The Hartford Steam Boiler Inspection and Insurance Company leases approximately 227,288 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.
The table above presents consolidated results of HSB Group, Inc. (HSB or the Company).
Engineering services revenue increased 9.9 percent in 1997 and 11.8 percent in 1996.
Also in June of 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information". This standard requires companies to report financial and descriptive information about reportable operating segments. It includes disclosure requirements relating to products and services, geographic areas and major customers. This statement will be effective with calendar year 1998, however application is not required for interim financial statements in the initial year. It is possible that this disclosure may redefine our segment information. However, the Company has not yet determined how SFAS No. 131 will be applied.
On December 1, 1996, HSBIIC increased its participation in IRI from 14 percent to 23.5 percent. IRI is an unincorporated, voluntary joint underwriting association which provides property insurance for the class of business known as Highly Protected Risks (HPR) for larger manufacturing, processing and industrial businesses, which have invested in protection against loss through the use of sprinklers and other means. IRI primarily writes policies on a syndicate basis which specifies to the insured the percentage share of risk accepted by each member of the association. Each member company, therefore, operates as a direct insurer or reinsurer on such policies and participates in the premiums and losses generated thereunder in proportion to its membership interest. In 1995 and prior, HSBIIC's membership share was .5 percent.
In essence, IRI facilitates the proportional sharing of risk under one policy where each member is essentially considered to be the direct writer for reporting, premium tax and other regulatory purposes. Liability on such policies is several and not joint, and therefore, members are not responsible for policy liabilities of the other members. An increased participation does not expose HSBIIC to the effect of adverse loss development on claims incurred prior to the effective date of the increase; conversely a decrease in participation doesn't release HSBIIC from the effects of adverse development.
To support HSB's expanded role, on December 31, 1997, a business trust formed by HSB sold $300 million of 20 year, 7 percent Convertible Capital Securities in a private placement to ERC. The Convertible Capital Securities are convertible into HSB common stock, at any time, subject to regulatory approval, at a conversion price of $85. $250 million of the proceeds were contributed to HSBIIC and $50 million was retained by HSB. (See note 12).
Loss ratio 44.4% 45.6% 39.8% Expense ratio 47.3% 49.1% 50.9% Combined ratio 91.7% 94.7% 90.7% - - --------------------------------------------------------------------
Insurance operations include the underwriting results of HSBIIC, HSB Engineering Insurance Limited (EIL), The Boiler Inspection and Insurance Company of Canada (BI&I), The Allen Insurance Company, Ltd., HSB of Connecticut, HSB of Texas and HSBIIC's participation in IRI and various other pools.
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 the Company has primary responsibility to its insureds, a careful evaluation of the financial strength of those reinsurers it cedes business to is performed. The Company's reinsurance costs continue to be impacted by its prior loss experience and business growth.
For the years ended December 31, 1997 1996 1995 - - -------------------------------------------------------------------------------- Provision for claims and adjustment expenses occurring in the current year $ 209.5 $ 214.2 $ 152.2 Increase (decrease) in estimated claims and adjustment expenses arising in prior years* 8.4 (9.8) 2.7 ----------------------------- Total incurred claims and adjustment expenses $ 217.9 $ 204.4 $ 154.9
* Includes approximately $3.3, $4.9 and $1.1 million subrogation recoveries, respectively.
The loss ratio decreased 1.2 percentage points in 1997 as compared to 1996 primarily as a result of fewer weather-related losses. The 1996 increase of 5.8 percentage points as compared to 1995, was primarily the result of the high frequency of claims and unusually severe winter weather. Adverse development in 1997 added 1.7 percentage points to the loss ratio, while positive development in 1996 benefited the loss ratio by 2.2 percentage points. 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 Consolidated 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 Consolidated Statements of Financial Position is a function of the pay-out patterns associated with the types of coverages involved. The majority of claims the Company incurs 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. The Company doesn't discount its loss reserves.
HSBIIC is involved in three arbitration or litigation proceedings regarding the extent to which certain explosion events are insured under boiler and machinery policies of HSBIIC or under the all-risk property insurance policies issued by other companies. Management believes HSBIIC's policies do not provide coverage for losses resulting from explosion events that are the subject of these proceedings.
