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| HCC > SEC Filings for HCC > Form 10-Q on 8-May-2009 | All Recent SEC Filings |
8-May-2009
Quarterly Report
• non-risk-bearing fee and commission income received by our underwriting agencies and brokers,
• ceding commissions in excess of policy acquisition costs earned by our insurance companies,
• investment income earned by all of our operations,
• realized investment gains and losses related to our fixed income securities portfolio, and
• other operating income and losses, mainly from strategic investments and events that do not occur each year.
We produced $600.7 million of revenue in the first quarter of 2009, an increase
of 6% compared to the first quarter of 2008. This increase principally resulted
from a combined $20.0 million of other operating income and $5.0 million of fee
and commission income related to the commutation of a reinsurance contract that
had been accounted for using the deposit method of accounting, as well as
$9.0 million of losses on trading securities in the 2008 quarter.
During the past several years, we substantially increased our shareholders'
equity by retaining most of our earnings and issuing additional shares of common
stock. With this additional equity, we increased the underwriting capacity of
our insurance companies and made strategic acquisitions, adding new lines of
business or expanding those with favorable underwriting characteristics. Since
January 2008, we have acquired an insurance business and five underwriting
agencies for total consideration of $84.0 million. Net earnings and cash flows
from each acquired entity are included in our operations beginning on the
effective date of each transaction.
The following section discusses our key operating results. Amounts in the
following tables are in thousands, except for earnings per share, percentages,
ratios and number of employees. Comparisons refer to the first quarter of 2009
compared to the same quarter of 2008, unless otherwise noted. Certain 2008
amounts have been adjusted to reflect our adoption of a new accounting standard
as of January 1, 2009. See the "Accounting Pronouncements Adopted in 2009"
section below for additional information.
Results of Operations
Net earnings were $83.2 million ($0.73 per diluted share) in 2009 compared to
$80.5 million ($0.69 per diluted share) in 2008. The increase in net earnings
primarily resulted from the commutation of a reinsurance contract that had been
accounted for using the deposit method of accounting and other items described
below. Diluted earnings per share benefited from the repurchase of 4.7 million
shares of our common stock in 2008 and the first quarter of 2009. The share
repurchases reduced our diluted weighted-average shares outstanding, which were
113.3 million in the first quarter of 2009 and 116.4 million in the first
quarter of 2008.
The following items affected pretax earnings in 2009 compared to 2008:
Three months ended March 31,
2009 2008
Pretax earnings (loss) from:
Commutation of reinsurance contract, net of related costs $ 15,600 $ -
Prior years' positive (adverse) reserve development (4,727 ) 5,127
Other-than-temporary impairments of fixed income securities (3,113 ) -
Trading securities - (9,028 )
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• In 2009, we commuted all liability loss-free under a contract to provide reinsurance coverage for certain residential mortgage guaranty contracts. We had been recording revenue under this contract using the deposit method of accounting because we determined the contract did not transfer significant underwriting risk. We received a cash termination payment of $25.0 million in the quarter. The termination increased other operating income by $20.5 million and fee and commission income by $5.0 million. This revenue was offset by $9.9 million of expenses for reinsurance and other direct costs. The expenses were recorded in other operating expense in the first quarter of 2009.
• In 2009, we had adverse development of our prior years' net loss reserves of $4.7 million, primarily from reserve increases in certain of our group life, accident and health businesses. We had favorable development of $5.1 million in 2008 primarily from the re-estimation of our net exposure on certain case basis reserves.
• We recognized other-than-temporary impairments on securities in our available for sale fixed income securities portfolio of $3.1 million in 2009, which we recorded in net realized investment loss. Our 2009 impairment losses were offset by gains on investments sold in the quarter. There were no other-than-temporary impairments recorded in 2008.
• Our trading portfolio, which we liquidated during 2008, had fair value losses of $9.0 million in the first three months of 2008. These losses are reported in other operating income (loss).
The following table sets forth the relationships of certain income statement items as a percent of total revenue.
