HCC Notes 2003 Results and 2004 Earnings Guidance

Houston-based HCC Insurance Holdings Inc. reported results for the fourth quarter and for the full year that ended Dec. 31, 2003.

Net earnings for the fourth quarter 2003 increased significantly to $50.5 million, or $0.77 per share, compared to $31.5 million, or $0.50 per share, for the same period in 2002.

Net earnings for the full year 2003 increased substantially to $143.6 million, or $2.23 per share, compared to $105.8 million, or $1.68 per share, for the full year 2002.

Stephen Way, chairman and CEO, said, “2003 was the best year in our history and we are very pleased with our results.” He added, “We are not resting on our laurels and look forward to our future challenges and successes.”

The company has provided 2004 net earnings guidance with a range between $2.65 and $2.75 per share. The company expects total revenue to increase approximately 25 percent in 2004, including growth of net earned premium by 30 percent, fee and commission income by 15 percent and investment income by 10 percent. The GAAP combined ratio is expected to remain fairly constant around 85 percent to 88 percent on significantly increased net earned premium.

There were several non-recurring items recorded in the fourth quarter 2003 and a summary of these important items follows:

HCC completed the sale of all of the assets of its retail broking subsidiary HCC Employee Benefits Inc., following an unsolicited approach from Houston based Capital Risk LLC, a subsidiary of Jardine Lloyd Thompson Group, PLC. The initial after tax gain related to this sale, which was recorded in the fourth quarter 2003, was $30.1 million, or $0.47 per share. This transaction is subject to an earnout formula and could result in a further gain, which would be recorded in 2004. Management believes that the disposition of this non-core business was opportunistic and the resulting cashflow was immediately utilized in the company’s recent acquisition of American Contractors Indemnity Company.

The company reached an agreement with various reinsurers to commute certain reinsurance recoverables relating to the company’s discontinued A&H line of business. This transaction results in the company receiving a cash payment from the reinsurers in consideration for discounting the recoverables and reassuming any losses. The after tax discount recorded was $18.7 million, or $0.29 per share. It is expected that future investment income will overcome the discount given on this transaction.

Management has been proactive about commuting some of its reinsurance recoverables and will continue to do this where it is in the best interest of the company. Management has a positive view of commutations such as this because they result in removing older recoverables from the company’s balance sheet, increased future investment income and a reduction in the overall amount of recoverables.

The company and its independent auditors have determined that the company needs to adjust the basis upon which the fee and commission income of its agency and intermediary subsidiaries are accounted.

Accordingly, the company has restated its financial statements for the first three quarters of 2003 and the company will amend previously filed quarterly reports on Form 10-Q for those quarters. The cumulative effect of the change, $3.9 million, which is recorded in the first quarter of 2003, is not material to prior years but the effect of the change in basis of accounting became material in 2003 as a result of recent acquisitions. It is strictly a timing difference. The maximum timing difference is 12 months and the average timing difference is approximately six months on the portion of the affected revenue and the related components. The change does not impact the overall amount of fee and commissions ultimately earned or previously collected in cash by the company. The change does not affect the net earnings of the company’s reporting segments but, rather, results solely from adjustments to the consolidating entries made in the preparation of the company’s consolidated financial statements. Likewise, the change does not affect cash flow from operations.

The effect of this change on earnings for fiscal year 2003 is $13.0 million, or $0.20 per share. The effect of this change has been reflected in management’s guidance for 2004.

Way commented, “There is no effect on the future growth prospects of the company from this accounting change.”

Total revenue for the full year 2003 increased by 41 percent to a record $929.1 million compared to 2002, driven by significant increases in net earned premium, fee and commission income and investment income. The company anticipates continued revenue growth in 2004.

Comparing the full year 2003 to the previous year, the company’s insurance company subsidiaries’ net written premium increased 59 percent to $865.5 million and net earned premium increased 46 percent to $738.3 million.

During the same period, gross written premium reached a record $1.74 billion, growing 50 percent from the previous year. Premium growth is due to increased rates, a reduction in ceded reinsurance, organic growth and greater renewal retentions. The company expects premium to continue to grow through at least 2004.

The GAAP combined ratio was higher in 2003 at 91 percent compared to 86 percent in the previous year. This increase was primarily the impact of the reinsurance commutation recorded in the fourth quarter, which added 4 percent to the full year loss ratio. Management is confident of maintaining its combined ratio at or below this level going forward on rising earned premium revenue.

For the full year of 2003 compared to the same period in 2002, fee and commission income increased 22 percent to $129.8 million, primarily due to organic growth of existing lines of business and acquisitions made in late 2002. During the same period, other operating income increased to $13.2 million from $7.0 million, due in part to the timing of acquisitions and dispositions of strategic investments.

In 2003, cashflow from operations was significantly higher rising more than 200 percent to $528.1 million compared to the previous year. During the same period, net investment income grew 25 percent to $47.3 million, primarily due to substantially increased investment assets resulting from increased loss reserves due to higher retentions, as well as significant cash flow from operations and despite low yields from our continuing short duration and conservative investment philosophy.

As of Dec. 31, 2003, total assets increased 32 percent to $4.9 billion; total investments increased 46 percent to $1.7 billion; shareholders’ equity increased 19 percent to $1.0 billion; and book value per share increased 16 percent to $16.37, all compared to Dec. 31, 2002 and all at record levels.