A lower court ruling in one of these cases held that an explosion did occur, and that HSBIIC was not liable for losses of the insured resulting from the explosion. In a further action, the court denied HSBIIC's motion for summary judgment on certain issues, thus leaving HSBIIC potentially liable for certain unquantified losses resulting from events prior to the explosion. In the first quarter of 1997 HSBIIC and the property insurer jointly settled the case with the insured. HSBIIC's ultimate share of the settlement will be determined in an arbitration proceeding with the property insurer. HSBIIC has incurred gross losses and loss adjustment expenses (LAE) of $40.7 million and a net loss, after taking into account reinsurance recoverables, of $6.5 million, of which $5 million represents claim costs and the remaining $1.5 million represents LAE. As a result of payments made to date, at December 31, 1997, HSBIIC carried gross loss and LAE reserves of $2.8 million and recoverables from reinsurers of $2.8 million.
Engineering services revenue increased 9.8 percent in comparison to 1996. This was primarily attributable to increased sales of $3.2 million at HSBRT and a modest increase in revenues from our engineering operations based in Asia. Engineering services revenues in 1996 increased 11.8 percent in comparison to 1995. The growth in revenues was primarily due to increases generated by HSBRT as their revenues were $4.8 million (35 percent) higher in 1996 compared to 1995, almost entirely attributable to increases in volume. Margins declined in 1997 as the Company decreased the staff utilization domestically in order to develop new growth opportunities. The Company is also maintaining staff levels in Asia during the current economic downturn at somewhat lower productivity levels as the Company continues to have confidence in its long-term growth prospects in the region.
For the years ended December 31, 1997 1996 1995 - - ------------------------------------------------------------------------------- Net investment income $ 36.8 $ 32.3 $ 28.9 Realized investment gains 14.1 12.1 2.8 ------------------------------------------- Income from investment operations $ 50.9 $ 44.4 $ 31.7 Total cash and invested assets, at fair value $ 996.7 $ 600.9 $ 550.5
Unrealized gains, pre-tax $ 95.3 $ 81.4 $ 65.4 - - --------------------------------------------------------------------------------
earnings. The Company does not engage in cash flow underwriting; it seeks to have underwriting profit each year. None of the Company's claim reserves are discounted as most claims settle, on average, within one year. Therefore, the Company does not use duration measurements in managing its interest rate exposure. Instead, the Company manages its portfolio by laddering its maturities such that the average maturity is generally maintained between 5-10 years. This technique provides the Company with a predictable cash flow each year that enables it to respond to the previously discussed parameters that impact its investment strategy.
In the fourth quarter of 1997, HSBIIC settled all of its outstanding contracts which required HSBIIC to pay its counterparty $30.7 million in foregone appreciation on its portfolio. The Company's U.S. common stock portfolio has experienced a total return of $57 million (which includes price appreciation of approximately $54 million) since December 31, 1996, and has had a price movement correlation with the S&P 500 Index well in excess of 80 percent.
Net investment income for 1997 increased $4.5 million compared to 1996. Investable assets increased in 1997 in comparison to 1996 as the Company invested the proceeds from its capital securities offerings. Net investment income was impacted earlier in 1997 by calls of high yielding preferred stocks. Net investment income increases also reflected more investable funds, which were invested during a period of declining rates in comparison to our portfolio averages, and a modest change in the mix of the portfolio from tax preferred investments to more taxable investments with higher pre-tax yields. Higher interest costs relate to a larger amount of commercial paper outstanding.
Through its U.K. subsidiary, EIL, the Company writes business in Malaysia and is required to maintain approximately 50 million ringgit denominated investments on deposit in that country. The Company intends to maintain its current level of deposits in that currency, which equated to $12.8 million at December 31, 1997. Due to the recent fluctuations of currencies in southeast Asia, realized investment gains were reduced by approximately $7.4 million during 1997.
