-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Q5HbY1MN40oP1V1CKlM69qYiQdeNumG7o8iUPx0xoMxBVIC4zxWkl3WTaD8r4G0J 2WI7cS3/Tls/tanhm3PN0w== 0000950129-01-001824.txt : 20010409 0000950129-01-001824.hdr.sgml : 20010409 ACCESSION NUMBER: 0000950129-01-001824 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 8 CONFORMED PERIOD OF REPORT: 20001231 FILED AS OF DATE: 20010402 FILER: COMPANY DATA: COMPANY CONFORMED NAME: HCC INSURANCE HOLDINGS INC/DE/ CENTRAL INDEX KEY: 0000888919 STANDARD INDUSTRIAL CLASSIFICATION: FIRE, MARINE & CASUALTY INSURANCE [6331] IRS NUMBER: 760336636 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 001-13790 FILM NUMBER: 1589121 BUSINESS ADDRESS: STREET 1: 13403 NORTHWEST FRWY CITY: HOUSTON STATE: TX ZIP: 77040-6094 BUSINESS PHONE: 7136907300 10-K 1 h85541e10-k.txt HCC INSURANCE HOLDINGS, INC. - DATED 12/31/2000 1 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 --------------------- FORM 10-K (MARK ONE) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2000 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM TO COMMISSION FILE NUMBER 0-20766 HCC INSURANCE HOLDINGS, INC. (Exact name of Registrant as Specified in Its Charter) DELAWARE 76-0336636 (State or other jurisdiction (IRS Employer of incorporation or organization) Identification No.) 13403 NORTHWEST FREEWAY HOUSTON, TEXAS 77040-6094 (Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (713) 690-7300 Securities Registered Pursuant to Section 12(b) of the Act:
NAME OF EACH EXCHANGE TITLE OF EACH CLASS ON WHICH REGISTERED ------------------- --------------------- COMMON STOCK, $1.00 PAR VALUE New York Stock Exchange
Securities Registered Pursuant to Section 12(g) of the Act: NONE 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 [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (sec.229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant's 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. [ ] The aggregate market value on March 16, 2001, of the voting stock held by non-affiliates of the registrant was approximately $1.3 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 registrant's Common Stock, $1.00 par value, as of March 16, 2001 was 58,697,666. DOCUMENTS INCORPORATED BY REFERENCE Information called for in Part III of this Form 10-K is incorporated by reference to the Registrant's definitive Proxy Statement to be filed within 120 days of the close of the Registrant's fiscal year in connection with the Registrant's annual meeting of shareholders. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 2 TABLE OF CONTENTS HCC INSURANCE HOLDINGS, INC.
PAGE ---- PART I. ITEM 1. Business.................................................... 2 ITEM 2. Properties.................................................. 26 ITEM 3. Legal Proceedings........................................... 26 ITEM 4. Submission of Matters to a Vote of Security Holders......... 26 PART II. ITEM 5. Market for the Registrant's Common Equity and Related Stockholder Matters......................................... 27 ITEM 6. Selected Financial Data..................................... 28 ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations................................... 30 ITEM 7A. Quantitative and Qualitative Disclosure About Market Risk... 41 ITEM 8. Financial Statements and Supplementary Data................. 42 ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures................................... 42 PART III. ITEM 10. Directors and Executive Officers of the Registrant.......... 43 ITEM 11. Executive Compensation...................................... 43 ITEM 12. Security Ownership of Certain Beneficial Owners and Management.................................................. 43 ITEM 13. Certain Relationships and Related Transactions.............. 43 PART IV. ITEM 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K......................................................... 43 SIGNATURES............................................................ 44
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. 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 strategies, competitive strengths, goals, growth of our businesses 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 forward-looking statements. Many possible events or factors could affect our future financial results and performance. These 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 as of 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. 3 PART I ITEM 1. BUSINESS TERMINOLOGY As used in this report, unless otherwise required by the context, the terms "we," "us," "our" and the "Company," 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. OVERVIEW Our company, HCC Insurance Holdings, Inc., is a Delaware corporation formed in 1991 as a holding company for insurance companies, underwriting agencies and intermediary operations. It's predecessor company was formed in 1974. Our principal and executive offices are located at 13403 Northwest Freeway, Houston, Texas 77040 and our telephone number is (713) 690-7300. We maintain an internet website at www.hcch.com. The reference to our website address does not constitute the incorporation by reference of the information contained at that site in this report. We provide specialized property and casualty, and accident and health insurance coverages, underwriting agency and intermediary services and other insurance related services both to commercial customers and individuals. We operate primarily in the United States and in the United Kingdom, although some of our operations have a broader international scope. We underwrite insurance on both a direct basis, where we insure a risk in exchange for a premium, and reinsurance basis, where we insure all or a portion of another insurance company's risk in exchange for all or portion of the premium. We market our products both directly to customers and through a network of independent and affiliated agents and brokers. Since our founding, we have been consistently profitable, generally reporting annual increases in gross written premium and total revenue. During the period 1996 through 2000, we had an average statutory combined ratio of 94.7% versus the less favorable 105.2% (1996-1999) recorded by the U.S. property and casualty insurance industry overall. During the same period, our gross written premium increased from $337.3 million to $967.5 million, an increase of 187% while net written premium increased 55% from $183.0 million to $283.8 million. During this period, our revenues increased from $270.8 million to $466.2 million, an increase of 72%. During the period December 31, 1996 through December 31, 2000, our shareholders' equity increased from $296.5 million to $529.4 million, a 79% increase. After giving effect to the March, 2001 public offering of our Common Stock, our pro forma shareholders' equity as of December 31, 2000 would have been $682.3 million. During the same four-year period, our assets increased from $965.8 million to $2.7 billion, a 184% increase. Our insurance companies are risk-bearing and focus their underwriting activities on providing insurance and/or reinsurance in the following lines of business: - accident and health; - general aviation; - marine and offshore energy; - medical stop-loss; - property; and - workers' compensation. 2 4 Our principal insurance company subsidiaries are Houston Casualty Company in Houston, Texas and London, England; HCC Life Insurance Company in Houston, Texas; U.S. Specialty Insurance Company in Houston, Texas; and Avemco Insurance Company in Frederick, Maryland. In the United States, certain of our insurance companies operate on an admitted, or licensed, basis. Our other insurance companies operate in some states on a surplus lines basis as a non-admitted, or unlicensed, insurer offering insurance coverage not otherwise available from an admitted insurer in the relevant state. Our operating property and casualty insurance companies are rated "A+ (Superior)" by A.M. Best Company and "AA (Very Strong)" by Standard and Poor's, two nationally recognized independent rating agencies. These ratings are intended to provide an independent opinion of an insurer's ability to meet its obligations to policyholders and are not evaluations directed at investors. Our underwriting agencies are fee-based, non-risk bearing and underwrite on behalf of our insurance companies and other insurance companies. Our underwriting agencies generate revenues based entirely on management fees and profit commissions and specialize in medical stop-loss insurance and a variety of accident and health related insurance and reinsurance products. Our principal underwriting agency subsidiaries are LDG Reinsurance Corporation in Wakefield, Massachusetts and New York City, New York; and HCC Benefits Corporation in Atlanta, Georgia; Costa Mesa, California; Wakefield, Massachusetts; Minneapolis, Minnesota; and Dallas, Texas. We have recently consolidated the operations of certain of our agencies with certain of our insurance companies to improve operational efficiencies. Our combined gross written premium in 2000 was over $1.4 billion, after intercompany eliminations. Our insurance company operations wrote $967.5 million of gross written premium and our underwriting agencies wrote $1.1 billion of written premium, before intercompany eliminations. Our intermediary subsidiaries are fee based and non-risk bearing and provide insurance and reinsurance brokerage services for our insurance companies and our clients. 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. These operations consist of: - consulting on risks; - marketing risks; - placing risks; and - servicing risks. Our intermediaries specialize in developing and marketing employee benefit plans on a retail basis and in placing reinsurance for both accident and health, and property and casualty lines of business. Our principal intermediary subsidiaries are HCC Intermediaries, Inc. in Houston, Texas; HCC Employee Benefits, Inc. in Houston, Texas and Atlanta, Georgia; and Rattner Mackenzie Limited in London, England. We also operate insurance claims adjusting and other service operations which support our operations as well as provide services for other clients. In addition, we make strategic investments, usually in businesses that complement our operations. Our revenues from these investments are comprised of dividends from, or equity in earnings of, the company in which we invested and gains or losses on the sale of such investments. OUR STRATEGY Our business philosophy as an insurer is to maximize underwriting profits while limiting risk in order to preserve shareholders' equity and maximize earnings. We concentrate our insurance writings in selected, narrowly defined lines of business where we believe we can achieve an underwriting profit. We focus on lines of business that have relatively short lead times between the occurrence of an insured event and the 3 5 reporting of claims. We market our insurance products both directly to customers and through independent or affiliated agents and brokers. The property and casualty insurance industry is cyclical, and individual lines of business experience their own cycles within that overall industry cycle. In our insurance company operations, we believe our operational flexibility, experienced underwriting personnel and access to, and expertise in, the reinsurance marketplace allow 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 severe competition. In addition, we believe that our underwriting agencies and intermediary subsidiaries complement our insurance underwriting activities. Our ability to utilize affiliated insurers, underwriting agencies, intermediaries and service providers permits us to retain a greater portion of the gross revenue derived from written premium. We purchase reinsurance by transferring part of the risk we have assumed (known as ceding) to a reinsurance company in exchange for part of the premium we receive in connection with the risk. We purchase reinsurance to limit the net loss from both individual and catastrophic risks to our insurance companies. 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. In 2000, due to a hardening of the respective markets, premium rates in the accident and health, general aviation and medical stop-loss lines of business increased. We anticipate continued improvements in these markets in 2001. In response to these changing market conditions, we plan to continue to expand the underwriting activities in our insurance company operations. As part of this expansion, we have recently consolidated certain of our underwriting agencies with certain of our insurance companies for the purpose of streamlining our business. We have consolidated the operations of our domestic general aviation underwriting agency, HCC Aviation, and our occupational accident and workers' compensation underwriting agency, HCC Employer Services into those U.S. Specialty, and the operations of our London-based accident and health underwriting agency, LDG Re (London) with those of the London branch of Houston Casualty. We believe that the consolidation of these operations will result in greater efficiency in these businesses. We expect that this consolidation will result in a reduction in our management fee revenues and the net earnings of our underwriting agencies, but that any such reduction will be more than offset over time by increases in the net earnings of our insurance companies. The cost of this restructuring was $1.0 million (after-tax) and was taken in the fourth quarter of 2000. As market conditions warrant, we anticipate reviewing other agency operations to determine if similar consolidation activities will provide greater operating efficiencies. We also acquire or make strategic investments in companies that present an opportunity for future profits or for enhancement of our business. We expect to continue to seek to acquire complementary businesses with established managements and established reputations in the insurance industry. We believe that we can enhance acquired businesses through the synergies created by our underwriting capabilities and our other operations. However, our business plan is shaped by our underlying business philosophy, which is to maximize underwriting profit, while preserving 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: - emphasize the underwriting of lines of business in which premium rates, the availability and cost of reinsurance, and market conditions warrant; - limit our net loss exposure to our insurance company subsidiaries from a catastrophe loss through the use of reinsurance; and - review the potential acquisition of specialty insurance operations and other strategic investments. 4 6 INDUSTRY SEGMENT INFORMATION Financial information concerning the Company's operations by industry segment is set forth in the Consolidated Financial Statements and the Notes thereto. MAJOR ACQUISITIONS We have made a series of strategic acquisitions that have furthered our overall business strategy. Our recent larger transactions are described below: On January 31, 1999, we acquired PEPYS Holdings Limited. PEPYS is a holding company for Rattner Mackenzie. The total initial consideration was $54.8 million in cash and deferred payments of $8.3 million in cash and 414,207 shares of our common stock. We may pay additional amounts in the future based upon the attainment of certain earnings benchmarks over the ensuing four years. Rattner Mackenzie provides intermediary services for reinsurance business placed by our insurance company subsidiaries as well as other insurance and reinsurance companies and underwriting agencies, primarily in the accident and health area. On December 20, 1999, we acquired all of the outstanding shares of the publicly traded The Centris Group, Inc. following a tender offer at a price of $12.50 per share in cash. We paid a total of $149.5 million for the Centris acquisition. Centris was the parent corporation of a group of insurance companies and underwriting agencies principally operating in the medical stop-loss line of business. Centris' primary insurance company subsidiary was the entity now known as HCC Life Insurance Company. HCC Life's operations were relocated to Houston, and it has become a subsidiary of Houston Casualty. The medical stop-loss underwriting agency operations of Centris have been combined with HCC Benefits' operations. On January 19, 2001, we issued 996,805 shares of our common stock to acquire the Schanen Consulting Corporation and its operating subsidiary, Schanen Consulting Group, L.L.C. Schanen provides employee benefit consulting and retail insurance intermediary services and has been consolidated with HCC Employee Benefits' operations. We continue to evaluate possible acquisition candidates and we may complete additional acquisitions during 2001. Any future acquisitions will be designed to expand and strengthen our existing lines of business and perhaps provide access to additional specialty sectors, which we expect to contribute to our overall growth. DISPOSITIONS In March, 2000, we sold Trafalgar Insurance Company, an Oklahoma domiciled surplus lines insurance company subsidiary, for a price which approximated its shareholders' equity in accordance with generally accepted accounting principles in the United States, or GAAP. In September, 2000, we sold a substantial portion of the assets of The Wheatley Group, Ltd., a subsidiary of Avemco Corporation. Neither of these operations were material to our financial condition, results of operations or cash flows. 5 7 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 for the years indicated (dollars in thousands):
2000 1999 1998 -------------- -------------- -------------- Accident and health reinsurance..... $193,714 20% $158,264 28% $114,787 23% Aviation............................ 191,089 20 210,029 37 203,573 41 Marine and offshore energy.......... 26,102 3 18,694 3 34,941 7 Medical stop-loss................... 368,450 38 69,258 12 7,046 1 Property............................ 53,275 5 63,309 11 106,515 21 Workers' compensation and alternative workers' compensation...................... 49,872 5 27,202 5 8,958 2 Other............................... 84,955 9 21,575 4 22,456 5 -------- --- -------- --- -------- --- Total gross written premium................. $967,457 100% $568,331 100% $498,276 100% ======== === ======== === ======== ===
This table shows our insurance companies' actual premium retained, otherwise known as the net written premium, by line of business and the percentage of each line to total net written premium for the years indicated (dollars in thousands):
2000 1999 1998 -------------- -------------- -------------- Accident and health reinsurance..... $ 61,855 22% $ 37,725 27% $ 39,949 33% Aviation............................ 79,794 28 68,513 49 53,030 44 Marine and offshore energy.......... 8,435 3 6,616 5 7,978 6 Medical stop-loss................... 100,353 35 20,332 15 3,415 3 Property............................ 10,015 4 2,945 2 8,356 7 Workers' compensation and alternative workers' compensation...................... 8,697 3 673 -- 1,059 1 Other............................... 14,639 5 3,120 2 8,096 6 -------- --- -------- --- -------- --- Total net written premium................. $283,788 100% $139,924 100% $121,883 100% ======== === ======== === ======== ===
Underwriting DIRECT We underwrite direct business produced through independent agents and brokers, affiliated intermediaries, and by direct marketing efforts. Our direct underwriting includes general aviation, medical stop-loss and workers' compensation business. Reinsurance Our insurance companies participate in certain insurance and reinsurance underwriting pools managed by our underwriting agency subsidiary, LDG Re, in the accident and health line of business. Our insurance company subsidiaries also write facultative, or individual account, reinsurance, particularly in the aviation, marine and offshore energy and property lines of business. Our facultative underwriting is typically on international business in order to comply with local licensing requirements or as reinsurance of captive insurance companies controlled by others, and can be considered direct business for most purposes, since we maintain underwriting and claims control. However, we record all of this business under the caption of "Reinsurance Assumed" in our financial statements. 6 8 Aviation Aviation underwriting was one of our largest lines of business in 2000 and in recent years we have grown into a market leader in the aviation insurance industry. We insure general aviation risks, both domestically and internationally, including: - antique and vintage military aircraft; - cargo operations; - commuter airlines; - corporate aircraft; - fixed base operations; - military and law enforcement aircraft; - private aircraft owners and pilots; and - rotor wing aircraft. We offer coverages that include hulls, engines, avionics and other systems, liabilities, war, cargo and other ancillary coverages. At this time, we do not generally insure major airlines, major manufacturers 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, our largest and most important insurance company subsidiary, since 1981. Avemco Insurance has been insuring aviation risks since 1959. Our gross written premium has remained relatively flat during the period 1998 to 2000. During this period we have successfully re-underwritten our book of business, removing under-performing types of business where the premium rates were insufficient, and focusing on areas where increasing rates were able to generate profitable business. Our aviation net written premium increased during the period because we increased our retentions, i.e., the portion of risk that we retain for our own account. We maintain reinsurance on both a proportional basis, where we share a proportional part of the original premium and losses with reinsurers, and an excess of loss basis, where we transfer liability, premium and loss on a non-proportional basis above our net retention of risk to reinsurers, to protect us against severe losses on individual risks and catastrophe exposures. We believe that the aviation risks we underwrite carry a relatively low level of catastrophe exposures. Marine and Offshore Energy We underwrite marine risks for ocean going vessels as well as inland, coastal trading and fishing vessels. The marine risks we write include: - hull and machinery; - liabilities, including protection and indemnity; - marine cargo; and - various ancillary coverages. We have underwritten marine risks since 1984, primarily in Houston Casualty. Competition has created downward pressure on premium rates since 1996, causing a reduction in our gross written premium since 1997 and a corresponding decrease in net written premium. We maintain marine reinsurance on both a proportional and an excess of loss basis. We believe that the marine risks we underwrite carry a relatively low level of catastrophe exposure. 7 9 We have been underwriting offshore energy risks since 1988, primarily in Houston Casualty. The offshore energy risks we write include drilling rigs, production and gathering platforms, and pipelines. We underwrite physical damage, liabilities, business interruption and various ancillary coverages. Rates have declined significantly during the past few years to levels where underwriting profitability is difficult to obtain. As a result, we have underwritten offshore energy risks on a very selective basis, striving for quality rather than quantity. We maintain offshore energy reinsurance on both a proportional basis and an excess of loss basis to protect us against severe losses on individual risks and the catastrophe exposure that exists, for example, from a hurricane or a major platform explosion. Property We specialize in writing risks of large, often multinational, corporations, covering a variety of commercial risks including: - factories; - hotels; - industrial plants; - natural gas facilities; - office buildings; - petrochemical plants; - refineries; - retail locations; and - utilities. The insurance we offer includes business interruption, physical damage and catastrophe risks including flood and earthquake. We have written property business since 1986, primarily through Houston Casualty. Gross written premium declined from $106.5 million in 1998 to $53.3 million in 2000 as premium rates were soft due in a large part to excess capacity and the absence of significant catastrophe losses. Net written premium increased slightly from $8.4 million to $10.0 million in the same period. Our property gross written premium exceeds our net written premium by a substantial amount due to the amount of facultative reinsurance, which is the separately negotiated reinsurance of all or part of the coverage provided by a single policy, and other reinsurance purchased in order to protect us from catastrophe losses. We maintain reinsurance on both a proportional basis and an excess of loss basis to ensure adequate reinsurance protection, particularly against catastrophe exposures. We estimate our aggregate probable maximum loss in any individual catastrophe zone and maintain catastrophe reinsurance to cover such exposure to any one occurrence. Accident and Health Reinsurance We began writing accident and health reinsurance risks through Houston Casualty during 1996. LDG Re is the primary producer and underwriter of this business. Our gross written premium increased from $114.8 million in 1998 to $193.7 million in 2000. This growth reflects Houston Casualty's increased participation in, and the growth of, the business written by LDG Re. Net written premium in this area increased because Houston Casualty retained a larger percentage of the increased gross premium. 8 10 Medical Stop-loss We write medical stop-loss business for employer sponsored self-insured health plans. When measured on a gross written premium basis, medical stop-loss was our largest single line of business in 2000. Our underwriting agency subsidiary, HCC Benefits, produces and underwrites this business on behalf of our insurance companies. We first began writing this business in our insurance companies in 1997 and gross written premium and net written premium have increased as a result of greater participation by our insurance company subsidiaries, primarily HCC Life and Avemco Insurance. HCC Benefits' business has grown both internally and through acquisitions, most notably of Centris. HCC Benefits began underwriting this business in 1980. The 2000 gross written premium underwritten in our insurance company subsidiaries was $368.5 million and net written premium was $100.4 million. We maintain reinsurance on a proportional basis and believe that these risks carry a relatively low level of catastrophe exposure. Workers' Compensation and Alternative Workers' Compensation We began writing statutory workers' compensation business in 1998, primarily through U.S. Specialty. We also underwrite alternative workers' compensation and occupational accident insurance to independent truckers. As market conditions warrant, it is our intent to grow this line of business in the future, both internally and through acquisition. Losses in this line of business generally take longer to develop than in our other lines of business. We maintain reinsurance on both a proportional and excess of loss basis. There is a relatively low level of catastrophe exposure in our workers' compensation line of business because we do not write significant amounts of business in states with high potential claim concentrations such as California. Other Business Our other lines of business principally consist of discontinued operations or disposed of lines of business including provider excess, lender's single interest and small property and casualty business. Principal Insurance Company Subsidiaries HOUSTON CASUALTY COMPANY Houston Casualty is our principal insurance company subsidiary. It is rated "A+ (Superior), IX" by A.M. Best and "AA" by Standard & Poor's. Houston Casualty operates worldwide and is licensed in Texas and operates on a surplus lines basis in 46 states. Houston Casualty receives business through independent agents and brokers, our underwriting agency and intermediary subsidiaries, and other insurance and reinsurance companies. Houston Casualty has a highly experienced staff of underwriters trained to deal with the high value, complicated exposures prevailing in many of the lines of business in which we specialize. As of December 31, 2000, Houston Casualty's policyholders' surplus was $231.2 million, which is its total admitted assets less total liabilities determined in accordance with statutory accounting principles, or SAP. Houston Casualty's GAAP shareholder's equity was $317.4 million as of December 31, 2000. HOUSTON CASUALTY COMPANY -- LONDON Houston Casualty operates a full branch office in the United Kingdom. Houston Casualty established its London branch operation in order to more closely align its underwriting operations with the London market, a historical focal point for much of the business that Houston Casualty underwrites. Houston Casualty London underwrites accident and health reinsurance, marine and offshore energy and property business. HCC LIFE INSURANCE COMPANY HCC Life is an Indiana domiciled life insurance company which became a direct subsidiary of Houston Casualty in December, 1999 following the Centris acquisition. HCC Life is rated 9 11 "A - (Excellent), VII" by A.M. Best and operates as an accident, health and life insurer on an admitted basis in 41 states and the District of Columbia. As of December 31, 2000, HCC Life had statutory policyholders' surplus of $63.3 million and GAAP shareholder's equity of $80.3 million. U.S. SPECIALTY INSURANCE COMPANY U.S. Specialty is a Texas domiciled property and casualty insurance company. It is a direct subsidiary of Houston Casualty. U.S. Specialty is rated "A+ (Superior), VIII" by A.M. Best and "AA" by Standard & Poor's. U.S. Specialty operates on an admitted basis throughout the United States, primarily writing general aviation, workers' compensation and alternative workers' compensation insurance. As of December 31, 2000, U.S. Specialty had statutory policyholders' surplus of $106.1 million and GAAP shareholder's equity of $116.9 million. AVEMCO INSURANCE COMPANY Avemco Insurance is a Maryland domiciled property and casualty insurer, is rated "A+ (Superior), VII" by A.M. Best and "AA" by Standard & Poor's, and is operating as a direct market underwriter of general aviation business on an admitted basis throughout the United States and Canada (except Quebec). In addition, Avemco Insurance has become the primary insurer of medical stop-loss products produced and underwritten by HCC Benefits. As of December 31, 2000, Avemco Insurance had statutory policyholders' surplus of $85.9 million and GAAP shareholder's equity of $98.7 million. UNDERWRITING AGENCY OPERATIONS Our underwriting agencies act on behalf of our insurance companies and those of other firms, 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 management fees and profit commissions. These subsidiaries are in a position to direct and control business that they produce. Our insurance companies serve as policy issuing companies for most of the business written by our underwriting agencies. Our insurance companies may retain a portion of the risk and reinsure the remainder with unaffiliated insurance companies or reinsure all of the risk. In instances where our insurance companies are not the policy issuing company, our insurance companies may reinsure the business written by the underwriting agencies. Management fees generated by our underwriting agencies in 2000 amounted to $96.1 million. Lines of Business This table shows our underwriting agencies' written premium by lines of business for the periods indicated (dollars in thousands):
2000 1999 1998 ---------------- -------------- -------------- Accident and health reinsurance... $ 443,041 41% $452,017 53% $356,530 50% Aviation.......................... 92,412 9 91,156 11 92,668 13 Medical stop-loss................. 402,908 38 184,302 22 182,528 26 Workers' compensation and alternative workers' compensation.................... 97,877 9 106,758 12 52,529 8 Other............................. 37,313 3 13,883 2 21,932 3 ---------- --- -------- --- -------- --- Total premium........... $1,073,551 100% $848,116 100% $706,187 100% ========== === ======== === ======== ===
10 12 Underwriting Agency Subsidiaries LDG REINSURANCE CORPORATION LDG Re, with operations in Wakefield, Massachusetts and New York, New York, acts as an underwriting manager writing accident and health special risks, workers' compensation and alternative workers' compensation reinsurance. LDG Re generated approximately $355.6 million of written premium in 2000, the majority of which was written on behalf of non-affiliated insurance companies. HCC BENEFITS CORPORATION HCC Benefits, with its home office in Atlanta, Georgia and regional offices in Costa Mesa, California; Wakefield, Massachusetts; Minneapolis, Minnesota; and Dallas, Texas, acts as an underwriting manager writing medical stop-loss products for employer sponsored self-insured health plans. In 2000, HCC Benefits generated approximately $402.9 million of medical stop-loss written premium and $32.5 million of other written premium, the majority of which was underwritten on behalf of HCC Life and Avemco Insurance. OTHER AGENCY OPERATIONS We have recently consolidated certain of our underwriting agencies with certain of our insurance companies for the purpose of streamlining our business. We have consolidated the operations of our domestic general aviation underwriting agency, HCC Aviation, and our occupational accident and workers' compensation underwriting agency, HCC Employer Services, into U.S. Specialty and the operations of our London-based accident and health underwriting agency, LDG Re (London) with those of the London branch of Houston Casualty. INTERMEDIARY OPERATIONS Our intermediary subsidiaries provide a variety of services, including marketing, placing, consulting on and servicing insurance risks for their clients, which include medium to large corporations, insurance and reinsurance companies and other risk taking entities. The intermediary subsidiaries 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 company subsidiaries, which may retain a portion of the risk. Commission income generated by our intermediary subsidiaries in 2000 amounted to $42.5 million. HCC Employee Benefits, Inc. HCC Employee Benefits, based in Houston, Texas, is a retail insurance agency and consulting firm specializing in life, accident and health insurance for employee benefit plans of medium and large commercial customers throughout the United States. We acquired Schanen Consulting Corporation of Atlanta, Georgia in January 2001 and consolidated its operations with those of HCC Employee Benefits. HCC Intermediaries, Inc. HCC Intermediaries, based in Houston, Texas, is an intermediary specializing in marketing and servicing large, complicated insurance and reinsurance programs placed on behalf of multinational clients operating in our lines of business. This business is placed with domestic and international insurance companies, including our insurance companies, on a direct basis and through other intermediaries. In addition, HCC Intermediaries acts as a reinsurance intermediary on behalf of affiliated and non-affiliated insurance companies. Rattner Mackenzie Limited Rattner Mackenzie is an intermediary based in London, England. Rattner Mackenzie is a Lloyd's broker specializing in accident and health reinsurance and some specialty property and casualty lines of business. Rattner Mackenzie is considered a market leader in its core businesses. Rattner Mackenzie 11 13 serves as an intermediary for reinsurance business placed by unaffiliated insurance and reinsurance companies and underwriting agencies as well as our insurance company subsidiaries. OTHER OPERATIONS Our other operations provide insurance related services to our subsidiaries, our reinsurers and unaffiliated entities. The revenue earned from these services primarily consists of fees or commissions. The primary operating entities in this segment provide insurance claims adjusting services. Additionally, this revenue may be in the form of equity in the earnings of a company in which we invest, or dividends or gains or losses from the disposition of these investments. Other operating income was $25.5 million in 2000. Revenue and earnings can vary considerably from period to period depending on investment or disposition activity. REINSURANCE CEDED We purchase reinsurance to reduce our net liability on individual risks, to protect against catastrophe losses and to achieve a desired ratio of net written premium to policyholders' surplus. We purchase reinsurance on both a proportional and an excess of loss basis. We believe that we reinsure our risks to a greater extent than most of our competitors and most other insurance companies. We use this strategy to protect our shareholders' equity. Under our current reinsurance protections, we have limited our net retained loss, or the amount we keep for our own account, across any single line of business to a maximum of approximately $1.8 million for any one risk and $3.0 million for any one event, but significantly less on most risks. The type, cost and limits of reinsurance we purchase can vary from year to year based upon our desired retention levels and the availability of quality reinsurance at an acceptable price. Our reinsurance programs renew throughout the year and during 2001 some of those renewed contained price increases which are not material to our underwriting results. Additionally, we retained higher percentages of our business in connection with certain lines of business which are reinsured on a proportional basis. We plan to continue to increase our retentions as underwriting conditions improve. We consider the maintenance of reinsurance protection to be an important part of our business plan, protecting shareholders' equity from catastrophe losses and fluctuations in the insurance market cycles of the insurance industry. We have built important relationships over the years with many core reinsurers. We intend to continue to share our business with these partners as underwriting profitability returns in an improving market in order to build even stronger relationships for the future. We believe that increased retentions during profitable periods are made possible not at the sacrifice of core reinsurers but through reduction of facultative reinsurance and the natural attrition of certain reinsurers who exit lines of business or curtail their writings for other reasons. This reduction in reinsurance market capacity causes rates to rise but the increased rates historically have been passed on to the original insureds. We structure a specific reinsurance program for each line of business we underwrite. We place this reinsurance in order to protect our insurance companies from exposure to foreseeable events. We place reinsurance proportionally to cover loss frequency and catastrophe exposure. We obtain additional reinsurance on an excess of loss basis to cover individual risk severity of loss and on a catastrophe basis to cover exposure from occurrences involving multiple risks, such as those resulting from a hurricane or an earthquake. Additionally, we may also obtain facultative reinsurance protection on an excess of loss or proportionate basis on any single risk. We do not intend to expose our assets to any net loss in excess of our reinsurance protection. We write business in areas exposed to catastrophe losses and have exposures to this type of loss in California, the United States Atlantic Coast, certain United States Gulf Coast states, particularly Florida and Texas, the Caribbean, Mexico and the North Sea. We carefully assess our overall exposure to a single catastrophic event and apply procedures that are more conservative than are typically used by the industry to ascertain our probable maximum loss from any single event. We maintain reinsurance protection which we believe is sufficient to cover any foreseeable event. 12 14 In general, we receive an overriding (ceding) commission on the premium ceded to reinsurers. This compensates our insurance company 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 with the reinsurers in any net profits generated under such treaties. Various intermediaries, including HCC Intermediaries and Rattner Mackenzie, arrange for the placement of this reinsurance coverage on our behalf and are compensated, directly or indirectly, by the reinsurers. The table below shows property and casualty reinsurance balances relating to the reinsurers with net recoverable balances greater than $10.0 million as of December 31, 2000. The total recoverables column includes paid loss recoverable, outstanding loss recoverable, incurred but not reported recoverables and ceded unearned premium (dollars in thousands).
LETTERS OF CREDIT, A.M. BEST TOTAL CASH DEPOSITS AND REINSURER RATING LOCATION RECOVERABLES OTHER PAYABLES NET - --------- --------- -------------- ------------ ------------------ -------- December 31, 2000 Underwriters at Lloyd's............... A United Kingdom $220,849 $28,602 $192,247 GE Reinsurance Corporation............ A++ Illinois 38,152 4,881 33,271 AXA Reinsurance Company............... A+ Delaware 40,886 9,131 31,755 Underwriters Indemnity Company........ A- Texas 33,912 2,416 31,496 SCOR Reinsurance Company.............. A+ New York 28,419 734 27,685 American Re-Insurance Company......... A++ Delaware 23,487 2,249 21,238 Transamerica Occidental Life Ins. Co. ................................ A+ California 17,056 151 16,905 Federal Insurance Company............. A++ Indiana 21,185 6,708 14,477 St. Paul Fire and Marine Insurance Co. ................................ A+ Minnesota 14,290 -- 14,290 Odyssey America Reinsurance Corp. .... A Connecticut 24,602 11,741 12,861 American Fidelity Assurance Corp. .... A+ Oklahoma 21,745 10,680 11,065 NAC Reinsurance Company............... A+ New York 10,972 94 10,878 Chartwell Insurance Company........... A Minnesota 11,308 677 10,631
Lloyds of London is an insurance and reinsurance marketplace composed of many independent underwriting syndicates financially supported by a central trust fund. As of December 31, 2000, the net recoverable due from Underwriters at Lloyd's, aggregating $192.2 million, represented balances due from over 140 different syndicates; five of which each had a net recoverable balance in excess of $10.0 million. The largest net recoverable balance from an individual Lloyd's syndicate as of December 31, 2000 was $26.5 million. HCC Life previously sold its entire block of life insurance and annuity business to Life Reassurance Corporation of America (rated A++ by A.M. Best) in the form of an indemnity reinsurance contract. Ceded life and annuity benefits amounted to $86.8 million as of December 31, 2000. During 2000, a number of reinsurers have delayed or suspended the payment of amounts recoverable under certain reinsurance contracts to which we are a party. Such delays have affected, though not materially to date, the investment income of our insurance companies, but not to any extent their liquidity. We limit our liquidity exposure by holding funds, letters of credit or other security such that net balances due are significantly less than the gross balances shown in our consolidated balance sheets. In addition, a number of reinsurers have claimed they are not liable for payment to us and, in one or more cases, have sought arbitration of these matters. We believe these claims are without merit and expect to collect the full amount recoverable. We are currently in negotiations with most of these parties. If such negotiations do not result in a satisfactory resolution of the matters in question, we will seek a judicial or arbitral determination of these matters. During 1999, we recorded a provision for reinsurance totaling $29.5 million in connection with the insolvency of a reinsurer. We expect this provision to be sufficient. We also recorded a $14.0 million provision following a commutation (the contractual settlement of outstanding and future liabilities) with 13 15 another reinsurer, the majority of which represents the present value discount of ceded losses. Commutations are typical in the reinsurance community and should not be construed negatively. Commutations can be used to bring finality to an open contract or, as in this case, to negate any exposure to a reinsurer's financial condition. A discount is given for cash settlement of future losses and such discount is usually recovered by future investment income. However, GAAP requires that the discount be recorded at the time of the commutation. OPERATING RATIOS Premium to Surplus Ratio This table shows, for the years indicated, the ratio of statutory gross written premium and net written premium to statutory policyholders' surplus for our property and casualty insurance company subsidiaries (dollars in thousands):
2000 1999 1998 1997 1996 -------- -------- -------- -------- -------- GWP............................. $972,154 $576,184 $500,962 $346,094 $340,367 NWP............................. 283,947 150,261 123,315 143,068 189,022 Policyholders' surplus.......... 326,249 315,474 369,401 331,922 288,863 GWP ratio....................... 298.0% 182.6% 135.6% 104.3% 117.8% GWP industry average(1)......... * 154.1% 147.9% 154.7% 179.9% NWP ratio....................... 87.0% 47.6% 33.4% 43.1% 65.4% NWP industry average(1)......... * 85.5% 84.3% 89.7% 105.2%
- --------------- (1) Source: A.M. Best. * 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, or NAIC, provide that a property and casualty insurer's 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. In the past, our property and casualty insurance companies have maintained premium to surplus ratios significantly lower than such guidelines and generally below industry norms. The gross written premium ratio has increased during 2000 with the acquisition of Centris' book of medical stop-loss business and the increasing use of our insurance company subsidiaries as the issuing company for business written by our underwriting agencies. This ratio is expected to stabilize at or decrease from its 2000 level as statutory policyholders' surplus increases due to the retention of earnings and other increases in policyholders' surplus. 14 16 Statutory Combined Ratio The underwriting experience of a property and casualty insurance company is indicated by its SAP combined ratio, which is a combination of the loss ratio, or the ratio of insured losses and loss adjustment expenses to net earned premium, and the expense ratio, which is the ratio of policy acquisition costs and other underwriting expenses, net of ceding commissions, to net written premium. Our insurance subsidiaries' loss ratio, expense ratio and combined ratio are shown in the following table for the years indicated:
2000 1999 1998 1997 1996 ---- ----- ----- ----- ----- Loss ratio..................................... 71.1% 107.1% 67.2% 61.6% 64.4% Expense ratio.................................. 27.0 22.8 15.7 17.2 19.2 ---- ----- ----- ----- ----- Combined ratio................................. 98.1% 129.9% 82.9% 78.8% 83.6% ==== ===== ===== ===== ===== Combined ratio excluding the effects of the provision for reinsurance in 1999............ 104.1% ===== Industry average(1)............................ * 107.8% 105.6% 101.6% 105.7%
- --------------- (1) Source: A.M. Best. * Not available The SAP basis ratio data is not intended to be a substitute for results of operations on the basis of GAAP. The differences between SAP and GAAP are described in Note (15) of our consolidated financial statements included in this report. Including this information on a SAP basis is meaningful and 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. A.M. Best reports on insurer performance on a SAP basis to provide for more standardized comparisons among individual companies, as well as overall industry performance. RESERVES Applicable insurance laws require us to maintain reserves to cover our estimated ultimate liability for reported and incurred but not reported, or IBNR, losses under insurance and reinsurance policies that we wrote and for loss adjustment expenses relating to the investigation and settlement of policy claims. In most cases, we estimate such losses and claims costs through an evaluation of individual claims. However, for some types of claims, we use an average reserving method until more information becomes available to permit an evaluation of individual claims. We establish loss reserves for individual claims by evaluating reported claims on the basis of: - jurisdiction of the occurrence; - our experience with the insured and the line of business and policy provisions relating to the particular type of claim; - our knowledge of the circumstances surrounding the claim; - the information and reports received from ceding insurance companies where applicable; - the potential for ultimate exposure; - the severity of injury or damage; and - the type of loss. We establish loss reserves for incurred but not reported losses based in part on statistical information and in part on industry experience with respect to the probable number and nature of claims arising from occurrences that have not been reported. We also establish our reserves based on predictions of future 15 17 events, our estimates of future trends in claims severity, and other subjective factors. Currently all reserves are recorded on an undiscounted basis. The net GAAP and SAP reserves of each of our insurance companies are established in conjunction with and reviewed by our in-house actuarial staff, and our SAP reserves are certified annually by our independent actuaries. In 2000, PricewaterhouseCoopers LLP certified the SAP reserves of our insurance companies with the exception of one acquired with the Centris Group. This former Centris subsidiary's SAP reserves were certified by another independent actuary. With respect to some classes of risks, the period of time between the occurrence of an insured event and the final settlement of a claim may be many years, and during this period it often becomes necessary to adjust the claim estimates either upward or downward. Certain classes of marine and offshore energy and workers' compensation insurance underwritten by our insurance companies have historically had longer lead times between the occurrence of an insured event, reporting of the claim, and final settlement. In such cases, we are forced to estimate reserves over long periods of time with the possibility of several adjustments to reserves. Other classes of insurance that we underwrite, such as most aviation, property and medical stop-loss, historically have shorter lead times between the occurrence of an insured event, reporting of the claim and final settlement. The reserves with respect to these classes are, therefore, less likely to be adjusted. The majority of the risks currently underwritten by our insurance companies tend to have shorter lead times. 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. However, 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, directly and through reinsurance, risks which 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 earnings. We may attempt to limit our exposure to future currency fluctuations through the use of foreign currency forward contracts. The loss development triangles below show changes in our GAAP reserves in subsequent years from the prior loss estimates based on experience as of 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, the 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 as of 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, as of the date indicated, the difference between the latest re-estimated liability and the reserves as originally estimated. 16 18 This loss development triangle shows development in loss reserves on a gross basis (dollars in thousands):
2000 1999 1998 1997 1996 1995 1994 1993 1992 -------- -------- -------- -------- -------- -------- -------- -------- --------- Balance sheet reserves:..... $944,117 $871,104 $460,511 $275,008 $229,049 $200,756 $170,957 $144,178 $ 129,503 Reserve adjustments from acquisition and disposition of subsidiaries.............. -- 989 (136) -- -- -- -- -- -- -------- -------- -------- -------- -------- -------- -------- -------- --------- Adjusted reserves....... 944,117 872,093 460,375 275,008 229,049 200,756 170,957 144,178 129,503 Cumulative paid as of: One year later............ 424,379 229,746 160,324 119,453 118,656 97,580 82,538 83,574 Two years later........... 367,512 209,724 179,117 167,459 143,114 126,290 130,379 Three years later......... 241,523 193,872 207,191 166,541 157,509 158,973 Four years later.......... 212,097 214,046 192,540 176,472 182,193 Five years later.......... 226,762 195,930 195,269 192,512 Six years later........... 202,844 197,147 213,052 Seven years later......... 203,075 215,280 Eight years later......... 221,403 Re-estimated liability as of: End of year............... 944,117 872,093 460,375 275,008 229,049 200,756 170,957 144,178 129,503 One year later............ 870,201 550,409 308,501 252,236 243,259 186,898 163,967 162,827 Two years later........... 545,955 316,250 249,013 248,372 207,511 183,015 176,817 Three years later......... 304,281 250,817 247,053 214,738 203,137 194,419 Four years later.......... 247,245 248,687 220,695 211,546 215,531 Five years later.......... 248,559 217,892 218,182 222,746 Six years later........... 219,196 214,498 234,115 Seven years later......... 216,820 231,269 Eight years later......... 233,995 Cumulative redundancy (deficiency).............. $ 1,892 $(85,580) $(29,273) $(18,196) $(47,803) $(48,239) $(72,640) $(104,492)
The gross deficiencies reflected in the table for the years prior to 1999 result from three principal conditions: - The development of large claims on individual policies which were either reported late or for which reserves were increased as subsequent information became available. However, as these policies were substantially reinsured, there was no material effect to our net earnings. - During 1999, in connection with the insolvency of one of our reinsurers 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. - For the years prior to 1997, the runoff of the retrocessional excess of loss business, which we underwrote between 1988 and 1991, experienced gross development. This development was due primarily to the delay in reporting of losses by the London insurance market, coupled with the unprecedented number of catastrophe losses during that period. This business was substantially reinsured and there was no material effect to our net earnings. 17 19 This loss development triangle shows development in loss reserves on a net basis (dollars in thousands):
2000 1999 1998 1997 1996 1995 1994 1993 1992 -------- -------- -------- -------- -------- -------- -------- -------- -------- Gross reserves.................. $944,117 $871,104 $460,511 $275,008 $229,049 $200,756 $170,957 $144,178 $129,503 Less reinsurance recoverables... 694,245 597,498 341,599 155,374 111,766 101,497 95,279 82,289 81,075 -------- -------- -------- -------- -------- -------- -------- -------- -------- Reserves, net of reinsurance.... 249,872 273,606 118,912 119,634 117,283 99,259 75,678 61,889 48,428 Reserve adjustments from acquisition and disposition of subsidiaries.................. -- 440 (410) -- -- -- -- -- -- Effect on loss reserves of 1999 write off of reinsurance recoverables.................. -- -- 63,851 15,008 2,636 1,442 51 -- -- -------- -------- -------- -------- -------- -------- -------- -------- -------- Adjusted reserves, net of reinsurance................... 249,872 274,046 182,353 134,642 119,919 100,701 75,729 61,889 48,428 Cumulative paid, net of reinsurance, as of: One year later................ 145,993 56,052 48,775 47,874 41,947 36,500 29,258 18,978 Two years later............... 103,580 64,213 66,030 56,803 49,283 41,207 32,733 Three years later............. 80,227 72,863 64,798 56,919 46,576 36,536 Four years later.............. 81,620 67,355 60,441 51,536 38,480 Five years later.............. 72,627 61,781 53,110 40,327 Six years later............... 66,591 53,879 40,550 Seven years later............. 58,353 41,133 Eight years later............. 45,552 Nine years later.............. Ten years later............... Re-estimated liability, net of reinsurance, as of: End of year................... 249,872 274,046 182,353 134,642 119,919 100,701 75,729 61,889 48,428 One year later................ 264,461 186,967 120,049 116,145 95,764 72,963 59,659 45,812 Two years later............... 175,339 116,745 101,595 94,992 74,887 60,079 44,964 Three years later............. 110,673 97,353 85,484 76,474 62,224 46,129 Four years later.............. 95,118 80,890 73,660 64,377 48,993 Five years later.............. 79,626 69,528 64,103 50,785 Six years later............... 70,642 59,408 50,585 Seven years later............. 60,960 46,071 Eight years later............. 47,629 Nine years later.............. Ten years later............... Cumulative redundancy (deficiency).................. $ 9,585 $ 7,014 $ 23,969 $ 24,801 $ 21,075 $ 5,087 $ 929 $ 799 1991 1990 -------- -------- Gross reserves.................. $123,248 $108,027 Less reinsurance recoverables... 83,727 60,194 -------- -------- Reserves, net of reinsurance.... 39,521 47,833 Reserve adjustments from acquisition and disposition of subsidiaries.................. -- -- Effect on loss reserves of 1999 write off of reinsurance recoverables.................. -- -- -------- -------- Adjusted reserves, net of reinsurance................... 39,521 47,833 Cumulative paid, net of reinsurance, as of: One year later................ 18,416 23,450 Two years later............... 23,057 33,815 Three years later............. 31,903 35,912 Four years later.............. 33,875 42,465 Five years later.............. 34,970 43,422 Six years later............... 36,203 43,690 Seven years later............. 35,413 44,611 Eight years later............. 35,960 43,715 Nine years later.............. 39,770 44,203 Ten years later............... 45,358 Re-estimated liability, net of reinsurance, as of: End of year................... 39,521 47,833 One year later................ 38,575 44,887 Two years later............... 38,656 45,435 Three years later............. 39,176 44,689 Four years later.............. 40,407 45,507 Five years later.............. 43,418 46,805 Six years later............... 45,142 48,932 Seven years later............. 43,924 50,190 Eight years later............. 39,858 49,732 Nine years later.............. 41,513 47,422 Ten years later............... 46,818 Cumulative redundancy (deficiency).................. $ (1,992) $ 1,015
We believe that our loss reserves are adequate to provide for all material net incurred losses. 18 20 The following table provides a reconciliation of the gross liability of loss and loss adjustment expenses, or LAE, on a GAAP basis for the three years ended December 31, 2000 (dollars in thousands):
2000 1999 1998 -------- -------- -------- Reserves for loss and LAE at beginning of year....... $871,104 $460,511 $275,008 Reserve adjustments from acquisition and disposition of subsidiaries.................................... 1,709 146,233 3,877 Provision for loss and LAE for claims occurring In the current year................................... 775,538 595,425 461,429 Increase in estimated loss and LAE for claims occurring in prior years(1)........................ (1,892) 90,034 33,493 -------- -------- -------- Incurred loss and LAE................................ 773,646 685,459 494,922 -------- -------- -------- Loss and LAE payments for claims occurring during: Current year....................................... 277,963 191,353 152,972 Prior years........................................ 424,379 229,746 160,324 -------- -------- -------- Loss and LAE payments................................ 702,342 421,099 313,296 -------- -------- -------- Reserves for loss and LAE at end of the year......... $944,117 $871,104 $460,511 ======== ======== ========
- --------------- (1) Changes in loss and loss adjustment expense reserves on a GAAP basis, 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. This table provides a reconciliation of the liability for loss and loss adjustment expense, net of reinsurance ceded, on a GAAP basis for the periods indicated (dollars in thousands):
2000 1999 1998 -------- -------- -------- Reserves for loss and LAE at beginning of year....... $273,606 $118,912 $119,634 Reserve adjustments from acquisition and disposition of subsidiaries.................................... 514 55,523 3,877 Effect on loss reserves of write off of ceded outstanding and IBNR reinsurance recoverables...... -- 82,343 -- Provision for loss and LAE for claims occurring In the current year................................... 208,055 105,036 105,895 Increase (decrease) in estimated loss and LAE for claims occurring in prior years(2)................. (9,585) 4,614 (14,593) -------- -------- -------- Incurred loss and LAE................................ 198,470 109,650 91,302 -------- -------- -------- Loss and LAE payments for claims occurring during: Current year....................................... 76,725 36,770 47,126 Prior years........................................ 145,993 56,052 48,775 -------- -------- -------- Loss and LAE payments................................ 222,718 92,822 95,901 -------- -------- -------- Reserves for loss and LAE at end of the year......... $249,872 $273,606 $118,912 ======== ======== ========
- --------------- (2) Changes in loss and loss adjustment expense reserves on a GAAP basis, 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. Although we experienced a gross loss deficiency during 1999 and 1998, the business was substantially reinsured and, therefore, there was no material effect to our insurance companies on a net loss basis. During 2000, we had net loss and loss adjustment expense redundancy of $9.6 million relating to prior year losses compared to a deficiency of $4.6 million in 1999 and a redundancy of $14.6 million in 1998. 19 21 The deficiencies and redundancies in the net reserves result from our continued review with our actuaries of loss reserves and the increase or reduction of reserves 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 environmental pollution losses, because Houston Casualty 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 HCC Life, Avemco Insurance and U.S. Specialty, because of the types of risks insured, are not considered to have significant environmental exposures. We do not expect to experience any material development in reserves for environmental pollution claims. INVESTMENTS Insurance company investments must comply with applicable 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, corporate bonds, and preferred and common equity securities. As of December 31, 2000, we had $710.3 million of investment assets. The majority of our investment assets are held by our insurance companies. All of our 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 Committee and is reviewed on a regular basis. In January, 2000, we engaged a nationally prominent investment advisor, New England Asset Management, a subsidiary of Berkshire Hathaway, Inc., to oversee our investments and to make recommendations to our Board's Investment Committee. Although we generally intend to hold fixed income securities to maturity, we regularly re-evaluate our position based upon market conditions. Beginning in the second quarter of 2000, our purchases have been focused on taxable fixed income investments. These purchases have had no significant effect on the average credit rating of our investments, but have shortened the duration of our investment portfolio. Prior to that time our investments were concentrated in obligations of states, municipalities and political subdivisions. As of December 31, 2000, our fixed income securities have a weighted average maturity of five years and a weighted average duration of four years. Our financial statements reflect an unrealized gain on fixed income securities available for sale as of December 31, 2000, of $11.0 million. We have maintained a substantial level of cash and liquid short-term instruments in our insurance company subsidiaries in order to maintain the ability to fund losses of our insureds. Our underwriting agencies and intermediaries typically have short-term investments, which are fiduciary funds held on behalf of others. As of December 31, 2000, we had cash and short-term investments of approximately $263.3 million, of which $181.5 million were in our agency and intermediary subsidiaries. This table shows a profile of our investments. The table shows the average amount of investments, income earned, and the yield thereon for the periods indicated (dollars in thousands):
2000 1999 1998 -------- -------- -------- Average investments.................................. $618,478 $545,876 $505,796 Net investment income................................ 39,794 30,933 29,335 Average yield(1)..................................... 6.4% 5.7% 5.8% Average tax equivalent yield(1)...................... 7.3% 7.2% 7.6%
- --------------- (1) Excluding realized and unrealized capital gains and losses. 20 22 This table summarizes, by type, the estimated market value of our investments as of December 31, 2000 (dollars in thousands):
AMOUNT PERCENT OF TOTAL -------- ---------------- Short-term investments...................................... $262,982 37% U.S. Treasury securities.................................... 72,612 10 Obligations of states, municipalities and political subdivisions.............................................. 62,506 9 Special revenue fixed income securities..................... 146,809 21 Corporate fixed income securities........................... 103,700 14 Mortgage-backed securities.................................. 40,792 6 Foreign government securities............................... 7,425 1 Marketable equity securities................................ 6,282 1 Other investments........................................... 7,182 1 -------- --- Total investments................................. $710,290 100% ======== ===
This table summarizes, by rating, the market value of our investments in fixed income securities as of December 31, 2000 (dollars in thousands):
AMOUNT PERCENT OF TOTAL -------- ---------------- AAA......................................................... $207,021 48% AA.......................................................... 108,448 25 A........................................................... 115,377 26 BBB......................................................... 2,998 1 -------- --- Total fixed income securities..................... $433,844 100% ======== ===
The table set forth below indicates the expected maturity distribution of the estimated market value of the Company's fixed income securities as of December 31, 2000 (dollars in thousands):
AMOUNT PERCENT OF TOTAL -------- ---------------- One year or less............................................ $ 28,366 7% One year to five years...................................... 166,001 38 Five years to ten years..................................... 85,391 20 Ten years to fifteen years.................................. 60,987 14 More than fifteen years..................................... 52,307 12 -------- --- Securities with fixed maturities.................. 393,052 91 Mortgage-backed securities.................................. 40,792 9 -------- --- Total fixed income securities..................... $433,844 100% ======== ===
The weighted average life of our mortgage-backed securities is four years. The value of our portfolio of fixed income securities is inversely correlated to changes in market interest rates. In addition, some of our fixed income securities have call or prepayment options. This could subject us to a reinvestment risk should interest rates fall or issuers call their securities and we are forced to invest the proceeds at lower interest rates. We mitigate this risk by investing in securities with varied maturity dates, so that only a portion of the portfolio will mature at any point in time. BANK LOAN On December 17, 1999, we entered into a $300.0 million Revolving Loan Facility with a group of banks. We can borrow up to $300.0 million under the facility on a revolving basis until it expires on December 18, 2004. Outstanding advances bear interest at agreed upon rates. The facility is collateralized in part by the pledge of the stock of Houston Casualty and Avemco Insurance and by the stock of and guarantees entered into by our principal underwriting agency and intermediary subsidiaries. The facility 21 23 agreement contains certain restrictive covenants, including minimum net worth requirements for us and certain of our subsidiaries, restrictions on certain extraordinary corporate actions, notice requirements for certain material occurrences, and required maintenance of specified financial ratios. We believe that the restrictive covenants and our obligations that are contained in the facility agreement are typical for financing arrangements comparable to our facility. As of December 31, 2000, total debt outstanding under the facility was $207.5 million and the weighted average interest rate was 8.18%. During March 2001, we reduced debt outstanding under the facility to $55.0 million using the proceeds from our recent public stock offering. 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. However, a form of federal financial services modernization legislation enacted in 1999 is expected to result in additional federal regulation of the insurance industry. 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 will determine to directly regulate the business of insurance has not been determined by lawmakers. Also, various foreign governments regulate our international operations. 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, in common with other insurers, 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. The regulation and supervision of our insurance operations relates primarily to: - approval of policy forms and premium rates; - licensing of insurers and their agents; - periodic examinations of our operations and finances; - prescribing the form and content of records of financial condition required to be filed; - requiring deposits for the benefit of policyholders; - requiring certain methods of accounting; - requiring reserves for unearned premium, losses and other purposes; - restrictions on the ability of our insurance companies to pay dividends to us; - restrictions on the nature, quality and concentration of investments; - restrictions on transactions between insurance companies and their affiliates; - restrictions on the size of risks insurable under a single policy; and - standards of solvency, including risk-based capital measurements. 22 24 In general, 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 which 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. Houston Casualty is domiciled in Texas. It operates on an admitted basis in Texas and may write reinsurance on all lines of business that it may write on a direct basis. Houston Casualty is an accredited reinsurer in 35 states and an approved surplus lines insurer or is otherwise permitted to write surplus lines insurance in 46 states, three United States territories and the District of Columbia. When a reinsurer obtains accreditation from a particular state, insurers within that state are permitted to obtain statutory credit for risks ceded to the reinsurer. Surplus lines insurance is offered by non-admitted companies on risks which are not insured 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 follow specific state laws prior to placing a risk with a surplus lines insurer. Houston Casualty operates a branch office in London, England which is subject to regulation by regulatory authorities in the United Kingdom. Avemco Insurance is domiciled in Maryland and operates as a licensed admitted insurer in all states, the District of Columbia, and all Canadian provinces except Quebec. U.S. Specialty is domiciled in Texas and operates as a licensed admitted insurer in all states and the District of Columbia. HCC Life is domiciled in Indiana, and operates as a licensed admitted insurer in 41 states and the District of Columbia. 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 to the payment of dividends above a specified level. Dividends in excess of those thresholds are "extraordinary dividends" and subject to prior regulatory approval. Underwriting Agencies and Intermediaries In addition to the regulation of insurance companies, the states impose licensing and other requirements on the insurance agency and service operations of our other subsidiaries. These regulations relate primarily to: - advertising and business practice rules; - contractual requirements; - financial security - licensing as agents, brokers, intermediaries, managing general agents or third party administrators; - limitations on authority; and - recordkeeping requirements.. The manner of operating our underwriting agency and intermediary activities in particular states may vary according to the licensing requirements of the particular state, which may require, among other things, that we operate in the state through a local corporation. In a few states, licenses are issued only to individual residents or locally-owned business entities. In such cases, we may have arrangements with residents or business entities licensed to act in the state. 23 25 Statutory Accounting Principles The principal differences between statutory accounting principles, or SAP, and generally accepted accounting principles, or GAAP, the method by which we report our financial results to our shareholders in accordance with SEC requirements, are: - a liability is recorded for certain reinsurance recoverables under SAP, whereas under GAAP there is no such provision unless the recoverables are deemed to be not collectible. - certain assets which are considered "non-admitted assets" are eliminated from a balance sheet prepared in accordance with SAP but are included in a balance sheet prepared in accordance with GAAP; - certain reserves are recognized under SAP but not under GAAP; - deferred taxes are not provided under SAP; - fixed-income investments classified as available for sale are recorded at market value for GAAP and at amortized cost under SAP; - reinsurance balances are recorded on a gross basis under GAAP and on a net basis under SAP; and - under SAP, policy acquisition costs are expensed as incurred and under GAAP such costs are deferred and amortized to expense as the related premium is earned. The NAIC adopted Statements of Statutory Accounting Principles in March, 1998 as a product of its attempt to codify statutory accounting principles. Although subject to adoption by the individual states, an effective date of January 1, 2001 was established for implementation of the statements. Prior to the codification project, a comprehensive guide to statutory accounting principles did not exist. Codification is new and will evolve over time. The cumulative effect of codification is expected to increase statutory policyholders' surplus of our insurance company subsidiaries by approximately $6.0 million. We expect that the statutory surplus of our insurance companies after adoption will continue to be in excess of their regulatory risk-based capital requirements. Insurance Holding Company Acts Because we are an insurance holding company, we are subject to the insurance holding company system regulatory requirements of the states of Arkansas, California, Indiana, Maryland, Pennsylvania and Texas. 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. Risk-Based Capital The NAIC 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 a company's business and assets. It is designed to identify companies with the capital levels that may require regulatory attention. As of December 31, 2000, each of our domestic insurance company subsidiaries' total adjusted capital is significantly in excess of the NAIC authorized control level risk-based capital. Insurance Regulatory Information System The NAIC has also 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 insurer's financial 24 26 condition and stability. Our insurance company subsidiaries Insurance Regulatory Information System ratios generally fall within the usual prescribed ranges except in satisfactorily explainable circumstances such as when there is a large reinsurance transaction, capital change, merger or planned growth. Pending or Proposed Legislation 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 NAIC, which seeks to promote uniformity of, and to enhance the state regulation of, insurance. In addition, the NAIC and state insurance regulators, as part of the NAIC's 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 current 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 will have significant implications on the banking, insurance and securities industries and could result in more cross-industry consolidations among banks, insurance companies and securities firms and increased competition in many of the areas of our operations. It also mandated the adoption of laws allowing reciprocity among the states in the licensing of agents and the adoption of laws and regulations dealing with the protection of the privacy of policyholder information. Also, the federal government has conducted investigations of the current condition of the insurance industry in the United States to determine whether to impose overall federal regulation of insurers. In the past several years there have been a number of recommendations that the industry's anti-trust exemption be removed and the industry placed under federal regulation. If so, we believe state regulation of the insurance business would likely continue. This could result in an additional layer of federal regulation. 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 its results of operations. EMPLOYEES As of December 31, 2000, we had 958 employees. The employees include five executive officers, 19 senior management, 78 management and 856 other personnel. Of this number, 168 are employed by our insurance company subsidiaries, 521 are employed by our underwriting agency subsidiaries, 116 are employed by our intermediary subsidiaries, 69 are employed by our insurance services subsidiaries and 84 are employed at the corporate headquarters and elsewhere. With the restructuring of certain agency operations, 214 employees will move from the agency segment to the insurance company segment in 2001. 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. 25 27 ITEM 2. PROPERTIES Our principal and executive offices are located in Houston, Texas, in an approximately 51,000 square foot building owned by Houston Casualty. Houston Casualty also owns a 77,000 square foot building adjacent to its home office building. We also maintain offices in over 30 locations elsewhere in the United States and England. The majority of these additional locations are in leased facilities. Besides our home office, our principal office facilities are as follows:
SUBSIDIARY LOCATION SQ. FT. LEASE TERMINATION DATE - ---------- -------- ------- ---------------------- Avemco Insurance Frederick, Maryland 40,000 Owned U.S. Specialty Aviation Division Dallas, Texas 40,000 March 31, 2004 HCC Benefits Costa Mesa, California 22,000 March 31, 2007 Atlanta, Georgia 21,000 January 31, 2006 HCC Employee Benefits Houston, Texas 20,000 August 31, 2001 U.S. Specialty Workers' Compensation Division Northbrook, Illinois 19,000 April 1, 2005 LDG Re Wakefield, Massachusetts 34,000 October 31, 2001 Rattner Mackenzie London, England 15,000 September 29, 2003
ITEM 3. LEGAL PROCEEDINGS We are party to numerous lawsuits and other proceedings that arise in the normal course of our business. Many of such lawsuits 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 and other proceedings which relate to disputes over contractual relationships with third parties, or which involve alleged errors and omissions on the part of our subsidiaries. We believe the resolution of any such lawsuits will not have a material adverse effect on our financial condition, results of operations or cash flows. 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 2000. 26 28 PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS 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 during the period January 1, 1999 through December 31, 2000, as reported by the New York Stock Exchange were as follows:
2000 1999 --------------- --------------- HIGH LOW HIGH LOW ------ ------ ------ ------ First quarter...................................... $15.00 $11.50 $21.44 $16.00 Second quarter..................................... 19.69 10.94 22.69 17.94 Third quarter...................................... 22.94 18.69 25.13 13.88 Fourth quarter..................................... 27.19 17.63 16.69 8.00
On March 16, 2001, the last reported sales price of our common stock as reported by the New York Stock Exchange was $24.55. SHAREHOLDERS We have one class of authorized capital stock: 250,000,000 shares of common stock, par value $1.00 per share. As of March 16, 2001, there were 58,697,666 shares of issued and outstanding common stock held by 1,028 shareholders of record; however, we believe there are in excess of 15,000 beneficial owners. DIVIDEND POLICY Beginning in June, 1996, we announced a planned quarterly program of paying cash dividends to shareholders. We paid a cash dividend of $0.02 per share in July, 1996 and in each succeeding quarter through the first quarter of 1997. We have increased the quarterly cash dividend in each year and beginning in October, 2000, our quarterly dividend was $0.06 per share. 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, we are prohibited from paying dividends in excess of an agreed upon maximum amount in any fiscal year. That limitation should not affect our ability to pay dividends in a manner consistent with our past practice and current expectations. 27 29 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 Management's Discussion and Analysis of Financial Condition and Results of Operations included elsewhere in this Report.
