protection, | ||
| the ability and willingness of reinsurers to pay balances due us, | ||
| the occurrence of terrorist activities, | ||
| our ability to maintain our competitive position, | ||
| changes in our assigned financial strength ratings, | ||
| our ability to raise capital and funds for liquidity in the future, | ||
| attraction and retention of qualified employees, | ||
| fluctuations in securities markets, which may reduce the value of our investment assets, reduce investment income or generate realized investment losses, | ||
| our ability to successfully expand our business through the acquisition of insurance-related companies, | ||
| impairment of goodwill, |
3
| the ability of our insurance company subsidiaries to pay dividends in needed amounts, | ||
| fluctuations in foreign exchange rates, | ||
| failures or constraints of our information technology systems, | ||
| changes to the countrys health care delivery system, | ||
| the effect, if any, of climate change, on the risks we insure, | ||
| change of control, and | ||
| difficulties with outsourcing relationships. |
We describe these risks and uncertainties in greater detail in Item 1A, Risk Factors in our Annual
Report on Form 10-K for the year ended December 31, 2009.
These events or factors could cause our results or performance to differ materially from those we
express in our forward-looking statements. Although we believe that the assumptions underlying our
forward-looking statements are reasonable, any of these assumptions, and, therefore, also the
forward-looking statements based on these assumptions, could themselves prove to be inaccurate. In
light of the significant uncertainties inherent in the forward-looking statements that are included
in this Report, our inclusion of this information is not a representation by us or any other person
that our objectives or plans will be achieved.
Our forward-looking statements speak only at the date made, and we will not update these
forward-looking statements unless the securities laws require us to do so. In light of these risks,
uncertainties and assumptions, any forward-looking events discussed in this Report may not occur.
4
HCC Insurance Holdings, Inc. and Subsidiaries
Condensed Consolidated Balance Sheets
(unaudited, in thousands except per share data)
March 31, | December 31, | |||||||
2010 | 2009 | |||||||
ASSETS |
||||||||
Investments |
||||||||
Fixed income securities available for sale, at fair value (amortized cost: 2010
$4,638,702; 2009 $4,381,762) |
$ | 4,802,585 | $ | 4,538,073 | ||||
Fixed income securities held to maturity, at amortized cost (fair value: 2010 $137,607;
2009 $104,008) |
135,619 | 102,792 | ||||||
Short-term investments, at cost, which approximates fair value |
576,576 | 810,673 | ||||||
Other investments |
4,535 | 4,691 | ||||||
Total investments |
5,519,315 | 5,456,229 | ||||||
Cash |
59,892 | 129,460 | ||||||
Restricted cash and cash investments |
146,512 | 146,133 | ||||||
Premium, claims and other receivables |
641,341 | 600,332 | ||||||
Reinsurance recoverables |
1,028,948 | 1,016,411 | ||||||
Ceded unearned premium |
261,256 | 270,436 | ||||||
Ceded life and annuity benefits |
60,603 | 61,313 | ||||||
Deferred policy acquisition costs |
209,083 | 208,463 | ||||||
Goodwill |
821,698 | 822,006 | ||||||
Other assets |
119,021 | 123,608 | ||||||
Total assets |
$ | 8,867,669 | $ | 8,834,391 | ||||
LIABILITIES |
||||||||
Loss and loss adjustment expense payable |
$ | 3,495,705 | $ | 3,492,309 | ||||
Life and annuity policy benefits |
60,603 | 61,313 | ||||||
Reinsurance balances payable |
157,735 | 182,661 | ||||||
Unearned premium |
1,022,950 | 1,044,747 | ||||||
Deferred ceding commissions |
67,876 | 71,595 | ||||||
Premium and claims payable |
174,164 | 154,596 | ||||||
Notes payable |
298,522 | 298,483 | ||||||
Accounts payable and accrued liabilities |
496,286 | 497,504 | ||||||
Total liabilities |
5,773,841 | 5,803,208 | ||||||
SHAREHOLDERS EQUITY |
||||||||
Common stock, $1.00 par value; 250,000 shares authorized (shares issued: 2010 119,650 and
2009 118,724; outstanding: 2010 114,977 and 2009 114,051) |
119,650 | 118,724 | ||||||
Additional paid-in capital |
923,666 | 914,339 | ||||||
Retained earnings |
2,033,063 | 1,977,254 | ||||||
Accumulated other comprehensive income |
116,248 | 119,665 | ||||||
Treasury stock, at cost (shares: 2010 and 2009 4,673) |
(98,799 | ) | (98,799 | ) | ||||
Total shareholders equity |
3,093,828 | 3,031,183 | ||||||
Total liabilities and shareholders equity |
$ | 8,867,669 | $ | 8,834,391 | ||||
See Notes to Condensed Consolidated Financial Statements.
5
HCC Insurance Holdings, Inc. and Subsidiaries
Condensed Consolidated Statements of Earnings
(unaudited, in thousands except per share data)
Three months ended March 31, | ||||||||
2010 | 2009 | |||||||
REVENUE |
||||||||
Net earned premium |
$ | 509,587 | $ | 502,388 | ||||
Fee and commission income |
20,993 | 30,294 | ||||||
Net investment income |
49,249 | 45,218 | ||||||
Other operating income |
9,906 | 22,896 | ||||||
Net realized investment gain |
4,525 | 3,055 | ||||||
Other-than-temporary impairment loss |
||||||||
Total loss |
| (3,113 | ) | |||||
Portion recognized in other comprehensive income |
| | ||||||
Net loss recognized in earnings |
| (3,113 | ) | |||||
Total revenue |
594,260 | 600,738 | ||||||
EXPENSE |
||||||||
Loss and loss adjustment expense, net |
326,521 | 315,566 | ||||||
Policy acquisition costs, net |
92,656 | 88,692 | ||||||
Other operating expense |
66,668 | 68,998 | ||||||
Interest expense |
5,390 | 4,639 | ||||||
Total expense |
491,235 | 477,895 | ||||||
Earnings before income tax expense |
103,025 | 122,843 | ||||||
Income tax expense |
31,671 | 39,673 | ||||||
Net earnings |
$ | 71,354 | $ | 83,170 | ||||
Earnings per common share |
||||||||
Basic |
$ | 0.62 | $ | 0.73 | ||||
Diluted |
$ | 0.62 | $ | 0.73 | ||||
See Notes to Condensed Consolidated Financial Statements.
6
HCC
Insurance Holdings, Inc. and Subsidiaries
Condensed Consolidated Statement of Changes in Shareholders
Equity
(unaudited, in thousands except per share data)
Accumulated | ||||||||||||||||||||||||
Additional | other | Total | ||||||||||||||||||||||
Common | paid-in | Retained | comprehensive | Treasury | shareholders | |||||||||||||||||||
stock | capital | earnings | income | stock | equity | |||||||||||||||||||
Balance at December 31, 2009 |
$ | 118,724 | $ | 914,339 | $ | 1,977,254 | $ | 119,665 | $ | (98,799 | ) | $ | 3,031,183 | |||||||||||
Comprehensive income |
||||||||||||||||||||||||
Net earnings |
| | 71,354 | | | 71,354 | ||||||||||||||||||
Other comprehensive income |
||||||||||||||||||||||||
Change in unrealized gain on
investments, net of tax |
| | | 4,579 | | 4,579 | ||||||||||||||||||
Other, net of tax |
| | | (7,996 | ) | | (7,996 | ) | ||||||||||||||||
Total other comprehensive income |
(3,417 | ) | ||||||||||||||||||||||
Comprehensive income |
67,937 | |||||||||||||||||||||||
Issuance of 344 shares for exercise of
options, including tax effect |
344 | 6,829 | | | | 7,173 | ||||||||||||||||||
Stock-based compensation |
582 | 2,498 | | | | 3,080 | ||||||||||||||||||
Cash dividends declared, $0.135 per share |
| | (15,545 | ) | | | (15,545 | ) | ||||||||||||||||
Balance at March 31, 2010 |
$ | 119,650 | $ | 923,666 | $ | 2,033,063 | $ | 116,248 | $ | (98,799 | ) | $ | 3,093,828 | |||||||||||
See Notes to Condensed Consolidated Financial Statements.
7
HCC
Insurance Holdings, Inc. and Subsidiaries
Condensed
Consolidated Statements of Cash Flows
(unaudited, in thousands)
Three months ended March 31, | ||||||||
2010 | 2009 | |||||||
Operating activities |
||||||||
Net earnings |
$ | 71,354 | $ | 83,170 | ||||
Adjustments to reconcile net earnings to net cash provided by operating activities |
||||||||
Change in premium, claims and other receivables |
(24,890 | ) | (28,719 | ) | ||||
Change in reinsurance recoverables |
(21,839 | ) | (29,973 | ) | ||||
Change in ceded unearned premium |
7,548 | (217 | ) | |||||
Change in loss and loss adjustment expense payable |
28,921 | 67,544 | ||||||
Change in reinsurance balances payable |
(23,913 | ) | 11,481 | |||||
Change in unearned premium |
(17,600 | ) | (11,335 | ) | ||||
Change in premium and claims payable, net of restricted cash |
19,413 | 8,859 | ||||||
Change in accounts payable and accrued liabilities |
(18,215 | ) | (7,556 | ) | ||||
Stock-based compensation expense |
3,080 | 4,783 | ||||||
Depreciation and amortization expense |
3,971 | 3,579 | ||||||
(Gain) loss on investments |
(5,011 | ) | 1,020 | |||||
Other, net |
19,657 | 30,966 | ||||||
Cash provided by operating activities |
42,476 | 133,602 | ||||||
Investing activities |
||||||||
Sales of available for sale fixed income securities |
67,689 | 119,092 | ||||||
Maturity or call of available for sale fixed income securities |
115,793 | 69,280 | ||||||
Maturity or call of held to maturity fixed income securities |
8,260 | 85,821 | ||||||
Cost of available for sale fixed income securities acquired |
(381,704 | ) | (210,093 | ) | ||||
Cost of held to maturity fixed income securities acquired |
(44,901 | ) | (59,515 | ) | ||||
Change in short-term investments |
223,947 | (177,715 | ) | |||||
Proceeds from sales of strategic and other investments |
| 48,579 | ||||||
Payments for purchase of businesses, net of cash received |
(36,348 | ) | (32,966 | ) | ||||
Proceeds from sale of subsidiary |
14,851 | | ||||||
Other, net |
(3,824 | ) | (3,482 | ) | ||||
Cash used by investing activities |
(36,237 | ) | (160,999 | ) | ||||
Financing activities |
||||||||
Advances on line of credit |
| 80,000 | ||||||
Sale of common stock |
7,173 | 2,090 | ||||||
Payments on convertible notes |
(64,472 | ) | | |||||
Purchase of common stock |
| (35,464 | ) | |||||
Dividends paid |
(15,460 | ) | (14,182 | ) | ||||
Other, net |
(3,048 | ) | 619 | |||||
Cash provided (used) by financing activities |
(75,807 | ) | 33,063 | |||||
Net increase (decrease) in cash |
(69,568 | ) | 5,666 | |||||
Cash at beginning of year |
129,460 | 27,347 | ||||||
Cash at end of period |
$ | 59,892 | $ | 33,013 | ||||
See Notes to Condensed Consolidated Financial Statements.
8
HCC Insurance Holdings, Inc. and Subsidiaries
Notes to
Condensed Consolidated Financial Statements
(unaudited, in thousands except per share data)
(1) General Information
HCC Insurance Holdings, Inc. and its subsidiaries (collectively, we, us or our) include domestic
and foreign property and casualty and life insurance companies and underwriting agencies. We
provide specialized property and casualty, surety, and group life, accident and health insurance
coverages and related agency services to commercial customers and individuals. We market our
products both directly to customers and through a network of independent brokers, producers,
agents and third party administrators. Our lines of business include diversified financial
products (which includes directors and officers liability, errors and omissions liability
(known as professional indemnity outside the U.S.), employment practices liability, surety,
credit, and fidelity coverages); group life, accident and health (which includes medical
stop-loss, short-term medical, occupational accident, and other coverages); aviation; our London
market account (which includes energy, property, property treaty, marine, and accident and health
coverages); and other specialty lines of insurance (which includes public entity, U.K. liability,
event cancellation, contingency, and other coverages). We operate primarily in the United States,
the United Kingdom, Spain and Ireland, although some of our operations have a broader
international scope.
