| USI HOLDINGS CORP Item 1A Risk Factors Risks Related to Our Business We may be unsuccessful in adequately growing our cash earnings per share and our failure to do so may negatively impact the price of our common stock |
| Our financial objectives state our intention to grow our cash earnings per share (defined as income from continuing operations plus amortization of intangible assets on a diluted per share basis) |
| As a means to accomplish this goal, we focus on generating organic growth in revenues, creating efficiencies in our operations and making disciplined and accretive acquisitions |
| These strategies and activities may not result in achieving our desired cash earnings per share growth |
| Due in part to our acquisition strategy, we may have difficulty in maintaining a balanced mix of P&C and Health & Welfare (including employee benefits, retirement services, wealth management products and specialized benefits services products) revenues, thereby adversely impacting our desired organic growth |
| In addition, we may have difficulty in acquiring only those businesses that are accretive to our cash earnings per share |
| Due in part to the decentralized nature of our operations and the variety of types of businesses we seek to acquire, we may have difficulty in integrating operations, systems and management of our acquired businesses, which could negatively impact the growth in our cash earnings per share |
| If we fail to adequately achieve our cash earnings per share growth objective, the price of our common stock could be negatively affected |
| We may be unsuccessful in growing revenues organically, and our failure to do so may negatively impact the price of our common stock |
| Our business plan contemplates that we will grow organically (defined as total revenue growth less the impact of acquisitions and divestitures) over the long-term through all insurance industry cycles and economic market cycles |
| As part of our strategy to grow organically, we seek to maintain a balance of revenues in P&C insurance versus Health & Welfare, increase sales production through our sales management program, and cross-sell multiple lines of business to existing clients |
| To date these strategies and activities have not resulted in achieving our desired organic growth |
| Due in part to our acquisition strategy, we may have difficulty in acquiring a balance of revenue thereby adversely impacting our revenue diversity |
| Due in part to the decentralized nature of our operations, we may have difficulty in focusing our sales managers and sales professionals on our sales management program and cross-selling strategy |
| In addition, we may have difficulty in integrating acquired operations, newly hired sales managers and sales professionals into our sales management program and cross-selling strategy |
| If we fail to succeed in our organic revenue growth strategy, the price of our common stock could be negatively affected |
| We may be unsuccessful in expanding our margins and, if this were to occur, the market price of our common stock could decrease, perhaps significantly |
| Our business plan includes expanding our margins to achieve a balanced performance and efficiency level |
| As part of our strategy to expand our margins, we seek to streamline and centralize information technology, accounting and administrative services, consolidate the back-office operations of our insurance brokerage businesses on a regional basis, benchmark all key expense categories, identify best practices, and implement plans to bring all operations to target margin levels |
| These strategies and activities may not have the desired results in achieving our goal of increasing our margins |
| Due in part to our acquisition strategy, we may have difficulty in acquiring businesses that have margins in excess of our current margins thereby adversely impacting our margins |
| Due in part to the decentralized nature of our operation, we may have difficulty in focusing our local managers on our margin expansion strategy program |
| In addition, we may have difficulty in integrating acquired operations into our margin expansion strategy |
| If we fail to meet expectations, the market price of our common stock could be negatively affected |
| Our continued growth is partly based on our ability to acquire and integrate operations successfully, and our failure to do so may negatively affect our financial results and internal control over financial reporting |
| Our business plan includes making acquisitions of traditional insurance businesses which augment our organic growth |
| Competition to acquire traditional insurance brokerage businesses is intense |
| As part of our 7 ______________________________________________________________________ [36]Table of Contents business strategy, we will seek to acquire such businesses and may experience heightened price competition from our peers |
| We also seek to acquire businesses in the core benefits and benefits enrollment and communication |
| Due in part to the decentralized nature of our operations, as well as the variety of types of businesses we seek to acquire, we may have difficulty integrating the operations, systems and management of our acquired companies and may lose key employees of acquired companies |
| Also, we may be required to obtain additional financing to pursue our acquisition strategy; however, our ability to do so is limited by the terms of our existing credit facility, which contains covenants that, among other things, may limit our ability to make certain acquisitions as well as impose restrictions on our ability to incur additional debt |
