-----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, Nv465IaAySY6S872rE9xeiEHt/SaaAvGfl44JiHVh0yVeDl8WA7qAfnGkEl9wJeN Mtc2F17ElcYR5907v/MiHA== 0001047469-99-013044.txt : 19990402 0001047469-99-013044.hdr.sgml : 19990402 ACCESSION NUMBER: 0001047469-99-013044 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 12 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990331 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-K405 SEC ACT: SEC FILE NUMBER: 001-13790 FILM NUMBER: 99583310 BUSINESS ADDRESS: STREET 1: 13403 NORTHWEST FRWY CITY: HOUSTON STATE: TX ZIP: 77040-6094 BUSINESS PHONE: 7136907300 10-K405 1 10-K405 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K /X/ Annual Report pursuant to Section 13 or 15(d)of the Securities Exchange Act of 1934 (Fee required). / / Transaction report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 (No fee required). For the fiscal year ended _______December 31, 1998_______________________ 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 of (IRS Employer incorporation or organization) Identification No.) 13403 Northwest Freeway, Houston, Texas 77040-6094 - -------------------------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) (713) 690-7300 - -------------------------------------------------------------------------------------------- (Registrant's telephone number, including area code)
Securities registered pursuant to Section 12 (b) of the Act: TITLE OF EACH CLASS NAME OF EACH EXCHANGE OF 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 (Section229.405 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. /X/ The aggregate market value on March 19, 1999, of the voting stock held by non-affiliates of the registrant was approximately $752.9 million. 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 19, 1999 was 48,809,264. 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. TABLE OF CONTENTS HCC INSURANCE HOLDINGS, INC.
PAGE ----- PART I. ITEM 1. Business.......................................................................... 3 ITEM 2. Properties........................................................................ 27 ITEM 3. Legal Proceedings................................................................. 27 ITEM 4. Submission of Matters to a Vote of Security Holders............................... 27 PART II. ITEM 5. Market for the Registrant's Common Equity and Related Stockholder Matters......... 28 ITEM 6. Selected Financial Data........................................................... 29 ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations........................................................................ 31 ITEM 7A. Quantitative and Qualitative Disclosure About Market Risk......................... 42 ITEM 8. Financial Statements and Supplementary Data....................................... 43 ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures....................................................................... 43 PART III. ITEM 10. Directors and Executive Officers of the Registrant................................ 44 ITEM 11. Executive Compensation............................................................ 44 ITEM 12. Security Ownership of Certain Beneficial Owners and Management.................... 44 ITEM 13. Certain Relationships and Related Transactions.................................... 44 PART IV. ITEM 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K................... 45 SIGNATURES.............................................................................................. 46
THIS REPORT ON FORM 10-K (THIS "REPORT") CONTAINS CERTAIN FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933, AS AMENDED, AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED, WHICH ARE INTENDED TO BE COVERED BY THE SAFE HARBORS CREATED THEREBY. INVESTORS ARE CAUTIONED THAT ALL FORWARD-LOOKING STATEMENTS NECESSARILY INVOLVE RISKS AND UNCERTAINTY, INCLUDING, WITHOUT LIMITATION, THE RISK OF A SIGNIFICANT NATURAL DISASTER, THE INABILITY OF THE COMPANY TO REINSURE CERTAIN RISKS, THE ADEQUACY OF ITS LOSS RESERVES, THE FINANCIAL VIABILITY OF REINSURERS, THE EXPANSION OR CONTRACTION IN ITS VARIOUS LINES OF BUSINESS, THE IMPACT OF INFLATION, THE IMPACT OF YEAR 2000 ISSUES, CHANGING LICENSING REQUIREMENTS AND REGULATIONS IN THE UNITED STATES AND IN FOREIGN COUNTRIES, THE ABILITY OF THE COMPANY TO INTEGRATE ITS RECENTLY ACQUIRED BUSINESSES, THE EFFECT OF PENDING OR FUTURE ACQUISITIONS AS WELL AS ACQUISITIONS WHICH HAVE RECENTLY BEEN CONSUMMATED, GENERAL MARKET CONDITIONS, COMPETITION, LICENSING AND PRICING. ALL STATEMENTS, OTHER THAN STATEMENTS OF HISTORICAL FACTS, INCLUDED OR INCORPORATED BY REFERENCE IN THIS REPORT THAT ADDRESS ACTIVITIES, EVENTS OR DEVELOPMENTS THAT THE COMPANY EXPECTS OR ANTICIPATES WILL OR MAY OCCUR IN THE FUTURE, INCLUDING, WITHOUT LIMITATION, SUCH THINGS AS FUTURE CAPITAL EXPENDITURES (INCLUDING THE AMOUNT AND NATURE THEREOF), BUSINESS STRATEGY AND MEASURES TO IMPLEMENT SUCH STRATEGY, COMPETITIVE STRENGTHS, GOALS, EXPANSION AND GROWTH OF THE COMPANY'S BUSINESSES AND OPERATIONS, PLANS, REFERENCES TO FUTURE SUCCESS, AS WELL AS OTHER STATEMENTS WHICH INCLUDES WORDS SUCH AS "ANTICIPATE", "BELIEVE", "PLAN", "ESTIMATE", "EXPECT", AND "INTEND" AND OTHER SIMILAR EXPRESSIONS, CONSTITUTE FORWARD-LOOKING STATEMENTS. ALTHOUGH THE COMPANY BELIEVES THAT THE ASSUMPTIONS UNDERLYING THE FORWARD-LOOKING STATEMENTS CONTAINED HEREIN ARE REASONABLE, ANY OF THE ASSUMPTIONS COULD OVER TIME PROVE TO BE INACCURATE AND THEREFORE, THERE CAN BE NO ASSURANCE THAT THE FORWARD-LOOKING STATEMENTS INCLUDED IN THIS REPORT WILL THEMSELVES PROVE TO BE ACCURATE. IN LIGHT OF THE SIGNIFICANT UNCERTAINTIES INHERENT IN THE FORWARD-LOOKING STATEMENTS INCLUDED HEREIN, THE INCLUSION OF SUCH INFORMATION SHOULD NOT BE REGARDED AS A REPRESENTATION BY THE COMPANY OR ANY OTHER PERSON THAT THE OBJECTIVES AND PLANS OF THE COMPANY WILL BE ACHIEVED. 2 PART I ITEM 1. BUSINESS GENERAL HCC Insurance Holdings, Inc. ("HCC") is a Delaware corporation with principal and executive offices located at 13403 Northwest Freeway, Houston, Texas 77040. HCC and its consolidated subsidiaries are collectively referred to herein as the "Company" unless the context otherwise requires. HCC, through its subsidiaries, provides specialized property and casualty insurance coverages, underwriting agency and intermediary services and other insurance related services both to commercial customers and individuals. The Company's insurance products are underwritten on both a direct and reinsurance basis and are marketed by the Company and through a network of independent and affiliated agents and brokers. The Company's principal insurance company subsidiaries are Houston Casualty Company ("HC") in Houston, Texas, London, England and Amman, Jordan; U.S. Specialty Insurance Company ("USSIC") in Houston, Texas; and Avemco Insurance Company ("AIC") in Frederick, Maryland. The principal underwriting agency subsidiaries are LDG Reinsurance Corporation ("LDG Re") in Wakefield, Massachusetts; HCC Aviation Insurance Group, Inc. ("HCCA") in Dallas, Texas and Glendale, California; HCC Employer Services, Inc. ("HCCES") in Northbrook, Illinois, Dallas, Texas and Montgomery, Alabama; and HCC Benefits Corporation ("HCCB") in Atlanta, Georgia, Wakefield, Massachusetts, Minneapolis, Minnesota and Kansas City, Kansas. The Company's principal intermediary subsidiaries are HCC Intermediaries, Inc. ("HCCI") in Houston, Texas; HCC Employee Benefits, Inc. ("HCCEB") in Houston, Texas; and, effective January 1, 1999, Rattner Mackenzie Limited ("RML") in London, England and Amman, Jordan. Since its founding in 1974, the Company and its predecessor companies have been consistently profitable, generally reporting annual increases in gross written premium ("GWP"), management fees, commission income and total revenue. During the period 1996 through 1998, the Company's insurance company subsidiaries had an average combined ratio of 81.8% versus the less favorable 103.7% recorded by the U.S. property and casualty insurance industry overall (1996-1997). During the same period, the Company's GWP increased from $337.3 million to $498.3 million, an increase of 48%, management fees increased from $28.7 million to $74.0 million an increase of 158%, commission income increased from $21.5 million to $38.4 million, an increase of 79% and net earnings increased from $38.6 million to $72.3 million, an increase of 87%. The Company's insurance companies' underwriting activities are focused on providing aviation, marine, offshore energy, property, medical stop-loss, accident and health, workers' compensation and lenders' single interest insurance and reinsurance on a worldwide basis. As an insurer in the USA, the Company operates on a surplus lines or a non-admitted basis through HC and on an admitted basis through AIC and USSIC. The Company's domestic insurance company subsidiaries are rated "A+" (Superior) by A.M. Best Company ("A.M. Best") and are rated "AA" (Very Strong) by Standard & Poor's Corporation ("S&P"). An A.M. Best or S&P rating is intended to provide an independent opinion of an insurer's ability to meet its obligations to policyholders and should not be considered as an investment recommendation. The Company's underwriting agencies underwrite on behalf of affiliated and non-affiliated insurance companies. These agency operations specialize in domestic general aviation insurance, medical stop-loss coverage for employer sponsored self-insured health plans, occupational accident coverage for self-insured truckers, workers' compensation insurance and a variety of accident and health related insurance and reinsurance products. Beginning in 1996 with the acquisition of LDG Management Company, Incorporated ("LDG"), the Company commenced a strategy of acquiring through merger or purchase, a number of privately held companies whose business was underwriting agency activities, primarily in the medical stop-loss, workers' compensation and domestic general aviation insurance businesses. This was done in an effort to further diversify the Company's operations and to enhance the Company's ability to anticipate 3 and capitalize on opportunities resulting from changing market conditions in the insurance industry. As a result of these acquisitions, the Company's management fees from underwriting agencies have increased to $74.0 million. The Company's underwriting agency operations generated $704.0 million in written premium during 1998. Further acquisitions are likely in the area. Brokerage operations are performed by the Company's intermediary subsidiaries. The Company's intermediary operations consist of marketing, placing, consulting on and servicing insurance risks for its clients, which include insurance companies and other risk taking entities. The Company's intermediary subsidiaries specialize in employee benefits on a retail basis and reinsurance for both accident and health and property and casualty clients. The Company significantly expanded its intermediary operations internally and through acquisition in 1998 and continued this expansion in January, 1999 with the acquisition of PEPYS Holdings Limited ("PEPYS") and its operating subsidiary, RML. Since 1995, the Company's commission income from its intermediary operations has increased from $5.9 million (prior to pooling-of-interests restatements) to $38.4 million. Further acquisitions are contemplated. Two subsidiaries of the Company perform insurance related services for customers of the Company's insurance and agency subsidiaries and for unrelated entities. These services include insurance claims adjustment and servicing and computer software development and sales. From time to time the Company will make strategic operational investments, generally in companies or operations in or related to the insurance industry. Certain of these investments are intended to enhance the Company's operations through strategic partnering in areas common to the investee and the Company. The Company's revenue from these investments is comprised of equity in earnings of the investee, dividends and gains on the sale of these investments. STRATEGY The Company's operating philosophy as an insurer is to maximize underwriting profits while preserving shareholders' equity. The Company concentrates its writings in selected, narrowly defined lines of business in which it believes there is a substantial opportunity to achieve underwriting profits. The Company primarily underwrites first party coverages and lines of business which have relatively short lead times between the occurrence of an insured event and the reporting of claims to the Company. The Company's insurance products are marketed both directly and through independent and affiliated agents. With respect to its underwriting management, marketing and related services, the Company seeks to offer quality underwriting, decision-making, support, reinsurance capacity and financial and other resources to take advantage of market opportunities for the development of new products. The property and casualty insurance underwriting business has historically been cyclical (though mainly not seasonal) and within the overall cycle of the industry, particular lines of business experience their own cycles. These cycles are characterized by periods of excess capital and significant competition in policy pricing, terms and conditions, followed by periods of capital shortages, typically resulting from adverse loss experience, which leads to decreased competition, higher premium rates and stricter underwriting standards. The position of a particular line of business in its respective underwriting cycle depends on prevailing premium rates, availability and cost of reinsurance, and other market conditions. The Company considers each of these factors in determining when to increase or decrease premium volume in each line. With this approach, the Company focuses on increasing net earnings rather than premium volume or market share. The Company purchases a substantial amount of reinsurance to limit its net loss from both individual and catastrophic risks. The degree to which the Company reinsures varies by, among other things, the particular risks inherent in the policies underwritten, pricing of available reinsurance and competitive conditions within the relevant line of business. 4 In its insurance company operations, the Company believes its operational flexibility, experienced underwriting personnel and access to and expertise in the reinsurance marketplace allow the Company to implement its 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, through its acquisition and ownership of insurance underwriting agencies and intermediary businesses, the Company believes that those service based businesses can both complement the Company's underwriting activities and serve as a source of revenue which may not be subject to the same level of volatility as traditional underwriting revenues. Many of the Company's insurance underwriting agency and intermediary subsidiaries act as agents or intermediaries on behalf of the Company's insurance company subsidiaries as well as for non-affiliated insurers or other risk taking entities. Additionally, a claims adjusting and servicing subsidiary provides services for the insurance company subsidiaries and their customers. The ability of the Company's insurance company subsidiaries to utilize an affiliated insurance underwriting agency, intermediary or services provider, and the corollary ability of such insurance underwriting agency, intermediary and services subsidiaries to place business with or provide other services to an affiliated insurer, permits the Company to earn a greater portion of the total income derived from generated premium. The Company's business plan is to expand its underwriting activities and continue the growth of its insurance underwriting agency and intermediary operations. The Company will also, from time to time, make strategic operational investments in companies that present an opportunity for future profit from sale or for enhancement of the Company's business. However, the Company's business plan is shaped by its underlying operating philosophy, which is to maximize underwriting profit opportunities, while preserving shareholders' equity. The Company expects to continue to seek to acquire complementary businesses with established management and reputation in the insurance industry, whose business, the Company believes, can be enhanced through the synergism created by the Company's underwriting capabilities and its other owned insurance related businesses. As a result, the Company's primary interests are not necessarily in expanding market share or GWP, but rather in increasing net earnings. To accomplish this objective, the Company: (i) has been and is prepared to emphasize or reduce underwritings in certain lines of business as premium rates, the availability and cost of reinsurance and other market conditions warrant; (ii) will continue to attempt to limit its downside net loss exposure through the effective, prudent and conservative use of reinsurance; (iii) will, as conditions warrant, emphasize the growth of its insurance underwriting agency and intermediary operations, which can be expected to result in continuing growth of management fees and commission income as a portion of total revenues; and (iv) will continue to review the possible acquisition of other specialty insurance companies and of other strategic operational investments that may, after a period of growth, increase in value or that represent strong strategic partners. 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 On May 24, 1996, the Company issued 6,250,000 shares of its Common Stock to acquire all of the outstanding shares of LDG. LDG, now operating as LDG Re, acts on behalf of insurance and reinsurance companies as a reinsurance underwriting manager in the following lines of business: accident and health special risks and alternative workers' compensation. LDG Re generally concentrates on lines of business that have relatively short lead times between the occurrence of an insured event and the reporting of claims. On November 27, 1996, the Company issued 1,136,400 shares of its Common Stock and paid $1.7 million in cash to acquire all of the outstanding shares of North American Special Risks Associates, Inc. ("NASRA"). NASRA, now known as HCCES, provides underwriting management and claims 5 administration services to insurance and reinsurance companies primarily for occupational accident insurance for self-employed truckers and alternative workers' compensation insurance. On June 17, 1997, the Company issued 8,511,625 shares of its Common Stock and 604,575 options to purchase its Common Stock in order to acquire all of the outstanding shares and options to purchase shares of Avemco Corporation ("Avemco"), the parent corporation of a group of insurance and insurance services companies. Avemco, through its insurance company subsidiaries, provides property and casualty insurance in the general aviation, lenders' single interest and short-term health lines of business. Avemco's primary insurance company subsidiaries were AIC and USSIC. Following the acquisition, the operations of USSIC have been relocated to Houston, Texas and it has become a subsidiary of HC. AIC and USSIC operate on an admitted basis throughout the United States and AIC also operates as an admitted insurer in Canada (except Quebec). Avemco's principal insurance underwriting agency and services operations are focused in three areas: (i) underwriting management services for lenders' single interest coverage for banks and other financial institutions; (ii) underwriting management services for short-term health and travel insurance marketed to foreign students and others resident in the United States; and (iii) insurance related computer products, software and services for property and casualty insurance companies throughout the United States. On February 27, 1998, the Company issued 1,600,000 shares of its Common Stock to acquire all of the outstanding shares of The Kachler Corporation ("Kachler"), now known as HCCEB. Kachler was a retail insurance agency specializing in life, accident and health insurance for employee benefit plans of medium and large commercial customers throughout the United States. On January 31, 1999, the Company acquired all of the outstanding stock of PEPYS. PEPYS is the sole shareholder of RML. The total initial consideration was $54.8 million in cash and deferred payments of $8.3 million in cash and 414,207 shares of the Company's Common Stock. Additional amounts may be paid in the future based upon the attainment of certain earnings benchmarks over the next four years. RML, the operating entity, provides intermediary services for reinsurance business placed by the Company's insurance company subsidiaries as well as unaffiliated insurance and reinsurance companies and underwriting agencies. PENDING ACQUISITIONS There are currently no acquisitions pending; however, the Company is evaluating a number of possible acquisition candidates and expects to complete one or more acquisitions during the remainder of 1999. The Company believes these future acquisitions will expand and strengthen its existing lines of business and perhaps provide access to additional specialty sectors, which management expects will contribute to the growth of the Company. INSURANCE COMPANY OPERATIONS The Company's property and casualty insurance company businesses specialize in underwriting aviation, marine, offshore energy, property, medical stop-loss, accident and health, workers' compensation and lenders' single interest risks. 6 LINES OF BUSINESS The following table sets forth the Company's insurance company subsidiaries' GWP by line of business and the percent to total GWP for the three years ended December 31, 1998 (dollars in thousands):
1998 1997 1996 --------------------- --------------------- --------------------- Aviation................................................. $ 203,573 41% $ 164,519 47% $ 140,725 42% Accident and health reinsurance.......................... 115,441 23 39,845 12 11,095 3 Property................................................. 106,515 21 85,379 25 118,154 35 Offshore energy.......................................... 21,682 5 7,469 2 8,496 2 Lenders' single interest................................. 17,944 4 21,877 6 22,870 7 Marine................................................... 13,259 3 22,847 7 32,433 10 Medical stop-loss........................................ 7,046 1 3,388 1 1,909 1 Workers' compensation.................................... 8,304 1 -- -- -- -- Other.................................................... 4,512 1 1,075 -- 1,596 -- ---------- --- ---------- --- ---------- --- Total GWP................................................ $ 498,276 100% $ 346,399 100% $ 337,278 100% ---------- --- ---------- --- ---------- --- ---------- --- ---------- --- ---------- ---
The following table sets forth the Company's insurance company subsidiaries' net written premium ("NWP") by line of business and the percent to total NWP for the three years ended December 31, 1998 (dollars in thousands):
1998 1997 1996 --------------------- --------------------- --------------------- Aviation................................................. $ 53,030 44% $ 75,280 53% $ 104,815 57% Accident and health reinsurance.......................... 40,519 33 24,777 17 10,942 6 Property................................................. 8,356 7 8,636 6 16,442 9 Lenders' single interest................................. 6,614 5 11,097 8 19,726 11 Marine................................................... 5,654 5 17,271 12 25,918 14 Medical stop-loss........................................ 3,415 3 3,388 2 1,909 1 Offshore energy.......................................... 2,324 2 1,416 1 3,472 2 Workers' compensation.................................... 1,482 -- -- -- -- -- Other.................................................... 489 1 988 1 (190) -- ---------- --- ---------- --- ---------- --- Total NWP................................................ $ 121,883 100% $ 142,853 100% $ 183,034 100% ---------- --- ---------- --- ---------- --- ---------- --- ---------- --- ---------- ---
UNDERWRITING DIRECT--The Company underwrites direct business produced through independent agents and brokers, affiliated intermediaries, and by direct marketing efforts, primarily in small general aviation business. REINSURANCE--The Company's current reinsurance underwriting activities are primarily in the accident and health lines of business where the Company's insurance company subsidiaries participate in various insurance and reinsurance underwriting pools managed by its underwriting agency subsidiaries and facultative (individual account) reinsurance, particularly in the aviation and property lines of business. The Company underwrites facultative reinsurance in most of its lines of business. Typically, this is on international business in order to comply with local licensing requirements or as reinsurance of captives, and usually can be considered direct business, as the Company maintains underwriting and claims control. However, all of this business is recorded under the caption of "Reinsurance Assumed". AVIATION--Aviation underwriting presently represents the Company's largest overall line of business and in recent years the Company has grown into a market leader in the aviation insurance industry. The Company insures general aviation risks, including private aircraft owners and pilots, fixed base operations, rotor wing aircraft, corporate aircraft, cargo operations, commuter airlines and similar operations, both 7 domestically and internationally. At this time, the Company does not generally insure major airlines, major manufacturers or satellites. The coverages underwritten include hull (including engines, avionics and other systems), liabilities, war, cargo and various ancillary coverages. The Company has been underwriting aviation risks since 1981 through HC. AIC has been insuring aviation risks since 1959. GWP has risen consistently since 1996, increasing from a combined $140.7 million to $203.6 million in 1998. This growth has occurred due to internal growth and acquisitions. Although, due to market conditions, domestic risks had not been a focus for the Company since the early 1990's, HC increased its writing of domestic general aviation risks late in 1996 and with the acquisition of AIC and USSIC in mid-1997, the Company achieved the position of a major participant in the domestic general aviation insurance market. The Company's position is further enhanced by its subsidiary aviation underwriting agency operations which underwrite on behalf of affiliated and non-affiliated insurance companies. In 1998 and 1997, the Company experienced a decline in NWP due to the implementation of the Company's reinsurance program at AIC following its acquisition in 1997. Reinsurance is maintained on both a proportional and an excess of loss basis to protect the Company against individual risk severity of loss and catastrophe exposure. Management believes that the aviation risks underwritten by the Company carry a relatively low level of catastrophe exposure. MARINE--The Company underwrites marine risks for ocean going vessels ("Blue Water"), inland and coastal trading vessels ("Brown Water"), fishing vessels. The coverages written include hull and machinery, liabilities (including protection and indemnity), marine cargo and various ancillary coverages. The Company has underwritten marine risks since 1984. Premium rates were adequate during 1995 but competition has created downward pressure on these rates causing a reduction in the Company's GWP from $32.4 million in 1996 to $13.3 million in 1998 and a corresponding decrease in NWP from $25.9 million to $5.7 million for the same period. Reinsurance is maintained on an excess of loss basis to protect the Company against individual risk severity of loss and catastrophe exposure. Management believes that the marine risks underwritten by the Company carry a relatively low level of catastrophe exposure. OFFSHORE ENERGY--The Company has been underwriting offshore energy risks since 1988. Offshore energy risks include drilling rigs, production and gathering platforms, and pipelines. Coverages underwritten include physical damage, liabilities, business interruption and various ancillary coverages. Rates have declined significantly during the past few years to levels where underwriting profitability is unlikely. Underwriting has been on a very selective basis, striving for quality rather than quantity. The increase in GWP and NWP during 1998 was the result of one large policy. Reinsurance is maintained on both a proportional and an excess of loss basis to protect the Company against individual risk severity of loss and the catastrophic exposure that exists, for example, from a hurricane in the Gulf of Mexico. PROPERTY--The Company specializes in writing risks of large, often multinational corporations, covering such commercial risks as hotels, office buildings, retail locations, factories, industrial plants, utilities, refineries, natural gas facilities and petrochemical plants. Coverage includes business interruption, physical damage and catastrophe risks including flood and earthquake. The Company has written property business since 1986. GWP increased to $118.2 million in 1996 as premium rates increased following the Northridge earthquake in 1994. During 1996, premium rates began to soften and this trend has continued through 1998 due in a large part to excess capacity and the absence of significant catastrophe losses. GWP has declined from $118.2 million in 1996 to $106.5 million in 1998. NWP also declined from $16.4 million to $8.4 million in the same period. Property NWP will always be substantially less than GWP due to the amount of facultative reinsurance and reinsurance purchased in order to protect the Company from catastrophe exposure. 8 Reinsurance is maintained on both a proportional and an excess of loss basis to ensure adequate protection, particularly against catastrophic exposures. As an example, in 1998 the Company had gross losses of $53.7 million with respect to hurricanes Georges and Mitch. The after-tax net loss, after reinsurance, with respect to these hurricanes was $3.8 million. The Company conservatively estimates its aggregate exposure in any individual catastrophe zone and maintains catastrophe reinsurance to cover its exposure to any one occurrence. ACCIDENT AND HEALTH REINSURANCE--The Company began underwriting accident and health reinsurance risks through HC during 1996. These risks are produced primarily by LDG Re, the underwriting agency which was acquired by the Company during that year. The risks underwritten include reinsurance in the accident and health special risks and alternative workers' compensation areas and occupational accident insurance for self-employed truckers. The Company's GWP increased from $11.1 million in 1996 to $115.4 million in 1998. This growth is from the Company's increased participation in various insurance and reinsurance pools managed by its underwriting agency subsidiaries. Management believes that its accident and health reinsurance business carries a relatively low level of catastrophe exposure. MEDICAL STOP-LOSS--Medical stop-loss business is written on an aggregate and specific basis for employer sponsored self-insured health plans. The business is produced by an underwriting agency subsidiary of the Company. The Company first began writing this business in 1996 and GWP has increased, as a result of greater participation by an insurance company subsidiary in the business underwritten by an underwriting agency subsidiary which produces this business. LENDERS' SINGLE INTEREST--USSIC began writing lenders' single interest risks in 1984. GWP decreased from $22.9 million in 1996 to $17.9 million in 1998 due to a competitive market. Due to the implementation of a new reinsurance program when USSIC was acquired in June, 1997, (part of the Avemco merger) NWP decreased even further from $19.7 million in 1996 to $6.6 million in 1998. This coverage is marketed to banks and other financial institutions and addresses risks of physical loss or damage to the property collateralizing installment loans (primarily automobiles). All of the lenders' single interest risks underwritten by the Company are produced by the Company's subsidiary, Avemco Financial Services, Inc. ("AFS"). Reinsurance is maintained on a proportional basis to protect against frequency of loss. Management believes that its lenders' single interest business carries a relatively low level of catastrophe exposure. WORKERS' COMPENSATION--The Company began writing statutory workers' compensation business in 1998 and expects to expand these writings significantly through HCCES. It is the intent of the Company to grow this line of business in the future internally and through acquisition. GWP will increase as an insurance company subsidiary of HCC serves as a policy issuing company for HCCES's business. The Company currently reinsures this business, except for a small retention. Losses in this line of business generally take longer to develop than in the Company's other lines of business, but, due to the Company's reinsurance, management does not believe that the longer development period will adversely affect the Company's underwriting results. INSURANCE COMPANY SUBSIDIARIES HOUSTON CASUALTY COMPANY--HC, the Company's principal insurance company subsidiary, is rated A+, VIII by A.M. Best and AA by Standard & Poor's and operates worldwide in most of the lines of business in which the Company specializes. HC's business is produced by independent agents and brokers, the group's underwriting agency and intermediary subsidiaries, AIC, USSIC, the Company's subsidiary Trafalgar Insurance Company ("TIC"), and other insurance and reinsurance companies worldwide. HC 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 the Company specializes. As of December 31, 1998, HC had statutory policyholders' surplus of $262.4 million. 9 HOUSTON CASUALTY COMPANY--LONDON--HC was authorized by Her Majesty's Treasury in 1998 to operate a full branch office in the United Kingdom. HC is in the process of staffing this branch and expects it to become fully operational towards the end of 1999. HC established the branch in London in order to be closer to some of the markets in which HC operates and to have access to a larger pool of insurance talent. The Company intends to transfer underwriting responsibility for all lines of business HC writes, except aviation, to this branch. HC-London initially began writing accident and health business in early 1999 through Feasey Slot Management, Ltd., an underwriting agency in which the Company has a strategic investment. HOUSTON CASUALTY COMPANY--JORDAN--HC also established a branch operation in Amman, Jordan in 1998 with the assumption of all of the business of IMG Insurance Company Ltd. ("IMG"). IMG, formerly a subsidiary of the Company, was liquidated in 1998. Due to the similar nature of IMG's business to that written by HC, management determined that an HC branch operation in Jordan rather than an independently capitalized subsidiary would be a more productive and efficient utilization of the Company's capital. Additionally, management believes that this action can be expected to enhance the direct presence of HC in the Middle Eastern, Asian and African markets and is expected to lead to increased underwriting opportunities for the Company. TRAFALGAR INSURANCE COMPANY--TIC, which was organized in 1993, is a wholly owned subsidiary of HC. TIC, an Oklahoma domiciled property and casualty insurance company, is rated A+, V by A.M. Best. TIC currently underwrites primarily domestic property risks and was historically utilized by HC to offer insurance on a surplus lines basis in certain jurisdictions where HC is not otherwise permitted to do so. As of December 31, 1998, TIC had statutory policyholders' surplus of $15.2 million, a decrease of $15.7 million from December 31, 1997 due to a special dividend paid to HC. As a result of changes in the operations of the Company's insurance company subsidiaries, including the relocation and change in focus of USSIC's operations, management has determined that TIC is no longer a necessary component of the Company's insurance company operations and intends to effect the disposition of TIC during 1999. Its business will be transferred to other insurance company subsidiaries of the Company. U.S. SPECIALTY INSURANCE COMPANY--USSIC is a Texas domiciled property and casualty insurance company and former subsidiary of AIC, which became a direct subsidiary of HC in December, 1997. The Company was re-domesticated from Maryland to Texas in 1998. USSIC is rated A+, VII by A.M. Best and AA by Standard & Poor's and has historically been an underwriter of general aviation and lenders' single interest risks through a network of independent agents. USSIC operates on an admitted basis throughout the United States. The Company expects to continue USSIC's operation, primarily writing general aviation and workers' compensation insurance produced by underwriting agency subsidiaries of the Company. During December, 1998, the Company increased the policyholders' surplus of USSIC by $32.5 million and as of December 31, 1998, USSIC had statutory policyholders' surplus of $79.2 million. AVEMCO INSURANCE COMPANY--AIC was organized in 1959 and became a subsidiary of the Company in June, 1997. AIC is a Maryland domiciled property and casualty insurer, is rated A+, VII by A.M. Best and AA by Standard & Poor's and operates primarily as a direct market underwriter of general aviation business on an admitted basis throughout the United States and Canada (except Quebec) and as an insurer of lenders' single interest risks produced by AFS. In addition, as a part of the Company's overall operations, AIC has become an insurer of medical stop-loss products underwritten by an underwriting agency subsidiary of the Company. At December 31, 1998, AIC had statutory policyholders' surplus of $104.9 million. UNDERWRITING AGENCY OPERATIONS The Company's underwriting agency subsidiaries act on behalf of insurance and reinsurance companies, conducting business in the areas of insurance underwriting management and claims administration. The underwriting agency subsidiaries do not assume any insurance or reinsurance risk themselves and the 10 revenues generated are based entirely on management fees and profit commissions. These subsidiaries are in a position to direct and control business that they produce. In addition, certain of the business written by the underwriting agencies is insured or reinsured by the Company's insurance company subsidiaries. In some cases, the insurance company subsidiaries serve as policy issuing companies for this business. The insurance company subsidiaries may retain a portion of the risk and reinsure the remainder with other unaffiliated insurance companies or reinsure all of the risk. LINES OF BUSINESS The following table sets forth the Company's underwriting agency subsidiaries' premium by lines of business for the three years ended December 31, 1998 (dollars in thousands):
1998 1997 1996 ----------------------- --------------------- --------------------- Accident and health reinsurance........................... $ 427,005 61% $ 305,625 64% $ 175,627 64% Medical stop-loss......................................... 158,707 22 93,435 20 78,597 28 Aviation.................................................. 92,668 13 49,581 10 -- -- Lenders' single interest.................................. 18,325 3 21,848 5 22,871 8 Workers' compensation..................................... 4,429 1 -- -- -- -- Other..................................................... 2,890 -- 2,950 1 -- -- ---------- --- ---------- --- ---------- --- Total premium......................................... $ 704,024 100% $ 473,439 100% $ 277,095 100% ---------- --- ---------- --- ---------- --- ---------- --- ---------- --- ---------- ---
UNDERWRITING AGENCY SUBSIDIARIES LDG REINSURANCE CORPORATION--LDG Re, based in Wakefield, Massachusetts, acts as an underwriting manager providing accident and health special risks and alternative workers' compensation reinsurance. In 1998, LDG Re generated approximately $378.9 million of written premium, the majority of which was written on behalf of non-affiliated insurance companies. HCC BENEFITS CORPORATION--HCCB, based in Atlanta, Georgia, acts as an underwriting manager providing medical stop-loss and excess coverage insurance products to employer sponsored self-insured health plans. In 1998, HCCB generated approximately $158.7 million of written premium, the majority of which was underwritten on behalf of non-affiliated insurance companies. HCC AVIATION GROUP, INC.--HCCA, based in Dallas, Texas, provides the base, along with the Company's insurance company subsidiary AIC, around which the Company has rapidly developed a significant presence in the domestic general aviation market. HCCA provides underwriting management services on behalf of affiliated and non-affiliated insurance companies in the areas of private and corporate aircraft, commercial agricultural aircraft, antique and vintage military aircraft, small to medium sized airports, and commercial operators. During 1998, HCCA generated approximately $95.6 million of written premium. HCC EMPLOYER SERVICES, INC.--HCCES acts as an underwriting manager providing occupational accident and health insurance to self-employed truckers from its Northbrook, Illinois office and workers' compensation insurance to small and medium size businesses from its Montgomery, Alabama office. HCCES generated approximately $52.5 million in premium in 1998, the majority of which was underwritten on behalf of non-affiliated insurance companies. AVEMCO FINANCIAL SERVICES, INC.--AFS, based in Baltimore, Maryland, acts as an underwriting manager providing lenders' single interest coverage to banks and other financial institutions. During 1998, AFS generated approximately $18.3 million in written premium, all on behalf of affiliated insurance companies, USSIC and AIC. 11 Management fees generated by underwriting agency subsidiaries in 1998 amounted to $74.0 million, a substantial increase of 45% over 1997. INTERMEDIARY OPERATIONS The services performed by the Company's insurance intermediary subsidiaries consist of marketing, placing, consulting on and servicing insurance risks for their clients, which include medium to large corporations, insurance and reinsurance companies or other risk taking entities. The intermediary subsidiaries earn commission income and to a lesser extent fees for certain services, generally from the underwriters with whom the business is placed. Certain of these risks may be initially underwritten by the Company's insurance company subsidiaries, which may retain a portion of the risk. HCC EMPLOYEE BENEFITS, INC.,--HCCEB, 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. HCC INTERMEDIARIES, INC.--HCCI is an intermediary based in Houston, Texas specializing in marketing and servicing large, complicated insurance and reinsurance programs placed on behalf of multinational clients operating in the same lines of business that the Company underwrites. This business is placed with domestic and international insurance companies, including affiliated insurance companies, on a direct basis and through other intermediaries. In addition, HCCI acts as a reinsurance intermediary on behalf of affiliated and non-affiliated insurance companies. RATTNER MACKENZIE LIMITED--RML is an intermediary based in London, England. RML is a Lloyd's broker specializing in accident and health reinsurance and certain specialty property and casualty lines of business. Management believes that RML is considered a market leader in its core businesses. RML serves as an intermediary for reinsurance business placed by the Company's insurance company subsidiaries as well as unaffiliated insurance and reinsurance companies and underwriting agencies. Commission income generated by intermediary subsidiaries in 1998 amounted to $38.4 million, a substantial increase of 59% over 1997. OTHER OPERATIONS The Company's other operations consist of subsidiaries that are not insurance companies, underwriting agencies or intermediaries. These operations generally are insurance related services that may be performed for the Company's subsidiaries, its reinsurers or unaffiliated entities. The revenue earned from these services primarily consists of fees, commissions or the sales price of product sold. The two subsidiaries currently operating in this segment provide insurance claims adjusting services and development and sale of insurance industry related software. Additionally, other operations include the returns received from certain insurance related strategic operational investments which the Company makes from time to time. Certain of these investments provide strategic partnering opportunities. These returns may be in the form of equity in the earnings of the investee, dividends or gains from the disposition of these investments. Other operating income was $22.3 million in 1998, up 46% from 1997. COMBINED INSURANCE COMPANY AND UNDERWRITING AGENCY OPERATIONS The Company's combined GWP was over $1.0 billion in 1998 with its insurance company operations underwriting $498.3 million and its underwriting agency operations underwriting $704.0 million. 12 REINSURANCE CEDED The Company principally utilizes reinsurance to reduce its net liability on individual risks, to protect against catastrophic losses and to achieve a desired ratio of NWP to policyholders' surplus. Various intermediaries, including HCCI and RML, facilitate the placement of this reinsurance coverage on behalf of the Company and are compensated, directly or indirectly, by the reinsurers. Reinsurance is ceded on both a proportional and an excess of loss basis. Management believes that the Company reinsures its risks to a greater extent than most of its competitors and most other insurance companies. This strategy greatly reduces the likelihood of a significant net loss from insurance company operations and protects the Company's shareholders' equity. Under its current reinsurance protections, the Company has limited its net retained loss, across any single line of business, to a maximum of approximately $1.0 million for any one risk, but significantly less on most risks. The type, cost and limits of reinsurance purchased can vary from year to year based upon the Company's desired retention levels and the availability of adequate reinsurance at a reasonable price. The Company's reinsurance programs renew throughout the year. Programs that expired in 1998 have been renewed at comparable costs. The availability of reinsurance continues to be an important part of the Company's business plan, protecting Shareholders equity from catastrophe losses and the inconsistencies of the insurance cycle. Important relationships have been built up over the years with many core Reinsurers who have supported the Company in good and bad times. The Company will continue to share its business with these partners when underwriting profitability returns, to allow them to recoup losses and build even stronger relationships in the future. Increased retentions during profitable periods is 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, severely curtail their writings or become insolvent. This reduction in reinsurance market capacity causes rates to rise but the increased rates historically have been passed on to the primary market clients. The Company structures a specific reinsurance program for each line of business it underwrites. This reinsurance is placed in order to protect the Company from exposure to foreseeable events. The Company places reinsurance proportionally to cover loss frequency and catastrophe exposure on an excess of loss basis to cover individual risk severity of loss and catastrophe exposure from occurrences involving multiple risks, such as those resulting from a hurricane or an earthquake. The Company does not intend to expose itself to any net loss in excess of its reinsurance protection. 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 the United States, certain United States Gulf Coast states, particularly in Florida and Texas, the Caribbean and Mexico. The Company carefully 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. The Company receives an overriding (ceding) commission on the premium ceded to reinsurers which compensates the Company for the direct costs associated with the production of the premium, 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 the Company's reinsurance treaties allow for a sharing with the Company by the reinsurers of any net profits generated under such treaties. The ceding of reinsurance does not discharge the Company from liability to its policyholders. The Company is required to pay losses even if the reinsurer fails to meet its obligations under the reinsurance contract. To minimize its exposure to reinsurance credit risk, the Company places its reinsurance with a diverse group of financially sound reinsurers. The Company's 1999 treaty reinsurance program was placed 13 with more than 52 domestic and foreign reinsurers. As of December 31, 1998, the total amount recoverable from reinsurers was approximately $372.7 million, of which $33.6 million represents paid losses recoverable (in the ordinary course of business) and $341.6 million represents outstanding losses recoverable, less a $2.5 million reserve for uncollectible reinsurance. In addition, ceded unearned premium was $149.6 million. At December 31, 1998, the Company held $166.5 million of irrevocable letters of credit and $8.1 million in cash to collateralize a portion of the total amount recoverable and had other payable balances due to its reinsurers of $227.6 million as potential offsets against reinsurance recoverables. The estimated duration for the Company's outstanding losses is two years, as the majority of the Company's business has historically had shorter lead times between the occurrence of an insured event and the final settlements. The following table shows reinsurance balances relating to the reinsurers with a total recoverable balance greater than $10.0 million and the collateral and potential offsets held by the Company as of December 31, 1998:
LETTERS OF REINSURANCE CREDIT, RECOVERABLES AND CASH DEPOSITS CEDED UNEARNED AND OTHER REINSURER LOCATION PREMIUM PAYABLES - --------------------------------------------------------- ------------------- ---------------- ---------------- Underwriters at Lloyd's.................................. United Kingdom $ 93,280,000 $ 37,040,000 Underwriters Indemnity Company*.......................... Texas 51,576,000 11,039,000 New Cap Reinsurance Corp. Ltd............................ Australia 49,924,000 40,764,000 Reinsurance Australia Corporation, Ltd................... Australia 41,606,000 44,411,000 SCOR Reinsurance Company................................. New York 38,703,000 11,402,000 AXA Reinsurance Company.................................. Delaware 28,667,000 10,513,000 GIO Insurance Limited.................................... Australia 24,011,000 25,158,000 Monegasque De Reassurances............................... Monaco 13,454,000 12,936,000 Overseas Partners Limited................................ Bermuda 12,718,000 10,919,000 TIG Reinsurance Company.................................. Connecticut 12,591,000 2,534,000 St. Paul Fire and Marine Insurance Co.................... Minnesota 12,278,000 4,349,000
- ------------------------ * Underwriters Indemnity Company was acquired by RLI Corporation, an insurance holding company, (NYSE: RLI) in January, 1999. Prior to the Company's acquisition of Avemco, AIC retained a greater percentage of overall premiums written than HC and TIC. Following the acquisition, the Company implemented a program of reinsurance for AIC which is more consistent with the reinsurance programs utilized by the Company's other insurance company subsidiaries. The effect of this change was to limit the net retained exposure of AIC, to reduce net earned premium and to reduce the effect on net earnings of large losses and a high frequency of losses. Due to the Company's financial analysis of active and potential reinsurers and its conservative strategy of diversifying its reinsurers, the Company has never incurred a significant loss on recoverables from reinsurers. The Company has established a reserve of $2.5 million as of December 31, 1998, which is intended to reduce the effects of any recoverable problem. However, the adverse economic environment in the insurance industry has placed great pressure on reinsurers and the results of their operations. These conditions could, ultimately, affect reinsurers' solvency. Historically, there have been insolvencies following a period of competitive pricing in the industry, such as the marketplace is experiencing today. Therefore, while management believes that the reserve is adequate, conditions can 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. 14 OPERATING RATIOS PREMIUM TO SURPLUS RATIO The following table shows, for the periods indicated, the ratio of statutory GWP and NWP to statutory policyholders' surplus for the Company's property and casualty insurance company subsidiaries:
FOR THE YEARS ENDED DECEMBER 31, (DOLLARS IN THOUSANDS) ---------------------------------------------------------- 1998 1997 1996 1995 1994 ---------- ---------- ---------- ---------- ---------- GWP.................................................. $ 500,962 $ 346,094 $ 340,367 $ 338,753 $ 283,530 NWP.................................................. 123,315 143,068 189,022 184,028 133,143 Policyholders' surplus............................... 369,401 331,922 288,863 251,125 206,596 GWP ratio............................................ 135.6% 104.3% 117.8% 134.9% 137.2% GWP industry average (1)............................. * 154.7 179.9 194.0 221.8 NWP ratio............................................ 33.4% 43.1% 65.4% 73.3% 64.4% NWP industry average (1)............................. * 89.7 105.2 113.0 129.7
