The Company's principal and executive offices are located in Houston, Texas, in an approximately 51,000 square foot building owned by HC. HC also owns an 77,000 square foot building, acquired in 1998, adjacent to its home office building. The Company also maintains sales and administration offices or other facilities in over 40 locations elsewhere in the United States and in England. The majority of these additional locations are in leased facilities.
(1) These amounts have been adjusted to reflect the effects of the five-for-two stock split payable as a 150% stock dividend to shareholders of record April 30, 1996.
THIS REPORT ON FORM 10-K (THIS "REPORT") CONTAINS CERTAIN FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933, AS AMENDED, AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED, WHICH ARE INTENDED TO BE COVERED BY THE SAFE HARBORS CREATED THEREBY. INVESTORS ARE CAUTIONED THAT ALL FORWARD-LOOKING STATEMENTS NECESSARILY INVOLVE RISKS AND UNCERTAINTY, INCLUDING, WITHOUT LIMITATION, THE RISK OF A SIGNIFICANT NATURAL DISASTER, THE INABILITY OF THE COMPANY TO REINSURE CERTAIN RISKS, THE ADEQUACY OF ITS LOSS RESERVES, THE FINANCIAL VIABILITY OF REINSURERS, THE EXPANSION OR CONTRACTION IN ITS VARIOUS LINES OF BUSINESS, THE IMPACT OF INFLATION, THE IMPACT OF POTENTIAL YEAR 2000 INSURANCE COVERAGE ISSUES, CHANGING LICENSING REQUIREMENTS AND REGULATIONS IN THE UNITED STATES AND IN FOREIGN COUNTRIES, THE ABILITY OF THE COMPANY TO INTEGRATE ITS RECENTLY ACQUIRED BUSINESSES, THE EFFECT OF PENDING OR FUTURE ACQUISITIONS AS WELL AS ACQUISITIONS WHICH HAVE RECENTLY BEEN CONSUMMATED, GENERAL MARKET CONDITIONS, COMPETITION, LICENSING AND PRICING. ALL STATEMENTS, OTHER THAN STATEMENTS OF HISTORICAL FACTS, INCLUDED OR INCORPORATED BY REFERENCE IN THIS REPORT THAT ADDRESS ACTIVITIES, EVENTS OR DEVELOPMENTS THAT THE COMPANY EXPECTS OR ANTICIPATES WILL OR MAY OCCUR IN THE FUTURE, INCLUDING, WITHOUT LIMITATION, SUCH THINGS AS FUTURE CAPITAL EXPENDITURES (INCLUDING THE AMOUNT AND NATURE THEREOF), BUSINESS STRATEGY AND MEASURES TO IMPLEMENT SUCH STRATEGY, COMPETITIVE STRENGTHS, GOALS, EXPANSION AND GROWTH OF THE COMPANY'S BUSINESSES AND OPERATIONS, PLANS, REFERENCES TO FUTURE SUCCESS, AS WELL AS OTHER STATEMENTS WHICH INCLUDE WORDS SUCH AS "ANTICIPATE,", "BELIEVE", "ESTIMATE", "EXPECT", "INTEND", "PLAN", "PROBABLY" AND OTHER SIMILAR EXPRESSIONS, CONSTITUTE FORWARD-LOOKING STATEMENTS. ALTHOUGH THE COMPANY BELIEVES THAT THE ASSUMPTIONS UNDERLYING THE FORWARD-LOOKING STATEMENTS CONTAINED HEREIN ARE REASONABLE, ANY OF THE ASSUMPTIONS COULD OVER TIME PROVE TO BE INACCURATE AND THEREFORE, THERE CAN BE NO ASSURANCE THAT THE FORWARD-LOOKING STATEMENTS INCLUDED IN THIS REPORT WILL THEMSELVES PROVE TO BE ACCURATE. IN LIGHT OF THE SIGNIFICANT UNCERTAINTIES INHERENT IN THE FORWARD-LOOKING STATEMENTS INCLUDED HEREIN, THE INCLUSION OF SUCH INFORMATION SHOULD NOT BE REGARDED AS A REPRESENTATION BY THE COMPANY OR ANY OTHER PERSON THAT THE OBJECTIVES AND PLANS OF THE COMPANY WILL BE ACHIEVED.
YEAR END DECEMBER 31, 1999 VERSUS YEAR END DECEMBER 31, 1998
Total revenue increased 11% to $341.9 million in 1999, from $308.0 million in 1998. The revenue increase was principally a result of increases in non-risk bearing management fees and commission income. This growth is from new business and acquisitions. It is anticipated that revenue from the insurance company subsidiaries will begin to grow in 2000 as earned premium and investment income begin to rise as a result of higher retentions and cash flow from increased gross written premium.
Net realized investment losses from sales or write-downs of equity securities were $3.9 million in 1999, compared to losses of $166,000 in 1998. In 1999, the Company recognized a $4.3 million realized loss from the write down of one equity investment to its estimated fair market value based upon market quotations and a sale expectation. Net realized investment losses from disposition of fixed income securities were $164,000 in 1999, compared to gains of $1.0 million in 1998. The losses in 1999 resulted from the sale of bonds by HC in connection with the funding of the Centris acquisition.