Net investment income increased 11.8 percent in 1996 due to an increased level of investable assets and to a lesser extent by dividend increases on the Company's common stock investments. Invested assets growth was due to significant cash flow from
Liquidity refers to the Company's ability to generate sufficient funds to meet the cash requirements of its business operations. HSB is a holding company whose principal
subsidiary is HSBIIC. HSB relies on investment income, primarily in the form of dividends from HSBIIC in order to meet its short and long-term liquidity requirements including the service requirements for its capital securities. The Company receives a regular inflow of cash from maturing investments and engineering services and insurance operations. The mix of the investment portfolio is managed to respond to expected claim pay-out patterns and the service requirements equivalent of the Company's capital securities. HSB also maintains a highly liquid short-term portfolio to provide for immediate cash needs and since the issuance of the $110 million of Global Floating Rate Capital Securities in July 1997, which are discussed below, to offset a portion of interest rate risk relating to such securities. The Company's short-term portfolio at December 31, 1997 reflects the temporary investment of the proceeds from the $300 million Convertible Capital Securities discussed below. It is unlikely that HSB will maintain such high levels of short-term investments; however, given the current interest rate environment, HSB is proceeding carefully to structure an appropriate investment portfolio.
On January 27, 1997 the Board of Directors renewed HSBIIC's authorization to repurchase up to one million of its common shares. At its July meeting, the HSB Board of Directors increased the authorization to repurchase shares to two million. Through December 31, 1997, HSB has purchased approximately one million shares at a cost of $54 million. On January 26, 1998 the Board of Directors renewed HSB's authorization to repurchase up to two million shares of its common stock. At December 31, 1997 treasury stock of $85.9 million was reclassified to retained earnings and additional paid-in capital to reflect the elimination of the concept of treasury shares in accordance with the Connecticut Business Corporation Act which became effective January 1, 1997. For comparative purposes, treasury stock of $59.5 million was likewise reclassified at December 1996.
In 1996 the Company began a comprehensive effort to assess and address issues relating to the ability of its policy processing and other operational systems to properly recognize calendar dates beginning in the year 2000. The analysis indicated roughly 30 percent of existing code is compliant, roughly 60 percent is represented by legacy systems, which were scheduled to be replaced before the end of 1998 due to current business needs, and the remainder will be addressed through modification to compliant code or discontinuation. The impact of year 2000 expenditures on a stand alone basis is not clearly evident as the Company is replacing legacy applications due to changing business needs and such replacement applications will be year 2000 compliant. However, the overall cost of modification efforts and application replacement, which include substantial enhancements to business functionality, has been estimated at $13-$20 million over a three year period. Certain of the costs related to the replacement of legacy applications due to changing business needs will be capitalized consistent with the Company's existing capitalization policy.
expectations depending on the outcome of certain factors described with such forward-looking statements and other factors including: significant natural disasters and severe weather conditions; changes in interest rates and the performance of the financial markets; changes in the availability, cost and collectibility of reinsurance; changes in domestic and foreign laws, regulations and taxes; the entry of new or stronger competitors and the intensification of pricing competition; the loss of current customers or the inability to obtain new customers; changes in the coverage terms selected by insurance customers, including higher deductibles and lower limits; the adequacy of loss reserves; changes in asset valuations; consolidation and restructuring in the insurance industry; changes in the Company's participation in joint underwriting associations, and in particular IRI; changes in the demand and customer base for engineering and inspection services offered by the Company, whether resulting from changes in the law or otherwise, and other general market conditions.
Consolidated Statements of Changes in Shareholders' Equity for the years ended December 31, 1997, 1996 and 1995. 46
Schedule II - Condensed Financial Information of HSB Group, Inc. 80
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of HSB Group, Inc. and its subsidiaries as of December 31, 1997 and 1996, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1997, 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, present fairly, in all material respects, the information required to be included therein.
For the years then ended December 31, (in millions, except per share amounts)
Non-cash investing and financing activities: Issuance of HSB convertible preferred stock in exchange for EIG, Co. preferred stock in 1996, and conversion into HSB common stock in 1997. (See note 3).
Prepaid acquisition costs, consisting principally of commissions and premium taxes, are amortized as the related insurance premiums are earned. All other acquisition costs are charged to operations as incurred.
Reinsurance assets represents amounts due from reinsurers for paid and unpaid claims, paid and unpaid loss adjustment expenses and the unearned portion of premiums ceded through reinsurance agreements.
Short-term investments have a maturity of one year or less and are carried at cost which, together with accrued interest thereon, approximates fair value. Fixed maturities include bonds, notes and redeemable preferred stocks. Equity securities include common and non-redeemable preferred stocks. All fixed maturities and equity securities are classified as available for sale. Accordingly, these investments are carried at estimated fair value. Estimated fair values of securities classified as available for sale are based principally upon quoted market prices. Unrealized gains and losses on investments classified as available for sale and foreign exchange gains and losses on certain investments in foreign operations where the U.S. dollar is not the functional currency are included net of income tax in shareholders' equity.
