CNA Financial Corp (CNA) 2010 Q1 法說會逐字稿

Good day, and welcome to the CNA Financial Corporation's first-quarter 2010 earnings conference call. Today's call is being recorded. At this time, I would like to turn the conference over to Nancy Bufalino. Please go ahead.

Thank you, Joseph. Good morning, and welcome to CNA's discussion of first-quarter 2010 financial results. Our press release was issued earlier this morning. Hopefully everyone has had an opportunity to review it, along with the financial supplement, which can be found on the CNA website.

With us this morning are Tom Motamed, our Chairman and Chief Executive Officer, and Craig Mense, our Chief Financial Officer. After Tom and Craig provide their remarks about the quarter, we will open it up for questions.

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 results -- further details.

In addition, forward-looking statements speak only as of today, May 3, 2010. 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 CNN's website at www.CNA.com.

With that, I'll turn the call over to CNA's Chairman and Chief Executive Officer, Tom Motamed.

Thank you, Nancy. Good morning, everyone and thank you for joining us today. We are pleased to report significantly improved first-quarter results. Net operating income was $223 million or $0.74 per common share as compared to $149 million or $0.44 per common share in the first quarter of 2009.

First-quarter net income was $245 million or $0.82 per common share compared with a net loss of $195 million or $0.84 per common share in 2009.

These results were driven by investment income and realized gains.

WE are also pleased to report improvement in our capital position. Book value per common share increased 6% from year-end 2009 to $37.97, reflecting a $10.2 billion of GAAP common shareholders' equity.

In our core Property-Casualty Operations, the first quarter combined ratio was 102% compared with 98.2% in the first quarter of 2009. The difference is attributable to 2.7 points of catastrophe losses this year as compared to 0.9 points in the first quarter of 2009. Despite the increase, we view our catastrophe losses as reasonable in a quarter that saw heavy catastrophe losses across the industry.

Also this quarter, we took 2.7 points of favorable development compared with 3.7 points in last year's first quarter. Before development and catastrophes, the first-quarter combined ratio was 102% as compared to 101% in 2009.

The first-quarter 2010 accident year loss ratio was 71.1% as compared to 70% in 2009. Before catastrophes, this quarter's ratio was 68.4% as compared to 69.1% in the first quarter of last (technical difficulty). On a full-year basis, the 2009 accident year loss ratio before catastrophes was 69.1% as well. Net written premiums decreased 7%. [As I will] describe in some detail later, a large portion of this decline related to exposure decreases and return premiums in our Commercial segment. Excluding currency fluctuations, our premiums decreased 8%.

The Property-Casualty 2010 expense ratio increased 2 points to 33.5. One point was the result of costs related to the IT outsourcing initiative which I will describe later, as well as lower net earned premiums and additional production and underwriting staff in the field. The other point was from higher agency compensation and from industry assessments. I will revisit expenses at the end of my remarks.

CNA Specialty continues to perform well, delivering a combined ratio of 92.5% compared with 89.1% in the first quarter of 2009. Catastrophes added 0.3 points compared with 0.2 points in the first quarter of last year. Before catastrophes and development, the first-quarter combined ratio was 96.4% compared with 94% in 2009. Specialty's first-quarter 2010 accident year loss ratio was 65.7% as compared to 65.1% in 2009. Before catastrophes, this quarter's ratio was 65.4% as compared to 64.9% in the first quarter of last year.

On a full-year basis, 2009 accident year loss ratio before catastrophes was 64.9% as well. The 0.5 point period over period difference was driven by margin compression, with the loss trend exceeding the change in earned rate. Specialty's net written premiums were down 2%.

With respect to renewals, our rates decreased 1%, which is a two-point improvement -- of improvement over the prior year period. The ratio of new to lost business was 1.1-to-1, unchanged from the first quarter last year. Our retention improved 1 point to 86%, and our policy count was virtually flat.

Specialty continues to enjoy a healthy flow of business. First-quarter submissions increased 11% in our professional and management liability businesses. Our written-to-quoted ratio improved 4 points to 37%. Overall, we are maintaining our underwriting discipline and market position in Specialty.

