See Notes 7 and 8 to Consolidated Financial Statements located in Item 8 of Part II herein for additional information.
(1) Prior year information has been restated to reflect Radian International LLC as a discontinued operation. (2) All per share data has been restated to reflect stock splits. (3) Excludes revenues from investments accounted for under the equity method. (4) Reflects the repurchase of approximately 1.0 in 1997, 0.3 in 1996, 0.1 in 1995, 0.1 in 1994, 0.2 in 1993. (5) Excludes charge for Proposition 103.
Earnings Per Share: Income from continuing operations: Basic $ 3.32 $ 2.71 $ 2.58 Diluted 3.29 2.71 2.58 Net income: Basic $ 3.32 $ 2.65 $ 3.07 Diluted 3.29 2.65 3.07 ------- ---------- ---------
Net income and income from continuing operations per common share on a diluted basis increased 24.2 percent and 21.4 percent, respectively, in 1997 from 1996 due to significantly higher underwriting gains in the Company's insurance operations. On July 28, 1997 the HSB Board ratified management's decision to exercise its option to put its share of Radian International LLC (Radian) to The Dow Chemical Company (Dow) on or about January 1, 1998 for approximately $144 million. Due to this decision, the results of Radian have been classified as discontinued operations and HSB's share of losses incurred subsequent to this decision of approximately $10 million pre-tax have been deferred until HSB's share of Radian has been transferred to Dow. On January 2, 1998 the Radian transaction closed resulting in an estimated after-tax gain of approximately $30 million, which includes absorption of the deferred loss. (See note 3). Income from continuing operations in 1996 increased 3.6 percent from 1995 as catastrophe losses from
Consolidated revenues grew 9.9 percent in 1997 and 16.6 percent in 1996. Insurance premiums grew 9.5 percent in 1997, with the increased participation in Industrial Risk Insurers (IRI) a contributing factor as well as growth in both the domestic and international books of business. Effective December 1, 1996, The Hartford Steam Boiler Inspection and Insurance Company (HSBIIC) increased its participation in IRI from 14 to 23.5 percent. The combined ratio for the Company improved to 91.7 percent in 1997 from 94.7 percent in 1996. In 1995 the combined ratio was 90.7 percent.
The effective tax rates on income from continuing operations before distributions on capital securities for 1997 was 26.8 percent compared to 25.1 percent and 27.0 percent for 1996 and 1995. Tax rate fluctuations occur as the levels of underwriting and engineering services results and realized gains change the mix of pre-tax income between fully taxable earnings and tax-preferred earnings that can be obtained by investing in certain instruments. Various tax credits (primarily foreign tax credits) also impact the effective rate. The Company continues to manage its use of tax advantageous investments to maximize after tax earnings.
In February 1997, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 128, "Earnings per Share". This statement establishes standards for computing and presenting earnings per share (EPS). It replaces the presentation of primary EPS with a presentation of basic EPS. It also requires dual presentation of basic and diluted EPS on the face of the Consolidated Statements of Operations and a reconciliation of the numerator and denominator of the basic EPS computation to the numerator and denominator of the diluted EPS computation. This statement was implemented at year end 1997. (See note 2).
At a special meeting of HSBIIC on June 23, 1997, shareholders voted to approve a proposal which enabled the formation of a new holding company, HSB Group, Inc. Shareholders of HSBIIC's common and convertible redeemable preferred stock became holders of HSB common and convertible redeemable preferred stock, respectively, through a share exchange approved by the shareholders. Certificates representing HSBIIC's common and convertible redeemable preferred stock automatically represent the corresponding shares of HSB common and convertible redeemable preferred stock. The holding company was formed in order to achieve greater operating and financial flexibility in connection with certain investments, business operations and financing activities.
On January 6, 1998, HSBIIC sold its interest in IRI to Employers Reinsurance Corporation (ERC) in accordance with a previously announced purchase and sale agreement between ERC and IRI's twenty-three member insurers. HSBIIC received gross proceeds of approximately $50 million, prior to transaction costs, for its 23.5 percent
share in IRI. Because the sale was structured in part as a reinsurance transaction, a portion of HSBIIC's gross proceeds will be utilized to reinsure in-force policies with ERC.
Contemporaneous with the close of the sale, IRI was reconstituted with ERC (with a 99.5 percent share) and HSBIIC (with a .5 percent share) as the sole members. Initially HSBIIC will write the business for the reconstituted IRI using its insurance licenses and will provide certain other services. HSBIIC will transfer its HPR manufacturing book of business to IRI and through various reinsurance arrangements with IRI/ERC will retain 85 percent of the equipment breakdown business and 15 percent of the property business of the combined insurance portfolio.