| We may also be similarly limited by our future debt instruments |
| Although we conduct due diligence in respect of the business and operations of each of the businesses we acquire, we may not identify all material facts concerning these businesses |
| Unanticipated events or liabilities relating to these businesses could have a material adverse effect on our financial condition |
| Furthermore, once we have integrated an acquired business, it may not achieve levels of revenue, profitability, or productivity comparable to our existing locations, or otherwise perform as expected |
| Our failure to integrate one or more acquired businesses so that they achieve our performance goals may have a material adverse effect on our results of operations and financial condition |
| In addition, due in part to the decentralized nature of our operations, once we have acquired a business, we may not be able to effectively audit the controls, especially transaction review and monitoring activities, of such businesses |
| Therefore, our failure to integrate one or more acquired businesses may negatively affect our internal control over financial reporting |
| We could fail to maintain an effective system of internal controls and, consequently, may not be able to report our financial results accurately |
| As a result, our current and potential shareholders could lose confidence in our financial reporting, which could harm our business and the price of our common stock |
| Although we have devoted significant management and financial resources to document, test, monitor and enhance our internal control over financial reporting in order to meet the requirements of the Sarbanes-Oxley Act of 2002, all internal control systems, no matter how well designed, have inherent limitations |
| Even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation |
| Our management concluded that, when individual deficiencies were considered in the aggregate, there was a material weakness in internal control over financial reporting in 2004 |
| Because of changes in conditions, the effectiveness of internal controls may vary over time |
| We cannot be certain that our internal control systems will be adequate or effective in preventing fraud or human error in the future or that new deficiencies of a material nature will not evolve and which we may not be able to correct |
| Any failure in the effectiveness of our internal control over financial reporting could have a material effect on our financial reporting or cause us to fail to meet reporting obligations, which could negatively impair our ability to execute our business strategy or, upon disclosure, could negatively impact the market price of our common stock |
| Recent litigation and state regulatory activities concerning industry practices and procedures could negatively impact our business, financial condition and/or results of operations |
| Since October 2004, the insurance industry has been under a significant level of scrutiny by various regulatory bodies, including state Attorneys General and the departments of insurance for various states, with respect to industry practices, including contingent compensation arrangements |
| Along with a number of other insurance brokers, we have received subpoenas from the Office of the Attorney General of the State of Connecticut, the Office of the Attorney General of the State of New York and the Florida Attorney General’s Office requesting documents and seeking information as part of their industry-wide investigations relating to 8 ______________________________________________________________________ [37]Table of Contents pricing and placement of insurance |
| We have also received an Investigative Demand from the Department of Justice of the State of North Carolina seeking similar information |
| The investigations center upon, among other items, allegations of bid rigging, tying arrangements and other fraudulent or unlawful business practices |
| We have cooperated fully with these requests and will continue to cooperate with regulators as they refine, prioritize and/or expand the areas of inquiry in their subpoenas and information requests |
| In addition to the state Attorney General investigations described above, a number of state departments of insurance have begun inquiries into compensation practices of brokers, agents and insurers as they affect consumers in their respective states |
| We have received and responded, or are in the process of responding, to inquiries from insurance regulators in several states |
| We are also named defendants in various industry class action litigation that focus on, among other things, the payment of contingent commissions by insurers to insurance brokers who sell their insurance and alleged bid rigging in the setting of insurance premium levels |
| The resolution of these matters may result in a loss, which could be material, to our business and/or lead to a decrease in or elimination of contingent commissions and override commissions, which would have a material adverse impact on our consolidated financial results |
| For further information on the matters discussed see Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Insurance Industry Investigations and Other Developments” and Note 15, “Contingencies” to our Consolidated Financial Statements |
| Contingent commissions are less predictable than our other revenues, which makes it difficult to forecast revenues; and decreases in these commissions may negatively impact our financial results |
