Principal office facilities of the Company, other than HC's owned facilities, are as follows:
(3) Book value per share is calculated by dividing shares outstanding into total shareholders' equity. Net tangible book value per share uses total shareholders' equity less goodwill as the numerator.
(4) Certain amounts in the 1997, 1996, 1995 and 1994 selected consolidated financial data have been reclassified to conform to the 1998 presentation. Such reclassifications had no effect on the Company's net earnings, shareholders' equity, or cash flows.
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 YEAR 2000 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 INCLUDES WORDS SUCH AS "ANTICIPATE", "BELIEVE", "PLAN", "ESTIMATE", "EXPECT", AND "INTEND" 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.
The Company's primary sources of revenue are earned premium and investment income derived from its insurance company operations, management fees generated from its underwriting agency operations, commission income produced by its intermediary operations and other operating income. The Company's core underwriting activities involve providing aviation, marine, offshore energy, property, medical stop-loss, accident and health, workers' compensation and lenders' single interest insurance, which is underwritten on both a direct and a reinsurance basis, marketed directly by the Company and produced by independent agents. Many of the Company's lines of business have relatively short lead times between the occurrence of an insured event and the reporting of claims to the Company.
The Company's underwriting agency operations underwrite domestic general aviation, medical stop-loss, occupational accident, workers' compensation, accident and health insurance and reinsurance business.
Operations whose revenue are included in other operating income consist of insurance services operations which may support the Company's operations as well as service unaffiliated customers. Additionally, this revenue includes revenue from strategic operational investments and gains and losses from their disposition. The Company may make such strategic operational investments from time to time, generally in businesses that complement the Company's operations.
The following table sets forth certain premium revenue information for the three years ended December 31, 1998 (dollars in thousands):
YEAR ENDED DECEMBER 31, 1998 VERSUS YEAR ENDED DECEMBER 31, 1997
Total revenue increased 10% to $308.0 million in 1998 from $280.3 million in 1997. GWP increased 44% to $498.3 million in 1998 from $346.4 million in 1997, due primarily to increased aviation, property and accident and health premium. NWP for 1998 decreased to $121.9 million from $142.9 million in 1997, due to an increase in the amount of ceded reinsurance. Net earned premium decreased to $143.1 million in 1998 compared to $162.6 million in 1997 reflecting the reduction in NWP and the reduced retentions of the Company. Management expects GWP to increase significantly during 1999 primarily due to internal growth as the Company's underwriting agency subsidiaries transfer business from non-affiliated insurance companies to the Company's insurance company subsidiaries. NWP will increase also, due to the increase in GWP, although at a lower rate due to the continued low retention of risk. Net earned premium is expected to decrease slightly in 1999, irrespective of the expected increase in NWP, due to decreased retentions in 1998 which affect 1999 earned premium.
Management fees in 1998 increased 45% to $74.0 million from $51.0 million in 1997, reflecting internal growth and the acquisition of several underwriting agencies during the period. The Company expects management fees to continue to increase substantially during 1999 due to the effects of recent and future acquisitions and internal growth.
Commission income increased to $38.4 million in 1998 from $24.2 million in 1997 an increase of 59%. The increase is a result of internal growth and a number of large transactions. Commission income is expected to grow in 1999, primarily as a result of the acquisition of RML in January, 1999.
Net realized investment losses from sales of equity securities were $166,000 during 1998, compared to losses of $154,000 in 1997. Net realized investment gains from disposition of fixed income securities were $1.0 million during 1998, compared to losses of $174,000 in 1997. The gains in 1998 resulted principally from the sale of bonds upon the liquidation of IMG.
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. To further mitigate against subsequent catastrophes, the Company currently maintains lower retentions and anticipates further reductions in overall catastrophe exposure in the future.
expects the increase in AIC's loss reserves to be adequate to cover any subsequent adverse development of AIC's prior losses.
Merger expense represents non-recurring items incurred to consummate the acquisitions and mergers which are accounted for as pooling-of-interests.
Management fees in 1997 increased 78% to $51.0 million from $28.7 million in 1996, reflecting internal growth and the acquisition of several underwriting agencies in 1997. Commission income in 1997
During 1996, the Company sold one of its subsidiaries. This sale generated an after tax gain of $2.2 million or $0.05 per share and is included in other operating income.
Policy acquisitions costs, which are net of ceding commissions on reinsurance ceded, increased $5.4 million or 65% between 1997 and 1996. The increase reflects a higher average commission rate due to increase in the accident and health line of business plus a $5.2 million ceded profit commission in 1996 compared to $519,000 in 1997.
AIC, acquired in June, 1997, recorded a $10.0 million increase in loss and LAE reserves during December, 1997, predominately relating to 1995 and 1996 claims incurred prior to the Company's acquisition of AIC. This increase in reserves was made to bring AIC's reserving practices consistent with the more conservative method used by the Company's other insurance company operations. Management expects the increase in AIC's loss reserves to be adequate to cover any subsequent adverse development of AIC's prior losses.
Compensation expense increased $9.4 million or 22% in 1997, to $51.5 million due to the increase in personnel resulting from acquisitions completed during 1997, along with an increase in management personnel to oversee the operations of the rapidly expanding group.