For the years ended December 31, 1997 1996 1995 - - ------------------------------------------------------------------- Gross earned premiums $ 609.3 $ 556.5 $ 455.0 Ceded premiums 118.1 107.9 65.9 -------------------------------- Insurance premiums $ 491.2 $ 448.6 $ 389.1
Insurance premiums in 1997 increased 9.5 percent from 1996. This growth is primarily attributable to the increased participation in IRI ($22.4 million) and to growth in both the domestic and global markets. The increase in 1996 was a result of the increased participation in IRI ($22.6 million) as well as growth in the global markets. It is possible
Insurance premiums representing coverage outside the U.S. increased 7.1 percent to $93.3 million from $87.1 million in 1996 and $73.3 million from 1995. In certain areas of the Company's direct domestic and international businesses, the market is experiencing price erosion. The Company will not write business at rates which would lessen its ability to maintain underwriting profit. Increases in ceded premium of 9.5 percent in 1997 were primarily due to the additional participation in IRI and the purchase of facultative reinsurance at EIL. The Company continues to see opportunities for growth, particularly in those countries where the infrastructure development is moving to the private sector. At the same time, softening of the pricing in this market has occurred globally as the number of insurers offering capacity has expanded.
Domestically, exclusive of IRI, premiums increased approximately $16.3 million, or 5.0 percent in 1997 and 3.9 percent in 1996. These increases were a combination of growth in written premiums from our client companies in 1997 and 1996 respectively, and reflects the addition of new client companies, offset by a loss of business as a result of industry consolidation. The insurance industry, in general, continues to undergo significant restructuring and consolidation. Considerable merger and acquisition activity has occurred recently and more is possible in the future. Depending on the specific companies involved in these activities and other market factors, the level of reinsured business the Company assumes in the future could be impacted. HSB is positioned to benefit from these changes over the long term due to its strong market position and reinsurance relationships with more than 100 multi-line carriers; while over the shorter term, there is both opportunity and challenge.
HSBIIC has accrued $6.5 million with respect to the other two cases for potential LAE, including legal costs to defend HSBIIC's position. One case is in the process of pre-trial summary judgment motions and appeals; the other case is involved in both arbitration and litigation proceedings. A trial date has not been set for either case. In the event that HSBIIC is held liable for one or both of the remaining claims, amounts in excess of HSBIIC's net maximum aggregate retention of $8.5 million is recoverable from reinsurers. Claim amounts potentially recoverable from reinsurers in the event of a possible adverse outcome in these cases could range, in the aggregate, from $40 million to $195 million.
For the years ended December 31, 1997 1996 1995 - - ------------------------------------------------------------------------------ Engineering services revenues $ 61.3 $ 55.8 $ 49.9 Engineering services expenses 57.0 48.5 43.2 Operating gain $ 4.3 $ 7.3 $ 6.7 -------------------------------- Engineering services margin 7.1% 13.2% 13.3% - - ------------------------------------------------------------------------------
Engineering services operations include the results of HSBIIC's and BI&I's engineering services, HSB Reliability Technologies (HSBRT), HSB Professional Loss Control, HSB International, and the Company's interest in Integrated Process Technologies, LLC.
The Company's investment strategy continues to be to maximize total return on the investment portfolio through investment income and capital appreciation. Investment strategies for any given year are developed based on many factors including operational results, tax implications, regulatory requirements, interest rates, dividends to stockholders and market conditions. The investment portfolio includes a wide variety of high quality equity securities and both domestic and foreign fixed maturities. The Company continues to manage its use of tax advantageous investments to maximize after tax investment
On December 19, 1996, HSBIIC entered into three "zero cost collar contracts" to mitigate the effects of market risk on its U.S. common stock portfolio (which, for management purposes, included certain convertible preferreds). Each contract had a notional value of $50 million and maturity dates ranging from November 1997 to January 1998. The contracts were European style, which meant they only settled upon maturity. The contracts, which were entered into when the S&P 500 Index was 744.3, allowed HSBIIC to recover from the counterparty if the index was below 695.2 at the time of maturity, and required HSBIIC to reimburse the counterparty if the index was above a range of 811.3 to 818.7 at the time of maturity.
operations during 1995 as well as the portfolio transfer arising from the increased participation in IRI during 1996. Investment income in the global market also increased as these operations have shown significant growth over the past year.
HSB's investment portfolio continues to consist of high grade domestic and foreign investments. Excluding short-term investments, HSB's investments are primarily comprised of publicly traded, highly liquid securities. At the end of 1997, HSB's fixed maturities portfolio comprised 26.1 percent of the value of the invested assets. The credit quality of HSB's bond investments at December 31, 1997, averaged a AA rating. HSB's portfolio does not include any bonds in default as to either principal or interest. Bonds held at December 31, 1997, had a fair value of $113 million. Redeemable preferred stocks averaged a BBB rating. Declining yields available on new fixed maturities relative to higher yields on maturing investments over the past few years have also moderated investment income growth.
