CNA Financial Corp (CNA) 2008 Q4 法說會逐字稿

Good day and welcome to the CNA Financial Corporation's fourth quarter and full-year 2008 earnings conference call. Today's call is being recorded. At this time I would like to the turn the conference over to Nancy Bufalino. Please go ahead.

Thank you. Good morning and welcome to CNA's fourth quarter and full-year financial results call. Hopefully everyone has had an opportunity to review the press release and financial supplement which were released earlier this morning and can be found on the CNA web site.

This morning we are happy to have us with our new Chairman and CEO, Tom Motamed, and Craig Mense, our CFO. Tom and Craig will provide some prepared remarks before opening up for questions from the investment community.

Before we get started I would like to advise everyone that during this call there may be forward-looking statements made and references to non-GAAP financial measures. Please see the sections of the earnings release headed Financial Measures and forward-looking Statements for further details. In addition, the forward-looking statements speak only as of today, February 9th, 2009. CNA expressly disclaims any obligation to update or revise any forward-looking statements made during this call.

This call is being recorded and webcast. During the next week, the call may be accessed again on CNA's website at www.CNA.com.

With that I will turn the call over to CNA's Chairman and CEO, Tom Motamed.

Good morning, everyone, and thank you for joining us today. Many of you know me from my previous life, and I look forward to renewing our acquaintance in my new position at CNA.

My first analysts call at CNA coincides with prolonged and severe disruptions in the debt and equity markets. These conditions resulted in significant losses in our investment portfolio, as well as declines in our net investment income during 2008. The impact is clear to see in our fourth quarter and full year results. As you read in our press release, CNA had a $21 million operating loss for the fourth quarter, or $0.15 pr share. And a net loss of $336 million, or $1.31 per share. Both were driven by investment results, whether it was the $309 million of limited partnership losses that adversely affected operating income, or the $419 million of investment impairment that contributed to a $314 million realized loss.

For the year, net operating income was $533 million or $1.91 per share. Catastrophe losses reduced earnings by $0.89 per share.

The net loss of $299 million reflects the investment and catastrophe losses. I am pleased to say that operating performance of our core property casualty business was a much better story. And that will be my focus this morning before turning it over to Craig who will discuss our reserve position, investments, capital management and other topics. Property and casualty operations, which consist of specialty and standard lines, delivered a fourth quarter combined ratio of 89.1%. The best quarterly result in seven years. Favorable development reduced the quarter's combined ratio by 11.8 points. Catastrophe losses added 0.6 points. Before development and cats the combined ratio was 100.3%.

For the full year, the combined ratio was 98% which included 4.4 points of favorable development and 5.7 points of catastrophe losses. Before development and cats, the combined ratio was 96.7%.

In the quarter, the favorable development is primarily attributed to first party coverages in standard lines, mainly property and marine, and the CNA Global businesses in specialty which include our international operations and First Insurance Company of Hawaii. This quarter's favorable development continues a recent trend that now shows eight straight quarters of favorable development for property casualty operations. We believe this reflects our prudent reserving philosophy and we are confident in the adequacy and accuracy of our reserves.

For the full year, favorable development in standard lines was driven by the first party coverages. And specialty lines, the drivers were CNA Global and HealthPro for years 2003 through 2006. As for premium volume, net written premiums decreased about 4% in the fourth quarter and the year. We continue to focus on underwriting discipline in all of our business segments.

Now let us take a closer look at specialty lines and standard lines starting with specialty. Specialty lines, which represent 60% of total premiums, delivered a fourth quarter combined ratio of 87.5% in 2008 compared with 91.1% in 2007. Favorable development in the quarter had a 14 point impact in 2008 versus 2.6 points in 2007. Before development and catastrophe losses, the fourth quarter combined ratio was 101% in 2008 as compared to 93.4% in 2007. During the quarter, the current accident year was unfavorably impacted by 7 points to reflect our exposure to claims arising from the credit crisis. For the year, the combined ratio was 90.1% which included favorable prior year development of 5.4 points. Before development and catastrophes, the 2008 combined ratio was 95%.

