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| HCC > SEC Filings for HCC > Form 10-Q on 3-Aug-2012 | All Recent SEC Filings |
3-Aug-2012
Quarterly Report
The following Management's Discussion and Analysis should be read in conjunction with the Consolidated Financial Statements and the related Notes as of June 30, 2012 and December 31, 2011.
Overview
We are a specialty insurance group with offices in the United States, the United Kingdom, Spain and Ireland, transacting business in approximately 180 countries. Our shares trade on the New York Stock Exchange and closed at $30.81 on July 27, 2012, resulting in market capitalization of $3.1 billion.
We underwrite a variety of relatively non-correlated specialty insurance products, including property and casualty, accident and health, surety and credit product lines. We market our insurance products through a network of independent agents and brokers, managing general agents and directly to consumers. In addition, we assume insurance written by other insurance companies. We manage our businesses through five insurance underwriting segments and our Investing segment. Our insurance underwriting segments are U.S. Property & Casualty, Professional Liability, Accident & Health, U.S. Surety & Credit and International.
Our business philosophy is to maximize underwriting profit while managing risk. We concentrate our insurance writings in selected specialty lines of business in which we believe we can achieve meaningful underwriting profit. We also rely on our experienced underwriting personnel and our access to and expertise in the reinsurance marketplace to limit or reduce risk. Our business plan is shaped by our underlying business philosophy. As a result, our primary objective is to maximize net earnings and grow book value per share, rather than to grow gross written premium or our market share.
Our major domestic and international insurance companies have financial strength ratings of AA (Very Strong) from Standard & Poor's Corporation, A+ (Superior) from A.M. Best Company, Inc., AA (Very Strong) from Fitch Ratings and A1 (Good Security) from Moody's Investors Service, Inc.
Key facts about our consolidated group as of and for the six months and quarter ended June 30, 2012 were as follows:
• We had consolidated shareholders' equity of $3.3 billion, with a book value per share of $33.19.
• We generated year-to-date net earnings of $176.1 million, or $1.71 per diluted share. Our second quarter earnings were $93.5 million, or $0.92 per diluted share.
• We produced total revenue of $1.2 billion and $632.3 million in the first six months and second quarter, respectively. In the first six months, 90% related to net earned premium and 9% related to net investment income.
• In the first six months, we recognized $12.3 million of net catastrophe losses - $4.0 million in our U.S. Property & Casualty segment from storms in the United States and $8.3 million in our International segment from other small catastrophes. The second quarter included net catastrophe losses of $4.7 million.
• Our year-to-date net loss ratio was 59.8% and our combined ratio was 85.0%.
• Our debt to capital ratio was 15.0%.
• We purchased $126.4 million, or 4.1 million shares, of our common stock at an average cost of $30.88 per share in the first six months of 2012.
• We declared dividends of $0.31 per share and paid $32.0 million of dividends in the first six months of 2012.
Comparisons in the following sections refer to the first six months of 2012 compared to the same period of 2011, unless otherwise noted. Certain 2011 amounts have been adjusted to reflect our adoption of a new accounting standard as of January 1, 2012. See Note 1, "General Information - Accounting Guidance Adopted in 2012" to the Consolidated Financial Statements for a description of this guidance and the impact of our retrospective adoption on prior year results. Amounts in tables are in thousands, except for earnings per share, percentages, ratios and number of employees.
Results of Operations
Our results and key metrics for the six months and quarter ended June 30, 2012
and 2011 were as follows:
Six months ended June 30, Three months ended June 30,
2012 2011 2012 2011
Net earnings $ 176,077 $ 116,468 $ 93,493 $ 69,478
Earnings per diluted share $ 1.71 $ 1.02 $ 0.92 $ 0.61
Net loss ratio 59.8 % 66.0 % 59.6 % 63.8 %
Expense ratio 25.2 25.9 25.3 25.4
Combined ratio 85.0 % 91.9 % 84.9 % 89.2 %
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In 2012, we recognized catastrophe losses from United States storms, primarily in our public risk line of business within our U.S. Property and Casualty segment and from other small catastrophes in our property treaty line of business within our International segment. In 2011, we recognized losses from catastrophic events in Japan, New Zealand, Australia, the United States and Denmark. We reinsure a portion of our exposure to catastrophic events, although we incur some additional cost for reinstatement premium to continue our reinsurance coverage for future loss events. The following table summarizes our catastrophe losses, as well as the impact on our net earnings and key metrics in 2012 and 2011:
Six months ended June 30, Three months ended June 30,
2012 2011 2012 2011
Gross losses $ 14,795 $ 120,259 $ 7,735 $ 15,059
Net losses, after reinsurance and
reinstatement premium $ 12,257 $ 73,328 $ 4,653 $ 21,863
Impact of net catastrophe losses on:
Net earnings per diluted share $ (0.08) $ (0.42) $ (0.03) $ (0.13)
Net loss ratio (percentage points) 1.1 % 6.6 % 0.9 % 3.9 %
Combined ratio (percentage points) 1.1 % 6.9 % 0.8 % 4.1 %
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Revenue
Total revenue increased $93.3 million in the first six months of 2012, compared to the same period in 2011, primarily due to higher net earned premium.
