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HCC > SEC Filings for HCC > Form 10-Q on 6-Nov-2012All Recent SEC Filings

Show all filings for HCC INSURANCE HOLDINGS INC/DE/

Form 10-Q for HCC INSURANCE HOLDINGS INC/DE/


6-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following Management's Discussion and Analysis should be read in conjunction with the Consolidated Financial Statements and the related Notes as of September 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 $35.08 on October 26, 2012, resulting in market capitalization of $3.6 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 our 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 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 nine months and quarter ended September 30, 2012 were as follows:

We had consolidated shareholders' equity of $3.5 billion, with a book value per share of $34.60.

We generated year-to-date net earnings of $283.1 million, or $2.76 per diluted share. Our third quarter earnings were $107.1 million, or $1.05 per diluted share.

We produced total revenue of $1.9 billion and $631.7 million in the first nine months and third quarter, respectively. In the first nine months, 89% related to net earned premium and 9% related to net investment income.

In the first nine months, we recognized $20.3 million of pretax net catastrophe losses - $4.4 million in our U.S. Property & Casualty segment from storms in the United States and $15.9 million in our International segment from other small catastrophes. The third quarter included pretax net catastrophe losses of $8.0 million.

We recorded net favorable loss development of $34.6 million in the first nine months and third quarter of 2012.

Our year-to-date net loss ratio was 57.9% and our combined ratio was 83.3%.

Our debt to capital ratio was 13.5%.

We purchased $141.5 million, or 4.5 million shares, of our common stock at an average cost of $31.15 per share in the first nine months of 2012.

We increased our regular cash dividend to $0.165 per share, marking the 16th consecutive year of increases in our dividend. In the first nine months of 2012, we declared dividends of $0.475 per share and paid $47.6 million of dividends.


Table of Contents

Comparisons in the following sections refer to the first nine months of 2012 compared to the same period of 2011, unless otherwise noted. Amounts in tables are in thousands, except for earnings per share, percentages, ratios and number of employees. We adjusted certain 2011 amounts to reflect our adoption of a new accounting standard in 2012 (see Note 1, "General Information" to the Consolidated Financial Statements). We also recast all prior segment data to reflect our exit from two lines of business previously included in our Accident & Health segment (see Note 10, "Segments").

Results of Operations

Our results and key metrics for the first nine months and third quarter of 2012
and 2011 were as follows:



                                              Nine months ended September 30,                      Three months ended September 30,
                                               2012                     2011                        2012                     2011

Net earnings                              $       283,139          $       176,905             $        107,062          $       60,437

Earnings per diluted share                $          2.76          $          1.57             $           1.05          $         0.56


Net loss ratio                                       57.9 %                   67.4 %                       53.9 %                  69.9 %
Expense ratio *                                      25.4                     25.2                         25.2                    23.2


Combined ratio *                                     83.3 %                   92.6 %                       79.1 %                  93.1 %

* 2011 adjusted to reflect 2012 change in Exited Lines.

In 2012, we recognized catastrophe losses from United States storms, primarily in our aviation and public risk lines 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. Our third quarter 2011 catastrophe losses, which primarily related to Hurricane Irene in the United States, impacted our U.S. Property and Casualty and International segments. 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:

                                              Nine months ended September 30,                      Three months ended September 30,
                                               2012                     2011                         2012                     2011
Net losses, after reinsurance
and reinstatement premium                 $        20,283          $       107,915             $          8,026          $       34,587
Impact of net catastrophe losses
on:
Net earnings per diluted share            $         (0.13 )        $         (0.63 )           $          (0.05 )        $        (0.21 )
Net loss ratio (percentage
points)                                              1.3  %                   6.5  %                       1.4  %                  6.2  %
Combined ratio (percentage
points)                                              1.3  %                   6.7  %                       1.4  %                  6.3  %

We recognized net favorable loss development of $34.6 million in the first nine months of 2012, compared to net adverse loss development of $21.6 million in the same period of 2011. See the "Loss and Loss Adjustment Expense" and "Segment Operations" sections below for discussion of our 2012 and 2011 loss activity.


Table of Contents

Revenue

Total revenue increased $114.4 million in the first nine months of 2012, primarily due to higher net earned premium.

Gross written premium, net written premium and net earned premium are detailed below by segment.