FOR THE YEARS ENDED DECEMBER 31, (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) (1) ---------------------------------------------------- 2000 1999 1998 1997 1996 -------- -------- -------- -------- -------- STATEMENT OF EARNINGS DATA Revenue Net earned premium.................... $267,647 $141,362 $143,100 $162,571 $170,068 Management fees....................... 96,058 90,713 74,045 51,039 28,651 Commission income..................... 42,492 54,552 38,441 24,209 21,477 Net investment income................. 39,794 30,933 29,335 27,587 23,593 Net realized investment gain (loss)... (5,321) (4,164) 845 (328) 8,341 Other operating income................ 25,497 28,475 22,268 15,239 18,656 -------- -------- -------- -------- -------- Total revenue................. 466,167 341,871 308,034 280,317 270,786 Expense Loss and LAE.......................... 198,470 109,650 91,302 96,514 114,464 Operating expense Policy acquisition costs, net...... 23,743 8,177 10,978 13,580 8,218 Compensation expense............... 78,446 77,488 56,077 51,458 42,102 Provision for reinsurance.......... -- 43,462 -- -- -- Other operating expense............ 52,515 52,736 36,063 31,628 26,382 Merger expense..................... -- -- 107 8,069 26,160 -------- -------- -------- -------- -------- Total operating expense....... 154,704 181,863 103,225 104,735 102,862 Interest expense...................... 20,347 12,964 6,021 6,004 4,993 -------- -------- -------- -------- -------- Total expense................. 373,521 304,477 200,548 207,253 222,319 -------- -------- -------- -------- -------- Earnings before income tax provision.......................... 92,646 37,394 107,486 73,064 48,467 Income tax provision.................. 37,202 12,271 35,208 23,305 9,885 -------- -------- -------- -------- -------- Net earnings before accounting change........................... 55,444 25,123 72,278 49,759 38,582 Cumulative effect of accounting change................................ (2,013) -- -- -- -- -------- -------- -------- -------- -------- Net Earnings....................... $ 53,431 $ 25,123 $ 72,278 $ 49,759 $ 38,582 ======== ======== ======== ======== ======== BASIC EARNINGS PER SHARE DATA: Earnings before accounting change..... $ 1.11 $ 0.51 $ 1.51 $ 1.06 $ 0.86 Cumulative effect of accounting change............................. (0.04) -- -- -- -- -------- -------- -------- -------- -------- Net Earnings.......................... $ 1.07 $ 0.51 $ 1.51 $ 1.06 $ 0.86 ======== ======== ======== ======== ======== Weighted average shares outstanding... 49,745 49,061 47,920 46,995 44,795 ======== ======== ======== ======== ======== DILUTED EARNINGS PER SHARE DATA: Earnings before accounting change..... $ 1.10 $ 0.51 $ 1.48 $ 1.03 $ 0.84 Cumulative effect of accounting change............................. (0.04) -- -- -- -- -------- -------- -------- -------- -------- Net Earnings.......................... $ 1.06 $ 0.51 $ 1.48 $ 1.03 $ 0.84 ======== ======== ======== ======== ======== Weighted average shares outstanding... 50,622 49,649 48,936 48,209 46,043 ======== ======== ======== ======== ======== Cash dividends declared, per share...... $ 0.22 $ 0.20 $ 0.16 $ 0.12 $ 0.06 ======== ======== ======== ======== ========
28 30
DECEMBER 31, (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) --------------------------------------------------------------------------- PRO FORMA(3) 2000 2000 1999 1998 1997 1996 ------------ ---------- ---------- ---------- ---------- -------- (UNAUDITED) BALANCE SHEET DATA: Total investments......... $ 710,626 $ 710,290 $ 581,322 $ 525,646 $ 518,772 $468,725 Premium, claims and other receivables............. 562,868 562,868 622,087 382,630 252,618 168,300 Reinsurance recoverables............ 789,412 789,412 736,485 372,672 176,965 132,328 Ceded unearned premium.... 114,469 114,469 133,657 149,568 84,610 71,758 Goodwill.................. 266,015 266,015 263,687 88,043 34,758 10,922 Total assets......... 2,743,312 2,742,976 2,664,724 1,709,069 1,198,132 965,793 Loss and LAE payable...... 944,117 944,117 871,104 460,511 275,008 229,049 Unearned premium.......... 190,550 190,550 188,524 201,050 152,094 156,268 Notes payable............. 59,633 212,133 242,546 121,600 80,750 72,917 Shareholders' equity...... 682,271 529,435 457,428 439,863 365,601 296,524 Book value per share(2)... 11.86 10.46 9.29 9.12 7.66 6.49
- --------------- (1) Certain amounts in the 1999, 1998, 1997, and 1996 selected consolidated financial data have been reclassified to conform to the 2000 presentation. Such reclassifications had no effect on the Company's net earnings, shareholders' equity, or cash flows. (2) Book value per share is calculated by dividing the sum of shares outstanding plus contractually issuable shares into total shareholders' equity. (3) During March 2001, we sold 6.9 million shares of our Common Stock in a public offering at a price of $23.35 per share. Most of the net proceeds of approximately $152.8 million was used to pay down our notes payable. The unaudited pro forma balance sheet data shows the effect of the transactions as if they had occurred December 31, 2000. 29 31 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW We primarily receive our revenue from earned premium from derived from our insurance company operations, management fees generated by our underwriting agency operations, commission income produced by our intermediary operations, investment income from all of our operations and capital and other operating income. Our core underwriting activities involve providing accident and health reinsurance and aviation, marine and offshore energy, medical stop-loss, property and workers' compensation insurance, each of which is marketed either directly to customers or through a network of independent or affiliated agents and brokers. During the past several years, we have substantially increased our shareholders' equity through the issuance of equity securities and through our retained earnings, thereby enabling us to increase the underwriting capacity of our insurance companies. With this additional equity, we increased underwriting activity across many of our core lines of business, emphasizing lines of business and individual opportunities with the most favorable underwriting characteristics at a particular point in the insurance cycle. As an insurer, we also purchase reinsurance for each of our lines of business. We purchase different types of reinsurance in amounts we consider appropriate for each of our lines of business based upon market conditions and the level of risk we wish to retain. During 1999 and 2000, our underwriting agencies underwrote aviation, medical stop-loss, occupational accident and workers' compensation insurance and a variety of accident and health related insurance and reinsurance products on behalf of our insurance companies and unaffiliated insurance companies. Our underwriting agency activities are fee based and non-risk bearing. Effective January 1, 2001, in conjunction with the expansion of underwriting activities by our insurance companies and in an effort to streamline certain of our operations, we consolidated the operations of certain of our agency operations, with those of certain of our insurance companies. We have consolidated the operations of our domestic general aviation underwriting agency, HCC Aviation, and our occupational accident and workers' compensation underwriting agency, HCC Employer Services, with those of U.S. Specialty, and the operations of our London-based accident and health reinsurance underwriting agency subsidiary, LDG Re (London), with those of the London branch of Houston Casualty. These consolidations will result in a reduction in management fee income and the net earnings from our underwriting agency segment, but such reduction will be more than offset over time by increases in net earnings of our insurance company segment. The cost of this restructuring was $1.0 million (after-tax) and was recorded in the fourth quarter of 2000. A total of 26 employees were or will be terminated as a result of this consolidation. As market conditions warrant, we anticipate reviewing our other agency operations to determine if similar consolidation activities will provide greater operating efficiencies. Our intermediaries are fee based, non-risk bearing and place reinsurance for our insurance companies and underwriting agencies and for other non-affiliated insurance companies and risk taking entities, as well as insurance on behalf of medium and large corporate clients. Other operating income is generated through our insurance services operations, which support our own operations as well as provide services for other clients. Additionally, other operating income may include the equity in the earnings of a company in which we invest, dividends or gains or losses from the disposition of these investments. From 1998 through 2000, in response to adverse market conditions, we focused our acquisition activities on expanding our underwriting agency and intermediary operations for three principal reasons: - to increase the management fees and commission income components of our total revenue, which we believed were a more predictable and stable source of revenue than the potential underwriting gain from insurance company operations during periods of overly competitive pricing; 30 32 - to insulate our Company from a decline in our revenue growth rate as insurance premium rates became more competitive in our specialty lines of business and we became more selective in our underwriting, resulting in reduced earned premium; - to provide a future source of premium revenue to our insurance companies and greater control of premium distribution channels. In 1999, due to a reduction in reinsurance capacity, rates began to increase, particularly in the accident and health reinsurance, general aviation and medical stop-loss lines of business. Market conditions continued to improve in 2000 and we anticipate further improvement in 2001. In response to these changing market conditions, we plan to continue to expand these underwriting activities in our insurance companies and in our other lines of business as they also improve. During December, 1999, we acquired all of the outstanding shares of The Centris Group, Inc. in a transaction accounted for using the purchase method of accounting. Therefore, the results of operations and cash flows of Centris are included in the condensed consolidated statements of earnings and cash flows for the twelve months ended December 31, 2000, but are not included in the condensed consolidated statement of earnings and cash flows for the twelve months ended December 31, 1999 and earlier periods. Centris was the parent corporation of a group of insurance companies and underwriting agencies principally operating in the medical stop-loss line of business. Centris' primary insurance company subsidiary was the entity now known as HCC Life Insurance Company. Following the acquisition, HCC Life's operations were relocated to Houston, and it became a subsidiary of Houston Casualty. Centris' medical stop-loss underwriting agency operations have been combined with HCC Benefits' operations. Since the date of the acquisition, the premium rates for medical stop-loss have increased substantially and the loss ratio has greatly improved for the 2000 business underwritten by the combined operations. In connection with the integration of Centris' operations with our own, we took a restructuring charge, which was accrued at the date of acquisition. From 1992 through 1999, our employee count had grown from less than 100 to more than 1,000. In the fourth quarter of 1999, we determined, based upon a review of our operations, that our operating efficiency and profitability could be enhanced principally by reducing the employee count in certain operations. We therefore implemented a restructuring plan which resulted in the termination of 92 of our employees during 1999. This restructuring resulted in a decreased level of operating expenses in 2000 for the operating entities affected. RESULTS OF OPERATIONS The following table sets forth certain premium revenue information for the three years ended December 31, 2000 (dollars in thousands):
2000 1999 1998 --------- --------- --------- Direct............................................ $ 676,730 $ 291,513 $ 228,629 Reinsurance assumed............................... 290,727 276,818 269,647 --------- --------- --------- Gross written premium........................... 967,457 568,331 498,276 Reinsurance ceded................................. (683,669) (428,407) (376,393) --------- --------- --------- Net written premium............................. 283,788 139,924 121,883 Change in unearned premium........................ (16,141) 1,438 21,217 --------- --------- --------- Net earned premium.............................. $ 267,647 $ 141,362 $ 143,100 ========= ========= =========
31 33 The following table sets forth the relationships of certain income statement items as a percent of total revenue for the three years ended December 31, 2000:
2000 1999 1998 ----- ----- ----- Net earned premium.......................................... 57.4% 41.4% 46.5% Management fees............................................. 20.6 26.5 24.0 Commission income........................................... 9.1 16.0 12.5 Net investment income....................................... 8.5 9.0 9.5 Net realized investment gain (loss)......................... (1.1) (1.2) 0.3 Other operating income...................................... 5.5 8.3 7.2 ----- ----- ----- Total revenue..................................... 100.0 100.0 100.0 Loss and LAE................................................ 42.6 32.1 29.6 Net operating expense *..................................... 33.2 53.2 33.5 Interest expense............................................ 4.3 3.8 2.0 ----- ----- ----- Earnings before income tax provision.............. 19.9 10.9 34.9 Income tax provision........................................ 8.0 3.6 11.4 ----- ----- ----- Net earnings before accounting change............. 11.9% 7.3% 23.5% ===== ===== =====
- --------------- * Includes provision for reinsurance in 1999. Year Ended December 31, 2000 Versus Year Ended December 31, 1999 Our total revenue increased 36% to $466.2 million in 2000 compared to 1999. This revenue increase resulted from the higher retention of premium underwritten by our insurance companies, particularly in the medical stop-loss line of business, and increased investment income. We expect the upward trend in revenue to continue. Our net investment income increased 29% to $39.8 million in 2000 compared to 1999. This increase was primarily due to a higher level of invested assets which resulted from the greater retentions of premium underwritten by our insurance companies, the investment of cash received during the first quarter of 2000 from our commutation with a reinsurer and cash flow from operations. We expect cash flow to continue to improve, thereby increasing net investment income, which could be substantially offset by falling interest rates. In 2000, we engaged General Re New England Asset Management, a subsidiary of Berkshire Hathaway, Inc. and a nationally prominent investment advisor, particularly to insurance companies, and undertook an in-depth review and restructuring of our investment portfolio. As a part of this restructuring, we have shortened our investment portfolio's duration but have not significantly changed the average credit rating. Our net realized investment losses from sales or write downs of equity securities was $5.6 million in 2000, compared to losses of $3.9 million in 1999. In 2000, we recognized a $5.1 million realized loss from the write down of an equity investment to its estimated fair market value based upon market quotations compared to a similar write down of $4.3 million in 1999. Our net realized investment gains from the disposition of fixed income securities were $203,000 in 2000, compared to losses of $164,000 in 1999. Our compensation expense increased to $78.4 million during 2000 from $77.5 million in 1999. This increase reflects a normal progressional increase due to business growth plus the increase due to the Centris acquisition, offset by the savings resulting from the 1999 fourth quarter restructuring and the sale of non-core subsidiaries. Other than the restructuring expenses discussed below, other operating expenses increased to $51.8 million from $47.2 million for similar reasons. Included in other operating expense are restructuring expenses of $761,000 in 2000 and $5.5 million in 1999. Currency conversion losses amounted to $330,000 in 2000, compared to gains of $442,000 in 1999. Our interest expense was $20.3 million in 2000 compared to $13.0 million in 1999. This increase is a result of higher interest rates and increased debt outstanding, principally as a result of funding the Centris 32 34 acquisition. Interest expense will be down substantially in 2001 as a result of our reduced level of debt following our equity offering in March, 2001. Our income tax expense was $35.9 million in 2000 compared to $12.3 million in 1999. Our effective tax rate was 40% in the 2000 period compared to 33% in 1999. Most of the increase in the effective tax rate was due to non-deductible goodwill amortization relating to the Centris acquisition, a shift of fixed income investments to taxable instruments from tax exempt instruments and increased underwriting agency income which is subject to state income taxes. Our net earnings in 2000 increased 113% to $53.4 million or $1.06 per diluted share from $25.1 million or $0.51 per diluted share in 1999. These increases result principally from improved underwriting results, an increase in investment income and the effects of the provision for reinsurance and a larger restructuring expense recorded during 1999. In 2000, we incurred a $2.0 million after-tax charge for a change in accounting principles to conform our agency and intermediary revenue recognition principles to those required by the guidance in SEC Staff Accounting Bulletin Number 101 entitled "Revenue Recognition in Financial Statements." The change was not material to earnings before cumulative effect of accounting change for 2000. Our book value per share was $10.46 as of December 31, 2000, up from $9.29 as of December 31, 1999. During March 2001, we sold 6.9 million shares of our common stock at a price of $23.25 per share. If this transaction had occurred on December 31, 2000, our pro forma book value per share would have increased to $11.86. SEGMENTS Insurance Companies Gross written premium generated by our insurance companies increased 70% to $967.5 million in 2000 compared to 1999 due to new business, rate increases, increased participation by our insurance companies in the business underwritten by our underwriting agencies and the acquisition of Centris. Net written premium generated by our insurance companies in 2000 increased 103% to $283.8 million compared to 1999, as our insurance companies have increased retentions in many of their lines of business as underwriting results showed improvement. Net earned premium increased 89% to $267.6 million during 2000 for the same reasons. We expect net premium increases to continue in 2001. Loss and loss adjustment expense incurred by our insurance companies increased to $198.5 million in 2000 from $109.7 million in 1999. The increase in net loss and loss adjustment expense is due to the higher level of net retained premium, net of the effect of improved underwriting results. The GAAP net loss ratio decreased to 74.2% in 2000 from 77.6% in 1999. In 2000, we also recorded a $4.4 million increase in reserves for discontinued lines of business acquired with our 1999 acquisition of Centris. This increase represents 1.6% of the 2000 net loss ratio. The GAAP gross loss ratio decreased to 79.4% in 2000 from 116.5% in 1999. The general improvement in our loss ratios result from the effects of increased premium rates in certain lines of business, reduced writings in other unprofitable lines of business and a general improvement in market conditions, particularly in the domestic aviation and medical stop-loss lines of business. The statutory net combined ratio of our insurance companies was 98.1% for 2000 compared to 129.9% (104.1% excluding effects of the provision for reinsurance) in 1999. During 2000, we had net loss and LAE redundancy of $9.6 million relating to prior year losses compared to a deficiency of $4.6 million in 1999 and we had gross loss and LAE redundancy of $1.9 million compared to a deficiency of $90.0 million in 1999. The 1999 gross deficiency results from two principal conditions. The first is the development of large claims on individual policies which were either reported late or for which reserves were increased as subsequent information became available. However, as these policies were substantially reinsured, there was no material effect to our net earnings. Secondly, during 1999 in connection with the insolvency of one of our reinsurers and with the commutation, finalized subsequent to year end, 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 33 35 might conservatively expect. These reserves were then used as the basis for the determination of the provision for reinsurance recorded in 1999. The other deficiencies and redundancies in the reserves result from our continued review with our actuaries of loss reserves and the increase or reduction of such reserves as losses are finally settled and claims exposures are reduced. We continue to believe we have provided for all material net incurred losses. Policy acquisition costs, which are net of commissions on ceded reinsurance, increased to $23.7 million during 2000 from $8.2 million for 1999. This increase in costs results from higher retained premium and the resulting reduced ceding commissions. Net earnings of our insurance companies increased to $24.2 million in 2000 from a loss of $10.7 million in 1999, primarily as a result of improved underwriting results, the effect of the provision for reinsurance recorded in 1999 and the increase in investment income. UNDERWRITING AGENCIES Premiums underwritten by our underwriting agencies increased 27% to $1.1 billion for 2000 compared to 1999. Management fees generated by our underwriting agencies increased 6% to $96.1 million in 2000 compared to 1999. These increases resulted primarily from the increased premium volume in the medical stop-loss line of business, which was due to rate increases and the Centris acquisition. The increase in management fees was disproportionate to the increase in written premium as a result of higher policy issuance fees and increased retentions by our insurance companies which reduced management fees earned by our underwriting agencies. These reductions are offset by an equal reduction in net policy acquisition costs of our insurance companies. Net earnings of our underwriting agencies increased 13% to $19.4 million in 2000 from $17.2 million in 1999 due to increased revenue, a smaller restructuring charge in 2000 than in 1999 and higher pretax margins primarily as a result of the successful integration of the Centris acquisition. INTERMEDIARIES Commission income decreased to $42.5 million in 2000 from $54.6 million in 1999. Net earnings of our intermediary subsidiaries decreased to $9.2 million in 2000 from $13.6 million in 1999. These decreases were due to a significant reduction in the amount of ceded reinsurance placed on behalf of our insurance companies as a result of their planned increase in retentions. In January 2001, we acquired all of the outstanding shares of Schanen Consulting for 996,805 shares of our common stock. This transaction will be recorded using the pooling-of-interests method of accounting. Schanen Consulting's operations have been consolidated with those of HCC Employee Benefits, our specialty retail employee benefits agency. OTHER OPERATIONS Other operating revenue decreased to $25.5 million during 2000 from $28.5 million for the same period in 1999. Net earnings of our other operations decreased to $6.0 million in 2000 from $7.6 million in 1999. Revenue and earnings can vary considerably from period to period depending on investment or disposition activity. RESTRUCTURING As of December 31, 1999, we accrued a restructuring liability of $4.0 million related to our ongoing operations. As of December 31, 2000, all restructuring costs had been paid or adjusted with the exception of a remaining liability of $105,000. During 2000, we determined that one of the leased offices scheduled to be closed would be retained. Therefore, we reversed $789,000 (included as a credit in other operating expenses in the consolidated financial statements) of the restructuring expense recorded during the fourth quarter of 1999, of which $514,000 was the reversal of the accrual for future lease payments and $275,000 was the reversal of the write-off of certain assets. 34 36 As of December 31, 1999, we had also accrued a restructuring liability related to our acquisition of Centris. Changes in the accrual between December 31, 1999 and December 31, 2000 are shown in the table below:
ACCRUED PAID 2000 ACCRUED AT 12/31/99 IN 2000 ADJUSTMENTS AT 12/31/00 ----------- ---------- ----------- ----------- Contractual executive severance accruals........................... $5,866,000 $6,027,000 $ 166,000 $ 5,000 Other severance accruals............. 397,000 541,000 258,000 114,000 Lease obligation accruals............ 848,000 1,004,000 1,196,000 1,040,000 ---------- ---------- ---------- ---------- Total...................... $7,111,000 $7,572,000 $1,620,000 $1,159,000 ========== ========== ========== ==========
The adjustments in 2000 were recorded as management decided to take additional steps to integrate parts of the Centris operations. During the fourth quarter of 2000, we also recorded a restructuring charge and associated expenses of $1.5 million. A total of 26 employees were or will be terminated as a result of our restructuring of certain underwriting agency operations and their integration into our insurance company operations. The charges affected both segments and consisted of $557,000 accrued severance pay to be paid at various times throughout 2001 and $992,000 for the write down or write off of various impaired assets, primarily redundant computer software. Year Ended December 31, 1999 Versus Year Ended December 31, 1998 Our revenue increased 11% to $341.9 million in 1999, from $308.0 million in 1998. The revenue increase was principally a result of increases in non-risk bearing management fees and commission income. This growth is from new business and acquisitions. Our net investment income increased 5% to $30.9 million in 1999 from $29.3 million in 1998, reflecting a slightly higher level of investment assets and increased interest rates earned on short-term investments. Our net realized investment losses from sales or write downs of equity securities were $3.9 million in 1999, compared to losses of $166,000 in 1998. In 1999, we recognized a $4.3 million realized loss from the write down of one equity investment to its estimated fair market value based upon market quotations. Our net realized investment losses from the disposition of fixed income securities were $164,000 in 1999, compared to gains of $1.0 million in 1998. The losses in 1999 resulted from the sale of bonds in connection with the funding of the Centris acquisition. Our compensation expense increased to $77.5 million in 1999, from $56.1 million in 1998. This increase reflects a normal progressional increase due to business growth as well as the effect of acquisitions. Other operating expenses increased $11.1 million to $47.2 million, before restructuring expenses of $5.5 million, during the same period for similar reasons. Our currency conversion gains amounted to $442,000 in 1999, compared to gains of $219,000 in 1998. We recorded a restructuring charge and associated expenses of $5.5 million during the fourth quarter of 1999. Since our initial public offering in 1992, we have completed more than fifteen acquisitions. During that time, total employees had grown from less than 100 to more than 1,000. As a result of this rapid growth, we believe certain operating inefficiencies occurred. At the beginning of the fourth quarter of 1999, we made a review of our operations and determined that they could be made more efficient, principally by reducing the employee count in certain operations. We believe that this restructuring will strengthen our corporate and management structure and enhance future earnings by improving operating efficiency and therefore profitability. The charge included severance pay of $3.8 million for 92 employees, $1.0 million related to lease costs of office space made redundant as a result of the restructuring plan and an asset write down of $647,000, principally of leasehold improvements, and other assets related to the redundant space. 35 37 Our interest expense was $13.0 million for 1999, an increase of $6.9 million from 1998. The increase is a result of increased debt outstanding as a result of funding for acquisitions. Our income tax expense was $12.3 million in 1999 compared to $35.2 million in 1998. The decrease was due to the reduction in earnings before income tax. Our effective tax rate for both years was approximately the same. Our net earnings in 1999 decreased to $25.1 million from $72.3 million in 1998, due to the provision for reinsurance, which equated to $28.3 million after income taxes, or $0.57 per diluted share, the higher net loss ratio and the restructuring expense, which, after income taxes, amounted to $0.07 per diluted share. Diluted earnings per share decreased to $0.51 per share from $1.48 per share during the same period. Our book value per share was $9.29 as of December 31, 1999, up from $9.12 as of December 31, 1998. SEGMENTS Insurance Companies Gross written premium for our insurance companies increased 14% to $568.3 million in 1999, from $498.3 million in 1998. Our accident and health reinsurance, medical stop-loss and workers' compensation lines of business showed strong growth because our insurance companies continued to participate in more of the business written by our underwriting agencies. This growth was partially offset by reductions in offshore energy and property premium as a result of the continuing extremely soft conditions in these markets. Net written premium for our insurance companies increased 15% in 1999 to $139.9 million from $121.9 million in 1998, as a result of increases in retained aviation and medical stop-loss premium. Net earned premium decreased slightly in 1999 to $141.4 million from $143.1 million in 1998 as changes in earned premium lag behind changes in written premium. Loss and loss adjustment expense incurred by our insurance companies increased to $109.7 million in 1999, from $91.3 million in 1998, and the GAAP net loss ratio increased to 77.6% in 1999, from 63.8% in 1998. The GAAP gross loss ratio was 116.5% in 1999 compared to 109.2% in 1998. The deterioration is primarily from poor results in the aviation, medical stop-loss and property lines of business. We have taken steps to reduce these gross loss ratios, primarily by increasing premium rates and more selective underwriting. The statutory net combined ratio was 129.9% (104.1% excluding the effects of the provision for reinsurance) in 1999 compared to 82.9% in 1998. During 1999, we had a net loss and loss adjustment expense deficiency of $4.6 million relating to prior year losses compared to a redundancy of $14.6 million in 1998. During 1999, we had a gross loss and loss adjustment expense deficiency of $90.0 million compared to a deficiency of $33.5 million in 1998. The 1999 gross deficiency results from two principal conditions. The first is the development of large claims on individual policies which were either reported late or for which reserves were increased as subsequent information became available. However, because these policies were substantially reinsured, there was no material effect to our net earnings. Secondly, during 1999, in connection with the insolvency of one of our reinsurers and with the commutation of all liabilities of 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 we recorded in 1999. The other deficiencies and redundancies in the reserves result from our continued review with our actuaries of loss reserves and the increase or reduction of those reserves as losses are finally settled and claims exposures are reduced. In 1999, our insurance companies recorded a $43.5 million provision for reinsurance to reflect an estimated $29.5 million pre-tax loss for the insolvency of a reinsurer and an estimated $14.0 million pre-tax loss, the majority of which represents the discount on ceded reserves related to the commutation we initiated of all liabilities with another reinsurer. The commutation was settled for cash and other assets totaling $56.5 million in February, 2000. 36 38 Our insurance companies' policy acquisition costs, which are net of ceding commissions on reinsurance ceded, decreased $2.8 million to $8.2 million in 1999, from $11.0 million in 1998. This decrease reflects a greater amount of gross premium ceded and, therefore, a higher level of ceding commissions. Net earnings of our insurance companies decreased to a loss of $10.7 million in 1999, from a profit of $33.8 million in 1998, as a result of the provision for reinsurance, the effect of restructuring and the higher net loss ratio. Underwriting Agencies Management fees generated by our underwriting agencies increased 23% to $90.7 million in 1999, from $74.0 million in 1998. Premium underwritten on behalf of both our insurance companies and other insurance companies increased to $848.1 million in 1999, an increase of 20% from $706.2 million in 1998. Both increases resulted from acquisitions and internal growth of existing operations. The underwriting agency segment also incurred a $1.9 million, net of income tax, restructuring expense in 1999. In addition to its impact on the agency segment, growth in underwriting agency premium has a positive impact on both the insurance company segment and the intermediary segment. Net earnings of our underwriting agencies decreased to $17.2 million in 1999, from $19.4 million in 1998. Acquisitions made during 1998 and 1999 had not yet had a positive impact on net earnings due to licensing and other regulatory requirements, which were still in process. Intermediaries Commission income generated by our intermediaries increased 42% to $54.6 million in 1999, from $38.4 million in 1998, primarily as a result of the January 1, 1999 acquisition of Rattner Mackenzie. Net earnings of the intermediaries decreased to $13.6 million in 1999 from $16.9 million in 1998. The increase in net earnings generated by Rattner Mackenzie was offset by fewer large brokerage transactions in 1999 and other reductions, including a $902,000 (net of income tax) restructuring expense in 1999. Other Operations Our other operating revenue increased 28% to $28.5 million in 1999, from $22.3 million in 1998. There was a general increase in revenue of the service operations, net of the decrease in revenue related to operations disposed of in late 1998. Other operating net earnings increased to $7.6 million in 1999, from $4.8 million in 1998 due principally to the higher earnings of the service operations. Revenue and earnings can vary considerably from period to period depending on investment or disposition activity. LIQUIDITY AND CAPITAL RESOURCES We receive substantial cash from premiums, reinsurance recoverables, and management fee and commission income and, to a lesser extent, investment income, and proceeds from sales and redemptions of investments and other assets. Our principal cash outflows are for the payment of claims and loss adjustment expenses, payment of premiums to reinsurers, purchase of investments, debt service, and repayment policy acquisition costs, operating expenses, income and other taxes and dividends. Variations in operating cash flows can occur due to timing differences in either the payment of claims and the collection of related recoverables or the collection of receivables and the payment of related payable amounts. We limit our liquidity exposure by holding funds, letters of credit and other security such that net balances due to us are less than the gross balances shown in our condensed consolidated balance sheets. We maintain a substantial level of cash and liquid short-term investments which are used to meet anticipated payment obligations. Our consolidated cash and investment portfolio increased $116.5 million, or 19% since December 31, 1999, and totaled $724.3 million as of December 31, 2000, of which $277.0 million was cash and short-term investments. The increase in investments resulted from increased 37 39 operating cash flows and from the collection of a commutation receivable. Total assets increased slightly to $2.7 billion as of December 31, 2000. Our investment portfolio includes a high percentage of liquid investments and generates a significant amount of investment income, which serves as a source of cash flow. The average tax equivalent yield on investments was 7.3% in 2000, compared to 7.2% in 1999. The weighted average duration of the portfolio was four years as of December 31, 2000. Over 99% of our fixed income securities were rated A or better by Standard & Poor's. The value of our portfolio of fixed income securities is inversely correlated to changes in market interest rates. In addition, 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. 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. As of December 31, 2000, certain of our subsidiaries maintained revolving lines of credit with a bank in the combined maximum amount of $55.0 million available through December 31, 2001. 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 $68.8 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 bank's prime rate of interest less 1% (8.5% at December 31, 2000). At December 31, 2000, letters of credit totaling $26.4 million had been issued to insurance companies by the bank on behalf of the subsidiaries, with total securities of $33.1 million collateralizing the lines. During March 2001, we sold 6.9 million shares of our common stock in a public offering at a price of $23.35 per share. Net proceeds from the offering amounted to approximately $152.8 million after deducting underwriting discounts and commissions and estimated offering expenses. Most of the proceeds, $152.5 million, were used to pay down our bank facility. On December 17, 1999, we entered into a $300.0 million Revolving Loan Facility with a group of banks. We can borrow up to $300.0 million under the facility on a revolving basis until it expires on December 18, 2004. Outstanding advances under the facility bear interest at agreed upon rates. The facility is collateralized in part by the pledge of the stock of Houston Casualty and Avemco Insurance and by the stock of and guarantees entered into by our principal underwriting agency and intermediary subsidiaries. The facility agreement contains certain restrictive covenants, including minimum net worth requirements for us and certain of our subsidiaries, restrictions on certain extraordinary corporate actions, notice requirements for certain material occurrences, and required maintenance of specified financial ratios. We believe that the restrictive covenants and our obligations that are contained in the facility agreement are typical for financing arrangements comparable to our facility. As of December 31, 2000, total debt outstanding under the facility was $207.5 million and the weighted average interest rate was 8.18%. During March 2001, we reduced debt outstanding under the facility to $55.0 million using the proceeds from our recent public stock offering. Property and casualty insurance companies domiciled in the State of Texas are limited in the payment of dividends to their shareholders in any twelve-month period, without the prior written consent of the Commissioner of Insurance, to the greater of statutory net income for the prior calendar year or 10% of its statutory policyholders' surplus as of the prior year end. Houston Casualty and U.S. Specialty, both Texas domiciled companies, paid no dividends in 1999 or 2000. During 2001, Houston Casualty's ordinary dividend capacity will be approximately $23.1 million and U.S. Specialty's ordinary dividend capacity will be approximately $10.6 million. Under the laws of the State of Maryland, Avemco Insurance may only pay dividends out of statutory earned surplus. The maximum amount of dividends that Avemco Insurance may pay without prior regulatory approval in any twelve-month period is the greater of its statutory net income (under certain conditions) for the prior calendar year or 10% of its statutory policyholders' surplus as of the prior year end. Avemco Insurance paid an extraordinary dividend of $45.0 million during December, 1999, but paid 38 40 no dividends during 2000. During 2001, Avemco Insurance will have an ordinary dividend capacity of approximately $18.2 million. HCC Life Insurance Company is limited by the laws of the State of Indiana in the amount of dividends it may pay in any twelve-month period, without prior regulatory approval, to the greater of its statutory net gain from operations for the prior calendar year or 10% of its policyholders' surplus as of the prior year end. HCC Life paid no dividends in 2000. During 2001, HCC Life's ordinary dividend capacity will be approximately $6.3 million. As of December 31, 2000, we had a net deferred tax asset of $6.7 million compared to $18.3 million as of December 31, 1999. Due to our history of consistent earnings and expectations for future earnings and to the ability to carry losses back to profitable years for tax purposes, we expect to be able to fully realize the benefit of our net deferred tax asset. The overall increase in underwriting activity by our insurance companies and the Centris acquisition in December, 1999 resulted in increases in gross loss reserves, life and annuity policy benefits and gross unearned premiums. Related amounts of reinsurance recoverables, ceded life and policy benefits and ceded unearned premium also increased. We continue to collect our receivables and recoverables generally in the ordinary course of business and we have not incurred and do not expect to incur any significant liquidity difficulties as a result of the substantial growth in gross amounts due. However, during 2000, a number of reinsurers have delayed or suspended the payment of amounts recoverable under certain reinsurance contracts to which we are a party. Such delays have affected, though not materially to date, the investment income of our insurance companies, but not to any extent their liquidity. We limit our liquidity exposure by holding funds, letters of credit or other security such that net balances due are significantly less than the gross balances shown in our consolidated balance sheets. In addition, a number of reinsurers have claimed they are not liable for payment to us and, in one or more cases, have sought arbitration of these matters. We believe these claims are without merit and expect to collect the full amount recoverable. We are currently in negotiations with most of these parties. If such negotiations do not result in a satisfactory resolution of the matters in question, we will seek a judicial or arbitral determination of these matters. As of December 31, 2000, 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. Regulatory guidelines suggest that a property and casualty insurer's 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. In the past, our property and casualty insurance companies have maintained premium to surplus ratios significantly lower than such guidelines and generally below industry norms. For the year ended December 31, 2000, our statutory gross written premium to policyholders' surplus was 298.0% compared to 182.6% for the year ended December 31, 1999. For the year ended December 31, 2000, our statutory net written premium to policyholders' surplus was 87.0% compared to 47.6% for the year ended December 31, 1999. The gross written premium ratio has increased during 2000 with the acquisition of Centris' book of medical stop-loss business and the increasing use of our insurance companies as the issuing company for business written by our underwriting agencies. This ratio is expected to stabilize at or decrease from its 2000 level as statutory policyholders' surplus increases due to the retention of earnings and other increases in policyholders' surplus. IMPACT OF INFLATION Our operations, like those of other property and casualty insurers, are susceptible to the effects of inflation, as 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, for competitive reasons, such premiums may not fully offset the effects of inflation. However, because the majority of our 39 41 business is comprised of lines which 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, the effects of inflation are minimized. A significant 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 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. Also, the market value of our investments vary depending on economic and market conditions and 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 $300.0 million bank loan floats with that of the market. Any significant increase in interest rates could have a material adverse effect on our earnings, depending on the amount borrowed on our bank facility. FOREIGN EXCHANGE RATE FLUCTUATIONS We underwrite risks which 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 with respect to fluctuations in the exchange rate between the major European currencies and the U.S. Dollar. For the year ended December 31, 2000, our loss from currency conversion was $(330,000) compared to gains of $442,000 in 1999 and $219,000 in 1998. On a limited basis, we enter into foreign currency forward contracts as a hedge against foreign currency fluctuations. Rattner Mackenzie has revenue streams in U.S. Dollars and Canadian Dollars ("CAD") but its expenses are paid in British Pound Sterling ("GBP"). To mitigate our foreign exchange risk, we entered into foreign currency forward contracts expiring at staggered times through December 31, 2001. As of December 31, 2000 we had forward contracts to sell U.S. $7.5 million for GBP at an average rate of 1.00 GBP equals U.S. $1.50 and to sell CAD $600,000 for GBP at an average exchange rate of 1.00 GBP equals CAD $2.18. This compares with December 31,1999 when we had forward contracts to sell U.S. $12.0 million for GBP at an average rate of 1.00 GBP equals U.S. $1.60. The foreign currency forward contracts are used to convert currency at a known rate in an amount which approximates average monthly expenses. This permits us to limit the foreign currency exchange risk of the recurring monthly expenses. In the future, we may continue to limit our exposure to currency fluctuations through the use of foreign currency forward contracts. We utilize these foreign currency forward contracts strictly as a hedge against existing exposure to foreign currency fluctuations rather than as a form of speculation or trading investment. EFFECTS OF RECENT ACCOUNTING PRONOUNCEMENTS Statement of Financial Accounting Standards ("SFAS") No. 133 entitled "Accounting for Derivative Instruments and Hedging Activities" was issued in June 1998, and became effective for us January 1, 2001. We utilize derivatives or hedging strategies on a limited basis. The cumulative effect adjustment due to this change in accounting has been calculated by us and is not material to our financial position, results of operations or cash flows nor do we expect the adoption of SFAS No. 133 to be material on an ongoing basis due to our limited use of derivatives. The National Association of Insurance Commissioners adopted Statements of Statutory Accounting Principles in March, 1998 as a product of its attempt to codify statutory accounting principles. Although subject to adoption by the individual states, an effective date of January 1, 2001 was established for 40 42 implementation of the statements. Prior to the codification project, a comprehensive guide to statutory accounting principles did not exist. Codification is new and will evolve over time. The cumulative effect of codification is expected to increase statutory policyholders' surplus of our insurance company subsidiaries by approximately $6.0 million. We expect that the statutory surplus of our insurance company subsidiaries after adoption will continue to be in excess of their regulatory risk-based capital requirements. In addition, the Financial Accounting Standards Board has recently announced that it proposes to change the accounting for certain acquisitions and goodwill. This pronouncement, if finally adopted, could affect the way we account for and the structure of future acquisitions. Final rules implementing the announced standards are not expected until the second quarter of 2001 and no date has been established for adopting the final standards. EURO CONVERSION On January 1, 1999, certain member countries of the European Union irrevocably fixed the conversion rates between their national currencies and a common currency, the Euro, which became the common legal currency of those countries on that date. The participating countries' former national currencies will continue to serve as legal tender and as denominations of the Euro until January 1, 2002. The conversion to the Euro is scheduled to be completed on July 1, 2002, when the national currencies will cease to exist. We do not expect the introduction of the Euro to have a material effect on our business, financial condition or results of operations. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK Our principal assets and liabilities are financial instruments which are subject to the market risk of potential losses from adverse changes in market rates and prices. Our primary market risk exposures are: interest rate risk on fixed income securities and interest expense on variable rate debt, equity risk on marketable equity securities, credit risk on reinsurance recoverables and foreign currency exchange rate risk. To manage the exposures of our investment risks, we generally invest in investment grade securities with characteristics of duration and liquidity to reflect the underlying characteristics of the insurance liabilities of our insurance companies. We have not historically used derivatives to manage any of our investment related market risks. Caution should be used in evaluating overall market risk from the information below. Actual results could differ materially from estimates below for a variety of reasons, including, among other things: - amounts and balances on which the estimates are based are likely to change over time; - assumptions used in the models may prove to be inaccurate; - market changes could be different from market changes assumed below; and - not all factors and balances are taken into account. Interest Rate Risk The value of our portfolio of fixed income securities is inversely correlated to changes in the market interest rates. In addition, 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. We attempt to mitigate this risk by investing in securities with varied maturity dates, so that only a portion of the portfolio will mature at any point in time. The fair value of our fixed income securities as of December 31, 2000 was $433.8 million and was $342.6 million, as of December 31, 1999. If market interest rates were to change 1%, (e.g. from 6% to 5%) the fair value of our fixed income securities would change approximately $17.9 million as of December 31, 2000. This compares to change in value of $17.2 million as of December 31, 1999 for the same 1% change in market interest rates. The change in fair value was determined using duration modeling assuming no prepayments. 41 43 Our $300 million bank loan is subject to variable interest rates. Thus, our interest expense is directly correlated to market interest rates. As of December 31, 2000, we had $207.5 million in debt outstanding under the bank loan. At this debt level, a 1% change in market interest rates (e.g. from 8.0% to 7.0%) would change our annual interest expense by $2.1 million. As of December 31, 1999, we had $235.0 million in debt outstanding under the bank loan. At that debt level, the 1% change in market interest rates would have changed interest expense by $2.4 million. During March 2001, we reduced our debt under the bank loan to $55.0 million. At that debt level, a 1% change in market interest rates would change our annual interest expense $550,000. Equity Risk Our portfolio of marketable equity securities is subject to equity price risk due to market changes. The fair value of our marketable equity securities as of December 31, 2000 was $6.3 million, compared to $20.0 million as of December 31, 1999. If the market price of all marketable equity securities were to change by 10% as of these dates, the fair value of our equity portfolio would have changed $628,000 as of December 31, 2000 and $2.0 million as of December 31, 1999. Credit Risk See Reinsurance Ceded section contained in Item 1., Business, and Footnote (8) in the Notes to Consolidated Financial Statements. Foreign Exchange Risk The table below shows the net amounts of significant foreign currency balances at December 31, 2000 and 1999 converted to U.S. Dollars. It also shows the expected dollar change in fair value that would occur if exchange rates changed 10% from exchange rates in effect at those times:
2000 1999 --------------------------- --------------------------- HYPOTHETICAL HYPOTHETICAL U.S. DOLLAR 10% CHANGE IN U.S. DOLLAR 10% CHANGE IN EQUIVALENT FAIR VALUE EQUIVALENT FAIR VALUE ----------- ------------- ----------- ------------- British Pound Sterling............ $7,486,000 $749,000 $5,974,000 $597,000 Euro and 11 national currencies... 1,345,000 135,000 1,054,000 105,000 Cape Verde Escudo................. 1,685,000 169,000 38,000 4,000
See Foreign Exchange Rate Fluctuations section contained in Item 7, Management's Discussion and Analysis, and Footnotes (1) and (9) in the Notes to Consolidated Financial Statements for additional information. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The financial statements and financial statement schedules listed in the accompanying index are filed as part of this Report. ITEM 9.CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES None. 42 44 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT For information regarding Directors and Executive Officers of the Registrant, reference is made to the Registrant's definitive proxy statement for its Annual Meeting of Shareholders, which will be filed with the Securities and Exchange Commission within 120 days after December 31, 2000, and which is incorporated herein by reference. ITEM 11. EXECUTIVE COMPENSATION For information regarding Executive Compensation, reference is made to the Registrant's definitive proxy statement for its Annual Meeting of Shareholders, which will be filed with the Securities and Exchange Commission within 120 days after December 31, 2000, and which is incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT For information regarding Security Ownership of Certain Beneficial Owners and Management, reference is made to the Registrant's definitive proxy statement for its Annual Meeting of Shareholders, which will be filed with the Securities and Exchange Commission within 120 days after December 31, 2000, and which is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS For information regarding Certain Relationships and Related Transactions, reference is made to the Registrant's definitive proxy statement for its Annual Meeting of Shareholders, which will be filed with the Securities and Exchange Commission within 120 days after December 31, 2000, and which is incorporated herein by reference. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) EXHIBITS The exhibits listed on the accompanying Index to Exhibits are filed as part of this Report. (b) FINANCIAL STATEMENT SCHEDULES The financial statements and financial statement schedules listed in the accompanying index are filed as part of this Report. (c) REPORTS ON FORM 8-K No reports on Form 8-K were filed by us during the fourth quarter of 2000. 43 45 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. HCC Insurance Holdings, Inc. -------------------- (Registrant) By: /s/ STEPHEN L. WAY ---------------------------------- Stephen L. Way Chairman of the Board and Chief Executive Officer Dated: March 30, 2001 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
NAME TITLE DATE ---- ----- ---- /s/ STEPHEN L. WAY Chairman of the Board of March 30, 2001 - ----------------------------------------------------- Directors and Chief Executive (Stephen L. Way) Officer (Principal Executive Officer) /s/ MARVIN P. BUSH* Director March 30, 2001 - ----------------------------------------------------- (Marvin P. Bush) /s/ FRANK J. BRAMANTI* Director and Executive Vice March 30, 2001 - ----------------------------------------------------- President (Frank J. Bramanti) /s/ PATRICK B. COLLINS* Director March 30, 2001 - ----------------------------------------------------- (Patrick B. Collins) /s/ JAMES R. CRANE* Director March 30, 2001 - ----------------------------------------------------- (James R. Crane) /s/ J. ROBERT DICKERSON* Director March 30, 2001 - ----------------------------------------------------- (J. Robert Dickerson) /s/ EDWARD H. ELLIS, JR. Senior Vice President and Chief March 30, 2001 - ----------------------------------------------------- Financial Officer (Chief (Edward H. Ellis, Jr.) Accounting Officer) /s/ EDWIN H. FRANK, III* Director March 30, 2001 - ----------------------------------------------------- (Edwin H. Frank, III) /s/ ALAN W. FULKERSON* Director March 30, 2001 - ----------------------------------------------------- (Alan W. Fulkerson)
44 46
NAME TITLE DATE ---- ----- ---- /s/ WALTER J. LACK* Director March 30, 2001 - ----------------------------------------------------- (Walter J. Lack) /s/ STEPHEN J. LOCKWOOD* Director and Vice Chairman March 30, 2001 - ----------------------------------------------------- (Stephen J. Lockwood) /s/ JOHN N. MOLBECK, JR. Director, President and Chief March 30, 2001 - ----------------------------------------------------- Operating Officer (John N. Molbeck, Jr.) *By: /s/ JOHN N. MOLBECK, JR. March 30, 2001 ------------------------------------------------ John N. Molbeck, Jr., Attorney-in-fact
