HCC Attacks Specialty Lines From All Angles

Way builds growing empire withunderwriters, agency ownerships, strategicinvestments

Such a choice may have struck his buddies as unusual to say theleast. But if it did, he will certainly have the last laugh now asnearly four decades later his HCC Insurance Holdings Inc. looksforward to a record year with over $2 billion in premium in thesometimes cutthroat world of specialty insurance.

The Houston-based company includes a diverse group ofaffiliatesspecialty insurers, managing general underwritingagencies and a reinsurance intermediary. But there is a method tohis madness.

"We write only specialty business and stay very focused," said Mr.Way, chairman and chief executive officer of HCC Insurance Holdingsin Houston, Texas. "Most of our subsidiaries operate independently.There is no major effort to cross sell."

Mr. Way also sees the companys own risk management policy as one ofthe keys to success. "A lot of insurance companies are taking riskoff of Corporate Americas balance sheet and putting it on theirs.They dont stop to look at their own risk management to protecttheir own capital," Mr. Way said.

HCCs policy of reinsuring all catastrophe risk remains key to thecompanys risk management program.

"We also protect ourselves against volatility in any one particularline of business," Mr. Way said. "So we are smoothing out potentialbumps in specialty insurance to make it a more predictableoutcome."

When prices soften dramatically, the company will often reinsuremore risk than it would normally. "But that is not a market we arelooking for," Mr. Way said. "That is a market that comes along andwe are forced to deal with it as our competitors do."

For the most part HCCs impressive numbers over the past decade havewon analysts' praise. But Standard & Poors Polina Chernyak saidthe companys significant use of reinsurance posed a recoverablerisk.

At a recent S&P seminar, Mr. Way commented on the industrywiderecoverability problem. "Everyone pays claims today, but when youget to the bottom of the cycle, they [reinsurers] often dont paywillingly," he said.

Company spokesperson Byron Way (Stephens son) said the firmsdecreasing reliance on reinsurance as it retains more of its ownrisk will in turn ameliorate any recoverable issues.

Success in specialty lines requires the kind of underwritingdiscipline that is often extolled from top insurance executives,but sometimes honored mainly in the breach. The successful carriershave a keen sense for making sure rates and risk are in line innumerous kinds of businesses, industry analysts note.

"It is not so much going in and out of lines, because we willgenerally stay in a line of business," Mr. Way said. "But dont tryto grow your company if the profit is not there because it willblow your company up," he warned.

The companys rapid premium growth has raised some concerns. Grosspremiums in HCC Insurance Holdings Diversified Financial ProductsDivision rose 56 percent in the second quarter. (Diversifiedrepresents directors and officers liability insurance as well aserrors and omissions coverage.)

Ms. Chernyak sees some potential pitfalls in this kind of growth."We are concerned with their increased balance sheet risk andgreater utilization of capital at the operating level," Ms.Chernyak said. "They are stretching their capacity rightnow."

In addition, HCC is retaining more of the risk in response tofavorable market conditions in its lines of business. But while thecompanys appetite for more liability risk increases, it will stillshy away from general liability and umbrella covers that havecaused its rivals so many troubles.

HCCs "double-A" S&P rating puts it in the catbird seat, atleast within its peer group, when it comes to negotiating terms andconditions, according to Mr. Way.

One thing Ms. Chernyak admires about the HCC model is the goodrevenue diversification the company achieves through riskactivities in its insurance companies and non-risk business throughits ownership of several underwriting agencies and insuranceintermediaries.

For example, last year fee and commission income grew 23 percentfrom 2002, and Mr. Way sees it rising again this year, noting itincreased 41 percent in the first six months of 2004.

Craig Kelbel, HCC executive vice president, who heads up thecompanys agency operations, said the tight supervision kept overthe managing general underwriting agencies contributes to solidbottom line results and few nasty surprises.

"I think the one thing we do different is that we do actuallymanage our agencies," Mr. Kelbel said. "We are very involved intheir businesses and are able to compare one agency to another toget a good feeling of what the results should be."

HCC MGAs include:

HCC Benefits Corp., which sells medical stop-loss products andgroup life products.

Professional Indemnity Agency Inc., which sells D&O, kidnap andransom, and miscellaneous errors and omissions policies.

Continental Underwriters, which writes commercial marinebusiness.

HCC Global Financial, which provides D&O coverage to public andprivate companies.

Mr. Kelbel said HCC benefits from the agencies expertise andlong-time relationships with distributors, while they in turnbenefit from the parent's "double-A" rating.

Even though HCC is rapidly approaching midsized status, Mr. Kelbelsaid its "small-company mentality" ensures that critical elementssuch as fast turnaround time for quotes and responsiveness toclaims do not get lost in the shuffle.

HCC reported roughly $200 million in shareholders' equity in 1995afigure which stood at more than $1.1 billion on June 30, 2004whileassets now top $5 billion, according to second-quarter financialreports. Such growth could not have been accomplished without arobust mergers and acquisitions program that has usually resultedin a couple of deals each year.

Most recently, the company expanded in the surety business with theacquisition of American Contractors Indemnity Corp. In addition,strategic investments that fall short of full ownershipsuch as thecompanys $40 million stake in Argonautcomplete the picture.