Three months ended March 31,
2009 2008
(as adjusted)
Net earned premium 83.6 % 87.0 %
Fee and commission income 5.0 5.5
Net investment income 7.5 8.4
Other operating income (loss) 3.9 (0.9 )
Total revenue 100.0 100.0
Loss and loss adjustment expense, net 52.5 51.6
Policy acquisition costs, net 14.8 16.3
Other operating expense 11.5 10.4
Interest expense 0.8 0.9
Earnings before income tax expense 20.4 20.8
Income tax expense 6.6 6.6
Net earnings 13.8 % 14.2 %
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Gross written premium, net written premium and net earned premium are detailed below. Gross written premium increased from growth in our diversified financial products line of business and our 2008 acquisitions, offset by a reduction due to the discontinuance of an assumed quota share agreement in 2008. See the "Insurance Company Segment" section below for further discussion of the relationship and changes in premium revenue.
Three months ended March 31,
2009 2008
Gross written premium $ 602,387 $ 582,999
Net written premium 491,250 493,647
Net earned premium 502,388 493,546
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The table below shows the source of our fee and commission income. Although fee and commission income was relatively flat quarter over quarter, 2009 includes the $5.0 million termination payment for commutation of a reinsurance contract that had been accounted for using the deposit method of accounting. Excluding the termination revenue, the decrease in 2009 primarily related to lower income from reinsurance overrides on quota share treaties.
Three months ended March 31,
2009 2008
Agencies $ 24,576 $ 22,284
Insurance companies 5,718 8,715
Fee and commission income $ 30,294 $ 30,999
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The sources of net investment income are detailed below.
Three months ended March 31,
2009 2008
Fixed income securities
Taxable $ 25,105 $ 22,452
Exempt from U.S. income taxes 20,333 18,472
Total fixed income securities 45,438 40,924
Short-term investments 1,794 8,592
Alternative investments (962 ) (1,205 )
Other investments - 267
Total investment income 46,270 48,578
Investment expense (1,052 ) (957 )
Net investment income $ 45,218 $ 47,621
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Net investment income decreased 5% in 2009 primarily due to earning
significantly lower market interest rates on our short-term investments. This
decrease was partially offset by an 11% increase in income on our fixed income
securities, which was generated from higher invested balances. Our fixed income
securities portfolio increased from $3.9 billion at March 31, 2008 to
$4.3 billion at March 31, 2009. The growth in fixed income securities resulted
primarily from cash flow from operations.
Our loss from alternative investments, which were primarily fund-of-fund hedge
fund investments, was the same quarter over quarter. We reduced our exposure to
these funds by redeeming $52.6 million in the fourth quarter of 2008 and the
remaining $44.3 million through April 2009. We have collected $90.6 million of
these redeemed funds through April 2009.
We recognized $3.1 million of other-than-temporary impairments in the first
quarter of 2009, which were offset by realized gains on the sales of other fixed
income securities. There were no other-than-temporary impairments in the first
quarter of 2008.
Other operating income was a gain of $22.9 million in 2009 compared to a loss of
$4.9 million in 2008. The 2009 gain included the $20.0 million termination
payment to commute a reinsurance contract that had been accounted for using the
deposit method of accounting. The 2008 loss resulted from reduction in the fair
value of previously-held trading securities. Period to period comparisons in
this category may vary substantially, depending on acquisition of new
investments, income or loss related to changes in the market values of certain
investments, and gains or losses related to any disposition. The following table
details the components of our other operating income (loss).
Three months ended March 31,
2009 2008
Contract using deposit accounting $ 20,532 $ -
Trading securities - (9,028 )
Strategic investments 750 913
Financial instruments 363 1,336
Other 1,251 1,833
Other operating income (loss) $ 22,896 $ (4,946 )
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Loss and loss adjustment expense increased 8% quarter over quarter, due to the
increase in net earned premium and the compound effect of adverse reserve
development in 2009 and positive development in 2008. Policy acquisition costs
decreased 4% quarter over quarter principally due to lower commission rates on
certain lines of business and a change in the mix of business. See the
"Insurance Company Segment" section below for further discussion of the changes
in loss and loss adjustment expense and policy acquisition costs.