- ------------------------ *--Not available (1) Source: A.M. Best. While there is no statutory requirement regarding a permissible premium to surplus ratio, guidelines established by the National Association of Insurance Commissioners ("NAIC") provide that a property and casualty insurer's annual statutory GWP should not exceed 900% and NWP should not exceed 300% of its policyholders' surplus. In keeping with its philosophy of protecting its shareholders' equity and limiting its aggregate loss exposure, the Company maintains premium to surplus ratios significantly lower than such guidelines, and, as indicated above, below industry norms. COMBINED RATIO The underwriting experience of a property and casualty insurance company is indicated by its combined ratio. The Company's insurance subsidiaries' loss ratio, expense ratio and combined ratio, determined on the basis of statutory accounting principles ("SAP"), are shown in the following table:
1998 1997 1996 1995 1994 --------- --------- --------- --------- --------- Loss ratio....................................................... 67.2% 61.6% 64.4% 66.4% 62.5% Expense ratio.................................................... 15.7 17.2 19.2 18.1 20.4 --------- --------- --------- --------- --------- Combined ratio................................................... 82.9% 78.8% 83.6% 84.5% 82.9% --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- Industry average (1)............................................. * 101.6% 105.8% 106.4% 108.4%
- ------------------------ * Not available (1) Source: A.M. Best. The SAP basis ratio data is not intended to be a substitute for results of operations on the basis of generally accepted accounting principles ("GAAP"). The differences between SAP and GAAP are shown in Note (15) of the Company's consolidated financial statements. Including this information on a SAP basis is meaningful and useful to allow a comparison of the Company's operating results with those of other companies in the insurance industry. 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. 15 RESERVES Applicable insurance laws and regulations require that reserves be maintained for the payment of loss and loss adjustment expense ("LAE") with respect to both reported and incurred but not reported ("IBNR") claims under insurance and reinsurance policies issued by the Company's insurance company subsidiaries. In most cases, the Company establishes reserves through an evaluation of individual claims. In some types of aviation claims, an average reserving method is utilized until more information becomes available which will permit a more specific individual evaluation of claims. In the case of direct and facultative reinsurance business, loss reserves are determined by evaluating reported claims on the basis of the type of loss, jurisdiction of the occurrence, knowledge of the circumstances surrounding the claim, severity of injury or damage, potential for ultimate exposure, experience with the insured and the line of business and policy provisions relating to the particular type of claim. The Company establishes loss reserves for excess of loss and proportional reinsurance claims based on information and reports received from ceding companies. Loss reserves for IBNR losses are determined in part on the basis of statistical information and in part on industry experience with respect to the probable number and nature of claims arising from occurrences which have not been reported. The Company does not discount any of its loss reserves. 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 insurance and workers' compensation insurance underwritten by the Company have historically had longer lead times between the occurrence of an insured event, reporting of the claim to the Company, and final settlement. In such cases, the Company is forced to estimate reserves over long periods of time, with the possibility of several adjustments to reserves. Other classes of insurance, such as most aviation, property and accident and health business the Company underwrites, historically have shorter lead times between the occurrence of an insured event, reporting of the claim to the Company and final settlement. The reserves with respect to such classes are, therefore, less likely to be adjusted. The classes of insurance with shorter lead times currently represent the majority of the risks underwritten by the Company's insurance company operations. The reserving process is intended to provide implicit recognition of the impact of inflation and other factors affecting loss payments by taking into account changes in historical payment patterns and perceived probable 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, some of which are interdependent. The Company underwrites, directly and through reinsurance, risks which are denominated in a number of foreign currencies, and therefore establishes and maintains 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 the Company's earnings. From time to time, the Company may attempt to limit its exposure to future currency fluctuations through the use of foreign currency forward contracts. The following loss development triangles show changes in reserves in subsequent years from the prior loss estimates based on experience as of the end of each succeeding year on the basis of GAAP. 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 each of the years indicated, the gross reserve liability including the reserve for IBNR losses. The first section of each table shows, by year, the cumulative amounts of loss and LAE 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 December 31, 1998, the difference between the latest re-estimated liability and the reserves as originally estimated. 16 The following loss development triangle shows development in loss reserves on a gross basis:
1998 1997 1996 1995 1994 1993 1992 ---------- ---------- ---------- ---------- ---------- ---------- ----------- Balance sheet reserves:.............. $ 460,511 $ 275,008 $ 229,049 $ 200,756 $ 170,957 $ 144,178 $ 129,503 Cumulative paid as of: One year later..................... 160,324 119,453 118,656 97,580 82,538 83,574 Two years later.................... 179,117 167,459 143,114 126,290 130,379 Three years later.................. 207,191 166,541 157,509 158,973 Four years later................... 192,540 176,472 182,193 Five years later................... 195,269 192,512 Six years later.................... 213,052 Re-estimated liability as of: End of year........................ 460,511 275,008 229,049 200,756 170,957 144,178 129,503 One year later..................... 308,501 252,236 243,259 186,898 163,967 162,827 Two years later.................... 249,013 248,372 207,511 183,015 176,817 Three years later.................. 247,053 214,738 203,137 194,419 Four years later................... 220,695 211,546 215,531 Five years later................... 218,182 222,746 Six years later.................... 234,115 Cumulative redundancy (deficiency)... $ (33,493) $ (19,964) $ (46,297) $ (49,738) $ (74,004) $ (104,612)
During 1998 the Company had gross loss and LAE deficiency of $33.5 million compared to deficiencies of $23.2 million in 1997 and $42.5 million in 1996. The gross deficiency comes from two primary sources. Firstly, the development of several large claims on individual policies which were either reported late or reserves were increased as subsequent information became available. However, as most of these policies were substantially reinsured, there was no material effect to the Company's net earnings. Secondly, the run-off of the retrocessional excess of loss business which the Company underwrote between 1988 and 1991. This development is due primarily to the delay in reporting of catastrophe losses by the London insurance market, coupled with the unprecedented number of catastrophes during the period in which the Company underwrote this business. This business is also substantially reinsured, thereby not having a material effect on the Company's net earnings. [THE REMAINDER OF THIS PAGE LEFT INTENTIONALLY BLANK] 17 The following loss development triangle shows development in loss reserves on a net basis:
1998 1997 1996 1995 1994 1993 1992 --------- --------- --------- --------- --------- --------- --------- Gross reserves for loss and LAE................. $ 460,511 $ 275,008 $ 229,049 $ 200,756 $ 170,957 $ 144,178 $ 129,503 Less reinsurance recoverables................... 341,599 155,374 111,766 101,497 95,279 82,289 81,075 --------- --------- --------- --------- --------- --------- --------- Reserves for loss and LAE, net of reinsurance... 118,912 119,634 117,283 99,259 75,678 61,889 48,428 Cumulative paid, net of reinsurance as of One year later................................ 48,775 47,874 41,947 36,500 29,258 18,978 Two years later............................... 66,030 56,803 49,283 41,207 32,733 Three years later............................. 64,798 56,919 46,576 36,536 Four years later.............................. 60,441 51,536 38,480 Five years later.............................. 53,110 40,327 Six years later............................... 40,550 Seven years later............................. Eight years later............................. Nine years later.............................. Ten years later............................... Re-estimated liability, net of reinsurance as of End of year................................... 118,912 119,634 117,283 99,259 75,678 61,889 48,428 One year later................................ 105,041 113,509 94,322 72,912 59,659 45,812 Two years later............................... 98,959 93,550 74,836 60,079 44,964 Three years later............................. 84,042 76,423 62,224 46,129 Four years later.............................. 73,609 64,377 48,993 Five years later.............................. 64,103 50,785 Six years later............................... 50,585 Seven years later............................. Eight years later............................. Nine years later.............................. Ten years later............................... Cumulative redundancy (deficiency).............. $ 14,593 $ 18,324 $ 15,217 $ 2,069 $ (2,214) $ (2,157) 1991 1990 1989 1988 --------- --------- --------- --------- Gross reserves for loss and LAE................. $ 123,248 $ 108,027 $ 96,477 $ 76,754 Less reinsurance recoverables................... 83,727 60,194 45,160 30,481 --------- --------- --------- --------- Reserves for loss and LAE, net of reinsurance... 39,521 47,833 51,317 46,273 Cumulative paid, net of reinsurance as of One year later................................ 18,416 23,450 22,660 18,414 Two years later............................... 23,057 33,815 34,300 27,698 Three years later............................. 31,903 35,912 40,806 33,601 Four years later.............................. 33,875 42,465 41,878 36,256 Five years later.............................. 34,970 43,422 46,734 36,045 Six years later............................... 36,203 43,690 47,164 37,718 Seven years later............................. 35,413 44,611 47,229 38,338 Eight years later............................. 43,715 47,928 38,415 Nine years later.............................. 46,308 39,006 Ten years later............................... 38,195 Re-estimated liability, net of reinsurance as of End of year................................... 39,521 47,833 51,317 46,273 One year later................................ 38,575 44,887 49,475 43,362 Two years later............................... 38,656 45,435 47,313 42,463 Three years later............................. 39,176 44,689 48,085 40,352 Four years later.............................. 40,407 45,507 47,884 40,937 Five years later.............................. 43,418 46,805 47,933 40,384 Six years later............................... 45,142 48,932 48,086 40,071 Seven years later............................. 43,924 50,190 49,392 39,880 Eight years later............................. 49,732 50,324 40,587 Nine years later.............................. 50,101 41,014 Ten years later............................... 40,570 Cumulative redundancy (deficiency).............. $ (4,403) $ (1,899) $ 1,216 $ 5,703
18 The Company believes that its reserves are adequate to provide for all net incurred losses. The following table provides a reconciliation of the gross liability of loss and LAE on a GAAP basis for the three years ended December 31, 1998 (dollars in thousands):
1998 1997 1996 ---------- ---------- ---------- Reserves for loss and LAE at beginning of year............................... $ 275,008 $ 229,049 $ 200,756 Reserves acquired with purchase of subsidiary................................ 3,877 1,919 -- Provision for loss and LAE for claims occurring in the current year.......... 461,429 269,505 185,502 Increase in estimated loss and LAE for claims occurring in prior years (1)... 33,493 23,187 42,503 ---------- ---------- ---------- Incurred loss and LAE........................................................ 494,922 292,692 228,005 ---------- ---------- ---------- Loss and LAE payments for claims occurring during: Current year............................................................... 152,972 129,199 81,056 Prior years................................................................ 160,324 119,453 118,656 ---------- ---------- ---------- Loss and LAE payments........................................................ 313,296 248,652 199,712 ---------- ---------- ---------- Reserves for loss and LAE at end of the year................................. $ 460,511 $ 275,008 $ 229,049 ---------- ---------- ---------- ---------- ---------- ----------
- ------------------------ (1) Changes in loss and LAE 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. The following table provides a reconciliation of the liability for loss and LAE, net of reinsurance ceded, on a GAAP basis for the three years ended December 31, 1998 (dollars in thousands):
1998 1997 1996 ---------- ---------- ---------- Reserves for loss and LAE at beginning of year............................... $ 119,634 $ 117,283 $ 99,259 Reserves acquired with purchase of subsidiary................................ 3,877 1,919 -- Provision for loss and LAE for claims occurring in the current year.......... 105,895 100,288 119,401 Decrease in estimated loss and LAE for claims occurring in prior years (2)... (14,593) (3,774) (4,937) ---------- ---------- ---------- Incurred loss and LAE........................................................ 91,302 96,514 114,464 ---------- ---------- ---------- Loss and LAE payments for claims occurring during: Current year............................................................... 47,126 48,208 54,493 Prior years................................................................ 48,775 47,874 41,947 ---------- ---------- ---------- Loss and LAE payments........................................................ 95,901 96,082 96,440 ---------- ---------- ---------- Reserves for loss and LAE at end of the year................................. $ 118,912 $ 119,634 $ 117,283 ---------- ---------- ---------- ---------- ---------- ----------
- ------------------------ (2) Changes in loss and LAE 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 the Company experienced a gross loss deficiency during the three years ended December 31, 1998, because the business is substantially reinsured in the lines where adverse development has occurred, there is no material adverse effect on a net loss basis. During 1998, the Company had net loss and LAE redundancy of $14.6 million relating to prior year losses compared to redundancies of $3.8 million in 1997 and $4.9 million in 1996. The redundancies in the net reserves result from the Company's and its actuaries continued review of its loss reserves and the 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. 19 AIC, acquired in June, 1997, recorded a $10.0 million increase in loss and LAE reserves during December, 1997, predominately related to 1995 and 1996 claims incurred prior to the Company's acquisition of AIC. This deficiency is included in the net redundancy recorded for 1997. This increase in reserves was made in an effort to bring AIC's reserving practices consistent with the more conservative method used by the Company's other insurance company operations. The Company expects the increase in loss reserves to be adequate to cover any subsequent adverse development of AIC's prior 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 insured, 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. INVESTMENTS Insurance company investments must comply with applicable laws and regulations which prescribe the type, quality and concentration of investments. In general, these laws and regulations permit investments, within specified limits and subject to certain qualifications, in Federal, state and municipal obligations, corporate bonds, preferred and common equity securities. As of December 31, 1998, the Company had $525.6 million of investment assets, the majority of which were held by its insurance company subsidiaries. The Company's investment policy is determined by the Company's Board of Directors and is reviewed on a regular basis. Pursuant to its investment policy, the Company concentrates its investments in obligations of states, municipalities and political subdivisions, the interest income from which is predominantly exempt from Federal income tax. The interest rates on these securities are normally lower than rates on comparable taxable securities. The Company's portfolio of fixed income securities available for sale principally consists of intermediate term, tax-exempt securities. The Company generally intends to hold such securities to maturity. However, the Company regularly re-evaluates its position based upon market conditions, which may cause the Company to restructure its portfolio and realize gains or losses in order to maximize its total return on investments. Accordingly, all fixed income securities are classified as available for sale and are recorded at market value. The Company's financial statements reflect an unrealized ("mark-to-market") gain on fixed income securities available for sale as of December 31, 1998, of $18.1 million. Since the Company's intention is to hold these securities until maturity, it does not currently expect to realize any significant gain or loss on these investments. The Company has maintained a substantial level of cash and liquid short-term instruments in its insurance company subsidiaries in order to maintain the ability to fund large physical damage losses of the Company's insureds, should they occur. As of December 31, 1998, the Company had cash and short-term investments of approximately $145.1 million of which $70.6 million are in the Company's insurance company subsidiaries. The following tables reflect the investments of the Company (dollars are expressed in thousands). The table set forth below reflects the average amount of investments, income earned, and the yield thereon for the three years ended December 31, 1998:
1998 1997 1996 ---------- ---------- ---------- Average investments.......................................................... $ 522,209 $ 496,010 $ 461,778 Net investment income........................................................ 29,335 27,587 23,593 Average yield (1)............................................................ 5.6% 5.6% 5.1% Average tax equivalent yield (1)............................................. 7.3% 7.3% 6.9%
- ------------------------ (1) Excluding realized and unrealized capital gains and losses. 20 The table set forth below summarizes, by type, the investments of the Company as of December 31, 1998:
AMOUNT PERCENT OF TOTAL ---------- ----------------- Short-term investments................................................................ $ 129,084 25% U.S. Treasury securities.............................................................. 19,773 4 Obligations of states, municipalities and political subdivisions...................... 163,798 31 Special revenue....................................................................... 208,355 40 Other fixed income securities......................................................... 1,312 -- Marketable equity securities.......................................................... 2,252 -- Other investments..................................................................... 1,072 -- ---------- --- Total investments................................................................... $ 525,646 100% ---------- --- ---------- ---
The table set forth below indicates the expected maturity distribution of the Company's fixed income securities as of December 31, 1998:
AMOUNT PERCENT OF TOTAL ---------- ----------------- One year or less...................................................................... $ 7,828 2% One year to five years................................................................ 151,878 39 Five years to ten years............................................................... 123,749 31 Ten years to fifteen years............................................................ 83,608 21 More than fifteen years............................................................... 26,175 7 ---------- --- Total fixed income securities....................................................... $ 393,238 100% ---------- --- ---------- ---
BANK LOAN On March 8, 1999, the Company entered into a Loan Agreement (the "Facility") with a group of banks. The Facility includes a $150 million Revolving Loan Facility and $100 million Short Term Revolving Loan Facility. Borrowing under the Facility may be made from time to time by the Company for general corporate purposes through the Short Term Revolving Loan Facility until its expiration on March 7, 2000 and through the Revolving Loan Facility until its expiration on February 28, 2002. Outstanding loans under the Facility bear interest at agreed upon rates. The Facility is collateralized in part by the pledge of the stock of HC, AIC, and USSIC and by the pledge of stock and guaranties entered into by the Company's principal underwriting agency and intermediary subsidiaries. The Facility agreement contains certain restrictive covenants, including, without limitation, 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. The initial funding available under the Facility was used, among other things, to refinance existing indebtedness of the Company including all outstanding indebtedness under the Company's $120.0 million revolving credit facility entered into as of December 30, 1997, which has been terminated. As of March 13, 1999, total debt outstanding under the Facility was $176.0 million with $150.0 million due under the $150.0 million Revolving Loan Facility and $26.0 million due under the $100.0 million Short Term Revolving Loan Facility. The increase in debt subsequent to December 31, 1998 resulted from the funding of the purchase price of acquisitions. 21 FOREIGN EXCHANGE The Company's balances denominated in foreign currency fluctuate as transactions are recorded and settled. From time to time, the Company has entered into foreign currency forward contracts as a hedge against foreign currency fluctuations. Such activity has been on a very limited basis in the past. The Company did not hedge this risk in 1998, and there were no open foreign currency forward contracts as of December 31, 1998. In the future, the Company may limit its exposure to currency fluctuations through the use of foreign currency forward contracts. The Company utilizes these foreign currency forward contracts strictly as a hedge against existing exposure to foreign currency fluctuations and it does not do so as any form of speculative or trading investment. COMPETITION The insurance business is generally highly competitive. The Company faces competition from domestic and foreign insurers and underwriting agency and intermediary operations, many of whom are larger and have greater financial, marketing and management resources than the Company. The Company's profitability is affected by many other factors, including rate competition, severity and frequency of claims, interest rates, state regulations, court decisions, the judicial climate and general business conditions, all of which are outside the control of the Company. Although as an insurer, the Company's underwriting strategy is to concentrate its writings in selected, narrowly defined lines of business, the Company faces competition in these selected lines of business both from other specialty insurance companies as well as larger, more diversified insurance companies which underwrite multiple lines of business, including the lines of business underwritten by the Company. The Company's medical stop-loss business involves a diversified field of participants from small, start-up operations to large, well-established organizations. Significant growth in the number of medical stop-loss insurance underwriters and underwriting managers in the past several years has increased the level of competition in this area of the Company's business. The Company also faces intense and growing pressure in this area from alternatives to employer sponsored self-insured health plans, such as fully-insured plans, HMOs and Point of Service plans, as well as from large well established direct insurers and competing underwriting managers providing similar medical stop-loss products to those offered by the Company to employer sponsored self-insured health plans. Competition in the reinsurance marketplace is primarily due to an increase in the number of reinsurers participating in the market as well as a tendency by reinsureds to retain a greater percentage of their own risk. The Company competes with other reinsurance underwriting managers and domestic and international reinsurance companies. The Company's results of operations may also be affected by the competition for reinsurance business between broker reinsurance markets and direct marketing reinsurance companies. The Company also competes with many reinsurance intermediaries in the broker reinsurance market, some of which are affiliated with primary insurance brokers with substantial financial resources. In its underwriting agency and services operations, the Company competes with a large number of publicly traded and private firms which operate as independent insurance agencies or insurance services providers as well as with insurance companies which market insurance products directly through their employees or affiliated insurance agencies. In each of the business areas in which the Company is engaged, a significant number of the Company's competitors have financial resources, employees, facilities, market recognition, marketing, management, experience, and other resources substantially greater than those of the Company. In addition to competition in the operation of its business, the Company faces competition from a variety of sources in attracting and retaining qualified employees. REGULATION The activities of the Company are subject to licensing requirements and extensive regulation under the laws of the United States and its various states, territories and possessions, as well as the laws of other countries in which the Company's subsidiaries operate. Currently, insurance companies are generally not subject to any Federal regulation of their insurance business because of the existence of a Federal law 22 commonly known as the McCarran-Ferguson Act, which provides the insurance industry with immunity from certain aspects of the Federal anti-trust law and exempts the business of insurance from Federal regulation. Therefore, in the United States, the Company's operations are regulated primarily at the state level. The Company's business depends on the validity of, and continued good standing under, the licenses and approvals pursuant to which it operates, as well as compliance with pertinent regulations. The Company therefore devotes significant efforts toward obtaining and maintaining its licenses and compliance with a diverse and complex regulatory structure. The Company's insurance subsidiaries, in common with other insurers, are subject to regulation and supervision by the states and by other jurisdictions in which they do business. Within the states, the method of such regulation varies but generally has its source in statutes that delegate regulatory and supervisory powers to an insurance official. The regulation and supervision relates primarily to approval of policy forms and rates, the standards of solvency that must be met and maintained, including risk based capital measurements, the licensing of insurers and their agents, the nature of and limitations of investments, restrictions of the size of risks which may be insured under a single policy, deposits of securities for the benefit of policyholders, methods of accounting, periodic examinations of the affairs of insurance companies, the form and content of records of financial condition required to be filed, and reserves for unearned premiums, losses and other purposes. In general, such regulations are intended primarily for the protection of policyholders rather than shareholders. Compliance is monitored by the state insurance departments through periodic regulatory reporting procedures and periodic examinations. The quarterly and annual financial reports to the regulators in the United States utilize accounting principles which are different from the GAAP used by the Company in its reports to shareholders. SAP, in keeping with the intent to assure the protection of policyholders, is generally based on a liquidation concept while GAAP is based on a going-concern concept. In addition to the regulatory supervision of the insurance company subsidiaries of the Company, as an insurance holding company, the Company is subject to regulation under the insurance holding company system regulatory acts in the states of California, Maryland, Missouri, Oklahoma and Texas, which contain certain reporting requirements including registration and the filing of annual reports. In such registration and annual reports, the Company is required to provide current information regarding its capital structure, general financial condition, ownership, management, and the identity of each member of its insurance holding company system. The Company is also required to provide prior notice to insurance regulatory authorities of certain agreements and transactions between the Company and its affiliates. These agreements and transactions must satisfy certain standards set forth in the insurance laws and regulations of such states. Insurance holding company laws also regulate the payment of dividends and other distributions by insurance companies to their shareholders. Additionally, the underwriting agency, intermediary and services operations of the Company are subject to state insurance laws and regulations which may require the licensing of insurance agents, brokers, reinsurance intermediaries, reinsurance underwriting managers, third party administrators and underwriting agents and which regulate certain aspects of their business. These laws and regulations may include requirements for certain provisions in contracts entered into between the Company and various insurers or reinsurers, record keeping and reporting requirements, limitations on authority, advertising and business practice rules, and other matters. The manner of operating the Company's agency activities in particular states may vary according to the licensing requirements of the particular state, which may require, among other things, that a firm 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, the Company has arrangements with residents or business entities licensed to act in the state. There can be no assurance given that the Company has all such required licenses, approvals or complying contracts or that such licenses, approvals or complying contracts can always be obtained or continued. In all jurisdictions, the applicable laws and regulations are subject to amendment or interpretation by regulatory authorities. Generally, such authorities are vested with relatively broad discretion to 23 grant, renew and revoke licenses and approvals, and to implement regulations, and licenses may be denied or revoked for various reasons, including the violations of such regulations, conviction of crimes and the like. In some instances, the Company follows practices based on its interpretations, or those that it believes may be generally followed by the industry, of laws and regulations, which may be different from the requirements or interpretations of regulatory authorities. Accordingly, the possibility exists that the Company may be precluded or temporarily suspended from carrying on some or all of its activities or otherwise penalized in a given jurisdiction. Such preclusion or suspension could have a materially adverse effect on the business and results of operations of the Company. HC is domiciled and licensed as an admitted insurer in Texas, is an accredited reinsurer in 35 states (including Texas), and is an approved surplus lines insurer or is otherwise permitted to write surplus lines insurance in 46 states, three U.S. 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 (unlicensed) companies on risks which are not insured by admitted (licensed) companies. All surplus lines insurance is written through licensed surplus lines insurance brokers, who are required to ensure that no licensed admitted insurer will write a particular risk prior to placing that risk with a surplus lines insurer. Additionally, HC through its operations in Amman, Jordan (formerly IMG), is able under Jordanian law to directly underwrite non-Jordanian risks and reinsure Jordanian risks. In December, 1998, HC received regulatory approval to operate a full branch office in the United Kingdom. Such approval will impose additional regulatory requirements on HC, but management expects that such approval will also permit HC to take advantage of increased opportunities in the London insurance market, a historical focal point for specialty property and casualty risks. AIC is domiciled and licensed as an admitted insurer in Maryland and operates as a licensed admitted insurer in all other states, the District of Columbia, and all Canadian provinces (except Quebec). USSIC is domiciled and licensed as an admitted insurer in Texas and operates as a licensed admitted insurer in all other states and the District of Columbia. TIC is domiciled and licensed as an admitted insurer in Oklahoma, is an accredited reinsurer in three states (including Oklahoma), and is an approved surplus lines insurer or is otherwise permitted to write surplus lines insurance in 33 states and the District of Columbia. Under the laws of the State of Texas, HC and USSIC must maintain minimum statutory capital of $1.0 million and minimum statutory surplus of $1.0 million and may only pay dividends out of statutory earned surplus. The maximum amount of dividends that HC and USSIC may pay without prior regulatory approval in any 12 month period is the greater of each of their statutory net income for the prior year, or 10% of each of their statutory policyholders' surplus as of the prior year end. The maximum amount each company could pay as dividends at December 31, 1998, was $38.2 million and $7.9 million, respectively. Under the laws of the State of Maryland, AIC may only pay dividends out of its statutory earned surplus. The maximum amount of dividends that AIC may pay without prior regulatory approval in any 12 month period is the greater of its statutory net income (under certain conditions) or 10% of its statutory policyholders' surplus. The maximum amount at December 31, 1998 was $10.5 million. Under the laws of the State of Oklahoma, TIC may only pay dividends out of surplus funds. The maximum amount TIC may pay HC without prior regulatory approval is the greater of statutory net income excluding realized capital gains or 10% of statutory capital and surplus. That amount at December 31, 1998 was $2.2 million. On December 31, 1998, TIC paid a special dividend of $15.3 million to HC, as approved by state regulatory authorities. As a result of this transaction, any dividends by TIC during the period ended December 31, 1999 would require the prior approval of the Oklahoma Department of Insurance. 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 threshold levels that vary with the size and mix of a company's business. It is designed to identify companies with the capital levels that may require regulatory attention. As of December 31, 1998, each of the Company's domestic insurance 24 company subsidiaries' total adjusted capital is significantly in excess of the NAIC authorized control level risk-based capital. The NAIC has also developed a rating system, the Insurance Regulatory Information System ("IRIS"), primarily intended to assist sate insurance departments in overseeing the financial condition of all insurance companies operating within their respective states. IRIS consists of eleven key financial ratios that address various aspects of each insurer's financial condition and stability. The Company's insurance company subsidiaries IRIS ratios generally fall within the usual prescribed ranges except in satisfactorily explainable circumstances such as when there is a large reinsurance transaction, capital change or merger. 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. The majority of 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, have re-examined existing laws and regulations, specifically focusing on insurance company investments, issues relating to the solvency of insurance companies, licensing and market conduct issues, interpretations of existing laws, the development of new laws, and the definition of extraordinary dividends. Also, Congress and certain Federal agencies have conducted investigations of the current condition of the insurance industry in the United States to determine whether to impose Federal regulation of insurers and reinsurers. In the past several years there have been a number of recommendations that the McCarran-Ferguson Act (which generally exempts the insurance business from Federal regulation) be repealed entirely or modified to remove the industry's anti-trust exemption and subject it to Federal regulation. If the McCarran-Ferguson Act were to be repealed or modified, state regulation of the insurance business would continue. This could result in an additional layer of Federal regulation. In addition, in recent years, various 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 are generally considered to include the banking, insurance and securities industries. Such measures, which are often referred to as financial services modernization, have as a principal objective the elimination or modification of current regulatory impediments to cross-industry combinations involving banks, securities firms and insurance companies. It is likely that some form of financial services modernization legislation will eventually be enacted at the Federal level which could have significant implications on the banking, insurance and securities industries. If enacted, such legislation could result in significant cross-industry consolidations among banks, insurance companies and securities firms and increased competition in many of the areas of the Company's operations. Also from time to time, Congress and certain states have considered various legislative proposals which would provide for governmental earthquake insurance coverage. The Company does not know at this time the extent to which any or all such Federal or state legislative or regulatory initiatives will or may be adopted, and no assurance can be given that they would not, if adopted, have a material adverse effect on the Company or its results of operations. The NAIC adopted Statements of Statutory Accounting Principles ("SSAPs") in March, 1998 as a product of its attempt to codify statutory accounting principles. While subject to adoption by the individual states, the NAIC has established an effective date of January 1, 2001 for the SSAPs. Prior to the codification project, a comprehensive guide to statutory accounting principles did not exist. Codification is new and will evolve over time. Based upon the SSAPs as currently published, the Company does not expect their adoption to have a material effect on the policyholders' surplus of its individual insurance company subsidiaries. The only material effect on statutory net income is that the statutory net income for HC will be decreased or increased by a change in the method of recording equity in earnings or losses of subsidiaries. Currently HC records the equity in earnings or losses of its subsidiaries as a component of statutory net income. When codification becomes effective, the equity in earnings or losses of subsidiaries 25 will be recorded as an unrealized gain or loss which is a direct increase or decrease to policyholders' surplus. Income will not be recognized until such time (if any) that dividends are received from the subsidiaries and recorded in statutory net income. EMPLOYEES As of December 31, 1998, the Company had 1,085 employees, which included five executive officers, 51 senior management, 93 management and 936 other personnel. Of this number, 241 were employed by the Company's insurance subsidiaries, 587 were employed by the Company's underwriting agency subsidiaries, 93 were employed by the Company's insurance intermediary subsidiaries and 164 were employed by the Company's insurance services subsidiaries. The Company is not a party to any collective bargaining agreement and has not experienced work stoppages or strikes as a result of labor disputes. The Company considers relations with its employees to be good. [THE REMAINDER OF THIS PAGE LEFT INTENTIONALLY BLANK] 26 ITEM 2. PROPERTIES The Company's principal and executive offices are located in Houston, Texas, in an approximately 52,000 square foot building owned by HC. HC also owns an 81,000 square foot building, acquired in 1998, adjacent to its home office building. The Company also maintains sales and administration offices or other facilities in over 30 locations elsewhere in the United States and in England, Turkey and Jordan. The majority of these additional locations are in leased facilities. Principal office facilities of the Company, other than HC's owned facilities, are as follows:
SUBSIDIARY LOCATION SQUARE FOOT LEASE TERMINATION DATE - ---------- ---------------------------- ----------- ----------------------- LDG Re Wakefield, Massachusetts 34,000 October 31, 2001 AIC Frederick, Maryland 40,000 Owned HCCA Dallas, Texas 36,000 February 28, 2004 HCCEB Houston, Texas 27,000 August 31, 2001 and October 31, 2002
ITEM 3. LEGAL PROCEEDINGS The Company is a party to numerous claims and lawsuits which arise in the normal course of its business. Many of the pending lawsuits involve claims under policies underwritten or reinsured by the Company, the liabilities for which management believes have been adequately included in its established loss reserves. The Company believes the resolution of these lawsuits will not have a material adverse effect on its 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 1998. [THE REMAINDER OF THIS PAGE LEFT INTENTIONALLY BLANK] 27 PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS MARKET INFORMATION The Company's Common Stock trades on the New York Stock Exchange ("NYSE") under the ticker symbol "HCC". The high and low sales prices for quarterly periods during the period January 1, 1997 through December 31, 1998, as reported by the NYSE were as follows:
1998 1997 ------------------ ------------------ HIGH LOW HIGH LOW ------- ------- ------- ------- First quarter............................................................. $23 15/16 $15 5/8 $29 1/2 $22 1/2 Second quarter............................................................ 23 11/16 19 5/8 28 5/8 21 1/2 Third quarter............................................................. 22 15/16 18 1/8 32 11/16 23 1/4 Fourth quarter............................................................ 21 1/4 16 1/16 29 3/8 18 1/8
On March 19, 1999, the closing sales price of one share of the Company's Common Stock as reported by the NYSE was $18 7/16. SHAREHOLDERS The Company has one class of authorized capital stock: 250,000,000 shares of Common Stock, par value $1.00 per share. As of March 19, 1999, there were 48,809,264 shares of issued and outstanding Common Stock held by 1,629 shareholders of record; however, the Company believes there are in excess of 15,000 beneficial owners. DIVIDENDS Beginning in June, 1996, the Company announced a planned quarterly program of paying cash dividends to shareholders. The Company paid a cash dividend in July, 1996 of $0.02 per share and in each succeeding quarter until the first quarter of 1997. The Company increased the quarterly cash dividend to $0.03 per share in April, 1997 and to $0.04 per share beginning in April, 1998 and on March 8, 1999 to $0.05 per share beginning in April, 1999. The Board of Directors may review the Company's dividend policy from time to time, and any determination with respect thereto will be made in light of regulatory and other conditions then existing, including the Company's earnings, financial condition, capital requirements, loan covenants, and other related factors. Under the terms of the Company's March 8, 1999 Facility, the Company is prohibited from paying dividends in excess of an agreed upon maximum amount in any fiscal year. Such limitation will not affect the ability of the Company to pay dividends in a manner consistent with its past practice and current expectations. 28 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, (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)(1)(4) -------------------------------------------------------------- 1998 1997 1996 1995 1994 ------------ ------------ ---------- ---------- ---------- STATEMENT OF EARNINGS DATA: Revenue Net earned premium............................. $ 143,100 $ 162,571 $ 170,068 $ 158,632 $ 121,422 Management fees................................ 74,045 51,039 28,651 25,373 21,208 Commission income.............................. 38,441 24,209 21,477 21,053 16,921 Net investment income.......................... 29,335 27,587 23,593 21,757 17,786 Net realized investment gain (loss)............ 845 (328) 8,341 1,636 434 Other operating income......................... 22,268 15,239 18,656 10,371 9,832 ------------ ------------ ---------- ---------- ---------- Total revenue.............................. 308,034 280,317 270,786 238,822 187,603 Expense Loss and LAE................................... 91,302 96,514 114,464 105,374 75,898 Operating expense Policy acquisition costs..................... 10,978 13,580 8,218 10,634 9,470 Compensation expense......................... 56,077 51,458 42,102 48,162 41,728 Other operating expense...................... 36,063 31,628 26,382 26,540 21,429 Merger expense............................... 107 8,069 26,160 -- -- ------------ ------------ ---------- ---------- ---------- Net operating expense...................... 103,225 104,735 102,862 85,336 72,627 Interest expense............................... 6,021 6,004 4,993 6,471 5,697 ------------ ------------ ---------- ---------- ---------- Total expense.............................. 200,548 207,253 222,319 197,181 154,222 ------------ ------------ ---------- ---------- ---------- Earnings before income tax provision........... 107,486 73,064 48,467 41,641 33,381 Income tax provision........................... 35,208 23,305 9,885 9,896 7,328 ------------ ------------ ---------- ---------- ---------- Net earnings............................... $ 72,278 $ 49,759 $ 38,582 $ 31,745 $ 26,053 ------------ ------------ ---------- ---------- ---------- ------------ ------------ ---------- ---------- ---------- BASIC EARNINGS PER SHARE DATA: Earnings per share (2)......................... $ 1.51 $ 1.06 $ 0.86 $ 0.75 $ 0.69 ------------ ------------ ---------- ---------- ---------- ------------ ------------ ---------- ---------- ---------- Weighted average shares outstanding (2)........ 47,920 46,995 44,795 42,577 37,970 ------------ ------------ ---------- ---------- ---------- ------------ ------------ ---------- ---------- ---------- DILUTED EARNINGS PER SHARE DATA: Earnings per share (2)......................... $ 1.48 $ 1.03 $ 0.84 $ 0.74 $ 0.68 ------------ ------------ ---------- ---------- ---------- ------------ ------------ ---------- ---------- ---------- Weighted average shares outstanding (2)........ 48,936 48,209 46,043 43,113 38,529 ------------ ------------ ---------- ---------- ---------- ------------ ------------ ---------- ---------- ---------- Cash dividends declared, per share............... $ 0.16 $ 0.12 $ 0.06 ------------ ------------ ---------- ------------ ------------ ----------
29
DECEMBER, 31 (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)(1)(4) -------------------------------------------------------------- 1998 1997 1996 1995 1994 ------------ ------------ ---------- ---------- ---------- BALANCE SHEET DATA: Total investments................................ $ 525,646 $ 518,772 $ 468,725 $ 454,831 $ 348,259 Reinsurance recoverables......................... 372,672 176,965 132,328 117,700 116,365 Premium, claims and other receivables............ 382,630 252,618 168,300 155,164 133,822 Ceded unearned premium........................... 149,568 84,610 71,758 78,460 65,595 Total assets..................................... 1,709,069 1,198,132 965,793 896,476 752,798 Loss and LAE payable............................. 460,511 275,008 229,049 200,756 170,957 Unearned premium................................. 201,050 152,094 156,268 151,976 114,347 Total debt....................................... 121,600 80,750 72,917 71,628 99,508 Shareholders' equity............................. 439,863 365,601 296,524 255,484 168,760 Net tangible book value per share (2) (3)........ $ 7.29 $ 6.93 $ 6.20 $ 5.39 $ 3.88 Book value per share (2) (3)..................... $ 9.12 $ 7.66 $ 6.49 $ 5.70 $ 4.23
- ------------------------ (1) On February 27, 1998, the Company acquired all of the outstanding stock of Kachler. This business combination has been accounted for as pooling-of-interests and, accordingly, the consolidated financial data shown in this table has been restated to include the accounts and operations of Kachler for all periods presented. (2) These amounts have been adjusted to reflect the effects of the three-for-two stock split payable as a 50% stock dividend to shareholders of record March 15, 1994, and the five-for-two stock split payable as a 150% stock dividend to shareholders of record April 30, 1996. (3) Book value per share is calculated by dividing shares outstanding into total shareholders' equity. Net tangible book value per share uses total shareholders' equity less goodwill as the numerator. (4) Certain amounts in the 1997, 1996, 1995 and 1994 selected consolidated financial data have been reclassified to conform to the 1998 presentation. Such reclassifications had no effect on the Company's net earnings, shareholders' equity, or cash flows. 30 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS THIS REPORT ON FORM 10-K (THIS "REPORT") CONTAINS CERTAIN FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933, AS AMENDED, AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED, WHICH ARE INTENDED TO BE COVERED BY THE SAFE HARBORS CREATED THEREBY. INVESTORS ARE CAUTIONED THAT ALL FORWARD-LOOKING STATEMENTS NECESSARILY INVOLVE RISKS AND UNCERTAINTY, INCLUDING, WITHOUT LIMITATION, THE RISK OF A SIGNIFICANT NATURAL DISASTER, THE INABILITY OF THE COMPANY TO REINSURE CERTAIN RISKS, THE ADEQUACY OF ITS LOSS RESERVES, THE FINANCIAL VIABILITY OF REINSURERS, THE EXPANSION OR CONTRACTION IN ITS VARIOUS LINES OF BUSINESS, THE IMPACT OF INFLATION, THE IMPACT OF YEAR 2000 ISSUES, CHANGING LICENSING REQUIREMENTS AND REGULATIONS IN THE UNITED STATES AND IN FOREIGN COUNTRIES, THE ABILITY OF THE COMPANY TO INTEGRATE ITS RECENTLY ACQUIRED BUSINESSES, THE EFFECT OF PENDING OR FUTURE ACQUISITIONS AS WELL AS ACQUISITIONS WHICH HAVE RECENTLY BEEN CONSUMMATED, GENERAL MARKET CONDITIONS, COMPETITION, LICENSING AND PRICING. ALL STATEMENTS, OTHER THAN STATEMENTS OF HISTORICAL FACTS, INCLUDED OR INCORPORATED BY REFERENCE IN THIS REPORT THAT ADDRESS ACTIVITIES, EVENTS OR DEVELOPMENTS THAT THE COMPANY EXPECTS OR ANTICIPATES WILL OR MAY OCCUR IN THE FUTURE, INCLUDING, WITHOUT LIMITATION, SUCH THINGS AS FUTURE CAPITAL EXPENDITURES (INCLUDING THE AMOUNT AND NATURE THEREOF), BUSINESS STRATEGY AND MEASURES TO IMPLEMENT SUCH STRATEGY, COMPETITIVE STRENGTHS, GOALS, EXPANSION AND GROWTH OF THE COMPANY'S BUSINESSES AND OPERATIONS, PLANS, REFERENCES TO FUTURE SUCCESS, AS WELL AS OTHER STATEMENTS WHICH INCLUDES WORDS SUCH AS "ANTICIPATE", "BELIEVE", "PLAN", "ESTIMATE", "EXPECT", AND "INTEND" AND OTHER SIMILAR EXPRESSIONS, CONSTITUTE FORWARD-LOOKING STATEMENTS. ALTHOUGH THE COMPANY BELIEVES THAT THE ASSUMPTIONS UNDERLYING THE FORWARD-LOOKING STATEMENTS CONTAINED HEREIN ARE REASONABLE, ANY OF THE ASSUMPTIONS COULD OVER TIME PROVE TO BE INACCURATE AND THEREFORE, THERE CAN BE NO ASSURANCE THAT THE FORWARD-LOOKING STATEMENTS INCLUDED IN THIS REPORT WILL THEMSELVES PROVE TO BE ACCURATE. IN LIGHT OF THE SIGNIFICANT UNCERTAINTIES INHERENT IN THE FORWARD-LOOKING STATEMENTS INCLUDED HEREIN, THE INCLUSION OF SUCH INFORMATION SHOULD NOT BE REGARDED AS A REPRESENTATION BY THE COMPANY OR ANY OTHER PERSON THAT THE OBJECTIVES AND PLANS OF THE COMPANY WILL BE ACHIEVED. GENERAL The Company's primary sources of revenue are earned premium and investment income derived from its insurance company operations, management fees generated from its underwriting agency operations, commission income produced by its intermediary operations and other operating income. The Company's core underwriting activities involve providing aviation, marine, offshore energy, property, medical stop-loss, accident and health, workers' compensation and lenders' single interest insurance, which is underwritten on both a direct and a reinsurance basis, marketed directly by the Company and produced by independent agents. Many of the Company's lines of business have relatively short lead times between the occurrence of an insured event and the reporting of claims to the Company. During recent years, the Company has substantially increased its shareholders' equity through the issuance of equity securities, incurrence of debt, and earnings, thereby enabling it to increase the underwriting capacity of its insurance company subsidiaries. The Company has utilized this additional equity by increasing underwriting activity across many of its core lines of business, emphasizing lines of business and individual opportunities with the most favorable underwriting characteristics at a particular point in time. In each line of business, as an insurer, the Company also cedes premium through the purchase of reinsurance in types and amounts appropriate to the line of business, market conditions and the Company's desired net risk retention profile. The Company's underwriting agency operations underwrite domestic general aviation, medical stop-loss, occupational accident, workers' compensation, accident and health insurance and reinsurance business. The Company's intermediary operations also place insurance and reinsurance for the Company's insurance company and underwriting agency operations and other non-affiliated insurance companies and risk taking entities, as well as on behalf of medium to large corporate clients. 31 Since 1996, the Company has focused its acquisition activities on expanding its underwriting agency and intermediary operations for three principal reasons. Firstly is an attempt to increase the management fees and commission income components of the Company's total revenue, which management believes to be a more predictable and more stable source of revenue than the potential underwriting gain from insurance company operations. Secondly, an effort to insulate the Company from a decline in its net earnings growth rate as insurance premium rates become more competitive in the lines of business in which the Company specializes in and the Company becomes more selective in its underwriting approach, resulting in reduced earned premium. Thirdly, to provide a future source of premium revenue to the Company's insurance company subsidiaries. Operations whose revenue are included in other operating income consist of insurance services operations which may support the Company's operations as well as service unaffiliated customers. Additionally, this revenue includes revenue from strategic operational investments and gains and losses from their disposition. The Company may make such strategic operational investments from time to time, generally in businesses that complement the Company's operations. RESULTS OF OPERATIONS The following table sets forth certain premium revenue information for the three years ended December 31, 1998 (dollars in thousands):
