Our major office facilities, with more than 25,000 square feet, are as follows:
We underwrite and manage a variety of largely non-correlated specialty insurance products through five insurance underwriting segments: U.S. Property & Casualty, Professional Liability, Accident & Health, U.S. Surety & Credit and International. We market our insurance products through a network of independent agents and brokers, through managing general agents owned by the company, and directly to consumers. In addition, we assume insurance written by other insurance companies.
Key facts about our consolidated group as of and for the year ended December 31, 2014 are as follows:
We generated net earnings of $458.3 million, or $4.61 per diluted share.
We purchased $224.7 million of our common stock at an average cost of $47.70 per share. At year-end, we had $351.9 million remaining under our current $500 million share buyback authorization.
The following sections discuss our key operating results. The reason for any significant variances between 2013 and 2012 are the same as those discussed for variances between 2014 and 2013, unless otherwise noted. Amounts in tables are in thousands, except for earnings per share, percentages, ratios and number of employees.
investment income earned on our consolidated investment portfolio by our Investing segment,
Total revenue increased $115.6 million in 2014, compared to 2013, due to an $84.4 million increase in net earned premium and higher net realized investment gains. The $11.1 million increase in total revenue in 2013, compared to 2012, related to higher net realized investment gains.
The 2014 and 2013 growth in gross written premium from our insurance underwriting segments occurred primarily in: 1) the Accident & Health segment, from the growth of our medical stop-loss and short-term medical products, 2) the International segment, from increased writings in our surety & credit and liability lines of business and 3) the U.S. Property & Casualty segment, from our growing casualty line of business. Our net written premium increased in 2014, compared to 2013, due to growth in the Accident & Health segment and was flat in 2013, compared to 2012, due to increased reinsurance in 2013, primarily in the U.S. Property & Casualty segment. Net earned premium increased in 2014 as the medical stop-loss and short-term medical products were earned in less than twelve months. See the “Segment Operations” section below for further discussion of the relationship and changes in premium revenue within each insurance segment.
Loss and loss adjustment expense increased $4.4 million in 2014 and decreased $15.6 million in 2013, compared to the respective prior year. The 2014 increase was primarily due to growth in the business and lower net favorable development in 2014, partially offset by lower catastrophe losses in 2014. The 2013 decrease was primarily due to a lower accident year net loss ratio in 2013 and flat net earned premium year-over-year. Excluding catastrophes, our accident year net loss ratio was 56.7% for 2014, 58.5% for 2013 and 59.1% for 2012. See the “Segment Operations” section below for additional discussion of the changes in net loss development and net loss ratios for each segment.
Other operating expense included $25.1 million, $16.2 million and $13.2 million of stock-based compensation expense in the respective three years. Stock-based compensation expense was higher in 2014 due to accelerated expense for certain unvested restricted stock awards for which the performance criteria were achieved in 2014, as well as higher grant prices due to the increase in our stock price. In 2014, we granted $17.4 million of restricted stock awards and units, with a weighted-average life of 2.9 years. At December 31, 2014, there was approximately $29.3 million of total unrecognized compensation expense related to unvested restricted stock awards and units, options and our employee stock purchase plan, which is expected to be recognized over a weighted-average period of 1.6 years. In 2015, we expect to recognize $15.9 million of expense for all stock-based awards outstanding at year-end 2014.
Interest expense was $28.1 million, $26.2 million and $25.6 million in 2014, 2013 and 2012, respectively, and included $19.3 million per year for our Senior Notes. Our interest expense has increased due to a higher amount of outstanding borrowings on our $825.0 million Revolving Loan Facility, mainly to fund purchases of our common stock.
Each of our insurance segments bears risk for insurance coverage written within its portfolio of insurance products. Each segment generates income from premium written by our underwriting agencies, through third party agents and brokers, or on a direct basis. Certain segments also write facultative or individual account reinsurance, as well as treaty reinsurance business. In some cases, we purchase reinsurance to limit our losses from both individual policy losses and multiple policy losses from catastrophic occurrences and from aggregate losses in a year. Our segments maintain disciplined expense management and a streamlined management structure, which results in favorable expense ratios. The following provides operational information about our insurance underwriting segments, Investing segment and Corporate & Other category.
