e10vk
UNITED STATES SECURITIES AND
EXCHANGE COMMISSION
Washington, D.C.
20549
Form 10-K
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ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934.
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934.
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For the fiscal year ended
December 31, 2006
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Commission file
number 001-13790
HCC Insurance Holdings,
Inc.
(Exact name of registrant as
specified in its charter)
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Delaware
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76-0336636
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(State or other jurisdiction
of
incorporation or organization)
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(IRS Employer
Identification No.)
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13403 Northwest Freeway,
Houston, Texas
(Address of principal
executive offices)
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77040-6094
(Zip Code)
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(713) 690-7300
(Registrants telephone
number, including area code)
Securities
registered pursuant to Section 12(b) of the
Act:
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Title of each class:
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Name of each exchange on which registered:
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Common Stock, $1.00 par Value
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New York Stock Exchange
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Securities registered pursuant to Section 12(g) of
the Act: NONE
Indicate by check mark if the registrant is a well-known
seasoned issuer as defined in Rule 405 of the Securities
Act. Yes o No þ
Indicate by check mark if the registrant is not required to file
reports pursuant to Section 13 or Section 15(d) of the
Exchange
Act. Yes o No þ
Indicate by check mark whether the registrant (1) has filed
all reports required to be filed by Section 13 or 15
(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has
been subject to such filing requirements for the past
90 days. Yes þ No o
Indicate by check mark if disclosure of delinquent filers
pursuant to Item 405 of
Regulation S-K
(§229.405 of this chapter) is not contained herein and will
not be contained, to the best of registrants knowledge, in
definitive proxy or information statements incorporated by
reference in Part III of this
Form 10-K
or any amendment to this
Form 10-K. o
Indicate by check mark whether the registrant is a large
accelerated filer, an accelerated filer, or a non-accelerated
filer. See definition of accelerated filer and
large accelerated filer in
Rule 12b-2
of the Exchange Act. (Check one):
Large accelerated
filer þ Accelerated
filer o Non-accelerated
filer o
Indicate by check mark whether the registrant is a shell company
(as defined in
Rule 12b-2
of the Exchange
Act). Yes o No þ
The aggregate market value on June 30, 2006 (the last
business day of the registrants most recently completed
second fiscal quarter) of the voting stock held by
non-affiliates of the registrant was approximately
$3.2 billion. For purposes of the determination of the
above-stated amount, only Directors and executive officers are
presumed to be affiliates, but neither the registrant nor any
such person concede that they are affiliates of the registrant.
The number of shares outstanding of the registrants Common
Stock, $1.00 par value, at February 16, 2007 was
111.9 million.
DOCUMENTS
INCORPORATED BY REFERENCE:
Information called for in Part III of this
Form 10-K
is incorporated by reference to the registrants definitive
Proxy Statement to be filed within 120 days of the close of
the registrants fiscal year in connection with the
registrants annual meeting of shareholders.
HCC
INSURANCE HOLDINGS, INC.
TABLE OF
CONTENTS
FORWARD-LOOKING
STATEMENTS
This report on
Form 10-K
contains certain forward-looking statements within
the meaning of Section 27A of the Securities Act of 1933
and Section 21E of the Securities Exchange Act of 1934,
which are intended to be covered by the safe harbors created by
those laws. We have based these forward-looking statements on
our current expectations and projections about future events.
These forward-looking statements include information about
possible or assumed future results of our operations. All
statements, other than statements of historical facts, included
or incorporated by reference in this Report that address
activities, events or developments that we expect or anticipate
may occur in the future, including such things as future capital
expenditures, business strategy, competitive strengths, goals,
growth of our business and operations, plans and references to
future successes may be considered forward-looking statements.
Also, when we use words such as anticipate,
believe, estimate, expect,
intend, plan, probably or
similar expressions, we are making forward-looking
statements.
Many risks and uncertainties may impact the matters addressed
in these forward-looking statements, which could affect our
future financial results and performance, including, among other
things:
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the effects of catastrophic losses;
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the cyclical nature of the insurance business;
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inherent uncertainties in the loss estimation process, which
can adversely impact the adequacy of loss reserves;
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the effects of emerging claim and coverage issues;
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the effects of extensive governmental regulation of the
insurance industry;
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potential credit risk with brokers;
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our assessment of underwriting risk;
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our increased retention of risk, which could expose us to
greater potential losses;
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the adequacy of reinsurance protection;
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the ability or willingness of reinsurers to pay balances due
us;
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the occurrence of terrorist activities;
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our ability to maintain our competitive position;
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changes in our assigned financial strength ratings;
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our ability to raise capital in the future;
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attraction and retention of qualified employees;
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fluctuations in the fixed income securities market, which may
reduce the value of our investment assets;
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our ability to successfully expand our business through the
acquisition of insurance-related companies;
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our ability to receive dividends from our insurance company
subsidiaries in needed amounts;
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fluctuations in foreign exchange rates;
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failures of our information technology systems, which could
adversely affect our business;
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impairment of goodwill;
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developments in the SECs informal inquiry related to
our stock option granting procedures;
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litigation related to our stock option investigation;
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the loss of our Founder as a Director, Chairman of the Board
and Chief Executive Officer; and
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change of control.
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We describe these risks and uncertainties in greater detail
in Item 1A, Risk Factors.
These events or factors could cause our results or
performance to differ materially from those we express in our
forward-looking statements. Although we believe that the
assumptions underlying our forward-looking statements are
reasonable, any of these assumptions, and, therefore, also the
forward-looking statements based on these assumptions, could
themselves prove to be inaccurate. In light of the significant
uncertainties inherent in the forward-looking statements which
are included in this Report, our inclusion of this information
is not a representation by us or any other person that our
objectives and plans will be achieved.
Our forward-looking statements speak only at the date made,
and we will not update these forward-looking statements unless
the securities laws require us to do so. In light of these
risks, uncertainties and assumptions, any forward-looking events
discussed in this Report may not occur.
2
PART I
Business
Overview
HCC Insurance Holdings, Inc. is a Delaware corporation, which
was formed in 1991. Its predecessor corporation was formed in
1974. Our principal executive offices are located at 13403
Northwest Freeway, Houston, Texas 77040, and our telephone
number is
(713) 690-7300.
We maintain an Internet web-site at www.hcc.com. The
reference to our Internet web-site address in this Report does
not constitute the incorporation by reference of the information
contained at the web-site in this Report. We will make
available, free of charge through publication on our Internet
web-site, a copy of our Annual Report on
Form 10-K
and quarterly reports on
Form 10-Q
and any current reports on
Form 8-K
or amendments to those reports, filed with or furnished to the
Securities and Exchange Commission (SEC) as soon as reasonably
practicable after we have filed or furnished such materials with
the SEC.
As used in this report, unless otherwise required by the
context, the terms we, us and
our refer to HCC Insurance Holdings, Inc. and its
consolidated subsidiaries and the term HCC refers
only to HCC Insurance Holdings, Inc. All trade names or
trademarks appearing in this report are the property of their
respective holders.
We provide specialized property and casualty, surety, and group
life, accident and health insurance coverages and related agency
and reinsurance brokerage services to commercial customers and
individuals. We concentrate our activities in selected, narrowly
defined, specialty lines of business. We operate primarily in
the United States, the United Kingdom, Spain, Bermuda and
Ireland. Some of our operations have a broader international
scope. We underwrite insurance both on a primary basis, where we
insure a risk in exchange for a premium, and on a reinsurance
basis, where we insure all or a portion of another insurance
companys risk in exchange for all or a portion of the
premium. We market our products both directly to customers and
through a network of independent and affiliated brokers,
producers and agents.
Since our founding, we have been consistently profitable,
generally reporting annual increases in total revenue and
shareholders equity. During the period 2002 through 2005,
which is the latest period for which industry information is
available, we had an average statutory combined ratio of 89.8%
versus the less favorable 101.7% (source: A.M. Best
Company, Inc.) recorded by the U.S. property and casualty
insurance industry overall. During the period 2002 through 2006,
our gross written premium increased from $1.2 billion to
$2.2 billion, an increase of 83%, while net written premium
increased 232% from $545.9 million to $1.8 billion.
During this period, our revenue increased from
$666.8 million to $2.1 billion, an increase of 211%.
During the period December 31, 2002 through
December 31, 2006, our shareholders equity increased
131% from $884.7 million to $2.0 billion and our
assets increased 105% from $3.7 billion to
$7.6 billion.
Our insurance companies are risk-bearing and focus their
underwriting activities on providing insurance
and/or
reinsurance in the following lines of business:
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Diversified financial products
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Group life, accident and health
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Aviation
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London market account
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Other specialty lines
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Our operating insurance companies are rated AA (Very
Strong) (3rd of 22 ratings) by Standard &
Poors Corporation and AA− (Very Strong) by Fitch
Ratings (4th of 24 ratings). Avemco Insurance Company, HCC
Life Insurance Company, Houston Casualty Company and
U.S. Specialty Insurance Company are rated A+
(Superior) (2nd of 16 ratings) by A.M. Best
Company, Inc. American Contractors Indemnity Company, Perico
Life Insurance Company, United States Surety Company and HCC
Insurance Company are rated A (Excellent)
(3rd of 16 ratings). Standard & Poors, Fitch
Ratings and A.M. Best are nationally recognized
3
independent rating agencies. These financial strength ratings
are intended to provide an independent opinion of an
insurers ability to meet its obligations to policyholders
and are not evaluations directed at investors.
Our underwriting agencies underwrite on behalf of our insurance
companies and in certain situations for other non-affiliated
insurance companies. They receive fees for these services and do
not bear any of the insurance risk of the companies for which
they underwrite. Our underwriting agencies generate revenues
based on fee income and profit commissions and specialize in
contingency (including contest indemnification, event
cancellation and weather coverages); directors and
officers liability; individual disability (for athletes
and other high profile individuals); kidnap and ransom;
employment practices liability; marine; professional indemnity;
public entity; mortgage, residual value and title insurance; and
other specialty lines of business. Our principal underwriting
agencies are Covenant Underwriters, G.B. Kenrick &
Associates, HCC Global Financial Products, HCC Indemnity
Guaranty Agency, HCC Specialty Underwriters, Professional
Indemnity Agency, and RA&MCO Insurance Services.
Our brokers provide reinsurance and insurance brokerage services
for our insurance companies, agencies and our clients and
receive fees for their services. A reinsurance broker structures
and arranges reinsurance between insurers seeking to cede
insurance risks and reinsurers willing to assume such risks.
Reinsurance brokers do not bear any of the insurance risks of
their client companies. They earn commission income, and to a
lesser extent, fees for certain services, generally paid by the
insurance and reinsurance companies with whom the business is
placed. Insurance broker operations consist of consulting with
retail and wholesale clients by providing information about
insurance coverage and marketing, placing and negotiating
particular insurance risks. Our brokers specialize in placing
insurance and reinsurance for group life, accident and health,
surety, marine, and property and casualty lines of business. Our
brokers are Rattner Mackenzie, HCC Risk Management and
Continental Underwriters.
Our
Strategy
Our business philosophy is to maximize underwriting profits and
produce non-risk-bearing fee and commission income while
limiting risk in order to preserve shareholders equity and
maximize earnings. We concentrate our insurance writings in
selected, narrowly defined, specialty lines of business where we
believe we can achieve an underwriting profit. We also rely on
our experienced underwriting personnel and our access to and
expertise in the reinsurance marketplace to achieve our
strategic objectives. We market our insurance products both
directly to customers and through affiliated and independent
brokers, agents and producers.
The property and casualty insurance industry and individual
lines of business within the industry are cyclical. There are
times when a large number of companies offer insurance on
certain lines of business, causing premiums to trend downward.
During other times, insurance companies limit their writings in
certain lines of business due to lack of capital or following
periods of excessive losses. This results in an increase in
premiums for those companies that continue to write insurance in
those lines of business.
In our insurance company operations, we believe our operational
flexibility, which permits us to shift the focus of our
insurance underwriting activity among our various lines of
business and also to shift the emphasis from our insurance
risk-bearing business to our non-insurance, fee-based business,
allows us to implement a strategy of emphasizing more profitable
lines of business during periods of increased premium rates and
de-emphasizing less profitable lines of business during periods
of increased competition. In addition, we believe that our
underwriting agencies and brokers complement our insurance
underwriting activities. Our ability to utilize affiliated
insurers, underwriting agencies and reinsurance brokers permits
us to retain a greater portion of the gross revenue derived from
written premium.
After a period in which premium rates rose substantially,
premium rates in several of our lines of business became more
competitive during the past three years. The rate decreases were
more gradual than the prior rate increases; thus, our
underwriting activities remain profitable. During the past
several years, we expanded our underwriting activities and
increased our retentions in response to these market conditions.
During 2005 and 2006, we again increased our retentions on
certain of our lines of business that were not generally exposed
to catastrophe risk and where profit margins were usually more
predictable. These higher retention levels
4
increased our net written and earned premium and have resulted
in additional underwriting profits and net earnings.
Through reinsurance, our insurance companies transfer or cede
all or part of the risk we have underwritten to a reinsurance
company in exchange for all or part of the premium we receive in
connection with the risk. We purchase reinsurance to limit the
net loss to our insurance companies from both individual and
catastrophic risks. The amount of reinsurance we purchase varies
by, among other things, the particular risks inherent in the
policies underwritten, the pricing of reinsurance and the
competitive conditions within the relevant line of business.
When we determine to retain more underwriting risk in a
particular line of business, we do so with the intention of
retaining a greater portion of any underwriting profits without
increasing our exposure to severe or catastrophe losses. In this
regard, we may purchase less proportional or quota share
reinsurance applicable to that line, thus accepting more of the
risk but possibly replacing it with specific excess of loss
reinsurance, where we transfer to reinsurers both premium and
losses on a non-proportional basis for individual and
catastrophic risks above a retention point. Additionally, we may
obtain facultative reinsurance protection on individual risks.
In some cases, we may choose not to purchase reinsurance in a
line of business where we believe there has been a favorable
loss history, our policy limits are relatively low or we
determine there is a low likelihood of catastrophe exposure.
We also acquire or make strategic investments in companies that
present an opportunity for future profits or for the enhancement
of our business. We expect to continue to acquire complementary
businesses. We believe that we can enhance acquired businesses
through the synergies created by our underwriting capabilities
and our other operations.
Our business plan is shaped by our underlying business
philosophy, which is to maximize underwriting profit and net
earnings while preserving and achieving long-term growth of
shareholders equity. As a result, our primary objective is
to increase net earnings rather than market share or gross
written premium.
In our ongoing operations, we will continue to:
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emphasize the underwriting of lines of business where there is
an anticipation of underwriting profits based on various factors
including premium rates, the availability and cost of
reinsurance, policy terms and conditions, and market conditions;
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limit our insurance companies aggregate net loss exposure
from a catastrophic loss through the use of reinsurance for
those lines of business exposed to such losses and
diversification into lines of business not exposed to such
losses; and
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consider the potential acquisition of specialty insurance
operations and other strategic investments.
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Industry
Segment and Geographic Information
Financial information concerning our operations by industry
segment and geographic data is included in the Consolidated
Financial Statements and Notes thereto.
Recent
Acquisitions
We have made a series of acquisitions that have furthered our
overall business strategy. Our recent major transactions are
described below:
On January 31, 2004, we acquired all of the shares of
Surety Associates Holding Co., Inc., the parent company of
American Contractors Indemnity Company, a California-domiciled
surety company. We paid $46.8 million for the acquisition.
American Contractors Indemnity Company now operates with our
other surety operations as part of our HCC Surety Group.
On October 1, 2004, we acquired all of the shares of InsPro
Corporation, a California underwriting agency specializing in
professional indemnity insurance and which does business as
RA&MCO Insurance
5
Services. We paid $7.0 million and issued
74,750 shares of our common stock in connection with the
acquisition. RA&MCO operates as a division of Professional
Indemnity Agency.
On February 25, 2005, we acquired United States Surety
Company through a merger effected with its parent company, USSC
Holdings, Inc. We issued 1.2 million shares of our common
stock in connection with the acquisition. United States Surety
Company is a Maryland-domiciled surety company and now operates
as a part of our HCC Surety Group.
On July 14, 2005, we acquired the remaining 66% of De
Montfort Group Limited that we did not own for
$10.5 million and 274,000 shares of our common stock.
We acquired our initial 34% interest in January 2005. The key
operating subsidiary, De Montfort Insurance Company, provides
surety and credit insurance. It has been renamed HCC
International Insurance Company, and a significant amount of our
other United Kingdom operations were combined with this company
in 2006.
On December 1, 2005, we acquired Perico Ltd., a medical
stop-loss insurance underwriting agency headquartered in
St. Louis, Missouri. We paid $30.0 million and issued
158,599 shares of our common stock in connection with the
acquisition.
On December 13, 2005, we acquired MIC Life Insurance
Corporation, a Delaware-domiciled insurance company, for
$20.0 million. MIC has been renamed Perico Life Insurance
Company and operations are located in St. Louis, Missouri.
On December 21, 2005, we acquired the remaining 80% of
Illium Insurance Group, Ltd. that we did not own for
$2.5 million. We acquired our initial 20% interest in
March 2004. Illium Insurance Group Ltd. is the parent
of a managing agent for a syndicate at Lloyds of London,
which specializes in United Kingdom third party liability,
employers liability and commercial motor risks. One of our
insurance companies has been and will continue to be a
substantial participant in this syndicate.
On June 30, 2006, we acquired Novia Underwriters, Inc., an
underwriting agency based in Indianapolis, Indiana, specializing
in medical stop-loss insurance, for $5.5 million cash.
Novias business has been absorbed into Perico Life.
On July 1, 2006, we acquired G.B. Kenrick &
Associates, Inc., an underwriting agency located in Auburn
Hills, Michigan, recognized as a premier underwriter of public
entity insurance, for $18.0 million cash. Kenrick operates
as a subsidiary of Professional Indemnity Agency.
On October 2, 2006, we acquired the assets of the Health
Products Division of Allianz Life Insurance Company of North
America (the Health Products Division) for cash consideration of
$140.0 million and assumed the outstanding loss reserves.
The Health Products Divisions operations include medical
stop-loss insurance for self-insured corporations and groups;
medical excess insurance for HMOs; provider excess insurance for
integrated delivery systems; excess medical reinsurance to small
and regional insurance carriers; and LifeTrac, a network for
providing organ and bone marrow transplants. The Health Products
Division currently writes approximately $250.0 million in
annual gross premium. We integrated the Health Products
Divisions operations into HCC Life Insurance Company.
We continue to evaluate acquisition opportunities and we may
complete additional acquisitions during 2007. Any future
acquisitions will be designed to expand and strengthen our
existing lines of business or to provide access to additional
specialty sectors, which we expect to contribute to our overall
growth.
6
Insurance
Company Operations
Lines
of Business
This table shows our insurance companies total premium
written, otherwise known as gross written premium, by line of
business and the percentage of each line to total gross written
premium (dollars in thousands):
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2006
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2005
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2004
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Diversified financial products
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$
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956,057
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43
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%
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$
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908,526
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45
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%
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$
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857,299
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43
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%
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Group life, accident and health
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621,639
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28
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593,382
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29
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584,747
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30
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Aviation
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216,208
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10
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210,530
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10
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204,963
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10
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London market account
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234,868
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10
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144,425
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7
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178,950
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9
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Other specialty lines
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205,651
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9
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176,139
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9
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133,964
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7
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Discontinued lines of business
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1,225
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5,284
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15,230
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1
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Total gross written
premium
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$
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2,235,648
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100
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%
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$
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2,038,286
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100
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%
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$
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1,975,153
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100
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%
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This table shows our insurance companies actual premium
retained, otherwise known as net written premium, by line of
business and the percentage of each line to total net written
premium (dollars in thousands):
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2006
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2005
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2004
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Diversified financial products
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$
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794,232
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44
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%
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$
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675,942
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45
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%
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$
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404,870
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37
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%
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Group life, accident and health
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590,811
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33
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502,805
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34
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343,996
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31
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Aviation
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166,258
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9
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130,743
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9
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144,687
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13
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London market account
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127,748
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7
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78,809
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5
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107,509
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10
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Other specialty lines
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133,481
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7
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109,106
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7
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83,980
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7
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Discontinued lines of business
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22
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3,819
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20,477
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2
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|
|
|
|
|
|
|
Total net written
premium
|
|
$
|
1,812,552
|
|
|
|
100
|
%
|
|
$
|
1,501,224
|
|
|
|
100
|
%
|
|
$
|
1,105,519
|
|
|
|
100
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
This table shows our insurance companies net written
premium as a percentage of gross written premium, otherwise
referred to as percentage retained, for our continuing lines of
business:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
Diversified financial products
|
|
|
83
|
%
|
|
|
74
|
%
|
|
|
47
|
%
|
Group life, accident and health
|
|
|
95
|
|
|
|
85
|
|
|
|
59
|
|
Aviation
|
|
|
77
|
|
|
|
62
|
|
|
|
71
|
|
London market account
|
|
|
54
|
|
|
|
55
|
|
|
|
60
|
|
Other specialty lines
|
|
|
65
|
|
|
|
62
|
|
|
|
63
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Continuing lines of business
percentage retained
|
|
|
81
|
%
|
|
|
74
|
%
|
|
|
55
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Underwriting
We underwrite primary business produced through affiliated
underwriting agencies, through independent and affiliated
brokers and producers and by direct marketing efforts. We also
write facultative or individual account reinsurance as well as
some treaty reinsurance business.
7
Diversified
Financial Products
We underwrite a variety of financial insurance risks in our
diversified financial products line of business. These risks
include:
|
|
|
|
|
directors and officers liability
|
|
|
employment practices liability
|
|
|
mortgage guaranty
|
|
|
professional indemnity
|
|
|
residual value insurance
|
|
|
surety and credit
|
|
|
other financial products
|
We began to underwrite this line of business through a
predecessor company in 1977. Our insurance companies started
participating in this business in 2001. We have substantially
increased our level of business through the acquisition of a
number of agencies and insurance companies that operate in this
line of business, both domestically and internationally. Each of
the acquired entities has significant experience in its
respective specialty within this line of business. We have also
formed entities developed around teams of experienced
underwriters, which offer these products.
In 2002 and 2003, following several years of insurance industry
losses, significant rate increases were experienced throughout
our diversified financial products line of business,
particularly directors and officers liability, which
we began underwriting opportunistically in 2002. We benefited
greatly from these improved conditions despite the fact that we
had not been involved in the past losses. Rates have softened in
2004, 2005 and 2006 for some of the products in this line, but
our underwriting margins are still very profitable. There is
also considerable investment income derived from diversified
financial products due to the extended periods involved in
claims resolution.
We had previously maintained reinsurance on our diversified
financial products line of business, primarily on a proportional
basis, but over the past two years have substantially increased
our retentions. Although individual losses primarily in the
directors and officers public company liability
business may have potential severity, there is a relatively low
risk of catastrophe exposure in this line of business and a
reasonable expectation of underwriting profitability. Net
premium written for the United States public company
directors and officers liability was approximately
$244.3 million in 2006. The remainder of the diversified
financial products business is less volatile with relatively low
limits.
Group
Life, Accident and Health
We write medical stop-loss business through HCC Life Insurance
Company and since its December 2005 acquisition, Perico Life
Insurance Company. Our medical stop-loss insurance provides
coverages to companies, associations and public entities that
elect to self-insure their employees medical coverage for
losses within specified levels, allowing them to manage the risk
of excessive health insurance exposure by limiting aggregate and
specific losses to a predetermined amount. We first began
writing this business through a predecessor company in 1980. Our
insurance companies started participating in this business in
1997. This line of business has grown both organically and
through acquisitions. We are considered a market leader in
medical stop-loss insurance. We also underwrite a small program
of group life insurance offered to our insureds as a complement
to our medical stop-loss products and we began writing medical
excess insurance for various insureds, an operation we acquired
in the acquisition of the Health Products Division in 2006.
Premium rates rose substantially beginning in 2000 and, although
competition has increased in recent years and the amount of
premium rate increases has decreased, underwriting results have
remained profitable. Premium rate increases together with
deductible increases are still adequate to cover medical cost
trends. Medical stop-loss business has relatively low limits, a
low level of catastrophe exposure and a generally predictable
result. Therefore, we have increased our retentions annually
since 2001 and currently buy no reinsurance for this line of
business.
We began writing alternative workers compensation and
occupational accident insurance in 1996. This business is
currently written through U.S. Specialty Insurance Company.
These products have relatively low limits, a relatively low
level of catastrophe exposure and a generally predictable result.
8
Aviation
We are a market leader in the general aviation insurance
industry insuring aviation risks, both domestically and
internationally. Types of aviation business include:
|
|
|
|
|
antique and vintage military aircraft
|
|
|
cargo operators
|
|
|
commuter airlines
|
|
|
corporate aircraft
|
|
|
fixed base operations
|
|
|
military and law enforcement aircraft
|
|
|
private aircraft owners
|
|
|
rotor wing aircraft
|
We offer coverages that include hulls, engines, avionics and
other systems, liabilities, cargo and other ancillary coverages.
We generally do not insure major airlines, major manufacturers,
products or satellites. Insurance claims related to general
aviation business tend to be seasonal, with the majority of the
claims being incurred during the spring and summer months.
We have been underwriting aviation risks through Houston
Casualty Company since 1981 and since 1959 in Avemco Insurance
Company and U.S. Specialty Insurance Company, which were
acquired in 1997. We are one of the largest writers of personal
aircraft insurance in the United States. Our aviation gross
premium has remained relatively stable since 1998, although we
have increased our retentions as this business is predominantly
written with small limits and has generally predictable results.