Basis of Presentation
Our unaudited condensed consolidated financial statements have been prepared in conformity with
accounting principles generally accepted in the United States of America (GAAP) and include the
accounts of HCC Insurance Holdings, Inc. and its subsidiaries. We have made all adjustments that,
in our opinion, are necessary for a fair statement of results of the interim periods, and all
such adjustments are of a normal recurring nature. All significant intercompany balances and
transactions have been eliminated in consolidation. The condensed consolidated financial
statements should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2009. The condensed consolidated balance sheet at December
31, 2009 was derived from the audited financial statements, but does not include all disclosures
required by GAAP.
Management must make estimates and assumptions that affect amounts reported in our condensed
consolidated financial statements and in disclosures of contingent assets and liabilities.
Ultimate results could differ from those estimates. We have reclassified certain amounts in our
2009 condensed consolidated financial statements to conform to the 2010 presentation. None of our
reclassifications had an effect on our consolidated net earnings, shareholders equity or cash
flows.
Accounting Guidance Adopted in 2010
A new accounting standard, originally issued as SFAS No. 167, Amendments to FASB Interpretation
No. 46(R), became effective January 1, 2010. The guidance, which was incorporated into Accounting
Standards Codification (ASC) Topic 810, Consolidation, changes various aspects of accounting for
and disclosures of interests in variable interest entities. Our adoption of this guidance as of
January 1, 2010 had no material impact on our condensed consolidated financial statements.
Effective January 1, 2010, we adopted Accounting Standards Update No. 2010-06, which incorporated
changes in disclosure requirements into ASC Topic 820, Fair Value Measurements and Disclosures.
When applicable, we have included the additional required disclosures in the notes to our
condensed consolidated financial statements.
Derivative Financial Instruments
At December 31, 2009, we had interests in two long-term mortgage impairment insurance contracts
that are denominated in British pound sterling. The exposure with respect to these two contracts
is measured based on movement in a specified United Kingdom housing index. In the first quarter
of 2010, we commuted our interest in one contract for $8.3 million cash. We recognized a gain of
$8.0 million, which is included in other operating income in our condensed consolidated
statements of earnings. The remaining contract qualifies as a derivative financial instrument, is
unhedged and is reported at fair value in other assets in our condensed consolidated balance
sheets. We record changes in fair value and any
foreign exchange gain/loss on this contract as a component of other operating income.
9
HCC
Insurance Holdings, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(unaudited, in thousands except per share data)
Stock-based Compensation
In the first quarter of 2010, we granted the following shares of restricted stock, restricted
stock units and stock options for the purchase of shares of our common stock. The fair value of
the restricted stock, restricted stock units and stock options will be expensed over the vesting
period.
Weighted-average | ||||||||||||||||
Number of | grant date | Aggregate | Vesting | |||||||||||||
shares | fair value | fair value | period | |||||||||||||
Restricted stock |
601 | $28.24 | $16,986 | 3-10 years | ||||||||||||
Restricted stock units |
22 | 28.30 | 636 | 4-10 years | ||||||||||||
Stock options |
130 | 6.78 | 882 | 5 years |
Income Taxes
For the three months ended March 31, 2010 and 2009, the income tax provision was calculated based
on an estimated effective tax rate for each fiscal year. Our effective tax rate differs from the
United States Federal statutory rate primarily due to the effect of tax-exempt municipal bond
interest.
Disposition
In
2010, we sold an inactive subsidiary, HCC
Insurance Company, for $14.7 million
cash.
(2) Fair Value Measurements
We value financial assets and financial liabilities at fair value. In determining fair value, we
generally apply the market approach, which uses prices and other relevant data based on market
transactions involving identical or comparable assets and liabilities. We classify our financial
instruments into the following three-level hierarchy:
| Level 1 Inputs are based on quoted prices in active markets for identical instruments. |
| Level 2 Inputs are based on observable market data (other than quoted prices), or are derived from or corroborated by observable market data. | ||
| Level 3 Inputs are unobservable and not corroborated by market data. |
Our Level 1 investments are primarily U.S. Treasuries listed on stock exchanges. We use quoted
prices for identical instruments to measure fair value.
Our Level 2 investments include most of our fixed income securities, which consist of U.S.
government agency securities, municipal bonds, certain corporate debt securities, and certain
mortgage-backed and asset-backed securities. Our Level 2 instruments also include our interest
rate swap agreements, which were reflected as liabilities in our
condensed consolidated balance sheets. We measure fair value for the majority of our Level 2 investments using quoted
prices of securities with similar characteristics. The remaining investments are valued using
pricing models or matrix pricing. The fair value measurements consider observable assumptions,
including benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided
markets, benchmark securities, bids, offers, default rates, loss severity and other economic
measures.
We use independent pricing services to assist us in determining fair value for over 99% of our
Level 1 and Level 2 investments. The pricing services provide a single price or quote per
security. We use data provided by our third party investment manager to value the remaining Level
2 investments. To validate that these quoted and modeled prices are reasonable estimates of fair
value, we perform various quantitative and qualitative procedures, including: 1) evaluation of
the underlying methodologies, 2) analysis of recent sales activity, 3) analytical review of our
fair values against current market prices, and 4) comparison of the pricing services fair value
to other pricing services fair value for the same investment. Based on these procedures, we did
not adjust the prices or quotes provided by our independent pricing services or third party
investment managers as of March 31, 2010 or
10
HCC
Insurance Holdings, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(unaudited, in thousands except per share data)
December 31, 2009. In addition, we did not apply GAAP criteria for determining the fair value of
securities in inactive markets since no markets for our investments were judged to be inactive as
of March 31, 2010 or December 31, 2009.
Our Level 3
securities include certain fixed income securities and two insurance contracts that
we account for as derivatives. We determine fair value based on internally developed models that
use assumptions or other data that are not readily observable from objective sources. Because we
use the lowest level significant input to determine our hierarchy classifications, a financial
instrument may be classified in Level 3 even though there may be significant readily-observable
inputs. We commuted our interest in one insurance contract in the first quarter of 2010. For the
remaining insurance contract, we determine fair value based on our estimate of the present value
of expected future cash flows, modified to reflect specific contract terms.
The
following tables present our assets and interest rate swap liabilities that were measured
at fair value.
Level 1 | Level 2 | Level 3 | Total | |||||||||||||
March 31, 2010 |
||||||||||||||||
Fixed income securities |
||||||||||||||||
U.S. government and government agency securities |
$ | 175,950 | $ | 181,059 | $ | | $ | 357,009 | ||||||||
Fixed income securities of states,
municipalities and political subdivisions |
| 1,110,823 | | 1,110,823 | ||||||||||||
Special purpose revenue bonds of states,
municipalities and political subdivisions |
| 1,262,201 | | 1,262,201 | ||||||||||||
Corporate fixed income securities |
| 562,106 | 151 | 562,257 | ||||||||||||
Residential mortgage-backed securities |
| 1,014,909 | | 1,014,909 | ||||||||||||
Commercial mortgage-backed securities |
| 146,816 | 2,758 | 149,574 | ||||||||||||
Asset-backed securities |
| 10,657 | 1,315 | 11,972 | ||||||||||||
Foreign government securities |
| 210,110 | | 210,110 | ||||||||||||
Foreign non-government securities |
| 123,730 | | 123,730 | ||||||||||||
Total fixed income securities |
175,950 | 4,622,411 | 4,224 | 4,802,585 | ||||||||||||
Other investments |
13 | | | 13 | ||||||||||||
Other assets |
| | 291 | 291 | ||||||||||||
Total assets measured at fair value |
$ | 175,963 | $ | 4,622,411 | $ | 4,515 | $ | 4,802,889 | ||||||||
Accounts payable and accrued liabilities |
$ | | $ | (1,871 | ) | $ | | $ | (1,871 | ) | ||||||
Total liabilities measured at fair value |
$ | | $ | (1,871 | ) | $ | | $ | (1,871 | ) | ||||||
11
HCC Insurance Holdings, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(unaudited, in thousands except per share data)
Level 1 | Level 2 | Level 3 | Total | |||||||||||||
December 31, 2009 | ||||||||||||||||
Fixed income securities |
||||||||||||||||
U.S. government and government agency securities |
$ | 178,927 | $ | 134,620 | $ | | $ | 313,547 | ||||||||
Fixed income securities of states,
municipalities and political subdivisions |
| 1,059,426 | | 1,059,426 | ||||||||||||
Special purpose revenue bonds of states,
municipalities and political subdivisions |
| 1,146,334 | | 1,146,334 | ||||||||||||
Corporate fixed income securities |
| 559,673 | 151 | 559,824 | ||||||||||||
Residential mortgage-backed securities |
| 944,182 | | 944,182 | ||||||||||||
Commercial mortgage-backed securities |
| 143,412 | 2,805 | 146,217 | ||||||||||||
Asset-backed securities |
| 13,059 | 1,306 | 14,365 | ||||||||||||
Foreign government securities |
| 227,681 | | 227,681 | ||||||||||||
Foreign non-government securities |
| 126,497 | | 126,497 | ||||||||||||
Total fixed income securities |
178,927 | 4,354,884 | 4,262 | 4,538,073 | ||||||||||||
Other investments |
14 | | | 14 | ||||||||||||
Other assets |
| | 432 | 432 | ||||||||||||
Total assets measured at fair value |
$ | 178,941 | $ | 4,354,884 | $ | 4,694 | $ | 4,538,519 | ||||||||
Accounts payable and accrued liabilities |
$ | | $ | (2,367 | ) | $ | | $ | (2,367 | ) | ||||||
Total liabilities measured at fair value |
$ | | $ | (2,367 | ) | $ | | $ | (2,367 | ) | ||||||
We excluded from our fair value disclosures our held to maturity investment portfolio measured
at amortized cost and two other investments measured at cost. Our held to maturity portfolio had
a fair value of $137.6 million at March 31, 2010 and $104.0 million at December 31, 2009. The
two other investments collectively were valued at $4.1 million at both balance sheet dates.
The following table presents the changes in fair value of our Level 3 assets.
2010 | 2009 | |||||||||||||||||||||||
Fixed | Fixed | |||||||||||||||||||||||
income | Other | income | Other | |||||||||||||||||||||
securities | assets | Total | securities | assets | Total | |||||||||||||||||||
Balance at beginning of year |
$ | 4,262 | $ | 432 | $ | 4,694 | $ | 6,515 | $ | 16,100 | $ | 22,615 | ||||||||||||
Net redemptions |
(100 | ) | (8,342 | ) | (8,442 | ) | (281 | ) | | (281 | ) | |||||||||||||
Gains and (losses) unrealized |
62 | (141 | ) | (79 | ) | 567 | 363 | 930 | ||||||||||||||||
Gains realized |
| 8,342 | 8,342 | 30 | | 30 | ||||||||||||||||||
Transfers out of Level 3 |
| | | (1,746 | ) | | (1,746 | ) | ||||||||||||||||
Balance at March 31 |
$ | 4,224 | $ | 291 | $ | 4,515 | $ | 5,085 | $ | 16,463 | $ | 21,548 | ||||||||||||
Unrealized gains and losses on our Level 3 fixed income securities are reported in other
comprehensive income within shareholders equity, and unrealized gains and losses on our Level 3
other assets are reported in other operating income. We transferred investments from Level 3 to
Level 2 in the first quarter of 2009 because we were able to determine their fair value using
inputs based on observable market data at March 31, 2009. There were no investments transferred
between Level 1 and Level 2 for either period.