1998 1997 1996 ----------- ----------- ----------- Direct..................................................................... $ 228,629 $ 177,728 $ 178,969 Reinsurance assumed........................................................ 269,647 168,671 158,309 ----------- ----------- ----------- Gross written premium.................................................... 498,276 346,399 337,278 Reinsurance ceded.......................................................... (376,393) (203,546) (154,244) ----------- ----------- ----------- Net written premium...................................................... 121,883 142,853 183,034 Change in unearned premium................................................. 21,217 19,718 (12,966) ----------- ----------- ----------- Net earned premium......................................................... $ 143,100 $ 162,571 $ 170,068 ----------- ----------- ----------- ----------- ----------- -----------
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, 1998:
1998 1997 1996 ----------- ----------- ----------- Net earned premium................................................................ 46.5% 58.0% 62.8% Management fees................................................................... 24.0 18.2 10.6 Commission income................................................................. 12.5 8.7 7.9 Net investment income............................................................. 9.5 9.8 8.7 Net realized investment gain (loss)............................................... 0.3 (0.1) 3.1 Other operating income............................................................ 7.2 5.4 6.9 ----- ----- ----- Total revenue................................................................... 100.0 100.0 100.0 Loss and LAE...................................................................... 29.6 34.4 42.3 Net operating expense............................................................. 33.5 37.4 38.0 Interest expense.................................................................. 2.0 2.1 1.8 ----- ----- ----- Earnings before income tax provision............................................ 34.9 26.1 17.9 Income tax provision.............................................................. 11.4 8.3 3.7 ----- ----- ----- Net earnings.................................................................... 23.5% 17.8% 14.2% ----- ----- ----- ----- ----- -----
32 YEAR ENDED DECEMBER 31, 1998 VERSUS YEAR ENDED DECEMBER 31, 1997 Total revenue increased 10% to $308.0 million in 1998 from $280.3 million in 1997. GWP increased 44% to $498.3 million in 1998 from $346.4 million in 1997, due primarily to increased aviation, property and accident and health premium. NWP for 1998 decreased to $121.9 million from $142.9 million in 1997, due to an increase in the amount of ceded reinsurance. Net earned premium decreased to $143.1 million in 1998 compared to $162.6 million in 1997 reflecting the reduction in NWP and the reduced retentions of the Company. Management expects GWP to increase significantly during 1999 primarily due to internal growth as the Company's underwriting agency subsidiaries transfer business from non-affiliated insurance companies to the Company's insurance company subsidiaries. NWP will increase also, due to the increase in GWP, although at a lower rate due to the continued low retention of risk. Net earned premium is expected to decrease slightly in 1999, irrespective of the expected increase in NWP, due to decreased retentions in 1998 which affect 1999 earned premium. Management fees in 1998 increased 45% to $74.0 million from $51.0 million in 1997, reflecting internal growth and the acquisition of several underwriting agencies during the period. The Company expects management fees to continue to increase substantially during 1999 due to the effects of recent and future acquisitions and internal growth. Commission income increased to $38.4 million in 1998 from $24.2 million in 1997 an increase of 59%. The increase is a result of internal growth and a number of large transactions. Commission income is expected to grow in 1999, primarily as a result of the acquisition of RML in January, 1999. Net investment income increased 6% to $29.3 million in 1998 from $27.6 million in 1997 reflecting a slightly higher level of investment assets. In 1998, the Company also utilized a substantial amount of its non-insurance company subsidiary cash flow to reduce debt and therefore interest expense, limiting the amount of cash subject to short-term investment. Management expects to follow this strategy in 1999, which, together with expected lower interest rates will produce investment income comparable to 1998. Net realized investment losses from sales of equity securities were $166,000 during 1998, compared to losses of $154,000 in 1997. Net realized investment gains from disposition of fixed income securities were $1.0 million during 1998, compared to losses of $174,000 in 1997. The gains in 1998 resulted principally from the sale of bonds upon the liquidation of IMG. Other operating income increased from $15.2 million in 1997 to $22.3 million in 1998, principally as a result of a $4.0 million pre-tax gain on the sale of one of the Company's subsidiaries whose operations were not material to those of the Company. Additionally, revenue of a service company subsidiary increased $2.0 million in 1998. Policy acquisition costs, which are net of ceding commissions on reinsurance ceded, decreased $2.6 million or 19% between 1998 and 1997. The decrease reflects a lower level of retained premium. Operating earnings for 1998 were impacted by Hurricanes Georges and Mitch. The gross loss from these hurricanes amounted to more than $50.0 million before reinsurance, with Georges being the largest catastrophe loss ever incurred by the Company. The net retained loss after reinsurance and taxes was $3.8 million, or $0.08 per share. This catastrophe further demonstrates how the Company's conservative reinsurance philosophy protects shareholders' equity and limits the impact of a major catastrophe loss. To further mitigate against subsequent catastrophes, the Company currently maintains lower retentions and anticipates further reductions in overall catastrophe exposure in the future. AIC, acquired in June, 1997, recorded a $10.0 million increase in loss and LAE reserves during December, 1997, predominantly relating to 1995 and 1996 claims incurred prior to the Company's acquisition of AIC. This increase in reserves was made to bring AIC's reserving practices consistent with the more conservative method used by the Company's other insurance company operations. Management 33 expects the increase in AIC's loss reserves to be adequate to cover any subsequent adverse development of AIC's prior losses. Loss and LAE decreased $5.2 million in 1998, to $91.3 million, reflecting the reduction in risk retention, despite the catastrophe loss in 1998 from the Hurricanes Georges and Mitch. Excluding the effects of the catastrophe loss in 1998 and AIC's reserve strengthening in 1997, loss and LAE decreased $692,000 and the Company's GAAP loss ratio increased to 60.0% in 1998 from 53.2% in 1997. Including these effects, the Company's GAAP loss ratio increased to 63.8% for 1998 from 59.4% in 1997. Both increases reflect the higher incurred losses and LAE on substantially lower earned premium in 1998 when compared to 1997. Additionally, the increased loss ratios reflect a general deterioration in pricing in 1998 coupled with a higher frequency of attritional losses. The Company's insurance company subsidiaries statutory combined ratio was 82.9% for 1998 compared to 78.8% for 1997. The Company's combined ratio remains significantly better than the industry average. During 1998, the Company had net loss and LAE redundancy of $14.6 million relating to prior year losses compared to a redundancy of $3.8 million in 1997. During 1998, the Company had gross loss and LAE deficiency of $33.5 million compared to a deficiency of $23.2 million in 1997. The gross deficiency results from the development of several large claims on individual policies which were either reported late or reserves were increased as subsequent information became available. However, as most of these policies were substantially reinsured, there is no material effect to the Company's net earnings. The redundancies in the net reserves result from the Company's and its actuaries' continued review of its loss reserves and the reduction of such reserves as losses are finally settled and claims exposures are reduced. The Company continues to believe it has materially provided for all net incurred losses. Compensation expense increased $4.6 million or 9% in 1998 to $56.1 million due to the increase in personnel resulting from acquisitions completed during 1998, along with an increase in management personnel to oversee the operations of the rapidly expanding group. Other operating expense increased 14% to $36.1 million in 1998. These expenses reflect increased expenditures required to meet the overall growth in business and from acquisitions. Currency conversion gains amounted to $219,000 in 1998, compared to losses of $884,000 in 1997. Merger expense represents non-recurring items incurred to consummate the acquisitions and mergers which are accounted for as pooling-of-interests. Income tax expense was $35.2 million in 1998, compared to $23.3 million in 1997. The Company's effective tax rate was 32.8% in 1998 compared to 31.9% in 1997. As net income from the underwriting agency and intermediary operations grow, the Company's effective tax rate increases due to state income taxes and the mitigation of the effect of tax exempt municipal bond income on the combined effective tax rate. Net earnings increased 45% to $72.3 million in 1998, from $49.8 million in 1997. Diluted earnings per share increased 44% to $1.48in 1998 from $1.03 in 1997. YEAR ENDED DECEMBER 31, 1997 VERSUS YEAR ENDED DECEMBER 31, 1996 Total revenue increased to $280.3 million in 1997 from $270.8 million in 1996. GWP increased to $346.4 million in 1997 from $337.3 million in 1996, due primarily to increased aviation and accident and health premium offset by decreased property and marine premium. NWP for 1997 decreased to $142.9 million from $183.0 million in 1996, due to an increase in the amount of ceded reinsurance. Net earned premium decreased to $162.6 million in 1997 compared to $170.1 million in 1996 reflecting the reduction in NWP and the reduced retentions of the Company. Management fees in 1997 increased 78% to $51.0 million from $28.7 million in 1996, reflecting internal growth and the acquisition of several underwriting agencies in 1997. Commission income in 1997 34 increased 13% to $24.2 million from $21.5 million in 1996, reflecting internal growth. Net investment income increased 17% to $27.6 million in 1997 from $23.6 million in 1996 reflecting a higher level of investment assets. Net realized investment losses from sales of equity securities were $154,000 during 1997, compared to gains of $8.3 million in 1996. During 1996, the Company systematically liquidated the majority of its equity portfolio. Net realized investment losses from disposition of fixed income securities were $174,000 during 1997, compared to gains of $29,000 in 1996. During 1996, the Company sold one of its subsidiaries. This sale generated an after tax gain of $2.2 million or $0.05 per share and is included in other operating income. Policy acquisitions costs, which are net of ceding commissions on reinsurance ceded, increased $5.4 million or 65% between 1997 and 1996. The increase reflects a higher average commission rate due to increase in the accident and health line of business plus a $5.2 million ceded profit commission in 1996 compared to $519,000 in 1997. AIC, acquired in June, 1997, recorded a $10.0 million increase in loss and LAE reserves during December, 1997, predominately relating to 1995 and 1996 claims incurred prior to the Company's acquisition of AIC. This increase in reserves was made to bring AIC's reserving practices consistent with the more conservative method used by the Company's other insurance company operations. Management expects the increase in AIC's loss reserves to be adequate to cover any subsequent adverse development of AIC's prior losses. Loss and LAE decreased $18.0 million in 1997, to $96.5 million, reflecting the increased use of reinsurance, despite the $10.0 million reserve strengthening charge taken by AIC. During 1997, the Company had net loss and LAE redundancy of $3.8 million relating to prior year losses compared to a redundancy of $4.9 million in 1996. During 1997, the Company had gross loss and LAE deficiency of $23.2 million compared to a deficiency of $42.5 million in 1996. The gross deficiency comes from two primary sources. Firstly, the development of several large claims on individual policies which were either reported late or reserves were increased as subsequent information became available; however, as most of these policies were substantially reinsured, there is no material effect to the Company's net earnings. Secondly, is the run-off of the retrocessional excess of loss business which the Company underwrote between 1988 and 1991. This development, $1.6 million in 1997 compared to $11.3 million in 1996, is primarily due to the delay in reporting of catastrophe losses by the London insurance market, coupled with the unprecedented number of catastrophes during the period in which the Company underwrote this business. This business is also substantially reinsured, thereby not having a material effect on the Company's net earnings. Compensation expense increased $9.4 million or 22% in 1997, to $51.5 million due to the increase in personnel resulting from acquisitions completed during 1997, along with an increase in management personnel to oversee the operations of the rapidly expanding group. Other operating expense increased 20% to $31.6 million in 1997. These expenses reflect increased expenditures required to meet the overall growth in business and from acquisitions. Currency conversion losses amounted to $884,000 in 1997, compared to losses of $181,000 in 1996. Merger expense represents non-recurring items incurred to consummate the acquisitions and mergers which are accounted for as pooling-of-interests. The amounts incurred during 1996 were due to the combination with LDG and included a compensatory stock grant of $24.0 million to certain key LDG employees immediately prior to the merger. Interest expense during 1997 increased 20% to $6.0 million from $5.0 million during 1996 due to the increased level of indebtedness primarily to fund the cash portion of acquisitions. 35 Income tax expense was $23.3 million in 1997, compared to $9.9 million in 1996. The 1996 amount included a deferred tax benefit of $9.6 million which was recorded in connection with the compensatory stock grant to certain key LDG employees. The compensation expense was a non-cash item; however, $9.6 million of actual cash tax savings will be recognized beginning from the grant date. Most of the other merger expenses are not deductible for income tax purposes. Also, as an S Corporation, LDG was exempt from Federal income taxes through May 21, 1996. Had LDG been subject to Federal income tax during the period January 1, 1996 to May 21, 1996, additional income tax expense of $2.3 million would have been recorded in 1996. Net earnings increased 29% to $49.8 million in 1997 from $38.5 million in 1996. Diluted earnings per share increased 23% to $1.03 in 1997 from $0.84 in 1996. The Company's insurance company subsidiaries' statutory combined ratio was 78.8% for 1997 compared to 83.6% in 1996. The Company's combined ratio remains significantly better than the industry average. LIQUIDITY AND CAPITAL RESOURCES The Company receives substantial cash from premiums, reinsurance recoverables, management fees and commission income and, to a lesser extent, investment income, and proceeds from sales and redemptions of investment assets. The principal cash outflows are for the payment of claims and LAE, payment of premiums to reinsurers, purchase of investments, debt service, policy acquisition costs, operating expenses, income and other taxes and dividends. At December 31, 1998, several of the Company's subsidiaries maintained revolving lines of credit with a bank in the combined maximum amount of $40.0 million available through December 30, 1999. Advances under the lines of credit are primarily used to fund draws, if any, on letters of credit issued by the bank on behalf of the subsidiaries. The lines of credit are collateralized by securities having an aggregate market value of up to $50.0 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 (7.75% at December 31, 1998). At December 31, 1998, letters of credit totaling $19.8 million had been issued to insurance companies by the bank on behalf of the subsidiaries, with total securities collateralizing the line of $24.8 million. On March 8, 1999, the Company entered into a Loan Agreement (the "Facility") with a group of banks. The Facility includes a $150.0 million Revolving Loan Facility and $100.0 million Short Term Revolving Loan Facility. Borrowing under the Facility may be made from time to time by the Company for general corporate purposes through the Short Term Revolving Loan Facility until its expiration on March 7, 2000 and through the Revolving Loan Facility until its expiration on February 28, 2002. Outstanding loans under the Facility bear interest at agreed upon rates. The Facility is collateralized in part by the pledge of the stock of HC, AIC, and USSIC and by the pledge of stock and guaranties entered into by the Company's principal underwriting agency and intermediary subsidiaries. The Facility agreement contains certain restrictive covenants, including, without limitation, 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. The initial funding available under the Facility was used, among other things, to refinance existing indebtedness of the Company including all outstanding indebtedness under the Company's $120.0 million revolving credit facility entered into as of December 30, 1997, which has been terminated. As of March 13, 1999, total debt outstanding under the Facility was $176.0 million with $150.0 million due under the $150.0 million Revolving Loan Facility and $26.0 million due under the $100.0 million Short 36 Term Revolving Loan Facility. The increase in debt subsequent to December 31, 1998 resulted from the funding of the purchase price of acquisitions. The Company maintains a substantial level of cash and liquid short-term investments which are used to meet anticipated payment obligations. As of December 31, 1998, the Company had cash and short-term investments of approximately $145.1 million. The Company's consolidated investment portfolio of $525.6 million as of December 31, 1998 (of which $129.1 million is short-term investments), is available to provide additional liquidity and cash for operations. Property and casualty insurance companies domiciled in the State of Texas are limited in the payment of dividends to their shareholders in any 12 month period, without the prior written consent of the Commissioner of Insurance, to the greater of statutory net income or 10% of statutory policyholders' surplus. HC paid no dividends to HCC in 1998. During 1999, HC's ordinary dividend capacity will be approximately $38.2 million. Under the laws of the State of Maryland, AIC may only pay dividends out of statutory earned surplus. The maximum amount of dividends that AIC may pay without prior regulatory approval in any 12 month period is the greater of its statutory net income (under certain conditions) or 10% of its statutory policyholders' surplus. The maximum amount at December 31, 1998 was $10.5 million. The Company believes that its operating cash flows, short-term investments and the Facility will provide sufficient sources of liquidity to meet its anticipated needs for the foreseeable future. At December 31, 1998, the Company had a net deferred tax asset of $3.4 million compared to $6.6 million at December 31, 1997. Due to the Company's history of consistent earnings and expectations for the future, it is more likely than not that the Company will be able to realize the benefit of its deferred tax asset. The overall increase in activities at the insurance company subsidiaries resulted in increases in gross loss reserves, gross unearned premiums, deferred policy acquisition costs and deferred ceding commissions since December 31, 1997. The Company continues to collect its receivables and recoverables generally in the ordinary course and has not incurred and does not expect to incur any significant liquidity difficulties as a result of the substantial growth in gross amounts due. The Company limits any liquidity exposure it may have by holding funds, letters of credit or other security such that net balances due to it are significantly less than the gross balances shown in the consolidated balance sheet. As of December 31, 1998, each of the domestic insurance company subsidiaries' total adjusted capital is significantly in excess of the NAIC authorized control level risk-based capital. Industry and regulatory guidelines suggest that a property and casualty insurer's annual statutory GWP should not exceed 900% of its statutory policyholders' surplus and NWP should not exceed 300% of its statutory policyholders' surplus. The Company's insurance company subsidiaries maintain a premium to surplus ratio significantly lower than such guidelines, and for the year ended December 31, 1998, their annual statutory GWP was 135.6% of their statutory policyholders' surplus and their NWP was 33.4% of their statutory policyholders' surplus. IMPACT OF INFLATION The Company's 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 LAE are known. Although management considers the potential effects of inflation when setting premium rates, for competitive reasons, such premiums may not adequately compensate the Company for the effects of inflation. However, as the majority of the Company's business is comprised of lines which have short lead times between the occurrence of an insured event, reporting of the claims to the Company and the final settlement of the claims, the effects of inflation are minimized. 37 A significant portion of the Company's revenue is related to healthcare insurance and reinsurance products which are subject to the effects of the underlying inflation of medical 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. No express provision for inflation is made, although trends are considered when setting underwriting terms and claim reserves. Claim reserves are subject to a continuing review process to assess their adequacy and are adjusted as deemed appropriate. In addition, the market value of the investments held by the Company varies depending on economic and market conditions and interest rates, which are highly sensitive to the policies of governmental and regulatory authorities. Any significant increase in interest rates could therefore have a material adverse effect on the market value of the Company's investments. In addition, the Company's $250.0 million Facility's interest rate floats with that of the market. Any significant increase in interest rates could result in increased interest costs under the Facility, which could have a material adverse effect on earnings. EXCHANGE RATE FLUCTUATIONS The Company underwrites risks which are denominated in a number of foreign currencies. It establishes and maintains loss reserves with respect to these policies in their respective currencies. These reserves are subject to exchange rate fluctuations which can have an effect on the Company's net earnings. The Company's principal area of exposure is with respect to fluctuation in the exchange rate between the major European currencies and the United States Dollar. For the years ended December 31, 1998, 1997 and 1996, the gain (loss) from currency conversion was $219,000, ($884,000) and ($181,000), respectively. The Company's balances denominated in foreign currencies fluctuate as transactions are recorded and settled. From time to time the Company has entered into foreign currency forward contracts as a hedge against foreign currency fluctuations. Such activity has been on a very limited basis in the past. The Company did not hedge this risk in 1998 and there were no open foreign currency forward contracts as of December 31, 1998. In the future, the Company may limit its exposure to currency fluctuations through the use of foreign currency forward contracts. 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. EFFECTS OF RECENT ACCOUNTING PRONOUNCEMENTS The Company adopted Statement of Financial Accounting Standards (SFAS") No. 130 entitled "Reporting Comprehensive Income" in 1998. This statement required that all components of comprehensive income be reported in a full set of financial statements and that the amount of total comprehensive income be reported. Other comprehensive income includes gains and losses that are excluded from net income, but are added to or deducted from net earnings in order to calculate comprehensive income. Unrealized investment gains and losses of investments and net unrealized gains and losses on foreign currency translation are examples of such items. The Company also adopted SFAS No. 131 entitled "Disclosures about Segments of an Enterprise and Related Information" in 1998. This statement changed the way the Company reports information about its operating segments. The agency segment from prior years is now split into the underwriting agency and intermediary segments. The corporate and other segment from prior years is now split into two segments, other operations and corporate. Adoption of SFAS No. 131 had no effect on the Company's consolidated financial position, results of operations or shareholders' equity. SFAS No. 133 entitled "Accounting for Derivative Instruments and Hedging Activities" was issued in June, 1998. The statement is effective for all fiscal quarters and years beginning after June 15, 1999. The 38 Company has utilized derivatives or hedging strategies only infrequently in the past and in immaterial amounts, although it may do so more frequently in the future as it expands its foreign operations. The Company is not a party to any derivatives or hedging activities at December 31, 1998. The effect of the Statement as well as the timing of its adoption are currently being reviewed by management. In December, 1997, the American Institute of Certified Public Accountants' Accounting Executives Standards Committee ("AcSEC") issued Statement of Position ("SOP") 97-3, "Accounting by Insurance and Other Enterprises for Insurance-Related Assessments," which provides guidance on accounting by all entities that are subject to insurance-related assessments. It requires that entities should recognize liabilities for insurance-related assessments when certain specified criteria have been met. This SOP is effective for financial statements for fiscal years beginning after December 15, 1998. The Company does not expect the adoption of this SOP to have a material effect on the Company's financial position, results of operations or shareholders' equity. In November, 1998, AcSEC issued SOP 98-7, "Deposit Accounting: Accounting for Insurance and Reinsurance Contracts That Do Not Transfer Insurance Risk." The SOP provides guidance as to the use of deposit accounting for insurance and reinsurance contracts that do not transfer insurance risk. This SOP is effective for financial statements for fiscal years beginning after June 15, 1999. The Company does not expect the adoption of this SOP to have a material effect on the Company's financial position, results of operations or shareholders' equity. YEAR 2000 The Year 2000 issue is the result of date coding within computer programs that were written using just two digits rather than four digits to define the applicable year. If not corrected, these date codes could cause computers to fail to calculate dates beyond 1999 and, as a result, computer applications could fail or create erroneous results by or at the Year 2000. The Company, together with outside vendors engaged by the Company, has made assessments of the Company's potential Year 2000 exposure related to its computerized information systems and is currently engaged in efforts to remediate and test these systems for potential Year 2000 exposures. The Company has also made assessments of the potential Year 2000 exposure associated with its embedded technology systems, such as telephone systems, environmental control systems and elevators, and does not believe that it has significant Year 2000 exposure in this area. The Company is currently involved in discussion with important suppliers, business partners, customers and other third parties to determine the extent to which the Company may be vulnerable to the failure of these parties to identify and correct their own Year 2000 issues. Based upon information received from these third parties, management does not believe that the Company has any significant Year 2000 exposures related to its third party relationships. In addition to its own systems and third-party relationships, the Company may also have exposure in the property and casualty operations of its insurance company subsidiaries to claims asserted under certain insurance policies for damages caused by an insured's failure to address its own Year 2000 computer problems. Together with other companies in the insurance industry, the Company has and continues to evaluate the potential insurance exposures arising from Year 2000 problems or responses. The Company's insurance company subsidiaries do not generally offer policies of insurance marketed as Year 2000 liability coverage. However, due to the nature of certain of the policies, such as policies of property insurance, insureds may attempt to submit claims for coverage under such policies which may be result from Year 2000 related causes. In this regard, the Company is currently assessing what modifications or responses may be appropriate related to the insurance coverages currently offered by such subsidiaries in light of coverage issues associated with the Year 2000 problem. Due to the difficulty in accurately assessing potential Year 2000 losses, if any, related to Year 2000 coverage issues, it is not possible to reasonably estimate their potential effects on the Company's financial position and results of operations. 39 The Company's own software vendor subsidiary has completed its Year 2000 compliance plan, and, based upon the results, management believes that the subsidiary's products are Year 2000 compliant. The Company is utilizing and will continue to utilize both internal and external resources to evaluate and mitigate its Year 2000 exposures in advance of respective critical dates. Further, in the ongoing acquisition of technology and business equipment, the Company generally requires that its vendors certify the Year 2000 compliance of acquired products. The Company relies upon such certifications. During the two years ended December 31, 1998, the Company expensed $546,000 with respect to Year 2000 compliance and capitalized $6 million with respect to new software purchases and installations which are Year 2000 compliant. The total estimated remaining cost of modification of existing software and new Year 2000 compliant systems is $1.5 million which includes $1.2 million attributable to the planned purchase and implementation of new systems. The cost of this new software is being capitalized. The remaining estimated cost of $230,000 will be expensed as incurred over the next twelve months. The Company does not track internal costs with respect to the expenses related to Year 2000 remediation. The level of expense anticipated in connection with the Year 2000 issues is not expected to have a material effect on the Company's results of operations. The costs of the Company's Year 2000 compliance efforts are expected to be funded out of operating cash flow, which is sufficient to provide funding. To date, no material information technology projects of the Company have been delayed as a result of the Company's Year 2000 compliance efforts. The Company believes that its Year 2000 compliance plan will be successful based upon its progress to date. Many of the Company's major systems have been replaced or remediated, where necessary, including that of a major insurance company subsidiary, and are currently successfully processing business and information that contain the Year 2000 or later years. No new information has come to management's attention that would indicate that the plan should be altered significantly or that the plan will not be successful in the time frame prescribed by the plan. Nevertheless, the Company is in the process of developing a contingency plan for the remote possibility that there could be an unforeseen Year 2000 failure. Such plan will develop and document procedures to address any material Year 2000 failures until remediation of the related systems could be performed. The dates of expected completion and the costs of the Company's Year 2000 remediation efforts are based on management's estimates, which were derived utilizing assumptions of future events, including the availability of certain resources, third party remediation plans and other factors. There can be no guarantee that these estimates will be achieved, and if the actual timing and costs for the Company's Year 2000 remediation program differ materially from those anticipated, the Company's financial results and financial condition could be significantly affected. Additionally, despite testing by the Company, the Company's systems may contain undetected errors or defects associated with Year 2000 date functions. The inability of the Company to correctly identify significant Year 2000 issues for remediation or to complete its Year 2000 remediation and testing efforts prior to respective critical dates, the failure of its contingency planning, the failure of third parties with whom the Company has an important relationship to identify, remediate and test their own Year 2000 issues and the resulting disruption which could occur in the Company's systems, the impact of future acquisitions in which Year 2000 issues in the acquired systems have not been remediated or tested and the inability of the Company to adequately address coverage issues related to its insurance company subsidiaries, could have material adverse effects on the Company's business, results of operations, cash flows and financial condition. 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 their common legal currency on that date. The participating countries' former national currencies will continue to serve as legal tender and denominations of the Euro between January 1, 1999 and January 1, 2002. The 40 conversion to the Euro is scheduled to be completed on July 1, 2002, when the national currencies will cease to exist. The Company does not expect the introduction of the Euro to have a material effect on the Company's business, software plans, financial condition or results of operations. [THE REMAINDER OF THIS PAGE LEFT INTENTIONALLY BLANK] 41 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK The Company's 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. The Company's 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 its reinsurance recoverables and foreign currency exchange risk. To manage its exposures of investment risks, the Company generally invests in investment grade securities with characteristics of duration and liquidity to reflect the underlying characteristics of its insurance liabilities. The Company does not use derivatives to manage any of its 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 (but not limited to): - Market changes could be different from market changes assumed below, - Amounts and balances on which the estimates are based are likely to change over time, - Not all factors and balances are taken into account, and - Assumptions used in the models may prove to be inaccurate. INTEREST RATE RISK The Company's portfolio of fixed income securities is inversely correlated to changes in the market interest rates. In addition, some of the companies fixed income securities have call or prepayment options, which could subject the Company to reinvestment risk. Should interest rates fall, issuers call their securities, and the Company reinvests the proceeds at lower interest rates. The fair value of the Company's fixed income securities as of December 31, 1998 was $393.2 million. If interest rates were to change 1%, the fair value of the Company's fixed income securities would change approximately $21.9 million. The change in fair value was determined using duration modeling assuming no prepayments. The Facility entered into by the Company is subject to variable interest rates. Thus, the Company's interest expense is directly correlated to market interest rates. As of March 31, 1999, the Company had $176.0 million in debt outstanding. At this debt level, a 1% change in market interest rates would change the Company's interest expense by $1.8 million. EQUITY RISK The Company's portfolio of marketable equity securities is subject to equity price risk due to market changes. The fair value of the Company's marketable equity securities (including those designated as strategic operational investments) as of December 31, 1998 was $18.2 million. If the market price of all marketable equity securities were to change by 10%, the fair value of the Company's equity portfolio would change $1.8 million. 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 Company underwrites risks which are denominated in a number of foreign currencies. It establishes and maintains loss reserves with respect to these policies in their respective currencies, as well as having varying receivable and payable balances at any point in time. These amounts are subject to 42 exchange rate fluctuations which can have an effect on the Company's net earnings. The Company's principal area of exposure is with respect to fluctuation in the exchange rate between the major European currencies and the United Sates Dollar. The table below shows the net amounts of significant foreign currency balances at December 31, 1998 converted to US Dollars. It also shows the expected dollar change in fair value that would occur if exchange rates changed 10% from December 31, 1998 exchange rates.
HYPOTHETICAL 10% US DOLLAR CHANGE IN EQUIVALENT FAIR VALUE ------------ ---------------- Great Britain Pound............................................................... $ 8,086,000 $ 809,000 11 Euro currencies................................................................ 2,296,000 230,000
On a historical basis, the eleven national currencies which are now in the process of being converted to the Euro have not always had their relative exchange rates change together. However, with the fixing of exchange rates on January 1, 1999, relative to the new Euro, these currencies will now behave as one currency. From time to time the Company enters into foreign currency forward contracts as a hedge against foreign currency fluctuations. The Company did not hedge this risk in 1998 and there were no open foreign currency forward contracts as of December 31, 1998. In the future, the Company may limit its exposure to currency fluctuations through the use of foreign currency forward contracts. 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. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The consolidated financial statements required in response to this section are submitted as part of Item 14 of this report. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES None. 43 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, 1998, 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, 1998, 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, 1998, 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, 1998, and which is incorporated herein by reference. [THE REMAINDER OF THIS PAGE LEFT INTENTIONALLY BLANK] 44 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 the Company during the fourth quarter of 1998. [THE REMAINDER OF THIS PAGE LEFT INTENTIONALLY BLANK] 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 Dated: March 31, 1999 AND CHIEF EXECUTIVE OFFICER 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 - ------------------------------ --------------------------- ------------------- Chairman of the Board of /s/ STEPHEN L. WAY Directors and Chief - ------------------------------ Executive Officer March 31, 1999 (Stephen L. Way) (Principal Executive Officer) /s/ ARTHUR S. BERNER* - ------------------------------ Director March 31, 1999 (Arthur S. Berner) /s/ JAMES M. BERRY* - ------------------------------ Director March 31, 1999 (James M. Berry) /s/ FRANK J. BRAMANTI* - ------------------------------ Director and Executive Vice March 31, 1999 (Frank J. Bramanti) President /s/ PATRICK B. COLLINS* - ------------------------------ Director March 31, 1999 (Patrick B. Collins) /s/ J. ROBERT DICKERSON* - ------------------------------ Director March 31, 1999 (J. Robert Dickerson) Senior Vice President and /s/ EDWARD H. ELLIS, JR. Chief Financial Officer - ------------------------------ (Chief Accounting March 31, 1999 (Edward H. Ellis, Jr.) Officer) /s/ EDWIN H. FRANK, III* - ------------------------------ Director March 31, 1999 (Edwin H. Frank, III) /s/ ALAN W. FULKERSON* - ------------------------------ Director March 31, 1999 (Alan W. Fulkerson)
46 /s/ WALTER J. LACK* - ------------------------------ Director March 31, 1999 (Walter J. Lack) /s/ STEPHEN J. LOCKWOOD* - ------------------------------ Director and Vice Chairman March 31, 1999 (Stephen J. Lockwood) /s/ JOHN N. MOLBECK, JR. - ------------------------------ Director and President March 31, 1999 (John N. Molbeck, Jr.) /s/ PETER B. SMITH, JR.* - ------------------------------ Director and Executive Vice March 31, 1999 (Peter B. Smith, Jr.) President
*By: /s/ JOHN N. MOLBECK, JR. ------------------------- March 31, 1999 John N. Molbeck, Jr., ATTORNEY-IN-FACT 47 INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES Reports of Independent Accountants................................................... F-1 Consolidated Balance Sheets at December 31, 1998 and 1997............................ F-3 Consolidated Statements of Earnings for the three years ended December 31, 1998...... F-4 Consolidated Statements of Comprehensive Income for the three years ended December 31, 1998........................................................................... F-5 Consolidated Statements of Changes in Shareholders' Equity for the three years ended December 31, 1998.................................................................. F-6 Consolidated Statements of Cash Flows for the three years ended December 31, 1998.... F-9 Notes to Consolidated Financial Statements........................................... F-10 SCHEDULES: Reports of Independent Accountants on Financial Statement Schedules....... S-1 Schedule 1 Summary of Investments other than Investments in Related Parties........ S-3 Schedule 2 Condensed Financial Information of Registrant........................... S-4 Schedule 3 Supplementary Insurance Information..................................... S-9 Schedule 4 Reinsurance............................................................. 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. 48 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 - ------------ (A)3.4 --Bylaws of HCC Insurance Holdings, Inc., as amended. (J)3.7 --Restated Certificate of Incorporation of HCC Holdings, Inc., filed with the Delaware Secretary of State on July 23, 1996. (A)4.1 --Specimen of Common Stock Certificate, $1.00 par value, of HCC Insurance Holdings, Inc. (A)10.17 --Cost Allocation Agreement dated September 1, 1991, by and among HCC Holdings, A Texas Corporation, Houston Casualty Company, Trafalgar Reinsurance Company Ltd., Houston Re Corporation and HCC Underwriters, A Texas Corporation (A)10.19 --Agreement for Allocation of Federal Income Tax dated November 29, 1991, by and among HCC Holdings, Inc., Houston Casualty Company, SBS Insurance Holdings, Trafalgar Reinsurance Company, Ltd., HCC Underwriters and Houston Re Corporation (A)10.23 --HCC Insurance Holdings, Inc. 1992 Incentive Stock Option Plan (A)10.24 --Program License Agreement dated April 29, 1992, by and between EPG America, Inc., and HCC Holdings, Inc. pertaining to license for the computer services described therein (B)10.227 --Loan Agreement dated August 24, 1993 in the original principal amount of $29,250,000 executed by HCC Insurance Holdings, Inc., payable to First Interstate Bank of Texas, N.A. together with Promissory Note and Commercial Pledge Agreement relating thereto. (B)10.227.1 --Change in Loan Agreement dated February 7, 1994 between HCC Insurance Holdings, Inc. and First Interstate Bank of Texas, N.A. relating to the $29,250,000 loan. (B)10.228 --Promissory Note dated February 25, 1994 in the original principal amount of $12,000,000 executed by Houston Casualty Company, payable to First Interstate Bank of Texas, N.A. together with Commercial Pledge Agreement relating thereto. (C)10.302 --Aircraft Dry Lease Agreement effective January 4, 1995 between SLW Aviation, Inc. and HCC Insurance Holdings, Inc. (C)10.303 --Stock Purchase Agreement effective January 1, 1994 between River Investments Limited and HCC Underwriters, A Texas Corporation related to the acquisition of 25% of Middle East Insurance Brokers Ltd. (C)10.304 --Stock Purchase Agreement effective October 1, 1994 between various shareholders of Middle East Insurance Brokers Ltd. and HCC Insurance Holdings, Inc. related to the acquisition of 75% of Middle East Insurance Brokers Ltd. (C)10.305 --Stock Purchase Agreement effective October 1, 1994 between various shareholders of International Marine & General Insurance Company Ltd. and HCC Insurance Holdings, Inc. related to the acquisition of 100% of International Marine & General Insurance Company Ltd. (C)10.306 --Loan Agreement dated November 29, 1994 in the original principal amount of $20,000,000 executed by HCC Insurance Holdings, Inc., payable to First Interstate Bank of Texas, N.A. together with the Promissory Note.
49
EXHIBIT NUMBER - ------------ (D)10.320 --Promissory note dated April 30, 1995, in the original principal amount of $12,000,000 executed by Houston Casualty Company, payable to First Interstate Bank of Texas, N.A. (E)10.324 --HCC Insurance Holdings, Inc. 1994 Non-employee Director Stock Option Plan. (F)10.325 --HCC Insurance Holdings, Inc. 1995 Flexible Incentive Plan. (H)10.326 --Agreement and Plan of Reorganization dated February 22, 1996 between various shareholders of LDG Management Company Incorporated and affiliated companies and HCC Insurance Holdings, Inc. related to the acquisition of 100% of the common stock of LDG Management Company Incorporated and affiliated companies. (I)10.327 --Agreement and Plan of Reorganization dated February 28, 1997 between Avemco Corporation and HCC Insurance Holdings, Inc. related to the intent to merge in a stock for stock transaction. (J)10.328 --HCC Insurance Holdings, Inc. 1996 Non-employee Director Stock Option Plan. (K)10.329 --HCC Insurance Holdings, Inc. 1995 Flexible Incentive Plan. (L)10.330 --Agreement and Plan of Reorganization dated November 27, 1996 between various shareholders of North American Special Risk Associates and affiliated companies and HCC Insurance Holdings, Inc. related to the acquisition of 100% of the common stock of North American Special Risk Associates, Inc. and affiliated companies. (L)10.331 --Agreement of Purchase and Sale dated January 23, 1997, between TRM International, Inc., Unicover Manager, Inc., North American Special Risk Associates, Inc. and HCC Insurance Holdings, Inc. (L)10.332 --Revolving Line of Credit Note dated October 7, 1996, in the original principal amount of $12,000,000 executed by Houston Casualty Company, payable to Wells Fargo Bank (Texas), National Association together with Credit Agreement and General Pledge Agreement and Amendment relating thereto. (L)10.333 --Revolving Line of Credit Note dated January 10, 1997, in the original principal amount of $10,000,000 executed by HCC Insurance Holdings, Inc., payable to Wells Fargo Bank (Texas), National Association together with Credit Agreement and General Pledge Agreement relating thereto. (N)10.334 --Agreement and Plan of Reorganization dated April 30, 1997 among Interworld Corporation, Aviation & Marine Insurance Group, Inc., various shareholders of those companies and HCC Insurance Holdings, Inc. related to the acquisition of 100% of the common stock of Interworld Corporation. (O)10.335 --Stock Purchase Agreement dated June 27, 1997 between Sandra L. Ruder and HCC Insurance Holdings, Inc. related to the purchase of 100% of the common stock of Managed Group Underwriting, Inc. (P)10.336 --Stock Purchase Agreement dated July 31, 1997 between Continental Aviation Underwriters, Inc., the shareholders thereof, and HCC Insurance Holdings, Inc. related to the purchase of 100% of the common stock of Continental Aviation Underwriters, Inc. (P)10.337 --Acquisition Agreement dated August 8, 1997 between Southern Aviation Insurance Underwriters, Inc., Aviation Claims Administrators, Inc., the shareholders thereof, and HCC Insurance Holdings, Inc. related to the acquisition of 100% of the common stock of Southern Aviation Insurance Underwriters, Inc. and Aviation Claims Administrators, Inc.
50
EXHIBIT NUMBER - ------------ (P)10.338 --Line of Credit Agreements payable to Wells Fargo Bank (Texas), National Association executed by HCC Insurance Holdings, Inc., Houston Casualty Company and IMG Insurance Company, Ltd. together with the Credit Agreements and Security Agreements related thereto. (Q)10.339 --Loan Agreement ($120,000,000 Revolving Loan Facility) dated as of December 19, 1997 among HCC Insurance Holdings, Inc. as Borrower, Wells Fargo Bank (Texas), National Association, as Agent and as a Lender, NationsBank of Texas, N.A. as Documentation Agent and as a Lender, and the Other Lenders' Now or Hereafter Parties Thereto. (R)10.340 --Agreement and Plan of Reorganization dated as of February 27, 1998 among HCC Insurance Holdings, Inc. and various shareholders of The Kachler Corporation related to the acquisition of 100% of the common stock of The Kachler Corporation. (R)10.341 --Purchase Agreement dated as of February 28, 1998, among HCC Insurance Holdings, Inc., Bethany A. Belanger, the partners of Guarantee Insurance Resources and others related to the acquisition of 100% of the partnership assets and liabilities of Guarantee Insurance Resources and 100% of the common stock of Insurance Alternatives, Inc. (M)10.342 --HCC Insurance Holdings, Inc. 1997 Flexible Incentive Plan. (S)10.343 --Agreement and Plan of Reorganization dated as of September 23, 1998 among HCC Insurance Holdings, Inc.; The Kachler Corporation; J.E. Stone and Associates, Inc. and the shareholders of J.E. Stone and Associates, Inc. related to the acquisition of 100% of the common stock of J.E. Stone and Associates, Inc. 10.344 --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. (T)10.345 --HCC Insurance Holdings, Inc. 1997 Flexible Incentive Plan, as amended. (U)10.346 --HCC Insurance Holdings, Inc. 1996 Non-Employee Director Stock Option Plan, as restated and amended. 10.347 --Employment Agreement effective as of January 1, 1998, between HCC Insurance Holdings, Inc. and John N. Molbeck, Jr.. 10.348 --Employment Agreement effective as of January 1, 1998, between HCC Insurance Holdings, Inc. and Stephen J. Lockwood. 10.349 --Employment Agreement effective as of January 1, 1998, between HCC Insurance Holdings, Inc. and Frank J. Bramanti. 10.350 --Employment Agreement effective as of January 1, 1998, between HCC Insurance Holdings, Inc. and Peter B. Smith. (V)10.351 --Loan Agreement ($150,000,000 Revolving Loan Facility and $100,000,000 Short Term Revolving Loan Facility) dated as of March 8, 1999 among HCC Insurance Holdings, Inc. as Borrower, Wells Fargo Bank (Texas), National Association, as Agent and as Lender, Nationsbank, N.A., as Documentation Agent and as a Lender, and The Other Lenders Now or Hereafter Parties Thereto. 12 --Statement Regarding Computation of Ratios 21 --Subsidiaries of HCC Insurance Holdings, Inc.