London
Market Account
Our London market account business consists of marine, energy,
property, and accident and health business, and has been
primarily underwritten by Houston Casualty Companys London
branch office. During 2006, we began to utilize HCC
International Insurance Company to underwrite the
non-U.S. based
risks that comprise this line of business. This line includes
most of our catastrophe exposure. We have underwritten these
risks for more than 15 years, increasing or decreasing our
premium volume depending on market conditions, which can be very
volatile in this line. The following table presents the details
of net premium written within the London market account line of
business (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
Marine
|
|
$
|
26,664
|
|
|
$
|
23,799
|
|
|
$
|
19,537
|
|
Energy
|
|
|
57,619
|
|
|
|
15,621
|
|
|
|
26,258
|
|
Property
|
|
|
18,049
|
|
|
|
18,379
|
|
|
|
19,613
|
|
Accident and health
|
|
|
25,416
|
|
|
|
21,010
|
|
|
|
42,101
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total London market account net
written premium
|
|
$
|
127,748
|
|
|
$
|
78,809
|
|
|
$
|
107,509
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
We underwrite marine risks for ocean-going vessels including
hull, protection and indemnity, liabilities and cargo. We have
underwritten marine risks since 1984 in varying amounts
depending on market conditions.
In our energy business, we underwrite physical damage and
business interruption. We have been underwriting both onshore
and offshore energy risks since 1988. This business includes:
|
|
|
|
|
drilling rigs
|
|
|
gas production and gathering platforms
|
|
|
natural gas facilities
|
|
|
petrochemical plants
|
|
|
pipelines
|
|
|
refineries
|
Rates were relatively low for an extended period of time,
reaching levels where underwriting profitability was difficult
to achieve. As a result, we have underwritten energy risks on a
very selective basis, striving for quality rather than quantity.
Underwriting profitability was adversely impacted by the 2004
and 2005 hurricane activity, but this has resulted in rates
increasing substantially and policy conditions becoming more
stringent. The business was very profitable in 2006 as there
were no catastrophe losses. However, we continue to reinsure
much of our catastrophe exposure, buying substantial amounts of
reinsurance both on a proportional and excess basis.
9
We underwrite property business specializing in risks of large,
often multinational, corporations, covering a variety of
commercial properties including:
|
|
|
|
|
factories
|
|
|
hotels
|
|
|
industrial plants
|
|
|
office buildings
|
|
|
retail locations
|
|
|
utilities
|
We have written property business since 1986, including business
interruption, physical damage and catastrophe risks, including
flood and earthquake. Rates increased significantly following
September 11, 2001, but had trended downward by 2005
despite the hurricane activity of 2004. The massive losses from
hurricanes in 2005 resulted in substantial rate increases, but
due to over capacity, policy conditions have remained unchanged,
unlike energy risks. Accordingly, we substantially reduced our
involvement in policies with exposures in the Florida and
U.S. Gulf Coast regions. We continue to buy substantial
catastrophe reinsurance, unlike many industry participants,
which has shown to be adequate during 2004 and 2005 when large
amounts of industry capital were lost. While seriously affecting
our earnings in the third quarters of 2004 and 2005, we still
were able to produce record annual earnings in those years, and
this business was profitable in 2006 as there were no
significant catastrophe losses.
We began writing London market accident and health risks in
1996, including trip accident, medical and disability. Due to
past experience and other market factors, we significantly
decreased premiums starting in 2004, although our business is
now much more stable and profitable.
Our London market account is reinsured both proportionally and
on an excess of loss basis. Catastrophe exposure is closely
monitored and reinsurance is purchased accordingly to limit our
net exposure to a level that any loss is not expected to impact
our capital. Previous net catastrophe losses from Hurricane
Andrew in 1992, the Northridge Earthquake in 1994, the terrorist
attacks on September 11, 2001, and the hurricanes of 2004
and 2005 did not exceed net earnings in the affected quarter.
Other
Specialty Lines
In addition to the above, we underwrite various other specialty
lines of business, including different types of property and
liability business, for which individual premiums by type of
business are not at this time significant to our overall results
of operations.
Insurance
Companies
Houston
Casualty Company
Houston Casualty Company is our largest insurance company
subsidiary. It is domiciled in Texas and insures risks
worldwide. Houston Casualty Company receives business through
independent agents and brokers, our underwriting agencies and
reinsurance brokers, and other insurance and reinsurance
companies. Houston Casualty Company writes diversified financial
products, aviation, London market account and other specialty
lines of business. It is also an issuing carrier for our
affiliated underwriting agencies. Houston Casualty
Companys 2006 gross written premium, including Houston
Casualty Company-London, was $738.6 million.
Houston
Casualty Company-London
Houston Casualty Company operates a branch office in London,
England, in order to more closely align its underwriting
operations with the London market, a historical focal point for
some of the business that it underwrites. Houston Casualty
Company-London underwrites diversified financial products and
London market account business, some of which is produced by our
affiliated underwriting agencies. In 2006, we focused the
underwriting activities of Houston Casualty
Company-Londons office on risks based in the United
States. We began to use HCC International Insurance Company as a
platform for much of the European and other international risks
previously underwritten by Houston Casualty Company-London.
10
HCC
International Insurance Company
HCC International Insurance Company PLC, writes diversified
financial products business, primarily surety, credit and
professional indemnity products, and
non-United
States based London market account risks. HCC International
Insurance Company has been in operation since 1982 and is
domiciled in the United Kingdom. HCC International Insurance
Companys 2006 gross written premium was
$156.3 million. We intend to continue to expand the
underwriting activities of HCC International Insurance Company
and to use it as an integral part of a European platform for our
international insurance operations.
U.S. Specialty
Insurance Company
U.S. Specialty Insurance Company is a Texas-domiciled
property and casualty insurance company. It primarily writes
diversified financial products, aviation and accident and health
business. U.S. Specialty Insurance Company acts as an
issuing carrier for certain business underwritten by our
underwriting agencies. U.S. Specialty Insurance
Companys gross written premium in 2006 was
$497.8 million.
HCC
Life Insurance Company
HCC Life Insurance Company is an Indiana-domiciled life
insurance company. It operates as a group life, accident and
health insurer. In early 2005, we consolidated the operations of
our underwriting agency, HCC Benefits Corporation, into HCC Life
Insurance Company. In 2006, the Health Products Division was
acquired and integrated into HCC Life Insurance Company. HCC
Life Insurance Companys gross written premium in 2006 was
$539.0 million.
Avemco
Insurance Company
Avemco Insurance Company is a Maryland-domiciled property and
casualty insurer and operates as a direct market underwriter of
general aviation business. It has also been an issuing carrier
for accident and health business and some other lines of
business underwritten by our underwriting agencies and an
unaffiliated underwriting agency. Avemco Insurance
Companys gross written premium in 2006 was
$92.2 million.
American
Contractors Indemnity Company
American Contractors Indemnity Company is a California-domiciled
surety company. It writes court, specialty contract, license and
permit and bail bonds. American Contractors Indemnity Company
has been in operation since 1990 and operates as a part of our
HCC Surety Group. American Contractors Indemnity Companys
2006 gross written premium was $83.3 million.
HCC
Europe
Houston Casualty Company Europe, Seguros y Reaseguros, S.A. is a
Spanish insurer. It underwrites diversified financial products
business. HCC Europe is also an issuing carrier for business
underwritten by our underwriting agencies and has been in
operation since 1978. HCC Europes gross written premium in
2006 was $165.5 million.
HCC
Reinsurance Company
HCC Reinsurance Company Limited is a Bermuda-domiciled
reinsurance company that writes assumed reinsurance from our
insurance companies and from unaffiliated insurance companies
and a limited amount of primary insurance. HCC Reinsurance
Company is an issuing carrier for diversified financial products
business underwritten by our underwriting agency, HCC Indemnity
Guaranty. HCC Reinsurance Company also reinsures our
proportional interest in Lloyds of London Syndicate 4040, which
is managed by our subsidiary Illium Managing Agency, Ltd. Illium
Managing Agency was acquired in December 2005. It writes
business included in our other specialty line of business. HCC
Reinsurance Companys gross written premium in 2006 was
$81.7 million.
11
HCC
Specialty Insurance Company
HCC Specialty Insurance Company is an Oklahoma-domiciled
property and casualty insurance company in operation since 2002.
It writes diversified financial products and other specialty
lines of business produced by our underwriting agencies. HCC
Specialty Insurance Companys gross written premium in 2006
was $19.0 million and is 100% ceded to Houston Casualty
Company.
United
States Surety Company
United States Surety Company is a Maryland-domiciled surety
company that has been in operation since 1996. It writes
contract bonds and operates as a part of our HCC Surety Group.
United States Surety Companys 2006 gross written premium
was $21.1 million.
Perico
Life Insurance Company
Perico Life Insurance Company was a previously dormant company
acquired in December 2005 and is a Delaware-domiciled life
insurance company. Perico Life Insurance Company now operates as
a group life, accident and health insurer. In 2006, we
consolidated the operations of our recently acquired
underwriting agencies, Novia Underwriters, Inc. and Perico Ltd.,
into Perico Life Insurance Company. Perico Life Insurance
Companys 2006 gross written premium was $32.4 million.
HCC
Insurance Company
HCC Insurance Company is an Indiana-domiciled property and
casualty insurance company. It writes business included in our
other specialty lines of business produced by one of our
underwriting agencies. HCC Insurance Companys gross
written premium in 2006 was $5.9 million and is 100% ceded
to Houston Casualty Company.
Underwriting
Agency Operations
Our underwriting agencies act on behalf of affiliated and
non-affiliated insurance companies and provide insurance
underwriting management and claims administration services. Our
underwriting agencies do not assume any insurance or reinsurance
risk themselves and generate revenues based entirely on fee
income and profit commissions. These subsidiaries are in a
position to direct and control business they produce. Our
insurance companies serve as policy issuing companies for the
majority of the business written by our underwriting agencies.
If an unaffiliated insurance company serves as the policy
issuing company, our insurance companies may reinsure the
business written by our underwriting agencies. Total revenue
generated by our underwriting agencies in 2006 amounted to
$148.7 million.
Professional
Indemnity Agency
Professional Indemnity Agency, Inc., based in Mount Kisco, New
York and with operations in San Francisco, California,
Concord, California, and Auburn Hills, Michigan, acts as an
underwriting manager for diversified financial products
specializing in directors and officers liability and
professional indemnity, kidnap and ransom, employment practice
liability, public entity and other specialty lines of business
on behalf of affiliated and unaffiliated insurance companies. It
has been in operation since 1977.
HCC
Specialty Underwriters
HCC Specialty Underwriters Inc., with its home office in
Wakefield, Massachusetts and with branch offices in London,
England, Los Angeles, California and New York, New York, acts as
an underwriting manager for sports disability, contingency and
other group life, accident and health and specialty lines of
business on behalf of affiliated and unaffiliated insurance
companies. It has been in operation since 1982.
12
HCC
Global Financial Products
HCC Global Financial Products, LLC acts as an underwriting
manager for diversified financial products, specializing in
directors and officers liability business on behalf
of affiliated insurance companies. It has been in operation
since 1999, underwriting domestic business from Farmington,
Connecticut and international business from Barcelona, Spain and
London, England.
Covenant
Underwriters
Covenant Underwriters, Ltd. is an underwriting agency based in
Covington, Louisiana with an office in New York, New York,
specializing in commercial marine insurance underwritten on
behalf of affiliated and unaffiliated insurance companies. It
has been in operation through predecessor entities since 1993.
HCC
Indemnity Guaranty Agency
HCC Indemnity Guaranty Agency, Inc. is an underwriting agency
based in New York, New York, specializing in mortgage guaranty,
structured products, title and residual value insurance and
reinsurance on behalf of affiliated insurance companies. It has
been in operation since 2004.
Illium
Insurance Group
Illium Insurance Group, Ltd. is the parent of a managing agent
for a syndicate at Lloyds of London, which specializes in
United Kingdom third party liability, employers liability
and commercial motor risks. One of our insurance companies is a
substantial participant in this syndicate. We may use Illium and
its managed syndicate as a platform for expanding our operations
within the Lloyds market. It has been in operation since
2004.
Reinsurance
and Insurance Broker Operations
Our reinsurance and insurance brokers provide a variety of
services, including marketing, placing, consulting on and
servicing insurance risks for their clients, which include
medium to large corporations, unaffiliated and affiliated
insurance and reinsurance companies, and other risk-taking
entities. The brokers earn commission income and, to a lesser
extent, fees for certain services, generally paid by the
underwriters with whom the business is placed. Some of these
risks may be initially underwritten by our insurance companies
and they may retain a portion of the risk. Total revenue
generated by our brokers in 2006 amounted to $31.3 million.
Rattner
Mackenzie
Rattner Mackenzie Limited is a reinsurance broker based in
London, England with additional operations in Hamilton, Bermuda
and Mt. Kisco, New York. Rattner Mackenzie specializes in group
life, accident and health reinsurance and some specialty
property and casualty lines of business. It operates as a
Lloyds broker for insurance and reinsurance business
placed on behalf of unaffiliated and affiliated insurance
companies, reinsurance companies and underwriting agencies and
has been in operation since 1989.
Continental
Underwriters
Continental Underwriters Ltd. is an insurance broker based in
Covington, Louisiana, specializing in commercial marine
insurance and has been in operation since 1970.
HCC
Risk Management
HCC Risk Management Corporation, based in Houston, Texas, is a
reinsurance broker specializing in placing reinsurance on behalf
of affiliated and unaffiliated insurance companies and has been
in operation since 1991.
13
Other
Operations
Other operating income consists of 1) equity in the
earnings of mainly insurance-related companies in which we
invest, 2) dividends and interest from certain other
insurance-related strategic investments and gains or losses from
the disposition of these investments, 3) income related to
two mortgage impairment insurance contracts which, while written
as insurance policies, receive accounting treatment as
derivative financial instruments, 4) the profit or loss
from a portfolio of trading securities and 5) other
miscellaneous income. Other operating income was
$77.0 million in 2006, but can vary considerably from
period to period depending on the amount of investment or
disposition activity. In the fourth quarter of 2006, we began
liquidating our trading portfolio, a process that will be
completed in 2007, investing the proceeds primarily in fixed
income securities.
Operating
Ratios
Premium
to Surplus Ratio
This table shows the ratio of statutory gross written premium
and net written premium to statutory policyholders surplus
for our property and casualty insurance companies (dollars in
thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
2003
|
|
|
2002
|
|
|
Gross written premium
|
|
$
|
2,243,843
|
|
|
$
|
2,049,116
|
|
|
$
|
1,992,361
|
|
|
$
|
1,746,413
|
|
|
$
|
1,163,397
|
|
Net written premium
|
|
|
1,812,896
|
|
|
|
1,495,931
|
|
|
|
1,121,343
|
|
|
|
867,795
|
|
|
|
545,475
|
|
Policyholders
surplus
|
|
|
1,342,054
|
|
|
|
1,110,268
|
|
|
|
844,851
|
|
|
|
591,889
|
|
|
|
523,807
|
|
Gross written premium ratio
|
|
|
167.2
|
%
|
|
|
184.6
|
%
|
|
|
235.8
|
%
|
|
|
295.1
|
%
|
|
|
222.1
|
%
|
Gross written premium industry
average(1)
|
|
|
*
|
|
|
|
192.7
|
%
|
|
|
201.6
|
%
|
|
|
219.3
|
%
|
|
|
244.4
|
%
|
Net written premium ratio
|
|
|
135.1
|
%
|
|
|
134.7
|
%
|
|
|
132.7
|
%
|
|
|
146.6
|
%
|
|
|
104.1
|
%
|
Net written premium industry
average(1)
|
|
|
*
|
|
|
|
99.8
|
%
|
|
|
108.5
|
%
|
|
|
117.4
|
%
|
|
|
130.3
|
%
|
(1) Source: A.M. Best Company, Inc.
* Not available
While there is no statutory requirement regarding a permissible
premium to policyholders surplus ratio, guidelines
established by the National Association of Insurance
Commissioners provide that a property and casualty
insurers annual statutory gross written premium should not
exceed 900% and net written premium should not exceed 300% of
its policyholders surplus. However, industry standards and
rating agency criteria place these ratios at 300% and 200%,
respectively. Our property and casualty insurance companies have
maintained ratios lower than such guidelines.
14
Combined
Ratio GAAP
The underwriting experience of a property and casualty insurance
company is indicated by its combined ratio. The GAAP combined
ratio is a combination of the loss ratio (the ratio of incurred
losses and loss adjustment expenses to net earned premium) and
the expense ratio (the ratio of policy acquisition costs and
other underwriting expenses, net of ceding commissions, to net
earned premium). We calculate the GAAP combined ratio using
financial data derived from our consolidated financial
statements reported under accounting principles generally
accepted in the United States of America (generally accepted
accounting principles). Our insurance companies GAAP loss
ratios, expense ratios and combined ratios are shown in the
following table:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
2003
|
|
|
2002
|
|
|
Loss ratio
|
|
|
59.2
|
%
|
|
|
67.1
|
%
|
|
|
63.8
|
%
|
|
|
66.1
|
%
|
|
|
60.8
|
%
|
Expense ratio
|
|
|
25.0
|
|
|
|
26.1
|
|
|
|
26.7
|
|
|
|
24.6
|
|
|
|
25.5
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Combined ratio
GAAP
|
|
|
84.2
|
%
|
|
|
93.2
|
%
|
|
|
90.5
|
%
|
|
|
90.7
|
%
|
|
|
86.3
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Combined
Ratio Statutory
The statutory combined ratio is a combination of the loss ratio
(the ratio of incurred losses and loss adjustment expenses to
net earned premium) and the expense ratio (the ratio of policy
acquisition costs and other underwriting expenses, net of ceding
commissions, to net written premium). We calculate the statutory
combined ratio using financial data derived from the combined
financial statements of our insurance company subsidiaries
reported in accordance with statutory accounting principles. Our
insurance companies statutory loss ratios, expense ratios
and combined ratios are shown in the following table:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
2003
|
|
|
2002
|
|
|
Loss ratio
|
|
|
60.0
|
%
|
|
|
67.1
|
%
|
|
|
64.3
|
%
|
|
|
66.8
|
%
|
|
|
62.0
|
%
|
Expense ratio
|
|
|
24.0
|
|
|
|
25.5
|
|
|
|
26.7
|
|
|
|
23.0
|
|
|
|
23.9
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Combined ratio
Statutory
|
|
|
84.0
|
%
|
|
|
92.6
|
%
|
|
|
91.0
|
%
|
|
|
89.8
|
%
|
|
|
85.9
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Industry average
|
|
|
*
|
|
|
|
100.7
|
%
|
|
|
98.3
|
%
|
|
|
100.1
|
%
|
|
|
107.5
|
%
|
* Not available
The statutory ratio data is not intended to be a substitute for
results of operations in accordance with generally accepted
accounting principles. We believe including this information is
useful to allow a comparison of our operating results with those
of other companies in the insurance industry. The source of the
industry average is A.M. Best Company, Inc. A.M. Best
Company, Inc. reports insurer performance based on statutory
financial data to provide more standardized comparisons among
individual companies and to provide overall industry
performance; this data is not an evaluation directed at
investors.
Reserves
Our net loss and loss adjustment expense reserves are composed
of reserves for reported losses and reserves for incurred but
not reported losses, less a reduction for reinsurance
recoverables related to those reserves. Reserves are recorded by
product line and are undiscounted, except for reserves related
to acquisitions.
The process of estimating our loss and loss adjustment expense
reserves involves a considerable degree of judgment by
management and is inherently uncertain. The recorded reserves
represent managements best estimate of unpaid loss and
loss adjustment expense by line of business. Because we provide
insurance coverage in specialized lines of business that often
lack statistical stability, management considers many factors
and not just actuarial point estimates in determining ultimate
expected losses and the level of net reserves required and
recorded.
15
To record reserves on our lines of business, we utilize expected
loss ratios, which management selects based on the following:
1) information used to price the applicable policies,
2) historical loss information where available, 3) any
public industry data for that line or similar lines of business
and 4) an assessment of current market conditions.
Management also considers the point estimates and ranges
calculated by our actuaries, together with input from our
experienced underwriting and claims personnel. Because of the
nature and complexities of the specialized types of business we
insure, management may give greater weight to the expectations
of our underwriting and claims personnel, who often perform a
claim by claim review, rather than to the actuarial estimates.
However, we utilize the actuarial point and range estimates to
monitor the adequacy and reasonableness of our recorded reserves.
Each quarter-end, management compares recorded reserves to the
most recent actuarial point estimate and range for each line of
business. If the recorded reserves vary significantly from the
actuarial point estimate, management determines the reasons for
the variances and may adjust the reserves up or down to an
amount that, in managements judgment, is adequate based on
all of the facts and circumstances considered, including the
actuarial point estimates. We consistently maintain total
consolidated net reserves above the total actuarial point
estimate but within the actuarial range.
Our actuaries utilize standard actuarial techniques in making
their actuarial point estimates. These techniques require a high
degree of judgment, and changing conditions can cause
fluctuations in the reserve estimates. We believe that our
review process is effective, such that any required changes are
recognized in the period of change as soon as the need for the
change is evident. Reinsurance recoverables offset our gross
reserves based upon the contractual terms of our reinsurance
agreements.
With the exception of 2004, our net reserves historically have
shown positive development except for the effects of losses from
commutations, which we have completed in the past and may
negotiate in the future. Commutations can produce negative prior
year development since, under generally accepted accounting
principles, any excess of undiscounted reserves assumed over
assets received must be recorded as a loss at the time the
commutation is completed. Economically, the loss generally
represents the discount for the time value of money that will be
earned over the payout of the reserves; thus, the loss may be
recouped as investment income is earned on the assets received.
Based on our reserving techniques and our past results, we
believe that our net reserves are adequate.
The reserving process is intended to reflect the impact of
inflation and other factors affecting loss payments by taking
into account changes in historical payment patterns and
perceived trends. There is no precise method for the subsequent
evaluation of the adequacy of the consideration given to
inflation, or to any other specific factor, or to the way one
factor may impact another.
We underwrite primary and reinsurance risks that are denominated
in a number of foreign currencies and, therefore, maintain loss
reserves with respect to these policies in the respective
currencies. These reserves are subject to exchange rate
fluctuations, which may have an effect on our net earnings.
The loss development triangles below show changes in our
reserves in subsequent years from the prior loss estimates,
based on experience at the end of each succeeding year, on the
basis of generally accepted accounting principles. The estimate
is increased or decreased as more information becomes known
about the frequency and severity of losses for individual years.
A redundancy means the original estimate was higher than the
current estimate; a deficiency means that the current estimate
is higher than the original estimate.
The first line of each loss development triangle presents, for
the years indicated, our gross or net reserve liability
including the reserve for incurred but not reported losses. The
first section of each table shows, by year, the cumulative
amounts of loss and loss adjustment expense paid at the end of
each succeeding year. The second section sets forth the
re-estimates in later years of incurred losses, including
payments, for the years indicated. The cumulative
redundancy (deficiency) represents, at the date indicated,
the difference between the latest re-estimated liability and the
reserves as originally estimated.