45 47 INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES Report of Independent Accountants........................... F-1 Consolidated Balance Sheets at December 31, 2000 and 1999... F-2 Consolidated Statements of Earnings for the three years ended December 31, 2000................................... F-3 Consolidated Statements of Comprehensive Income for the three years ended December 31, 2000....................... F-4 Consolidated Statements of Changes in Shareholders' Equity for the three years ended December 31, 2000............... F-5 Consolidated Statements of Cash Flows for the three years ended December 31, 2000................................... F-6 Notes to Consolidated Financial Statements.................. F-7 SCHEDULES: Report of Independent Accountants on Financial Statement Schedules....................................... S-1 Schedule 1 Summary of Investments other than Investments in Related Parties........................................... S-2 Schedule 2 Condensed Financial Information of Registrant... S-3 Schedule 3 Supplementary Insurance Information............. S-8 Schedule 4 Reinsurance..................................... S-9 Schedule 5 Valuation and Qualifying Accounts............... S-10
Schedules other than those listed above have been omitted because they are either not required, not applicable, or the required information is shown in the Consolidated Financial Statements and related notes thereto or other Schedules. 46 48 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Shareholders HCC Insurance Holdings, Inc. In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of earnings, comprehensive income, changes in shareholders' equity and cash flows present fairly, in all material respects, the financial position of HCC Insurance Holdings, Inc. and its subsidiaries at December 31, 2000 and 1999, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2000, in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. As discussed in Note 1, effective January 1, 2000 the Company changed its method of revenue recognition for certain contracts as prescribed by the Securities and Exchange Commission's Staff Accounting Bulletin No. 101 entitled "Revenue Recognition in Financial Statements". /s/ PricewaterhouseCoopers LLP Houston, Texas March 21, 2001 F-1 49 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
DECEMBER 31, PRO FORMA ------------------------------- DECEMBER 31, 2000 2000 1999 ----------------- -------------- -------------- (UNAUDITED, SEE NOTE 2) ASSETS Investments: Fixed income securities, at market (cost: 2000 $422,821,000; 1999 $343,534,000)................ $ 433,844,000 $ 433,844,000 $ 342,641,000 Marketable equity securities, at market (cost: 2000 $8,896,000; 1999 $22,493,000)................... 6,282,000 6,282,000 19,970,000 Short-term investments, at cost, which approximates market.......................................... 263,318,000 262,982,000 215,694,000 Other investments, at cost, which approximates fair value........................................... 7,182,000 7,182,000 3,017,000 -------------- -------------- -------------- Total investments.......................... 710,626,000 710,290,000 581,322,000 Cash................................................. 14,038,000 14,038,000 26,533,000 Restricted cash and cash investments................. 101,738,000 101,738,000 84,112,000 Premium, claims and other receivables................ 562,868,000 562,868,000 622,087,000 Reinsurance recoverables............................. 789,412,000 789,412,000 736,485,000 Ceded unearned premium............................... 114,469,000 114,469,000 133,657,000 Ceded life and annuity benefits...................... 86,760,000 86,760,000 95,760,000 Deferred policy acquisition costs.................... 39,108,000 39,108,000 40,450,000 Property and equipment, net.......................... 39,289,000 39,289,000 37,804,000 Goodwill............................................. 266,015,000 266,015,000 263,687,000 Other assets......................................... 18,989,000 18,989,000 42,827,000 -------------- -------------- -------------- Total assets............................... $2,743,312,000 $2,742,976,000 $2,664,724,000 ============== ============== ============== LIABILITIES Loss and loss adjustment expense payable............. $ 944,117,000 $ 944,117,000 $ 871,104,000 Life and annuity policy benefits..................... 86,760,000 86,760,000 95,760,000 Reinsurance balances payable......................... 113,346,000 113,346,000 113,373,000 Unearned premium..................................... 190,550,000 190,550,000 188,524,000 Deferred ceding commissions.......................... 30,013,000 30,013,000 39,792,000 Premium and claims payable........................... 589,830,000 589,830,000 598,638,000 Notes payable........................................ 59,633,000 212,133,000 242,546,000 Accounts payable and accrued liabilities............. 46,792,000 46,792,000 57,559,000 -------------- -------------- -------------- Total liabilities.......................... 2,061,041,000 2,213,541,000 2,207,296,000 SHAREHOLDERS' EQUITY Common Stock, $1.00 par value; 250,000,000 shares authorized; (shares issued and outstanding: pro forma 57,245,201; 2000 50,345,201; 1999 48,839,027)........................................ 57,245,000 50,345,000 48,839,000 Additional paid-in capital........................... 342,891,000 196,955,000 176,359,000 Retained earnings.................................... 277,422,000 277,422,000 234,922,000 Accumulated other comprehensive income (loss)........ 4,713,000 4,713,000 (2,692,000) -------------- -------------- -------------- Total shareholders' equity................. 682,271,000 529,435,000 457,428,000 -------------- -------------- -------------- Total liabilities and shareholders' equity................................... $2,743,312,000 $2,742,976,000 $2,664,724,000 ============== ============== ==============
See Notes to Consolidated Financial Statements. F-2 50 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF EARNINGS
FOR THE YEARS ENDED DECEMBER 31, ------------------------------------------ 2000 1999 1998 ------------ ------------ ------------ REVENUE Net earned premium................................. $267,647,000 $141,362,000 $143,100,000 Management fees.................................... 96,058,000 90,713,000 74,045,000 Commission income.................................. 42,492,000 54,552,000 38,441,000 Net investment income.............................. 39,794,000 30,933,000 29,335,000 Net realized investment gain (loss)................ (5,321,000) (4,164,000) 845,000 Other operating income............................. 25,497,000 28,475,000 22,268,000 ------------ ------------ ------------ Total revenue............................ 466,167,000 341,871,000 308,034,000 EXPENSE Loss and loss adjustment expense................... 198,470,000 109,650,000 91,302,000 Operating expense: Policy acquisition costs, net.................... 23,743,000 8,177,000 10,978,000 Compensation expense............................. 78,446,000 77,488,000 56,077,000 Provision for reinsurance........................ -- 43,462,000 -- Other operating expense.......................... 52,515,000 52,736,000 36,170,000 ------------ ------------ ------------ Total operating expense.................. 154,704,000 181,863,000 103,225,000 Interest expense................................... 20,347,000 12,964,000 6,021,000 ------------ ------------ ------------ Total expense............................ 373,521,000 304,477,000 200,548,000 ------------ ------------ ------------ Earnings before income tax provision............... 92,646,000 37,394,000 107,486,000 Income tax provision............................... 37,202,000 12,271,000 35,208,000 ------------ ------------ ------------ Earnings before cumulative effect of accounting change........................................... 55,444,000 25,123,000 72,278,000 Cumulative effect of accounting change, net of deferred tax effect of $1,335,000................ (2,013,000) -- -- ------------ ------------ ------------ Net Earnings............................. $ 53,431,000 $ 25,123,000 $ 72,278,000 ============ ============ ============ Basic earnings per share data: Earnings before accounting change................ $ 1.11 $ 0.51 $ 1.51 Cumulative effect of accounting change........... (0.04) -- -- ------------ ------------ ------------ Net Earnings..................................... $ 1.07 $ 0.51 $ 1.51 ============ ============ ============ Weighted average shares outstanding.............. 49,745,000 49,061,000 47,920,000 ============ ============ ============ Diluted earnings per share data: Earnings before accounting change................ $ 1.10 $ 0.51 $ 1.48 Cumulative effect of accounting change........... (0.04) -- -- ------------ ------------ ------------ Net Earnings..................................... $ 1.06 $ 0.51 $ 1.48 ============ ============ ============ Weighted average shares outstanding.............. 50,622,000 49,649,000 48,936,000 ============ ============ ============
See Notes to Consolidated Financial Statements. F-3 51 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
FOR THE YEARS ENDED DECEMBER 31, --------------------------------------- 2000 1999 1998 ----------- ----------- ----------- Net earnings.......................................... $53,431,000 $25,123,000 $72,278,000 Other comprehensive income net of tax: Foreign currency translation adjustment............. (172,000) 167,000 (344,000) Investment gains (losses): Investment gains (losses) during the year, net of income tax charge (benefit) of $2,386,000 in 2000, ($8,042,000) in 1999 and $1,283,000 in 1998........................................... 4,118,000 (15,271,000) 2,598,000 Less reclassification adjustment for (gains) losses included in net earnings, net of income tax (charge) benefit of $1,862,000 in 2000, $1,457,000 in 1999 and ($296,000) in 1998...... 3,459,000 2,707,000 (549,000) ----------- ----------- ----------- Other comprehensive income (loss)................... 7,405,000 (12,397,000) 1,705,000 ----------- ----------- ----------- Comprehensive income............................. $60,836,000 $12,726,000 $73,983,000 =========== =========== ===========
See Notes to Consolidated Financial Statements. F-4 52 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
ACCUMULATED ADDITIONAL OTHER TOTAL COMMON PAID-IN RETAINED COMPREHENSIVE SHAREHOLDERS' STOCK CAPITAL EARNINGS INCOME (LOSS) EQUITY ----------- ------------ ------------ ------------- ------------- Balance as of December 31, 1997....... $47,759,000 $154,633,000 $155,209,000 $ 8,000,000 $365,601,000 Net earnings.......................... -- -- 72,278,000 -- 72,278,000 Other comprehensive income............ -- -- -- 1,705,000 1,705,000 206,504 shares of Common Stock issued for exercise of options, including tax benefit of $925,000............. 206,000 1,997,000 -- -- 2,203,000 287,025 shares of Common Stock issued for purchased companies............. 287,000 5,472,000 -- -- 5,759,000 Cash dividends declared, $0.16 per share............................... -- -- (7,683,000) -- (7,683,000) ----------- ------------ ------------ ------------ ------------ Balance as of December 31, 1998........................... 48,252,000 162,102,000 219,804,000 9,705,000 439,863,000 Net earnings.......................... -- -- 25,123,000 -- 25,123,000 Other comprehensive income (loss)..... -- -- -- (12,397,000) (12,397,000) 505,555 shares of Common Stock issued for exercise of options, including tax benefit of $1,156,000........... 506,000 4,277,000 -- -- 4,783,000 101,330 shares of Common Stock issued for purchased companies............. 101,000 1,899,000 -- -- 2,000,000 414,207 shares of Common Stock contractually issuable in the future.............................. -- 8,271,000 -- -- 8,271,000 Cash dividends declared, $0.20 per share............................... -- -- (9,733,000) -- (9,733,000) Contractual adjustments to previous acquisitions........................ (20,000) (190,000) (272,000) -- (482,000) ----------- ------------ ------------ ------------ ------------ Balance as of December 31, 1999........................... 48,839,000 176,359,000 234,922,000 (2,692,000) 457,428,000 Net earnings.......................... -- -- 53,431,000 -- 53,431,000 Other comprehensive income............ -- -- -- 7,405,000 7,405,000 1,266,701 shares of Common Stock issued for exercise of options, including tax benefit of $3,627,000.......................... 1,266,000 19,596,000 -- -- 20,862,000 Issuance of 144,973 shares of contractually issuable Common Stock............................... 145,000 (145,000) -- -- -- Issuance of 94,500 shares of contingently issuable Common Stock............................... 95,000 1,145,000 -- -- 1,240,000 Cash dividends declared, $0.22 per share............................... -- -- (10,931,000) -- (10,931,000) ----------- ------------ ------------ ------------ ------------ Balance as of December 31, 2000........................... $50,345,000 $196,955,000 $277,422,000 $ 4,713,000 $529,435,000 =========== ============ ============ ============ ============
See Notes to Consolidated Financial Statements. F-5 53 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, --------------------------------------------- 2000 1999 1998 ------------- ------------- ------------- Cash flows from operating activities: Net earnings...................................... $ 53,431,000 $ 25,123,000 $ 72,278,000 Adjustments to reconcile net earnings to net cash provided by operating activities: Change in premium, claims and other receivables.................................. 52,923,000 (92,206,000) (102,804,000) Change in reinsurance recoverables............. (52,007,000) (284,504,000) (195,707,000) Change in ceded unearned premium............... 19,188,000 31,408,000 (64,958,000) Change in deferred policy acquisition costs, net.......................................... (8,664,000) (4,659,000) 5,666,000 Change in other assets......................... 13,362,000 (12,081,000) 410,000 Change in loss and loss adjustment expense payable...................................... 72,311,000 264,360,000 181,626,000 Change in reinsurance balances payable......... (348,000) (15,098,000) 47,069,000 Change in unearned premium..................... 2,689,000 (31,138,000) 46,074,000 Change in premium and claims payable, net of restricted cash.............................. (25,749,000) 102,114,000 64,364,000 Change in accounts payable and accrued liabilities.................................. (12,229,000) 4,707,000 (9,205,000) Net realized investment (gain) loss............ 5,321,000 4,164,000 (845,000) Gains on sales of other operating investments.................................. (5,739,000) (5,523,000) (4,694,000) Provision for reinsurance...................... -- 43,462,000 -- Depreciation and amortization expense.......... 19,876,000 13,398,000 7,388,000 Other, net..................................... (2,772,000) (2,630,000) 3,382,000 ------------- ------------- ------------- Cash provided by operating activities........ 131,593,000 40,897,000 50,044,000 Cash flows from investing activities: Sales of fixed income securities.................. 137,175,000 131,485,000 18,212,000 Maturity or call of fixed income securities....... 34,341,000 17,050,000 30,202,000 Sales of equity securities........................ 7,969,000 2,886,000 4,160,000 Dispositions of other operating investments....... 27,803,000 15,905,000 3,324,000 Change in short-term investments.................. (68,577,000) (14,935,000) (24,667,000) Cash paid for companies acquired, net of cash received....................................... (8,909,000) (186,923,000) (33,011,000) Cost of investments acquired...................... (244,586,000) (70,736,000) (43,968,000) Purchase of property and equipment and other...... (9,474,000) (9,076,000) (15,320,000) ------------- ------------- ------------- Cash used by investing activities............ (124,258,000) (114,344,000) (61,068,000) Cash flows from financing activities: Proceeds from notes payable....................... 26,700,000 547,000,000 74,200,000 Sale of Common Stock.............................. 20,862,000 4,783,000 2,203,000 Payments on notes payable......................... (57,042,000) (458,600,000) (49,950,000) Dividends paid.................................... (10,350,000) (9,221,000) (7,139,000) ------------- ------------- ------------- Cash provided (used) by financing activities................................ (19,830,000) 83,962,000 19,314,000 ------------- ------------- ------------- Net change in cash........................... (12,495,000) 10,515,000 8,290,000 Cash as of beginning of year................. 26,533,000 16,018,000 7,728,000 ------------- ------------- ------------- Cash as of end of year....................... $ 14,038,000 $ 26,533,000 $ 16,018,000 ============= ============= =============
See Notes to Consolidated Financial Statements. F-6 54 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (1) GENERAL INFORMATION AND SIGNIFICANT ACCOUNTING AND REPORTING POLICIES HCC Insurance Holdings, Inc. ("the Company" or "HCC") and its subsidiaries, include domestic and foreign property and casualty and life insurance companies, underwriting agencies, intermediaries and service companies. HCC, through its subsidiaries, provides specialized property and casualty and life and health insurance to commercial customers in the areas of accident and health reinsurance and aviation, marine and offshore energy, medical stop-loss, property and workers' compensation insurance. The principal insurance company subsidiaries are Houston Casualty Company ("HC") in Houston, Texas, and London, England; HCC Life Insurance Company ("HCCL") in Houston, Texas; U.S. Specialty Insurance Company ("USSIC") in Houston, Texas; and Avemco Insurance Company ("AIC") in Frederick, Maryland. The underwriting agency subsidiaries provide underwriting management and claims servicing for insurance and reinsurance companies, specializing in aviation, medical stop-loss, occupational accident and workers' compensation insurance and a variety of accident and health related reinsurance products. The principal agency subsidiaries are LDG Reinsurance Corporation ("LDG Re") in Wakefield, Massachusetts and New York City, New York; and HCC Benefits Corporation ("HCCB") in Atlanta, Georgia, Costa Mesa, California, Wakefield, Massachusetts, Minneapolis, Minnesota and Dallas, Texas. We have recently consolidated the operations of other of the Company's agencies with certain of the Company's insurance companies. The intermediary subsidiaries provide brokerage, consulting and other intermediary services to insurance and reinsurance companies, commercial customers and individuals in the same lines of business as the insurance companies operate. The Company's principal intermediary subsidiaries are HCC Intermediaries, Inc. ("HCCI") in Houston, Texas; HCC Employee Benefits, Inc. ("HCCEB") in Houston, Texas and Atlanta, Georgia; and Rattner Mackenzie Limited ("RML") in London, England. The service company subsidiaries perform various insurance related services for insurance companies. The preparation of financial statements in conformity with generally accepted accounting principles in the United States ("GAAP") requires management to make estimates and assumptions. This affects amounts reported in the financial statements and the disclosure of contingent assets and liabilities. Actual results could differ from those estimates. A description of the significant accounting and reporting policies utilized by the Company in preparing the consolidated financial statements is as follows: Principles of Consolidation The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. Investments Fixed income securities and marketable equity securities are classified as available for sale and are carried at quoted market value, if readily marketable, or at management's estimated fair value, if not readily marketable. The change in unrealized gain or loss with respect to these securities is recorded as a component of other comprehensive income, net of the related deferred income tax effects, if any. Fixed income securities available for sale are purchased with the original intent to hold to maturity, but they may be available for sale if market conditions warrant, or if the Company's investment policies dictate, in order to maximize the Company's investment yield. Short-term investments and restricted short-term investments are carried at cost, which approximates market value. For the mortgage-backed securities portion of the fixed income portfolio, the Company recognizes income using a constant effective yield based on anticipated prepayments and the estimated economic life of the securities. When actual prepayments differ significantly from anticipated prepayments, the estimated F-7 55 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) economic life is recalculated and the remaining unamortized premium or discount is amortized prospectively over the remaining economic life. The realized gain or loss on investment transactions is determined on an average cost basis and included in earnings on the trade date. When impairment of the value of an investment is considered other than temporary, the decrease in value is reported in earnings as a realized investment loss and a new cost basis is established. Property and Equipment Property and equipment are carried at cost, net of accumulated depreciation. Depreciation expense is provided using the straight-line method over the estimated useful lives of the related assets. Amortization of leasehold improvements is provided using the straight-line method over the shorter of the estimated useful life or the term of the respective lease. Upon disposal of assets, the cost and related accumulated depreciation are removed from the accounts and the resulting gain or loss is included in earnings. Costs incurred in developing or purchasing management information systems are capitalized and included in property and equipment. These costs are amortized over their estimated useful lives from the dates the systems are placed in service. Earned Premium, Deferred Policy Acquisition Costs and Ceding Commissions of Insurance Company Subsidiaries Written premium, net of reinsurance, is primarily included in earnings on a pro rata basis over the lives of the related policies. However, for certain types of business, it is recognized over the period of risk in proportion to the amount of insurance risk provided. Policy acquisition costs, including commissions, taxes, fees and other direct costs of underwriting policies, less ceding commissions allowed by reinsurers, including expense allowances, are deferred and charged or credited to earnings proportionate to the premium earned. Historical and current loss and loss adjustment expense experience and anticipated investment income are considered in determining the recoverability of deferred policy acquisition costs. Management Fees and Commission Income When there is no future servicing obligation, management fees and commission income are recognized on the revenue recognition date, which is the later of the effective date of policy, the date when the premium can be reasonably established, or the date when substantially all the services relating to the insurance placement have been rendered to the client. When additional services are required, the service revenue is deferred and recognized over the service period. The Company also records an allowance for estimated return commissions which the Company may be required to pay upon the early termination of policies. The Company changed certain of its revenue recognition methods for its agencies and intermediaries to agree with guidance contained in SEC Staff Accounting Bulletin Number 101 ("SAB 101") entitled "Revenue Recognition in Financial Statements." Previously, the Company's agencies and intermediaries recognized revenue in conformity with principles that historically had been considered generally accepted accounting principles for insurance agents and brokers. The Company had recognized return commissions when the event occurred that caused the return and accrued a liability for future servicing costs, when significant, instead of deferring revenue. The after-tax cumulative non-cash charge resulting from the adoption of SAB 101 was $2.0 million. As required by this new accounting guidance, the Company has restated the 2000 first quarter results for the cumulative effect of the change in accounting. The change was not material to earnings before cumulative effect of accounting change for the year ended December 31, 2000 or to net earnings for any prior year presented. F-8 56 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Other Operating Revenue The Company has two primary sources of other operating revenue, which are included in the Company's other operations segment. The first source is a variety of insurance related services, principally claims adjusting services. These revenues are recorded when the service is performed. The second source is income from and gains or losses from the disposition of investments made in this segment. The income is recognized as earned and the gains or losses from the sale of investments are recognized upon consummation of the transaction or upon other-than-temporary impairment. Premium and Other Receivables The Company uses the gross method for reporting receivables and payables on brokered transactions. Management reviews the collectibility of its receivables on a current basis and provides an allowance for doubtful accounts if it deems that there are accounts which are doubtful of collection. The amount of the allowance as of December 31, 2000 and 1999 was $3.2 million and $1.7 million, respectively. Management's estimate of the level of the allowance could change as conditions change in the future. Loss and Loss Adjustment Expense Payable of Insurance Company Subsidiaries Loss and loss adjustment expense payable is based on estimates of payments to be made for reported and incurred but not reported ("IBNR") losses and anticipated salvage and subrogation receipts. Currently all reserves are recorded on an undiscounted basis. Estimates for reported losses are based on all available information, including reports received from ceding companies on business. Estimates for IBNR are based both on the Company's and the industry's experience. While management believes that amounts included in the accompanying financial statements are adequate, such estimates may be more or less than the amounts ultimately paid when the claims are settled. The estimates are continually reviewed and any changes are reflected in current operations. Reinsurance The Company records all reinsurance recoverables and ceded unearned premiums as assets and deferred ceding commissions as a liability. All such amounts are recorded in a manner consistent with the underlying reinsured contracts. Management has also recorded a reserve for uncollectible reinsurance based on current estimates of collectibility. These estimates could change and affect the level of the reserve needed. Goodwill In connection with the Company's acquisitions of subsidiaries accounted for as purchases, the excess of cost over fair value of net assets acquired is being amortized using the straight-line method over twenty years for acquired agency operations which operate in existing lines of business and in the same country. Goodwill related to acquired agency operations which represent the Company's initial entry into new lines of business or new countries is amortized over thirty years. Goodwill related to acquired insurance company operations is amortized over forty years. Managements of the acquired businesses have successfully operated in their markets for a number of years and, with the additional capital provided by the Company, will be positioned to take advantage of increased opportunities. Accumulated amortization of goodwill as of December 31, 2000 and 1999, was $24.9 million and $11.9 million, respectively. The Company's accounting policy regarding the assessment of the recoverability of the carrying value of long-lived assets, including goodwill and other intangibles and property and equipment, is to review the carrying value of the assets if the facts and circumstances suggest that they may be impaired. If this review indicates that the carrying value will not be recoverable, as determined based on projected undiscounted future cash flows, the carrying value is reduced to its estimated fair value. Amortization of goodwill charged to F-9 57 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) income for the years ended December 31, 2000, 1999 and 1998 was $13.0 million, $6.7 million and $3.0 million, respectively. Cash and Short-term Investments Cash consists of cash in banks, generally in operating accounts. The Company classifies certificates of deposit, corporate demand notes receivable, commercial paper and money market funds as short-term investments. Short-term investments are classified as investments in the consolidated balance sheets as they relate principally to the Company's investment activities. As of December 31, 2000 and 1999 the Company included $158.3 million and $138.5 million, respectively, of certain fiduciary funds in short-term investments. These are funds held by underwriting agency or intermediary subsidiaries for the benefit of insurance or reinsurance clients. The Company earns the interest on these funds. The Company generally maintains its cash deposits in major banks and invests its short-term investments with major banks and in investment grade commercial paper and repurchase agreements. These securities typically mature within 90 days and, therefore, bear minimal risk. The Company has not experienced any losses on its cash deposits or its short-term investments. Restricted Cash and Cash Investments In conjunction with the management of reinsurance pools, the Company's agency subsidiaries withhold premium funds for the payment of claims. These funds are shown as restricted cash and cash investments in the consolidated balance sheets. The corresponding liability is included within premium and claims payable in the consolidated balance sheets. These amounts are considered fiduciary funds, and interest earned on these funds accrues to the benefit of the members of the reinsurance pools. Therefore, the Company does not include these amounts as cash in the consolidated statements of cash flows. Foreign Currency The functional currency of most foreign subsidiaries and branches is the U.S. Dollar. Assets and liabilities recorded in foreign currencies are translated into U.S. Dollars at exchange rates in effect at the balance sheet date. Transactions in foreign currencies are translated at the rates of exchange in effect on the date the transaction occurs. Translation gains and losses are recorded in earnings and included in other operating expenses. The Company's foreign currency transactions are principally denominated in British Pound Sterling ("GBP") and other European currencies. For the years ended December 31, 2000, 1999 and 1998, the gain (loss) from currency conversion was $(330,000), $442,000 and $219,000, respectively. Some foreign subsidiaries or branches have a functional currency of either the GBP or the Canadian Dollar ("CAD"). The cumulative translation adjustment, representing the effect of translating these subsidiaries' or branches' assets and liabilities into U.S. Dollars, is included in the foreign currency translation adjustment within accumulated other comprehensive income. On a limited basis, the Company enters into foreign currency forward contracts as a hedge against foreign currency fluctuations. RML has revenue streams in U.S. Dollars and Canadian Dollars but its expenses are paid in GBP. To mitigate the foreign exchange risk, the Company entered into foreign currency forward contracts expiring at staggered times through December, 2001. The foreign currency forward contracts are used to convert currency at a known rate in an amount which approximates average monthly expenses. Thus, the effect of these transactions is to limit the foreign currency exchange risk of the recurring monthly expenses. The Company utilizes these foreign currency forward contracts strictly as a hedge against existing exposure to foreign currency fluctuations rather than as a form of speculative or trading investment. F-10 58 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) To the extent the foreign exchange forward contracts qualify for hedge accounting treatment, the gain ($4,000 as of December 31, 2000), or loss due to changes in fair value is not recognized in the financial statements until realized, at which time the gain or loss is recognized along with the offsetting loss or gain on the hedged item. To the extent the foreign currency forward contracts do not qualify for hedge accounting treatment, the gain or loss due to changes in fair value is recognized in the consolidated statements of earnings, but is generally offset by changes in value of the underlying exposure. Income Tax The companies file a consolidated Federal income tax return and include the foreign subsidiaries' income to the extent required by law. Deferred income tax is accounted for using the liability method, which reflects the tax impact of temporary differences between the bases of assets and liabilities for financial reporting purposes and such bases as measured by tax laws and regulations. Earnings Per Share Basic earnings per share is based on the weighted average number of common shares outstanding during the year divided into net earnings. Diluted earnings per share is based on the weighted average number of common shares outstanding plus the potential common shares outstanding during the year divided into net earnings. Outstanding common stock options, when dilutive, are considered to be potential common stock for the purpose of the diluted calculation. The treasury stock method is used to calculate potential common stock outstanding due to options. Contingent shares to be issued are included in the earnings per share computation when the underlying conditions for issuance have been met. Effects of Recent Accounting Pronouncements Statement of Financial Accounting Standards ("SFAS") No. 133 entitled "Accounting for Derivative Instruments and Hedging Activities" was issued in June, 1998 and is effective for the Company January 1, 2001. The Company has utilized derivatives or hedging strategies on a limited basis. After adoption, hedge effectiveness will be measured by comparing RML's actual GBP expenses with proceeds from the forward currency forward contracts. The cumulative effect adjustment due to this change in accounting has been calculated by the Company and is not material to its financial position, results of operations or cash flows nor does the Company expect the adoption of SFAS No. 133 to be material on an ongoing basis due to its limited use of derivatives. In addition, the Financial Accounting Standards Board has recently announced that it proposes to change the accounting for certain acquisitions and goodwill. This pronouncement, if finally adopted, could affect the way the Company accounts for and the structure of future acquisitions. Final rules implementing the announced standards are not expected until the second quarter of 2001 and no date has been established for adopting the final standards. Reclassifications Certain amounts in the 1999 and 1998 consolidated financial statements have been reclassified to conform with the 2000 presentation. Such reclassifications had no effect on the Company's shareholders' equity, net earnings or cash flows. F-11 59 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (2) ACQUISITIONS AND SUBSEQUENT EVENTS Public Offering of Common Stock During March 2001, the Company sold 6.9 million shares of the Company's Common Stock in a public offering at a price of $23.35 per share. Net proceeds from the offering amounted to approximately $152.8 million after deducting underwriting discounts and commissions and estimated offering expenses. Most of the proceeds, $152.5 million, were used to pay down the bank Facility. The unaudited pro forma consolidated balance sheet gives effect to the proceeds of the public offering as if it had occurred at December 31, 2000. Schanen Acquisition On January 19, 2001, the Company acquired all of the outstanding shares of Schanen Consulting Corporation and its operating subsidiary, Schanen Consulting Group, L.L.C. (collectively "Schanen") in exchange for 996,805 shares of the Company's Common Stock. This business combination will be recorded using the pooling-of-interests method of accounting. The table below shows the pro forma effects on revenue, net earnings and net earnings per share as if the two entities had been combined for the three years ended December 31, 2000:
2000 1999 1998 ------------ ------------ ------------ Revenue: HCC...................................... $466,167,000 $341,871,000 $308,034,000 Schanen.................................. 7,436,000 3,694,000 2,370,000 ------------ ------------ ------------ Combined total revenue........... $473,603,000 $345,565,000 $310,404,000 ============ ============ ============ Net earnings: HCC...................................... $ 53,431,000 $ 25,123,000 $ 72,278,000 Schanen.................................. 2,037,000 1,449,000 832,000 ------------ ------------ ------------ Combined net earnings............ $ 55,468,000 $ 26,572,000 $ 73,110,000 ============ ============ ============ Combined net earnings per share data: Basic.................................... $ 1.09 $ 0.53 $ 1.49 ============ ============ ============ Diluted.................................. $ 1.07 $ 0.52 $ 1.46 ============ ============ ============
F-12 60 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Purchase Acquisitions In 1999 and 1998, the Company acquired certain businesses in transactions accounted for using the purchase method of accounting. On a combined basis, the fair value of assets acquired was $549.5 million in 1999 and $44.9 million in 1998. The fair value of liabilities assumed was $499.8 million in 1999 and $46.2 million in 1998. The total consideration was $227.4 million in 1999 and $50.0 million in 1998. The results of operations of these businesses have been included in the consolidated financial statements beginning on the effective date of each transaction. The following table lists these transactions:
CONSIDERATION ------------------------ SHARES OF GOODWILL COMPANY'S AMORTIZATION EFFECTIVE COMMON GOODWILL PERIOD DATE STOCK CASH RECOGNIZED IN YEARS --------- --------- ------------ ------------ ------------ 1999 RML............................... 01/01/99 414,207 $ 64,600,000 $ 70,800,000 30 Midwest Stop Loss Underwriting.... 01/28/99 101,330 3,000,000 4,800,000 20 Centris........................... 12/31/99 -- 149,500,000 101,900,000 20 1998 Guarantee Insurance Resources..... 03/01/98 29,029 $ 21,400,000 $ 20,900,000 20 J.E. Stone and Associates, Inc.... 10/01/98 257,496 5,200,000 9,700,000 20 Sun Employer Services, Inc. ...... 11/01/98 500 17,600,000 21,300,000 30 North American Insurance Management Corporation's occupational accident operations..................... 11/24/98 -- 4,000,000 4,000,000 20
The following unaudited pro forma summary presents information as if the 1999 purchase acquisitions had occurred at the beginning of each year after giving effect to certain adjustments including amortization of goodwill, increased interest expense from debt issued to fund the acquisitions and Federal income taxes. Similar information for the 1998 acquisitions is not included in this presentation as it is immaterial to the 1998 consolidated financial statements. The pro forma summary is for information purposes only, does not necessarily reflect the actual results that would have occurred, nor is it necessarily indicative of future results of the combined companies. Centris, whose results are included in the pro forma financial information below, in 1999 experienced both a loss from discontinued operations of $13.2 million and significant underwriting losses.
FOR THE YEARS ENDED DECEMBER 31, --------------------------------- UNAUDITED PROFORMA INFORMATION 1999 1998 - ------------------------------ --------------- --------------- Revenue.................................................. $447,239,000 $493,551,000 Earnings (loss) from continuing operations............... (2,062,000) 69,905,000 Net earnings (loss)...................................... (15,293,000) 46,637,000 Basic earnings (loss) per share from continuing operations............................................. (0.04) 1.46 Diluted earnings (loss) per share from continuing operations............................................. (0.04) 1.43 Basic earnings (loss) per share.......................... (0.31) 0.97 Diluted earnings (loss) per share........................ (0.31) 0.95
F-13 61 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (3) INVESTMENTS Substantially all of the Company's fixed income securities are investment grade; most are A rated or better. The cost or amortized cost, gross unrealized gain or loss and estimated market value of investments in fixed income and marketable equity securities, all of which are classified as available for sale, are as follows:
COST OR GROSS GROSS AMORTIZED UNREALIZED UNREALIZED ESTIMATED COST GAIN LOSS MARKET VALUE ------------ ----------- ----------- ------------ December 31, 2000: Marketable equity securities...... $ 8,896,000 $ 264,000 $(2,878,000) $ 6,282,000 US Treasury securities............ 71,155,000 1,482,000 (25,000) 72,612,000 Obligations of states, municipalities and political subdivisions.................... 203,768,000 5,961,000 (414,000) 209,315,000 Corporate fixed income securities...................... 100,881,000 3,008,000 (189,000) 103,700,000 Mortgage-backed securities........ 39,722,000 1,183,000 (113,000) 40,792,000 Foreign government securities..... 7,295,000 132,000 (2,000) 7,425,000 ------------ ----------- ----------- ------------ Total securities......... $431,717,000 $12,030,000 $(3,621,000) 440,126,000 ============ =========== =========== ============ December 31, 1999: Marketable equity securities...... $ 22,493,000 $ 8,000 $(2,531,000) $ 19,970,000 US Treasury securities............ 57,941,000 96,000 (532,000) 57,505,000 Obligations of states, municipalities and political subdivisions.................... 263,395,000 2,548,000 (2,839,000) 263,104,000 Corporate fixed income securities...................... 14,459,000 -- (190,000) 14,269,000 Mortgage-backed securities........ 529,000 -- -- 529,000 Foreign government securities..... 7,210,000 24,000 -- 7,234,000 ------------ ----------- ----------- ------------ Total securities......... $366,027,000 $ 2,676,000 $(6,092,000) $362,611,000 ============ =========== =========== ============
The amortized cost and estimated market value of fixed income securities at December 31, 2000, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. The weighted average life of the Company's mortgage-backed securities is four years.
ESTIMATED AMORTIZED COST MARKET VALUE -------------- ------------ Due in 1 year or less....................................... $ 28,258,000 $ 28,366,000 Due after 1 year through 5 years............................ 162,899,000 166,001,000 Due after 5 years through 10 years.......................... 82,861,000 85,391,000 Due after 10 years through 15 years......................... 59,201,000 60,987,000 Due after 15 years.......................................... 49,880,000 52,307,000 ------------ ------------ Securities with fixed maturities.......................... 383,099,000 393,052,000 Mortgage-backed securities.................................. 39,722,000 40,792,000 ------------ ------------ Total fixed income securities..................... $422,821,000 $433,844,000 ============ ============
As of December 31, 2000, the Company's insurance company subsidiaries had deposited fixed income securities with an amortized cost of approximately $32.8 million (market: $33.5 million) to meet the deposit requirements of various insurance departments. F-14 62 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) All investments in fixed income securities and other investments were income producing for the twelve months preceding December 31, 2000. The sources of net investment income for the three years ended December 31, 2000, are detailed below:
2000 1999 1998 ----------- ----------- ----------- Fixed income securities....................... $22,074,000 $20,098,000 $20,711,000 Short-term investments........................ 18,043,000 10,915,000 8,079,000 Equity securities............................. 59,000 36,000 35,000 Other......................................... 4,000 -- 607,000 ----------- ----------- ----------- Total investment income............. 40,180,000 31,049,000 29,432,000 Investment expense............................ (386,000) (116,000) (97,000) ----------- ----------- ----------- Net investment income............... $39,794,000 $30,933,000 $29,335,000 =========== =========== ===========
Realized pre-tax gain (loss) on the sale or write down of investments is as follows:
GAIN LOSS NET ---------- ----------- ----------- For the year ended December 31, 2000: Fixed income securities........................ $1,173,000 $ (970,000) $ 203,000 Marketable equity securities................... 567,000 (6,195,000) (5,628,000) Other investments.............................. 104,000 -- 104,000 ---------- ----------- ----------- Realized gain (loss)................. $1,844,000 $(7,165,000) $(5,321,000) ========== =========== =========== For the year ended December 31, 1999: Fixed income securities........................ $1,226,000 $(1,390,000) $ (164,000) Marketable equity securities................... 450,000 (4,391,000) (3,941,000) Other investments.............................. 120,000 (179,000) (59,000) ---------- ----------- ----------- Realized gain (loss)................. $1,796,000 $(5,960,000) $(4,164,000) ========== =========== =========== For the year ended December 31, 1998: Fixed income securities........................ $1,132,000 $ (121,000) $ 1,011,000 Marketable equity securities................... 245,000 (411,000) (166,000) ---------- ----------- ----------- Realized gain (loss)................. $1,377,000 $ (532,000) $ 845,000 ========== =========== ===========
Unrealized pre-tax net investment gains (losses) on investments for three years ended December 31, 2000 are as follows:
2000 1999 1998 ----------- ------------ ----------- Fixed income securities...................... $11,916,000 $(19,024,000) $ 3,551,000 Marketable equity securities................. (91,000) (3,025,000) 888,000 Strategic operational investments............ -- 2,900,000 (1,403,000) ----------- ------------ ----------- Net unrealized investment gain (loss)........................... $11,825,000 $(19,149,000) $ 3,036,000 =========== ============ ===========
F-15 63 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (4) PROPERTY AND EQUIPMENT The following table summarizes property and equipment at December 31, 2000 and 1999:
ESTIMATED 2000 1999 USEFUL LIFE ----------- ----------- -------------- Buildings and improvements.................. $19,332,000 $20,001,000 30 to 45 years Furniture, fixtures and equipment........... 17,286,000 16,580,000 3 to 10 years Management information systems.............. 34,078,000 27,769,000 3 to 10 years ----------- ----------- Total property and equipment...... 70,696,000 64,350,000 Less accumulated depreciation and amortization.............................. (31,407,000) (26,546,000) ----------- ----------- Property and equipment, net....... $39,289,000 $37,804,000 =========== ===========
Depreciation and amortization expense on property and equipment was approximately $6.9 million, $6.7 million and $4.4 million for the years ended December 31, 2000, 1999 and 1998, respectively. (5) NOTES PAYABLE Notes payable as of December 31, 2000 and 1999 are shown in the table below. The estimated fair value of the notes payable is based on current rates offered to the Company for debt with similar terms and approximates the carrying value at the balance sheet dates.
PRO FORMA DECEMBER 31, 2000 2000 1999 ----------------- ------------ ------------ (UNAUDITED, SEE NOTE 2) Acquisition notes................................ $ 4,633,000 $ 4,633,000 $ 7,546,000 Facility......................................... 55,000,000 207,500,000 235,000,000 ----------- ------------ ------------ Total notes payable.................... $59,633,000 $212,133,000 $242,546,000 =========== ============ ============
On December 17, 1999, the Company entered into a $300.0 million Revolving Loan Facility (the "Facility") with a group of banks. Borrowing under the Facility may be made from time to time on a revolving basis until the Facility's expiration on December 18, 2004. Outstanding advances under the Facility bear interest at agreed upon rates. The Facility is collateralized in part by the stock of HC and AIC and by the stock and guarantees entered into by the Company's principal underwriting agency and intermediary subsidiaries. The Facility agreement contains certain restrictive covenants, including minimum net worth requirements for the Company and certain subsidiaries, restrictions on certain extraordinary corporate actions, notice requirements for certain material occurrences, and required maintenance of specified financial ratios. Management believes that the restrictive covenants and other obligations of the Company which are contained in the Facility agreement are typical for financing arrangements comparable to the Facility. As of December 31, 2000, total debt outstanding under the Facility was $207.5 million and the weighted average interest rate was 8.18%. During March 2001, the Company reduced the debt outstanding under the Facility to $55.0 million using the proceeds from its recent public stock offering (see Note 2). The acquisition notes are payable to former owners of RML. The notes are payable in decreasing amounts in four annual installments beginning January 31, 2000. The notes carry no stated interest, but were discounted at 6.25% for financial reporting purposes when the acquisition of RML was recorded. The interest rate used was based on current rates offered to the Company as of RML's acquisition date. At December 31, 2000, certain of the Company's subsidiaries maintained revolving lines of credit with a bank in the combined maximum amount of $55.0 million available through December 31, 2001. Advances under the lines of credit are limited to amounts required to fund draws, if any, on letters of credit issued by the F-16 64 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 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 $68.8 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 bank's prime rate of interest less 1% (8.5% at December 31, 2000). At December 31, 2000, letters of credit totaling $26.4 million had been issued to insurance companies by the bank on behalf of the subsidiaries, with total securities of $33.1 million collateralizing the lines. (6) INCOME TAX As of December 31, 2000 and 1999, the Company had income taxes receivable of $13.2 million and $34.0 million, respectively, included in other assets in the consolidated balance sheets. The components of the income tax provision for the three years ended December 31, 2000 are as follows:
2000 1999 1998 ----------- ----------- ----------- Current....................................... $26,948,000 $12,963,000 $32,498,000 Deferred...................................... 8,919,000 (692,000) 2,710,000 ----------- ----------- ----------- Total income tax provision.......... $35,867,000 $12,271,000 $35,208,000 =========== =========== ===========
The net deferred tax asset is included in other assets in the consolidated balance sheets. The composition of deferred tax assets and liabilities as of December 31, 2000 and 1999, is as follows:
2000 1999 ----------- ------------ Tax net operating loss carryforwards...................... $ 9,698,000 $ 11,692,000 Excess of financial unearned premium over tax............. 4,919,000 2,512,000 Effect of loss reserve discounting and salvage and subrogation accrual for tax............................. 7,434,000 9,585,000 Unrealized loss on decrease in value of securities available for sale (shareholders' equity)............... -- 1,611,000 Excess of financial accrued expenses over tax............. 5,520,000 10,063,000 Allowance for bad debts, not deductible for tax........... 2,484,000 2,380,000 Foreign branch net operating loss carryforwards........... 1,912,000 463,000 Valuation allowance....................................... (9,666,000) (12,091,000) ----------- ------------ Total assets.................................... 22,301,000 26,215,000 Unrealized gain on increase in value of securities available for sale (shareholders' equity)............... 2,400,000 -- Deferred policy acquisition costs, net of ceding commissions, deductible for tax......................... 5,237,000 1,634,000 Amortizable goodwill...................................... 3,816,000 2,346,000 Property and equipment depreciation and other items....... 4,183,000 3,984,000 ----------- ------------ Total liabilities............................... 15,636,000 7,964,000 ----------- ------------ Net deferred tax asset.......................... $ 6,665,000 $ 18,251,000 =========== ============
F-17 65 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Changes in the valuation allowance account applicable to the net deferred tax asset for the three years ended December 31, 2000 are as follows:
2000 1999 1998 ----------- ----------- -------- Balance, beginning of year...................... $12,091,000 $ 50,000 $ 98,000 Increase (decrease) charged (credited) to income........................................ -- 453,000 (48,000) Valuation allowance related to acquired net operating loss carryforwards.................. 3,262,000 11,588,000 -- Reduction in valuation allowance resulting from waiver of previously acquired net operating loss carryforwards............................ (5,687,000) -- -- ----------- ----------- -------- Balance, end of year.................. $ 9,666,000 $12,091,000 $ 50,000 =========== =========== ========
In connection with the acquisition of Centris in 1999, the Company acquired approximately $35.0 million in net operating losses for Federal income tax purposes. As of December 31, 1999 a valuation allowance was established to reduce the acquired net operating loss deferred tax asset to zero. During 2000, under applicable Treasury regulations, the Company irrevocably waived (reduced) the level of the carryforwards to approximately $16.0 million. As a consequence of this waiver, the deferred tax asset and the related deferred tax valuation allowance applicable to the waived net operating losses were reduced by the same amount ($5.7 million) resulting in no change in net deferred tax assets. As of December 31, 2000, the Company has Federal net operating loss carryforwards of approximately $16.0 million which will expire in varying amounts through the year 2020. Future use of the carryforwards is subject to material statutory limitations due to prior changes of ownership. Any future tax benefit realized from the pre-acquisition loss carryforwards will not be credited to future income but will reduce goodwill recorded in connection with the applicable purchase transaction. As of December 31, 2000, the Company also has approximately $5.0 million of losses from foreign branches which are limited to use against future income of the respective foreign branches. The following table summarizes the differences between the Company's effective tax rate for financial statement purposes and the Federal statutory rate for the three years ended December 31, 2000:
2000 1999 1998 ----------- ----------- ----------- Statutory tax rate.......................... 35.0% 35.0% 35.0% Federal tax at statutory rate............... $31,255,000 $13,088,000 $37,620,000 Nontaxable municipal bond interest and dividends received deduction.............. (3,545,000) (5,460,000) (5,753,000) Other non deductible expenses............... 620,000 622,000 312,000 Non deductible goodwill amortization........ 2,497,000 475,000 138,000 State income taxes.......................... 4,202,000 3,011,000 3,521,000 Foreign income taxes........................ 1,537,000 4,793,000 440,000 Foreign tax credit.......................... (1,826,000) (4,354,000) (440,000) Other, net.................................. 1,127,000 96,000 (630,000) ----------- ----------- ----------- Income tax provision........................ $35,867,000 $12,271,000 $35,208,000 =========== =========== =========== Effective tax rate.......................... 40.2% 32.8% 32.8% =========== =========== ===========
(7) SEGMENT AND GEOGRAPHIC DATA The Company classifies its activities into four operating business segments based upon services provided: 1) insurance company operations, 2) underwriting agency operations, 3) intermediary operations, and 4) other operations. See Note 1 for a description of the services provided by and the principal subsidiaries included in F-18 66 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) the insurance company, underwriting agency and intermediary segments. The other operations segment performs various insurance related services and contains insurance related investments made from time to time. The primary operating entities in this segment principally provide insurance claims adjusting services. Also included in other operations is income from gains or losses from the disposition of the investments. Corporate includes general corporate operations, and those minor operations not included in an operating segment. Inter-segment revenue consists primarily of management fees of the underwriting agency segment, commission income of the intermediary segment and service revenue of the other operations charged to the insurance company segment on business retained by the Company's insurance company subsidiaries. Inter- segment pricing (either flat rate fees or as a percentage premium) approximates what is charged to unrelated parties for similar services. The performance of each segment is evaluated by management based upon net earnings. Net earnings is calculated after tax and after all corporate expense allocations, amortization of goodwill, interest expense on debt incurred at the purchase date and intercompany eliminations have been charged or credited to the individual segments. The following tables show information by business segment and geographic location. Geographic location is determined by physical location of the Company's offices and does not represent the location of insureds or reinsureds from whom the business was generated.