Financial investments which qualify for hedge accounting are recorded at market with gains and losses reflected in shareholders' equity. To the extent such instruments do not qualify for hedge accounting, related gains and losses are reflected in results of operations.
Goodwill represents the cost of acquiring a business which is in excess of the fair value of its net assets. 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 $20.7 and $12.1 million at December 31, 1997 and 1996, respectively. HSB evaluates the reliability of goodwill based upon projections of undiscounted cash flows.
In February 1997, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 128, "Earnings per Share". This statement establishes standards for computing and presenting earnings per share (EPS). It replaces the presentation of primary EPS with a presentation of basic EPS. It also requires dual presentation of basic and diluted EPS on the face of the Consolidated Statements of Operations and a reconciliation of the numerator and denominator of the basic EPS computation to the numerator and denominator of the diluted EPS computation. The requirements of this statement are effective for year end 1997 financial statements with prior period restatement required. The effect of this standard on EPS net income is as follows:
and descriptive information about reportable operating segments. It includes disclosure requirements relating to products and services, geographic areas and major customers. This statement will be effective for 1998, however, application is not required for interim financial statements in the initial year. It is possible that this disclosure may redefine our segment information. However, HSB has not yet determined how SFAS No. 131 will be applied.
On July 15, 1997, HSB sold $110 million of 30 year Global Floating Rate Capital Securities in a private placement. On December 31, 1997, HSB sold $300 million of 20 year fixed rate Convertible Capital Securities to Employers Reinsurance Corporation (ERC), a subsidiary of GE Capital Services. (See note 12).
In January 1996, HSBIIC and The Dow Chemical Company (Dow) formed a new entity, Radian International LLC (Radian). According to the terms of the agreement, the ownership of Radian was initially 60 percent Dow and 40 percent HSBIIC, via the wholly
The agreement provided HSBIIC the option to put its share of the venture to Dow any time during the period from December 31, 1997 to December 31, 1998 upon giving appropriate notice. On July 28, 1997 the HSB Board of Directors ratified management's decision to put its share of Radian to Dow on or about January 1, 1998. Due to this decision, the results of Radian have been classified as discontinued operations. HSB's share of Radian's losses generated subsequent to this decision of approximately $10 million pre-tax have been deferred until HSB's share of Radian was sold and a gain recognized.
On January 2, 1998 HSB exercised its option to put its share of Radian to Dow for approximately $144 million. This transaction will result in an after tax gain of approximately $30 million which will be recorded in the first quarter of 1998.
1997* 1996* 1995 - - --------------------------------------------------------- Assets $ 159.7 $ 156.3 $ 108.6 Liabilities 88.4 62.1 37.1
On January 6, 1998 HSBIIC sold its interest in Industrial Risk Insurers (IRI) to ERC in accordance with a previously announced purchase and sale agreement between ERC and IRI's twenty-three member insurers. IRI is an unincorporated, voluntary joint underwriting association which underwrites property insurance on highly protected risks. HSBIIC received gross proceeds of approximately $50 million, prior to transaction costs, for its 23.5 percent share in IRI. Because the sale was structured in part as a reinsurance transaction, a portion of HSBIIC's gross proceeds will be utilized to reinsure in-force policies with ERC.