Total assets $ 1,540.2 $ 1,116.3 Short-term investments 379.2 97.9 Cash 45.3 4.5 Short-term borrowings 42.4 3.2 Capital securities of subsidiary Trust I 108.8 -- Capital securities of subsidiary Trust II 300.0 -- Convertible redeemable preferred stock -- 20.0 Common shareholders' equity 345.3 345.6 - - --------------------------------------------------------------------------------
On July 15, 1997, HSB sold $110 million of 30 year Global Floating Rate Capital Securities (Capital Securities), in a private placement. The securities are generally non-callable for ten years, but may be called earlier by HSB upon the occurrence of certain tax events including loss of deductibility of interest on the securities. The securities were issued through HSB Capital I (Trust I), a Delaware business trust created by HSB, at a floating rate equal to 90 day LIBOR plus .91 percent. The current coupon at December 31, 1997 is 6.7 percent. Holders of the Capital Securities will be entitled to receive preferential cumulative cash distributions accumulating from the date of original issuance and payable quarterly in arrears. HSB has the right to defer payment of distributions on the securities at any time or from time to time for a period not exceeding 20 consecutive quarterly periods with respect to each deferral period. During an extension period, interest will continue to accrue and the amount of distributions to which holders of the Capital Securities are entitled will accumulate, and the Company will be prohibited from paying any cash dividends on its common stock. The Company has irrevocably and unconditionally guaranteed all of Trust I's obligations under the Capital Securities. The Company has used or may use the proceeds for general corporate purposes, including the repurchase of HSB common stock; funding investments in, or extensions of credit to, subsidiaries; repayment of maturing debt; and financing possible future acquisitions. HSB subsequently filed a registration statement covering securities with terms identical in all material respects and offered to exchange registered securities for the original Capital Securities. The exchange was completed on December 11, 1997. The floating rate Capital Securities are currently rated BBB by Standard & Poor's and BBB+ by Duff & Phelps credit rating agency.
On December 31, 1997, HSB sold $300 million of 20 year Convertible Capital Securities in a private placement to ERC. The Convertible Capital Securities are callable by HSB at its option (i) at any time after seven years; (ii) upon the occurrence of certain tax events including loss of deductibility of the interest on the securities; (iii) in the event that HSB vetoes a prospective purchaser of the Convertible Capital Securities; or (iv) in the event
of a change in control of ERC. The Convertible Capital Securities are mandatorily redeemable on December 31, 2017, and are redeemable at par plus a redemption premium, at the option of ERC, in the event of a change in control of HSB within five years following issuance of the securities.
The Convertible Capital Securities are convertible, in whole or in part, at ERC's option at any time, subject to regulatory approval, into shares of HSB common stock at a conversion price of $85, subject to adjustment. HSB has provided certain registration rights to ERC in connection with the common stock into which the Convertible Capital Securities are convertible pursuant to a Registration Rights Agreement dated December 31, 1997. Were ERC to exercise its conversion rights in total, it would hold, on a fully diluted basis, approximately 15.3 percent of HSB's common stock. Pursuant to certain provisions contained in the Purchase Agreement dated December 31, 1997, ERC has agreed to certain "standstill" arrangements which for a period of five years will preclude ERC from purchasing any common stock of HSB, other than by exercise of its conversion rights, and will limit its ability to take certain other actions with respect to HSB during that period.
The securities were issued through HSB Capital II, (Trust II), a Delaware business trust created by HSB, at a 7 percent coupon, payable semi-annually. The Convertible Capital Securities rank pari passu with the Capital Securities issued July 1997. Holders of the Convertible Capital Securities will be entitled to receive preferential cumulative cash distributions accumulating from the date of original issuance and payable semi-annually in arrears. HSB has the right to defer payment of interest at any time or from time to time for a period not exceeding 10 consecutive semi-annual periods with respect to each deferral period. During an extension period, interest will continue to accrue and the amount of distributions to which holders of the Convertible Capital Securities are entitled will accumulate, and HSB will be prohibited from paying any cash dividends on its common stock. HSB has irrevocably and unconditionally guaranteed all of Trust II's obligations under the Convertible Capital Securities.
Cash provided from operations was $26.1 million in 1997 compared to $92.9 million for 1996. Insurance operations cash flow (excluding IRI) decreased as net claims paid increased 21.8 percent compared to the same period in 1996, and premiums collected were 1.9 percent higher than last year. Payments to reinsurers for ceded premium increased approximately 17 percent in the current year. HSBIIC's participation in IRI impacted components of the Consolidated Statements of Cash Flows for 1997, including a positive impact of $1.5 million and $2.2 million for 1997 and 1996, respectively, to cash provided from operations.
Capital resources consist of shareholders' equity, convertible redeemable preferred stock, capital securities and debt outstanding, and represent those funds deployed or available to be deployed to support business operations. Common shareholders' equity of $345.3 million at December 31, 1997 decreased $0.3 million since December 31, 1996. The decrease reflects net income of $66.3 million year to date and an increase in unrealized
investment gains, net of tax, of $7.0 million, offset by dividends of $47 million and $54 million of share repurchases. Also, on October 30, 1997, the sole holder of convertible redeemable preferred stock converted into 398,406 shares of common stock, adding $20 million to common shareholders' equity.