Specialty lines net written premiums declined 4% for the quarter, 2% for the year. The fourth quarter decline was primarily driven by the impact of currency fluctuations on our Canadian and European businesses. The ratio of new to lost business was 1.2 to 1. We retained 84.6% of renewal business, consistent with the past few quarters, and 3 points better than the fourth quarter of '07. Renewal rate decreases averaged 2.5%, a slight improvement over the past few quarters, and 2 points better than the fourth quarter of '07.

I would now like to give you some color on the specialty marketplace. Competition remains strong and pervasive in the fourth quarter as underwriters press for new business while showing a willingness to reduce rates in order to retain renewals. Although pricing seems to be part of every equation, we saw little evidence of pressure to modify terms and conditions. Regarding the market dislocations that occurred in 2008, we are seeing significant price reductions by incumbents to retain accounts. Surprisingly enough, we do not see brokers and agents replacing these positions but rather taking the price reduction and, in some cases, reducing the line participation.

On a more positive note, we continue to see price strengthening in the financial institutions segment and a stabilization of commercial D&O pricing. As for standard lines, the fourth quarter combined ratio was 90.9% in 2008 compared with 105.4% in 2007. Favorable development in the quarter had a 9.2 point impact in 2008 versus 2.9 points in 2007. Before development and catastrophe losses, the fourth quarter combined ratio was 99.4% in 2008 as compared to 105.8% in 2007. For the year the ratio of 107% which included favorable prior year development of 3.2 points. Before development and catastrophes, the 2008 combined ratio was 98.8%.

Net written premiums decreased 4% in the fourth quarter, 7% for the year. The ratio of new to lost business was 1.2 to 1. We retained 85.1% of the business available to renew, three points better than in the third quarter and four points better than the second quarter. Rate decreases on renewals averaged 3.2%. This, too represents an improvement over the previous two quarters. In fact, the fourth quarter rate decline was the lowest in eight quarters.

With respect to the standard lines marketplace, we see the same trends as on the specialty side. While rate decreases moderated somewhat in the fourth quarter, it is still a very competitive market. Carriers are fighting to hold their renewals and new business pricing on the best accounts is still very aggressive. This has been complicated by new entrants in the ocean cargo, monoline umbrella, property and energy segments.

Although we are quite pleased with the deceleration of rate declines and hopefully a bottoming out of rates, we are closely watching our exposure factors such as payrolls, sales, and insured valuations. Since price is a composite of rate and exposure, the current condition of our economy is and will continue to impact overall price and ultimately premium growth.

Turning briefly to expense, CNA continues to run at stable and competitive expense levels. The property casual operations fourth quarter expense ratio was 30%. For the year we ran at 29.6%, our third consecutive year below 30.

With that, I will turn it over to Craig.

Thanks, Tom. Good morning, everyone. As Tom outlined, CNA's property casualty core insurance operations turned in another strong performance during the fourth quarter, as measured by their 89.1% combined ratio. As importantly, the operating fundamentals for those businesses is improving, especially with regard to rate and retention. We have a well established brand and an excellent competitive position.

In addition to solid business operating performance, the company has a solid reserve position, a track record of eight straight quarters of positive loss development in C&P operations, much diminished reinsurance recoverable credit risk, and substantial enterprise liquidity. We believe that we have the flexibility and financial resources to successfully manage this company through the market stresses that we are all currently experiencing.

Let me now turn to investment results and the investment portfolio. Fourth quarter pretax investment income was $170 million compared with $574 million in the prior year period. These results include $45 million of losses from our trading portfolio in the current period compared with $31 million of trading losses in the previous period. Excluding the impact of trading gains and losses, the primary driver of decreased results was our portfolio of limited partnership investments. Limited partnership losses during the quarter were $309 million compared with LP income of $41 million in the fourth quarter of '07.