Gross written premium, net written premium and net earned premium are detailed below by segment.
Six months ended June 30, Three months ended June 30,
2012 2011 2012 2011
U.S. Property & Casualty $ 318,613 $ 265,511 $ 165,466 $ 135,961
Professional Liability 245,750 262,272 144,505 161,152
Accident & Health 434,264 397,823 218,141 201,523
U.S. Surety & Credit 110,702 113,953 56,209 60,182
International 364,911 351,581 207,235 183,233
Exited Lines 2 150 (3) 31
Total gross written premium $ 1,474,242 $ 1,391,290 $ 791,553 $ 742,082
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Six months ended June 30, Three months ended June 30,
2012 2011 2012 2011
U.S. Property & Casualty $ 197,894 $ 180,436 $ 105,566 $ 93,714
Professional Liability 171,137 190,648 100,224 116,857
Accident & Health 433,740 397,500 217,856 201,395
U.S. Surety & Credit 96,096 105,101 51,392 55,394
International 301,623 274,922 167,053 142,482
Exited Lines 2 150 (3) 31
Total net written premium $ 1,200,492 $ 1,148,757 $ 642,088 $ 609,873
U.S. Property & Casualty $ 177,852 $ 159,175 $ 88,834 $ 78,921
Professional Liability 200,905 203,174 99,467 102,424
Accident & Health 436,397 400,657 218,730 202,117
U.S. Surety & Credit 100,844 101,403 53,115 50,039
International 196,472 168,164 105,188 90,717
Exited Lines 2 158 (3) 33
Total net earned premium $ 1,112,472 $ 1,032,731 $ 565,331 $ 524,251
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Growth in premium occurred in the U.S. Property & Casualty segment from our new business lines added in 2011 and increased aviation, public risk, contingency, residual value and title reinsurance premium; the Accident & Health segment from higher writings of our medical stop-loss product; and the International segment from new business and pricing increases in our energy line of business. In 2011, we recorded $11.6 million ($12.7 million ceded, net of $1.1 million assumed) of catastrophe-related reinstatement premium, which reduced the International segment's 2011 net written and net earned premium. See the "Segment Operations" section below for further discussion of the relationship and changes in premium revenue within each segment.
Net investment income, which is included in our Investing segment, increased 6% year-over-year primarily due to higher income from fixed maturity securities, generated from an increased amount of investments. Our fixed maturity portfolio increased 9% from $5.6 billion at June 30, 2011 to $6.1 billion at June 30, 2012. In addition, we invested $92.6 million in an equities portfolio in the second quarter of 2012. The growth in investments resulted primarily from cash flow from operations and a $192.7 million increase in the net unrealized gain on available for sale securities since June 30, 2011.
The following table details the components of our other operating income. The fee and commission income relates to third party agency and broker commissions.
Six months ended June 30, Three months ended June 30,
2012 2011 2012 2011
Fee and commission income $ 10,542 $ 13,221 $ 6,139 $ 6,612
Financial instruments 330 385 115 122
Other 1,517 1,190 934 741
Other operating income $ 12,389 $ 14,796 $ 7,188 $ 7,475
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Loss and Loss Adjustment Expense
The tables below detail, by segment, our net loss and loss adjustment expense
and our net loss ratios.
