The Hartford Steam Boiler Inspection and Insurance Company leases approximately 233,145 square feet for its home office at One State Street, Hartford, Connecticut under a long-term capital lease with One State Street Limited Partnership. In addition to its home office facility, the Company leases facilities for its branch offices and subsidiaries throughout the United States and Canada, and in a small number of other foreign locations. The Company considers the office facilities and other operating resources to be suitable and adequate for its current and anticipated level of operations.
See Notes 7 and 11 to Consolidated Financial Statements located in Item 8 of Part II herein for additional information.
(1) Excludes revenues from investments accounted for under the equity method.
(3) Excludes charge for Proposition 103. Had the $2.9 million charge been included, the expense ratio would have been 51.3 % and the combined ratio would have been 93.8%.
Pro forma, exclusive of Radian: Total revenues $548.8 $470.0 $419.5 Percent change 16.8% 12.0%
Net income $ 53.4 $ 62.6 $ 51.9 Net income per common share $ 2.65 $ 3.07 $ 2.54
Net income in 1996 declined 14.7 percent from 1995. In our domestic insurance operations, catastrophe losses from unusually severe weather conditions depressed underwriting results. Despite this, HSB continues to produce combined ratios under 100 percent due to the Company's emphasis on disciplined underwriting. The reduction in pretax underwriting results of $12.4 million was essentially offset by a $13.4 million increase in income from investment operations.
While HSB experienced growth in most of its engineering businesses, results for the Radian International LLC joint venture (owned 60 percent by Dow Chemical and 40 percent by HSB), were disappointing, largely due to delays associated with the transition of Radian's client mix to one that is more commercial based than government based. Radian's contribution to pretax earnings declined by approximately $15.7 million during 1996, which compares to the decline in consolidated pretax profits of $15.0 million. Revenue shortfalls caused the venture to reduce its work force during the year by about 10 percent, resulting in a charge of $3.5 million. Increases in 1995 consolidated earnings relative to 1994 were a result of continued improvement in underwriting results for the insurance business and higher margins in engineering services operations, which outpaced the planned reduction in realized capital gains.
quarter of the year subsequent to the change in membership participation. This additional participation increased revenue and expenses for 1996 as well as several balance sheet accounts.
Consolidated revenues in 1995 were greater than 1994 due to the impact of the acquisition and full consolidation of EIG, Co. and growth in both the domestic and global insurance markets. On December 30, 1994, the Company acquired the remaining 50 percent interest in EIG, a partnership which was jointly formed with General Reinsurance Corporation (Gen Re) in 1988. EIG was the parent of Engineering Insurance Company Limited, a London based insurer which offers machinery breakdown coverage to business and industry outside the United States and Canada (see note 2). At the time of the acquisition, EIG was incorporated with the Company acquiring all of the common shares and Gen Re acquiring all of the preferred shares of the new Company, EIG, Co. Effective December 30, 1996 HSB opted to exchange the EIG, Co. preferred stock for HSB convertible preferred stock.
Gross earned premium $556.5 $455.0 $381.7 Ceded premium 107.9 65.9 45.1 - ---------------------------------------------------------- Insurance premium $448.6 $389.1 $336.6 Claims and adjustment expenses 204.4 154.9 143.2 Underwriting, acquisition and other expenses 222.4 200.0 172.7 - ---------------------------------------------------------- Underwriting gain $ 21.8 $ 34.2 $ 20.7
Loss ratio 45.6% 39.8% 42.5% Expense ratio 49.1% 50.9% 50.5% Combined ratio 94.7% 90.7% 93.0%
Insurance operations include the underwriting results of HSB, HSB Engineering Insurance Limited (EIL), The Boiler Inspection and Insurance Company of Canada (BI&I), The Allen Insurance Company, Ltd. and HSB's participation in IRI and various other pools.
Insurance premiums in 1996 increased 15.3 percent from 1995. This increase is primarily attributable to the increased participation in IRI ($33.2 million) and to growth in the global markets. The significant increase in 1995 was primarily attributable to the acquisition and full consolidation of EIL.
The Company participates in various facultative, quota share and excess of loss reinsurance agreements to limit its exposure, particularly to catastrophic losses and high risk lines, and to provide additional capacity to write business. The Company re-evaluates its exposures and reinsurance needs annually to implement a program which corresponds with the level of exposure the Company is willing to retain. Because HSB has primary responsibility to its insureds, the Company carefully evaluates the financial strength of those reinsurers it cedes business to. The Company's reinsurance costs continue to be impacted by its prior loss experience and business growth. In 1996, the Company's reinsurance ceded costs increased $42 million from 1995, which was almost entirely attributable to its increased participation in IRI.