Turning to CNA Commercial, the first-quarter combined ratio was 109.5% compared to 105% in 2009. Catastrophes added 4.7 points compared with 1.4 points in the first quarter last year. Before catastrophes and development, the first-quarter combined ratio was 106.3% compared with 106.1% in 2009. Commercial's first-quarter accident year loss ratio was 75.3% as compared to 73.6% in 2009. Before catastrophes, this quarter's ratio improved to 70.8% from 72.2% in the first quarter of last year.

On a full-year basis, the 2009 accident year loss ratio before catastrophes was 72.3% comparable to the first quarter 2009 results.

Commercial's net written premium decreased 10%. Half of the decrease was the result of exposure decreases and return premiums. The other half relates to reprofiling of our Commercial book, pushing harder on rate and being more selective on new business. Rate increases were 1% in the first quarter of 2010, a two-point improvement over last year's first quarter.

Retention declined to 79% from 83%. The new-to-loss business ratio was 0.9-to-1 as compared to 1.4-to-1 in the first quarter last year. First-quarter submissions in Commercial are up 13. However, our written-to-quoted ratio decreased 2 points to 24%, in line with our more selective underwriting and pricing strategies.

Now I would like to come back to expenses, starting with headcount. Total headcount is down approximately 2% (technical difficulty) first quarter last year. This decrease also reflects a reallocation of personnel. We made investments in additional production and underwriting staff in the field, while increasing the efficiency of the staff support units.

During the first quarter, we began the outsourcing of certain IT functions. The outsourcing initiatives carry an estimated total one-time cost of $41 million, of which $25 million was incurred in the first quarter. The majority of the remaining cost will be recognized throughout the remainder of 2010.

We expect to achieve an annual run rate savings of approximately $65 million. A significant portion of the annual savings is expected to be realized in 2011, with full annual savings in 2012 and beyond. Some or all of these savings may be reinvested in the business, either in IT or other investment to drive our strategies for top- and bottom-line growth.

With that, I will turn it over to Craig.

Thanks, Tom. Good morning, everyone. The first-quarter's highlights include net operating income of $223 million, an 8% operating return on equity, net income of $245 million, continued improvement in the value of our investment portfolio, our 13th straight quarter of favorable P&C reserve development and an increase of over $2.00 in book value per share. I would characterize the quarter as very respectable and reflective of our focused efforts and measurable progress.

As you heard from Tom, our Specialty business continues to deliver superior results, and our Commercial business results reflect improving discipline. The modest level of cat losses and favorable prior-year reserve development were approximately the same this quarter. Both results reflect our disciplined underwriting and reserving practices.

Our balance sheet and capital position remain very strong and showed consistent improvement again this quarter. We continue to maintain a very conservative capital structure and to exhibit a strong cash flow and liquidity profile.

Earnings and the increased valuations of our investments continue to drive capital growth. Book value per common share improved 6% from year-end 2009 to $37.97. Regulatory capital increased 3% to $9.6 billion. Improved levels of net investment income, primarily from limited partnerships, were significant contributors to operating income. First-quarter net investment income totaled $590 million, up from $420 million in the prior-year period, an increase of 40%. The improvement was driven by our LP investments, which produced first-quarter pretax income of $72 million compared with a $70 million loss in 2009. The first-quarter rate of return on LPs was approximately 4%.

Income from the remainder of our portfolio, mainly fixed maturities, also improved, increasing approximately 5% from the prior-year period, reflecting our continued growth in investable assets and a reduced cash and short-term investments position.

Net income for the quarter of $245 million included $22 million of after-tax realized investment gains. These results include an after-tax impairment losses of $39 million. The impairments were spread across several asset classes and largely reflect intent to sell decisions that are part of our ongoing management of the portfolio. Credit impairments made up less than 30% of the total.

The market value of our investment portfolio increased by over $800 million during the first quarter, driven by improved valuations as well as operating cash flow. The portfolio's pre-tax net unrealized gain was $560 million at March 31, 2010. This compares to a $25 million net gain position at year-end 2009. We continue to benefit from improved valuations as credit spreads narrow, as well as from the recovery of our structured portfolio.

