CNA Financial Corp (CNA) 2011 Q1 法說會逐字稿

Good day and welcome to the CNA Financial Corporation's first-quarter 2011 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 ma'am.

Good morning and welcome to CNA's discussion of our first-quarter 2011 financial results.

Our press release was issued earlier this morning and can be found on the CNA website at www.CNA.com, along with our financial supplement.

On the call this morning are Tom Motamed, our Chairman and Chief Executive Officer, and Craig Mense, our Chief Financial Officer. Following Tom and Craig's discussion of the quarterly results, we will open it up for your question.

Before turning it over to Tom, I would like to advise everyone that, during this call, there may be forward-looking statements made and references to non-GAAP financial measures. Any forward-looking statements involve risks and uncertainties that may cause results -- actual results to differ materially from the statements made during this call. Information concerning those risks is contained in the earnings release and in CNA's most recent 10-K and 10-Q on file with the SEC. In addition, the forward-looking statements speak only as of today, May 2, 2011, and CNA expressly disclaims any obligation to update or revise any forward-looking statements made during this call.

With respect to non-GAAP measures, reconciliations of the most comparable GAAP measures have also been provided in our most recent 10-K and 10-Q as well as the financial supplement.

Finally, this call is being recorded and webcast. During the next week, the call may be accessed again on CNA's website.

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

Thank you Nancy. Good morning everyone. Thank you for joining us today.

We are pleased to report our first-quarter results. The highlights were our core Property-Casualty operations net written premiums had increased 6%, driven by growth in CNA Specialty. CNA Commercial's net written premiums were flat, a dramatic improvement from last year's negative trend. Our Commercial segment generated slightly over 1 point of improvement in the accident year loss ratio before catastrophes, reflecting the positive impact of our ongoing underwriting initiatives to improve profitability.

Our capital position continued to improve. Book value per common share increased 3% to $41.75 with GAAP common shareholders equity increasing to $11.2 billion. We completed a $400 million debt offering with the proceeds used to prepay senior notes due in August of this year. We signed a definitive merger agreement with CNA Surety.

Finally, we announced a quarterly common stock dividend of $0.10 per share.

Turning to our financial results, first-quarter net operating income was $216 million, or $0.80 per common share, in 2011, as compared to $223 million or $0.74 per common share in 2010. Net income in the first quarter was $223 million or $0.83 per common share, as compared to $245 million or $0.82 per common share in the first quarter of 2010. First-quarter net operating income from Property-Casualty operations improved to $261 million in 2011 from $226 million in 2010. Our Catastrophe losses were higher quarter-over-quarter, but the increase was more than offset by higher investment income and improved underwriting results before catastrophes.

The first-quarter net operating loss from our non-core segments increased to $45 million in 2011 from $3 million in 2010. Craig will discuss the non-core segment results in a moment.

The Property and Casualty Operations combined ratio improved slightly to 101.9% as compared to 102.1% in the prior-year period. The ratio included 3.7 points of Catastrophe losses in the current quarter as compared to 2.7 points in the first quarter of 2010. Favorable prior-year development reduced the first-quarter combined ratio by 2 points in 2011 compared with a 2.7 point help in 2010. Excluding development in catastrophes, the first-quarter 2011 combined ratio improved nearly 2 points to 100.2%, which was primarily expense-driven. The first-quarter expense ratio was 31.7% in 2011 as compared to 33.5% in 2010.

Two nonrecurring items accounted for the improvement. This year's first-quarter expenses were reduced by recoveries of insurance receivables written off in prior years. Last year's first quarter included one-time expense charges associated with our IT outsourcing initiative.

The Property and Casualty Operations first-quarter accident year loss ratio excluding catastrophes was 68.5% in both 2011 and 2010.

In CNA Specialty, we grew net written premiums 13% in the first quarter, a continuation of the growth we achieved in last year's fourth quarter. Renewal rates were essentially flat in this year's first quarter, a 1 point improvement over last year's first quarter. First-quarter renewal retention was 85% in 2011 as compared to 86% in 2010. Exposures increased approximately 1% in the first quarter.

Specialty's first-quarter ratio of new loss business was 1.7-to-1. Quarter-over-quarter, [evictions] increased 23%. The hit ratio improved by 3 points to 36%. We are especially pleased by strong new business production in professional and management liability as well as our Warranty business. We generated 5% growth in policy count in professional and management liability. These results validate our investment of more than 70 additional Specialty underwriters since mid 2009.