The carrying value of our limited partnership investments at year end was approximately $1.7 billion. We have 82 active LP investments across a broad range of strategies. The majority of them invest in marketable securities while engaging in various risk management techniques. We have minimal exposure to private equity, approximately 7%, and real estate less than 1%.

Our fourth quarter 2008 LP numbers reflect results through December for roughly 40% of the reported value, whereas 45% are on a one month lag, and the remainder are on a more than one month lag which is typically 90 days. That means that the majority of the bad news in last year's fourth quarter has already been reflected in our results.

Overall, our portfolio of limited partnerships continues to be an attractive investment. Despite their performance in recent quarters these holdings bring diversification to the overall portfolio with less volatility and higher absolute returns in equities. We continue to believe they will perform well over the long term, just as they have over the last decade. As an aside, these LPs have produced an annualized return of approximately 10% over the last ten years which compares to returns from the S&P 500 of a negative 1.4%.

After tax net realized investment losses were $314 million this quarter compared with a loss of $61 million in the prior year period. Those realized losses included after tax impairments of $419 million, the majority of which were driven by credit issues. The impairments were primarily recorded in the corporate and other taxable bonds and asset backed bond sectors. Book value per share at year end 2008 was $20.92 per share which reflects after tax accumulated other comprehensive income adjustments of $3.9 billion. Excluding accumulated other comprehensive income, book value per share was $35.50 at year end 2008.

The extreme market valuations of the third quarter continued into the fourth quarter before before stabilizing somewhat in mid December. These valuations affected virtually all asset classes. Our net unrealized loss position stood at $5.4 billion pretax as of year end 2008. Our investment portfolio is highly liquid, well diversified and of high quality. There has been no change to the average credit rating of our fixed income portfolio which is AA minus. The effective duration of the total portfolio was 5.8 year, up from 5.6 years at September 30th. The increase is attributable to duration extension in the structured securities sector.

As I have described in earlier calls and presentations, we segregate assets in our investment portfolio to facilitate asset liabilities duration management. The larger portfolio, approximately 76% or $25.2 billion of our interest rate sensitive securities, supports the P&C and corporate segments. That portfolio had a 4.5 year duration as of the end of the fourth quarter. The second smaller portfolio, approximately $8.2 billion or 24% of our interest rate sensitive securities, are segmented and aligned to support certain long term interest sensitive liabilities, primarily in the life group noncore segment. We refer to this portfolio as our matched portfolio. That portfolio had a 9.9 year duration as of the end of the fourth quarter.

It is important to recognize that roughly 80% of unrealized losses as of December 31, 2008 were in investment grade securities. In addition, over 50% of those losses are in securities with maturities that are over ten years. These longer maturity assets are generally aligned with liabilities in the matched portfolio that have a duration need of ten years or longer. Many of the liabilities held in the matched portfolio are subject to cash flow testing that essentially requires us to own the long duration bonds that have been significantly affected by turmoil in capital markets during the past year. Among the liabilities that the matched portfolio supports are long term care and structured settlements which do not have potential policy liquidity demands that many other life products contain.

The nature of the liability cash flows, both in the matched portfolio and the property and casualty portfolio, greatly mitigates the risk of unexpected liquidity stress. In addition, of course, we maintain substantial liquidity in our insurance subsidiaries and generate significant positive operating cash flow.

The Company generated over $3 billion in operating cash flows in 2008. In addition we held $3.6 billion in cash and short term investments at year end 2008. At the Loews Investor Conference in November, we outlined our ability to generate positive cash flow under extreme and prolonged market stress scenarios. Even in these highly improbable scenarios we would not be forced to sell investments to meet liquidity needs. In short, we have the ability to hold currently underwater securities until maturity if necessary.