Our effort to reposition the investment portfolio to manage risk and volatility and to drive more consistent performance in the future has been largely completed. The majority of our investment purchases in the first quarter of 2010 were centered in investment-grade corporate bonds and taxable municipal bonds. During the quarter, we made net purchases of $1.4 billion of investment-grade corporates, which increased this asset class to 44% of invested assets at fair value as compared to 42% at 2009 year-end and 24% at year-end 2008.

We added approximately $1.1 billion of taxable municipal bonds during the quarter. Our total investment in this class was $1.2 billion at quarter-end. These investments are included within the taxable fixed maturities lines shown on pages 5 and 6 of our financial documents.

Cash and short-term investments were reduced to $2.6 billion at the end of the first quarter as compared to $4.1 billion at year-end 2009. This level of cash and short-term holdings still significantly exceeds our expected liquidity needs.

Our investment decisions reflect our sustained emphasis on diversification, quality and liquidity, as well as the importance of ensuring that our portfolio is aligned with the needs of our insurance business.

The effective duration of the overall portfolio was 6.1 years at quarter-end compared with 5.8 at year-end [2009]. This change largely reflects the reduction of our short-term holdings.

We continue to segment our portfolio to facilitate our disciplined approach to asset liability management. The effective duration of the assets which support our P&C liabilities was 4.4 years at quarter-end, which is within our target range. The fair value of these assets totaled $29.9 billion and represented approximately 75% of our fixed income investments. About a quarter of our fixed income investments, which total approximately $10.8 [billion] at fair value, are held in a separately segmented portfolio to match our long-duration [life-like] liabilities associated with businesses and runoff. These assets had an effective duration of 11 years, which is in line with the portfolio target.

Our operating cash flow remains very strong. In the first quarter of 2010, we generated approximately [$250] million of operating cash flow, excluding trading activity and after paying for dividends. During the quarter, we received approximately $750 million of principal cash [repayments].

Returning to a discussion of our capital position, all of our capital metrics -- total capital, statutory surplus, RBC ratios, debt to capital, coverage ratio and all rating agency capital models are well above our target level. Our regulatory capital levels reflect our sustained improvement.

Our statutory surplus increased from $9.3 billion at year-end to $9.6 billion at the end of the first quarter. We now have over $930 million of dividend capacity in our primary insurance subsidiaries. Our financial flexibility is further enhanced by slightly over $350 million of cash and short-term investments that we continue to maintain at the holding company, which is more than 2 times our annual debt obligations.

Now I would like to report briefly on our non-core businesses. Our Life & Group Non-Core segment (technical difficulty) first-quarter net operating income of $1 million compared with a net operating loss of $22 million in 2009. The increase was primarily driven by improved performance in our (technical difficulty) deposit business and an assumed reinsurance computation in our group reinsurance runoff business that had a favorable impact on reserve development.

The corporate segment produced a first-quarter net operating loss of $3 million in 2010 as compared to a net operating loss of $9 million in 2009. The improvement was driven by higher net investment income.

With that, I will turn it back to Tom.

Thank you, Craig. All in all, we had a good quarter. Net operating income of $223 million or $0.74 per common share, net income of $245 million or $0.82 per common share, continued strong performance by our Specialty business and incremental progress on improving the profitability of Commercial.

Favorable results from a catastrophe perspective, 2.7 points of catastrophe losses in a quarter marked by heavy losses industrywide; strong investment results, with $22 million in after-tax capital gains; and a $535 million improvement in our unrealized position; improvement in our capital position, reflected in a 6% increase in book value per common share to $37.97, with GAAP common shareholders' equity increasing to $10.2 billion.

I would like to close with a few comments on our outlook. At the end of 2009, we anticipated that market conditions might begin to improve in light of low investment returns, the depletion of reserve redundancies and (technical difficulty) --

Ladies and gentlemen, please stand by. The conference will resume momentarily.