51
EXHIBIT NUMBER - ------------ 23 --Consent of Independent Accountants--PricewaterhouseCoopers LLP dated March 26, 1999 23.1 --Consent of Independent Accountants--KPMG LLP dated March 26, 1999--included at page S-2 24 --Powers of Attorney 27 --EDGAR Financial Data Schedule--December 31, 1998 27.1 --EDGAR Financial Data Schedule--Restated December 31, 1997 and 1996
- ------------------------ (A)Incorporated by reference to the Exhibits to HCC Insurance Holdings, Inc.'s Registration Statement (Registration No. 33-48737) filed October 27, 1992. (B)Incorporated by reference to the Exhibits to HCC Insurance Holdings, Inc.'s Form 10-K for the fiscal year ended December 31, 1993. (C)Incorporated by reference to the Exhibits to HCC Insurance Holdings, Inc.'s Form 10-K for the fiscal year ended December 31, 1994. (D)Incorporated by reference to the Exhibits to HCC Insurance Holdings, Inc.'s Form 10-Q for the fiscal quarter ended March 31, 1995. (E)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. (F)Incorporated by reference to the Exhibits to HCC Insurance Holdings, Inc.'s Registration Statement on Form S-8 (Registration No. 33-94468) filed July 11, 1995. (G)Incorporated by reference to the Exhibits to HCC Insurance Holdings, Inc.'s Form 10-K for fiscal year ended December 31, 1995. (H)Incorporated by reference to the Exhibits to HCC Insurance Holdings, Inc.'s Registration Statement (Registration No. 333-3652) filed April 15, 1996. (I)Incorporated by reference to the Exhibits to HCC Insurance Holdings, Inc. Preliminary Registration Statement filed March 7, 1997. (J)Incorporated by reference to the Exhibits to HCC Insurance Holdings, Inc.'s Registration Statement on Form S-8 (Registration No. 333-14479) filed October 18, 1996. (K)Incorporated by reference to the Exhibits to HCC Insurance Holdings, Inc.'s Registration Statement on Form S-8 (Registration No. 333-14471) filed October 18, 1996. (L)Incorporated by reference to the Exhibits to HCC Insurance Holdings, Inc.'s Form 10-K for fiscal year ended December 31, 1996. (M)Incorporatedby reference to Exhibit A to the HCC Insurance Holdings, Inc.'s Proxy Statement for the May 22, 1997 Annual Meeting of Shareholders filed April 30, 1997. (N)Incorporated by reference to the Exhibits to HCC Insurance Holdings, Inc.'s Form 10-Q for the fiscal quarter ended March 31, 1997. (O)Incorporated by reference to the Exhibits to HCC Insurance Holdings, Inc.'s Form 10-Q for the fiscal quarter ended June 30, 1997. (P)Incorporated by reference to the Exhibits to HCC Insurance Holdings, Inc.'s Form 10-Q for the fiscal quarter ended September 30, 1997. 52 (Q)Incorporated by reference to the Exhibits to HCC Insurance Holdings, Inc.'s Form 8-K filed January 6, 1998. (R)Incorporated by reference to Exhibits to HCC Insurance Holdings, Inc.'s Form 10-K for the fiscal year ended December 31, 1998. (S)Incorporated by reference to the Exhibits to HCC Insurance Holdings, Inc.'s Form 10-Q for the fiscal quarter ended September 30, 1998. (T)Incorporated by reference to the Exhibit A to the HCC Insurance Holdings, Inc. Proxy Statement for the May 21, 1998 Annual Meeting of Shareholders filed April 24, 1998. (U)Incorporated by reference to the Exhibit B to the HCC Insurance Holdings, Inc. Proxy Statement for the May 21, 1998 Annual Meeting of Shareholders filed April 24, 1998. (V)Incorporated by reference to the Exhibit 10.1 to the HCC Insurance Holdings, Inc. Form 8-K filed March 15, 1999. 53 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Shareholders of HCC Insurance Holdings, Inc. In our opinion, based on our audits and the report of the other auditors, 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, 1998 and 1997, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the HCC Insurance Holding Inc.'s management; our responsibility is to express an opinion on these financial statements based on our audits. We did not audit the 1996 consolidated financial statements of Avemco Corporation, which statements reflect total revenues constituting 43.7 percent and net earnings constituting 24.0 percent of the related consolidated financial statement totals for the year ended December 31, 1996. Those statements were audited by other auditors whose report dated January 31, 1997 except for Note 12, of which the date is February 28, 1997 and except for Note 14, of which the date is February 18, 1998, has been furnished to us, and our opinion, insofar as it relates to data included for 1996 is based solely on the report of the other auditors. We conducted our audits of these statements in accordance with generally accepted auditing standards 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 and the report of the other auditors provide a reasonable basis for the opinion expressed above. PRICEWATERHOUSECOOPERS LLP Houston, Texas March 26, 1999 F-1 REPORT OF INDEPENDENT AUDITORS' The Board of Directors and Shareholder Avemco Corporation: We have audited the consolidated statements of income, stockholders' equity and cash flows of Avemco Corporation and subsidiaries for the year ended December 31, 1996 (not included separately herein). These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit. We conducted our audit in accordance with generally accepted auditing standards. Those standards 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. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.We believe that our audit provides a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated results of operations of Avemco Corporation and subsidiaries and their cash flows for the year ended December 31, 1996, in conformity with generally accepted accounting principles. KPMG LLP Washington, D.C. January 31, 1997 (February 28, 1997, as to note 12 and February 18, 1998, as to note 14) F-2 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
DECEMBER 31, ---------------------------------- 1998 1997 ---------------- ---------------- ASSETS Investments: Fixed income securities, at market (cost: 1998 $375,107,000; 1997 $395,121,000)............................. $ 393,238,000 $ 409,701,000 Marketable equity securities, at market (cost: 1998 $1,750,000; 1997 $4,202,000)................................. 2,252,000 3,816,000 Short-term investments, at cost, which approximates market................. 129,084,000 105,255,000 Other investments, at cost, which approximates fair value.................. 1,072,000 -- ---------------- ---------------- Total investments...................................................... 525,646,000 518,772,000 Cash......................................................................... 16,018,000 7,728,000 Restricted cash and cash investments......................................... 84,276,000 60,063,000 Reinsurance recoverables..................................................... 372,672,000 176,965,000 Premium, claims and other receivables........................................ 382,630,000 252,618,000 Ceded unearned premium....................................................... 149,568,000 84,610,000 Deferred policy acquisition costs............................................ 27,227,000 21,604,000 Property and equipment, net.................................................. 32,983,000 19,926,000 Goodwill..................................................................... 88,043,000 34,758,000 Other assets................................................................. 30,006,000 21,088,000 ---------------- ---------------- TOTAL ASSETS........................................................... $ 1,709,069,000 $ 1,198,132,000 ---------------- ---------------- ---------------- ---------------- LIABILITIES Loss and loss adjustment expense payable..................................... $ 460,511,000 $ 275,008,000 Reinsurance balances payable................................................. 90,983,000 43,914,000 Unearned premium............................................................. 201,050,000 152,094,000 Deferred ceding commissions.................................................. 30,842,000 19,553,000 Premium and claims payable................................................... 337,909,000 237,770,000 Notes payable................................................................ 121,600,000 80,750,000 Accounts payable and accrued liabilities..................................... 26,311,000 23,442,000 ---------------- ---------------- Total liabilities...................................................... 1,269,206,000 832,531,000 SHAREHOLDERS' EQUITY Common Stock, $1.00 par value; 250,000,000 shares authorized; (issued: 1998 48,252,478 shares; 1997 47,758,929 shares)................... 48,252,000 47,759,000 Additional paid-in capital................................................... 162,102,000 154,633,000 Retained earnings............................................................ 219,804,000 155,209,000 Accumulated other comprehensive income....................................... 9,705,000 8,000,000 ---------------- ---------------- Total shareholders' equity............................................. 439,863,000 365,601,000 ---------------- ---------------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY............................. $ 1,709,069,000 $ 1,198,132,000 ---------------- ---------------- ---------------- ----------------
See Notes to Consolidated Financial Statements. F-3 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF EARNINGS
FOR THE YEARS ENDED DECEMBER 31, ---------------------------------------------- 1998 1997 1996 -------------- -------------- -------------- REVENUE Net earned premium.............................................. $ 143,100,000 $ 162,571,000 $ 170,068,000 Management fees................................................. 74,045,000 51,039,000 28,651,000 Commission income............................................... 38,441,000 24,209,000 21,477,000 Net investment income........................................... 29,335,000 27,587,000 23,593,000 Net realized investment gain (loss)............................. 845,000 (328,000) 8,341,000 Other operating income.......................................... 22,268,000 15,239,000 18,656,000 -------------- -------------- -------------- Total revenue............................................. 308,034,000 280,317,000 270,786,000 EXPENSE Loss and loss adjustment expense................................ 91,302,000 96,514,000 114,464,000 Operating expense: Policy acquisition costs, net................................. 10,978,000 13,580,000 8,218,000 Compensation expense.......................................... 56,077,000 51,458,000 42,102,000 Other operating expense....................................... 36,063,000 31,628,000 26,382,000 Merger expense................................................ 107,000 8,069,000 26,160,000 -------------- -------------- -------------- Net operating expense..................................... 103,225,000 104,735,000 102,862,000 Interest expense................................................ 6,021,000 6,004,000 4,993,000 -------------- -------------- -------------- Total expense............................................. 200,548,000 207,253,000 222,319,000 -------------- -------------- -------------- Earnings before income tax provision...................... 107,486,000 73,064,000 48,467,000 Income tax provision............................................ 35,208,000 23,305,000 9,885,000 -------------- -------------- -------------- NET EARNINGS.............................................. $ 72,278,000 $ 49,759,000 $ 38,582,000 -------------- -------------- -------------- -------------- -------------- -------------- BASIC EARNINGS PER SHARE DATA: Earnings per share.............................................. $ 1.51 $ 1.06 $ 0.86 -------------- -------------- -------------- -------------- -------------- -------------- Weighted average shares outstanding............................. 47,920,000 46,995,000 44,795,000 -------------- -------------- -------------- -------------- -------------- -------------- DILUTED EARNINGS PER SHARE DATA: Earnings per share.............................................. $ 1.48 $ 1.03 $ 0.84 -------------- -------------- -------------- -------------- -------------- -------------- Weighted average shares outstanding............................. 48,936,000 48,209,000 46,043,000 -------------- -------------- -------------- -------------- -------------- --------------
See Notes to Consolidated Financial Statements. F-4 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
FOR THE YEARS ENDED DECEMBER 31, ------------------------------------------- 1998 1997 1996 ------------- ------------- ------------- Net earnings........................................................ $ 72,278,000 $ 49,759,000 $ 38,582,000 Other comprehensive income net of tax: Foreign currency translation adjustment........................... (344,000) (215,000) 95,000 Investment gains (losses): Investment gains (losses) during the year, net of deferred tax charge (benefit) of $1,283,000 in 1998, $2,373,000 in 1997 and ($82,000) in 1996............................................. 2,598,000 4,470,000 (251,000) Less reclassification adjustment for (gains) losses included in net earnings, net of deferred tax (charge) benefit of ($296,000) in 1998, $115,000 in 1997 and ($2,919,000) in 1996.......................................................... (549,000) 213,000 (5,422,000) ------------- ------------- ------------- Other comprehensive income (loss)............................... 1,705,000 4,468,000 (5,578,000) ------------- ------------- ------------- COMPREHENSIVE INCOME............................................ $ 73,983,000 $ 54,227,000 $ 33,004,000 ------------- ------------- ------------- ------------- ------------- -------------
See Notes to Consolidated Financial Statements. F-5 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
ACCUMULATED ADDITIONAL OTHER COMMON PAID-IN RETAINED COMPREHENSIVE STOCK CAPITAL EARNINGS INCOME ------------- -------------- -------------- ------------- BALANCE AS OF DECEMBER 31, 1995......................... $ 19,100,000 $ 137,588,000 $ 140,258,000 $ 9,110,000 Net earnings............................................ -- -- 38,582,000 -- Other comprehensive income (loss)....................... -- -- -- (5,578,000) 28,648,869 shares of Common Stock issued for 150% stock dividend............................................... 28,649,000 (28,649,000) -- -- 132,108 shares of Common Stock issued for exercise of options, including tax benefit of $366,000............. 132,000 837,000 -- -- Cash dividends declared, $0.06 per share................ -- -- (2,104,000) Compensatory grant of pooled company stock prior to merger................................................. -- 23,682,000 -- -- Dividends to shareholders of pooled companies prior to merger................................................. -- -- (7,705,000) -- Capitalize undistributed earnings of pooled company upon conversion from S Corporation.......................... -- 3,840,000 (3,840,000) -- 1,136,400 shares of Common Stock issued for acquisition............................................ 1,136,000 -- (1,452,000) -- Repurchase of 520,000 shares of common stock by pooled company prior to merger................................ -- -- -- -- Other................................................... -- 1,217,000 (1,607,000) -- ------------- -------------- -------------- ------------- BALANCE AS OF DECEMBER 31, 1996..................... $ 49,017,000 $ 138,515,000 $ 162,132,000 $ 3,532,000 ------------- -------------- -------------- ------------- ------------- -------------- -------------- ------------- TOTAL TREASURY SHAREHOLDERS' STOCK EQUITY -------------- -------------- BALANCE AS OF DECEMBER 31, 1995......................... $ (50,570,000) $ 255,486,000 Net earnings............................................ -- 38,582,000 Other comprehensive income (loss)....................... -- (5,578,000) 28,648,869 shares of Common Stock issued for 150% stock dividend............................................... -- -- 132,108 shares of Common Stock issued for exercise of options, including tax benefit of $366,000............. -- 969,000 Cash dividends declared, $0.06 per share................ (2,104,000) Compensatory grant of pooled company stock prior to merger................................................. -- 23,682,000 Dividends to shareholders of pooled companies prior to merger................................................. -- (7,705,000) Capitalize undistributed earnings of pooled company upon conversion from S Corporation.......................... -- -- 1,136,400 shares of Common Stock issued for acquisition............................................ -- (316,000) Repurchase of 520,000 shares of common stock by pooled company prior to merger................................ (7,909,000) (7,909,000) Other................................................... 1,809,000 1,419,000 -------------- -------------- BALANCE AS OF DECEMBER 31, 1996..................... $ (56,670,000) $ 296,526,000 -------------- -------------- -------------- --------------
See Notes to Consolidated Financial Statements. F-6 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY--(CONTINUED) FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
ACCUMULATED ADDITIONAL OTHER COMMON PAID-IN RETAINED COMPREHENSIVE STOCK CAPITAL EARNINGS INCOME ------------- -------------- -------------- ------------- BALANCE AS OF DECEMBER 31, 1996......................... $ 49,017,000 $ 138,515,000 $ 162,132,000 $ 3,532,000 Net earnings............................................ -- -- 49,759,000 -- Other comprehensive income.............................. -- -- -- 4,468,000 726,898 shares of Common Stock issued for exercise of options, including tax benefit of $1,725,000........... 727,000 9,743,000 -- -- 1,332,024 shares of Common Stock issued for acquisitions........................................... 1,332,000 9,805,000 (1,507,000) -- Cash dividends declared, $0.12 per share................ -- -- (5,219,000) -- Repurchase of 14,895 shares of common stock by pooled company prior to merger................................ -- -- -- -- Retirement of 3,316,636 shares of treasury stock........ (3,317,000) (3,430,000) (50,247,000) -- Other................................................... -- -- 291,000 -- ------------- -------------- -------------- ------------- BALANCE AS OF DECEMBER 31, 1997..................... $ 47,759,000 $ 154,633,000 $ 155,209,000 $ 8,000,000 ------------- -------------- -------------- ------------- ------------- -------------- -------------- ------------- TOTAL TREASURY SHAREHOLDERS' STOCK EQUITY -------------- -------------- BALANCE AS OF DECEMBER 31, 1996......................... $ (56,670,000) $ 296,526,000 Net earnings............................................ -- 49,759,000 Other comprehensive income.............................. -- 4,468,000 726,898 shares of Common Stock issued for exercise of options, including tax benefit of $1,725,000........... -- 10,470,000 1,332,024 shares of Common Stock issued for acquisitions........................................... -- 9,630,000 Cash dividends declared, $0.12 per share................ -- (5,219,000) Repurchase of 14,895 shares of common stock by pooled company prior to merger................................ (324,000) (324,000) Retirement of 3,316,636 shares of treasury stock........ 56,994,000 -- Other................................................... -- 291,000 -------------- -------------- BALANCE AS OF DECEMBER 31, 1997..................... $ -- $ 365,601,000 -------------- -------------- -------------- --------------
See Notes to Consolidated Financial Statements. F-7 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY--(CONTINUED) FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
ADDITIONAL COMMON PAID-IN RETAINED STOCK CAPITAL EARNINGS ------------- -------------- -------------- BALANCE AS OF DECEMBER 31, 1997.......................................... $ 47,759,000 $ 154,633,000 $ 155,209,000 Net earnings............................................................. -- -- 72,278,000 Other comprehensive income............................................... -- -- -- 206,504 shares of Common Stock issued for exercise of options, including tax benefit of $925,000................................................. 206,000 1,997,000 -- 287,025 shares of Common Stock issued for acquisitions................... 287,000 5,472,000 -- Cash dividends declared, $0.16 per share................................. -- -- (7,683,000) ------------- -------------- -------------- BALANCE AS OF DECEMBER 31, 1998...................................... $ 48,252,000 $ 162,102,000 $ 219,804,000 ------------- -------------- -------------- ------------- -------------- -------------- ACCUMULATED OTHER TOTAL COMPREHENSIVE SHAREHOLDERS' INCOME EQUITY ------------- -------------- BALANCE AS OF DECEMBER 31, 1997.......................................... $ 8,000,000 $ 365,601,000 Net earnings............................................................. -- 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................................................. -- 2,203,000 287,025 shares of Common Stock issued for acquisitions................... -- 5,759,000 Cash dividends declared, $0.16 per share................................. -- (7,683,000) ------------- -------------- BALANCE AS OF DECEMBER 31, 1998...................................... $ 9,705,000 $ 439,863,000 ------------- -------------- ------------- --------------
See Notes to Consolidated Financial Statements. F-8 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, ----------------------------------------------- 1998 1997 1996 --------------- -------------- -------------- Cash flows from operating activities: Net earnings.................................................. $ 72,278,000 $ 49,759,000 $ 38,582,000 Adjustments to reconcile net earnings to net cash provided by operating activities: Change in reinsurance recoverables.......................... (195,707,000) (70,972,000) (14,628,000) Change in premium, claims and other receivables............. (102,804,000) (84,309,000) (13,084,000) Change in ceded unearned premium............................ (64,958,000) (12,852,000) 6,702,000 Change in deferred policy acquisition costs, net............ 5,666,000 5,857,000 (3,379,000) Change in deferred income tax, net of tax effect of unrealized gain or loss................................... 2,381,000 3,475,000 (7,430,000) Change in loss and loss adjustment expense payable.......... 181,626,000 45,959,000 28,293,000 Change in reinsurance balances payable...................... 47,069,000 24,800,000 (28,061,000) Change in unearned premium.................................. 46,074,000 (4,174,000) 4,292,000 Change in premium and claims payable, net of restricted cash...................................................... 64,364,000 98,952,000 2,483,000 Change in accounts payable and accrued liabilities.......... (9,205,000) (2,794,000) 248,000 Net realized investment (gain) loss......................... (845,000) 328,000 (8,341,000) Other gains................................................. (4,694,000) -- (3,307,000) Non-cash compensation expense............................... -- -- 24,176,000 Depreciation and amortization expense....................... 7,388,000 5,189,000 4,045,000 Other, net.................................................. 1,411,000 (5,101,000) (1,128,000) --------------- -------------- -------------- Cash provided by operating activities..................... 50,044,000 54,117,000 29,463,000 Cash flows from investing activities: Sales of fixed income securities.............................. 18,212,000 27,090,000 24,399,000 Maturity or call of fixed income securities................... 30,202,000 19,173,000 17,573,000 Sales of equity securities.................................... 4,160,000 17,656,000 41,202,000 Other proceeds................................................ 3,324,000 -- 13,957,000 Change in short-term investments.............................. (24,667,000) (26,562,000) (7,296,000) Cash paid for companies acquired, net of cash received.................................................... (33,011,000) (12,948,000) (1,753,000) Cost of investments acquired.................................. (43,968,000) (87,084,000) (97,909,000) Purchase of property and equipment and other.................. (15,320,000) (6,718,000) (2,762,000) --------------- -------------- -------------- Cash used by investing activities......................... (61,068,000) (69,393,000) (12,589,000) Cash flows from financing activities: Proceeds from notes payable................................... 74,200,000 97,500,000 44,000,000 Sale of Common Stock.......................................... 2,203,000 10,470,000 969,000 Payments on notes payable..................................... (49,950,000) (89,667,000) (42,711,000) Dividends paid................................................ (7,139,000) (4,550,000) (9,092,000) Repurchase common stock....................................... -- (324,000) (7,909,000) --------------- -------------- -------------- Cash provided (used) by financing activities.............. 19,314,000 13,429,000 (14,743,000) --------------- -------------- -------------- Net change in cash........................................ 8,290,000 (1,847,000) 2,131,000 Cash at beginning of year................................. 7,728,000 9,575,000 7,444,000 --------------- -------------- -------------- Cash at end of year....................................... $ 16,018,000 $ 7,728,000 $ 9,575,000 --------------- -------------- -------------- --------------- -------------- --------------
See Notes to Consolidated Financial Statements. F-9 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (1) GENERAL INFORMATION AND SIGNIFICANT ACCOUNTING AND REPORTING POLICIES HCC Insurance Holdings, Inc. and its subsidiaries (collectively, "the Company" or "HCC"), include domestic and foreign property and casualty insurance companies, underwriting agencies, intermediaries and service companies. HCC, through its subsidiaries, provides specialized property and casualty insurance primarily to commercial customers worldwide, underwritten on both a direct and reinsurance basis, in the aviation, marine, property, offshore energy, medical stop-loss, accident and health, workers' compensation and lenders' single interest lines of business. The principal insurance company subsidiaries are Houston Casualty Company ("HC") in Houston, Texas, London, England and Amman, Jordan; 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, primarily in the medical stop-loss, accident and health, workers' compensation and aviation lines of business. The principal agency subsidiaries are LDG Reinsurance Corporation ("LDG Re") in Wakefield, Massachusetts; HCC Aviation Insurance Group, Inc. ("HCCA") in Dallas, Texas and Glendale, California; HCC Employer Services, Inc. ("HCCES") in Northbrook, Illinois, Dallas, Texas and Montgomery, Alabama; and HCC Benefits Corporation ("HCCB") in Atlanta, Georgia, Wakefield, Massachusetts, Minneapolis, Minnesota and Kansas City, Kansas. 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 company subsidiaries operate. The Company's principal intermediary subsidiaries are HCC Intermediaries, Inc. ("HCCI") in Houston, Texas; HCC Employee Benefits, Inc. ("HCCEB") in Houston, Texas; and Rattner Mackenzie Limited ("RML") in London, England and Amman, Jordan. The service company subsidiaries perform various insurance related services for insurance companies. The preparation of financial statements in conformity with generally accepted accounting principles ("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. During February 1998, the Company acquired all of the outstanding common stock of The Kachler Corporation ("Kachler") in a transaction accounted for as a pooling-of-interests. (See Note 2) The Company's financial statements have been restated to include the accounts and operations of Kachler for all periods presented. 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 related deferred income tax, 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 F-10 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (1) GENERAL INFORMATION AND SIGNIFICANT ACCOUNTING AND REPORTING POLICIES (CONTINUED) maximize the Company's investment yield. Short-term investments and restricted short-term investments are carried at cost, which approximates market value. 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 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 Management fees and commission income are recognized on the revenue recognition date, which is the later of the effective date of the policy, the date when the premium can be reasonably estimated, or the date when substantially all required services relating to the insurance placement have been rendered to the client. Management fees and commission income relating to additional or return premiums or other policy adjustments are recognized when the events occur and the amounts become known or can be estimated. PREMIUM AND OTHER RECEIVABLES The Company has adopted 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 at December 31, 1998 and 1997, is not material. F-11 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (1) GENERAL INFORMATION AND SIGNIFICANT ACCOUNTING AND REPORTING POLICIES (CONTINUED) LOSS AND LOSS ADJUSTMENT EXPENSE PAYABLE OF INSURANCE COMPANY SUBSIDIARIES Loss and loss adjustment expense payable is based on undiscounted estimates of payments to be made for reported and incurred but not reported ("IBNR") losses and anticipated salvage and subrogation receipts. Estimates for reported losses are based on all available information, including reports received from ceding companies on assumed 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 estimated and recorded in a manner consistent with the underlying reinsured contracts. Management has recorded a reserve for uncollectible reinsurance based on estimates of collectibility. The adverse economic environment in the insurance industry has placed great pressure on reinsurers and the results of their operations. These conditions could, ultimately, affect reinsurers' solvency. Historically, there have been insolvencies following a period of competitive pricing in the industry, such as the marketplace is experiencing today. Therefore, while management believes that the reserve is adequate, conditions can 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. 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 underwriting agency and intermediary operations which operate in existing lines of business and in the same country as existing operations. Goodwill related to such acquired 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, 1998 and 1997, was $5.2 million and $2.8 million, respectively. The Company has no reason to expect major changes in the business conditions in which the acquired companies operate which might affect the recoverability of the recorded goodwill. However, in the event business conditions change, the recoverability will be re-evaluated based upon revised projections of future undiscounted operating income and cash flows and, if impaired, the balances will be adjusted accordingly. Amortization of goodwill charged to income for the years ended December 31, 1998, 1997 and 1996, was $3.0 million, $1.6 million and $684,000, respectively. F-12 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (1) GENERAL INFORMATION AND SIGNIFICANT ACCOUNTING AND REPORTING POLICIES (CONTINUED) 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. 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 TRANSLATION The functional currency of most foreign subsidiaries and branches is the United States dollar. Assets and liabilities recorded in foreign currencies are translated into United States 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. From time to time the Company enters into foreign currency forward contracts as a hedge against foreign currency fluctuations. Gains or losses in the market value of foreign currency forward contracts are recognized in the statements of earnings concurrently with the gains and losses on the hedged balances. For the years ended December 31, 1998, 1997 and 1996, the gain (loss) from currency conversion was $219,000, ($884,000) and ($181,000), 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 United States dollars, is included in the foreign currency translation adjustment within accumulated other comprehensive income. COMPUTER PRODUCTS AND SERVICES Revenue from custom software products is recognized using the percentage of completion method of accounting. Revenue from other software contracts is recognized when delivery has occurred, other remaining vendor obligations are no longer significant, and collectibility is probable. Revenue from the sale of computer hardware is recognized when delivery has occurred. Maintenance support is recognized F-13 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (1) GENERAL INFORMATION AND SIGNIFICANT ACCOUNTING AND REPORTING POLICIES (CONTINUED) pro rata over the term of the maintenance agreement. Revenue from such products and services is included in other operating income. Software production costs are capitalized when the technological feasibility of a new product has been established. The capitalized costs are amortized based upon current and future revenue for each product with a minimum of straight-line amortization over the remaining estimated economic life of the product. All other software development costs are expenses as incurred. 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. A company acquired in a pooling-of-interests transaction was an S Corporation prior to the pooling. Therefore, Federal income tax expense was not provided for that company's earnings until the S Corporation election was terminated on May 22, 1996. EARNINGS PER SHARE Basic earnings per share are based on the weighted average number of common shares outstanding during the year divided into net earnings. Diluted earnings per share are 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 diluted earnings per share computation only when the underlying conditions for issuance have been met. COMPREHENSIVE INCOME The Company adopted Statement of Financial Accounting Standards ("SFAS") No. 130 entitled "Reporting Comprehensive Income" in 1998. This statement required that all components of comprehensive income be reported in a full set of financial statements and that the amount of total comprehensive income be reported. Other comprehensive income includes gains and losses that are excluded from net income, but are added to or deducted from net earnings in order to calculate comprehensive income. Unrealized investment gains and losses of investments and net unrealized gains and losses on foreign currency translation are examples of such items. SEGMENT REPORTING The Company also adopted SFAS No. 131 entitled "Disclosures about Segments of an Enterprise and Related Information" in 1998. This statement changed the way the Company reports information about its operating segments. The agency segment from prior years is now split into the underwriting agency and intermediary segments. The corporate and other segment from prior years is now split into two segments, F-14 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (1) GENERAL INFORMATION AND SIGNIFICANT ACCOUNTING AND REPORTING POLICIES (CONTINUED) other operations and corporate. Adoption of SFAS No. 131 had no effect on the Company's consolidated financial position, results of operations or shareholders' equity. EFFECTS OF RECENT ACCOUNTING PRONOUNCEMENTS SFAS No. 133 entitled "Accounting for Derivative Instruments and Hedging Activities" was issued in June, 1998. The statement is effective for all fiscal quarters and years beginning after June 15, 1999. The Company has utilized derivatives or hedging strategies only infrequently in the past and in immaterial amounts, although it may do so more frequently in the future as it expands its foreign operations. The Company is not a party to any derivatives or hedging activities at December 31, 1998. The effect of the Statement as well as the timing of its adoption are currently being reviewed by management. In December, 1997, the American Institute of Certified Public Accountants' Accounting Executives Standards Committee ("AcSEC") issued Statement of Position ("SOP") 97-3, "Accounting by Insurance and Other Enterprises for Insurance-Related Assessments," which provides guidance on accounting by all entities that are subject to insurance-related assessments. It required that entities should recognize liabilities for insurance-related assessments when certain specified criteria have been met. This SOP is effective for financial statements for fiscal years beginning after December 15, 1998. The Company does not expect the adoption of this SOP to have a material effect on the Company's financial position, results of operations or shareholders' equity. In November, 1998, AcSEC issued SOP 98-7, "Deposit Accounting: Accounting for Insurance and Reinsurance Contracts That Do Not Transfer Insurance Risk" which provides guidance as to the use of deposit accounting for insurance and reinsurance contracts that do not transfer insurance risk. This SOP is effective for financial statements for fiscal year beginning after June 15, 1999. The Company does not expect the adoption of this SOP to have a material effect on the Company's financial position, results of operations or shareholders' equity. RECLASSIFICATIONS Certain amounts in the 1997 and 1996 consolidated financial statements and the quarterly financial data (See Note 18) have been reclassified to conform with the 1998 presentation and to reflect application of SFAS No. 130 and SFAS No. 131. Such reclassifications had no effect on the Company's shareholders' equity, net earnings or cash flows. (2) ACQUISITIONS AND DISPOSITIONS ACQUISITIONS On February 27, 1998, the Company acquired all of the outstanding common stock of The Kachler Corporation ("Kachler") in exchange for 1,600,000 shares of the Company's common stock. The acquisition was accounted for as a pooling-of-interests and, accordingly, the Company's consolidated financial statements have been restated to reflect the combination. Total revenue and net earnings of Kachler prior to the acquisition are immaterial in relation to the Company's revenue and net earnings. During 1998 the Company acquired four underwriting agency operations in transactions accounted for under the purchase method of accounting. The total consideration paid was 287,025 shares of the F-15 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (2) ACQUISITIONS AND DISPOSITIONS (CONTINUED) Company's Common Stock and $48.2 million in cash. On a combined basis, the fair value of assets acquired was $44.9 million and the fair value of liabilities assumed was $46.2 million. Goodwill in the aggregate amount of $55.9 million was recorded in connection with these transactions. The goodwill is being amortized over periods of twenty to thirty years. The results of operations of the businesses acquired in purchase transactions have been included in the consolidated financial statements beginning on the effective date of each transaction. In connection with one of the acquisitions, the Company will also issue up to 378,000 shares of its common stock on a contingent basis assuming certain future financial benchmarks are met. Contingent shares issued will be recorded as additional consideration at the current fair value if and when the financial benchmarks are met. The following unaudited proforma summary presents information as if the 1998 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. The proforma 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. The unaudited proforma summary information for companies acquired in 1997 in purchase transactions is not presented due to immateriality.
FOR THE YEARS ENDED DECEMBER 31, ------------------------------ 1998 1997 -------------- -------------- UNAUDITED PROFORMA INFORMATION Revenue.......................................................................... $ 322,263,000 $ 303,351,000 Net earnings..................................................................... 71,965,000 48,029,000 Basic earnings per share......................................................... 1.50 1.02 Diluted earnings per share....................................................... 1.47 1.00
ACQUISITION SUBSEQUENT TO DECEMBER 31, 1998 The Company acquired the outstanding common stock of PEPYS Holdings Limited and its operating subsidiary, Rattner Mackenzie Limited, effective January 1, 1999. The consideration consisted of 414,207 shares of the Company's Common Stock to be paid over a four year period and cash consideration of $54.8 million, $8.3 million of which is to be paid over a four year period. According to the terms of the transaction, the Company will issue additional cash consideration if certain earnings benchmarks are exceeded during the next four years. This acquisition will be accounted for under the purchase method of accounting. DISPOSITION SUBSEQUENT TO DECEMBER 31, 1998 In January, 1999, the Company sold its 21% interest in Underwriters Indemnity Holdings, Inc. ("UIH"), the parent of Underwriters Indemnity Company, for $8.2 million. The Company realized a pre-tax gain of $4.9 million in connection with UIH's acquisition by RLI Corporation, an insurance holding company. The Company's investment in UIH, which was accounted for by the equity method, was not material to the Company's financial position and results of operations. F-16 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. No high-yield corporate bonds are owned or contemplated. The 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:
GROSS GROSS ESTIMATED AMORTIZED UNREALIZED UNREALIZED MARKET COST GAIN LOSS VALUE -------------- ------------- ------------- -------------- December 31, 1998: Marketable equity securities.................... $ 1,750,000 $ 502,000 $ -- $ 2,252,000 US Treasury securities.......................... 19,183,000 627,000 (37,000) 19,773,000 Obligations of states, municipalities and political subdivisions........................ 354,663,000 18,257,000 (767,000) 372,153,000 Other fixed income securities................... 1,261,000 51,000 -- 1,312,000 -------------- ------------- ------------- -------------- Total securities.............................. $ 376,857,000 $ 19,437,000 $ (804,000) $ 395,490,000 -------------- ------------- ------------- -------------- -------------- ------------- ------------- -------------- December 31, 1997: Marketable equity securities.................... $ 4,202,000 $ 140,000 $ (526,000) $ 3,816,000 Redeemable preferred stock...................... 788,000 7,000 -- 795,000 US Treasury securities.......................... 11,807,000 410,000 (3,000) 12,214,000 Obligations of states, municipalities and political subdivisions........................ 382,108,000 14,883,000 (704,000) 396,287,000 Other fixed income securities................... 418,000 -- (13,000) 405,000 -------------- ------------- ------------- -------------- Total securities.............................. $ 399,323,000 $ 15,440,000 $ (1,246,000) $ 413,517,000 -------------- ------------- ------------- -------------- -------------- ------------- ------------- --------------
The Company also has strategic operational investments (included in other assets) which were purchased to provide partnering and other opportunities. Such investments are accounted for in the same manner as other equity investments. The cost, gross unrealized loss, and estimated market value of marketable equity securities designated as strategic operational investments as of December 31, 1998 and 1997 are as follows:
1998 1997 ------------- ------------- Cost................................................................................ $ 18,842,000 $ 6,019,000 Gross unrealized loss............................................................... (2,900,000) (1,497,000) ------------- ------------- Estimated market value............................................................ $ 15,942,000 $ 4,522,000 ------------- ------------- ------------- -------------
F-17 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (3) INVESTMENTS (CONTINUED) The amortized cost and estimated market value of fixed income securities at December 31, 1998, 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.
ESTIMATED AMORTIZED MARKET COST VALUE -------------- -------------- Due in 1 year or less............................................................ $ 7,752,000 $ 7,828,000 Due after 1 year through 5 years................................................. 146,452,000 151,878,000 Due after 5 years through 10 years............................................... 116,921,000 123,749,000 Due after 10 years through 15 years.............................................. 79,566,000 83,608,000 Due after 15 years............................................................... 24,416,000 26,175,000 -------------- -------------- Total fixed income securities................................................ $ 375,107,000 $ 393,238,000 -------------- -------------- -------------- --------------
As of December 31, 1998, the Company's insurance company subsidiaries had deposited fixed income securities with an amortized cost of approximately $19.8 million (market: $20.9 million) to meet the deposit requirements of various insurance departments. The sources of net investment income for the three years ended December 31, 1998, are detailed below:
1998 1997 1996 ------------- ------------- ------------- Fixed income securities............................................. $ 20,711,000 $ 20,937,000 $ 19,140,000 Short-term investments.............................................. 8,079,000 5,680,000 3,906,000 Equity securities................................................... 35,000 572,000 1,106,000 Other............................................................... 607,000 445,000 18,000 ------------- ------------- ------------- Total investment income........................................... 29,432,000 27,634,000 24,170,000 Investment expense.................................................. (97,000) (47,000) (577,000) ------------- ------------- ------------- Net investment income............................................. $ 29,335,000 $ 27,587,000 $ 23,593,000 ------------- ------------- ------------- ------------- ------------- -------------
All investments in fixed income securities and other investments were income producing for the twelve months preceding December 31, 1998. F-18 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (3) INVESTMENTS (CONTINUED) Realized pre-tax gain (loss) on the sale of investments is as follows:
GAIN LOSS NET ------------- ------------- ------------- 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 ------------- ------------- ------------- ------------- ------------- ------------- For the year ended December 31, 1997: Fixed income securities............................................ $ 68,000 $ (242,000) $ (174,000) Marketable equity securities....................................... 113,000 (267,000) (154,000) ------------- ------------- ------------- Realized gain (loss)............................................. $ 181,000 $ (509,000) $ (328,000) ------------- ------------- ------------- ------------- ------------- ------------- For the year ended December 31, 1996: Fixed income securities............................................ $ 543,000 $ (514,000) $ 29,000 Marketable equity securities....................................... 9,002,000 (690,000) 8,312,000 ------------- ------------- ------------- Realized gain (loss)............................................. $ 9,545,000 $ (1,204,000) $ 8,341,000 ------------- ------------- ------------- ------------- ------------- -------------
Unrealized pre-tax net investment gains (losses) on investments for three years ended December 31, 1998 is as follows:
1998 1997 1996 ------------- ------------- ------------- Fixed income securities............................................ $ 3,551,000 $ 8,869,000 $ (2,451,000) Marketable equity securities....................................... 888,000 (201,000) (6,223,000) Strategic operational investments.................................. (1,403,000) (1,497,000) -- ------------- ------------- ------------- Net unrealized investment gain (loss)............................ $ 3,036,000 $ 7,171,000 $ (8,674,000) ------------- ------------- ------------- ------------- ------------- -------------
(4) OPERATIONAL PROPERTY AND EQUIPMENT The following table summarizes property and equipment at December 31, 1998 and 1997:
ESTIMATED 1998 1997 USEFUL LIFE -------------- -------------- ---------------- Buildings and improvements..................................... $ 18,995,000 $ 13,291,000 30 to 45 years Furniture, fixtures and equipment.............................. 13,752,000 13,334,000 3 to 10 years Management information systems................................. 20,615,000 13,799,000 3 to 7 years -------------- -------------- Total property and equipment............................... 53,362,000 40,424,000 Less accumulated depreciation and amortization................. (20,379,000) (20,498,000) -------------- -------------- Property and equipment, net................................ $ 32,983,000 $ 19,926,000 -------------- -------------- -------------- --------------
Depreciation and amortization expense on property and equipment was approximately $4.4 million, $3.5 million and $3.4 million for the years ended December 31, 1998, 1997 and 1996, respectively. F-19 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (5) NOTES PAYABLE Notes payable as of December 31, 1998 and 1997 are shown in the table below. The estimated fair value of the notes payable as of December 31, 1998 and 1997, which is based on current rates offered to the Company for debt with similar terms, approximates the carrying value.