INSURANCE UNDERWRITING OTHER COMPANY AGENCY INTERMEDIARY OPERATIONS CORPORATE TOTAL ------------ ------------ ------------ ----------- ----------- ------------ For the year ended December 31, 2000: Revenue: Domestic............................. $276,240,000 $ 99,808,000 $24,089,000 $23,826,000 $ 1,035,000 $424,998,000 Foreign.............................. 15,054,000 4,446,000 21,669,000 -- -- 41,169,000 Inter-segment........................ -- 16,404,000 345,000 1,468,000 -- 18,217,000 ------------ ------------ ----------- ----------- ----------- ------------ Total segment revenue.......... $291,294,000 $120,658,000 $46,103,000 $25,294,000 $ 1,035,000 484,384,000 ============ ============ =========== =========== =========== Inter-segment revenue.................. (18,217,000) ------------ Consolidated total revenue..... $466,167,000 ============ Net earnings (loss): Domestic............................. $ 27,289,000 $ 18,758,000 $ 7,809,000 $ 5,960,000 $(4,710,000) $ 55,106,000 Foreign.............................. (3,094,000) 672,000 1,366,000 -- -- (1,056,000) ------------ ------------ ----------- ----------- ----------- ------------ Total segment net earnings (loss)....................... $ 24,195,000 $ 19,430,000 $ 9,175,000 $ 5,960,000 $(4,710,000) 54,050,000 ============ ============ =========== =========== =========== Inter-segment eliminations........... (619,000) ------------ Consolidated net earnings...... $ 53,431,000 ============ Other items: Net investment income................ $ 27,948,000 $ 7,547,000 $ 3,293,000 $ 476,000 $ 530,000 $ 39,794,000 Depreciation and amortization........ 3,662,000 11,926,000 3,535,000 385,000 368,000 19,876,000 Interest expense..................... 103,000 9,222,000 4,846,000 2,000 6,174,000 20,347,000 Restructuring expense................ 749,000 798,000 (789,000) 3,000 -- 761,000 Capital expenditures................. 3,124,000 4,651,000 1,021,000 219,000 1,074,000 10,089,000 Income tax provision (benefit)....... 8,308,000 19,565,000 6,402,000 3,578,000 (1,604,000) 36,249,000 Inter-segment eliminations........... (382,000) ------------ Consolidated income tax provision........................ $ 35,867,000 ============
F-19 67 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The agency segment incurred the $2.0 million reduction in net income resulting from the cumulative effect of the Company's adoption of SAB 101 effective January 1, 2000. For 2000, earnings before income taxes were $90.7 million for domestic subsidiaries and a loss before income taxes of $1.4 million for foreign subsidiaries. The insurance company subsidiaries increased their policy issuance fees on certain 2000 contracts to reflect current market conditions, which had the effect of reducing the underwriting agencies' management fees $11.4 million for the year ended December 31, 2000, but as the insurance company segment reduced its net policy acquisition costs by a like amount, there was no effect to consolidated net income.
INSURANCE UNDERWRITING OTHER COMPANY AGENCY INTERMEDIARY OPERATIONS CORPORATE TOTAL ------------ ------------ ------------ ----------- ----------- ------------ For the year ended December 31, 1999: Revenue: Domestic............................... $151,044,000 $91,385,000 $31,778,000 $27,364,000 $ 681,000 $302,252,000 Foreign................................ 10,676,000 3,699,000 25,244,000 -- -- 39,619,000 Inter-segment.......................... -- 3,170,000 594,000 1,133,000 -- 4,897,000 ------------ ----------- ----------- ----------- ----------- ------------ Total segment revenue............ $161,720,000 $98,254,000 $57,616,000 $28,497,000 $ 681,000 346,768,000 ============ =========== =========== =========== =========== Inter-segment revenue.................. (4,897,000) ------------ Consolidated total revenue....... $341,871,000 ============ Net earnings (loss): Domestic............................... $ (8,631,000) $17,129,000 $ 9,042,000 $ 7,643,000 $(2,279,000) $ 22,904,000 Foreign................................ (2,078,000) 21,000 4,575,000 -- -- 2,518,000 ------------ ----------- ----------- ----------- ----------- ------------ Total segment net earnings (loss)......................... $(10,709,000) $17,150,000 $13,617,000 $ 7,643,000 $(2,279,000) 25,422,000 ============ =========== =========== =========== =========== Inter-segment eliminations............. (299,000) ------------ Consolidated net earnings........ $ 25,123,000 ============ Other items: Net investment income.................. $ 23,400,000 $ 4,186,000 $ 2,491,000 $ 424,000 $ 432,000 $ 30,933,000 Depreciation and amortization.......... 2,880,000 5,898,000 3,776,000 264,000 580,000 13,398,000 Interest expense....................... 19,000 3,809,000 4,640,000 -- 4,496,000 12,964,000 Restructuring expense.................. 687,000 3,278,000 1,453,000 -- 71,000 5,489,000 Capital expenditures................... 2,405,000 5,339,000 110,000 585,000 637,000 9,076,000 Income tax provision (benefit)......... (13,324,000) 13,969,000 8,608,000 4,454,000 (1,242,000) 12,465,000 Inter-segment eliminations............. (194,000) ------------ Consolidated income tax provision.... $ 12,271,000 ============
The insurance company segment incurred a provision for reinsurance totaling $28.3 million, net of income tax, during 1999. Also during 1999, earnings before income taxes was $32.3 million for domestic subsidiaries and $5.1 million for foreign subsidiaries.
INSURANCE UNDERWRITING OTHER COMPANY AGENCY INTERMEDIARY OPERATIONS CORPORATE TOTAL ------------ ------------ ------------ ----------- ----------- ------------ For the year ended December 31, 1998: Revenue: Domestic............................... $156,715,000 $79,367,000 $33,086,000 $21,168,000 $ 2,121,000 $292,457,000 Foreign................................ 11,049,000 3,438,000 991,000 99,000 -- 15,577,000 Inter-segment.......................... -- 1,975,000 1,876,000 1,252,000 -- 5,103,000 ------------ ----------- ----------- ----------- ----------- ------------ Total segment revenue............ $167,764,000 $84,780,000 $35,953,000 $22,519,000 $ 2,121,000 313,137,000 ============ =========== =========== =========== =========== Inter-segment revenue.................... (5,103,000) ------------ Consolidated total revenue....... $308,034,000 ============ Net earnings (loss): Domestic............................... $ 32,909,000 $19,283,000 $16,263,000 $ 5,210,000 $(2,676,000) $ 70,989,000 Foreign................................ 926,000 105,000 657,000 (399,000) -- 1,289,000 ------------ ----------- ----------- ----------- ----------- ------------ Net earnings (loss).............. $ 33,835,000 $19,388,000 $16,920,000 $ 4,811,000 $(2,676,000) $ 72,278,000 ============ =========== =========== =========== =========== ============ Other items: Net investment income.................. $ 22,995,000 $ 3,949,000 $ 362,000 $ 536,000 $ 1,493,000 $ 29,335,000 Depreciation and amortization.......... 2,011,000 4,094,000 406,000 422,000 455,000 7,388,000 Interest expense....................... (58,000) 1,963,000 91,000 -- 4,025,000 6,021,000 Capital expenditures................... 10,405,000 2,685,000 660,000 205,000 1,365,000 15,320,000 Income tax provision (benefit)......... 9,485,000 13,025,000 10,702,000 2,885,000 (889,000) 35,208,000
F-20 68 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Assets by business segment and geographic location are shown in the following table:
INSURANCE UNDERWRITING OTHER COMPANY AGENCY INTERMEDIARY OPERATIONS CORPORATE TOTAL -------------- ------------ ------------ ----------- ----------- -------------- December 31, 2000: Domestic.............. $1,596,012,000 $559,649,000 $ 87,474,000 $ 6,908,000 $34,299,000 $2,284,342,000 Foreign............... 146,825,000 37,729,000 274,080,000 -- -- 458,634,000 -------------- ------------ ------------ ----------- ----------- -------------- Total assets...... $1,742,837,000 $597,378,000 $361,554,000 $ 6,908,000 $34,299,000 $2,742,976,000 ============== ============ ============ =========== =========== ============== December 31, 1999: Domestic.............. $1,567,855,000 $520,122,000 $114,818,000 $16,984,000 $42,102,000 $2,261,881,000 Foreign............... 83,882,000 28,756,000 290,205,000 -- -- 402,843,000 -------------- ------------ ------------ ----------- ----------- -------------- Total assets...... $1,651,737,000 $548,878,000 $405,023,000 $16,984,000 $42,102,000 $2,664,724,000 ============== ============ ============ =========== =========== ==============
During the year ended December 31, 1998, one broker in London, England, produced gross written premium ("GWP") to the Company of approximately $46.1 million. This represents 10% of the Company's total GWP for that year. During 2000 and 1999, no customer produced in excess of 10% of the Company's total GWP. (8) REINSURANCE In the normal course of business, the Company's insurance company subsidiaries cede a substantial portion of their premium to non-affiliated domestic and foreign reinsurers through quota share, surplus, excess of loss and facultative reinsurance agreements. Although the ceding of reinsurance does not discharge the primary insurer from liability to its policyholder, the subsidiaries participate in such agreements for the purpose of limiting their loss exposure, protect against catastrophic loss and diversifying their business. Most of the reinsurance assumed by the Company's insurance company subsidiaries was underwritten directly by one of the Company's underwriting agency subsidiaries, but issued by other non-affiliated companies in order to satisfy local licensing, contractual or other requirements. The following table represents the effect of such reinsurance transactions on net premium and loss and loss adjustment expense:
LOSS AND LOSS WRITTEN ADJUSTMENT PREMIUM EARNED PREMIUM EXPENSE ------------- -------------- ------------- For the year ended December 31, 2000: Direct business......................... $ 676,730,000 $ 663,458,000 $ 493,647,000 Reinsurance assumed..................... 290,727,000 311,137,000 279,999,000 Reinsurance ceded....................... (683,669,000) (706,948,000) (575,176,000) ------------- ------------- ------------- Net amounts................... $ 283,788,000 $ 267,647,000 $ 198,470,000 ============= ============= ============= For the year ended December 31, 1999: Direct business......................... $ 291,513,000 $ 294,130,000 $ 261,696,000 Reinsurance assumed..................... 276,818,000 294,103,000 423,763,000 Reinsurance ceded....................... (428,407,000) (446,871,000) (575,809,000) ------------- ------------- ------------- Net amounts................... $ 139,924,000 $ 141,362,000 $ 109,650,000 ============= ============= ============= For the year ended December 31, 1998: Direct business......................... $ 228,629,000 $ 192,536,000 $ 202,858,000 Reinsurance assumed..................... 269,647,000 260,539,000 292,064,000 Reinsurance ceded....................... (376,393,000) (309,975,000) (403,620,000) ------------- ------------- ------------- Net amounts................... $ 121,883,000 $ 143,100,000 $ 91,302,000 ============= ============= =============
F-21 69 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Ceding commissions netted with policy acquisition costs in the consolidated statements of earnings are $214.7 million, $117.0 million and $59.1 million for the years ended December 31, 2000, 1999 and 1998, respectively. The table below represents the composition of reinsurance recoverables in the accompanying consolidated balance sheets:
2000 1999 ------------ ------------ Reinsurance recoverable on paid losses................... $ 99,224,000 $ 91,318,000 Commuted receivable...................................... -- 53,210,000 Reinsurance recoverable on outstanding losses............ 376,778,000 382,565,000 Reinsurance recoverable on IBNR.......................... 317,467,000 214,933,000 Reserve for uncollectible reinsurance.................... (4,057,000) (5,541,000) ------------ ------------ Total reinsurance recoverables................. $789,412,000 $736,485,000 ============ ============
The insurance company subsidiaries require reinsurers not authorized by the subsidiaries' respective states of domicile to collateralize their reinsurance obligations to the Company. The table below shows amounts held by the Company as collateral plus other credits available for potential offset as of December 31, 2000 and 1999:
2000 1999 ------------ ------------ Payables to reinsurers................................... $200,591,000 $212,962,000 Letters of credit........................................ 142,494,000 154,111,000 Cash deposits............................................ 23,813,000 19,882,000 ------------ ------------ Total credits.................................. $366,898,000 $386,955,000 ============ ============
In order to minimize its exposure to reinsurance credit risk, the Company evaluates the financial condition of its reinsurers and places its reinsurance with a diverse group of financially sound companies. The following table shows reinsurance balances relating to the reinsurers with a net recoverable balance greater than $10.0 million as of December 31, 2000 and 1999. The total recoverables column includes paid loss recoverable, outstanding loss recoverable, IBNR recoverable and ceded unearned premium.
LETTERS OF CREDIT, A.M. BEST TOTAL CASH DEPOSITS AND REINSURER RATING LOCATION RECOVERABLES OTHER PAYABLES NET - --------- --------- -------------- ------------ ------------------ ------------ December 31, 2000: Underwriters at Lloyd's................ A United Kingdom $220,849,000 $28,602,000 $192,247,000 GE Reinsurance Corporation............. A++ Illinois 38,152,000 4,881,000 33,271,000 AXA Reinsurance Company................ A+ Delaware 40,886,000 9,131,000 31,755,000 Underwriters Indemnity Company......... A- Texas 33,912,000 2,416,000 31,496,000 SCOR Reinsurance Company............... A+ New York 28,419,000 734,000 27,685,000 American Re-Insurance Company.......... A++ Delaware 23,487,000 2,249,000 21,238,000 Transamerica Occidental Life Ins. Co................................... A+ California 17,056,000 151,000 16,905,000 Federal Insurance Company.............. A++ Indiana 21,185,000 6,708,000 14,477,000 St. Paul Fire and Marine Insurance Co................................... A+ Minnesota 14,290,000 -- 14,290,000 Odyssey America Reinsurance Corp....... A Connecticut 24,602,000 11,741,000 12,861,000 American Fidelity Assurance Corp....... A+ Oklahoma 21,745,000 10,680,000 11,065,000 NAC Reinsurance Corporation............ A+ New York 10,972,000 94,000 10,878,000 Chartwell Insurance Company............ A Minnesota 11,308,000 677,000 10,631,000
F-22 70 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
LETTERS OF CREDIT, A.M. BEST TOTAL CASH DEPOSITS AND REINSURER RATING LOCATION RECOVERABLES OTHER PAYABLES NET - --------- --------- -------------- ------------ ------------------ ------------ December 31, 1999: Underwriters at Lloyd's................ A United Kingdom $156,650,000 $22,805,000 $133,845,000 Underwriters Indemnity Company......... A- Texas 50,451,000 4,201,000 46,250,000 SCOR Reinsurance Company............... A+ New York 41,137,000 1,740,000 39,397,000 AXA Reinsurance Company................ A+ Delaware 37,690,000 5,013,000 32,677,000 NAC Reinsurance Company................ A+ New York 23,153,000 6,105,000 17,048,000 Transamerica Occidental Life Ins. Co................................... A+ California 22,481,000 6,102,000 16,379,000 St. Paul Fire and Marine Insurance Co................................... A+ Minnesota 17,577,000 1,721,000 15,856,000 Odyssey America Reinsurance Corp....... A Connecticut 19,114,000 5,891,000 13,223,000 Sun Life Assurance Company of Canada... A++ Canada 17,996,000 4,786,000 13,210,000 GE Reinsurance......................... A++ Illinois 16,535,000 4,869,000 11,666,000 Chartwell Insurance Company............ A Minnesota 12,736,000 2,074,000 10,662,000
Lloyds of London is an insurance and reinsurance marketplace composed of many independent underwriting syndicates financially supported by a central trust fund. As of December 31, 2000, the net recoverable due from Underwriters at Lloyd's, aggregating $192.2 million, represented balances due from over 140 different syndicates, five of which each had a net recoverable balance in excess of $10.0 million. The largest net recoverable balance from an individual Lloyd's syndicate as of December 31, 2000 was $26.5 million. HCCL previously sold its entire block of life insurance and annuity business to Life Reassurance Corporation of America (rated A++ by A.M. Best) in the form of an indemnity reinsurance contract. Ceded life and annuity benefits amounted to $86.8 million and $95.8 million as of December 31, 2000 and 1999, respectively. The Company has a reserve of $4.1 million as of December 31, 2000 for potential collectibility issues related to reinsurance recoverables. The adverse economic environment in the worldwide insurance industry has placed great pressure on reinsurers and the results of their operations. Ultimately, these conditions could affect reinsurers' solvency. Historically, there have been insolvencies following a period of competitive pricing in the industry, such as the marketplace has experienced for the last several years. Therefore, while management believes that the reserve is adequate based on current available information, conditions may change or additional information might be obtained that would affect management's estimate of the adequacy of the level of the reserve and which may result in a future increase or decrease in the reserve. Management continually reviews the Company's financial exposure to the reinsurance market and continues to take actions to protect shareholders' equity. During 2000, a number of reinsurers have delayed or suspended the payment of amounts recoverable under certain reinsurance contracts to which the Company is a party. Such delays have affected, though not materially to date, the investment income of the Company's insurance company subsidiaries, but not to any extent their liquidity. The Company limits its liquidity exposure by holding funds, letters of credit or other security such that net balances due are significantly less than the gross balances shown on the Company's consolidated balance sheets. In addition, a number of reinsurers have claimed they are not liable for payments to us and, in one or more cases, have sought arbitration of these matters. The Company believes these claims are without merit and expects to collect the full amount recoverable. The Company is currently in negotiations with most of these parties. If such negotiations do not result in a satisfactory resolution of the matters in question, the Company will seek a judicial or arbitral determination of these matters. During 1999, the Company recorded a provision for reinsurance totaling $29.5 million in connection with the insolvency of a reinsurer. The Company expects this provision to be sufficient. The Company also recorded a $14.0 million provision following a commutation (the contractual settlement of outstanding and future liabilities) with another reinsurer, the majority of which represents the present value discount of ceded losses. F-23 71 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (9) COMMITMENTS AND CONTINGENCIES Litigation The Company is party to numerous lawsuits and other proceedings that arise in the normal course of its business. Many of such lawsuits and other proceedings involve claims under policies that the Company's insurance company subsidiaries underwrite as an insurer or reinsurer, the liabilities for which management believes have been adequately included in the Company's loss reserves. Also, from time to time, the Company is a party to lawsuits and other proceedings which relate to disputes over contractual relationships with third parties, or which involve alleged errors and omissions on the part of its subsidiaries. Management believes the resolution of any such lawsuits will not have a material adverse effect on the Company's financial condition, results of operations or cash flows. Foreign Currency Forward Contracts On a limited basis, the Company enters into foreign currency forward contracts as a hedge against foreign currency fluctuations. RML has revenue streams in U.S. Dollars and Canadian Dollars but incurs expenses in GBP. To mitigate the foreign exchange risk, the Company entered into foreign currency forward contracts expiring at staggered times through December, 2001. As of December 31, 2000, the Company had forward contracts to sell US $7.5 million for GBP at an average rate of 1.00 GBP equals US $1.50 and to sell CAD $600,000 for GBP at an average rate of 1.00 GBP equals CAD $2.18. The foreign currency forward contracts are used to convert currency at a known rate in an amount which approximates average monthly expenses. Thus, the effect of these transactions is to limit the foreign currency exchange risk of the recurring monthly expenses. The Company utilizes these foreign currency forward contracts strictly as a hedge against existing exposure to foreign currency fluctuations rather than as a form of speculative or trading investment. The fair value of foreign currency forward contracts December 31, 2000 was $14,000. Leases The Company leases administrative office facilities under long-term non-cancelable operating lease agreements expiring at various dates through September, 2007. In addition to rent, the agreements generally require the payment of utilities, real estate taxes, insurance and repairs. The Company has recognized rent expense on a straight-line basis over the terms of these leases. In addition, the Company leases computer equipment and automobiles under operating leases expiring at various dates through the year 2004. Rent expense under operating leases amounted to $7.1 million, $5.7 million, and $4.3 million, for the years ended December 31, 2000, 1999 and 1998, respectively. At December 31, 2000, future minimum annual rental payments required under long-term, non-cancelable operating leases, excluding certain expenses payable by the Company, are as follows:
FOR THE YEARS ENDED DECEMBER 31, AMOUNT DUE - -------------------------------- ----------- 2001................................................... $ 5,999,000 2002................................................... 4,957,000 2003................................................... 4,543,000 2004................................................... 3,163,000 2005................................................... 2,172,000 Thereafter............................................. 2,059,000 ----------- Total future minimum annual rental payments due........................................ $22,893,000 ===========
F-24 72 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Catastrophe Exposure The Company writes business in areas exposed to catastrophic losses and has significant exposures to this type of loss in California, the Atlantic Coast of United States, certain United States Gulf Coast states, particularly Florida and Texas, the Caribbean and Mexico. The Company assesses its overall exposures to a single catastrophic event and applies procedures that it believes are more conservative than are typically used by the industry to ascertain the Company's probable maximum loss ("PML") from any single event. The Company maintains reinsurance protection which it believes is sufficient to cover any foreseeable event. Loan Guarantee During 1999, the Company guaranteed the construction financing debt of a partnership in which the company is a limited partner. The total amount of the loan commitment is $11.5 million, of which $11.1 million was funded as of December 31, 2000. (10) RELATED PARTY TRANSACTIONS Certain of the Company's Directors are officers, directors or owners of business entities with which the Company transacts business. Balances with these business entities and other related parties included in the accompanying consolidated balance sheets are as follows:
2000 1999 ---------- ---------- Marketable equity securities................................ $2,725,000 $5,051,000 Other investments........................................... 7,182,000 3,017,000 Premiums, claims and other receivables...................... 435,000 3,347,000 Notes payable............................................... 4,633,000 7,546,000
Transactions with these business entities and other related parties included in the accompanying consolidated statements of earnings are as follows:
2000 1999 1998 ----------- ----------- ----------- Gross earned premium.......................... $ -- $ -- $ 1,716,000 Ceded earned premium.......................... -- -- 14,543,000 Commission income............................. -- -- 1,544,000 Investment income............................. 112,000 206,000 64,000 Net realized investment loss.................. (5,067,000) (4,521,000) -- Other operating income........................ 89,000 5,221,000 968,000 Gross loss and loss adjustment expense........ -- -- 3,282,000 Ceded loss and loss adjustment expense........ -- -- 37,107,000 Other operating expense....................... 757,000 578,000 840,000 Interest expense.............................. 74,000 418,000 177,000
The Company has committed to invest $5.0 million in an investment partnership managed by a related party. As of December 31, 2000, $3.4 million had been invested under this commitment. In 1998, HC bought an office building to be occupied by the Company from a partnership in which an officer and Director was a partner. The purchase price of $6.0 million was based upon independent appraisal. (11) EMPLOYEE BENEFIT PLANS The Company has a defined contribution retirement plan under Section 401(k) of the Internal Revenue Code which covers substantially all of the employees residing in the United States who meet specified service requirements. The contributions are discretionary and are determined by management as of the beginning of F-25 73 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) each calendar year. The Company currently matches each employee's contribution to the 401(k) plan up to 6% of the employee's salary. Employees of the Company who reside outside the United States receive comparable benefits under different plans. The Company contributed $3.2 million, $3.1 million, and $1.7 million to the plans for the years ended December 31, 2000, 1999 and 1998, respectively, which is included in compensation expense in the accompanying consolidated statements of earnings. (12) SHAREHOLDERS' EQUITY Under the Texas Insurance Code, HC and USSIC must each maintain minimum statutory capital of $1.0 million and minimum statutory surplus of $1.0 million, and can only pay dividends out of statutory surplus funds. In addition, they are limited in the amount of dividends which they may pay in any twelve-month period, without prior regulatory approval, to the greater of statutory net income for the prior calendar year or ten percent (10%) of statutory policyholders' surplus as of the prior calendar year end. During 2001, HC's and USSIC's ordinary dividend capacities will be approximately $23.1 million and $10.6 million, respectively. AIC is limited by the State of Maryland in the amount of dividends which it may pay in any twelve-month period, without prior regulatory approval, to the greater of statutory net income (under certain conditions) for the prior calendar year or ten percent (10%) of statutory policyholders' surplus as of the prior year end. During 2001, AIC's ordinary dividend capacity will be approximately $18.2 million. HCCL is limited by the laws of the State of Indiana in the amount of dividends it may pay in any twelve-month period, without prior regulatory approval, to the greater of net gain from operations for the prior calendar year or ten percent (10%) of statutory capital and surplus as of the prior year end. During 2001, HCCL's ordinary dividend capacity will be approximately $6.3 million. As of December 31, 2000, all of the domestic insurance company subsidiaries total adjusted capital is significantly in excess of the NAIC authorized control level risk-based capital. The components of accumulated other comprehensive income (loss) are as follows:
ACCUMULATED UNREALIZED OTHER FOREIGN CURRENCY INVESTMENT COMPREHENSIVE TRANSLATION GAIN (LOSS) INCOME (LOSS) ---------------- ------------ ------------- Balance December 31, 1997................. $(306,000) $ 8,306,000 $ 8,000,000 Net change for year....................... (344,000) 2,049,000 1,705,000 --------- ------------ ------------ Balance December 31, 1998................. (650,000) 10,355,000 9,705,000 Net change for year....................... 167,000 (12,564,000) (12,397,000) --------- ------------ ------------ Balance December 31, 1999................. (483,000) (2,209,000) (2,692,000) Net change for year....................... (172,000) 7,577,000 7,405,000 --------- ------------ ------------ Balance December 31, 2000................. $(655,000) $ 5,368,000 $ 4,713,000 ========= ============ ============
(13) >STOCK OPTIONS The Company has five option plans, the 1994 Non-employee Director Stock Option Plan, the 1996 Non-employee Director Stock Option Plan, the 1992 Incentive Stock Option Plan, the 1995 Flexible Incentive Plan, and the 1997 Flexible Incentive Plan. All plans are administered by the Compensation Committee of the Board of Directors. Each option may be used to purchase one share of Common Stock of the Company. As of December 31, 2000, 6,149,243 shares of Common Stock were reserved for the exercise of options, of which 5,494,229 shares were reserved for options previously granted and 655,014 shares were reserved for future issuances of options. F-26 74 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Options vest over a zero to five year period and expire four to ten years after grant date. All options have been granted at fixed exercise prices, generally at the market price of the Company's Common Stock on the grant date. Any excess of the market price on the grant date over the exercise price is recognized as compensation expense in the accompanying consolidated financial statements. If the fair value method of valuing compensation related to options would have been used, pro forma net earnings and pro forma diluted earnings per share would have been $48.7 million, or $0.96 per share, for the year ended December 31, 2000; $20.7 million, or $0.42 per share, for the year ended December 31, 1999; and $65.4 million, or $1.34 per share, for the year ended December 31, 1998. The fair value of each option grant was estimated on the grant date using the Black-Scholes single option pricing model with the following weighted average assumptions: a) risk free interest rate of 6.4% for 2000, 5.7% for 1999 and 5.3% for 1998, b) expected volatility factor of .3, c) dividend yield of 0.89% for 2000, 1.52% for 1999 and 0.91% for 1998, and d) expected option life of four years for 2000 and 1999, and five years for 1998. The average fair value of options granted during the years ended December 31, 2000, 1999 and 1998 was $4.51, $4.16 and $5.23, respectively. The following table provides an analysis of stock option activity during the three years ended December 31, 2000:
2000 1999 1998 --------------------- --------------------- -------------------- AVERAGE AVERAGE AVERAGE NUMBER EXERCISE NUMBER EXERCISE NUMBER EXERCISE OF SHARES PRICE OF SHARES PRICE OF SHARES PRICE ---------- -------- ---------- -------- --------- -------- Outstanding, beginning of year....................... 5,470,008 $16.08 5,459,766 $16.73 3,508,226 $16.22 Granted at market value...... 1,745,000 13.59 1,869,600 13.48 2,779,500 17.01 Forfeitures and expirations................ (434,242) 18.32 (1,327,243) 18.36 (192,462) 21.48 Exercised.................... (1,286,537) 14.34 (532,115) 7.88 (635,498) 14.05 ---------- ------ ---------- ------ --------- ------ Outstanding, end of year..... 5,494,229 $15.54 5,470,008 $16.08 5,459,766 $16.73 ========== ====== ========== ====== ========= ====== Exercisable, end of year..... 2,716,705 $16.59 2,982,872 $16.84 2,792,707 $15.92 ========== ====== ========== ====== ========= ======
Options outstanding and exerciseable as of December 31, 2000 are shown on the following schedule:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE --------------------------------------- -------------------- AVERAGE AVERAGE AVERAGE RANGE OF NUMBER REMAINING EXERCISE NUMBER EXERCISE EXERCISE PRICES OF SHARES CONTRACTUAL LIFE PRICE OF SHARES PRICE - --------------- --------- ---------------- -------- --------- -------- Under $16.00................... 2,614,400 4.80 years $11.53 952,454 $11.41 $16.00-$16.99.................. 1,434,546 3.51 16.45 821,319 16.46 Over $16.99.................... 1,445,283 5.30 21.88 942,932 21.94 --------- ---------- ------ --------- ------ Total options........ 5,494,229 4.59 years $15.54 2,716,705 $16.59 ========= ========== ====== ========= ======
F-27 75 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (14) EARNINGS PER SHARE The following table provides reconciliation of the denominators used in the earnings per share calculations for the three years ended December 31, 2000:
2000 1999 1998 ----------- ----------- ----------- Net earnings................................... $53,431,000 $25,123,000 $72,278,000 =========== =========== =========== Reconciliation of number of shares outstanding: Shares of Common Stock outstanding at year end.......................................... 50,345,000 48,839,000 48,252,000 Changes in Common Stock due to issuance........ (908,000) (241,000) (332,000) Contingent shares to be issued................. 39,000 49,000 -- Common Stock contractually issuable in the future....................................... 269,000 414,000 -- ----------- ----------- ----------- Weighted average Common Stock outstanding........................ 49,745,000 49,061,000 47,920,000 Additional dilutive effect of outstanding options (as determined by the application of the treasury stock method)................... 877,000 588,000 1,016,000 ----------- ----------- ----------- Weighted average Common Stock and potential common stock outstanding........................ 50,622,000 49,649,000 48,936,000 =========== =========== ===========
As of December 31, 2000, there were approximately 1.5 million options that were not included in the computation of diluted earnings per share because to do so would have been antidilutive. As part of a 1999 purchase agreement, up to 378,000 shares of the Company's Common Stock are to be issued if certain conditions are met. Of these shares, 94,500 have been issued and 39,000 are included in the 2000 computation because the contingency had been partially met. The remainder of the contingent shares were not included in the earnings per share computation because the conditions for issuance of the remaining shares have not yet been met. (15) STATUTORY INFORMATION The Company's insurance company subsidiaries file financial statements prepared in accordance with statutory accounting practices prescribed or permitted by domestic or foreign insurance regulatory authorities. The differences between statutory financial statements and financial statements prepared in accordance with GAAP vary between domestic and foreign jurisdictions. The principal differences are that for statutory financial statements deferred policy acquisition costs are not recognized, deferred income taxes are not recorded, bonds are generally carried at amortized cost, certain assets are non-admitted and charged directly to surplus, a liability for a provision for reinsurance is recorded and charged directly to surplus and insurance assets and liabilities are presented net of reinsurance. The Company's use of permitted statutory accounting practices does not have a significant impact on statutory surplus. Statutory policyholders' surplus, and net income for the three years ended December 31, 2000, after intercompany eliminations, of the Company's insurance company subsidiaries included in those companies' respective filings with regulatory authorities are as follows:
2000 1999 1998 ------------ ------------ ------------ Statutory policyholders' surplus........... $326,249,000 $315,474,000 $369,401,000 Statutory net income (loss)................ 13,749,000 (8,707,000) 53,162,000
F-28 76 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Statutory policyholders' surplus has been adversely affected by statutory adjustments for reinsurance recoverables which, although required statutorily, have no effect on net earnings or shareholders' equity. The statutory net loss for 1999 includes a $25.5 million loss, net of income tax, from the provision for reinsurance. The National Association of Insurance Commissioners adopted Statements of Statutory Accounting Principles in March, 1998 as a product of its attempt to codify statutory accounting principles. Although subject to adoption by the individual states, an effective date of January 1, 2001 was established for implementation of the statements. Prior to the codification project, a comprehensive guide to statutory accounting principles did not exist. Codification is new and will evolve over time. The cumulative effect of codification is expected to increase statutory policyholders' surplus of the Company's insurance company subsidiaries by approximately $6.0 million. The Company expects that the statutory surplus of its insurance company subsidiaries after adoption will continue to be in excess of their regulatory risk-based capital requirements. (16) OTHER INFORMATION Supplemental Cash Flow Information Supplemental cash flow information for the three years ended December 31, 2000, is summarized below:
2000 1999 1998 ----------- ----------- ----------- Interest paid................................. $17,418,000 $13,694,000 $ 5,409,000 Income tax paid............................... 11,859,000 23,116,000 30,662,000 Dividends declared but not paid at year end... 3,023,000 2,442,000 1,930,000
The unrealized gain or loss on securities available for sale, deferred taxes related thereto and the issuance of the Company's Common Stock for the purchase of subsidiaries are non-cash transactions which have been included as direct increases or decreases in shareholders' equity. The cumulative effect of accounting change due to the Company's adoption of SAB 101 is a non-cash charge to earnings. Restructuring As of December 31, 1999, the Company had accrued two separate restructuring liabilities, one relating to HCC's ongoing operations ("HCC Internal") and another relating to HCC's acquisition of Centris. Changes in the accruals between December 31, 1999 and December 31, 2000 are shown in the tables below:
ACCRUED AT 2000 ACCRUED AT 12/31/99 PAID IN 2000 ADJUSTMENTS 12/31/00 ----------- ------------ ----------- ----------- HCC Internal Restructuring Severance........................... $3,115,000 $3,115,000 $ -- $ -- Other............................... 911,000 292,000 (514,000) 105,000 ---------- ---------- --------- -------- Total....................... $4,026,000 $3,407,000 $(514,000) $105,000 ========== ========== ========= ========
During 2000, the Company determined that one of the leased offices scheduled to be closed would be retained. Therefore, the Company reversed $789,000 (included as a credit in other operating expenses) of the restructuring expense recorded during the fourth quarter of 1999, of which $514,000 was the reversal of the accrual for the future lease payments and $275,000 was the reversal of the write down of certain assets. F-29 77 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
ACCRUED AT 2000 ACCRUED AT 12/31/99 PAID IN 2000 ADJUSTMENTS 12/31/00 ----------- ------------ ----------- ----------- Centris Restructuring Contractual executive severance accruals........................ $5,866,000 $6,027,000 $ 166,000 $ 5,000 Other severance accruals........... 397,000 541,000 258,000 114,000 Lease obligation accruals.......... 848,000 1,004,000 1,196,000 1,040,000 ---------- ---------- ---------- ---------- Total...................... $7,111,000 $7,572,000 $1,620,000 $1,159,000 ========== ========== ========== ==========
The adjustments in 2000 were recorded as management decided to take additional steps to integrate parts of the Centris operations. During the fourth quarter of 2000, the Company also recorded a restructuring charge and associated expenses of $1.5 million. A total of 26 employees were or will be terminated as a result of the Company's restructuring of certain underwriting agency operations and their integration into the Company's insurance company operations. The charges affected both segments and consisted of $557,000 accrued severance pay to be paid at various times throughout 2001 and $992,000 for the write down or write off of various impaired assets, primarily redundant computer software. Restructuring charges of $761,000 in 2000 and $5.5 million in 1999 are included in other operating expenses in the consolidated statements of earnings. (17) LIABILITY FOR UNPAID LOSS AND LOSS ADJUSTMENT EXPENSE The following table provides a reconciliation of the liability of loss and loss adjustment expense ("LAE"), for the three years ended December 31, 2000:
2000 1999 1998 ------------ ------------ ------------ Reserves for loss and LAE at beginning of the year............................................. $871,104,000 $460,511,000 $275,008,000 Less reinsurance recoverables...................... 597,498,000 341,599,000 155,374,000 ------------ ------------ ------------ Net reserves at beginning of the year............ 273,606,000 118,912,000 119,634,000 Net reserve adjustments from acquisition and disposition of subsidiaries...................... 514,000 55,523,000 3,877,000 Effect on loss reserves of write off of ceded outstanding and IBNR reinsurance recoverables.... -- 82,343,000 -- Provision for loss and LAE for claims occurring in the current year................................. 208,055,000 105,036,000 105,895,000 Increase (decrease) in estimated loss and LAE for claims occurring in prior years.................. (9,585,000) 4,614,000 (14,593,000) ------------ ------------ ------------ Incurred loss and LAE, net of reinsurance........ 198,470,000 109,650,000 91,302,000 ------------ ------------ ------------ Loss and LAE payments for claims occurring during: Current year....................................... 76,725,000 36,770,000 47,126,000 Prior years........................................ 145,993,000 56,052,000 48,775,000 ------------ ------------ ------------ Loss and LAE payments, net of reinsurance........ 222,718,000 92,822,000 95,901,000 ------------ ------------ ------------ Net reserves at end of the year.................... 249,872,000 273,606,000 118,912,000 Plus reinsurance recoverables...................... 694,245,000 597,498,000 341,599,000 ------------ ------------ ------------ Reserves for loss and LAE at end of the year.................................... $944,117,000 $871,104,000 $460,511,000 ============ ============ ============
F-30 78 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) During 2000, the Company had net loss and LAE redundancy of $9.6 million relating to prior year losses compared to a deficiency of $4.6 million in 1999 and a redundancy of $14.6 million in 1998. The deficiencies and redundancies in the reserves result from the Company's and its actuaries' continued review of its loss reserves and the increase or reduction of such reserves as losses are finally settled and claims exposures are reduced. The Company believes it has provided for all material net incurred losses. The Company has no material exposure to environmental pollution losses, as HC only began writing business in 1981 and policies issued by HC 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 AIC and USSIC, because of the types of risks incurred, principally general aviation, are not considered to have significant environmental exposures. Therefore, the Company should not experience any material development in reserves from environmental pollution claims. (18) QUARTERLY FINANCIAL DATA (UNAUDITED; AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
FOURTH QUARTER THIRD QUARTER SECOND QUARTER FIRST QUARTER ------------------ ------------------ ------------------ ------------------ 2000 1999 2000 1999 2000 1999 2000 1999 -------- ------- -------- ------- -------- ------- -------- ------- Total revenue...................... $108,308 $84,308 $118,681 $83,093 $119,089 $82,483 $120,089 $91,987 Earnings (loss) before accounting change........................... 13,404 (4,991) 16,994 9,118 12,411 287 12,635 20,709 Cumulative effect of accounting change........................... -- -- -- -- -- -- (2,013) -- -------- ------- -------- ------- -------- ------- -------- ------- Net earnings (loss)................ $ 13,404 $(4,991) $ 16,994 $ 9,118 $ 12,411 $ 287 $ 10,622 $20,709 ======== ======= ======== ======= ======== ======= ======== ======= Basic earnings (loss) per share data: Earnings (loss) before accounting change........................... $ 0.27 $ (0.10) $ 0.34 $ 0.19 $ 0.25 $ 0.01 $ 0.26 $ 0.42 Cumulative effect of accounting change........................... -- -- -- -- -- -- (0.04) -- -------- ------- -------- ------- -------- ------- -------- ------- Earnings (loss) per share.......... $ 0.27 $ (0.10) $ 0.34 $ 0.19 $ 0.25 $ 0.01 $ 0.22 $ 0.42 ======== ======= ======== ======= ======== ======= ======== ======= Weighted average shares outstanding...................... 50,184 49,193 49,742 49,130 49,528 48,951 49,403 48,764 ======== ======= ======== ======= ======== ======= ======== ======= Diluted earnings (loss) per share data: Earnings (loss) before accounting change........................... $ 0.26 $ (0.10) $ 0.33 $ 0.18 $ 0.25 $ 0.01 $ 0.25 $ 0.42 Cumulative effect of accounting change........................... -- -- -- -- -- -- (0.04) -- -------- ------- -------- ------- -------- ------- -------- ------- Earnings (loss) per share.......... $ 0.26 $ (0.10) $ 0.33 $ 0.18 $ 0.25 $ 0.01 $ 0.21 $ 0.42 ======== ======= ======== ======= ======== ======= ======== ======= Weighted average shares outstanding...................... 51,533 49,193 51,040 49,866 50,086 49,971 49,709 49,544 ======== ======= ======== ======= ======== ======= ======== =======
During 1999, pre-tax provisions for reinsurance of $29.5 million and $14.0 million were recorded in the second quarter and fourth quarter, respectively. Also, during the fourth quarter of 1999, the Company recorded a pre-tax restructuring expense of $5.5 million. During the fourth quarter of 2000, the Company recorded a $4.4 million pre-tax increase in reserves of discontinued lines of business that were part of the 1999 Centris acquisition and a $1.5 million in pre-tax restructuring expense. The sum of the quarters earnings (loss) per share may not equal the annual amounts due to rounding. The net earnings shown in the above table for the first quarter of 2000 do not match the amount reported in the Form 10-Q filed with the SEC due to the cumulative effect of the change in accounting principle subsequently recorded due to the Company's adoption of SAB 101. F-31 79 REPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULES To the Board of Directors and Shareholders HCC Insurance Holdings, Inc.: Our report on the consolidated financial statements of HCC Insurance Holdings, Inc., which included an emphasis paragraph related to a change in the Company's method of revenue recognition for certain contracts, is included on page F-1 of this Form 10-K. In connection with our audits of such financial statements, we have also audited the financial statements schedules listed in Item 14(b) of this Form 10-K. These financial statement schedules are the responsibility of the Company's management. In our opinion, these financial statement schedules present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. /s/ PricewaterhouseCoopers LLP Houston, Texas March 21, 2001 S-1 80 SCHEDULE 1 HCC INSURANCE HOLDINGS, INC. SUMMARY OF INVESTMENTS OTHER THAN INVESTMENTS IN RELATED PARTIES DECEMBER 31, 2000
COLUMN A COLUMN B COLUMN C COLUMN D - -------- ------------ ------------ --------------- AMOUNT AT WHICH SHOWN IN THE TYPE OF INVESTMENT COST VALUE BALANCE SHEET - ------------------ ------------ ------------ --------------- Fixed maturities: Bonds -- United States government and government agencies and authorities..................... $ 71,155,000 $ 72,612,000 $ 72,612,000 Bonds -- states, municipalities and political subdivisions................................. 61,076,000 62,506,000 62,506,000 Bonds -- special revenue........................ 142,692,000 146,809,000 146,809,000 Bonds -- corporate.............................. 100,881,000 103,700,000 103,700,000 Mortgage backed securities...................... 39,722,000 40,792,000 40,792,000 Bonds -- foreign government..................... 7,295,000 7,425,000 7,425,000 ------------ ------------ ------------ Total fixed maturities.................. 422,821,000 $433,844,000 433,844,000 ------------ ============ ------------ Equity securities: Common stocks -- banks, trusts and insurance companies.................................... 2,551,000 $ 1,511,000 1,511,000 Common stocks -- industrial..................... 3,342,000 1,575,000 1,575,000 Non-redeemable preferred stocks................. 3,003,000 3,196,000 3,196,000 ------------ ------------ ------------ Total equity securities................. 8,896,000 $ 6,282,000 6,282,000 ------------ ============ ------------ Short-term investments............................ 262,982,000 262,982,000 Other investments................................. 7,182,000 7,182,000 ------------ ------------ Total investments....................... $701,881,000 $710,290,000 ============ ============
S-2 81 SCHEDULE 2 HCC INSURANCE HOLDINGS, INC. CONDENSED FINANCIAL INFORMATION OF REGISTRANT BALANCE SHEETS
DECEMBER 31, --------------------------- 2000 1999 ------------ ------------ ASSETS Cash........................................................ $ 886,000 $ 23,000 Short-term investments...................................... 2,660,000 395,000 Investment in subsidiaries.................................. 614,536,000 626,802,000 Receivable from subsidiaries................................ 1,437,000 5,840,000 Intercompany loans to subsidiaries.......................... 126,325,000 76,260,000 Other assets................................................ 3,974,000 3,996,000 ------------ ------------ Total assets...................................... $749,818,000 $713,316,000 ============ ============ LIABILITIES AND SHAREHOLDERS' EQUITY Notes payable............................................... $207,500,000 $235,000,000 Note payable to related party............................... 4,633,000 7,546,000 Deferred Federal income tax................................. 562,000 948,000 Accounts payable and accrued liabilities.................... 7,688,000 12,394,000 ------------ ------------ Total liabilities................................. 220,383,000 255,888,000 Total shareholders' equity........................ 529,435,000 457,428,000 ------------ ------------ Total liabilities and shareholders' equity........ $749,818,000 $713,316,000 ============ ============
See Notes to Condensed Financial Information. S-3 82 SCHEDULE 2 HCC INSURANCE HOLDINGS, INC. CONDENSED FINANCIAL INFORMATION OF REGISTRANT STATEMENTS OF EARNINGS
FOR THE YEARS ENDED DECEMBER 31, --------------------------------------- 2000 1999 1998 ----------- ----------- ----------- Equity in earnings of subsidiaries.................... $60,379,000 $30,948,000 $75,228,000 Interest income from subsidiaries..................... 9,160,000 4,165,000 2,052,000 Interest income....................................... 343,000 146,000 285,000 Net realized investment gain.......................... -- -- 840,000 Other income.......................................... 146,000 73,000 -- ----------- ----------- ----------- Total revenue............................... 70,028,000 35,332,000 78,405,000 Interest expense...................................... 20,249,000 12,907,000 6,036,000 Other operating expense............................... 1,582,000 266,000 1,730,000 ----------- ----------- ----------- Total expense............................... 21,831,000 13,173,000 7,766,000 ----------- ----------- ----------- Earnings before income tax benefit.......... 48,197,000 22,159,000 70,639,000 Income tax benefit.................................... 5,234,000 2,964,000 1,639,000 ----------- ----------- ----------- Net earnings................................ $53,431,000 $25,123,000 $72,278,000 =========== =========== ===========
See Notes to Condensed Financial Information. S-4 83 SCHEDULE 2 HCC INSURANCE HOLDINGS, INC. CONDENSED FINANCIAL INFORMATION OF REGISTRANT STATEMENTS OF COMPREHENSIVE INCOME
FOR THE YEARS ENDED DECEMBER 31, ---------------------------------------- 2000 1999 1998 ----------- ------------ ----------- Net earnings......................................... $53,431,000 $ 25,123,000 $72,278,000 Other comprehensive income net of tax: Foreign currency translation adjustment............ (172,000) 167,000 (344,000) Investment gains (losses): Investment gains during the year, net of deferred tax charge of $294,000 in 1998.................. -- -- 546,000 Consolidated subsidiaries' investment gains (losses) during the year, net of deferred tax charge (benefit) of, $2,386,000 in 2000; $(8,042,000) in 1999; and $1,205,000 in 1998.... 4,118,000 (15,271,000) 2,454,000 Less reclassification adjustment for gains included in net earnings, net of deferred tax charge of $294,000 in 1998................................ -- -- (546,000) Less consolidated subsidiaries' reclassification adjustments for (gains) losses included in net earnings, net of deferred tax (charge) benefit of $1,862,000 in 2000; $1,457,000 in 1999, and ($218,000) in 1998.............................. 3,459,000 2,707,000 (405,000) ----------- ------------ ----------- Other comprehensive income (loss).................... 7,405,000 (12,397,000) 1,705,000 ----------- ------------ ----------- Comprehensive income....................... $60,836,000 $ 12,726,000 $73,983,000 =========== ============ ===========
See Notes to Condensed Financial Information. S-5 84 SCHEDULE 2 HCC INSURANCE HOLDINGS, INC. CONDENSED FINANCIAL INFORMATION OF REGISTRANT STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, ------------------------------------------- 2000 1999 1998 ------------ ------------- ------------ Cash flows from operating activities: Net earnings.................................... $ 53,431,000 $ 25,123,000 $ 72,278,000 Adjustment to reconcile net earnings to net cash provided (used) by operating activities: Undistributed net income of subsidiaries........ (60,379,000) (30,948,000) (75,228,000) Change in deferred Federal income tax, net of tax effect of unrealized gain or loss........ (885,000) 687,000 3,934,000 Changes in other assets and other............... (245,000) 2,252,000 -- Depreciation.................................... 24,000 29,000 29,000 Increase in accrued interest receivable added to intercompany loan balances................... (5,160,000) (4,035,000) (2,052,000) Change in accounts payable and accrued liabilities.................................. (5,286,000) (7,819,000) 124,000 Net realized investment gain.................... -- -- (840,000) ------------ ------------- ------------ Cash used by operating activities............ (18,500,000) (14,711,000) (1,755,000) Cash flows from investing activities: Sales of other operating investments............ 307,000 -- -- Sales of fixed income securities................ -- -- 16,680,000 Cash contributions to subsidiaries.............. (1,130,000) (36,030,000) (62,000) Purchase of subsidiaries........................ (10,345,000) (201,947,000) (30,355,000) Change in short-term investments................ (2,265,000) 4,144,000 (3,339,000) Cost of investment acquired..................... -- (2,898,000) (2,525,000) Change in receivable from subsidiaries.......... 4,403,000 10,084,000 (4,056,000) Intercompany loans to subsidiaries.............. (16,509,000) (27,404,000) (34,530,000) Payments on intercompany loans to subsidiaries................................. 42,838,000 66,595,000 15,986,000 Cash dividends from subsidiaries................ 21,598,000 93,228,000 24,450,000 ------------ ------------- ------------ Cash provided (used) by investing activities................................. 38,897,000 (94,228,000) (17,751,000) Cash flows from financing activities: Proceeds from note payable...................... 26,700,000 547,000,000 74,200,000 Payments on notes payable....................... (57,042,000) (433,600,000) (49,950,000) Sale of Common Stock............................ 21,158,000 4,783,000 2,203,000 Dividends paid.................................. (10,350,000) (9,221,000) (7,139,000) ------------ ------------- ------------ Cash provided (used) by financing activities................................. (19,534,000) 108,962,000 19,314,000 ------------ ------------- ------------ Net change in cash.............................. 863,000 23,000 (192,000) Cash as of beginning of year.................... 23,000 -- 192,000 ------------ ------------- ------------ Cash as of end of year.......................... $ 886,000 $ 23,000 $ -- ============ ============= ============
See Notes to Condensed Financial Information. S-6 85 HCC INSURANCE HOLDINGS, INC. CONDENSED FINANCIAL INFORMATION OF REGISTRANT NOTES TO CONDENSED FINANCIAL INFORMATION (1) The accompanying condensed financial information should be read in conjunction with the consolidated financial statements and the related notes thereto of HCC Insurance Holdings, Inc. and Subsidiaries. Investments in subsidiaries are accounted for using the equity method. (2) Intercompany loans to subsidiaries are demand notes issued primarily to fund the cash portion of acquisitions. They bear interest at a rate set by management, which approximates the interest rate charged to the Company for similar debt. As of December 31, 2000, the interest rate on intercompany loans was 8%. S-7 86 SCHEDULE 3 HCC INSURANCE HOLDINGS, INC. SUPPLEMENTARY INSURANCE INFORMATION (DOLLARS IN THOUSANDS)
COLUMN A COLUMN B COLUMN C(1) COLUMN D(1) COLUMN F COLUMN G(2) COLUMN H - ---------------------------- ----------------- ----------------- ----------- -------- -------------- ----------------- DECEMBER 31, FOR THE YEARS ENDED DECEMBER 31, - --------------------------------------------------------------------------------- --------------------------------------------- FUTURE POLICY BENEFITS, CLAIMS, BENEFITS, LOSSES, LOSSES AND DEFERRED POLICY CLAIMS AND LOSS UNEARNED PREMIUM NET INVESTMENT SETTLEMENT SEGMENTS ACQUISITION COSTS EXPENSES PREMIUMS REVENUE INCOME EXPENSES - -------- ----------------- ----------------- ----------- -------- -------------- ----------------- 2000 Insurance Company.......... $ 9,095 $1,030,877 $190,550 $267,647 $27,948 $198,470 Underwriting Agency........ 7,547 Intermediary............. 3,293 Other Operations........... 476 Corporate.............. 530 ------- ---------- -------- -------- ------- -------- Total................ $ 9,095 $1,030,877 $190,550 $267,647 $39,794 $198,470 ======= ========== ======== ======== ======= ======== 1999 Insurance Company.......... $ 658 $ 966,864 $188,524 $141,362 $23,400 $109,650 Underwriting Agency........ 4,186 Intermediary............. 2,491 Other Operations........... 424 Corporate.............. 432 ------- ---------- -------- -------- ------- -------- Total................ $ 658 $ 966,864 $188,524 $141,362 $30,933 $109,650 ======= ========== ======== ======== ======= ======== 1998 Insurance Company.......... $(3,615) $ 460,511 $201,050 $143,100 $22,995 $ 91,302 Underwriting Agency........ 3,949 Intermediary............. 362 Other Operations........... 536 Corporate.............. 1,493 ------- ---------- -------- -------- ------- -------- Total................ $(3,615) $ 460,511 $201,050 $143,100 $29,335 $ 91,302 ======= ========== ======== ======== ======= ======== COLUMN A COLUMN I COLUMN J(3) COLUMN K - ---------------------------- ----------------- ----------- -------- FOR THE YEARS ENDED DECEMBER 31, - ---------------------------- ------------------------------------------ AMORTIZATION OF OTHER DEFERRED POLICY OPERATING PREMIUM SEGMENTS ACQUISITION COSTS EXPENSES WRITTEN - -------- ----------------- ----------- -------- 2000 Insurance Company.......... $23,743 $ 19,849 $283,788 Underwriting Agency........ 69,092 Intermediary............. 25,679 Other Operations........... 15,755 Corporate.............. 586 ------- -------- -------- Total................ $23,743 $130,961 $283,788 ======= ======== ======== 1999 Insurance Company.......... $ 8,177 $ 63,963 $139,924 Underwriting Agency........ 63,325 Intermediary............. 30,416 Other Operations........... 16,399 Corporate.............. (417) ------- -------- -------- Total................ $ 8,177 $173,686 $139,924 ======= ======== ======== 1998 Insurance Company.......... $10,978 $ 17,555 $121,883 Underwriting Agency........ 50,325 Intermediary............. 8,241 Other Operations........... 14,936 Corporate.............. 1,190 ------- -------- -------- Total................ $10,978 $ 92,247 $121,883 ======= ======== ========
- --------------- (1) Columns C and D are shown ignoring the effects of reinsurance. (2) Net investment income was allocated to the subsidiary, and therefore the segment, on which the related investment asset was recorded. (3) Other operating expenses is after all corporate expense allocations and amortization of goodwill have been charged or credited to the individual segments. Note: Column E is omitted because the Company has no other policy claims and benefits payable. S-8 87 SCHEDULE 4 HCC INSURANCE HOLDINGS, INC. REINSURANCE
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E COLUMN F - -------- ------------- -------------- ------------ ------------ ---------- (1) PERCENT OF ASSUMED FROM AMOUNT CEDED TO OTHER OTHER ASSUMED DIRECT AMOUNT COMPANIES COMPANIES NET AMOUNT TO NET ------------- -------------- ------------ ------------ ---------- For the year ended December 31, 2000: Life insurance in force...... $633,988,000 $633,851,000 $ 0 $ 137,000 0% ============ ============ ============ ============ === Earned premium: Property and liability insurance.................. $290,928,000 $285,020,000 $ 92,253,000 $ 98,161,000 94% Accident and health insurance.................. 372,530,000 421,928,000 218,884,000 169,486,000 129% ------------ ------------ ------------ ------------ Total.............. $663,458,000 $706,948,000 $311,137,000 $267,647,000 116% ============ ============ ============ ============ === For the year ended December 31, 1999: Life insurance in force...... $832,305,000 $799,573,000 $ 0 $ 32,732,000 0% ============ ============ ============ ============ === Earned premium: Property and liability insurance.................. $230,879,000 $277,089,000 $127,495,000 $ 81,285,000 157% Accident and health insurance.................. 63,251,000 169,782,000 166,608,000 60,077,000 277% ------------ ------------ ------------ ------------ Total.............. $294,130,000 $446,871,000 $294,103,000 $141,362,000 208% ============ ============ ============ ============ === For the year ended December 31, 1998: Earned premium: Property and liability insurance.................. $190,030,000 $233,549,000 $140,354,000 $ 96,835,000 145% Accident and health insurance.................. 2,506,000 76,426,000 120,185,000 46,265,000 260% ------------ ------------ ------------ ------------ Total.............. $192,536,000 $309,975,000 $260,539,000 $143,100,000 182% ============ ============ ============ ============ ===
- --------------- (1) Most of the reinsurance assumed by the Company's insurance company subsidiaries was underwritten directly by one of the Company's underwriting agency subsidiaries, but issued by other non-affiliated companies in order to satisfy local licensing, contractual or other requirements. S-9 88 SCHEDULE 5 HCC INSURANCE HOLDINGS, INC. VALUATION AND QUALIFYING ACCOUNTS
2000 1999 1998 ----------- ------------ ---------- Reserve for uncollectible reinsurance: Balance as of beginning of year..................... $ 5,541,000 $ 2,499,000 $2,535,000 Total provision charged to expense.................. 465,000 43,650,000 60,000 Total amounts written off........................... (1,949,000) (40,608,000) (96,000) ----------- ------------ ---------- Balance as of end of year........................... $ 4,057,000 $ 5,541,000 $2,499,000 =========== ============ ========== Allowance for doubtful accounts: Balance as of beginning of year..................... $ 1,729,000 $ 284,000 $ 220,000 Acquisitions of subsidiaries........................ -- 629,000 -- Total provision charged to expense.................. 2,740,000 1,171,000 783,000 Total amounts written off........................... (1,219,000) (355,000) (719,000) ----------- ------------ ---------- Balance as of end of year........................... $ 3,250,000 $ 1,729,000 $ 284,000 =========== ============ ==========
S-10 89 INDEX TO EXHIBITS (Items denoted by a letter are incorporated by reference to other documents previously filed with the Securities and Exchange Commission as set forth at the end of this index. Items not denoted by a letter are being filed herewith.)
