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Table of Contents

 

 

UNITED STATES

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, 2015.
¨ 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

 

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes þ   No ¨

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 þ   No ¨

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 definitions 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 ¨ Non-accelerated filer ¨ Smaller reporting company ¨
(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes ¨   No þ

Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date.

On April 30, 2015, there were approximately 95.7 million shares of common stock outstanding.

 

 

 


Table of Contents

HCC Insurance Holdings, Inc. and Subsidiaries

Table of Contents

 

         Page    

Part I. FINANCIAL INFORMATION

  

Item 1. Financial Statements (Unaudited)

  

Consolidated Balance Sheets — March 31, 2015 and December 31, 2014

   5

Consolidated Statements of Earnings — Three months ended March 31, 2015 and 2014

   6

Consolidated Statements of Comprehensive Income — Three months ended March 31, 2015 and 2014

   7

Consolidated Statement of Changes in Shareholders’ Equity — Three months ended March 31, 2015

   8

Consolidated Statements of Cash Flows — Three months ended March 31, 2015 and 2014

   9

Notes to Consolidated Financial Statements

   10

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

   27

Item 3. Quantitative and Qualitative Disclosures About Market Risk

   40

Item 4. Controls and Procedures

   41

Part II. OTHER INFORMATION

  

Item 1. Legal Proceedings

   42

Item 1A. Risk Factors

   42

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

   42

Item 3. Defaults Upon Senior Securities

   42

Item 4. Mine Safety Disclosures

   42

Item 5. Other Information

   42

Item 6. Exhibits

   43

Signatures

   44

 

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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. These forward-looking statements reflect our current expectations and projections about future events and 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. Generally, words such as “anticipate,” “believe,” “estimate,” “expect,” “intend,” “plan,” “probably” or similar expressions indicate 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 catastrophe losses,

 

    volatility in crop prices and crop yields,

 

    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 past and future potential economic or credit market downturns, including any potential ratings downgrade or impairment of the debt securities of sovereign issuers,

 

    the effects of emerging claim and coverage issues,

 

    the effects of extensive governmental regulation of the insurance industry,

 

    changes to the country’s health care delivery system,

 

    the effects of climate change on the risks we insure,

 

    potential risk with agents and 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,

 

    fluctuations in securities markets, which may reduce the value of our investment portfolio, reduce investment income or generate realized investment losses,

 

    changes in our assigned financial strength ratings,

 

    our ability to raise capital and funds for liquidity in the future,

 

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Table of Contents
    attraction and retention of qualified employees,

 

    our ability to successfully expand our business through the acquisition of insurance-related companies,

 

    impairment of goodwill,

 

    the ability of our insurance company subsidiaries to pay dividends in needed amounts,

 

    fluctuations in foreign exchange rates,

 

    failure of, or loss of security related to, our information technology systems,

 

    difficulties with outsourcing relationships, and

 

    change of control.

We described 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, 2014.

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, 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


Table of Contents

HCC Insurance Holdings, Inc. and Subsidiaries

Consolidated Balance Sheets

(unaudited, in thousands except per share data)

 

     March 31,
2015
     December 31,
2014
 

ASSETS

     

Investments

     

Fixed maturity securities – available for sale, at fair value (amortized cost:

    2015 – $6,192,036 and 2014 – $6,352,737)

   $         6,452,444        $     6,610,368    

Equity securities – available for sale, at fair value (cost: 2015 – $325,435

    and 2014 – $291,070)

     334,763          296,352    

Short-term investments, at cost (approximates fair value)

     325,154          258,186    
  

 

 

    

 

 

 

Total investments

  7,112,361       7,164,906    
  

 

 

    

 

 

 

Cash

  93,464       102,093    

Restricted cash and securities

  122,526       119,010    

Premium, claims and other receivables

  727,615       553,027    

Reinsurance recoverables

  1,176,141       1,168,900    

Ceded unearned premium

  332,646       316,715    

Ceded life and annuity benefits

  48,590       48,499    

Deferred policy acquisition costs

  236,661       220,321    

Goodwill

  949,351       905,636    

Other assets

  226,942       115,239    
  

 

 

    

 

 

 

Total assets

$ 11,026,297     $ 10,714,346    
  

 

 

    

 

 

 

LIABILITIES

Loss and loss adjustment expense payable

$ 3,693,165     $ 3,728,085    

Life and annuity policy benefits

  48,590       48,499    

Reinsurance, premium and claims payable

  434,198       301,476    

Unearned premium

  1,305,327       1,198,930    

Deferred ceding commissions

  101,169       94,202    

Notes payable

  889,290       824,251    

Accounts payable and accrued liabilities

  621,131       615,552    
  

 

 

    

 

 

 

Total liabilities

  7,092,870       6,810,995    
  

 

 

    

 

 

 

SHAREHOLDERS’ EQUITY

Common stock, $1.00 par value; 250,000 shares authorized (shares issued: 2015 – 126,794 and 2014 – 126,472; outstanding: 2015 – 95,868 and 2014 – 96,521)

  126,794       126,472    

Additional paid-in capital

  1,115,796       1,113,551    

Retained earnings

  3,526,071       3,441,424    

Accumulated other comprehensive income

  172,262       175,014    

Treasury stock, at cost (shares: 2015 – 30,926 and 2014 – 29,951)

  (1,007,496)      (953,110)   
  

 

 

    

 

 

 

Total shareholders’ equity

  3,933,427       3,903,351    
  

 

 

    

 

 

 

Total liabilities and shareholders’ equity

$ 11,026,297     $ 10,714,346    
  

 

 

    

 

 

 

See Notes to Consolidated Financial Statements.

 

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HCC Insurance Holdings, Inc. and Subsidiaries

Consolidated Statements of Earnings

(unaudited, in thousands except per share data)

 

     Three months ended March 31,  
     2015      2014  

REVENUE

     

Net earned premium

   $         600,563        $         562,612    

Net investment income

     53,482          56,806    

Other operating income

     9,219          9,266    

Net realized investment gain

     13,186          20,246    
  

 

 

    

 

 

 

Total revenue

  676,450       648,930    
  

 

 

    

 

 

 

EXPENSE

Loss and loss adjustment expense, net

  365,162       330,746    

Policy acquisition costs, net

  75,211       69,041    

Other operating expense

  77,483       87,052    

Interest expense

  7,766       7,119    
  

 

 

    

 

 

 

Total expense

  525,622       493,958    
  

 

 

    

 

 

 

Earnings before income tax expense

  150,828       154,972    

Income tax expense

  37,911       47,061    
  

 

 

    

 

 

 

Net earnings

$ 112,917     $ 107,911    
  

 

 

    

 

 

 

Earnings per common share

Basic

$ 1.17     $ 1.08    
  

 

 

    

 

 

 

Diluted

$ 1.17     $ 1.07    
  

 

 

    

 

 

 

See Notes to Consolidated Financial Statements.

 

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HCC Insurance Holdings, Inc. and Subsidiaries

Consolidated Statements of Comprehensive Income

(unaudited, in thousands)

 

     Three months ended March 31,  
     2015      2014  

Net earnings

   $ 112,917        $ 107,911    

Other comprehensive income (loss)

     

Investment gains:

     

Investment gains during the period

     20,009          86,080    

Income tax charge

     7,205          30,570    
  

 

 

    

 

 

 

Investment gains, net of tax

  12,804       55,510    
  

 

 

    

 

 

 

Less reclassification adjustments to:

Net realized investment gain

  13,186       20,246    

Income tax expense

  4,615       7,086    
  

 

 

    

 

 

 

Total reclassifications included in net earnings, net of tax

  8,571       13,160    
  

 

 

    

 

 

 

Net unrealized investment gains

  4,233       42,350    
  

 

 

    

 

 

 

Foreign currency translation adjustment

  (7,052)      788    

Income tax benefit

  (67)      (432)   
  

 

 

    

 

 

 

Foreign currency translation adjustment, net of tax

  (6,985)      1,220    
  

 

 

    

 

 

 

Other comprehensive income (loss)

  (2,752)      43,570    
  

 

 

    

 

 

 

Comprehensive income

$         110,165     $         151,481    
  

 

 

    

 

 

 

See Notes to Consolidated Financial Statements.

 

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HCC Insurance Holdings, Inc. and Subsidiaries

Consolidated Statement of Changes in Shareholders’ Equity

Three months ended March 31, 2015

(unaudited, in thousands except per share data)

 

    Common
stock
    Additional
paid-in
capital
    Retained
earnings
    Accumulated
other
comprehensive
income
    Treasury
stock
    Total
shareholders’
equity
 

Balance at December 31, 2014

  $ 126,472       $ 1,113,551       $ 3,441,424       $ 175,014       $ (953,110)      $ 3,903,351    

Net earnings

                  112,917                       112,917    

Other comprehensive loss

                         (2,752)               (2,752)   

Stock-based compensation

    371         4,260                              4,631    

Issuance of 39 shares for exercise of options, including tax effect

    39         3,570                              3,609    

Issuance of 49 shares for employee stock purchase plan

    49         1,975                              2,024    

Surrender of 137 shares of restricted stock for employees’ tax liabilty

    (137)        (7,560)                             (7,697)   

Purchase of 975 common shares

                                (54,386)        (54,386)   

Cash dividends declared, $0.295 per share

                  (28,270)                      (28,270)   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at March 31, 2015

$     126,794     $   1,115,796     $   3,526,071     $     172,262     $   (1,007,496)    $     3,933,427    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

See Notes to Consolidated Financial Statements.