"We use these investments to create opportunities for futureacquisitions, to share in business that we do not access throughour existing operations, or simply make an investment return," Mr.Way said in his chairmans letter this year.

So far, Mr. Way plans to stick to investments in the specialtylines business, not only for the margins but to keep better controlof his companys destiny.

While Ms. Chernyak sees such a "significant appetite foracquisitions" portending possible future indigestion, othersdisagree.

Advest Inc. equity analyst Elizabeth Malone has given the companyits highest rating with a target price of $38, up from its currentprice of $29.58. "We believe the company will continue tosuccessfully execute its unique acquisition strategy," shesaid.

Such a spike will be particularly welcome for Mr. Way, consideringthe opposite direction the share price took at the heart of thesoft market in 1999 when he told shareholders that it was not agood time to look for top-line revenue growth.

"We were practicing full disclosure long before it was mandatory,"Mr. Way said.

What started out as Stephen L. Way International wholesale andreinsurance brokerage in 1974, today is an enterprise that garnerednearly $1 billion in revenue last year.

While a tale such as his might seem pretty unlikely today withcapital requirements as they are, Mr. Way was asked if he were thesame teen today, would he have ended up founding Google? "Thatwouldnt be such a bad plan," he said with a laugh.


Who Is HCC?

Focus: Specialty insurance since 1974

Locations: Based in Houston, Texas, withinternational offices in Bermuda, Spain and the UnitedKingdom.

Operations include insurance companies,underwriting agencies and intermediaries.

Property-Casualty Insurance Companies:

Houston Casualty Company, the principalinsurance company subsidiary in Houston, operates on a surpluslines basis in the United States and worldwide, writing accidentand health, directors and officers, errors and omissions, aviationinsurance.

Houston Casualty Company-London Branch, a full branchoffice for accident and health; D&O, E&O, property, marineand energy insurance on a worldwide basis.

Houston Casualty Company Europe, a Spanishproperty-casualty insurer operating throughout the European Union,writing surety, E&O, D&O.

US Specialty Insurance Company, a Texas- domiciled p-cinsurer company operating on an admitted basis throughout theUnited States; writes aviation, occupational accident, alternativeworkers' compensation, E&O, D&O.

Avemco Insurance Company, a Maryland-domiciled admittedcarrier writing aviation insurance on a direct-response basis, andaccident and health insurance underwritten through an affiliatedunderwriting agency and non-affiliates.

Underwriting Agencies:

ASU International Inc., based in Woburn,Mass. Specialties: event cancellation; specialty disabilityinsurance for athletes, entertainers and high-profileindividuals.

HCC Diversified Financial Products Ltd., based in London,specializing in E&O throughout the United Kingdom.

HCC Benefits Corp., based in Atlanta. Specialties: medicalstop-loss and group term life insurance for employer-sponsored,self-insured health plans.

HCC Global Financial Products, based in Farmington, Conn.Specializes in D&O.

Professional Indemnity Agency Inc., based in Mount Kisco,N.Y. Specialties: kidnap & ransom; miscellaneous E&O;D&O.

Intermediaries:

HCC Risk Management Corp., based inHouston, is a wholesale and reinsurance broker marketing andservicing large, complicated insurance and reinsurance programs inall of the specialty lines written by the group.

Rattner Mackenzie Ltd., based in London. is a specialistinsurance and reinsurance broker.

Financial Information:

Total Assets$5.3 billion at June 30, 2004.

Shareholders' equity of $1.1 billion at June 30, 2004.

Gross written premiums: $980.8 million for first-half 2004, $1.7billion in 2003, and $1.2 billion in 2002.

Net written premiums were $544.8 million for first-half 2004,$865.5 in 2003, and $545.9 million in 2002.

Ratings: "A-plus" (superior) from A.M. Best Company; "double-A"(very strong) from Standard & Poors.

Source: HCC Holdings Web site (www.hcch.com)


Heard At This Year's S&P Conference

While Standard & Poor's analysts report that reinsurancerecoverables at $172 billion fell as a percentage of surplusto 49percent in 2003the level of reinsurance disputes is still beingdisputed.

HCC's CEO Stephen Way was one of the speakers who weighed in on theissue at the S&P conference in June, countering comments madeby a representative of a reinsurance brokerage.

"I definitely think there has not been an uptick in the number ofdisputes," said Roderick Thaler, executive vice president andnational director for Willis Re in New York. "What reinsurers aredoing is asking a lot more questions, and that's only prudent. Ifyou have long-tail claims that are coming out of 10, 20 years ago,you should ask questions."

"Now the real story," countered Stephen Way, chairman and CEO ofHCC Insurance Holdings in Houston. "More questions, moreexcuses."

"You see it at the bottom of the cycle. You don't see it in thehard market. Everyone pays their claims today. They want yourbusiness, they want the premiums, they want their profits. But whenyou get to the bottom of the cycle, they don't pay. They don't paybecause they can't pay, or they don't pay because they don't wantto pay."

"Solvent reinsurers that don't pay are a much bigger problem inthis industry than insolvent reinsurersby 100 times," headded.

By Susanne Sclafane

Reproduced from National Underwriter Edition, September 16,2004. Copyright 2004 by The National Underwriter Company in theserial publication. All rights reserved.Copyright in this articleas an independent work may be held by the author.