EXHIBIT NUMBER DESCRIPTION ------- ----------- (B)3.1 -- Bylaws of HCC Insurance Holdings, Inc., as amended. (A)3.2 -- Restated Certificate of Incorporation and Amendment of Certificate of Incorporation of HCC Insurance Holdings, Inc., filed with the Delaware Secretary of State on July 23, 1996 and May 21, 1998, respectively. (B)4.1 -- Specimen of Common Stock Certificate, $1.00 par value, of HCC Insurance Holdings, Inc. (C)10.1 -- Stock Purchase Agreement dated effective October 1, 1998 by and among HCC Insurance Holdings, Inc., and Sun Employer Services, Inc. and Howard V. Barton and Elizabeth A. Barton. (D)10.2 -- Share Purchase Agreement dated January 29, 1999, among HCC Insurance Holdings, Inc. and Gerald Axel, Barry J. Cook, Gary J. Lockett, Christopher F.B. Mays, Mark E. Rattner, Marshall Rattner, Inc., John Smith and Keith W. Steed. 10.3 -- Agreement and Plan of Merger dated as of January 19, 2001 by and among HCC Insurance Holdings, Inc., HCC Employee Benefits, Inc. and James Scott Schanen, Lisa Rae Schanen, Conor Schanen qsst, Austin Schanen qsst, Kevin Tolbert and Schanen Consulting Corporation. (E)10.4 -- Loan Agreement ($300,000,000 Revolving Loan Facility) dated as of December 17, 1999 among HCC Insurance Holdings, Inc. as Borrower, Wells Fargo Bank (Texas), National Association, as Agent, lead arranger and lender, Bank of America, N.A. as documentation agent and lender, Bank of New York as senior managing agent and lender, Bank One, N.A. as co-agent and lender, First Union National Bank as syndications agent and lender and Dresdner Bank AG, New York and Grand Cayman Branches, as co-agent and a lender. (F)10.5 -- HCC Insurance Holdings, Inc. 1994 Nonemployee Director Stock Option Plan. (G)10.6 -- HCC Insurance Holdings, Inc. 1992 Incentive Stock Option Plan, as amended and restated. (G)10.7 -- HCC Insurance Holdings, Inc. 1995 Flexible Incentive Plan, as amended and restated. (G)10.8 -- HCC Insurance Holdings, Inc. 1997 Flexible Incentive Plan, as amended and restated. (G)10.9 -- HCC Insurance Holdings, Inc. 1996 Nonemployee Director Stock Option Plan, as amended and restated. (D)10.10 -- Employment Agreement effective as of January 1, 1999, between HCC Insurance Holdings, Inc. and Stephen L. Way. (G)10.11 -- Employment Agreement effective as of January 5, 2000, between HCC Insurance Holdings, Inc. and John N. Molbeck, Jr. 10.12 -- Employment Agreement effective as of January 5, 2000, between HCC Insurance Holdings, Inc. and Benjamin D. Wilcox. 10.13 -- Employment Agreement effective as of January 5, 2000, between HCC Insurance Holdings, Inc. and Frank J. Bramanti. (H)10.14 -- Employment Agreement effective as of January 5, 2000, between HCC Insurance Holdings, Inc. and Edward H. Ellis, Jr.
90
EXHIBIT NUMBER DESCRIPTION ------- ----------- (I)10.15 -- Agreement and Plan of Merger dated as of October 11, 1999 among HCC Insurance Holdings, Inc., Merger Sub of Delaware, Inc. and The Centris Group, Inc. 12 -- Statement Regarding Computation of Ratios 21 -- Subsidiaries of HCC Insurance Holdings, Inc. 23 -- Consent of Independent Accountants -- PricewaterhouseCoopers LLP dated March 30, 2001 24 -- Powers of Attorney
- --------------- (A) Incorporated by reference to the Exhibits to HCC Insurance Holdings, Inc.'s Registration Statement on Form S-8 (Registration No. 333-61687) filed August 17, 1998. (B) Incorporated by reference to the Exhibits to HCC Insurance Holdings, Inc.'s Registration Statement on Form S-1 (Registration No. 33-48737) filed October 27, 1992. (C) Incorporated by reference to Exhibits to HCC Insurance Holdings, Inc.'s Form 10-K for the fiscal year ended December 31, 1998. (D) Incorporated by reference to the Exhibits to HCC Insurance Holdings, Inc.'s Form 10-Q for the fiscal quarter ended March 31, 1999. (E) Incorporated by reference to the Exhibits to HCC Insurance Holdings, Inc.'s Form 8-K filed December 20, 1999. (F) Incorporated by reference to the Exhibits to HCC Insurance Holdings, Inc.'s Registration Statement on Form S-8 (Registration No. 33-94472) filed July 11, 1995. (G) Incorporated by reference to Exhibits to HCC Insurance Holdings, Inc.'s Form 10-K for the fiscal year ended December 31, 1999. (H) Incorporated by reference to the Exhibits to HCC Insurance Holdings, Inc.'s Form 10-Q for the fiscal quarter ended March 31, 2000. (I) Incorporated by reference to the Exhibits to HCC Insurance Holdings, Inc.'s Schedule 14D-1 Tender Offer Statement in respect to shares of The Centris Group, Inc. filed October 18, 1999. EX-10.3 2 h85541ex10-3.txt AGREEMENT AND PLAN OF MERGER - DATED 1/19/01 1 EXHIBIT 10.3 AGREEMENT AND PLAN OF MERGER DATED AS OF JANUARY 19, 2001 BY AND AMONG HCC INSURANCE HOLDINGS, INC., HCC EMPLOYEE BENEFITS, INC. AND JAMES SCOTT SCHANEN, LISA RAE SCHANEN, CONNOR SCHANEN QSST, AUSTIN SCHANEN QSST, KEVIN TOLBERT AND SCHANEN CONSULTING CORPORATION 2 TABLE OF CONTENTS
PAGE ---- ARTICLE 1 THE MERGER ...............................................................2 Section 1.1 The Merger...............................................2 Section 1.2 Conversion of Stock......................................3 Section 1.3 Exchange of Certificates.................................3 Section 1.4 Escrow...................................................4 ARTICLE 2 THE SURVIVING CORPORATION.................................................4 Section 2.1 Certificates of Incorporation............................4 Section 2.2 Bylaws...................................................5 Section 2.3 Directors and Officers...................................5 ARTICLE 3 REPRESENTATIONS AND WARRANTIES OF SELLERS.................................5 Section 3.1 Corporate Existence and Power............................5 Section 3.2 Authorization............................................5 Section 3.3 Governmental Authorization...............................6 Section 3.4 Non-Contravention........................................6 Section 3.5 Capitalization...........................................7 Section 3.6 Subsidiaries and Joint Ventures..........................8 Section 3.7 Financial Statements.....................................8 Section 3.8 Absence of Certain Changes...............................8 Section 3.9 No Undisclosed Liabilities..............................10 Section 3.10 Accounting Matters......................................10 Section 3.11 Litigation..............................................10 Section 3.12 Taxes...................................................11 Section 3.13 Employee Benefit Plans, ERISA...........................11 Section 3.14 Material Agreements.....................................13 Section 3.15 Properties..............................................14 Section 3.16 Environmental Matters...................................15 Section 3.17 Labor Matters...........................................15 Section 3.18 Compliance with Laws....................................16 Section 3.19 Trademarks, Tradenames, Etc.............................16 Section 3.20 Sales Negotiations......................................16 Section 3.21 Broker's Fees...........................................16 Section 3.22 Knowledge of the Sellers................................16 Section 3.23 Retained Earnings.......................................16 Section 3.24 Absence of Questionable Payments........................16 Section 3.25 Bank Accounts...........................................17 Section 3.26 Accounts Receivable.....................................17 Section 3.27 Full Disclosure.........................................17 Section 3.28 Sophistication; Accreditation...........................17 Section 3.29 Claims Against the Company..............................17 Section 3.30 HSR Representation......................................17 Section 3.31 Investment for Own Account..............................18 Section 3.32 Legends.................................................18 Section 3.33 Waiver of Dissenter's Rights............................18 Section 3.34 Assignment of Commissions...............................18
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PAGE ---- ARTICLE 4 REPRESENTATIONS AND WARRANTIES OF HCC AND MERGER SUB.......................................................19 Section 4.1 Corporate Existence and Power...........................19 Section 4.2 Corporate Authorization.................................19 Section 4.3 Governmental Authorization..............................19 Section 4.4 Non-Contravention.......................................19 Section 4.5 Broker's Fees...........................................20 Section 4.6 SEC Filings.............................................20 Section 4.7 Full Disclosure.........................................20 Section 4.8 Knowledge of Purchasers.................................20 ARTICLE 5 COVENANTS OF THE SELLERS.................................................21 Section 5.1 Conduct of SCG..........................................21 Section 5.2 Access to Financial and Operational Information.........22 Section 5.3 Other Offers............................................22 Section 5.4 Maintenance of Business.................................23 Section 5.5 Compliance with Obligations.............................23 Section 5.6 Notices of Certain Events...............................23 Section 5.7 Necessary Consents......................................23 Section 5.8 Regulatory Approval.....................................24 Section 5.9 Satisfaction of Conditions Precedent....................24 Section 5.10 Shareholder Approval....................................24 Section 5.11 Affiliates Agreement....................................24 Section 5.12 Non-Competition, Non-Solicitation and Confidentiality...25 ARTICLE 6 COVENANTS OF PURCHASERS..................................................26 Section 6.1 Conduct of Purchasers...................................26 Section 6.2 Obligation of Merger Sub................................26 Section 6.3 Notice to Affiliates....................................27 ARTICLE 7 COVENANTS OF PURCHASERS AND SELLERS......................................27 Section 7.1 Advice of Changes.......................................27 Section 7.2 Regulatory Approvals....................................27 Section 7.3 Certain Filings.........................................27 Section 7.4 Communications..........................................27 Section 7.5 Satisfaction of Conditions Precedent....................28 Section 7.6 Tax Cooperation.........................................28 Section 7.7 Confidentiality.........................................28 ARTICLE 8 CONDITIONS TO CLOSING....................................................29 Section 8.1 Conditions to Obligations of Purchasers.................29 Section 8.2 Conditions to Obligations of Sellers....................31 Section 8.3 Conditions to Obligations of Each Party.................32 ARTICLE 9 POST-CLOSING COVENANTS...................................................33 Section 9.1 Listing of HCC Common Stock.............................33 Section 9.2 Publication of Post-Merger Results......................33 Section 9.3 Employee Benefits.......................................33 Section 9.4 Covenants Relating to Sales under Rule 144..............33 Section 9.5 Pooling-of-Interests....................................34 Section 9.6 Assignment of Commissions...............................34 ARTICLE 10 TERMINATION OF AGREEMENT................................................35 Section 10.1 Termination.............................................35 Section 10.2 Effect of Termination...................................35
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PAGE ---- ARTICLE 11 CLOSING MATTERS.........................................................36 Section 11.1 The Closing.............................................36 ARTICLE 12 INDEMNIFICATION AND REMEDIES............................................36 Section 12.1 General Indemnification by the Shareholders.............36 Section 12.2 Limitation and Expiration...............................37 Section 12.3 Agreement to Indemnify..................................38 Section 12.4 HCC Agreement to Indemnify..............................39 Section 12.5 Procedure for Indemnification; Third Party Claims.......40 Section 12.6 Limitation on Liability.................................40 ARTICLE 13 MISCELLANEOUS...........................................................41 Section 13.1 Appointment of Representative...........................41 Section 13.2 Further Assurances......................................42 Section 13.3 Fees and Expenses.......................................42 Section 13.4 Notices.................................................42 Section 13.5 Governing Law...........................................43 Section 13.6 Binding Upon Successors and Assigns, Assignment.........43 Section 13.7 Severability............................................43 Section 13.8 Entire Agreement........................................43 Section 13.9 Amendment and Waivers...................................44 Section 13.10 No Waiver...............................................44 Section 13.11 Construction of Agreement...............................44 Section 13.12 Counterparts............................................44 Section 13.13 Shareholder Knowledge...................................44
iii 5 AGREEMENT AND PLAN OF MERGER THIS AGREEMENT AND PLAN OF MERGER (this "Agreement") is entered into effective as of the 19th day of January, 2001 by and among HCC Insurance Holdings, Inc., a Delaware corporation ("HCC"), HCC Employee Benefits, Inc., a Delaware corporation and a wholly-owned subsidiary of HCC ("Merger Sub," Merger Sub and HCC are sometimes collectively referred to herein as the "Purchasers"); James Scott Schanen ("Schanen"), Lisa Rae Schanen ("LRS"), Connor Schanen qsst ("Connor"), Austin Schanen qsst ("Austin") and Kevin Tolbert ("Tolbert") (Schanen, LRS, Connor, Austin, and Tolbert being herein sometimes collectively called the "Shareholders" or the "Sellers"); and Schanen Consulting Corporation, a Georgia corporation ("SCC" which, unless the context otherwise requires, includes its predecessor and subsidiary, The Schanen Consulting Group, LLC). Sellers and Purchasers are sometimes referred to herein as the "Parties." RECITALS: A. The Boards of Directors of each of HCC, Merger Sub and SCC have determined to engage in a transaction pursuant to which (i) SCC will merge with and into Merger Sub (the "Merger") in accordance with the laws of the State of Georgia and the State of Delaware and the provisions of this Agreement, (ii) at the Effective Time (as defined herein) the capital stock of SCC (the "SCC Common Stock") shall be converted into shares of common stock, par value $1.00 per share, of HCC (the "HCC Common Stock") in the manner herein described, all upon the terms and subject to the conditions set forth herein. B. The Board of Directors of SCC has approved and has resolved, subject to the terms of this Agreement, to recommend that shareholders of SCC approve the Merger, this Agreement and the Articles of Merger (as defined herein) in accordance with Georgia law. C. The Board of Directors of HCC has approved the Merger, this Agreement and the Articles of Merger. HCC, as the sole shareholder of Merger Sub, has approved the Merger, this Agreement and the Articles of Merger in accordance with Delaware law. D. The parties intend for the transactions contemplated by this Agreement to qualify as a plan of reorganization in accordance with the provisions of Section 368(a) of the Internal Revenue Code of 1986, as amended (the "Code"), and to be accounted for as a "pooling-of-interests" for accounting purposes. NOW, THEREFORE, in consideration of the foregoing and the mutual representations, warranties, covenants and agreements set forth herein, the parties hereto do hereby agree as follows: 1 6 ARTICLE 1 THE MERGER SECTION 1.1 THE MERGER. (a) Subject to the terms and conditions of this Agreement, SCC will be merged with and into Merger Sub in accordance with the laws of the State of Georgia ("Georgia Law") and the laws of the State of Delaware ("Delaware Law"), whereupon the separate existence of SCC shall cease, and Merger Sub shall be the surviving corporation (the "Surviving Corporation"). (b) As soon as practicable after satisfaction or, to the extent permitted hereunder, waiver of all conditions to the Merger, SCC and Merger Sub shall (i) file articles of merger, in substantially the form attached hereto as Exhibit "A-1" (the "Articles of Merger"), in the Office of the Secretary of the State of Georgia, and make all such other filings or recordings required by Georgia Law and as required by the Georgia Business Corporation Act in connection with the Merger and (ii) file a certificate of merger, in substantially the form attached hereto as Exhibit "A-2" (the "Certificate of Merger"), in the office of the Secretary of State of the State of Delaware, and make all such other filings or recordings required by Delaware Law and as required by the Delaware General Corporation Law ("DGCL"). The Merger shall become effective upon completion of the filing of the Articles of Merger with the Office of the Secretary of the State of Georgia and the filing of the Certificate of Merger with the office of the Secretary of State of Delaware, in accordance with the relevant provisions of Georgia Law or Delaware Law, as applicable (the "Effective Time"). The date on which the Effective Time shall occur is referred to herein as the "Effective Date." (c) From and after the Effective Time, the Surviving Corporation shall possess all the rights, privileges, powers and franchises and be subject to all of the restrictions, disabilities and duties of SCC and Merger Sub, all as provided under Georgia Law or Delaware Law, as applicable. Without limiting the generality of the foregoing, and subject thereto, at the Effective Time (i) all the rights, privileges, immunities, powers and franchises, of a public as well as of a private nature, and all property, real, personal and mixed, and all debts due on whatever account, including without limitation subscriptions to shares, and all other choses in action, and all and every other interest of or belongings to or due to the Merger Sub or SCC shall be taken and deemed to be transferred to, and vested in, the Surviving Corporation without further act or deed; and all property, rights and privileges, immunities, powers and franchises, and all and every other interest shall be thereafter as effectually the property of the Surviving Corporation, as they were of Merger Sub and SCC, and (ii) all debts, liabilities, duties and obligations of Merger Sub and SCC, subject to the terms hereof, shall become the debts, liabilities and duties of the Surviving Corporation, and the Surviving Corporation shall thenceforth be responsible and liable for all the debts, liabilities, duties and obligations of Merger Sub and SCC, and neither the rights of creditors nor any liens upon the property of Merger Sub or SCC shall be impaired by the Merger, and may be enforced against the Surviving Corporation. 2 7 SECTION 1.2 CONVERSION OF STOCK. At the Effective Time, each share of SCC Common Stock outstanding immediately prior to the Effective Time shall automatically and without any action on the part of the holder thereof cease to be outstanding and be converted into the right to receive 797.44 shares of HCC Common Stock (the "Merger Consideration"). No fractional shares shall be issued and each holder of SCC Common Stock shall be entitled to the nearest whole share of HCC Common Stock rounded upwards if such fractional share exceeds 0.5 and otherwise rounded downwards, provided, however, that HCC shall under no circumstances be obligated hereunder to issue shares of HCC Common Stock in excess of an aggregate of 996,800 shares of HCC Common Stock. Each share of common stock of Merger Sub issued and outstanding immediately prior to the Effective Time shall continue to be issued and outstanding as one share of common stock of the Surviving Corporation. SECTION 1.3 EXCHANGE OF CERTIFICATES. (a) As of the Effective Time, all shares of SCC Common Stock other than shares of SCC Common Stock held by Stockholders ("Dissenting Shareholders") duly exercising appraisal rights pursuant to Georgia Law ("Dissenting Shares") that are outstanding immediately prior thereto will, by virtue of the Merger and without further action, cease to exist, and all such shares of SCC Common Stock will be converted into the right to receive from HCC the number of shares of HCC Common Stock determined as set forth in Section 1.2 hereof. (b) At and after the Effective Time, each certificate representing outstanding shares of SCC Common Stock will represent the number of shares of HCC Common Stock into which such shares of SCC Common Stock are converted and such shares of HCC Common Stock will be deemed registered in the name of the holder of such certificate. At the Effective Time, each holder of shares of SCC Common Stock will surrender the certificates for such shares (the "SCC Certificates") to HCC for cancellation. Promptly following the Effective Time and receipt of the SCC Certificates, HCC will cause to be issued to such surrendering holder certificates for the number of shares of HCC Common Stock to which such holder is entitled pursuant to the terms hereof. Shares of SCC Common Stock held by Dissenting Shareholders shall thereafter represent the right to require the Surviving Corporation to purchase such shares of SCC Common stock for their "fair value" as determined in accordance with Georgia Law. (c) All shares of HCC Common Stock delivered upon the surrender of SCC Certificates in accordance with the terms hereof will be delivered to the registered holder. After the Effective Time, there will be no further registration of transfers of the shares of SCC Common Stock on the stock transfer books of SCC. If, after the Effective Time, SCC Certificates are presented for transfer or for any other reason, they will be canceled and exchanged and certificates therefor will be delivered as provided for herein. 3 8 (d) Until SCC Certificates representing SCC Common Stock outstanding prior to the Merger are surrendered pursuant to this Section 1.3, such certificates will be deemed, for all purposes, to evidence ownership of the number of whole shares of HCC Common Stock into which the shares of SCC Common Stock will have been converted. (e) If prior to the Merger, HCC recapitalizes either through a split-up of its outstanding shares into a greater number, or through a combination of its outstanding shares into a lesser number, or reorganizes, reclassifies or otherwise changes its outstanding shares into the same or a different number of shares of other classes, or declares a dividend on its outstanding shares payable in shares or securities convertible into shares (but not cash), the number of shares of HCC Common Stock into which the shares of SCC Common Stock are to be converted will be adjusted in proportion to such change. SECTION 1.4 ESCROW. Pursuant to an Escrow Agreement to be entered into on or before the Closing Date (as hereinafter defined) in substantially the form of Exhibit 1.4 (the "Escrow Agreement"), among HCC, each of the Shareholders and First Union National Bank as escrow agent, HCC will withhold for a period of 36 months following the Closing Date, an amount equal to 10% of the Merger Consideration (the "Escrow Amount"). On the Closing Date, HCC will deposit, or cause to be deposited in escrow pursuant to the Escrow Agreement, the number of shares representing the Escrow Amount. The Escrow Amount shall be provided by each of the Shareholders in an amount equal to 10% of the number of shares such Shareholder will receive upon the consummation of the Merger. The Escrow Amount will be held as collateral for the indemnification obligations of the Shareholders pending its release from escrow in accordance with the terms of the Escrow Agreement. SECTION 1.5 DISSENTERS' RIGHTS. If any Dissenting Shareholder shall be entitled to require SCC to purchase such Shareholders' shares for their "fair value" as provided in Section 14-2-1302 of the Georgia Business Corporation Code, SCC shall give HCC notice thereof, and HCC shall have the right to participate in all negotiations and proceedings with respect to any such demands. Neither SCC nor the Surviving Corporation shall, except with the prior written consent of HCC, voluntarily make any payment with respect to, or offer to settle, any such demand for payment. If any Dissenting Shareholder shall fail to perfect or shall have effectively withdrawn or lost the right to dissent, the shares held by such Dissenting Shareholder shall thereupon be entitled to be surrendered in exchange for HCC Common Stock as provided by Section 1.3 hereof. ARTICLE 2 THE SURVIVING CORPORATION SECTION 2.1 CERTIFICATES OF INCORPORATION. At the Effective Time, the Certificate of Incorporation of Merger Sub as in effect immediately prior to the Effective Time shall be the Certificate of Incorporation of the Surviving Corporation. 4 9 SECTION 2.2 BYLAWS. At the Effective Time, the Bylaws of Merger Sub as in effect immediately prior to the Effective Time shall be the Bylaws of the Surviving Corporation. SECTION 2.3 DIRECTORS AND OFFICERS. From and after the Effective Time, until successors are duly elected or appointed and qualified in accordance with Delaware Law, the directors and officers of Merger Sub at the Effective Time shall become the directors and the officers of the Surviving Corporation. ARTICLE 3 REPRESENTATIONS AND WARRANTIES OF SELLERS Except as otherwise set forth with appropriate section references in the Sellers Disclosure Schedule, each of which exception shall specifically identify or cross reference to provisions of this Article 3 to which such exception relates, and in order to induce Purchasers to enter into and perform this Agreement, and the Operative Agreements (as herein defined) each of the Sellers represent and warrant to Purchasers as of the date of this Agreement and as of the Closing Date as follows: SECTION 3.1 CORPORATE EXISTENCE AND POWER. SCC is a corporation duly organized and validly existing under the laws of the state of Georgia, and has all corporate powers and all material governmental licenses, authorizations, consents and approvals (collectively, "Governmental Authorizations") required to carry on its business as now conducted, except such Governmental Authorizations the failure of which to have obtained would not have a Material Adverse Effect, as hereinafter defined, on SCC. Sellers have delivered to Purchasers true and complete copies of SCC's Articles or Certificate of Incorporation and Bylaws as currently in effect. SCC is duly qualified to do business as a foreign corporation and is in good standing in each jurisdiction where the character of the property owned or leased by it or the nature of its activities makes such qualification necessary, except where the failure to be so qualified would not have a Material Adverse Effect on SCC. For purposes of this Agreement, a "Material Adverse Effect," with respect to any person or entity, means a material adverse effect on the condition (financial or otherwise), business, properties, assets, liabilities (including contingent liabilities), results of operations or prospects of such person or entity; provided, however, that a Material Adverse Effect shall not include any change in general economic conditions or changes that affect a person or entity's industry generally; and "Material Adverse Change" means a change or a development involving a prospective change which is reasonably likely to result in a Material Adverse Effect. SECTION 3.2 AUTHORIZATION. Each Seller represents and warrants that such Seller has full right, power and authority to enter into this Agreement and each other agreement to be entered into by such Seller in connection with the transactions contemplated hereby (the "Operative Agreements") and that this Agreement and such Operative Agreements constitute, or upon execution will constitute, valid and binding agreements of such Seller, enforceable against such Seller in accordance with their respective terms, except as such enforcement may be limited by bankruptcy, insolvency 5 10 or other similar laws affecting the enforcement of creditors' rights generally or by general principles of equity, regardless of whether such enforceability is considered in a proceeding of equity or at law. SECTION 3.3 GOVERNMENTAL AUTHORIZATION. The execution, delivery and performance by each of the Sellers of this Agreement and the Operative Agreements, and the consummation of the transactions contemplated hereunder and thereunder require no action by any of the Sellers or any filing by them with any governmental body, agency, official or authority other than in respect of: (a) compliance with any applicable requirements of the Securities Act of 1933, as amended (the "Securities Act") and the rules and regulations promulgated thereunder; (b) compliance with any applicable foreign or state securities or "blue sky" laws; (c) compliance with any requirements of any federal, state, foreign or other insurance or reinsurance or intermediaries, or agent or managing general agent or third party administrators' laws, including licensing or other related laws; (d) Compliance with any applicable requirements of the New York Stock Exchange ("NYSE"); or (e) such other filings or registrations with, or authorizations, consents or approvals of, governmental bodies, agencies, officials or authorities, the failure of which to make or obtain (i) would not reasonably be expected to have a Material Adverse Effect on SCC, or (ii) would not materially adversely affect the ability of either of SCC or Purchasers to consummate the transactions contemplated hereby and to operate their businesses as heretofore operated. SECTION 3.4 NON-CONTRAVENTION. The execution, delivery and performance by each of the Sellers of this Agreement and the Operative Agreements, and the consummation by each of the Sellers of the transactions contemplated hereby and thereby do not and will not: (a) contravene or conflict with SCC's Articles or Certificate of Incorporation or Bylaws; (b) assuming compliance with the matters referred to in Section 3.3, contravene or conflict with or constitute a violation of any provision of any law, regulation, judgment, injunction, order or decree binding upon or applicable to the Sellers; (c) conflict with or result in a breach or violation of, or constitute a default under, or result in a contractual right to cause the termination or cancellation of or loss of 6 11 a material benefit under, or right to accelerate, any material agreement, contract or other instrument binding upon SCC or any material license, franchise, permit or other similar authorization held by SCC; (d) result in the creation or imposition of any Lien (as hereinafter defined) on any material asset of SCC; or (e) invalidate or adversely affect any permit, license or authorization or status used in connection with SCC's business; except, with respect to clauses (b), (c) and (d) above, for contraventions, defaults, losses, Liens and other matters referred to in such clauses that would not be reasonably expected to have individually or in the aggregate, a Material Adverse Effect on SCC. For purposes of this Agreement, the term "Lien" means, with respect to any asset, any mortgage, lien, pledge, charge, security interest or encumbrance of any kind in respect of such asset. SECTION 3.5 CAPITALIZATION. (a) As of the date of this Agreement, the authorized capital stock of SCC consists of 100,000 shares of a single class designated as common stock, 1,250 shares of which are issued and outstanding. All of such outstanding shares are owned by the Shareholders free of any Liens or other encumbrances in the amounts set forth on Schedule 3.5 of the Sellers Disclosure Schedule. (b) All outstanding shares of SCC have been duly authorized and validly issued and are fully paid and nonassessable and free from any preemptive rights. Except as set forth in and as otherwise contemplated by this Agreement, for SCC there are outstanding (i) no shares of capital stock or other voting securities, (ii) no securities convertible into or exchangeable for shares of its capital stock or voting securities, (iii) no options or other rights to acquire, and no obligation to issue, any capital stock, voting securities or securities convertible into or exchangeable for its capital stock or other voting securities (the items in clauses (i), (ii) and (iii) of this subsection (b) being referred to collectively as the "SCC Securities"), (iv) no obligations to repurchase, redeem or otherwise acquire any SCC Securities, and (v) no contractual rights of any person or entity to include any SCC Securities in any registration statement filed under the Securities Act. 7 12 SECTION 3.6 SUBSIDIARIES AND JOINT VENTURES. (a) For purposes of this Agreement, (i) "Subsidiary" means, with respect to any entity, any corporation of which securities or other ownership interests having ordinary voting power to elect a majority of the board of directors or other persons performing similar functions are directly or indirectly owned by such entity, and (ii) "Joint Venture" means, with respect to any entity, any corporation or organization (other than such entity and any Subsidiary thereof) of which such entity or any Subsidiary thereof is, directly or indirectly, the beneficial owner of 25% or more of any class of equity securities or equivalent profit participation interest. (b) As of the date hereof SCC owns all of the membership interests ("Interests") in The Schanen Consulting Group, LLC ("LLC") and no person or entity is entitled to acquire any Interests in LLC nor are there any securities exchangeable or convertible into such Interests, and LLC is not required to redeem or repurchase any Interests. Except for such ownership of LLC, SCC does not have any Subsidiary and is not a party to any Joint Venture. SECTION 3.7 FINANCIAL STATEMENTS. Sellers have delivered to Purchasers the audited balance sheets as of December 31, 1999, and unaudited balance sheets for December 31, 1998, and December 31, 1997, audited income statements for the annual period ended December 31, 1999, and unaudited income statements for the annual periods ending December 31, 1998, and December 31, 1997 and unaudited balance sheets and income statements for the period as of or ending September 30, 2000 (collectively, the "Financial Statements"). For purposes of this Agreement, the "Balance Sheet Date" shall mean December 31, 1999, unless the Effective Date is later than January 30, 2001, in which case it shall mean December 31, 2000. The Financial Statements present fairly in all material respects, substantially in conformity with generally accepted accounting principles consistently applied (except as indicated in the notes thereto), the financial position of SCC as of the dates thereof and results of operations and cash flows for the periods therein indicated (subject to normal year-end adjustments in the case of any interim financial statements and the absence of certain footnotes in the case of unaudited financial statements). SCC does not have any material debt, liability or obligation of any nature, whether accrued, absolute, contingent or otherwise, and whether due or to become due, that is not reflected, reserved against or disclosed in the Financial Statements except for (i) those that are not required to be reported in accordance with the aforesaid accounting principles; (ii) normal or recurring liabilities incurred since December 31, 1999 in the ordinary course of business or (iii) as disclosed in the Sellers Disclosure Schedule. SECTION 3.8 ABSENCE OF CERTAIN CHANGES. Since December 31, 1999, SCC has in all material respects conducted its business in the ordinary course and there has not been: (a) any Material Adverse Change with respect thereto or any event, occurrence or development of a state of circumstances or facts known to any of the 8 13 Sellers, which as of the date hereof could reasonably be expected to have a Material Adverse Effect on SCC, including the loss of or knowledge of future loss of a client which generates $100,000 or more of commission and/or fee revenue; (b) issued any capital stock or other securities or made any declaration, setting aside or payment of any dividend or other distribution by SCC other than dividend distributions to the Shareholders and distributions to partners; (c) any repurchase, redemption or other acquisition by SCC of any outstanding shares of capital stock or other securities or other ownership interests in SCC; (d) any amendment of any term of any outstanding securities of SCC; (e) any damage, destruction or other property or casualty loss (whether or not covered by insurance) affecting the business, assets, liabilities, earnings or prospects of SCC that, individually or in the aggregate, has had or would reasonably be expected to have a Material Adverse Effect on SCC; (f) any increase in indebtedness for borrowed money or capitalized lease obligations of SCC, except in the ordinary course of business; (g) any sale, assignment, transfer or other disposition of any tangible or intangible asset material to the business of SCC, except in the ordinary course of business and for a fair and adequate consideration; (h) any amendment, termination or waiver by SCC of any right of substantial value under any agreement, contract or other written commitment to which it is a party or by which it is bound which could reasonably be expected to have a Material Adverse Effect on SCC; (i) any material reduction in the amounts of coverage provided by existing casualty and liability insurance policies with respect to the business or properties of SCC; (j) any (i) grant of any severance or termination pay to any director, officer or employee of SCC, (ii) entering into of any employment, deferred compensation or other similar agreement (or any amendment to any such existing agreement) with any director, officer or employee of SCC other than the Non-Competition Agreements contemplated by this Agreement, (iii) any increase in benefits payable under any existing severance or termination pay policies or employment agreements, or (iv) any increase in compensation, bonus or other benefits payable to directors, officers or employees of SCC, in each case other than in the ordinary course of business consistent with past practice; (k) any new or amendment to or alteration of any existing bonus, incentive. compensation, severance, stock option, stock appreciation right, pension, matching gift, profit-sharing, employee stock ownership, retirement, pension group insurance, death 9 14 benefit, or other fringe benefit plan, arrangement or trust agreement adopted or implemented by SCC which would result in a material increase in cost; (l) any capital expenditures, capital additions or capital improvements incurred or undertaken by SCC in excess of $10,000, or any non-budgeted expenditure in excess of $5,000; (m) any change in accounting methods or practices or internal control procedures; (n) any payment, loan or advance of any amount to, or sale, transfer or lease of any properties or assets (real, personal or mixed, tangible or intangible) to any of the Shareholders, or any of SCC's officers, directors or employees or any affiliate of any such persons; (o) any cancellation or threat of cancellation from any company that affects more than 1% of SCC's business; or (p) the entering into of any agreement by SCC or any person on behalf of SCC to take any of the foregoing actions. SECTION 3.9 NO UNDISCLOSED LIABILITIES. There are no existing liabilities of SCC of any kind whatsoever that are, individually or in the aggregate, material to SCC, other than: (a) liabilities disclosed or provided for in the respective audited financial statements as of and for the fiscal year ended December 31, 1999 (including the notes thereto) of SCC; (b) liabilities incurred in the ordinary course of business consistent with past practice since December 31, 1999; or (c) liabilities under this Agreement or indicated in the Sellers Disclosure Schedule. SECTION 3.10 ACCOUNTING MATTERS. Neither SCC nor any of the Shareholders has taken or agreed to take any action that (without giving effect to any action taken or agreed to be taken by HCC or any of its affiliates) would prevent HCC from accounting for the business combination to be effected by the Merger as a pooling-of-interests. SECTION 3.11 LITIGATION. Other than actions, suits, proceedings, claims or investigations occurring in the ordinary course of business involving respective amounts in controversy of less than $10,000 each and $20,000 in the aggregate, there is no action, suit, proceeding, claim or investigation pending against, nor has SCC or any Seller received notice of a claim threatened against SCC or any of its assets or against or involving any of its officers, directors or employees in connection with the business or 10 15 affairs of SCC, including, without limitation, any such claims for indemnification arising under any agreement to which SCC is a party. SCC has not received notice that it is subject, or in default with respect, to any writ, order, judgment, injunction or decree which could, individually or in the aggregate, have a Material Adverse Effect. SECTION 3.12 TAXES. (a) SCC and LLC (i) have filed when due (taking into account extensions) with the appropriate federal, state, local, foreign and other governmental agencies, all tax returns, estimates and reports required to be filed by it, (ii) either paid when due and payable or established adequate reserves or otherwise accrued on the Financial Statements all federal. state, local or foreign taxes, levies, imposts, duties, licenses and registration fees and charges of any nature whatsoever, and unemployment and social security taxes and income tax withholding, including interest and penalties thereon (each individually a "Tax" and collectively the "Taxes") and there are no tax deficiencies claimed in writing by any taxing authority that, in the aggregate, would result in any tax liability in excess of the amount of the reserves or accruals and (iii) has or will establish in accordance with its normal accounting practices and procedures accruals and reserves that, in the aggregate, are adequate for the payment of all Taxes not yet due and payable and attributable to any period preceding the Effective Date. The Sellers Disclosure Schedule sets forth those tax returns for all periods that currently are the subject of audit or extension by any federal, state, local or foreign taxing authority. (b) There are no Taxes, interest, penalties, assessments or deficiencies claimed in writing by any taxing authority to be due in respect of any tax returns filed by SCC (or any predecessor corporations). Neither SCC nor any predecessor corporation or entity, has executed or filed with the Internal Revenue Service ("IRS") or any other taxing authority any agreement or other document extending, or having the effect of extending, the period of assessment or collection of any Taxes. (c) SCC is not a party to nor bound by (or will prior to the Effective Date become a party to or bound by) any Tax indemnity, Tax sharing or Tax allocation agreement or other similar arrangement. SCC is not a member of an affiliated group or filed or been included in a combined, consolidated or unitary Tax return. (d) SCC has maintained a valid S election pursuant to the Code since its incorporation and there is no corporate income tax due from SCC. SECTION 3.13 EMPLOYEE BENEFIT PLANS, ERISA. (a) SCC is not a party to any oral or written (i) employment, severance, collective bargaining or consulting agreement not terminable on 60 days' or less notice, (ii) agreement with any executive officer or other key employee (A) the benefits of which are contingent, or the terms of which are materially altered, upon the occurrence of a transaction involving SCC of the nature of any of the transactions contemplated by this Agreement, (B) providing any term of employment or compensation guarantee extending 11 16 for a period longer than one year, or (C) providing severance benefits or other benefits after the termination of employment of such executive officer or key employee regardless of the reason for such termination of employment, (iii) agreement, plan or arrangement under which any person may receive payments subject to the tax imposed by Section 4999 of the Code, or (iv) agreement or plan, including, without limitation, any stock option plan, stock appreciation right plan, restricted stock plan or stock purchase plan, the benefits of which would be increased, or the vesting of benefits of which will be accelerated, by the occurrence of any of the transactions contemplated by this Agreement or the value of any of the benefits of which will be calculated on the basis of any of the transactions contemplated by this Agreement. (b) Neither SCC nor any corporation or other entity which under Section 4001(b) of the Employee Retirement Income Security Act of 1974, as amended ("ERISA"), is under common control with SCC (an "ERISA Affiliate") maintains or within the past five years has maintained, contributed to, or been obligated to contribute to, any "Employee Pension Benefit Plan" ("Pension Plan") or any "Employee Welfare Benefit Plan" ("Welfare Plan") as such terms are defined in Sections 3(2) and 3(l) respectively of ERISA, which is subject to ERISA, except as described on Schedule 3.13(b). Each Pension Plan and Welfare Plan disclosed in Schedule 3.13(b) and the Sellers Disclosure Schedule (which Plans have been heretofore delivered to Purchasers) and maintained by SCC has been maintained in all material respects in compliance with their terms and all provisions of ERISA and the Code (including rules and regulations thereunder) applicable thereto. (c) No Pension Plan or Welfare Plan is currently subject to an audit or other investigation by the IRS, the Department of Labor (the "DOL"), the Pension Benefit Guaranty Corporation or any other governmental agency or office nor are any such Plans subject to any lawsuits or legal proceedings of any kind or to any material pending disputed claims by employees or beneficiaries covered under any such Plan or by any other parties. (d) No "prohibited transaction," as defined in Section 406 of ERISA or Section 4975 of the Code, resulting in liability to SCC or any ERISA Affiliate has occurred with respect to any Pension Plan or Welfare Plan. None of the Sellers has any knowledge of any breach of fiduciary responsibility under Part 4 of Title I of ERISA which may result in liability of SCC or any ERISA Affiliate, any trustee, administrator or fiduciary of any Pension Plan or Welfare Plan. (e) Neither SCC nor any ERISA Affiliate, since January 1, 1986, has maintained or contributed to, or been obligated or required to contribute to, a "Multiemployer Plan," as such term is defined in Section 4001(a)(3) of ERISA. Neither SCC nor any ERISA Affiliate has either withdrawn, partially or completely, or instituted steps to withdraw, partially or completely, from any Multiemployer Plan nor has any event occurred which would enable a Multiemployer Plan to give notice of and demand payment of any withdrawal liability with respect to SCC or any ERISA Affiliate. 12 17 (f) There is no contract, agreement, plan or arrangement covering any employee or former employee of SCC or any ERISA Affiliate that, individually or collectively, could give rise to the payment of any amount that would not be deductible pursuant to the terms of Sections 162(a)(1) or 280G of the Code. (g) With respect to either of SCC and each ERISA Affiliate. Schedule 3.13(b) and the Sellers Disclosure Schedule correctly identifies each material agreement, policy, plan or other arrangement, whether written or oral, express or implied, fixed or contingent, to which SCC is a party or by which SCC or any property or asset of SCC is bound, which is or relates to a pension, option, bonus, deferred compensation, retirement, stock purchase, profit-sharing, severance pay, health, welfare, incentive, vacation, sick leave, medical disability, hospitalization, life or other insurance or fringe benefit plan, policy or arrangement. Each such agreement, policy, plan or other arrangement has been maintained in all material respects in compliance with its terms and all provisions of ERISA and the Code (including rules and regulations thereunder) applicable thereto. (h) Neither SCC nor any ERISA Affiliate maintains or has maintained or contributed to any Pension Plan that is or was subject to Section 302 of Title IV of ERISA or Section 412 of the Code. Sellers have made available to Purchasers, for each Pension Plan which is intended to be "qualified" within the meaning of Section 401(a) of the Code, a copy of the most recent determination letter issued by the IRS to the effect that each such Plan is so qualified and that each trust created thereunder is tax exempt under Section 501 of the Code, and each of the Sellers is unaware of any fact or circumstances that would jeopardize the qualified status of each such Pension Plan or the tax exempt status of each trust created thereunder. (i) One or more of the benefit plans of SCC listed in the Sellers Disclosure Schedule may be subject to the Consolidated Omnibus Budget Reconciliation Act of 1985, as amended ("COBRA"). If so, each such plan has been operated in, and is in compliance with COBRA. All notices required to be given under COBRA have been timely and properly given in accordance with COBRA, and the rules and regulations promulgated thereunder, and no employee, former employee or "qualified beneficiary" (as defined in COBRA) has any claim or contingent claim against SCC or any ERISA Affiliate. SCC does not provide retiree benefits of any kind, including health, medical, life, etc. and SCC has not agreed to continue any employee benefits after termination of employment other than COBRA. SECTION 3.14 MATERIAL AGREEMENTS. (a) The Sellers Disclosure Schedule includes a complete and accurate list of all contracts, agreements, leases (other than Property Leases, as hereinafter defined), and instruments to which SCC is a party or by which it or its properties or assets are bound (1) which individually involve net payments or receipts in excess of $10,000 per annum, inclusive of contracts entered into with customers and suppliers in the ordinary course of business, or (2) that pertain to employment or severance benefits for any officer, director or employee of SCC, whether written or oral, but exclusive of contracts, agreements, 13 18 leases and instruments terminable without penalty upon 60 days' or less prior written notice to the other party or parties thereto, or (3) to which any of the Shareholders is the opposing contracting party (the "Material Agreements"). (b) Neither SCC nor, to the knowledge of any of the Sellers, any other party is in default under any Material Agreement and no event has occurred which (after notice or lapse of time or both) would become a breach or default under, or would permit modification, cancellation, acceleration or termination of, any Material Agreement or result in the creation of any security interest upon, or any person obtaining any right to acquire, any properties, assets or rights of SCC, which, in any such case, has had or would reasonably be expected to have a Material Adverse Effect. (c) To the knowledge of each of the Sellers, each such Material Agreement is in full force and effect and is valid and legally binding and there are no unresolved disputes involving or with respect to any Material Agreement. No party to a Material Agreement has advised SCC that it intends either to terminate a Material Agreement or to refuse to renew a Material Agreement upon the expiration of the term thereof. No representation or warranty is made that all benefits contemplated in the Material Agreements will be received. (d) SCC is not in violation of, or in default with respect to, any term of its Articles of Incorporation or Bylaws. (e) Except as set forth on Schedule 3.14 of the Sellers Disclosure Schedule, SCC has no: (1) noncompetition agreement or other arrangement that would prevent SCC from carrying on its business anywhere in the world; (2) material dispute with any of its suppliers, customers, or distributors; (3) joint venture contracts, arrangements or any other agreement that involves the sharing of profits with any other person; or (4) agreements or commitments to provide indemnification. SECTION 3.15 PROPERTIES. SCC does not own any real estate, and all leases of real property to which SCC is a party or by which it is bound ("Property Leases") are in full force and effect and are set forth in Sellers Disclosure Schedule. There exists no default under such Property Leases, nor any event (other than the transactions contemplated by this Agreement) which with notice or lapse of time or both would constitute a default thereunder. All of the properties and assets which are owned by SCC are owned free and clear of any Lien, except for Liens which do not have a Material Adverse Effect. SCC has good and indefeasible title subject to no Liens, other than those permitted under this Section 3.15, to all of the properties and assets necessary for the 14 19 conduct of its business other than to the extent that the failure to have such title would not have a Material Adverse Effect. SECTION 3.16 ENVIRONMENTAL MATTERS. (a) For the purposes of this Agreement, the following terms have the following meanings: "Environmental Laws" shall mean any and all federal, state, local and foreign statutes, laws (including case law), regulations, ordinances, rules, judgments. orders. decrees, codes, plans, injunctions. permits, concessions, grants, franchises, licenses. agreements and governmental restrictions relating to human health, the environment or to emissions, discharges or releases of pollutants, contaminants, Hazardous Substances (as hereinafter defined) or wastes into the environment or otherwise relating to the manufacture, processing, distribution, use, treatment, storage, disposal, transport or handling of pollutants, contaminants, Hazardous Substances or wastes or the clean-up or other remediation thereof. "Environmental Liabilities" shall mean all liabilities, whether vested or unvested. contingent or fixed, actual or potential, which (i) arise under or relate to Environmental Laws and (ii) relate to actions occurring or conditions existing on or prior to the Effective Time. "Hazardous Substances" shall mean any toxic, radioactive, caustic or otherwise hazardous substance, including petroleum, its derivatives, by-products and other hydrocarbons, or any substance having any constituent elements displaying any of the foregoing characteristics. "Regulated Activity" shall mean any generation, treatment, storage, recycling, transportation, disposal or release of any Hazardous Substances. (b) No notice, notification, demand, request for information, citation, summons. complaint or order has been received, no complaint has been filed, no penalty has been assessed and no investigation or review is pending, or to any Seller's knowledge, has been threatened by any governmental entity or other party with respect to any (i) alleged violation of any Environmental Law by SCC, (ii) alleged failure by SCC to have any environmental permit, certificate, license, approval, registration or authorization required in connection with the conduct of its business or (iii) Regulated Activity of SCC. (c) SCC does not have any Environmental Liabilities and there has been no release of Hazardous Substances into the environment by SCC or with respect to any of their properties which has had, or would reasonably be expected to have, a Material Adverse Effect. SECTION 3.17 LABOR MATTERS. SCC is not a party to any collective bargaining agreement or other labor union contract applicable to persons employed by it, nor does 15 20 any of the Sellers know of any activities or proceedings of any labor union to organize any such employees. SECTION 3.18 COMPLIANCE WITH LAWS. Except for violations which do not have and would not reasonably be expected to have, individually or in the aggregate, a Material Adverse Effect, SCC has not received any notice that it is in violation of, or has violated, any applicable provisions of any laws, statutes, ordinances or regulations or any term of any judgment, decree, injunction or order binding against it. SECTION 3.19 TRADEMARKS, TRADENAMES, ETC. SCC owns or possesses, or holds a valid right or license to use, all intellectual property, patents, trademarks, tradenames, service marks, copyrights and licenses (collectively "Intellectual Property"), and all rights with respect to the foregoing, necessary for the conduct of its business as now conducted, without any known conflict with the rights of others. A schedule of all such Intellectual Property is set forth on Schedule 3.19 of the Sellers Disclosure Schedule. SECTION 3.20 SALES NEGOTIATIONS. Except as contemplated by this Agreement, there are currently no discussions to which SCC or any of the Sellers is a party relating to (a) the sale of any material portion of the assets of SCC, (b) any merger, consolidation, liquidation, dissolution or similar transaction involving SCC whereby SCC will issue any securities or for which SCC is required to obtain the approval of its shareholders or partners, or (c) the sale of any SCC Common Stock. SECTION 3.21 BROKER'S FEES. None of SCC or the Sellers nor anyone acting on the behalf or at the request thereof has any liability to any broker, finder, investment banker or agent, or has agreed to pay any brokerage fees, finder's fees or commissions, or to reimburse any expenses of any broker, finder, investment banker or agent in connection with this Agreement. SECTION 3.22 KNOWLEDGE OF THE SELLERS. As used in this Agreement, "knowledge of the Sellers" means the actual knowledge of Schanen or any Seller, or the following officers of SCC: the Chief Executive Officer, Chief Operating Officer, Chief Financial Officer, President or any Executive Vice President or any person performing the functions of such office whether having such title or not. SECTION 3.23 RETAINED EARNINGS. At the Closing the retained earnings of SCC are equal to at least $1,495,000. SECTION 3.24 ABSENCE OF QUESTIONABLE PAYMENTS. Neither SCC nor any director, officer, agent, employee, or any Seller acting on behalf of SCC has used any SCC funds for unlawful contributions, payments, gifts or entertainment, or made any unlawful expenditures relating to political activities to domestic or foreign government officials or others. SCC has reasonable financial controls to prevent such or unlawful contributions, payments, gifts, entertainment or expenditures. Neither SCC, or any current director or officer, agent, employee or any Seller acting on behalf of SCC has accepted or received any unlawful contributions, payments, gifts or expenditures. To its 16 21 knowledge, SCC has at all times complied, and is in compliance, in all respects with the Foreign Corrupt Practices Act and all applicable foreign laws and regulations relating to prevention of corrupt practices and similar matters. SECTION 3.25 BANK ACCOUNTS. Section 3.25 of Sellers Disclosure Schedule sets forth the names and locations of all banks, trust companies, savings and loan associations and other financial institutions at which SCC maintains safe deposit boxes or accounts of any nature and the names of all persons authorized to draw thereon, make withdrawals therefrom, or have access to such safe deposit boxes or accounts. SECTION 3.26 ACCOUNTS RECEIVABLE. All accounts receivable of SCC reflected in the Financial Statements or existing at the Effective Date, represent sales actually made or work actually performed in the ordinary course of business and are recorded in SCC's books consistent with the presentation applied in the Financial Statements for the year ended December 31, 1999. Set forth on Schedule 3.26 to the Sellers Disclosure Schedule are a full and complete list and aging study of all such accounts receivable. SECTION 3.27 FULL DISCLOSURE. No information furnished by SCC or the Sellers or their representatives in connection with this Agreement (including, but not limited to, the Financial Statements and all information in the Sellers Disclosure Schedule and each of the other Operative Agreements) contains any untrue statement of a material fact or omits to state a material fact necessary in order to make the statement so made or information so delivered not misleading. SECTION 3.28 SOPHISTICATION; ACCREDITATION. Each Shareholder is: (a) either alone or with the assistance of a professional advisor, a sophisticated investor, able to fend for himself or herself in the transactions contemplated by this Agreement and the Operative Agreements to which such Shareholder is a party and has such knowledge and experience in financial and business matters that he or she is capable of evaluating the merits and risks of the prospective investment in HCC; or (b) an "accredited investor" as defined in Regulation D of the Securities Act. SECTION 3.29 CLAIMS AGAINST THE COMPANY. Each Shareholder does not have any claims against SCC other than claims for accrued salaries and reimbursement of expenses, in the ordinary course of business, consistent with past practices. SECTION 3.30 HSR REPRESENTATION. Each Shareholder is his, her or its own ultimate parent entity as defined under the rules and regulations promulgated under the HSR Act. Each Shareholder either: (a) is not a $10 million person as defined under the HSR Act; or (b) is a $10 million person but is acquiring HCC Common Stock solely for the purposes of investment within the meaning of 16 C.F.R. Section 802.9. 