At December 31, 1997, HSBIIC had significant short-term borrowing capacity. HSBIIC is currently authorized to issue up to $75 million of commercial paper. Commercial paper outstanding at December 31, 1997 and December 31, 1996 was $42.4 million and $3.2 million, respectively. In early January, Standard & Poor's and Duff & Phelps credit rating services reaffirmed their highest ratings for the commercial paper. HSBIIC had authorized a guaranty of up to 40 percent of Radian's $40 million credit facility with Dow. At December 31, 1997 the amount guaranteed was $14.3 million. Such guaranty terminated upon the sale of HSBIIC's interest in Radian to Dow on January 2, 1998.
Certain statements contained in this report are forward-looking and are based on management's current expectations. Actual results may differ materially from such
Consolidated Statements of Operations for the years ended December 31, 1997, 1996 and 1995. 43
Consolidated Statements of Cash Flows for the years ended December 31, 1997, 1996 and 1995. 45
To the Shareholders and Board of Directors of HSB Group, Inc., the newly formed parent of The Hartford Steam Boiler Inspection and Insurance Company:
We have audited the consolidated financial statements and the financial statement schedules of HSB Group, Inc. and its subsidiaries listed in Item 8 of this Form 10-K. These financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits.
Consolidated Statements of Changes in Shareholders' Equity - - ---------------------------------------------------------- For the years ended December 31, (in millions)
Liabilities for claims and adjustment expenses for boiler and machinery, property and other coverages represent estimated reserves on claims and adjustment expenses reported but not yet settled and the cost of claims and adjustment expenses incurred but not yet reported. Reserves for claims and adjustment expenses are undiscounted and are gross of amounts recoverable from reinsurers. Reserves are reduced for estimated amounts of salvage and subrogation and deductibles from customers. HSB records subrogation when recoverability is probable, such as when a judgment is returned, liability is admitted to or settlement is reached. The length of time that reserves for claims and adjustment expenses are carried on the Consolidated Statements of Financial Position is a function of the pay-out patterns associated with the types of coverages involved. Estimates for these reserves reflect such variables as past loss experience, changes in judicial interpretation of legal liability, policy coverage and inflation. The establishment of such reserves frequently require complex engineering judgments. Due to the nature of the variables involved in the reserving process, subjective judgments are an integral component. Previously estimated reserves are regularly adjusted as loss experience develops and new information becomes available. Since reserves are based on estimates, the ultimate liability may be more or less than such reserves. The effects of changes in estimated reserves are included in the results of operations in the period in which the estimates are changed. (See note 10).
Fixed assets are carried at cost less accumulated depreciation. Depreciation is calculated on the basis of estimated useful lives using straight-line and accelerated methods. Upon retirement or replacement, any gain or loss is included in results of operations.
The following is a reconciliation of the numerator and denominator of the calculation of basic and diluted EPS for income from continuing operations for the years ended 1997, 1996 and 1995:
On December 31, 1997, HSB sold $300 million of convertible capital securities. The securities carry a 7 percent coupon and are convertible into 3,529,411 shares. (See note 12). Due to the timing of the issuance, the securities had minimal impact on the EPS calculation in 1997, but will affect the diluted calculation in 1998.
In June 1997, FASB issued SFAS No. 130, "Reporting Comprehensive Income", which requires items that comprise comprehensive income be reported in a financial statement display with the same prominence as other financial statements. This presentation will include such items as market value adjustments of securities, foreign currency translation, and certain adjustments made for benefit plans, which are currently reported as components of the Consolidated Statements of Changes in Shareholders' Equity. This statement will be effective beginning in 1998 with retroactive restatement of prior periods required.
Also in June of 1997, FASB issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information". This standard requires companies to report financial
At a special meeting of The Hartford Steam Boiler Inspection and Insurance Company (HSBIIC) on June 23, 1997, shareholders voted to approve a proposal which enabled the formation of a new holding company, HSB Group, Inc. (HSB). Shareholders of HSBIIC's common and convertible redeemable preferred stock became holders of HSB's common and convertible redeemable preferred stock, respectively, through a share exchange approved by the shareholders. Certificates representing HSBIIC's common and convertible redeemable preferred stock automatically represent the corresponding shares of HSB common and convertible redeemable preferred stock. HSBIIC remains the principal subsidiary of HSB.