12
HCC Insurance Holdings, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(unaudited, in thousands except per share data)
(3) Investments
Substantially all of our fixed income securities are investment grade and 97% are rated A or
better. The cost or amortized cost, gross unrealized gain or loss, and fair value of investments
in fixed income securities that are classified as available for sale were as follows:
Cost or | Gross | Gross | ||||||||||||||
amortized | unrealized | unrealized | Fair | |||||||||||||
cost | gain | loss | value | |||||||||||||
March 31, 2010 |
||||||||||||||||
U.S. government and government agency securities |
$ | 351,461 | $ | 6,419 | $ | (871 | ) | $ | 357,009 | |||||||
Fixed income securities of states, municipalities
and political subdivisions |
1,067,684 | 45,344 | (2,205 | ) | 1,110,823 | |||||||||||
Special purpose revenue bonds of states,
municipalities and political subdivisions |
1,223,431 | 41,097 | (2,327 | ) | 1,262,201 | |||||||||||
Corporate fixed income securities |
538,805 | 23,593 | (141 | ) | 562,257 | |||||||||||
Residential mortgage-backed securities |
980,331 | 39,161 | (4,583 | ) | 1,014,909 | |||||||||||
Commercial mortgage-backed securities |
147,001 | 3,725 | (1,152 | ) | 149,574 | |||||||||||
Asset-backed securities |
12,513 | 500 | (1,041 | ) | 11,972 | |||||||||||
Foreign government securities |
200,183 | 9,961 | (34 | ) | 210,110 | |||||||||||
Foreign non-government securities |
117,293 | 6,437 | | 123,730 | ||||||||||||
Total available for sale fixed income securities |
$ | 4,638,702 | $ | 176,237 | $ | (12,354 | ) | $ | 4,802,585 | |||||||
December 31, 2009 |
||||||||||||||||
U.S. government and government agency securities |
$ | 308,618 | $ | 6,255 | $ | (1,326 | ) | $ | 313,547 | |||||||
Fixed income securities of states, municipalities
and political subdivisions |
1,012,262 | 49,491 | (2,327 | ) | 1,059,426 | |||||||||||
Special purpose revenue bonds of states,
municipalities and political subdivisions |
1,101,566 | 46,551 | (1,783 | ) | 1,146,334 | |||||||||||
Corporate fixed income securities |
537,347 | 22,594 | (117 | ) | 559,824 | |||||||||||
Residential mortgage-backed securities |
915,203 | 35,130 | (6,151 | ) | 944,182 | |||||||||||
Commercial mortgage-backed securities |
151,357 | 630 | (5,770 | ) | 146,217 | |||||||||||
Asset-backed securities |
15,118 | 445 | (1,198 | ) | 14,365 | |||||||||||
Foreign government securities |
219,985 | 7,914 | (218 | ) | 227,681 | |||||||||||
Foreign non-government securities |
120,306 | 6,191 | | 126,497 | ||||||||||||
Total available for sale fixed income securities |
$ | 4,381,762 | $ | 175,201 | $ | (18,890 | ) | $ | 4,538,073 | |||||||
13
HCC Insurance Holdings, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(unaudited, in thousands except per share data)
The amortized cost and fair value of investments in fixed income securities that are
classified as held to maturity were as follows:
March 31, 2010 | December 31, 2009 | |||||||||||||||
Amortized | Amortized | |||||||||||||||
cost | Fair value | cost | Fair value | |||||||||||||
U.S. government securities |
$ | 12,986 | $ | 13,296 | $ | 14,988 | $ | 15,257 | ||||||||
Foreign government securities |
79,194 | 80,274 | 80,210 | 81,066 | ||||||||||||
Foreign non-government securities |
43,439 | 44,037 | 7,594 | 7,685 | ||||||||||||
Total held to maturity fixed income securities |
$ | 135,619 | $ | 137,607 | $ | 102,792 | $ | 104,008 | ||||||||
All fixed income securities were income producing in 2010. The following table displays the
gross unrealized losses and fair value of all available for sale fixed income securities
that were in a continuous unrealized loss position for the periods indicated:
Less than 12 months | 12 months or more | Total | ||||||||||||||||||||||
Unrealized | Unrealized | Unrealized | ||||||||||||||||||||||
Fair value | losses | Fair value | losses | Fair value | losses | |||||||||||||||||||
March 31, 2010 |
||||||||||||||||||||||||
U.S. government and government agency
securities |
$ | 79,931 | $ | (871 | ) | $ | | $ | | $ | 79,931 | $ | (871 | ) | ||||||||||
Fixed income securities of states,
municipalities and political
subdivisions |
113,823 | (1,122 | ) | 17,787 | (1,083 | ) | 131,610 | (2,205 | ) | |||||||||||||||
Special purpose revenue bonds of
states, municipalities and political
subdivisions |
194,288 | (1,802 | ) | 22,171 | (525 | ) | 216,459 | (2,327 | ) | |||||||||||||||
Corporate fixed income securities |
31,350 | (141 | ) | | | 31,350 | (141 | ) | ||||||||||||||||
Residential mortgage-backed securities |
151,297 | (1,100 | ) | 37,997 | (3,483 | ) | 189,294 | (4,583 | ) | |||||||||||||||
Commercial mortgage-backed securities |
25 | | 21,942 | (1,152 | ) | 21,967 | (1,152 | ) | ||||||||||||||||
Asset-backed securities |
| | 6,278 | (1,041 | ) | 6,278 | (1,041 | ) | ||||||||||||||||
Foreign government securities |
| | 3,984 | (34 | ) | 3,984 | (34 | ) | ||||||||||||||||
Total |
$ | 570,714 | $ | (5,036 | ) | $ | 110,159 | $ | (7,318 | ) | $ | 680,873 | $ | (12,354 | ) | |||||||||
14
HCC Insurance Holdings, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(unaudited, in thousands except per share data)
Less than 12 months | 12 months or more | Total | ||||||||||||||||||||||
Unrealized | Unrealized | Unrealized | ||||||||||||||||||||||
Fair value | losses | Fair value | losses | Fair value | losses | |||||||||||||||||||
December 31, 2009 |
||||||||||||||||||||||||
U.S. government and government agency
securities |
$ | 101,542 | $ | (1,326 | ) | $ | | $ | | $ | 101,542 | $ | (1,326 | ) | ||||||||||
Fixed income securities of states,
municipalities and political
subdivisions |
48,836 | (985 | ) | 19,816 | (1,342 | ) | 68,652 | (2,327 | ) | |||||||||||||||
Special purpose revenue bonds of
states, municipalities and political
subdivisions |
76,305 | (1,305 | ) | 25,261 | (478 | ) | 101,566 | (1,783 | ) | |||||||||||||||
Corporate fixed income securities |
13,773 | (117 | ) | | | 13,773 | (117 | ) | ||||||||||||||||
Residential mortgage-backed securities |
147,621 | (2,018 | ) | 40,568 | (4,133 | ) | 188,189 | (6,151 | ) | |||||||||||||||
Commercial mortgage-backed securities |
30,209 | (418 | ) | 73,451 | (5,352 | ) | 103,660 | (5,770 | ) | |||||||||||||||
Asset-backed securities |
2,476 | (246 | ) | 7,532 | (952 | ) | 10,008 | (1,198 | ) | |||||||||||||||
Foreign government securities |
4,153 | (130 | ) | 8,593 | (88 | ) | 12,746 | (218 | ) | |||||||||||||||
Total |
$ | 424,915 | $ | (6,545 | ) | $ | 175,221 | $ | (12,345 | ) | $ | 600,136 | $ | (18,890 | ) | |||||||||
A security has an impairment loss when its fair value is less than its cost or amortized cost at
the balance sheet date. We evaluate the securities in our fixed income securities portfolio for
possible other-than-temporary impairment losses at each quarter end. During 2010 and 2009, our
reviews covered all impaired securities where the loss exceeded $0.5 million and the loss either
exceeded 10% of cost or the security had been in a loss position for longer than twelve
consecutive months.
For other-than-temporary impairment losses, we recognize an other-than-temporary impairment loss
in earnings in the period that we determine: 1) we intend to sell the security, 2) it is more
likely than not that we will be required to sell the security before recovery of its amortized
cost basis or 3) the security has a credit loss. We recognized no other-than-temporary impairment losses
in the first quarter of 2010, compared to $3.1 million of other-than-temporary impairment credit
losses in the first quarter of 2009.
At March 31, 2010, we had $5.0 million after-tax of other-than-temporary impairments, primarily
related to mortgage-backed and asset-backed securities, included in accumulated other
comprehensive income within shareholders equity. The credit-related portion of our pretax
other-than-temporary impairment loss recognized in earnings, for which a portion of the
other-than-temporary loss was recognized in other comprehensive income, did not change in the
first quarter of 2010 and was $3.8 million at March 31, 2010.
We do not consider the $12.4 million of gross unrealized losses in our fixed income securities
portfolio at March 31, 2010 to be other-than-temporary impairments as of that date because: 1) we
received all contractual interest and principal payments on these securities as of March 31, 2010,
2) we do not intend to sell the securities, 3) it is more likely than not that we will not be
required to sell the securities before recovery of their amortized cost bases and 4) the
unrealized loss relates to non-credit factors, such as interest rate changes and market
conditions.
15
HCC Insurance Holdings, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(unaudited, in thousands except per share data)
The amortized cost and fair value of our fixed income securities at March 31, 2010, by contractual
maturity, are shown below. Expected maturities may differ from contractual maturities because
borrowers may have the right to call or prepay obligations with or without call or prepayment
penalties. The weighted-average life of our mortgage-backed and asset-backed securities at March
31, 2010 was 3.7 years.
Available for sale | Held to maturity | |||||||||||||||
Cost or amortized | Amortized | |||||||||||||||
cost | Fair value | cost | Fair value | |||||||||||||
Due in 1 year or less |
$ | 309,014 | $ | 313,966 | $ | 38,205 | $ | 38,404 | ||||||||
Due after 1 year through 5 years |
1,104,920 | 1,156,837 | 87,012 | 88,515 | ||||||||||||
Due after 5 years through 10 years |
803,390 | 838,882 | 10,402 | 10,688 | ||||||||||||
Due after 10 years through 15 years |
687,406 | 706,459 | | | ||||||||||||
Due after 15 years |
594,127 | 609,986 | | | ||||||||||||
Securities with fixed maturities |
3,498,857 | 3,626,130 | 135,619 | 137,607 | ||||||||||||
Asset-backed and mortgage-backed securities |
1,139,845 | 1,176,455 | | | ||||||||||||
Total fixed income securities |
$ | 4,638,702 | $ | 4,802,585 | $ | 135,619 | $ | 137,607 | ||||||||
The sources of net investment income were as follows:
Three months ended March 31, | ||||||||
2010 | 2009 | |||||||
Fixed income securities |
$ | 48,599 | $ | 45,438 | ||||
Short-term investments |
190 | 884 | ||||||
Other |
1,508 | (52 | ) | |||||
Total investment income |
50,297 | 46,270 | ||||||
Investment expense |
(1,048 | ) | (1,052 | ) | ||||
Net investment income |
$ | 49,249 | $ | 45,218 | ||||
Realized pretax gains (losses) on the sale of investments, which exclude other-than-temporary
impairment losses, were as follows:
Three months ended March 31, | ||||||||||||||||||||||||
2010 | 2009 | |||||||||||||||||||||||
Gains | Losses | Net | Gains | Losses | Net | |||||||||||||||||||
Fixed income securities |
$ | 4,901 | $ | (223 | ) | $ | 4,678 | $ | 2,970 | $ | (451 | ) | $ | 2,519 | ||||||||||
Other |
2 | (155 | ) | (153 | ) | 683 | (147 | ) | 536 | |||||||||||||||
Realized gain (loss) |
$ | 4,903 | $ | (378 | ) | $ | 4,525 | $ | 3,653 | $ | (598 | ) | $ | 3,055 | ||||||||||
16
HCC Insurance Holdings, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(unaudited, in thousands except per share data)
(4) Earnings Per Share
The following table details the numerator and denominator used in our earnings per share
calculations.