 

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HCC Insurance Holdings, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

(unaudited, in thousands)

 

     Three months ended March 31,  
     2015      2014  

Operating activities

     

Net earnings

   $ 112,917        $ 107,911    

Adjustments to reconcile net earnings to net cash provided by operating activities:

     

Change in premium, claims and other receivables

     11,039          (44,966)   

Change in reinsurance recoverables

     169,610          55,197    

Change in ceded unearned premium

     16,972          (5,939)   

Change in loss and loss adjustment expense payable

     (209,125)         (53,892)   

Change in unearned premium

     50,280          32,475    

Change in reinsurance, premium and claims payable

     (893)         71,873    

Change in accounts payable and accrued liabilities

     (70,757)         (51,885)   

Stock-based compensation expense

     4,631          4,214    

Depreciation and amortization expense

     5,517          4,169    

Gain on investments

     (13,186)         (20,246)   

Other, net

     (45,859)         (3,447)   
  

 

 

    

 

 

 

Cash provided by operating activities

  31,146       95,464    
  

 

 

    

 

 

 

Investing activities

Sales of available for sale fixed maturity securities

  167,206       119,011    

Sales of equity securities

  66,412       144,075    

Maturity or call of available for sale fixed maturity securities

  159,814       131,204    

Cost of available for sale fixed maturity securities acquired

  (128,692)      (179,789)   

Cost of equity securities acquired

  (100,594)      (70,841)   

Change in short-term investments

  (73,033)      (248,749)   

Payments for purchase of businesses, net of cash received

  (100,398)      (2,579)   

Other, net

  (1,328)      (2,224)   
  

 

 

    

 

 

 

Cash used by investing activities

  (10,613)      (109,892)   
  

 

 

    

 

 

 

Financing activities

Advances on line of credit

  150,000       100,000    

Payments on line of credit

  (100,004)      (30,000)   

Sale of common stock

  5,633       8,428    

Purchase of common stock

  (44,546)      (30,774)   

Dividends paid

  (28,451)      (22,575)   

Other, net

  (11,794)      3,572    
  

 

 

    

 

 

 

Cash provided (used) by financing activities

  (29,162)      28,651    
  

 

 

    

 

 

 

Net increase (decrease) in cash

  (8,629)      14,223    

Cash at beginning of year

  102,093       58,301    
  

 

 

    

 

 

 

Cash at end of period

$         93,464     $         72,524    
  

 

 

    

 

 

 

See Notes to Consolidated Financial Statements.

 

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HCC Insurance Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(unaudited, tables in thousands except per share data)

(1) General Information and Significant Accounting and Reporting Policies

HCC Insurance Holdings, Inc. (HCC) and its subsidiaries (collectively we, us or our) include domestic and foreign property and casualty and life insurance companies and underwriting agencies with offices in the United States, the United Kingdom, Spain and Ireland. We underwrite a variety of largely non-correlated specialty insurance products, including property and casualty, accident and health, agriculture, surety and credit product lines, in approximately 180 countries. We market our products through a network of independent agents and brokers, through managing general agents owned by the company, and directly to consumers. In addition, we assume insurance written by other insurance companies.

Basis of Presentation

Our unaudited 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 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 consolidated financial statements include the results of operations and cash flows of Producers Ag Insurance Group, Inc. (ProAg) from January 1, 2015, the effective acquisition date (see Note 2, “Acquisition”).

The consolidated financial statements should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2014. The consolidated balance sheet at December 31, 2014 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 consolidated financial statements and in disclosures of contingent assets and liabilities. Ultimate results could differ from those estimates.

In conjunction with the acquisition of ProAg in the first quarter of 2015, HCC’s executive management changed the structure under which it manages and evaluates the results of our numerous product lines. See Note 3, “Segments” for discussion of our new reporting structure.

New Accounting and Reporting Policies

The following policies changed in the first quarter of 2015.

Agriculture

The majority of premium written in our new agriculture business relates to multi-peril crop insurance (MPCI), written through the federal crop insurance program administered by the U.S. Department of Agriculture’s Risk Management Agency and the Federal Crop Insurance Corporation (FCIC). We record written premium for our agriculture business as we process acreage reports received from the policyholders. Written premium is earned ratably over the period of risk commencing on the final planting date set by the FCIC, which approximates the start of planting season, and ending on the estimated crop harvest date.

We have a net receivable (payable) due from (to) the FCIC for settlement of MPCI reinsurance. If a net receivable, it is reflected in our consolidated balance sheet with premium, claims and other receivables. If a net payable, it is reflected in our consolidated balance sheet with reinsurance, premium and claims payable.

Income Taxes

Effective in 2015, for certain foreign subsidiaries, we do not provide deferred tax liabilities on undistributed earnings that are essentially permanent in duration. For other foreign subsidiaries, we provide U.S. taxes on undistributed earnings at the U.S. statutory rate of 35%, offset by an adjustment for foreign tax credits, when required. In prior years, we provided U.S. taxes on all undistributed earnings of our foreign subsidiaries at the U.S. statutory rate of 35%, offset by an adjustment for foreign tax credits, when required.

 

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HCC Insurance Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(unaudited, tables in thousands except per share data)

 

Recent Accounting Guidance

An accounting standard issued in 2014 will change the manner in which most companies recognize revenue. The standard requires that revenue reflect the transfer of goods or services to customers based on the consideration/payment the company expects to be entitled to in exchange for those goods or services; however, the standard does not change the accounting for insurance contracts or investment income. The new standard also requires enhanced disclosures about revenue. This accounting guidance is currently expected to be effective in the first quarter of 2018. The standard may be applied on a full retrospective or modified retrospective approach. We are currently assessing the impact the implementation of this standard will have on our consolidated financial statements.

An accounting standard issued in 2015 changes the presentation of debt issuance costs related to a recognized debt liability. The standard requires debt issuance costs be presented as a reduction of the debt liability, rather than as a deferred charge asset. This accounting guidance is effective at March 31, 2016 and must be applied retrospectively. We had debt issuance costs of $4.0 million at March 31, 2015 and $4.2 million at December 31, 2014 that were included in other assets in our consolidated balance sheets. Under this guidance, these debt issuance costs would be reclassified as a reduction to notes payable in our consolidated balance sheets. Application of this guidance will have no impact on our consolidated financial position, results of operations or cash flows.

(2) Acquisition

Effective January 1, 2015, we completed the acquisition of all of the capital stock of ProAg from CUNA Mutual Group for $104.5 million cash, subject to a net worth adjustment. ProAg writes multi-peril crop, crop hail and other named peril insurance. Crop insurance is a non-correlated line of business we strategically targeted to add to our diversified portfolio of specialty insurance businesses. On April 28, 2015, the parties agreed to reduce the purchase price by $2.1 million in finalization of the net worth adjustment. Our initial accounting of this business acquisition, recorded as of March 31, 2015, will change by an immaterial amount based on the settlement of the final purchase price. We expect to complete this accounting in the second quarter of 2015.

As of March 31, 2015, we allocated the provisional purchase price to the acquired identifiable assets and liabilities of ProAg based on estimated fair values at the acquisition date. We recorded $458.5 million of tangible assets, primarily receivables and reinsurance recoverables, and $453.0 million of liabilities, primarily reserves and reinsurance payables. The majority of these assets and liabilities related to ProAg’s reinsurance year 2014, which is 100% ceded to the FCIC and third party reinsurers (including CUNA Mutual Group) under existing reinsurance agreements. We expect settlement of reinsurance year 2014 amounts to occur with all parties during the fourth quarter of 2015.

We also recognized $54.0 million of intangible assets and $45.0 million of goodwill, neither of which is tax deductible. The goodwill primarily represents the value of ProAg’s assembled workforce and opportunities for future expansion utilizing ProAg’s infrastructure. The intangible assets relate to agent relationships and ProAg’s trade name with fair values of $23.0 million and $8.0 million, respectively, which will be amortized over a useful life of 15 years and 10 years, respectively. Indefinite-lived intangible assets of $23.0 million relate to state and federal insurance licenses, which will be reviewed annually for impairment. Intangible assets are included in other assets in our consolidated balance sheet.

(3) Segments

In the first quarter of 2015, following the acquisition of ProAg, HCC’s executive management changed the structure under which it manages and evaluates the results of our numerous product lines. We now report our results in four operating segments, consisting of three insurance underwriting segments: 1) North America Property & Casualty, 2) Accident & Health and 3) International, and the Investing segment.

 

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HCC Insurance Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(unaudited, tables in thousands except per share data)

 

Each of our three insurance underwriting segments bears risk for insurance coverage written within its portfolio of insurance products. Each segment generates income from premium written by our underwriting agencies, through third party agents and brokers, or on a direct basis. Fee and commission income earned by our agencies from third party insurance companies is included in segment revenue. Each segment incurs insurance losses, acquisition costs, claims management costs and other administrative expenses related to our insurance companies and underwriting agencies. Internal claims department costs are managed and reported as a component of loss and loss adjustment expense. We monitor and assess each segment’s pretax results based on underwriting profit, gross and net written premium, and its combined ratio, consisting of the segment’s net loss ratio and expense ratio.

Included in the portfolio of products for each insurance underwriting segment are the following key products:

 

    North America Property & Casualty – directors’ and officers’ liability (D&O), primary and excess casualty, small account errors and omissions liability, employment practices liability, agriculture, aviation, sports and entertainment, public risk, surety, and various smaller products.

 

    Accident & Health – medical stop-loss, short-term domestic and international medical, and travel.

 

    International – marine and energy, property treaty, property (direct and facultative), accident and health, D&O, professional indemnity, casualty, surety, and credit.

The North America Property & Casualty segment includes the former U.S. Property & Casualty segment, the U.S. portion of the former Professional Liability segment, the Surety portion of the former U.S. Surety & Credit segment and ProAg’s agriculture business. The International segment includes the former International segment, the International portion of the former Professional Liability segment, and the Credit portion of the former U.S. Surety & Credit segment. The Accident & Health and Investing segments are unchanged from the prior presentation. All prior period information has been recast to present our segment disclosures and information on a comparable basis with our new segment reporting structure.

The Investing segment includes our consolidated investment portfolio, as well as all investment income, investment related expenses, realized investment gains and losses, and other-than-temporary impairment credit losses on investments. All investment activity is reported as revenue, consistent with our consolidated presentation.

In addition to our segments, we include a Corporate & Other category to reconcile segment results to consolidated totals. The Corporate & Other category includes: 1) corporate operating expenses not allocated to the segments, 2) interest expense on notes payable, 3) foreign currency expense (benefit) and 4) underwriting results of our Exited Lines. Our Exited Lines include product lines that we no longer write and do not expect to write in the future.

 

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Table of Contents

HCC Insurance Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(unaudited, tables in thousands except per share data)

 

The following tables present information by business segment.

 

     North America
Property
& Casualty
     Accident
& Health
     International      Investing      Corporate
& Other
     Consolidated  
Three months ended March 31, 2015                                          

Net earned premium

   $ 209,239        $     254,950        $     136,377        $       $ (3)       $ 600,563    

Other revenue

     6,102          2,013          1,008          66,668          96          75,887    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Segment revenue

  215,341       256,963       137,385       66,668       93       676,450    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Loss and LAE

  116,436       187,011       61,443            272       365,162    

Other expense

  68,348       38,665       47,311            6,136       160,460    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Segment expense

  184,784       225,676       108,754            6,408       525,622    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Segment pretax earnings (loss)

$ 30,557     $ 31,287     $ 28,631     $     66,668     $     (6,315)    $ 150,828    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
Three months ended March 31, 2014                                          

Net earned premium

   $ 201,334        $ 232,143        $ 128,844        $       $ 291        $     562,612    

Other revenue

     5,431          1,640          976          77,052          1,219          86,318    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Segment revenue

  206,765       233,783       129,820       77,052       1,510       648,930    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Loss and LAE

  103,553       170,805       56,314            74       330,746    

Other expense

  57,538       34,573       46,475            24,626       163,212    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Segment expense

  161,091       205,378       102,789            24,700       493,958    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Segment pretax earnings (loss)

$ 45,674     $ 28,405     $ 27,031     $ 77,052     $ (23,190)    $     154,972    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

13


Table of Contents

HCC Insurance Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(unaudited, tables in thousands except per share data)

 

In conjunction with the resegmentation, we reassigned the goodwill associated with the lines of business in our former Professional Liability and U.S. Surety & Credit reporting units at December 31, 2014 to the applicable North America Property & Casualty and International reporting units. We allocated goodwill to the lines of business within the former reporting units based on the relative fair value of each line of business to the sum of the former reporting unit’s total fair value at December 31, 2014. We noted no indicators of impairment as of December 31, 2014, after allocation of the goodwill.