In December 1994, HSBIIC acquired the remaining 50 percent interest in Engineering Insurance Group (EIG), a partnership which was jointly formed by HSBIIC and General Reinsurance Corporation (Gen Re) in 1988. The partnership was the parent of Engineering Insurance Company Limited, a London based insurer formed in 1989 principally to offer machinery breakdown coverage to business and industry outside the United States and Canada. Coincident with the December 1994 acquisition, the partnership was incorporated with HSBIIC acquiring all outstanding common shares and Gen Re acquiring preferred shares of the new company, EIG, Co. HSBIIC had the option to request Gen Re to exchange the EIG, Co. preferred stock for HSBIIC convertible redeemable preferred stock at the end of 1996. This option was exercised on December 30, 1996 resulting in the issuance of 2,000 shares of HSBIIC convertible redeemable preferred stock. On October 30, 1997, these shares were converted into 398,406 shares of common stock of HSB. (See note 12).
owned subsidiaries of each company. At the date of the transaction, HSBIIC transferred virtually all of the assets and liabilities of Radian Corporation at historical cost to Radian. No gain was recognized on the transfer.
Revenues 288.0 229.6 202.2 Expenses 314.0 233.6 188.1 - - ---------------------------------------------------------
*Presented at 100 percent--HSBIIC's interest in Radian during these periods was 40 percent.
the equipment breakdown business and 15 percent of the property business of the combined insurance portfolio.
To support HSB's expanded role, on December 31, 1997, a business trust formed by HSB sold $300 million of 20 year Convertible Capital Securities in a private placement to ERC. These capital securities are convertible into HSB common stock, at any time, subject to regulatory approval, at a conversion price of $85. $250 million of the proceeds were contributed by HSB to HSBIIC and $50 million was retained at HSB. (See note 12).
HSB is a multi-national company operating primarily in North American, European, and Asian markets. The Company operates three principal businesses -- insurance, engineering services and investments. The Company primarily offers coverage for machinery intensive risks and provides insurance against losses from accidents to boilers, pressure vessels, and a wide variety of mechanical and electrical machinery and equipment, along with a high level of inspection services aimed at loss prevention. The Company also offers professional scientific and technical consulting for industry and government on a worldwide basis. While the principal market for insurance and engineering services is the United States, the Company continues to see growth opportunities in overseas markets.
For the years ended December 31, 1997 1996 1995 - - ------------------------------------------------------------------------------- U.S. $ 491.6 $ 444.9 $ 383.4 Non-U.S 111.8 103.9 87.3 -------------------------------------
At December 31, 1997 1996 1995 - - ------------------------------------------------------------------------------- U.S. $1,247.7 $ 858.3 $ 743.1 Non-U.S. 292.5 258.0 211.0 -------------------------------------- Total $1,540.2 $1,116.3 $ 954.1 -------------------------------------- - - -------------------------------------------------------------------------------
HSB's foreign operations (primarily insurance) are widely dispersed such that no country or logical aggregation of countries in a geographic area compromise a significant concentration with respect to either revenues or identifiable assets.
Revenues from continuing operations - - ----------------------------------- For the years ended December 31, 1997 1996 1995 - - ------------------------------------------------------------------------ Insurance premiums $ 491.2 $ 448.6 $ 389.1 Engineering services 61.3 55.8 49.9 Net investment income and realized investment gains 50.9 44.4 31.7 ------------------------------- Total $ 603.4 $ 548.8 $ 470.7 -------------------------------
HSBIIC is a Connecticut domiciled insurance company which is licensed to conduct business in all 50 states, the District of Columbia, Puerto Rico and the U.S. Virgin Islands. The annual statements for state insurance regulatory authorities are currently prepared using accounting methods prescribed or permitted by such authorities (statutory basis) and are not consolidated. Statutory accounting practices (SAP) also differ in certain other respects from GAAP. With respect to HSBIIC, these differences are primarily comprised of the accounting for prepaid acquisition costs, deferred income taxes, fixed maturity investments, valuation of certain non-insurance affiliates and employee benefit plans. At year-end 1997 and 1996, policyholders' surplus on a statutory basis was $550.8
HSBIIC is currently subject to various regulations that limit the maximum amount of dividends available to its shareholders without prior approval of insurance regulatory authorities. Under SAP, approximately $55.1 million of statutory surplus is available for distribution to HSB Group, Inc. in 1998 without prior regulatory approval.
Realized investment gains (losses): Fixed maturities: Bonds: Gains $ 0.5 $ 2.0 $ 0.7 Losses (0.3) (0.2) (1.5) ------------------------
Net gains 43.0 11.3 4.0 Non-redeemable preferred stocks: Gains 7.7 4.2 0.2 Losses (0.2) (4.0) (0.7) ------------------------ Net gains (losses) 7.5 0.2 (0.5) Foreign Exchange Losses (7.4) -- -- Collar Contracts Losses (30.7) -- -- Other Gains 1.4 -- -- ------------------------ Realized investment gains $ 14.1 $ 12.1 $ 2.8 ------------------------ ------------------------------------------------------------------------------
There were no material declines in the realizable value of investments considered to be other than temporary for 1997 or 1995. Realized investment gains and losses for 1996
included $0.8 million of losses on non-redeemable preferred stock arising from declines in the realizable value of investments considered to be other than temporary.