Contemporaneous with the close of the sale, IRI was reconstituted with ERC (with a 99.5 percent share) and HSBIIC (with a .5 percent share) as its sole members. Initially HSBIIC will write the business for the reconstituted IRI using its insurance licenses and will provide certain other services. It is anticipated that HSBIIC will transfer its domestic highly protected risk manufacturing book of business to IRI and will retain 85 percent of
Total $ 603.4 $ 548.8 $ 470.7 ------------------------------------- - - -------------------------------------------------------------------------------
Income from continuing operations before taxes and distributions on capital - - ---------------------------------------------------------------------------- securities - - ----------
For the years ended December 31, 1997 1996 1995 - - ------------------------------------------------------------------------------- U.S. $ 74.1 $ 52.7 $ 53.4 Non-U.S. 19.6 20.2 18.8 ---------------------------------------- Total $ 93.7 $ 72.9 $ 72.2 ---------------------------------------- - - -------------------------------------------------------------------------------
The following presents financial data of continuing operations of the Company based on industry segments:
Income from continuing operations before income taxes and distributions on - - -------------------------------------------------------------------------- capital securities - - ------------------
For the years ended December 31, 1997 1996 1995 - - -------------------------------------------------------------------------- Insurance $ 39.8 $ 21.8 $ 34.2 Engineering 4.3 7.3 6.7 Investment 49.6 43.8 31.3 --------------------------------------- Total $ 93.7 $ 72.9 $ 72.2 - - --------------------------------------------------------------------------
Identifiable assets At December 31, 1997 1996 1995 - - -------------------------------------------------------------------------- Insurance $ 308.0 $ 309.9 $ 180.8 Engineering 95.6 91.4 97.0 Investment 996.7 600.9 553.8 Other 139.9 114.1 122.5 -------------------------------------- Total $1,540.2 $1,116.3 $ 954.1 - - --------------------------------------------------------------------------
and $292.4 million, respectively. Statutory net income, adjusted to include the earnings of all HSBIIC domestic insurance subsidiaries for 1997, 1996, and 1995 was $42.9, $32.1, and $66.7 million, respectively.
6. Investments 1997 1996 1995 - - -------------------------------------------------------------------------------- Income from Investment Operations Net investment income: Short-term interest $ 6.7 $ 4.8 $ 6.2 Fixed maturities: Taxable interest 9.6 9.8 9.0 Tax exempt interest 2.1 1.8 1.9 Redeemable preferred dividends 7.2 7.9 6.3 Equity securities: Common dividends 4.7 4.6 4.0 Non-redeemable preferred dividends 8.3 5.9 4.6 Other 2.1 1.0 1.2 ------------------------ Total investment income 40.7 35.8 33.2 Investment expenses (3.9) (3.5) (4.3) ------------------------ Net investment income $ 36.8 $ 32.3 $ 28.9 ------------------------
Net gains (losses) 0.1 (1.2) 0.1 Equity securities: Common stocks: Gains 48.1 14.6 11.4 Losses (5.1) (3.3) (7.4) ------------------------
1997 1996 1995 - - ------------------------------------------------------------------------------- Unrealized Investment Gains, Net of Tax Fixed maturities: Gains $ 7.9 $ 6.1 $ 9.3 Losses (0.6) (1.6) (1.6) --------------------------- Net gains 7.3 4.5 7.7 Equity securities: Gains 94.3 82.0 64.2 Losses (1.8) (2.2) (3.8) --------------------------- Net gains 92.5 79.8 60.4 Foreign exchange losses (4.5) (2.9) (2.7) --------------------------- Total unrealized investment gains 95.3 81.4 65.4 Income taxes (35.5) (28.6) (21.5) --------------------------- Unrealized investment gains, net of tax $ 59.8 $ 52.8 $ 43.9 -------------------------- - - ------------------------------------------------------------------------------
with internationally recognized financial institutions, which were expected to perform under the terms of the contract, and by evaluating the credit worthiness 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, 1997 and 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 the 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.
Fixed assets are summarized as follows: 1997 1996 - - -------------------------------------------------------------------------------- Land and buildings $ 5.0 $ 7.3 Furniture, equipment, leasehold improvements, and other 57.1 65.7 Systems development costs 6.6 0.6 ------------------------ $ 68.7 $ 73.6 Less accumulated depreciation and amortization (32.3) (41.3) ------------------------ Fixed assets $ 36.4 $ 32.3 ------------------------ - - --------------------------------------------------------------------------------
The Company has a policy capitalizing certain systems development costs. Systems development costs are amortized over estimated useful lives of 3 to 5 years.
In 1996 the Company began a comprehensive effort to assess and address issues relating to the ability of its policy processing and other operational systems to properly recognize calendar dates beginning in the year 2000. The analysis indicated roughly 30 percent of existing code is compliant, roughly 60 percent is represented by legacy systems, which were scheduled to be replaced before the end of 1998 due to current business needs, and the remainder will be addressed through modification to compliant code or discontinuation. The impact of year 2000 expenditures on a stand alone basis is not clearly evident as the Company is replacing legacy applications due to changing business needs and such replacement applications will be year 2000 compliant. However, the overall cost of modification efforts and application replacement, which include substantial enhancements to business functionality, has been estimated at $13-$20 million over a three year period. Certain of the costs related to the replacement of legacy
applications due to changing business needs are being capitalized consistent with the Company's existing capitalization policy.