Three months ended March 31, | ||||||||
2010 | 2009 | |||||||
Net earnings |
$ | 71,354 | $ | 83,170 | ||||
Less: net earnings attributable to unvested restricted stock and restricted stock units |
(752 | ) | (396 | ) | ||||
Net earnings available to common stock |
$ | 70,602 | $ | 82,774 | ||||
Weighted-average common shares outstanding |
113,668 | 112,799 | ||||||
Dilutive effect of outstanding options (determined using treasury stock method) |
456 | 235 | ||||||
Dilutive effect of convertible debt (determined using treasury stock method) |
| 255 | ||||||
Weighted-average common shares and potential common shares outstanding |
114,124 | 113,289 | ||||||
Anti-dilutive stock options not included in treasury stock method computation |
3,413 | 6,509 | ||||||
(5) Segment and Geographic Data
The performance of each segment is evaluated by our management based on net earnings. Net
earnings is calculated on an after-tax basis and after corporate expense allocations, interest
expense on debt incurred for acquired companies and intercompany eliminations have been charged
or credited to our individual segments. All stock-based compensation is included in the corporate
segment because it is not included in managements evaluation of the other segments. All
contractual and discretionary bonuses are expensed in the respective employees segment in the
year the bonuses are earned. Any such bonuses that will be paid by restricted stock awards, which
will be granted by the Compensation Committee in the following year, are reversed on the
corporate segment, which will record the appropriate stock-based compensation expense as the
awards vest in future years.
17
HCC Insurance Holdings, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(unaudited, in thousands except per share data)
The following tables show information by business segment and geographic location. Geographic
location is determined by physical location of our offices and does not represent the location of
insureds or reinsureds from whom the business was generated.
Insurance | Other | |||||||||||||||||||
Company | Agency | Operations | Corporate | Total | ||||||||||||||||
Three months ended March 31, 2010 |
||||||||||||||||||||
Revenue: |
||||||||||||||||||||
Domestic |
$ | 460,478 | $ | 10,926 | $ | 1,919 | $ | 683 | $ | 474,006 | ||||||||||
Foreign |
116,963 | 3,291 | | | 120,254 | |||||||||||||||
Inter-segment |
| 14,707 | 185 | | 14,892 | |||||||||||||||
Total segment revenue |
$ | 577,441 | $ | 28,924 | $ | 2,104 | $ | 683 | 609,152 | |||||||||||
Inter-segment eliminations |
(14,892 | ) | ||||||||||||||||||
Consolidated total revenue |
$ | 594,260 | ||||||||||||||||||
Net earnings (loss): |
||||||||||||||||||||
Domestic |
$ | 70,694 | $ | (3,326 | ) | $ | 815 | $ | (5,451 | ) | $ | 62,732 | ||||||||
Foreign |
5,990 | (1,089 | ) | | | 4,901 | ||||||||||||||
Total segment net earnings (loss) |
$ | 76,684 | $ | (4,415 | ) | $ | 815 | $ | (5,451 | ) | 67,633 | |||||||||
Inter-segment eliminations |
3,721 | |||||||||||||||||||
Consolidated net earnings |
$ | 71,354 | ||||||||||||||||||
Other items: |
||||||||||||||||||||
Net investment income |
$ | 48,498 | $ | 59 | $ | 1 | $ | 691 | $ | 49,249 | ||||||||||
Depreciation and amortization |
1,170 | 1,855 | 22 | 924 | 3,971 | |||||||||||||||
Interest expense |
260 | 4,246 | | 884 | 5,390 | |||||||||||||||
Capital expenditures |
807 | 889 | 1 | 2,127 | 3,824 | |||||||||||||||
Tax expense: |
||||||||||||||||||||
Income tax expense (benefit) |
$ | 32,532 | $ | (2,794 | ) | $ | 256 | $ | (725 | ) | $ | 29,269 | ||||||||
Inter-segment eliminations |
2,402 | |||||||||||||||||||
Consolidated income tax expense |
$ | 31,671 | ||||||||||||||||||
18
HCC Insurance Holdings, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(unaudited, in thousands except per share data)
Insurance | Other | |||||||||||||||||||
Company | Agency | Operations | Corporate | Total | ||||||||||||||||
Three
months ended March 31, 2009 |
||||||||||||||||||||
Revenue: |
||||||||||||||||||||
Domestic |
$ | 470,386 | $ | 18,010 | $ | 2,278 | $ | 652 | $ | 491,326 | ||||||||||
Foreign |
103,103 | 6,309 | | | 109,412 | |||||||||||||||
Inter-segment |
| 23,747 | 254 | | 24,001 | |||||||||||||||
Total segment revenue |
$ | 573,489 | $ | 48,066 | $ | 2,532 | $ | 652 | 624,739 | |||||||||||
Inter-segment eliminations |
(24,001 | ) | ||||||||||||||||||
Consolidated total revenue |
$ | 600,738 | ||||||||||||||||||
Net earnings (loss): |
||||||||||||||||||||
Domestic |
$ | 69,913 | $ | 3,161 | $ | 1,013 | $ | (7,606 | ) | $ | 66,481 | |||||||||
Foreign |
16,002 | 215 | | | 16,217 | |||||||||||||||
Total segment net earnings (loss) |
$ | 85,915 | $ | 3,376 | $ | 1,013 | $ | (7,606 | ) | 82,698 | ||||||||||
Inter-segment eliminations |
472 | |||||||||||||||||||
Consolidated net earnings |
$ | 83,170 | ||||||||||||||||||
Other items: |
||||||||||||||||||||
Net investment income |
$ | 44,220 | $ | 210 | $ | 4 | $ | 784 | $ | 45,218 | ||||||||||
Depreciation and amortization |
1,126 | 1,747 | 22 | 684 | 3,579 | |||||||||||||||
Interest expense (benefit) |
279 | 3,734 | (7 | ) | 633 | 4,639 | ||||||||||||||
Capital expenditures |
496 | 2,088 | 10 | 888 | 3,482 | |||||||||||||||
Tax expense: |
||||||||||||||||||||
Income tax expense (benefit) |
$ | 38,236 | $ | 3,376 | $ | 589 | $ | (2,479 | ) | $ | 39,722 | |||||||||
Inter-segment eliminations |
(49 | ) | ||||||||||||||||||
Consolidated income tax expense |
$ | 39,673 | ||||||||||||||||||
19
HCC Insurance Holdings, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(unaudited, in thousands except per share data)
The following tables present selected revenue items by line of business and major product lines.
Three months ended March 31, | ||||||||
2010 | 2009 | |||||||
Diversified financial products |
||||||||
Directors and officers |
$ | 92,918 | $ | 82,802 | ||||
Errors and omissions |
53,893 | 59,405 | ||||||
Other |
11,826 | 10,976 | ||||||
U.S. surety and credit |
46,749 | 44,492 | ||||||
International surety and credit. |
18,189 | 16,409 | ||||||
223,575 | 214,084 | |||||||
Group life, accident and health |
||||||||
Medical stop-loss |
161,766 | 159,483 | ||||||
Other medical |
25,021 | 33,053 | ||||||
Other |
6,855 | 8,552 | ||||||
193,642 | 201,088 | |||||||
Aviation |
28,943 | 32,814 | ||||||
London market account |
||||||||
Energy |
16,187 | 9,235 | ||||||
Property treaty |
6,754 | | ||||||
Other |
13,227 | 14,439 | ||||||
36,168 | 23,674 | |||||||
Other specialty lines |
||||||||
Public risk |
11,490 | 8,620 | ||||||
HCC Lloyds |
10,185 | 10,790 | ||||||
Other |
5,542 | 11,314 | ||||||
27,217 | 30,724 | |||||||
Discontinued lines |
42 | 4 | ||||||
Total net earned premium |
$ | 509,587 | $ | 502,388 | ||||
Property and casualty |
$ | 17,680 | $ | 24,418 | ||||
Accident and health |
3,313 | 5,876 | ||||||
Fee and commission income |
$ | 20,993 | $ | 30,294 | ||||
20
HCC Insurance Holdings, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(unaudited, in thousands except per share data)
(6) | Reinsurance | |
In the normal course of business, our insurance companies cede a portion of their premium to domestic and foreign reinsurers through treaty and facultative reinsurance agreements. Although ceding for reinsurance purposes does not discharge the direct insurer from liability to its policyholder, our insurance companies participate in such agreements in order to limit their loss exposure, protect them against catastrophic loss and diversify their business. The following table presents the effect of such reinsurance transactions on our premium and loss and loss adjustment expense. |
Written | Earned | Loss and loss adjustment |
||||||||||
premium | premium | expense | ||||||||||
Three months ended March 31, 2010 |
||||||||||||
Direct business |
$ | 509,192 | $ | 571,962 | $ | 360,951 | ||||||
Reinsurance assumed |
113,304 | 69,240 | 52,835 | |||||||||
Reinsurance ceded |
(124,245 | ) | (131,615 | ) | (87,265 | ) | ||||||
Net amounts |
$ | 498,251 | $ | 509,587 | $ | 326,521 | ||||||
Three months ended March 31, 2009 |
||||||||||||
Direct business |
$ | 532,032 | $ | 549,037 | $ | 362,270 | ||||||
Reinsurance assumed |
70,355 | 64,140 | 36,665 | |||||||||
Reinsurance ceded |
(111,137 | ) | (110,789 | ) | (83,369 | ) | ||||||
Net amounts |
$ | 491,250 | $ | 502,388 | $ | 315,566 | ||||||
Ceding commissions that are netted against policy acquisition costs in the condensed consolidated statements of earnings were $16.4 million and $12.5 million in the first quarter of 2010 and 2009, respectively, | ||||||||||||
The table below shows the components of reinsurance recoverables in our condensed consolidated balance sheets. | ||||||||||||
March 31, | December 31, | |||||||||||
2010 | 2009 | |||||||||||
Reinsurance recoverable on paid losses |
$ | 91,858 | $ | 82,887 | ||||||||
Reinsurance recoverable on outstanding losses |
472,538 | 495,964 | ||||||||||
Reinsurance recoverable on incurred but not reported losses |
467,497 | 440,505 | ||||||||||
Reserve for uncollectible reinsurance |
(2,945 | ) | (2,945 | ) | ||||||||
Total reinsurance recoverables |
$ | 1,028,948 | $ | 1,016,411 | ||||||||
21
HCC Insurance Holdings, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(unaudited, in thousands except per share data)
The tables below present the calculation of net reserves, net unearned premium and net deferred policy acquisition costs. |
March 31, | December 31, | |||||||
2010 | 2009 | |||||||
Loss and loss adjustment expense payable |
$ | 3,495,705 | $ | 3,492,309 | ||||
Reinsurance recoverable on outstanding losses |
(472,538 | ) | (495,964 | ) | ||||
Reinsurance recoverable on incurred but not reported losses |
(467,497 | ) | (440,505 | ) | ||||
Net reserves |
$ | 2,555,670 | $ | 2,555,840 | ||||
Unearned premium |
$ | 1,022,950 | $ | 1,044,747 | ||||
Ceded unearned premium |
(261,256 | ) | (270,436 | ) | ||||
Net unearned premium |
$ | 761,694 | $ | 774,311 | ||||
Deferred policy acquisition costs |
$ | 209,083 | $ | 208,463 | ||||
Deferred ceding commissions |
(67,876 | ) | (71,595 | ) | ||||
Net deferred policy acquisition costs |
$ | 141,207 | $ | 136,868 | ||||
(7) | Supplemental Information |
Supplemental information was as follows: |
Three months ended March 31, | ||||||||
2010 | 2009 | |||||||
Income taxes paid |
$ | 12,850 | $ | 20,214 | ||||
Interest paid |
222 | 3,442 | ||||||
Comprehensive income |
67,937 | 107,536 |
22
HCC Insurance Holdings, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(unaudited, in thousands except per share data)
(8) | Commitments and Contingencies | |
Catastrophe Exposure and Loss |
We have exposure to catastrophic losses caused by natural perils (such as hurricanes and earthquakes), as well as from man-made events (such as terrorist attacks). The incidence and severity of catastrophic losses is unpredictable. We assess our exposures in areas most vulnerable to natural catastrophes and apply procedures to ascertain our probable maximum loss from a single event. We maintain reinsurance protection that we believe is sufficient to limit our exposure to a foreseeable event. In the first quarter of 2010, we recognized gross losses from catastrophic events, primarily the Chilean earthquake, of $31.9 million. After reinsurance, our pretax loss was $20.6 million. | ||
Litigation |
We are a party to lawsuits, arbitrations and other proceedings that arise in the normal course of our business. Many of such lawsuits, arbitrations and other proceedings involve claims under policies that we underwrite as an insurer or reinsurer, the liabilities for which, we believe, have been adequately included in our loss reserves. Also, from time to time, we are a party to lawsuits, arbitrations and other proceedings that relate to disputes with third parties, or that involve alleged errors and omissions on the part of our subsidiaries. We have provided accruals for these items to the extent we deem the losses probable and reasonably estimable. Although the ultimate outcome of these matters cannot be determined at this time, based on present information, the availability of insurance coverage and advice received from our outside legal counsel, we believe the resolution of any such matters will not have a material adverse effect on our consolidated financial position, results of operations or cash flows. |
Indemnifications |
In conjunction with the sales of business assets and subsidiaries, we have provided indemnifications to the buyers. Certain indemnifications cover typical representations and warranties related to our responsibilities to perform under the sales contracts. Under other indemnifications, we agree to reimburse the purchasers for taxes or ERISA-related amounts, if any, assessed after the sale date but related to pre-sale activities. We cannot quantify the maximum potential exposure covered by all of our indemnifications because the indemnifications cover a variety of matters, operations and scenarios. Certain of these indemnifications have no time limit. For those with a time limit, the longest such indemnification expires in 2025. We accrue a loss when a valid claim is made by a purchaser and we believe we have potential exposure. At March 31, 2010, we have recorded a liability of $13.0 million and have provided a $3.0 million escrow account and $9.7 million of letters of credit to cover our obligations or anticipated payments under these indemnifications. |
23
Item 2. Managements Discussion and Analysis of Financial Condition and Results of
Operations
The following Managements Discussion and Analysis should be read in conjunction with the Condensed
Consolidated Financial Statements and the related Notes thereto.
