CNA Financial Corp (CNA) 2005 Q1 法說會逐字稿

Good day and welcome to the CNA Financial Corporation's first earnings conference call. [OPERATOR INSTRUCTIONS]. We'll now turn the call over to Ms. Dawn Jaffray. Please go ahead.

Thank you, operator, and good morning. We'd like to welcome you to CNA's first quarter 2005 financial results conference call. My name is Dawn Jaffray and I'm Senior Vice President, Corporate Finance with responsibility for investor relations.

By now, all of you should have received our earnings release and financial supplement. If not, you can access these documents at our website at www.cna.com, under the investor relations menu. For your reference, this call is being webcast and can be accessed, again, on our website after we have concluded. With us this morning is Steve Lilienthal, our CEO and Craig Mense, our CFO. Jim Lewis, our President of Property and Casualty Operations could not be with us today due to a death in his family. Gary Owcar, our Executive Vice President of Worldwide Standard Lines will speak today to PC operations results.

During this call there may be forward-looking statements made and references to non-GAAP financial measures. Please see the section of the earnings release, available on our website headed Forward Looking Statements, with regard to both. The forward-looking statements speak only as of today, May 3, 2005.

Further, the Company expressly disclaims any obligation to update or revise any forward-looking statements made during this call. There will be time for questions from the investment community following the conclusion of our remarks. Members of the news media -- Members of the news media may call Charlie Boesel at 312-822-2592 or Katrina Parker at 312-822-5167. And investment analyst questions may be directed to Ken De Vries at 312-822-1111.

And with that, I'll turn over the call to Steve.

Thank you, Dawn, and good morning to you all. Thanks for joining us today.

CNA had a good first quarter. Our businesses continue to operate in a normalized mode, and we're continuing the progress generated by the initiatives put in place in 2003 and early 2004. Controlled orderly execution continues to be our focus. Our core property casualty operations had a first quarter combined ratio of 99%, and this is our sixth consecutive quarter of combined ratios under 100, before the impact of catastrophes in the third quarter of 2004. Meanwhile, our run-off operations continued to perform in a very orderly fashion.

The steadily -- The steady on-going progress is evident in our financial results. First quarter net income, before realized investment gains and losses, was 192 million. This was down 17 million from the first quarter of '04, but still reflective of strong fundamentals, improved current net calendar year loss ratios in our core businesses, and decreased operating expenses. More on this in a moment.

Net income of $178 million included $14 million of realized investment losses, which include a $9 million after tax impairment loss related to loans made under a credit facility to a national contractor. Quarter-over-quarter comparisons are not meaningful, due to a significant impairment charge in '04 associated with the sale of our life business.

Operationally, we continued the solid performance from last year. Property casualty operations maintain healthy production levels, while continuing to fine-tune our business mix. We add another point of rate. Retention was flat, and business growth continued in a controlled, selective fashion. 2005 net paid and case loss ratio of approximately 63%, 2 points better than 2004, underscores the improved fundamentals of our business.

Overall property casualty operations is performing well and is holding the line on underwriting discipline in a moderating rate environment. We'll provide more details on this in a moment.

Expense management continues to be a major focus for CNA. The 1 point improvement in our property casualty operation expense ration is directionally appropriate. But 31% is not acceptable by my standards, and will require additional focus throughout 2005. And Craig will talk this more broadly in his remarks.

Going forward, CNA remains well-rounded in the fundamentals. We're seeing a loosening of the standards, aggressive pricing, pressure from new entrants across many lines of business. None of this comes as a surprise, nor is it a game that we intend to play. CNA is committed to underwriting discipline. And as I have said before, we will adjust our portfolio to reflect changing market conditions, rather than attempting to maintain market share. We will likewise adjust our expense structure, as necessary. In summary, we had a good quarter. Solid operating performance from our core property casualty business, close attention to the fundamentals, and well-positioned to keep it going.

Before turning the call over to Craig, I would like address three statements we announced today. From a financial perspective, the impact of the restatement is not significant. On an after-tax basis, 29 million negative impact on our year end '04 equity, approximately .3%, that's .003 of our cash equity of $9 billion, and a $2 million positive impact on our 2005 net income.

As we previously disclosed, CNA has received subpoenas and other inquiries from a number of regulators. And in response, we did a thorough review of all the finite reinsurance arrangements on our books. In connection with that review, we examined our prior relationship with Accord Re, an entity in which CNA acquired a minority interest by way of the continental acquisition in 1995. CNA decided to address this accounting issue via the restatement. More details on the restatement are contained in a press release and Form 8-K filing.