The Company leases its home office facility at One State Street under a long-term capital lease with the One State Street Limited Partnership (Partnership). The lease obligation of $26.1 million was recorded at July 1, 1983 at an interest rate of 15 percent. An asset of $26.1 million was also recorded in 1983. Accumulated amortization on the asset was $10.8 and $10.1 million at December 31, 1997 and 1996, 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 facility's variable operating expenses. This amounted to approximately $2.6, $2.8 and $2.8 million for the years ended 1997, 1996 and 1995, respectively.
The Company owns the One State Street land and leases it to the Partnership. The Company receives a base rent for the land and a participation in the net cash flow of the Partnership. If the facility is sold, the Company will receive 50 percent or more of the sales proceeds in excess of the mortgages, all operating expenses and costs of sale and the rental obligations pursuant to the land lease. Under certain circumstances, the Company has the right to purchase the facility.
In addition to its home office facility, the Company leases facilities and certain equipment which are accounted for as operating leases. Lease expenses amounted to $8.4, $5.7 and $4.7 million in 1997, 1996 and 1995, respectively.
At December 31, 1997, 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:
1998 $ 5.0 1999 4.4 2000 2.9 2001 1.6 2002 0.8 2003 and thereafter 0.3 ------- Total $15.0 -------
Net written premiums $ 498.5 $ 454.4 $ 408.3 ------------------------------------ Earned premiums: Direct $ 370.1 $ 343.4 $ 279.7 Assumed 239.2 213.1 175.3 Ceded (118.1) (107.9) (65.9) ------------------------------------ Insurance premiums $ 491.2 $ 448.6 $ 389.1 ------------------------------------ - - --------------------------------------------------------------------------------
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. Under the reinsurance agreements, the Company's reinsured companies may include equipment breakdown exposures in their multi-peril policies, and such risks will be assumed by the Company under the terms of the agreement. These plans generally provide that the Company will assume 100 percent of each boiler and machinery risk, subject to the capacity specified in the agreement, and will receive the entire equipment breakdown premium except for a ceding commission, which will be retained by the reinsured company for commissions to agents and brokers, premium taxes and handling expenses.
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 which do not comply with the risk transfer provisions of SFAS No. 113, "Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts". The Company recorded $45.2, $113.9 and $28.5 million of reinsurance recoveries as a reduction of its claims and adjustment expenses for the years ended December 31, 1997, 1996 and 1995, respectively. Reinsurance recoverable on paid claims and adjustment expenses was $8.0 million at both December 31, 1997 and 1996.
Reconciliation of Gross Liability for Claims and Adjustment Expenses - - --------------------------------------------------------------------
The following table displays information concerning the primary participant in the Company's current reinsurance program as of December 31, 1997:
As of December 31, 1997 no other reinsurance asset of the Company due from any single reinsurer exceeded 3 percent of shareholders' equity. Certain Lloyds' syndicates participate in the excess of loss reinsurance program, primarily in the excess layers. The highest aggregate percentage participation of such syndicates, at 44.6 percent, is in the $50 million excess of $100 million layer. No individual syndicate has more than a 7.7 percent participation in any of the excess layers. The Company's reinsurance asset in the aggregate from all Lloyds' syndicates is less than 2 percent of shareholders' equity at December 31, 1997. Lloyd's has historically participated more heavily in the higher treaty layers, including those years relating to the arbitration and litigation cases discussed below.
The obligations of HSBIIC's reinsurers with respect to these cases are not in dispute. Therefore, management believes that any adverse outcomes in these cases will not, in the aggregate, have a material effect on either the results of operations or financial condition of the Company. HSBIIC's reinsurance contracts do not require HSBIIC to reimburse its reinsurers for any losses such reinsurers might incur should these cases not be decided in HSBIIC's favor. Nevertheless, reinsurers often quote rates for future coverages based upon their or other reinsurers' experience on a particular account. Therefore, in the event HSBIIC's reinsurers pay significant sums pursuant to the arbitration or litigation proceedings described above, it is likely HSBIIC's reinsurance rates would increase in future periods. However, given the insured capacity that exists in reinsurance markets worldwide, coupled with HSBIIC's ability to negotiate a redesign or restructuring of its reinsurance program, it does not necessarily mean that such an increase would be material.