The goodwill balances by reportable segment, after allocation of the goodwill in our former reporting units, are presented below. We noted no indicators of impairment in our goodwill as of March 31, 2015.

 

     North America
Property

& Casualty
     Accident
& Health
     International      Total  

Balance at beginning of year

   $ 552,006        $         144,113        $ 209,517        $     905,636    

Acquisition of ProAg

     45,000                          45,000    

Other, principally foreign exchange

     100                  (1,385)         (1,285)   
  

 

 

    

 

 

    

 

 

    

 

 

 

Balance at March 31, 2015

$         597,106     $ 144,113     $     208,132     $ 949,351    
  

 

 

    

 

 

    

 

 

    

 

 

 
The table below presents total assets by segment following our resegmentation.   
                   March 31,      December 31,  
                   2015      2014  

North America Property & Casualty

         $ 2,232,696        $ 1,894,756    

Accident & Health

           244,394          242,278    

International

           1,092,640          1,073,889    

Investing

           7,178,088          7,228,608    

Corporate & Other

           278,479          274,815    
        

 

 

    

 

 

 

Total

$     11,026,297     $     10,714,346    
        

 

 

    

 

 

 

 

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Table of Contents

HCC Insurance Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(unaudited, tables in thousands except per share data)

 

(4) Investments

The cost or amortized cost, gross unrealized gain or loss, and fair value of our fixed maturity and equity securities, all of which are classified as available for sale, were as follows:

 

     Cost or
amortized
cost
     Gross
unrealized
gain
     Gross
unrealized
loss
     Fair value  
March 31, 2015                            

U.S. government and government agency securities

   $ 73,540        $ 983        $ (7)       $ 74,516    

Fixed maturity securities of states, municipalities and political subdivisions

     877,954          56,164          (55)         934,063    

Special purpose revenue bonds of states, municipalities and political subdivisions

     2,253,237          143,514          (1,065)         2,395,686    

Corporate securities

     726,320          28,287          (2,584)         752,023    

Residential mortgage-backed securities

     770,957          22,259          (1,806)         791,410    

Commercial mortgage-backed securities

     567,340          26,032          (592)         592,780    

Asset-backed securities

     369,289          1,051          (1,038)         369,302    

Foreign government securities

     124,957          471          (3,396)         122,032    

Foreign corporate securities

     428,442          7,830          (15,640)         420,632    
  

 

 

    

 

 

    

 

 

    

 

 

 

Total fixed maturity securities

$         6,192,036     $         286,591     $         (26,183)    $         6,452,444    
  

 

 

    

 

 

    

 

 

    

 

 

 

Equity securities

$ 325,435     $ 25,464     $ (16,136)    $ 334,763    
  

 

 

    

 

 

    

 

 

    

 

 

 
December 31, 2014                            

U.S. government and government agency securities

   $ 70,279        $ 827        $ (137)       $ 70,969    

Fixed maturity securities of states, municipalities and political subdivisions

     896,130          58,738          (160)         954,708    

Special purpose revenue bonds of states, municipalities and political subdivisions

     2,246,707          143,291          (986)         2,389,012    

Corporate securities

     777,242          25,983          (4,656)         798,569    

Residential mortgage-backed securities

     805,458          20,215          (3,979)         821,694    

Commercial mortgage-backed securities

     593,956          19,707          (2,032)         611,631    

Asset-backed securities

     369,103          316          (2,592)         366,827    

Foreign government securities

     119,479          767          (1,554)         118,692    

Foreign corporate securities

     474,383          10,776          (6,893)         478,266    
  

 

 

    

 

 

    

 

 

    

 

 

 

Total fixed maturity securities

$ 6,352,737     $ 280,620     $ (22,989)    $ 6,610,368    
  

 

 

    

 

 

    

 

 

    

 

 

 

Equity securities

$ 291,070     $ 24,069     $ (18,787)    $ 296,352    
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents

HCC Insurance Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(unaudited, tables in thousands except per share data)

 

Substantially all of our fixed maturity securities are investment grade. The following tables display the gross unrealized losses and fair value of all available for sale 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, 2015

                                   

Fixed maturity securities

           

U.S. government and government agency securities

  $ 421       $      $ 3,985       $ (7)      $ 4,406       $ (7)   

Fixed maturity securities of states, municipalities and political subdivisions

    16,379         (55)                      16,379         (55)   

Special purpose revenue bonds of states, municipalities and political subdivisions

    84,718         (587)        17,341         (478)        102,059         (1,065)   

Corporate securities

    66,827         (1,578)        42,230         (1,006)        109,057         (2,584)   

Residential mortgage-backed securities

    75,826         (540)        104,754         (1,266)        180,580         (1,806)   

Commercial mortgage-backed securities

    12,013         (155)        25,852         (437)        37,865         (592)   

Asset-backed securities

    73,934         (119)        91,570         (919)        165,504         (1,038)   

Foreign government securities

    51,165         (3,392)        1,242         (4)        52,407         (3,396)   

Foreign corporate securities

    167,020         (12,267)        20,657         (3,373)        187,677         (15,640)   

Equity securities

    139,886         (12,696)        11,501         (3,440)        151,387         (16,136)   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

$ 688,189     $ (31,389)    $ 319,132     $ (10,930)    $ 1,007,321     $ (42,319)   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

December 31, 2014

                                   

Fixed maturity securities

           

U.S. government and government agency securities

  $ 14,813       $ (8)      $ 11,236       $ (129)      $ 26,049       $ (137)   

Fixed maturity securities of states, municipalities and political subdivisions

    3,857         (21)        19,337         (139)        23,194         (160)   

Special purpose revenue bonds of states, municipalities and political subdivisions

    4,041         (19)        100,947         (967)        104,988         (986)   

Corporate securities

    211,111         (2,498)        48,091         (2,158)        259,202         (4,656)   

Residential mortgage-backed securities

    37,434         (100)        226,256         (3,879)        263,690         (3,979)   

Commercial mortgage-backed securities

    5,228         (26)        99,868         (2,006)        105,096         (2,032)   

Asset-backed securities

    181,579         (1,245)        78,797         (1,347)        260,376         (2,592)   

Foreign government securities

    55,280         (1,498)        7,187         (56)        62,467         (1,554)   

Foreign corporate securities

    182,163         (4,587)        21,571         (2,306)        203,734         (6,893)   

Equity securities

    111,251         (17,839)        3,934         (948)        115,185         (18,787)   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

$ 806,757     $ (27,841)    $ 617,224     $ (13,935)    $ 1,423,981     $ (41,776)   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

16


Table of Contents

HCC Insurance Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(unaudited, tables in thousands except per share data)

 

At March 31, 2015, we held approximately 2,910 fixed maturity and equity securities, of which 20% included at least one lot in an unrealized loss position. 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 our securities for possible other-than-temporary impairment losses at each quarter end. Our reviews cover all impaired securities where the loss exceeds $1.0 million and the loss either exceeds 10% of cost or the security had been in a loss position for longer than twelve consecutive months. We do not consider the $42.3 million of gross unrealized losses in our portfolio at March 31, 2015 to be other-than-temporary impairments as these losses relate to non-credit factors, such as interest rate changes, fluctuations in exchange rates and market conditions. We recognized no other-than-temporary impairment losses in the first quarter of 2015 and 2014.

The amortized cost and fair value of our fixed maturity securities at March 31, 2015, 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 was 5.1 years at March 31, 2015.

 

     Cost or
amortized cost
     Fair value  

Due in 1 year or less

   $ 156,470        $ 153,783    

Due after 1 year through 5 years

     1,117,553          1,138,249    

Due after 5 years through 10 years

     1,322,979          1,400,954    

Due after 10 years through 15 years

     884,731          945,028    

Due after 15 years

     1,002,717          1,060,938    
  

 

 

    

 

 

 

Securities with contractual maturities

  4,484,450       4,698,952    

Mortgage-backed and asset-backed securities

  1,707,586       1,753,492    
  

 

 

    

 

 

 

Total fixed maturity securities

$   6,192,036     $   6,452,444    
  

 

 

    

 

 

 

Realized pretax gains (losses) on the sale of investments included the following:

 

     Three months ended March 31,  
     2015      2014  

Gains

     

Fixed maturity securities

   $ 13,876        $ 1,132    

Equity securities

     10,311          24,438    
  

 

 

    

 

 

 

Total gains

  24,187       25,570    
  

 

 

    

 

 

 

Losses

Fixed maturity securities

  (1,472)      (2,155)   

Equity securities

  (9,529)      (3,169)   
  

 

 

    

 

 

 

Total losses

  (11,001)      (5,324)   
  

 

 

    

 

 

 

Net

Fixed maturity securities

  12,404       (1,023)   

Equity securities

  782       21,269    
  

 

 

    

 

 

 

Net realized investment gain

$         13,186     $       20,246    
  

 

 

    

 

 

 

 

17


Table of Contents

HCC Insurance Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(unaudited, tables in thousands except per share data)

 

(5) Fair Value Measurements

Our financial instruments include assets and liabilities carried at fair value, as well as assets and liabilities carried at cost or amortized cost but disclosed at fair value in our financial statements. 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 consist of U.S. Treasuries, money market funds and equity securities traded in an active exchange market. We use unadjusted quoted prices for identical instruments to measure fair value.

Our Level 2 investments include most of our fixed maturity securities, which consist of U.S. government agency securities, foreign government securities, municipal bonds (including those held as restricted securities), corporate debt securities, bank loans, foreign debt securities, mortgage-backed and asset-backed securities (including collateralized loan obligations), and deposits supporting our Lloyd’s syndicate business. Level 2 also includes certificates of deposit and other interest-bearing deposits at banks, which we report as short-term investments. We measure fair value for the majority of our Level 2 investments using matrix pricing and observable market data, including benchmark securities or yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, bids, offers, default rates, loss severity and other economic measures. We measure fair value for our structured securities using observable market data in cash flow models.