| Many insurance companies pay us contingent commissions for achieving specified premium volume goals set by them and/or the loss experience of the insurance we place with them |
| We generally receive these commissions in the first and second quarters of each year; however, we have no control over the ability of insurance companies to estimate loss reserves, which affects the amount of contingent commissions that we will receive |
| Placement service revenue includes payments or allowances by insurance companies based upon such factors as the overall volume of business placed by the broker with that insurer, the aggregate commissions paid by the insurer for that business during specific periods or the profitability or loss to the insurer of the risks placed |
| This revenue reflects compensation for services provided by brokers to the insurance market |
| These services include new product development, the development and provision of technology, administration and the delivery of information on developments among broad client segments and the insurance markets |
| In addition, because no significant incremental operating costs are incurred when contingent commissions are realized, a significant decrease in these commissions can cause a disproportionate decrease in net income |
| Any decrease in the contingent commissions we receive would reduce our revenues and, to a greater degree, decrease our income from continuing operations before income tax benefit, on a percentage basis |
| A significant decrease in contingent commissions would consequently have a negative impact on our financial results and limit our ability to incur and service debt and comply with financial covenants in our existing credit facility |
| For further information on the matters discussed see Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Insurance Industry Investigations and Other Developments” and Note 15, “Contingencies” to our Consolidated Financial Statements |
| The cyclical nature of P&C premium rates may make our financial results volatile and unpredictable |
| Commissions from the brokering of insurance products represent a majority of our revenues |
| Commissions are typically determined as a percentage of premium rates |
| We have no control over the insurance premium rates on which these commissions are calculated |
| For example, from 1987 through 1999, the P&C insurance industry experienced a period of flat to declining premium rates, which negatively affected 9 ______________________________________________________________________ [38]Table of Contents commissions earned by insurance brokers |
| Starting in 2002, years of underwriting losses for P&C insurance companies combined with the downturn in the equity markets caused insurers to increase premium rates |
| Additionally, the insurance industry was affected by the events of September 11, 2001, which resulted in one of the largest insurance losses in America’s history and accelerated increases in premium rates for particular lines of commercial P&C insurance |
| In response to rising premiums, some of our customers increased their deductibles and/or reduced their insurance coverage in order to reduce the impact of the premium increases |
| These trends prompted by the hard market negatively impacted our revenues |
| The hard market, for many lines of insurance, began to slow in the second half of 2002 |
| By the second half of 2003, premiums in most P&C lines of insurance began to flatten or decrease, with some, such as property, by as much as 20prca |
| In 2004 and through 2005, the soft market persisted, negatively affecting brokers’ revenue |
| Some clients use the savings on insurance premiums to purchase more coverage, somewhat offsetting the negative impact in our commissions due to falling premiums |
| Through 2005, the competitive pricing dynamic was consistent throughout most account sizes and most geographic regions, with the workers compensation market in California a notable exception where we have seen premiums decline by as much as 50prca |
| If the soft market persists, it may continue to negatively impact our P&C insurance brokerage revenues |
| We act as brokers for state insurance funds such as those in California which could choose to reduce brokerage commissions and/or contingent commissions we receive, which could negatively affect our financial results |
| In response to perceived excessive cost or inadequacy of available insurance, states have from time to time created state insurance funds and assigned risk pools, which compete directly, on a subsidized basis, with private insurance providers |
| We act as agents and brokers for state insurance funds such as those in California and other states in which we operate |
| These state funds could choose to reduce the brokerage commissions and/or contingent commissions we receive |
| If these reductions in commissions occurred in a state in which we have substantial operations, such as California, they could substantially affect the profitability of our operations in that state or cause us to change our marketing focus |
| In addition, any decrease in these commissions would reduce our revenues and, to a greater degree, decrease our income from continuing operations before income taxes, on a percentage basis |
| A significant decrease in these commissions would consequently have a negative impact on our financial results and limit our ability to incur and service debt and comply with financial covenants in our credit facility |
| Government regulation and resulting market dynamics relating to the group health plans we sell could negatively affect our financial results |