The amortized cost, estimated fair values (based principally upon quoted market prices) and gross unrealized gains and losses of fixed maturities at December 31, were as follows: - - -------------------------------------------------------------------------------- Estimated Gross Gross Amortized Fair Unrealized Unrealized Category Cost Value Gains Losses - - -------------------------------------------------------------------------------- Redeemable preferred stocks $ 131.2 $ 135.4 $ 4.7 $ 0.5 States and municipalities 37.6 39.7 2.2 0.1 Foreign governments 33.1 33.5 0.4 -- Corporate and other 39.2 39.8 0.6 -- ------------------------------------------- Total fixed maturities $ 241.1 $ 248.4 $ 7.9 $ 0.6 - - --------------------------------------------------------------------------------
- - -------------------------------------------------------------------------------- Estimated Gross Gross Amortized Fair Unrealized Unrealized Category Cost Value Gains Losses - - -------------------------------------------------------------------------------- Redeemable preferred stocks $ 99.6 $ 101.6 $ 3.1 $ 1.1 States and municipalities 39.4 40.7 1.6 0.3 Foreign governments 30.1 30.5 0.5 0.1 Corporate and other 62.2 63.0 0.9 0.1 ------------------------------------------- Total fixed maturities $ 231.3 $ 235.8 $ 6.1 $ 1.6 - - --------------------------------------------------------------------------------
The amortized cost and estimated fair value of fixed maturities at December 31, by contractual years-to-maturity follows. Actual maturities may differ from contractual maturities because borrowers may have the right to prepay obligations.
- - ---------------------------------------------------------------- Estimated Amortized Fair Maturity Cost Value - - ---------------------------------------------------------------- One year or less $ 13.3 $ 13.7 Over one year through five years 98.6 101.1 Over five years through ten years 32.8 34.1 Over ten years 96.4 99.5 -------------------- Total fixed maturities $ 241.1 $ 248.4 -------------------- - - ----------------------------------------------------------------
- - -------------------------------------------------------------------------------- Estimated Gross Gross Fair Unrealized Unrealized Cost Value Gains Losses - - -------------------------------------------------------------------------------- Common stocks $ 97.5 $ 179.0 $ 82.2 $ 0.7 Non-redeemable preferred stocks 133.8 144.8 12.1 1.1 ------------------------------------------ Total equity securities $ 231.3 $ 323.8 $ 94.3 $ 1.8 ------------------------------------------ - - --------------------------------------------------------------------------------
- - ------------------------------------------------------------------------------- Estimated Gross Gross Fair Unrealized Unrealized Cost Value Gains Losses - - -------------------------------------------------------------------------------
Common stocks $ 95.7 $ 168.3 $ 73.6 $ 1.0 Non-redeemable preferred stocks 87.2 94.4 8.4 1.2 ------------------------------------------ Total equity securities $ 182.9 $ 262.7 $ 82.0 $ 2.2 ------------------------------------------ - - -------------------------------------------------------------------------------
On December 19, 1996, HSBIIC entered into three "zero cost collar contracts" to mitigate the effects of market risk on its U.S. common stock portfolio (which, for management purposes, included certain convertible preferreds). Each contract had a notional value of $50 million and maturity dates ranging from November 1997 to January 1998. The contracts, which were entered into when the S&P 500 Index was 744.3, allowed HSBIIC to recover from the counterparty if the index was below 695.2 at the time of maturity, and required HSBIIC to reimburse the counterparty if the index was above a range of 811.3 to 818.7 at the time of maturity. In the fourth quarter of 1997 HSBIIC settled all of its outstanding contracts resulting in realized losses of $30.7 million for the year, all of which were offset by and represented portfolio appreciation and returns that were realized.
The Company's U.S. common stock portfolio has experienced a total return of $57 million (which includes price appreciation of approximately $54 million) since December 31, 1996, and has had a price movement correlation with the S&P 500 Index well in excess of 80 percent.
The collar subjected the Company to market and counterparty credit risk. The Company managed this exposure by frequently modeling the effects of potential future price movements on the value of the collar and HSB's portfolio and by entering into contracts
Property and equipment are stated at cost. Depreciation expense is computed using straight-line and accelerated methods over the estimated useful lives of 31.5 years for buildings and 3 to 10 years for equipment and furniture. Leasehold improvements are amortized over the shorter of the assets' life or the remaining contractual lease term.
1997 1996 1995 - - -------------------------------------------------------------------------------- Written premiums: Direct $ 361.4 $ 338.6 $ 285.3 Assumed 257.1 232.6 182.9 Ceded (120.0) (116.8) (59.9) ----------------------------------
Although the Company assumes the role of reinsurer, it continues to have selling and underwriting responsibilities as well as involvement in inspecting and claims adjusting. In effect, the Company becomes the equipment breakdown insurance department of the reinsured company and provides all equipment breakdown underwriting (that is, the examination and evaluation of the risk based on its engineering judgments), claims and engineering services as if it were part of that organization. Traditionally, as part of the underwriting process, the Company retains the right to decline or restrict coverage in the same manner as it does for its own business. In 1996 the Company began to write a simplified program (referred to as ReSource) under which a reinsured company agrees to include equipment breakdown insurance on an entire portfolio of accounts meeting specific underwriting guidelines and occupancy parameters, which the Company agrees to reinsure for equipment breakdown losses.