Other operating expense, which includes compensation expense, increased 17% in
2009. The 2009 increase included compensation and other operating expenses of
subsidiaries acquired in the fourth quarter of 2008 and the first quarter of
2009. In addition, 2009 other operating expense included $9.9 million of
expenses for costs directly related to commuting the reinsurance contract that
had been accounted for using the deposit method of accounting. We had 1,937
employees at March 31, 2009 compared to 1,757 a year earlier, with the increase
primarily due to acquisitions.
Other operating expense includes $3.6 million and $2.9 million in the first
quarter of 2009 and 2008, respectively, of stock-based compensation expense,
after the effect of the deferral and amortization of policy acquisition costs
related to stock-based compensation for our underwriters. At March 31, 2009,
there was approximately $30.6 million of total unrecognized compensation expense
related to unvested options and restricted stock awards and units that is
expected to be recognized over a weighted-average period of 2.7 years.
Our effective income tax rate was 32.3% for 2009, compared to 31.8% for 2008.
The higher effective rate in 2009 primarily relates to a slight increase in
non-deductible expenses.
At March 31, 2009, book value per share was $24.14, up from $23.27 at
December 31, 2008. Total assets were $8.6 billion and shareholders' equity was
$2.7 billion, compared to $8.3 billion and $2.6 billion, respectively, at
December 31, 2008. We repurchased 1.7 million shares of our common stock in the
first quarter of 2009, which increased book value per share by $0.04.
Segments
Insurance Company Segment
Net earnings of our insurance company segment decreased $1.7 million, or 2%,
between 2009 and 2008, as the effects from an increased loss ratio and lower
investment income were greater than the effects from increased earned premium
and the net impact of the commutation of a reinsurance contract that had been
accounted for using the deposit method of accounting. Even though there is
pricing competition in certain of our markets, our margins remain at an
acceptable level of profitability.
Premium
Gross written premium is 3% higher in 2009, due to growth in our diversified
financial products line of business and our recent acquisitions, partially
offset by discontinuance of an assumed quota share contract in 2008. The overall
percentage of retained premium, as measured by the percent of net written
premium to gross written premium, decreased to 82% in 2009 from 85% in 2008.
The following tables provide premium information by line of business.
Gross Net NWP Net
written written as % of earned
premium premium GWP premium
Three months ended March 31, 2009
Diversified financial products $ 245,112 $ 203,363 83 % $ 214,084
Group life, accident and health 216,993 199,056 92 201,088
Aviation 41,952 30,611 73 32,814
London market account 44,749 26,394 59 23,674
Other specialty lines 53,577 31,822 59 30,724
Discontinued lines 4 4 nm 4
Totals $ 602,387 $ 491,250 82 % $ 502,388
Three months ended March 31, 2008
Diversified financial products $ 211,364 $ 180,501 85 % $ 192,177
Group life, accident and health 210,534 202,375 96 192,446
Aviation 44,828 32,346 72 34,993
London market account 40,936 29,028 71 27,090
Other specialty lines 75,343 49,403 66 46,846
Discontinued lines (6 ) (6 ) nm (6 )
Totals $ 582,999 $ 493,647 85 % $ 493,546
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nm - Not meaningful
The changes in premium volume and retention levels between quarters resulted
principally from the following factors:
• Diversified financial products - Gross and net written premium increased
because we wrote more domestic directors' and officers' liability business
at higher prices in 2009 and generated additional premium from title
insurance and new lines of business. Premium volume in our other major
products in this group was stable, although pricing for certain of these
products is down slightly. Earned premium increased in 2009 for the same
reasons. Our retention rate was lower because we are reinsuring more
directors' and officers' liability business in 2009.
• Group life, accident and health - The increase in gross written premium was due to writing more sports disability business, which is substantially reinsured. The premium increase from a company acquired in late 2008 was offset by lower premium in our organic lines of business. The increase in net earned premium was due to our acquisition of MultiNational Underwriters in the first quarter of 2008.
