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Despite hurricanes Katrina, Rita and
Wilma and a reinsurance commutation, we were still able to record the
best results in our history, helping propel our shareholders’ equity to
a record $1.7 billion. We had an exceptional year in 2005 and remain
very optimistic about the future and our ability to continue to return
above average results for our shareholders.
Net earnings increased 20% to $195.9 million, or $1.79 per diluted share
in 2005 compared to $163.0 million, or $1.65 per diluted share in 2004,
even with after tax losses of $58.2 million, or $0.53 per diluted share
for hurricane activity and $16.9 million, or $0.15 per diluted share due
to the reinsurance commutation. Clearly, our ability to achieve record
earnings despite these losses is due to the profitability of our
non-catastrophe businesses and strong investment income.
Total revenue grew 28% to a record $1.6 billion in 2005 compared to the
previous year, primarily driven by a 36% increase in earned premium to
$1.4 billion and a 52% increase in investment income to $98.9 million.
Cash flow from operations remained very strong in 2005 at $624.0
million.
Our insurance companies had a very good year despite the hurricanes,
with margins remaining at very acceptable levels on all but catastrophe
business. Diversified financial products, which includes directors’ &
officers’ liability, professional indemnity, credit and surety
businesses, continued to grow profitably and now represents more than
45% of our net written premium. Group life, accident & health business
represents 34% of our net written premium and though somewhat more
competitive now, it still produces very acceptable margins. Although
smaller in premium size, aviation and our other specialty lines
contributed strongly to our earnings. Our markets are generally very
stable, but international directors’ & officers’ liability and
professional indemnity are becoming increasingly more competitive
although margins remain acceptable. Property and energy rates are rising
significantly following the losses in 2005 and there are opportunities
to be considered in both lines.
As our capital has grown and our business continues to be profitable, we
have substantially increased our retention of premium in all
non-catastrophe lines of business. This has proven to be a very good
strategy as profit margins have been excellent and the increased premium
has sustained strong cash flow and driven investment assets to record
levels. In 2005, our net written premium increased by 36% to $1.5
billion and while we do not expect the same rate of growth in 2006, we
are continually changing the mix of business that we write so we can
emphasize the most profitable aspects of each line. Going forward, we
have intentionally reduced our exposure to Gulf of Mexico and Florida
property business in an effort to stabilize our exposure to windstorms,
but large losses bring new opportunities and we remain prepared to
capitalize on them when they arise.
Our fee and commission revenue is produced by our underwriting agencies
and intermediaries. We have seen a reduction in this revenue in 2005 as
a result of our planned increased retentions which decreased ceding
commission to our insurance companies and commission earned by our
reinsurance intermediaries. However, the non-affiliated business
produced by our intermediaries has grown and is expected to provide a
positive trend in the revenue of this segment by the end of 2006.
Reinsurance recoverables should have peaked in 2005 as our business
remained profitable to our reinsurers and the amount of reinsurance we
purchased was reduced. Unfortunately, hurricanes Katrina, Rita and Wilma
changed all that and our recoverables increased more than $250 million
to new high levels. This increase was partially offset by the
opportunistic commutation of $145 million of older recoverables. A
commutation is where we take back the outstanding and incurred but not
reported loss reserves from a reinsurer together with a negotiated
amount of cash, discounted to represent approximate present day cash
value. The charge for the discount is offset by future investment income
on the cash received and any savings if the losses are eventually
settled for less than the reserved amounts. We have been particularly
successful in these commutations over the years and intend to be
proactive about additional transactions as they become available. The
quality of our reinsurance recoverables continues to improve and we
expect the total amount to reduce in 2006 barring any further
catastrophe losses.
Net investment income continues to outperform, rising 52% in 2005 to
$98.9 million compared to the previous year. This gain is driven by
increased investment assets as a result of strong cash flow, our equity
offerings in 2004 and 2005, the reinsurance commutation and increasing
net loss reserves due to longer settlement periods on our liability
business. Although we are prepared to invest part of our funds in higher
yielding instruments if the risk reward ratio warrants it, our
investments remain very conservative with most of our assets invested in
fixed income bonds, both taxable and exempt, with an average S&P rating
of AAA. Maturities are still relatively short and could be lengthened
for additional yield. Investment assets have grown from $885.7 million
in 2001 to $3.3 billion in 2005 and are expected to continue to
increase. We expect investment income to rise through at least 2006 for
all of these reasons.