16
This loss development triangle shows development in loss
reserves on a gross basis (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
2003
|
|
|
2002
|
|
|
2001
|
|
|
2000
|
|
|
1999
|
|
|
1998
|
|
|
1997
|
|
|
1996
|
|
|
Balance sheet reserves
|
|
$
|
3,097,051
|
|
|
$
|
2,813,720
|
|
|
$
|
2,089,199
|
|
|
$
|
1,525,313
|
|
|
$
|
1,158,915
|
|
|
$
|
1,132,258
|
|
|
$
|
944,117
|
|
|
$
|
871,104
|
|
|
$
|
460,511
|
|
|
$
|
275,008
|
|
|
$
|
229,049
|
|
Reserve adjustments from
acquisition and disposition of subsidiaries
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
5,587
|
|
|
|
|
|
|
|
(66,571
|
)
|
|
|
(32,437
|
)
|
|
|
(136
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Adjusted reserves
|
|
|
3,097,051
|
|
|
|
2,813,720
|
|
|
|
2,089,199
|
|
|
|
1,525,313
|
|
|
|
1,164,502
|
|
|
|
1,132,258
|
|
|
|
877,546
|
|
|
|
838,667
|
|
|
|
460,375
|
|
|
|
275,008
|
|
|
|
229,049
|
|
Cumulative paid at:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
One year later
|
|
|
|
|
|
|
689,126
|
|
|
|
511,766
|
|
|
|
396,077
|
|
|
|
418,809
|
|
|
|
390,232
|
|
|
|
400,279
|
|
|
|
424,379
|
|
|
|
229,746
|
|
|
|
160,324
|
|
|
|
119,453
|
|
Two years later
|
|
|
|
|
|
|
|
|
|
|
780,130
|
|
|
|
587,349
|
|
|
|
548,941
|
|
|
|
612,129
|
|
|
|
537,354
|
|
|
|
561,246
|
|
|
|
367,512
|
|
|
|
209,724
|
|
|
|
179,117
|
|
Three years later
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
772,095
|
|
|
|
659,568
|
|
|
|
726,805
|
|
|
|
667,326
|
|
|
|
611,239
|
|
|
|
419,209
|
|
|
|
241,523
|
|
|
|
193,872
|
|
Four years later
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
823,760
|
|
|
|
803,152
|
|
|
|
720,656
|
|
|
|
686,730
|
|
|
|
435,625
|
|
|
|
259,067
|
|
|
|
212,097
|
|
Five years later
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
921,920
|
|
|
|
758,126
|
|
|
|
721,011
|
|
|
|
453,691
|
|
|
|
262,838
|
|
|
|
223,701
|
|
Six years later
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
835,994
|
|
|
|
725,639
|
|
|
|
462,565
|
|
|
|
267,038
|
|
|
|
225,595
|
|
Seven years later
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
752,733
|
|
|
|
462,126
|
|
|
|
270,362
|
|
|
|
227,177
|
|
Eight years later
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
464,748
|
|
|
|
268,939
|
|
|
|
228,621
|
|
Nine years later
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
269,751
|
|
|
|
230,745
|
|
Ten years later
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
232,169
|
|
Re-estimated liability at:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
End of year
|
|
|
3,097,051
|
|
|
|
2,813,720
|
|
|
|
2,089,199
|
|
|
|
1,525,313
|
|
|
|
1,164,502
|
|
|
|
1,132,258
|
|
|
|
877,546
|
|
|
|
838,667
|
|
|
|
460,375
|
|
|
|
275,008
|
|
|
|
229,049
|
|
One year later
|
|
|
|
|
|
|
2,810,419
|
|
|
|
2,118,471
|
|
|
|
1,641,426
|
|
|
|
1,287,003
|
|
|
|
1,109,098
|
|
|
|
922,080
|
|
|
|
836,775
|
|
|
|
550,409
|
|
|
|
308,501
|
|
|
|
252,236
|
|
Two years later
|
|
|
|
|
|
|
|
|
|
|
2,112,303
|
|
|
|
1,666,931
|
|
|
|
1,393,143
|
|
|
|
1,241,261
|
|
|
|
925,922
|
|
|
|
868,438
|
|
|
|
545,955
|
|
|
|
316,250
|
|
|
|
249,013
|
|
Three years later
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,690,729
|
|
|
|
1,464,448
|
|
|
|
1,384,608
|
|
|
|
1,099,657
|
|
|
|
854,987
|
|
|
|
547,179
|
|
|
|
304,281
|
|
|
|
250,817
|
|
Four years later
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,506,360
|
|
|
|
1,455,046
|
|
|
|
1,102,636
|
|
|
|
900,604
|
|
|
|
537,968
|
|
|
|
305,022
|
|
|
|
247,245
|
|
Five years later
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,480,193
|
|
|
|
1,135,143
|
|
|
|
887,272
|
|
|
|
522,183
|
|
|
|
295,975
|
|
|
|
249,853
|
|
Six years later
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,137,652
|
|
|
|
894,307
|
|
|
|
521,399
|
|
|
|
296,816
|
|
|
|
243,015
|
|
Seven years later
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
899,212
|
|
|
|
513,918
|
|
|
|
292,544
|
|
|
|
242,655
|
|
Eight years later
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
511,323
|
|
|
|
291,164
|
|
|
|
241,904
|
|
Nine years later
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
287,021
|
|
|
|
244,687
|
|
Ten years later
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
242,651
|
|
Cumulative redundancy
(deficiency)
|
|
|
|
|
|
$
|
3,301
|
|
|
$
|
(23,104
|
)
|
|
$
|
(165,416
|
)
|
|
$
|
(341,858
|
)
|
|
$
|
(347,935
|
)
|
|
$
|
(260,106
|
)
|
|
$
|
(60,545
|
)
|
|
$
|
(50,948
|
)
|
|
$
|
(12,013
|
)
|
|
$
|
(13,602
|
)
|
17
The gross deficiencies reflected in the above table for years
1998 through 2004 resulted from the following:
|
|
|
|
|
During 2005 and 2004, we recorded $49.8 million and
$127.7 million, respectively, in gross losses related to
the 2001 and 2000 accident years on certain run-off assumed
accident and health reinsurance business reported in our
discontinued lines of business, due to our processing of
additional information received and our continuing evaluation of
reserves on this business. The recording of these losses also
affected the 2003 and 2002 years in the above table.
|
|
|
|
During 2005, we reduced our gross reserves on the 2004
hurricanes by $13.4 million to reflect current estimates of
our remaining liabilities, which partially offset the 2005
adverse development discussed above.
|
|
|
|
During 2003, we recorded $132.9 million in gross losses
related to 1999 and 2000 accident years on certain run-off
assumed accident and health reinsurance business reported in our
discontinued lines of business, due to our processing of
additional information received and our continuing evaluation of
reserves on this business. The recording of these losses also
affected the 2002 and 2001 years in the above table.
|
|
|
|
The 2000 and 1999 years in the table were also negatively
affected by late reporting loss information received during 2001
for certain discontinued business.
|
The gross development in 2004 resulted in a $30.5 million
negative effect on our net losses. The remainder of the gross
development discussed above did not have a material effect on
our net losses because the majority of the gross losses were
reinsured.
The gross reserves in the discontinued lines of business,
particularly with respect to run-off assumed accident and health
reinsurance business, produced substantial negative development
from 2003 through 2005. This assumed accident and health
reinsurance is primarily excess coverage for large losses
related to workers compensation policies. Losses tend to
develop and affect excess covers considerably after the original
loss was incurred. Additionally, certain primary insurance
companies that we reinsured have experienced financial
difficulty and some of them are in liquidation, with guaranty
funds now responsible for administering the business. Losses
related to this business are historically late reporting. While
we attempt to anticipate these conditions in setting our gross
reserves, we have only been partially successful to date and
there could be additional negative development in these reserves
in the future. The gross losses that have developed negatively
have been substantially reinsured and therefore have little
effect on our net earnings.
The gross deficiencies reflected in the table for the years
prior to 1999 resulted from two principal conditions:
|
|
|
|
|
We had development of large claims on individual policies which
were either reported late or for which reserves were increased
as subsequent information became available. As these policies
were substantially reinsured, there was no material effect on
our net earnings.
|
|
|
|
During 1999, in connection with the insolvency of one of the
insurance companies that we reinsured and the commutation of all
liabilities with another, we re-evaluated all loss reserves and
incurred but not reported loss reserves related to business
placed with these reinsurers to determine the ultimate losses we
might conservatively expect. These reserves were then used as
the basis for the determination of the provision for reinsurance
recorded in 1999.
|
18
The following table provides a reconciliation of the gross
liability for loss and loss adjustment expense payable on the
basis of generally accepted accounting principles (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
Reserves for loss and loss
adjustment expense payable at beginning of year
|
|
$
|
2,813,720
|
|
|
$
|
2,089,199
|
|
|
$
|
1,525,313
|
|
Reserve additions from acquired
businesses
|
|
|
146,811
|
|
|
|
19,236
|
|
|
|
15,537
|
|
Incurred loss and loss adjustment
expense:
|
|
|
|
|
|
|
|
|
|
|
|
|
Provision for loss and loss
adjustment expense for claims occurring in current year
|
|
|
1,222,139
|
|
|
|
1,567,501
|
|
|
|
1,173,042
|
|
Increase (decrease) in estimated
loss and loss adjustment expense for claims occurring in prior
years*
|
|
|
(3,301
|
)
|
|
|
29,272
|
|
|
|
116,113
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Incurred loss and loss adjustment
expense
|
|
|
1,218,838
|
|
|
|
1,596,773
|
|
|
|
1,289,155
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss and loss adjustment expense
payments for claims occurring during:
|
|
|
|
|
|
|
|
|
|
|
|
|
Current year
|
|
|
393,192
|
|
|
|
379,722
|
|
|
|
344,729
|
|
Prior years
|
|
|
689,126
|
|
|
|
511,766
|
|
|
|
396,077
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss and loss adjustment expense
payments
|
|
|
1,082,318
|
|
|
|
891,488
|
|
|
|
740,806
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Reserves for loss and loss
adjustment expense payable at end of year
|
|
$
|
3,097,051
|
|
|
$
|
2,813,720
|
|
|
$
|
2,089,199
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
* |
|
Changes in loss and loss adjustment expense reserves for losses
occurring in prior years reflect the gross effect of the
resolution of losses for other than the reserve value and the
subsequent adjustments of loss reserves. |
19
This loss development triangle shows development in loss
reserves on a net basis (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
2003
|
|
|
2002
|
|
|
2001
|
|
|
2000
|
|
|
1999
|
|
|
1998
|
|
|
1997
|
|
|
1996
|
|
|
Reserves, net of reinsurance
|
|
$
|
2,108,961
|
|
|
$
|
1,533,433
|
|
|
$
|
1,059,283
|
|
|
$
|
705,200
|
|
|
$
|
458,702
|
|
|
$
|
313,097
|
|
|
$
|
249,872
|
|
|
$
|
273,606
|
|
|
$
|
118,912
|
|
|
$
|
119,634
|
|
|
$
|
117,283
|
|
Reserve adjustments from
acquisition (disposition) of subsidiaries
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
5,587
|
|
|
|
|
|
|
|
(6,048
|
)
|
|
|
(3,343
|
)
|
|
|
(410
|
)
|
|
|
|
|
|
|
|
|
Effect on loss reserves of 1999
write off of reinsurance recoverables
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
63,851
|
|
|
|
15,008
|
|
|
|
2,636
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Adjusted reserves, net of
reinsurance
|
|
|
2,108,961
|
|
|
|
1,533,433
|
|
|
|
1,059,283
|
|
|
|
705,200
|
|
|
|
464,289
|
|
|
|
313,097
|
|
|
|
243,824
|
|
|
|
270,263
|
|
|
|
182,353
|
|
|
|
134,642
|
|
|
|
119,919
|
|
Cumulative paid, net of
reinsurance, at:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
One year later
|
|
|
|
|
|
|
222,336
|
|
|
|
172,224
|
|
|
|
141,677
|
|
|
|
115,669
|
|
|
|
126,019
|
|
|
|
102,244
|
|
|
|
145,993
|
|
|
|
56,052
|
|
|
|
48,775
|
|
|
|
47,874
|
|
Two years later
|
|
|
|
|
|
|
|
|
|
|
195,663
|
|
|
|
135,623
|
|
|
|
152,674
|
|
|
|
131,244
|
|
|
|
139,659
|
|
|
|
174,534
|
|
|
|
103,580
|
|
|
|
64,213
|
|
|
|
66,030
|
|
Three years later
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
124,522
|
|
|
|
115,214
|
|
|
|
163,808
|
|
|
|
118,894
|
|
|
|
185,744
|
|
|
|
113,762
|
|
|
|
80,227
|
|
|
|
72,863
|
|
Four years later
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
88,998
|
|
|
|
93,405
|
|
|
|
138,773
|
|
|
|
180,714
|
|
|
|
121,293
|
|
|
|
81,845
|
|
|
|
81,620
|
|
Five years later
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
59,936
|
|
|
|
158,935
|
|
|
|
197,416
|
|
|
|
120,452
|
|
|
|
84,986
|
|
|
|
81,968
|
|
Six years later
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
137,561
|
|
|
|
200,833
|
|
|
|
127,254
|
|
|
|
87,626
|
|
|
|
82,681
|
|
Seven years later
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
188,901
|
|
|
|
131,631
|
|
|
|
89,194
|
|
|
|
84,108
|
|
Eight years later
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
132,614
|
|
|
|
88,061
|
|
|
|
84,847
|
|
Nine years later
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
88,229
|
|
|
|
84,770
|
|
Ten years later
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
85,253
|
|
Re-estimated liability, net of
reinsurance, at:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
End of year
|
|
|
2,108,961
|
|
|
|
1,533,433
|
|
|
|
1,059,283
|
|
|
|
705,200
|
|
|
|
464,289
|
|
|
|
313,097
|
|
|
|
243,824
|
|
|
|
270,263
|
|
|
|
182,353
|
|
|
|
134,642
|
|
|
|
119,919
|
|
One year later
|
|
|
|
|
|
|
1,526,907
|
|
|
|
1,084,677
|
|
|
|
735,678
|
|
|
|
487,403
|
|
|
|
306,318
|
|
|
|
233,111
|
|
|
|
260,678
|
|
|
|
186,967
|
|
|
|
120,049
|
|
|
|
116,145
|
|
Two years later
|
|
|
|
|
|
|
|
|
|
|
1,083,955
|
|
|
|
770,497
|
|
|
|
500,897
|
|
|
|
338,194
|
|
|
|
222,330
|
|
|
|
254,373
|
|
|
|
175,339
|
|
|
|
116,745
|
|
|
|
101,595
|
|
Three years later
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
792,099
|
|
|
|
571,403
|
|
|
|
366,819
|
|
|
|
259,160
|
|
|
|
244,650
|
|
|
|
171,165
|
|
|
|
110,673
|
|
|
|
97,353
|
|
Four years later
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
585,741
|
|
|
|
418,781
|
|
|
|
267,651
|
|
|
|
258,122
|
|
|
|
163,349
|
|
|
|
107,138
|
|
|
|
95,118
|
|
Five years later
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
453,537
|
|
|
|
296,396
|
|
|
|
254,579
|
|
|
|
155,931
|
|
|
|
103,243
|
|
|
|
93,528
|
|
Six years later
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
305,841
|
|
|
|
271,563
|
|
|
|
157,316
|
|
|
|
101,538
|
|
|
|
91,413
|
|
Seven years later
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
277,841
|
|
|
|
156,376
|
|
|
|
99,872
|
|
|
|
90,951
|
|
Eight years later
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
155,016
|
|
|
|
97,965
|
|
|
|
90,534
|
|
Nine years later
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
96,205
|
|
|
|
90,011
|
|
Ten years later
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
89,235
|
|
Cumulative redundancy
(deficiency)
|
|
|
|
|
|
$
|
6,526
|
|
|
$
|
(24,672
|
)
|
|
$
|
(86,899
|
)
|
|
$
|
(121,452
|
)
|
|
$
|
(140,440
|
)
|
|
$
|
(62,017
|
)
|
|
$
|
(7,578
|
)
|
|
$
|
27,337
|
|
|
$
|
38,437
|
|
|
$
|
30,684
|
|
20
The table below provides a reconciliation of the liability for
loss and loss adjustment expense payable, net of reinsurance
ceded, on the basis of generally accepted accounting principles
(in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
Net reserves for loss and loss
adjustment expense payable at beginning of year
|
|
$
|
1,533,433
|
|
|
$
|
1,059,283
|
|
|
$
|
705,200
|
|
Net reserve additions from
acquired businesses
|
|
|
146,811
|
|
|
|
12,491
|
|
|
|
11,647
|
|
Incurred loss and loss adjustment
expense:
|
|
|
|
|
|
|
|
|
|
|
|
|
Provision for loss and loss
adjustment expense for claims occurring in current year
|
|
|
1,018,382
|
|
|
|
894,303
|
|
|
|
614,752
|
|
Increase (decrease) in estimated
loss and loss adjustment expense for claims occurring in prior
years *
|
|
|
(6,526
|
)
|
|
|
25,394
|
|
|
|
30,478
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Incurred loss and loss adjustment
expense
|
|
|
1,011,856
|
|
|
|
919,697
|
|
|
|
645,230
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss and loss adjustment expense
payments for claims occurring during:
|
|
|
|
|
|
|
|
|
|
|
|
|
Current year
|
|
|
360,803
|
|
|
|
285,814
|
|
|
|
161,117
|
|
Prior years
|
|
|
222,336
|
|
|
|
172,224
|
|
|
|
141,677
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss and loss adjustment expense
payments
|
|
|
583,139
|
|
|
|
458,038
|
|
|
|
302,794
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net reserves for loss and loss
adjustment expense payable at end of year
|
|
$
|
2,108,961
|
|
|
$
|
1,533,433
|
|
|
$
|
1,059,283
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
* |
Changes in loss and loss adjustment expense reserves for losses
occurring in prior years reflect the net effect of the
resolution of losses for other than the reserve value and the
subsequent adjustments of loss reserves.
|
We had net loss and loss adjustment expense adverse development
(redundancy) relating to prior year losses of
$(6.5) million in 2006, $25.4 million in 2005 and
$30.5 million in 2004. The 2006 redundancy resulted from
reductions of $17.7 million of prior year hurricane
reserves plus $9.0 million redundancy primarily from our
aviation and energy lines, partially offset by a commutation
charge of $20.2 million, which primarily related to the
2001 accident years. The 2005 development resulted from a
commutation charge of $26.0 million, which primarily
related to the 2001 and 2000 accident years, and a net
redundancy of $0.6 million from all other sources. In 2004,
as a result of adverse development in run-off assumed accident
and health reinsurance business in our discontinued lines of
business, we strengthened our reserves on this line to bring
them above our actuarial point estimate. Our 2004 deficiency
included $27.3 million related to this charge, which
primarily affected the 2001 and 2000 accident years, and we had
a net deficiency of $3.2 million from all other sources.
Deficiencies and redundancies in the reserves occur as we
continually review our loss reserves with our actuaries,
increasing or reducing loss reserves as a result of such reviews
and as losses are finally settled and claims exposures are
reduced. We believe we have provided for all material net
incurred losses.
We have no material exposure to asbestos claims or environmental
pollution losses. Our largest insurance company subsidiary only
began writing business in 1981, and its policies normally
contain pollution exclusion clauses which limit pollution
coverage to sudden and accidental losses only, thus
excluding intentional dumping and seepage claims. Policies
issued by our other insurance company subsidiaries do not have
significant environmental exposures because of the types of
risks covered.
Enterprise
Risk Management
We are in the process of formalizing an Enterprise Risk
Management (ERM) strategy to manage risks appropriately
throughout our organization. Within ERM, we are creating an
event and risk repository for managing and maintaining our risk
profile, so it remains current and supports a no
surprises environment. ERM will ensure that our internal
controls framework is effective in design and operation and
aligned with
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our business risk. We are implementing processes and practices
that will allow us to assess risks in a more transparent,
structured and consistent manner and provide clarity to our risk
response process, resulting in our improved management of risks.
ERM will also identify potential opportunities for our business.
To support our ERM objective, we have assigned the
responsibility for implementation to an Executive Vice President
and invested in professional expertise and technology. With ERM,
we strive to implement superior risk management practices at all
levels of the organization.
Regulation
The business of insurance is extensively regulated by the
government. At this time, the insurance business in the United
States is regulated primarily by the individual states.
Additional federal regulation of the insurance industry may
occur in the future.
Our business depends on our compliance with applicable laws and
regulations and our ability to maintain valid licenses and
approvals for our operations. We devote a significant effort
toward obtaining and maintaining our licenses and compliance
with a diverse and complex regulatory structure. In all
jurisdictions, the applicable laws and regulations are subject
to amendment or interpretation by regulatory authorities.
Generally, regulatory authorities are vested with broad
discretion to grant, renew and revoke licenses and approvals and
to implement regulations governing the business and operations
of insurers and insurance agents.
Insurance
Companies
Our insurance companies are subject to regulation and
supervision by the states and by other jurisdictions in which
they do business. Regulation by the states varies, but generally
involves regulatory and supervisory powers of a state insurance
official. In the United States, the regulation and supervision
of our insurance operations relates primarily to:
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approval of policy forms and premium rates;
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licensing of insurers and their agents;
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periodic examinations of our operations and finances;
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prescribing the form and content of records of financial
condition required to be filed;
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requiring deposits for the benefit of policyholders;
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requiring certain methods of accounting;
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requiring reserves for unearned premium, losses and other
purposes;
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restrictions on the ability of our insurance companies to pay
dividends;
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restrictions on the nature, quality and concentration of
investments;
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restrictions on transactions between insurance companies and
their affiliates;
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restrictions on the size of risks insurable under a single
policy; and
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standards of solvency, including risk-based capital measurement
(which is a measure developed by the National Association of
Insurance Commissioners and used by state insurance regulators
to identify insurance companies that potentially are
inadequately capitalized).
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In the United States, state insurance regulations are intended
primarily for the protection of policyholders rather than
shareholders. The state insurance departments monitor compliance
with regulations through periodic reporting procedures and
examinations. The quarterly and annual financial reports to the
state insurance regulators utilize accounting principles that
are different from the generally accepted accounting principles
we use in our reports to shareholders. Statutory accounting
principles, in keeping with the intent to assure the protection
of policyholders, are generally based on a liquidation concept,
while generally accepted accounting principles are based on a
going-concern concept.
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In the United States, state insurance regulators classify
primary insurance companies and some individual lines of
business as admitted (also known as
licensed) insurance or non-admitted
(also known as surplus lines) insurance. Surplus
lines insurance is offered by non-admitted companies on risks
that are not insured in the particular state by admitted
companies. All surplus lines insurance is required to be written
through licensed surplus lines insurance brokers, who are
required to be knowledgeable of and to follow specific state
laws prior to placing a risk with a surplus lines insurer. Our
insurance companies offer products on both an admitted and
surplus lines basis.
In the United Kingdom, the Financial Services Authority
supervises all securities, banking and insurance businesses,
including Lloyds of London. The Financial Services
Authority oversees compliance with established periodic auditing
and reporting requirements, risk assessment reviews, minimum
solvency margins, dividend restrictions, restrictions governing
the appointment of key officers, restrictions governing
controlling ownership interests and various other requirements.
All of our United Kingdom operations, including Houston Casualty
Company-London, are authorized and regulated by the Financial
Services Authority.
HCC Europe is domiciled in Spain and operates on the equivalent
of an admitted basis throughout the European Union.
HCC Europes primary regulator is the General Directorate
of Insurance and Pension Funds of the Ministry of the Economy
and Treasury (Dirección General de Seguros y Fondos de
Pensiones del Ministerio de Economía y Hacienda).
U.S. state insurance regulations also affect the payment of
dividends and other distributions by insurance companies to
their shareholders. Generally, insurance companies are limited
by these regulations in the payment of dividends above a
specified level. Dividends in excess of those thresholds are
extraordinary dividends and are subject to prior
regulatory approval. Many states require prior regulatory
approval for all dividends.
Underwriting
Agencies and Reinsurance and Insurance Brokers
In addition to the regulation of insurance companies, the states
impose licensing and other requirements on the underwriting
agency and service operations of our other subsidiaries. These
regulations relate primarily to:
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advertising and business practice rules;
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contractual requirements;
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financial security;
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licensing as agents, brokers, reinsurance brokers, managing
general agents or third party administrators;
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limitations on authority; and
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recordkeeping requirements.
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Statutory
Accounting Principles
The principal differences between statutory accounting
principles for our domestic insurance company subsidiaries and
generally accepted accounting principles, the method by which we
report our consolidated financial results to our shareholders,
are as follows:
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a liability is recorded for certain reinsurance recoverables
under statutory accounting principles whereas, under generally
accepted accounting principles, there is no such provision
unless the recoverables are deemed to be doubtful of collection;
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certain assets that are considered non-admitted
assets are eliminated from a balance sheet prepared in
accordance with statutory accounting principles but are included
in a balance sheet prepared in accordance with generally
accepted accounting principles;
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only some of the deferred tax asset is recognized under
statutory accounting principles;
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fixed income investments classified as available for sale are
recorded at market value for generally accepted accounting
principles and at amortized cost under statutory accounting
principles;
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outstanding losses and unearned premium are reported on a gross
basis under generally accepted accounting principles and on a
net basis under statutory accounting principles; and
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under statutory accounting principles, policy acquisition costs
are expensed as incurred and, under generally accepted
accounting principles, such costs are deferred and amortized to
expense as the related premium is earned.
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Our international insurance company subsidiaries
accounting principles are prescribed by regulatory authorities
in each country. The prescribed principles do not vary
significantly from generally accepted accounting principles.
Insurance
Holding Company Acts
Because we are an insurance holding company, we are subject to
the insurance holding company system regulatory requirements of
a number of states. Under these regulations, we are required to
report information regarding our capital structure, financial
condition and management. We are also required to provide prior
notice to, or seek the prior approval of, insurance regulatory
authorities of certain agreements and transactions between our
affiliated companies. These agreements and transactions must
satisfy certain regulatory requirements.
Assessments
Many states require insurers licensed to do business in their
state to bear a portion of the loss suffered by some insureds as
a result of the insolvency of other insurers or to bear a
portion of the cost of insurance for high-risk or
otherwise uninsured individuals. Depending upon state law,
insurers can be assessed an amount that is generally limited to
between 1% and 2% of premiums written for the relevant lines of
insurance in that state. Part of these payments may be
recoverable through premium rates, premium tax credits or policy
surcharges. Significant increases in assessments could limit the
ability of our insurance subsidiaries to recover such
assessments through tax credits or other means. In addition,
there have been some legislative efforts to limit policy
surcharges or repeal the tax offset provisions. We cannot
predict the extent to which such assessments may increase or
whether there may be limits imposed on our ability to recover or
offset such assessments.
Insurance
Regulations Concerning Change of Control
Many state insurance regulatory laws contain provisions that
require advance approval by state agencies of any change of
control of an insurance company that is domiciled or, in some
cases, has substantial business in that state.
Control is generally presumed to exist through the
ownership of 10% or more of the voting securities of a domestic
insurance company or of any company that controls a domestic
insurance company. HCC owns, directly or indirectly, all of the
shares of stock of insurance companies domiciled in a number of
states. Any purchaser of shares of common stock representing 10%
or more of the voting power of our common stock will be presumed
to have acquired control of our domestic insurance subsidiaries
unless, following application by that purchaser, the relevant
state insurance regulators determine otherwise. Any transactions
that would constitute a change in control of any of our
individual insurance subsidiaries would generally require prior
approval by the insurance departments of the states in which the
insurance subsidiary is domiciled. Also, one of our insurance
subsidiaries is domiciled in the United Kingdom and another in
Spain. Insurers in those countries are also subject to change of
control restrictions under their individual regulatory
frameworks. These requirements may deter or delay possible
significant transactions in our common stock or the disposition
of our insurance companies to third parties, including
transactions which could be beneficial to our shareholders.
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Risk-Based
Capital
The National Association of Insurance Commissioners has
developed a formula for analyzing insurance companies called
risk-based capital. The risk-based capital formula is intended
to establish minimum capital thresholds that vary with the size
and mix of an insurance companys business and assets. It
is designed to identify companies with capital levels that may
require regulatory attention. At December 31, 2006, each of
our domestic insurance companies total adjusted capital
was significantly in excess of the authorized control level
risk-based capital.
Insurance
Regulatory Information System
The National Association of Insurance Commissioners has
developed a rating system, the Insurance Regulatory Information
System, primarily intended to assist state insurance departments
in overseeing the financial condition of all insurance companies
operating within their respective states. The Insurance
Regulatory Information System consists of eleven key financial
ratios that address various aspects of each insurers
financial condition and stability. Our insurance companies
Insurance Regulatory Information System ratios generally fall
within the usual prescribed ranges.
Terrorism
Risk Insurance Act
The Federal Terrorism Risk Insurance Act was initially enacted
in 2002, and subsequently extended through the end of 2007, for
the purpose of ensuring the availability of insurance coverage
for terrorist acts in the United States. The law establishes a
financial backstop program to assist the commercial property and
casualty insurance industry in providing coverage related to
future acts of terrorism within the United States. It is unknown
at this time whether or not the law will be extended beyond
December 31, 2007 or on what terms. If it is not renewed,
our current policies allow us to cancel the terrorism coverage
in force at that time and we will no longer be required to offer
the coverage.