| Reform of the health care system is a topic of discussion at both the state and federal levels in the United States |
| Proposed bills and regulations vary widely and range from reform of the existing employer-based system of insurance to a single-payer, public program |
| Several groups are urging consideration by the Congress of a national health care plan |
| If any of these initiatives ultimately become effective, they could have a material effect on the profitability or marketability of the health insurance products and services we sell or on our business, financial condition and results of operations |
| We are dependent on key sales and management professionals who could end their employment with us, which could negatively affect our financial results and impair our ability to implement our business strategy |
| Our success substantially depends on our ability to attract and retain senior management and the individual sales professionals and teams that service our clients and maintain client relationships |
| If key sales professionals and senior managers were to end their employment with us, or if we experience significant turnover among our key sales professionals, it could negatively affect the execution of our business strategy, disrupt our client relationships and have a corresponding negative effect on our financial results, marketing and other objectives 10 ______________________________________________________________________ [39]Table of Contents and impair our ability to implement our strategy |
| Our senior managers and substantially all of our sales professionals are subject to employment agreements containing confidentiality and non-solicitation provisions |
| If any of them were to leave and litigate to be released from these agreements, it could lead to costly litigation and some courts may not enforce these agreements |
| The loss of the services of David L Eslick, our chairman, president and chief executive officer, could adversely affect our ability to carry out our business plan |
| Although we operate with a decentralized management system, the services of David L Eslick, our chairman, president and chief executive officer, are key to the development and implementation of our business plan, including our growth strategy |
| Eslick’s services could, therefore, adversely affect our financial condition and future operating results |
| Further expenses related to margin improvement efforts and acquisition integration charges could adversely affect our financial results and negatively impact the price of our common stock |
| In the fourth quarter of 2004, we announced that our Board of Directors had approved a margin improvement plan in order to reduce ongoing operating expenses |
| As a result of this action, in 2004, we recorded expense of dlra12dtta4 million comprised of employee severance and related benefits for 28 employees of dlra3dtta4 million, facilities closures of dlra3dtta4 million, the modification of 34 sales professionals’ agreements of dlra2dtta9 million and service contract termination fees of dlra2dtta7 million |
| In 2005, we recorded additional margin improvement plan expense of dlra8dtta1 million comprised of employee severance and related benefits of dlra6dtta1 million and the modification of 58 sales professionals’ agreements of dlra2dtta0 million |
| Further margin improvement efforts may result in similar or greater expenses, which could negatively affect our financial results |
| If this were to occur, the price of our common stock could be negatively affected |
| In addition, as part of our acquisition of Summit Global Partners, Inc, we restructured the agreements of certain sales professionals and executives |
| As a result of these efforts, we recorded expenses of dlra8dtta1 million in the first quarter of 2005 |
| In exchange for this consideration, the employment agreements were conformed to our standard compensation structure for sales professionals and regional executives |
| Further integration of our existing businesses and businesses we may acquire in the future may result in similar or greater integration expenses, which could negatively affect our financial results |
| If this were to occur, the price of our common stock could be negatively affected |
| Our business, financial condition and/or results may be negatively affected by errors and omissions claims |
| We have extensive operations and are subject to claims and litigation in the ordinary course of business resulting from alleged errors and omissions in placing insurance and handling claims |
| Since errors and omissions claims against us may allege our potential liability for all or part of the amounts in question, claimants may seek large damage awards and these claims can involve significant defense costs |
| Errors and omissions could include, for example, our employees or sub-agents failing, whether negligently or intentionally, to place coverage or file claims on behalf of clients, to appropriately and adequately disclose insurer fee arrangements to our clients, to provide insurance carriers with complete and accurate information relating to the risks being insured or to appropriately apply funds that we hold for our clients on a fiduciary basis |
| It is not always possible to prevent or detect errors and omissions and the precautions we take may not be effective in all cases |
| The coverage limits and the amount of related deductibles of our errors and omissions insurance coverage are established annually based upon our assessment of our errors and omissions exposure, loss experience and the availability and pricing within the marketplace |