1998 1997 -------------- ------------- Acquisition note.................................................................. $ 16,600,000 $ -- Facility.......................................................................... 105,000,000 80,750,000 -------------- ------------- Total notes payable........................................................... $ 121,600,000 $ 80,750,000 -------------- ------------- -------------- -------------
Effective December 30, 1997, the Company executed a $120.0 million revolving credit facility ("Facility") with a group of banks. Borrowing under the Facility may be made by the Company until the expiration of the Facility on December 30, 1999, at which time all principal is due. Outstanding loans under the Facility bear interest at the Company's option of either the prime rate (7.75% at December 31, 1998) or at the current London Interbank Offering Rate ("LIBOR") (5.1% at December 31, 1998) plus 1%. The loan is collateralized in part by the common stock of HC and AIC. The agreement contains 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 the maintenance of required financial ratios. The acquisition note is a note payable to the former owner of Sun. The note bears interest at 6.4% and is due January 5, 1999. It was paid subsequent to year end utilizing funds received from a draw on the Facility. On March 8, 1999, the Company entered into a Loan Agreement (the "New Facility") with a group of banks. The New Facility includes a $150.0 million Revolving Loan Facility and $100.0 million Short Term Revolving Loan Facility. Borrowing under the New Facility may be made from time to time by the Company for general corporate purposes through the Short Term Revolving Loan Facility until its expiration on March 7, 2000 and through the Revolving Loan Facility until its expiration on February 28, 2002. Outstanding loans under the New Facility bear interest at agreed upon rates. The New Facility is collateralized in part by the pledge of the stock of HC, AIC, and USSIC and by the pledge of stock and guaranties entered into by the Company's principal underwriting agency and intermediary subsidiaries. The New Facility agreement contains certain restrictive covenants, including, without limitation, 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 New Facility agreement are typical for financing arrangements comparable to the New Facility. The initial funding available under the New Facility was used, among other things, to refinance existing indebtedness of the Company including all outstanding indebtedness under the Company's $120.0 million revolving credit facility entered into as of December 30, 1997, which has been terminated. At December 31, 1998, several of the Company's subsidiaries maintained revolving lines of credit with a bank in the combined maximum amount of $40.0 million available through December 30, 1999. Advances under the lines of credit are limited to amounts required to fund draws, if any, on letters of credit issued by the bank on behalf of the subsidiaries and short-term direct cash advances. The lines of credit are collateralized by securities having an aggregate market value of up to $50.0 million, the actual amount of F-20 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (5) NOTES PAYABLE (CONTINUED) 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 (7.75% at December 31, 1998). At December 31, 1998, letters of credit totaling $19.8 million had been issued to insurance companies by the bank on behalf of the subsidiaries, with total securities of $24.8 million collateralizing the line. (6) INCOME TAX Several of the Company's foreign subsidiaries are not subject to foreign income taxes and no material foreign income tax expense was incurred for the three years ended December 31, 1998. United States Federal income taxes are provided on all foreign earnings. As of December 31, 1998 and 1997, the Company had income taxes receivable of $2.9 million and $3.7 million, respectively, included in other assets in the consolidated balance sheets. For Federal income tax purposes, one subsidiary has approximately $3.2 million of net operating loss carry forwards which will expire in the year 2010. The components of the income tax provision for the three years ended December 31, 1998, are as follows:
1998 1997 1996 ------------- ------------- ------------- Current............................................................. $ 32,498,000 $ 19,375,000 $ 17,720,000 Deferred: Change in net deferred tax at current enacted tax rate............ 2,758,000 4,074,000 (7,835,000) Change in deferred tax valuation allowance........................ (48,000) (144,000) -- ------------- ------------- ------------- Total income tax provision...................................... $ 35,208,000 $ 23,305,000 $ 9,885,000 ------------- ------------- ------------- ------------- ------------- -------------
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, 1998 and 1997, is as follows:
1998 1997 ------------- ------------- Tax net operating loss carry forward............................................... $ 1,381,000 $ 4,806,000 Excess of financial unearned premium over tax...................................... 4,408,000 4,944,000 Effect of loss reserve discounting and salvage and subrogation accrual for tax..... 5,187,000 4,398,000 Bad debt and accrued expenses, deducted for financial over tax..................... 3,783,000 3,258,000 ------------- ------------- Total assets................................................................... 14,759,000 17,406,000 Excess of financial over currently taxable earnings from foreign subsidiaries...... -- 821,000 Unrealized gain on increase in value of securities available for sale (shareholders' equity)........................................................... 5,522,000 4,455,000 Deferred policy acquisition costs, net of ceding commissions, deductible for tax... 1,074,000 3,136,000 Amortizable goodwill............................................................... 1,011,000 598,000 Property and equipment depreciation and other items................................ 3,779,000 1,757,000 ------------- ------------- Total liabilities.............................................................. 11,386,000 10,767,000 ------------- ------------- Net deferred tax asset......................................................... $ 3,373,000 $ 6,639,000 ------------- ------------- ------------- -------------
F-21 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (6) INCOME TAX (CONTINUED) Changes in the valuation allowance account applicable to the net deferred tax asset for the three years ended December 31, 1998 are as follows:
1998 1997 1996 ---------- ---------- --------- Balance, beginning of year..................................................... $ 98,000 $ 54,000 $ -- Decrease credited to income.................................................... (48,000) (144,000) -- Valuation allowance acquired................................................... -- 188,000 54,000 ---------- ---------- --------- Balance, end of year....................................................... $ 50,000 $ 98,000 $ 54,000 ---------- ---------- --------- ---------- ---------- ---------
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, 1998:
1998 1997 1996 ------------- ------------- ------------- Statutory tax rate.................................................. 35.0% 35.0% 35.0% Federal tax at statutory rate....................................... $ 37,620,000 $ 25,572,000 $ 16,963,000 Nontaxable municipal bond interest and dividends received deduction......................................................... (5,753,000) (6,065,000) (5,792,000) State income taxes.................................................. 3,521,000 2,242,000 102,000 Other, net.......................................................... (180,000) 1,556,000 (1,388,000) ------------- ------------- ------------- Income tax provision............................................ $ 35,208,000 $ 23,305,000 $ 9,885,000 ------------- ------------- ------------- ------------- ------------- ------------- Effective tax rate.............................................. 32.8% 31.9% 20.4% ------------- ------------- ------------- ------------- ------------- -------------
F-22 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (7) SEGMENT AND GEOGRAPHIC DATA The Company classifies its activities into four operating business segments based upon services provided: 1) property and casualty 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 the insurance company, underwriting agency and intermediary segments. The other operations perform various insurance related services for insurance company subsidiaries and unaffiliated insurance companies. Also included in other operations is income from strategic operational 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, purchase price allocations 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, 1998: Revenue: Domestic................................. $157,019,000 $79,908,000 $33,086,000 $20,495,000 $ 1,795,000 $292,303,000 Foreign.................................. 11,203,000 3,438,000 991,000 99,000 -- 15,731,000 Inter-segment............................ 478,000 2,298,000 1,876,000 1,365,000 16,000 6,033,000 ----------- ------------ ------------ ---------- ----------- ----------- Total segment revenue.................. $168,700,000 $85,644,000 $35,953,000 $21,959,000 $ 1,811,000 314,067,000 ----------- ------------ ------------ ---------- ----------- ----------- ------------ ------------ ---------- ----------- Intersegment revenue..................... (6,033,000) ----------- CONSOLIDATED TOTAL REVENUE............. $308,034,000 ----------- ----------- Net earnings: Domestic................................. $32,942,000 $19,367,000 $16,262,000 $4,439,000 $(2,155,000) $70,855,000 Foreign.................................. 1,232,000 (155,000) 745,000 (399,000) -- 1,423,000 ----------- ------------ ------------ ---------- ----------- ----------- TOTAL NET EARNINGS..................... $34,174,000 $19,212,000 $17,007,000 $4,040,000 $(2,155,000) $72,278,000 ----------- ------------ ------------ ---------- ----------- ----------- ----------- ------------ ------------ ---------- ----------- ----------- Other items: Net investment income.................... $23,578,000 $3,949,000 $ 362,000 $ 545,000 $ 901,000 $29,335,000 Depreciation and amortization............ 1,884,000 4,093,000 271,000 429,000 711,000 7,388,000 Interest expense......................... (58,000) 1,963,000 91,000 -- 4,025,000 6,021,000 Income tax provision..................... 9,733,000 14,002,000 10,749,000 2,108,000 (1,384,000) 35,208,000 Capital expenditures..................... 10,405,000 2,685,000 660,000 205,000 1,365,000 15,320,000
F-23 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (7) SEGMENT AND GEOGRAPHIC DATA (CONTINUED)
INSURANCE UNDERWRITING OTHER COMPANY AGENCY INTERMEDIARY OPERATIONS CORPORATE TOTAL ----------- ------------ ------------ ---------- ----------- ----------- For the year ended December 31, 1997: Revenue: Domestic................................. $170,943,000 $55,838,000 $18,335,000 $15,343,000 $ 1,188,000 $261,647,000 Foreign.................................. 14,967,000 2,590,000 967,000 146,000 -- 18,670,000 Inter-segment............................ -- 3,067,000 1,213,000 1,812,000 1,271,000 7,363,000 ----------- ------------ ------------ ---------- ----------- ----------- Total segment revenue.................. $185,910,000 $61,495,000 $20,515,000 $17,301,000 $ 2,459,000 287,680,000 ----------- ------------ ------------ ---------- ----------- ----------- ------------ ------------ ---------- ----------- Intersegment revenue..................... (7,363,000) ----------- CONSOLIDATED TOTAL REVENUE............. $280,317,000 ----------- ----------- For the year ended December 31, 1997: Net earnings: Domestic................................. $34,274,000 $13,186,000 $6,104,000 $1,755,000 $(12,299,000) $43,020,000 Foreign.................................. 6,333,000 90,000 987,000 (671,000) -- 6,739,000 ----------- ------------ ------------ ---------- ----------- ----------- TOTAL NET EARNINGS..................... $40,607,000 $13,276,000 $7,091,000 $1,084,000 $(12,299,000) $49,759,000 ----------- ------------ ------------ ---------- ----------- ----------- ----------- ------------ ------------ ---------- ----------- ----------- Other items: Net investment income.................... $23,379,000 $2,620,000 $ 322,000 $ 128,000 $ 1,138,000 $27,587,000 Depreciation and amortization............ 1,453,000 2,490,000 173,000 492,000 581,000 5,189,000 Interest expense......................... 3,000 33,000 -- -- 5,968,000 6,004,000 Income tax provision..................... 13,172,000 9,818,000 4,128,000 436,000 (4,249,000) 23,305,000 Capital expenditures..................... 2,838,000 3,416,000 76,000 168,000 296,000 6,794,000 The corporate net loss in 1997 included an after tax charge of $7.2 million with respect to merger expenses. For the year ended December 31, 1996: Revenue: Domestic................................. $177,739,000 $35,467,000 $12,532,000 $17,820,000 $ 2,776,000 $246,334,000 Foreign.................................. 20,730,000 2,224,000 1,219,000 279,000 -- 24,452,000 Inter-segment............................ -- 4,139,000 646,000 1,689,000 1,363,000 7,837,000 ----------- ------------ ------------ ---------- ----------- ----------- Total segment revenue.................. $198,469,000 $41,830,000 $14,397,000 $19,788,000 $ 4,139,000 278,623,000 ----------- ------------ ------------ ---------- ----------- ----------- ------------ ------------ ---------- ----------- Intersegment revenue..................... (7,837,000) ----------- CONSOLIDATED TOTAL REVENUE............. $270,786,000 ----------- ----------- Net earnings: Domestic................................. $33,427,000 $(2,965,000) $3,166,000 $4,455,000 $(4,694,000) $33,389,000 Foreign.................................. 6,151,000 (1,551,000) 874,000 (281,000) -- 5,193,000 ----------- ------------ ------------ ---------- ----------- ----------- TOTAL NET EARNINGS..................... $39,578,000 $(4,516,000) $4,040,000 $4,174,000 $(4,694,000) $38,582,000 ----------- ------------ ------------ ---------- ----------- ----------- ----------- ------------ ------------ ---------- ----------- ----------- Other items: Net investment income.................... $20,146,000 $1,798,000 $ 179,000 $ 91,000 $ 1,379,000 $23,593,000 Depreciation and amortization............ 1,583,000 1,356,000 39,000 418,000 649,000 4,045,000 Interest expense......................... (25,000) 47,000 1,000 1,000 4,969,000 4,993,000 Income tax provision..................... 14,936,000 (6,710,000) 2,572,000 597,000 (1,510,000) 9,885,000 Capital expenditures..................... 617,000 1,786,000 62,000 253,000 215,000 2,933,000
Non-recurring compensation expense of $14.4 million (after tax) of a company prior to its acquisition in a pooling-of-interests transaction caused a net loss for the underwriting agency segment during 1996. F-24 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (7) SEGMENT AND GEOGRAPHIC DATA (CONTINUED) The corporate net loss in 1996 also included an after-tax charge of $2.1 million with respect to other merger expenses. Assets by business segment and geographic location are shown in the following table:
INSURANCE UNDERWRITING OTHER COMPANY AGENCY INTERMEDIARY OPERATIONS CORPORATE TOTAL ------------- ------------ ------------ ---------- ---------- ------------- December 31, 1998: Domestic................... $1,074,738,000 4$31,619,000 $52,940,000 $30,519,000 $25,823,000 $1,615,639,000 Foreign.................... 60,702,000 27,084,000 5,644,000 -- -- 93,430,000 ------------- ------------ ------------ ---------- ---------- ------------- TOTAL ASSETS............. $1,135,440,000 4$58,703,000 $58,584,000 $30,519,000 $25,823,000 $1,709,069,000 ------------- ------------ ------------ ---------- ---------- ------------- ------------- ------------ ------------ ---------- ---------- ------------- December 31, 1997: Domestic................... $ 777,666,000 2$65,619,000 $4,688,000 $22,107,000 $30,316,000 $1,100,396,000 Foreign.................... 66,572,000 25,680,000 5,374,000 110,000 -- 97,736,000 ------------- ------------ ------------ ---------- ---------- ------------- TOTAL ASSETS............. $ 844,238,000 2$91,299,000 $10,062,000 $22,217,000 $30,316,000 $1,198,132,000 ------------- ------------ ------------ ---------- ---------- ------------- ------------- ------------ ------------ ---------- ---------- -------------
During the years ended December 31, 1998, 1997 and 1996, one broker in London, England, produced gross written premium ("GWP") to the Company of approximately $46.1 million, $42.8 million and $25.7 million, respectively. This represents 10%, 12% and 7% of the Company's total GWP for those years. The Company has insureds and/or reinsureds in approximately 100 countries world-wide. The following table shows the geographical distribution of GWP written by the domestic insurance company subsidiaries based on location of the insureds and reinsureds for the three years ended December 31, 1998:
1998 1997 1996 ------------------------- ------------------------- ------------------------- GWP % GWP % GWP % -------------- --------- -------------- --------- -------------- --------- United States............................ $ 371,720,000 77% $ 224,833,000 68% $ 194,546,000 62% Asia..................................... 29,568,000 6 13,869,000 4 7,235,000 2 Europe................................... 29,553,000 6 24,581,000 7 39,135,000 13 Central America.......................... 18,770,000 4 15,109,000 5 19,253,000 6 South America............................ 16,406,000 4 24,492,000 7 26,033,000 8 Other.................................... 14,872,000 3 28,447,000 9 29,290,000 9 -------------- --------- -------------- --------- -------------- --------- Total GWP............................ $ 480,889,000 100% $ 331,331,000 100% $ 315,492,000 100% -------------- --------- -------------- --------- -------------- --------- -------------- --------- -------------- --------- -------------- ---------
(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 and diversifying their business. Substantially all of the reinsurance assumed by the Company's insurance company subsidiaries was underwritten directly by the Company but issued by other non-affiliated companies in order to satisfy local licensing or other F-25 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (8) REINSURANCE (CONTINUED) requirements. The following table represents the effect of such reinsurance transactions on net premium and loss and loss adjustment expense:
LOSS AND LOSS WRITTEN EARNED ADJUSTMENT PREMIUM PREMIUM EXPENSE -------------- -------------- -------------- For the year ended December 31, 1998: Direct business............................................... $ 228,629,000 $ 192,536,000 $ 202,858,000 Reinsurance assumed........................................... 269,647,000 260,539,000 292,063,000 Reinsurance ceded............................................. (376,393,000) (309,975,000) (403,619,000) -------------- -------------- -------------- Net amounts................................................. $ 121,883,000 $ 143,100,000 $ 91,302,000 -------------- -------------- -------------- -------------- -------------- -------------- For the year ended December 31, 1997: Direct business............................................... $ 177,728,000 $ 174,533,000 $ 126,861,000 Reinsurance assumed........................................... 168,671,000 180,339,000 165,831,000 Reinsurance ceded............................................. (203,546,000) (192,301,000) (196,178,000) -------------- -------------- -------------- Net amounts................................................. $ 142,853,000 $ 162,571,000 $ 96,514,000 -------------- -------------- -------------- -------------- -------------- -------------- For the year ended December 31, 1996: Direct business............................................... $ 178,969,000 $ 186,417,000 $ 122,940,000 Reinsurance assumed........................................... 158,309,000 146,606,000 105,085,000 Reinsurance ceded............................................. (154,244,000) (162,955,000) (113,561,000) -------------- -------------- -------------- Net amounts................................................. $ 183,034,000 $ 170,068,000 $ 114,464,000 -------------- -------------- -------------- -------------- -------------- --------------
Ceding commissions netted with policy acquisition costs in the consolidated statements of earnings are $59.1 million, $45.5 million and $39.3 million for the years ended December 31, 1998, 1997 and 1996, respectively. The table below represents the composition of reinsurance recoverables in the accompanying consolidated balance sheets:
1998 1997 -------------- -------------- Reinsurance recoverable on paid losses....................... $ 33,572,000 $ 24,126,000 Reinsurance recoverable on outstanding losses................ 279,086,000 140,516,000 Reinsurance recoverable on IBNR.............................. 62,513,000 14,858,000 Reserve for uncollectible reinsurance........................ (2,499,000) (2,535,000) -------------- -------------- Total reinsurance recoverables........................... $ 372,672,000 $ 176,965,000 -------------- -------------- -------------- --------------
The insurance company subsidiaries require reinsurers not authorized by their respective states of domicile to collateralize their reinsurance obligations to the Company with letters of credit or cash deposits. At December 31, 1998, the Company held letters of credit and cash deposits in the amounts of $166.5 million and $8.1 million, respectively, to collateralize a portion of the total amount recoverable and had other payable balances due to its reinsurers of $227.6 million as potential offsets against reinsurance F-26 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (8) REINSURANCE (CONTINUED) recoverables.. The Company has established a reserve of $2.5 million as of December 31, 1998, to absorb the effects of any recoverable problem. 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 total recoverable balance greater than $10.0 million and the collateral and potential offsets held by the Company as of each year end:
LETTERS OF REINSURANCE CREDIT, RECOVERABLES AND CASH DEPOSITS CEDED UNEARNED AND OTHER REINSURER LOCATION PREMIUM PAYABLES - --------------------------------------------------------- ------------------- ---------------- ---------------- December 31, 1998: Underwriters at Lloyd's................................ United Kingdom $ 93,280,000 $ 37,040,000 Underwriters Indemnity Company*........................ Texas 51,576,000 11,039,000 New Cap Reinsurance Corp. Ltd.......................... Australia 49,924,000 40,764,000 Reinsurance Australia Corporation, Ltd................. Australia 41,606,000 44,411,000 SCOR Reinsurance Company............................... New York 38,703,000 11,402,000 AXA Reinsurance Company................................ Delaware 28,667,000 10,513,000 GIO Insurance Limited.................................. Australia 24,011,000 25,158,000 Monegasque De Reassurances............................. Monaco 13,454,000 12,936,000 Overseas Partners Limited.............................. Bermuda 12,718,000 10,919,000 TIG Reinsurance Company................................ Connecticut 12,591,000 2,534,000 St. Paul Fire and Marine Insurance Co.................. Minnesota 12,278,000 4,349,000 December 31, 1997: Underwriters at Lloyd's................................ United Kingdom $ 31,687,000 $ 17,778,000 Underwriters Indemnity Company......................... Texas 28,925,000 6,825,000 Reinsurance Australia Corporation, Ltd................. Australia 28,921,000 31,965,000 SCOR Reinsurance Company............................... New York 23,625,000 10,707,000 AXA Reinsurance Company................................ Delaware 21,004,000 7,790,000 GIO Insurance Limited.................................. Australia 18,610,000 20,551,000 New Cap Reinsurance Corporation, Ltd................... Australia 18,496,000 16,295,000 Reliance Insurance Company............................. Pennsylvania 10,991,000 1,553,000
* Underwriters Indemnity Company was acquired by RLI Corporation, an insurance holding company, in January, 1999. Approximately $2.1 million in recoverables is due from reinsurers that are either under regulatory supervision or insolvent. The Company holds letters of credit and cash deposits totaling $1.9 million to collateralize these balances plus other credits of $1.1 million available for potential offset. The Company is involved in a dispute with one reinsurer over coverage and other issues. The Company believes the reinsurer's position is without merit and all amounts due from the reinsurer will be recovered. The total amount in dispute is approximately $2.3 million. F-27 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (9) COMMITMENTS AND CONTINGENCIES LITIGATION The Company is a party to numerous lawsuits arising in the normal course of business. Many of the pending lawsuits involve claims under policies underwritten or reinsured by the Company. Management believes that any liability for such claims has been adequately included in its established loss reserves. The Company believes the resolution of these lawsuits will not have a material adverse effect on its financial condition, results of operations or cash flows. FOREIGN CURRENCY FORWARD CONTRACTS The Company had no open foreign currency forward contracts as of December 31, 1998 or 1997. The Company may, from time to time, limit its exposure to currency fluctuations through the use of foreign currency forward contracts. 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. LEASES The Company leases administrative office facilities under long-term non-cancelable operating lease agreements expiring at various dates through November, 2005. 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 2002. Rent expense under these leases amounted to $4.3 million, $3.7 million and $2.5 million for the years ended December 31, 1998, 1997 and 1996, respectively. At December 31, 1998, future minimum annual rental payments required under the long-term non-cancelable operating leases, excluding certain expenses payable by the Company, are as follows:
FOR THE YEARS ENDED DECEMBER 31, AMOUNT DUE - --------------------------------------------------------------------------------------------------- ------------- 1999..................................................................................... $ 4,716,000 2000..................................................................................... 4,459,000 2001..................................................................................... 3,952,000 2002..................................................................................... 2,694,000 2003..................................................................................... 2,549,000 Thereafter.................................................................................. 1,321,000 ------------- Total future minimum annual rental payments due.................................................... $ 19,691,000 ------------- -------------
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. F-28 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (9) COMMITMENTS AND CONTINGENCIES (CONTINUED) The Company maintains reinsurance protection which it believes is sufficient to cover any foreseeable event. (10) RELATED PARTY TRANSACTIONS Certain of the Company's directors are officers, directors or owners of business entities with which the Company transacts business. The Company also owns a 21% interest in one of the entities. Balances with these business entities and other related parties included in the accompanying consolidated balance sheets are as follows:
1998 1997 ------------- ------------- Other investments.................................................................. $ 1,072,000 $ -- Reinsurance recoverables........................................................... 42,974,000 21,191,000 Premiums, claims and other receivables............................................. 4,986,000 2,677,000 Ceded unearned premium............................................................. 8,601,000 7,734,000 Strategic operational investments, included in other assets........................ 11,453,000 2,892,000 Loss and loss adjustment expense payable........................................... 3,863,000 661,000 Reinsurance balances payable....................................................... 6,337,000 5,564,000 Premium payable.................................................................... 560,000 1,754,000 Notes payable...................................................................... 16,600,000 -- Accounts payable and accrued liabilities........................................... 159,000 325,000
Transactions with these business entities and other related parties included in the accompanying consolidated statements of earnings are as follows:
1998 1997 1996 ------------- ------------- ------------- Gross earned premium................................................ $ 1,716,000 $ 672,000 $ 871,000 Ceded earned premium................................................ 14,543,000 16,041,000 12,050,000 Commission income................................................... 1,544,000 1,267,000 1,249,000 Investment income................................................... 64,000 397,000 -- Other operating income.............................................. 968,000 8,000 -- Gross loss and loss adjustment expense.............................. 3,282,000 671,000 661,000 Ceded loss and loss adjustment expense.............................. 37,107,000 17,868,000 5,852,000 Other operating expense............................................. 840,000 807,000 1,011,000 Interest expense.................................................... 177,000 14,000 --
Substantially all of the insurance related amounts shown on the above tables are due to balances and transactions with Underwriters Indemnity Company. Its parent was majority owned by a Director and was 21% owned by the Company. Its parent was sold to an unrelated party (RLI Insurance Company) in January, 1999. During 1997, the Company committed to invest $5.0 million in an investment partnership managed by a related party. At December 31, 1998, $1.1 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. F-29 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (11) EMPLOYEE BENEFIT PLANS The Company had various defined contribution retirement plans under Section 401(k) of the Internal Revenue Code which covered substantially all of the domestic employees who met specified service requirements. All of these plans were combined into one plan during 1998. The Company's contributions to these plans were based on varying percentages of the employees' contributions, up to varying maximum levels. The Company's contributions to the new combined plan are discretionary and are determined by management as of the beginning of each calendar year. The Company contributed $1.7 million, $858,000 and $997,000 to the plans for the years ended December 31, 1998, 1997 and 1996, respectively, which is included in compensation expense in the accompanying consolidated statements of earnings. A company acquired in a pooling-of-interests transaction in 1997 had a non-contributory defined benefit retirement plan covering substantially all of its employees who met specified age and service requirements. This plan was terminated in 1997, upon acquisition, at which time the participants' accounts became fully vested. In accordance with applicable regulations, the plan's assets were distributed to participants during 1998 and January 1999. Total pension expense (credit) under the plan amounted to $(604,000), $0, and ($590,000), for the years ended December 31, 1998, 1997 and 1996, respectively. A curtailment gain of $1.0 million was recognized in the 1996 pension credit as a result of the acquired company's decision to eliminate certain future service time credits. (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 capital and surplus as of the prior calendar year end. During 1999, HC and USSIC's ordinary dividend capacities will be approximately $38.2 million and $7.9 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 capital and surplus as of the prior year end. During 1999, AIC's ordinary dividend capacity will be approximately $10.5 million. As of December 31, 1998, all of the domestic insurance company subsidiaries total adjusted capital greatly exceeded the NAIC authorized control level risk-based capital. F-30 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (12) SHAREHOLDERS' EQUITY (CONTINUED) The components of accumulated other comprehensive income are as follows:
UNREALIZED ACCUMULATED FOREIGN INVESTMENT OTHER CURRENCY GAIN COMPREHENSIVE TRANSLATION (LOSS) INCOME (LOSS) ------------- ---------- -------------- Balance December 31, 1995........................ $ (186,000) $9,296,000 $ 9,110,000 Net change for year.............................. 95,000 (5,673,000) (5,578,000) ------------- ---------- -------------- Balance December 31, 1996........................ (91,000) 3,623,000 3,532,000 Net change for year.............................. (215,000) 4,683,000 4,468,000 ------------- ---------- -------------- 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 ------------- ---------- -------------- ------------- ---------- --------------
(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, 1998, 7,529,103 shares of Common Stock were reserved for the exercise of options, of which 5,459,766 shares were reserved for options previously granted and 2,069,337 shares were reserved for future issuances of options. Options vest over a zero to five year period and expire six 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. During 1996, such compensation expense amounted to $494,000. 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 $65.4 million, or $1.34 per share for the year ended December 31, 1998; $43.8 million, or $0.91 per share, for the year ended December 31, 1997; and $37.6 million, or $0.82 per share, for the year ended December 31, 1996. 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 5.3% for 1998, 6.2% for 1997 and 5.6% for 1996, b) expected volatility factor of .3, c) dividend yield of .91% for 1998, .56% for 1997 and .3% for 1996, and d) expected option life of five years for 1998 and 1997 and six years for 1996. F-31 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (13) STOCK OPTIONS (CONTINUED) Stock option activity is shown below.
1998 1997 1996 ------------------------------------ ------------------------------------ ----------------------- AVERAGE AVERAGE AVERAGE NUMBER OF EXERCISE AVERAGE NUMBER OF EXERCISE AVERAGE NUMBER OF EXERCISE SHARES PRICE FAIR VALUE SHARES PRICE FAIR VALUE SHARES PRICE ---------- ----------- ----------- ---------- ----------- ----------- ---------- ----------- Outstanding, beginning of year......................... 3,508,226 $ 16.22 3,124,793 $ 13.03 2,935,863 $ 11.71 Granted at market value........ 2,779,500 17.01 $ 5.23 1,301,500 22.88 $ 7.98 292,500 23.63 Granted below market value..... -- -- -- -- -- -- 60,000 13.01 Cancelled...................... (192,462) 21.48 (123,700) 24.37 (12,250) 11.51 Exercised...................... (635,498) 14.05 (530,542) 12.80 (120,420) 4.52 Pooled company option activity prior to combination: Granted at market value........ -- -- -- -- -- -- 45,600 15.25 Cancelled...................... -- -- (1,375) 15.84 (61,850) 20.02 Exercised...................... -- -- (262,450) 16.00 (14,650) 8.54 ---------- ----------- ---------- ----------- ---------- ----------- Outstanding, end of year....... 5,459,766 $ 16.73 3,508,226 $ 16.22 3,124,793 $ 13.03 ---------- ----------- ---------- ----------- ---------- ----------- ---------- ----------- ---------- ----------- ---------- ----------- Exercisable, end of year....... 2,792,707 $ 15.92 1,230,145 $ 11.60 1,491,792 $ 12.72 ---------- ----------- ---------- ----------- ---------- ----------- ---------- ----------- ---------- ----------- ---------- ----------- AVERAGE FAIR VALUE --------- Outstanding, beginning of year......................... Granted at market value........ $ 9.87 Granted below market value..... 11.51 Cancelled...................... Exercised...................... Pooled company option activity prior to combination: Granted at market value........ 4.69 Cancelled...................... Exercised...................... Outstanding, end of year....... Exercisable, end of year.......
Options outstanding at December 31, 1998, are shown on the following schedule:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE ---------------------------------------- AVERAGE ----------------------- REMAINING AVERAGE AVERAGE NUMBER OF CONTRACTUAL EXERCISE NUMBER OF EXERCISE RANGE OF EXERCISE PRICES SHARES LIFE PRICE SHARES PRICE - ---------------------------------------------------------- ---------- --------------- ----------- ---------- ----------- Under $16.50.............................................. 1,498,691 5.30 years $ 9.73 1,197,163 $ 9.48 $16.50.................................................... 1,564,500 5.05 16.50 240,000 16.50 $16.51-$22.25............................................. 1,025,525 6.51 18.71 409,025 18.24 Over $22.25............................................... 1,371,050 7.85 23.17 946,519 22.90 ---------- --------------- ----------- ---------- ----------- Total options............................................. 5,459,766 6.09 years $ 16.73 2,792,707 $ 15.92 ---------- --------------- ----------- ---------- ----------- ---------- --------------- ----------- ---------- -----------
F-32 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, 1998:
1998 1997 1996 ------------- ------------- ------------- Net earnings........................................................ $ 72,278,000 $ 49,759,000 $ 38,582,000 ------------- ------------- ------------- ------------- ------------- ------------- Reconciliation of number of shares outstanding: Shares of Common Stock outstanding at year end...................... 48,252,000 47,759,000 45,715,000 Changes in Common Stock due to issuance............................. (332,000) (764,000) (920,000) ------------- ------------- ------------- Weighted average Common Stock outstanding......................... 47,920,000 46,995,000 44,795,000 Additional dilutive effect of outstanding options (as determined by the application of the treasury stock method)..................... 1,016,000 1,214,000 1,248,000 ------------- ------------- ------------- Weighted average Common Stock and potential common stock outstanding..................................................... 48,936,000 48,209,000 46,043,000 ------------- ------------- ------------- ------------- ------------- -------------
As of December 31, 1998, there were approximately 1.7 million options that were not included in the computation of diluted earnings per share because to do so would have been antidilutive. There are 378,000 shares of the Company's Common Stock to be issued in connection with an acquisition accounted for under the purchase method of accounting, if certain conditions are met as of December 31, 1999 or in subsequent years. These shares were not included in the diluted earnings per share computation, because the conditions for issuance have not yet been met. F-33 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (15) STATUTORY TO GAAP RECONCILIATIONS Reconciliations of statutory policyholders' surplus as of December 31, 1998 and 1997, and net income for the three years ended December 31, 1998, of the Company's insurance company subsidiaries included in those companies' respective filings with regulatory authorities to the amounts shown in the accompanying consolidated financial statements on the basis of GAAP are as follows:
1998 1997 -------------- -------------- Statutory policyholders' surplus................................................. $ 369,401,000 $ 331,922,000 Difference in carrying value of fixed income securities.......................... 16,599,000 11,970,000 Difference in unearned premium................................................... 1,460,000 1,653,000 Assets non-admitted for statutory reporting...................................... 6,408,000 4,390,000 Deferred policy acquisition costs net of deferred ceding commissions capitalized for GAAP....................................................................... (3,294,000) 2,713,000 Deferred income taxes recorded for GAAP.......................................... 3,769,000 3,899,000 Statutory provisions for reinsurance, net of GAAP reserve for uncollectible reinsurance.................................................................... 17,657,000 5,838,000 Excess of statutory reserves over statement reserves............................. 954,000 -- Other............................................................................ 541,000 -- -------------- -------------- Shareholder's equity of insurance company subsidiaries on basis of GAAP........ 413,495,000 362,385,000 Equity attributable to non-insurance company parent and subsidiaries, net of elimination entries in consolidation........................................... 26,368,000 3,216,000 -------------- -------------- Total shareholders' equity per accompanying consolidated financial statements................................................................... $ 439,863,000 $ 365,601,000 -------------- -------------- -------------- --------------
1998 1997 1996 ------------- ------------- ------------- Statutory net income................................................ $ 53,162,000 $ 56,626,000 $ 45,079,000 Difference in unearned premium...................................... (193,000) 285,000 (4,175,000) Deferred income tax benefit not recorded for statutory purposes..... 1,136,000 380,000 552,000 Change in deferred policy acquisition costs and deferred ceding commissions capitalized for GAAP.................................. (6,395,000) (5,647,000) 3,279,000 Gain on transfer of subsidiary, eliminated for GAAP................. -- (4,663,000) -- Other, net.......................................................... 556,000 (30,000) 295,000 ------------- ------------- ------------- Net income of insurance company subsidiaries on basis of GAAP..... 48,266,000 46,951,000 45,030,000 Net income (loss) attributable to non-insurance parent and subsidiaries...................................................... 24,012,000 2,808,000 (6,448,000) ------------- ------------- ------------- Net earnings per accompanying consolidated financial statements... $ 72,278,000 $ 49,759,000 $ 38,582,000 ------------- ------------- ------------- ------------- ------------- -------------
The NAIC adopted Statements of Statutory Accounting Principles ("SSAPs") in March, 1998 as a product of its attempt to codify statutory accounting principles. While subject to adoption by the individual states, the NAIC has established an effective date of January 1, 2001 for the SSAPs. Prior to the F-34 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (15) STATUTORY TO GAAP RECONCILIATIONS (CONTINUED) codification project, a comprehensive guide to statutory accounting principles did not exist. Codification is new and will evolve over time. Based upon the SSAPs as currently published, the Company does not expect their adoption to have a material effect on the policyholders' surplus of its individual insurance company subsidiaries. The only material effect on statutory net income is that the statutory net income for HC will be decreased or increased by a change in the method of recording equity in earnings or losses of subsidiaries. Currently HC records the equity in earnings or losses of its subsidiaries as a component of statutory net income. When codification becomes effective, the equity in earnings or losses of subsidiaries will be recorded as an unrealized gain or loss which is a direct increase or decrease to policyholders' surplus. Income will not be recognized until such time (if any) that dividends are received from the subsidiaries and recorded in statutory net income. (16) SUPPLEMENTAL CASH FLOW INFORMATION Supplemental cash flow information for the three years ended December 31, 1998, is summarized below:
1998 1997 1996 ------------- ------------- ------------- Interest paid....................................................... $ 5,409,000 $ 6,712,000 $ 5,027,000 Income tax paid..................................................... 30,662,000 24,132,000 16,426,000 Dividends declared but not paid at year end......................... 1,930,000 1,386,000 717,000
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. F-35 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (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, 1998:
1998 1997 1996 -------------- -------------- -------------- Reserves for loss and LAE at beginning of the year.............. $ 275,008,000 $ 229,049,000 $ 200,756,000 Less reinsurance recoverables................................... 155,374,000 111,766,000 101,497,000 -------------- -------------- -------------- Net reserves at beginning of the year....................... 119,634,000 117,283,000 99,259,000 Net reserves acquired with purchase of subsidiary............... 3,877,000 1,919,000 -- Provision for loss and LAE for claims occurring in the current year.......................................................... 105,895,000 100,288,000 119,401,000 Decrease in estimated loss and LAE for claims occurring in prior years......................................................... (14,593,000) (3,774,000) (4,937,000) -------------- -------------- -------------- Incurred loss and LAE, net of reinsurance..................... 91,302,000 96,514,000 114,464,000 -------------- -------------- -------------- Loss and LAE payments for claims occurring during: Current year.................................................... 47,126,000 48,208,000 54,493,000 Prior years..................................................... 48,775,000 47,874,000 41,947,000 -------------- -------------- -------------- Loss and LAE payments, net of reinsurance..................... 95,901,000 96,082,000 96,440,000 -------------- -------------- -------------- Net reserves at end of the year................................. 118,912,000 119,634,000 117,283,000 Plus reinsurance recoverables................................... 341,599,000 155,374,000 111,766,000 -------------- -------------- -------------- Reserves for loss and LAE at end of the year................ $ 460,511,000 $ 275,008,000 $ 229,049,000 -------------- -------------- -------------- -------------- -------------- --------------
During 1998, the Company had net loss and LAE redundancy of $14.6 million relating to prior year losses compared to redundancies of $3.8 million in 1997 and $4.9 million in 1996. The redundancies in the net reserves result from the Company's and its advisors' continued review of its loss reserves and the 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. F-36 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (18) QUARTERLY FINANCIAL DATA (UNAUDITED)
FOURTH QUARTER THIRD QUARTER SECOND QUARTER FIRST QUARTER 1998 1998 1998 1998 -------------- ------------- -------------- ------------- Net earned premium................................ $ 39,129,000 $34,604,000 $ 35,440,000 $ 33,927,000 Management fees................................... 20,947,000 18,797,000 18,643,000 16,108,000 Commission income................................. 12,925,000 5,262,000 13,418,000 6,836,000 Net investment income............................. 8,139,000 7,184,000 7,322,000 6,690,000 Other operating income............................ 3,723,000 9,726,000 4,511,000 4,308,000 Total revenue..................................... 84,170,000 76,536,000 79,342,000 67,986,000 Loss and loss adjustment expense.................. 28,944,000 18,555,000 26,613,000 17,190,000 Merger expense.................................... -- 1,000 79,000 27,000 Total expense..................................... 61,805,000 43,182,000 53,042,000 42,519,000 Earnings before income tax provision.............. 22,365,000 33,354,000 26,300,000 25,467,000 Income tax provision.............................. 6,883,000 11,279,000 8,666,000 8,380,000 -------------- ------------- -------------- ------------- Net earnings...................................... $ 15,482,000 $22,075,000 $ 17,634,000 $ 17,087,000 -------------- ------------- -------------- ------------- -------------- ------------- -------------- ------------- Basic earnings per share data: Earnings per share................................ $ 0.32 $ 0.46 $ 0.37 $ 0.36 -------------- ------------- -------------- ------------- -------------- ------------- -------------- ------------- Weighted average shares outstanding............... 48,159,000 47,870,000 47,853,000 47,794,000 -------------- ------------- -------------- ------------- -------------- ------------- -------------- ------------- Diluted earnings per share data: Earnings per share................................ $ 0.32 $ 0.45 $ 0.36 $ 0.35 -------------- ------------- -------------- ------------- -------------- ------------- -------------- ------------- Weighted average shares outstanding............... 48,970,000 48,919,000 49,015,000 48,809,000 -------------- ------------- -------------- ------------- -------------- ------------- -------------- -------------
The fourth quarter of 1998 includes a charge of $3.8 million (after tax) for catastrophe losses related to hurricanes Georges and Mitch. F-37 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (18) QUARTERLY FINANCIAL DATA (UNAUDITED) (CONTINUED)
FOURTH QUARTER THIRD QUARTER SECOND QUARTER FIRST QUARTER 1997 1997 1997 1997 -------------- ------------- -------------- ------------- Net earned premium................................ $ 38,982,000 $31,437,000 $ 47,478,000 $ 44,674,000 Management fees................................... 18,371,000 13,142,000 9,919,000 9,607,000 Commission income................................. 6,662,000 4,880,000 5,991,000 6,676,000 Net investment income............................. 7,277,000 7,584,000 6,528,000 6,198,000 Other operating income............................ 3,699,000 4,028,000 3,974,000 3,538,000 Total revenue..................................... 74,921,000 61,107,000 73,652,000 70,637,000 Loss and loss adjustment expense.................. 25,977,000 14,467,000 29,452,000 26,618,000 Merger expense.................................... 487,000 305,000 5,404,000 1,873,000 Total expense..................................... 60,825,000 35,579,000 58,908,000 51,941,000 Earnings before income tax provision.............. 14,096,000 25,528,000 14,744,000 18,696,000 Income tax provision.............................. 3,474,000 8,408,000 5,760,000 5,663,000 -------------- ------------- -------------- ------------- Net earnings...................................... $ 10,622,000 $17,120,000 $ 8,984,000 $ 13,033,000 -------------- ------------- -------------- ------------- -------------- ------------- -------------- ------------- Basic earnings per share data: Earnings per share................................ $ 0.22 $ 0.36 $ 0.19 $ 0.28 -------------- ------------- -------------- ------------- -------------- ------------- -------------- ------------- Weighted average shares outstanding............... 47,696,000 47,431,000 46,720,000 46,115,000 -------------- ------------- -------------- ------------- -------------- ------------- -------------- ------------- Diluted earnings per share data: Earnings per share................................ $ 0.22 $ 0.35 $ 0.19 $ 0.27 -------------- ------------- -------------- ------------- -------------- ------------- -------------- ------------- Weighted average shares outstanding............... 48,636,000 48,722,000 47,983,000 47,448,000 -------------- ------------- -------------- ------------- -------------- ------------- -------------- -------------
A charge of $6.5 million (after tax) for reserve strengthening was recorded during the fourth quarter of 1997, predominantly relating to 1995 and 1996 claims incurred prior to the acquisition of AIC in 1997 in a pooling-of-interests transaction. F-38 REPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULES To the Board of Directors of HCC Insurance Holdings, Inc.: Our audits of the consolidated financial statements referred to in our report dated March 26, 1999, included on page F-1 of this Form 10-K also included an audit of the financial statement schedules listed in Item 14(b) of this Form 10-K. Our report states that for the year ended December 31, 1996, our opinion, insofar as it relates to data included for Avemco Corporation for 1996, is based solely on the report of the other auditors. In our opinion, based on our audits and the report of other auditors, 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. PRICEWATERHOUSECOOPERS LLP Houston, Texas March 26, 1999 S-1 INDEPENDENT AUDITORS' CONSENT AND REPORT ON SCHEDULES The Board of Directors and Shareholder Avemco Corporation: The audit referred to in our report dated January 31, 1997 (February 28, 1997, as to note 12 and February 18, 1998, as to note 14) includes the related financial statement schedules for the year ended December 31, 1996, not included separately herein. These financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statement schedules based on our audit. In our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein. We consent to incorporation by reference in the registration statements (Nos. 333-14479, 333-14471, 333-61673, 333-61687 and 333-68771) on Form S-8 of HCC Insurance Holdings, Inc. of our report dated January 31, 1997 (February 28, 1997, as to note 12 and February 18, 1998, as to note 14), relating to the consolidated statements of income, stockholders' equity, and cash flows of Avemco Corporation and subsidiaries for the year ended December 31, 1996, and all related schedules, which report appears in the December 31, 1998 annual report on Form 10-K of HCC Insurance Holdings, Inc. KPMG LLP Washington, D.C. March 26, 1999 S-2 SCHEDULE 1 HCC INSURANCE HOLDINGS, INC. SUMMARY OF INVESTMENTS OTHER THAN INVESTMENTS IN RELATED PARTIES DECEMBER 31, 1998
COLUMN D -------------- AMOUNT AT WHICH COLUMN A COLUMN B COLUMN C SHOWN IN THE - ---------------------------------------------------------------- -------------- -------------- BALANCE TYPE OF INVESTMENT COST VALUE SHEET - ---------------------------------------------------------------- -------------- -------------- -------------- Fixed maturities: Bonds--United States government and government agencies and authorities................................................. $ 19,183,000 $ 19,773,000 $ 19,773,000 Bonds--states, municipalities and political subdivisions...... 154,281,000 163,798,000 163,798,000 Bonds--special revenue........................................ 200,382,000 208,355,000 208,355,000 Bonds--Canadian government.................................... 259,000 302,000 302,000 Bonds--corporate.............................................. 1,002,000 1,010,000 1,010,000 -------------- -------------- -------------- Total fixed maturities.................................... 375,107,000 393,238,000 393,238,000 -------------- -------------- -------------- -------------- Equity securities: Common stocks--banks, trusts & insurance companies............ 1,259,000 $ 1,766,000 1,766,000 Common stocks--industrial..................................... 486,000 481,000 481,000 Non-redeemable preferred stocks............................... 5,000 5,000 5,000 -------------- -------------- -------------- Total equity securities................................... 1,750,000 $ 2,252,000 2,252,000 -------------- -------------- -------------- -------------- Short-term investments.......................................... 129,084,000 129,084,000 Other investments............................................... 1,072,000 1,072,000 -------------- -------------- Total investments......................................... $ 507,013,000 $ 525,646,000 -------------- -------------- -------------- --------------
S-3 SCHEDULE 2 HCC INSURANCE HOLDINGS, INC. CONDENSED FINANCIAL INFORMATION OF REGISTRANT BALANCE SHEETS
DECEMBER 31, ------------------------------ 1998 1997 -------------- -------------- ASSETS Cash............................................................................. $ -- $ 192,000 Short-term investments........................................................... 4,539,000 1,200,000 Investment in subsidiaries....................................................... 441,041,000 404,134,000 Intercompany loan to subsidiaries................................................ 103,426,000 41,250,000 Deferred Federal income tax...................................................... -- 5,174,000 Other assets..................................................................... 32,419,000 696,000 -------------- -------------- TOTAL ASSETS................................................................. $ 581,425,000 $ 452,646,000 -------------- -------------- -------------- -------------- LIABILITIES AND SHAREHOLDERS' EQUITY Notes payable.................................................................... $ 105,000,000 $ 80,750,000 Note payable to related party.................................................... 16,600,000 -- Payable to subsidiaries.......................................................... 14,558,000 4,755,000 Deferred Federal income tax...................................................... 261,000 -- Accounts payable and accrued liabilities......................................... 5,143,000 1,540,000 -------------- -------------- Total liabilities............................................................ 141,562,000 87,045,000 Total shareholders' equity................................................... 439,863,000 365,601,000 -------------- -------------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY................................... $ 581,425,000 $ 452,646,000 -------------- -------------- -------------- --------------
See Notes to Condensed Financial Information. S-4 SCHEDULE 2 HCC INSURANCE HOLDINGS, INC. CONDENSED FINANCIAL INFORMATION OF REGISTRANT STATEMENTS OF EARNINGS
FOR THE YEARS ENDED DECEMBER 31, ---------------------------------- 1998 1997 1996 ---------- ---------- ---------- Equity in earnings of subsidiaries.................... $75,228,000 $56,024,000 $41,905,000 Interest income from subsidiaries..................... 2,052,000 -- -- Interest income....................................... 285,000 24,000 41,000 Net realized investment gain.......................... 840,000 -- -- ---------- ---------- ---------- Total revenue..................................... 78,405,000 56,048,000 41,946,000 Interest expense...................................... 6,036,000 1,904,000 1,110,000 Merger related expenses............................... 107,000 3,326,000 907,000 Other operating expense............................... 1,623,000 2,032,000 1,832,000 ---------- ---------- ---------- Total expense......................................... 7,766,000 7,262,000 3,849,000 ---------- ---------- ---------- Earnings before income tax benefit................ 70,639,000 48,786,000 38,097,000 Income tax benefit.................................... 1,639,000 973,000 485,000 ---------- ---------- ---------- NET EARNINGS...................................... $72,278,000 $49,759,000 $38,582,000 ---------- ---------- ---------- ---------- ---------- ----------
See Notes to Condensed Financial Information. S-5 SCHEDULE 2 HCC INSURANCE HOLDINGS, INC. CONDENSED FINANCIAL INFORMATION OF REGISTRANT STATEMENTS OF COMPREHENSIVE INCOME
FOR THE YEARS ENDED DECEMBER 31, ---------------------------------- 1998 1997 1996 ---------- ---------- ---------- Net earnings.......................................... $72,278,000 $49,759,000 $38,582,000 Other comprehensive income net of tax: Foreign currency translation adjustment due to consolidated subsidiaries....................... (344,000) (215,000) 95,000 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 $1,205,000 in 1998, $2,373,000 in 1997 and ($82,000) in 1996.... 2,454,000 4,470,000 (251,000) 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 ($218,000) in 1998, $115,000 in 1997 and ($2,919,000) in 1996..................................... (405,000) 213,000 (5,422,000) ---------- ---------- ---------- Other comprehensive income (loss)........... 1,705,000 4,468,000 (5,578,000) ---------- ---------- ---------- COMPREHENSIVE INCOME........................ $73,983,000 $54,227,000 $33,004,000 ---------- ---------- ---------- ---------- ---------- ----------
See Notes to Condensed Financial Information. S-6 SCHEDULE 2 HCC INSURANCE HOLDINGS, INC. CONDENSED FINANCIAL INFORMATION OF REGISTRANT STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, ---------------------------------------------- 1998 1997 1996 -------------- -------------- -------------- Cash flows from operating activities: Net earnings................................................... $ 72,278,000 $ 49,759,000 $ 38,582,000 Adjustment to reconcile net earnings to net cash provided (used) by operating activities: Undistributed net income of subsidiaries....................... (75,228,000) (56,024,000) (41,905,000) Change in deferred Federal income tax, net of tax effect of unrealized gain or loss...................................... 3,934,000 197,000 (5,423,000) Depreciation................................................... 29,000 30,000 29,000 Change in intercompany loan to subsidiaries.................... (2,052,000) -- -- Change in payable to subsidiary and other...................... (3,932,000) (533,000) 8,971,000 Net realized investment gain................................... (840,000) -- -- -------------- -------------- -------------- Cash provided (used) by operating activities................. (5,811,000) (6,571,000) 254,000 Cash flows from investing activities: Sales of fixed income securities............................... 16,680,000 -- -- Cash contributions to subsidiaries............................. (62,000) (62,442,000) -- Purchase of subsidiaries....................................... (30,355,000) (6,483,000) (1,753,000) Change in short-term investments............................... (3,339,000) 2,790,000 (3,206,000) Cost of investment acquired.................................... (2,525,000) -- -- Intercompany loan to subsidiaries.............................. (34,530,000) (41,250,000) -- Payments on intercompany loan to subsidiaries.................. 15,986,000 -- -- Cash dividends from subsidiaries............................... 24,450,000 43,526,000 5,180,000 -------------- -------------- -------------- Cash provided (used) by investing activities................. (13,695,000) (63,859,000) 221,000 Cash flows from financing activities: Proceeds from note payable..................................... 74,200,000 97,500,000 -- Payments on notes payable...................................... (49,950,000) (33,000,000) -- Sale of Common Stock, net of costs............................. 2,203,000 10,470,000 843,000 Dividends paid................................................. (7,139,000) (4,550,000) (1,387,000) -------------- -------------- -------------- Cash provided (used) by financing activities................. 19,314,000 70,420,000 (544,000) -------------- -------------- -------------- Net decrease in cash......................................... (192,000) (10,000) (69,000) Cash at beginning of year.................................... 192,000 202,000 271,000 -------------- -------------- -------------- Cash at end of year.......................................... $ -- $ 192,000 $ 202,000 -------------- -------------- -------------- -------------- -------------- --------------
See Notes to Condensed Financial Information. S-7 HCC INSURANCE HOLDINGS, INC. CONDENSED FINANCIAL INFORMATION OF REGISTRANT NOTE 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, 1998, the interest rate on intercompany loans was 6 1/2%. S-8 SCHEDULE 3 HCC INSURANCE HOLDINGS, INC. SUPPLEMENTARY INSURANCE INFORMATION (DOLLARS IN THOUSANDS)
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN F COLUMN G COLUMN H ------------ --------------- ------------- ----------- ----------- --------------- ------------- (1) (1) (2) DECEMBER 31, ------------------------------------------- FOR THE YEARS ENDED DECEMBER 31, FUTURE POLICY ------------------------------------------- BENEFITS, BENEFITS, LOSSES, CLAIMS, DEFERRED POLICY CLAIMS LOSSES AND ACQUISITION AND LOSS UNEARNED PREMIUM NET INVESTMENT SETTLEMENT SEGMENTS COSTS EXPENSES PREMIUMS REVENUE INCOME EXPENSES -------------------------- --------------- ------------- ----------- ----------- --------------- ------------- 1998 Insurance Company......... $ (3,615) $ 460,511 $ 201,050 $ 143,100 $ 23,578 $ 91,302 Underwriting Agency....... 3,949 Intermediary.............. 362 Other Operations 545 Corporate................. 901 --------------- ------------- ----------- ----------- ------- ------------- Total..................... $ (3,615) $ 460,511 $ 201,050 $ 143,100 $ 29,335 $ 91,302 --------------- ------------- ----------- ----------- ------- ------------- --------------- ------------- ----------- ----------- ------- ------------- 1997 Insurance Company......... $ 2,051 $ 275,008 $ 152,094 $ 162,571 $ 23,379 $ 96,514 Underwriting Agency....... 2,620 Intermediary.............. 322 Other Operations.......... 128 Corporate................. 1,138 --------------- ------------- ----------- ----------- ------- ------------- Total..................... $ 2,051 $ 275,008 $ 152,094 $ 162,571 $ 27,587 $ 96,514 --------------- ------------- ----------- ----------- ------- ------------- --------------- ------------- ----------- ----------- ------- ------------- 1996 Insurance Company......... $ 7,908 $ 229,049 $ 156,268 $ 170,068 $ 20,146 $ 114,464 Underwriting Agency....... 1,798 Intermediary.............. 179 Other Operations.......... 91 Corporate................. 1,379 --------------- ------------- ----------- ----------- ------- ------------- Total..................... $ 7,908 $ 229,049 $ 156,268 $ 170,068 $ 23,593 $ 114,464 --------------- ------------- ----------- ----------- ------- ------------- --------------- ------------- ----------- ----------- ------- ------------- COLUMN I COLUMN J COLUMN K ------------- --------------- ----------- (2) AMORTIZATION OF DEFERRED POLICY ACQUISITION OTHER OPERATING PREMIUMS COSTS EXPENSES WRITTEN ------------- --------------- ----------- 1998 $ 10,978 $ 17,365 $ 121,883 54,184 8,106 10,397 2,195 ------------- ------- ----------- $ 10,978 $ 92,247 $ 121,883 ------------- ------- ----------- ------------- ------- ----------- 1997 $ 13,580 $ 17,588 $ 142,853 45,274 9,294 14,401 4,598 ------------- ------- ----------- $ 13,580 $ 91,155 $ 142,853 ------------- ------- ----------- ------------- ------- ----------- 1996 $ 8,218 $ 17,186 $ 183,034 53,649 7,649 11,195 4,965 ------------- ------- ----------- $ 8,218 $ 94,644 $ 183,034 ------------- ------- ----------- ------------- ------- -----------
- ------------------------ (1) Columns C and D are shown ignoring the effects of reinsurance. (2) Net investment income was allocated to the company, and therefore the segment, on which the related investment asset was recorded. Other operating expenses were allocated to the company, and therefore the corresponding segment, which actually incurred those expenses. Note: Column E is omitted because the Company has no other policy claims and benefits payable. S-9 SCHEDULE 4 HCC INSURANCE HOLDINGS, INC. REINSURANCE
COLUMN D -------------- COLUMN F COLUMN C (1) -------------- COLUMN A COLUMN B -------------- ASSUMED FROM COLUMN E PERCENT OF - --------------------------------------------- -------------- CEDED TO OTHER OTHER -------------- AMOUNT EARNED PREMIUM GROSS AMOUNT COMPANIES COMPANIES NET AMOUNT ASSUMED TO NET - --------------------------------------------- -------------- -------------- -------------- -------------- -------------- For the year ended December 31, 1998: 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% -------------- -------------- -------------- -------------- ------- -------------- -------------- -------------- -------------- ------- For the year ended December 31, 1997: Property and liability insurance............. $ 173,032,000 $ 177,371,000 $ 140,423,000 $ 136,084,000 103% Accident and health insurance................ 1,501,000 14,930,000 39,916,000 26,487,000 151% -------------- -------------- -------------- -------------- Total.................................... $ 174,533,000 $ 192,301,000 $ 180,339,000 $ 162,571,000 111% -------------- -------------- -------------- -------------- ------- -------------- -------------- -------------- -------------- ------- For the year ended December 31, 1996: Property and liability insurance............. $ 185,477,000 $ 162,829,000 $ 135,552,000 $ 158,200,000 86% Accident and health insurance................ 940,000 126,000 11,054,000 11,868,000 93% -------------- -------------- -------------- -------------- Total.................................... $ 186,417,000 $ 162,955,000 $ 146,606,000 $ 170,068,000 86% -------------- -------------- -------------- -------------- ------- -------------- -------------- -------------- -------------- -------
- ------------------------ (1) Substantially all of the reinsurance assumed by the Company's insurance company subsidiaries was underwritten directly by the Company but issued by other non-affiliated companies in order to satisfy local licensing or other requirements. S-10 EX-10.344 2 EXHIBIT 10.344 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- STOCK PURCHASE AGREEMENT DATED EFFECTIVE AS OF OCTOBER 1, 1998 BY AND AMONG HCC INSURANCE HOLDINGS, INC., AND SUN EMPLOYER SERVICES, INC. AN ALABAMA CORPORATION AND HOWARD V. BARTON AND ELIZABETH A. BARTON - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- TABLE OF CONTENTS
PAGE ARTICLE 1 SALE AND TRANSFER OF THE SUN COMMON STOCK. . . . . . . . . 2 Section 1.1 Sale of Sun Common Stock . . . . . . . . . . . . . . . . . 2 Section 1.2 Purchase Price . . . . . . . . . . . . . . . . . . . . . . 2 Section 1.3 Closing Deliveries . . . . . . . . . . . . . . . . . . . . 4 Section 1.4 Escrow Agreement . . . . . . . . . . . . . . . . . . . . . 4 Section 1.5 Additional Transfers . . . . . . . . . . . . . . . . . . . 4 ARTICLE 2 REPRESENTATIONS AND WARRANTIES OF SUN AND SHAREHOLDER . . . . . . . . . . . . . . . . . . 5 Section 2.1 Corporate Existence and Power. . . . . . . . . . . . . . . 5 Section 2.2 Authorization. . . . . . . . . . . . . . . . . . . . . . . 5 Section 2.3 Governmental Authorization . . . . . . . . . . . . . . . . 5 Section 2.4 Non-Contravention. . . . . . . . . . . . . . . . . . . . . 6 Section 2.5 Capitalization . . . . . . . . . . . . . . . . . . . . . . 7 Section 2.6 Subsidiaries and Related Entities. . . . . . . . . . . . . 7 Section 2.7 Sun Financial Statements . . . . . . . . . . . . . . . . . 8 Section 2.8 Absence of Certain Changes . . . . . . . . . . . . . . . . 8 Section 2.9 No Undisclosed Liabilities . . . . . . . . . . . . . . . .10 Section 2.10 Litigation . . . . . . . . . . . . . . . . . . . . . . . .10 Section 2.11 Taxes. . . . . . . . . . . . . . . . . . . . . . . . . . .10 Section 2.12 Employee Benefit Plans, ERISA. . . . . . . . . . . . . . .11 Section 2.13 Material Agreements. . . . . . . . . . . . . . . . . . . .13 Section 2.14 Properties . . . . . . . . . . . . . . . . . . . . . . . .13 Section 2.15 Environmental Matters. . . . . . . . . . . . . . . . . . .14 Section 2.16 Labor Matters. . . . . . . . . . . . . . . . . . . . . . .15 Section 2.17 Compliance with Laws . . . . . . . . . . . . . . . . . . .15 Section 2.18 Trademarks, Trade Names, Etc.. . . . . . . . . . . . . . .15 Section 2.19 Sale of Sun. . . . . . . . . . . . . . . . . . . . . . . .15 Section 2.20 Broker's Fees. . . . . . . . . . . . . . . . . . . . . . .15 Section 2.21 Investment Representation. . . . . . . . . . . . . . . . .15 Section 2.22 Investments. . . . . . . . . . . . . . . . . . . . . . . .16 Section 2.23 Investment Company . . . . . . . . . . . . . . . . . . . .16 Section 2.24 Licenses . . . . . . . . . . . . . . . . . . . . . . . . .17 Section 2.25 Internal Controls. . . . . . . . . . . . . . . . . . . . .17 Section 2.26 Insurance. . . . . . . . . . . . . . . . . . . . . . . . .17 Section 2.27 Financial Solvency . . . . . . . . . . . . . . . . . . . .17 Section 2.28 Year 2000 Issue. . . . . . . . . . . . . . . . . . . . . .17 Section 2.29 North Bay Assets . . . . . . . . . . . . . . . . . . . . .18
i TABLE OF CONTENTS (Cont.)