In 1995, the Company centralized and consolidated its treaty reinsurance ceded program to cover global operations. This strategy will enable HSB to more closely manage its reinsurance costs. In 1994 and continuing through 1996, HSB increased its non-IRI retentions in order to mitigate the rising cost of reinsurance.
The loss ratio increased by 5.8 percent in 1996 as compared to 1995. The increase is primarily the result of losses from unusually severe weather conditions (2.0 percent) and the increased share in IRI (1.7 percent). 1995 claims and adjustment expenses reflect the acquisition and full consolidation of EIG, Co. Claims and adjustment expenses, exclusive of EIG, Co., decreased $3.9 million in 1995 compared with 1994. Claim costs in 1994 include $4.8 million of losses related to the California earthquake. The components of claims and adjustment expenses, net of reinsurance, are displayed above.
Claims and adjustment expense reserves comprise one of the largest liabilities on the Company's Statements of Financial Position. Reserves are established to reflect the Company's estimates of total losses and loss adjustment expenses that will ultimately be paid under direct and assumed insurance contracts. Loss reserves include claims and adjustment expenses on claims that have been reported but not settled and those that have been incurred but not yet reported to the Company. The length of time that reserves are carried on the Statements of Financial Position is a function of the pay-out patterns associated with the types of coverages involved. The majority of risks the Company insures are short-tailed in nature, relative to the property/casualty industry as a whole, meaning they generally settle shortly after claims are reported. The Company's loss reserve estimates reflect such variables as past loss experience and inflation. In addition, due to the nature of much of the Company's coverages, complex engineering judgments are involved. Previously established loss reserves are regularly adjusted as loss experience develops and new information becomes available. Adjustments to previously established reserves are reflected in the financial statements in the period in which the estimates are changed.
Pro Forma* For the years ended December 31, 1996 1995 1994 - ---------------------------------------------------------
Net investment income $ 32.3 $ 28.2 $ 26.2 Realized investment gains 12.1 2.8 8.7 - --------------------------------------------------------- Income from investment operations $ 44.4 $ 31.0 $ 34.9 - --------------------------------------------------------- Total cash and invested assets, at fair value $600.9 $553.8 $489.7
The carrying value of the equity securities portfolio represented 44.0 percent of the investments at December 31, 1996. This included $79.8 million of unrealized investment gains, which had a net increase of $19.4 million from 1995 on a sharp upturn in the stock market in 1996. The Company also recorded $10.5 million of dividends and $11.5 million of net pretax realized gains from this portfolio in 1996. The Company's largest single holding accounted for less than 1 percent of total consolidated assets. Realized investment gains increased significantly over 1995 as the
Company managed its portfolio to respond to changing market conditions and tax planning opportunities. The redemption of callable securities generated $1.4 million of gains.
Cash provided by operating and investing activities was used to pay dividends, repay short-term borrowings and repurchase Company stock. The Company repurchased 279,200; 136,943; and 147,486 shares of its common stock in 1996, 1995 and 1994, respectively.
As previously noted, in December 1996, HSB exchanged EIG, Co. preferred stock of $20 million for HSB convertible preferred stock.
will be requesting that its shareholders approve the formation of a revised holding company structure at a special meeting in 1997.
Consolidated Statements of Changes in Shareholders' Equity for the years ended December 31, 1996, 1995 and 1994. 36
No other schedules are required to be filed herewith pursuant to Article 7 of Regulation S-X.
To the Shareholders and Board of Directors of The Hartford Steam Boiler Inspection and Insurance Company:
We have audited the consolidated financial statements and the financial statement schedules of The Hartford Steam Boiler Inspection and Insurance Company 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.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of The Hartford Steam Boiler Inspection and Insurance Company and its subsidiaries as of December 31, 1996 and 1995, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1996, in conformity with generally accepted accounting principles. In addition, in our opinion, the financial statement schedules referred to above, when considered in relation to the basic financial statements taken as a whole, presentfairly, in all material respects, the information required to be included therein.
Notes to Consolidated Financial Statements (in millions, except per share amounts)
The Company recognizes the majority of engineering services contract revenues as services are provided. Costs on such contracts are included in operations as incurred. Provisions are made for losses on contracts at the time such losses become known. In 1995, when Radian was a fully consolidated subsidiary, revenues were presented net of related subcontract costs. (See note 2.)
In December 1994, The Hartford Steam Boiler Inspection and Insurance Company (HSB) acquired the remaining 50 percent interest in Engineering Insurance Group (EIG), a partnership which was jointly formed by the Company 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 the Company acquiring all outstanding common shares and Gen Re acquiring all preferred shares of the new company, EIG, Co.