Don't know where we lost you, so I may repeat a paragraph. At the end of 2009 we anticipated the market conditions might begin to improve in light of low investment returns, the depletion of reserve redundancy and a generally weak economy. Instead, we are seeing competition intensifying across most lines. The weak economy continues to pressure premium volume, but the impact appears to be moderating.

As I mentioned, return premiums and exposure decreases reduced our commercial premium by approximately 5% this quarter, up two points from first-quarter 2009, but down a point from the fourth quarter of 2009.

In this environment, we believe we are well served by our steady and consistent focus on improving the profitability of our Commercial book, and continuing to build on the strengths of our Specialty book. As discussed previously, we have a three-part strategy.

First, developing and deepening expertise in an expanded set of industries. Across these industries, we continue to build under writing and pricing discipline, which is evident in our Commercial segment. Accident year results have improved. We are encouraged to have moved into positive rate territory. Increased submissions reflect producer understanding of our appetite and abilities. Our selective approach to underwriting and pricing is reflected in lower retention and hit ratios. We are determined to make Commercial a better business.

Second, managing the mix to improve profitability. We continue to execute our plans to grow Specialty and fix and grow Commercial. Specialty had another good quarter; a 92.5 combined ratio and healthy business flow speaks to our ability to maintain a strong market position without sacrificing underwriting discipline.

Third, extending our geographic reach and increasing our capabilities at the point-of-sale. We continue to focus on making our producer relationships more effective and building a distinctive market position. The opening of three new offices with two more on the horizon positions us to continue to improve business flow and drive profitable growth over time.

In addition, we continue to manage our expenses to support our strategies and build human capital. By reallocating personnel to underwriting and production positions, we are putting more of our resources to work and producing profitable business.

In summary, we believe that we are pulling on the right levers and making steady progress on becoming a higher performing company. Now we would be glad to take your questions.

(Operator Instructions) Jay Cohen, Bank of America Merrill Lynch.

I'll start with two questions. The first is, given the dividend capacity, given the liquidity at the holding company, it seems as if CNA is in a great position now to pay back the Loews Preferred. I'm wondering what your thoughts are on that.

I'd say we agree, so the capital position -- I guess there are several thoughts. One, the capital position is very strong, and we think the market is beginning to appreciate just how strong the credit is. But we do think it is still somewhat underappreciated, and we expect that to change over time. So we don't -- I guess the other thought is we don't have any particular external constraints. Admittedly, we are moving a bit cautiously -- or have moved a bit cautiously here, because of what we have lived through. But the payback is also economically compelling. But beyond, that I can't really comment on any specific capital plans.

Okay. And you would have to pay back that security before you pay a common dividend, correct?

That's correct.

Okay. Secondly, the accident year loss ratio excluding catastrophes in the Commercial business being better, I'm wondering, given the rate trend, I guess our overall expectation is generally to see that number deteriorate for just about everyone. Obviously, you guys are restructuring that business, reunderwriting it, and that clearly is having some impact.

Is there anything else going on where the non-cat loss is somewhat light this quarter? And I guess would you expect that number for the full year to be lower than where it was in 2009?

I think the first thing, Jay, if you look at some of the first-party coverages we have been able to, I'll say, improve our losses in those areas. If you looked at the first quarter of 2009, the property book took a lot of large hits. As you have described, we are reprofiling, repositioning the book, and what you find is first-party business is the first thing you can have an impact on. You live with casualty because of the tail for a longer period of time, but we are clearly seeing improvement by what we are doing on the first-party side.

The second thing is frequency is down in the Commercial lines arena for us. So that gives us some hope that we are getting out some of the gunk as well, so we are getting rid of some of the large losses and we are cutting down the frequency, so all of that is favorable.

As to how it plays out, you know the business is lumpy. First quarter, most people don't think it is a big cat quarter; everybody thinks it is the third. But clearly, from our perspective, we believe that a lot of the actions we have been taking are going to pay off, and whether they pay off second quarter, third quarter, fourth quarter, you know how written premium turns to earned, it is going to take some time to earn this stuff through. But we are optimistic, and we believe we are, as I said, pulling on the right levers.