PAGE ARTICLE 3 REPRESENTATIONS AND WARRANTIES OF HCC . . . . . . . . . .18 Section 3.1 Corporate Existence and Power. . . . . . . . . . . . . . .18 Section 3.2 Corporate Authorization. . . . . . . . . . . . . . . . . .18 Section 3.3 Governmental Authorization . . . . . . . . . . . . . . . .19 Section 3.4 Shares of HCC Common Stock . . . . . . . . . . . . . . . .19 Section 3.5 SEC Filings. . . . . . . . . . . . . . . . . . . . . . . .19 Section 3.6 Non-Contravention. . . . . . . . . . . . . . . . . . . . .20 Section 3.7 Absence of Certain Changes . . . . . . . . . . . . . . . .20 Section 3.8 Compliance with Laws . . . . . . . . . . . . . . . . . . .20 Section 3.9 Broker's Fees. . . . . . . . . . . . . . . . . . . . . . .21 Section 3.10 Investment Company . . . . . . . . . . . . . . . . . . . .21 Section 3.11 Capitalization of HCC. . . . . . . . . . . . . . . . . . .21 Section 3.12 Investigation. . . . . . . . . . . . . . . . . . . . . . .21 Section 3.13 Investment Representation. . . . . . . . . . . . . . . . .21 ARTICLE 4 COVENANTS OF THE SHAREHOLDER AND SUN . . . . . . . . . . .22 Section 4.1 Conduct of Sun . . . . . . . . . . . . . . . . . . . . . .22 Section 4.2 Access to Financial and Operational Information. . . . . .24 Section 4.3 Other Offers . . . . . . . . . . . . . . . . . . . . . . .24 Section 4.4 Maintenance of Business. . . . . . . . . . . . . . . . . .24 Section 4.5 Compliance with Obligations. . . . . . . . . . . . . . . .25 Section 4.6 Notices of Certain Events. . . . . . . . . . . . . . . . .25 Section 4.7 Necessary Consents . . . . . . . . . . . . . . . . . . . .25 Section 4.8 Regulatory Approval. . . . . . . . . . . . . . . . . . . .25 Section 4.9 Satisfaction of Conditions Precedent . . . . . . . . . . .25 Section 4.10 Communications . . . . . . . . . . . . . . . . . . . . . .26 ARTICLE 5 COVENANTS OF HCC. . . . . . . . . . . . . . . . . . . . .26 Section 5.1 Conduct of HCC. . . . . . . . . . . . . . . . . . . . . .26 Section 5.2 Listing of HCC Common Stock . . . . . . . . . . . . . . .26 Section 5.3 Compliance with Obligations. . . . . . . . . . . . . . . .26 Section 5.4 Notices of Certain Events. . . . . . . . . . . . . . . . .27 Section 5.5 Rule 144 . . . . . . . . . . . . . . . . . . . . . . . . .27 ARTICLE 6 COVENANTS OF HCC, THE SHAREHOLDER AND SUN . . . . . . . .27 Section 6.1 Advice of Changes. . . . . . . . . . . . . . . . . . . . .27 Section 6.2 Regulatory Approvals. . . . . . . . . . . . . . . . . . .27 Section 6.3 Certain Filings. . . . . . . . . . . . . . . . . . . . . .28 Section 6.4 Satisfaction of Conditions Precedent . . . . . . . . . . .28 Section 6.5 Confidentiality. . . . . . . . . . . . . . . . . . . . . .28
ii TABLE OF CONTENTS (Cont.)
PAGE Section 6.6 Tax Cooperation. . . . . . . . . . . . . . . . . . . . . .29 Section 6.7 Change of Name of Sun. . . . . . . . . . . . . . . . . . .29 Section 6.8 Public Disclosure of Transaction . . . . . . . . . . . . .29 ARTICLE 7 CONDITIONS TO CLOSING. . . . . . . . . . . . . . . . . . .29 Section 7.1 Conditions to Obligations of HCC. . . . . . . . . . . . .29 Section 7.2 Conditions to Obligations of the Shareholder . . . . . . .32 Section 7.3 Conditions to Obligations of Each Party. . . . . . . . . .33 ARTICLE 8 TERMINATION OF AGREEMENT . . . . . . . . . . . . . . . . .33 Section 8.1 Termination. . . . . . . . . . . . . . . . . . . . . . . .33 Section 8.2 Effect of Termination. . . . . . . . . . . . . . . . . . .34 ARTICLE 9 CLOSING MATTERS. . . . . . . . . . . . . . . . . . . . . .34 Section 9.1 The Closing. . . . . . . . . . . . . . . . . . . . . . . .34 ARTICLE 10 INDEMNIFICATION. . . . . . . . . . . . . . . . . . . . . .35 Section 10.1 Shareholder Agreement to Indemnify . . . . . . . . . . . .35 Section 10.2 Indemnification with Respect to Taxes and Licensing. . . .35 Section 10.3 Indemnification for Other Specified Claims . . . . . . . .35 Section 10.4 HCC Agreement to Indemnify . . . . . . . . . . . . . . . .36 Section 10.5 Indemnification of Claim by International Special Risks, Ltd.. . . . . . . . . . . . . . . . . . . . . . . .36 Section 10.6 Survival of Representations. . . . . . . . . . . . . . . .36 Section 10.7 Procedure for Indemnification; Third Party Claims. . . . .37 ARTICLE 11 MISCELLANEOUS. . . . . . . . . . . . . . . . . . . . . . .37 Section 11.1 Further Assurances.. . . . . . . . . . . . . . . . . . . .37 Section 11.2 Fees and Expenses. . . . . . . . . . . . . . . . . . . . .38 Section 11.3 Notices. . . . . . . . . . . . . . . . . . . . . . . . . .38 Section 11.4 Governing Law. . . . . . . . . . . . . . . . . . . . . . .39 Section 11.5 Binding upon Successors and Assigns, Assignment. . . . . .39 Section 11.6 Severability . . . . . . . . . . . . . . . . . . . . . . .39 Section 11.7 Entire Agreement . . . . . . . . . . . . . . . . . . . . .39 Section 11.8 Amendment and Waivers. . . . . . . . . . . . . . . . . . .39 Section 11.9 No Waiver. . . . . . . . . . . . . . . . . . . . . . . . .39 Section 11.10 Construction of Agreement. . . . . . . . . . . . . . . . .39 Section 11.11 Counterparts . . . . . . . . . . . . . . . . . . . . . . .40
iii STOCK PURCHASE AGREEMENT THIS STOCK PURCHASE AGREEMENT (this "Agreement") is entered into effective as of October 1, 1998 by and among HCC Insurance Holdings, Inc., a Delaware corporation ("HCC"), Sun Employer Services, Inc., an Alabama corporation ("Sun"), Howard V. Barton (the "Shareholder"), and Elizabeth A. Barton ("Barton"). RECITALS: A. The Shareholder owns all of the outstanding stock of Sun (the "Sun Common Stock"). B. Barton owns all of the outstanding stock of Professional Audit Service, Inc., an Alabama corporation ("PASI"), which prior to the Closing Date, hereinafter defined, will be transferred to Sun. C. HCC desires to purchase all of the outstanding stock of Sun from Shareholder after the PASI Stock has been transferred to Sun by Barton, and Shareholder desires to sell to HCC his shares in Sun (being all of the outstanding stock of Sun) for the consideration and on the terms set forth in this Agreement. D. The Shareholder and Barton as tenants-in-common own of record one Class F participating share (the "North Bay Share") in North Bay Reinsurance, Ltd., a Cayman Islands Exempted Company ("North Bay"). Prior to the Closing as defined herein, Sun will acquire such North Bay Share. E. Sun, the Shareholder and Barton own all of the outstanding membership interests in 7200 Copperfield Company, L.L.C., an Alabama limited liability company (the "Copperfield Drive LLC"), which in turn owns certain real property and a building located at 7200 Copperfield Drive, Montgomery, Alabama. In connection with this Agreement, the Shareholder and Barton will convey all of their membership interests in the Copperfield Drive LLC to Sun. F. Sun owns 50% of the membership interests in KIMCO, LLC ("KIMCO") an Alabama limited liability company. 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: ARTICLE 1 SALE AND TRANSFER OF THE SUN COMMON STOCK SECTION 1.1 SALE OF SUN COMMON STOCK. (a) Subject to the terms and conditions of this Agreement, Shareholder shall sell, transfer and deliver to HCC, and HCC shall purchase from Shareholder, all of the outstanding Sun Common Stock at the Closing, hereinafter defined. SECTION 1.2 PURCHASE PRICE. (a) The purchase price ("Purchase Price") shall be equal to $24,660,000 and shall be paid by HCC to Shareholder as follows: (i) $500,000 in cash (the "Cash Payment") shall be transferred by wire transfer at the Closing to such account as Shareholder shall specify, in immediately available funds; plus (ii) at the Closing, HCC shall deliver to the Shareholder a promissory note in the original principal amount of $16,600,000 due January 5, 1998 (the "Note"); plus (iii) 378,000 shares of common stock, par value $1.00 per share, of HCC (the "HCC Common Stock") valued at the HCC Stock Value (the "Share Payment"). As used herein, the HCC Stock Value means $20.00 per share. The Share Payment shall be paid as follows: (a) If the gross premium volume of Sun for 1999 equals or exceeds $80,000,000, then the entire Share Payment shall be made by March 1, 2000. (b) If the gross premium volume of Sun for 1999 is less than $80,000,000 but greater than the gross premium volume of Sun for 1998, then a portion of the Share Payment equal to the Achievement Percentage (defined below) multiplied by the full Share Payment shall be made by March 1, 2000. As used herein, the "Achievement Percentage" means the ratio (i) the gross premium volume of Sun for 1999 less the gross premium volume of Sun for 1998 bears to (ii) $80,000,000 less the gross premium volume of Sun for 1998. (c) If the Shareholder has received less then the full Share Payment, the Shareholder shall continue to be eligible to receive the remaining Share Payment with respect to subsequent years based on the respective Subsequent Year Achievement Percentages (defined below) for such subsequent years until the Share Payment has been made in full. As used herein, "Subsequent Year Achievement 2 Percentage" means the ratio (i) the actual gross premium volume of Sun for the particular year less the actual gross premium volume of Sun for the prior year bears to (ii) the target premium volume of Sun for the particular year as agreed to by the Shareholder and HCC less the actual gross premium volume of Sun for the prior year. The portion of the Share Payment made with respect to any year subsequent to 1999 shall be equal to the excess, if any, of (x) the Subsequent Year Achievement Percentage with respect to such year multiplied by the full Share Payment, over (y) the cumulative portion of the Share Payment made with respect to all prior years. The portion of the Share Payment with respect to any subsequent year shall be made by March 1 of the following year. The Share Payment shall be paid in full and shall become non-forfeitable upon a "Change of Control," as defined herein, of HCC, without regard to the provisions of clauses (a), (b), and (c) above. As used in this Agreement, a Change of Control shall be deemed to have occurred if (1) any "person" or "group" (within the meaning of Section 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 HCC 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 HCC's then outstanding voting common stock; (2) the shareholders of HCC approve a merger or consolidation 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 HCC prior to such consolidation or merger or (b) which would result in the voting securities of HCC 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 (3) the shareholders approve a plan of complete liquidation of HCC or an agreement for the sale or disposition by HCC of all or substantially all of HCC's assets. (iv) All HCC Common Stock to be delivered pursuant to this Agreement shall be restricted as to transfer and shall bear the following legend: "THE SHARES REPRESENTED BY THIS CERTIFICATE HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933. THESE SHARES HAVE BEEN ACQUIRED FOR INVESTMENT AND NOT WITH A VIEW TO DISTRIBUTION OR RESALE, AND MAY NOT BE SOLD, MORTGAGED, PLEDGED, HYPOTHECATED OR OTHERWISE TRANSFERRED WITHOUT AN EFFECTIVE REGISTRATION STATEMENT FOR SUCH SHARES UNDER THE SECURITIES ACT OF 1933, OR AN OPINION OF COUNSEL FOR THE CORPORATION THAT SUCH REGISTRATION IS NOT REQUIRED UNDER SUCH ACT." 3 SECTION 1.3 CLOSING DELIVERIES. At the Closing: (a) Shareholder shall deliver to HCC (i) certificates representing the Sun Common Stock, endorsed or transferred to HCC, which shall transfer to HCC good and indefeasible title to the Sun Common Stock, free and clear of all encumbrances; and (ii) such other documents including officers' certificates and opinions of counsel as may be required by this Agreement or reasonably requested by HCC. (b) HCC shall deliver to Shareholder (i) the Cash Payment to be transferred to an account designated by Shareholder in immediately available funds; and (ii) such other documents, including officer certificates and opinions of counsel as may be required by this Agreement or reasonably requested by Shareholder. SECTION 1.4 ESCROW AGREEMENT. Pursuant to an Escrow Agreement to be entered into on or before the Closing Date (as hereinafter defined) in substantially the form of Exhibit 1.5 (the "Escrow Agreement"), among HCC, the Shareholder and Harris Trust Company of New York, or such other entity mutually agreeable to HCC and the Shareholder, as Escrow Agent, HCC will withhold $2,460,000 in cash from the amount due under the Note (the "Escrow Payment"). On or before the due date of the Note, HCC will deposit, or cause to be deposited in escrow pursuant to the Escrow Agreement, the Escrow Payment which will be held as collateral for the indemnification obligations of the Shareholder pursuant to Article 10 and to the Escrow Agreement pending its release from escrow in accordance with the terms of the Escrow Agreement. In accordance with, and subject to, the Escrow Agreement, such escrow will be maintained for a period of two (2) years from the Closing Date. SECTION 1.5 ADDITIONAL TRANSFERS. At or before the Effective Time, and for the consideration provided for in Section 1.2 of this Agreement, (i) Barton shall transfer to Sun all of the PASI Shares, (ii) the Shareholder and Barton shall transfer to Sun their interest in the North Bay Share, and (iii) the Shareholder and Barton shall transfer to Sun all of their membership interests in the Copperfield Drive LLC, in each case free and clear of all liens and encumbrances. 4 ARTICLE 2 REPRESENTATIONS AND WARRANTIES OF SUN AND SHAREHOLDER Except as disclosed in a document referring specifically to this Agreement (the "Sun Disclosure Schedule") which has been delivered to HCC on or before the date hereof, Sun and the Shareholder (jointly and severally) represent and warrant to HCC as set forth below. SECTION 2.1 CORPORATE EXISTENCE AND POWER. Sun is a corporation duly organized, validly existing and in good standing under the laws of the state of its incorporation, 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 Sun. Sun has delivered to HCC true and complete copies of Sun's Articles of Incorporation and Bylaws as currently in effect. Sun 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 Sun. For purposes of this Agreement, a "Material Adverse Effect," with respect to any person or entity (including without limitation Sun and HCC), 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 and its affiliated companies and subsidiaries and/or parent corporation and/or corporations under the same stock ownership, taken as a whole; and "Material Adverse Change" means a change or a development involving a prospective change which would result in a Material Adverse Effect. SECTION 2.2 AUTHORIZATION. Each of the Shareholder, Sun, and Barton has full right, power and authority to enter into this Agreement and each other agreement to be entered into by it in connection with the transactions contemplated hereby. This Agreement and such other agreements contemplated hereby constitute, or upon execution will constitute, valid and binding agreements of the Shareholder, Sun and Barton, enforceable against each of them in accordance with their respective terms, except as such enforcement may be limited by bankruptcy, insolvency or other similar laws effecting the enforcement of creditors' rights generally or by general principles of equity. SECTION 2.3 GOVERNMENTAL AUTHORIZATION. The execution, delivery and performance by the Shareholder, Sun and Barton, of this Agreement, and the consummation of the transactions contemplated hereunder require no action by Sun, the Shareholder, or Barton or any filing by any of them with any governmental body, agency, official or authority having authority over Sun, other than in respect of: (a) compliance with the applicable requirements of the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended (the "HSR Act"); 5 (b) compliance with any applicable requirements of the Securities Act of 1933, as amended (the "Securities Act") and the rules and regulations promulgated thereunder; (c) compliance with any applicable foreign or state securities or "blue sky" laws; (d) compliance with any requirements of any federal, state, foreign or other insurance or reinsurance or intermediaries or managing general agent laws, including licensing or other related laws; and (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 Sun, or (ii) would not materially adversely affect the ability of any party to consummate the transactions contemplated hereby and operate their businesses as heretofore operated. SECTION 2.4 NON-CONTRAVENTION. Except with HCC's knowledge and written consent, the execution, delivery and performance by the Shareholder, Sun and Barton of this Agreement and each other agreement to be entered into in connection with this Agreement, and the consummation of the other transactions contemplated hereby and thereby do not and will not: (a) contravene or conflict with any of the organizational documents of Sun, PASI, KIMCO, the Copperfield Drive LLC, or North Bay; (b) assuming compliance with the matters referred to in Section 2.3, 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 Sun, the Shareholder, Barton, PASI, the Copperfield Drive LLC, KIMCO or North Bay; (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 Sun or any material license, franchise, permit or other similar authorization held by Sun, PASI, the Copperfield Drive LLC or KIMCO; (d) result in the creation or imposition of any Lien (as hereinafter defined) on any material asset of Sun, PASI, the Copperfield Drive LLC, or KIMCO or on the North Bay Share by reason of the actions of the Shareholder, Sun or Barton; or (e) result in the loss of any material benefits relating to the ownership of the North Bay Share, 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 6 have, individually or in the aggregate, a Material Adverse Effect on Sun. 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 2.5 CAPITALIZATION. (a) The entire authorized stock of Sun consists of 400 shares of common stock, $1.00 par value per share, of which, subsequent to the redemption referred to in Section 4.1(e) below, 94 shares are issued and outstanding, and 306 shares are held as treasury stock. All of the issued and outstanding shares of stock of Sun are owned by the Shareholder free of any Liens or other encumbrances. The Shareholder and Barton own of record the one share of common stock of Class F participating share of North Bay, and such ownership is free of any Liens or other encumbrances which have not been released. Such North Bay Share is the only issued and outstanding Class F participating share of North Bay. Sun owns a 50% membership interest in KIMCO. Sun owns such membership interest free of any Liens or other encumbrances. The entire capitalization of the Copperfield Drive LLC consists of a 50% membership interest owned by Shareholder and Barton and a 50% membership interest owned by Sun, in each case free of any Liens or other encumbrances. The entire authorized stock of PASI consists of 100 shares of Common Stock, $1.00 par value per share, of which 100 shares are issued and outstanding, and no shares are held as treasury stock. All of the issued and outstanding shares of stock of PASI are owned by Barton free of any Liens or other encumbrances. (b) All outstanding shares and membership interests set forth in (a) above have been duly authorized and validly issued and are fully paid and nonassessable, and the issuer complied with all applicable preemptive rights in issuing such shares or membership interests. Except as set forth in (a) above, there are outstanding (i) no shares of capital stock or other voting securities or equity interests, (ii) no securities convertible into or exchangeable for shares of its capital stock or voting securities or other equity interests, (iii) no options or other rights to acquire from any party, and no obligation to issue, any capital stock, voting securities or securities convertible into or exchangeable for its capital stock or other voting securities or equity interests (the items in clauses (i), (ii) and (iii) being referred to collectively as the "Sun Securities"), (iv) no obligations to repurchase, redeem or otherwise acquire any of Sun Securities and (v) no contractual rights of any person or entity to include any such securities in any registration statement proposed to be filed under the Securities Act. SECTION 2.6 SUBSIDIARIES AND RELATED ENTITIES. (a) Except as set forth in this Section, Sun does not control (whether directly or indirectly, and whether through the ownership of voting securities or by contract or proxy, and whether alone or in combination with others) any corporation, partnership, business organization or other similar entity. KIMCO, PASI, and the Copperfield Drive LLC are collectively sometimes hereinafter referred to as the "Sun Affiliated Entities". 7 (b) Each Sun Affiliated Entity is duly organized, validly existing, and in good standing under the laws of the state of Alabama, and has all 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 it. Sun has delivered to HCC true and complete copies of the organizational documents of each Sun Affiliated Entity as currently in effect. Each Sun Affiliated Entity is duly qualified to do business as a foreign entity 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 it. SECTION 2.7 SUN FINANCIAL STATEMENTS. Sun has delivered to HCC Sun's audited balance sheet (the "Audited Balance Sheet") as of June 30, 1998 (the "Balance Sheet Date") and an unaudited balance sheet as of June 30, 1997, Sun's audited income statements for the years ended June 30, 1998 and Sun's unaudited balance sheets and income statements for the year ended June 30, 1997 (collectively, the "Sun Financial Statements"). The Sun 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 Sun as of the dates thereof and results of operations and cash flows for the periods therein indicated (subject to the absence of certain footnotes in the case of unaudited financial statements). Sun has no 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 Audited Balance sheet, including the notes thereto, 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 June 30, 1998 in the ordinary course of business or (iii) liabilities under this Agreement or as disclosed in the Sun Disclosure Schedule. SECTION 2.8 ABSENCE OF CERTAIN CHANGES. Since June 30, 1998, Sun and each Sun Affiliated Entity 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 Sun, which as of the date hereof could reasonably be expected to have a Material Adverse Effect on Sun; (b) any declaration, setting aside or payment or any dividend or other distribution in respect of any shares of capital stock of Sun other than the declaration, setting aside or payment of dividends in accordance with its existing dividend policy or practice, which policy or practice is not inconsistent with Sun's past policy or practice; (c) except as required by Section 4.1(e) hereof, any repurchase, redemption or other acquisition by Sun of any outstanding shares of capital stock or other securities of or other ownership interests in Sun; 8 (d) any amendment of any term of any outstanding securities of Sun; (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 Sun which, individually or in the aggregate, has had or would reasonably be expected to have a Material Adverse Effect on Sun or any Sun Affiliated Entity; (f) any increase in indebtedness for borrowed money or capitalized lease obligations of Sun or any Sun Affiliated Entity, 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 Sun, except in the ordinary course of business and for a fair and adequate consideration; (h) any amendment, termination or waiver by Sun or any Sun Affiliated Entity 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; (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 Sun or any Sun Affiliated Entity; (j) any (i) grant of any severance or termination pay to any director, officer or employee of Sun or any Sun Affiliated Entity, (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 Sun, (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 Sun or any Sun Affiliated Entity, 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 benefit, or other fringe benefit plan, arrangement or trust agreement adopted or implemented by Sun or any Sun Affiliated Entity which would result in a material increase in cost; (l) any capital expenditures, capital additions or capital improvements in excess of $10,000; or (m) the entering into of any agreement by Sun or any Sun Affiliated Entity or any person on behalf of Sun or any Sun Affiliated Entity to take any of the foregoing actions. 9 SECTION 2.9 NO UNDISCLOSED LIABILITIES. There are no existing liabilities of Sun or any Sun Affiliated Entity of any kind whatsoever that are, individually or in the aggregate, material to Sun, other than: (a) liabilities disclosed, reserved against, or provided for in the Audited Balance Sheet (including the notes thereto); (b) liabilities incurred in the ordinary course of business consistent with past practice since June 30, 1998; and (c) liabilities under this Agreement or indicated in the Sun Disclosure Schedule. SECTION 2.10 LITIGATION. The Sun Disclosure Schedule sets forth all actions, suits, proceedings, claims or investigations pending against Sun or any Sun Affiliated Entity or relating to its business or the North Bay Share. Neither Sun nor any Sun Affiliated Entity nor any Shareholder has received written notice of a claim threatened against Sun or any Sun Affiliated Entity or any of its assets or against or involving any of its officers, directors or employees in connection with the business or affairs of Sun or any Sun Affiliated Entity or the North Bay Share, including, without limitation, any such claims for indemnification arising under any agreement to which Sun or any Sun Affiliated Entity is a party. Neither Sun nor any Sun Affiliated Entity has received written 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 on Sun or any Sun Affiliated Entity. SECTION 2.11 TAXES. (a) Sun and each Sun Affiliated Entity (i) has filed when due (taking into account extensions) with the appropriate federal, state, local, foreign and other governmental agencies, all material 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 Sun's Financial Statements all material 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 ("Taxes") and there are no tax deficiencies claimed in writing by any Taxing authority and received by Sun or any Sun Affiliated Entity or the Shareholder 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 Time. The Sun Disclosure Schedule sets forth those tax returns for all periods that currently are the subject of audit by any federal, state, local or foreign taxing authority. (b) There are no material taxes, interest, penalties, assessments or deficiencies claimed in writing by any Taxing authority and received by Sun or any Sun Affiliated Entity or the 10 Shareholder to be due in respect of any tax returns filed by Sun or any Sun Affiliated Entity (or any predecessor entity). Neither Sun nor any Sun Affiliated Entity nor any predecessor 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) Neither Sun nor any Sun Affiliated Entity is a party to or 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. Neither Sun nor any Sun Affiliated Entity is a member of an affiliated group or filed or been included in a combined, consolidated or unitary Tax return. SECTION 2.12 EMPLOYEE BENEFIT PLANS, ERISA. (a) Neither Sun nor any Sun Affiliated Entity is a party to any oral or written (i) employment, severance, 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 Sun or a Sun Affiliated Entity of the nature of any of the transactions contemplated by this Agreement, (B) providing any term of employment or compensation guarantee extending 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, or (iii) 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) Except as described in the Sun Disclosure Schedule, neither Sun 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 Sun (a "Sun 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(1) respectively of ERISA, which is subject to ERISA. Each Pension Plan and Welfare Plan disclosed in the Sun Disclosure Schedule (which Plans have been heretofore delivered to HCC) and maintained by Sun 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. 11 (d) No "prohibited transaction," as defined in Section 406 of ERISA or Section 4975 of the Code, resulting in liability to Sun or any Sun ERISA Affiliate has occurred with respect to any Pension Plan or Welfare Plan. Neither Sun nor the Shareholder has any knowledge of any breach of fiduciary responsibility under Part 4 of Title I of ERISA which has resulted in liability of Sun and Sun ERISA Affiliate, any trustee, administrator or fiduciary of any Pension Plan or Welfare Plan. (e) Neither Sun nor any Sun 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 Sun nor any Sun 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 Sun or any Sun ERISA Affiliate. (f) Except as described in the Sun Disclosure Schedule, there is no contract, agreement, plan or arrangement covering any employee or former employee of Sun or any Sun 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)(I) or 280G of the Code. (g) With respect to Sun and each Sun ERISA Affiliate, the Sun Disclosure Schedule correctly identifies each material agreement, policy, plan or other arrangement, whether written or oral, express or implied, fixed or contingent, other than plans disclosed in the Sun Disclosure Schedule pursuant to Section 2.12(b) above, to which Sun is a party or by which Sun is bound, which is or relates to a pension, option, bonus, deferred compensation, employment, 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, arrangement, or agreement. (h) Neither Sun nor any Sun 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. Sun has made available to HCC, 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 Sun 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. SECTION 2.13 MATERIAL AGREEMENTS. (a) The Sun Disclosure Schedule includes a complete and accurate list of all contracts, agreements, leases (other than Sun Property Leases, as hereinafter defined), and instruments to which Sun or any Sun Affiliated Entity is a party or by which it or its properties or assets are bound which individually involve net payments or receipts in excess of $25,000 per annum, inclusive of contracts 12 entered into with customers and suppliers in the ordinary course of business, or that pertain to employment or severance benefits for any officer, director or employee of Sun or any Sun Affiliated Entity, whether written or oral (the "Material Sun Agreements"). (b) Neither Sun nor any Sun Affiliated Entity nor, to the knowledge of Sun, any other party is in default under any Material Sun 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 Sun 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 Sun or any Sun Affiliated Entity, which, in any such case, has had or would reasonably be expected to have a Material Adverse Effect. (c) To the knowledge of Sun, each such Material Sun Agreement is in full force and effect and is valid and legally binding and there are no material unresolved disputes involving or with respect to any Material Sun Agreement. Except as described in the Sun Disclosure Schedule, no party to a Material Sun Agreement has advised Sun or the Shareholder that it intends either to terminate a Material Sun Agreement or to refuse to renew a Material Sun Agreement upon the expiration of the term thereof. No representation or warranty is made that all benefits contemplated in the Material Sun Agreements will be received. (d) Neither Sun nor any Sun Affiliated Entity is in violation of, or in default with respect to, any term of any of its organizational documents. SECTION 2.14 PROPERTIES. Neither Sun nor any Sun Affiliated Entity owns any real estate other than as described in the Sun Disclosure Schedule, and all leases of real property to which Sun or an Sun Affiliated Entity is a party or by which it is bound ("Sun Property Leases") are in full force and effect and are set forth on the Sun Disclosure Schedule. There exists no default under such Sun Property Leases, nor any event which with notice or lapse of time or both would constitute a default thereunder, which default would have a Material Adverse Effect. All of the properties and assets which are owned by Sun or an Sun Affiliated Entity are owned free and clear of any Lien, except for Liens described in the Sun Disclosure Schedule or Permitted Liens (as defined below). Sun or such Sun Affiliated Entity has good and indefeasible title with respect to such owned properties and assets subject to no Liens, other than those described in the Sun Disclosure Schedule or Liens permitted under this Section 2.14, and to all of the properties and assets necessary for the conduct of their business other than to the extent that the failure to have such title would not have a Material Adverse Effect. "PERMITTED LIENS" shall mean (i) any lien, encumbrance or defect which does not materially detract from the fair market value (free of such lien, encumbrance or defects) of the property or assets subject thereto or materially interfere with the current use by Sun of the property or assets subject thereto or affected thereby, (ii) any liens or encumbrances for taxes not delinquent or which are being contested in good faith, provided that adequate reserves for the same have been established in the most recent financial statements of Sun to the extent required by GAAP applied on a consistent basis, (iii) any liens or encumbrances for current taxes and assessments not yet past due, and (iv) any inchoate mechanics and materialmen's liens and encumbrances for construction in 13 process, (iv) any workmen's, repairmen's, warehousemen's and carrier's liens and encumbrances arising in the ordinary course of business which do not in the aggregate materially detract from the value of Sun's business assets or properties or materially impair the use thereof or which are being contested in good faith by appropriate proceedings which have the effect of preventing the forfeiture or sale of such business or property subject to any such lien or encumbrance and for which adequate reserves have been established in accordance with GAAP. SECTION 2.15 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 the knowledge of Sun or any Shareholder, has been threatened by any governmental entity or other party with respect to any (i) alleged violation of any Environmental Law, (ii) alleged failure to have any environmental permit, certificate, license, approval, registration or authorization required in connection with the conduct of its business or (iii) Regulated Activity. (c) Neither Sun nor any Sun Affiliated Entity has any material Environmental Liabilities and there has been no release of Hazardous Substances into the environment by Sun or any Sun 14 Affiliated Entity or with respect to any of its properties which has had, or would reasonably be expected to have, a Material Adverse Effect. SECTION 2.16 LABOR MATTERS. Neither Sun nor any Sun Affiliated Entity is a party to any collective bargaining agreement or other labor union contract applicable to persons employed by it, nor does it know of any activities or proceedings of any labor union to organize any such employees. SECTION 2.17 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, neither Sun nor any Sun Affiliated Entity has 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 2.18 TRADEMARKS, TRADE NAMES, ETC. Sun owns or possesses, or holds a valid right or license to use, all intellectual property, patents, trademarks, trade names, servicemarks, copyrights and licenses, 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. SECTION 2.19 SALE OF SUN. Except as contemplated by this Agreement, there are currently no discussions to which Sun or the Shareholder is a party relating to (a) the sale of any material portion of the assets of Sun, (b) any merger, consolidation, share exchange, liquidation, dissolution or similar transaction involving Sun, or (c) the transfer or issuance of any Sun Securities. SECTION 2.20 BROKER'S FEES. Neither Sun nor the Shareholder 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 2.21 INVESTMENT REPRESENTATION. The shares of HCC Common Stock to be acquired by the Shareholder pursuant to this Agreement will be acquired solely for his individual account, for investment purposes only and not with a view to the distribution thereof. The Shareholder is not participating, directly or indirectly, in any distribution or transfer of such HCC Common Stock, nor is the Shareholder participating, directly or indirectly, in underwriting any such distribution of HCC Common Stock within the meaning of the Securities Act. The Shareholder has such knowledge and experience in business matters that he is capable of evaluating the merits and risks of an investment in HCC and the acquisition of the shares of HCC Common Stock, and he is making an informed investment decision with respect thereto. The Shareholder has been informed by HCC that the shares of HCC Common Stock to be issued pursuant to this Agreement and the documents to be executed in connection herewith will not be registered under the Securities Act at the time of their issuance and may not be transferred, assigned or otherwise disposed of absent registration under the Securities Act or availability of an appropriate exemption therefrom. The Shareholder has further been informed that HCC will be under no obligation to register the shares of HCC Common Stock under the Securities Act or to take any steps to assist the Shareholder to 15 comply with any applicable exemption under the Securities Act with respect to the shares of HCC Common Stock. SECTION 2.22 INVESTMENTS. (a) The Sun Disclosure Schedule sets forth a true and complete list of all bonds, stocks, mortgages and other investments of any type owned by Sun as of the date hereof (collectively, the "Scheduled Investments"). Sun has good and marketable title to each of the Scheduled Investments. (b) Except as set forth on the Sun Disclosure Schedule, none of the Scheduled Investments is currently in default in the payment of principal or interest, and, to the knowledge of the Shareholder, no event has occurred which reasonably would be expected to result in a diminution of the value of any nonpublicly traded security owned by Sun. (c) There are no Liens on any of the Scheduled Investments, except for (i) those Scheduled Investments deposited with governmental authorities, as indicated on the Sun Disclosure Schedule, (ii) Liens which do not materially detract from the value of the Scheduled Investments subject thereto, and (iii) assets pledged to secure assumed reinsurance contract obligations which assets are listed on the Sun Disclosure Schedule. (d) Neither any of the Shareholder nor Sun has taken or omitted to take, any action which would result in Sun being unable to enforce the terms of any Scheduled Investment or which would cause any Scheduled Investment to be subject to any valid offset, defense or counterclaim against the right of Sun to enforce the terms of such Scheduled Investment. (e) Since June 30, 1998, Sun has not (i) purchased or otherwise invested in, or committed to purchase or otherwise invest in, any interest in real property (including without limitation any extension of credit secured by a mortgage or deed of trust), (ii) purchased or otherwise invested in, or committed to purchase or otherwise invest in, bonds, notes, debentures or other evidences of indebtedness rated lower than "Baa" by Moody's Investors Service Inc. or "BBB" by Standard & Poor's Corporation at the time of purchase, (iii) entered into any contract, agreement or arrangement with any affiliate with respect to the purchase or other acquisition, sale or other disposition or allocation of any Scheduled Investment or (iv) entered into any contract, agreement or arrangement with respect to any foreign investments. SECTION 2.23 INVESTMENT COMPANY. Sun is not an "investment company" within the meaning of the Investment Company Act of 1940. SECTION 2.24 LICENSES. Except as described in the Sun Disclosure Schedule, Sun and the Sun Affiliated Entities and North Bay possess all material licenses, certificates, authorizations and permits issued by, and have made all declarations and filings with, the appropriate federal, state or foreign regulatory agencies or bodies which are necessary or desirable for the ownership of the properties of Sun, the Sun Affiliated Entities and the North Bay Share or the conduct of the business of Sun, the Sun Affiliated Entities and North Bay and neither Sun nor the Sun Affiliated Entities nor 16 North Bay has received notification of any revocation or modification of any such license, certificate, authorization or permit and neither Sun, the Sun Affiliated Entities, nor North Bay, nor the Shareholder has any reason to believe that any such license, certificate, authorization or permit will not be renewed in the ordinary course. SECTION 2.25 INTERNAL CONTROLS. Sun maintains a system of internal accounting controls, which Sun reasonably believes is sufficient to provide reasonable assurances that (i) transactions are executed in accordance with management's general or specific authorization; (ii) transactions are recorded as necessary to permit preparation of financial statements in conformity with generally accepted accounting principles and to maintain asset accountability; (iii) access to assets is permitted only in accordance with management's general or specific authorization; and (iv) the recorded accountability for assets is compared with the existing assets at reasonable intervals and appropriate actions are taken with respect to any differences. SECTION 2.26 INSURANCE. Sun has insurance covering its properties, operations, personnel and businesses, which insurance is in amounts and insures against such losses and risks as are adequate to protect Sun and its businesses. Sun has not received notice from any insurer or agent of such insurer that capital improvements or other expenditures are required and necessary to be made in order to continue such insurance. SECTION 2.27 FINANCIAL SOLVENCY. On and immediately after the Closing Date, Sun will be "Solvent." As used in this paragraph, the term "Solvent" means, with respect to a particular date, that on such date (i) the present fair market value (or present fair salable value) of the assets of Sun is not less than the total amount required to pay the probable liabilities of Sun on its total existing debts and liabilities (including contingent liabilities) as they become absolute and matured; (ii) Sun is able to realize upon its assets and pay its debts and other liabilities, contingent obligations and commitments as they mature and become due in the normal course of business; (iii) Sun has not incurred debts or liabilities beyond its ability to pay such debts and liabilities as they mature; and (iv) Sun does not engage in any business or transaction and is not about to engage in any business or transaction for which its property would constitute unreasonably small capital after giving due consideration to the prevailing practice of the industry in which Sun is engaged. In computing the amount of such contingent liabilities at any time, it is intended that such liabilities will be computed at the amount that, in light of all the facts and circumstances existing at such time, represents the amount that can reasonably be expected to become an actual or matured liability. SECTION 2.28 YEAR 2000 ISSUE. Sun is currently evaluating its operations and systems to determine the risk of computer hardware and software used by it becoming unable to recognize and properly execute date-sensitive functions involving certain dates prior to and any dates after December 31, 1999 (the "Year 2000 Issue") and has determined that such risk will be remedied on a timely basis without material expense and will not have a Material Adverse Effect. SECTION 2.29 NORTH BAY ASSETS. North Bay owns and controls, free of any Liens or encumbrances, each of the assets set forth on Schedule 2.29 attached hereto. North Bay began 17 beneficially holding ceded insurance premiums allocable to the Class F Participating share on January 1, 1997. Such assets have accumulated since Shareholder and Barton have owned of record the North Bay Share and there has never been a distribution of any cash or other assets to any of the holders or owners of record of the North Bay Share. ARTICLE 3 REPRESENTATIONS AND WARRANTIES OF HCC Except as disclosed in a document referring specifically to this Agreement or in a document, exhibit, or appendix filed with the Securities and Exchange Commission ("SEC") on or before the date hereof, (collectively referred to herein as the "HCC Disclosure Schedule") which has been delivered or made available to the Shareholder on or before the date hereof, HCC represents and warrants to the Shareholder: SECTION 3.1 CORPORATE EXISTENCE AND POWER. HCC is a corporation duly incorporated, validly existing and in good standing under the laws of the state of its incorporation. HCC 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 HCC. HCC 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 HCC. HCC has made available to Sun and the Shareholder true and complete copies of its Certificate of Incorporation and Bylaws, as currently in effect. SECTION 3.2 CORPORATE AUTHORIZATION. The execution, delivery and performance by HCC of this Agreement and each other agreement entered into by it in connection with the transactions contemplated hereby, and the consummation by HCC of the transactions contemplated hereby and thereby are within the corporate powers of HCC and have been duly authorized by all necessary corporate action. This Agreement and each other agreement entered into by it in connection with the transactions contemplated hereby constitutes, or upon execution will constitute, valid and binding agreements of HCC 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 3.3 GOVERNMENTAL AUTHORIZATION. The execution, delivery and performance by HCC 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 the applicable requirements of the HSR Act; 18 (b) compliance with any applicable requirements of the Securities Exchange Act of 1934 (the "Exchange Act") and the rules and regulations promulgated thereunder; (c) compliance with any applicable requirements of the Securities Act and the rules and regulations promulgated thereunder; (d) compliance with any applicable foreign or state securities or "blue sky" laws and the rules and regulations of the NYSE; (e) compliance with any applicable requirements of any insurance regulatory agency having authority over HCC; and (f) 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 HCC or (ii) would not materially adversely affect the ability of any party to consummate the transactions contemplated hereby and operate their businesses as heretofore operated. SECTION 3.4 SHARES OF HCC COMMON STOCK. Upon satisfaction of the conditions for issuance pursuant to this Agreement, the shares of HCC Common Stock to be issued to the Shareholder pursuant to this Agreement, and will be duly authorized, validly issued, fully paid and nonassessable. SECTION 3.5 SEC FILINGS. (a) HCC has since January 1, 1996 filed all forms, proxy statements, schedules, reports and other documents required to be filed by it with the SEC pursuant to the Exchange Act. (b) HCC has made available to Sun, the Shareholder and Barton or will make available in the case of any of the following documents filed with the SEC on or after the date hereof and prior to the Closing Date, (i) its annual reports on Form 10-K for its fiscal years ended December 31, 1997 and 1996; (ii) any current reports on Form 8-K since January 1, 1998 and its proxy or information statements relating to meetings of, or actions taken without a meeting by, the shareholders of HCC held since January 1, 1998; and (iii) all of its other reports, statements, schedules and registration statements filed with the SEC since December 31, 1997. 