(b) 1995 excludes minority interest and goodwill related to EIG, Co. 1994 Combined ratio excludes charge for Proposition 103.
(c) See note 4 to Notes to Consolidated Financial Statements in Item 8 of Part II herein regarding EIG, Co. consolidation.
Consolidated Statements of Operations for the years ended December 31, 1995, 1994 and 1993.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (in millions, except per share amounts)
The accompanying financial statements present the consolidated accounts of The Hartford Steam Boiler Inspection and Insurance Company and its subsidiaries (collectively, the Company) and are prepared in accordance with generally accepted accounting principles (GAAP). Significant intercompany transactions and balances have been eliminated in consolidation. The preparation of financial statements in accordance with GAAP requires the use of estimates in reporting certain assets and liabilities. Actual results could differ from those estimates.
Insurance premium revenues are net of reinsurance ceded and are generally earned on a pro rata basis over the contract period. The portion of gross insurance premiums not earned at the end of the period is recorded as unearned insurance premiums on the Consolidated Statements of Financial Position. Unearned ceded premiums are included in other assets on the Consolidated Statements of Financial Position.
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 recoverable from customers. 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, and 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 12.) The Company records subrogation when recoverability is probable, such as when a judgment is returned, liability is admitted to or settlement is reached.
The Company recognizes the majority of its engineering services revenues as the service is provided, net of related subcontract costs of $28.8, $21.5 and $24.6 million in 1995, 1994 and 1993, respectively. Generally, revenues from contracts are recognized on the percentage-of-completion method; costs on such contracts are included in operations as incurred. Provisions are made for losses on contracts at the time such losses become known.
Investment income is net of investment expenses. Realized investment gains and losses are determined on the basis of costs related to those investments sold and are recorded on the trade date. Also included in realized investment gains and losses are losses arising from declines in the realizable value of investments considered to be other than temporary. Unrealized gains and losses on investments classified as available for sale and foreign exchange gains and losses on certain investments in foreign operations are included net of income tax in Shareholders' equity.
Goodwill is generally amortized over 15 years and other intangible assets over their estimated useful lives. These assets are included in other assets on the Consolidated Statements of Financial Position and amounted to $21.5 and $22.9 million at December 31, 1995 and 1994, respectively. The Company evaluates the realizability of goodwill based upon projections of undiscounted cash flows.
In January 1996, HSB and The Dow Chemical Company (Dow) formed a new company, Radian International LLC (Limited Liability Company), which will provide environmental, information technology, and strategic chemical management services to industries and governments worldwide. According to the terms of the agreement, the ownership of Radian International LLC initially will be 60 percent Dow and 40 percent HSB, via the wholly owned subsidiaries of each company. Income will be subject to a preference return to HSB in the first two years. As is customary in joint ventures, the agreements between HSB and Dow specify certain circumstances under which the business can be sold, venture assets and liabilities can be distributed or partners' interests can be sold subject to certain rights of first refusal.
In 1995, the Company derived approximately 13 percent of its total revenues from engineering services contracts with various agencies and departments of the U.S. government.
*Includes $100.9 million resulting from consolidation of EIG, Co. (See note 4.)
HSB 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). Statutory accounting practices (SAP) differ in certain respects from GAAP. With respect to the Company's financial statements, 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 1995 and 1994, policyholders' surplus on a statutory basis was $280.6 and $238.0 million, respectively. Statutory net income, adjusted to include the earnings of all HSB domestic insurance subsidiaries for 1995, 1994 and 1993 was $66.7, $40.1 and $20.1 million, respectively.
The Company is currently subject to various regulations that limit the maximum amount of dividends available to shareholders without prior approval of insurance regulatory authorities. Under SAP, $65.3 million of statutory surplus is available for distribution to shareholders in 1996 without prior regulatory approval.
The NAIC is currently working on a model investment law that would provide guidelines for insurers in structuring their investment portfolios. These guidelines are intended to preserve principal, assure diversification as to investment, issuer and credit quality, and promote prudent investment management strategies to ensure companies are positioned to cover reasonably foreseeable contingencies. The guidelines are expected to be issued during 1996 for adoption by the states.
Regulator concerns about the consistency and comparability of SAP has prompted the NAIC to undertake a codification project that will replace prescribed or permitted SAP as the regulatory basis of accounting for insurance companies. Conversion to new statutory accounting standards is expected to be effective sometime after 1996.
Realized investment gains and losses for 1994 included $1.5 million of losses on common stocks arising from declines in the realizable value of investments considered to be other than temporary. There were no material declines in the realizable value of investments considered to be other than temporary for 1995.
The amortized cost and estimated fair value of fixed maturities at December 31, by contractual years-to-maturity follow. Actual maturities will differ from contractual maturities because borrowers may have the right to prepay obligations.
The Company writes direct business through agencies and brokerage firms. In addition, the Company assumes boiler and machinery business through treaty and facultative reinsurance with over 100 insurance companies and several insurance pools. A significant amount of this assumed book is underwritten by the Company. The insurance industry, in general, is undergoing a significant shakeout and consolidation. Considerable merger and acquisition activity has occurred recently and more is anticipated 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.
As a property insurer, the Company is subject to losses that may arise from catastrophic events. The Company participates in various facultative, quota share and excess of loss reinsurance agreements to limit its exposure, particularly to catastrophic losses, and to provide additional capacity to write business. In the unlikely event that ceded reinsurers are unable to meet their obligations, the Company would continue to have primary liability to policyholders for losses incurred. Reinsurance recoverable on unpaid claims and the unearned portion of ceded reinsurance premiums are reported as assets, rather than netted against the related liability accounts. The Company is not party to any contracts that do not comply with the risk transfer provisions of SFAS 113. The Company recorded $18.5 and $31.0 million of reinsurance recoveries as a reduction of its claims and adjustment expenses during the years 1995 and 1994, respectively. Reinsurance recoverable on paid claims and adjustment expenses was $2.5 and $6.8 million at December 31, 1995 and 1994, respectively.