We are responsible for the prices used in our fair value measurements. We use independent pricing services to assist us in determining fair value of all of our Level 2 investments. The pricing services provide a single price or quote per security. We use data provided by our third party investment managers and Lloyd’s of London to value the remaining Level 2 investments. To validate that these quoted 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. No markets for our investments were judged to be inactive at period end. Based on these procedures, we did not adjust the prices or quotes provided by our independent pricing services, third party investment managers or Lloyd’s of London as of March 31, 2015 or December 31, 2014.

Our Level 2 financial instruments also include our notes payable. We determine the fair value of our 6.30% Senior Notes based on quoted prices in an inactive market. The fair value of borrowings under our Revolving Loan Facility approximates the carrying amount because interest is based on 30-day LIBOR plus a margin.

Our Level 3 securities include certain fixed maturity securities and an insurance contract that we account for as a derivative and classify in other assets. Our Level 3 category also includes liabilities for future earnout payments due to former owners of businesses we acquired, which are classified within accounts payable and accrued liabilities. We determine fair value of the derivative and the earnout payments based on internally developed models that use assumptions or other data that are not readily observable from objective sources.

 

18


Table of Contents

HCC Insurance Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(unaudited, tables in thousands except per share data)

 

The following tables present the fair value of our financial instruments that were carried or disclosed at fair value. Unless indicated, these items were carried at fair value on our consolidated balance sheets. There were no material transfers between Level 1, Level 2 or Level 3 in the first quarter of 2015 and 2014.

 

                                                                                       
     Level 1      Level 2      Level 3      Total  

March 31, 2015

                           

Fixed maturity securities

           

U.S. government and government agency securities

   $ 69,238        $ 5,278        $       $ 74,516    

Fixed maturity securities of states, municipalities and political subdivisions

             934,063                  934,063    

Special purpose revenue bonds of states, municipalities and political subdivisions

             2,395,686                  2,395,686    

Corporate securities

             751,875          148          752,023    

Residential mortgage-backed securities

             791,410                  791,410    

Commercial mortgage-backed securities

             592,780                  592,780    

Asset-backed securities

             369,302                  369,302    

Foreign government securities

             122,032                  122,032    

Foreign corporate securities

             420,632                  420,632    
  

 

 

    

 

 

    

 

 

    

 

 

 

Total fixed maturity securities

  69,238       6,383,058       148       6,452,444    

Equity securities

  334,763                 334,763    

Short-term investments*

  187,436       137,718            325,154    

Restricted cash and securities

       3,156            3,156    

Premium, claims and other receivables

       53,212            53,212    

Other assets

  17            1,395       1,412    
  

 

 

    

 

 

    

 

 

    

 

 

 

Total assets measured at fair value

$     591,454     $     6,577,144     $     1,543     $     7,170,141    
  

 

 

    

 

 

    

 

 

    

 

 

 

Notes payable*

$    $ 936,968     $    $ 936,968    

Accounts payable and accrued liabilities - earnout liabilities

       3,156       8,301       11,457    
  

 

 

    

 

 

    

 

 

    

 

 

 

Total liabilities measured at fair value

$    $ 940,124     $ 8,301     $ 948,425    
  

 

 

    

 

 

    

 

 

    

 

 

 

 

* Carried at cost or amortized cost on consolidated balance sheet.

 

19


Table of Contents

HCC Insurance Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(unaudited, tables in thousands except per share data)

 

                                                                                       
     Level 1      Level 2      Level 3      Total  

December 31, 2014

                           

Fixed maturity securities

           

U.S. government and government agency securities

   $ 63,663        $ 7,306        $       $ 70,969    

Fixed maturity securities of states, municipalities and political subdivisions

             954,708                  954,708    

Special purpose revenue bonds of states, municipalities and political subdivisions

             2,389,012                  2,389,012    

Corporate securities

             798,421          148          798,569    

Residential mortgage-backed securities

             821,694                  821,694    

Commercial mortgage-backed securities

             611,631                  611,631    

Asset-backed securities

             366,827                  366,827    

Foreign government securities

             118,692                  118,692    

Foreign corporate securities

             478,266                  478,266    
  

 

 

    

 

 

    

 

 

    

 

 

 

Total fixed maturity securities

  63,663       6,546,557       148       6,610,368    

Equity securities

  296,352                 296,352    

Short-term investments*

  159,297       98,889            258,186    

Restricted cash and securities

       2,729            2,729    

Premium, claims and other receivables

       56,493            56,493    

Other assets

  18            1,306       1,324    
  

 

 

    

 

 

    

 

 

    

 

 

 

Total assets measured at fair value

$     519,330     $     6,704,668     $     1,454     $     7,225,452    
  

 

 

    

 

 

    

 

 

    

 

 

 

Notes payable*

$    $ 875,094     $    $ 875,094    

Accounts payable and accrued liabilities - earnout liabilities

       2,729       8,744       11,473    
  

 

 

    

 

 

    

 

 

    

 

 

 

Total liabilities measured at fair value

$    $ 877,823     $ 8,744     $ 886,567    
  

 

 

    

 

 

    

 

 

    

 

 

 

 

* Carried at cost or amortized cost on consolidated balance sheet.

 

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HCC Insurance Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(unaudited, tables in thousands except per share data)

 

(6) Reinsurance

In the normal course of business, our insurance companies cede a portion of their premium to reinsurers through treaty and facultative reinsurance agreements. Although reinsurance 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 losses and diversify their business. The following tables present the effect of such reinsurance transactions on our premium, loss and loss adjustment expense and policy acquisition costs.

 

                                         
     Three months ended March 31,  
     2015      2014  

Direct written premium

   $ 717,048        $ 620,512    

Reinsurance assumed

     109,088          126,210    

Reinsurance ceded

     (157,220)         (156,540)   
  

 

 

    

 

 

 

Net written premium

$ 668,916     $ 590,182    
  

 

 

    

 

 

 

Direct earned premium

$ 703,584     $ 637,313    

Reinsurance assumed

  71,168       76,023    

Reinsurance ceded

  (174,189)      (150,724)   
  

 

 

    

 

 

 

Net earned premium

$ 600,563     $ 562,612    
  

 

 

    

 

 

 

Direct loss and loss adjustment expense

$ 458,726     $ 359,629    

Reinsurance assumed

  27,216       41,802    

Reinsurance ceded

  (120,780)      (70,685)   
  

 

 

    

 

 

 

Net loss and loss adjustment expense

$ 365,162     $ 330,746    
  

 

 

    

 

 

 

Policy acquisition costs

$ 115,070     $ 104,645    

Ceding commissions

  (39,859)      (35,604)   
  

 

 

    

 

 

 

Net policy acquisition costs

$ 75,211     $ 69,041    
  

 

 

    

 

 

 

The table below shows the components of our reinsurance recoverables in our consolidated balance sheets.

 

                                         
     March 31,      December 31,  
     2015      2014  

Reinsurance recoverable on paid losses

   $ 95,157        $ 99,937    

Reinsurance recoverable on outstanding losses

     448,069          443,059    

Reinsurance recoverable on incurred but not reported losses

     634,415          627,404    

Reserve for uncollectible reinsurance

     (1,500)         (1,500)   
  

 

 

    

 

 

 

Total reinsurance recoverables

$ 1,176,141     $ 1,168,900    
  

 

 

    

 

 

 

 

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HCC Insurance Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(unaudited, tables in thousands except per share data)

 

At each quarter end, we review our financial exposure to the reinsurance market based on our individual reinsurance recoverable balances as of the prior quarter end. We take actions to collect outstanding balances or to mitigate our exposure to possible uncollectible amounts. We had a $1.5 million reserve for potentially uncollectible amounts at March 31, 2015. Reinsurance recoverables related to our settlement of Spanish surety bond claims totaled $86.3 million at March 31, 2015, including $43.4 million on paid losses. Our reinsurers have paid our reinsurance claims in full on a timely basis, with the exception of a small number of reinsurers that are currently in run-off and disputing balances owed us. Recoverables from these run-off reinsurers totaled $41.5 million, including $36.8 million on paid losses, at March 31, 2015 (at quarter-end foreign currency exchange rate). No payments have been received from these reinsurers despite their participation in contracts on essentially the same terms of our other reinsurers. We are vigorously pursuing collection of these recoverables, including through arbitration where necessary, and believe these amounts are fully recoverable. Accordingly, we have not recorded a reserve for uncollectibility related to these amounts. While we believe our current reserve is adequate based on information currently available, market conditions may change or additional information might be obtained that may require us to change the reserve in the future.

(7) Liability for Unpaid Loss and Loss Adjustment Expense

The table below provides a reconciliation of our liability for loss and loss adjustment expense payable (referred to as reserves). We recognized no prior year loss development in the first quarter of 2015 and 2014.

 

                                         
     Three months ended March 31,  
     2015      2014  

Reserves at beginning of period

   $ 3,728,085        $ 3,902,132    

Less reinsurance recoverables on reserves

     1,070,463          1,122,731    
  

 

 

    

 

 

 

Net reserves at beginning of period

  2,657,622       2,779,401    

Net reserve additions from acquired business

  9,386         

Net loss and loss adjustment expense

  365,162       330,746    

Net loss and loss adjustment expense payments

  (388,538)      (363,858)   

Foreign currency adjustment

  (32,951)      2,552    
  

 

 

    

 

 

 

Net reserves at end of period

  2,610,681       2,748,841    

Plus reinsurance recoverables on reserves

  1,082,484       1,098,576    
  

 

 

    

 

 

 

Reserves at end of period

$ 3,693,165     $ 3,847,417    
  

 

 

    

 

 

 

 

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HCC Insurance Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(unaudited, tables in thousands except per share data)

 

(8) Notes Payable

Our notes payable consisted of the following:

 

                                         
     March 31,      December 31,  
     2015      2014  

6.30% Senior Notes

   $ 299,290        $ 299,251    

$825.0 million Revolving Loan Facility

     590,000          525,000    
  

 

 

    

 

 

 

Total notes payable

$ 889,290     $ 824,251    
  

 

 

    

 

 

 

There have been no changes to the terms and conditions related to our 6.30% Senior Notes or the $825.0 million Revolving Loan Facility (the Facility) from those described in Note 7, “Notes Payable” to the Consolidated Financial Statements in our Annual Report on Form 10-K for the year ended December 31, 2014. We were in compliance with debt covenants related to our 6.30% Senior Notes and the Facility at March 31, 2015.