19 (c) As of its filing date, no such report or statement filed pursuant to the Exchange Act contained any untrue statement of a material fact or omitted to state any material fact necessary in order to make the statements made therein, in the light of the circumstances under which they were made, not misleading. (d) No registration statement filed pursuant to the Securities Act, if declared effective by the SEC, as of the date such statement or amendment became effective, contained any untrue statement of a material fact or omitted to state any material fact required to be stated therein or necessary to make the statements therein not misleading. SECTION 3.6 NON-CONTRAVENTION. The execution, delivery and performance by HCC of this Agreement and each other agreement to be entered into in connection with this Agreement, and the consummation of the other transactions contemplated hereby and thereby do not and will not: (a) contravene or conflict with the organizational documents of HCC; (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 HCC; (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 HCC or any material license, franchise, permit or other similar authorization held by HCC, except, with respect to clauses (b) and (c) above, for contraventions, defaults, losses, 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 HCC. SECTION 3.7 ABSENCE OF CERTAIN CHANGES. Since the date of filing with the SEC of its most recent quarterly report on Form 10-Q, there has not been any Material Adverse Change with respect to the business of HCC or any event, occurrence, or development of a set of circumstances or facts known to HCC, which as of the date hereof could reasonably be expected to have a Material Adverse Effect on HCC. SECTION 3.8 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 on HCC, HCC has received no 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 3.9 BROKER'S FEES. Neither HCC nor anyone acting on behalf of HCC or at the request of HCC has any liability to any broker, finder, investment banker or agent, or has agree to 20 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 3.10 INVESTMENT COMPANY. HCC is not an "investment company" within the meaning of the Investment Company Act of 1940. SECTION 3.11 CAPITALIZATION OF HCC. The authorized capital stock of HCC consists of 250,000,000 shares of HCC Common Stock. As of September 30, 1998, there were 48,132,307 shares of HCC Common Stock issued and outstanding. All outstanding shares of HCC Common Stock have been duly authorized and validly issued and are fully paid and nonassessable and free from any preemptive rights. Except as set forth in this Section and as otherwise contemplated by this Agreement and except as disclosed in public filings made by HCC with the SEC prior to the Closing Date or on the HCC Disclosure Schedule and except for changes since September 30, 1998 resulting from the exercise of employee and director stock options, or in connection with other acquisitions, mergers or similar transactions there are outstanding (i) no shares of capital stock or other voting securities of HCC, (ii) no securities of HCC convertible into or exchangeable for shares of capital stock or voting securities of HCC and (iii) no options or other rights to acquire from HCC, and no obligation of HCC to issue, any capital stock, voting securities or securities convertible into or exchangeable for capital stock or other voting securities of HCC (the items in clauses (i), (ii) and (iii) being referred to collectively as the "HCC Securities"). There are no outstanding obligations of HCC to repurchase, redeem or otherwise acquire any HCC Securities. SECTION 3.12 INVESTIGATION. To HCC's knowledge it has been afforded an opportunity to conduct an investigation of Sun. HCC has been afforded an opportunity to ask questions of Sun employees. Each of the parties hereto represent and acknowledge that no investigation made by HCC shall in any way affect any representation or warranty given by Sun, the Shareholder or Barton, or any other party hereto, nor shall such investigation act as a waiver, estoppel or create any equitable or legal defense to any action brought by HCC in connection with the transactions contemplated hereunder or as a result of any such investigation or affect the Shareholder's indemnification obligations set forth in Article 10 hereof. SECTION 3.13 INVESTMENT REPRESENTATION. The shares of Sun Common Stock to be acquired by HCC pursuant to this Agreement will be acquired solely for HCC's account, for investment purposes only and not with a view to the distribution thereof. HCC is not participating, directly or indirectly, in any distribution or transfer of such Sun Common Stock, nor is it participating, directly or indirectly, in underwriting any such distribution of Sun Common Stock within the meaning of the Securities Act. HCC has such knowledge and experience in business matters that it is capable of evaluating the merits and risks of an investment in Sun and the acquisition of the shares of Sun Common Stock, and it is making an informed investment decision with respect thereto. 21 ARTICLE 4 COVENANTS OF THE SHAREHOLDER AND SUN From the date hereof until the occurrence of the earlier of (i) the Effective Time or (ii) termination of this Agreement pursuant to Section 8.1 hereof (except that the covenants under Sections 4.8, 4.9, and 4.10 shall continue in effect beyond Closing), Sun and the Shareholder agree that: SECTION 4.1 CONDUCT OF SUN. Sun and the Sun Affiliated Entities each shall in all material respects conduct its business in the ordinary course except as specifically permitted in clause (e) below. Without limiting the generality of the foregoing, from the date hereof until the Effective Time, except as contemplated by this Agreement or as otherwise permitted with the written consent of HCC: (a) Neither Sun nor the Sun Affiliated Entities will adopt or propose any change in its organizational documents; (b) Neither Sun nor the Sun Affiliated Entities will 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 June 30, 1998, or increase the compensation payable to any other employees (other than (i) increases in the ordinary course of business which are not in the aggregate material, or (ii) pursuant to plans disclosed in Sun Disclosure Schedule), or adopt or amend any employee benefit plan or arrangement (oral or written), except that Sun agrees, except as agreed to by HCC, to terminate each of Sun's Pension Plans, Welfare Plan or any other retirement benefit plans on or before the Closing Date; (c) Neither Sun nor the Sun Affiliated Entities will issue any securities; (d) Sun and the Sun Affiliated Entities will each keep in full force and effect any existing directors' and officers' liability insurance and will not modify or reduce the coverage thereunder; (e) Neither Sun nor the Sun Affiliated Entities will pay any dividend or make any other distribution to holders of its capital stock nor redeem or otherwise acquire any securities, except that prior to the Effective Time Sun shall redeem six shares of the Sun Common Stock from the Shareholder in exchange for the property described on Exhibit "B" attached hereto (the "Barton Ridge Property", which for purposes hereof includes all interests in Plantation Gear, LLC) and the 52' Hatteras yacht known as "Sundancer" (which for purposes hereof includes all of the interests in Sun Harbor LLC), owned by Sun free and clear of the liabilities secured thereby; (f) Neither Sun nor the Sun Affiliated Entities will, directly or indirectly, dispose of or acquire any material properties or assets except in the ordinary course of business; 22 (g) Neither Sun nor the Sun Affiliated Entities will incur any additional indebtedness for borrowed money; (h) Neither Sun nor the Sun Affiliated Entities will enter into any extraordinary transaction outside of the ordinary course of its business as presently conducted, make any capital expenditure in excess of $10,000, or incur any non-budgeted expense over $5,000; (i) Neither Sun nor the Sun Affiliated Entities will amend or change the period of exercisability or accelerate the exercisability of any outstanding options or warrants to acquire shares of capital stock, or accelerate, amend or change the vesting period of any outstanding restricted stock; (j) Neither Sun nor the Sun Affiliated Entities will (i) change accounting methods except as necessitated by changes which Sun or the Sun Affiliated Entities is required to make in order to prepare its federal, state and local tax returns; (ii) amend or terminate any contract, agreement or license to which it is a party (except pursuant to arrangements previously disclosed in writing to HCC or disclosed in the Sun Disclosure Schedule) except those amended or terminated in the ordinary course of business, consistent with past practices, or involving changes which are not materially adverse in amount or effect to Sun or the Sun Affiliated Entities individually or taken as a whole; (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 Sun or the Sun Affiliated Entities taken as a whole, 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 the ordinary course of business, consistent with past practice; (v) waive or release any material right or claim except in the ordinary course of business, consistent with past practice; (vi) issue or sell any shares of its capital stock of any class or any other of its securities, or issue or create any warrants, obligations, subscriptions, options, convertible securities, stock appreciation rights or other commitments to issue shares of capital stock, 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 HCC 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 HCC for its review prior to such agreement or filing; and (ix) terminate the employment of any key executive employee; (k) The Shareholder will maintain, and shall cause the Sun Affiliated Entities to maintain, all insurance agency licenses or authorizations currently held by the Shareholder or the Sun Affiliated Entities; and (l) Neither Sun, the Sun Affiliated Entities, nor the Shareholder will directly or indirectly, agree or commit to do any of the foregoing. 23 SECTION 4.2 ACCESS TO FINANCIAL AND OPERATIONAL INFORMATION. Sun and the Shareholder will give HCC, its counsel, financial advisors, auditors and other authorized representatives reasonable access during normal business hours to their offices, properties, books and records, will furnish to HCC, 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 HCC in its investigation of the business of Sun and the Sun Affiliated Entities and in the planning for the combination of the businesses of Sun and the Sun Affiliated Entities and HCC following the consummation of the transactions contemplated by this Agreement; PROVIDED that no investigation pursuant to this Section shall affect any representation or warranty given hereunder. In addition, following the public announcement of this Agreement or the transactions contemplated hereby, Sun will cooperate in arranging joint meetings among representatives of Sun and HCC and persons with whom they maintain business relationships. SECTION 4.3 OTHER OFFERS. Neither Sun nor the Shareholder will, directly or indirectly, through representatives or otherwise, (i) solicit, entertain, or negotiate with respect to, or in any manner encourage, discuss, or consider, any Acquisition Proposal (as hereinafter defined), or (ii) disclose any information relating to Sun, or afford access to the properties, books, or records of Sun, directly or indirectly, in connection with any Acquisition Proposal or possible or proposed Acquisition Proposal. To the extent that Sun or the Shareholder or any of their respective officers, directors, employees or other agents is currently involved in any discussions with respect to any Acquisition Proposal or contemplated or proposed Acquisition Proposal, Sun and the Shareholder shall terminate, and shall use their best efforts to cause, where applicable, their respective officers, directors, employees or other agents to terminate, such discussions immediately. Subject to their fiduciary duties, the Board of Directors of Sun, and Shareholder, shall not (i) approve or recommend, or propose to approve or recommend, any Acquisition Proposal (other than an Acquisition Proposal made by HCC or an affiliate of HCC), or (ii) approve or authorize the entering into any agreement with respect to any Acquisition Proposal. 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 Sun or the acquisition of any equity interest in, or a substantial portion of the assets of, Sun or the Sun Affiliated Entities other than the transactions contemplated by this Agreement. SECTION 4.4 MAINTENANCE OF BUSINESS. Sun will, and the Shareholder shall cause Sun and the Sun Affiliated Entities to, use commercially reasonable efforts 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 Sun or the Shareholder becomes aware of a material deterioration or facts which are likely to result in a material deterioration in the relationship of Sun or the Sun Affiliated Entities with any customers, supplier, licensor or others having business relationships with it, such party will promptly in writing bring such information to the attention of the HCC. SECTION 4.5 COMPLIANCE WITH OBLIGATIONS. Sun shall, and the Shareholder shall cause Sun and the Sun Affiliated Entities to, use commercially reasonable efforts to comply in all material 24 respects with (i) all applicable federal, state, local and foreign laws, rules and regulations, (ii) all material 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 Sun or the Sun Affiliated Entities or North Bay and its respective properties or assets. SECTION 4.6 NOTICES OF CERTAIN EVENTS. Sun or the Shareholder shall, upon obtaining knowledge of any of the following, promptly notify HCC 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 Sun 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 4.7 NECESSARY CONSENTS. After the Closing, the Shareholder shall use commercially reasonable efforts to obtain such written consents and take such other actions as may be necessary or appropriate to allow Sun or any successor to carry on its business as a subsidiary of HCC after the Closing Date (as defined in Section 9.1 hereof). SECTION 4.8 REGULATORY APPROVAL. Sun and, where required pursuant to the rules or regulations of any regulatory agency, the Shareholder will 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 reasonably required, or which HCC may reasonably request, in connection with the consummation of the transaction provided for in this Agreement. Sun and the Shareholder will use commercially reasonable efforts to obtain or assist HCC in obtaining all such authorizations, approvals and consents. SECTION 4.9 SATISFACTION OF CONDITIONS PRECEDENT. Sun and the Shareholder shall use commercially 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 4.10 COMMUNICATIONS. Without the prior approval of HCC, neither Sun nor any Shareholder will disclose any information relating to the transactions contemplated by this 25 Agreement, other than to HCC or an officer, director, attorney, or advisor of Sun or the Shareholder who needs to know such information in connection with the negotiation or consummation of the transactions contemplated hereby. ARTICLE 5 COVENANTS OF HCC SECTION 5.1 CONDUCT OF HCC. From the date hereof until the occurrence of the earlier of (i) the Effective Time or (ii) the termination of this Agreement pursuant to Section 8.1 hereof, HCC agrees that, except as otherwise permitted with the written consent of the Shareholder, which consent shall not be unreasonably withheld, HCC 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 HCC in any manner from acquiring other businesses or substantially all of the assets thereof. Without limiting the generality of the foregoing, from the date hereof until the Effective Time, except as contemplated hereby or previously disclosed by HCC to the Shareholder in writing: (a) HCC will not adopt or propose any change in its Certificate of Incorporation or Bylaws; (b) HCC will not take any action that would result in a failure to maintain the trading of HCC Common Stock on the NYSE; and (c) HCC will not agree or commit to do any of the foregoing. SECTION 5.2 LISTING OF HCC COMMON STOCK. HCC shall use reasonable efforts to cause the shares of HCC Common Stock to be issued hereunder to be approved for listing on the NYSE within 90 days following the Closing. SECTION 5.3 COMPLIANCE WITH OBLIGATIONS. From the date hereof until the occurrence of the earlier of (i) the Effective Time or (ii) the termination of this Agreement pursuant to Section 8.1 hereof, HCC agrees that, except as otherwise permitted with the written consent of the Shareholder, which consent shall not be unreasonably withheld, HCC shall use its commercially reasonable efforts to comply in all material respects with (i) all applicable federal, state, local and foreign laws, rules and regulations, (ii) all material 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 HCC and its subsidiaries and their respective properties or assets; except to the extent that the failure to comply with matters in clauses (i), (ii) and (iii) would not have a Material Adverse Effect on HCC. 26 SECTION 5.4 NOTICES OF CERTAIN EVENTS. From the date hereof until the occurrence of the earlier of (i) the Effective Time or (ii) the termination of this Agreement pursuant to Section 8.1 hereof, HCC shall, upon obtaining knowledge of any of the following, promptly notify the Shareholder 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 HCC 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 the transactions contemplated by this Agreement. SECTION 5.5 RULE 144. For so long as the shares of HCC Common Stock to be issued by HCC to the Shareholder hereunder constitute restricted securities within the meaning of Rule 144 promulgated under the Securities Act, but paragraph (k) of Rule 144 does not apply to the resale of such shares, HCC shall file such reports and take such further actions as may be required pursuant to such Rule 144 to allow the continued sale of such HCC Common Stock by the Shareholder thereunder. ARTICLE 6 COVENANTS OF HCC, THE SHAREHOLDER AND SUN SECTION 6.1 ADVICE OF CHANGES. From the date hereof until the occurrence of the earlier of (i) the Effective Time or (ii) termination of this Agreement pursuant to Section 8.1 hereof, each party hereto agrees that such party will promptly advise the others in writing (i) of any event known to any of its executive officers or the Shareholder 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 6.2 REGULATORY APPROVALS. From the date hereof until the occurrence of the earlier of (i) the Effective Time or (ii) termination of this Agreement pursuant to Section 8.1 hereof, each party hereto agrees that such party 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 27 requested in connection with the consummation of the transactions contemplated by this Agreement. Each party shall use its commercially reasonable efforts to obtain all such authorizations, approvals and consents. SECTION 6.3 CERTAIN FILINGS. From the date hereof until the occurrence of the earlier of (i) the Effective Time or (ii) termination of this Agreement pursuant to Section 8.1 hereof, each party hereto agrees that such party will cooperate with the other parties: (a) in connection with the preparation of any filing required by the HSR Act; (b) 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 (c) 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 6.4 SATISFACTION OF CONDITIONS PRECEDENT. From the date hereof until the occurrence of the earlier of (i) the Effective Time or (ii) termination of this Agreement pursuant to Section 8.1 hereof, each party hereto agrees that such party will use commercially reasonable 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 6.5 CONFIDENTIALITY. (a) For a period of five (5) years from the date of this Agreement, each such 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 that in connection with this Agreement or the transactions contemplated hereby unless such information is already known to such party or to others not bound by a duty of confidentiality or unless such information becomes publicly available through no fault of such party, unless 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 unless the furnishing or use of such information is required by or necessary or appropriate in connection with legal proceedings. This Section 6.5(a) shall not apply to HCC following the Closing, if the Closing occurs. 28 (b) If the transactions contemplated by this Agreement are not consummated, each party will return or destroy as much of such written information as may be reasonably requested. Whether or not the Closing takes place, the Shareholder waives, and will upon request cause Sun to waive, any cause of action, right or claim arising out of the access of HCC or its representatives to any trade secrets or other confidential information of Sun except for the intentional competitive misuse by HCC of such trade secrets or confidential information. SECTION 6.6 TAX COOPERATION. HCC, Sun, and the Shareholder shall cooperate in the preparation, execution, and filing of all returns, questionnaires, applications, or other documents regarding any sales, use, transfer, value, stock transfer, or stamp taxes, or any transfer, recording, registration, or other fees, or any similar taxes or fees which become payable in connection with the transactions contemplated by this Agreement. SECTION 6.7 CHANGE OF NAME OF SUN. HCC reserves the right, at its sole discretion, to change the name of Sun, or to change the structure, organization or operations of Sun, or to move the business and operations of Sun, as determined by HCC in its sole discretion. However, Sun shall grant to Shareholder a non-exclusive, royalty-free license to use the name "Sun" (but not the name "Sun Employer Services") in connection with any business other than the insurance, benefits and related consulting businesses. Without limiting the foregoing, the Shareholder shall have the right to utilize the name "Sun" and the logo of Sun on his Hatteras boat (and any successor boat or affiliated equipment) and with respect to any marina business with which the Shareholder is associated. SECTION 6.8 PUBLIC DISCLOSURE OF TRANSACTION. Subject to written advice of counsel with respect to the legal requirements relating to a public disclosure of the transactions contemplated hereby, the timing and content of any announcements, press releases, or other public statements concerning the transactions contemplated herein will be determined solely by HCC, with input from Sun. ARTICLE 7 CONDITIONS TO CLOSING SECTION 7.1 CONDITIONS TO OBLIGATIONS OF HCC. The obligations of HCC hereunder are subject to the fulfillment or satisfaction, on and as of the Closing Date, of each of the following conditions (any one or more of which may be waived by HCC, but only in a writing signed by HCC): (a) The representations and warranties of Sun and the Shareholder set forth herein remain true and accurate in all material respects on and as of the Closing Date with the same force and effect as if they had been made on the Closing Date (except to the extent a representation or warranty speaks specifically as of an earlier date and except for changes contemplated by this 29 Agreement) and the Shareholder shall have provided HCC with a certificate executed by the Shareholder dated as of the Closing Date, to such effect. (b) Sun and the Shareholder shall have performed and complied in all material respects with all of the covenants applicable to them contained herein on or before the Closing Date, and HCC shall receive a certificate to such effect signed by the Shareholder. (c) Except as set forth in the Sun Disclosure Schedule or the Sun Financial Statements, there shall have been no Material Adverse Change in Sun since June 30, 1998. (d) 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 the Material Sun Agreements shall have been obtained. (e) HCC shall have received the opinion of counsel to Sun and the Shareholder in form and substance satisfactory to HCC. (f) HCC shall have determined that all underwriting agreements and related reinsurance agreements, agency agreements, and commission sharing agreements of Sun in force on the date hereof, including, without limitation, Sun's Agreement with Monumental General Casualty Company and Monumental Life Insurance Company ("Monumental"), which includes a fronting fee of 6% to Monumental, a 22% management fee to Sun, a 3% claims administration fee to Sun, and the ceding of 100% of the employer liability premium (at a rate of 10% of the total gross written premium) to North Bay, will remain in full force and effect, without restriction or modification as a result of the transactions contemplated hereby, for a period of at least 12 months following the Closing Date. (g) The Shareholder shall be alive and not, in any way, Disabled. For purposes of this Agreement, the Shareholder shall be deemed to be "Disabled" if he is unable to engage in any substantial portion of his regular duties for Sun 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 reasonably expected to last for a continuous period of not less than 12 months. (h) Sun shall have received the unqualified opinion of independent public accountants to Sun on their audited financial statements for the year ended June 30, 1998. (i) Sun shall have delivered to HCC its audited balance sheet and its audited income statement for the year ended June 30, 1998. (j) Sun is expected to earn, on a pro-forma basis, as reasonably determined by HCC, at least $3,300,000 before income tax for the year ending June 30, 1999. 30 (k) The retained earnings, as calculated in accordance with GAAP, applied on a basis consistent with the basis applied in the preparation of the Audited Balance Sheet, of Sun immediately after the Effective Time will equal or exceed $2,000,000. (l) The Shareholder shall have tendered all the Sun Common Stock for sale pursuant to this Agreement. No claim shall have been filed, made or threatened by any other person or entity asserting that he, she or it is entitled to any part of the Purchase Price. (m) The Shareholder shall have executed and delivered to HCC a five year worldwide Non-Competition Agreement covering all aspects of the insurance business from the date of separation of employment from HCC and Sun and their successors, in a form satisfactory to HCC. (n) All plans, policies, arrangements, and agreements described in Section 2.12 hereof shall have been terminated, except as approved in writing by HCC. (o) On or prior to the Closing Date, the Shareholder shall have furnished HCC with evidence of such consents as the Shareholder shall know, or HCC shall determine, to be required to enable HCC to continue to enjoy the benefit of any lease, license, permit, contract or other agreement or instrument to or of which Sun is a party or beneficiary and which can, by its terms (with consent) and consistent with applicable law, be so enjoyed after the transfer of the Sun Common Stock to HCC. 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 transfer of the Sun Common Stock to HCC, and such lease, license, permit, or contract is required in order for the business of Sun to continue to be conducted following the transfer of the Sun Common Stock in the same manner as conducted previously, HCC shall have obtained, or been furnished by the Shareholder an equivalent of, that lease, license, permit, or contract effective as of and after the Closing Date. (p) HCC shall have received resignations of all persons who are officers or directors of Sun immediately prior to the Closing. (q) HCC shall have received general releases in favor of Sun and HCC executed by the Shareholder, Barton, and such other employees, officers, or directors of Sun as HCC may designate. Those releases will not relate to rights or obligations arising under this Agreement. (r) HCC shall have received possession of all corporate, accounting, business and tax records of Sun. (s) 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 HCC and HCC's counsel. 31 (t) HCC shall have determined that North Bay shall have adequately reserved against all losses incurred by it and shall have a minimum IBNR level for net retained business of at least $1,000,000. (u) HCC or a subsidiary of HCC shall have entered into arrangements reasonably satisfactory to HCC with each of Michael S. Hoover and Howard V. Barton, II with respect to their continuing employment. (v) The assets set forth on Schedule 2.29 shall be held of record and beneficially by North Bay. (w) Bobby G. Black and Joan Black shall each have executed a Purchase Agreement, and an Employment Termination Agreement and Release and Assignment in form and substance acceptable to HCC. (x) Michael S. Hoover shall have executed a Purchase Agreement and Assignment relating to the sale of his interest in KIMCO. SECTION 7.2 CONDITIONS TO OBLIGATIONS OF THE SHAREHOLDER. The obligations of the Shareholder hereunder are subject to the fulfillment or satisfaction, on and as of the Closing 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 HCC set forth herein shall be true and accurate in all material respects on and as of the Closing Date with the same force and effect as if they had been made on the Closing 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 HCC shall have provided the Shareholder with a certificate executed by an authorized officer of each of HCC, dated as of the Closing Date, to such effect. For the purposes of determining the accuracy of the representations and warranties of HCC, any change or effect in the business of HCC that results in substantial part as a consequence of the public announcement or pendency of the intended acquisition of the Sun Common Stock by HCC shall not be deemed a Material Adverse Change or Material Adverse Effect or other breach of representation or warranty with respect to HCC. (b) HCC shall have performed and complied with all of its covenants contained herein in all material respects on or before the Closing Date, and the Shareholder shall have received a certificate to such effect signed by any authorized officer of HCC. (c) Except as set forth in the HCC Disclosure Schedule, there shall have been no Material Adverse Change in HCC since June 30, 1998. (d) The Shareholder shall have received from Winstead Sechrest & Minick P.C., counsel to HCC, an opinion in form and substance satisfactory to the Shareholder. 32 (e) 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 Shareholder and his counsel. SECTION 7.3 CONDITIONS TO OBLIGATIONS OF EACH PARTY. The respective obligations of the parties hereunder at Closing are subject to the fulfillment, on and as of the Closing 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 (each party agreeing to use its commercially reasonable 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 HCC, Sun, or the Shareholder or would be reasonably likely to subject any of HCC, Sun, or the Shareholder or any of their respective directors or officers to penalties or criminal liability. (c) The waiting period (and any extension thereof) applicable to the consummation of the Merger under the HSR Act, if applicable, shall have expired or been terminated. ARTICLE 8 TERMINATION OF AGREEMENT SECTION 8.1 TERMINATION. This Agreement may be terminated at any time prior to the Closing Date: (a) By the mutual consent of the Shareholder and the Board of Directors of HCC. (b) By the Board of Directors of HCC, if the Shareholder shall have become Disabled or shall have died, or if there has been a material breach by Sun or the Shareholder of any representation, warranty or covenant contained in this Agreement which cannot be, or has not been, cured within 15 days after written notice of such breach is given to the Shareholder, provided that the right to effect such cure shall not extend beyond the date set forth in subparagraph (d) below. 33 (c) By the Shareholder, if there has been a material breach by HCC of any representation, warranty, or covenant contained in this Agreement which cannot be, or has not been, cured within 15 days after written notice of such breach is given to HCC, provided that the right to effect such cure shall not extend beyond the date set forth in subparagraph (e) below. (d) By the Board of Directors of HCC, if all conditions of Closing set forth in Sections 7.1 and 7.3 of this Agreement have not been satisfied or waived by November 15, 1998, provided, however, that HCC shall not be entitled to terminate this Agreement pursuant to this subparagraph (d) if it is in willful and material violation of any of its representations, warranties, or covenants contained in this Agreement. (e) By the Shareholder, if all conditions of Closing set forth in Sections 7.2 and 7.3 of this Agreement have not been satisfied or waived by November 15, 1998, provided, however, that the Shareholder shall not be entitled to terminate this Agreement pursuant to this subparagraph (e) if the Shareholder or Sun is in willful and material violation of any representation, warranty, or covenant contained in this Agreement. (f) 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 8.2 EFFECT OF TERMINATION. Upon termination of this Agreement pursuant to this Article 8, this Agreement shall be void and of no effect and shall result in no obligation of or liability to any party or their respective directors, officers, employees, agents or Shareholder other than the obligations under Section 6.5 hereof, unless such termination was the result of an intentional breach of any representation, warranty or covenant in this Agreement, in which case the party who breached the representation, warranty or covenant shall be liable to the other parties for damages, and all costs and expenses incurred in connection with the preparation, negotiation, execution and performance of this Agreement. ARTICLE 9 CLOSING MATTERS SECTION 9.1 THE CLOSING. Subject to termination of this Agreement as provided in Article 8 above, the closing of the transactions provided for herein (the "Closing") will take place at the offices of Winstead Sechrest & Minick P.C., 910 Travis Street, Suite 2400, Houston, Texas 77002 at 10:00 a.m., Houston Time on November 5, 1998, or, if all conditions to Closing have not been satisfied or waived by such date, such other place, time and date as the Shareholder and HCC may mutually select (herein sometimes called the "Effective Time" or the "Closing Date"). 34 ARTICLE 10 INDEMNIFICATION SECTION 10.1 SHAREHOLDER AGREEMENT TO INDEMNIFY. Subject to the limitations set forth in this Article 10, from and after the Effective Time, the Shareholder will indemnify and hold harmless HCC and its officers, directors, agents, employees, successors, and assigns and each person, if any, who controls or may control HCC within the meaning of the Securities Act (hereinafter referred to individually as a "Sun Indemnified Person" and collectively as "Sun Indemnified Persons") from and against any and all claims, demands, actions, causes of action, losses, costs, damages, liabilities and expenses including, without limitation, reasonable legal fees, (net of: (i) any recoveries under insurance policies or any amounts that would have been recoverable under insurance policies if the Surviving Corporation had continued to maintain the same insurance coverage maintained by Sun on the date of this Agreement; (ii) recoveries from third parties; and (iii) tax savings known to Sun Indemnified Persons at the time of making of claims hereunder) made against or incurred by Sun Indemnified Persons (hereafter in this Section 10 referred to as "HCC Damages"), arising out of any material misrepresentation or breach of or default under any of the representations, warranties, covenants or agreements given or made in this Agreement or any certificate or exhibit delivered by or on behalf of Sun or the Shareholder pursuant hereto. The indemnification provided for in this Section 10.1 will not apply unless and until the aggregate HCC Damages for which one or more Sun Indemnified Persons seeks indemnification exceeds $150,000 in the aggregate, in which event the indemnification provided for will include all HCC Damages (a franchise deductible). The Sun Indemnified Persons are only entitled to be reimbursed for the actual indemnified expenditures or damages incurred by them for the above described losses. Such Sun Indemnified Persons are not entitled to consequential, special, or other speculative or punitive categories of damages. Notwithstanding the foregoing, in no event shall the Shareholder have any obligation for indemnification pursuant to this Section 10.1 in excess of an aggregate of $15,000,000. SECTION 10.2 INDEMNIFICATION WITH RESPECT TO TAXES AND LICENSING. In addition to the indemnification provided in Section 10.1 above, the Shareholder will indemnify and hold harmless the Sun Indemnified Persons from and against all HCC Damages, whenever incurred, arising out of: (i) any Taxes including, without limitation any Taxes accruing out of the redemption of stock in exchange for the Barton Ridge Property and other property set forth in Section 4.1(e) or (ii) from the failure to have obtained any license including without limitation, any managing general agent's license, relating to the business of Sun or any Sun Affiliated Entity or North Bay attributable to any period preceding the Effective Time. SECTION 10.3 INDEMNIFICATION FOR OTHER SPECIFIED CLAIMS. In addition to the indemnification provided in Sections 10.1 and 10.2 above, the Shareholder will indemnify and hold harmless the Sun Indemnified Persons from and against all HCC Damages, whenever incurred, arising out of any liability or claimed liability of Sun or any Sun Affiliated Entity or Shareholder or 35 Barton to (i) William G. McKnight; (ii) Specialty Assistance Services, Inc.; (iii) Bobby G. Black or Joan Black. SECTION 10.4 HCC AGREEMENT TO INDEMNIFY. Subject to the limitations set forth in this Article 10, from and after the Effective Time, HCC will indemnify and hold harmless the Shareholder, Barton and each of their administrators, heirs, personal representatives, successors and assigns (hereinafter in this Section 10.4 referred to individually as an "HCC Indemnified Person" and collectively as "HCC Indemnified Persons") from and against any and all claims, demands, actions, causes of action, losses, costs, damages, liabilities and expenses including, without limitation, reasonable legal fees (net of: (i) any recoveries under insurance policies; (ii) recoveries from third parties; and (iii) tax savings known to HCC Indemnified Persons at the time of making a claim hereunder) (hereafter in this Section 10.4 referred to as "Sun 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 in this Agreement or any certificate or exhibit delivered by or on behalf of HCC pursuant hereto. The indemnification provided for in this Section 10.4 will not apply unless and until the aggregate Sun Damages for which one or more HCC Indemnified Person seeks indemnification exceeds $150,000 in the aggregate, in which event the indemnification provided for will include all Sun Damages (a franchise deductible). The HCC Indemnified Persons are only entitled to be reimbursed for the actual indemnified expenditures or damages incurred by them for the above described losses. Such HCC Indemnified Persons are not entitled to consequential, special, or other speculative or punitive categories of damages. Notwithstanding the foregoing, in no event shall HCC have any obligation for indemnification pursuant to this Section 10.4 in excess of an aggregate of $15,000,000. SECTION 10.5 INDEMNIFICATION OF CLAIM BY INTERNATIONAL SPECIAL RISKS, LTD. In addition to the indemnification provided in Section 10.4 above, HCC will indemnify and hold harmless the HCC Indemnified Persons from and against all Sun Damages, whenever incurred, arising out of any liability or claims of liability of the Shareholder or any affiliate of the Shareholder regarding the contract between Sun and International Special Risks, Ltd. and HCC will not seek any indemnity from the Shareholder with respect to any such claim. SECTION 10.6 SURVIVAL OF REPRESENTATIONS. Unless any representation, warranty, covenant or agreement is required to terminate at an earlier time in order to maintain the applicable pooling-of-interests accounting treatment, each representation, warranty, covenant and agreement set forth in this Agreement will remain operative and in full force and effect for a period of one year after the Closing (the last date of such one year period being herein called the "Final Date"), regardless of any investigation made by or on behalf of the parties to this Agreement, upon which Final Date such representations, warranties, covenants and agreements shall expire and be of no further force and effect except for the covenants set forth in Section 6.5 hereof and except that the indemnification provided for in Sections 10.2 and 10.3 of this Agreement shall survive until a final resolution of all such matters. Except as provided in the preceding sentence, any litigation or other action of any kind arising out of or attributable to a breach of any representation, warranty, covenant or agreement contained in this Agreement, must be commenced prior to the Final Date. If not so commenced prior 36 to the Final Date, any claims or indemnifications brought under this Article 10 (except for those relating to a breach of the covenants set forth in Section 6.5 hereof or relating to indemnification under Sections 10.2 or 10.3 hereof) will thereafter conclusively be deemed to be waived regardless of when such claim is or should have been discovered. Any such claim for indemnification brought under this Article 10, brought before the Final Date, shall survive until a final resolution of such claim is effective. As set forth herein, no investigation by any party hereto into the business, operations and conditions of the other party shall diminish in any way the effect of any representation or warranty made by any such party in this Agreement or shall relieve any party of any of its obligations under this Agreement. SECTION 10.7 PROCEDURE FOR INDEMNIFICATION; THIRD PARTY CLAIMS. (a) Promptly after receipt by an indemnified party under this Article 10 of notice of a claim against it for indemnification brought under this Article 10 (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. (b) If any Claim referred to in this Article 10 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 and, to the extent that it wishes to assume the defense of the Claim and, after written notice from the indemnifying party to the indemnified party of its election to assume the defense of the Claim, the indemnifying party shall assume such defense and will not be liable to the indemnified party under this Article 10 for any fees of other counsel or any other expenses with respect to the defense of the Claim in each case subsequently incurred by the indemnified party in connection with the defense of the Claim ARTICLE 11 MISCELLANEOUS SECTION 11.1 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. 37 SECTION 11.2 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, provided, however that if the transaction contemplated by this Agreement is consummated, the expenses of Shareholder and Barton shall be paid by Sun. SECTION 11.3 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, return receipt requested, postage prepaid, or sent by prepaid overnight courier or confirmed telecopier, addressed as follows: HCC: HCC Insurance Holdings, Inc. 13403 Northwest Freeway Houston, Texas 77040-6094 Telecopy: (713) 462-2401 Attention: Frank J. Bramanti, Executive Vice President With a copy (which shall not constitute notice) to: Winstead Sechrest & Minick P.C. 910 Travis, Suite 2400 Houston, Texas 77002-5895 Telecopy: (713) 650-2400 Attention: Arthur S. Berner, Esq. Shareholder, Barton or, prior to the Closing, Sun: Mr. Howard V. Barton 8213 Marsh Pointe Drive Montgomery, Alabama 36117 With a copy (which shall not constitute notice) to: Capell, Howard, Knabe & Cobbs, P.A. 57 Adams Avenue Montgomery, Alabama 36104-4045 Telecopy: (334) 323-8888 Attention: Henry H. Hutchinson, Esq. 38 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. SECTION 11.4 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. SECTION 11.5 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 other; provided, however, that HCC shall be permitted at any time prior to the Effective Time to cause the assignment of its rights and obligations under this Agreement to a wholly owned (directly or indirectly) subsidiary of HCC (without in any way relieving HCC of its obligations under this Agreement). SECTION 11.6 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 11.7 ENTIRE AGREEMENT. This Agreement, together with the Confidentiality Agreement, and any other agreement and instrument referenced herein constitute the entire understanding and 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 the parties with respect hereto. SECTION 11.8 AMENDMENT AND WAIVERS. Any and all amendments and modifications of this Agreement must be in writing and signed by HCC and the Shareholder. No term, provision, or condition of this Agreement or any breach thereof may be waived except in a writing signed by HCC (in the case of a waiver by HCC) or by the Shareholder (in the case of a waiver by Sun or the Shareholder). Any such waiver shall not be deemed to constitute a waiver of any other term, provision, condition, or any succeeding breach thereof, unless such waiver so expressly states. SECTION 11.9 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 11.10 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," "includes" and "including" when used herein shall be deemed in each case to be followed by the words "without limitation." 39 SECTION 11.11 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. IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the date first above written. [REMAINDER OF PAGE INTENTIONALLY LEFT BLANK] 40 HCC INSURANCE HOLDINGS, INC. By: /s/ Frank J. Bramanti ----------------------------------- Name: Frank J. Bramanti, Title: Executive Vice President SIGNATURE PAGE OF STOCK PURCHASE AGREEMENT SUN EMPLOYER SERVICES, INC., an Alabama corporation By: /s/ Howard V. Barton ----------------------------------- Name: Howard V. Barton Title: President /s/ Howard V. Barton -------------------------------------- Howard V. Barton, individually /s/ Elizabeth A. Barton -------------------------------------- Elizabeth A. Barton SIGNATURE PAGE OF STOCK PURCHASE AGREEMENT EX-10.348 3 EXHIBIT 10.348 EMPLOYMENT AGREEMENT This Employment Agreement ("Agreement") is entered into as of the 1st day of January, 1998 (the "Effective Date"), between HCC INSURANCE HOLDINGS, INC. ("HCC" or "Company"), and JOHN N. MOLBECK, JR. ("Executive"), sometimes collectively referred to herein as the "Parties." R E C I T A L S: WHEREAS, Executive is to be employed as 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 Committee; WHEREAS, it is the desire of 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; and WHEREAS, Executive is desirous of committing himself to serve HCC on the terms herein provided. NOW, THEREFORE, in consideration of the foregoing and of the respective covenants and agreements set forth below, the Parties agree as follows: 2. TERM. The Company hereby agrees to employ Executive as its 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). On or before December 31, 1999, Executive shall assume the additional responsibilities of Chief Executive Officer of HCC. 3. DUTIES. (a) DUTIES AS EMPLOYEE OF THE COMPANY. Executive shall, subject to the supervision of the Chief Executive Officer and Board (until such time as Employee is elected Chief Executive Officer, at which time Employee shall be subject to the supervision of the Chairman of the Board and Board), have general management and control of HCC 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 EMPLOYMENT AGREEMENT - Page 1 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 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. 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. 4. COMPENSATION AND RELATED MATTERS. (a) BASE SALARY. Executive shall receive a base salary paid by the Company at the annual rate of $500,000, during the period beginning on the Effective Date payable not less frequently than in substantially equal monthly installments. The base salary shall be increased by $25,000 each January 1, commencing January 1, 1999, until Executive's base salary reaches $600,000. 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 based on HCC's annual operating earnings per share ("OEPS") as set forth below: $50,000 bonus if OEPS growth is 10% or more in any one year; $100,000 bonus if OEPS growth is 15% or more in any one year period; and $200,000 bonus if OEPS growth is 20% or more in any one year period. For purposes of this Agreement, OEPS is defined as HCC's consolidated net earnings less capital gains/losses, currency gains/losses, and any nonrecurring merger and acquisition income or EMPLOYMENT AGREEMENT - Page 2 expenses as reported in HCC's Annual Report on Form 10-K. (c) STOCK OPTIONS. In addition to stock options previously granted to Executive, if any, in partial consideration for Executive's non-competition agreement, set forth herein, Executive shall be provided with additional options to purchase HCC shares as follows: (1) On January 7, 1998, an option to acquire 200,000 shares, exercisable at a price of $16.50 per share and vesting at 20% per year beginning on December 31, 1998 and on each of the four December 31st thereafter; (2) For each year beginning with the year ending December 31, 1999, of Executive's employment hereunder; 15,000 shares if, on such December 31, the price of the HCC Common Stock has increased since the previous January 1, by an amount that is greater than or equal to 10%, but less than 15%; 20,000 shares if, on such December 31, the price of the HCC Common Stock has increased since the previous January 1, by an amount that is greater than or equal to 15%, but less than 20%; 25,000 shares if, on such December 31, the price of the HCC Common Stock has increased since the previous January 1, by an amount that is greater than or equal to 20%, but less than 25%; and 30,000 shares if, on such December 31, the price of the HCC Common Stock has increased since the previous January 1, by an amount that is greater than or equal to 25%; and An additional option to acquire an additional 5,000 shares for each additional 5% increase in the price of the HCC Common Stock since the previous January 1. Each of such options set forth in this Subparagraph (ii) shall be priced at the average of the closing prices of HCC shares for the month of December of the year of the grant and shall vest immediately. For purposes of this Subparagraph, the granting of any option shall not be pro-rated if the criteria set forth herein are not achieved in full. (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 EMPLOYMENT AGREEMENT - Page 3 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 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-five (25) 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 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: (i) have use of a 1998 Mercedes 500 SEL automobile, and the Company shall pay all expenses related to Executive's use of such car, including gasoline, insurance, and maintenance; (ii) be allowed to travel on business utilizing first class passage (whether domestic or international); (iii) receive an annual country club dues allowance of up to $16,000; and (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). (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. EMPLOYMENT AGREEMENT - Page 4 5. 