We do have other finite reinsurance contracts on our books and at these, we believe our accounting is appropriate. In any event, we will continue to fully cooperate with all regulatory inquires and respond to the various subpoenas, interrogatories and other information requests that we have received from state and federal regulatory authorities in connection with the ongoing insurance industry investigations into the subject of finite reinsurance. In light of the fact that these regulatory inquiries are still open, I will not be commenting any further on these matters, as has been our practice over the past several quarters.

With that I will turn it over to Craig. Thanks, Steve, and good morning, everyone. Steve provide you'd with a summary of this quarter's major events. I'd like to give you a bit more detail on the financials before turning it over to Gary.

Today we reported first quarter operating income, before realized investment losses, of 192 million, or $0.68 per share. This is down somewhat from 209 million or $0.76 per share in the prior year period. The per share amounts include the impact of undeclared preferred stock dividends. Property and casualty net operating income was $180 million for the quarter, down 5% from the prior year. Improvements in the current net calendar year loss ratio was more than offset by $36 million of after-tax prior year reserve strengthening, primarily in DNO and ENS, as well as $6 million after-tax unfavorable arbitration ruling on two reinsurance treaties, which are also related to our ENS business. While the net impact of the arbitration was modest, it does cause some distortion on the inner-lines combined ratio, due to the fact that it has an impact on (inaudible) premiums. losses, commission and interest expense.

The Life & Group non-core segment reported net operating income of $1 million for the quarter, compared to $19 million in the prior period. The major drivers here are the absence of earnings from our individual life business, which we sold in April last year, and improved life settlement contract results.

The corporate and other non-core segment reported net operating income of $11 million, compared to $1 million in the prior period. This improvement is due primarily to lower reinsurance bad-debt provisions and our continued strong focus on expenses.

Net investment income from the quarter was $406 million, down 15% from the first quarter of 2004. This change was primarily due to two factors. First, our core bond portfolio was diminished by the sale of the life business last year. Second, we had mark-to-market losses in our trading portfolio versus gains in the prior year period. Now the majority of the trading portfolio results are fully offset by changes in policy holder reserves. Page 10 of the financial supplement provides the components of net investment income for both periods. And I'd suggest you look at those. If you take out the noise associated with the Life & Group segment results, you will see that NII increased modestly first quarter 2005 over first quarter 2004.

Realized investment losses for the quarter were $14 million after-tax. That amount includes $9 million after-tax impairment on loans to a major national contractor, and CNA surety customer.

I'm pleased to report that we are making steady progress in our expense management efforts, the success of which is reflected in our improving expense ratio. You will see that our property and casualty operations expense ratio declined from 32% or to 30.9, or 1.1 points this quarter. The progress in the expense ratio is encouraging and, as Steve said, it is certainly headed in the right direction, but it's far from at a satisfactory level. You will recall that our goal for 2005 is to further reduce our expense base by $100 million. We are on track to meet that goal. Ongoing expense studies and functional analyses are continually underway in order to identify any and all potential for improved efficiency or expense reduction. We expect to sustain our focused efforts on expenses.

With that, I'll turn it over to Gary.

Thanks, Craig. And good morning, everyone.

Property and casualty operations had a solid first quarter with a sub-100 combined ratio. As Steve mentioned, this marks our sixth consecutive quarter of sub-100 combined ratios when you exclude the third quarter '04 catastrophes. Operationally, we executed our strategies, responded to changes in the market, and continued to leverage the \ breath of CNA products with cross-sell strategies. In short, the first quarter represents a good start to 2005. You can see this in our key business indicators.

Starting with premium volume, property and casualty operations gross written premium was 2.3 billion for the first quarter, essentially flat with the prior year period. Standard lines was down 3% for the quarter, while special lines was up 8%. The same trend has been evident in our business volume for the past year or so. We have been growing in specialty, where the market has been stronger. In standard, we have taken a more cautious stance, pulling back on workers compensation and problem classes, such as residential construction. The changes in our business mix go back to our strategy of portfolio management, something we have discussed with you before. Now let's look at rate.

The gradual moderation we experienced last year continued into '05. We put one point of rate on the book in the first quarter. This comes after a 3% increase in the fourth quarter and a 5% increase for all of 2004. In standard lines, rate was flat in the first quarter. Specialty had average rate increases, up 2%. For the market as a whole, we expect rates to continue to moderate going forward. Workers compensation pricing, in particular, is softening in spite of continued escalation of medical costs.