Other operating expense increased 20% to $31.6 million in 1997. These expenses reflect increased expenditures required to meet the overall growth in business and from acquisitions. Currency conversion losses amounted to $884,000 in 1997, compared to losses of $181,000 in 1996.
Merger expense represents non-recurring items incurred to consummate the acquisitions and mergers which are accounted for as pooling-of-interests. The amounts incurred during 1996 were due to the combination with LDG and included a compensatory stock grant of $24.0 million to certain key LDG employees immediately prior to the merger.
Net earnings increased 29% to $49.8 million in 1997 from $38.5 million in 1996. Diluted earnings per share increased 23% to $1.03 in 1997 from $0.84 in 1996.
The Company's insurance company subsidiaries' statutory combined ratio was 78.8% for 1997 compared to 83.6% in 1996. The Company's combined ratio remains significantly better than the industry average.
At December 31, 1998, the Company had a net deferred tax asset of $3.4 million compared to $6.6 million at December 31, 1997. Due to the Company's history of consistent earnings and expectations for the future, it is more likely than not that the Company will be able to realize the benefit of its deferred tax asset.
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 provision for inflation is made, although trends are considered when setting underwriting terms and claim reserves. Claim reserves are subject to a continuing review process to assess their adequacy and are adjusted as deemed appropriate. In addition, the market value of the investments held by the Company varies depending on economic and market conditions and interest rates, which are highly sensitive to the policies of governmental and regulatory authorities. Any significant increase in interest rates could therefore have a material adverse effect on the market value of the Company's investments. In addition, the Company's $250.0 million Facility's interest rate floats with that of the market. Any significant increase in interest rates could result in increased interest costs under the Facility, which could have a material adverse effect on earnings.
The Company underwrites risks which are denominated in a number of foreign currencies. It establishes and maintains loss reserves with respect to these policies in their respective currencies. These reserves are subject to exchange rate fluctuations which can have an effect on the Company's net earnings. The Company's principal area of exposure is with respect to fluctuation in the exchange rate between the major European currencies and the United States Dollar. For the years ended December 31, 1998, 1997 and 1996, the gain (loss) from currency conversion was $219,000, ($884,000) and ($181,000), respectively.
The Company's balances denominated in foreign currencies fluctuate as transactions are recorded and settled. From time to time the Company has entered into foreign currency forward contracts as a hedge against foreign currency fluctuations. Such activity has been on a very limited basis in the past. The Company did not hedge this risk in 1998 and there were no open foreign currency forward contracts as of December 31, 1998. In the future, the Company may limit its exposure to currency fluctuations through the use of foreign currency forward contracts. The Company utilizes these foreign currency forward contracts strictly as a hedge against existing exposure to foreign currency fluctuations rather than as a form of speculative or trading investment.
The Company also adopted SFAS No. 131 entitled "Disclosures about Segments of an Enterprise and Related Information" in 1998. This statement changed the way the Company reports information about its operating segments. The agency segment from prior years is now split into the underwriting agency and intermediary segments. The corporate and other segment from prior years is now split into two segments, other operations and corporate. Adoption of SFAS No. 131 had no effect on the Company's consolidated financial position, results of operations or shareholders' equity.
SFAS No. 133 entitled "Accounting for Derivative Instruments and Hedging Activities" was issued in June, 1998. The statement is effective for all fiscal quarters and years beginning after June 15, 1999. The
In December, 1997, the American Institute of Certified Public Accountants' Accounting Executives Standards Committee ("AcSEC") issued Statement of Position ("SOP") 97-3, "Accounting by Insurance and Other Enterprises for Insurance-Related Assessments," which provides guidance on accounting by all entities that are subject to insurance-related assessments. It requires that entities should recognize liabilities for insurance-related assessments when certain specified criteria have been met. This SOP is effective for financial statements for fiscal years beginning after December 15, 1998. The Company does not expect the adoption of this SOP to have a material effect on the Company's financial position, results of operations or shareholders' equity.
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 results by or at the Year 2000.
In addition to its own systems and third-party relationships, the Company may also 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. Together with other companies in the insurance industry, the Company has and continues to evaluate the potential insurance exposures arising from Year 2000 problems or responses. The Company's insurance company subsidiaries do 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 attempt to submit claims for coverage under such policies which may be result from Year 2000 related causes. In this regard, the Company is currently assessing what modifications or responses may be appropriate related to the insurance coverages currently offered by such subsidiaries in light of coverage issues associated with the Year 2000 problem. Due to the difficulty in accurately assessing potential Year 2000 losses, if any, related to Year 2000 coverage issues, it is not possible to reasonably estimate their potential effects on the Company's financial position and results of operations.
The Company believes that its Year 2000 compliance plan will be successful based upon its progress to date. Many of the Company's major systems have been replaced or remediated, where necessary, including that of a major insurance company subsidiary, and are currently successfully processing business and information that contain the Year 2000 or later years. No new information has come to management's attention that would indicate that the plan should be altered significantly or that the plan will not be successful in the time frame prescribed by the plan. Nevertheless, the Company is in the process of developing a contingency plan for the remote possibility that there could be an unforeseen Year 2000 failure. Such plan will develop and document procedures to address any material Year 2000 failures until remediation of the related systems could be performed.