The weighted-average interest rate on borrowings under the Facility at March 31, 2015 was 1.4%. The borrowings and letters of credit issued under the Facility reduced our available borrowing capacity on the Facility to $230.1 million at March 31, 2015.

(9) Income Taxes

The following table summarizes the differences between our effective tax rate for financial statement purposes and the Federal statutory rate.

 

                                         
     Three months ended March 31,  
     2015     2014  

Statutory tax rate

     35.0      35.0 
  

 

 

   

 

 

 

Federal tax at statutory rate

$ 52,790     $ 54,240    

Nontaxable municipal bond interest and dividend received deduction

  (9,752)      (8,927)   

State income taxes, net of federal tax benefit

  717       834    

Foreign income taxes

  9,951       7,226    

Foreign tax credit

  (9,776)      (7,226)   

Indefinitely reinvested earnings of foreign subsidiaries

  (9,134)        

Uncertain tax positions (net of federal tax benefit on state positions: $93 in 2015 and $144 in 2014)

  2,234       320    

Other, net

  881       594    
  

 

 

   

 

 

 

Income tax expense

$ 37,911     $ 47,061    
  

 

 

   

 

 

 

Effective tax rate

  25.1    30.4 
  

 

 

   

 

 

 

 

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HCC Insurance Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(unaudited, tables in thousands except per share data)

 

In the first quarter of 2015, we made an initial assertion that we would indefinitely reinvest the cumulative undistributed earnings of certain foreign subsidiaries primarily organized in the United Kingdom and Spain, which have statutory tax rates of 20.0% and 28.0%, respectively. We made no similar assertion in the first quarter of 2014 or in any periods previously reported. Our 2015 assertion generated a tax benefit of $9.1 million, which included $5.9 million on cumulative undistributed foreign earnings through December 31, 2014 and $3.2 million on undistributed foreign earnings recorded in the first quarter of 2015. Our assertion excluded undistributed foreign earnings that previously have been taxed as deemed dividend inclusions under U.S. tax rules, as well as 2015 earnings for which an assertion cannot be made unless certain U.S. tax regulations are extended for 2015 and future years. At March 31, 2015, our foreign earnings considered to be indefinitely reinvested outside the United States totaled $321.2 million, all of which are subject to U.S. taxes, offset by an adjustment for foreign tax credits, if repatriated. In cases where we could not assert or do not intend to assert indefinite reinvestment of the undistributed earnings of certain foreign subsidiaries, we provided taxes on such undistributed earnings at the U.S. statutory rate of 35.0%, offset by an adjustment for foreign tax credits, where applicable.

(10) Accumulated Other Comprehensive Income

The components of accumulated other comprehensive income in our consolidated balance sheets were as follows:

 

                                                              
     Net unrealized
investment
gains
     Foreign
currency
translation
adjustment
     Accumulated
other
comprehensive
income
 

Three months ended March 31, 2015

                    

Balance at December 31, 2014

   $ 169,984        $ 5,030        $ 175,014    

Other comprehensive income (loss)

     4,233          (6,985)         (2,752)   
  

 

 

    

 

 

    

 

 

 

Balance at March 31, 2015

$ 174,217     $ (1,955)    $ 172,262    
  

 

 

    

 

 

    

 

 

 

(11) Earnings Per Share

The following table details the numerator and denominator used in our earnings per share calculations.

 

                                         
     Three months ended March 31,  
     2015      2014  

Net earnings

   $ 112,917        $ 107,911    

Less: net earnings attributable to unvested restricted stock

     (1,641)         (1,692)   
  

 

 

    

 

 

 

Net earnings available to common stock

$ 111,276     $ 106,219    
  

 

 

    

 

 

 

Weighted-average common shares outstanding

  94,881       98,662    

Dilutive effect of outstanding securities (determined using treasury stock method)

  316       251    
  

 

 

    

 

 

 

Weighted-average common shares and potential common shares outstanding

  95,197       98,913    
  

 

 

    

 

 

 

Earnings per common share

Basic

$ 1.17     $ 1.08    
  

 

 

    

 

 

 

Diluted

$ 1.17     $ 1.07    
  

 

 

    

 

 

 

 

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Table of Contents

HCC Insurance Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(unaudited, tables in thousands except per share data)

 

(12) Stock-Based Compensation

In 2015, we granted the following shares of restricted stock and restricted stock units.

 

     Number
of shares
     Weighted-average
grant date

fair value
     Aggregate fair
value
     Vesting
period
 

Restricted stock

     299           $ 55.81               $     16,692             1 - 4 years   

Restricted stock units

     4             55.78                 245             4 years   

Certain awards of restricted stock and restricted stock units contain a performance condition based on the ultimate results for the applicable underwriting year. The number of such shares that vest could be higher or lower than initially granted. We measure fair value for these awards based on the closing price of our common stock on the grant date, and we recognize expense on a straight-line basis over the vesting period for those restricted stock awards or units expected to vest.

Certain of our executive officers were granted performance-based restricted stock in 2015. This restricted stock vests after three years and can vest from 0% to 200% of the initial shares granted. Vesting is based equally on an operating return on equity performance factor and a total shareholder return performance factor.

(13) Commitments and Contingencies

Catastrophe and Large Loss Exposure

We have exposure to catastrophic and other large losses caused by natural perils (such as hurricanes, tornados, earthquakes, tsunamis, floods, droughts and hail storms), and man-made events (such as terrorist attacks). The incidence, timing and severity of these losses are 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 to reduce our potential losses from a future event. In the first quarter of 2015 and 2014, we recognized accident year net catastrophe losses, after reinsurance and reinstatement premium, of $5.0 million and $4.6 million, respectively, related to various small catastrophes.

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, individually or in the aggregate, have a material adverse effect on our consolidated financial position, results of operations or cash flows.

 

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Table of Contents

HCC Insurance Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(unaudited, tables in thousands except per share data)

 

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 and some have no time limit. For those with a time limit, the longest indemnification expires in 2025. We accrue a loss when a valid claim is made by a purchaser and we believe we have potential exposure.

(14) Supplemental Information

Supplemental cash flow information was as follows:

 

                                         
     Three months ended March 31,  
     2015      2014  

Income taxes paid (refunded)

   $ 28,926       $ (478

Interest paid

     2,161         1,539   

Dividends declared but not paid at end of period

     28,270         22,500   

Purchases of common stock not paid at end of period

     9,840         639   

 

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Table of Contents

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following Management’s Discussion and Analysis should be read in conjunction with our Consolidated Financial Statements and the related Notes as of March 31, 2015 and December 31, 2014.

Overview

We are a specialty insurance group with offices in the United States, the United Kingdom, Spain and Ireland, transacting business in approximately 180 countries. Our shares trade on the New York Stock Exchange and closed at $56.96 on April 30, 2015, resulting in market capitalization of $5.4 billion.

We underwrite and manage a variety of largely non-correlated specialty insurance products through these three insurance underwriting segments: North America Property & Casualty, Accident & Health and International. We market our insurance products through a network of independent agents and brokers, through managing general agents owned by the company, and directly to consumers. In addition, we assume insurance written by other insurance companies.

Our organization is focused on generating consistent, industry-leading combined ratios. We concentrate our insurance writings in selected specialty lines of business in which we believe we can achieve meaningful underwriting profit. We rely on experienced underwriting personnel working within defined and monitored limits, as well as our access to and expertise in the reinsurance marketplace, to limit or reduce risk. By focusing on underwriting profitability, we are able to accomplish our primary objectives of maximizing net earnings and growing book value per share.

Our major insurance companies have financial strength ratings of AA (Very Strong) from Standard & Poor’s Financial Services LLC, A+ (Superior) from A.M. Best Company, Inc., AA (Very Strong) from Fitch Ratings, and A1 (Good Security) from Moody’s Investors Service, Inc.

At March 31, 2015, we had consolidated shareholders’ equity of $3.9 billion and book value per share of $41.03. In the first quarter of 2015, we purchased $54.4 million of our common stock at an average cost of $55.77 per share and paid $28.5 million of dividends at $0.295 per share. We produced total revenue of $676.5 million in the first quarter of 2015, compared to $648.9 million in the same quarter of 2014. Our first quarter results and key metrics were as follows:

 

                                         
     Three months ended March 31,  
     2015     2014  

Net earnings

   $ 112,917       $ 107,911    
  

 

 

   

 

 

 

Earnings per diluted share

$ 1.17     $ 1.07    
  

 

 

   

 

 

 

Net loss ratio

  60.8    58.8 

Expense ratio

  25.7       24.6    
  

 

 

   

 

 

 

Combined ratio

  86.5    83.4 
  

 

 

   

 

 

 

Our consolidated results for the first quarter of 2015 include the results of Producers Ag Insurance Group, Inc. (ProAg), which we acquired for a final purchase price of $102.4 million, effective January 1, 2015. ProAg contributed $72.6 million, $54.7 million and $17.0 million of gross written, net written and net earned premium, respectively, to consolidated premium in the first quarter of 2015. Including $2.0 million of transaction costs, ProAg’s operations generated a net loss of $7.7 million, or $0.08 per diluted share, in the first quarter of 2015. The majority of this loss relates to the seasonal nature of the crop insurance business. ProAg’s operations increased our first quarter 2015 consolidated loss ratio, expense ratio and combined ratio by 0.8, 1.1 and 1.9 percentage points, respectively. Assuming ProAg’s operations remain in line with our expectations, we expect ProAg will break even for full year 2015, and its higher net earned premium in the second half of 2015 will normalize its expense ratio for 2015.

 

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Table of Contents

Comparisons in the following sections refer to the first quarter of 2015, compared to the same period of 2014. The 2015 consolidated financial statements include ProAg’s financial position, results of operations and cash flows; there are no comparable amounts in our 2014 consolidated financial position, results of operations and cash flows. Amounts in tables are in thousands, except for earnings per share, percentages, ratios and number of employees.

Reporting Segment Changes

In the first quarter of 2015, following the acquisition of ProAg, HCC’s executive management changed the structure under which it manages and evaluates the results of our numerous product lines. We now report our results in four operating segments, consisting of three insurance underwriting segments: 1) North America Property & Casualty, 2) Accident & Health and 3) International, and the Investing segment. See Note 3, “Segments” in the accompanying consolidated financial statements for additional information about our new segments. All prior period information in this Form 10-Q has been recast to present our segment disclosures and information on a comparable basis with our new segment reporting structure.

Revenue

Gross written premium, net written premium and net earned premium are detailed below by segment.