Waiver of collateral requirements is becoming commonplace with large lot-sensitive accounts, a trend that troubles us and has caused us to pull back from the segment. Across many lines of business, pricing is becoming more aggressive and terms and condition Morse liberal, a game we won't play. In this environment, the strengths we have built over the last few years become even more important. Underwriting discipline is well ingrained. We know which risks to fight for and which to let go. In addition, the breath of our product offering enables us to shrink in growth selectively.

Turning to retention, property casualty operations came in at 75%, about even with first quarter '04. Standard lines retention was 69% during the quarter, with specialty running at 89%. These figures reflect the same portfolio management strategy you see in our premiums. In standard, we walked away from a significant number of large casualty accounts. This is business we like, but not at prices below the cost of risk. In specialty it's a different story. Here we're able to retain business that lines up with our underwriting appetite and our pricing standards.

Now let's turn to new business. We wrote approximately $380 million of new business in the first quarter, or 22% of the books. This compares with approximately 450 million in the prior year period, or 24% of the book.

Controls and quality at the heart of our strategy for new business, we continue to focus on selling more CNA products to existing customers. This is our cross-sell strategy. New cross-sell premium amounted to $115 million during the first quarter, or approximately 30% of new business. We like cross-sell business for a number of reasons. It drives retention, and it also mitigates adverse selection, because we already know and like these customers. In addition, we continue to track key indicators of new business quality. For instance, there is the spread between paid and case loss ratios for new business and renewal business. I have mentioned the new versus renewal spread in prior calls. We look forward to our front-line underwriters keeping this spread in a relatively narrow range.

Loss ratios, now let's turn to the loss ratios. For the first quarter, the property and casualty net calendar year loss ratio was approximately 68%, up 3 points from the prior year period. Our first quarter loss ratio includes 1 point from the reinsurance arbitration Craig mentioned in his remarks. The arbitration also impacted the standard lines net calendar year loss ratio. The 71% we reported for the first quarter includes 2 points from the arbitration. On the specialty side, we reported a very respectable 62%. Overall, our net calendar year loss ratios reflect solid underlying performance.

You see the same thing in the accident year results. The property and casualty operations net accident year loss ratio for 2005 is approximately 63%, a 2-point improvement over 2004. Net accident year loss ratios for standard lines and specialty lines were approximately 64% and 59% respectively. By the way, these accident year loss ratios are all evaluated as of first quarter '05.

Turning to a combined ratio, property casualty operations came in at 99%, 2 points higher than the first quarter last year. Standard lines came in at approximately 104%, up 4 points from the prior year period. Specialty continued to shine. Its combined ratio for the quarter was approximately 89%, on a par with the first quarter last year.

The combined ratios were impacted by factors that have already been discussed. The reinsurance arbitration added 2 points to the ratio for P&C Ops and two points for standard lines. Also impacting our ratios was unfavorable development in our ENS and DNS notebooks.

Also, as you heard from Craig, our expense initiatives taking hold. Reduced expenses were worth 1 point improvement on the PNC operations combined ratio of 2 points per standard lines. Not that we are satisfied, but it is definitely movement in the right direction.

In summary, we started the year well. Selective disciplined underwriting, improving retention, good loss ratios, and expense initiatives starting to show in our results. 2005 is all about quality, consistent earnings. Our challenge is to stay focused and keep it going. And with that, I'll turn it back to Dawn.

Thanks, Gary. I would now like to open the line for questions. Operator?

Thank you, Ms. Jaffray. [OPERATOR INSTRUCTIONS] We'll take our first question from Donna Halverstat (ph) at Goldman Sachs.

Good morning. I was just curious how many more quarters of controlled orderly execution you think you need before Moody's and S&P start taking off their negative outlooks?

I'm sorry, I was having a little bit of trouble hearing, but was it how many more quarters --

How many more solid quarters do think you need to post before you start to see the rating agencies take off their negative outlooks?

Well, Fitch already has taken it off. And I guess I really wouldn't be able to speculate on any of the other agencies as to what their attitude would be. You know, we're just going about our business and doing it quarter by quarter and showing them that we can deliver. And I think that's a decision for them to make. We're happy to help them with it.

Ms. Halverstat, anything else?

Not today.