Income taxes (benefit) consisted of the following: 1997 1996 1995 - - -------------------------------------------------------------------------------- Current provision: U.S $ 16.8 $ 17.3 $ 12.3 Foreign 7.0 7.4 8.2 -------------------------------- Total current provision 23.8 24.7 20.5 -------------------------------- Deferred provision: U.S 1.1 (6.0) 0.4 Foreign 0.2 (0.4) (1.4) -------------------------------- Total deferred provision 1.3 (6.4) (1.0) -------------------------------- Total income taxes $ 25.1 $ 18.3 $ 19.5 -------------------------------- - - --------------------------------------------------------------------------------
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, 1997 and 1996 are as follows:
Federal income tax returns for the years 1995 and 1994 are currently under examination by the Internal Revenue Service.
HSBIIC has a commercial paper program with a limit of $75 million. Commercial paper outstanding at December 31, 1997 and 1996 was $42.4 million and $3.2 million, respectively. Commercial paper outstanding at year end 1997 matured on or before January 6, 1998. Long-term debt consists of $25.1 million of senior notes due May 15, 2000 at an interest rate of 6.83 percent. Current market value is estimated to be $25.3 million.
On December 30, 1996, HSBIIC exercised its right to exchange 2,000 shares of EIG, Co. preferred stock, which was issued at the time HSBIIC acquired the remaining 50 percent interest in EIG, Co. from Gen Re, for 2,000 shares of HSBIIC's convertible redeemable preferred stock. The stock had no par value, but had voting rights and carried a quarterly dividend of $162.50. The stock was converted on October 30, 1997 into 398,406 shares of HSB common stock at a price of $50.20 per share.
On July 15, 1997, HSB sold $110 million of 30 year Global Floating Rate Capital Securities (Capital Securities) in a private placement. The securities are generally non-callable for ten years but may be called earlier by HSB upon the occurrence of certain tax events including loss of deductibility of interest on the securities. The securities were
The Convertible Capital Securities are convertible, in whole or in part, at ERC's option at any time, subject to regulatory approval, into shares of Company common stock at a conversion price of $85, subject to adjustment. The Company has provided certain registration rights to ERC in connection with the common stock into which the Convertible Capital Securities are convertible pursuant to a Registration Rights Agreement dated December 31, 1997. Were ERC to exercise its conversion rights in total, it would hold, on a fully diluted basis, approximately 15.3 percent of the Company's common stock. Pursuant to certain provisions contained in the Purchase Agreement dated December 31, 1997, ERC has agreed to certain "standstill" arrangements, which for a period of five years will preclude ERC from purchasing any common stock of the Company, other than by exercise of its conversion rights, and will limit its ability to take certain other actions with respect to the Company during that period.
distributions accumulating from the date of original issuance and payable semi-annually in arrears. HSB has the right to defer payment of interest at any time or from time to time for a period not exceeding 10 consecutive semi-annual periods with respect to each deferral period. During an extension period, interest will continue to accrue and the amount of distributions to which holders of the Convertible Capital Securities are entitled will accumulate, and HSB will be prohibited from paying any cash dividends on its common stock. HSB has irrevocably and unconditionally guaranteed all of Trust II's obligations under the Convertible Capital Securities.
The estimated fair value of the Capital Securities issued by Trust I and Trust II is equal to their carrying value.
At December 31, 1997 1996 - - -------------------------------------------------------------------- Additional paid in capital $ 2.8 $ 2.0 Retained earnings 83.1 57.5 --------------------------------- Total $85.9 $ 59.5 --------------------------------- - - --------------------------------------------------------------------
HSBIIC had guaranteed 40 percent of Radian's loan outstanding with Dow. The guaranty was terminated on January 2, 1998 in conjunction with the sale of HSBIIC's interest in Radian to Dow.
HSB maintains various types of pension plans covering employees of 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 1997, 1996 or 1995. Assets available for plan benefits include approximately $20.9 million of Company stock at December 31, 1997.