We have a $7.8 billion structured portfolio that is well diversified and of high quality, 90% in government or AA rated or better securities. This portfolio is paying down monthly, generating over $150 million in principal cash flows per month in 2008. While it is likely these cash flows will decrease somewhat in 2009, they will still be a healthy contributor to our overall cash flow. Exposure to subprime and Alt-A is decreasing. Additionally, CNA has approximately $660 million of exposure to commercial mortgage backed securities.

For the month of January we saw our unrealized loss position improve modestly, roughly 1%, on an overall basis. While this may not mean the end to the negative news, it does reflect improvement in some sectors of the market such as municipal securities.

Before opening up the call for questions I would like to report briefly on our noncore businesses as well as our capital management activity during the quarter. The Life Group segment produced a fourth quarter net operating loss of $39 million in 2008 versus a loss of $17 million in 2007. The difference was primarily the result of adverse investment performance on a portion of our pension deposit business. The corporate segment had a fourth quarter net operating loss of $105 million in 2008 versus a $29 million loss in 2007. The decline was primarily the result of reduced investment income.

During the quarter we completed our annual ground up reserve analysis for both our asbestos and pollution liabilities. As a result of the analysis we made no change to our carried asbestos reserve and increased our pollution reserves by $80 million pretax.

Turning to capital management, we completed a $1.25 billion preferred stock issued to Loews, as announced in our last call. We contributed $1 billion of the proceeds to our major insurance subsidiary, Continental Casualty, in the form of a surplus note. Subsequently, we further bolstered the surplus of Continental Casualty with another $500 million cash contribution. In addition, we drew on our $250 million credit facility to retire $200 million of CNA public debt that matured in the fourth quarter.

Despite the pressure that valuations have put on capital we have maintained a consistent and healthy, as measured by RBC level of regulatory capital. We also still maintain holding company cash of over $500 million, which now represents more three times our annual level of net corporate obligations. The lack of debt maturities until 2011 and bank revolver maturity in 2012 should provide further comfort.

Let me finish where I started. Our company has built a solid foundation, capable of withstanding prolonged market stress. CNA is well positioned to capitalize on opportunities likely to emerge in the insurance marketplace in 2009 and beyond.

With that, let me turn it back to Tom.

Thanks, Craig. Before we open it up for questions, I would like to close with two summary observations. First, our insurance businesses performed well in the fourth quarter, as they did for all of 2008. I am also pleased to say it was not a unique quarter from the standpoint of core business performance. Good things have been happening here for some time. Consistently solid net operating income from property casualty operations, combined ratio consistently below 100, expense ratio consistently below 30, solid accident year results, prudent reserving practices, eight consecutive quarters of favorable development, and positive trends in rate and retention.

Second we don't underestimate the challenges of the insurance and financial markets. Against this backdrop you shall expect us the stay on the fundamentals and to achieve continuous improvement in our business performance over time. With the earnings potential of our core business and the highly liquid financial position, we are excited by the opportunities that present themselves in 2009. With that, we will take your questions.

(Operator Instructions). We will take as many questions as time permits. We will pause for a moment. We will take our fist question from Jay Cohen with Bank of America.

Yes, it is actually Bank of America/Merrill Lynch still. Two questions. The first one may be more numbers oriented. The second question bigger picture. On the first one, the accident year combined ratio excluding catastrophe losses seems to have jumped in the fourth quarter versus the first three. Had been running about 96 now all of a sudden it is at 100. This is for property casualty operations. And I am wondering what's behind that increase.

And then secondly, Tom, if you could talk about your main focus at the company. You have been there now for a bit of time. You've had a chance to look at things. As you look into 2009, 2010 what is your main focuses that you will be working on?

Yes Jay. This is Larry. On the first question, the comparison of the accident year loss ratios from fourth quarter was that the first quarter? What was your point of compare?