• Aviation - Our aviation premium volume was essentially flat due to continuing competition and lack of growth in the aviation industry. Pricing on this line remains competitive, although we have seen price increases on the international portion of this business.
• London market account - Gross written premium was higher and our retention rate was lower in 2009 due to the timing of writing a large insurance policy, which is substantially reinsured. Net written and net earned premium were lower in 2009 because we wrote a smaller portion of our annual Gulf of Mexico energy policies in the first quarter of 2009. We expect to write a larger portion in the second quarter of 2009.
• Other specialty lines - Premium decreased due to expiration of an assumed quota share contract in the second quarter of 2008 and discontinuance of a motor line written through one of our Lloyd's syndicates in mid-2008. The decrease in the retention rate was due to the change in mix of business in this line.
Losses and Loss Adjustment Expenses
Our net redundant (adverse) development relating to prior year losses included
in net incurred loss and loss adjustment expense was ($4.7 million) in 2009
compared to $5.1 million in 2008. The development primarily resulted from the
re-estimation of our net claims exposure for certain products, primarily in the
life, accident and health line of business in 2009 and the London market line of
business in 2008. Deficiencies and redundancies in reserves occur as we review
our loss reserves with our actuaries, increasing or reducing loss reserves as a
result of such reviews and as losses are finally settled or claims exposures
change.
We write directors' and officers' liability, professional indemnity and
fiduciary liability coverage for public and private companies and not-for-profit
organizations and continue to closely monitor our exposure to subprime and
credit related issues. We provide coverage for certain financial institutions,
which have potential exposure to shareholders' lawsuits. At March 31, 2009, we
had 17 "Side A only" and 62 "non-Side A only" directors' and officers'
liability, professional indemnity and fiduciary liability claims related to
subprime and credit related issues. Based on our present knowledge, we believe
our ultimate losses from these coverages will be contained within our current
overall loss reserves for these lines of business.
We have no material exposure to environmental or asbestos losses.
We believe we have provided for all material net incurred losses as of March 31,
2009.
Our gross loss ratio was 65.1% in 2009 and 59.9% in 2008. The increase in gross
loss ratio primarily related to higher gross losses in our directors' and
officers', aviation, fidelity, and film completion and film production lines of
business, a portion of which we reinsure. The following table provides
comparative net loss ratios by line of business.
Three months ended March 31,
2009 2008
Net Net Net Net
earned loss earned loss
premium ratio premium ratio
Diversified financial products $ 214,084 51.8 % $ 192,177 46.2 %
Group life, accident and health 201,088 74.6 192,446 74.5
Aviation 32,814 61.3 34,993 57.6
London market account 23,674 41.3 27,090 33.2
Other specialty lines 30,724 81.0 46,846 66.9
Discontinued lines 4 nm (6 ) nm
Totals $ 502,388 62.8 % $ 493,546 59.4 %
Expense ratio 24.5 24.3
Combined ratio 87.3 % 83.7 %
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nm - Not meaningful comparison
The changes in net loss ratios between periods resulted principally from the
following factors:
• Diversified financial products - The higher net loss ratio in 2009 resulted
from our increased estimation of losses on certain lines of business,
particularly for our directors' and officers' liability and credit
businesses.
• Group life, accident and health - While remaining flat quarter-over-quarter, the 2009 net loss ratio reflects lower losses on our medical stop-loss business, offset by adverse development and higher losses on short-term medical and other coverages.
• Aviation - The 2009 net loss ratio reflects higher incurred claims.
• London market account - The 2009 net loss ratio includes redundant reserve development on prior hurricane losses, which reduced the loss ratio 4.2 percentage points. The 2008 net loss ratio includes redundant reserve development related to our property and energy businesses, which decreased the loss ratio 10.2 percentage points.
• Other specialty lines - We incurred losses on our film completion and film production businesses in 2009, which increased the net loss ratio 19.7 percentage points.
The table below provides a reconciliation of our reserves for loss and loss adjustment expense payable, net of reinsurance ceded, the amount of our paid claims and our net paid loss ratios.
Three months ended March 31,
2009 2008
Net reserves for loss and loss adjustment expense payable at
. . .
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