Under the Act, we are required to offer terrorism coverage to
our commercial policyholders in certain lines of business, for
which we may, when warranted, charge an additional premium. The
policyholders may or may not accept such coverage. This law also
established a deductible that each insurer would have to meet
before U.S. Federal reimbursement would occur. For 2007,
our deductible is approximately $106.3 million. The Federal
Government would provide reimbursement for 85% of any additional
covered losses in 2007 up to the maximum amount set out in the
Act.
Legislative
Initiatives
In recent years, state legislatures have considered or enacted
laws that modify and, in many cases, increase state authority to
regulate insurance companies and insurance holding company
systems. State insurance regulators are members of the National
Association of Insurance Commissioners, which seeks to promote
uniformity of and to enhance the state regulation of insurance.
In addition, the National Association of Insurance Commissioners
and state insurance regulators, as part of the National
Association of Insurance Commissioners state insurance
department accreditation program and in response to new federal
laws, have re-examined existing state laws and regulations,
specifically focusing on insurance company investments, issues
relating to the solvency of insurance companies, licensing and
market conduct issues, streamlining agent licensing and policy
form approvals, adoption of privacy rules for handling
policyholder information, interpretations of existing laws, the
development of new laws and the definition of extraordinary
dividends.
In recent years, a variety of measures have been proposed at the
federal level to reform the current process of Federal and state
regulation of the financial services industries in the United
States, which include the banking, insurance and securities
industries. These measures, which are often referred to as
financial services modernization, have as a principal objective
the elimination or modification of regulatory barriers to
cross-industry combinations involving banks, securities firms
and insurance companies. A form of financial services
modernization legislation was enacted at the Federal level in
1999 through the Gramm-Leach-Bliley Act. That Federal
legislation was expected to have significant implications on the
banking, insurance and securities industries and to result in
more cross-industry consolidations among banks, insurance
companies
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and securities firms and increased competition in many of the
areas of operations. Such wide-spread cross-industry
consolidation has not occurred to date. It also mandated the
adoption of laws allowing reciprocity among the states in the
licensing of agents and, along with other Federal laws, mandated
the adoption of laws and regulations dealing with the protection
of the privacy of policyholder information. Also, the Federal
Government has from time to time considered whether to impose
overall federal regulation of insurers. If so, we believe state
regulation of the insurance business would likely continue. This
could result in an additional layer of federal regulation. In
addition, some insurance industry trade groups are actively
lobbying for legislation that would allow an option for a
separate Federal charter for insurance companies. The full
extent to which the Federal Government could decide to directly
regulate the business of insurance has not been determined by
lawmakers.
State regulators in many states have initiated or are
participating in industry-wide investigations of sales and
marketing practices in the insurance industry. Such
investigations have resulted in restitution and settlement
payments by some companies and criminal charges against some
individuals. The investigations have led to changes in the
structure of compensation arrangements, the offering of certain
products and increased transparency in the marketing of many
insurance products. We have cooperated fully with any such
investigations and, based on presently available information, do
not expect any adverse results from such investigations.
We do not know at this time the full extent to which these
Federal or state legislative or regulatory initiatives will or
may affect our operations and no assurance can be given that
they would not, if adopted, have a material adverse effect on
our business or our results of operations.
Employees
At December 31, 2006, we had 1,660 employees. Of this
number, 929 are employed by our insurance companies, 471 are
employed by our underwriting agencies, 99 are employed by our
reinsurance and insurance brokers and 161 are employed at the
corporate headquarters and elsewhere. We are not a party to any
collective bargaining agreement and have not experienced work
stoppages or strikes as a result of labor disputes. We consider
our employee relations to be good.
Item 1A. Risk
Factors
Risks
Relating to our Industry
Because
we are a property and casualty insurer, our business may suffer
as a result of unforeseen catastrophic losses.
Property and casualty insurers are subject to claims arising
from catastrophes. Catastrophic losses have had a significant
impact on our historical results. Catastrophes can be caused by
various events, including hurricanes, tsunamis, windstorms,
earthquakes, hailstorms, explosions, severe winter weather and
fires and may include man-made events, such as terrorist
attacks. The incidence, frequency and severity of catastrophes
are inherently unpredictable. The extent of losses from a
catastrophe is a function of both the total amount of insured
exposure in the area affected by the event and the severity of
the event. Insurance companies are not permitted to reserve for
a catastrophe until it has occurred. Catastrophes can cause
losses in a variety of our property and casualty lines, and most
of our past catastrophe-related claims have resulted from
hurricanes and earthquakes; however, we experienced a
significant loss as a result of the September 11, 2001
terrorist attack. Most of our exposure to catastrophes comes
from our London market account. Although we typically purchase
reinsurance protection for risks we believe bear a significant
level of catastrophe exposure, the nature or magnitude of losses
attributed to a catastrophic event or events may result in
losses that exceed our reinsurance protection. It is therefore
possible that a catastrophic event or multiple catastrophic
events could have a material adverse effect on our financial
position, results of operations and liquidity.
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The
insurance and reinsurance business is historically cyclical, and
we expect to experience periods with excess underwriting
capacity and unfavorable premium rates, which could cause our
results to fluctuate.
The insurance and reinsurance business historically has been a
cyclical industry characterized by periods of intense price
competition due to excessive underwriting capacity, as well as
periods when shortages of capacity permitted an increase in
pricing and, thus, more favorable premium levels. An increase in
premium levels is often, over time, offset by an increasing
supply of insurance and reinsurance capacity, either by capital
provided by new entrants or by the commitment of additional
capital by existing insurers or reinsurers, which may cause
prices to decrease. Any of these factors could lead to a
significant reduction in premium rates, less favorable policy
terms and fewer opportunities to underwrite insurance risks,
which could have a material adverse effect on our results of
operations and cash flows. In addition to these considerations,
changes in the frequency and severity of losses suffered by
insureds and insurers may affect the cycles of the insurance and
reinsurance business significantly. These factors may also cause
the price of our common stock to be volatile.
Our
loss reserves are based on an estimate of our future liability,
which may prove to be inadequate.
We maintain loss reserves to cover our estimated liability for
unpaid losses and loss adjustment expenses, including legal and
other fees as well as a portion of our general expenses, for
reported and unreported claims incurred at the end of each
accounting period. Reserves do not represent an exact
calculation of liability. Rather, reserves represent an estimate
of what we expect the ultimate settlement and administration of
claims will cost. These estimates, which generally involve
actuarial projections, are based on our assessment of facts and
circumstances then known, as well as estimates of future trends
in claims severity, frequency, judicial theories of liability
and other factors. These variables are affected by both internal
and external events, such as changes in claims handling
procedures, inflation, judicial trends and legislative changes.
Many of these items are not directly quantifiable in advance.
Additionally, there may be a significant reporting delay between
the occurrence of the insured event and the time it is reported
to us. The inherent uncertainties of estimating reserves are
greater for certain types of liabilities, particularly those in
which the various considerations affecting the type of claim are
subject to change and in which long periods of time may elapse
before a definitive determination of liability is made. Reserve
estimates are continually refined in a regular and ongoing
process as experience develops and further claims are reported
and settled. Adjustments to reserves are reflected in our
results of operations in the periods in which such estimates are
changed. Because setting reserves is inherently uncertain, there
can be no assurance that current reserves will prove adequate in
light of subsequent events. If actual claims prove to be greater
than our reserves, our financial position, results of operations
and liquidity may be adversely affected.
The
effects of emerging claim and coverage issues on our business
are uncertain.
As industry practices and legal, judicial, social and other
environmental conditions change, unexpected and unintended
issues related to claims and coverage may emerge. These issues
may adversely affect our business by either extending coverage
beyond our underwriting intent or by increasing the number or
size of claims. In some instances, these changes may not become
apparent until some time after we have issued insurance or
reinsurance contracts that are affected by the changes. As a
result, the full extent of liability under our insurance or
reinsurance contracts may not be known for many years after a
contract is issued and our financial position and results of
operations may be adversely affected.
We are
subject to extensive governmental regulation, which could
adversely affect our business.
We are subject to extensive governmental regulation and
supervision. Our business depends on compliance with applicable
laws and regulations and our ability to maintain valid licenses
and approvals for our operations. Most insurance regulations are
designed to protect the interests of policyholders rather than
shareholders and other investors. In the United States, this
regulation is generally administered by departments of insurance
in each state in which we do business and includes a
comprehensive framework of oversight of our operations and
review of our financial position. U.S. Federal legislation
may lead to additional federal regulation of the insurance
industry in the coming years. Also, foreign governments regulate
our international
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operations. Each foreign jurisdiction has its own unique
regulatory framework that applies to our operations in that
jurisdiction. Regulatory authorities have broad discretion to
grant, renew or revoke licenses and approvals. Regulatory
authorities may deny or revoke licenses for various reasons,
including the violation of regulations. In some instances, we
follow practices based on our interpretations of regulations, or
those we believe to be generally followed by the industry, which
may be different from the requirements or interpretations of
regulatory authorities. If we do not have the requisite licenses
and approvals and do not comply with applicable regulatory
requirements, the insurance regulatory authorities could
preclude or temporarily suspend us from carrying on some or all
of our activities or otherwise penalize us. That type of action
could have a material adverse effect on our results of
operations. Also, changes in the level of regulation of the
insurance industry (whether federal, state or foreign), or
changes in laws or regulations themselves or interpretations by
regulatory authorities, could have a material adverse effect on
our business. Virtually all states require insurers licensed to
do business in that state to bear a portion of the loss suffered
by some insureds as the result of impaired or insolvent
insurance companies. The effect of these arrangements could
adversely affect our results of operations.
Our
reliance on brokers subjects us to their credit
risk.
In accordance with industry practice, we generally pay amounts
owed on claims under our insurance and reinsurance contracts to
brokers, and these brokers, in turn, pay these amounts to the
clients that have purchased insurance or reinsurance from us.
Although the law is unsettled and depends upon the facts and
circumstances of the particular case, in some jurisdictions, if
a broker fails to make such a payment, we might remain liable to
the insured or ceding insurer for the deficiency. Conversely, in
certain jurisdictions, when the insured or ceding insurer pays
premiums for these policies to brokers for payment over to us,
these premiums might be considered to have been paid and the
insured or ceding insurer will no longer be liable to us for
those amounts, whether or not we have actually received the
premiums from the broker. Consequently, we assume a degree of
credit risk associated with brokers with whom we transact
business. However, due to the unsettled and fact-specific nature
of the law, we are unable to quantify our exposure to this risk.
To date, we have not experienced any material losses related to
these credit risks.
Risks
Relating to our Business
Our
inability to accurately assess underwriting risk could reduce
our net income.
Our underwriting success is dependent on our ability to
accurately assess the risks associated with the business on
which the risk is retained. We rely on the experience of our
underwriting staff in assessing these risks. If we fail to
assess accurately the risks we retain, we may fail to establish
appropriate premium rates and our reserves may be inadequate to
cover our losses, which could reduce our net income. The
underwriting process is further complicated by our exposure to
unpredictable developments, including
earthquakes,weather-related events and other natural
catastrophes, as well as war and acts of terrorism.
Our
increased retentions in various lines of business expose us to a
greater portion of potential losses.
Over the past few years, we have significantly increased our
retentions, or the part of the risk we retain for our own
account, in a number of the lines of business underwritten by
our insurance companies. The determination to reduce the amount
of reinsurance we purchase or not to purchase reinsurance for a
particular risk or line of business is based on a variety of
factors including market conditions, pricing, availability of
reinsurance, the level of our capital and loss history. Such
determinations have the effect of increasing our financial
exposure to losses associated with such risks or in the subject
line of business and could have a material adverse effect on our
financial position, results of operations and cash flows in the
event of significant losses associated with such risks or lines
of business.
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If we
are unable to purchase adequate reinsurance protection for some
of the risks we have underwritten, we will be exposed to any
resulting losses.
We purchase reinsurance for a portion of the risks underwritten
by our insurance companies, especially volatile and
catastrophe-exposed risks. Market conditions beyond our control
determine the availability and cost of the reinsurance
protection we purchase. In addition, the historical results of
reinsurance programs and the availability of capital also affect
the availability of reinsurance. Our reinsurance facilities are
generally subject to annual renewal. We cannot assure that we
can maintain our current reinsurance facilities or that we can
obtain other reinsurance facilities in adequate amounts and at
favorable rates. Further, we cannot determine what effect
catastrophic losses will have on the reinsurance market in
general and on our ability to obtain reinsurance in adequate
amounts and at favorable rates in particular. If we are unable
to renew or to obtain new reinsurance facilities, either our net
exposures would increase or, if we are unwilling to bear such an
increase, we would have to reduce the level of our underwriting
commitments, especially in catastrophe-exposed risks. Either of
these potential developments could have a material adverse
effect on our financial position, results of operations and cash
flows. The lack of available reinsurance may also adversely
affect our ability to generate fee and commission income in our
underwriting agency and reinsurance broker operations.
If the
companies that provide our reinsurance do not pay all of our
claims, we could incur severe losses.
We purchase reinsurance by transferring, or ceding, part of the
risk we have assumed as a primary insurer to a reinsurance
company in exchange for part of the premium we receive in
connection with the risk. Through reinsurance, we have the
contractual right to collect the amount above our retention from
our reinsurers. Although reinsurance makes the reinsurer liable
to us to the extent the risk is transferred or ceded to the
reinsurer, it does not relieve us, the reinsured, of our full
liability to our policyholders. Accordingly, we bear credit risk
with respect to our reinsurers. We cannot assure you that our
reinsurers will pay all of our reinsurance claims, or that they
will pay our claims on a timely basis. Additionally,
catastrophic losses from multiple primary insurers may
accumulate within the more concentrated reinsurance market and
result in claims which adversely impact the financial condition
of such reinsurers and thus their ability to pay such claims. If
we become liable for risks we have ceded to reinsurers or if our
reinsurers cease to meet their obligations to us, whether
because they are in a weakened financial position as a result of
incurred losses or otherwise, our financial position, results of
operations and cash flows could be materially adversely affected.
As a
primary insurer, we may have significant exposure for terrorist
acts.
To the extent that reinsurers have excluded coverage for
terrorist acts or have priced such coverage at rates that we
believe are not practical, we, in our capacity as a primary
insurer, do not have reinsurance protection and are exposed for
potential losses as a result of any terrorist acts. To the
extent an act of terrorism is certified by the Secretary of
Treasury, we may be covered under The Terrorism Risk Insurance
Act, originally enacted in 2002 and subsequently extended, for
up to 85% of our losses in 2007. However, any such coverage
would be subject to a mandatory deductible. Our deductible under
the Act during 2007 is $106.3 million. If the Act is not
extended beyond its currently stated termination date of
December 31, 2007 or replaced by a similar program, our
liability for terrorist acts could be a material amount.
We may
be unsuccessful in competing against larger or more well
established business rivals.
In our specialty insurance operations, we compete in
narrowly-defined niche classes of business such as the insurance
of private aircraft (aviation), directors and
officers liability (diversified financial products),
employer sponsored, self-insured medical plans (medical
stop-loss), professional indemnity (diversified financial
products) and surety (diversified financial products), as
distinguished from such general lines of business as automobile
or homeowners insurance. We compete with a large number of other
companies in our selected lines of business, including:
Lloyds, ACE and XL in our London market business; American
International Group and U.S. Aviation Insurance Group (a
subsidiary of Berkshire Hathaway, Inc.) in our aviation line of
business; United Health, Symetra Financial Corp. and Hartford
Life in our group life, accident and health business; and
American International Group, The Chubb Corporation, ACE,
St. Paul Travelers and XL in our diversified financial
products business. We face competition from specialty insurance
companies,
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underwriting agencies and reinsurance brokers, as well as from
diversified financial services companies that are larger than we
are and that have greater financial, marketing and other
resources than we do. Some of these competitors also have longer
experience and more market recognition than we do in certain
lines of business. In addition to competition in the operation
of our business, we face competition from a variety of sources
in attracting and retaining qualified employees. We cannot
assure you that we will maintain our current competitive
position in the markets in which we operate, or that we will be
able to expand our operations into new markets. If we fail to do
so, our results of operations and cash flows could be materially
adversely affected.
If
rating agencies downgrade our financial strength ratings, our
business and competitive position in the industry may
suffer.
Ratings have become an increasingly important factor in
establishing the competitive position of insurance companies.
Our insurance companies are rated by Standard &
Poors Corporation, Fitch Ratings and A.M. Best
Company, Inc. whose financial strength ratings reflect their
opinions of an insurance companys and insurance holding
companys financial strength, operating performance,
strategic position and ability to meet its obligations to
policyholders and are not evaluations directed to investors. Our
ratings are subject to periodic review by those entities and the
continuation of those ratings cannot be assured. If our ratings
are reduced from their current levels, our financial position
and results of operations could be adversely affected.
We may
require additional capital in the future, which may not be
available or may only be available on unfavorable
terms.
Our future capital requirements depend on many factors,
including our ability to write new business successfully and to
establish premium rates and reserves at levels sufficient to
cover losses. We may need to raise additional funds through
financings or curtail our growth and reduce our assets. Any
equity or debt financing, if available at all, may be on terms
that are not favorable to us. In the case of equity financings,
dilution to our shareholders could result and, in any case, such
securities may have rights, preferences and privileges that are
senior to those of our common stock. If we cannot obtain
adequate capital on favorable terms or at all, our business,
results of operations and liquidity could be adversely affected.
As a result of the delayed filing of our Quarterly Reports on
Form 10-Q
for the second and third quarters of 2006, we are ineligible to
register our securities on
Form S-3
or use our previously filed shelf registration statement for one
year after December 27, 2006, the date these reports were
filed with the SEC. We may use
Form S-1
to raise capital and borrow money utilizing public debt or to
complete acquisitions of other companies, which could increase
transaction costs and adversely impact our ability to raise
capital and borrow money or complete acquisitions in a timely
manner.
Standard & Poors Corporation, Fitch Ratings and
A.M. Best Company rate our credit strength. If our credit
ratings are reduced, it might significantly impede our ability
to raise capital and borrow money.
We may
be unable to attract and retain qualified
employees.
We depend on our ability to attract and retain experienced
underwriting talent and other skilled employees who are
knowledgeable about our business. Certain of our senior
underwriters and other skilled employees have employment
agreements that are for definite terms, and there is no
assurance we will retain these employees beyond the current
terms of their agreements. If the quality of our underwriting
team and other personnel decreases, we may be unable to maintain
our current competitive position in the specialized markets in
which we operate and be unable to expand our operations into new
markets, which could adversely affect our business.
We
invest a significant amount of our assets in fixed income
securities that have experienced market fluctuations, which may
greatly reduce the value of our investment
portfolio.
At December 31, 2006, $3.0 billion of our
$3.9 billion investment portfolio was invested in fixed
income securities. The fair value of these fixed income
securities and the related investment income fluctuate
30
depending on general economic and market conditions. With
respect to our investments in fixed income securities, the fair
value of these investments generally increases or decreases in
an inverse relationship with fluctuations in interest rates,
while net investment income realized by us from future
investments in fixed income securities will generally increase
or decrease with interest rates. In addition, actual net
investment income
and/or cash
flows from investments that carry prepayment risk (such as
mortgage-backed and other asset-backed securities) may differ
from those anticipated at the time of investment as a result of
interest rate fluctuations. An investment has prepayment risk
when there is a risk that the timing of cash flows that result
from the repayment of principal might occur earlier than
anticipated because of declining interest rates or later than
anticipated because of rising interest rates. Although we
maintain an investment grade portfolio (98% are rated
A or better), our fixed income securities are also
subject to credit risk. If any of the issuers of our fixed
income securities suffer financial setbacks, the ratings on the
fixed income securities could fall (with a concurrent fall in
fair value) and, in a worst case scenario, the issuer could
default on its financial obligations. Historically, the impact
of market fluctuations has affected our financial statements.
Because all of our fixed income securities are classified as
available for sale, changes in the fair value of our securities
are reflected in our other comprehensive income. Similar
treatment is not available for liabilities. Therefore, interest
rate fluctuations could adversely affect our financial position.
Unrealized pre-tax net investment gains (losses) on investments
in fixed income securities were $6.9 million in 2006,
$(29.3) million in 2005 and $(9.3) million in 2004.
Our
strategy of acquiring other companies for growth may not
succeed.
Our strategy for growth includes growing through acquisitions of
insurance industry related companies. This strategy presents
risks that could have a material adverse effect on our business
and financial performance, including: 1) the diversion of
our managements attention, 2) our ability to
assimilate the operations and personnel of the acquired
companies, 3) the contingent and latent risks associated
with the past operations of, and other unanticipated problems
arising in, the acquired companies, 4) the need to expand
management, administration and operational systems and
5) increased competition for suitable acquisition
opportunities and qualified employees. We cannot predict whether
we will be able to acquire additional companies on terms
favorable to us or if we will be able to successfully integrate
the acquired operations into our business. We do not know if we
will realize any anticipated benefits of completed acquisitions
or if there will be substantial unanticipated costs associated
with new acquisitions. In addition, future acquisitions by us
may result in potentially dilutive issuances of our equity
securities, the incurrence of additional debt
and/or the
recognition of potential impairment of goodwill and other
intangible assets. Each of these factors could adversely affect
our financial position and results of operations. Moreover, our
ability to use equity securities or to incur additional debt for
acquisitions may be negatively affected by our inability to use
Form S-3
or our previously filed shelf registration for one year after
December 27, 2006.
We are
an insurance holding company and, therefore, may not be able to
receive dividends in needed amounts from our
subsidiaries.
Historically, we have had sufficient cash flow from our
non-insurance company subsidiaries to meet our corporate cash
flow requirements for paying principal and interest on
outstanding debt obligations, dividends to shareholders and
corporate expenses. However, in the future we may rely on
dividends from our insurance companies to meet these
requirements. The payment of dividends by our insurance
companies is subject to regulatory restrictions and will depend
on the surplus and future earnings of these subsidiaries, as
well as the regulatory restrictions. As a result, should our
other sources of funds prove to be inadequate, we may not be
able to receive dividends from our insurance companies at times
and in amounts necessary to meet our obligations, which could
adversely affect our financial position and liquidity.
Because
we operate internationally, fluctuations in currency exchange
rates may affect our receivable and payable balances and our
reserves.
We underwrite insurance coverages that are denominated in a
number of foreign currencies, and we establish and maintain our
loss reserves with respect to these policies in their respective
currencies. Our net
31
earnings could be adversely affected by exchange rate
fluctuations, which would adversely affect receivable and
payable balances and reserves. Our principal area of exposure
relates to fluctuations in exchange rates between the major
European currencies (particularly the British pound sterling and
the Euro) and the U.S. dollar. Consequently, a change in
the exchange rate between the U.S. dollar and the British
pound sterling or the Euro could have an adverse effect on our
results of operations.
Our
information technology systems may fail or suffer a loss of
security, which could adversely affect our
business.
Our business is highly dependent upon the successful and
uninterrupted functioning of our computer and data processing
systems. We rely on these systems to perform actuarial and other
modeling functions necessary for writing business, as well as to
process and make claims payments. We have a highly trained staff
that is committed to the development and maintenance of these
systems. However, the failure of these systems could interrupt
our operations. This could result in a material adverse effect
on our business results.
In addition, a security breach of our computer systems could
damage our reputation or result in liability. We retain
confidential information regarding our business dealings in our
computer systems. We may be required to spend significant
capital and other resources to protect against security breaches
or to alleviate problems caused by such breaches. It is critical
that these facilities and infrastructure remain secure. Despite
the implementation of security measures, this infrastructure may
be vulnerable to physical break-ins, computer viruses,
programming errors, attacks by third parties or similar
disruptive problems. In addition, we could be subject to
liability if hackers were able to penetrate our network security
or otherwise misappropriate confidential information.
We are
exposed to goodwill impairment risk as part of our business
acquisition strategy.
We have recorded goodwill in connection with the majority of our
business acquisitions. We are required to perform goodwill
impairment tests at least annually and whenever events or
circumstances indicate that the carrying value may not be
recoverable from estimated future cash flows. As a result of our
annual and other periodic evaluations, we may determine that a
portion of the goodwill carrying value needs to be written down
to fair value, which could adversely affect our financial
position and results of operations.
The
SECs informal inquiry related to our stock option granting
procedures is ongoing, and the scope and outcome could have a
negative impact on the price of our securities and on our
business.
In connection with a voluntary independent investigation by a
Special Committee of the Board of Directors of our past
practices related to granting stock options, the SEC commenced
an informal inquiry into our option pricing practices. We have
provided the results of our internal review and independent
investigation to the SEC, and we have responded to informal
requests for documents and additional information. We intend to
fully cooperate with the SEC. We are unable to predict the
outcome of the informal inquiry, but it may result in additional
professional fees, including our advancement of attorneys
fees incurred by our Directors, certain officers and certain
former executives and Directors; may continue to occupy the time
and attention of our management team; could have a material
adverse impact on our stock price, including increased stock
price volatility; and could negatively impact our business and
our ability to raise and borrow additional funds in the future.
Furthermore, if we are subject to adverse findings in this or
any other regulatory proceeding or governmental enforcement
action, we could be required to pay damages and penalties or
have other remedies imposed, which could harm our business,
financial condition, results of operations and cash flows.
The
matters relating to the Special Committee of the Board of
Directors investigation of our historical stock option
granting practices and the restatement of our consolidated
financial statements have resulted in our being named as a party
in two derivative legal actions and may result in future
litigation, which could harm our business and financial
condition.