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 EMPLOYMENT AGREEMENT - Page 5 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 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 EMPLOYMENT AGREEMENT - Page 6 this Agreement including, without limitation, a failure to elect Executive the Chief Executive Officer of the Company on or before December 31, 1999; 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 ninety (90) 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 (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 if there is a termination by the Company without Cause or by Executive for Good Reason, any stock options and other stock-related grants ("Stock Awards") which Executive has received under any of the HCC stock plans shall vest immediately; provided, however, that the right to receive options referenced in Paragraph 3(c)(2) above shall terminate upon termination from employment for any reason, and further, if there is a termination for Good Reason or by the Company other than for Cause, all options shall be exercisable for one year 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, through December 31, 2002 the Company, at its sole expense, shall continue to EMPLOYMENT AGREEMENT - Page 7 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 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 not 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 EMPLOYMENT AGREEMENT - Page 8 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 for which Executive would have been eligible had he completed the Basic Term (except as set forth in Paragraph 4(b)(2)), shall be accelerated, and Executive's estate or beneficiary shall be vested in such Stock Awards as of the date of Executive's termination. (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. 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. (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. 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 EMPLOYMENT AGREEMENT - Page 9 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. 6. 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 Options 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 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 Basis Term, 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 Basic Term, 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 EMPLOYMENT AGREEMENT - Page 10 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 Company's trade secrets, proprietary information, EMPLOYMENT AGREEMENT - Page 11 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 Agreement will not breach or constitute a default of any other agreement or contract to EMPLOYMENT AGREEMENT - Page 12 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. 7. 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, HCC hereby retains Executive as a consultant (an independent contractor and not as an employee) for a period of ten (10) 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 200 hours of service per year, or, as requested by the Company, up to a total of 600 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 2,000 (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 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 $100,000 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 EMPLOYMENT AGREEMENT - Page 13 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. 8. 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. 9. BINDING AGREEMENT. Executive understands that his obligations under this Agreement are binding upon Executive's heirs, successors, personal representatives, and legal representatives. 10. 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: John N. Molbeck, Jr. 3424 Ella Lee Lane Houston, Texas 77027 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: Winstead Sechrest & Minick P.C. Suite 2400 910 Travis Street Houston, Texas 77002-5895 Fax: (713) 650-2400 EMPLOYMENT AGREEMENT - Page 14 11. 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. 12. 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. 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. 14. 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. 15. 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. 16. 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. EMPLOYMENT AGREEMENT - Page 15 17. GOVERNING LAW. This Agreement shall be governed by and construed in accordance with the laws of the State of Texas. 18. 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. 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/ John N. Molbeck, Jr. By: /s/ Stephen L. Way - -------------------------------- ------------------------------------ JOHN N. MOLBECK, JR. STEPHEN L. WAY Chief Executive Officer and Chairman of the Board Dated: 1/23/98 Dated: 1/23/98 -------------------------- -------------------------------------- EMPLOYMENT AGREEMENT - Page 16 EX-10.349 4 EXHIBIT 10.349 EMPLOYMENT AGREEMENT This Employment Agreement ("Agreement") is entered into effective as of the 1st day of January, 1998 (the "Effective Date"), between HCC INSURANCE HOLDINGS, INC. ("HCC" or the "Company"), and STEPHEN J. LOCKWOOD ("Executive"), sometimes collectively referred to herein as the "Parties". R E C I T A L S: WHEREAS, Executive is to be employed as Vice Chairman of the Board of Directors of HCC and Chairman and Chief Executive Officer of LDG Reinsurance Corporation ("LDG"); and WHEREAS, it is the desire of the Board of Directors of HCC (the "Board") to directly engage Executive in the capacities set forth above; and WHEREAS, Executive is desirous of committing himself to serve HCC on the terms herein provided. NOW, THEREFORE, in consideration of the foregoing and of the respective covenants and agreements set forth below, the Parties agree as follows: 2. TERM. The Company hereby agrees to employ Executive as its Vice Chairman of the Board of Directors, as the Chairman and Chief Executive Officer of LDG and as a director of HCC Benefits, Inc. ("Benefits"), 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). At any time on or after January 1, 2000, and prior to December 31, 2002, Executive may, at his option, cease to be a full time employee and elect to begin the Consulting Period as defined in Section 6 hereof. (The period of time beginning as of the date Executive commences the Consulting Period, if before December 31, 2002, and ending on December 31, 2002 is hereinafter called the "Early Consulting Period"). 3. DUTIES. (a) DUTIES AS EMPLOYEE OF THE COMPANY. Executive shall, subject to the supervision of the Board act as Vice Chairman of the Board of HCC, Chairman and Chief Executive Officer of LDG, and a director of Benefits in the ordinary course of its business with all such powers as may be reasonably incident to such responsibilities. Executive shall report to the Chairman of the Board or the President of HCC. During normal business hours Executive shall devote his full time and attention to diligently attending to the business of the Company and its subsidiaries during his term of employment hereunder. During his term of employment, Executive shall not directly or indirectly render any services of a business, commercial, or EMPLOYMENT AGREEMENT - Page 1 professional nature to any other person, firm, corporation, or organization, whether for compensation or otherwise, without the prior written consent 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 and its subsidiaries as set forth 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 director and to serve on the Senior Management Committee of HCC. If elected, Executive agrees that he shall not be entitled to receive any compensation for serving as a Director of HCC or any of HCC's subsidiaries other than the compensation to be paid to Executive by the Company pursuant to this Agreement. 4. COMPENSATION AND RELATED MATTERS. (a) BASE SALARY. Executive shall receive an initial base salary paid by the Company at the annual rate of $450,000, during 1998 and 1999. Subject to Executive's right to begin the Consulting Period, as set forth in Section 6, if Executive no longer acts as the Chief Executive Officer of LDG such base salary shall be reduced to $100,000 beginning January 1, 2000 or such later date as Executive ceases to act as Chief Executive Officer of LDG and shall remain at $100,000 during the remainder of the Basic Term. All base salary payments shall be payable in substantially equal monthly installments. For purposes of this Agreement, "Base Salary" shall mean the Executive's initial base salary and, when changed, the changed base salary. (b) BONUS PAYMENTS. Executive shall be eligible to receive, in addition to the Base Salary, an annual cash bonus payment in an amount, which may be zero, to be determined in the sole discretion of the Company's Compensation Committee. (c) STOCK OPTIONS. In addition to stock options previously granted to Executive, in partial consideration for Executive's non-competition agreements, set forth herein, Executive shall be provided with additional options to purchase HCC shares as follows: (1) 150,000 shares to be granted effective as of January 7, 1998, at an exercise price of $16.50 per share vesting in two equal installments of 75,000 shares on December 31, 1998 and December 31, 1999; (2) 50,000 shares on December 31 of each year during the Basic Term if, but only if, Executive is maintaining the position of Chief Executive Officer of LDG and if not maintaining such position on such date such option shall be reduced to 25,000 options if, but only if, Executive is acting as Chairman of LDG. Such options EMPLOYMENT AGREEMENT - Page 2 shall be priced at the average closing price of HCC shares for the month of December of the year of the grant. Any option so granted shall vest immediately. (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 Board for its senior executive officers) in performing services hereunder, provided that Executive properly accounts therefor in accordance with Company policy and such expenses are approved by the Chairman of the Board or President of HCC. (e) OTHER BENEFITS. Executive shall be entitled to participate in or receive benefits under any 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 subsection (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 fifty (50) paid vacation days per year for each of the calendar years ended December 31 of the Basic Term while Executive is a full-time Employee. There shall be no carryover of unused vacation from year to year. For purposes of this Section, weekends shall not count as vacation days, and Executive shall also be entitled to all paid holidays 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 HCC in accordance with any practice established by the Company's Compensation Committee. Notwithstanding, and in addition to, any perquisites to which Executive is entitled pursuant to the preceding sentence, Executive shall: (i) have use of a Mercedes 500 SEL automobile, and the Company shall pay all expenses related to Executive's use of such car, including gasoline, insurance, and maintenance; and (ii) be allowed to travel on business utilizing: (x) First Class Domestic and International passage plus (y) for so long as Executive remains as Chief Executive Officer or Chairman of the Board of LDG, up to $3,000,000 of corporate aircraft expense (not to exceed $650,000 in each of the calendar years ending December 31, 1998 and 1999 and $575,000 in each of the calendar years EMPLOYMENT AGREEMENT - Page 3 ending December 31, 2000 and 2001 and $550,000 in the calendar year ending December 31, 2002). To avoid confusion, Executive's use of the corporate aircraft shall terminate if Executive ceases to be both Chief Executive Officer and the Chairman of the Board of LDG but not if he ceases to hold only one of such positions while retaining the other. In addition, Executive's right to use corporate aircraft shall immediately terminate upon Executive's death or termination for Cause, whether during the Basic Term, the Early Consulting Period, or the Consulting Period. From and after the Effective Date, Executive shall be entitled to utilization of an office and employees (whose compensation will not exceed $75,000 per year). (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. 5. 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 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 constitutes 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 Board with his attorney if so desired by Executive, and following which the Board by action of not less than two-thirds (2/3rd) of its members furnishes to Executive a written resolution specifying in detail with 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: EMPLOYMENT AGREEMENT - Page 4 (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 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 inconsistent with, or a substantial and material alteration in the nature or status of, Executive's duties and responsibilities; EMPLOYMENT AGREEMENT - Page 5 (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) Executive's required relocation to any place other than his current office exceeding a distance of one hundred (100) miles from Wakefield, Massachusetts, 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 if such material breach has not been cured within thirty (30) days following written notice of such breach by Executive to the Company setting forth with reasonable specificity the nature of the breach; 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 ninety (90) 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 without Cause or if Executive terminates for Good Reason (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 Event (unless the remainder of the Basic Term is less than 12 months in which case, for an amount of time equal to the remainder of the Basic Term), Base Salary (as defined in Section 3(a), at the rate in effect immediately prior to the Termination Event, payable quarterly, in arrears. (2) Subject to any contrary provisions of any stock option grant or plan that might provide for acceleration of vesting of options at an earlier date than set forth herein, if there is a Change of Control or if there is a termination without Cause, any EMPLOYMENT AGREEMENT - Page 6 stock options which Executive has received under the HCC Stock Option Plans shall vest immediately; provided, however, that the right to receive options referenced in Section 3(c)(2) above shall terminate upon termination from employment for any reason, and further, if there is a termination for Good Reason, all unvested options shall be void. (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 (such other amounts and benefits shall be hereinafter referred to as the "Other Benefits"). Without limiting the preceding sentence, 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 in 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 Section 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 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 (b)(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 Section, 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 (b)(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 EMPLOYMENT AGREEMENT - Page 7 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 hereunder, and there shall be not offset in any compensation received from such other employment against the Base Salary set forth above; provided, however, that such compensation may terminate if acceptance of such employment would violate any of the provisions of Section 5, below If Executive's employment is terminated pursuant to this subsection (b) on or after October 1 of any year, any cash or stock bonus which Executive would otherwise have been awarded in such year shall be awarded as if termination had not taken place. (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 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 Section 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 options for which Executive would have been eligible had he completed the Basic Term (except as set forth in Section 4(b)(2), shall be accelerated, and Executive's estate or beneficiary shall be vested in such options as of the date of Executive's termination. (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 for the remainder of the Basic Term 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 options shall vest immediately upon the date of such Disability. (e) VOLUNTARY TERMINATION BY EXECUTIVE AND TERMINATION FOR CAUSE: BENEFITS. Executive may terminate his employment with the Company by giving written notice EMPLOYMENT AGREEMENT - Page 8 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. The Company may terminate Executive's employment with Cause at any time. Upon such a termination by Executive 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 later of the date of termination or the date of the Board's decision as set forth herein. Upon a voluntary termination by employee or termination for Cause, Executive shall be entitled to receive no further salary nor consulting payments as set forth herein. Upon such termination, all unvested options shall terminate and be of no further force or effect. (f) DIRECTOR POSITIONS. Executive agrees that upon termination of employment, for any reason, at the request of the Chairman of the Board, and if Executive owns less than 2,000,000 shares of HCC Common Stock or if Executive has been terminated for Cause, he will immediately tender his resignation from any and all Board positions held with the Company and/or any of its subsidiaries and affiliates, including without limitation, as Vice Chairman of the Company, Chairman of LDG, and a Director of Benefits. If Executive remains as a Director, after such termination, Executive shall be compensated as an outside director. While an outside Director, Executive shall be entitled to First Class Business Travel but shall no longer be entitled to use of corporate aircraft. (g) SEVERANCE PAYMENT. In addition to all other payments due hereunder in the event of Executive's termination other than for Cause, as both Chief Executive Officer and Chairman of the Board of LDG, Executive shall receive a severance payment in the amount of $1.3 million reduced by the corporate aircraft expense previously utilized by Executive since January 1, 1998 in excess of $300,000 in each calendar year beginning January 1, 1998. At the Company's sole election, such severance may be paid in cash or by permitting the Executive to incur additional corporate aircraft expense. 6. 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 Options 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: EMPLOYMENT AGREEMENT - Page 9 (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, 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 three (3) years (the "Non-Competition Period"; unless there shall be a Change of Control of HCC, in which case the Non-Competition Period shall be reduced to 18 months) after the termination of the Basic Term, 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 subsection (c) shall not operate to prevent Executive from engaging in retail insurance or re-insurance activities during such three-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 three (3) year period, Executive shall continue to be obligated under the Confidential Information Section 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 three (3) years after the termination of the Basic Term (unless there shall be a Change EMPLOYMENT AGREEMENT - Page 10 of Control of HCC in which case such period shall be reduced to 18 months), 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 three (3) 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 Section 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 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 EMPLOYMENT AGREEMENT - Page 11 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 the 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 Sections 5(a), (b), (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 the 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 Sections 5(b), (c), (d), or (e) or (f) 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 this 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 Section do not excuse Executive from complying with the agreements contained herein. (o) SURVIVABILITY. The agreements contained in Sections 5(c) through (g) shall survive the termination of this Agreement for any reason. 7. CONSULTING AGREEMENT. (a) Effective upon Executive's termination of employment for any reason other than Executive's termination prior to the end of the Basic Term EMPLOYMENT AGREEMENT - Page 12 by the Company for Cause, HCC hereby retains Executive as a consultant (an independent contractor and not as an employee) for a period of five (5) years (the "Consulting Period"). Termination of the Basic Term shall not effect the Parties' rights and obligations under this Section 6. Subject to the following, Executive agrees to provide, if requested, a minimum of 100 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 (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 three-year period provided for in Section 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 constitute hours of Consulting Services for purposes of this Section 6. The Parties contemplate that, when appropriate, the Consulting Services shall be performed at Executive's office, residence or at LDG's executive offices in Wakefield, Massachusetts, 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 but Executive shall not be entitled to utilize corporate aircraft during the Consulting Period. HCC shall pay Executive $100,000 per year (the "Yearly Consulting Fee") and a total of $500,000 (the "Total Consulting Fee") during the Consulting Period, payable monthly in arrears, provided, however, if Executive works in excess of 100 hours in any calendar year, such calendar year's Yearly Consulting Fee shall be increased by multiplying the number of hours in excess of 100 by $1,000 and such excess amount shall be reduced from the final Yearly Consulting Fee paid to Executive as set forth in this Section 6 and shall not increase the Total Consulting Fee. Executive may elect to delay payment for services but not the services themselves. Except as set forth below and in Sections 4(c) or 4(d) hereof, if Executive fails to provide the hours requested by the Company in any 12-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 Consulting Period neither he nor, 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. (b) If Executive has elected to begin the Early Consulting Period, during such Early Consulting Period Executive shall be required to provide Consulting Services in any amount of, at least, 500 hours per each calendar year. During such Early Consulting Period, EMPLOYMENT AGREEMENT - Page 13 Executive shall: (a) receive the Consulting Fee of $100,000 per year; (b) receive stock options in an amount equal to 25,000 shares per year (exercisable at a price as set forth in Section 3(c)(2) hereof); and (c) shall be entitled to the use of corporate aircraft in a manner determined in accordance with Section 3(g) hereof. During such Early Consulting Period, Executive shall receive no employment benefits from HCC. If Executive dies or becomes Disabled during the Early Consulting Period, for the remainder of such Early Consulting Period (but not for the Consulting Period) Executive (or, on his death, his beneficiary or estate) shall continue to receive as the case may be the Consulting Fee for the remainder of the Early Consulting Period. 8. ASSIGNMENT. This Agreement may be assigned by Company, but cannot be assigned by Executive. 9. BINDING AGREEMENT. Executive understands that his obligations under this Agreement are binding upon Executive's heirs, successors, personal representatives, and legal representatives. If to Executive: Stephen J. Lockwood 29 Bradlee Road Marblehead, MA 01945 Fax: _______________ If to Company: HCC Insurance Holdings, Inc. 13403 Northwest Freeway Houston, TX 77040 Att.: Chairman of the Board Fax: (713) 462-2401 with a copy (which shall Arthur S. Berner, Esq. not constitute notice) to: Winstead Sechrest & Minick P.C. Suite 2400 910 Travis Street Houston, TX 77002-5895 Fax: (713) 650-2400 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. 12. ARBITRATION. In the event any dispute arises out of Executive's employment with the Company, or separation therefrom, which cannot be resolved by the Parties, such dispute EMPLOYMENT AGREEMENT - Page 14 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 the Company. 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 the 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 his 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. IN WITNESS WHEREOF, the parties have executed this Agreement as of the date first written above. EXECUTIVE COMPANY HCC INSURANCE HOLDINGS, INC. EMPLOYMENT AGREEMENT - Page 15 /s/ Stephen J. Lockwood By: /s/ Stephen L. Way - -------------------------------- ------------------------------ STEPHEN J. LOCKWOOD STEPHEN L. WAY Chief Executive Officer and Chairman of the Board Dated: 3/3/99 Dated: 3/3/99 -------------------------- --------------------------- EMPLOYMENT AGREEMENT - Page 16 EX-10.350 5 EXHIBIT 10.350 EMPLOYMENT AGREEMENT This Employment Agreement ("Agreement") is entered into effective as of the 1st day of January, 1998 (the "Effective Date"), between HCC INSURANCE HOLDINGS, INC. ("HCC" or "Company"), and FRANK J. BRAMANTI ("Executive"), sometimes collectively referred to herein as the "Parties." R E C I T A L S: 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 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; and WHEREAS, Executive is desirous of committing himself to serve HCC on the terms herein provided. NOW, THEREFORE, in consideration of the foregoing and of the respective covenants and agreements set forth below, the Parties agree as follows: 1. TERM. 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 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 EMPLOYMENT AGREEMENT - Page 1 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 $325,000, during the period beginning on the Effective Date hereof and ending December 31, 2002, payable not less frequently than in substantially equal monthly installments. In such event, Executive will be entitled to paid vacation as set forth in Subparagraph 3(f)(i). At any time on or after January 1, 2000, Executive may, at his option, remain as a full-time employee with increased vacation, in which case his Base Salary shall be reduced to $275,000 annually (the "Reduced Salary). In such event, Executive will be entitled to paid vacation as set forth in Subparagraph 3(f)(ii) and shall be entitled to continued benefits from the Company. Alternatively, at Executive's sole discretion and election, on or before January 1, 2000, Executive may voluntarily terminate his employment with the Company and elect to become a consultant to the Company for the remainder of the Basic Term (the "Consulting Period") at an annual consulting fee of $150,000. In such event, Executive shall be required to perform 300 hours of service per annum on behalf of the Company as directed by the President or Chairman of the Board (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). Executive's travel time shall constitute hours 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. EMPLOYMENT AGREEMENT - Page 2 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. (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) STOCK OPTIONS. In addition to stock options previously granted to Executive, in partial consideration for Executive's non-competition agreements, set forth herein, Executive shall be provided with additional options to purchase HCC shares as follows: (1) 100,000 shares to be granted effective as of January 7, 1998, at an exercise price of $16.50 per share vesting in two equal installments of 50,000 each on December 31, 1998 and December 31, 1999; and (2) 25,000 shares on December 31, of each year this Agreement is in effect and Executive is a full time employee on such date. Such options shall be priced at the average closing price of HCC shares for the month of December of the year of the grant. Any options so granted shall vest immediately. Executive shall receive no options if he is acting as a consultant. (d) 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. (e) 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. EMPLOYMENT AGREEMENT - Page 3 (f) VACATIONS. (i) Executive shall be entitled to thirty (30) paid vacation days per year during the Basic Term, provided however, (ii) if Executive should elect to remain a full-time employee and not a consultant after January 1, 2000 at the Reduced Salary, Executive shall be entitled to sixty (60) paid vacation days per year from such date. 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 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 1998 Mercedes 500 SEL automobile, and the Company shall pay all expenses related to Executive's use of such car, including gasoline, insurance, and maintenance; (ii) be allowed to travel on business utilizing first class passage (whether domestic or international); (iii) be reimbursed for annual club dues for Lakeside Country Club; and (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). (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(b)(4), 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; (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 EMPLOYMENT AGREEMENT - Page 4 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 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 EMPLOYMENT AGREEMENT - Page 5 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 ninety (90) 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 (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, EMPLOYMENT AGREEMENT - Page 6 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 termination by the Company without Cause or by Executive for Good Reason any stock options and other stock-related grants ("Stock Awards") which Executive has received under any of the HCC stock plans shall vest immediately; provided, however, that the options provided for in Paragraph 3(c)(2) shall be granted as of the Termination Date and shall be priced at the closing price of HCC shares as of such date. If there is a termination for Good Reason or by the Company other than for Cause, all options shall be exercisable for one year 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, 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 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 EMPLOYMENT AGREEMENT - Page 7 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 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 for which Executive would have been eligible had he completed the Basic Term (except as set forth in Paragraph 4(b)(2)), shall be accelerated, and Executive's estate or beneficiary shall be vested in such Stock Awards as of the date of Executive's termination. (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 EMPLOYMENT AGREEMENT - Page 8 any subsequent cash or stock bonuses. In addition, all outstanding Stock Awards shall vest immediately upon such termination due to Disability. (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. (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 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 Options 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 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. EMPLOYMENT AGREEMENT - Page 9 (b) CONFLICTS OF INTEREST. Executive agrees that during the Basic Term, 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 Basic Term 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 (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, EMPLOYMENT AGREEMENT - Page 10 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 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, EMPLOYMENT AGREEMENT - Page 11 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. (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: EMPLOYMENT AGREEMENT - Page 12 If to Executive: Frank J. Bramanti 13707 Cottrell Court Houston, TX 77077 Fax: (281) 558-5461 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: Winstead Sechrest & Minick P.C. Suite 2400 910 Travis Street Houston, Texas 77002-5895 Fax: (713) 650-2400 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 EMPLOYMENT AGREEMENT - Page 13 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. 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. 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: 1/23/98 Dated: 1/23/98 ------------------------- --------------------------------- EMPLOYMENT AGREEMENT - Page 14 EX-10.351 6 EXHIBIT 10.351 EMPLOYMENT AGREEMENT This Employment Agreement ("Agreement") is entered into effective as of the 1st day of January, 1998 (the "Effective Date"), between HCC INSURANCE HOLDINGS, INC. ("HCC" or "Company"), and PETER B. SMITH, JR. ("Executive"), sometimes collectively referred to herein as the "Parties." R E C I T A L S: 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 Committee; WHEREAS, it is the desire of 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; and WHEREAS, Executive is desirous of committing himself to serve HCC on the terms herein provided. NOW, THEREFORE, in consideration of the foregoing and of the respective covenants and agreements set forth below, the Parties agree as follows: 1. TERM. 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, President, and 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 consent of the Chairman of the Board. However, Executive shall have the right EMPLOYMENT AGREEMENT - Page 1 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. 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, member of the Executive Committee and member of the 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. Executive will serve as President and Chief Executive Officer of Houston Casualty Company, U.S. Specialty Insurance Company and Trafalgar Insurance Company and as Chairman of Avemco Insurance Company. 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 paid by the Company at the annual rate of $325,000, during the period beginning on the Effective Date payable not less frequently than in substantially equal monthly installments. Such Base Salary shall increase $25,000 each January 1, commencing January 1, 1999 until Executive's base salary reaches $425,000. 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 based on HCC's annual operating earnings per share ("OEPS"), as set forth below: $37,500 bonus if OEPS growth is 10% or more in any one year period; $75,000 bonus if OEPS growth is 15% or more in any one year period; and $150,000 bonus if OEPS growth is 20% or more in any one year period. For purposes of this Agreement, OEPS is defined as HCC's consolidated net earnings less capital EMPLOYMENT AGREEMENT - Page 2 gains/losses, currency gains/losses, and any nonrecurring merger and acquisition income or expenses as reported in HCC's Annual Report on Form 10-K. (c) STOCK OPTIONS. In addition to stock options previously granted to Executive, in partial consideration for Executive's non-competition agreements, set forth herein, effective December 31, 1998, Executive shall be provided with additional options to purchase HCC shares as follows: (1) On January 7, 1998, an option to acquire 100,000 shares, exercisable at a price of $16.50 per share and vesting at 20% per year beginning on December 31, 1998 and for each of the four years thereafter; (2) For each year beginning with the year ending December 31, 1999, of Executive's employment hereunder; 10,000 shares if, on such December 31, the price of the HCC Common Stock has increased since the previous January 1, by an amount that is greater than or equal to 10%, but less than 15%; 15,000 shares if, on such December 31, the price of the HCC Common Stock has increased since the previous January 1, by an amount that is greater than or equal to 15%, but less than 20%; 20,000 shares if, on such December 31, the price of the HCC Common Stock has increased since the previous January 1, by an amount that is greater than or equal to 20%, but less than 25%; and 25,000 shares if, on such December 31, the price of the HCC Common Stock has increased since the previous January 1, by an amount that is greater than or equal to 25%. Each of such options set forth in this subparagraph (ii) shall be priced at the average of the closing prices of HCC shares for the month of December of the year of the grant and shall vest immediately. For purposes of this Subparagraph, the granting of any option shall not be pro-rated if the criteria set forth herein are not achieved in full. (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 EMPLOYMENT AGREEMENT - Page 3 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, 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. (f) VACATIONS. Executive shall be entitled to twenty five (25) 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 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: (i) have use of a 1998 Mercedes SEL automobile, and the Company shall pay all expenses related to Executive's use of such car, including gasoline, insurance, and maintenance; (ii) be allowed to travel on business utilizing first class passage (whether domestic or international); (iii) receive annual club dues for the Houston City Club, the Country Club of Fairfield, and Lochinvar Golf Club; and (iv) receive a total of $1,000,000 term life insurance (which shall be an addition to the standard benefits provided to Executive under the Company's group life insurance program 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. 5. TERMINATION. (a) DEFINITIONS. EMPLOYMENT AGREEMENT - Page 4 (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 material 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 EMPLOYMENT AGREEMENT - Page 5 (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 (v) Any failure by the Company to obtain the assumption and EMPLOYMENT AGREEMENT - Page 6 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 ninety (90) 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 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 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 if there is a termination by the Company without Cause or by Executive for Good Reason, any stock options and other stock-related grants ("Stock Awards") which Executive has received under any of the HCC stock plans shall vest immediately; provided, however, that the right to receive options referenced in Paragraph 3(c)(2) above shall terminate upon termination from employment for any reason, and further, if there is a termination for Good Reason, or by the Company other than for Cause, all options shall be exercisable for one year 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, 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 or benefits are taxable to Executive EMPLOYMENT AGREEMENT - Page 7 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 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 not 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 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 EMPLOYMENT AGREEMENT - Page 8 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 accelerated, and Executive's estate or beneficiary shall be vested in such Stock Awards as of the date of Executive's termination. (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. (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 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. (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. 6. 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 Options 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 EMPLOYMENT AGREEMENTS - Page 9 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, 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 Basic Term, 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 (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 EMPLOYMENT AGREEMENT - Page 10 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 EMPLOYMENT AGREEMENT - Page 11 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 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. EMPLOYMENT AGREEMENT - Page 12 (o) SURVIVABILITY. The agreements contained in Paragraph 5(c)-(g) shall survive the termination of this Agreement for any reason. 7. ASSIGNMENT. 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. 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 (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: Peter B. Smith, Jr. 2150 Brentwood Houston, Texas 77019 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: Winstead Sechrest & Minick P.C. Suite 2400 910 Travis Street Houston, Texas 77002-5895 Fax: (713) 650-2400 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. EMPLOYMENT AGREEMENT - Page 13 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. 12. ARBITRATION. In the event any dispute arises out of Executive's employment with the Company, or separation therefrom, 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 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 EMPLOYMENT AGREEMENT - Page 14 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. 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/ Peter B. Smith, Jr. By: /s/ Stephen L. Way - -------------------------------- ---------------------------------- PETER B. SMITH, JR. STEPHEN L. WAY Chief Executive Officer and Chairman of the Board Dated: 1/23/98 Dated: 1/23/98 -------------------------- ------------------------------- EMPLOYMENT AGREEMENT - Page 15 EX-12 7 EXHIBIT 12 EXHIBIT 12 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES STATEMENT OF RATIOS
======================================================================================================================= FOR THE YEARS ENDED DECEMBER 31, (DOLLARS IN THOUSANDS) 1998 1997 1996 1995 1994 - ----------------------------------------------------------------------------------------------------------------------- Gross premium to surplus ratio: Gross written premium $ 500,962 $ 346,094 $ 340,367 $ 338,753 $ 283,530 Policyholders' surplus 369,401 331,922 288,863 251,125 206,596 Premium to surplus ratio (1) 135.6% 104.3% 117.8% 134.9% 137.2% (Gross premium to surplus ratio = gross written premium divided by policyholders' surplus) Net premium to surplus ratio: Net written premium $ 123,315 $ 143,068 $ 189,022 $ 184,028 $ 133,143 Policyholders' surplus 369,401 331,922 288,863 251,125 206,596 Premium to surplus ratio (1) 33.4% 43.1% 65.4% 73.3% 64.4% (Net premium to surplus ratio = net written premium divided by policyholders' surplus) Loss ratio: Incurred loss and LAE $ 95,435 $ 100,158 $ 115,521 $ 106,346 $ 76,494 Net earned premium 142,108 162,626 179,490 160,145 122,393 Loss ratio (1) 67.2% 61.6% 64.4% 66.4% 62.5% (Loss ratio = incurred loss and LAE divided by net earned premium) Expense ratio: Underwriting expense $ 19,417 $ 24,627 $ 36,379 $ 33,239 $ 27,137 Net written premium 123,315 143,068 189,022 184,028 133,143 Expense ratio (1) 15.7% 17.2% 19.2% 18.1% 20.4% (Expense ratio = underwriting expense divided by net written premium) Combined ratio (1) 82.9% 78.8% 83.6% 84.5% 82.9% (Combined ratio = loss ratio plus expense ratio)
(1) Calculated for the Company's insurance company subsidiaries on the basis of statutory accounting principles. EX-21 8 EXHIBIT 21 EXHIBIT 21 HCC INSURANCE HOLDINGS, INC. SUBSIDIARIES
STATE OR COUNTRY NAME OF INCORPORATION ---- ---------------- 1. 7200 Copperfield Company, LLC Alabama 2. Airway Underwriters of Michigan Michigan 3. Avemco Corporation Delaware 4. Avemco Financial Services Inc. Maryland 5. Avemco Insurance Company Maryland 6. Aviation & Marine Premium Acceptance Corporation Texas 7. Continental Aviation Underwriters, Inc. Tennessee 8. Eagle Aerobatic Flight Team, Inc. Wisconsin 9. Eastern Aviation & Marine Underwriters, Inc. Maryland 10. Guarantee Insurance Resources, Inc. Georgia 11. HCC Aviation Insurance Group Texas 12. HCC Benefits Corporation Delaware 13. HCC Employee Benefits, Inc. Delaware 14. HCC Employer Services of Oklahoma, Inc. Oklahoma 15. HCC Employer Services, Inc. Alabama 16. HCC Intermediaries, Inc. Texas 17. HCC Intermediate Holdings, Inc. Delaware 18. HCC Reinsurance Company Limited Bermuda 19. HCC Service Corporation Delaware 20. HCC U.K. Acquisition Limited U.K. 21. HCC Underwriters, a Texas Corporation Texas 22. Hinchcliff International Group Services, Inc. Maryland 23. Houston Casualty Company Texas 24. Insurance Alternatives, Inc. Georgia 25. International Aviation Underwriters, Inc. Texas 26. KIMCO, LLC Alabama 27. LDG Insurance Agency Incorporated Massachusetts 28. LDG Management Company Incorporated Massachusetts 29. LDG Reinsurance Corporation Delaware 30. Loss Management Services, Inc. Maryland 31. Managed Group Underwriting, Inc. Kansas 32. Matterhorn Bank Programs, Inc. Maryland 33. MEDEKS International Saglik Ve Sigorta Destek Idari Hizmetleri A.S. (Turkey) Turkey 34. Medical Reinsurance Underwriters Incorporated Massachusetts 35. Middle East Insurance Brokers, Limited (Jordan) Jordan 36. Midwest Stop Loss Underwriters, Incorporated Minnesota 37. NASRA TPA, Inc. Illinois 38. NEWECC, Inc. Nevada 39. North American Special Risk Associates, Inc. Illinois 40. PEPYS Holdings Limited (U.K.) U.K. 41. PEPYS Management Services Limited (U.K.) U.K. 42. Professional Audit Service, Inc. Alabama 43. Rattner Mackenzie Limited (U.K.) U.K. 44. SBS Insurance Holdings, a Texas Corporation Texas 45. Signal Aviation Insurance Services, Inc. Nevada 46. Southern Aviation Insurance Underwriters, Inc. Alabama 47. Specialty Insurance Underwriters, Inc. Missouri 48. SRRF Management Incorporated Massachusetts 49. The Wheatley Group, Ltd. New York 50. Trafalgar Insurance Company Oklahoma 51. U.S. Specialty Insurance Company Texas 52. Universal Loss Management, Inc. Delaware
EX-23 9 EXHIBIT 23 EXHIBIT 23 CONSENT OF INDEPENDENT ACCOUNTANTS We consent to the incorporation by reference in the registration statements of HCC Insurance Holdings, Inc. on Forms S-8 (File Nos. 333-14479, 333-14471, 333-61673, 333-61687, and 333-68771) of our reports dated March 26, 1999, on our audits of the consolidated financial statements and financial statement schedules of HCC Insurance Holdings, Inc. as of December 31, 1998 and 1997, and for the three year period ended December 31, 1998, which reports are included in this Annual Report on Form 10-K. Our reports state that they are based on the reports of KPMG LLP, independent certified public accountants with respect to their audit of the 1996 consolidated financial statements of Avemco Corporation. PRICEWATERHOUSECOOPERS LLP Houston, Texas March 26, 1999 EX-24 10 EXHIBIT 24 EXHIBIT 24 POWERS OF ATTORNEY 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/ ARTHUR S. BERNER -------------------- Arthur S. Berner Date: March 22, 1999 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 M. BERRY -------------------- James M. Berry Date: March 22, 1999 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 22, 1999 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 22, 1999 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 22, 1999 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 22, 1999 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 22, 1999 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 22, 1999 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 22, 1999 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/ PETER B. SMITH, JR. ----------------------- Peter B. Smith, Jr. Date: March 22, 1999 EX-27 11 EXHIBIT 27
7 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION FROM THE CONSOLIDATED FINANCIAL STATEMENTS FOUND IN THE COMPANY'S FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1998, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. YEAR DEC-31-1998 JAN-01-1998 DEC-31-1998 393,238,000 0 0 2,252,000 0 0 525,646,000 16,018,000 372,672,000 (3,615,000) 1,709,069,000 460,511,000 201,050,000 0 0 121,600,000 0 0 48,252,000 391,611,000 1,709,069,000 143,100,000 29,335,000 845,000 134,754,000 91,302,000 10,978,000 92,247,000 107,486,000 35,208,000 72,278,000 0 0 0 72,278,000 1.51 1.48 119,634,000 105,895,000 (14,593,000) 47,126,000 48,775,000 118,912,000 (14,593,000)
EX-27.1 12 EXHIBIT 27.1
7 THIS SCHEDULE HAS BEEN RESTATED DUE TO THE COMPANY'S MERGER WITH KACHLER, WHICH WAS COUNTED FOR AS A POOLING-OF-INTERESTS. SEE NOTES 1 AND 2 TO THE CONSOLIDATED FINANCIAL STATEMENTS FOUND IN THE COMPANY'S FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1998. THIS SCHEDULE IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. YEAR YEAR DEC-31-1997 DEC-31-1996 JAN-01-1997 JAN-01-1996 DEC-31-1997 DEC-31-1996 409,701,000 377,555,000 0 0 0 0 3,816,000 12,477,000 0 0 0 0 518,772,000 468,725,000 7,728,000 9,575,000 176,965,000 132,328,000 2,051,000 7,908,000 1,198,132,000 965,793,000 275,008,000 229,049,000 152,094,000 156,268,000 0 0 0 0 80,750,000 72,917,000 0 0 0 0 47,759,000 49,017,000 317,842,000 247,509,000 1,198,132,000 965,793,000 162,571,000 170,068,000 27,587,000 23,593,000 (328,000) 8,341,000 90,487,000 68,784,000 96,514,000 114,464,000 13,580,000 8,218,000 91,155,000 94,644,000 73,064,000 48,467,000 23,305,000 9,885,000 49,759,000 38,582,000 0 0 0 0 0 0 49,759,000 38,582,000 1.06 0.86 1.03 0.84 117,283,000 99,259,000 100,288,000 119,401,000 (3,774,000) (4,937,000) 48,208,000 54,493,000 47,874,000 41,947,000 119,634,000 117,283,000 (3,774,000) (4,937,000)
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