Overview
We are a specialty insurance group with offices in the United States, the United Kingdom, Spain and
Ireland, transacting business in approximately 150 countries. Our group consists of insurance
companies, underwriting agencies and participation in an active Lloyds of London syndicate that we
manage. Our shares trade on the New York Stock Exchange and closed at $27.60 on March 31, 2010. We
had a market capitalization of $3.1 billion at April 30, 2010.
We underwrite a variety of relatively non-correlated specialty lines of business identified as
diversified financial products; group life, accident and health; aviation; London market account;
and other specialty lines of business. Products in each line are marketed by our insurance
companies, agencies and the syndicate, through a network of independent agents and brokers,
directly to customers or through third party administrators. The majority of our business is low
limit or small premium business that has less intense price competition, as well as lower
catastrophe and volatility risk. We reinsure a significant portion of our catastrophic exposure to
hurricanes and earthquakes to minimize the impact on our net earnings and shareholders equity.
Our major domestic and international insurance companies have a financial strength rating of AA
(Very Strong) from Standard & Poors Corporation. Our major domestic insurance companies have a
financial strength rating of AA (Very Strong) from Fitch Ratings, A1 (Good Security) from
Moodys Investors Service, Inc., and A+ (Superior) from A.M. Best Company, Inc.
Key facts about our consolidated group as of and for the quarter ended March 31, 2010 are as
follows:
| We had consolidated shareholders equity of $3.1 billion. Our book value per share increased to $26.91. |
| We had net earnings of $71.4 million, or $0.62 per diluted share. |
| We produced $594.3 million of total revenue. |
| We recognized $20.6 million of net catastrophic losses, primarily related to the Chilean earthquake. This loss increased our first quarter loss ratio by 4.0 percentage points. |
| Our loss ratio, including the catastrophic losses, was 64.1% and our combined ratio was 90.3%. |
| We declared dividends of $0.135 per share and paid $15.5 million of dividends. |
| We hold a $4.9 billion portfolio of fixed income securities with an average rating of AA+ and a total investment portfolio of $5.5 billion. |
Comparisons in the following sections refer to the first three months of 2010 compared to the same
period of 2009, unless otherwise noted. Amounts in tables are in thousands, except for earnings per
share, percentages, ratios and number of employees.
24
Results of Operations
Net earnings were $71.4 million ($0.62 per diluted share) in the first three months of 2010,
compared to $83.2 million ($0.73 per diluted share) in the same period of 2009. The 2010 net
earnings included $20.6 million (pretax) of net catastrophic losses, primarily from the Chilean
earthquake, partially offset by a $5.0 million pretax gain, net of related expenses, that we
realized from commuting a derivative contract. The 2009 net earnings included a $15.6 million
pretax gain, net of related expenses, from the commutation of the
MGIC reinsurance contract.
These items are described more fully below:
| In 2010, we incurred a gross loss of $31.9 million and a net loss of $20.6 million after reinsurance related to several catastrophic events that occurred in the first quarter, including the Chilean and Haitian earthquakes and the European windstorm Xynthia. The net catastrophic losses increased our first quarter 2010 loss ratio and combined ratio by 4.0 percentage points and decreased net earnings by $0.12 per diluted share. | |
| In 2010, we commuted our interest in a long-term mortgage impairment insurance contract that had been accounted for as a derivative financial instrument. The contract was denominated in British pound sterling. We received £5.6 million ($8.3 million) of cash and recognized a gain of $8.0 million, which was included in other operating income, and incurred related expenses of $3.0 million, which were included in other operating expense in the condensed consolidated statements of earnings. | |
| In 2009, we commuted, loss-free, all liability under a contract with Mortgage Guarantee Insurance Corporation (MGIC) to provide reinsurance coverage for certain residential mortgage guaranty contracts. We had been recording revenue under this contract using the deposit method of accounting because we determined the contract did not transfer significant underwriting risk. We received a cash termination payment of $25.0 million in the first quarter. As a result of the termination, other operating income increased $20.5 million, and fee and commission income increased $5.0 million. This additional revenue was partially offset by $9.9 million of expenses for reinsurance and other direct costs, which were recorded in other operating expense. |
The following table sets forth the relationships of statement of earnings line items as a
percent of total revenue.
Three months ended March 31, | ||||||||
2010 | 2009 | |||||||
Net earned premium |
85.8 | % | 83.6 | % | ||||
Fee and commission income |
3.5 | 5.0 | ||||||
Net investment income |
8.3 | 7.5 | ||||||
Other operating income |
1.6 | 3.9 | ||||||
Net realized investment gain |
0.8 | 0.5 | ||||||
Other-than-temporary impairment loss |
| (0.5 | ) | |||||
Total revenue |
100.0 | 100.0 | ||||||
Loss and loss adjustment expense, net |
55.0 | 52.5 | ||||||
Policy acquisition costs, net |
15.6 | 14.8 | ||||||
Other operating expense |
11.2 | 11.5 | ||||||
Interest expense |
0.9 | 0.8 | ||||||
Earnings before income tax expense |
17.3 | 20.4 | ||||||
Income tax expense |
5.3 | 6.6 | ||||||
Net earnings |
12.0 | % | 13.8 | % | ||||
Revenue
Total
revenue decreased $6.5 million in 2010 due to: 1) the
$25.0 million from the 2009 commutation of the MGIC reinsurance contract, partially
offset by 2) higher net earned premium in 2010 and 3) $8.0 million of revenue in 2010 related to
the gain on the commutation of a derivative contract.
Gross written premium, net written premium and net earned premium are detailed below. Growth in
written premium occurred primarily in our London market account line of business, directly related
to property treaty business that we began to write in late 2009. The increase in net earned premium
was due to growth in our directors and officers liability business in 2009 and 2010. See the
Insurance Company Segment section below for further discussion of the relationship and changes in
premium revenue.
25
Three months ended March 31, | ||||||||
2010 | 2009 | |||||||
Gross written premium |
$ | 622,496 | $ | 602,387 | ||||
Net written premium |
498,251 | 491,250 | ||||||
Net earned premium |
509,587 | 502,388 |
The table below shows the source of our fee and commission income, which decreased 31% in 2010.
The decrease primarily related to the sale of our U.K. reinsurance broker and the sale of the
operations of our commercial marine agency business, both in 2009, and a $5.0 million termination
payment from the 2009 commutation of the MGIC reinsurance
contract.
Three months ended March 31, | ||||||||
2010 | 2009 | |||||||
Agencies |
$ | 15,061 | $ | 24,576 | ||||
Insurance companies |
5,932 | 5,718 | ||||||
Fee and commission income |
$ | 20,993 | $ | 30,294 | ||||
The sources of net investment income are detailed below.
Three months ended March 31, | ||||||||
2010 | 2009 | |||||||
Fixed income securities |
||||||||
Taxable |
$ | 26,868 | $ | 25,105 | ||||
Exempt from U.S. income taxes |
21,731 | 20,333 | ||||||
Total fixed income securities |
48,599 | 45,438 | ||||||
Short-term investments |
190 | 884 | ||||||
Other |
1,508 | (52 | ) | |||||
Total investment income |
50,297 | 46,270 | ||||||
Investment expense |
(1,048 | ) | (1,052 | ) | ||||
Net investment income |
$ | 49,249 | $ | 45,218 | ||||
Net investment income increased 9% in 2010, primarily due to higher income from fixed income
securities, generated from an increased amount of investments. Our fixed income securities
portfolio increased 14% from $4.3 billion at March 31, 2009 to $4.9 billion at March 31, 2010. The
growth in fixed income securities resulted primarily from cash flow from operations and
reinvestment of funds that were held in short-term investments at December 31, 2009. Short-term
investment income declined in the first quarter of 2010, due to lower short-term market interest
rates. Other interest income in 2010 included $0.6 million of interest related to a tax refund, and
in 2009 included a $1.0 million loss on hedge fund investments, which were liquidated in late 2008.
Other operating income was $9.9 million in 2010 compared to $22.9 million in 2009. The 2010 amount
included an $8.0 million gain related to commuting a derivative contract. The 2009 income included
$20.5 million from the commutation of the MGIC reinsurance
contract. Period to period comparisons of our other operating income may vary
substantially, depending on earnings generated by new transactions or investments, income or loss
related to changes in the fair value of certain investments, and gains or losses related to
dispositions. The following table details the components of our other operating income.
Three months ended March 31, | ||||||||
2010 | 2009 | |||||||
Contract using deposit accounting |
$ | | $ | 20,532 | ||||
Strategic investments |
410 | 750 | ||||||
Financial instruments |
8,200 | 363 | ||||||
Other |
1,296 | 1,251 | ||||||
Other operating income |
$ | 9,906 | $ | 22,896 | ||||
26
Expenses
Loss and loss adjustment expense increased year-over-year primarily due to the $20.6 million of net
catastrophic losses incurred in 2010. Excluding the catastrophic losses, the 2010 loss and loss
adjustment expense was 3% lower than in 2009. Our loss ratio was
64.1% for 2010 (which included 4.0 percentage points for the catastrophes), compared to 62.8% in
2009. Policy acquisition costs increased in 2010 due to: 1) our 2009 policy acquisition costs being
lower due to the effect of a $3.8 million premium deficiency reserve recorded at December 31, 2008,
which reduced the amount of policy acquisition costs recognized throughout 2009 and 2) the higher
amount of premium earned in 2010. See the Insurance Company Segment section below for further
discussion of the changes in our loss and loss adjustment expense and policy acquisition costs.