17 22 SECTION 3.31 INVESTMENT FOR OWN ACCOUNT. The HCC Common Stock is being acquired by each Shareholder for investment for his, her or its respective account, not as a nominee or agent, and not with a view to the distribution of any part thereof. Each such Shareholder has no present intention of selling, granting any participation in, or otherwise distributing any of the HCC Common Stock in a manner contrary to the Securities Act or any applicable state's securities or Blue Sky Law, nor does any such Shareholder have any contract, undertaking, agreement or arrangement with any person or entity to sell, transfer or grant a participation to such person or entity with respect to any of the HCC Common Stock. Each Shareholder has further been informed that Purchaser is under no obligation to register the HCC Common Stock under the Securities Act. SECTION 3.32 LEGENDS. It is understood that the Certificates evidencing the HCC Common Stock may bear one or more legends, including a legend substantially as follows: "Securities evidenced by this Certificate have not been registered under the Securities Act of 1933, as amended, the ("Act") or applicable state's securities laws, and no interest may be sold, distributed, assigned, offered, pledged or otherwise transferred unless (a) there is an effective registration statement under the Act and applicable state securities laws covering such transaction involving such securities, (b) this Corporation receives an opinion of legal counsel for the whole of these securities satisfactory to this Corporation stating that such transaction is exempt from registration, or (c) this corporation otherwise satisfies itself that such transaction is exempt from registration." SECTION 3.33 WAIVER OF DISSENTER'S RIGHTS. Schanen and Tolbert hereby waive any right to exercise any dissenter's rights under Georgia law. SECTION 3.34 ASSIGNMENT OF COMMISSIONS. Schanen and Tolbert represent and warrant that all commissions, fees or other amounts due for business which each has written as an employee or agent of SCC or Merger Sub, and Schanen represents and warrants that any other commissions, fees or other amounts attributable to persons other than Schanen or Tolbert who are agents or employees of SCC or Merger Sub have been irrevocably assigned by Schanen, Tolbert or any such person to SCC or Merger Sub; provided, however, that commissions due on premiums earned, whether received or not, by Tolbert prior to December 31, 2000, shall be paid to him as the funds are received by Merger Sub. 18 23 ARTICLE 4 REPRESENTATIONS AND WARRANTIES OF HCC AND MERGER SUB Except as otherwise set forth with the appropriate section references in the Purchasers Disclosure Schedule, each of which exception shall specifically identify or cross reference the provisions of this Article 4 to which such exception relates, and in order to induce Sellers to enter into and perform this Agreement and the Operative Agreements, and except as disclosed in any document, exhibit or appendix filed with the Securities and Exchange Commission ("SEC") which has been filed on or before the date hereof or the Effective Date, the Purchasers represent and warrant to the Sellers as of the date of this Agreement and as of the Closing Date as follows: SECTION 4.1 CORPORATE EXISTENCE AND POWER. Each Purchaser is a corporation duly incorporated, validly existing and in good standing under the laws of the state of its incorporation. Each Purchaser has all corporate powers and all material Governmental Authorizations required to carry on its business as now conducted, except such Governmental Authorizations the failure of which to have obtained would not have a Material Adverse Effect on Purchasers. SECTION 4.2 CORPORATE AUTHORIZATION. The execution, delivery and performance by each Purchaser of this Agreement, and the consummation by Purchaser of the transactions contemplated hereby and thereby are within the corporate powers of each Purchaser and have been duly authorized by all necessary corporate action. This Agreement constitutes, or upon execution will constitute, valid and binding agreements of each Purchaser enforceable in each case in accordance with their respective terms, except as such enforcement may be limited by bankruptcy, insolvency or other similar laws affecting the enforcement of creditors' rights generally or by general principles of equity. SECTION 4.3 GOVERNMENTAL AUTHORIZATION. The execution, delivery and performance by each Purchaser of this Agreement, require no action by or in respect of, or filing with, any governmental body, agency, official or authority other than: (a) compliance with any applicable requirements of the Securities Exchange Act of 1934 (the "Exchange Act") and the NYSE and the rules and regulations promulgated under each; (b) such other filings or registrations with, or authorizations, consents or approvals of, governmental bodies, agencies, officials or authorities, the failure of which to make or obtain (i) would not reasonably be expected to have a Material Adverse Effect on Purchasers or (ii) would not materially adversely affect the ability of the Sellers or Purchasers to consummate the transactions contemplated hereby and operate their businesses as heretofore operated. SECTION 4.4 NON-CONTRAVENTION. The execution, delivery and performance by each Purchaser of this Agreement and the consummation by each Purchaser of the transactions contemplated hereby and thereby do not and will not: 19 24 (a) contravene or conflict with the Certificate of Incorporation or Bylaws of each Purchaser; (b) assume compliance with the matters referred to in Section 4.3, contravene or conflict with or constitute a violation of any provision of any law, regulation, judgment, injunction, order or decree binding upon or applicable to each Purchaser; (c) conflict with or result in a breach or violation of, or constitute a default under, or result in a contractual right to cause the termination or cancellation of or loss of a material benefit under, or right to accelerate, any material agreement, contract or other instrument binding upon Purchasers or any other Subsidiary of Purchasers or any material license, franchise, permit or other similar authorization held by Purchasers or any Subsidiary of Purchasers; or (d) result in the creation or imposition of any Lien on any material asset of Purchasers; except, with respect to clauses (b), (c) and (d) above, for contraventions, defaults, losses, Liens and other matters referred to in such clauses that in the aggregate would not be reasonably expected to have, individually or in the aggregate, a Material Adverse Effect on each Purchaser. SECTION 4.5 BROKER'S FEES. Neither Purchasers, nor anyone acting on the behalf or at the request thereof has any liability to any broker, finder, investment banker or agent, or has agreed to pay any brokerage fees, finder's fees or commissions, or to reimburse any expenses of any broker, finder, investment banker or agent in connection with the transactions contemplated by this Agreement. SECTION 4.6 SEC FILINGS. HCC has made available to each of the Shareholders true and complete copies of its Annual Reports on Form 10-K, its Quarterly Reports on Form 10-Q and its Proxy Statements on Schedule 14-A filed in connection with annual meeting of Shareholders for the years ended December 31, 1999, 1998 and 1997. HCC has filed all documents required to be filed under the Exchange Act. As of their respective filing dates, each of the document required to be filed by HCC and so filed, complied in all material respects with the requirements of the Exchange Act, and the applicable rules and regulations of the SEC promulgated thereunder. SECTION 4.7 FULL DISCLOSURE. No information furnished by HCC to any Shareholder or its or their representative in connection with this Agreement or the Operative Agreements contains any untrue statement of a material fact or omits to state a material fact necessary in order to make this statement so made or information so delivered not misleading. SECTION 4.8 KNOWLEDGE OF PURCHASERS. As used in this Agreement, "knowledge of Purchasers" means the actual knowledge of the Chief Executive Officer, Chief 20 25 Operating Officer, President, Chief Financial Officer, or any Executive Vice President of Purchasers. ARTICLE 5 COVENANTS OF THE SELLERS SECTION 5.1 CONDUCT OF SCC. From the date of the execution of this Agreement until Closing, the Sellers shall cause SCC to conduct its businesses in the ordinary course. Without limiting the generality of the foregoing, from the date hereof until the Closing or a termination of this Agreement, and except as contemplated by this Agreement, each of the Sellers shall cause SCC to: (a) not adopt or propose any change in its Articles or Certificate of Incorporation or Bylaws or partnership agreement; (b) not enter into or amend any employment agreements (oral or written) or increase the compensation payable or to become payable by it to any of its officers, directors, or consultants over the amount payable as of September 30, 2000, or increase the compensation payable to any other employees, or adopt or amend any employee benefit plan or arrangement (oral or written), or (iv) adopt or amend any employee benefit plan or arrangement (oral or written); (c) not issue any SCC Securities or LLC Interests; (d) not terminate any existing directors and officers or similar liability insurance and not modify or reduce the coverage thereunder; (e) not pay any dividend or make any other distribution to holders of SCC Securities; (f) not, directly or indirectly, dispose of or acquire any material properties or assets except in the ordinary course of business; (g) not incur any additional indebtedness for borrowed money except pursuant to existing arrangements which have been disclosed to Purchasers prior to the date hereof; (h) not (i) change accounting methods; (ii) amend or terminate any contract, agreement or license to which it is a party (except pursuant to arrangements previously disclosed in writing to Purchasers or disclosed in the Sellers Disclosure Schedule) except those amended or terminated in the ordinary course of business, consistent with past practices; (iii) lend any amount to any person or entity, other than advances for travel and expenses which are incurred in the ordinary course of business consistent with past practices, and which are not material in amount to SCC, which travel and expenses shall be documented by receipts for the claimed amounts, (iv) enter into any guarantee or suretyship for any obligation except for the endorsements of checks and other negotiable instruments in ordinary course of business, consistent with past practice; (v) waive or 21 26 release any material right or claim; (vi) issue or sell any SCC Securities, or issue or create any warrants, obligations, subscriptions, options, convertible securities, stock appreciation rights or other commitments to issue SCC Securities, or take any action other than this transaction to accelerate the vesting of any outstanding option or other security (except pursuant to existing arrangements disclosed in writing to Purchasers before the date of this Agreement); (vii) merge, consolidate or reorganize with or acquire any entity; (viii) agree to any audit assessment by any tax authority or file any federal or state income or franchise Tax return unless copies of such returns have been delivered to Purchasers for its review prior to such agreement or filing; and (ix) terminate the employment of any key executive employee; (i) not take any action or engage in any activity which would result in SCC losing its S corporation status for federal income tax purposes; (j) not take any action or make any distribution which would cause the SCC shareholders' retained equity, determined in accordance with generally accepted accounting principles, and exclusive of any capitalized non-compete or other employment-related compensation to be less than $400,000; (k) not take any action which could prevent HCC from accounting for the business combination to be effected by the Merger, as a pooling-of-interests; (l) not enter into any transaction incurring capital expenditures over $10,000 or incurring any non-budgeted expense item over $5,000, in each case, in the aggregate; and (m) not, directly or indirectly, agree or commit to do any of the foregoing. SECTION 5.2 ACCESS TO FINANCIAL AND OPERATIONAL INFORMATION. The Sellers will give Purchasers, its counsel, financial advisors, auditors and other authorized representatives reasonable access during normal business hours to the offices, properties, books and records of SCC and LLC, will furnish to Purchasers, its counsel, financial advisors, auditors and other authorized representatives such financial and operating data as such persons may reasonably request and will instruct its employees, counsel and financial advisors to cooperate with Purchasers in its investigation of the businesses of SCC and in the planning for the combination of the businesses of SCC and Purchasers following the consummation of the transactions contemplated by this Agreement; provided that no investigation pursuant to this Section or otherwise shall affect any representation or warranty given hereunder. In addition, following the public announcement of this Agreement or the transactions contemplated hereby, the Sellers will cooperate in arranging joint meetings among representatives of SCC and Purchasers and persons with whom SCC maintains business relationships. SECTION 5.3 OTHER OFFERS. The Sellers will not, and will not permit SCC to, directly or indirectly, (i) take any action to solicit, initiate or discuss any Acquisition Proposal (as hereinafter defined), or (ii) engage in negotiations with, or disclose any 22 27 nonpublic information relating to, SCC or afford access to the properties, books or records of SCC to, any person or entity that may be considering making, or has made, an Acquisition Proposal. To the extent that any of the Sellers or SCC or any of its officers, directors, employees or other agents are currently involved in any discussions with respect to any Acquisition Proposal or contemplated or proposed Acquisition Proposal, Sellers shall suspend, and shall cause, where applicable, SCC and its officers, directors, employees or other agents to suspend, such discussions immediately. The term "Acquisition Proposal" as used herein means any offer or proposal for, or any indication of interest in, a merger or other business combination involving SCC or LLC or the acquisition of any equity interest in, or a substantial portion of the assets of, SCC or LLC other than the transactions contemplated by this Agreement. SECTION 5.4 MAINTENANCE OF BUSINESS. The Sellers will use their best efforts to cause SCC to carry on its business, keep available the services of its officers and employees and preserve its relationships with those of its customers, agents, suppliers, licensors and others having business relationships with it that are material to its business in substantially the same manner as it has prior to the date hereof. If any of the Sellers becomes aware of a material deterioration or facts which are likely to result in a material deterioration in the relationship with any customer, supplier, licensor or others having business relationships with it, such Seller will promptly in writing bring such information to the attention of the Purchasers. SECTION 5.5 COMPLIANCE WITH OBLIGATIONS. The Sellers shall use their best efforts to cause SCC to comply in all material respects with (i) all applicable federal, state, local and foreign laws, rules and regulations, (ii) all agreements and obligations, including its respective charter and bylaws, by which it, its properties or its assets may be bound, and (iii) all decrees, orders, writs, injunctions, judgments, statutes, rules and regulations applicable to SCC and its properties or assets. SECTION 5.6 NOTICES OF CERTAIN EVENTS. Any Seller shall, upon obtaining knowledge of any of the following, promptly notify Purchasers of: (a) any notice or other communication from any person alleging that the consent of such person is or may be required in connection with this Agreement, (b) any notice or other communication from any governmental or regulatory agency or authority in connection with this Agreement, and (c) any actions, suits, claims, investigations or other judicial proceedings commenced or threatened against SCC which, if pending on the date of this Agreement, would have been required to have been disclosed pursuant hereto or which relate to the consummation of transactions contemplated by this Agreement. SECTION 5.7 NECESSARY CONSENTS. After the Effective Date, each of the Sellers shall use its best efforts to obtain such written consents and take such other actions as 23 28 may be necessary or appropriate to allow Purchasers to hold and carry on the acquired businesses after the Closing. SECTION 5.8 REGULATORY APPROVAL. Each of the Sellers will, and will cause SCC to, where required pursuant to the rules or regulations of any regulatory agency, execute and file, or join in the execution and filing, with any application or other document that may be necessary in order to obtain any Governmental Authorization which may be reasonably required, or which Purchasers may reasonably request, in connection with the consummation of the transaction provided for in this Agreement. Each of the Sellers will, and will cause SCC to, use reasonable best efforts to obtain or assist Purchasers in obtaining all such Governmental Authorizations. SECTION 5.9 SATISFACTION OF CONDITIONS PRECEDENT. Each of the Sellers shall use all reasonable efforts to cause the transactions provided for in this Agreement to be consummated, and, without limiting the generality of the foregoing to obtain all consents and authorizations of third parties and to make all filings with, and give all notices to, third parties that may be necessary or reasonably required on its part in order to effect the transactions provided for herein. SECTION 5.10 SHAREHOLDER APPROVAL. At the earliest practicable date, SCC will duly call and hold a Special Shareholders Meeting, or duly take action by the written consent of its Shareholders, whereby this Agreement, the Merger and related matters will be submitted for the consideration and approval of its Shareholders (the "Shareholder Vote") which approval will be recommended by the Board of Directors of SCC. The Shareholder Vote will be effected in compliance with applicable law. SECTION 5.11 AFFILIATES AGREEMENT. To facilitate the treatment of the Merger for accounting purposes as a pooling-of-interest, SCC and each Shareholder shall deliver to HCC simultaneously with the execution of this Agreement, a written agreement (the "Affiliates Agreement") in form and substance reasonably satisfactory to HCC. 24 29 SECTION 5.12 NON-COMPETITION, NON-SOLICITATION AND CONFIDENTIALITY. Schanen and Tolbert agree as follows: (a) During the period of three (3) years after the termination ("Employment Termination") of their respective employment with HCC, SCC or any of their successors, affiliates or subsidiaries (collectively, the "Employer"), Schanen or Tolbert shall not for any reason, within any of the markets in which Employer or its affiliates has sold products or services or formulated a plan to sell products or services into a market during the last twelve (12) months of their respective employment, as the case may be, engage in or contribute their knowledge to any work which is competitive with or similar to a product, process, apparatus, service, or development on which the person in question worked or with respect to which such person had access to Confidential Information while employed by Employer. Following the expiration of said three (3) year period, Schanen and Tolbert each shall continue to be obligated under the Confidential Information set forth in paragraph (d) of this Section not to use or to disclose Confidential Information of Employer so long as it shall not be publicly available. It is understood that the geographical area set forth in this covenant is divisible so that if this clause is invalid or unenforceable in an included geographic area, that area is severable and the clause remains in effect for the remaining included geographic areas in which the clause is valid. (b) That for a period of three (3) years after their respective Employment Termination, neither will solicit or accept any business from any customer or client or prospective customer or client with whom he dealt or solicited while employed by Employer. (c) For a period of three (3) years after their respective Employment Termination, neither will either directly or indirectly, on his own behalf or on behalf of others, solicit, attempt to hire, or hire any person employed by Employer to work for him or for another entity, firm, corporation, or individual. (d) Neither Schanen nor Tolbert will, except as Employer may otherwise consent or direct in writing, reveal or disclose, sell, use, lecture upon, publish or otherwise disclose to any third party any Confidential Information, or authorize anyone else to do these things at any time either during or subsequent to his employment. This paragraph shall continue in full force and effect after termination of Schanen or Tolbert's employment. Schanen and Tolbert's obligations under this paragraph with respect to any specific Confidential Information shall cease when that specific portion of the Confidential Information becomes publicly known, in its entirety and without combining portions of such information obtained separately. It is understood that such Confidential Information of Employer include matters that Schanen and Tolbert conceive or develop, as well as matters Schanen and Tolbert learn from other employees of Employer. Confidential Information is defined to include information: (1) disclosed to or known by Schanen or Tolbert, as applicable, as a consequence of or through his employment with SCC; (2) not generally known outside of Employer; and (3) which relates to any aspect of Employer or its business, finances, operation plans, budgets, research, or strategic 25 30 development. "Confidential Information" includes, but is not limited to Employer's trade secrets, proprietary information, financial documents, long range plans, customer lists, employer compensation, marketing strategy, existing contracts and contractual forms and terms, data bases, costing data, computer software developed by Employer, investments made by Employer, and any information provided to Employer by a third party under restrictions against disclosure or use by Employer or others. (e) Upon termination of his employment with Employer, Schanen or Tolbert, if requested by Employer, shall reaffirm in writing his recognition of the importance of maintaining the confidentiality of Employer's Confidential Information and proprietary information, and reaffirm any other obligations set forth in this Agreement. (f) Neither Schanen nor Tolbert has used or disclosed any Confidential Information he may have obtained from Employer prior to signing this Agreement, in any way inconsistent with the provisions of this Agreement. (g) Any breach of paragraphs (a), (b) or (c) above cannot be remedied solely by money damages, and that in addition to any other remedies Employer may have, Employer shall be entitled to obtain injunctive relief against Schanen or Tolbert, as the case may be. Nothing herein, however, shall be construed as limiting Employer's right to pursue any other available remedy at law or in equity, including recovery of damages. (h) In the event either of Schanen or Tolbert breaches paragraphs (a), (b) or (c) of this Section, the restrictive time periods contained in those provisions will be extended by the period of time he was in violation of such provisions. (i) The agreements contained in this Section are independent of the other agreements contained herein. Accordingly, failure of Employer to comply with any of its obligations outside of this Section do not excuse Schanen and Tolbert from complying with the agreements contained herein. ARTICLE 6 COVENANTS OF PURCHASERS SECTION 6.1 CONDUCT OF PURCHASERS. From the date hereof until the Closing or a termination of this Agreement, Purchasers shall in all material respects conduct its business in the ordinary course, provided, however, that nothing in this Agreement shall be construed to prohibit or otherwise restrain Purchasers in any manner from acquiring other businesses or substantially all of the assets thereof. SECTION 6.2 OBLIGATION OF MERGER SUB. HCC shall take all action necessary to cause Merger Sub to perform its obligations under this Agreement and to consummate the Merger on the terms and conditions set forth in this Agreement. 26 31 SECTION 6.3 NOTICE TO AFFILIATES. HCC shall, at least 30 days prior to the Effective Date, cause to be delivered to each person HCC believes to be an "Affiliate" (as that term is used in paragraph (c) and (d) of Rule 145 under the Securities Act), of HCC a notice informing such persons of restrictions on transfers resulting from the Merger being accounted for as a pooling-of-interest in accordance with generally accepted accounting principles and the rules, regulations and policies of the SEC. ARTICLE 7 COVENANTS OF PURCHASERS AND SELLERS SECTION 7.1 ADVICE OF CHANGES. Each Party will promptly advise the others in writing (i) of any event known to it, him or her or any of its executive officers occurring subsequent to the date of this Agreement that in its reasonable judgment renders any representation or warranty of such Party contained in this Agreement, if made on or as of the date of such event or the Effective Date, untrue, inaccurate or misleading in any material respect and (ii) of any Material Adverse Change in the business condition of the Party. SECTION 7.2 REGULATORY APPROVALS. The Parties shall execute and file, or join in the execution and filing of, any application or other document that may be necessary in order to obtain the authorization, approval or consent of any governmental body, federal, state, local or foreign, which may be required or reasonably requested by Purchasers in connection with the consummation of the transactions contemplated by this Agreement, including filings under the HSR Act, if determined to be applicable by counsel for Purchasers. Each Party shall use its reasonable best efforts to obtain all such authorizations, approvals and consents, and the costs therefor shall be paid by Purchasers. SECTION 7.3 CERTAIN FILINGS. The Parties shall cooperate with one another: (a) in determining whether any action by or in respect of, or filing with, any governmental body, agency or official, or authority is required, or any actions, consents, approvals or waivers are required to be obtained from Parties to any material contracts, in connection with the consummation of the transactions contemplated by this Agreement; and (b) in seeking any such actions, consents, approvals or waivers or making any such filings, furnishing information required in connection therewith and seeking timely to obtain any such actions, consents, approvals or waivers. SECTION 7.4 COMMUNICATIONS. None of the Sellers shall make any disclosure to the public or to any person or entity, other than their officers, employees, or advisors who need to know such information in connection with the negotiation and consummation of the transactions contemplated by this Agreement, of the negotiation, execution, terms, or subject matter of this Agreement without the prior written consent of Purchasers. Unless required by law, prior to consummation, Purchasers shall not make any further public announcement in connection with the negotiation and consummation of the transactions 27 32 contemplated by this Agreement, without the prior consent of Schanen, which consent shall not be unreasonably withheld or delayed. Notwithstanding the foregoing, Sellers and Purchasers shall have the right to disclose the transaction contemplated by this Agreement to the insurers, reinsurers, brokers, agents and third-party administrators that work with SCC, and Purchasers shall have the right to disclose the transaction contemplated by this Agreement to financial analysts, lenders, regulating agencies, and its shareholders. SECTION 7.5 SATISFACTION OF CONDITIONS PRECEDENT. Each of the Parties will use its best efforts to satisfy or cause to be satisfied all the conditions precedent that are applicable to each of them, and to cause the transactions contemplated by this Agreement to be consummated, and, without limiting the generality of the foregoing, to obtain all material consents and authorizations of third parties and to make filings with, and give all notices to, third parties that may be necessary or reasonably required on its part in order to effect the transactions contemplated hereby. SECTION 7.6 TAX COOPERATION. The Parties shall cooperate in the preparation, execution and filing of all returns, questionnaires, applications or other documents regarding any sales, use, transfer, value-added, stock transfer or stamp taxes, any transfer, recording, registration or other fees, and any similar taxes or fees which become payable in connection with the transactions contemplated by this Agreement. The Parties shall also cooperate in the preparation of income and franchise tax returns for 2000 and 2001, including the preparation of short-year returns for the portion of 2001 preceding the Closing. SECTION 7.7 CONFIDENTIALITY. Between the date of this Agreement and the Effective Date, each Party will maintain in confidence, and cause its directors, officers, employees, agents, and advisors to maintain in confidence, and not use to the detriment of another Party, any written or oral or other information obtained in confidence from another Party in connection with this Agreement or the transactions contemplated hereby unless (1) such information is already known to such Party or to others not bound by a duty of confidentiality, (2) such information becomes publicly available through no fault of such Party, (3) the use of such information is necessary, or appropriate in making any filing or obtaining any consent or approval required for the consummation of the transaction contemplated hereby, or (4) the furnishing or use of such information is required by or necessary or appropriate in connection with legal proceedings. Upon a termination of this Agreement, each Party will return or destroy as much of such written information as may be reasonably requested. 28 33 ARTICLE 8 CONDITIONS TO CLOSING SECTION 8.1 CONDITIONS TO OBLIGATIONS OF PURCHASERS. The obligations of Purchasers hereunder are subject to the fulfillment or satisfaction, on and as of the Effective Date, of each of the following conditions (any one or more of which may be waived by Purchasers, but only in a writing signed by Purchasers): (a) The representations and warranties contained in Article 3 (considered collectively) and each of those representations and warranties (considered individually) remain true and accurate in all material respects on and as of the Effective Date with the same force and effect as if they had been made on the Effective Date (except to the extent a representation or warranty speaks specifically as of an earlier date and except for changes contemplated by this Agreement) without giving effect to any supplement to the Sellers Disclosure Schedule and Sellers shall have provided Purchasers with a certificate, dated as of the Effective Date, to such effect. (b) Each of the representations and warranties in Section 3.1, Section 3.5, Section 3.6, Section 3.7, Section 3.10 and Section 3.27 must be accurate in all respects as of the date of this Agreement and must be accurate in all respects as of the Effective Date as if made on the Effective Date without giving effect to any supplement to the Sellers Disclosure Schedule. (c) Sellers shall have performed and complied in all material respects with all of their covenants (considered individually and collectively) contained herein required to be performed on or before the Effective Date. Each of the covenants set forth in Section 5.1(e), (h) and (k) shall have been performed in all respects as of the Effective Date. Purchasers shall have received a certificate to such effect signed by each of the Sellers. (d) There shall have been no Material Adverse Change in SCC since September 30, 2000. (e) All written consents, assignments, waivers or authorizations, other than Governmental Authorizations, that are required as a result of the transaction contemplated by this Agreement for the continuation in full force and effect of any Material Agreements shall have been obtained. (f) Purchasers shall have received an opinion of counsel to Sellers and SCC in form and substance satisfactory to Purchasers. (g) All agency and commission fee agreements, overrides and business contracts (collectively "Fee Agreements") of SCC in force on the date of this Agreement shall be in force on the Effective Date, without restriction or modification as a result of the consummation of the Merger for a period at least equal to the remainder of their respective annual terms. 29 34 (h) The Sellers shall have received and caused to be delivered to Purchasers the opinion of Holland, Shipes & Vann, P.C. on the financial statements of SCC and the related supplemental schedules for the year ended December 31, 1999. (i) Sellers shall have arranged for Purchasers' review of the audit or review workpapers for SCC for each of fiscal year 1999 and the three prior fiscal years. (j) Until the Closing, SCC shall continue to qualify as an S corporation. (k) Schanen and Tolbert (collectively, the "Key Employees") and such other key employees of SCC as Purchasers shall require, shall each have executed and delivered to Purchasers a Non-Competition Agreement in form and substance reasonably satisfactory to Purchasers and the Key Employees shall have entered into an agreement with the Purchasers providing for their continued employment. All other employment or consulting agreements of SCC other than those described on the Sellers' Disclosure Schedule shall at Purchaser's request be terminated without any payment by or further obligation of SCC. (l) Each of the Key Employees shall be alive and not in any way, Disabled. For purposes of this Agreement, a person shall be deemed to be "Disabled" if he is unable to engage in any substantial portion of his regular duties for SCC or any Affiliate of SCC by reason of any medically determinable physical or mental impairment which can be expected to result in death or which has lasted or can be expected to last for a continuous period of not less than three (3) months. (m) Shareholders shall have furnished Purchasers with evidence of such consents as Shareholders shall know, or Purchasers shall determine, to be required to enable Purchasers to continue to enjoy the benefit of any lease, license, permit, contract or other agreement or instrument to which SCC is a party or beneficiary and which can, by its terms (with consent) and consistent with applicable law, be so enjoyed after the Merger. If there is in existence any lease, governmental license, permit or contract that, by its terms or applicable law, expires, terminates or is otherwise rendered invalid upon the Merger, and such lease, license, permit, or contract is required in order for the business of SCC to continue to be conducted following the Merger in the same manner as conducted previously, Purchasers shall have obtained, or been furnished by Shareholders an equivalent of, that lease, license, permit, or contract effective as of and after the Effective Date. (n) Purchasers shall have received resignations of all persons who are officers or directors, as applicable, of SCC immediately prior to the Closing. (o) Purchasers shall have received general releases in favor of SCC and Purchasers executed by each of the Sellers, Lisa Bianchi, and Susan Kaufman. Those releases will not relate to rights or obligations arising under this Agreement. 30 35 (p) Purchasers shall have received possession of all corporate, accounting, business and tax records of SCC. (q) The form and substance of all actions, proceedings, instruments and documents required to consummate the transactions contemplated by this Agreement shall have been satisfactory in all reasonable respects to Purchasers and Purchasers' counsel. (r) Purchasers and SCC shall have received the letters from Holland, Shipes & Vann, P.C., accountants for SCC and addressed to Purchasers and SCC stating that SCC qualifies as an entity that may be a party to a business combination for which the pooling-of-interests accounting method of accounting would be available. (s) No order of any court or administrative agency shall be in effect that enjoins, restrains, conditions or prohibits consummation of this Agreement or any Operative Agreement, no litigation, investigation or administrative proceeding shall be pending or threatened that would enjoin, restrain, condition or prevent consummation of this Agreement or any Operative Agreement. (t) Purchasers shall have received from each of the Shareholders an agreement that each such Shareholders shall dispose of any investment which is reasonably deemed by HCC to be in conflict with any of HCC's or SCC's operations within twelve (12) months after the Closing Date. (u) Purchasers shall have received from each Shareholder an agreement that any of the HCC Common Stock received hereunder shall be held for a minimum of one year period and shall be further subject to any limitations on sale contained in any rules or regulations of the SEC under the Securities Act or the Exchange Act, or which result in Purchaser losing the benefits of accounting for the business combination as a pooling of interests. (v) The Shareholders shall have entered into the Escrow Agreement. (w) Purchasers shall be satisfied that on a pro-forma basis SCC will earn at least $5,000,000 of pre-tax profit for the year ended December 31, 2000. SECTION 8.2 CONDITIONS TO OBLIGATIONS OF SELLERS. The Sellers' obligations hereunder are subject to the fulfillment or satisfaction, on and as of the Effective Date, of each of the following conditions (any one or more of which may be waived, but only in a writing signed by such Party): (a) The representations and warranties of Purchasers set forth herein shall be true and accurate in all material respects on and as of the Effective Date with the same force and effect as if they, had been made on the Effective Date (except to the extent a representation or warranty speaks specifically as of an earlier date and except for changes contemplated by this Agreement) and Purchasers shall have provided the Sellers with a 31 36 certificate executed by the President and the Chief Financial Officer of Purchasers, dated as of the Effective Date, to such effect. For the purpose of determining the accuracy of the representations and warranties of Purchasers, any change or effect in the business of Purchasers that results in substantial part as a consequence of the public announcement or pendency of the transactions contemplated hereby shall not be deemed a Material Adverse Change or Material Adverse Effect or other breach of representation or warranty with respect to Purchasers. (b) Purchasers shall have performed and complied with all of its covenants contained herein in all material respects on or before the Effective Date, and the Sellers shall have received a certificate to such effect signed by Purchasers' President and Chief Financial Officer. (c) Sellers shall have received from Haynes and Boone, LLP, counsel to Purchasers, an opinion in form and substance satisfactory to the Sellers, including the tax-free nature of the Merger. (d) The form and substance of all actions, proceedings, instruments and documents required to consummate the transactions contemplated by this Agreement shall have been satisfactory in all reasonable respects to the Shareholders and their counsel. (e) Purchasers shall have entered into letters of employment with Ms. Lisa Bianchi and Ms. Susan Kaufman providing for annual salaries of $200,000 each plus the right to share in any employee bonus pool established by the Purchasers. SECTION 8.3 CONDITIONS TO OBLIGATIONS OF EACH PARTY. The respective obligations of the Parties hereunder are subject to the fulfillment, on and as of the Effective Date. of each of the following conditions (any one or more of which may be waived by such Parties, but only in a writing signed by such Parties): (a) No statute, rule, regulation, executive order, decree, injunction or restraining order shall have been enacted, promulgated or enforced (and not repealed, superseded or otherwise made inapplicable) by any court or governmental authority which prohibits the consummation of the transaction contemplated by this Agreement or the Operative Agreements (each Party agreeing to use its reasonable best efforts to have any such order, decree or injunction lifted). (b) There shall have been obtained any and all Governmental Authorizations, permits, approvals and consents of securities or "blue sky" commissions of any jurisdiction and of any other governmental body or agency, that may reasonably be deemed necessary so that the consummation of the transaction contemplated by this Agreement will be in compliance with applicable laws, the failure to comply with which would have a Material Adverse Effect on Purchasers, SCC or would be reasonably likely to subject any of Purchasers or SCC or any of their respective directors or officers to penalties or criminal liability. 32 37 ARTICLE 9 POST-CLOSING COVENANTS SECTION 9.1 LISTING OF HCC COMMON STOCK. If required, HCC shall cause the shares of HCC Common Stock to be issued in the Merger to be approved for listing on the NYSE. SECTION 9.2 PUBLICATION OF POST-MERGER RESULTS. HCC shall use commercially reasonable efforts to cause financial results covering at least 30 days of post-Merger combined operations to be published in its first report of quarterly financial statements as soon as practicable and by the date such information is required to be filed with the SEC. SECTION 9.3 EMPLOYEE BENEFITS. Following the consummation of the Merger, as soon as reasonably practicable, HCC shall arrange to make generally available to the employees of SCC, the benefits generally applicable to employees of HCC. SECTION 9.4 COVENANTS RELATING TO SALES UNDER RULE 144. (a) SEC Reporting Requirements, Etc. For so long as any shares of the HCC Common Stock are owned of record by any of the Sellers, HCC agrees that: (i) HCC shall maintain in full force and effect at all times the registration of the HCC Common Stock with the SEC pursuant to Section 12 of the Exchange Act, and shall at all times remain subject to the reporting requirements of Section 13 of the Exchange Act; (ii) HCC shall at all times file, when due, all reports required to be filed with the SEC pursuant to Section 13 of the Exchange Act; and (iii) HCC shall from time to time take such other action that may be required of an issuer of securities under Rule 144 promulgated under the Securities Act ("Rule 144"), to maintain the eligibility of the HCC Common Stock for sale thereunder. (b) Sales of HCC Common Stock under Rule 144. HCC agrees that, beginning on a date that is one year from the Closing, not later than three business days after its receipt of written notice from a Seller (each, a "144 Sale Notice," substantially in the form of Exhibit B hereto), notifying HCC that certain shares of HCC Common Stock have been sold under the provisions of Rule 144 (the "Sale Shares"), HCC shall, at its cost and in accordance with and subject to the provisions of Rule 144: (1) Remove, or cause to be removed, all restrictive legends appearing on any share certificates evidencing the Sale Shares or otherwise applicable to the Sale Shares; 33 38 (2) Rescind any stop transfer instructions given at any time by HCC to its stock transfer agent (the "Transfer Agent") that terminate or expire upon a sale of the shares to which such instructions relate in compliance with Rule 144; and (3) Cause its attorneys to issue to the Transfer Agent a written opinion of counsel, stating therein (if true) that the Sale Shares may be transferred without restriction to the purchaser(s) thereof in reliance upon Rule 144 and that any stop transfer instructions with respect to the Sale Shares may be removed. Provided, however, that each 144 Sale Notice delivered to HCC shall be accompanied by (i) a standard representation letter to HCC from the securities brokerage firm that sold the Sale Shares for such Seller, and (ii) a copy of Form 144 filed with the SEC in connection with the sale of the Sale Shares under Rule 144. (c) Pre-Sale Confirmations. HCC agrees that not later than five business days after receiving a written request from a Seller, HCC will confirm, in writing (if true), that the Seller is the registered owner of the shares of HCC Common Stock identified in such written request and that there are no stop transfer instructions in effect with respect to such shares (other than instructions that will terminate or expire upon a sale of such shares in accordance with Rule 144). (d) No Effect on Other Rights. Nothing herein shall limit or restrict any rights available to any of the Sellers arising under any federal or state securities laws or regulations. (e) Assignment. Each of the Sellers shall have the right, upon written notice to HCC, to transfer, convey and assign all of such Sellers rights arising under this Section 9.4 to any person or entity that acquires any HCC Common Stock from such Seller in a private, non-public transaction (whereupon such other person or entity shall be referred to as a "Seller" for purposes of this Section 9.4). (f) Definition. For purposes hereof, "business days" means any day other than a Saturday, Sunday and U.S. Federal holiday. SECTION 9.5 POOLING-OF-INTERESTS. Shareholders shall take no action which could or would result in Purchasers losing the benefits of accounting for the merger as a pooling-of-interests. SECTION 9.6 ASSIGNMENT OF COMMISSIONS. Schanen and Tolbert and each other person who is entitled to commissions, fees or other amounts attributable to business written by any such person for business written on behalf of SCC or Merger Sub shall irrevocably assign the rights to such fees, commissions or other amounts to SCC or Merger Sub. 34 39 ARTICLE 10 TERMINATION OF AGREEMENT SECTION 10.1 TERMINATION. This Agreement may be terminated at any time prior to the Effective Date: (a) By the mutual consent of the Shareholders and Purchasers. (b) By Purchasers or by the Shareholders if there has been a material breach by the other of any representation or warranty contained in this Agreement, which in either case cannot be, or has not been, cured within 15 days after written notice of such breach is given to the Party committing such breach, provided that the right to effect such cure shall not extend beyond the date set forth in subparagraph (c) below. (c) By Purchasers or by the Shareholders if all conditions of Closing required by Article 8 hereof have not been met or waived by January 31, 2001 (the "Termination Date"). Provided, however, that neither Purchasers nor Shareholders, shall be entitled to terminate this Agreement pursuant to this subparagraph (c) if such Party is in material violation of any of its representations, warranties or covenants in this Agreement. (d) If any governmental authority shall have issued an order, decree or ruling or taken any other action permanently enjoining, restraining or otherwise prohibiting the transactions contemplated by this Agreement and such order, decree, ruling or other action shall have become final and nonappealable. SECTION 10.2 EFFECT OF TERMINATION. Each Party's right of termination under Section 10.1 is in addition to any other rights it may have under this Agreement or otherwise, and the exercise of a right of termination will not be an election of remedies. If this Agreement is terminated pursuant to Section 10.1, all further obligations of the Parties under this Agreement will terminate except that the obligations in Section 7.7, Section 13.3, Section 13.5, Section 13.6 and Section 13.11 will survive; provided, however, that if this Agreement is terminated by a Party because of the breach of the Agreement by the other Party or because one or more of the conditions to the terminating Party's obligations under this Agreement is not satisfied as a result of the other Party's failure to comply with its obligations under this Agreement, the terminating Party's right to pursue all legal remedies will survive such termination unimpaired. 35 40 ARTICLE 11 CLOSING MATTERS SECTION 11.1 THE CLOSING. Subject to termination of this Agreement as provided in Article 10 above, the closing of the transactions provided for herein (the "Closing") will take place at the offices of Haynes and Boone, LLP, 1000 Louisiana, Suite 4300, Houston, Texas 77002 at 9:00 a.m., Houston Time on January 19, 2001 or, if all conditions to Closing have not been satisfied or waived by such date, such other place, time and date as the Shareholders and Purchasers may mutually select (the "Closing Date"). Such Closing may, with the consent of all Parties, take place by delivery and exchange of documents by facsimile or electronic mail transmission with originals to follow by overnight mail service courier. ARTICLE 12 INDEMNIFICATION AND REMEDIES SECTION 12.1 GENERAL INDEMNIFICATION BY THE SHAREHOLDERS. Each Shareholder, jointly and severally (the "Indemnifying Parties") to the extent hereinafter set forth, covenants and agrees to indemnify, defend, protect and hold harmless HCC, Merger Sub and the Surviving Corporation and their respective officers, directors, employees, shareholders, members, assigns, successors and affiliates (individually, an "Indemnified Party" and collectively, "Indemnified Parties") from, against and in respect of: (a) all liabilities, losses, claims, damages, punitive damages, causes of action, lawsuits, administrative proceedings (including informal proceedings), investigations, audits, demands, assessments, adjustments, judgments, settlement payments, deficiencies, penalties, fines, interest (including interest from the date of such damages) and costs and expenses (including without limitation reasonable attorneys' fees and disbursements of every kind, nature and description) (collectively, "Damages") suffered, sustained, incurred or paid by the Indemnified Parties in connection with, resulting from or arising out of, directly or indirectly: (i) any breach of any representation or warranty of SCC or the Shareholders set forth in this Agreement or any schedule or certificate, delivered by or on behalf of SCC or the Shareholders in connection herewith; or (ii) any nonfulfillment of any covenant or agreement by the Shareholders, or, prior to the Effective Time, SCC, under this Agreement; or (iii) the business, operations or assets of SCC prior to the Closing Date or the actions or omissions of SCC's officers, employees or agents prior to the Closing Date; or 36 41 (iv) the matters disclosed on the Disclosure Schedule or the nonfulfillment of any representation, covenant or agreement described in Section 3.5, Section 3.6, Section 3.10, Section 3.12 or Section 3.13; or (v) the failure of SCC or any Shareholder to obtain any necessary consent relating to the leasing by SCC of the leasehold property utilized by SCC; or (vi) fraud; and (b) any and all Damages incident to any of the foregoing or to the enforcement of this Section 12.1; and (c) all representations, warranties, covenants and obligations in this Agreement, the Disclosure Schedules, the supplements to the Disclosure Schedules, the certificates delivered pursuant to this Agreement and any other certificate or document delivered pursuant to this Agreement will survive the Closing. The right to indemnification, payment of Damages or other remedies based on such representations, warranties, covenants and obligations will not be affected by any investigation conducted with respect to, or any knowledge acquired (or capable of being acquired) at any time, whether before or after the execution and delivery of this Agreement or the Closing Date, with respect to the accuracy or inaccuracy of or compliance with any such representation, warranty, covenant or obligation. The waiver of any condition based on the accuracy of any representation or warranty, or on the performance of or compliance with any covenant or obligation, will not affect the right to indemnification, payment of Damages or other remedies based on such representation, warranties, covenants and obligations. SECTION 12.2 LIMITATION AND EXPIRATION. Notwithstanding the above: (a) (i) there shall be no liability for indemnification under Section 12.1 unless the aggregate amount of Damages exceeds $100,000 (the "Franchise Deductible"); provided, however, if Damages exceed the Franchise Deductible, the Indemnifying Persons shall be liable for all such Damages and (ii) provided, further that the Franchise Deductible shall not apply to Damages arising out of any breaches of the covenants of the Shareholders set forth in this Agreement or representations and warranties made in Section 3.1, Section 3.5, Section 3.6, Section 3.10 or Section 3.12 or for fraud (the "Deductible Exclusions"); (b) the aggregate amount of any Shareholders' liability under this Article 12 except for matters referred to as Deductible Exclusions shall not exceed an amount equal to the Merger Consideration valued at the Closing Date Price, defined below and received by such Shareholder; (c) the indemnification obligations under this Article 12, or under any certificate or writing furnished in connection herewith, shall terminate at the date that is the later of clause (i) or (ii) of this Section 12.2(c): 37 42 (i) (1) with respect to claims relating to or arising out of (i) any Taxes arising out of or relating to the business of SCC; or (ii) any taxes arising out of the payment of salaries, wages, bonuses, commissions, distributions or the granting of options or stock to any shareholder during their entire term as an employee, whether a shareholder at the time of payment or not; (iii) any taxes arising out of the reorganization of the shareholdings or the reorganization of the structure of the entities prior to the Closing Date; or (iv) the irrevocable assignment of all commissions, fees or other amounts due to SCC; or (v) any damages or expenses arising from or related to the claims alleged by Dr. Arun Misra against Tolbert, SCC or any other employee or shareholder of SCC: (A) the date that is six (6) months after the expiration of the longest applicable federal or state statute of limitation (including extensions thereof), or (B) if there is no applicable statute of limitation, ten (10) years after the Closing Date; or (2) with respect to claims other than those specified in clause (i)(1) of this Section 12.2(c) that are of a nature and of sufficient materiality typically expected to be encountered in the audit process, on the completion of the first independent audit of the financial statements of the combined operations of HCC and SCC; or (3) with respect to all claims other than those referred to in clause (i)(1) or (2) of this Section 12.2(c), twelve (12) months after the Effective Time; or (ii) the final resolution of claims or demands pending as of the relevant dates described in clause (i) of this Section 12.2(c) (such claims referred to as "Pending Claims") and Possible Claims. For purposes of this Agreement, a Possible Claim shall be one in which an Indemnified Party has notified the Indemnifying Party that a possible claim or demand may be made against the Indemnified Party for which indemnification under this Article 12, might be applicable, provided, however, that a Possible Claim, which has not become a Pending Claim, shall not extend the term of the Escrow Agreement beyond the Escrow Agreement's termination date by more than three (3) months. SECTION 12.3 AGREEMENT TO INDEMNIFY. Subject to the limitations set forth in this Article 12 and except as set forth in Section 12.2, each Shareholder shall be liable severally and Pro Rata (as hereinafter defined) (hereafter in this Section 12.3 referred to as "HCC Damages"). "Pro Rata" for purposes of Section 12.1 and Section 12.2 with respect to each Shareholder shall mean the proportion that such Shareholder's holdings of SCC Common Stock as of the time immediately prior to the Effective Time bears to the total shares of SCC Common Stock held by all Shareholders as of the time immediately prior to the Effective Time. In seeking indemnification for HCC Damages under this Article 12 following the Closing, the Indemnified Persons' remedy will be limited to receiving up to that number of shares of HCC Common Stock determined by dividing (a) the amount of the HCC Damages by (b) the closing sale price of HCC's Common 38 43 Stock on the NYSE on the Effective Date (the "Closing Date Price"). Provided, however, that irrespective as to the number of claims asserted by Indemnified Persons hereunder and the amount of the HCC Damages for which indemnification is sought, any such Shareholder, in the aggregate, shall under no circumstances be required to make indemnification payments hereunder beyond the Closing Date Price multiplied by the number of shares of HCC Common Stock received by such Shareholder at the time of the Merger (the "Maximum Shareholder Liability"). Notwithstanding anything to the contrary set forth herein, in the event that at the time of the resolution of any such indemnification claim, such Shareholder does not hold the number of shares of HCC Common Stock (including any shares otherwise acquired at any time before or after the Effective Time or at any time after any claim is made for indemnification) necessary to settle any indemnification claim, then such Shareholder shall pay in cash or other immediately available funds the cash equivalent of the remainder of his in-stock indemnification obligations under this Section 12.3 up to his Maximum Shareholder Liability. In lieu of HCC Common Stock, any Shareholder shall have the option to pay in cash or other immediately available funds the cash equivalent of all or any part of his in-stock Maximum Shareholder Liability. SECTION 12.4 HCC AGREEMENT TO INDEMNIFY. Subject to the limitations set forth in this Article 12, HCC will indemnify and hold harmless SCC, and the SCC Shareholders and their officers, shareholders, directors, administrators, successors and assigns from and against any and all claims, demands, actions, causes of action, losses, costs, damages, liabilities and expenses including, without limitation, reasonable legal fees, (hereafter in this Section 12.4 referred to as "SCC Damages") arising out of any misrepresentation or breach of or default under any of the representations, warranties, covenants and agreements given or made by HCC or Merger Sub in this Agreement or any certificate or exhibit delivered by or on behalf of HCC or Merger Sub pursuant hereto. In seeking indemnification for SCC Damages under this Section 12.4 following the Closing, the Indemnified Party's remedy will be limited to receiving that number of additional shares of HCC Common Stock determined by dividing (a) the amount of the SCC Damages by (b) the Closing Date Price. Provided, however, that irrespective of the number of claims asserted by Indemnified Persons hereunder in the amount of the SCC Damages for which indemnification is sought, HCC, in the aggregate, shall under no circumstances be obligated to make an indemnification payment hereunder beyond that number of additional shares of HCC Common Stock equal to the total number of shares of HCC Common Stock provided to the SCC Shareholders on the Effective Date (the "Maximum HCC Liability"). The indemnification provided for in this Section 12.4 will not apply unless and until the aggregate SCC Damages for which one or more Indemnified Party seeks indemnification exceeds $100,000 in the aggregate, in which event the indemnification provided for will include all SCC Damages (a Franchise Deductible) up to the Maximum HCC Liability. The Franchise Deductible and Maximum HCC Liability shall not apply to damages arising from fraud. 