| Our premiums and deductibles associated with the purchase of errors and omission coverages may be higher in certain years because of adverse market conditions for buyers of these coverages |
| Recently, prices have increased and coverage terms have become far more restrictive because of 11 ______________________________________________________________________ [40]Table of Contents reduced insurer capacity in the marketplace |
| While we endeavor to purchase coverage that is appropriate to our assessment of our risk, it is possible that the frequency, nature or magnitude of claims for direct or consequential damages increases; negatively impacting our financial results |
| Our business, financial condition and/or results may be negatively affected if in the future our errors and omissions insurance proves to be inadequate or unavailable |
| In addition, errors and omissions claims may harm our reputation or divert management resources away from operating our business |
| Competition in our industry is intense and, if we are unable to compete effectively, we may lose clients and our financial results may be negatively affected |
| We face competition in both our Insurance Brokerage and Specialized Benefits Services segments |
| We compete for clients on the basis of reputation, client service, program, price and product offerings and the ability to tailor our products and services to the specific needs of a client |
| Our client base fluctuates over time as a result of competition in our industry as well as other factors |
| If we lose one or more of our larger clients and are not able to replace them or otherwise mitigate our loss sufficiently, our financial results could be negatively affected |
| Additionally, a substantial portion of our business is nonrecurring and must be replaced with new sales each year |
| In our Insurance Brokerage segment, competition is intense in all of our business lines and in every insurance market |
| We believe that most of our competition is from numerous local and regional brokerage firms that focus primarily on middle-market businesses and, to a lesser extent, from larger national brokerage firms |
| In addition, insurance companies compete with us by directly soliciting clients without the assistance of an independent broker or agent |
| Additional competitive pressures arise from the entry of new market participants, such as banks, securities firms, accounting firms and other institutions that offer insurance-related products and services |
| Our Specialized Benefits Services segment competes with consulting firms, brokers, third-party administrators, producer groups and insurance companies |
| A number of our competitors offer attractive alternative programs |
| We believe that most of our competition is from large, diversified financial services organizations that are willing to expend significant resources to enter our markets and from larger competitors that pursue an acquisition or consolidation strategy similar to ours |
| We also compete with other brokers and other financial institutions that pursue an acquisition or consolidation strategy similar to ours |
| These include Arthur J Gallagher, Brown & Brown, Hilb, Rogal & Hobbs, Hub International Limited and Lockton Companies, Inc, as well as a number of regional banks |
| Our high level of indebtedness may put us at a competitive disadvantage relative to insurance brokers and other distributors of financial products and services |
| As of December 31, 2005, our total indebtedness of dlra236dtta5 million and our total indebtedness measured as a percentage of our total capitalization of 57dtta7prca were higher than those of brokers that we consider to be generally comparable to us, including Arthur J Gallagher and Brown & Brown |
| As a result, we may be less able to compete effectively with our peers when acquiring other brokerage operations that are seeking cash purchase consideration versus stock purchase consideration |
| Additionally, with a lower level of indebtedness, our peers are likely to have greater flexibility to direct cash flow from operations toward hiring additional sales professionals, capital expenditures and other forms of reinvestment in their businesses than we have currently |
| Failure to comply with financial covenants in our credit facility could cause all or a portion of our debt to become immediately due and payable |
| Under our credit facility, we must comply with financial covenants which limit our flexibility in responding to changing business and economic conditions |
| 12 ______________________________________________________________________ [41]Table of Contents Amounts due under our credit facility and under future debt instruments could become immediately due and payable as a result of our failure to comply with the restrictive covenants they contain, which, in turn, could cause all or a portion of our other debt to become immediately due and payable |
| Our ability to comply with these provisions in existing or future debt instruments may be affected by events beyond our control |
| If we are required to write down goodwill and other intangible assets, our financial condition and results would be negatively affected |
| When we acquire a business, a substantial portion of the purchase price of the acquisition is allocated to goodwill and other identifiable intangible assets |
| The purchase price is allocated to tangible and intangible assets and any excess is recorded as goodwill |