Other operating expense, which includes compensation expense, decreased 3% in 2010. We had 1,874
employees at March 31, 2010 compared to 1,937 a year earlier. In 2009, we sold our U.K. reinsurance
broker and the operations of our commercial marine agency business, which primarily accounts for
the reduction in other operating expense and the number of employees in 2010. In addition, other
operating expense for 2010 and 2009 included $3.0 million and $9.9 million of expense for costs
directly related to the commutations of a derivative contract and the MGIC reinsurance contract,
respectively. Currency conversion expense was $1.5 million in 2010, compared to a $0.1 million
benefit in 2009.
Other operating expense includes $3.2 million and $3.7 million in 2010 and 2009, respectively, of
stock-based compensation expense, after the effect of the deferral and amortization of policy
acquisition costs related to stock-based compensation for our underwriters. In the first quarter of
2010, we granted $17.6 million of restricted stock awards and units, with a weighted-average life
of 6.2 years. At March 31, 2010, there was approximately $28.8 million of total unrecognized
compensation expense related to unvested options and restricted stock awards and units that is
expected to be recognized over a weighted-average period of 4.1 years.
Our effective income tax rate was 30.7% for 2010, compared to 32.3% for 2009. The lower effective
rate in 2010 related to the increased benefit from tax-exempt investment income relative to a lower
pretax income base.
At March 31, 2010, total assets were $8.9 billion and shareholders equity was $3.1 billion,
compared to $8.8 billion and $3.0 billion, respectively, at December 31, 2009. Our book value per
share was $26.91, which increased from $26.58 at December 31, 2009.
Segments
Insurance Company Segment
Net earnings of our insurance company segment decreased $9.2 million, or 11%, in the first quarter
of 2010. We recognized catastrophe losses in 2010 of $20.6 million (pretax and net of reinsurance).
In addition, the commutation of the MGIC reinsurance contract
generated $20.5 million in insurance company revenue in 2009. These
two items more than offset the effect of higher net earned premium and greater investment income
recognized in 2010, as well as the gain in 2010 from the commutation of a derivative contract.
Premium
Gross written premium was 3% higher in 2010 due to the addition of our property treaty business,
which we began writing in late 2009, partially offset by reductions in other lines of business due
to the soft insurance market. The overall percentage of retained premium, as measured by the
percent of net written premium to gross written premium, was 80% and 82% in the first quarter of
2010 and 2009, respectively.
27
The following tables provide premium information by line of business.
Gross | NWP | |||||||||||||||
Written | Net Written | as% of | Net Earned | |||||||||||||
Premium | Premium | GWP | Premium | |||||||||||||
Three months ended March 31, 2010 |
||||||||||||||||
Diversified financial products |
||||||||||||||||
Directors and officers |
$ | 84,168 | $ | 55,956 | 66 | % | $ | 92,918 | ||||||||
Errors and omissions |
56,348 | 47,963 | 85 | 53,893 | ||||||||||||
Other |
16,412 | 12,921 | 79 | 11,826 | ||||||||||||
U.S. surety and credit |
54,021 | 47,419 | 88 | 46,749 | ||||||||||||
International surety and credit |
21,305 | 19,636 | 92 | 18,189 | ||||||||||||
232,254 | 183,895 | 79 | 223,575 | |||||||||||||
Group life, accident and health |
||||||||||||||||
Medical stop-loss |
161,766 | 161,766 | 100 | 161,766 | ||||||||||||
Other medical |
22,318 | 22,318 | 100 | 25,021 | ||||||||||||
Other |
22,298 | 5,148 | 23 | 6,855 | ||||||||||||
206,382 | 189,232 | 92 | 193,642 | |||||||||||||
Aviation |
37,521 | 26,021 | 69 | 28,943 | ||||||||||||
London market account |
||||||||||||||||
Energy |
16,582 | 9,842 | 59 | 16,187 | ||||||||||||
Property treaty |
37,630 | 35,257 | 94 | 6,754 | ||||||||||||
Other |
39,750 | 23,451 | 59 | 13,227 | ||||||||||||
93,962 | 68,550 | 73 | 36,168 | |||||||||||||
Other specialty lines |
||||||||||||||||
Public risk |
16,712 | 9,205 | 55 | 11,490 | ||||||||||||
HCC Lloyds |
17,602 | 16,273 | 92 | 10,185 | ||||||||||||
Other |
18,021 | 5,033 | 28 | 5,542 | ||||||||||||
52,335 | 30,511 | 58 | 27,217 | |||||||||||||
Discontinued lines |
42 | 42 | nm | 42 | ||||||||||||
Totals |
$ | 622,496 | $ | 498,251 | 80 | % | $ | 509,587 | ||||||||
28
Gross | NWP | |||||||||||||||
Written | Net Written | as% of | Net Earned | |||||||||||||
Premium | Premium | GWP | Premium | |||||||||||||
Three
months ended March 31, 2009 |
||||||||||||||||
Diversified financial products |
||||||||||||||||
Directors and officers |
$ | 94,284 | $ | 67,467 | 72 | % | $ | 82,802 | ||||||||
Errors and omissions |
62,359 | 54,652 | 88 | 59,405 | ||||||||||||
Other |
25,774 | 21,832 | 85 | 10,976 | ||||||||||||
U.S. surety and credit |
44,133 | 42,402 | 96 | 44,492 | ||||||||||||
International surety and credit |
18,562 | 17,010 | 92 | 16,409 | ||||||||||||
245,112 | 203,363 | 83 | 214,084 | |||||||||||||
Group life, accident and health |
||||||||||||||||
Medical stop-loss |
159,486 | 159,484 | 100 | 159,483 | ||||||||||||
Other medical |
31,606 | 31,606 | 100 | 33,053 | ||||||||||||
Other |
25,901 | 7,966 | 31 | 8,552 | ||||||||||||
216,993 | 199,056 | 92 | 201,088 | |||||||||||||
Aviation |
41,952 | 30,611 | 73 | 32,814 | ||||||||||||
London market account |
||||||||||||||||
Energy |
14,814 | 6,177 | 42 | 9,235 | ||||||||||||
Property treaty |
| | | | ||||||||||||
Other |
29,935 | 20,217 | 68 | 14,439 | ||||||||||||
44,749 | 26,394 | 59 | 23,674 | |||||||||||||
Other specialty lines |
||||||||||||||||
Public risk |
19,934 | 15,116 | 76 | 8,620 | ||||||||||||
HCC Lloyds |
11,222 | 9,681 | 86 | 10,790 | ||||||||||||
Other |
22,421 | 7,025 | 31 | 11,314 | ||||||||||||
53,577 | 31,822 | 59 | 30,724 | |||||||||||||
Discontinued lines |
4 | 4 | nm | 4 | ||||||||||||
Totals |
$ | 602,387 | $ | 491,250 | 82 | % | $ | 502,388 | ||||||||
nm Not meaningful |
The changes in premium volume and retention levels between quarters resulted principally from the
following factors:
| Diversified financial products Gross written premium was higher in 2009 because we wrote more directors and officers liability and errors and omissions business due to the perception of some of our competitors in the market place at that time. The pricing for credit insurance improved in 2010, and our premium has increased accordingly. Our retention rate was lower in 2010 due to lower quota share retention on our international directors and officers liability business and higher excess of loss premium. Net earned premium increased in 2010 primarily due to the high volume of directors and officers liability business written in 2009, primarily in the second half of the year. |
| Group life, accident and health The decrease in premium was due to our discontinuance of the provider excess business in late 2009. |
29
| Aviation We wrote less aviation premium in 2010 due to continuing competition for U.S. business and lack of growth in the aviation industry. Our international writings were stable due to improved pricing in the international market. |
| London market account Premium increased primarily due to our new property treaty business, which we started writing in late 2009. On a full year basis, our retained premium on the property treaty business is expected to approximate 80%. |
| Other specialty lines Although premium and retention ratios by product changed quarter-over-quarter, due to changes in the mix of business, total premium and the overall retention rate were essentially flat for our other specialty lines. |
Losses and Loss Adjustment Expenses
Our gross loss ratio was 64.5% and 65.1% in 2010 and 2009, respectively. The 2010 gross loss ratio
included 5.0 percentage points related to the catastrophes in 2010.
The table below shows the composition of net incurred loss and loss adjustment expense.
Three months ended March 31, | ||||||||||||||||
2010 | 2009 | |||||||||||||||
Loss | Loss | |||||||||||||||
Amount | ratio | Amount | ratio | |||||||||||||
2010 catastrophes |
$ | 20,588 | 4.0 | % | $ | | | % | ||||||||
Adverse reserve development |
5,010 | 1.0 | 4,727 | 0.9 | ||||||||||||
All other net incurred loss and loss adjustment expense |
300,923 | 59.1 | 310,839 | 61.9 | ||||||||||||
Net incurred loss and loss adjustment expense |
$ | 326,521 | 64.1 | % | $ | 315,566 | 62.8 | % | ||||||||
The adverse reserve development relating to prior year losses was approximately the same amount in both the
first quarter of
2010 and 2009. The development in each year primarily resulted from the re-estimation of our net
claim exposure for products primarily in the life, accident and health line of business.
Deficiencies and redundancies in reserves occur as we review our loss reserves with our actuaries,
increasing or reducing loss reserves as a result of such reviews and as losses are finally settled
or claims exposures change.
We write directors and officers liability, errors and omissions liability and fiduciary liability
coverage for public and private companies and not-for-profit organizations and continue to closely
monitor our exposure to subprime lending issues. We provide coverage for certain financial
institutions, which have potential exposure to shareholders lawsuits. At March 31, 2010, we had
17 Side A only and 77 non-Side A only directors and officers liability, errors and omissions
liability and fiduciary liability claims related to subprime issues, compared to 17 and 75 claims,
respectively, at December 31, 2009. Based on our present knowledge, we believe our ultimate losses
from these coverages will be contained within our current overall loss reserves for these lines of
business.
We have no material exposure to environmental or asbestos losses.
We believe
we have provided for all material net incurred losses as of March 31, 2010. In
addition, we have no material exposure to the Transocean event in
April 2010, due to our facultative reinsurance coverage for this large loss.
30
The following table provides comparative net loss ratios by line of business and major product
lines.