The agreement provides that during 1998, HSB has the right to put its share of Radian International LLC to Dow for net proceeds of approximately $145 million. In 1996, HSB's interest in Radian International LLC of $79.7 million was accounted for in the consolidated financial statements under the equity method of accounting. Had the formation of the joint venture occurred at the beginning of 1995 total revenues and total expenses would have been $470.7 and $398.5 million, respectively, and consolidated assets and liabilities at December 31, 1995 would have been $954.1 and $613.0, respectively.
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. Revenues, expenses and all significant segment specific assets and liabilities are reported in the Company's financial statements. The Company does not allocate all assets between business segments. 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, 1996 1995 1994 - ------------------------------------------------------------------------------ Revenues U.S. $ 444.9 $581.7 $561.6 Non-U.S. 103.9 90.5 42.0 - ------------------------------------------------------------------------------ Total revenues $ 548.8 $672.2 $603.6 - ------------------------------------------------------------------------------ Income before taxes U.S. $ 51.1 $ 68.6 $ 66.9 Non-U.S. 20.2 17.7 6.7 - ------------------------------------------------------------------------------ Total income $ 71.3 $ 86.3 $ 73.6 ==============================================================================
Estimated Amortized Fair Maturity Cost Value - --------------------------------------------------------------------------- One year or less $ 18.2 $ 18.1 Over one year through five years 105.0 107.3 Over five years through ten years 48.0 48.6 Over ten years 60.1 61.8 - --------------------------------------------------------------------------- Total fixed maturities $231.3 $235.8 ===========================================================================
The cost, estimated fair values (based principally upon quoted market prices) and gross unrealized gains and losses of equity securities at December 31, were as follows:
On December 19, 1996 the Company entered into three "zero cost collar" contracts to mitigate the effects of market risk on its common stock portfolio. Each contract has a notional amount of $50.0 million and maturity dates ranging from November 1997 to January 1998. The fair value of the contracts at December 31, 1996 is estimated to be $(.1) million based upon quotes obtained from the counterparties to the contract. The contracts, which were entered into when the S&P index was 744.3, allow the Company to recover from the counterparty if the index is below 695.20 at the time of maturity and require the Company to reimburse the counterparty if the index is above a range of 811.287 to 818.730 at the time of maturity. The collar subjects the Company to off balance-sheet risk which includes market and counterparty credit risk. The Company manages this exposure by entering into contracts with internationally recognized financial institutions, which are expected to perform under the terms of the contract, and evaluating the creditworthiness of such institutions by taking into account credit ratings and other factors.
The Company held no derivative financial instruments in its investment portfolio at December 31, 1995. The Company sells covered call options, at times, to protect against adverse changes in market values. Premiums received on options written are deferred and recognized as a component of gross realized gains when option contracts are exercised or expire. During 1995, aggregate premiums received by the Company on covered call options amounted to less than $.1 million. Net gains recognized on sales of underlying instruments amounted to less than $.1 million for 1995. Generally the duration of covered call options written by the Company does not exceed thirty days.
Amounts billed $10.9 $45.9 Amounts unbilled 1.0 18.1 Amounts due upon completion of contracts -- 5.5 - ------------------------------------------------------------------------------ 11.9 69.5 Less allowance for bad debts (.2) (.7) - ------------------------------------------------------------------------------ Engineering services receivable $11.7 $68.8 ==============================================================================
Land and buildings $ 7.3 $ 7.4 Furniture, equipment and other 65.7 129.9 - ---------------------------------------------------------------------- 73.0 137.3 Less accumulated depreciation (41.3) (75.0) - ---------------------------------------------------------------------- Fixed assets $31.7 $ 62.3 ======================================================================
1996 1995 1994 - ------------------------------------------------------------------------------ Written premiums: Direct $338.6 $285.3 $251.7 Assumed 232.6 182.9 137.9 Ceded (116.8) (59.9) (49.3) - ------------------------------------------------------------------------------ Net written insurance premiums $454.4 $408.3 $340.3 - ------------------------------------------------------------------------------ Earned premiums: Direct $343.4 $279.7 $242.6 Assumed 213.1 175.3 139.1 Ceded (107.9) (65.9) (45.1) - ------------------------------------------------------------------------------ Net earned insurance premiums $448.6 $ 389.1 $336.6 ==============================================================================
The Company writes direct business through agencies and brokerage firms. In addition, the Company assumes boiler and machinery exposures from 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 restructuring 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.