39 44 SECTION 12.5 PROCEDURE FOR INDEMNIFICATION; THIRD PARTY CLAIMS. (a) Promptly after receipt by an Indemnified Party under this Article 12 of notice of a claim or if the Indemnified Party believes it is or could be entitled to indemnification under this Article 12 (collectively a "Claim"), the Indemnified Party will, if a claim is to be made against an Indemnifying Party, give prompt written notice to the Indemnifying Party of the Claim, but the failure to promptly notify the Indemnifying Party will not relieve the Indemnifying Party of any Liability that it may have to any Indemnified Party, except to the extent that the Indemnifying Party demonstrates that the defense of such action is prejudiced by the Indemnified Party's failure to give such prompt notice. Such notice shall contain a description in reasonable detail of facts upon which such Claim is based and, to the extent known, the amount thereof. Such notice shall serve to preserve the Indemnified Party's claim for indemnity against the Indemnifying Party without regard to the expiration of the time periods set forth in Section 12.2 hereof. (b) If any Claim referred to in this Article 12 is made by a third party against an Indemnified Party and such Indemnified Party gives written notice to the Indemnifying Party of the Claim, the Indemnifying Party will be entitled to participate in the defense of Claim but under all circumstances HCC shall be entitled to assume the defense of the Claim and, thereafter, if HCC has so assumed the defense, no other Party hereto will be liable under this Article 12 for any fees of counsel or any other expenses with respect to the defense of the Claim in each case subsequently incurred in connection with the defense of the Claim unless such other Party elects to retain its separate counsel. If HCC is not the Indemnifying Party and elects, in writing, not to assume the defense, the Indemnifying Party shall assume the defense and HCC will not be liable for any fees or expenses with respect to the defense of the Claim, unless HCC elects to retain its separate counsel. SECTION 12.6 LIMITATION ON LIABILITY. It is a fundamental point of mutual agreement among all Parties hereto that the Parties' liability for and in respect of this Agreement and the Merger shall, except for matters relating to Deductible Exclusions, be limited to the absolute, fixed dollar amounts and for the absolute, fixed time limitations specified in this Article 12. These limitations of amount of liability and time to assert any such liability shall apply to all claims and other demands, charges, allegations, liabilities, responsibilities, exposures and the like. 40 45 ARTICLE 13 MISCELLANEOUS SECTION 13.1 APPOINTMENT OF REPRESENTATIVE. Subject to the successorship provisions of this Section 13.1, Schanen (the "Representative") is hereby irrevocably appointed as the attorney-in-fact and representative of the interests of the Shareholders for all purposes of this Agreement, and notice is hereby given thereof to HCC and Merger Sub, and, without independent verification, HCC and Merger Sub may rely upon Representative's undertakings in such capacity. The Representative shall have full and irrevocable authority on behalf of the Shareholders, and shall promptly and completely exercise such authority in a timely fashion to: (a) participate in, represent and bind the Shareholders in all respects with respect to any arbitration or legal proceeding relating to this Agreement, including, without limitation, the defense and settlement of any matter, and the calculation thereof for every purpose thereunder, consent to jurisdiction, enter into any settlement, and consent to entry of judgment, each with respect to any or all of the Shareholders; (b) receive, accept and give notices and other communications relating to this Agreement; (c) take any action that the Representative deems necessary or desirable in order to fully effectuate the transactions contemplated by this Agreement; (d) execute and deliver any instrument or document that the Representative deems necessary or desirable in the exercise of his authority under this Section 13.1; and (e) waive the fulfillment of any condition or conditions to the Closing. Those Shareholders who, as of the Effective Date, hold a majority of the SCC Common Stock may, at any time and by written action delivered to HCC, remove the Representative or any successor thereto, but such removal shall be effective only upon the replacement of such Representative or successor by a new Representative designated, by written notice delivered to HCC, by those Shareholders who, as of the date hereof hold a majority of SCC Common Stock, provided, however, that any such notice shall be effective upon actual receipt by HCC. Any such written notice shall be delivered to HCC in accordance with the notice provisions set forth in Section 13.4 hereof. If any Representative shall have died, become Disabled or unable to serve, those Shareholders who, as of the date hereof, hold a majority of SCC Common Stock shall promptly designate by written notice delivered to HCC, a replacement Representative. Any costs and expenses incurred by the Representative in connection with actions taken pursuant to or permitted by this Section 13.1 will be borne by the Shareholders and paid or reimbursed to the Representative Pro Rata. The foregoing authorization is granted and conferred in consideration for the various agreements and covenants of HCC and Merger Sub contained herein. In 41 46 consideration of the foregoing, and subject to the successorship provisions of this Section 13.1, this authorization granted to the Representative shall be irrevocable and shall not be terminated by any act of any of the Shareholders or by operation of law, whether by death or incompetence of any Shareholder or by the occurrence of any other event except the termination of this Agreement pursuant to Section 10.1 hereof. If after the execution hereof any such Shareholder shall die or become incompetent, the Representative is nevertheless authorized and directed to exercise the authority granted in this Section 13.1 as if such death or incompetence had not occurred and regardless of notice thereof. The Representative shall have no liability to any Shareholder for any act or omission or obligation hereunder, provided that such action or omission is taken by the Representative in good faith and without willful misconduct. SECTION 13.2 FURTHER ASSURANCES. Each party agrees to cooperate fully with the other parties and to execute such further instruments, documents and agreements and to give such further written assurances as may be reasonably requested by any other party to better evidence and reflect the transactions described herein and contemplated hereby and to carry into effect the intents and purposes of this Agreement. SECTION 13.3 FEES AND EXPENSES. Until otherwise agreed by the parties, each party shall bear its own fees and expenses, including counsel fees and fees of brokers and investment bankers contracted by such party, in connection with the transaction contemplated hereby. SECTION 13.4 NOTICES. Whenever any party hereto desires or is required to give any notice, demand, or request with respect to this Agreement, each such communication shall be in writing and shall be effective only if it is delivered by personal service or mailed, United States registered or certified mail, postage prepaid, or sent by facsimile, or prepaid overnight courier addressed as follows: HCC and Merger Sub: HCC Insurance Holdings, Inc. 13403 Northwest Freeway Houston, Texas 77040-6094 Attention: General Counsel Fax: (713) 744-9648 with a copy (which shall not constitute notice) to: Haynes and Boone, LLP 1000 Louisiana Street, Suite 4300 Houston, Texas 77002-5012 Attention: Arthur S. Berner, Esq. Fax: (713) 236-5652 42 47 SCC and Schanen (individually and as Representative) James Scott Schanen 7000 Central Parkway, Suite 1220 - Atlanta, Georgia 30328 Fax: (770) 551-2166 with a copy (which shall not constitute notice) of any notice to SCC or any Shareholder to: Epstein Becker & Green, P.C. Suite 1400 - The Lenox Building 3399 Peachtree Road, N.E. Atlanta, Georgia 30326 Attention: Robert N. Berg, Esq. Fax: (404) 812-5699 Such communications shall be effective when they are received by the addressee thereof. Any party may change its address for such communications by giving notice thereof to other parties in conformity with this Section. In the event Schanen is no longer the Representative, such successor Representative's address shall be the address for the Shareholders. SECTION 13.5 GOVERNING LAW. The internal laws of the State of Texas (irrespective of its choice of law principles) will govern the validity of this Agreement, the construction of its terms, and the interpretation and enforcement of the rights and duties of the parties hereto. Any dispute arising hereunder shall lie exclusively in the state courts of the State of Texas, or in the Federal courts sitting in Harris County, Texas. SECTION 13.6 BINDING UPON SUCCESSORS AND ASSIGNS, ASSIGNMENT. This Agreement and the provisions hereof shall be binding upon each of the parties, their permitted successors and assigns. This Agreement may not be assigned by any party without the prior consent of the others, provided, however, that HCC shall be permitted at any time prior to the Effective Time to cause the assignment of Merger Sub's rights and obligations under this Agreement to another wholly-owned Subsidiary of HCC (without in any way relieving HCC of its obligations under this Agreement with respect to Merger Sub or the Merger). SECTION 13.7 SEVERABILITY. If any provision of this Agreement, or the application thereof, shall for any reason or to any extent be invalid or unenforceable, the remainder of this Agreement and application of such provision to other persons or circumstances shall continue in full force and effect and in no way be affected, impaired or invalidated. SECTION 13.8 ENTIRE AGREEMENT. This Agreement and the Operative Agreements and instruments referenced herein constitute the entire understanding and 43 48 agreement of the parties with respect to the subject matter hereof and supersede all prior and contemporaneous agreements or understandings, inducements or conditions, express or implied, written or oral, between parties with respect hereto. SECTION 13.9 AMENDMENT AND WAIVERS. Any amendment or waiver affecting the Shareholders shall be valid if consented to in writing by the Representative or Shareholders holding a majority of the shares of SCC Common Stock (i) if given or made prior to the Effective Time, such majority as determined as of the date of such amendment or waiver, and (ii) if given or made at or after the Effective Time, such majority as determined immediately prior to the Effective Time. Any term or provision of this Agreement may be amended, and the observance of any term of this Agreement may be waived (either generally or in a particular instance and either retroactively or prospectively) only by a writing signed by those persons as provided in this Section 13.9. The waiver by a party of any breach hereof or default in the performance hereof shall not be deemed to constitute a waiver of any other default or any succeeding breach or default, unless such waiver so expressly states. At any time before the Effective Time, this Agreement may be amended or supplemented by SCC, the Shareholders or HCC with respect to any of the terms contained in this Agreement. SECTION 13.10 NO WAIVER. The failure of any party to enforce any of the provisions hereof shall not be construed to be a waiver of the right of such party thereafter to enforce such provisions. SECTION 13.11 CONSTRUCTION OF AGREEMENT. A reference to an Article, Section or an Exhibit shall mean an Article of, a Section in, or Exhibit to, this Agreement unless otherwise explicitly set forth. The titles and headings herein are for reference purposes only and shall not in any manner limit the construction of this Agreement which shall be considered as a whole. The words "include," and "including" when used herein shall be deemed in each case to be followed by the words "without limitation." No Party shall be deemed to have prepared this Agreement for purpose of aiding in the construction thereof. SECTION 13.12 COUNTERPARTS. This Agreement may be executed in any number of counterparts, each of which shall be an original as against any Party whose signature appears thereon and all of which together shall constitute one and the same instrument. This Agreement shall become binding when one or more counterparts hereof, individually or taken together, shall bear the signatures of all the Parties reflected hereon as signatories. SECTION 13.13 SHAREHOLDER KNOWLEDGE. THE SHAREHOLDERS ACKNOWLEDGE THAT THEY (a) HAVE KNOWLEDGE AND EXPERIENCE IN BUSINESS AND FINANCIAL MATTERS THAT ENABLE THEM TO EVALUATE THE MERITS AND RISKS OF ENTERING INTO THIS AGREEMENT, (b) HAVE READ AND UNDERSTAND THE PROVISIONS HEREOF, (c) ARE NOT IN A DISPARATE BARGAINING POSITION, AND (d) HAVE BEEN REPRESENTED BY, OR HAVE HAD THE OPPORTUNITY TO BE REPRESENTED BY, LEGAL COUNSEL IN CONNECTION WITH THE NEGOTIATION 44 49 AND EXECUTION OF THIS AGREEMENT. THE SHAREHOLDERS EACH FURTHER ACKNOWLEDGE AND AGREE THAT IN EXECUTING THIS AGREEMENT, NO PROMISE OR AGREEMENT WHICH IS NOT HEREIN EXPRESSED HAS BEEN MADE TO SUCH SHAREHOLDER AND SUCH SHAREHOLDER HAS NOT RELIED UPON ANY STATEMENT OR REPRESENTATION PERTAINING TO THE SUBJECT MATTER HEREOF MADE BY HCC, OR ANY OTHER PARTY. THE SHAREHOLDERS FURTHER ACKNOWLEDGE THAT THEY UNDERSTAND THAT THE LAW FIRM OF EPSTEIN BECKER & GREEN, P.C. DOES NOT REPRESENT THEIR INDIVIDUAL INTERESTS AND REPRESENTS ONLY SCC AND THE SHAREHOLDERS GENERALLY. THE SHAREHOLDERS AGREE THAT TO THE EXTENT REQUIRED BY APPLICABLE LAW TO BE EFFECTIVE, THIS PARAGRAPH CONSTITUTES A CONSPICUOUS NOTICE. [REMAINDER OF PAGE INTENTIONALLY LEFT BLANK] 50 IN WITNESS WHEREOF, the Parties hereto have executed this Agreement effective as of the date first above written. PURCHASERS: HCC INSURANCE HOLDINGS, INC. By: /s/ FRANK J. BRAMANTI --------------------------------------- Name: Frank J. Bramanti, Title: Executive Vice President HCC EMPLOYEE BENEFITS, INC. By: /s/ FRANK J. BRAMANTI --------------------------------------- Name: Frank J. Bramanti, Title: Executive Vice President SHAREHOLDERS: /s/ JAMES SCOTT SCHANEN - ------------------------------------------ JAMES SCOTT SCHANEN /s/ LISA RAE SCHANEN - ------------------------------------------ LISA RAE SCHANEN - ------------------------------------------ CONNOR SCHANEN QSST By: /s/ LISA RAE SCHANEN -------------------------------------- Trustee - ------------------------------------------ AUSTIN SCHANEN QSST By: /s/ LISA RAE SCHANEN -------------------------------------- Trustee /s/ KEVIN TOLBERT - ------------------------------------------ KEVIN TOLBERT (Signature page - Merger Agreement) 51 SCHANEN CONSULTING CORPORATION By: /s/ JAMES SCOTT SCHANEN -------------------------------------------------- Name: James Scott Schanen Title: President (Signature page - Merger Agreement) 52 Exhibit B [Shareholder's Name and Address] [Date] HCC Insurance Holdings, Inc. 13403 Northwest Freeway Houston, Texas 77040-6094 Attention: General Counsel Fax (713) 744-9647 Ladies and Gentlemen: The undersigned proposes to sell an aggregate of ______ shares of the common stock, $1.00 par value per share, (the "Stock") of HCC Insurance Holdings, Inc. (the "Company") through ___________(the "Broker") in accordance with the requirements of Rule 144, as amended ("Rule 144") promulgated under the Securities Act of 1933, as amended (the "Act"). The undersigned hereby requests that the restrictive legends now appearing upon certificates representing the Stock owned beneficially and of record by the undersigned be removed and that the stop transfer instructions to the Company's transfer agent (the "Transfer Agent") with respect to the Stock be rescinded, in accordance with and pursuant to Rule 144. It is understood, however that legends will only be removed and instructions rescinded in order to effect the transfer of Stock already sold in compliance with Rules 144 (the "Sale Shares") and after confirmation of this fact is received from the Broker who has executed my order to sell the Stock. In addition, if required by such Transfer Agent, the undersigned requests that your attorneys provide to the Transfer Agent a written opinion of counsel (the "Opinion"), confirming that the Sale Shares may be transferred without restriction to the purchaser(s) thereof in reliance upon Rule 144 and that any stop transfer instructions with respect to the Sale Shares may be removed. In support of this request and in consideration for the removal of such legends and rescission of such instructions to effect transfers after sales have been made in compliance with Rule 144, and in order to permit your attorneys to render the Opinion, the undersigned hereby represents, warrants and agrees with the Company and your attorneys who furnish the Opinion as follows: 1. Attached hereto is a fully completed and manually signed copy of a Notice of Proposed Sale of Securities Pursuant to Rule 144 ("Form 144") with respect to the sale of the Stock. As set forth on Form 144, the undersigned has been the beneficial owner of the Stock for a period of at least one (1) year prior to the date hereof as computed in accordance with paragraph (d) of Rule 53 144. The Stock was acquired by the undersigned in one or more transactions not involving a public offering. 2. At the time of any sale of the Stock for the undersigned, the aggregate number of shares of the Company's common stock that are restricted securities, as defined in Rule 144(a)(3), sold by the undersigned or for the undersigned's account and by or for the account of any person whose sales are required by paragraph (a)(2) and paragraph (e)(3) of Rule 144, to be aggregated with sales by or for it (other than shares registered under the Act or sold in private placement or Regulation A transactions) will not exceed the amounts permitted under Rule 144(e). 3. The undersigned represents and warrants that the undersigned is not acting in concert with any other person, firm or entity in connection with the sales contemplated herein. 4. The undersigned agrees that the Stock will only be sold in "brokers' transactions" within the meaning of Section 4(4) of the Act and the rules and regulations thereunder and otherwise in compliance with Rule 144. The undersigned has not solicited or arranged for the solicitation of, and will not solicit or arrange for the solicitation of, orders to buy the Stock in anticipation of or in connection with such proposed sale; and such sale or sales shall be made in transactions contemplated by paragraph (f) under Rule 144. The undersigned has no sell orders open in the Stock, or in any security convertible into the Stock with any other broker or bank and will not place any such sell orders pending the completion of this transaction. The undersigned has no present intention of selling any additional securities of the same class as the Stock or any securities convertible into the same class as the Stock. The undersigned has not made, and will not make, any payment in connection with the offering or sale of the Stock to any person, other than the usual and customary broker's commission paid to the Broker in connection therewith. 5. Concurrently with the placing with the Broker of an order to sell the Stock in reliance upon Rule 144, the undersigned will (i) mail or transmit to the Securities and Exchange Commission (the "SEC"), 450 Fifth Street, N.W., Washington, D.C. 20549, three fully completed signed copies of Form 144, one copy of which has been manually signed; (ii) if the Company's securities are admitted to trading on any national securities exchange, the undersigned will transmit one manually signed copy of the Form 144 to the principal exchange on which such securities are admitted to trading; (iii) mail or deliver to the Company and the Broker a manually signed copy of the Form 144 as sent to the SEC; and (iv) if all of the Stock for which the Form 144 is filed are not sold within ninety (90) days thereafter, to mail three copies of an amended and signed Form 144, one copy of which has been manually signed to the SEC, one manually signed copy of the amended Form 144 to any exchange as set forth in subsection (ii) hereof and one manually signed copy of amended Form 144 to the Company and the Broker 2 54 prior to the commencement of further sales, together with such documents evidencing reaffirmation of the warranties contained herein as Company may request. The undersigned represents that the information contained in the Form 144 which will be filed with the SEC with respect to the Stock, whether originally or as amended, will be complete and correct as at the dates thereon. 6. The undersigned represents that the undersigned presently has a bona fide intention of selling the Stock under the terms and conditions of Rule 144 and that the undersigned has no knowledge of any material adverse information in regard to the current and prospective operations of the Company which has not been publicly disclosed. 7. The Company has informed the undersigned that as of the date hereof it (i) 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 (ii) has been subject to the such filing requirements for the past ninety (90) days. The undersigned does not know of have any reason to believe that the Company has not complied with the reporting requirements referred to in Rule 144(c)(1). The IRS identification number and the SEC file number set forth on the attached Form 144 have been supplied by the Company and the Company has informed the undersigned that the number of shares of the Company's common stock shown as outstanding on such Form 144 is the number shown as outstanding by the most recent report or statement published by the Company. Sincerely, [Shareholder Name] 3 EX-10.12 3 h85541ex10-12.txt EMPLMT. AGMT. DATED JAN. 5, 2000- BENJAMIN WILCOX 1 EXHIBIT 10.12 EMPLOYMENT AGREEMENT This EMPLOYMENT AGREEMENT ("Agreement") is entered into as of the 5th day of January, 2000 (the "Effective Date"), between HOUSTON CASUALTY COMPANY ("HC" or "Company"), and BENJAMIN D. WILCOX ("Executive"), sometimes collectively referred to herein as the "Parties." RECITALS: WHEREAS, Executive is to be employed as President of and Chief Executive Officer of HC and Senior Vice President of HCC Insurance Holdings, Inc. ("HCC"); WHEREAS, it is the desire of the Boards of Directors of HC (the "Board") and HCC to (i) directly engage Executive as an officer of HC and its subsidiaries; and (ii) directly engage, if elected, the services of Executive as a director of HC and its subsidiaries; WHEREAS, Executive is desirous of committing himself to serve HC and HCC on the terms herein provided; and WHEREAS, Executive and HC have previously entered into an Employment Agreement effective as of December 7, 1998 (the "1998 Contract") which is to be cancelled, terminated and of no further force or effect. NOW, THEREFORE, in consideration of the foregoing and of the respective covenants and agreements set forth below, the Parties agree as follows: 1. TERMINATION OF 1998 CONTRACT AND TERM. Effective as of the Effective Date, the 1998 Contract shall be cancelled, terminated and of no further force or effect. The Company hereby agrees to elect Executive as its President and Chief Executive Officer and HCC hereby agrees to employ Executive as a Senior Vice President, and Executive hereby agrees to accept such employment, on the terms and conditions set forth herein, for the period commencing on the Effective Date and expiring as of 11:59 p.m. on December 31, 2002 (the "Basic Term") (unless sooner terminated as hereinafter set forth). 2. DUTIES. (a) DUTIES AS EMPLOYEE OF THE COMPANY. Executive shall, subject to the supervision of the Chairman of the Board and President of HCC, have general management and control of HC, and its subsidiaries in the ordinary course of its business with all such powers with respect to such management and control as may be reasonably incident to such responsibilities. During normal business hours, Executive shall devote his full time and attention to diligently attending to the business of the Company during the Basic Term. During the Basic Term, Executive shall not directly or indirectly render any services of a business, commercial, or professional nature to any other person, firm, corporation, or organization, whether for compensation or otherwise, 2 without the prior written consent of the Chairman of the Board. However, Executive shall have the right to engage in such activities as may be appropriate in order to manage his personal investments so long as such activities do not materially interfere or conflict with the performance of his duties to the Company hereunder. The conduct of such activity shall not be deemed to materially interfere or conflict with Executive's performance of his duties until Executive has been notified in writing thereof and given a reasonable period in which to cure the same. (b) OTHER DUTIES. Executive agrees to serve on the Senior Management Committee of HCC and as a Director of HC and its subsidiaries, provided Executive is indemnified for serving in any and all such capacities in a manner acceptable to the Company and Executive. If elected, Executive agrees that he shall not be entitled to receive any additional compensation for serving as a director other than the compensation to be paid to Executive by the Company pursuant to this Agreement. 3. COMPENSATION AND RELATED MATTERS. (a) BASE SALARY. From the Effective Date until December 31, 2000, Executive shall receive a base salary equal to $315,000, payable not less frequently than in substantially equal monthly installments. The base salary shall be increased by $15,000 on each of January 1, 2001 and 2002. For purposes of this Agreement, "Base Salary" shall mean the Executive's initial base salary and, when increased, the increased base salary. (b) BONUS PAYMENTS. Each year Executive shall be entitled to receive, in addition to the Base Salary, an annual bonus payment effective as of December 7, 2000, at the sole discretion of the Compensation Committee of HCC, but not less than $50,000 per year. (c) STOCK OPTIONS. In addition to the options previously provided to Executive to purchase 100,000 shares of HCC Common Stock at a price per share equal to $16-15/16, the terms of which shall remain in effect, Executive shall be provided additional stock options pursuant to the terms set forth on Exhibit A attached hereto. (d) EXPENSES. During the Basic Term, Executive shall be entitled to receive prompt reimbursement for all reasonable expenses incurred by him in accordance with the policies and procedures established by the Compensation Committee for the Company's senior executive officers in performing services hereunder, provided that Executive properly accounts therefor in accordance with Company policy. (e) OTHER BENEFITS. Executive shall be entitled to participate in or receive benefits under any compensatory employee benefit plan or other arrangement made available by the Company now or in the future to its senior executive officers and key management employees, subject to and on a basis consistent with the terms, conditions, and overall administration of such plan or arrangement. Nothing paid to Executive under any plan or arrangement presently in effect or made available in the future shall be deemed to be in lieu of the Base Salary payable to Executive 2 3 pursuant to Paragraph (a) of this Section. The Company shall not make any changes in any employee benefit plans or other arrangements in effect on the date hereof or subsequently in effect in which Executive currently or in the future participates (including, without limitation, each pension and retirement plan, supplemental pension and retirement plan, savings and profit sharing plan, stock or unit ownership plan, stock or unit purchase plan, stock or unit option plan, life insurance plan, medical insurance plan, disability plan, dental plan, health and accident plan, or any other similar plan or arrangement) that would adversely affect Executive's rights or benefits thereunder, unless such change occurs pursuant to a program applicable to substantially all executives of the Company and does not result in a proportionately greater reduction in the rights of or benefits to Executive as compared with any other executive of the Company. (f) VACATIONS. Executive shall be entitled to twenty (20) paid vacation days per year during the Basic Term. There shall be no carryover of unused vacation from year to year. For purposes of this Paragraph, weekends shall not count as vacation days, and Executive shall also be entitled to all paid holidays and personal days given by the Company to its senior executive officers. (g) PERQUISITES. Executive shall be entitled to receive the perquisites and fringe benefits appertaining to an executive officer of HC in accordance with any practice established by the Compensation Committee. Notwithstanding, and in addition to, any perquisites to which Executive is entitled pursuant to the preceding sentence, Executive shall: (i) have a car allowance of $1,250 per month; (ii) be allowed to travel on business utilizing first class domestic passage and business class international passage (and, upon approval of the Chief Executive Officer, will be entitled to travel with Executive's spouse); (iii) receive annual country club dues at the Lochinvar Golf and the Bayou Clubs; and (iv) receive a total of $1,000,000 life insurance (either term or "split dollar" in HC's discretion), which shall be in addition to the standard benefits provided to the Executive under the Company's or HCC's group life insurance programs that covers officers. (h) PRORATION. Any payments or benefits payable to Executive hereunder in respect of any calendar year during which Executive is employed by the Company for less than the entire year, unless otherwise provided in the applicable plan or arrangement, shall be prorated in accordance with the number of days in such calendar year during which he is so employed. Notwithstanding the foregoing, any payments pursuant to Paragraphs 4(c) or 4(d) of this Agreement shall not be subject to proration. 4. TERMINATION. (a) DEFINITIONS. (1) "CAUSE" shall mean: (i) Material dishonesty which is not the result of an inadvertent or innocent mistake of Executive with respect to the Company or any of its subsidiaries; 3 4 (ii) Willful misfeasance or nonfeasance of duty by Executive intended to injure or having the effect of injuring in some material fashion the reputation, business, or business relationships of the Company or any of its subsidiaries or any of their respective officers, directors, or employees; (iii) Material violation by Executive of any material term of this Agreement; or (iv) Conviction of Executive of any felony, any crime involving moral turpitude or any crime other than a vehicular offense which could reflect in some material fashion unfavorably upon the Company or any of its subsidiaries. Executive may not be terminated for Cause unless and until there has been delivered to Executive written notice from the Board supplying the particulars of Executive's acts or omissions that the Board believes constitute Cause, a reasonable period of time (not less than 30 days) has been given to Executive after such notice to either cure the same or to meet with the Board, with his attorney if so desired by Executive, and following which the Board by action of not less than two-thirds of its members furnishes to Executive a written resolution specifying in detail its findings that Executive has been terminated for Cause as of the date set forth in the notice to Executive. (2) A "CHANGE OF CONTROL" shall be deemed to have occurred if: (i) Any "person" or "group" (within the meaning of Sections 13(d) and 14(d)(2) of the Securities Exchange Act of 1934) other than a trustee or other fiduciary holding securities under an employee benefit plan of the Company becomes the "beneficial owner" (as defined in Rule 13d-3 under the Securities Exchange Act of 1934), directly or indirectly, of 50% or more of the Company's then outstanding voting common stock; or (ii) At any time during the period of three (3) consecutive years (not including any period prior to the date hereof), individuals who at the beginning of such period constituted the Board (and any new director whose election by the Board or whose nomination for election by the Company's shareholders were approved by a vote of at least two-thirds of the directors then still in office who either were directors at the beginning of such period or whose election or nomination for election was previously so approved) cease for any reason to constitute a majority thereof; or (iii) The shareholders of the Company approve a merger or consolidation of the Company with any other corporation, other than a merger or consolidation (a) in which a majority of the directors of the surviving entity were directors of the Company prior to such consolidation or merger, and (b) which would result in the voting securities of the 4 5 Company outstanding immediately prior thereto continuing to represent (either by remaining outstanding or by being changed into voting securities of the surviving entity) more than 50% of the combined voting power of the voting securities of the surviving entity outstanding immediately after such merger or consolidation; or (iv) The shareholders approve a plan of complete liquidation of the Company or an agreement for the sale or disposition by the Company of all or substantially all of the Company's assets. (3) A "DISABILITY" shall mean the absence of Executive from Executive's duties with the Company on a full-time basis for 180 consecutive days, or 180 days in a 365-day period, as a result of incapacity due to mental or physical illness which results in the Executive being unable to perform the essential functions of his position, with or without reasonable accommodation. (4) A "GOOD REASON" shall mean any of the following (without Executive's express written consent): (i) Following a Change of Control, a material alteration in the nature or status of Executive's title, duties or responsibilities, or the assignment of duties or responsibilities inconsistent with Executive's status, title, duties and responsibilities; (ii) A failure by the Company to continue in effect any employee benefit plan in which Executive was participating, or the taking of any action by the Company that would adversely affect Executive's participation in, or materially reduce Executive's benefits under, any such employee benefit plan, unless such failure or such taking of any action adversely affects the senior members of corporate management of the Company generally to the same extent; (iii) A relocation of the Company's principal executive offices, or Executive's relocation to any place other than the principal executive offices, exceeding a distance of fifty (50) miles from the Company's current executive office located in Houston, Texas, except for reasonably required travel by Executive on the Company's business; (iv) Any material breach by the Company of any provision of this Agreement; or (v) Any failure by the Company to obtain the assumption and performance of this Agreement by any successor (by merger, consolidation, or otherwise) or assign of the Company. However, Good Reason shall exist with respect to an above specified matter only if such matter is not corrected by the Company within thirty (30) days of its receipt of written notice of such matter from Executive, and in no event shall a termination by Executive occurring more than one hundred eighty (180) days following the date of the event described above be a termination for Good Reason due to such event. 5 6 (5) "TERMINATION DATE" shall mean the date Executive is terminated for any reason pursuant to this Agreement. (b) TERMINATION WITHOUT CAUSE OR TERMINATION FOR GOOD REASON: BENEFITS. In the event there is a termination by the Company without Cause, or if Executive terminates for Good Reason (a "Termination Event"), this Agreement shall terminate, except as provided in Paragraph 6, and Executive shall be entitled to the following severance benefits: (1) For a period of twelve (12) months after the Termination Date (unless the remainder of the Basic Term is less than twelve (12) months in which case, for an amount of time equal to the remainder of the Basic Term), Base Salary (as defined in Paragraph 3(a)), at the rate, and payable quarterly unless such termination is by the Company without Cause, in which event such amount of Base Salary shall be paid in a lump sum within ten (10) days of the Termination Event. (2) If there is a Change of Control or a Termination Event, any stock options ("Stock Awards") which Executive has received under this Agreement shall vest immediately; and if there is a Termination Event all such Stock Awards shall be exercisable for one (1) year from the date of such Termination Event or the remainder of their term, whichever is less. (3) To the extent not theretofore paid or provided, the Company shall timely pay or provide to Executive any other amounts or benefits required to be paid or provided or which Executive is eligible to receive under any plan, program, policy or practice, or contract or agreement of the Company and its affiliated companies for the period of time equal to the remainder of the Basic Term (such other amounts and benefits shall be hereinafter referred to as the "Other Benefits"). Without limiting the preceding sentence or any other provision of this Agreement, through December 31, 2003 the Company, at its sole expense, shall continue to provide (through its own plan and/or individual policies) Executive (and Executive's dependents) with health benefits no less favorable than the group health plan benefits provided during such period to any senior executive officer of the Company or any affiliated company (to the extent any such coverage or benefits are taxable to Executive by reason of being provided under a self-insured health plan of the Company or an affiliate, the Company shall make Executive "whole" for the same on an after-tax basis). In any event, the Other Benefits provided for pursuant to this Paragraph shall be secondary to any benefits and coverage Executive (or his dependents) receive from another employer. (4) If Executive receives any payments whether or not pursuant to this Agreement which are subject to an excise tax imposed under Section 4999 of the Internal Revenue Code of 1986, as amended, or any similar tax imposed under federal, state, or local law (collectively, "Excise Taxes"), the Company shall pay to Executive (on or before the date 6 7 on which the Company is required to withhold such Excise Taxes), 1) an additional amount equal to all Excise Taxes then due and payable, and 2) the amount necessary to defray Executive's increased (federal, state, and local) tax liability arising due to payment of the amount specified in this Subsection (4) which shall include any costs and expenses, including penalties and interest incurred by Executive in connection with any audit, proceedings, etc. related to the payment of such Excise Taxes or this payment. For purposes of calculating the amount payable to Executive under this Paragraph, the federal and state income tax rates used shall be the highest marginal federal and state rates applicable to ordinary income in Executive's state of residence, taking into account any federal income tax deductions or credits available to Executive for state income taxes. The Company shall cause its independent auditors to calculate such amount and provide Executive a copy of such calculation at least ten (10) days prior to the date specified above for payment of such amount. It is the intent of the Parties that this Subsection (4) shall place Executive in the same net after-tax position Executive would have been in had no payment been subject to an Excise Tax and, notwithstanding anything herein to the contrary, it shall be construed to effectuate said result. (5) All accrued compensation and unreimbursed expenses through the Termination Date. Such amounts shall be paid to Executive in a lump sum in cash within thirty (30) days after the Termination Date; and (6) Executive shall be free to accept other employment during such period, and there shall be no offset of any employment compensation earned by Executive in such other employment during such period against payments due Executive under this Paragraph (4), and there shall be no offset in any compensation received from such other employment against the Base Salary set forth above. (c) TERMINATION IN EVENT OF DEATH: BENEFITS. If Executive's employment is terminated by reason of Executive's death during the Basic Term, this Agreement shall terminate, except as provided in Paragraph 6, without further obligation to Executive's legal representatives under this Agreement, other than for payment of all accrued compensation, unreimbursed expenses, the timely payment or provision of Other Benefits through the date of death, and, if such death occurs on or after October 1 of any year, such cash bonus as Executive would otherwise have been awarded in such year if Executive's death had not occurred. Such amounts shall be paid to Executive's estate or beneficiary, as applicable, in a lump sum in cash within ninety (90) days after the date of death. With respect to the provision of Other Benefits, the term Other Benefits as used in this Paragraph 4(c) shall include, without limitation, and Executive's estate and/or beneficiaries shall be entitled to receive, benefits at least equal to the most favorable benefits provided by the Company to the estates and beneficiaries of other executive level employees of the Company under such plans, programs, practices, and policies relating to death benefits, if any, as in effect with respect to other executives and their beneficiaries at any time during the 120-day period immediately preceding the date of death. Additionally, all Stock Awards for which Executive would have been eligible had he completed the Basic Term (except as set forth in Paragraph 4(b)(2)), shall be 7 8 accelerated, and Executive's estate or beneficiary shall be vested in such Stock Awards as of the date of Executive's termination. Additionally, all Stock Awards shall be vested immediately and shall be exercisable for the greater of one year after the date of such vesting or the remaining term of such option. (d) TERMINATION IN EVENT OF DISABILITY: BENEFITS. If Executive's employment is terminated by reason of Executive's Disability during the Basic Term, this Agreement shall continue in full force for a period of one (1) year following such Disability and if such Disability occurs on or after October 1 of any year Executive shall be entitled to the same cash or stock bonus in such year that Executive would have been awarded if such Disability had not occurred. Following such one (1) year period, this Agreement shall continue in full force except that (a) the Base Salary shall be reduced by 50% and (b) Executive shall not be entitled to any subsequent cash bonuses. In addition, all outstanding Stock Awards shall vest immediately upon such termination due to Disability. If Executive's Disability occurs prior to the commencement of the Consulting Period, defined below, in addition to the amounts provided for herein, Executive shall receive the Consulting Fee, defined below, at such time as it would have otherwise been earned, whether or not Executive can perform Consulting Services, defined below. Additionally, all Stock Awards shall be vested immediately and shall be exercisable for the greater of one year after the date of such vesting or the remaining term of such option. (e) VOLUNTARY TERMINATION BY EMPLOYEE AND TERMINATION FOR CAUSE: BENEFITS. Executive may terminate his employment with the Company without Good Reason by giving written notice of his intent and stating an effective Termination Date at least ninety (90) days after the date of such notice; provided, however, that the Company may accelerate such effective date by paying Executive through the proposed Termination Date and also vesting awards that would have vested but for this acceleration of the proposed Termination Date. Upon such a termination by Executive except as provided in Paragraph 6 or upon termination for Cause by the Company, this Agreement shall terminate and the Company shall pay to Executive all accrued compensation, unreimbursed expenses and the Other Benefits through the Termination Date. All unvested options shall be void. Such amounts shall be paid to Executive in a lump sum in cash within thirty (30) days after the date of termination. (f) DIRECTOR POSITIONS. Executive agrees that upon termination of employment, for any reason, at the request of the Chairman of the Board, he will immediately tender his resignation from any and all Board positions held with the Company and/or any of its subsidiaries and affiliates. If Executive remains as a director, after such termination, Executive shall be compensated as an outside director. 5. NON-COMPETITION, NON-SOLICITATION, AND CONFIDENTIALITY. Executive recognizes and agrees that the benefit of not being employed at-will, is provided in consideration for, among other things, the agreements contained in this Section, as well as the Stock Awards granted to Executive pursuant to this Agreement. The Company agrees that while employed pursuant to this Agreement, Executive will be provided with confidential information of Company; specialized 8 9 training on how to perform his duties; and contact with the Company's customers and potential customers. Furthermore, in the event Executive is terminated without Cause, or terminates for Good Reason, and more than one (1) year remains on the existing Basic Term, then Executive shall receive additional consideration in an amount equal to the quotient of the Base Salary divided by 12, which shall thereupon be multiplied by the number of months remaining in the Basic Term minus 12 months and which shall be paid in one lump sum within ten (10) days of such termination. In consideration of all of the foregoing, Executive agrees as follows: (a) NON-COMPETITION DURING EMPLOYMENT. Executive agrees during the Basic Term he will not compete with the Company by engaging in the conception, design, development, production, marketing, or servicing of any product or service that is substantially similar to the products or services which the Company provides, and that he will not work for, in any capacity, assist, or become affiliated with as an owner, partner, etc., either directly or indirectly, any individual or business which offers or performs services, or offers or provides products substantially similar to the services and products provided by Company. (b) CONFLICTS OF INTEREST. Executive agrees that during the Basic Term and any Consulting Period, he will not engage, either directly or indirectly, in any activity (a "Conflict of Interest") which might adversely affect the Company or its affiliates, including ownership of a material interest in any supplier, contractor, distributor, subcontractor, customer or other entity with which the Company does business or accepting any material payment, service, loan, gift, trip, entertainment, or other favor from a supplier, contractor, distributor, subcontractor, customer or other entity with which the Company does business, and that Executive will promptly inform the Chairman of the Company as to each offer received by Executive to engage in any such activity. Executive further agrees to disclose to the Company any other facts of which Executive becomes aware which might in Executive's good faith judgment reasonably be expected to involve or give rise to a Conflict of Interest or potential Conflict of Interest. (c) NON-COMPETITION AFTER TERMINATION. Executive agrees that Executive shall not, at any time during the period of two (2) years after the later of the termination of the Basic Term or the Consulting Period, for any reason, within any of the markets in which the Company has sold products or services or formulated a plan to sell products or services into a market during the last twelve (12) months of Executive's employ or which the Company enters into within three (3) months thereafter, engage in or contribute Executive's knowledge to any work which is competitive with or similar to a product, process, apparatus, service, or development on which Executive worked or with respect to which Executive had access to Confidential Information while employed by the Company; provided, however, this Paragraph 9 10 (c) shall not operate to prevent Executive from engaging in retail insurance activities during such two-year period to the extent such activities do not compete or permit any other person or entity to compete with any business the Company or any of its subsidiaries or affiliated companies were engaged in at the time of such termination or which the Company enters into within three (3) months thereafter. Following the expiration of said two (2) year period, Executive shall continue to be obligated under the Confidential Information Paragraph of this Agreement not to use or to disclose Confidential Information of the Company so long as it shall not be publicly available. It is understood that the geographical area set forth in this covenant is divisible so that if this clause is invalid or unenforceable in an included geographic area, that area is severable and the clause remains in effect for the remaining included geographic areas in which the clause is valid. (d) NON-SOLICITATION OF CUSTOMERS. Executive further agrees that for a period of two (2) years after the termination of the Basic Term, he will not solicit or accept any business from any customer or client or prospective customer or client with whom Executive dealt or solicited while employed by Company during the last twelve (12) months of his employment. (e) NON-SOLICITATION OF EMPLOYEES. Executive agrees that for the duration of the Basic Term, and for a period of two (2) years after the termination of the Basic Term, he will not either directly or indirectly, on his own behalf or on behalf of others, solicit, attempt to hire, or hire any person employed by Company to work for Executive or for another entity, firm, corporation, or individual. (f) CONFIDENTIAL INFORMATION. Executive further agrees that he will not, except as the Company may otherwise consent or direct in writing, reveal or disclose, sell, use, lecture upon, publish or otherwise disclose to any third party any Confidential Information or proprietary information of the Company, or authorize anyone else to do these things at any time either during or subsequent to his employment with the Company. This Section shall continue in full force and effect after termination of Executive's employment and after the termination of this Agreement. Executive's obligations under this Paragraph with respect to any specific Confidential Information and proprietary information shall cease when that specific portion of the Confidential Information and proprietary information becomes publicly known, in its entirety and without combining portions of such information obtained separately. It is understood that such Confidential Information and proprietary information of the Company include matters that Executive conceives or develops, as well as matters Executive learns from other employees of Company. Confidential Information is defined to include information: (1) disclosed to or known by the Executive as a consequence of or through his employment with the Company; (2) not generally known outside the Company; and (3) which relates to any aspect of the Company or its business, finances, operation plans, budgets, research, or strategic development. "Confidential Information" includes, but is not limited to the Company's trade secrets, proprietary information, financial documents, long range plans, customer lists, employer compensation, marketing strategy, data bases, costing data, computer software developed by the Company, investments made by the Company, and any information provided to the Company by a third party under restrictions against disclosure or use by the Company or others. (g) RETURN OF DOCUMENTS, EQUIPMENT, ETC. All writings, records, and other documents and things comprising, containing, describing, discussing, explaining, or evidencing any Confidential Information, and all equipment, components, parts, tools, and the like in Executive's custody or possession that have been obtained or prepared in the course of Executive's employment with the Company shall be the exclusive property of the Company, shall not be copied and/or 10 11 removed from the premises of the Company, except in pursuit of the business of the Company, and shall be delivered to the Company, without Executive retaining any copies, upon notification of the termination of Executive's employment or at any other time requested by the Company. The Company shall have the right to retain, access, and inspect all property of Executive of any kind in the office, work area, and on the premises of the Company upon termination of Executive's employment and at any time during employment by the Company to ensure compliance with the terms of this Agreement. (h) REAFFIRM OBLIGATIONS. Upon termination of his employment with the Company, Executive, if requested by Company, shall reaffirm in writing Executive's recognition of the importance of maintaining the confidentiality of the Company's Confidential Information and proprietary information, and reaffirm any other obligations set forth in this Agreement. (i) PRIOR DISCLOSURE. Executive represents and warrants that he has not used or disclosed any Confidential Information he may have obtained from Company prior to signing this Agreement, in any way inconsistent with the provisions of this Agreement. (j) CONFIDENTIAL INFORMATION OF PRIOR COMPANIES. Executive will not disclose or use during the period of his employment with the Company any proprietary or Confidential Information or Copyright Works which Executive may have acquired because of employment with an employer other than the Company or acquired from any other third party, whether such information is in Executive's memory or embodied in a writing or other physical form. (k) BREACH. Executive agrees that any breach of Paragraphs 5(a), (c), (d), (e) or (f) above cannot be remedied solely by money damages, and that in addition to any other remedies Company may have, Company is entitled to obtain injunctive relief against Executive. Nothing herein, however, shall be construed as limiting Company's right to pursue any other available remedy at law or in equity, including recovery of damages and termination of this Agreement and/or any payments that may be due pursuant to this Agreement. (l) RIGHT TO ENTER AGREEMENT. Executive represents and covenants to Company that he has full power and authority to enter into this Agreement and that the execution of this Agreement will not breach or constitute a default of any other agreement or contract to which he is a party or by which he is bound. (m) EXTENSION OF POST-EMPLOYMENT RESTRICTIONS. In the event Executive breaches Paragraphs 5(b), (d), or (e) above, the restrictive time periods contained in those provisions will be extended by the period of time Executive was in violation of such provisions. (n) ENFORCEABILITY. The agreements contained in Section 5 are independent of the other agreements contained herein. Accordingly, failure of the Company to comply with any of its obligations outside of this Paragraph do not excuse Executive from complying with the agreements contained herein. 11 12 (o) SURVIVABILITY. The agreements contained in Paragraphs 5(c)-(g) shall survive the termination of this Agreement for any reason. 6. CONSULTING AGREEMENT. Effective upon Executive's termination of employment for any reason other than Executive's termination prior to the end of the Basic Term by the Company for Cause, HC hereby retains Executive as a consultant (an independent contractor and not as an employee) for a period of three (3) years (the "Consulting Period"). Termination of the Basic Term shall not effect the Parties' rights and obligations under this Paragraph 6. Subject to the following, Executive agrees to provide, if requested, a minimum of 166 hours of service per year, or, as requested by the Company, up to a total of 500 hours during any one year of the Consulting Period; provided, however, that the total number of hours to be worked over the duration of the Consulting Period shall not exceed 500 hours (the "Consulting Services"). The Consulting Services to be provided shall be commensurate with Executive's training, background, experience and prior duties with the Company. Executive agrees to make himself reasonably available to provide such Consulting Services during the Consulting Period; provided, however, the Company agrees that it shall provide reasonable advance notice to Executive of its expected consulting needs and any request for Consulting Services hereunder shall not unreasonably interfere with Executive's other business activities and personal affairs as determined in good faith by Executive. In addition, Executive shall not be required to perform any requested Consulting Services which, in Executive's good faith opinion, would cause Executive to breach any fiduciary duty or contractual obligation Executive may have to another employer. Further, during the Consulting Period, Executive shall not be subject to any non-competition provisions except for the two-year period provided for in Paragraph 5(c). Unless waived by Executive, Executive shall not be required to perform Consulting Services for more than four (4) days during any week or for more than eight (8) hours during any day. Executive's travel time shall not constitute hours of Consulting Services for purposes of this Paragraph 6. The Parties contemplate that, when appropriate, the Consulting Services shall be performed at Executive's office, residence or at the Company's executive offices in Houston, Texas and may be performed at such other locations only as they may mutually agree upon. Executive shall be properly reimbursed for all travel and other expenses reasonably incurred by Executive in rendering the Consulting Services. HCC shall pay Executive $200,000 per year (the "Consulting Fee") during the Consulting Period, payable monthly in arrears. Executive may elect to delay payment for services but not the services themselves. Except as set forth below and in Paragraphs 4(c) or 4(d) hereof, if Executive fails to provide the hours requested by the Company in any 24-month period, Executive's rights to receive any further Consulting Fee shall immediately terminate. During the Consulting Period, Executive shall receive no employment benefits from HCC. If Executive dies or becomes Disabled during the Basic Term (or as an employee of the Company following the Basic Term) or during the Consulting Period he (or, on his death, his beneficiary or estate) shall receive or continue to receive as the case may be the Consulting Fee during the remainder of the Consulting Period as if such death or Disability had not occurred. 7. ASSIGNMENT. This Agreement cannot be assigned by Executive. The Company may assign this Agreement only to a successor (whether direct or indirect, by purchase, merger, 12 13 consolidation or otherwise) to all or substantially all of the business and assets of the Company provided such successor expressly agrees in writing reasonably satisfactory to Executive to assume and perform this Agreement in the same manner and to the same extent that the Company would be required to perform it if no such succession and assignment had taken place. Failure of the Company to obtain such written agreement prior to the effectiveness of any such succession shall be a material breach of this Agreement. 8. BINDING AGREEMENT. Executive understands that his obligations under this Agreement are binding upon Executive's heirs, successors, personal representatives, and legal representatives. 9. NOTICES. All notices pursuant to this Agreement shall be in writing and sent certified mail, return receipt requested, addressed as set forth below, or by delivering the same in person to such party, or by transmission by facsimile to the number set forth below. Notice deposited in the United States Mail, mailed in the manner described hereinabove, shall be effective upon deposit. Notice given in any other manner shall be effective only if and when received: If to Executive: Benjamin D. Wilcox 2904 Ferndale Houston, Texas 77009 Fax: (713) 610-1974 If to Company: HCC Insurance Holdings, Inc. 13403 Northwest Freeway Houston, Texas 77040 Fax: (713) 462-2401 with a copy (which shall Arthur S. Berner, Esq. not constitute notice) to: Haynes and Boone, LLP 1000 Louisiana Street, Suite 4300 Houston, Texas 77002-5012 Fax: (713) 236-5652 10. WAIVER. No waiver by either party to this Agreement of any right to enforce any term or condition of this Agreement, or of any breach hereof, shall be deemed a waiver of such right in the future or of any other right or remedy available under this Agreement. 