In our Aviation line of business, we recognized favorable development in 2014 and 2013 based on recording these reserves in line with actuarially-indicated results since the respective prior year annual review.
Our Professional Liability segment pretax earnings decreased $28.0 million in 2014, compared to 2013, primarily due to $26.3 million of favorable loss development in 2013. Pretax earnings increased $7.5 million in 2013, compared to 2012, due to an improved net loss ratio, primarily related to re-underwriting of our diversified financial products (DFP) line of business beginning in 2012. The segment’s premium decreased from 2012 to 2014, primarily due to lower writings of DFP from re-underwriting this business. Net written premium and net earned premium also reflect the impact of reinsurance during the past three years.
The segment had net favorable (adverse) loss development of ($1.0) million in 2014, $26.3 million in 2013 and $25.9 million in 2012. The development in each year resulted from our annual review of reserves for this segment, which we conducted in the third quarter of each year. The majority of the insurance coverage in this segment is provided through “claims made” policies, and the final settlement value of these claims is not expected to be determined for several years due to the underlying complex nature of the claims. Accordingly, changes to our ultimate losses for a given underwriting year typically result from management’s revised expectations, as compared to the prior year reserve review, with respect to the settlement value of known claims.
The 2013 net favorable development consisted of $15.5 million for our U.S. D&O product and $10.8 million for our International D&O product. Our 2013 reserve review indicated better than expected experience for underwriting years prior to 2007 as well as 2009 and 2010 (totaling $64.2 million), partially offset by reserve strengthening of $37.9 million in underwriting years 2007 and 2008, which were impacted by the worldwide financial crisis.
The 2012 net favorable development consisted of $9.0 million for our U.S. D&O product and $16.9 million for our International D&O product. Our 2012 reserve review indicated that incurred loss development, primarily for underwriting years 2005 and 2006, was lower than expected as compared to our 2011 reserve review, primarily due to actual outcomes on reported claims. This favorable development was partially offset by higher estimates of ultimate losses in the 2008 underwriting year.
The following tables summarize the operations of the Accident & Health segment.
Our medical stop-loss business provides annual coverage for groups of employees, and claims are reported and settled within 12 to 15 months for each reporting year. Claims for our Other business, particularly the short-term medical product, are reported and settled quickly. We generally conducted our annual review of the segment’s reserves in the fourth quarter. Our reserve reviews indicated lower than expected claims activity related to our medical stop-loss product in: 1) 2014 - for underwriting years 2012 and 2013, 2) 2013 - for underwriting years 2011 and 2012 and 3) 2012 - for underwriting year 2011.
Our U.S. Surety & Credit segment pretax earnings decreased $14.3 million in 2014, compared to 2013, primarily due to recognizing more net favorable loss development in 2013 than in 2014. The segment’s pretax earnings increased $5.4 million in 2013, compared to 2012, due to increased net favorable loss development in 2013. Premium in our credit line of business increased in 2014 due to writing new business. Premium in our surety line of business has remained relatively flat due to competition and economic conditions impacting the construction industry.
The segment incurred lower net catastrophe losses in 2014 than in 2013 and 2012. We recognized no large catastrophe losses in 2014. In the prior years, we recognized pretax catastrophe losses, including reinstatement premium, for these major catastrophic events: 1) 2013 - European floods ($15.0 million) and German hail storms ($13.0 million) and 2) 2012 - Superstorm Sandy ($23.9 million). The remaining losses related to small catastrophes that impacted our property treaty business. The following table summarizes the segment’s accident year catastrophe losses, as well as the impact on key metrics:
The totals in the above table include favorable development from prior years’ catastrophes of $5.4 million, $6.0 million and $18.9 million in 2014, 2013 and 2012, respectively, primarily related to these events: 1) 2014 - European floods, 2) 2013 - Superstorm Sandy and 3) 2012 - Hurricane Irene and the Japan earthquake and tsunami.