 

                                         
     Three months ended March 31,  
     2015      2014  

North America Property & Casualty

   $ 349,377        $ 288,274    

Accident & Health

     260,144          235,917    

International

     216,618          222,240    

Exited Lines

     (3)         291    
  

 

 

    

 

 

 

Total gross written premium

$ 826,136     $ 746,722    
  

 

 

    

 

 

 

North America Property & Casualty

$ 238,227     $ 177,132    

Accident & Health

  255,918       234,751    

International

  174,774       178,008    

Exited Lines

  (3)      291    
  

 

 

    

 

 

 

Total net written premium

$ 668,916     $ 590,182    
  

 

 

    

 

 

 

North America Property & Casualty

$ 209,239     $ 201,334    

Accident & Health

  254,950       232,143    

International

  136,377       128,844    

Exited Lines

  (3)      291    
  

 

 

    

 

 

 

Total net earned premium

$ 600,563     $ 562,612    
  

 

 

    

 

 

 

Growth in premium occurred primarily in our North America Property & Casualty segment, due to our new agriculture business, and in our Accident & Health segment, from growth of our medical stop-loss and short-term medical products. See the “Segment Operations” section below for further discussion of the relationship and changes in premium within each insurance underwriting segment.

Net investment income, which is included in our Investing segment, decreased 6% quarter-over-quarter primarily due to lower dividend income following our sale of equity securities in 2014. Our net realized investment gains decreased $7.1 million in the first quarter of 2015, as we sold a large block of equity securities in the first quarter of 2014. See the “Investing Segment” section below for further discussion of our investing activities.

 

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Table of Contents

Loss and Loss Adjustment Expense

The tables below detail our net loss and loss adjustment expense and our net loss ratios on a consolidated basis and for our segments.

 

                                         
     Three months ended March 31,  
     2015     2014  

North America Property & Casualty

   $ 116,436       $ 103,553    

Accident & Health

     187,011         170,805    

International

     61,443         56,314    

Exited Lines

     272         74    
  

 

 

   

 

 

 

Net loss and loss adjustment expense

$ 365,162     $ 330,746    
  

 

 

   

 

 

 

North America Property & Casualty

  55.6    51.4 

Accident & Health

  73.4       73.6    

International

  45.1       43.7    
  

 

 

   

 

 

 

Consolidated net loss ratio

  60.8    58.8 
  

 

 

   

 

 

 

Consolidated accident year net loss ratio

  60.8    58.8 
  

 

 

   

 

 

 

Net paid loss ratio

  64.7    64.7 
  

 

 

   

 

 

 

Net loss and loss adjustment expense (referred to as loss expense) increased $34.4 million in the first quarter of 2015 compared to the same period in 2014. The higher loss expense stemmed from our: 1) North America Property & Casualty segment, due to the addition of our agriculture business, 2) Accident & Health segment, from growth of our medical stop-loss and short-term medical products and 3) International segment, due to growth in our specialty lines of business. We recognized no prior year loss development or large catastrophes in the first quarter of 2015 and 2014. See the “Segment Operations” section below for additional discussion of the changes in our loss expense, as well as discussion of the net loss ratios for each segment for 2015 and 2014.

While our net paid loss ratio remained constant quarter-over-quarter, the mix of paid losses varied in the two quarters. The amount of claims paid fluctuates due to the timing of claims settlement, the occurrence of catastrophic events and commutations, and the mix of our business. To settle claims related to Spanish surety bonds, we paid $10.0 million and $35.4 million net of reinsurance in the first quarter of 2015 and 2014, respectively. This activity increased the respective net paid loss ratio by 1.7 and 6.3 percentage points in these quarters.

Policy Acquisition Costs

The percentage of policy acquisition costs to net earned premium was 12.5% and 12.3% for the first quarter of 2015 and 2014, respectively. The difference between periods primarily related to increased commissions due to proportionately higher writings of our short-term medical product.

Other Operating Expense

Other operating expense includes a foreign currency benefit of $18.0 million recognized in the first quarter of 2015, compared to foreign currency expense of $3.9 million recognized in the first quarter of 2014. The significant change in the foreign currency benefit/expense related to strengthening of the U.S. dollar relative to the British pound sterling and the Euro during the first quarter of 2015.

 

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Table of Contents

Excluding the effect of foreign currency benefit/expense, other operating expense increased 15% quarter-over-quarter, mainly due to increased compensation and operating costs in 2015 related to ProAg’s operations. Our employee count has grown to 2,480 at March 31, 2015, from 1,983 at December 31, 2014, primarily due to our acquisition of ProAg. Other operating expense included stock-based compensation expense of $4.6 million in 2015 and $4.2 million in 2014. At March 31, 2015, there was approximately $40.5 million of total unrecognized compensation expense, related to unvested restricted stock awards and units, stock options and our employee stock purchase plan, that is expected to be recognized over a weighted-average period of 2.0 years.

Interest Expense

Interest expense was $7.8 million and $7.1 million in the first quarter of 2015 and 2014, respectively, and included $4.8 million for our Senior Notes in both years.

Income Tax Expense

Our effective income tax rate was 25.1% for the first quarter of 2015, compared to 30.4% for the same period of 2014. In the first quarter of 2015, we made an initial assertion that we would indefinitely reinvest $321.2 million of cumulative undistributed earnings of certain foreign subsidiaries primarily organized in the United Kingdom and Spain. As a result of this assertion, we recognized a tax benefit of $9.1 million, which included $5.9 million on cumulative undistributed foreign earnings through December 31, 2014 and $3.2 million on undistributed foreign earnings recorded in the first quarter of 2015. We made no similar assertion in the first quarter of 2014. If these cumulative earnings were to be repatriated in the future, we would be subject to U.S. income taxes at 35.0%, offset by an adjustment for foreign tax credits. Our future effective tax rate may fluctuate due to tax law and tax rate changes in the United States and foreign taxing jurisdictions, as well as the interaction and complexity of taxation within the various jurisdictions.

Segment Operations

Each of our insurance underwriting segments bears risk for insurance coverage written within its portfolio of insurance products. Each segment generates income from premium written by our underwriting agencies, through third party agents and brokers, or on a direct basis. Certain segments also write facultative or individual account reinsurance, as well as treaty reinsurance business. In some cases, we purchase reinsurance to limit our losses from both individual policy losses and multiple policy losses from catastrophic occurrences and from aggregate losses in a year. Our segments maintain disciplined expense management and a streamlined management structure, which results in favorable expense ratios. The following provides operational information about our insurance underwriting segments, the Investing segment and the Corporate & Other category.

 

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Table of Contents

North America Property & Casualty Segment

The segment’s product groupings and their major products are:

 

    Liability – directors’ and officers’ liability (D&O), primary and excess casualty, small account errors and omissions liability, and employment practices liability.
    Agriculture – ProAg’s products, including multi-peril crop, crop hail, and other named peril.
    Other Specialty – aviation, sports and entertainment, public risk, surety, and various smaller products.

The following tables summarize the operations of the North America Property & Casualty segment.

 

                                         
     Three months ended March 31,  
     2015     2014  

Net earned premium

   $ 209,239       $ 201,334    

Other revenue

     6,102         5,431    
  

 

 

   

 

 

 

Segment revenue

  215,341       206,765    
  

 

 

   

 

 

 

Loss and loss adjustment expense, net

  116,436       103,553    

Other expense

  68,348       57,538    
  

 

 

   

 

 

 

Segment expense

  184,784       161,091    
  

 

 

   

 

 

 

Segment pretax earnings

$ 30,557     $ 45,674    
  

 

 

   

 

 

 

Net loss ratio

  55.6    51.4 

Expense ratio

  32.7       28.6    
  

 

 

   

 

 

 

Combined ratio

  88.3    80.0 
  

 

 

   

 

 

 

Liability

$ 101,507     $ 96,075    

Agriculture

  16,989         

Other Specialty

  90,743       105,259    
  

 

 

   

 

 

 

Total net earned premium

$ 209,239     $ 201,334    
  

 

 

   

 

 

 

Liability

  62.1    63.7 

Agriculture

  88.0         

Other Specialty

  42.4       40.2    
  

 

 

   

 

 

 

Total net loss ratio

  55.6    51.4 
  

 

 

   

 

 

 

Liability

$ 128,277     $ 121,537    

Agriculture

  72,615         

Other Specialty

  148,485       166,737    
  

 

 

   

 

 

 

Total gross written premium

$ 349,377     $ 288,274    
  

 

 

   

 

 

 

 

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Table of Contents
                             
     Three months ended March 31,  
     2015      2014  

Liability

   $ 95,951        $ 85,403    

Agriculture

     54,657            

Other Specialty

     87,619          91,729    
  

 

 

    

 

 

 

Total net written premium

$       238,227     $       177,132    
  

 

 

    

 

 

 

Our North America Property & Casualty segment pretax earnings decreased $15.1 million quarter-over-quarter, driven by a pretax loss in our agriculture business of $8.7 million, which included $0.6 million for amortization of purchased intangibles related to the ProAg acquisition. The seasonal nature of the agriculture business results in net earned premium being concentrated in the third quarter, while mostly fixed operating expenses are incurred relatively evenly throughout the year. Excluding the results of Agriculture, the segment’s pretax earnings decreased $6.4 million in 2015, primarily due to the timing of net earned premium from our title product, which is included in Other Specialty. We wrote more title premium in the first quarter of 2014, compared to the first quarter of 2015.

Written and earned premium increased in 2015 due to our new agriculture business. Excluding Agriculture, net earned premium decreased in 2015 due to reduced premium from title and other products included in Other Specialty, partially offset by growth in our primary casualty product included in Liability. The segment’s net loss ratio and expense ratio increased in 2015, primarily due to the agriculture business, which added 2.8 percentage points and 2.9 percentage points, respectively. The majority of the agriculture premium will earn in the second half of the year; therefore, we expect the Agriculture operations will be in line with our break even expectations for full year 2015 and the segment’s 2015 expense ratio will decline significantly by year end.

 

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Accident & Health Segment

The following tables summarize the operations of the Accident & Health segment.

 

                                         
     Three months ended March 31,  
     2015     2014  

Net earned premium

   $ 254,950       $ 232,143    

Other revenue

     2,013         1,640    
  

 

 

   

 

 

 

Segment revenue

  256,963       233,783    
  

 

 

   

 

 

 

Loss and loss adjustment expense, net

  187,011       170,805    

Other expense

  38,665       34,573    
  

 

 

   

 

 

 

Segment expense

  225,676       205,378    
  

 

 

   

 

 

 

Segment pretax earnings

$ 31,287     $ 28,405    
  

 

 

   

 

 

 

Net loss ratio

  73.4    73.6 

Expense ratio

  15.2       14.9    
  

 

 

   

 

 

 

Combined ratio

  88.6    88.5 
  

 

 

   

 

 

 

Total gross written premium

$ 260,144     $ 235,917    
  

 

 

   

 

 

 

Total net written premium

$ 255,918     $ 234,751    
  

 

 

   

 

 

 

The Accident & Health segment pretax earnings increased 10% in the first quarter of 2015, compared to the same period of 2014. This increase was directly attributable to writing new medical stop-loss and short-term medical business, as well as rate increases on renewal business in 2015. The segment’s expense ratio increased in 2015 due to higher commissions, primarily due to proportionately higher writings of our short-term medical product.