Specialty's first-quarter combined ratio was 94.9% in 2011 as compared to 92.5% in the first quarter of 2010. Favorable prior-year development reduced these ratios by 3 points and 4.2 points respectively. The impact of catastrophes was minimal in both periods.

Before development and catastrophes, Specialty's first quarter combined ratio was 97.6% in 2011 compared with 96.4% in 2010. Specialty's ex-cat accident year loss ratio was 66.9% in the first quarter of 2011, an increase of 1.5 points over first quarter of 2010 but relatively unchanged from full year 2010.

Turning to CNA Commercial, first-quarter net written premiums were flat in 2011, a welcome improvement from last year's premium trend, even as we continue to focus on improved pricing and risk selection. Renewal rates in Commercial increased 2% in the first quarter, our sixth consecutive quarter of positive rate increase. Renewal retention was 79%, a 1 point improvement from the prior year's first quarter.

As for Commercial's flow of business, first-quarter submissions were up 6% and the hit ratio was down 1 point to 24%. The new-to-lost business ratio was 1.1-to-1.

The return premium audit that reduced our premium volume in prior quarters continues to moderate. In last year's first quarter, return premium audits represented three points of a 10% decrease in net written premiums. This year, return premium audited added negative 1 point impact. The return premiums continue to be concentrated in our construction business.

CNA's COMMERCIAL first-quarter combined ratio was 107.7% in 2011 as compared with 109.8% in 2010. These ratios included Catastrophe losses of 6.6 points and 4.7 points respectively. The first-quarter favorable prior-year development was 1.2 points in 2011 and 1.5 points in 2010.

Before catastrophes and development, Commercial's first-quarter combined ratio improved more than 4 points to 102.3%. Three points of the improvement are from the expense ratio which included the one-time items I mentioned earlier. More significantly, we are pleased to note that Commercial's first quarter ex-cat accident year loss ratio improved more than 1 point to 69.9%, driven by our underwriting strategies.

With that, I will turn it over to Craig. Craig?

Thanks Tom. Good morning everyone.

I would characterize the first quarter as a good one from an operating perspective. We produced steady earnings and demonstrated meaningful progress across a number of fronts.

CNA's net operating income was $216 million and operating return on equity of 8.1%. Operating income attributable to common shareholders increased 8% as compared to the prior-year period to $0.80 per common share. Operating EPS in the prior-year period was reduced by the dividend paid on the senior preferred stock which was fully redeemed over the course of the last year.

Our Property and Casualty business delivered improved operating earnings of $261 million, up 15% over last year's first quarter, fueled by investment income and helped by lower expenses, increased revenue, and a stable accident year loss ratio.

First-quarter net income of $223 million includes after-tax realized capital gains of $8 million. Impairment losses were modest, and as in previous periods, the impairments largely reflects intent-to-sell decisions that are part of our ongoing portfolio management.

We continue to build on the strength of our balance sheet and to improve our financial flexibility. We maintain a conservative capital structure. All key capital adequacy metrics show consistently improving trends and our liquidity profile remains strong.

As previously announced, we completed a $400 million debt offering in February and used the proceeds to prepay senior Notes due in August of this year. Our current outstanding debt maturities are well distributed with no significant maturity until December of 2014.

Book value per common share increased 3% from year-end 2010 to $41.75 per share, reflecting first-quarter earnings and an approximate $100 million increase in the market value of our investment portfolio. Our investment portfolio's pretax net unrealized gain stood at approximately $1.3 billion at quarter end.

Our common shareholders equity, excluding other comprehensive income, increased 2% from year-end 2010 to $10.8 billion, or $40.20 per common share. Our statutory surplus also increased 3% to $10.1 billion from year-end 2010. We continue to maintain approximately $1 billion of dividend capacity in our primary insurance operating company.

We were pleased to have announced that we had signed a definitive agreement for CNA to acquire the public minority stake in CNA Surety for $26.55 per share. We continue to firmly believe that the transaction is in the best interest of all parties. The next step is the commencement of a tender offer which we expect to commence as soon as practical. Subject to the satisfaction of the conditions for the tender offer, we currently anticipate that the transaction will be completed by the end of the second quarter. We expect the transaction will dilute our book value marginally but will be immediately accretive to earnings per share.