Six months ended June 30, Three months ended June 30,
2012 2011 2012 2011
U.S. Property & Casualty $ 100,927 $ 92,428 $ 51,666 $ 44,944
Professional Liability 134,323 138,015 65,168 71,752
Accident & Health 324,717 291,605 163,004 146,747
U.S. Surety & Credit 26,723 29,687 15,690 14,648
International 79,623 130,393 41,856 56,221
Exited Lines (560) (260) (559) (30)
Net loss and loss adjustment expense $ 665,753 $ 681,868 $ 336,825 $ 334,282
U.S. Property & Casualty 56.7 % 58.1 % 58.2 % 56.9 %
Professional Liability 66.9 67.9 65.5 70.1
Accident & Health 74.4 72.8 74.5 72.6
U.S. Surety & Credit 26.5 29.3 29.5 29.3
International 40.5 77.5 39.8 62.0
Consolidated net loss ratio 59.8 % 66.0 % 59.6 % 63.8 %
Consolidated accident year net loss ratio 59.8 % 63.9 % 59.6 % 61.2 %
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Loss development represents an increase or decrease in estimates of ultimate losses related to prior accident years. Deficiencies and redundancies in ultimate loss estimates occur as we review our loss exposure with our actuaries, increasing or reducing estimates of our ultimate losses as a result of such reviews and as losses are finally settled or claims exposures change. The excess of total recorded net reserves over the actuarial point estimate approximated 4.3% of our recorded net reserves at June 30, 2012, compared to 4.2% at December 31, 2011. We recognized no development in the first six months of 2012, compared to adverse development of $22.3 million in the first six months of 2011 (of which $13.3 million was recognized in the second quarter), primarily in our Professional Liability segment. Our consolidated accident year net loss ratio was lower in 2012, compared to 2011, primarily due to higher catastrophe losses in 2011. See the "Segment Operations" section below for additional discussion of the changes in our net loss and loss adjustment expense and net loss ratios for each segment.
The table below provides a reconciliation of our consolidated reserves for loss and loss adjustment expense payable, net of reinsurance ceded, the amount of our paid claims, and our net paid loss ratio.
Six months ended June 30, Three months ended June 30,
2012 2011 2012 2011
Net reserves for loss and loss
adjustment expense payable at
beginning of period $ 2,683,483 $ 2,537,772 $ 2,699,717 $ 2,611,096
Net reserve additions from
acquired businesses 14,705 645 - -
Foreign currency adjustment (4,456) 27,986 (21,579) 5,770
Net loss and loss adjustment
expense 665,753 681,868 336,825 334,282
Net loss and loss adjustment
expense payments (610,490) (635,326) (265,968) (338,203)
Net reserves for loss and loss
adjustment expense payable at end
of period $ 2,748,995 $ 2,612,945 $ 2,748,995 $ 2,612,945
Net paid loss ratio 54.9 % 61.5 % 47.0 % 64.5 %
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Our net paid loss ratio decreased in 2012 due to substantially lower claims payments in our Professional Liability segment and our energy line of business in the second quarter of 2012, compared to the same period in 2011. We paid $27.5 million in the first quarter of 2012 and $26.7 million in the second quarter of 2011 to commute large contracts included in our Exited Lines. These commutations had no material effect on net earnings but increased our net paid loss ratios by 2.5 percentage points for the first six months of 2012, and 2.6 percentage points and 5.1 percentage points for the first six months and second quarter of 2011, respectively. The amount of claims paid fluctuates period to period due to our mix of business and the timing of claims settlement and catastrophic events.
Policy Acquisition Costs
Our policy acquisition cost percentage was 12.9% and 13.1% for the first six months of 2012 and 2011, respectively, and 13.2% and 12.6% for the second quarter of 2012 and 2011, respectively. The lower year-to-date percentage primarily relates to a change in the mix of business. The 2011 policy acquisition cost percentage was increased 0.1 percentage points due to $11.6 million of reinstatement premium (recorded as a reduction of net earned premium).
Other Operating Expense
For the first six months of 2012, 62% of our other operating expense related to compensation and benefits for our 1,866 employees. Other operating expense increased 5% year-over-year, primarily due to increased bonus expense related to higher net earnings in 2012. Other operating expense decreased 2% quarter-over-quarter, primarily due to higher foreign currency benefit in 2012. We recognized foreign currency benefit of $1.4 million and $4.2 million in the first six months and second quarter of 2012, respectively, directly related to the fluctuations in the British pound sterling. The foreign currency benefit was $2.0 million and $0.8 million in the first six months and second quarter of 2011, respectively. Other operating expense included stock-based compensation expense of $6.4 million in 2012 and $7.8 million in 2011. At June 30, 2012, there was approximately $26.7 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 2.8 years.
Interest Expense
Interest expense on debt and short-term borrowings was $13.1 million and $11.0 million in the first six months of 2012 and 2011, respectively, and $6.2 million and $5.4 million in the second quarter of 2012 and 2011, respectively. Our interest expense increased in 2012 due to a higher amount of outstanding borrowings on our $600.0 million Revolving Loan Facility, primarily to fund purchases of our common stock. Our interest expense for 2012 and 2011 included $9.7 million for our Senior Notes.
Income Tax Expense
Our effective income tax rate was 29.9% for the first six months of 2012, compared to 27.1% for the same period of 2011. The higher effective rate in 2012 is due to the relationship of pretax income and tax-exempt investment income in the two periods. Our pretax income was substantially lower in the first six months of 2011 due to $73.3 million of net catastrophe losses, whereas our tax-exempt investment income was essentially flat during the 2012 and 2011 six-month periods.