Three months ended March 31, | ||||||||||||||||
2010 | 2009 | |||||||||||||||
Net | Net | Net | Net | |||||||||||||
earned | loss | earned | loss | |||||||||||||
premium | ratio | premium | ratio | |||||||||||||
Diversified financial products |
||||||||||||||||
Directors and officers |
$ | 92,918 | 63.1 | % | $ | 82,802 | 60.7 | % | ||||||||
Errors and omissions |
53,893 | 57.1 | 59,405 | 55.2 | ||||||||||||
Other |
11,826 | 34.2 | 10,976 | 50.0 | ||||||||||||
U.S. surety and credit |
46,749 | 26.5 | 44,492 | 30.5 | ||||||||||||
International surety and credit |
18,189 | 44.0 | 16,409 | 53.0 | ||||||||||||
223,575 | 50.9 | 214,084 | 51.8 | |||||||||||||
Group life, accident and health |
||||||||||||||||
Medical stop-loss |
161,766 | 73.9 | 159,483 | 72.6 | ||||||||||||
Other medical |
25,021 | 76.9 | 33,053 | 88.7 | ||||||||||||
Other |
6,855 | 54.2 | 8,552 | 57.1 | ||||||||||||
193,642 | 73.6 | 201,088 | 74.6 | |||||||||||||
Aviation |
28,943 | 56.6 | 32,814 | 61.3 | ||||||||||||
London market account |
||||||||||||||||
Energy |
16,187 | 77.8 | 9,235 | 29.5 | ||||||||||||
Property treaty |
6,754 | 177.0 | | | ||||||||||||
Other |
13,227 | 80.7 | 14,439 | 48.8 | ||||||||||||
36,168 | 97.4 | 23,674 | 41.3 | |||||||||||||
Other specialty lines |
||||||||||||||||
Public risk |
11,490 | 70.0 | 8,620 | 68.8 | ||||||||||||
HCC Lloyds |
10,185 | 61.2 | 10,790 | 67.4 | ||||||||||||
Other |
5,542 | 78.7 | 11,314 | 103.4 | ||||||||||||
27,217 | 68.5 | 30,724 | 81.0 | |||||||||||||
Discontinued lines |
42 | nm | 4 | nm | ||||||||||||
Totals |
$ | 509,587 | 64.1 | % | $ | 502,388 | 62.8 | % | ||||||||
Expense ratio |
26.2 | 24.5 | ||||||||||||||
Combined ratio |
90.3 | % | 87.3 | % | ||||||||||||
nm | Not meaningful comparison |
The changes in net loss ratios between periods resulted principally from the following factors:
| London market account The 2010 net loss ratios for all major product lines included the effect of the first quarter catastrophe losses, which increased the total London market account loss ratio by 56.9 percentage points. The 2009 net loss ratios included redundant reserve development on prior year hurricanes, which reduced the total London market account loss ratio by 4.2 percentage points. | ||
| Other specialty lines We incurred large losses on our film completion and film production businesses in 2009, which increased the total other specialty lines net loss ratio by 19.7 percentage points. |
31
The table below provides a reconciliation of our reserves for loss and loss adjustment expense
payable, net of reinsurance ceded, the amount of our paid claims and our net paid loss ratios.
Three months ended March 31, | ||||||||
2010 | 2009 | |||||||
Net reserves for loss and loss adjustment expense payable at beginning of period |
$ | 2,555,840 | $ | 2,416,271 | ||||
Net reserve additions from reinsurance to close of our Lloyds syndicate business |
8,110 | 30,209 | ||||||
Foreign currency adjustment |
(27,113 | ) | (18,272 | ) | ||||
Incurred loss and loss adjustment expense |
326,521 | 315,566 | ||||||
Loss and loss adjustment expense payments |
(307,688 | ) | (271,299 | ) | ||||
Net reserves for loss and loss adjustment expense payable at end of period |
$ | 2,555,670 | $ | 2,472,475 | ||||
Net paid loss ratio |
60.4 | % | 54.0 | % | ||||
The net paid loss ratio is the percentage of losses paid, net of reinsurance, divided by net earned
premium for the period. The net paid loss ratio was higher in 2010, primarily due to
a higher amount of claims payments for our directors and officers liability, credit and medical stop-loss
businesses than in the prior year quarter.
Policy Acquisition Costs
Policy acquisition costs, which are reported net of the related portion of commissions on
reinsurance ceded, as a percentage of net earned premium increased to 18.2% in 2010 from 17.7% in
the first quarter of 2009, principally due to the effect of a $3.8 million premium deficiency
reserve recorded at December 31, 2008, which reduced the amount of policy acquisition costs
recognized throughout 2009. The GAAP expense ratio of 26.2% in 2010 exceeded the expense ratio of
24.5% in the first quarter of 2009 primarily due to higher expenses related to our international
business and higher currency conversion expense. In addition, the 2009 expense ratio included a
benefit from reversing a provision for uncollectible reinsurance.
Agency Segment
Revenue from our agency segment was $28.9 million in 2010, compared to $48.1 million in 2009. The
reduction was expected due to the sale of our U.K. reinsurance broker and the sale of the
operations of our commercial marine agency business in 2009. In addition, we had $5.0 million of
revenue in 2009 from a termination payment from the commutation of the MGIC
reinsurance contract. As a result of this lower revenue, the
segment had a net loss of $4.4 million in 2010 compared to net earnings of $3.4 million in 2009. We
expect the agency segment will generate net earnings for full year 2010 due to the seasonality of
business written by our largest agency.
Other Operations Segment
Revenue and net earnings from our other operations segment were $2.1 million and $0.8 million,
respectively, in 2010 compared to $2.5 million and $1.0 million, respectively, in 2009. Results of
this segment may vary substantially period to period depending on our investment in or disposition
of strategic investments.
Liquidity and Capital Resources
Credit market disruptions in recent years have resulted in a tightening of available sources of
credit and significant liquidity concerns for many companies. We believe we have sufficient
sources of liquidity at a reasonable cost at the present time, based on the following:
| We held $636.5 million of cash and liquid short-term investments at March 31, 2010, compared to $940.1 million at December 31, 2009. We reinvested $234.1 million of short-term investments in higher yielding fixed income securities in the first quarter of 2010. |
32
| Our insurance companies have sufficient resources to pay potential claims in 2010. As of December 31, 2009, we projected they will pay $1.2 billion of claims and collect approximately $314.7 million of reinsurance recoveries in 2010. At December 31, 2009, our insurance companies had approximately $1.2 billion of cash, short-term investments, maturing bonds, and principal payments from asset-backed and mortgage-backed securities that will be available to pay these expected claims in 2010. There has been no significant change in our expectations of our subsidiaries ability to pay claims as of March 31, 2010. | ||
| Our available for sale bond portfolio had a fair value of $4.8 billion at March 31, 2010, compared to $4.5 billion at December 31, 2009, and has an average rating of AA+. We intend to hold these securities until their maturity, but we would be able to sell securities to generate cash if the need arises. Should we sell certain securities in the portfolio before their maturity, we cannot be assured that we would recoup the full reported fair value of the securities sold at the time of sale. | ||
| Our debt consists of $300.0 million principal amount of unsecured 6.30% Senior Notes due November 15, 2019. Our debt to total capital ratio was 8.8% at March 31, 2010 and 9.0% at December 31, 2009. | ||
| We have a committed $575.0 million Revolving Loan Facility at a rate of 30-day LIBOR plus 25 basis points that matures December 19, 2011. At March 31, 2010, we had $553.4 million of unused capacity, which we can draw against at any time at our request. If we do, we believe that the banks will be able and willing to perform on their commitments to us. The facility agreement contains two restrictive financial covenants, with which we were in compliance at March 31, 2010. | ||
| In the first quarter of 2010, we transferred $22.2 million of outstanding letters of credit, which had been issued in 2009 on behalf of certain of our subsidiaries, to our Revolving Loan Facility. This transfer released $26.4 million of fixed income securities that had previously been held as collateral for these letters of credit. The letters of credit now reduce available borrowing capacity under our Revolving Loan Facility. | ||
| During 2010, there was no significant change in our Standby Letter of Credit Facility used to guarantee our performance in our Lloyds of London syndicates. | ||
| Our domestic insurance subsidiaries have the ability to pay $217.8 million in dividends in 2010 to our holding company without obtaining special permission from state regulatory authorities. Our underwriting agencies have no restrictions on the amount of dividends that can be paid to our holding company. The holding company can utilize these dividends for any purpose, including to pay down debt, pay dividends to shareholders, fund acquisitions, repurchase common stock and pay operating expenses. Cash flow available to the holding company in 2010 is expected to be more than ample to cover the holding companys required cash disbursements. | ||
| We have a Universal Shelf registration statement that provides for the issuance of an aggregate of $1.0 billion of securities, of which we have $700.0 million of remaining capacity. These securities may be debt securities, equity securities, trust preferred securities, or a combination thereof. The shelf registration statement provides us the means to access the debt and equity markets relatively quickly, if we are satisfied with the current pricing in the financial market. |
Cash Flow
We receive substantial cash from premiums, reinsurance recoverables, outward commutations, fee and
commission income, proceeds from sales and redemptions of investments and investment income. Our
principal cash outflows are for the payment of claims and loss adjustment expenses, premium
payments to reinsurers, inward commutations, purchases of investments, debt service, policy
acquisition costs, operating expenses, taxes and dividends. Cash provided by operating activities
can fluctuate due to timing differences in the collection of premiums and reinsurance recoverables
and the payment of losses and premium and reinsurance balances payable and the completion of
commutations.
33
We generated cash from operations of $42.5 million and $133.6 million in the first three months of
2010 and 2009, respectively. The components of our net operating cash flows are summarized in the
following table.
Three months ended March 31, | ||||||||
2010 | 2009 | |||||||
Net earnings |
$ | 71,354 | $ | 83,170 | ||||
Change in premium, claims and other receivables, net of reinsurance, other
payables and restricted cash |
(29,390 | ) | (8,379 | ) | ||||
Change in unearned premium, net |
(10,052 | ) | (11,552 | ) | ||||
Change in loss and loss adjustment expense payable, net of reinsurance recoverables |
7,082 | 37,571 | ||||||
(Gain) loss on investments |
(5,011 | ) | 1,020 | |||||
Other, net |
8,493 | 31,772 | ||||||
Cash provided by operating activities |
$ | 42,476 | $ | 133,602 | ||||
We had $36.4 million of higher claims payments in 2010, compared to 2009, which was the largest
contributor to the reduction in cash provided by operating activities.
Timing differences in the payment of reinsurance balances payable
reduced our 2010 cash provided by operating activities by $35.4
million compared to the first quarter of 2009. In 2010, we received $8.3
million of cash to commute a derivative contract and, in 2009, we received $25.0 million to commute the
MGIC
reinsurance contract. Cash provided by operating activities can
fluctuate due to timing differences in the collection of premium and reinsurance recoverables and
the payment of claims and premium and reinsurance balances payable.
We maintain a substantial level of cash and liquid short-term investments to meet anticipated
payment obligations. During January 2010, we paid the final $64.5 million due to previous holders
of our 1.3% Convertible Notes that were submitted for conversion in
December 2009, using cash held
as of December 31, 2009. Our combined cash and short-term investments totaled $636.5 million at
March 31, 2010.
Investments
At March 31, 2010, we had $5.5 billion of total investments, an increase of $63.1 million from
December 31, 2009. This table summarizes our investments by type, substantially all of which are
reported at fair value, at March 31, 2010 and December 31, 2009.
March 31, 2010 | December 31, 2009 | |||||||||||||||
Amount | % | Amount | % | |||||||||||||
Short-term investments |
$ | 576,576 | 11 | % | $ | 810,673 | 15 | % | ||||||||
U.S. government and government agency securities |
369,995 | 7 | 328,535 | 6 | ||||||||||||
Fixed income securities of states, municipalities and political subdivisions |
1,110,823 | 20 | 1,059,426 | 19 | ||||||||||||
Special purpose revenue bonds of states, municipalities and political subdivisions |
1,262,201 | 23 | 1,146,334 | 21 | ||||||||||||
Corporate fixed income securities |
562,257 | 10 | 559,824 | 10 | ||||||||||||
Residential mortgage-backed securities |
1,014,909 | 18 | 944,182 | 17 | ||||||||||||
Commercial mortgage-backed securities |
149,574 | 3 | 146,217 | 3 | ||||||||||||
Asset-backed securities |
11,972 | | 14,365 | | ||||||||||||
Foreign government securities |
289,304 | 5 | 307,891 | 6 | ||||||||||||
Foreign non-government securities |
167,169 | 3 | 134,091 | 3 | ||||||||||||
Other investments |
4,535 | | 4,691 | | ||||||||||||
Total investments |
$ | 5,519,315 | 100 | % | $ | 5,456,229 | 100 | % | ||||||||
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This table shows the average amount of investments, net income earned, related yields and duration,
and average rating of our fixed income securities.