 

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International Segment

The segment’s product groupings and their major products are:

 

    London Market – marine and energy, property treaty, property (direct and facultative), and accident and health.
    Specialty – D&O, professional indemnity, casualty, surety, and credit.

The following tables summarize the operations of the International segment.

 

                                         
     Three months ended March 31,  
     2015     2014  

Net earned premium

   $ 136,377       $ 128,844    

Other revenue

     1,008         976    
  

 

 

   

 

 

 

Segment revenue

  137,385       129,820    
  

 

 

   

 

 

 

Loss and loss adjustment expense, net

  61,443       56,314    

Other expense

  47,311       46,475    
  

 

 

   

 

 

 

Segment expense

  108,754       102,789    
  

 

 

   

 

 

 

Segment pretax earnings

$ 28,631     $ 27,031    
  

 

 

   

 

 

 

Net loss ratio

  45.1    43.7 

Expense ratio

  34.7       36.1    
  

 

 

   

 

 

 

Combined ratio

  79.8    79.8 
  

 

 

   

 

 

 

London Market

$ 63,358     $ 61,661    

Specialty

  73,019       67,183    
  

 

 

   

 

 

 

Total net earned premium

$ 136,377     $ 128,844    
  

 

 

   

 

 

 

London Market

  38.9    36.5 

Specialty

  50.4       50.3    
  

 

 

   

 

 

 

Total net loss ratios

  45.1    43.7 
  

 

 

   

 

 

 

London Market

$ 117,931     $ 131,979    

Specialty

  98,687       90,261    
  

 

 

   

 

 

 

Total gross written premium

$ 216,618     $ 222,240    
  

 

 

   

 

 

 

London Market

$ 96,678     $ 107,259    

Specialty

  78,096       70,749    
  

 

 

   

 

 

 

Total net written premium

$ 174,774     $ 178,008    
  

 

 

   

 

 

 

Our International segment pretax earnings increased 6% in the first quarter of 2015, compared to the same period of 2014, primarily from higher net earned premium. Written premium from our Specialty products grew in 2015, but was more than offset by decreased writings in our London Market line of business, due to reduced pricing, expanded competition and lower energy prices. The segment’s 2015 expense ratio benefited from a stronger U.S. dollar compared to the British pound sterling and the Euro in the first quarter of 2015, compared to the first quarter of 2014.

 

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Investing Segment

We invest the majority of our funds in highly-rated fixed maturity securities, which are designated as available for sale securities. We held $6.5 billion of fixed maturity securities at March 31, 2015. Substantially all of our fixed maturity securities were investment grade and 74% were rated AAA or AA. In addition, we held $334.8 million of equity securities at March 31, 2015.

The following tables summarize the results and certain key metrics of our Investing segment.

 

                                         
     Three months ended March 31,  
     2015     2014  

Net investment income from:

    

Fixed maturity securities

    

Taxable

   $ 24,718       $ 23,260    

Exempt from U.S. income taxes

     27,341         28,583    
  

 

 

   

 

 

 

Total fixed maturity securities

  52,059       51,843    

Equity securities

  2,736       6,637    

Other

  418       431    
  

 

 

   

 

 

 

Total investment income

  55,213       58,911    

Investment expense

  (1,731)      (2,105)   
  

 

 

   

 

 

 

Total net investment income

  53,482       56,806    

Net realized investment gain

  13,186       20,246    
  

 

 

   

 

 

 

Segment pretax earnings

$ 66,668     $ 77,052    
  

 

 

   

 

 

 

Fixed maturity securities:

Average yield *

  3.3    3.5 

Average tax equivalent yield *

  4.1    4.4 

Weighted-average life

  8.0 years      8.2 years   

Weighted-average duration

  4.7 years      5.0 years   

Weighted-average rating

  AA      AA   

 

* Excluding realized and unrealized gains and losses.

 

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Table of Contents

This table summarizes our investments by type, all of which were reported at fair value, at March 31, 2015 and December 31, 2014.

 

     March 31, 2015     December 31, 2014  
     Amount     %     Amount     %  

Fixed maturity securities

        

U.S. government and government agency securities

   $ 74,516         1  %    $ 70,969         1  % 

Fixed maturity securities of states, municipalities and political subdivisions

     934,063         13        954,708         13   

Special purpose revenue bonds of states, municipalities and political subdivisions

     2,395,686         34        2,389,012         33   

Corporate securities

     752,023         10        798,569         11   

Residential mortgage-backed securities

     791,410         11        821,694         11   

Commercial mortgage-backed securities

     592,780         8        611,631         9   

Asset-backed securities

     369,302         5        366,827         5   

Foreign government securities

     122,032         2        118,692         2   

Foreign corporate securities

     420,632         6        478,266         7   

Equity securities

     334,763         5        296,352         4   

Short-term investments

     325,154         5        258,186         4   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total investments

$     7,112,361             100  %  $     7,164,906             100  % 
  

 

 

   

 

 

   

 

 

   

 

 

 

Our total investments decreased $52.5 million in 2015, principally due to cash paid for the acquisition of ProAg, partially offset by newly generated cash flow. At March 31, 2015, the net unrealized gain on our investment portfolio was $269.7 million, compared to $262.9 million at December 31, 2014. The increase in the net unrealized gain was due to the continuing decline in interest rates in 2015. Rates on 10-year U.S. Treasury notes declined 24 basis points in the first quarter of 2015.

In the first quarter of 2015, we sold bonds with a book value of approximately $155.0 million, and realized a net gain of $12.4 million, primarily related to our merger of certain International subsidiaries. In the first quarter of 2014, we sold equity securities with a book value of $142.0 million, and realized a net gain of $21.3 million, in order to reposition our overall investment portfolio.

The ratings of our individual securities within our fixed maturity securities portfolio at March 31, 2015 were as follows:

 

     Amount     %  

AAA

   $ 1,054,210         16  % 

AA

     3,733,587         58   

A

     1,242,483         20   

BBB

     277,370         4   

BB and below

     144,794         2   
  

 

 

   

 

 

 

Total fixed maturity securities

$     6,452,444             100  % 
  

 

 

   

 

 

 

 

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Corporate & Other

The following table summarizes activity in the Corporate & Other category.

 

     Three months ended March 31,  
             2015                     2014          

Net earned premium

   $ (3)      $             291    

Other revenue

     96         1,219    
  

 

 

   

 

 

 

Total revenue

  93       1,510    
  

 

 

   

 

 

 

Loss and loss adjustment expense, net

  272       74    

Other expense – Exited Lines

  608       683    

Other expense – Corporate

          15,772       12,971    

Interest expense

  7,736       7,061    

Foreign currency expense (benefit)

  (17,980)      3,911    
  

 

 

   

 

 

 

Total expense

  6,408       24,700    
  

 

 

   

 

 

 

Pretax loss

$ (6,315)    $ (23,190)   
  

 

 

   

 

 

 

Our Corporate expenses not allocated to the segments increased quarter-over-quarter, primarily due to professional services of $2.0 million incurred in connection with our acquisition of ProAg in 2015. The impact of foreign currency benefit/expense fluctuated period-over-period principally due to changes in the value of the British pound sterling and the Euro relative to the U.S. dollar. We hold available for sale securities denominated in non-functional currencies to economically hedge the currency exchange risk on our loss reserves denominated in non-functional currencies. The foreign currency benefit/expense related to loss reserves is recorded through the income statement, while the foreign currency benefit/expense related to available for sale securities is recorded through other comprehensive income within shareholders’ equity. This mismatch may cause fluctuations in our reported foreign currency benefit/expense in future periods.

 

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Table of Contents

Liquidity and Capital Management

We believe we have sufficient sources of liquidity at both a consolidated and insurance company legal entity level to pay claims and meet our other contractual obligations and liabilities as they become due in the short-term and long-term. Our current sources of liquidity include: 1) significant operating cash flow generated by our insurance companies, 2) our investment portfolio, most of which is held by our insurance companies, 3) our revolving loan facility and 4) a $1.0 billion shelf registration. Our sources of liquidity are discussed below.

Cash Flow

We manage the liquidity of our insurance companies such that each subsidiary’s anticipated claims payments will be met by its own current operating cash flows, cash, short-term investments or investment maturities. Our insurance companies receive substantial cash from premiums, reinsurance recoverables, surety collateral, outward commutations, proceeds from sales and redemptions of investments, and investment income. Their principal cash outflows are for the payment of claims and loss adjustment expenses, premium payments to reinsurers, return of surety collateral, inward commutations, purchases of investments, policy acquisition costs, operating expenses, taxes and dividends paid to the parent company. We report all of the insurance companies’ investing activity in our Investing segment for segment reporting purposes. Our parent company’s principal cash inflows relate to its investment portfolio and dividends paid by the insurance companies, and its principal cash outflows relate to debt service, acquisitions, operating expenses, dividends paid to shareholders and common stock purchases. Cash provided by operating activities can fluctuate due to timing differences in the collection of premium receivables, reinsurance recoverables and surety collateral; the payment of losses, premium payables and return of surety collateral; and the completion of commutations.

The components of our net operating cash flows are summarized in the following table.

 

     Three months ended March 31,  
     2015     2014  

Net earnings

   $ 112,917       $ 107,911    

Change in premium, claims and other receivables, net of reinsurance, premium and claims payable

     10,146         26,907    

Change in unearned premium, net

     67,252         26,536    

Change in loss and loss adjustment expense payable, net of reinsurance recoverables

     (39,515     1,305    

Change in accounts payable and accrued liabilities

     (70,757     (51,885

Gain on investments

     (13,186     (20,246

Other, net

     (35,711     4,936    
  

 

 

   

 

 

 

Cash provided by operating activities

$ 31,146     $ 95,464    
  

 

 

   

 

 

 

Our cash provided by operating activities was $31.1 million in the first quarter of 2015, compared to $95.5 million in the same period of 2014. We paid $28.9 million of income tax payments in 2015, compared to minimal payments in 2014. Other fluctuations in our cash provided by operating activities relate to the timing of the collection and the payment of insurance-related receivables and payables. Related to Spanish surety bonds, we paid claims of $16.5 million and collected reinsurance of $6.9 million in the first quarter of 2015, compared to paying claims of $85.0 million and collecting reinsurance of $72.4 million in the first quarter of 2014. At March 31, 2015, we had gross reserves of $68.0 million, ceded reserves of $42.9 million, and paid loss recoverables from reinsurers of $43.4 million related to Spanish surety bonds. The net impact of our payment of claims and collection of recoverables related to these bonds will continue to impact our cash provided by operating activities in future periods.