The pension expense for the U.S. pension plans was a net credit to earnings for 1997, 1996 and 1995 due to the over funded status of the primary plan. The components of the credit were as follows:
1997 1996 1995 - - ------------------------------------------------------------------- Service costs $ 4.1 $ 3.6 $ 2.9 Interest costs 10.7 10.2 10.2 Return on assets (42.4) (20.1) (30.9) Net amortization and deferral 24.8 4.0 15.3 -------------------------------- Net pension credit $ (2.8) $ (2.3) $ (2.5) -------------------------------- - - -------------------------------------------------------------------
The Company makes contributions to the plans as claims are incurred. Contributions totaled $1.9, $2.4 and $2.6 million for 1997, 1996 and 1995, respectively. At December 31, 1997, 1996 and 1995 these plans were unfunded. Retirees' contributions to these plans vary, based upon retiree's age, years of service and coverage elected. The Company periodically amends the plan changing the contribution rate of retirees and amounts of coverage.
For the years ended December 31, 1997 1996 1995 - - -------------------------------------------------------------------------------- Service cost $ 0.3 $ 0.3 $ 0.3 Interest cost 2.1 2.0 2.3 Amortization of unrecognized obligations 0.1 -- -- Net periodic postretirement benefit cost $ 2.5 $ 2.3 $ 2.6 - - --------------------------------------------------------------------------------
1997 1996 - - -------------------------------------------------------------------------------- Accumulated postretirement benefit obligations for: Retirees $ 23.5 $ 22.0 Other fully eligible plan participants 1.5 1.0 Other active plan participants 4.9 3.8 ------------------- Total accumulated postretirement benefit obligation 29.9 26.8 Unrecognized net loss (5.5) (3.0) ------------------- Accrued postretirement benefit liability $ 24.4 $ 23.8 ------------------- - - --------------------------------------------------------------------------------
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 December 31, 1997 of $29.9 million by approximately $1.5 million and the aggregate of the service and interest cost for the year ended December 31, 1997 by $0.1 million.
HSB's Long-Term Incentive Plan grants senior management awards contingent upon achievement of specified performance objectives over a three year period which may be paid out in cash or shares of common stock (which may be restricted shares). The number of shares subject to issuance under this plan cannot exceed 150,000.
1997 1996 1995 - - -------------------------------------------------------------------------------- Restricted shares awarded 20,396 13,250 9,350 Weighted-average fair value of shares on grant date $ 47.89 $ 48.85 $ 42.78 - - --------------------------------------------------------------------------------
SFAS No. 123, "Accounting for Stock Based-Compensation" was issued in October 1995 for implementation by year end 1996. SFAS No. 123 allows the use of a fair value based method of accounting for an employee stock option or similar equity instruments or the intrinsic value based method prescribed by APB Opinion No. 25, "Accounting for Stock Issued to Employees" with pro forma disclosures of net income and earnings per share as if the fair value based method of accounting had been applied. The Company has elected to continue using the intrinsic value based method. Had the Company elected to recognize compensation cost using the fair value based method, compensation would
have been measured at date of grant and recognized over the service period. Pro forma net income and earnings per share would have been reduced as follows for 1997 and 1996:
1997 1996 - - ------------------------------------------------------------------------------ Net Income As Reported $66.3 $53.4 Pro Forma 64.5 51.4 Earnings per common share - basic As Reported $ 3.32 $ 2.65 Pro Forma 3.22 2.55 Earnings per common share - diluted As Reported $ 3.29 $ 2.65 Pro Forma 3.20 2.55 - - ------------------------------------------------------------------------------
*Total revenues exclude revenues for investments accounted for on the equity method.
Equity in net income of subsidiaries 35.4 ------------ Consolidated net income $ 34.0 ============
Assets Cash $ 0.7 Short-term investments, at cost 60.5 Investment in subsidiaries 657.0 Fixed maturities 11.8 Equity securities, at fair value 27.2 Other assets 23.9 ---------------
Total assets $ 781.1 =============== Liabilities Dividends payable $ 11.8 Other liabilities 15.1 ---------------
Company obligated mandatorily redeemable convertible 300.0 capital securities of subsidiary Trust II holding solely junior subordinated deferrable interest debentures of the Company.
Column A Column B Column C Column D Column E Column F Insurance Gross Ceded to Assumed Net Percentage of Premiums Amount Other From Other Amount Amount Companies Companies Assumed to Net - - -------------------------------------------------------------------------------