Next question from Angelo Gracey (ph), Merrill Lynch.

Good morning, everyone. Thank you for the call. I have a question about the restatement and and your comments about having examined the finite insurance transactions, or related type of transactions. And it seems like you've examined all them and Accord was the one area where you decided to restate. Can you provide a little bit more detail about your -- I guess your degree of confidence in risk transfer and the other transactions? And are you pretty much done with examining those transactions?

Angelo, I think the only thing I can say on that is exactly what I said in my opening remarks, that we have done an examination of our finites. And we do have finites on our books, and we believe that our accounting is appropriate for them, and we dealt with the issue we felt was there respect to Accord. And that's really all I can say about this.

The internal investigation is pretty much completed? Okay, that's fine. On the adverse development, can you provide a little more detail that was in DNO and ENO, which years, how much and is it a potential for some noise going forward?

This is Craig. I can tell you that it was -- the adverse development was split pretty evenly between standard and specialty lines. The DNO is really an isolated to an assumed reinsurance transaction. It's really related to the 2001. So it's part of those ugly years, but it's an assumed reinsurance transaction from '01 and prior. And the other part of the reserve development is really '99 and prior results, mostly from ENS and a little bit of comp.

And was there something in particular that happened during the fourth to the first quarter of -- between the fourth and the first quarter to -- for you to decide to add reserves with these -- are these very specific claims that just had some action involved?

Well, these are specific. But recall, we've talked before about that we have a very rigorous and regimented reserve review that Mike Fusco and group runs. And we have regular quarterly meetings and regular reviews on any number of lines consistent. And I think what we've said before, in other calls, has been that, as we see things, and these are specific incidents, then we deal with them. And that's exactly what happened here. These are things that emerged from those reviews. And we dealt with them.

Great. Thank you.

[OPERATOR INSTRUCTIONS] We'll go next to Bob Glasspiegel, Langen McAlenney.

Did you say the adverse development was about $0.26? That's what I calculate, 5.6 points on a billion 86 of premiums.

We said they were 36, Bob.

I'm sorry?

36 after tax.

$0.36?

I'm sorry, percent.

$0.36 per share?

Oh no, I'm sorry. I thought you were talking about dollars here.

Using page 12 of your (inaudible) supplement, you had 5.6 points of adverse development. And I multiply that on a billion 860 in premiums.

Sounds about right.

Okay. The finite cost seem to drop down a little bit more than the guidance suggest ed it would decline this year. Is there seasonality in the or is that a trend maybe we should extrapolate from?

I think you can -- you should stick with the guidance earlier. There's a little noise that came out of the Scan Re transaction that caused a little bit of that distortion. The number we'd given you earlier is still a good number, Bob.

Okay. Obviously a very strong quarter at a partnership. I assume we shouldn't project respectively as a run rate. Is that fair?

I think that's fair. But that's obviously a conscious decision we have. And it's a -- it's a conscious decision to invest that way. And we realize there is some variability that come out of those results that will go quarter-to-quarter. But we're certainly pleased with the outcome this quarter.

The final question, would this be a timely moment to rethink whether the finites make sense in today's world going forward, and have you thought about perhaps unwinding them and --?

We look at these -- we've looked at these treaties in the past, we've looked at them current, we'll look at them going forward. And basically, we'll deal with these in the best -- in the best way and in a way that makes the most economic sense for CNA.

Okay. It just seems like the ROE objective awfully challenge -- challenging to continue to charge current earnings for events that happened in the past. I'm sure that, as you negotiate with your reinsurers who may also look at having these finite transactions less favorably in today's world than they did in the past, this might be a timely time to negotiate for more strength than you've had in the past.

I think that's a good observation, Bob.

Okay, thank you.

[OPERATOR INSTRUCTIONS] And Ms. Jaffray, we have no other questions standing by at this time. I'll turn the conference back over to you for additional or closing remarks.

Thank you, operator. Once again, I call your attention to our disclosures concerning forward-looking statements in the earnings release and as previously started at the start of today's call.

Please note that a tape replay of today's conference call will be available for one week immediately following this call until May 10. You can access the replay by dialing 888-203-1112 or 719-457-0820 for international callers utilizing passcode 9033425. The call will also be archived later in the day for replay on the investor relations pages on our website.

Thank you for joining thus morning. We appreciate your participation in today's call.

Thank you again. That does conclude today's conference call. We thank you for your participation. You may disconnect at this time.