As a result of the Special Committees voluntary
independent investigation of our historical stock option
granting practices, we had to record non-cash compensation
expense in each year from 1997 through 2006. To
32
correct these accounting errors, we restated our consolidated
financial statements for the applicable periods and filed our
Annual Report on
Form 10-K/A
for 2005 and our Quarterly Report on
Form 10-Q/A
for the first quarter of 2006. The investigation and
restatements have exposed us to greater risks associated with
litigation. Publicity resulting from these actions may
materially adversely affect us, regardless of the cause or
effect of the actions. Since December 31, 2006, two
derivative actions have been filed naming a number of current
and former officers and Directors as defendants. The Company is
a nominal defendant. We cannot assure you about the outcome of
these two derivative lawsuits or any future litigation. The
conduct and resolution of litigation could be time consuming,
expensive, cause us to have to pay legal expenses in certain
instances to current and former officers and Directors, and may
distract management from the conduct of our business. In
addition, damages and other remedies awarded in any such
litigation could harm our business and financial condition.
The
loss of our Founder, Stephen L. Way, as a Director, Chairman of
the Board and Chief Executive Officer could weaken our strategic
leadership and may have a material adverse effect on our
business and development.
Since our founding, Stephen L. Ways leadership and
strategic direction have been critical elements to our success.
On November 17, 2006, Mr. Way resigned as Chief
Executive Officer and on February 20, 2007, he resigned as
a Director and Chairman of the Board. Although our executive
officers have experience in the insurance industry, they do not
have the same breadth of experience as Mr. Way in providing
the strategic direction for our future growth and development.
As a result, the loss of Mr. Ways services as a
Director, Chairman of the Board and Chief Executive Officer
could weaken our strategic leadership and may have a material
adverse effect on our business and continuing development.
We may
not be able to delay or prevent an inadequate or coercive offer
for change in control and regulatory rules and required
approvals might delay or deter a favorable change of
control.
Our certificate of incorporation and bylaws do not have
provisions that could make it more difficult for a third party
to acquire a majority of our outstanding common stock. As a
result, we may be more susceptible to an inadequate or coercive
offer that could result in a change in control than a company
whose charter documents have provisions that could delay or
prevent a change in control.
Many state insurance regulatory laws contain provisions that
require advance approval by state agencies of any change of
control of an insurance company that is domiciled or, in some
cases, has substantial business in that state.
Control is generally presumed to exist through the
ownership of 10% or more of the voting securities of a domestic
insurance company or of any company that controls a domestic
insurance company. We own, directly or indirectly, all of the
shares of stock of insurance companies domiciled in a number of
states. Any purchaser of shares of common stock representing 10%
or more of the voting power of our common stock will be presumed
to have acquired control of our domestic insurance subsidiaries
unless, following application by that purchaser, the relevant
state insurance regulators determine otherwise. Any transactions
that would constitute a change in control of any of our
individual insurance subsidiaries would generally require prior
approval by the insurance departments of the states in which the
insurance subsidiary is domiciled. Also, one of our insurance
subsidiaries is domiciled in the United Kingdom and another in
Spain. Insurers in those countries are also subject to change of
control restrictions under their individual regulatory
frameworks. These requirements may deter or delay possible
significant transactions in our common stock or the disposition
of our insurance companies to third parties, including
transactions that could be beneficial to our shareholders.
|
|
Item 1B.
|
Unresolved
Staff Comments
|
None.
33
Our principal and executive offices are located in Houston,
Texas, in buildings owned by Houston Casualty Company. We also
maintain offices in 50 locations elsewhere in the United
States, the United Kingdom, Spain, Bermuda and Ireland. The
majority of these additional locations are in leased facilities.
We are not dependent on our facilities to conduct business and
such office space is suitable for the conduct of our business.
Our principal office facilities are as follows:
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|
|
|
|
|
|
|
|
Subsidiary
|
|
Location
|
|
Sq. Ft.
|
|
|
Termination Date of Lease
|
|
Houston Casualty Company
|
|
Houston, Texas
|
|
|
77,000
|
|
|
Owned
|
HCC and Houston Casualty Company
|
|
Houston, Texas
|
|
|
51,000
|
|
|
Owned
|
Professional Indemnity Agency
|
|
Mount Kisco, New York
|
|
|
38,000
|
|
|
Owned
|
HCC Life Insurance Company
|
|
Atlanta, Georgia
|
|
|
31,000
|
|
|
December 31, 2011
|
U.S. Specialty Insurance
Company Aviation Division
|
|
Dallas, Texas
|
|
|
28,000
|
|
|
August 31, 2013
|
HCC Specialty Underwriters
|
|
Wakefield, Massachusetts
|
|
|
28,000
|
|
|
December 31, 2010
|
G. B. Kenrick &
Associates, Inc.
|
|
Auburn Hills, Michigan
|
|
|
27,000
|
|
|
May 31, 2012
|
HCC Surety Group
|
|
Los Angeles, California
|
|
|
26,000
|
|
|
May 31, 2009
|
Health Products Division
|
|
Minneapolis, Minnesota
|
|
|
25,000
|
|
|
September 30, 2012
|
HCC International and
Rattner MacKenzie
|
|
London, England
|
|
|
17,000
|
|
|
December 24, 2015
|
See also Note 12 to our Consolidated Financial Statements
included in this
Form 10-K.
|
|
Item 3.
|
Legal
Proceedings
|
Based on a voluntary independent investigation by a Special
Committee of the Board of Directors in 2006 of our past
practices related to granting stock options, we determined that
the price on the actual measurement date for a number of our
stock option grants from 1997 through 2005 and into 2006 did not
correspond to the price on the stated grant date and that
certain option grants were retroactively priced. The
investigation was conducted with the help of a law firm that was
not previously involved with our stock option plans and
procedures. The Special Committee completed the investigation on
November 16, 2006 and took specific actions as a result
thereof. The Securities and Exchange Commission (SEC) had
previously commenced an informal inquiry upon notification by us
of the initiation of our investigation. In connection with its
inquiry, we received document requests from the SEC and the SEC
is reviewing the work of the independent investigation. We
intend to fully cooperate with the SEC. We are unable to predict
the outcome of or the future costs related to the informal
inquiry.
We are party to lawsuits, arbitrations and other proceedings
that arise in the normal course of our business. Many of such
lawsuits, arbitrations and other proceedings involve claims
under policies that we underwrite as an insurer or reinsurer,
the liabilities for which, we believe, have been adequately
included in our loss reserves. Also, from time to time, we are a
party to lawsuits, arbitrations and other proceedings that
relate to disputes over contractual relationships with third
parties, or that involve alleged errors and omissions on the
part of our subsidiaries. We have provided accruals for these
items to the extent we deem the losses probable and reasonably
estimable.
Although the ultimate outcome of the above matters cannot be
determined at this time, based on present information, the
availability of insurance coverage and advice received from our
outside legal counsel, we believe the resolution of these
matters will not have a material adverse effect on our
consolidated financial position, results of operations or cash
flows.
34
The following lawsuits related to the outcome of the stock
option investigation have recently been filed:
Civil Action
No. 07-456;
Bacas, derivatively on behalf of HCC Insurance Holdings, Inc.
(HCC) v. Way et al.; In the United States District
Court for the Southern District of Texas, Houston
Division. The action was filed on
February 1, 2007. HCC is named as a nominal defendant in
this putative derivative action. The action purports to assert
claims on behalf of HCC against several current and former
officers and Directors alleging improper manipulation of grant
dates for option grants from 1995 through 2006. The complaint
purports to allege causes of action for accounting, breach of
fiduciary duty, aiding and abetting breach of fiduciary duty,
abuse of control, gross mismanagement, imposition of a
constructive fraud, corporate waste, unjust enrichment and
rescission, as well as a claim under Section 14(a) of the
Securities Exchange Act. Plaintiff seeks on behalf of HCC,
damages, punitive damages, disgorgement, restitution,
rescission, accounting, imposition of a constructive trust and
changes in HCCs corporate governance and internal
controls, as well as attorneys fees and costs. HCC has not
yet responded to the complaint.
Civil Action
No. 07-550;
International Brotherhood of Electrical Workers Local 98
Pension Fund, derivatively on behalf of nominal defendant HCC
Insurance Holdings, Inc. v. Way et al.; In the United
States District Court for the Southern District of Texas,
Houston Division. The action was filed on
February 8, 2007. HCC is named as a nominal defendant in
this putative derivative action. Plaintiff alleges claims
against current and former Directors of HCC alleging improper
manipulation of grant dates for option grants for the period
from 1997 through 2006. The complaint alleges that defendants
violated HCCs shareholder-approved stock option plans,
improperly accounted for allegedly backdated stock options, took
improper tax deductions based on allegedly backdated stock
options, issued false financial statements and improperly
exercised previously backdated options. The complaint purports
to allege causes of action for breach of fiduciary duty, unjust
enrichment, abuse of control, gross mismanagement, constructive
fraud, corporate waste, disgorgement, rescission and imposition
of a constructive trust, as well as claims under
Sections 14(a) and 10(b) of the Securities Exchange Act.
Plaintiff seeks, on behalf of HCC, damages, punitive damages,
disgorgement, restitution, rescission, accounting, imposition of
a constructive trust and changes in HCCs corporate
governance and internal controls as well as attorneys fees
and costs. HCC has not yet responded to the complaint.
|
|
Item 4.
|
Submission
of Matters to a Vote of Security Holders
|
There were no matters submitted to a vote of security holders
during the fourth quarter of 2006.
35
PART II
|
|
Item 5.
|
Market
For The Registrants Common Equity, Related Stockholder
Matters and Issuer Purchases of Equity Securities
|
Price
Range of Common Stock
Our common stock trades on the New York Stock Exchange under the
ticker symbol HCC.
The
intra-day
high and low sales prices for quarterly periods from
January 1, 2004 through December 31, 2006, as reported
by the New York Stock Exchange, were as follows:
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
|
High
|
|
|
Low
|
|
|
High
|
|
|
Low
|
|
|
High
|
|
|
Low
|
|
|
First quarter
|
|
$
|
34.89
|
|
|
$
|
29.25
|
|
|
$
|
26.17
|
|
|
$
|
21.31
|
|
|
$
|
23.17
|
|
|
$
|
20.01
|
|
Second quarter
|
|
|
34.92
|
|
|
|
28.51
|
|
|
|
26.96
|
|
|
|
23.05
|
|
|
|
22.93
|
|
|
|
20.30
|
|
Third quarter
|
|
|
33.99
|
|
|
|
28.82
|
|
|
|
28.89
|
|
|
|
25.11
|
|
|
|
22.39
|
|
|
|
19.23
|
|
Fourth quarter
|
|
|
35.15
|
|
|
|
28.81
|
|
|
|
32.95
|
|
|
|
26.91
|
|
|
|
22.83
|
|
|
|
18.35
|
|
On February 23, 2007, the last reported sales price of our
common stock as reported by the New York Stock Exchange was
$32.23 per share.
Shareholders
We have one class of authorized capital stock:
250.0 million shares of common stock, par value
$1.00 per share. On February 16, 2007, there were
111.9 million shares of issued and outstanding common stock
held by 822 shareholders of record; however, we estimate there
are approximately 62,000 beneficial owners.
Dividend
Policy
Cash dividends declared on a quarterly basis for the three years
ended December 31, 2006 were as follows:
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|
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
First quarter
|
|
$
|
.075
|
|
|
$
|
.057
|
|
|
$
|
.050
|
|
Second quarter
|
|
|
.100
|
|
|
|
.075
|
|
|
|
.050
|
|
Third quarter
|
|
|
.100
|
|
|
|
.075
|
|
|
|
.057
|
|
Fourth quarter
|
|
|
.100
|
|
|
|
.075
|
|
|
|
.057
|
|
Beginning in June 1996, we announced a planned quarterly program
of paying cash dividends to shareholders. Our Board of Directors
may review our dividend policy from time to time and any
determination with respect to future dividends will be made in
light of regulatory and other conditions at that time, including
our earnings, financial condition, capital requirements, loan
covenants and other related factors. Under the terms of our bank
loan facility, we are prohibited from paying dividends in excess
of an agreed upon maximum amount in any year. That limitation
should not affect our ability to pay dividends in a manner
consistent with our past practice and current expectations.
Securities
Authorized for Issuance Under Equity Compensation
Plans
The following table sets forth information as of
December 31, 2006, with respect to equity compensation
plans approved by shareholders under which HCCs common
stock is authorized for issuance (shares in thousands). All
outstanding stock options have been issued under plans approved
by shareholders.
|
|
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of
|
|
|
|
Number of
|
|
|
|
|
|
common shares
|
|
|
|
common shares
|
|
|
Weighted
|
|
|
available for
|
|
|
|
to be issued
|
|
|
average
|
|
|
future issuance
|
|
|
|
upon exercise
|
|
|
exercise price
|
|
|
under equity
|
|
|
|
of outstanding
|
|
|
of outstanding
|
|
|
compensation
|
|
Plan Category
|
|
stock options
|
|
|
stock options
|
|
|
plans
|
|
|
|
|
Equity compensation plans approved
by shareholders
|
|
|
7,181
|
|
|
$
|
22.23
|
|
|
|
4,412
|
|
36
Performance
Graph
The following graph shows a comparison of cumulative total
returns for an investment of $100.00 made on December 31,
2001 in the common stock of HCC Insurance Holdings, Inc., the
Standard & Poors 1500 Super Composite Index and
the Standard & Poors Midcap 400 Index. The graph
assumes that all dividends were reinvested.
COMPARISON
OF CUMULATIVE FIVE YEAR TOTAL RETURN
Total
Return to Shareholders
(Includes reinvestment of dividends)
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Company/Index
|
|
|
2001
|
|
|
2002
|
|
|
2003
|
|
|
2004
|
|
|
2005
|
|
|
2006
|
HCC Insurance Holdings, Inc.
|
|
|
$
|
100.00
|
|
|
|
$
|
90.18
|
|
|
|
$
|
117.71
|
|
|
|
$
|
123.82
|
|
|
|
$
|
168.59
|
|
|
|
$
|
184.42
|
|
S&P 1500 Super Composite Index
|
|
|
|
100.00
|
|
|
|
|
78.69
|
|
|
|
|
101.97
|
|
|
|
|
113.98
|
|
|
|
|
120.43
|
|
|
|
|
138.90
|
|
S&P Midcap 400 Index
|
|
|
|
100.00
|
|
|
|
|
85.49
|
|
|
|
|
115.94
|
|
|
|
|
135.05
|
|
|
|
|
152.00
|
|
|
|
|
167.69
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
37
|
|
Item 6.
|
Selected
Financial Data
|
The selected consolidated financial data set forth below has
been derived from the Consolidated Financial Statements. All
information contained herein should be read in conjunction with
the Consolidated Financial Statements, the related Notes thereto
and Managements Discussion and Analysis of Financial
Condition and Results of Operations included elsewhere in this
Report.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31,
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
2003
|
|
|
2002
|
|
|
|
(in thousands, except per share data) (1)
|
|
|
Statement of earnings
data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net earned premium
|
|
$
|
1,709,189
|
|
|
$
|
1,369,988
|
|
|
$
|
1,010,692
|
|
|
$
|
738,272
|
|
|
$
|
505,521
|
|
Fee and commission income
|
|
|
137,131
|
|
|
|
132,628
|
|
|
|
183,802
|
|
|
|
142,615
|
|
|
|
116,090
|
|
Net investment income
|
|
|
152,804
|
|
|
|
98,851
|
|
|
|
64,885
|
|
|
|
47,335
|
|
|
|
37,755
|
|
Net realized investment gain (loss)
|
|
|
(841
|
)
|
|
|
1,448
|
|
|
|
5,822
|
|
|
|
527
|
|
|
|
453
|
|
Other operating income
|
|
|
77,012
|
|
|
|
39,773
|
|
|
|
19,406
|
|
|
|
13,215
|
|
|
|
6,985
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenue
|
|
|
2,075,295
|
|
|
|
1,642,688
|
|
|
|
1,284,607
|
|
|
|
941,964
|
|
|
|
666,804
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Expense
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss and loss adjustment expense,
net
|
|
|
1,011,856
|
|
|
|
919,697
|
|
|
|
645,230
|
|
|
|
488,000
|
|
|
|
307,143
|
|
Policy acquisition costs, net
|
|
|
319,885
|
|
|
|
261,708
|
|
|
|
222,323
|
|
|
|
137,212
|
|
|
|
99,521
|
|
Other operating expense
|
|
|
222,324
|
|
|
|
180,990
|
|
|
|
168,045
|
|
|
|
144,574
|
|
|
|
101,513
|
|
Interest expense
|
|
|
11,396
|
|
|
|
7,684
|
|
|
|
8,374
|
|
|
|
7,453
|
|
|
|
8,301
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total expense
|
|
|
1,565,461
|
|
|
|
1,370,079
|
|
|
|
1,043,972
|
|
|
|
777,239
|
|
|
|
516,478
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings from continuing
operations before income tax expense
|
|
|
509,834
|
|
|
|
272,609
|
|
|
|
240,635
|
|
|
|
164,725
|
|
|
|
150,326
|
|
Income tax expense on continuing
operations
|
|
|
167,549
|
|
|
|
84,177
|
|
|
|
81,940
|
|
|
|
59,382
|
|
|
|
52,372
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings from continuing operations
|
|
|
342,285
|
|
|
|
188,432
|
|
|
|
158,695
|
|
|
|
105,343
|
|
|
|
97,954
|
|
Earnings from discontinued
operations, net of income taxes(2)
|
|
|
|
|
|
|
2,760
|
|
|
|
4,004
|
|
|
|
36,684
|
|
|
|
6,365
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net earnings
|
|
$
|
342,285
|
|
|
$
|
191,192
|
|
|
$
|
162,699
|
|
|
$
|
142,027
|
|
|
$
|
104,319
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic earnings per share
data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings from continuing operations
|
|
$
|
3.08
|
|
|
$
|
1.78
|
|
|
$
|
1.63
|
|
|
$
|
1.11
|
|
|
$
|
1.05
|
|
Earnings from discontinued
operations(2)
|
|
|
|
|
|
|
0.03
|
|
|
|
0.04
|
|
|
|
0.39
|
|
|
|
0.07
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net earnings
|
|
$
|
3.08
|
|
|
$
|
1.81
|
|
|
$
|
1.67
|
|
|
$
|
1.50
|
|
|
$
|
1.12
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average shares outstanding
|
|
|
111,309
|
|
|
|
105,463
|
|
|
|
97,257
|
|
|
|
94,919
|
|
|
|
93,338
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted earnings per share
data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings from continuing operations
|
|
$
|
2.93
|
|
|
$
|
1.72
|
|
|
$
|
1.61
|
|
|
$
|
1.09
|
|
|
$
|
1.04
|
|
Earnings from discontinued
operations(2)
|
|
|
|
|
|
|
0.03
|
|
|
|
0.04
|
|
|
|
0.38
|
|
|
|
0.07
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net earnings
|
|
$
|
2.93
|
|
|
$
|
1.75
|
|
|
$
|
1.65
|
|
|
$
|
1.47
|
|
|
$
|
1.11
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average shares outstanding
|
|
|
116,736
|
|
|
|
109,437
|
|
|
|
98,826
|
|
|
|
96,576
|
|
|
|
94,406
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash dividends declared, per share
|
|
$
|
0.375
|
|
|
$
|
0.282
|
|
|
$
|
0.213
|
|
|
$
|
0.187
|
|
|
$
|
0.170
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
38
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
2003
|
|
|
2002
|
|
|
|
|
|
|
(in thousands, except per share data) (1)
|
|
|
|
|
|
Balance sheet data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total investments
|
|
$
|
3,927,995
|
|
|
$
|
3,257,428
|
|
|
$
|
2,468,491
|
|
|
$
|
1,707,300
|
|
|
$
|
1,177,775
|
|
|
|
|
|
Premium, claims and other
receivables
|
|
|
864,705
|
|
|
|
884,654
|
|
|
|
891,360
|
|
|
|
934,252
|
|
|
|
789,226
|
|
|
|
|
|
Reinsurance recoverables
|
|
|
1,169,934
|
|
|
|
1,361,983
|
|
|
|
1,104,026
|
|
|
|
900,775
|
|
|
|
797,195
|
|
|
|
|
|
Ceded unearned premium
|
|
|
226,125
|
|
|
|
239,416
|
|
|
|
311,973
|
|
|
|
291,591
|
|
|
|
164,224
|
|
|
|
|
|
Goodwill
|
|
|
742,677
|
|
|
|
532,947
|
|
|
|
444,031
|
|
|
|
388,023
|
|
|
|
335,288
|
|
|
|
|
|
Total assets
|
|
|
7,630,132
|
|
|
|
7,028,800
|
|
|
|
5,900,568
|
|
|
|
4,883,345
|
|
|
|
3,738,963
|
|
|
|
|
|
Loss and loss adjustment expense
payable
|
|
|
3,097,051
|
|
|
|
2,813,720
|
|
|
|
2,089,199
|
|
|
|
1,525,313
|
|
|
|
1,158,915
|
|
|
|
|
|
Unearned premium
|
|
|
920,350
|
|
|
|
807,109
|
|
|
|
741,706
|
|
|
|
592,311
|
|
|
|
331,050
|
|
|
|
|
|
Premium and claims payable
|
|
|
646,224
|
|
|
|
753,859
|
|
|
|
766,765
|
|
|
|
784,038
|
|
|
|
759,910
|
|
|
|
|
|
Notes payable
|
|
|
308,887
|
|
|
|
309,543
|
|
|
|
311,277
|
|
|
|
310,404
|
|
|
|
230,027
|
|
|
|
|
|
Shareholders
equity
|
|
|
2,042,803
|
|
|
|
1,690,435
|
|
|
|
1,325,498
|
|
|
|
1,046,405
|
|
|
|
884,671
|
|
|
|
|
|
Book value per share(3)
|
|
$
|
18.28
|
|
|
$
|
15.26
|
|
|
$
|
12.99
|
|
|
$
|
10.91
|
|
|
$
|
9.45
|
|
|
|
|
|
|
|
|
(1) |
|
Certain amounts in the
2002-2005
selected consolidated financial data have been reclassified to
conform to the 2006 presentation. Such reclassifications had no
effect on our consolidated net earnings, shareholders
equity or cash flows. |
|
(2) |
|
We sold our retail brokerage operation, HCC Employee Benefits,
Inc., in 2003. The net earnings of HCC Employee Benefits, the
2003 gain on sale and the subsequent gains in 2004 and 2005 from
a contractual earnout are classified as discontinued operations.
Consistent with this presentation, all pre-sale revenue and
expense of HCC Employee Benefits was reclassified to
discontinued operations. |
|
(3) |
|
Book value per share is calculated by dividing the sum of
outstanding shares plus contractually issuable shares into total
shareholders equity. |
|
|
Item 7.
|
Managements
Discussion and Analysis of Financial Condition and Results of
Operations
|
The following Managements Discussion and Analysis should
be read in conjunction with the Selected Financial Data, the
Consolidated Financial Statements and the related Notes thereto.
Overview
We are a specialty insurance group with offices in the United
States, the United Kingdom, Spain, Bermuda and Ireland
transacting business in more than 100 countries. Our group
consists of insurance companies, underwriting agencies and
intermediaries. Our shares are traded on the New York Stock
Exchange and had a market capitalization of $3.5 billion at
January 31, 2007. We earned $342.3 million or
$2.93 per diluted share in 2006, compared to
$191.2 million or $1.75 per diluted share earned in
2005. The increase in earnings in 2006 was due to increased
revenue and the impact of hurricane losses on our 2005 results.
We grew shareholders equity by 21% in 2006 to
$2.0 billion at December 31, 2006, principally due to
net earnings.
In 2005 and 2004, the property and casualty insurance industry
suffered record losses from nine major hurricanes that affected
the Atlantic and Gulf Coasts of the United States. We recorded
gross losses of $394.6 million from the 2005 hurricanes and
$89.8 million from the 2004 hurricanes in the year they
occurred. Recoveries expected from our reinsurance programs
reduced these gross losses to net losses of $89.7 million
in 2005 and $33.1 million in 2004. There were no hurricane
losses in 2006. In 2006 and 2005, we also opportunistically
commuted two large reinsurance contracts related to run-off
assumed accident and health reinsurance business included in our
discontinued lines, for which we had $120.2 million in 2006
and
39
$145.7 million in 2005 of reinsurance recoverables as of
the date of commutation. As a result of these commutations, we
recognized losses of $20.2 million in 2006 and
$26.0 million in 2005, which principally represent the
discount for the time value of money on the reinsurance
recoverables. We expect to recoup these losses over future years
as we earn interest on the cash proceeds from the commutations
prior to the related claims being paid.
We underwrite a variety of specialty lines of business
identified as diversified financial products; group life,
accident and health; aviation; London market account; and other
specialty lines of business. Products in each line are marketed
by our insurance companies and agencies, either through a
network of independent agents and brokers, or directly to
customers. With the exception of our public company
directors and officers liability business, certain
international aviation and special financial product risks, and
our London market business, the majority of our business is
generally lower limit, smaller premium business that is less
susceptible to price competition, severity of loss or
catastrophe risk.
Our major insurance companies are rated AA (Very
strong) by Standard & Poors Corporation,
AA- (Very Strong) by Fitch Ratings and A+
(Superior), by A.M. Best Company, Inc.
We generate our revenue from five primary sources:
1) risk-bearing earned premium produced by our insurance
company operations, 2) non-risk-bearing fee and commission
income received by our underwriting agency and intermediary
operations, 3) ceding commissions in excess of policy
acquisition costs earned by our insurance company operations,
4) investment income earned by all of our operations and
5) other operating income. We produced $2.1 billion of
revenue in 2006, an increase of 26% over 2005, primarily from
higher net earned premium as a result of increased retentions,
recent acquisitions, organic growth, increased investment income
and increases in other operating income.
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.
Our acquisitions during the past three years are listed below.