That's great. If I could sneak one more and, and that is just the deepwater rig in the Gulf. Can you talk about your potential exposure? And if you have any views on the industry exposure, that would be interesting as well. And that would be my last one.

On the P&C side, we don't have any exposure to that. So clearly, from a claims standpoint, we are not in the energy business, we are not in that type of oil and gas. That is something that is not in our portfolio today, nor is it planned for the future.

Great. That's good. That's good. Thank you very much.

Bob Glasspiegel, Langen McAlenney-Janney.

Hopefully, the phone systems weren't part of this IT restructuring, because Tom, you were garbled all the way through until you had the blast at the end; then we could hear you loud and clear.

Let me be clear, Bob, that the telephones have nothing to do with IT transformation, and that will not be garbled, trust me.

Okay. I don't know whether you need to maybe put some of the numbers on your website or --. I mean, I'm not going to make you good through them all, but the numbers just were not clear for those on the call.

Just to follow a couple of them that I do need relative to Jay's line of questions, did you say you had $300 million at the holding company -- [lost] of excess?

Over 350, Bob.

350, and you have $900 million of dividend capacity?

That's correct.

Okay, so if you wanted to pay down the preferred, you said -- it would sound like you would have about $1 billion available to do it. Or is there some other number that just could cap the upside of how much you possibly could do?

I think you've got to take into account what it does to coverage ratios and what it does to leverage ratios as such.

I know. I'm just saying (multiple speakers) -- I'm just saying you couldn't do more than $1 billion -- or you could do about the $1 billion; that would tap all your cash at the holding company, with the increased borrowing.

Right.

Okay, and on Commercial lines, I applaud you for taking the stand you are to try to raise rates and lose business. How much tolerance for the top line declining do you have, Tom, and when does that strategy start to distress?

I think the short answer, Bob, is we have more tolerance to push the retention number down if we can get rate. Clearly, a point of rate is worth a lot more to us than a point of retention, so we are going to push rates. And right now, what I would tell you, it is month-to-month, it's a little lumpy. But some months are better than ever and we are maintaining our discipline, pushing rates, and so far we are pretty confident that we can still keep pushing that number up.

Okay. That's a great answer. Is there any -- someone is willing to write this business at lower rate than you are willing to write it, to take it from you. Is there any characterization of whether it's regionals, nationals, subs of Bermudas trying to grow US? Is there any sign of who has the appetite to write the stuff you don't?

We don't keep track of the pools. The reality is if they want to price it less, be our guest. We've lived with these accounts. We know what the performance is, and we know what we have to do to make them profitable. So clearly in this business, everybody thinks they are smarter than the other guy. Well, that's okay.

But from our perspective, we will shed Commercial business if we don't believe we can make money on it. We have said on earlier calls our objective is to make a profit in every line of business, every geography, and we are committed to that, and we are pleased with the returns to date. But as to who is writing it, I would say it is a little bit of everybody.

Thank you, Tom.

Amit Kumar, Macquarie.

Thanks and congrats on the quarter. I guess just staying on that topic of -- in terms of competition, it does seem to be a bit of variance from what others are saying. Can you just expand on that a bit more? Is it some specific lines and accounts, or is it terms and conditions, where you are seeing new competition emerge at this stage of the cycle?

Your question is Commercial?

Yes.

I would say a couple things. Clearly, I think others were pushing rates up earlier than we were. We were a little late to the party there. So as you have described and I think what you are saying is their rate profile is not necessarily going up. It might be stable or slumping a bit. So I think we got to the party a little late, so we are pushing now. So that would be one of my categorizations.

The other thing is when you look at our growth, or lack thereof in Commercial, we are looking at a good amount that were return premiums, because this business is retrospectively rated. And after return premiums, the fact is the economy is not great and exposures are down. We have a construction book of business, and that has taken a pretty good hit from the economy.

So I think clearly when we look at our numbers, we have pretty good confidence in why the rates are going up and why we are losing business. And obviously, return premiums are an economic issue.