It was the accident year combined ratio, ex cash, in the fourth quarter versus the first three quarters. My number is running closer to 96. This quarter was just over 100 for the standard in the specialty business combined.

The major change in the fourth quarter for the current accident year involved the specialty lines business and that was primarily taking action on the credit crisis including made-off exposures.

Right. That makes sense. Okay.

Jay, it is Tom. Good to hear you again.

Absolutely.

Sooner or later they will get the name of your firm correctly.

Maybe one day.

I guess, number one, I am pretty excited to be here. I think there's a lot of upside at CNA or I wouldn't have come here. Today is my 26th day. So I still have a lot to review and understand about CNA and how they operate and their position in the marketplace. But I guess I would start off by saying I want to be thorough and thoughtful about this strategy going forward. It would be great to make a lot of promises today, but I really want to do the right research and be able to tell you something at the end of the first quarter that has staying power.

All of that being said, a couple of real positives that I found when I got here, number one, a lot of support from the producer plants. They are very interested in CNA as the market, not only what we do today but what we could do for them in the future. As we mentioned on the call, we think that the underwriting results have improved a lot. And that is pretty good considering what has been going on with rates for the last few years. Definitely some clear underwriting strengths and capabilities in segments like HealthPro, construction, and programs. They really are well thought of by our producer plant and our customers. Strong service platforms. I think we have a first rate claims operation, risk control, as well as the back office. Probably the lost point I would make is some very, very capable people here at CNA and ultimately people make the difference.

With that, what you could expect to hear from me at the first quarter conference call is a lot more about how we expect to grow the top line and the bottom line, more on the underwriting appetite, customer segmentation and expertise from an underwriting and service standpoint, more about how we are going to develop our producer network to really produce great results not only for us but for them, and ultimately what our underwriting strategy will be going forward for those segments that we choose to play in. So, I think you are going to have to wait until the end of the first quarter but I will give you plenty then, Jay.

Great. Thank you.

(Operator Instructions). Our next question comes from Dan Johnson with Citadel investment Group.

Thank you. Good morning. Two questions, Craig. First, on the muni portfolio in the P&C business being carried at about $0.90, on the life side about $0.80, can you give us a little color as to what sort of munis were invested in. I don't know how you want to characterize it but it would be helpful to understand that. And finally can you touch on what sort of rating triggers the company has, say, within a notch or two, from where you stand today? Thank you very much.

Let me take the muni question first, and I would refer you to that part of my remarks where I mentioned the matched portfolio and the duration of those liabilities. So those are the longer duration which have been hit the hardest by the market valuation issue. So that is what is really driving those differences in the marks in the P&C munis and in the life group matched portfolio muni.

And then, if you would just rephrase, I am not sure exactly what your question is about rating notch.

Ratings triggers that you have whether it is, anywhere on the business, whether it is counterparties, financing, within a notch or two of where you is sit today, what should we be mindful of.

I would refer you back, Dan to the Loews investor conference presentation where we laid out a bunch of stress scenarios on liquidity, and we said if we were downgraded, if we had more than a two notch downgrade, there was less than like $70 million of potential collateral that would be accelerated. So it was de minimus and most of that was some form of claim settlement. So we don't have any, there's no potential stresses or walk-outs there in that regard.

Thank you very much.

(Operator Instructions). We will take our next question from [Ray Whitlander] with Tradewinds Global Investors.

Hi. Thanks for taking the calls. Can you just give us an idea of the distribution of the limited partnership portfolio? And the top five account for what percent of that portfolio?

Hold on one second. We will see if we can get that answer for you. But I would tell you it is very with well distributed across different strategies, and the results have been pretty evenly distributed across strategies, too. So really the two top sectors would be relative value and multi strategies and then long short equity plays. Those three would account for over 50%.

Okay. The disclosure in the 10-K is still fairly accurate, there's about 60 partnerships in there?

There are 82.

82, okay. Secondly, for the other taxable fixed income holdings, can you give us an idea of the average rating of that portfolio and the BB and minus components, as well.