Net earnings and cash flows from each acquired entity are
included in our operations beginning on the effective date of
each transaction.
|
|
|
|
|
Company
|
|
Segment
|
|
Effective Date Acquired
|
|
American Contractors Indemnity
Company
|
|
Insurance company
|
|
January 31, 2004
|
RA&MCO Insurance Services
|
|
Agency
|
|
October 1, 2004
|
United States Surety Company
|
|
Insurance company
|
|
March 1, 2005
|
HCC International Insurance Company
|
|
Insurance company
|
|
July 1, 2005
|
Perico Life Insurance Company
|
|
Insurance company
|
|
November 30, 2005
|
Perico Ltd.
|
|
Agency
|
|
December 1, 2005
|
Illium Insurance Group
|
|
Agency
|
|
December 31, 2005
|
Novia Underwriters, Inc.
|
|
Agency
|
|
June 30, 2006
|
G.B. Kenrick &
Associates, Inc.
|
|
Agency
|
|
July 1, 2006
|
Health Products Division
|
|
Insurance company
|
|
October 2, 2006
|
The following section discusses our key operating results. The
reasons for any significant variations between 2005 and 2004 are
the same as those discussed for variations between 2006 and
2005, unless otherwise noted. Amounts in the following tables
are in thousands, except for earnings per share, percentages,
ratios and number of employees.
Results
of Operations
Net earnings increased 79% to $342.3 million
($2.93 per diluted share) in 2006 from $191.2 million
($1.75 per diluted share) in 2005. Net earnings in 2006
included after-tax losses of $13.1 million ($0.11 per
diluted share) due to a large reinsurance commutation and
$9.3 million ($0.08 per diluted share) for costs
40
related to our stock option investigation. Net earnings in 2005
included after-tax losses of $58.2 million ($0.53 per
diluted share) due to the combined effects of five hurricanes
and $16.9 million ($0.15 per diluted share) due to a
reinsurance commutation. Growth in underwriting profits, net
investment income, other operating income and the lack of
hurricane losses contributed to the increase in 2006 earnings.
Net earnings increased 18% to $191.2 million ($1.75 per
diluted share) in 2005 from $162.7 million ($1.65 per
diluted share) in 2004. Net earnings in 2004 included an
after-tax loss of $21.5 million ($0.22 per diluted share)
due to the combined effects of four hurricanes.
During 2006 and 2005, we reached agreements with various
reinsurers to commute two large reinsurance contracts related to
run-off assumed accident and health reinsurance business
included in our discontinued lines, for which we had
$120.2 million in 2006 and $145.7 million in 2005 of
reinsurance recoverables at the date of commutation. In
consideration for discounting the recoverables and reassuming
the associated loss reserves, we agreed to accept cash payments
that were less than the related recoverables. We recorded a
pre-tax loss of $20.2 million in 2006 and
$26.0 million in 2005 related to these commutations, which
were included in loss and loss adjustment expense in our
insurance company segment.
During 2005 and 2004, catastrophic events occurred related to
three major hurricanes, Katrina, Rita and Wilma, and two others
(collectively, the 2005 hurricanes) and four major hurricanes,
Charley, Frances, Ivan and Jeanne (collectively, the 2004
hurricanes). We recognized pre-tax losses after reinsurance
recoveries and including the cost of premiums to reinstate our
reinsurance protection of $89.7 million in 2005 and
$33.1 million in 2004 in our insurance company segment as a
result of these hurricanes.
The following table shows the reported amounts, as well as the
effect on those amounts of the two commutations and the
hurricanes in the year they occurred. The table does not include
reserve reductions related to prior year hurricanes as follows:
$17.7 million in 2006 ($15.2 million for the 2005
hurricanes and $2.5 million for the 2004 hurricanes) and
$7.2 million in 2005 for the 2004 hurricanes. The impact on
ceded earned premium relates to the effect of premiums to
reinstate our excess of loss reinsurance, which reduced net
earned premium.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Effect of Commutations and Hurricanes
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
Gross incurred loss and loss
adjustment expense
|
|
$
|
1,218,838
|
|
|
$
|
1,596,773
|
|
|
$
|
1,289,155
|
|
|
$
|
|
|
|
$
|
394,625
|
|
|
$
|
89,795
|
|
Net incurred loss and loss
adjustment expense
|
|
|
1,011,856
|
|
|
|
919,697
|
|
|
|
645,230
|
|
|
|
20,199
|
|
|
|
99,226
|
|
|
|
23,335
|
|
Ceded earned premium
|
|
|
439,246
|
|
|
|
617,402
|
|
|
|
849,610
|
|
|
|
|
|
|
|
16,533
|
|
|
|
9,806
|
|
Net earnings (loss)
|
|
|
342,285
|
|
|
|
191,192
|
|
|
|
162,699
|
|
|
|
(13,129
|
)
|
|
|
(75,171
|
)
|
|
|
(21,464
|
)
|
Diluted earnings (loss) per share
|
|
|
2.93
|
|
|
|
1.75
|
|
|
|
1.65
|
|
|
|
(0.11
|
)
|
|
|
(0.69
|
)
|
|
|
(0.22
|
)
|
41
The following table shows our net loss, expense and combined
ratios and the effect that the losses related to the hurricanes
in the year they occurred and of the two commutations had on
these ratios. To determine the effect of the hurricanes and
commutations, we calculated the 2006, 2005 and 2004 net
loss ratios by excluding $20.2 million, $99.2 million
and $23.3 million, respectively, of losses from the
numerator of the net loss ratio and zero, $16.5 million and
$9.8 million, respectively, of reinstatement premium from
the denominator of both the net loss ratio and the expense ratio.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
Ratios:
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss ratio
|
|
|
59.2
|
%
|
|
|
67.1
|
%
|
|
|
63.8
|
%
|
Expense ratio
|
|
|
25.0
|
|
|
|
26.1
|
|
|
|
26.7
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Combined ratio
|
|
|
84.2
|
%
|
|
|
93.2
|
%
|
|
|
90.5
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Effect of hurricanes and
commutations:
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss ratio
|
|
|
1.2
|
%
|
|
|
7.9
|
%
|
|
|
2.9
|
%
|
Expense ratio
|
|
|
|
|
|
|
0.3
|
|
|
|
0.3
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Combined ratio
|
|
|
1.2
|
%
|
|
|
8.2
|
%
|
|
|
3.2
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The following table sets forth the relationships of certain
income statement items as a percent of total revenue.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
Net earned premium
|
|
|
82.3
|
%
|
|
|
83.4
|
%
|
|
|
78.7
|
%
|
Fee and commission income
|
|
|
6.6
|
|
|
|
8.1
|
|
|
|
14.3
|
|
Net investment income
|
|
|
7.4
|
|
|
|
6.0
|
|
|
|
5.1
|
|
Net realized investment gain
|
|
|
|
|
|
|
0.1
|
|
|
|
0.4
|
|
Other operating income
|
|
|
3.7
|
|
|
|
2.4
|
|
|
|
1.5
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenue
|
|
|
100.0
|
|
|
|
100.0
|
|
|
|
100.0
|
|
Loss and loss adjustment expense,
net
|
|
|
48.8
|
|
|
|
56.0
|
|
|
|
50.2
|
|
Policy acquisition costs, net
|
|
|
15.4
|
|
|
|
15.9
|
|
|
|
17.3
|
|
Other operating expense
|
|
|
10.7
|
|
|
|
11.0
|
|
|
|
13.1
|
|
Interest expense
|
|
|
0.5
|
|
|
|
0.5
|
|
|
|
0.7
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings from continuing
operations before income tax expense
|
|
|
24.6
|
|
|
|
16.6
|
|
|
|
18.7
|
|
Income tax expense
|
|
|
8.1
|
|
|
|
5.1
|
|
|
|
6.3
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings from continuing
operations
|
|
|
16.5
|
%
|
|
|
11.5
|
%
|
|
|
12.4
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenue increased 26% to $2.1 billion in 2006 and 28%
to $1.6 billion in 2005, driven by significant growth in
net earned premium and investment income, offset by the expected
decrease in fee and commission income in 2005. Approximately 28%
of the increase in revenue in 2006 and 6% in 2005 was due to the
acquisition of businesses. We expect total revenue to continue
to grow in 2007.
Gross written premium, net written premium and net earned
premium are detailed below. Premium increased from organic
growth, particularly in our diversified financial products line
of business, acquisitions and, with respect to net premiums,
from increased retentions. See the Insurance Company Segment
section below for further discussion of the relationship and
changes in premium revenue.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
Gross written premium
|
|
$
|
2,235,648
|
|
|
$
|
2,038,286
|
|
|
$
|
1,975,153
|
|
Net written premium
|
|
|
1,812,552
|
|
|
|
1,501,224
|
|
|
|
1,105,519
|
|
Net earned premium
|
|
|
1,709,189
|
|
|
|
1,369,988
|
|
|
|
1,010,692
|
|
42
The table below shows the source of our fee and commission
income.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
Agencies
|
|
$
|
92,566
|
|
|
$
|
94,972
|
|
|
$
|
127,453
|
|
Insurance companies
|
|
|
44,565
|
|
|
|
37,656
|
|
|
|
56,349
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fee and commission
income
|
|
$
|
137,131
|
|
|
$
|
132,628
|
|
|
$
|
183,802
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fee and commission income increased $4.5 million in 2006 as
a result of profit commissions from reinsurers, which were
triggered by reserve releases. Fee and commission income
decreased to $132.6 million in 2005, as expected, resulting
from a decrease in the level of ceded reinsurance by our
insurance company subsidiaries, which resulted in reduced
revenue from our reinsurance brokers and reduced ceding
commissions earned by our insurance companies and underwriting
agencies. Also, effective January 1, 2005, we consolidated
the operations of our largest underwriting agency into one of
our life insurance company subsidiaries. This higher retention
of our premium and the consolidation of operations resulted in
increased underwriting revenue and profitability in our
insurance company subsidiaries.
The sources of net investment income are detailed below.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
Fixed income securities
|
|
$
|
112,878
|
|
|
$
|
77,842
|
|
|
$
|
55,929
|
|
Short-term investments
|
|
|
30,921
|
|
|
|
21,208
|
|
|
|
9,735
|
|
Other investments
|
|
|
14,178
|
|
|
|
3,615
|
|
|
|
1,366
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total investment income
|
|
|
157,977
|
|
|
|
102,665
|
|
|
|
67,030
|
|
Investment expense
|
|
|
(5,173
|
)
|
|
|
(3,814
|
)
|
|
|
(2,145
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net investment income
|
|
$
|
152,804
|
|
|
$
|
98,851
|
|
|
$
|
64,885
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net investment income increased 55% in 2006 and 52% in 2005.
These increases were primarily due to higher investment assets,
which increased to $3.9 billion at December 31, 2006
compared to $3.3 billion at December 31, 2005 and
$2.5 billion at December 31, 2004, and higher interest
rates. The growth in investment assets resulted from:
1) cash flow from operations, 2) higher retentions,
3) commutations of reinsurance recoverables, 4) our
public offerings of common stock in 2005 and 2004 and
5) the increase in net loss reserves particularly from our
diversified financial products line of business, which generally
has a longer time period between reporting and payment of
claims. Average yields on our short-term investments increased
from 2.7% in 2005 to 4.5% in 2006 and our long-term tax
equivalent yield increased from 4.9% in 2005 to 5.2% in 2006. We
continue to invest our funds primarily in fixed income
securities, with a weighted average duration of 4.6 years
at December 31, 2006. We expect investment assets to
continue to increase in 2007, consistent with our anticipated
growth in revenue and earnings.
At December 31, 2006, our unrealized loss on fixed income
securities was $1.6 million, down from an unrealized loss
of $8.5 million at December 31, 2005, due to
fluctuations in market interest rates. The change in the
unrealized gain or loss, net of the related income tax effect,
is recorded in other comprehensive income and fluctuates with
changes in market interest rates. Our general policy has been to
hold our fixed income securities, which are classified as
available for sale, through periods of fluctuating interest
rates and to not realize significant gains or losses from their
sale. The unrealized loss on our fixed income securities
increased to $14.9 million at January 31, 2007 due to
an increase in interest rates.
Other operating income increased $37.2 million in 2006 and
$20.4 million in 2005. The 2006 increase was due to net
gains from trading securities and gains from the sales of
strategic investments. The 2005 increase related primarily to
gains from strategic investments, higher net gains from trading
securities and a $4.3 million gain on the sale of a dormant
subsidiary. Period to period comparisons in this category may
vary substantially depending on market values of trading
securities and other financial instruments and on income
43
from strategic investments or dispositions of such investments.
The following table details the components of other operating
income.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
Strategic investments
|
|
$
|
43,627
|
|
|
$
|
10,241
|
|
|
$
|
5,103
|
|
Trading securities
|
|
|
24,100
|
|
|
|
16,619
|
|
|
|
2,604
|
|
Financial instruments
|
|
|
4,772
|
|
|
|
3,898
|
|
|
|
4,297
|
|
Sale of non-operating assets
|
|
|
|
|
|
|
4,271
|
|
|
|
1,531
|
|
Other
|
|
|
4,513
|
|
|
|
4,744
|
|
|
|
5,871
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other operating
income
|
|
$
|
77,012
|
|
|
$
|
39,773
|
|
|
$
|
19,406
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss and loss adjustment expense increased 10% in 2006, and 43%
in 2005. Both years increased due to growth in net retained
premium. Additionally, hurricane losses and a commutation loss
affect the increase in losses in 2005 over 2004. Policy
acquisition costs increased 22% in 2006 and 18% in 2005,
primarily due to the growth in net earned premium. 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 23% in 2006 and 8% in 2005. The 2006 amount increased
for stock option expense under Statement of Financial Accounting
Standards (SFAS) No. 123(R); higher professional fees,
legal costs and other expenses related to the stock option
investigation; and operating expenses of subsidiaries acquired
in 2006 and the second half of 2005. The 2005 increase primarily
related to higher incentive compensation based on increased
profitability, operating expenses of subsidiaries acquired or
formed, and the expensing of $8.9 million for an
indemnification claim. We had 1,660 employees at
December 31, 2006, compared to 1,448 a year earlier. The
increase in employees was primarily due to acquisitions.
In 2006, we expensed $13.1 million ($9.4 million after
tax or $0.08 per diluted share) of stock-based compensation,
after the effect of the deferral and amortization of related
policy acquisition costs. Effective January 1, 2006, we
adopted SFAS No. 123(R), Share-Based Payment, using
the modified prospective method. We are recognizing compensation
expense in 2006 and thereafter for all previously granted but
unvested stock options as of January 1, 2006, and all
options granted after that date. Prior to adoption, we accounted
for our stock options in accordance with Accounting Principles
Board Opinion No. 25, Accounting for Stock Issued to
Employees, and recognized compensation expense of
$3.0 million in 2005 and $2.6 million in 2004. We made
no modifications to our stock option plans in conjunction with
our implementation of SFAS 123(R). The 2005 and 2004
consolidated financial statements were not restated to reflect
our adoption of SFAS 123(R). During adoption, we reviewed
our Black-Scholes assumptions and established a policy to align
our assumptions with the individual grant terms for all future
grants. This resulted in lower assumptions for expected
volatility and expected option life for our 2006 grants. At
December 31, 2006, there was approximately
$32.4 million of total unrecognized compensation expense
related to unvested options that is expected to be recognized
over a weighted-average period of 2.8 years. In 2007, we
expect to recognize $10.9 million of expense, including the
amortization of deferred policy acquisition costs, related to
stock-based compensation for options currently outstanding.
Our effective income tax rate on earnings from continuing
operations was 32.9% for 2006, compared to 30.9% for 2005 and
34.1% for 2004. The effective tax rate was lower in 2005 because
our tax exempt interest income increased as a percentage of our
pre-tax income and we recorded a special $2.8 million
repatriation tax benefit. The 2006 rate is a more normalized
rate.
In December 2003, we sold the business of our retail brokerage
subsidiary, HCC Employee Benefits, Inc., for $62.5 million
in cash. We recognized gains of $6.3 million
($4.0 million after-tax) in 2004 and $4.4 million
($2.8 million after-tax) in 2005 from a contractual
earnout, which is now completed. The after-tax gains on earnout
are reported as earnings from discontinued operations in the
consolidated statements of earnings. Cash flows from earnout are
included in investing activities.
44
At December 31, 2006, book value per share was $18.28, up
from $15.26 at December 31, 2005 and $12.99 at
December 31, 2004. Total assets were $7.6 billion and
shareholders equity was $2.0 billion, up from
$7.0 billion and $1.7 billion, respectively, at
December 31, 2005.
Segments
We operate our businesses in three segments: 1) insurance
company, 2) agency and 3) other operations. Our Chief
Executive Officer, as chief decision maker, monitors and
evaluates the individual financial results of each subsidiary in
the insurance company and agency segments. Each subsidiary
provides monthly reports of its actual and budgeted results,
which are aggregated on a segment basis for management review
and monitoring. The operating results of our insurance company
and agency segments are discussed below.
Insurance
Company Segment
Net earnings of our insurance company segment increased 116% to
$272.0 million in 2006 compared to $126.1 million in
2005, which in turn increased 15% from $109.3 million in
2004. The 2006 net earnings included $13.1 million of
after-tax losses related to a commutation. The 2005 net
earnings included $75.2 million of after-tax losses related
to hurricanes and a commutation, while 2004 net earnings
included $21.5 million of after-tax hurricane losses. The
growth in segment net earnings was driven by: 1) improved
underwriting results, 2) increased retentions, which
resulted in higher earned premium, 3) increased investment
income and 4) the operations of acquired subsidiaries.
Effective April 1, 2006 and January 1, 2005, we
consolidated two underwriting agencies into two insurance
companies; all operations after those dates have been reported
in our insurance company segment. Even though there is some
pricing competition in certain of our markets, our margins
remain at an acceptable level of profitability due to our
underwriting expertise and discipline. We expect net earnings
from our insurance companies to continue to grow in 2007.
Premium
Gross written premium increased 10% to $2.2 billion in 2006
and 3% in 2005. We expect gross written premium to continue to
grow in 2007. Net written premium increased 21% to
$1.8 billion and net earned premium increased 25% to
$1.7 billion in 2006 compared to increases of 36% and 36%,
respectively, in 2005 and 2004. These increases were primarily
due to higher retention levels on most non-catastrophe business,
acquisitions and the mix of business due to increased premium in
lines where we had greater retentions. The overall percentage of
retained premium increased to 81% in 2006 from 74% in 2005 and
56% in 2004. Net written and net earned premium are expected to
continue to grow in 2007.
The following table details premium amounts and their
percentages of gross written premium.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
|
Amount
|
|
|
%
|
|
|
Amount
|
|
|
%
|
|
|
Amount
|
|
|
%
|
|
|
Primary
|
|
$
|
1,867,908
|
|
|
|
84
|
%
|
|
$
|
1,768,284
|
|
|
|
87
|
%
|
|
$
|
1,674,075
|
|
|
|
85
|
%
|
Reinsurance assumed
|
|
|
367,740
|
|
|
|
16
|
|
|
|
270,002
|
|
|
|
13
|
|
|
|
301,078
|
|
|
|
15
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross written premium
|
|
|
2,235,648
|
|
|
|
100
|
|
|
|
2,038,286
|
|
|
|
100
|
|
|
|
1,975,153
|
|
|
|
100
|
|
Reinsurance ceded
|
|
|
(423,096
|
)
|
|
|
(19
|
)
|
|
|
(537,062
|
)
|
|
|
(26
|
)
|
|
|
(869,634
|
)
|
|
|
(44
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net written premium
|
|
|
1,812,552
|
|
|
|
81
|
|
|
|
1,501,224
|
|
|
|
74
|
|
|
|
1,105,519
|
|
|
|
56
|
|
Change in unearned premium
|
|
|
(103,363
|
)
|
|
|
(5
|
)
|
|
|
(131,236
|
)
|
|
|
(7
|
)
|
|
|
(94,827
|
)
|
|
|
(5
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net earned premium
|
|
$
|
1,709,189
|
|
|
|
76
|
%
|
|
$
|
1,369,988
|
|
|
|
67
|
%
|
|
$
|
1,010,692
|
|
|
|
51
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
45
The following tables provide premium information by line of
business.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross
|
|
|
|
|
|
NWP
|
|
|
|
|
|
|
Written
|
|
|
Net Written
|
|
|
as % of
|
|
|
Net Earned
|
|
|
|
Premium
|
|
|
Premium
|
|
|
GWP
|
|
|
Premium
|
|
|
Year ended December 31,
2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diversified financial products
|
|
$
|
956,057
|
|
|
$
|
794,232
|
|
|
|
83
|
%
|
|
$
|
728,861
|
|
Group life, accident and health
|
|
|
621,639
|
|
|
|
590,811
|
|
|
|
95
|
|
|
|
591,070
|
|
Aviation
|
|
|
216,208
|
|
|
|
166,258
|
|
|
|
77
|
|
|
|
152,886
|
|
London market account
|
|
|
234,868
|
|
|
|
127,748
|
|
|
|
54
|
|
|
|
112,362
|
|
Other specialty lines
|
|
|
205,651
|
|
|
|
133,481
|
|
|
|
65
|
|
|
|
123,981
|
|
Discontinued lines
|
|
|
1,225
|
|
|
|
22
|
|
|
|
nm
|
|
|
|
29
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Totals
|
|
$
|
2,235,648
|
|
|
$
|
1,812,552
|
|
|
|
81
|
%
|
|
$
|
1,709,189
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year ended December 31,
2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diversified financial products
|
|
$
|
908,526
|
|
|
$
|
675,942
|
|
|
|
74
|
%
|
|
$
|
531,136
|
|
Group life, accident and health
|
|
|
593,382
|
|
|
|
502,805
|
|
|
|
85
|
|
|
|
504,382
|
|
Aviation
|
|
|
210,530
|
|
|
|
130,743
|
|
|
|
62
|
|
|
|
136,197
|
|
London market account
|
|
|
144,425
|
|
|
|
78,809
|
|
|
|
55
|
|
|
|
93,017
|
|
Other specialty lines
|
|
|
176,139
|
|
|
|
109,106
|
|
|
|
62
|
|
|
|
97,721
|
|
Discontinued lines
|
|
|
5,284
|
|
|
|
3,819
|
|
|
|
nm
|
|
|
|
7,535
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Totals
|
|
$
|
2,038,286
|
|
|
$
|
1,501,224
|
|
|
|
74
|
%
|
|
$
|
1,369,988
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year ended December 31,
2004
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diversified financial products
|
|
$
|
857,299
|
|
|
$
|
404,870
|
|
|
|
47
|
%
|
|
$
|
310,809
|
|
Group life, accident and health
|
|
|
584,747
|
|
|
|
343,996
|
|
|
|
59
|
|
|
|
343,913
|
|
Aviation
|
|
|
204,963
|
|
|
|
144,687
|
|
|
|
71
|
|
|
|
127,248
|
|
London market account
|
|
|
178,950
|
|
|
|
107,509
|
|
|
|
60
|
|
|
|
111,341
|
|
Other specialty lines
|
|
|
133,964
|
|
|
|
83,980
|
|
|
|
63
|
|
|
|
69,089
|
|
Discontinued lines
|
|
|
15,230
|
|
|
|
20,477
|
|
|
|
nm
|
|
|
|
48,292
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Totals
|
|
$
|
1,975,153
|
|
|
$
|
1,105,519
|
|
|
|
56
|
%
|
|
$
|
1,010,692
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
nm |
|
Not meaningful comparison |
The changes in premium volume and retention levels between years
resulted principally from the following factors:
|
|
|
|
|
Diversified financial products The growth in our
gross written premium in 2006 resulted principally from organic
growth in our surety, credit and special financial products
businesses, where pricing is good and competition is reasonable.
Premium volume in the other major products was stable and the
pricing for these products is down slightly. In response to some
increased competition and a reduction in available reinsurance
at an acceptable cost, we scaled back our writing of
directors and officers liability business in 2005.
Our professional indemnity and surety business increased in 2005
due to organic growth and acquisitions. The growth in net
written and net earned premium in both years was due to
increased retentions resulting from a reduction in proportional
reinsurance, some of which has been replaced by excess of loss
reinsurance.
|
|
|
|
Group life, accident and health Gross written, net
written and net earned premium of our medical stop-loss product
increased $75.3 million in 2006 as a result of our
acquisition of the Health Products Division on October 2,
2006. The increase in gross written premium was partially offset
by a decrease in premium due to our non-renewing a book of
business which was 100% reinsured and, thus, did not impact net
written premium. Our retention of our medical stop-loss business
increased in 2006 and 2005 as we chose to reinsure less of this
non-volatile business, which has very little catastrophe
|
46
|
|
|
|
|
exposure. Profit margins remain at acceptable levels despite
increased competition from the fully insured market.
|
|
|
|
|
|
Aviation The growth in net written premium and
net earned premium in 2006 is due to the effect of recapture of
ceded unearned premium from a transfer of in force business.
Retention also increased as a result of a reduction in
proportional reinsurance. Retention levels are consistent
between 2005 and 2004 after removing the effect of a similar
recapture in 2004. The international aviation component of this
line is very competitive with downward pressure on pricing, but
margins on decreased premium volume are still acceptable. Our
domestic business is very stable.
|
|
|
|
London market account Gross written premium
increased in 2006 due to the substantial increase in rates in
the energy sector as a result of the 2005 hurricane losses. Net
written premium increased for the same reason and will be
reflected in increases in our net earned premium into 2007. In
2006, to increase our capacity and spread our risk in the energy
sector, we entered into a new quota share reinsurance agreement
which was renewed in 2007. Although the cost of our 2006 excess
of loss reinsurance increased, our potential profitability is
greater on the increased gross written premium. Our aggregate
exposure in Florida and the Gulf of Mexico was lower in 2006
than in 2005, and we are maintaining the reduced exposure in
2007. The decrease in premium writings in 2005 was due to more
selective underwriting in response to reduced premium rates from
increased competition. Retention percentages can vary due to the
effect of reinstatement premiums and the amount of earned
premium in relation to substantial, relatively fixed excess of
loss premiums. Premium rates in this line are stable.
|
|
|
|
Other specialty lines We experienced organic growth
in our other specialty lines of business from increased writings
in several products. The changing mix of products will affect
the retention percentages. Rates in this line have been
relatively stable.
|
Reinsurance
Annually, we analyze our overall threshold for risk in each line
of business based upon a number of factors including market
conditions, pricing, competition and the inherent risks
associated with the business type, then structure a specific
reinsurance program for each of our lines of business. Based on
our analysis of these factors, we may determine not to purchase
reinsurance for some lines of business. We generally purchase
reinsurance to reduce our net liability on individual risks and
to protect against catastrophe losses and volatility. We
purchase reinsurance on a proportional basis to cover loss
frequency, individual risk severity and catastrophe exposure.