Okay, that's helpful. Maybe just moving on to the IT transformation cost. Just trying to understand this a bit better. Is it all on back office kind of things, or does this improve the claims and distribution side of the business, too?

This is primarily what we would call home office expense. It is in the world of applications and mainframe. But somebody mentioned they may not have heard the numbers. The outsourcing initiative, the one-time cost is $41 million. We incurred $25 million of that in the first quarter. The remainder we will incur through the rest of the year.

But clearly, one of the things that we have done is simplify how we do business internally at CNA, and a lot of these costs are coming out because we are simplifying how we do things, eliminating systems that don't make a lot of sense and trying to build things that work across the Enterprise, as opposed to building things to satisfy every constituency in the Company.

Okay, that's helpful. A third question on the catastrophe losses. Can you just give some more color on that? What sort of policies are impacted, and what kind of losses did you see in the first quarter?

Well, you know, it's a property event. Whether you talk about Northeast storms, Chilean earthquake, these are all property losses in the first quarter. I would say in general they were smaller losses. It did not trigger any reinsurance. But we are pretty pleased with an overall 2.7 points of cat. It was $40 million all up. $27 million was in the Northeast, where the winter storms were frequent, and we had about $13 million in Chile.

Okay, that's helpful. And final question, just on the reserve releases, could you give -- and maybe I missed this in the comments -- could you just talk about what time periods did these reserve releases come from?

On the Commercial side, it would have been accident years 2007 and prior. And in the Specialty business, 80% of their releases would have been 2006 and prior; the remaining 20% in the 2007 accident year.

Okay. That's very helpful. That's all I have. Thanks.

(Operator Instructions) Ron Bobman, Capital Returns.

We could hear you fine in New York. It may have just been an aging analyst struggling.

You -- the premium numbers year-over-year in CNA Commercial obviously declined. And you touched on -- I think you used the words more selective or selective approach. And I think the ratio you talk about, sort of the win-to-quote or go the win-to-renewal ratio obviously dropped, I think, from 1.1 so 0.7.

So I'm curious to know how do you actually implement that more selective approach or selective approach. How does it sort of get distributed into the underwriting offices and underwriters' desks to sort of implement that selective approach? Thanks a lot.

Great question. I would say, first of all, it starts with a coherent, clear and convincing strategy at the home office level, which we have done in Commercial. We already had that in Specialty, so we started with that last year.

The first thing we did was we said we wanted to focus on approximately 10 industry verticals where we believed the opportunity for growth and profit were best, and to minimize the amount of business we wrote in other industries that did not fall within those 10.

And if you look at that, a year later, what I would tell you is that has turned out pretty well. We are writing more business in the areas we want, less in the other areas. So clearly, that is part of it from a new business standpoint. So the message is clear with our people in the field. It is becoming clearer and clearer with our producers, as we see more submissions in those areas we are interested in.

When it comes to rate, we are building more tools within CNA that allow underwriters to look more frequently at their portfolios to determine what they are doing in what we would call schedule credits and debits on accounts. In other words, how much price elasticity are we willing to take in certain lines of business and certain industry segments. And we have tightened that up quite a bit. And when we have done that, that has impacted retention as well.

So as we go to the market and say on our existing portfolio, we need more rate -- well, guess what, some of the buyers aren't willing to pay for a higher price and the business moves. But we are not going to sacrifice our objectives on getting more rate for the exposure. And clearly, every branch has metrics for rate, for exposure, for price change, for new business, for lost business, for retention. And we now watch that stuff very much more closely than we did in the past.

And we have also made our field offices responsible for most of the lines of business that CNA writes. We do have certain lines of business that are controlled from a central location. But we believe that we have created much more accountability at the point of sale for not only overall performance, but line of business performance and segment performance.

Thanks a lot. Best of luck.

It looks like there are no further questions at this time, thus, that will conclude today's question-and-answer session. We will turn it back over to our presenter, Tom Motamed, for any additional or closing remarks.

Thank you very much. Have a great day.

Ladies and gentlemen, thank you again for your participation. This does conclude today's conference call.