                                         Nine months ended September 30,          Three months ended September 30,
                                             2012                 2011                2012                  2011
U.S. Property & Casualty               $       481,024        $    409,733      $        162,411        $    144,222
Professional Liability                         377,876             392,903               132,126             130,631
Accident & Health                              622,613             565,235               209,738             191,472
U.S. Surety & Credit                           166,678             169,368                55,976              55,415
International                                  460,111             447,355                95,200              95,774
Exited Lines                                    31,703              35,543                10,312              11,333


Total gross written premium            $     2,140,005        $  2,020,137      $        665,763        $    628,847


U.S. Property & Casualty               $       297,866        $    273,212      $         99,972        $     92,776
Professional Liability                         264,398             287,494                93,261              96,846
Accident & Health                              622,018             564,805               209,647             191,359
U.S. Surety & Credit                           146,865             155,761                50,769              50,660
International                                  368,189             344,286                66,566              69,364
Exited Lines                                    31,463              35,533                10,092              11,329


Total net written premium              $     1,730,799        $  1,661,091      $        530,307        $    512,334


U.S. Property & Casualty               $       265,593        $    245,121      $         87,741        $     85,946
Professional Liability                         298,454             307,240                97,549             104,066
Accident & Health                              624,077             568,318               209,049             191,715
U.S. Surety & Credit                           154,232             153,309                53,388              51,906
International                                  302,303             267,458               105,831              99,294
Exited Lines                                    31,463              35,541                10,092              11,329


Total net earned premium               $     1,676,122        $  1,576,987      $        563,650        $    544,256

Growth in premium occurred in the U.S. Property & Casualty segment from our new business lines started in 2011 and increased public risk and residual value premium; in the Accident & Health segment from higher writings of our medical stop-loss product; and in the International segment from new business and pricing increases in our energy and property treaty lines of business. In 2011, we recorded $14.0 million ($15.9 million ceded, net of $1.9 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 5% year-over-year and 3% quarter-over-quarter primarily due to higher income from fixed maturity securities, generated from an increased amount of investments. Our fixed maturity portfolio increased 9% from $5.8 billion at September 30, 2011 to $6.3 billion at September 30, 2012. In addition, at September 30, 2012, we had $202.9 million of publicly traded equity securities, which is an asset class we added to our portfolio during 2012. The growth in investments resulted primarily from cash flow from operations and an increase of $185.2 million in the net unrealized gain on available for sale securities since September 30, 2011.


Table of Contents

The following table details the components of our other operating income. The fee and commission income relates to third party agency and broker commissions.

                                       Nine months ended September 30,           Three months ended September 30,
                                           2012                  2011                2012                  2011
Fee and commission income            $         20,682        $     21,708      $         10,140        $       8,487
Financial instruments                             552                 516                   222                  131
Other                                           1,995               1,401                   478                  211


Other operating income               $         23,229        $     23,625      $         10,840        $       8,829

Loss and Loss Adjustment Expense

The tables below detail, by segment, our net loss and loss adjustment expense and our net loss ratios.

                                       Nine months ended September 30,           Three months ended September 30,
                                           2012                  2011                2012                  2011
U.S. Property & Casualty             $       154,156         $   148,783       $        53,229         $     56,355
Professional Liability                       170,506             257,632                36,183              119,617
Accident & Health                            447,262             411,851               140,344              138,566
U.S. Surety & Credit                          42,444              42,351                15,721               12,664
International                                126,547             175,635                46,924               45,242
Exited Lines                                  28,852              25,988                11,613                7,928


Net loss and loss adjustment
expense                              $       969,767         $ 1,062,240       $       304,014         $    380,372


(Favorable) adverse loss
development:
U.S. Property & Casualty             $         2,138         $    (4,613)      $         2,138         $     (7,163)
Professional Liability                       (26,186)             48,137               (26,186)              31,153
Accident & Health                            (10,695)              1,956               (10,695)                  60
U.S. Surety & Credit                               -              (2,767)                    -               (2,786)
International                                      -             (20,623)                    -              (21,287)
Exited Lines                                     111                (467)                  111                 (620)

Total (favorable) adverse loss
development                                  (34,632)             21,623               (34,632)                (643)
Catastrophe losses                            21,406              93,907                 8,738               32,187
All other net loss and loss
adjustment expense                           982,993             946,710               329,908              348,828


Net loss and loss adjustment
expense                              $       969,767         $ 1,062,240       $       304,014         $    380,372


U.S. Property & Casualty                        58.0  %             60.7  %               60.7  %              65.6  %
Professional Liability                          57.1                83.9                  37.1                114.9
Accident & Health                               71.7                72.5                  67.1                 72.3
U.S. Surety & Credit                            27.5                27.6                  29.4                 24.4
International                                   41.9                65.7                  44.3                 45.6
Exited Lines                                    91.7                73.1                 115.1                 70.0


Consolidated net loss ratio                     57.9  %             67.4  %               53.9  %              69.9  %


Consolidated accident year net
loss ratio                                      59.9  %             66.0  %               60.1  %              70.0  %


Table of Contents

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 6.1% of our recorded net reserves at September 30, 2012, compared to 4.2% at December 31, 2011. We recognized (favorable) adverse loss development of $(34.6) million and $21.6 million in the first nine months of 2012 and 2011, respectively, and $(34.6) million and $(0.6) million in the third quarter of 2012 and 2011, respectively. Our consolidated accident year net loss ratio was lower in 2012 due to higher catastrophe losses and higher losses on our diversified financial products line of business 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.