Interest expense was $13.0 million for 1999, an increase of $6.9 million from 1998. The increase is a result of increased debt outstanding as a result of fundings for acquisitions.
Income tax expense was $12.3 million in 1999 compared to $35.2 million in 1998. The decrease was due to the reduction in earnings before income tax. The effective tax rates for both years were approximately the same. The effective tax rate is expected to increase in 2000 as a result of increased goodwill amortization which is not deductible for tax purposes, higher state income taxes and foreign taxes for which credit against United States taxes may be limited. The increased state income taxes result from expected increased income from intermediaries and brokers subject to state income taxes as well as an expected increase in income in states with higher income tax rates.
Net earnings in 1999 decreased to $25.1 million from $72.3 million in 1998, due to the provision for reinsurance, which equated to $28.3 million after income taxes, or $0.57 per diluted share, the higher net loss ratio and the restructuring expense, which, after income taxes, amounted to $0.07 per diluted share. Diluted earnings per share decreased to $0.51 per share from $1.48 per share during the same period.
GWP increased 14% to $568.3 million in 1999, from $498.3 million in 1998. Accident and health reinsurance, medical stop-loss and workers' compensation premium showed strong growth, as the insurance company subsidiaries continue to participate in more of the business written by underwriting agency subsidiaries. This growth was partially offset by reductions in property and offshore energy premium as a result of the continuing extremely soft conditions in these markets. NWP in 1999 increased 15% to $139.9 million from $121.9 million in 1998, as a result of increases in retained aviation and medical stop-loss premium. Net earned premium in 1999 decreased slightly to $141.4 million from $143.1 million in 1998 as changes in earned premium lag behind changes in written premium. It is anticipated that NWP will rise during 2000, as the insurance company subsidiaries begin to increase retentions as rates start to improve.
Policy acquisition costs, which are net of ceding commissions on reinsurance ceded, decreased $2.8 million to $8.2 million in 1999, from $11.0 million in 1998, reflecting a greater amount of gross premium ceded and, therefore, a higher level of ceding commissions.
Net earnings of the underwriting agencies decreased to $17.2 million in 1999, from $19.4 million in 1998. Recent acquisitions have not yet had a positive impact on net earnings due to licensing and other regulatory requirements, which are in process. In addition, the underwriting agency segment incurred a $1.4 million, net of income tax, restructuring expense in 1999. Growth in underwriting agency premium has a positive impact on both the insurance company segment and the intermediary segment.
Other operating revenue increased 28% to $28.5 million in 1999, from $22.3 million in 1998. There was a general increase in revenue of the service operations, net of the decrease in revenue related to operations disposed of in late 1998. Other operating net earnings increased to $7.6 million in 1999, from $4.8 million in 1998 due principally to the higher earnings of the service operations. Period to period comparisons may vary substantially depending on activity in the purchase or disposition of strategic investments.
Total revenue increased 10% to $308.0 million in 1998 from $280.3 million in 1997. The revenue growth resulted from increases in non-risk bearing management fees, commission income, and other
Net realized investment losses from sales of equity securities were $166,000 in 1998, compared to losses of $154,000 in 1997. Net realized investment gains from disposition of fixed income securities were $1.0 million in 1998, compared to losses of $174,000 in 1997. The gains in 1998 resulted principally from the sale of bonds upon the liquidation of a subsidiary.
Compensation expense increased $4.6 million or 9% in 1998 to $56.1 million due to the increase in personnel resulting from acquisitions completed during 1998, along with an increase in management personnel hired to oversee the integration of the Company's many acquisitions.
Other operating expense increased 14% to $36.1 million in 1998. These expenses reflect increased expenditures required to meet the overall growth in business and from acquisitions. Currency conversion gains amounted to $219,000 in 1998, compared to losses of $884,000 in 1997.
Operating earnings for 1998 were impacted by Hurricanes Georges and Mitch. The gross loss from these hurricanes amounted to more than $50.0 million before reinsurance, with Georges being the largest catastrophe loss ever incurred by the Company. The net retained loss after reinsurance and taxes was $3.8 million, or $0.08 per share. This catastrophe further demonstrates how the Company's conservative reinsurance philosophy protects shareholders' equity and limits the impact of a major catastrophe loss.
Loss and LAE decreased $5.2 million in 1998, to $91.3 million, reflecting the increased use of reinsurance, despite the catastrophe loss in 1998 from the hurricanes Georges and Mitch. Excluding the effect of the catastrophe loss in 1998 and AIC's reserve strengthening in 1997, loss and LAE decreased $692,000 and the Company's GAAP loss ratio increased to 60.0% in 1998 from 53.2% in 1997. Including these effects, the Company's GAAP loss ratio increased to 63.8% for 1998 from 59.4% in 1997. Both increases reflect the higher incurred losses and LAE on substantially lower earned premium in 1998 when compared to 1997. Additionally, the increased loss ratios reflect a general deterioration in pricing in 1998 coupled with a higher frequency of attritional losses. The Company's insurance company subsidiaries statutory combined ratio was 82.9% for 1998 compared to 78.8% for 1997.