Three months ended March 31, | ||||||||
2010 | 2009 | |||||||
Average investments, at cost |
$ | 5,327,676 | $ | 4,874,738 | ||||
Net investment income * |
49,249 | 45,218 | ||||||
Average short-term yield * |
0.1 | % | 1.2 | % | ||||
Average long-term yield * |
4.2 | % | 4.3 | % | ||||
Average long-term tax equivalent yield * |
5.0 | % | 5.2 | % | ||||
Average combined tax equivalent yield * |
4.4 | % | 4.7 | % | ||||
Weighted-average life of fixed income securities |
6.6 years | 6.1 years | ||||||
Weighted-average duration of fixed income securities |
5.0 years | 4.8 years | ||||||
Weighted-average combined duration |
4.5 years | 4.2 years | ||||||
Average rating of fixed income securities |
AA+ | AA+ |
* | Excluding realized and unrealized gains and losses. |
This table summarizes our investments in fixed income securities by their rating category at March
31, 2010.
Available for sale | Held to maturity | |||||||||||||||
at fair value | at amortized cost | |||||||||||||||
Amount | % | Amount | % | |||||||||||||
AAA |
$ | 2,267,486 | 47 | % | $ | 135,619 | 100 | % | ||||||||
AA |
1,697,665 | 35 | | | ||||||||||||
A |
691,650 | 15 | | | ||||||||||||
BBB |
112,549 | 2 | | | ||||||||||||
BB and below |
33,235 | 1 | | | ||||||||||||
Total fixed income securities |
$ | 4,802,585 | 100 | % | $ | 135,619 | 100 | % | ||||||||
The overall rating of our municipal bonds (consisting of our fixed income securities of states,
municipalities and political subdivisions and our special purpose revenue bonds of states,
municipalities and political subdivisions) was AA at March 31, 2010. Our portfolio of special
purpose revenue bonds at March 31, 2010 and December 31, 2009 included $112.5 million and $138.7
million, respectively, of pre-refunded bonds that are supported by U.S. government debt
obligations. The remaining special purpose bonds are secured by revenue sources specific to each
security, such as water, sewer and utility fees; highway tolls; airport usage fees; property, sales
and fuel taxes; college tuition and services fees; electric utilities and lease income. The table
below summarizes our percentage holdings of special purpose revenue bonds by revenue source:
March 31, | December 31, | |||||||
2010 | 2009 | |||||||
Water and sewer |
27 | % | 27 | % | ||||
Education |
16 | 14 | ||||||
Transportation |
13 | 13 | ||||||
Special tax |
10 | 11 | ||||||
Pre-refunded |
9 | 13 | ||||||
Leasing |
8 | 8 | ||||||
Electric |
7 | 7 | ||||||
Other |
10 | 7 | ||||||
Total |
100 | % | 100 | % | ||||
Many of our special purpose revenue bonds are insured by mono-line insurance companies or supported
by credit enhancement programs of various states and municipalities. We view bond insurance as
credit enhancement and not credit substitution. We base our investment decision on the strength of
the issuer. A credit review is performed on each issuer and on the sustainability of the revenue
source before we acquire a special purpose revenue bond and periodically, on an ongoing basis,
thereafter. The underlying average credit rating of our special purpose revenue bond issuers,
excluding any bond insurance, was AA at March 31, 2010. Although recent
35
economic conditions in the United States may reduce the source of revenue to support certain of
these securities, the majority are supported by revenue from essential sources, such as water and
sewer, education and transportation fees, which we believe generate a stable source of revenue.
At March 31, 2010, we held a corporate bond portfolio with a fair value of $562.3 million, an
overall rating of A, and a weighted-average life of approximately
3.1 years.
At March
31, 2010, we also held a
portfolio of residential mortgage-backed securities (MBSs) and collateralized mortgage-obligations
(CMOs) with a fair value of $1.0 billion. Within our residential MBS/CMO portfolio, $950.6 million
of securities, or 95%, were issued by the Federal National Mortgage Association (Fannie Mae), the
Government National Mortgage Association (GNMA) and the Federal Home Loan Mortgage Corporation
(Freddie Mac), which are backed by the U.S. government. Of the
remaining $64.3 million of residential mortgage-backed securities,
92% were collateralized by prime mortgages.
At March 31, 2010, we held a commercial MBS securities portfolio with a fair value of $149.6
million, an average rating of AA+, an average loan-to-value ratio of 70%, and a weighted-average
life of approximately 4.7 years. We owned no collateralized debt obligations (CDOs) or
collateralized loan obligations (CLOs), and we have never been counterparty to any credit default
swap transactions.
This table indicates the expected maturity distribution of our fixed income securities at March 31,
2010.
Asset-backed and | ||||||||||||||||||||||||||||||||
Available for sale at | mortgage-backed at | Held to maturity at | Total fixed income | |||||||||||||||||||||||||||||
amortized cost | amortized cost | amortized cost | securities | |||||||||||||||||||||||||||||
Amount | % | Amount | % | Amount | % | Amount | % | |||||||||||||||||||||||||
One year or less |
$ | 309,014 | 9 | % | $ | 305,647 | 27 | % | $ | 38,205 | 28 | % | $ | 652,866 | 14 | % | ||||||||||||||||
One year to five years |
1,104,920 | 31 | 834,198 | 73 | 87,012 | 64 | 2,026,130 | 42 | ||||||||||||||||||||||||
Five years to ten years |
803,390 | 23 | | | 10,402 | 8 | 813,792 | 17 | ||||||||||||||||||||||||
Ten years to fifteen years |
687,406 | 20 | | | | | 687,406 | 14 | ||||||||||||||||||||||||
More than fifteen years |
594,127 | 17 | | | | | 594,127 | 13 | ||||||||||||||||||||||||
Total fixed income
securities |
$ | 3,498,857 | 100 | % | $ | 1,139,845 | 100 | % | $ | 135,619 | 100 | % | $ | 4,774,321 | 100 | % | ||||||||||||||||
A security has an impairment loss when its fair value is less than its cost or amortized cost at
the balance sheet date. The gross unrealized losses of the individual securities within our
available for sale fixed income securities portfolios were $12.4 million at March 31, 2010,
compared to $18.9 million at December 31, 2009. We evaluate the securities in our fixed income
securities portfolio for possible other-than-temporary impairment losses at each quarter end. For a
description of the accounting polices and procedures that we use to determine our
other-than-temporary impairment losses, see Footnote 3, Investments, in the notes to these
condensed consolidated financial statements and Critical Accounting Policies
Other-than-temporary Impairments in Investments in Managements Discussion and Analysis of
Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended
December 31, 2009. We recognized no other-than-temporary impairment losses in the first quarter of
2010 and $3.1 million of other-than-temporary impairment credit losses in the first quarter of
2009.
At March 31, 2010, the net unrealized gain on our available for sale fixed income securities
portfolio was $163.9 million, compared to $156.3 million at December 31, 2009. The change in the
net unrealized gain, net of the related income tax effect, is recorded in other comprehensive
income and fluctuates with changes in market interest rates. Our general policy has been to hold
our fixed income securities, most of which are primarily classified as available for sale, through
periods of fluctuating interest rates and to not realize significant gains or losses from their
sale. We recognized $4.5 million and $3.1 million of net realized investment gains in 2010 and
2009, respectively.
36
Accounting Guidance Adopted in 2010
A new accounting standard, originally issued as SFAS No. 167, Amendments to FASB Interpretation No.
46(R), became effective January 1, 2010. The guidance, which was incorporated into Accounting
Standards Codification Topic 810, Consolidation, changes various aspects of accounting for and
disclosures of interests in variable interest entities. Our adoption of this guidance as of
January 1, 2010 had no material impact on our condensed consolidated financial statements.
Effective January 1, 2010, we adopted Accounting Standards Update No. 2010-06, which incorporated
changes in disclosure requirements into ASC Topic 820, Fair Value Measurements and Disclosures.
When applicable, we have included the additional required disclosures in the notes to our condensed
consolidated financial statements.
Critical Accounting Policies
We have made no changes in the identification or methods of application of our critical accounting
policies from the information provided in Item 7, Managements Discussion and Analysis of
Financial Condition and Results of Operations Critical Accounting Policies, in our Annual
Report on Form 10-K for the year ended December 31, 2009.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
There have been no material changes in market risk from the information provided in Item 7A,
Quantitative and Qualitative Disclosures About Market Risk, in our Annual Report on Form 10-K for
the year ended December 31, 2009.
Item 4. Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under
the Securities Exchange Act of 1934, as amended (the Act)) that are designed to ensure that
required information is recorded, processed, summarized and reported within the required timeframe,
as specified in rules set forth by the Securities and Exchange Commission. Our disclosure controls
and procedures are also designed to ensure that information required to be disclosed is accumulated
and communicated to management, including our Chief Executive Officer (CEO) and Chief Financial
Officer (CFO), to allow timely decisions regarding required disclosures.
Our management, with the participation of our CEO and CFO, evaluated the effectiveness of the
design and operation of our disclosure controls and procedures as of March 31, 2010. Based on this
evaluation, our CEO and CFO concluded that our disclosure controls and procedures were effective as
of March 31, 2010.
(b) Changes in Internal Control over Financial Reporting
During the first quarter of 2010, there were no changes in our internal control over financial
reporting that have materially affected, or are reasonably likely to materially affect, our
internal control over financial reporting.
37
Part II Other Information
Item 1. Legal Proceedings
We are a party to lawsuits, arbitrations and other proceedings that arise in the normal course of
our business. Many of such lawsuits, arbitrations and other proceedings involve claims under
policies that we underwrite as an insurer or reinsurer, the liabilities for which, we believe, have
been adequately included in our loss reserves. Also, from time to time, we are a party to lawsuits,
arbitrations and other proceedings that relate to disputes with third parties, or that involve
alleged errors and omissions on the part of our subsidiaries. We have provided accruals for these
items to the extent we deem the losses probable and reasonably estimable. Although the ultimate
outcome of these matters cannot be determined at this time, based on present information, the
availability of insurance coverage and advice received from our outside legal counsel, we believe
the resolution of any such matters will not have a material adverse effect on our consolidated
financial position, results of operations or cash flows.
Item 1A. Risk Factors
There have been no material changes in the risk factors described in our Annual Report on Form 10-K
for the year ended December 31, 2009.
Item 6. Exhibits
a. Exhibits
3.1 | Restated Certificate of Incorporation and Certificate of Amendment of Certificate of Incorporation of HCC Insurance Holdings, Inc., filed with the Delaware Secretary of State on July 23, 1996 and May 21, 1998, respectively (incorporated by reference to Exhibit 4.1 to our Registration Statement of Form S-8 (Registration No. 333-61687) filed August 17, 1998). | |
3.2 | Amended and Restated Bylaws of HCC Insurance Holdings, Inc., as amended, (incorporated by reference to Exhibit 3.1 to our Form 8-K filed April 3, 2008). | |
10.1 | First Amendment to Employment Agreement effective April 19, 2010, between HCC Insurance Holdings, Inc. and William T. Whamond (incorporated by reference to Exhibit 10.01 to our Form 8-K filed on April 19, 2010). | |
12 | Statement of Ratio of Earnings to Fixed Charges. | |
31.1 | Certification by Chief Executive Officer. | |
31.2 | Certification by Chief Financial Officer. | |
32 | Certification with Respect to Quarterly Report. |
38
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused
this report to be signed on its behalf by the undersigned, thereunto duly authorized.
HCC Insurance Holdings, Inc. | ||||||
(Registrant) | ||||||
May 7, 2010
|
/s/ John N. Molbeck, Jr. | |||||
(Date)
|
John N. Molbeck, Jr., President | |||||
and Chief Executive Officer | ||||||
May 7, 2010
|
/s/ Pamela J. Penny | |||||
(Date)
|
Pamela J. Penny, Executive Vice President | |||||
and Chief Accounting Officer |
39