                                    Nine months ended September 30,           Three months ended September 30,
                                        2012                2011                  2012                  2011
Net reserves for loss and loss
adjustment expense payable at
beginning of period               $     2,683,483       $   2,537,772       $      2,748,995       $   2,612,945
Net reserve additions from
acquired businesses                        14,705                 645                      -                   -
Foreign currency adjustment                11,261               5,364                 15,717             (22,622)
Net loss and loss adjustment
expense                                   969,767           1,062,240                304,014             380,372
Net loss and loss adjustment
expense payments                         (944,203)           (937,171)              (333,713)           (301,845)

Net reserves for loss and loss
adjustment expense payable at
end of period                     $     2,735,013       $   2,668,850       $      2,735,013       $   2,668,850


Net paid loss ratio                          56.3  %             59.4  %                59.2  %              55.5 %

The amount of claims paid fluctuates period to period due to our mix of business and the timing of claims settlement and catastrophic events. Our year-to-date net loss and loss adjustment expense payments include $27.5 million and $26.7 million that we paid in 2012 and 2011, respectively, to commute large contracts included in our Exited Lines. These commutations had no material effect on net earnings but increased our year-to-date net paid loss ratios by 1.6 percentage points in 2012 and 1.7 percentage points in 2011.

Policy Acquisition Costs

Our policy acquisition cost percentage was 12.6% and 12.2% for the first nine
months of 2012 and 2011, respectively, and 12.0% and 10.6% for the third quarter
of 2012 and 2011, respectively. We record profit commissions due from reinsurers
as an offset to policy acquisition costs, which impacted our policy acquisition
cost percentages as follows:



                                        Nine months ended September 30,             Three months ended September 30,
                                           2012                  2011                2012                    2011

Profit commissions                    $        10,013         $    16,494       $        7,403         $         15,684
Impact of profit commissions
(percentage points)                               0.6  %              1.1  %               1.3  %                   2.8  %


Table of Contents

Other Operating Expense

For the first nine months of 2012, 61% of our other operating expense related to compensation and benefits for our 1,875 employees. Other operating expense increased 10% year-over-year and 19% quarter-over-quarter, primarily due to increased compensation expense, including higher bonus expense directly related to higher pretax earnings in 2012, and the fluctuation in foreign currency gain and loss. We recognized foreign currency loss of $5.3 million and $6.8 million in the first nine months and third quarter of 2012, respectively, primarily related to the fluctuations in the British pound sterling. Conversely, we recognized foreign currency benefit of $2.5 million and $0.5 million in the first nine months and third quarter of 2011, respectively. Other operating expense included stock-based compensation expense of $10.6 million in 2012 and $10.4 million in 2011. At September 30, 2012, there was approximately $27.2 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 3.0 years.

Interest Expense

Interest expense on debt and short-term borrowings was $19.1 million and $16.6 million in the first nine months of 2012 and 2011, respectively, and $6.0 million and $5.6 million in the third 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 year-to-date interest expense for 2012 and 2011 included $14.5 million for our Senior Notes.

Income Tax Expense

Our effective income tax rate was 30.1% for the first nine 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 higher in 2012 from larger underwriting profit than in 2011, whereas our tax-exempt investment income was essentially flat in 2012 and 2011.


Table of Contents

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.




                                          Nine months ended September 30,           Three months ended September 30,
                                              2012                 2011                 2012                  2011

Net earned premium                      $       265,593        $    245,121       $         87,741        $     85,946
Other revenue                                    15,300              16,556                  8,415               6,890

Segment revenue                                 280,893             261,677                 96,156              92,836


Loss and loss adjustment expense, net           154,156             148,783                 53,229              56,355
Other expense                                    89,348              82,202                 29,581              26,627

Segment expense                                 243,504             230,985                 82,810              82,982


Segment pretax earnings                 $        37,389        $     30,692       $         13,346        $      9,854


Net loss ratio                                     58.0  %             60.7  %                60.7  %             65.6  %
Expense ratio                                      31.8                31.4                   30.8                28.7


Combined ratio                                     89.8  %             92.1  %                91.5  %             94.3  %


Aviation                                $        87,890        $     83,879       $         29,670        $     29,279
E&O                                              47,177              56,354                 15,198              17,997
Public Risk                                      48,363              36,523                 16,571              13,344
Other                                            82,163              68,365                 26,302              25,326


Total net earned premium                $       265,593        $    245,121       $         87,741        $     85,946


Aviation                                           56.9  %             64.9  %                58.9  %             67.1  %
E&O                                                74.1                73.7                  102.1               108.6
Public Risk                                        95.9                84.5                  130.8               115.1
Other                                              27.8                32.1                   (5.5)                7.1


Total net loss ratio                               58.0  %             60.7  %                60.7  %             65.6  %


Table of Contents

                                         Nine months ended September 30,          Three months ended September 30,
                                             2012                 2011                2012                  2011

Aviation                               $        117,300       $    116,933      $         34,430        $     37,877
E&O                                              46,483             52,961                14,990              15,963
Public Risk                                      67,066             55,724                23,821              21,426
Other                                           250,175            184,115                89,170              68,956


Total gross written premium            $        481,024       $    409,733      $        162,411        $    144,222

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