The insurance industry, in general, is undergoing a shakeout and consolidation. A significant amount of merger and acquisition activity has occurred recently and may continue in the future. Depending on the specific companies involved in these activities and other market factors, the level of reinsured business the Company assumes in the future could be impacted.
IRI is a voluntary joint underwriting association providing property insurance for the class of business known as Highly Protected Risks - larger manufacturing, processing, and industrial businesses which have invested in protection against loss through the use of sprinklers and other means. Effective December 1, 1996, HSBIIC increased its participation in IRI to 23.5 percent. Prior to the December 1, 1996 increase in participation, HSBIIC's interest in IRI was 14 percent. The 1996 increase resulted in HSBIIC assuming approximately $15.5 million net unearned premium reserves which have not been reflected in written premiums. Likewise in 1995, HSBIIC increased its participation from .5 percent to 14 percent resulting in the assumption of $27.9 million in the net unearned premium reserves which were also not reflected in written premiums. IRI has a fiscal year ending November 30 and provides quarterly reports to member companies of the association. As a result, HSBIIC's increases in participation were initially reflected in the first quarter financial reports for the subsequent year. Effective January 1, 1998 members of IRI sold their membership to ERC. (See note 3).
Reconciliation of Net Liability for Claims and Adjustment Expenses - - ------------------------------------------------------------------
1997 and 1996 claims and adjustment expenses incurred have been reduced by subrogation recoveries of approximately $3.3 million and $4.9 million, respectively. Subrogation recoveries applied against 1995 claims and adjustment expenses are immaterial.
The Company utilizes well-capitalized domestic and international reinsurance companies and syndicates for its reinsurance program and monitors their financial condition on an ongoing basis. For reinsurers that are not accredited in their state of domicile, the Company generally requires collateral for reinsurance recoverable from such carriers. Uncollectible reinsurance recoverables have not had, and are not expected by management to have in the future, a material adverse effect on the consolidated results of operations or financial position of the Company.
Reinsurer Ceded Written Reinsurance Asset 1997 A.M. Best's Premium Rating - - -------------------------------------------------------------------------------- General Reinsurance Corporation $38.6 $50.5 A++(Superior)
HSBIIC is involved in three arbitration or litigation proceedings regarding the extent to which certain explosion events are insured under boiler and machinery policies of HSBIIC or under the all-risk property insurance policies issued by other companies. Management believes HSBIIC's policies do not provide coverage for losses resulting from the explosion events that are the subject of these proceedings.
A lower court ruling in one of these cases held that an explosion did occur, and that HSBIIC was not liable for losses of the insured resulting from the explosion. In a further action, the court denied HSBIIC's motion for summary judgment on certain issues, thus leaving HSBIIC potentially liable for certain unqualified losses resulting from events prior to the explosion. In the first quarter of 1997, HSBIIC and the property insurer jointly settled the case with the insured. HSBIIC's ultimate share of the settlement will be determined in an arbitration proceeding with the property insurer. HSBIIC has incurred gross losses and loss adjustment expenses (LAE) of $40.7 million and a net loss after taking into account reinsurance recoverables of $6.5 million, of which $5 million represents claim costs and the remaining $1.5 million represents LAE. As a result of payments made to date, at December 31, 1997, HSBIIC carried gross loss and LAE reserves of $2.8 million and recoverables from reinsurers of $2.8 million.
1997 1996 - - -------------------------------------------------------------------------------- Deferred tax liabilities: Prepaid acquisition costs $ (13.2) $ (11.8) Accelerated depreciation (0.3) (2.0) Pension asset (13.3) (11.9) Unrealized investment gains (35.4) (28.6) Other (12.6) (12.7) --------------------- Total deferred tax liabilities (74.8) (67.0) --------------------- Deferred tax assets: Benefit plans 9.0 9.6 Capital lease 4.4 4.1 Unearned insurance premiums 15.0 14.0 Loss reserve discounting 5.9 6.5 Other 9.0 9.1 --------------------- Total deferred tax assets 43.3 43.3 --------------------- Net deferred tax liabilities $ (31.5) $ (23.7) --------------------- - - --------------------------------------------------------------------------------
HSB's capital structure is as follows: 1997 1996 - - --------------------------------------------------------------------------- Short-term borrowings $ 42.4 $ 3.2 Long-term borrowings * $ 25.1 $ 25.1 Convertible redeemable preferred stock -- $ 20.0 Company obligated mandatorily redeemable capital securities of subsidiary Trust I holding solely junior subordinated deferrable interest debenture of the Company $ 108.9 -- Company obligated mandatorily redeemable convertible capital securities of subsidiary Trust II holding solely junior subordinated deferrable interest debenture of the Company $ 300.0 -- Common shareholders' equity $ 345.3 $ 345.6 - - ---------------------------------------------------------------------------- *Excludes capital lease. (See note 8).