We continue to sustain our disciplined reserving practices. Our Property and Casualty business segment benefited from $34 million, or 2 points of pretax payroll reserve development.

Our track record of favorable development now extends over 17 consecutive quarters. We remain confident in the overall adequacy of our reserves.

Net operating income during the first quarter included pretax net investment income of $620 million, a 5% increase from the prior-year period, driven by our Limited Partnership investments which had another very strong quarter. Our LP investments produced first-quarter pretax income of $114 million in 2011, as compared to $72 million in 2010. The current-quarter rate of return was 4.9%.

Investment income other than from Limited Partnerships was down slightly quarter-over-quarter to $506 million pretax. The primary driver of the decline was a $1.1 billion decrease in our asset base, reflecting last year's loss portfolio transfer with National Indemnity, partially offset by a 4 basis point increase in average portfolio returns, reflecting a reduction over the past year in our short-term holdings and a $2.2 billion shift from tax-exempt to higher yielding taxable munis.

Our investment portfolio remains well diversified, liquid and high-quality, as well as aligned with our business objectives. The current allocation of assets is in line with our established longer-term targets. The average credit quality of the fixed maturity profile remained at A. We continue to segment our portfolio to facilitate our asset liability management discipline. The assets, which support our long-duration lifelike liability, had an effective duration of 11.2 years at quarter end, up slightly from fourth quarter last year and in line with portfolio targets. The effective duration of assets which support our traditional P&C liabilities was 4.6 years at quarter end, unchanged from the end of 2010's fourth quarter.

In the first quarter of 2011, we generated approximately $110 million of operating cash flow, excluding trading activity. Additionally, we received approximately $1 billion of cash principal repayments through paydowns, bond calls and maturity.

Our financial flexibility is further enhanced by approximately $140 million of cash and short-term investments held at the Holding Company level. At quarter end, these investments represented one-time or annual net pretax interest expense.

The full $250 million of our credit facility is also available to us.

Our Life group's non-core segments produced a first-quarter net operating loss of $18 million as compared with income of $1 million in the first quarter last year. This unfavorable comparison was primarily driven by the commutation of an assumed reinsurance agreement in the first quarter of 2010 that produced $15 million of after-tax favorable development. Results from our pension investment business were also down slightly while lower expenses partially offset these impacts.

Corporate segment produced a first-quarter net operating loss of $27 million in 2011 as compared to a loss of $4 million in 2010. The Corporate segment profile was change substantially by actions taken last year. Last year's asbestos and environmental loss portfolio transfer decreased our net reserve and associated asset and capital base. Consequently, investment income allocated to the segment was down significantly but was largely offset by reduced claim handling expenses. You will recall that we funded part of last year's senior preferred stock with redemption with long-term debt. That additional interest expense is also reflected in operating income while the more than offset benefit of the 10% preferred stock dividend elimination is only reflected in the earnings attributable to common shareholders calculation.

With that, I will turn it back to Tom.

All in all, we had a good first quarter. Our core Property & Casualty operations performed well. Investment results were strong, and our capital position continued to improve. We grew significantly in Specialty. In Commercial, we improved our premium trend while continuing to execute our underwriting strategies and improve our loss ratio. Looking ahead, we are well positioned to continue our progress on improving our financial and operational results.

With that, we would be glad to take your question.

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

Thank you. I guess first a numbers question. The benefit to the expense ratio from the recovery of the premiums receivable write-down, can you quantify that for us?

It's about $20 million, so close to 1.5 points in P&C on the expense ratio. It's all concentrated in Commercial, so about three in Commercial.

Got it. Second question, again more numbers question. The premium in the Commercial segment, my recollection is you had sold an Argentinian business. I'm wondering if that's still in this quarter distorted the comparison, or is that over at this point?

No, that's still in there. Last year would have been something close to $25 million of premium in the first quarter of '10.

So ex that, you've seen a little bit of growth then, it sounds like.

Yes.

Right, right. I guess the last question for now. The favorable reserve development in the quarter, which continued, but it was quite a bit smaller as far as the scale of that reserve release than what we've been seeing. And I know this number can jump around all over the place. This was the lowest number in really some time. Should we read anything into that? Have you seen any change in the claims trends that would suggest that this favorable development will eventually go away, given that it was a bit more modest this quarter?