We generally conduct our annual review of the International segment’s reserves in the fourth quarter. However, we accelerated our 2014 and 2013 annual reserve reviews to the third quarter of each year due to the timing of issues related to certain Spanish surety bonds and a growing actuarially-indicated redundancy in several lines of business.
In Property Treaty, the 2014 net favorable development included the release of $6.0 million of prior years’ catastrophe reserves related to the 2013 European floods, as well as $1.5 million of reserve strengthening for the 2011 Denmark storms. The remaining net favorable development related to better than expected results compared to the prior reserve review.
The net favorable development in Liability included favorable development related to our U.K. professional liability product as follows: 1) 2014 - $12.7 million (for 2013 and prior accident years), 2) 2013 - $16.1 million (for 2011 and prior accident years) and 3) 2012 - $12.8 million (for 2010 and prior accident years). In each year, the actual loss experience was better than our actuarial expectations in the prior year reserve review. In addition, there was net adverse development of $3.2 million in 2014 and $1.5 million in 2013, and net favorable development of $7.7 million in 2012, primarily related to other liability business for accident years 2011 and prior.
The previously discussed favorable and adverse development, as well as the lower accident year catastrophe losses in 2014, caused the significant variances in the segment and line of business net loss ratios year-over-year. The segment’s expense ratio increased in 2014 and 2013 due to higher compensation and benefits expense, as well as higher technology costs. In addition, the 2014 expense ratio increased due to the impact of the stronger British pound sterling relative to the U.S. dollar, compared to 2013, as most of the segment’s operating expenses are incurred in British pound sterling.
This table summarizes our investments by type, substantially all of which are reported at fair value, at December 31, 2014 and 2013. The methodologies used to determine the fair value of our investments are described in Note 3, “Fair Value Measurements” to the Consolidated Financial Statements.
At December 31, 2014, we held $2.4 billion of special purpose revenue bonds, as well as $954.7 million of general obligation bonds, which are issued by states, municipalities and political subdivisions and collectively referred to as municipal bonds in the investment market. The overall rating of our municipal bonds was AA at December 31, 2014. Within our municipal bond portfolio, we held $474.7 million of pre-refunded bonds, which are supported by U.S. government debt obligations. Our special purpose revenue bonds are secured by revenue sources specific to each security. At December 31, 2014, the percentages of our special purpose revenue bond portfolio supported by these major revenue sources were as follows: 1) education - 24%, 2) transportation - 22%, 3) water and sewer - 19% and 4) electric - 12%.
Many of our special purpose revenue bonds are insured by mono-line insurance companies or supported by credit enhancement programs of various states and municipalities. We view bond insurance as credit enhancement and not credit substitution. We base our investment decision on the strength of the issuer. A credit review is performed on each issuer and on the sustainability of the revenue source before we acquire a special purpose revenue bond and periodically thereafter. The underlying average credit rating of our special purpose revenue bond issuers, excluding any bond insurance, was AA at December 31, 2014. Although economic conditions in the United States may reduce the source of revenue to support certain of these securities, the majority are supported by revenue from essential sources, as indicated above, which we believe generate a stable source of revenue.
At December 31, 2014, we held corporate fixed securities issued by foreign corporations with an aggregate fair value of $478.3 million. In addition, we held securities issued by foreign governments, agencies or supranational entities with an aggregate fair value of $118.7 million. The following table details our holdings of foreign debt at December 31, 2014.
(1) Supranational represents investments in European Investment Bank, Inter-American Development Bank, International Bank for Reconstruction and Development, Asian Development Bank, and European System of Financial Supervisors.
(2) Includes all countries whose total foreign debt is individually less than $10.0 million.
Our Corporate & Other category includes operations not related to our segments, including unallocated corporate operating expenses, interest expense on notes payable, foreign currency expense (benefit) and underwriting results of our Exited Lines of business.