I'm sorry. You want to know of the --

There's good disclosure on the structured side, but on the other taxable, presumably all corporate, what is the average rating of that portfolio, how has that migrated, and what is the component that is BB and minus?

The high yield portfolio, meaning the below investment grade portfolio, is, market value about a little less than $2.6 billion. But over 40% of that is in bank debt. That has been beaten down by the market because of quantitative easing impacts on short term rates and just what people think extension but we feel comfortable about that position in the corporate structure and the security there. The overall fixed income portfolio is AA minus.

Right, but just the other taxable, because most of the structured is still AAA, right. So, can I just assume the other taxable is AA as well?

About a little over 10% is government and agencies, about 35% is AAAs. Another close to 30% is A and AA. About 17% BBB and then you have got the non-investment grade I talked about.

Okay. Finally, what tax rate do you use for the deferred tax asset against these unrealized losses?

It would be actually calculated by the individual security, by individual security, depending on where we are with the tax basis and where we are with a certain impairment basis, but it is roughly, somewhere in the lower 30s range.

Okay. Thanks.

We will take our next question from Bob Glasspiegel with Langen McAlenney

Good morning. I got bumped off so I apologize if you answered this, Tom. But could you talk about the due diligence process you went through before leaving what was a pretty good job to take this with respect to the investment portfolio and operations? And secondly, what sort of changes do you think you're going to be able to bring to the party strategically that you think should be done differently, or is it just a question of just keeping the operating agents on track?

Good morning, Bob. Number one, on due diligence, certainly all of the public information was available to me and I read that pretty thoroughly. Having been in the business for a few years, I certainly understood the marketplace and how the market works, whether it was by underwriting or I will say the sales distribution perspective. So in my old life we would run into CNA and I had some impressions of how CNA operated in the marketplace and how they performed as an underwriter. So I did a lot of home work.

I did talk to a lot of producers to get a feel for what CNA was about after I had left my prior employer. And quite honestly, I had a feeling that there was a lot of upside here, as I said earlier on the call. So I think the market is what the market is today. I think the market will hopefully change, maybe not right away but timing is everything in this business and I think we are in a pretty good position.

I did comment early about what I am going to do but just to be brief, I'm going to be pretty thorough and thoughtful about what CNA needs to do to be a great company and I expect that at the first quarter conference call I can tell you a lot more about what is happening. So from that perspective, we will come out and tell you what we expect to do to grow the top line, the bottom line, underwriting appetite, customer segmentation, talk about the distribution capabilities that we have today, and maybe what we will do in the future and underwriting strategy.

Nothing from investment or run off business management orientation? You didn't mention those as priorities.

Well, we are certainly interested in the performance of our investment portfolio, like any other insurer would be, and we continue to watch that very closely. I can tell you we have very good data and information here to track these things. I have been very impressed with the level of detail when I ask a question. So, just as I said, I will be thorough and thoughtful. We will continue to be thorough and thoughtful on all fronts. But this isn't Washington DC that has a plan in 16 days and they don't know how they're going to pull it off. We're going to have a plan and we're going to know how to pull it off.

Thank you. And good luck.

Thank,s Bob. We will take a follow up question from Jay Cohen with Bank of America/Merrill Lynch. Congratulations, Jay, they got it right.

Maybe we can get the name changed by then. Just a quick one for Craig. What's the debt to capital now you at the end of the year?

23%.

Say it again -- 43?

23.

23. Great. Okay. Thank you.

(Operator Instructions). It appears there are no further questions.

Thank you. Thank you all for joining us today. And once again I just call your attention to disclosures concerning forward-looking statements and non-GAAP measures. A taped replay of today's call will be available for one week immediately following this call until February 16th. You can see the replay details in our earnings release. Again we appreciate your participation and thank you again.

This concludes today's conference. We appreciate your participation.