Some of the proportional reinsurance agreements may have maximum
loss limits, the lowest of which is a 200% loss ratio. We also
purchase reinsurance on an excess of loss basis to cover
individual risk severity and catastrophe exposure. Additionally,
we may obtain facultative reinsurance protection on a single
risk. The type and amount of reinsurance we purchase varies year
to year based on our risk assessment, our desired retention
levels based on profitability and other considerations, and the
market availability of quality reinsurance at prices we consider
acceptable. Our reinsurance programs renew throughout the year
and, during 2006, some of those renewals contained price
increases, which were not material to our net underwriting
results. Our reinsurance generally does not cover war or
terrorism risks, which are excluded from most of our policies.
We decided for the 2006 and 2005 underwriting years to retain
more underwriting risk in certain lines of business with the
intention of retaining a greater proportion of any underwriting
profits. In doing so, we will necessarily purchase less
reinsurance applicable to a line or choose to restructure the
applicable reinsurance programs, obtaining more excess of loss
reinsurance and less proportional reinsurance, which
significantly reduces the amount of ceded premium. Also, we have
chosen not to purchase any reinsurance on other business where
volatility or catastrophe risks are considered remote.
In our proportional reinsurance programs, we generally receive
an overriding (ceding) commission on the premium ceded to
reinsurers. This compensates our insurance companies for the
direct costs associated with the production of the business, the
servicing of the business during the term of the policies ceded
and the costs associated with the placement of the related
reinsurance. In addition, certain of our reinsurance treaties
allow us to share in any net profits generated under such
treaties with the reinsurers. Various reinsurance
47
brokers, including subsidiaries, arrange for the placement of
this proportional and other reinsurance coverage on our behalf
and are compensated, directly or indirectly, by the reinsurers.
We have a reserve of $14.9 million at December 31,
2006 for potential collectibility issues related to reinsurance
recoverables, including disputed amounts and associated
expenses. While we believe the reserve is adequate based on
information currently available, conditions may change or
additional information might be obtained that may require us to
change the reserve in the future. We periodically review our
financial exposure to the reinsurance market and the level of
our reserve and continue to take actions in an attempt to
mitigate our exposure to possible loss.
Losses
and Loss Adjustment Expenses
The table below shows the composition of gross incurred loss and
loss adjustment expense.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
|
Amount
|
|
|
Loss Ratio
|
|
|
Amount
|
|
|
Loss Ratio
|
|
|
Amount
|
|
|
Loss Ratio
|
|
|
2005 hurricanes
|
|
$
|
12,670
|
|
|
|
0.6
|
%
|
|
$
|
394,625
|
|
|
|
19.9
|
%
|
|
$
|
|
|
|
|
|
%
|
2004 hurricanes
|
|
|
(2,984
|
)
|
|
|
(0.2
|
)
|
|
|
(13,423
|
)
|
|
|
(0.7
|
)
|
|
|
89,795
|
|
|
|
4.8
|
|
Other reserve redundancies
|
|
|
(28,041
|
)
|
|
|
(1.3
|
)
|
|
|
(7,080
|
)
|
|
|
(0.4
|
)
|
|
|
(11,594
|
)
|
|
|
(0.6
|
)
|
Discontinued line of business
adjustments
|
|
|
15,054
|
|
|
|
0.7
|
|
|
|
49,775
|
|
|
|
2.5
|
|
|
|
127,707
|
|
|
|
6.9
|
|
All other gross incurred loss and
loss adjustment expense
|
|
|
1,222,139
|
|
|
|
56.9
|
|
|
|
1,172,876
|
|
|
|
59.0
|
|
|
|
1,083,247
|
|
|
|
58.2
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross incurred loss and loss
expense adjustment
|
|
$
|
1,218,838
|
|
|
|
56.7
|
%
|
|
$
|
1,596,773
|
|
|
|
80.3
|
%
|
|
$
|
1,289,155
|
|
|
|
69.3
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Our gross adverse development (redundancy) relating to prior
year losses was $(3.3) million in 2006, $29.3 million
in 2005 and $116.1 million in 2004.
We increased our gross losses related to prior accident years on
certain run-off assumed accident and health reinsurance business
reported in our discontinued lines of business by
$15.1 million in 2006, $49.8 million in 2005 and
$127.7 million in 2004 due to our processing of additional
information received and our continuing evaluation of gross and
net reserves related to this business. We considered a
combination of factors including: 1) the nature of the
business, which is primarily excess of loss reinsurance,
2) late reported losses by insureds, reinsureds and state
guaranty associations and 3) changes in our actuarial
assumptions to reflect additional information received during
the year. The run-off assumed accident and health reinsurance
business is primarily reinsurance that provides excess coverage
for large losses related to workers compensation policies.
This business is slow to develop and may take as many as twenty
years to pay out. Primary losses must develop first before the
excess coverage attaches. Thus, the losses are reported to
excess of loss reinsurers later in the life cycle of the claim.
Compounding this late reporting is the fact that a number of
large insurance companies that were cedants of this business
failed and were taken over by state regulatory authorities in
2002 and 2003. The state guaranty associations covering these
failed companies have been slow to report losses to us. Based on
the higher amount of actual losses reported, we revised the
expected loss ratios used in our actuarial calculations. After
consideration of all available information, we increased our
gross and net reserves to amounts that management determined
were appropriate to cover losses projected, given the risk
inherent in this type of business.
48
The table below shows the composition of net incurred loss and
loss adjustment expense.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
|
Amount
|
|
|
Loss Ratio
|
|
|
Amount
|
|
|
Loss Ratio
|
|
|
Amount
|
|
|
Loss Ratio
|
|
|
2005 hurricanes
|
|
$
|
(15,215
|
)
|
|
|
(0.9
|
)%
|
|
$
|
73,185
|
|
|
|
5.3
|
%
|
|
$
|
|
|
|
|
|
%
|
2004 hurricanes
|
|
|
(2,483
|
)
|
|
|
(0.2
|
)
|
|
|
(7,167
|
)
|
|
|
(0.5
|
)
|
|
|
23,335
|
|
|
|
2.3
|
|
Discontinued line of business
commutations
|
|
|
20,199
|
|
|
|
1.2
|
|
|
|
26,041
|
|
|
|
1.9
|
|
|
|
|
|
|
|
|
|
Discontinued line of business
adjustments
|
|
|
4,898
|
|
|
|
0.3
|
|
|
|
8,929
|
|
|
|
0.7
|
|
|
|
27,326
|
|
|
|
2.7
|
|
Other reserve deficiencies
(redundancies)
|
|
|
(13,925
|
)
|
|
|
(0.8
|
)
|
|
|
(2,409
|
)
|
|
|
(0.2
|
)
|
|
|
3,152
|
|
|
|
0.3
|
|
All other net incurred loss and
loss adjustment expense
|
|
|
1,018,382
|
|
|
|
59.6
|
|
|
|
821,118
|
|
|
|
59.9
|
|
|
|
591,417
|
|
|
|
58.5
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net incurred loss and loss
adjustment expense
|
|
$
|
1,011,856
|
|
|
|
59.2
|
%
|
|
$
|
919,697
|
|
|
|
67.1
|
%
|
|
$
|
645,230
|
|
|
|
63.8
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The discontinued line of business and hurricane losses were
substantially reinsured; therefore, the net losses are
substantially less than the gross losses in each year. Our net
adverse development (redundancy) relating to prior year losses
was $(6.5) million in 2006, $25.4 million in 2005 and
$30.5 million in 2004, including $20.2 million in 2006
and $26.0 million in 2005 due to commutations that affected
our discontinued line of business. The commutation losses
primarily represent the discount for the time value of money on
the reinsurance recoverables commuted. We reduced our net loss
reserves on prior year hurricanes by $17.7 million in 2006
and $7.2 million in 2005 to reflect current estimates of
our remaining liabilities. As a result of adverse development of
certain run-off assumed accident and health reinsurance business
in our discontinued lines of business, we strengthened our
reserves for this line in all years to bring them above our
actuarial point estimate. See our discussion of factors that
caused the adverse development in the section covering gross
losses above. The other reserve redundancies in 2006 resulted
primarily from our year-end review of reserves and relate
primarily to loss reserves of various lines of business for
various accident years where the anticipated development was
considered to be less than the recorded reserves. In some cases,
the prior year redundancies were utilized to augment the 2006
accident year reserves for the same line of business.
Deficiencies and redundancies in reserves occur as a result of
our continuing review and as losses are finally settled or
claims exposures change. We have no material exposure to
environmental or asbestos losses and believe we have provided
for all material net incurred losses.
49
The following table provides comparative net loss ratios by line
of business.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
|
Net
|
|
|
Net
|
|
|
Net
|
|
|
Net
|
|
|
Net
|
|
|
Net
|
|
|
|
Earned
|
|
|
Loss
|
|
|
Earned
|
|
|
Loss
|
|
|
Earned
|
|
|
Loss
|
|
|
|
Premium
|
|
|
Ratio
|
|
|
Premium
|
|
|
Ratio
|
|
|
Premium
|
|
|
Ratio
|
|
|
Diversified financial products
|
|
$
|
728,861
|
|
|
|
48.2
|
%
|
|
$
|
531,136
|
|
|
|
48.1
|
%
|
|
$
|
310,809
|
|
|
|
47.6
|
%
|
Group life, accident and health
|
|
|
591,070
|
|
|
|
73.1
|
|
|
|
504,382
|
|
|
|
71.6
|
|
|
|
343,913
|
|
|
|
66.7
|
|
Aviation
|
|
|
152,886
|
|
|
|
53.8
|
|
|
|
136,197
|
|
|
|
67.3
|
|
|
|
127,248
|
|
|
|
63.2
|
|
London market account
|
|
|
112,362
|
|
|
|
43.0
|
|
|
|
93,017
|
|
|
|
106.0
|
|
|
|
111,341
|
|
|
|
65.9
|
|
Other specialty lines
|
|
|
123,981
|
|
|
|
56.0
|
|
|
|
97,721
|
|
|
|
72.6
|
|
|
|
69,089
|
|
|
|
63.5
|
|
Discontinued lines
|
|
|
29
|
|
|
|
nm
|
|
|
|
7,535
|
|
|
|
nm
|
|
|
|
48,292
|
|
|
|
nm
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Totals
|
|
$
|
1,709,189
|
|
|
|
59.2
|
%
|
|
$
|
1,369,988
|
|
|
|
67.1
|
%
|
|
$
|
1,010,692
|
|
|
|
63.8
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Expense ratio
|
|
|
|
|
|
|
25.0
|
|
|
|
|
|
|
|
26.1
|
|
|
|
|
|
|
|
26.7
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Combined ratio
|
|
|
|
|
|
|
84.2
|
%
|
|
|
|
|
|
|
93.2
|
%
|
|
|
|
|
|
|
90.5
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
nm Not meaningful comparison
Comments on significant changes in net loss ratios by line of
business follow:
|
|
|
|
|
Group life, accident and health Rate pressure from
competition as well as medical cost inflation have resulted in
increasing loss ratios in this line of business. Additionally,
in 2006 the loss ratio for the business acquired in the Health
Products Division acquisition were higher than the loss ratios
for our existing business, increasing our overall loss ratio.
Over time, we expect that the loss ratios for the acquired
business will be brought into line with the rest of our book.
Overall, our underwriting margins for this line of business
remain satisfactory.
|
|
|
|
Aviation The 2005 hurricanes increased the net loss
ratio by 5.0 percentage points in 2005 and the 2004 hurricanes
increased the net loss ratio by 6.5 percentage points. The
2005 net loss ratio also includes the positive impact from
the release of redundant reserves related to the 2004
hurricanes. Excluding the impact of the hurricanes, 2005 had
worse than expected underwriting experience due to some
unusually large international losses while 2006 underwriting
results were better than expected, due in part to the release of
redundant reserves on the 2004 and 2005 accident years.
|
|
|
|
London market account The adjustment of hurricane
reserves reduced the 2006 net loss ratio by
9.1 percentage points. The 2005 hurricanes increased the
net loss ratio by 63.2 percentage points and the 2004 hurricanes
increased the net loss ratio by 14.1 percentage points. The 2006
loss ratio was also adversely affected by higher than expected
attritional losses for energy business and poor underwriting
results for marine business. The London market account line of
business can have relatively high
year-to-year
volatility due to catastrophe exposure.
|
|
|
|
Other specialty lines The release of redundant
hurricane reserves reduced the 2006 net loss ratio by
3.9 percentage points. The 2005 hurricanes increased the
net loss ratio by 14.0 percentage points and the 2004 hurricanes
increased the net loss ratio by 6.5 percentage points.
|
|
|
|
Discontinued lines The commutation losses in 2006
and 2005 affected the net losses for those years. In addition,
the 2006, 2005 and 2004 net losses were impacted by loss
reserve strengthening of $4.9 million, $8.9 million
and $27.3 million, respectively, on certain run-off assumed
accident and health reinsurance business.
|
Our net paid loss ratios were 34.1%, 33.4% and 30.0% in 2006,
2005 and 2004, respectively. The paid loss ratio is the
percentage of losses paid, net of reinsurance, divided by net
earned premium for that year.
50
Policy
Acquisition Costs
Policy acquisition costs, which are net of the related portion
of commissions on reinsurance ceded, increased to
$319.9 million in 2006 from $261.7 million in 2005 and
$222.3 million in 2004. Policy acquisition costs as a
percentage of net earned premium decreased to 18.7% in 2006 from
19.1% in 2005 and 22% in 2004. The decrease in the acquisition
cost percentage from 2005 to 2006 is due to a change in the mix
of business. The decrease from 2004 to 2005 is due to a change
in the mix of business, reductions in commission rates on
certain lines of business and our increased retentions which
increased our net earned premium at a higher rate than our
non-commission acquisition costs.
The GAAP expense ratio of 25.0% in 2006 decreased in comparison
to 26.1% in 2005 due to the higher level of net earned premiums
in 2006 and the effect of reinstatement premiums in 2005. The
decrease between 2005 and 2004 results from the same factors as
the decrease in the policy acquisition percentage.
Statutory
Regulatory guidelines suggest that a property and casualty
insurers annual statutory gross written premium should not
exceed 900% of its statutory policyholders surplus and net
written premium should not exceed 300% of its statutory
policyholders surplus. However, industry standards and
rating agency criteria place these ratios at 300% and 200%,
respectively. Our property and casualty insurance companies have
maintained premium to surplus ratios lower than such guidelines.
For 2006, our statutory gross written premium to
policyholders surplus was 167.2% and our statutory net
written premium to policyholders surplus was 135.1%. At
December 31, 2006, each of our domestic insurance
companies total adjusted capital was significantly in
excess of the authorized control level risk-based capital level
prescribed by the National Association of Insurance
Commissioners.
Agency
Segment
Revenue from our agency segment decreased to $180.0 million
in 2006 from $188.9 million in 2005 and $226.8 million
in 2004, primarily due to the consolidation of two underwriting
agencies into our insurance companies effective January 1,
2005 and April 1, 2006, less business produced in certain
lines and the overall effect of ceding less reinsurance. These
effects were partially offset in 2006 due to acquisitions and
growth in certain other lines of business. While these actions
resulted in less fee and commission income to our agency
segment, they resulted in increased insurance company revenue
and net earnings. Segment earnings in 2005 are less than in 2004
primarily as a result of the same factors that caused the
decrease in revenue. Segment net earnings would have decreased
in 2006, except the agency segment benefited from lower
corporate cost allocations.
Other
Operations Segment
Revenue and net earnings from our other operations segment
increased to $75.1 million and $48.8 million,
respectively, in 2006 from $35.3 million and
$22.6 million, respectively, in 2005 and $13.0 million
and $7.9 million, respectively, in 2004 primarily due to
net gains from trading securities and the sale of strategic
investments. In the fourth quarter of 2006, we began liquidating
our trading portfolio, investing the proceeds primarily in fixed
income securities. We expect the trading portfolio to be fully
liquidated in 2007. Results of this segment may vary
substantially period to period depending on our investment in or
disposition of strategic investments and activity in our trading
portfolio.
Liquidity
and Capital Resources
Cash
Flow
We receive substantial cash from premiums, reinsurance
recoverables, commutations, fee and commission income, proceeds
from sales and redemptions of investments and investment income.
Our principal cash outflows are for the payment of claims and
loss adjustment expenses, premium payments to reinsurers,
purchases of investments, debt service, policy acquisition
costs, operating expenses, taxes and dividends.
51
Cash provided by operating activities can fluctuate due to
timing differences in the collection of premiums and reinsurance
recoverables and the payment of losses and premium and
reinsurance balances payable, the completion of commutations and
activity in our trading portfolio. Our cash provided by
operating activities has been strong in recent years due to:
1) our increasing net earnings, 2) growth in net
written premium and net loss reserves due to organic growth and
increased retentions, 3) commutations of selected
reinsurance agreements and 4) expansion of our diversified
financial products line of business as a result of which we
retain premium for a longer duration than had been the case
prior to entering this business.
The components of our net operating cash flows are detailed in
the following table.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
Net earnings
|
|
$
|
342,285
|
|
|
$
|
191,192
|
|
|
$
|
162,699
|
|
Change in premium, claims and
other receivables, net of reinsurance, other payables and
restricted cash
|
|
|
(139,906
|
)
|
|
|
(59,717
|
)
|
|
|
237
|
|
Change in unearned premium, net
|
|
|
122,571
|
|
|
|
121,242
|
|
|
|
104,895
|
|
Change in loss and loss adjustment
expense payable, net of reinsurance recoverables
|
|
|
328,569
|
|
|
|
454,859
|
|
|
|
349,813
|
|
Gain on sale of subsidiary
|
|
|
|
|
|
|
(8,717
|
)
|
|
|
(6,317
|
)
|
Change in trading portfolio
|
|
|
(19,919
|
)
|
|
|
(66,809
|
)
|
|
|
25,673
|
|
Other, net
|
|
|
19,788
|
|
|
|
(8,060
|
)
|
|
|
31,703
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash provided by operating
activities
|
|
$
|
653,388
|
|
|
$
|
623,990
|
|
|
$
|
668,703
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash provided by operating activities increased
$29.4 million in 2006 and decreased $44.7 million in
2005. Cash received from commutations, included in cash provided
by operating activities, totaled $12.8 million,
$180.8 million and $79.5 million in 2006, 2005 and
2004, respectively. Excluding the commutations, cash provided by
operating activities increased $197.4 million in 2006 and
decreased $146.0 million in 2005. The increase in 2006 was
primarily due to the increase in net earnings and activity in
our trading portfolio. The decrease in 2005 was principally due
to an increase in paid claims in 2005 as a result of payments of
2004 hurricane losses and claims related to business commuted in
2004, the timing of receipt of premiums and payment of payables,
and the effect of our trading portfolio activity. Cash flows are
expected to be strong again in 2007.
Investments
At December 31, 2006, we had $3.9 billion of
investment assets, an increase of $670.6 million from the
end of 2005. The increase resulted from strong operating cash
flows. The majority of our investment assets are held by our
insurance companies. All of our fixed income securities are
classified as available for sale and are recorded at market
value.
Our investment policy is determined by our Board of Directors
and our Investment and Finance Committee and is reviewed on a
regular basis. Our policy for each of our insurance company
subsidiaries must comply with applicable State and Federal
regulations which prescribe the type, quality and concentration
of investments. These regulations permit investments, within
specified limits and subject to certain qualifications, in
federal, state and municipal obligations, obligations of foreign
countries, corporate bonds and preferred and common equity
securities. The regulations generally allow certain other types
of investments subject to maximum limitations.
We engage independent investment advisors to oversee our fixed
income investments and to make investment recommendations. We
invest our funds principally in highly rated fixed income
securities. Our historical investment strategy is to maximize
interest income and yield, rather than to maximize total return.
In accordance with our strategy, realized gains and losses from
sales of investment securities are usually minimal, unless we
decide to capture gains to enhance statutory capital and surplus
of our insurance company subsidiaries. Although we generally
intend to hold fixed income securities to maturity, we regularly
re-evaluate
52
our position based on market conditions. Our portfolio turnover
will fluctuate, depending upon opportunities to increase yields
by replacing one security with another higher yielding security.
At December 31, 2006, we had cash and short-term
investments of $763.0 million, of which $492.9 million
is held by our insurance companies. We maintain cash and liquid
short-term instruments in our insurance companies in order to be
able to fund losses of our insureds. Cash and short-term
investments were higher than normal at December 31, 2006
due to proceeds from the liquidation of our trading portfolio
and, at December 31, 2005, due to proceeds from a common
stock offering and commutations that were consummated close to
year end. Those proceeds had not yet been invested on a longer
term basis.
This table shows a profile of our fixed income and short-term
investments. The table shows the average amount of investments,
income earned and the yield thereon.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
Average investments, at cost
|
|
$
|
3,529,671
|
|
|
$
|
2,822,686
|
|
|
$
|
2,054,620
|
|
Net investment income *
|
|
|
152,804
|
|
|
|
98,851
|
|
|
|
64,885
|
|
Average short-term yield *
|
|
|
4.5%
|
|
|
|
2.7%
|
|
|
|
1.7%
|
|
Average long-term yield *
|
|
|
4.4%
|
|
|
|
4.0%
|
|
|
|
3.9%
|
|
Average long-term tax equivalent
yield *
|
|
|
5.2%
|
|
|
|
4.9%
|
|
|
|
4.8%
|
|
Weighted average combined tax
equivalent yield *
|
|
|
5.0%
|
|
|
|
4.1%
|
|
|
|
3.8%
|
|
Weighted average maturity
|
|
|
6.9 years
|
|
|
|
7.6 years
|
|
|
|
6.6 years
|
|
Weighted average duration
|
|
|
4.6 years
|
|
|
|
4.9 years
|
|
|
|
4.6 years
|
|
Average S&P rating
|
|
|
AAA
|
|
|
|
AAA
|
|
|
|
AAA
|
|
|
|
|
* |
|
Excluding realized and unrealized investment gains and losses. |
This table summarizes the estimated market value of our
investments by type at December 31, 2006.
|
|
|
|
|
|
|
|
|
|
|
Amount
|
|
|
%
|
|
|
Short-term investments
|
|
$
|
714,685
|
|
|
|
18
|
%
|
U.S. government
|
|
|
121,580
|
|
|
|
3
|
|
States, municipalities and
political subdivisions
|
|
|
413,422
|
|
|
|
11
|
|
Special revenue fixed income
securities
|
|
|
948,280
|
|
|
|
24
|
|
Corporate fixed income securities
|
|
|
330,565
|
|
|
|
9
|
|
Asset-backed and mortgage-backed
securities
|
|
|
786,042
|
|
|
|
20
|
|
Foreign securities
|
|
|
407,304
|
|
|
|
10
|
|
Other investments
|
|
|
206,117
|
|
|
|
5
|
|
|
|
|
|
|
|
|
|
|
Total investments
|
|
$
|
3,927,995
|
|
|
|
100
|
%
|
|
|
|
|
|
|
|
|
|
This table summarizes, by rating, the market value of our
investments in fixed income securities at December 31, 2006.
|
|
|
|
|
|
|
|
|
|
|
Amount
|
|
|
%
|
|
|
AAA
|
|
$
|
2,358,078
|
|
|
|
78
|
%
|
AA
|
|
|
322,717
|
|
|
|
11
|
|
A
|
|
|
301,143
|
|
|
|
10
|
|
BBB
|
|
|
24,646
|
|
|
|
1
|
|
BB and below
|
|
|
609
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total fixed income
securities
|
|
$
|
3,007,193
|
|
|
|
100
|
%
|
|
|
|
|
|
|
|
|
|
53
This table indicates the expected maturity distribution of the
estimated market value of our fixed income securities at
December 31, 2006.
|
|
|
|
|
|
|
|
|
|
|
Amount
|
|
|
%
|
|
|
One year or less
|
|
$
|
149,192
|
|
|
|
5
|
%
|
One year to five years
|
|
|
657,305
|
|
|
|
22
|
|
Five years to ten years
|
|
|
593,783
|
|
|
|
20
|
|
Ten years to fifteen years
|
|
|
408,301
|
|
|
|
13
|
|
More than fifteen years
|
|
|
412,570
|
|
|
|
14
|
|
|
|
|
|
|
|
|
|
|
Securities with fixed maturities
|
|
|
2,221,151
|
|
|
|
74
|
|
Asset-backed and mortgage-backed
securities
|
|
|
786,042
|
|
|
|
26
|
|
|
|
|
|
|
|
|
|
|
Total fixed income
securities
|
|
$
|
3,007,193
|
|
|
|
100
|
%
|
|
|
|
|
|
|
|
|
|
The weighted average life of our asset-backed and
mortgage-backed securities is 6.7 years.
The market value of our fixed income securities is sensitive to
changing interest rates. As interest rates increase, the market
value will generally decrease and as rates decrease, the market
value will generally increase. The fluctuations in market value
are somewhat muted by the relatively short duration of our
portfolio and our relatively high level of investments in state
and municipal obligations. During 2006, the net pre-tax
unrealized loss on our fixed income securities decreased
$6.9 million due to market value changes. We estimate that
a 1% increase in interest rates would decrease the market value
of our fixed income securities by approximately
$138.3 million and a 1% decrease would increase the market
value by a like amount. Fluctuations in interest rates have a
minimal effect on the value of our short-term investments due to
their very short maturities. In our current position, higher
interest rates would have a positive effect on net earnings.
Some of our fixed income securities have call or prepayment
options. This could subject us to reinvestment risk should
interest rates fall or issuers call their securities and we
reinvest the proceeds at lower interest rates. In addition, for
asset-backed and mortgage-backed securities, prepayment risk
could reduce the yield we realize on the remaining principal of
these securities. We mitigate this risk by investing in
securities with varied maturity dates, so that only a portion of
our portfolio will mature at any point in time.