Segment Operations
Each of our insurance segments bears risk for insurance coverage written within its portfolio of insurance products. Each segment generates income from premium written by our underwriting agencies, through third party agents and brokers, or on a direct basis. The insurance segments also write facultative or individual account reinsurance, as well as treaty reinsurance business. In some cases, we purchase reinsurance to limit the segments' net losses from both individual policy losses and multiple policy losses from catastrophe occurrences. Our segments maintain disciplined expense management and a streamlined management structure, which results in favorable expense ratios. The following provides operational information about our five insurance segments and our Investing segment.
U.S. Property & Casualty Segment
The following tables summarize the operations of the U.S. Property & Casualty
segment.
Six months ended June 30, Three months ended June 30,
2012 2011 2012 2011
Net earned premium $ 177,852 $ 159,175 $ 88,834 $ 78,921
Other revenue 6,885 9,666 4,522 4,787
Segment revenue 184,737 168,841 93,356 83,708
Loss and loss adjustment expense, net 100,927 92,428 51,666 44,944
Other expense 59,767 55,575 30,045 27,169
Segment expense 160,694 148,003 81,711 72,113
Segment pretax earnings $ 24,043 $ 20,838 $ 11,645 $ 11,595
Net loss ratio 56.7 % 58.1 % 58.2 % 56.9 %
Expense ratio 32.4 32.9 32.2 32.5
Combined ratio 89.1 % 91.0 % 90.4 % 89.4 %
Aviation $ 58,220 $ 54,600 $ 29,397 $ 27,318
E&O 31,979 38,357 15,602 18,800
Public Risk 31,792 23,179 16,574 11,927
Other 55,861 43,039 27,261 20,876
Total net earned premium $ 177,852 $ 159,175 $ 88,834 $ 78,921
Aviation 55.8 % 63.7 % 64.5 % 68.9 %
E&O 60.8 57.3 60.6 55.0
Public Risk 77.8 66.9 63.9 60.5
Other 43.4 46.8 46.4 41.0
Total net loss ratio 56.7 % 58.1 % 58.2 % 56.9 %
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Six months ended June 30, Three months ended June 30,
2012 2011 2012 2011
Aviation $ 82,870 $ 79,056 $ 45,780 $ 37,608
E&O 31,493 36,998 14,602 17,305
Public Risk 43,245 34,298 23,461 16,845
Other 161,005 115,159 81,623 64,203
Total gross written premium $ 318,613 $ 265,511 $ 165,466 $ 135,961
Aviation $ 63,405 $ 59,085 $ 35,898 $ 31,691
E&O 30,235 36,586 13,730 17,020
Public Risk 35,567 26,396 19,973 13,144
Other 68,687 58,369 35,965 31,859
Total net written premium $ 197,894 $ 180,436 $ 105,566 $ 93,714
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Our U.S. Property & Casualty segment pretax earnings increased 15% year-over-year due to higher net earned premium and a lower net loss ratio. Net earned premium was higher in 2012 due to $6.0 million of additional premium from our new technical property, primary casualty and excess casualty underwriting teams, as well as increases in aviation, public risk, contingency, residual value and title reinsurance premium. These increases more than offset lower premium in our E&O line of business. Our new underwriting teams wrote $28.4 million of gross premium in the first six months of 2012, compared to $4.5 million in the same period of 2011. Segment earnings were impacted by $4.0 million of net catastrophe losses in the first quarter of 2012, primarily in our public risk line of business. The 2011 segment earnings and net loss ratio reflect the impact of $2.5 million of adverse loss development, including $1.0 million in the second quarter of 2011. The segment had no loss development in 2012.
Professional Liability Segment
The following tables summarize the operations of the Professional Liability
segment.
Six months ended June 30, Three months ended June 30,
2012 2011 2012 2011
Net earned premium $ 200,905 $ 203,174 $ 99,467 $ 102,424
Other revenue 267 249 134 48
Segment revenue 201,172 203,423 99,601 102,472
Loss and loss adjustment expense, net 134,323 138,015 65,168 71,752
Other expense 36,207 34,032 18,676 16,928
Segment expense 170,530 172,047 83,844 88,680
Segment pretax earnings $ 30,642 $ 31,376 $ 15,757 $ 13,792
Net loss ratio 66.9 % 67.9 % 65.5 % 70.1 %
Expense ratio 18.0 16.7 18.8 16.5
Combined ratio 84.9 % 84.6 % 84.3 % 86.6 %
U.S. D&O $ 170,667 $ 180,254 $ 84,413 $ 90,279
International D&O 30,238 22,920 15,054 12,145
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