Acquisitions continue to be part of our philosophy, helping increase
premiums, expand distribution, enter new lines and diversify operations.
During 2005 we closed our acquisitions of: De Montfort Group, based in
England, consisting of an insurance company and a service agency
specializing in credit and surety in the UK; United States Surety
Company, an insurance company based in Timonium, Maryland; Perico Ltd.,
Insurance Corporation, a non-operating shell which we capitalized and
renamed Perico Life Insurance Company; and Illium Insurance Group, a
Lloyd’s underwriting agency specializing in UK liabilities. These
businesses are all now successfully integrated into HCC and contributing
to the growth in earnings.
We are pleased to have entrepreneurial founders and other key
individuals that joined us through these acquisitions: James R.
Davidson, Martyn D. Ward and Nicholas J. Walklett with De Montfort;
Richard E. Klein and Carol T. Nevin at United States Surety; Carl C.
Petty, Jr. and Erwin F. Rittinger with Perico; and Russell J. Benzies
and A. Denis Burniston at Illium, each being a specialist in their
field.
We also start businesses and enter new lines by first hiring seasoned
veterans and then providing them with the resources to build their
business. In 2005, we did just that in the commercial credit line by
hiring Mark P. Reynolds from Exporters Insurance Company to head up HCC
Credit Group, which is now writing short and intermediate term credit
risks in the U.S. and internationally. Brian E. Duffy, Carl R. Nederman
and Mark P. Rickert joined us subsequently, having previously operated
independently in their own agency.
Strategic investments have been part of our business plan for some time
and have lead to acquisitions, or profitable dispositions of our
ownership. Our investments include: Argonaut Group (NASDAQ: AGII), where
we own approximately 2.5 million shares in a mandatorily convertible
preferred stock that continues to do very well; Indemco, a privately
owned, Houston-based underwriting agency writing surety for the energy
industry; and two more recent investments in the Tower Group (NASDAQ:
TWGP), a specialty property and casualty insurance company where we own
almost 10% of the outstanding shares; and Heritage Underwriting Agency,
a Lloyd’s underwriting agency specializing in worldwide property
insurance. We expect to continue to expand this unique investment
portfolio.
As we grow in size and complexity, it is important to ensure that we
have a strong, experienced and focused management team. Mindful of this
and the ever important need for succession, we continue to look for
candidates to lead the Company into the future. Such individuals will
preferably come from existing employees, or through our acquisition of
well-managed companies. Existing corporate Executive Vice Presidents
Edward H. Ellis, Jr. – CFO; Michael J. Schell – property & casualty;
Craig J. Kelbel – life, accident & health; Robert F. Thomas – credit &
surety; and Christopher L. Martin – General Counsel were joined by Barry
J. Cook, who was promoted to Chief Executive Officer of all
international operations; Farid F. Nagji to Executive Vice President of
the newly created position of Administration and Corporate Services; and
John N. Molbeck, Jr., who has been named to the position of President
and Chief Operating Officer of the Group. This is John’s second time
with us at this position and we are very pleased to have him back. Not
only will he contribute immediately by overseeing all operations, but he
will help for the longer term by assisting me in finding his successor
during the next three years.
I would like to remember two of our lost friends in aviation: Richard
(Dick) R. Gorsuch who worked for us in the 70’s and 80’s and was a great
aviation insurance man and a really good guy; and Audrey A. Dent who
worked for me on and off for 30 years. She was a very sincere woman and
a great team player at our USSIC Aviation office in Dallas. They will be
long remembered by those who knew them.
2005 was a memorable year for large losses and record results, uncommon
bedfellows, but we can do better and we will. Our goal is to continue to
grow our Company and shareholders’ equity while protecting that which we
have already achieved. Thanks to all of our management and employees
worldwide for their contribution to our success and particularly to the
special contributions made by Cory L. Moulton at PIA, R. Matthew
Fairfield at HCC Global International, Andrew G. Stone at HCC Global in
the U.S., Michael J. Donovan Senior Vice President of Aviation and
Pamela J. Penny Senior Vice President of Finance and all of her tireless
staff.
We are enthusiastically looking forward to 2006 and beyond. |