The average duration of claims in many of our lines of business
is relatively short and, accordingly, our investment portfolio
has a relatively short duration. In recent years, we have
expanded the directors and officers liability and
professional indemnity components of our diversified financial
products line of business, which have a longer claims duration
than our other lines of business. We are taking these changes
into consideration in determining the duration of our investment
portfolio.
The following table compares our insurance company
subsidiaries cash and investment maturities with their
estimated future claims payments at December 31, 2006.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Maturities/Estimated Payment Dates
|
|
|
|
Total
|
|
|
2007
|
|
|
2008-2009
|
|
|
2010-2011
|
|
|
Thereafter
|
|
|
Cash and investment maturities of
insurance companies
|
|
$
|
3,696,611
|
|
|
$
|
880,754
|
|
|
$
|
662,770
|
|
|
$
|
632,797
|
|
|
$
|
1,520,290
|
|
Estimated loss and loss adjustment
expense payments, net of reinsurance
|
|
|
2,108,961
|
|
|
|
748,517
|
|
|
|
704,248
|
|
|
|
369,517
|
|
|
|
286,679
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Estimated available cash
flow
|
|
$
|
1,587,650
|
|
|
$
|
132,237
|
|
|
$
|
(41,478
|
)
|
|
$
|
263,280
|
|
|
$
|
1,233,611
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As demonstrated in the above table, we maintain sufficient
liquidity to pay anticipated policyholder claims on their
expected payment dates. In addition, we can use current
operating cash flow to pay claims as they become due. We manage
the liquidity of our insurance company subsidiaries such that
each subsidiarys
54
anticipated claims payments will be met by its own current
operating cash flows, cash, short-term investments or investment
maturities. We do not foresee the need to sell securities prior
to their maturity to fund claims payments, nor do we anticipate
needing to use our $300.0 million Revolving
Loan Facility to pay claims. However, this credit facility
can provide additional short-term liquidity if an unexpected
event were to occur.
Contractual
Obligations
The following table presents a summary of our total contractual
cash payment obligations by estimated payment date at
December 31, 2006.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Estimated Payment Dates
|
|
|
|
Total
|
|
|
2007
|
|
|
2008-2009
|
|
|
2010-2011
|
|
|
Thereafter
|
|
|
Gross loss and loss adjustment
expense payable(1)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diversified financial products
|
|
$
|
1,290,310
|
|
|
$
|
306,240
|
|
|
$
|
522,171
|
|
|
$
|
303,908
|
|
|
$
|
157,991
|
|
Group life, accident and health
|
|
|
333,013
|
|
|
|
280,913
|
|
|
|
43,820
|
|
|
|
6,859
|
|
|
|
1,421
|
|
Aviation
|
|
|
172,311
|
|
|
|
87,246
|
|
|
|
57,470
|
|
|
|
19,315
|
|
|
|
8,280
|
|
London market account
|
|
|
454,220
|
|
|
|
210,048
|
|
|
|
189,102
|
|
|
|
48,758
|
|
|
|
6,312
|
|
Other specialty lines
|
|
|
233,564
|
|
|
|
79,748
|
|
|
|
95,130
|
|
|
|
39,682
|
|
|
|
19,004
|
|
Discontinued lines
|
|
|
613,633
|
|
|
|
96,145
|
|
|
|
178,473
|
|
|
|
123,875
|
|
|
|
215,140
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total loss and loss adjustment
expense payable
|
|
|
3,097,051
|
|
|
|
1,060,340
|
|
|
|
1,086,166
|
|
|
|
542,397
|
|
|
|
408,148
|
|
Life and annuity policy benefits
|
|
|
70,923
|
|
|
|
1,995
|
|
|
|
3,822
|
|
|
|
3,607
|
|
|
|
61,499
|
|
1.30% Convertible Notes(2)(3)
|
|
|
125,789
|
|
|
|
125,789
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2.00% Convertible Exchange
Notes(2)(3)
|
|
|
173,896
|
|
|
|
173,896
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other notes payable(3)
|
|
|
12,896
|
|
|
|
993
|
|
|
|
11,014
|
|
|
|
508
|
|
|
|
381
|
|
$300.0 million Revolving
Loan Facility
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating leases
|
|
|
85,143
|
|
|
|
9,202
|
|
|
|
21,067
|
|
|
|
18,119
|
|
|
|
36,755
|
|
Earnout liabilities
|
|
|
47,685
|
|
|
|
43,180
|
|
|
|
4,505
|
|
|
|
|
|
|
|
|
|
Indemnifications
|
|
|
16,897
|
|
|
|
4,295
|
|
|
|
3,240
|
|
|
|
5,843
|
|
|
|
3,519
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total obligations
|
|
$
|
3,630,280
|
|
|
$
|
1,419,690
|
|
|
$
|
1,129,814
|
|
|
$
|
570,474
|
|
|
$
|
510,302
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
In preparing the previous table, we made
the following estimates and assumptions.
|
|
(1)
|
The estimated loss and loss adjustment expense payments for
future periods assume that the percentage of ultimate losses
paid from one period to the next will be relatively consistent
over time. Actual payments will be influenced by many factors
and could vary from the estimated amounts above.
|
|
(2)
|
The 1.30% Convertible Notes mature in 2023 and the
2.00% Convertible Exchange Notes mature in 2021, but are
shown in the 2007 column since they may be surrendered for cash
at the option of the holders in the first quarter of 2007
because our stock traded at specified price levels in the fourth
quarter of 2006. Both convertible notes have various put and
redemption dates as disclosed in Note 6 to the Consolidated
Financial Statements.
|
|
(3)
|
Amounts include interest payable in respective periods.
|
Our acquisitions of HCC Global Financial Products, LLC (HCC
Global) and Covenant Underwriters, Ltd. and Continental
Underwriters Ltd. (collectively, CUL) include a contingency for
earnout payments based on earnings after the acquisition date,
as defined in the purchase agreement. When the conditions for
accrual have
55
been satisfied under the applicable purchase agreement, we
record a liability to the former owners with an offsetting
increase to goodwill. Accrued amounts are generally paid in the
next year. At December 31, 2006, we accrued earnouts
totaling $47.7 million related to these two acquisitions. The
purchase agreement for HCC Global requires us to pay an earnout
based on pre-tax earnings on business underwritten by HCC Global
from the acquisition date through September 30, 2007, with no
maximum amount due to the former owners. The contractual pre-tax
earnings include underwriting results on longer-duration
business written by HCC Global and, per the agreement, the
earnout cannot be finally determined until all future losses are
paid. The purchase agreement for CUL provides for a maximum
earnout of $15.0 million based on CULs 2004 through
2006 pre-tax earnings, but could be reduced based on the
ultimate underwriting results for those years.
In conjunction with the sales of business assets and
subsidiaries, we have provided indemnifications to the buyers.
Certain indemnifications cover typical representations and
warranties related to our responsibilities to perform under the
sales contracts. Other indemnifications agree to reimburse the
purchasers for taxes or ERISA-related amounts, if any, assessed
after the sale date but related to pre-sale activities. We
cannot quantify the maximum potential exposure covered by all of
our indemnifications because the indemnifications cover a
variety of matters, operations and scenarios. Certain of these
indemnifications have no time limit. For those with a time
limit, the longest such indemnification expires on
December 31, 2009.
We accrue a loss related to our indemnifications when a valid
claim is made by a buyer and we believe we have potential
exposure. We currently have several claims under
indemnifications that cover certain net losses alleged to have
been incurred in periods prior to our sale of certain
subsidiaries or otherwise alleged to be covered under
indemnification agreements related to such sales. As of
December 31, 2006, we have recorded a liability of
$16.9 million and have provided $5.2 million of
letters of credit to cover our obligations or anticipated
payments under these indemnifications.
Pursuant to our by-laws, Delaware Corporate law and certain
contractual agreements, we are required to advance
attorneys fees and other expenses and indemnify our
current and former Directors and officers for liabilities
arising from any action, suit or proceeding brought because the
individual was acting as an officer or director of our company.
Under certain limited circumstances, the individual may be
required to reimburse us for any advances or indemnification
payments made by us. In addition, we maintain directors
and officers liability insurance, which may cover certain
of these costs. We expense payments as advanced and recognize
offsets if cash reimbursement is received. During 2006, we
expensed $1.3 million of attorneys fees incurred by
current and former Directors and officers who claimed the right
to indemnity in conjunction with our stock option investigation.
It is not possible to determine the maximum potential impact on
our consolidated net earnings, since our by-laws, Delaware law
and our contractual agreements do not limit any such advances or
indemnification payments.
Subsidiary
Dividends
The principal assets of HCC are the shares of capital stock of
its insurance company subsidiaries. Historically, we have not
relied on dividends from our insurance companies to meet the
parent holding companys obligations, which are primarily
outstanding debt and debt service obligations, dividends to
shareholders and corporate expenses, since we have had
sufficient cash flow from our agencies and intermediaries to
meet our corporate cash flow requirements. However, as more
profit is now expected to be earned in our insurance companies,
we may have to partially depend on cash flow from our insurance
companies in the future.
The payment of dividends by our insurance companies is subject
to regulatory restrictions and will depend on the surplus and
future earnings of these subsidiaries. HCCs direct
domestic insurance company subsidiaries can pay an aggregate of
$172.1 million in dividends in 2007 without obtaining
special permission from state regulatory authorities. In 2006,
2005 and 2004, our insurance company subsidiaries paid HCC
dividends of $44.0 million, $50.0 million and
$20.0 million, respectively. The 2005 and 2004 dividends
were then contributed to another insurance company subsidiary.
56
Lines
of Credit
Our $300.0 million Revolving Loan Facility allows us
to borrow up to the maximum allowed by the facility on a
revolving basis until the facility expires on November 30,
2009. The facility is collateralized in part by the pledge of
our insurance companies stock and by guarantees entered
into by our underwriting agencies and reinsurance brokers. The
facility agreement contains certain restrictive covenants, which
we believe are typical for similar financing arrangements. We
had no borrowings under this facility at December 31, 2006.
In 2006, we entered into a $34.0 million Standby Letter of
Credit Facility and utilized that facility to replace a portion
of our funds at Lloyds of London with standby letters of
credit. Letters of credit issued under the Standby Letter of
Credit Facility are unsecured commitments of HCC. The Standby
Letter of Credit Facility contains standard restrictive
covenants, which in many cases are identical to or incorporate
by reference the restrictive covenants from our Revolving
Loan Facility.
At December 31, 2006, certain of our subsidiaries
maintained revolving lines of credit with a bank in the combined
maximum amount of $40.7 million available through
November 30, 2009. Advances under the lines of credit are
limited to amounts required to fund draws, if any, on letters of
credit issued by the bank on behalf of the subsidiaries and
short-term direct cash advances. The lines of credit are
collateralized by securities having an aggregate market value of
up to $50.8 million, the actual amount of collateral at any
one time being 125% of the aggregate amount outstanding.
Interest on the lines is payable at the banks prime rate
of interest (8.25% at December 31, 2006) for draws on
the letters of credit and either prime or prime less 1% on
short-term cash advances. At December 31, 2006, letters of
credit totaling $20.0 million had been issued to insurance
companies by the bank on behalf of our subsidiaries, with total
securities of $24.9 million collateralizing the lines.
Other
Our debt to total capital ratio was 13.1% at December 31,
2006 and 15.5% at December 31, 2005.
In the second quarter of 2006, we filed a Universal
Shelf registration statement with the SEC, which replaced
our previously filed registration statements and provides for
the issuance of an aggregate of $1.0 billion of our
securities. These securities may be debt securities, equity
securities, trust preferred securities, or a combination
thereof. We sold 4.7 million and 4.5 million shares of
our common stock at prices of $32.05 and $22.17 per share
in 2005 and 2004, respectively, under our shelf registrations.
Net proceeds of $150.0 million in 2005 were used to make
$108.0 million of capital contributions to our insurance
company subsidiaries and to fund acquisitions. We used the net
proceeds of $96.7 million in 2004 to make a
$75.0 million capital contribution to an insurance company
subsidiary and $17.0 million to pay down bank debt.
As a result of the delayed filing of our Quarterly Reports on
Form 10-Q
for the second and third quarters of 2006, we are ineligible to
register our securities on
Form S-3
or use our previously filed universal shelf registration
statement for one year after December 27, 2006, the date
these reports were filed with the SEC. We may use
Form S-1
to raise capital and borrow money utilizing public debt or to
complete acquisitions of other companies, which could increase
transaction costs and adversely impact our ability to raise
capital and borrow money or complete acquisitions in a timely
manner.
In connection with a voluntary independent investigation by a
Special Committee of the Board of Directors of our past
practices related to granting stock options, the SEC commenced
an informal inquiry into our option pricing practices. We have
provided the results of our internal review and independent
investigation to the SEC and we have responded to informal
requests for documents and additional information. We intend to
fully cooperate with the SEC. We are unable to predict the
outcome of or the future costs related to the informal inquiry,
but it may result in additional professional fees including our
advancement of attorneys fees incurred by our Directors,
certain officers and certain former executives and directors;
may continue to occupy the time and attention of our management
team; and could negatively impact our business and our ability
to raise and borrow additional funds in the future. Furthermore,
if we are subject to adverse findings in this or
57
any other regulatory proceeding or governmental enforcement
action, we could be required to pay damages and penalties or
have other remedies imposed, which could harm our business,
financial condition, results of operations and cash flows.
As a result of the investigation, we had to record non-cash
compensation expense in each year from 1997 through 2006. To
correct these accounting errors, we restated our consolidated
financial statements for the applicable periods and filed our
Annual Report on
Form 10-K/A
for 2005 and our Quarterly Report on
Form 10-Q/A
for the first quarter of 2006 on December 27, 2006. The
investigation and restatements have exposed us to greater risks
associated with litigation. Publicity resulting from these
actions may materially adversely affect us, regardless of the
cause or effect of the actions. Since December 31, 2006,
two derivative actions have been filed naming a number of
current and former officers and Directors. The Company is a
nominal defendant. We cannot assure you about the outcome of
these two derivative lawsuits or any future litigation. The
conduct and resolution of litigation could be time consuming,
expensive, cause us to have to advance expenses in certain
instances to current and former officers and Directors, and may
distract management from the conduct of our business. In
addition, damages and other remedies awarded in any such
litigation could harm our business and financial condition.
In connection with our stock option investigation, we incurred
$14.2 million of expense for professional services,
consulting fees and other related charges. The total includes
accruals of $4.3 million for the estimated cost to
reimburse certain employees for their lost spread on discounted
options and $2.3 million for our estimated liability to pay
our employees personal tax liabilities under
Section 409A of the Internal Revenue Code for options
exercised in 2006. Section 409A imposes certain
restrictions and additional taxes on the recipients of
discounted options. Prior to December 31, 2006, the final
date allowable under Section 409A, Directors and certain
officers agreed to reprice their unexercised discounted options
to the closing price on the actual accounting measurement date
as determined by the investigation; therefore, these options are
no longer subject to Section 409A. Prior to
December 31, 2007, the final date allowable under
Section 409A, we intend to offer all other employees who
received discounted options the same opportunity to reprice
their options to also relieve them from Section 409A
taxation. Employees accepting the offer will receive cash
payments sufficient to reimburse them for the reduced value of
their repriced options, calculated as the difference between the
original strike price of the option and the closing price of our
stock on the actual accounting measurement date. We expect to
pay up to several million dollars for additional professional
services fees in the next few months associated with matters
emanating from the investigation.
We believe that our operating cash flows, investments, Revolving
Loan Facility and other sources of liquidity are sufficient
to meet our operating needs for the foreseeable future.
Impact of
Inflation
Our operations, like those of other property and casualty
insurers, are susceptible to the effects of inflation because
premiums are established before the ultimate amounts of loss and
loss adjustment expense are known. Although we consider the
potential effects of inflation when setting premium rates, our
premiums, for competitive reasons, may not fully offset the
effects of inflation. However, because the majority of our
business is comprised of lines that have relatively short lead
times between the occurrence of an insured event, reporting of
the claims to us and the final settlement of the claims, or have
claims that are not significantly impacted by inflation, the
effects of inflation are minimized.
A portion of our revenue is related to healthcare insurance and
reinsurance products that are subject to the effects of the
underlying inflation of healthcare costs. Such inflation in the
costs of healthcare tends to generate increases in premiums for
medical stop-loss coverage, resulting in greater revenue but
also higher claim payments. Inflation also may have a negative
impact on insurance and reinsurance operations by causing higher
claim settlements than may originally have been estimated,
without an immediate increase in premiums to a level necessary
to maintain profit margins. We do not specifically provide for
inflation when setting underwriting terms and claim reserves,
although we do consider trends. We continually review claim
reserves to assess their adequacy and make necessary adjustments.
58
Inflation can also affect interest rates. Any significant
increase in interest rates could have a material adverse effect
on the market value of our investments. In addition, the
interest rate payable under our Revolving Loan Facility
fluctuates with market interest rates. Any significant increase
in interest rates could have a material adverse effect on our
net earnings, depending on the amount borrowed on that facility.
Foreign
Exchange Rate Fluctuations
We underwrite risks that are denominated in a number of foreign
currencies. As a result, we have receivables and payables in
foreign currencies and we establish and maintain loss reserves
with respect to our insurance policies in their respective
currencies. Our net earnings could be impacted by exchange rate
fluctuations affecting these balances. Our principal area of
exposure is related to fluctuations in the exchange rates
between the British pound sterling, the Euro and the
U.S. dollar. We constantly monitor the balance between our
receivables and payables and loss reserves to mitigate the
potential exposure should an imbalance be expected to exist for
other than a short period of time. Our gain (loss) from currency
conversion was zero in 2006 compared to $(1.0) million in
2005 and $1.2 million in 2004.
Critical
Accounting Policies
The preparation of our consolidated financial statements in
conformity with accounting principles generally accepted in the
United States of America (generally accepted accounting
principles) requires us to make estimates and assumptions when
applying our accounting policies. The following sections provide
information about our estimation processes related to certain of
our critical accounting policies.
Loss
and Loss Adjustment Expense
Our net loss and loss adjustment expense reserves are composed
of reserves for reported losses and reserves for incurred but
not reported losses, less a reduction for reinsurance
recoverables related to those reserves. Reserves are recorded by
product line and are undiscounted, except for reserves related
to acquisitions.
The process of estimating our loss and loss adjustment expense
reserves involves a considerable degree of judgment by
management and is inherently uncertain. The recorded reserves
represent managements best estimate of unpaid loss and
loss adjustment expense by line of business. Because we provide
insurance coverage in specialized lines of business that often
lack statistical stability, management considers many factors,
and not just the actuarial point estimates discussed below, in
determining ultimate expected losses and the level of net
reserves required and recorded.
To record reserves on our lines of business, we utilize expected
loss ratios, which management selects based on the following:
1) information used to price the applicable policies,
2) historical loss information where available, 3) any
public industry data for that line or similar lines of business
and 4) an assessment of current market conditions.
Management also considers the point estimates and ranges
calculated by our actuaries, together with input from our
experienced underwriting and claims personnel. Because of the
nature and complexities of the specialized types of business we
insure, management may give greater weight to the expectations
of our underwriting and claims personnel, who often perform a
claim by claim review, rather than to the actuarial estimates.
However, we utilize the actuarial point and range estimates to
monitor the adequacy and reasonableness of our recorded reserves.
Each quarter-end, management compares recorded reserves to the
most recent actuarial point estimate and range for each line of
business. If the recorded reserves vary significantly from the
actuarial point estimate, management determines the reasons for
the variances and may adjust the reserves up or down to an
amount that, in managements judgment, is adequate based on
all of the facts and circumstances considered, including the
actuarial point estimates. We consistently maintain total
consolidated net reserves above the total actuarial point
estimate but within the actuarial range.
59
The table below shows our recorded net reserves at
December 31, 2006 by line of business, the actuarial
reserve point estimates, and the high and low ends of the
actuarial reserve range as determined by our reserving actuaries.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Recorded
|
|
|
Actuarial
|
|
|
Low End of
|
|
|
High End of
|
|
|
|
Net Reserves
|
|
|
Point Estimate
|
|
|
Actuarial Range
|
|
|
Actuarial Range
|
|
|
Total net reserves
|
|
$
|
2,108,961
|
|
|
$
|
2,064,336
|
|
|
$
|
1,931,642
|
|
|
$
|
2,261,589
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Individual lines of business:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diversified financial products
|
|
$
|
848,636
|
|
|
$
|
843,742
|
|
|
$
|
729,862
|
|
|
$
|
997,876
|
|
Group life, accident and health
|
|
|
317,176
|
|
|
|
312,099
|
|
|
|
287,772
|
|
|
|
342,642
|
|
Aviation
|
|
|
104,213
|
|
|
|
101,127
|
|
|
|
93,923
|
|
|
|
110,146
|
|
London market account
|
|
|
205,684
|
|
|
|
194,894
|
|
|
|
185,149
|
|
|
|
220,027
|
|
Other specialty lines
|
|
|
151,928
|
|
|
|
144,208
|
|
|
|
136,440
|
|
|
|
162,655
|
|
Discontinued lines
|
|
|
481,324
|
|
|
|
468,266
|
|
|
|
409,577
|
|
|
|
568,096
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total net reserves
|
|
$
|
2,108,961
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The excess of the total recorded net reserves over the actuarial
point estimate was 2.2% of recorded net reserves at
December 31, 2006 compared to 1.6% at December 31,
2005. The percentage will vary in total and by line depending on
the potential volatility of the line, the severity of claims
reported and of claims incurred but not reported,
managements judgment with respect to the risk of
development, the nature of business acquired in acquisitions and
historical development patterns.
The actuarial point estimates represent our actuaries
estimate of the most likely amount that will ultimately be paid
to settle the net reserves we have recorded at a particular
point in time. While, from an actuarial standpoint, a point
estimate is considered the most likely amount to be paid, there
is inherent uncertainty in the point estimate, and it can be
thought of as the expected value in a distribution of possible
reserve estimates. The actuarial ranges represent our
actuaries estimate of a likely lowest amount and highest
amount that will ultimately be paid to settle the net reserves
we have recorded at a particular point in time. While there is
still a possibility of ultimately paying an amount below the
range or above the range, the actuarial probability is very
small. The range determinations are based on estimates and
actuarial judgments and are intended to encompass reasonably
likely changes in one or more of the variables that were used to
determine the point estimates.
The low end of the actuarial range and the high end of the
actuarial range for the total net reserves will not equal the
sum of the low and high ends for the individual lines of
business. Moreover, in actuarial terms, it would not be
appropriate to add the ranges for each line of business to
obtain a range around the total net reserves because this would
not reflect the diversification effects across our various lines
of business. The diversification effects result from the fact
that losses across the different lines of business are not
completely correlated.
In actuarial practice, some of our lines of business are more
effectively modeled by a statistical distribution that is skewed
or non-symmetric. These distributions are usually skewed towards
large losses, which causes the midpoint of the range to be above
the actuarial point estimate or mean value of the range. This
should be kept in mind when using the midpoint as a proxy for
the mean. Our assumptions, estimates and judgments can change
based on new information and changes in conditions and, if they
change, it will affect the determination of the range amounts.
60
The following table details, by major products within our lines
of business, the characteristics and major actuarial assumptions
utilized by our actuaries in the determination of actuarial
point estimates and ranges. We considered all major lines of
business written by the insurance industry when determining the
relative characteristics of claims duration, speed of loss
reporting and reserve volatility. Other companies may classify
their own insurance products in different lines of business or
utilize different actuarial assumptions.
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Claims
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Characteristics
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Speed of
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Loss
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Reserve
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Major Actuarial
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Line of Business
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Products
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Underwriting
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Duration
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Reporting
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Volatility
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Assumptions
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Diversified financial products
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Directors and
officers liability
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Primary
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Medium to
Long
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Moderate
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Medium to
High
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Historical and industry
loss reporting patterns
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Professional
indemnity
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Primary
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Medium
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Moderate
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Medium
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Historical loss reporting
patterns
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Surety
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Primary
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Medium
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Fast
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Low
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Historical loss payment
and reporting patterns
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Group life, accident and health
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Medical stop-loss
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Primary
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Short
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Fast
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Low
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Medical cost and
utilization trends
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Historical loss payment
and reporting patterns
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Rate changes
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Aviation
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Aviation
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Primary and
subscription
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Medium
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Fast
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Medium
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Historical loss payment
and reporting patterns
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London market account
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Accident and health
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Primary
and assumed
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Medium to
Long
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Slow
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High
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Historical loss payment
and reporting patterns
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Energy*
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Subscription
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Medium
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Moderate
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Medium
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Historical loss payment
and reporting patterns
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Property*
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Subscription
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Medium
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Moderate
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Medium
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Historical loss payment
and reporting patterns
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Historical large loss experience
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Marine
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Subscription
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Medium
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Moderate
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Medium
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Historical loss payment
and reporting patterns
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Historical large loss experience
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Other specialty
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Liability
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Primary and assumed
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Medium
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Moderate
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Medium
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Historical loss payment
and reporting patterns
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Property
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Primary and assumed
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Short
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Fast
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Low
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Historical loss payment
and reporting patterns
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Discontinued
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Accident
and health reinsurance
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Assumed
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Long
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Slow
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High
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Historical and industry
loss payment and reporting patterns
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*
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Includes catastrophe losses
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Assumed reinsurance represented 20% of our gross written premium
in 2006 and 35% of our gross reserves at December 31, 2006.
Approximately 41% of the assumed reinsurance reserves related to
run-off assumed accident and health reinsurance business in our
discontinued lines, 17% related to assumed reinsurance in our
London market account, 14% related to the assumed business in
our group life, accident and health line of business, and 11%
related to assumed reinsurance in our aviation and diversified
financial products lines of business. The remaining assumed
reinsurance reserves covered various minor reinsurance programs.
The table above recaps the underwriting, claims characteristics
and major actuarial assumptions for our assumed reinsurance
business.
The run-off assumed accident and health reinsurance business is
primarily reinsurance that provides excess coverage for large
losses related to workers compensation policies. As
discussed previously, we recorded $4.9 million of adverse