Effective December 1, 1995 the Company increased its participation in Industrial Risk Insurers (IRI) from approximately .5 percent to 14 percent. 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. IRI has a fiscal year ending November 30, and provides quarterly reports to member companies of the association. As a result, HSB's increased participation will initially be reflected in the first quarter financial reports for 1996.
The 1993 claims and adjustment expenses included adverse development of prior years' reserves. The adverse development of the 1992 year-end reserves was attributable to the settlement of certain large losses for which the Company initially determined it would not have liability, the settlement of some outstanding claims for more than was originally anticipated, unusually late notice of loss provided by the insured for several large losses, and reserves established for losses on which the coverage is being contested.
In 1993 the Company enhanced the evaluation techniques used in its reserving process. This process resulted in significant reserve strengthening in that year. The re-estimation of the 1993 reserve at December 31, 1994 resulted in an increase in the reserve estimate of less than 1 percent of the consolidated reserve balance.
A reconciliation of income taxes (benefit) at U.S. statutory rates to the income taxes (benefit) as reported is as follows:
Deferred income taxes reflect the net tax effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Components of the Company's deferred tax liabilities and assets as of December 31, 1995 and 1994 are as follows:
The Company leases its home office facility at One State Street under a long-term capital lease with the One State Street Limited Partnership. The lease obligation of $26.1 million was recorded at July 1, 1983 at an interest rate of 15 percent. Accumulated amortization was $9.3 and $8.6 million at December 31, 1995 and 1994, respectively. Terms of the lease require annual payments of approximately $4 million a year through June 30, 2018. In addition, the Company is required to pay over the lease term a proportional share of the facilities variable operating expenses. This amounted to approximately $2.8, $2.8 and $2.9 million for the years ended 1995, 1994 and 1993, respectively.
The Company owns the One State Street land and leases it to the One State Street Limited Partnership. The Company receives a base rental for the land and a participation in the cash flow of the Partnership. The Company has a right of first refusal should the Partnership decide to sell the facility. If the Company does not exercise its right of first refusal, it will receive 65 percent of the net sale proceeds.
Long-term debt at December 31, 1995 included $25.0 million of senior notes due May 15, 2000 at an interest rate of 6.83 percent. Long-term borrowings mature on or before December 31, 2001.
The Company maintains various types of pension plans covering employees of HSB and certain affiliates. The plans are non- contributory and benefits are based upon an employee's years of service and final average pay based upon the highest three out of five years. Vesting occurs after five years of service in compliance with the provisions of the Tax Reform Act of 1986. The Company's funding policy is to contribute an amount necessary to satisfy the minimum requirements under the Employee Retirement Income Security Act of 1974 and the Internal Revenue Code, plus such additional amounts as the Company determines appropriate. Assets available for plan benefits include approximately $16.8 million of Company stock at December 31, 1995.
The pension expense for the U.S. pension plans was a net credit to earnings for 1995, 1994 and 1993 due to the over funded status of the primary plan. The components of the credit were as follows:
The Company periodically amends the plan, changing the contribution rate of retirees and amounts of coverage.
The health care cost trend rate assumption has a significant effect on the amount reported. To illustrate, increasing the assumed health care cost trend rates by 1 percent each year would increase the accumulated postretirement benefit obligation as of January 1, 1995 of $27.2 million by approximately $1.6 million and the aggregate of the service and interest cost for the year ended December 31, 1995 by $.l million.
The Company has a Stock Option Plan under which key employees of the Company and its subsidiaries may be granted restricted stock and stock options.
The Company's restricted stock is an award of common shares that may not be sold or transferred during the restriction period, usually three years, from the date on which the award is granted. During the restriction period, the employee is the registered owner, receives dividends and may vote the restricted shares. Compensation expense is based on the market value of the Company's common stock at the date of grant and is recognized over the period of the restriction. Compensation expense for this plan in 1995, 1994, and 1993 was $1.1, $2.2 and $3.3 million, respectively. The unamortized compensation expense related to this plan is included in Benefit plans as a component of Shareholders' equity. These amounts were $.7 and $1.4 million in 1995 and 1994, respectively.
The Company has an Employee Stock Ownership Plan (ESOP) which is administered through The Hartford Steam Boiler Inspection and Insurance Company Leveraged Employee Stock Ownership Plan Trust. The final allocation of approximately 86,000 shares will be distributed to employees before January 31, 1996 in accordance with the Plan. ESOP expense was $1.5, $1.9 and $1.6 million for the years ended December 31, 1995, 1994 and 1993, respectively.
The rights entitle holders to purchase preferred shares at an exercise price of $110 per share. If an acquirer obtains 20 percent or more of the Company's common stock and the Board of Directors determines that such acquisition is not in the best interest of the shareholders, the rights will entitle holders to purchase common shares of the Company at a discount. If the Company is involved in a merger or other transactions in which shares are exchanged, the rights will entitle holders to purchase common shares of the acquirer at a discount.
The rights expire on November 28, 1998 and may be redeemed by the Company for $.01 per right any time until the tenth business day following public announcement that a 20 percent position has been acquired.
Schedule IV The Hartford Steam Boiler Inspection and Insurance Company Reinsurance (in millions)