Cash flows related to multi-peril crop insurance, which represents the majority of our agriculture business, differ from cash flows related to our other products. Premiums from insureds are transferred to the Federal Crop Insurance Corporation (FCIC) or paid by us on a preset schedule, if not paid by the insured. Claims paid to insureds are reimbursed by the FCIC within several days of payment. We settle each reinsurance year with the FCIC in October of the following year. Settlements with other reinsurers occur shortly after settlement with the FCIC. We pay the majority of agent commissions during the first nine months of the year and employee compensation and other operating expenses evenly throughout the year. Reimbursement from the FCIC for administrative and operating expenses occurs in October and is calculated as a percentage of gross written premium. The 2015 reimbursement is expected to cover approximately 45% of agents commissions, employee compensation and other operating expenses for the year. The timing of these cash flows has historically created quarterly volatility in ProAg’s operating cash flows. Our consolidated operating cash flow will be reduced in 2015 and 2016, as the 2015 reinsurance year will settle in October 2016.

 

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Table of Contents

Investments

At March 31, 2015, we held a $7.1 billion investment portfolio, which included $325.2 million of liquid short-term investments. Our fixed maturity and equity securities portfolios are classified as available for sale. We expect to hold our fixed maturity securities until maturity, but we would be able to sell these securities, as well as our equity securities, to generate cash if needed. The parent company held $681.8 million of cash and investments at March 31, 2015, which are available to cover the holding company’s required cash disbursements.

In the first quarter of 2015, we entered into a commitment to invest up to $150.0 million in a middle market senior loan program. The loans must meet certain criteria and are floating rate instruments generally tied to three-month LIBOR. We anticipate the loan program will be fully funded over the next twelve months and the loans will have an expected life of three years. To date, no loans have been funded under this agreement.

Revolving Loan Facility

We maintain an $825.0 million Revolving Loan Facility (Facility), of which $230.1 million of available capacity remained at March 31, 2015. During the past several years, we used the Facility to fund purchases of our common stock. We expect to continue to use the Facility to opportunistically repurchase stock. The Facility expires in April 2019. See Note 7, “Notes Payable” to the Consolidated Financial Statements in our Annual Report on Form 10-K for the year ended December 31, 2014 for additional information related to the Facility and our long-term indebtedness.

Subsidiary Dividends

We consider the undistributed earnings of certain foreign subsidiaries to be indefinitely reinvested and, accordingly, no U.S. deferred income taxes have been provided thereon. At March 31, 2015, our foreign subsidiaries associated with indefinitely reinvested foreign earnings had $243.1 million of cash and short-term investments and $63.9 million of undistributed foreign earnings considered to be previously taxed income under U.S. tax rules. We believe that future cash from our domestic operations, together with our ability to access funds available under our Facility, provide adequate resources to fund both our short-term and long-term operating requirements, capital expenditures, share repurchases, dividend payments, debt service requirements, acquisitions and new business development activities in the United States. We do not anticipate the need to repatriate either previously taxed or indefinitely reinvested foreign earnings to the United States to satisfy domestic liquidity needs arising in the ordinary course of business. In the event that we determine in the future to repatriate some or all of the foreign earnings that are considered indefinitely reinvested outside of the United States, we would be required to record additional tax expense at that time.

Share Purchases

In 2014, our Board of Directors (the Board) authorized a $500.0 million stock purchase plan (the Plan). Purchases under the Plan may be made in the open market or in privately negotiated transactions from time-to-time in compliance with applicable laws, rules and regulations, including Rule 10b-18 under the Securities Exchange Act of 1934, as amended. Purchases under the Plan will be made subject to market and business conditions, the level of cash generated from our operations, cash required for acquisitions, our debt covenant compliance, and other relevant factors. The Plan does not obligate us to purchase any particular number of shares, has no expiration date, and may be suspended or discontinued at any time at the Board’s discretion. As of April 30, 2015, $285.3 million of repurchase authority remains under the Plan.

 

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Table of Contents

We purchased our common stock in the first quarter of 2015 and 2014 as follows:

 

     Three months ended March 31,  
     2015      2014  

Shares of common stock

     975         736   

Total cost

   $ 54,386       $ 31,413   

Weighted-average cost per share

   $ 55.77       $ 42.66   

Shelf Registration

We have a new “Universal Shelf” registration statement, which was filed and became effective in March 2015 and expires in March 2018. The current Universal Shelf provides for the issuance of $1.0 billion of securities, which may be debt securities, equity securities, or a combination thereof. The Universal Shelf provides us the means to access the debt and equity markets relatively quickly, if we are satisfied with the current pricing in the financial markets.

Critical Accounting Policies

We provided information about our critical accounting policies in Item 7, “Management’s 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, 2014. We have made no changes in the identification or methods of application of these policies, except as described below.

Deferred Taxes

We recognize deferred tax assets and liabilities based on the differences between the financial statement carrying amounts and the tax bases of assets and liabilities. Beginning in the first quarter of 2015, for certain of our foreign subsidiaries, we do not provide deferred tax liabilities on undistributed earnings that are essentially permanent in duration. We regularly review our deferred tax assets for recoverability, taking into consideration our history of earnings, expectations for future earnings, taxable income in carryback years and the expected timing of the reversals of existing temporary differences. When we believe it is more likely than not that a deferred tax asset will not be realized, we establish a valuation allowance for that deferred tax asset. Although realization is not assured, we believe that, as of March 31, 2015, it is more likely than not that we will be able to realize the benefit of recorded deferred tax assets, with the exception of certain tax loss carryforwards for which valuation allowances have been provided. If there is a material change in the tax laws such that the actual effective tax rate changes or the time periods within which the underlying temporary differences become taxable or deductible change, we will reevaluate our assumptions, which could result in a change in the valuation allowance required.

Recent Accounting Guidance

See Note 1, “General Information — Recent Accounting Guidance” to the Consolidated Financial Statements for a description of recently issued accounting guidance that will impact our consolidated financial statements in future periods.

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, 2014.

 

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Table of Contents

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, 2015, except as otherwise noted below, using criteria established in the Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on this evaluation, our CEO and CFO concluded that our disclosure controls and procedures were effective in providing reasonable assurance of achieving the purposes described in Rule 13a-15(e) under the Act as of March 31, 2015.

Effective January 1, 2015, we completed the acquisition of ProAg and are currently in the process, but have not completed, the integration of ProAg’s policies, processes, technology and operations. In conducting the evaluation of the effectiveness of internal control over financial reporting as of March 31, 2015, our management excluded the internal controls related to ProAg’s systems and processes. We expect to complete our internal control evaluation related to ProAg during 2015.

(b) Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting that occurred during the quarter ended March 31, 2015 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

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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, individually or in the aggregate, 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, 2014.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

In 2014, the Board approved the purchase of up to $500.0 million of our common stock (the Plan). Purchases under the Plan may be made in the open market or in privately negotiated transactions from time-to-time in compliance with applicable laws, rules and regulations, including Rule 10b-18 under the Securities Exchange Act of 1934, as amended. Purchases under the Plan will be made, subject to market and business conditions, the level of cash generated from our operations, cash required for acquisitions, our debt covenant compliance, and other relevant factors. The Plan does not obligate us to purchase any particular number of shares, has no expiration date, and may be suspended or discontinued at any time at the Board’s discretion. Our purchases in the first quarter of 2015 were as follows:

 

Period    

   Total number of
    shares purchased    
     Average price
    paid per share    
   Total number of shares
purchased as part of
publicly announced
        plans or programs        
     Approximate dollar
value of shares that may
yet be purchased under
      the plans or programs      

January

     204,727           $53.01      204,727                   $341,069,419

February

     9,066           $53.26      9,066                   $340,586,548

March

     761,377           $56.54      761,377                   $297,534,932

Item 3. Defaults Upon Senior Securities

None.

Item 4. Mine Safety Disclosures

None.

Item 5. Other Information

None.

 

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Item 6. Exhibits

 

Exhibit
Number

   

2.1

    Stock Purchase Agreement, dated September 29, 2014, by and among CMFG Life Insurance Company, CUNA Mutual Investment Corporation and HCC Insurance Holdings, Inc. (incorporated by reference to Exhibit 2.1 to Current Report on Form 8-K filed on September 30, 2014).

3.1

    Restated Certificate of Incorporation and Amendment of Certificate of Incorporation of HCC Insurance Holdings, Inc., filed with Delaware Secretary of State on July 23, 1996 and May 21, 1998, respectively (incorporated by reference to Exhibit 4.1 to Registration Statement on Form S-8 (Registration No. 333-61687) filed on August 17, 1998).

3.2

    Fourth Amended and Restated Bylaws of HCC Insurance Holdings, Inc. (incorporated by reference to Exhibit 3.1 to Current Report on Form 8-K filed on August 22, 2013).

4.1

    Indenture, dated August 23, 2001, between HCC Insurance Holdings, Inc. and First Union National Bank related to Debt Securities (Senior Debt) (incorporated by reference to Exhibit 4.1 to Current Report on Form 8-K filed on August 24, 2001).

4.2

    Form of Fourth Supplemental Indenture, dated November 16, 2009, between HCC Insurance Holdings, Inc. and U.S. Bank National Association related to 6.30% Senior Notes due 2019 (incorporated by reference to Exhibit 4.2 to Current Report on Form 8-K filed on November 13, 2009).

12

 

  Statement Regarding Computation of Ratios.

31.1

 

  Certification by Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2

 

  Certification by Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1

 

  Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

101

 

  The following financial statements from the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2015 formatted in XBRL: 1) Consolidated Balance Sheets, 2) Consolidated Statements of Earnings, 3) Consolidated Statements of Comprehensive Income, 4) Consolidated Statement of Changes in Shareholders’ Equity, 5) Consolidated Statements of Cash Flows and 6) Notes to Consolidated Financial Statements.

 

 

Filed herewith.

 

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Table of Contents

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 6, 2015 /s/ Christopher J.B. Williams
(Date) Christopher J.B. Williams,
Chief Executive Officer
May 6, 2015 /s/ Pamela J. Penny
(Date) Pamela J. Penny, Executive Vice President
and Chief Accounting Officer

 

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