Policy acquisition costs, which are net of ceding commissions on reinsurance ceded, decreased $2.6 million to $11.0 million in 1998, from $13.6 million in 1997, reflecting a greater amount of gross premium ceded and, therefore, a higher level of ceding commissions.
On December 17, 1999, the Company entered into a Loan Agreement (the "Facility") with a group of banks. The Facility includes a $300.0 million Revolving Loan Facility. Borrowing under the Facility may be made from time to time by the Company for general corporate purposes until the Facility's expiration on December 18, 2004. Outstanding advances under the Facility bear interest at agreed upon rates. The Facility is collateralized in part by the pledge of the stock of HC, HCCL, AIC and USSIC and by the pledge of stock and guarantees entered into by the Company's principal underwriting agency and intermediary subsidiaries. The Facility agreement contains certain restrictive covenants, including, without limitation, minimum net worth requirements for the Company and certain subsidiaries, restrictions on certain extraordinary corporate actions, notice requirements for certain material occurrences, and required maintenance of specified financial ratios. Management believes that the restrictive covenants and other obligations of the Company which are contained in the Facility agreement are typical for financing arrangements comparable to the Facility. The initial funding available under the Facility was used, among other things, to refinance existing indebtedness of the Company including all outstanding indebtedness under the Company's $150.0 million Revolving Credit Facility and $100.0 million Short-term Revolving Loan Facility entered into as of March 8, 1999 which has been terminated, and to partially fund the Centris acquisition. As of December 31, 1999, total debt outstanding under the Facility was $235.0 million. Unrelated to the Facility, in December, 1999, the Company entered into an $80.0 million bridge loan with a bank in connection with the Centris acquisition. The full amount of the bridge loan was repaid prior to December 31, 1999, immediately following the Centris acquisition.
HCCL is limited by the State of Indiana in the amount of dividends it may pay in any twelve month period, without prior regulatory approval, to the greater of net gain from operations for the prior calendar
year or ten percent (10%) of statutory capital and surplus as of the prior year end. During 2000, HCCL's ordinary dividend capacity will be approximately $7.0 million.
The Company believes that its operating cash flows, short-term investments and the Facility will provide sufficient sources of liquidity to meet its anticipated needs for the foreseeable future.
The value of the Company's portfolio of fixed income securities is inversely correlated to changes in market interest rates. In addition, some of the Company's fixed income securities have call or prepayment options. This could subject the Company to reinvestment risk should interest rates fall or issuers call their securities and the Company reinvests the proceeds at lower interest rates. The Company mitigates this risk by investing in securities with varied maturity dates, so that only a portion of the portfolio will mature at any point in time.
A significant portion of the Company's revenue is related to healthcare insurance and reinsurance products which are subject to the effects of the underlying inflation of medical costs. Such inflation in the costs of healthcare tends to generate increases in premiums for medical stop-loss coverage, resulting in greater revenue, but also higher claim payments. Inflation may have a negative impact on insurance and reinsurance operations by causing higher claim settlements than may originally have been estimated without an immediate increase in premiums to a level necessary to maintain profit margins. No express
Statement of Financial Accounting Standards ("SFAS") No. 133 entitled "Accounting for Derivative Instruments and Hedging Activities" was issued in June, 1998 and is now effective for all fiscal quarters of fiscal years beginning after June 15, 2000, with early adoption permitted. The Company has utilized derivatives or hedging strategies only infrequently in the past and in immaterial amounts, although it is currently using derivatives and hedging strategies to a greater extent as it expands its foreign operations. The effects of SFAS No. 133, as well as the timing of its adoption, are currently being reviewed by management.
The Year 2000 issue is the result of date coding within computer programs that were written using just two digits rather than four digits to define the applicable year. If not corrected, these date codes could cause computers to fail to calculate dates beyond 1999 and, as a result, computer applications could fail or create erroneous information as a result of the Year 2000 date change. The Company's expenditures in
Although the Company experienced no material system failures attributed to the Year 2000 changeover, the Company may have exposure in the property and casualty operations of its insurance company subsidiaries to claims asserted under certain insurance policies for damages caused by an insured's failure to address its own Year 2000 computer problems. As with other companies in the insurance industry, the Company has evaluated and continues to evaluate the potential Year 2000 insurance exposures. The Company's insurance company subsidiaries did not generally offer policies of insurance marketed as Year 2000 liability coverage. However, due to the nature of certain of the policies, such as policies of property insurance, insureds may submit purported claims for coverage under such policies which may result from Year 2000 related causes. In this regard, the Company continues to assess appropriate responses to such attempted claims in light of Year 2000 coverage issues under the insurance coverages offered by such subsidiaries. The nature of the Company's response to such attempted claims are generally dependent on the particular facts and circumstances of the underlying claims and coverage. Management does not believe that Year 2000 coverage issues associated with the insurance coverages offered by the Company's insurance company subsidiaries will have a material adverse effect on the Company's results of operations.