issued through HSB Capital I (Trust I), a Delaware business trust created by HSB, at a floating rate tied to 90 day LIBOR. The current coupon is 6.7 percent. Holders of the Capital Securities will be entitled to receive preferential cumulative cash distributions accumulating from the date of original issuance and payable quarterly in arrears. HSB has the right to defer payment of distributions on the securities at any time or from time to time for a period not exceeding 20 consecutive quarterly periods with respect to each deferral period. During an extension period, interest will continue to accrue and the amount of distributions to which holders of the Capital Securities are entitled will accumulate, and HSB will be prohibited from paying any cash dividends on its common stock. HSB has irrevocably and unconditionally guaranteed all of Trust I's obligations under the Capital Securities. The Company has used or may use the proceeds for general corporate purposes, including the repurchase of HSB common stock; funding investments in, or extensions of credit to, subsidiaries; repayment of maturing debt; and financing possible future acquisitions. HSB subsequently filed a registration statement covering securities with terms identical in all material respects and offered to exchange registered securities for the original Capital Securities. The exchange was completed on December 11, 1997.
On December 31, 1997, HSB sold $300 million of 20 year Convertible Capital Securities in a private placement to ERC. The Convertible Capital Securities are callable by the Company at its option (i) at any time after seven years; (ii) upon the occurrence of certain tax events including loss of deductibility of the interest on the securities; (iii) in the event that the Company vetoes a prospective purchaser of the Convertible Capital Securities; or (iv) in the event of a change in control of ERC. The Convertible Capital Securities are mandatorily redeemable on December 31, 2017, and are redeemable at par plus a redemption premium, at the option of ERC, in the event of a change in control of the Company within five years following issuance of the securities.
The Connecticut Business Corporation Act, which became effective on January 1, 1997, eliminated the concept of treasury shares. Therefore, shares reacquired by the Company constitute authorized but unissued shares. As a result of this change in law, the Company eliminated the caption Treasury Stock from its balance sheet and reclassified the amounts as reductions to additional paid-in capital and retained earnings. These amounts were $85.9 and $59.5 million as of December 31, 1997 and 1996, respectively. The reclassifications were distributed as follows:
1997 1996 1995 - - ------------------------------------------------------------------------- Discount rate 7.25% 7.5% 7.5% Long-term rate of return on assets 10.00% 9.5% 9.5% Rate of increase in future compensation levels 4.50% 4.5% 5.0% - - -------------------------------------------------------------------------
The Company makes available health care and life insurance benefits for retired employees of the Company and certain subsidiaries.
The following table sets forth the amounts recognized in the Consolidated Statements of Financial Position at December 31, in accordance with SFAS No. 106, "Employers Accounting for Postretirement Benefits Other Than Pensions".
1997 1996 - - ---------------------------------------------------------------- Weighted average discount rate 7.25% 7.5% Current year health care cost trend rate 7.00% 8.0% Ultimate health care cost trend rate 4.50% 4.5% - - ----------------------------------------------------------------
For measurement purposes, the annual rate of increase in the per capita cost of covered health care benefits ranges from 7 percent in 1997 decreasing gradually to 4.5 percent by the year 2001 and remaining level thereafter.
A stock option award under HSB's stock option plan allows for the purchase of HSB common stock at no less than the market price on the date of grant. Options granted to date are exercisable no earlier than one year after the grant date and expire no more than ten years from the date of grant.
A summary of the status of HSB's stock options as of December 31, 1997, 1996 and 1995 and changes during the years ended on those dates is presented below:
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF HSB GROUP, INC. CONDENSED STATEMENT OF INCOME INFORMATION
Distributions on capital securities of subsidiary trusts, net of income taxes of $1.2 2.3 ------------
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF HSB GROUP, INC. BALANCE SHEET INFORMATION December 31, 1997 (In millions)
Company obligated mandatorily redeemable capital 108.9 securities of subsidiary Trust I holding solely junior subordinated deferrable interest debentures of the Company, net of unamortized discount of $1.1
Shareholders' Equity Common stock 10.0 Paid in capital 31.6 Unrealized investment gains, net of tax 59.8 Retained earnings 248.8 Benefit plans (4.9) ---------------
Operating Activities: Net income $ 34.0 Undistributed earnings of subsidiary (21.2) Increase in other assets (26.2) Increase in other liabilities 14.3
Investing Activities: Purchase of short-term investments, net (60.5) Purchase of fixed maturities (11.8) Purchase of equity securities (27.0) Contribution to subsidiaries (279.5)
Financing Activities: Dividends paid to shareholders (11.9) Net proceeds from issuance of company obligated 408.9 manditorily redeemable capital securities Options Exercised 5.5 Reacquisition of Stock (36.5) Other 12.6