Our Corporate expenses not allocated to the segments increased $10.0 million in 2014, compared to 2013, primarily due to: 1) an indemnification benefit of $5.1 million recognized in 2013, 2) higher incentive compensation based on the increase in consolidated pretax earnings and 3) expense related to certain unvested restricted stock awards for which the performance criteria were achieved in 2014. Our Corporate expenses not allocated to the segments decreased $6.3 million in 2013, compared to 2012, principally due to the $5.1 million indemnification benefit in 2013. We reduced our indemnification liability, which related to a 2001 subsidiary sale, due to favorable claims activity and successful subrogation recoveries. Our interest expense increased year-over-year due to higher borrowings on our Revolving Loan Facility.
The impact of foreign currency benefit/expense fluctuated year-over-year principally due to changes in the value of the British pound sterling and the Euro relative to the U.S. dollar. We hold available for sale securities denominated in non-functional currencies to economically hedge the currency exchange risk on our loss reserves denominated in non-functional currencies. The foreign currency benefit/expense related to loss reserves is recorded through the income statement, while the foreign currency benefit/expense related to available for sale securities is recorded through other comprehensive income within shareholders’ equity. This mismatch may cause fluctuations in our reported foreign currency benefit/expense in future periods.
Our cash provided by operating activities was $478.6 million in 2014, compared to $262.7 million in 2013 and $661.1 million in 2012. Cash provided by operating activities includes collateral funds we receive or refund for our U.S. surety business, for which we record a liability within accounts payable and accrued liabilities. We refunded U.S. surety collateral of $20.3 million in 2014 and $121.7 million in 2013, compared to a net receipt of $96.6 million in 2012. In addition, we paid $132.6 million of income tax payments in 2014, compared to $181.5 million in 2013 and $107.9 million in 2012.
Other fluctuations in our cash provided by operating activities relate to the timing of the collection and the payment of insurance-related receivables and payables. In regards to Spanish surety bonds, we paid claims of $243.3 million and collected reinsurance of $186.2 million in 2014, compared to paying claims of $153.9 million and collecting no reinsurance in 2013 as most claims were paid in the fourth quarter. We paid minimal claims in 2012. The net impact of our payment of claims and collection of recoverables related to these bonds will continue to impact our cash provided by operating activities in future periods.
We maintain an $825.0 million Revolving Loan Facility (Facility), of which $294.1 million of available capacity remained at December 31, 2014. During the past three years, we used the Facility primarily to fund repurchases of our common stock. We expect to continue to use the Facility to opportunistically repurchase stock in 2015. The Facility expires in April 2019. See Note 7, “Notes Payable” to the Consolidated Financial Statements for additional information related to the Facility and our long-term indebtedness.
Our domestic and foreign insurance companies paid HCC dividends of $377.2 million in 2014, $317.5 million in 2013 and $262.4 million in 2012. The payment of dividends by our insurance companies is subject to regulatory restrictions and will depend on the surplus and future earnings of these subsidiaries. HCC’s direct U.S. insurance company subsidiaries can pay an aggregate of $235.2 million in dividends in 2015 without obtaining special permission from U.S. state regulatory authorities.
Since our repurchase program began in 2008, we have purchased 30.0 million shares for $953.1 million, or $31.82 per share, through December 31, 2014. In the past three years, we purchased our common stock as follows:
We have a “Universal Shelf” registration statement that provides for the issuance of $1.0 billion of securities, which may be debt securities, equity securities, or a combination thereof. The Universal Shelf provides us the means to access the debt and equity markets relatively quickly, if we are satisfied with the current pricing in the financial markets. Our current shelf registration expires in March 2015; however, we expect to replace it with a similar shelf registration prior to expiration.
The following table summarizes our total contractual cash payment obligations by estimated payment date at December 31, 2014.
In preparing the contractual obligations table, we made the following estimates and assumptions:
(3) The $825.0 million Revolving Loan Facility expires in April 2019. In the above table, the outstanding borrowings of $525.0 million at December 31, 2014 are shown in 2019, with the annual interest of LIBOR plus 125 basis points on the outstanding balance and the annual commitment fee of 15 basis points on the unused balance shown in each applicable year.
(5) See Note 14, “Related Party Transactions” to the Consolidated Financial Statements for information related to our earnout liabilities.