| Under current accounting standards, if we determine that goodwill or intangible assets are impaired, we will be required to write down the value of such assets |
| Because goodwill and intangible assets comprise such a large percentage of our stockholders’ equity, any such write down would have a significant negative effect on our stockholders’ equity and financial results |
| The geographic concentration of our businesses could leave us vulnerable to an economic downturn or regulatory changes in those areas, resulting in a decrease in our revenues |
| For the years ended December 31, 2005, 2004 and 2003, our California- and New York-based businesses constituted approximately 34prca, 34prca and 30prca, respectively, of our consolidated revenues |
| Because our business is concentrated in these two states, the occurrence of adverse economic conditions or an adverse regulatory climate in either California or New York could negatively affect our financial results more than would be the case if our business were more geographically diversified |
| Failure to comply with regulations applicable to us could restrict our ability to conduct our business |
| We conduct business in a number of states and are subject to comprehensive regulation and supervision by government agencies in many of the states in which we do business |
| State laws grant supervisory agencies broad administrative powers |
| Our ability to conduct our business in the states in which we currently operate depends on our compliance with the rules and regulations established by the regulatory authorities in each of these states |
| State insurance regulators and the National Association of Insurance Commissioners continually re-examine existing laws and regulations, some of which affect us, including those relating to the licensing of insurance brokers and agents, premium rates, regulating unfair trade and claims practices, the regulation of the handling and investment of insurance carrier funds held in a fiduciary capacity, and regulation of business practices generally, including our compensation arrangements with insurers and clients |
| These examinations may result in the enactment of insurance-related laws and regulations, or the issuance of interpretations of existing laws and regulations, that adversely affect our business |
| More restrictive laws, rules or regulations may be adopted in the future that could make compliance more difficult and/or expensive |
| Specifically, recently adopted federal financial services modernization legislation addressing privacy issues, among other matters, is expected to lead to additional federal regulation of the insurance industry in the coming years, which could result in increased expenses or restrictions on our operations |
| In response to perceived excessive cost or inadequacy of available insurance, states have also from time to time created state insurance funds and assigned risk pools, which compete directly, on a subsidized basis, with private insurance providers |
| We act as agents and brokers for state insurance funds such as those in California, New York and other states in which we operate |
| These state funds could choose to reduce the sales or brokerage commissions we receive |
| In addition, these states could enact legislation to reform existing P&C and individual and group health care insurance regulations |
| If these reductions in commissions or changes in legislation occurred in a state in which we have substantial operations, such as California or New York, they could substantially affect the profitability of our operations in that state or cause us to change our marketing focus |
| 13 ______________________________________________________________________ [42]Table of Contents We depend on our information processing systems |
| Interruption or loss of our information processing systems could have a material adverse effect on our business |
| Our ability to provide administrative services depends on our capacity to store, retrieve, process and manage regionally centralized databases and expand and upgrade periodically our information processing capabilities |
| Interruption or loss of our information processing capabilities through loss of stored data, breakdown or malfunctioning of computer equipment and software systems, telecommunications failure, or damage caused by fire, tornadoes, lightning, electrical power outage or other disruption at these centralized locations could have a material adverse effect on our business, financial condition and results of operations |
| Our principal stockholder’s interests in our business may be different than yours and, therefore, may make decisions that are adverse to your interests |
| Capital Z Financial Services Fund II, LP and its affiliates (collectively, “Capital Z”) beneficially owned approximately 16dtta8prca of our voting common stock as of December 31, 2005 |
| Robert A Spass, one of our directors, is a partner of Capital Z As a result, Capital Z will have the ability to significantly influence matters requiring stockholder approval, including, without limitation, the election of directors, mergers, consolidations and sales of all or substantially all of our assets |
| Capital Z also may have interests that differ from yours and may vote in a way with which you disagree and which may be adverse to the interests of our other shareholders |
| In addition, this concentration of ownership may have the effect of preventing, discouraging or deferring a change of control, which could depress the market price of our common stock |