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 reinsurance assets, rather than netted against the related liability accounts. The Company is not party to any contracts which do not comply with the risk transfer provisions of Statement of Financial Accounting Standards (SFAS) No. 113, "Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts". The Company recorded $113.9, $28.5 and $31.0 million of reinsurance recoveries as a reduction of its claims and adjustment expenses for the years ended December 31, 1996, 1995 and 1994, respectively. Reinsurance recoverable on paid claims and adjustment expenses was $8.0 and $2.5 million at December 31, 1996 and 1995, respectively.
At December 31, 1996, future minimum rental commitments under noncancelable leases accounted for as operating leases with initial or remaining terms of more than one year were as follows:
Short-term borrowings $ 3.2 $ 13.4 Long-term borrowings* 25.1 25.6 Convertible preferred stock 20.0 -- Common shareholders' equity 345.6 341.1 *Excludes capital lease. See note 11. - --------------------------------------------------------------------------
The Company has a commercial paper program with a limit of $75 million. Commercial paper outstanding at December 31, 1996 and 1995 was $3.2 million and $12.0 million, respectively. Commercial paper outstanding at year end 1996 matures on January 23, 1997. Long-term debt consists of $25.1 million of senior notes due May 15, 2000 at an interest rate of 6.83 percent. Such amount approximates market at December 31, 1996.
On December 30, 1996, the Company exercised its right to exchange 2,000 shares of EIG, Co. preferred stock, which was issued at the time HSB acquired the remaining 50 percent interest in EIG, Co. from Gen Re, for 2,000 shares of HSB convertible preferred stock. The stock has no par value, but has voting rights and carries a quarterly dividend of $162.50 per share. The stock is convertible into 398,406 shares of HSB common stock at a price of $50.20 per share and may be redeemed at the option of the Company on or after the fifth anniversary of issuance and by Gen Re after the eighth anniversary.
The Company maintains various types of pension plans covering employees of HSB and certain subsidiaries. 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. As a result of the plan's investment returns, the Company made no contribution to the plan in 1996, 1995 or 1994. Assets available for plan benefits include approximately $16.6 million of Company stock at December 31, 1996.
The pension expense for the U.S. pension plans was a net credit to earnings for 1996, 1995 and 1994 due to the over funded status of the primary plan. The components of the credit were as follows:
1996 1995 1994 - ---------------------------------------------------------------------------- Service costs $ 3.6 $ 2.9 $ 3.6 Interest costs 10.2 10.2 9.7 Return on assets (20.1) (30.9) 6.6 Net amortization and deferral 4.0 15.3 (22.0) - ---------------------------------------------------------------------------- Net pension credit $(2.3) $(2.5) $(2.1) ============================================================================
Years Ended December 31, - ---------------------------------------------------------------------------- 1996 1995 1994 - ----------------------------------------------------------------------------
Service cost $ .3 $ .3 $ .3 Interest cost 2.0 2.3 2.2 Amortization of unrecognized obligations -- -- .2 - ---------------------------------------------------------------------------- Net periodic postretirement benefit cost $ 2.3 $ 2.6 $ 2.7 ============================================================================
1996 1995 - ------------------------------------------------------------------------------ Accumulated postretirement benefit obligations for: Retirees $22.0 $24.9 Other fully eligible plan participants 1.0 1.5 Other active plan participants 3.8 4.7 - ------------------------------------------------------------------------------ Total accumulated postretirement benefit obligation 26.8 31.1 Unrecognized net loss (3.0) (6.6) - ------------------------------------------------------------------------------ Accrued postretirement benefit liability $23.8 $24.5 ==============================================================================
Weighted average discount rate 7.5% 7.5% Current year health care cost trend rate 8.0% 10.0% Ultimate health care cost trend rate 4.5% 5.0%
For measurement purposes, the annual rate of increase in the per capita cost of covered health care benefits ranges from 8 percent in 1996 decreasing gradually to 4.5 percent by the year 2001 and remaining at that level thereafter. In the prior year, the range was from 10 percent in 1995 decreasing gradually to 5 percent by the year 2001 and remaining at that level thereafter.
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, 1996 of $27.4 million by approximately $1.5 million and the aggregate of the service and interest cost for the year ended December 31, 1996 by $.1 million.
A stock option award under the Company's stock option plan allows for the purchase of the Company's 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.
The following table summarizes information about stock options outstanding at December 31, 1996.
period. Pro forma net income and earnings per common share would have been reduced as follows for 1996 and 1995:
These pro forma disclosure amounts derived by the use of SFAS No. 123 are not indicative of future amounts. SFAS No. 123 is not applicable to options granted prior to 1995, and additional options may be granted in future years.
(a) Engineering Services and Insurance Premium Receivables written off as uncollectible.