11. SEVERABILITY. If any provision of this Agreement is determined to be void, invalid, unenforceable, or against public policy, such provisions shall be deemed severable from the Agreement, and the remaining provisions of the Agreement will remain unaffected and in full force and effect. 13 14 12. ARBITRATION. In the event any dispute arises out of Executive's employment with or by the Company, or separation/termination therefrom, whether as an employee or as a consultant, which cannot be resolved by the Parties to this Agreement, such dispute shall be submitted to final and binding arbitration. The arbitration shall be conducted in accordance with the National Rules for the Resolution of Employment Disputes of the American Arbitration Association ("AAA"). If the Parties cannot agree on an arbitrator, a list of seven (7) arbitrators will be requested from AAA, and the arbitrator will be selected using alternate strikes with Executive striking first. The cost of the arbitration will be shared equally by Executive and Company ; provided, however, the Company shall promptly reimburse Executive for all costs and expenses incurred in connection with any dispute in an amount up to, but not exceeding 20 percent of Executive's Base Salary (or, if the dispute arises during the Consulting Period, Executive's Base Salary as in effect immediately prior to the beginning of the Consulting Period) unless such termination was for Cause in which event Executive shall not be entitled to reimbursement unless and until it is determined he was terminated other than for Cause. Arbitration of such disputes is mandatory and in lieu of any and all civil causes of action and lawsuits either party may have against the other arising out of Executive's employment with Company, or separation therefrom. Such arbitration shall be held in Houston, Texas. 13. ENTIRE AGREEMENT. The terms and provisions contained herein shall constitute the entire agreement between the parties with respect to Executive's employment with Company during the time period covered by this Agreement. This Agreement replaces and supersedes any and all existing Agreements entered into between Executive and the Company relating generally to the same subject matter, if any, and shall be binding upon Executive's heirs, executors, administrators, or other legal representatives or assigns. 14. MODIFICATION OF AGREEMENT. This Agreement may not be changed or modified or released or discharged or abandoned or otherwise terminated, in whole or in part, except by an instrument in writing signed by the Executive and an officer or other authorized executive of Company. 15. UNDERSTAND AGREEMENT. Executive represents and warrants that he has read and understood each and every provision of this Agreement, and Executive understands that he has the right to obtain advice from legal counsel of choice, if necessary and desired, in order to interpret any and all provisions of this Agreement, and that Executive has freely and voluntarily entered into this Agreement. 16. GOVERNING LAW. This Agreement shall be governed by and construed in accordance with the laws of the State of Texas. 17. JURISDICTION AND VENUE. With respect to any litigation regarding this Agreement, Executive agrees to venue in the state or federal courts in Harris County, Texas, and agrees to waive and does hereby waive any defenses and/or arguments based upon improper venue and/or lack of personal jurisdiction. By entering into this Agreement, Executive agrees to personal jurisdiction in the state and federal courts in Harris County, Texas. 14 15 IN WITNESS WHEREOF, the Parties have executed this Agreement in multiple copies, effective as of the date first written above. EXECUTIVE COMPANY HOUSTON CASUALTY COMPANY /s/ Benjamin D. Wilcox By: /s/ Stephen L Way - ------------------------------ ------------------------------------- BENJAMIN D. WILCOX STEPHEN L. WAY, Chairman of the Board Dated: March 15, 2001 Dated: March 16, 2001 [SIGNATURE PAGE OF WILCOX EMPLOYMENT AGREEMENT] 16 EXHIBIT A STOCK OPTIONS. Executive shall be provided with options to purchase 100,000 shares of HCC Common Stock at a price per share equal to $12.0625, the closing price of HCC's Common Stock on the New York Stock Exchange on January 5, 2000 (the date of grant). Such shares will vest at 33-1/3% per year beginning on December 31, 2000 and 33-1/3% on each of the two December 31sts thereafter. Such options will expire on December 31, 2004 unless Executive is no longer a full-time employee of the Company, in which event such option shall expire on the later of the period otherwise set forth in Executive's Employment Agreement for exercise after termination or December 31, 2003. EX-10.13 4 h85541ex10-13.txt EMPLOYMENT AGREEMENT - FRANK J. BRAMANTI - 1/5/00 1 EXHIBIT 10.13 EMPLOYMENT AGREEMENT This EMPLOYMENT AGREEMENT ("Agreement") is entered into effective as of the 5th day of January, 2000 (the "Effective Date"), between HCC INSURANCE HOLDINGS, INC. ("HCC" or "Company"), and FRANK J. BRAMANTI ("Executive"), sometimes collectively referred to herein as the "Parties." RECITALS: WHEREAS, Executive is to be employed as Executive Vice President of HCC, and as an integral part of its management who participates in the decision-making process relative to short and long-term planning and policy for the Company, will serve on the Company's Executive Management Committee; WHEREAS, it is the desire to the Board of Directors of HCC (the "Board") to (i) directly engage Executive as an officer of HCC and its subsidiaries; and (ii) directly engage, if elected, the services of Executive as a director of HCC and its subsidiaries; WHEREAS, Executive is desirous of committing himself to serve HCC on the terms herein provided; and WHEREAS, Executive and HCC have previously entered into an Employment Agreement effective as of January 1, 1998 (the "1998 Contract") which is to be cancelled, terminated and of no further force or effect. NOW, THEREFORE, in consideration of the foregoing and of the respective covenants and agreements set forth below, the Parties agree as follows: 1. TERMINATION OF 1998 CONTRACT AND TERM. Effective as of the Effective Date, the 1998 Contract shall be cancelled, terminated and of no further force or effect. The Company hereby agrees to employ Executive as an Executive Vice President, and Executive hereby agrees to accept such employment, on the terms and conditions set forth herein, for the period commencing on the Effective Date and expiring as of 11:59 p.m. on December 31, 2002 (the "Basic Term") (unless sooner terminated as hereinafter set forth). 2. DUTIES. (a) DUTIES AS EMPLOYEE OF THE COMPANY. Executive shall, subject to the supervision of the Chief Executive Officer, the President, and the Board, have general management responsibilities in the ordinary course of HCC's business with all such powers with respect to such management as may be reasonably incident to such responsibilities. During normal business hours, Executive shall devote his full time and attention to diligently attending to the business of the Company during the Basic Term. During the Basic Term, Executive shall not directly or indirectly render any services of a business, commercial, or professional nature to any other person, firm, corporation, or organization, whether for compensation or otherwise, without the prior written 2 consent of the Chairman of the Board. However, Executive shall have the right to engage in such activities as may be appropriate in order to manage his personal investments so long as such activities do not interfere or conflict with the performance of his duties to the Company hereunder. The conduct of such activity shall not be deemed to materially interfere or conflict with Executive's performance of his duties until Executive has been notified in writing thereof and given a reasonable period in which to cure the same. (b) OTHER DUTIES. At all times during the Basic Term, the Company shall use its best efforts to cause Executive to be elected a director and to serve on the Executive Committee and Senior Management Committee of HCC. Any such failure to use its best efforts prior to a Change of Control shall be a material breach of this Agreement for purposes of Paragraph (4)(a)(iv). If elected, Executive agrees to serve as a director and on the Executive Committee and Senior Management Committee of HCC and of any of its subsidiaries and in one or more executive offices of any of HCC's subsidiaries, provided Executive is indemnified for serving in any and all such capacities in a manner acceptable to the Company and Executive. If elected, Executive agrees that he shall not be entitled to receive any compensation for serving as a director of HCC or in any capacities of HCC's subsidiaries other than the compensation to be paid to Executive by the Company pursuant to this Agreement.. 3. COMPENSATION AND RELATED MATTERS. (a) BASE SALARY. Executive shall receive a base salary (the "Base Salary") paid by the Company at the annual rate of $350,000, during the period beginning on January 1, 2000, and ending December 31, 2000; $375,000 for the period from January 1, 2001 through December 31, 2001; and $400,000 for the period from January 1, 2002 through December 31, 2002, payable not less frequently than in substantially equal monthly installments. Effective January 1, 2003, Executive's employment shall terminate with the Company and Executive shall become a consultant to the Company for the period beginning on such date and ending on December 31, 2005 (the "Consulting Period"). Executive shall receive an annual consulting fee and be required to perform the hours of consulting services (the "Consulting Services") as follows: during Year 1 of the Consulting Period - $200,000 and 200 annual hours; during Year 2 of the Consulting Period - $150,000 and 150 annual hours; and during Year 3 of the Consulting Period - $100,000 and 100 annual hours. The Consulting Services to be provided shall be commensurate with Executive's training, background, experience and prior duties with the Company. Executive agrees to make himself reasonably available to provide such Consulting Services during the Consulting Period; provided, however, the Company agrees that it shall provide reasonable advance notice to Executive of its expected consulting needs and any request for Consulting Services hereunder shall not unreasonably interfere with Executive's other business activities and personal affairs, as determined in good faith by Executive. In addition, Executive shall not be required to perform any requested Consulting Services which, in Executive's good faith opinion, would cause Executive to breach any fiduciary duty or contractual obligation Executive may have to another employer. Further, during the Consulting Period, Executive shall not be subject to any non-competition provisions except for the two-year period provided for in Paragraph 5(c). Executive's travel time shall constitute hours 2 3 of Consulting Services for purposes of this Paragraph 3(a). The Parties contemplate that, when appropriate, the Consulting Services shall be performed at Executive's office, residence or at the Company's executive offices in Houston, Texas and may be performed at such other locations only as they may mutually agree upon. Executive shall be promptly reimbursed for all travel and other expenses reasonably incurred by Executive in rendering the Consulting Services. Executive's annual consulting fee shall be paid quarterly in advance. In such event, Executive, acting as a consultant, shall be entitled to no further benefits from the Company other than medical insurance as set forth herein. At Executive's election, Executive may terminate his employment and commence the Consulting Period at any earlier time than as set forth herein. In such event, the Consulting Period shall commence on such date and shall terminate on the third anniversary thereof. (b) BONUS PAYMENTS. Executive shall be entitled to receive, in addition to the Base Salary, an annual cash bonus payment in an amount, which may be zero, to be determined at the sole discretion of the Compensation Committee. If Executive elects to become a Consultant, he shall receive no bonus. (c) EXPENSES. During the Basic Term, Executive shall be entitled to receive reimbursement for all reasonable expenses incurred by him in accordance with the policies and procedures established by the Board for the Company's senior executive officers in performing services hereunder, provided that Executive properly accounts therefor in accordance with Company policy. (d) OTHER BENEFITS. Except if Executive elects to become a consultant, as set forth above, Executive shall be entitled to participate in or receive benefits under any compensatory employee benefit plan or other arrangement made available by the Company now or in the future to its senior executive officers and key management employees, subject to and on a basis consistent with the terms, conditions, and overall administration of such plan or arrangement. Nothing paid to Executive under any plan or arrangement presently in effect or made available in the future shall be deemed to be in lieu of the Base Salary payable to Executive pursuant to Paragraph (a) of this Section. The Company shall not make any changes in any employee benefit plans or other arrangements in effect on the date hereof or subsequently in effect in which Executive currently or in the future participates (including, without limitation, each pension and retirement plan, supplemental pension and retirement plan, savings and profit sharing plan, stock or unit ownership plan, stock or unit purchase plan, stock or unit option plan, life insurance plan, medical insurance plan, disability plan, dental plan, health and accident plan, or any other similar plan or arrangement) that would adversely affect Executive's rights or benefits thereunder, unless such change occurs pursuant to a program applicable to substantially all executives of the Company and does not result in a proportionately greater reduction in the rights of or benefits to Executive as compared with any other executive of the Company. (e) VACATIONS. (i) Executive shall be entitled to thirty (30) paid vacation days per year during the Basic Term. There shall be no carryover of unused vacation from year to year. For 3 4 purposes of this Paragraph, weekends shall not count as vacation days, and Executive shall also be entitled to all paid holidays and personal days given by the Company to its senior executive officers. (f) PERQUISITES. During Executive's employment, but not during the Consulting Period, except as specifically set forth herein, Executive shall be entitled to receive the perquisites and fringe benefits appertaining to an executive officer of HCC in accordance with any practice established by the Compensation Committee. Notwithstanding, and in addition to, any perquisites to which Executive is entitled pursuant to the preceding sentence, Executive shall, whether acting as an employee or as a consultant: (i) have use of a new Mercedes 500 SEL automobile, and the Company shall pay all expenses related to Executive's use of such car, including gasoline, insurance, and maintenance, such automobile to be granted to Executive, without cost, on an "as-is" basis at the beginning of the Consulting Period; (ii) be allowed to travel on business utilizing first class passage (whether domestic or international) (such perquisite to be for the Basic Term and the Consulting Period); (iii) be reimbursed for annual club dues for Lakeside Country Club, such membership to be granted to Executive, without cost, at the beginning of the Consulting Period; (iv) receive a total of $1,000,000 term life insurance (which shall be in addition to the standard benefits provided to Executive under the Company's group life insurance program that covers officers); (v) in addition to the other benefits provided in this Agreement, Executive shall be entitled to receive medical insurance as currently provided under the Company's group program, as such group program may be changed from time-to-time in the future, and Executive shall be entitled to continue to be covered by such group program or, if not permitted under the terms of the group program, then the Company shall provide Executive with a medical insurance policy providing substantially similar benefits as to the group program, for the period ending on the date of the later to die of Executive or, if Executive is married on the date of his death, Executive's spouse or the date all of Executive's children complete college (as defined in the Company's group program). Executive shall be entitled to receive the medical benefits defined herein at no cost to the Executive. However, Executive's rights pursuant to this subsection (v) shall be void if Executive is terminated for Cause or if Executive voluntarily terminates his employment except as provided for herein; and (vi) HCC shall pay for Executive's preparation of estate planning and wealth preservation documents during the course of Executive's employment with the Company. Such estate planning and wealth preservation documents may be changed from time-to-time at the Company's cost and expense, pursuant to Executive's change in circumstances. (g) PRORATION. Any payments or benefits payable to Executive hereunder in respect of any calendar year during which Executive is employed by the Company for less than the entire year, unless otherwise provided in the applicable plan or arrangement, shall be prorated in accordance with the number of days in such calendar year during which he is so employed. Notwithstanding the foregoing, any payments pursuant to Paragraphs 4(b)(4), 4(c) or 4(d) of this Agreement shall not be subject to proration. 4 5 4. TERMINATION. (a) DEFINITIONS. (1) "CAUSE" shall mean: (i) Material dishonesty which is not the result of an inadvertent or innocent mistake of Executive with respect to the Company or any of its subsidiaries; (ii) Willful misfeasance or nonfeasance of duty by Executive intended to injure or having the effect of injuring in some material fashion the reputation, business, or business relationships of the Company or any of its subsidiaries or any of their respective officers, directors, or employees; (iii) Material violation by Executive of any material term of this Agreement; or (iv) Conviction of Executive of any felony, any crime involving moral turpitude or any crime other than a vehicular offense which could reflect in some material fashion unfavorably upon the Company or any of its subsidiaries. Executive may not be terminated for Cause unless and until there has been delivered to Executive written notice from the Board supplying the particulars of Executive's acts or omissions that the Board believes constitute Cause, a reasonable period of time (not less than 30 days) has been given to Executive after such notice to either cure the same or to meet with the Board, with his attorney if so desired by Executive, and following which the Board by action of not less than two-thirds of its members furnishes to Executive a written resolution specifying in detail its findings that Executive has been terminated for Cause as of the date set forth in the notice to Executive. (2) A "CHANGE OF CONTROL" shall be deemed to have occurred if: (i) Any "person" or "group" (within the meaning of Sections 13(d) and 14(d)(2) of the Securities Exchange Act of 1934) other than a trustee or other fiduciary holding securities under an employee benefit plan of the Company becomes the "beneficial owner" (as defined in Rule 13d-3 under the Securities Exchange Act of 1934), directly or indirectly, of 50% or more of the Company's then outstanding voting common stock; or (ii) At any time during the period of three (3) consecutive years (not including any period prior to the date hereof), individuals who at the beginning of such period constituted the Board (and any new director whose election by the Board or whose nomination for election by the Company's shareholders were approved by a vote of at least two-thirds of the directors then still in office who either were directors at the beginning of 5 6 such period or whose election or nomination for election was previously so approved) cease for any reason to constitute a majority thereof; or (iii) The shareholders of the Company approve a merger or consolidation of the Company with any other corporation, other than a merger or consolidation (a) in which a majority of the directors of the surviving entity were directors of the Company prior to such consolidation or merger, and (b) which would result in the voting securities of the Company outstanding immediately prior thereto continuing to represent (either by remaining outstanding or by being changed into voting securities of the surviving entity) more than 50% of the combined voting power of the voting securities of the surviving entity outstanding immediately after such merger or consolidation; or (iv) The shareholders approve a plan of complete liquidation of the Company or an agreement for the sale or disposition by the Company of all or substantially all of the Company's assets. (3) A "DISABILITY" shall mean the absence of Executive from Executive's duties with the Company on a full-time basis for 180 consecutive days, or 180 days in a 365-day period, as a result of incapacity due to mental or physical illness which results in the Executive being unable to perform the essential functions of his position, with or without reasonable accommodation. (4) A "GOOD REASON" shall mean any of the following (without Executive's express written consent): (i) Following a Change of Control, a material alteration in the nature or status of Executive's title, duties or responsibilities, or the assignment of duties or responsibilities inconsistent with Executive's status, title, duties and responsibilities; (ii) A failure by the Company to continue in effect any employee benefit plan in which Executive was participating, or the taking of any action by the Company that would adversely affect Executive's participation in, or materially reduce Executive's benefits under, any such employee benefit plan, unless such failure or such taking of any action adversely affects the senior members of corporate management of the Company generally to the same extent; (iii) A relocation of the Company's principal executive offices, or Executive's relocation to any place other than the principal executive offices, exceeding a distance of fifty (50) miles from the Company's current executive office located in Houston, Texas, except for reasonably required travel by Executive on the Company's business; (iv) Any material breach by the Company of any provision of this Agreement; or 6 7 (v) Any failure by the Company to obtain the assumption and performance of this Agreement by any successor (by merger, consolidation, or otherwise) or assign of the Company. However, Good Reason shall exist with respect to an above specified matter only if such matter is not corrected by the Company within thirty (30) days of its receipt of written notice of such matter from Executive, and in no event shall a termination by Executive occurring more than one hundred eighty (180) days following the date of the event described above be a termination for Good Reason due to such event. (5) "TERMINATION DATE" shall mean the date Executive is terminated for any reason pursuant to this Agreement. (b) TERMINATION WITHOUT CAUSE, OR TERMINATION FOR GOOD REASON: BENEFITS. In the event there is a termination by the Company without Cause, or if Executive terminates for Good Reason within one hundred eighty (180) days after a Change of Control (a "Termination Event"), this Agreement shall terminate and Executive shall be entitled to the following severance benefits: (1) For a period of twelve (12) months after the Termination Date (unless the remainder of the Basic Term is less than twelve (12) months, in which case, for an amount of time equal to the remainder of the Basic Term), Base Salary (as defined in Paragraph 3(a)), at the rate and payable quarterly unless such termination is by the Company without Cause, in which event such amount of Base Salary shall be paid in a lump sum within ten (10) days of the Termination Event. (2) If there is a Change of Control or a Termination Event any stock options ("Stock Awards") which Executive has received under this Agreement shall vest immediately, and if there is a Termination Event, all such Stock Awards shall be exercisable for thirty (30) days from the date of such Termination Event or the remainder of their term, whichever is less. (3) To the extent not theretofore paid or provided, the Company shall timely pay or provide to Executive any other amounts or benefits required to be paid or provided or which Executive is eligible to receive under any plan, program, policy or practice, or contract or agreement of the Company and its affiliated companies for the period of time equal to the remainder of the Basic Term (such other amounts and benefits shall be hereinafter referred to as the "Other Benefits"). Without limiting the preceding sentence and without limiting any other provision of this Agreement, through December 31, 2002 the Company, at its sole expense, shall continue to provide (through its own plan and/or individual policies) Executive (and Executive's dependents) with health benefits no less favorable than the group health plan benefits provided during such period to any senior executive officer of the Company or any affiliated company (to the extent any such coverage 7 8 or benefits are taxable to Executive by reason of being provided under a self-insured health plan of the Company or an affiliate, the Company shall make Executive "whole" for the same on an after-tax basis). In any event, the Other Benefits provided for pursuant to this Paragraph shall be secondary to any benefits and coverage Executive (or his dependents) receive from another employer. (4) If any such Termination occurs on or after October 1 of any year, such cash and/or stock bonus that Executive otherwise would have received if such Termination had not taken place. (5) If Executive receives any payments whether or not pursuant to this Agreement which are subject to an excise tax imposed under Section 4999 of the Internal Revenue Code of 1986, as amended, or any similar tax imposed under federal, state, or local law (collectively, "Excise Taxes"), the Company shall pay to Executive (on or before the date on which the Company is required to withhold such Excise Taxes), 1) an additional amount equal to all Excise Taxes then due and payable, and 2) the amount necessary to defray Executive's increased (federal, state, and local) tax liability arising due to payment of the amount specified in this Subsection (5) which shall include any costs and expenses, including penalties and interest incurred by Executive in connection with any audit, proceedings, etc. related to the payment of such Excise Taxes or this payment. For purposes of calculating the amount payable to Executive under this Paragraph, the federal and state income tax rates used shall be the highest marginal federal and state rates applicable to ordinary income in Executive's state of residence, taking into account any federal income tax deductions or credits available to Executive for state income taxes. The Company shall cause its independent auditors to calculate such amount and provide Executive a copy of such calculation at least ten (10) days prior to the date specified above for payment of such amount. It is the intent of the Parties that this Subsection (5) shall place Executive in the same net after-tax position Executive would have been in had no payment been subject to an Excise Tax and, notwithstanding anything herein to the contrary, it shall be construed to effectuate said result. (6) All accrued compensation and unreimbursed expenses through the Termination Date. Such amounts shall be paid to Executive in a lump sum in cash within thirty (30) days after the Termination Date; and (7) Executive shall be free to accept other employment during such period, and there shall be no offset of any employment compensation earned by Executive in such other employment during such period against payments due Executive under this Paragraph (4), and there shall be no offset in any compensation received from such other employment against the Base Salary set forth above. (c) TERMINATION IN EVENT OF DEATH: BENEFITS. If Executive's employment is terminated by reason of Executive's death during the Basic Term, this Agreement shall terminate 8 9 without further obligation to Executive's legal representatives under this Agreement, other than for payment of all accrued compensation, unreimbursed expenses, the timely payment or provision of Other Benefits through the date of death, and, if such death occurs on or after October 1 of any year, such cash or stock bonus as Executive would otherwise have been awarded in such year if Executive's death had not occurred. Such amounts shall be paid to Executive's estate or beneficiary, as applicable, in a lump sum in cash within ninety (90) days after the date of death. With respect to the provision of Other Benefits, the term Other Benefits as used in this Paragraph 4(c) shall include, without limitation, and Executive's estate and/or beneficiaries shall be entitled to receive, benefits at least equal to the most favorable benefits provided by the Company to the estates and beneficiaries of other executive level employees of the Company under such plans, programs, practices, and policies relating to death benefits, if any, as in effect with respect to other executives and their beneficiaries at any time during the 120-day period immediately preceding the date of death. Additionally, all Stock Awards shall be vested immediately and shall be exercisable for the greater of one year after the date of such vesting or the remaining term of such option. (d) TERMINATION IN EVENT OF DISABILITY: BENEFITS. If Executive's employment is terminated by reason of Executive's Disability during the Basic Term, this Agreement shall continue in full force for a period of one (1) year following such Disability and if such Disability occurs on or after October 1 of any year Executive shall be entitled to the same cash or stock bonus in such year that Executive would have been awarded if such Disability had not occurred. Following such one (1) year period, this Agreement shall continue in full force except that (a) the Base Salary shall be reduced by 50% and (b) Executive shall not be entitled to any subsequent cash or stock bonuses. In addition, all outstanding Stock Awards shall vest immediately upon such termination due to Disability. Additionally, all Stock Awards shall be vested immediately and shall be exercisable for the greater of one year after the date of such vesting or the remaining term of such option. (e) VOLUNTARY TERMINATION BY EMPLOYEE AND TERMINATION FOR CAUSE: BENEFITS. Executive may terminate his employment with the Company without Good Reason by giving written notice of his intent and stating an effective Termination Date at least ninety (90) days after the date of such notice; provided, however, that the Company may accelerate such effective date by paying Executive through the proposed Termination Date and also vesting awards that would have vested but for this acceleration of the proposed Termination Date. Upon such a termination by Executive, except as provided in Paragraph 3(a), or upon termination for Cause by the Company, this Agreement shall terminate, and the Company shall pay to Executive all accrued compensation, unreimbursed expenses and the Other Benefits through the Termination Date. Such amounts shall be paid to Executive in a lump sum in cash within thirty (30) days after the date of termination. In addition, all unvested stock options shall terminate and all vested options will terminate thirty (30) days after the Termination Date. (f) DIRECTOR POSITIONS. Executive agrees that upon termination of employment, for any reason, at the request of the Chairman of the Board, Executive will immediately tender his resignation from any and all Board positions held with the Company and/or any of its subsidiaries 9 10 and affiliates. If Executive remains as a director, after such termination, Executive shall be compensated as an outside director. 5. NON-COMPETITION, NON-SOLICITATION, AND CONFIDENTIALITY. Executive recognizes and agrees that the benefit of not being employed at-will, is provided in consideration for, among other things, the agreements contained in this Section as well as the Stock Awards granted to Executive pursuant to this Agreement. The Company agrees that while employed pursuant to this Agreement, Executive will be provided with confidential information of Company; specialized training on how to perform his duties; and contact with the Company's customers and potential customers. Furthermore, in the event Executive is terminated without Cause, or terminates for Good Reason; and more than one (1) year remains on the existing Basic Term, then Executive shall receive additional consideration in an amount equal to the quotient of the Base Salary divided by 12, which shall thereupon be multiplied by the number of months remaining in the Basic Term minus 12 months, and which shall be paid in one lump sum within ten (10) days of such termination. In consideration of all of the foregoing, Executive agrees as follows: (a) NON-COMPETITION DURING EMPLOYMENT. Executive agrees during the Basic Term and the Consulting Period he will not compete with the Company by engaging in the conception, design, development, production, marketing, or servicing of any product or service that is substantially similar to the products or services which the Company provides, and that he will not work for, in any capacity, assist, or become affiliated with as an owner, partner, etc., either directly or indirectly, any individual or business which offers or performs services, or offers or provides products substantially similar to the services and products provided by Company, provided, Executive shall not be prevented from owning no more than 2% of any Company whose stock is publicly traded. (b) CONFLICTS OF INTEREST. Executive agrees that during the Basic Term and the Consulting Period, he will not engage, either directly or indirectly, in any activity (a "Conflict of Interest") which might adversely affect the Company or its affiliates, including ownership of a material interest in any supplier, contractor, distributor, subcontractor, customer or other entity with which the Company does business or accepting any material payment, service, loan, gift, trip, entertainment, or other favor from a supplier, contractor, distributor, subcontractor, customer or other entity with which the Company does business, and that Executive will promptly inform the Chairman of the Company as to each offer received by Executive to engage in any such activity. Executive further agrees to disclose to the Company any other facts of which Executive becomes aware which might in Executive's good faith judgment reasonably be expected to involve or give rise to a Conflict of Interest or potential Conflict of Interest. (c) NON-COMPETITION AFTER TERMINATION. Executive agrees that Executive shall not, at any time during the period of two (2) years after the termination of the later of the Basic Term or the Consulting Period for any reason, within any of the markets in which the Company has sold products or services or formulated a plan to sell products or services into a market during the last 10 11 twelve (12) months of Executive's employ or which the Company enters into within three (3) months thereafter, engage in or contribute Executive's knowledge to any work which is competitive with or similar to a product, process, apparatus, service, or development on which Executive worked or with respect to which Executive had access to Confidential Information while employed by the Company; provided, however, this Paragraph (c) shall not operate to prevent Executive from engaging in retail insurance or re-insurance activities during such two-year period to the extent such activities do not compete or permit any other person or entity to compete with any business the Company or any of its subsidiaries or affiliated companies were engaged in at the time of such termination or which the Company enters into within three (3) months thereafter. Following the expiration of said two (2) year period, Executive shall continue to be obligated under the Confidential Information Paragraph of this Agreement not to use or to disclose Confidential Information of the Company so long as it shall not be publicly available. It is understood that the geographical area set forth in this covenant is divisible so that if this clause is invalid or unenforceable in an included geographic area, that area is severable and the clause remains in effect for the remaining included geographic areas in which the clause is valid. (d) NON-SOLICITATION OF CUSTOMERS. Executive further agrees that for a period of two (2) years after the termination of the Basic Term, he will not solicit or accept any business from any customer or client or prospective customer or client with whom Executive dealt or solicited while employed by Company during the last twelve (12) months of his employment. (e) NON-SOLICITATION OF EMPLOYEES. Executive agrees that for the duration of the Basic Term, and for a period of two (2) years after the termination of the Basic Term, he will not either directly or indirectly, on his own behalf or on behalf of others, solicit, attempt to hire, or hire any person employed by Company to work for Executive or for another entity, firm, corporation, or individual. (f) CONFIDENTIAL INFORMATION. Executive further agrees that he will not, except as the Company may otherwise consent or direct in writing, reveal or disclose, sell, use, lecture upon, publish or otherwise disclose to any third party any Confidential Information or proprietary information of the Company, or authorize anyone else to do these things at any time either during or subsequent to his employment with the Company. This Section shall continue in full force and effect after termination of Executive's employment and after the termination of this Agreement. Executive's obligations under this Paragraph with respect to any specific Confidential Information and proprietary information shall cease when that specific portion of the Confidential Information and proprietary information becomes publicly known, in its entirety and without combining portions of such information obtained separately. It is understood that such Confidential Information and proprietary information of the Company include matters that Executive conceives or develops, as well as matters Executive learns from other employees of Company. Confidential Information is defined to include information: (1) disclosed to or known by the Executive as a consequence of or through his employment with the Company; (2) not generally known outside the Company; and (3) which relates to any aspect of the Company or its business, finances, operation plans, budgets, research, or strategic development. "Confidential Information" includes, but is not limited to the 11 12 Company's trade secrets, proprietary information, financial documents, long range plans, customer lists, employer compensation, marketing strategy, data bases, costing data, computer software developed by the Company, investments made by the Company, and any information provided to the Company by a third party under restrictions against disclosure or use by the Company or others. (g) RETURN OF DOCUMENTS, EQUIPMENT, ETC. All writings, records, and other documents and things comprising, containing, describing, discussing, explaining, or evidencing any Confidential Information, and all equipment, components, parts, tools, and the like in Executive's custody or possession that have been obtained or prepared in the course of Executive's employment with the Company shall be the exclusive property of the Company, shall not be copied and/or removed from the premises of the Company, except in pursuit of the business of the Company, and shall be delivered to the Company, without Executive retaining any copies, upon notification of the termination of Executive's employment or at any other time requested by the Company. The Company shall have the right to retain, access, and inspect all property of Executive of any kind in the office, work area, and on the premises of the Company upon termination of Executive's employment and at any time during employment by the Company to ensure compliance with the terms of this Agreement. (h) REAFFIRM OBLIGATIONS. Upon termination of his employment with the Company, Executive, if requested by Company, shall reaffirm in writing Executive's recognition of the importance of maintaining the confidentiality of the Company's Confidential Information and proprietary information, and reaffirm any other obligations set forth in this Agreement. (i) PRIOR DISCLOSURE. Executive represents and warrants that he has not used or disclosed any Confidential Information he may have obtained from Company prior to signing this Agreement, in any way inconsistent with the provisions of this Agreement. (j) CONFIDENTIAL INFORMATION OF PRIOR COMPANIES. Executive will not disclose or use during the period of his employment with the Company any proprietary or Confidential Information or Copyright Works which Executive may have acquired because of employment with an employer other than the Company or acquired from any other third party, whether such information is in Executive's memory or embodied in a writing or other physical form. (k) BREACH. Executive agrees that any breach of Paragraphs 5(a), (c), (d), (e) or (f) above cannot be remedied solely by money damages, and that in addition to any other remedies Company may have, Company is entitled to obtain injunctive relief against Executive. Nothing herein, however, shall be construed as limiting Company's right to pursue any other available remedy at law or in equity, including recovery of damages and termination of this Agreement and/or any payments that may be due pursuant to this Agreement. (l) RIGHT TO ENTER AGREEMENT. Executive represents and covenants to Company that he has full power and authority to enter into this Agreement and that the execution of this 12 13 Agreement will not breach or constitute a default of any other agreement or contract to which he is a party or by which he is bound. (m) EXTENSION OF POST-EMPLOYMENT RESTRICTIONS. In the event Executive breaches Paragraphs 5(b), (d), or (e) above, the restrictive time periods contained in those provisions will be extended by the period of time Executive was in violation of such provisions. (n) ENFORCEABILITY. The agreements contained in Section 5 are independent of the other agreements contained herein. Accordingly, failure of the Company to comply with any of its obligations outside of this Paragraph do not excuse Executive from complying with the agreements contained herein. (o) SURVIVABILITY. The agreements contained in Paragraphs 5(c)-(g) shall survive the termination of this Agreement for any reason. 6. ASSIGNMENT. This Agreement cannot be assigned by Executive. The Company may assign this Agreement only to a successor (whether direct or indirect, by purchase, merger, consolidation or otherwise) to all or substantially all of the business and assets of the Company provided such successor expressly agrees in writing reasonably satisfactory to Executive to assume and perform this Agreement in the same manner and to the same extent that the Company would be required to perform it if no such succession and assignment had taken place. Failure of the Company to obtain such written agreement prior to the effectiveness of any such succession shall be a material breach of this Agreement. 7. BINDING AGREEMENT. Executive understands that his obligations under this Agreement are binding upon Executive's heirs, successors, personal representatives, and legal representatives. 8. NOTICES. All notices pursuant to this Agreement shall be in writing and sent certified mail, return receipt requested, addressed as set forth below, or by delivering the same in person to such party, or by transmission by facsimile to the number set forth below (which shall not constitute notice). Notice deposited in the United States Mail, mailed in the manner described hereinabove, shall be effective upon deposit. Notice given in any other manner shall be effective only if and when received: If to Executive: Frank J. Bramanti 13707 Cottrell Court Houston, Texas 77077 Fax: (281) 558-5461 13 14 If to Company: HCC Insurance Holdings, Inc. 13403 Northwest Freeway Houston, Texas 77040 Fax: (713) 462-2401 with a copy (which shall Arthur S. Berner, Esq. not constitute notice) to: Haynes and Boone, LLP 1000 Louisiana Street, Suite 4300 Houston, Texas 77002-5012 Fax: (713) 236-5652 9. WAIVER. No waiver by either party to this Agreement of any right to enforce any term or condition of this Agreement, or of any breach hereof, shall be deemed a waiver of such right in the future or of any other right or remedy available under this Agreement. 10. SEVERABILITY. If any provision of this Agreement is determined to be void, invalid, unenforceable, or against public policy, such provisions shall be deemed severable from the Agreement, and the remaining provisions of the Agreement will remain unaffected and in full force and effect. 11. ARBITRATION. In the event any dispute arises out of Executive's employment with or by the Company, or separation/termination therefrom, whether as an employee or as a consultant which cannot be resolved by the Parties to this Agreement, such dispute shall be submitted to final and binding arbitration. The arbitration shall be conducted in accordance with the National Rules for the resolution of Employment Disputes of the American Arbitration Association ("AAA"). If the Parties cannot agree on an arbitrator, a list of seven (7) arbitrators will be requested from AAA, and the arbitrator will be selected using alternate strikes with Executive striking first. The cost of the arbitration will be shared equally by Executive and Company; provided, however, the Company shall promptly reimburse Executive for all costs and expenses incurred in connection with any dispute in an amount up to, but not exceeding twenty percent (20%) of Executive's Base Salary (or, if the dispute arises during the Consulting Period, Executive's Base Salary as in effect immediately prior to the beginning of the Consulting Period) unless such termination was for Cause in which event Executive shall not be entitled to reimbursement unless and until it is determined he was terminated other than for Cause. Arbitration of such disputes is mandatory and in lieu of any and all civil causes of action and lawsuits either party may have against the other arising out of Executive's employment with Company, or separation therefrom. Such arbitration shall be held in Houston, Texas. 12. ENTIRE AGREEMENT. The terms and provisions contained herein shall constitute the entire agreement between the parties with respect to Executive's employment with Company during the time period covered by this Agreement. This Agreement replaces and supersedes any and all existing Agreements entered into between Executive and the Company relating generally to the same 14 15 subject matter, if any, and shall be binding upon Executive's heirs, executors, administrators, or other legal representatives or assigns. 13. MODIFICATION OF AGREEMENT. This Agreement may not be changed or modified or released or discharged or abandoned or otherwise terminated, in whole or in part, except by an instrument in writing signed by the Executive and an officer or other authorized executive of Company. 14. UNDERSTAND AGREEMENT. Executive represents and warrants that he has read and understood each and every provision of this Agreement, and Executive understands that he has the right to obtain advice from legal counsel of choice, if necessary and desired, in order to interpret any and all provisions of this Agreement, and that Executive has freely and voluntarily entered into this Agreement. 15. GOVERNING LAW. This Agreement shall be governed by and construed in accordance with the laws of the State of Texas. 16. JURISDICTION AND VENUE. With respect to any litigation regarding this Agreement, Executive agrees to venue in the state or federal courts in Harris County, Texas, and agrees to waive and does hereby waive any defenses and/or arguments based upon improper venue and/or lack of personal jurisdiction. By entering into this Agreement, Executive agrees to personal jurisdiction in the state and federal courts in Harris County, Texas. [REMAINDER OF THIS PAGE LEFT INTENTIONALLY BLANK] 15 16 IN WITNESS WHEREOF, the Parties have executed this Agreement in multiple copies, effective as of the date first written above. EXECUTIVE COMPANY HCC INSURANCE HOLDINGS, INC. /s/ FRANK J. BRAMANTI By: /s/ STEPHEN L. WAY - ----------------------------------- --------------------------------- FRANK J. BRAMANTI STEPHEN L. WAY, Chief Executive Officer and Chairman of the Board Dated: June 16, 2000 Dated: June 17, 2000 ----------------------------- ------------------------------ [SIGNATURE PAGE OF BRAMANTI EMPLOYMENT AGREEMENT] EX-12 5 h85541ex12.txt STATEMENT REGARDING COMPUTATION OF RATIOS 1 EXHIBIT 12 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES STATEMENT OF RATIOS ================================================================================ FOR THE YEARS ENDED DECEMBER 31, (DOLLARS IN THOUSANDS)
ADJUSTED 2000 1999 (2) 1999 1998 1997 1996 - --------------------------------------------------------------------------------------------------------------------------------- Gross premium to surplus ratio: Gross written premium $972,154 $576,184 $500,962 $346,094 $340,367 Policyholders' surplus 326,249 315,474 369,401 331,922 288,863 Premium to surplus ratio (1) 298.0% 182.6% 135.6% 104.3% 117.8% (Gross premium to surplus ratio = gross written premium divided by policyholders' surplus) Net premium to surplus ratio: Net written premium $283,947 $150,261 $123,315 $143,068 $189,022 Policyholders' surplus 326,249 315,474 369,401 331,922 288,863 Premium to surplus ratio (1) 87.0% 47.6% 33.4% 43.1% 65.4% (Net premium to surplus ratio = net written premium divided by policyholders' surplus) Loss ratio: Incurred loss and LAE $190,272 $119,093 $160,908 $ 95,435 $100,158 $115,521 Net earned premium 267,481 146,850 150,304 142,108 162,626 179,490 Loss ratio (1) 71.1% 81.1% 107.1% 67.2% 61.6% 64.4% (Loss ratio = incurred loss and LAE divided by net earned premium) Expense ratio: Underwriting expense $ 76,548 $ 33,427 $ 34,220 $ 19,417 $ 24,627 $ 36,379 Net written premium 283,947 145,200 150,261 123,315 143,068 189,022 Expense ratio (1) 27.0% 23.0% 22.8% 15.7% 17.2% 19.2% (Expense ratio = underwriting expense divided by net written premium) Combined ratio (1) 98.1% 104.1% 129.9% 82.9% 78.8% 83.6% (Combined ratio = loss ratio plus expense ratio)
(1) Calculated for the Company's insurance company subsidiaries on the basis of statutory accounting principles. (2) Excluding the effects of the provision for reinsurance in 1999. EX-21 6 h85541ex21.txt SUBSIDIARIES OF HCC INSURANCE HOLDINGS, INC. 1 EXHIBIT 21 HCC INSURANCE HOLDINGS, INC. SUBSIDIARIES
STATE OR COUNTRY NAME OF INCORPORATION ---- ---------------- 1. Avemco Corporation Delaware 2. Avemco Services, Inc. Maryland 3. Avemco Insurance Company Maryland 4. Aviation & Marine Premium Acceptance Corporation Texas 5. Centris Insurance Company Indiana 6. Centris Underwriting Agencies, Inc. Indiana 7. Eagles Aerobatic Flight Team, Inc. Wisconsin 8. Eastern Aviation & Marine Underwriters, Inc. Maryland 9. HCC Acquisitions (U.K.) Limited United Kingdom 10. HCC Administrators, Inc. Illinois 11. HCC Aviation Insurance Group, Inc. Texas 12. HCC Benefits Corporation Delaware 13. HCC Employee Benefits, Inc. Delaware 14. HCC Employer Services, Inc. Alabama 15. HCC Employer Services, Inc. Illinois 16. HCC Intermediaries, Inc. Texas 17. HCC Intermediate Holdings, Inc. Delaware 18. HCC Life Insurance Company Indiana 19. HCC Reinsurance Company Limited Bermuda 20. HCC Risk Management, Inc. Indiana 21. HCC Service Company, Ltd. Texas 22. HCC Service Delaware, LLC Delaware 23. HCC Underwriters, a Texas Corporation Texas 24. HCCS Corporation Delaware 25. Houston Casualty Company Texas 26. Interra, Inc. Indiana 27. Interra Reinsurance Group, Inc. Indiana 28. Intellicare, Inc. Alabama 29. LDG Insurance Agency Incorporated Massachusetts 30. LDG Re (London ) Ltd. United Kingdom 31. LDG Re Worldwide Limited Delaware 32. LDG Reinsurance Corporation Massachusetts 33. Loss Management Services, Inc. Maryland 34. Merger Sub, Inc. Texas 35. National Insurance Underwriters Arkansas 36. PEPYS Holdings Limited United Kingdom 37. PEPYS Management Services Limited United Kingdom 38. Rattner Mackenzie Limited United Kingdom 39. Rattner MacKenzie Limited (RML) (Exempted) Co. Jordan 40. SBS Insurance Holdings, a Texas Corporation Texas 41. Select Benefits, Inc. Indiana 42. Signal Aviation Insurance Services, Inc. Nevada 43. Specialty Insurance Underwriters, Inc. Missouri 44. The Centris Group, Inc. Delaware 45. The Schanen Consulting Group, LLC Georgia 46. The Wheatley Group, Ltd. New York 47. USBenefits Insurance Services, Inc. California 48. USF Insurance Company Pennsylvania 49. US Holdings, Inc. Delaware 50. U.S. Specialty Insurance Company Texas 51. Universal Loss Management, Inc. Delaware 52. VASA Brougher, Inc. Indiana 53. VASA Insurance Group, Inc. Indiana 54. VASA North America, Inc. Indiana
EX-23 7 h85541ex23.txt CONSENT OF PRICEWATERHOUSECOOPERS LLP - 3/27/01 1 EXHIBIT 23 CONSENT OF INDEPENDENT ACCOUNTANTS We hereby consent to the incorporation by reference in the registration statements on Form S-8 (Nos. 333-14471, 333-14479, 333-61673, 333-61687, 333-68771 and 333-89905) and Form S-3 (Nos. 333-46432, 333-46432-01, 333-46432-02) of HCC Insurance Holdings, Inc. of our reports which include an emphasis paragraph related to a change in the Company's method of revenue recognition for certain contracts, dated March 21, 2001, relating to the financial statements and financial statement schedules, which appear in HCC Insurance Holdings, Inc.'s Annual Report on Form 10-K for the year ended December 31, 2000. /s/ PricewaterhouseCoopers LLP Houston, Texas March 30, 2001 EX-24 8 h85541ex24.txt POWERS OF ATTORNEY 1 EXHIBIT 24 POWERS OF ATTORNEY 2 POWER OF ATTORNEY Know all men by these presents, that the undersigned constitutes and appoints Stephen L. Way and John N. Molbeck, Jr., and each of them, his true and lawful attorney-in-fact and agent, with full power of substitution and re-substitution, for him and in his name, place and stead, in any and all capacities, to sign this Annual Report on Form 10-K and any and all amendments thereto, and to file same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto such attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that such attorneys-in-fact and agents or any of the, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof. /s/ MARVIN P. BUSH ------------------------- Marvin P. Bush Date: March 19, 2001 3 POWER OF ATTORNEY Know all men by these presents, that the undersigned constitutes and appoints Stephen L. Way and John N. Molbeck, Jr., and each of them, his true and lawful attorney-in-fact and agent, with full power of substitution and re-substitution, for him and in his name, place and stead, in any and all capacities, to sign this Annual Report on Form 10-K and any and all amendments thereto, and to file same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto such attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that such attorneys-in-fact and agents or any of the, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof. /s/ FRANK J. BRAMANTI ------------------------- Frank J. Bramanti Date: March 16, 2001 4 POWER OF ATTORNEY Know all men by these presents, that the undersigned constitutes and appoints Stephen L. Way and. John N. Molbeck, Jr., and each of them, his true and lawful attorney-in-fact and agent, with full power of substitution and re-substitution, for him and in his name, place and stead, in any and all capacities, to sign this Annual Report on Form 10-K and any and all amendments thereto, and to file same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto such attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that such attorneys-in-fact and agents or any of the, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof. /s/ PATRICK B. COLLINS ------------------------- Patrick B. Collins Date: March 20, 2001 5 POWER OF ATTORNEY Know all men by these presents, that the undersigned constitutes and appoints Stephen L. Way and John N. Molbeck, Jr., and each of them, his true and lawful attorney-in-fact and agent, with full power of substitution and re-substitution, for him and in his name, place and stead, in any and all capacities, to sign this Annual Report on Form 10-K and any and all amendments thereto, and to file same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto such attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that such attorneys-in-fact and agents or any of the, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof. /s/ JAMES R. CRANE ------------------------- James R. Crane Date: March 19, 2001 6 POWER OF ATTORNEY Know all men by these presents, that the undersigned constitutes and appoints Stephen L. Way and John N. Molbeck, Jr., and each of them, his true and lawful attorney-in-fact and agent, with full power of substitution and re-substitution, for him and in his name, place and stead, in any and all capacities, to sign this Annual Report on Form 10-K and any and all amendments thereto, and to file same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto such attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that such attorneys-in-fact and agents or any of the, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof. /s/ J. ROBERT DICKERSON ------------------------- J. Robert Dickerson Date: March 20, 2001 7 POWER OF ATTORNEY Know all men by these presents, that the undersigned constitutes and appoints Stephen L. Way and. John N. Molbeck, Jr., and each of them, his true and lawful attorney-in-fact and agent, with full power of substitution and re-substitution, for him and in his name, place and stead, in any and all capacities, to sign this Annual Report on Form 10-K and any and all amendments thereto, and to file same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto such attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that such attorneys-in-fact and agents or any of the, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof. /s/ EDWIN H. FRANK, III ------------------------- Edwin H. Frank, III Date: March 16, 2001 8 POWER OF ATTORNEY Know all men by these presents, that the undersigned constitutes and appoints Stephen L. Way and John N. Molbeck, Jr., and each of them, his true and lawful attorney-in-fact and agent, with full power of substitution and re-substitution, for him and in his name, place and stead, in any and all capacities, to sign this Annual Report on Form 10-K and any and all amendments thereto, and to file same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto such attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that such attorneys-in-fact and agents or any of the, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof. /s/ ALLAN W. FULKERSON ------------------------- Allan W. Fulkerson Date: March 27, 2001 9 POWER OF ATTORNEY Know all men by these presents, that the undersigned constitutes and appoints Stephen L. Way and John N. Molbeck, Jr., and each of them, his true and lawful attorney-in-fact and agent, with full power of substitution and re-substitution, for him and in his name, place and stead, in any and all capacities, to sign this Annual Report on Form 10-K and any and all amendments thereto, and to file same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto such attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that such attorneys-in-fact and agents or any of the, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof. /s/ WALTER J. LACK ------------------------- Walter J. Lack Date: March 21, 2001 10 POWER OF ATTORNEY Know all men by these presents, that the undersigned constitutes and appoints Stephen L. Way and John N. Molbeck, Jr., and each of them, his true and lawful attorney-in-fact and agent, with full power of substitution and re-substitution, for him and in his name, place and stead, in any and all capacities, to sign this Annual Report on Form 10-K and any and all amendments thereto, and to file same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto such attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that such attorneys-in-fact and agents or any of the, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof. /s/ STEPHEN J. LOCKWOOD ------------------------- Stephen J. Lockwood Date: March 16, 2001 -----END PRIVACY-ENHANCED MESSAGE-----