Maybe I can start. I don't know if Tom wants to add anything to this. But I would say if you looked at the amount of favorable development this year's first quarter, it's pretty consistent with what it was in first quarter of last year, both in dollars and point terms. Just remember what our behavior has been. We look at -- we don't look at all of the reserves every quarter. This quarter, we looked at something slightly less than 25% of the reserves. Decisions we made were based on the estimate changes on the reserves we looked at this quarter, so when we're confident in the numbers, we act to release it. I don't think I'd take it any further than that.

I think as Craig said, Jay, last year's first quarter was 2.7 points of favorable development. This year, it's 2; that's pretty close. It's lumpy quarter-to-quarter, depending on what we review. So we don't think it's remarkable.

I do see now a pattern where the first quarter has tended to be smaller as far as the reserve change versus the other three. So that's helpful. Let me stop at -- what's that?

You are correct.

I'll stop asking questions. Maybe I'll buzz back in for another one. Thanks.

Amit Kumar, Macquarie.

Thanks and congrats on the quarter. Maybe just starting with the Catastrophe losses, first of all can you expand on what these losses were in Q1? Maybe also touch upon the recent Q2 losses and how that could impact your results.

First of all, on the first quarter, it's $55 million. $29 million relate to the winter storms in the US, $25 million to Japan earthquake/tsunami, and if you combine Australia and New Zealand, about $1 million. As far as what's gone on in the US, claims are still coming in, but it's not material relative to dollars at this point in time.

Okay, that's helpful. The Japanese loss, can you give some more color? Where exactly did that come from?

If you look at Property, we write accounts that have exposure around the globe. That is typically called shared and layered business, so along with other insurers, we think in most cases a very small piece of the pie. So I would describe it as small losses, but there are a bunch of them. But as I said, it's $25 million; it's less than the US winter storms.

Got it, that's actually quite helpful. Moving on, and this is a topic which we have touched upon previously, now that you're closer to closing this SUR acquisition, maybe we can revisit the discussion on capital management and refresh us on what your thoughts are for a special dividend since we cannot buy back stock.

This is Craig. So we don't -- we make it a practice of not commenting on future capital actions.

Maybe you can just share how do you think about capital, do you plan to continue to grow your topline, or where are we headed, just based on the leverage?

We are very happy with the capital levels, so we certainly have more than enough capital to support the growth in the businesses, in the business that we see. We have more than of capital to deal with unforeseen circumstances, and then we certainly have another level of capital that we could decide something else to do with. But really nothing to talk about at this point.

Okay. Just one other question and I'll come back. On the Life and on core, the $44 million, $47 million loss, that seemed to be a bit higher than the Q4 number. I'm just wondering is that sort of a good run rate going forward, or were there any other one-timers in Q1 numbers?

Let's break it down between the two segments. So Life and Group loss was $18 million. That's pretty consistent with the $15 million loss we had in Q4. The Corporate loss this quarter was $27 million, which is pretty consistent with (inaudible) core loss in the fourth quarter was $22 million. So this year in the first quarter, you kind of get the full amount of the interest expense coming through in Corporate. But I think both of those are relatively consistent with what you should expect and pretty consistent with what we produced over the last year. In the corporate sense, we kind of redid the Corporate segment.

Got it. That's all for now. I will re-queue. Thanks.

(Operator Instructions). Bob Glasspiegel, Langen McAlenney.

I was wondering if we could stay on CNA Surety. Now that we've got a definitive agreement, I would love to have any commentary about motivations for doing it and in general what is going on in pricing in that business relative to the rest of your specialty business? Are the rates and retention rates similar?

I think, Bob, what we said a while ago was we like the Surety business, we understand the Surety business. We thought it was a logical next step for us at CNA Financial to go after the remaining outstanding shares. So, we think it's a good business. That's why we are buying the rest of the shares. But --

I was going to say, near-term, what's going on in pricing and persistency trends, retention trends in that business compared to the rest of your Specialty book?

I think they reported on Friday, so that would be public information.

Okay.

When we own it, we will tell you more.

Can you break out the staff surplus for your Life and PC? Is the GAAP equity sort of effect associated with us businesses (inaudible) as far as --?

We don't (multiple speakers) we have not broken out how we've allocated GAAP equity.

Okay. What do think the trend is for your surplus levels of the Life Company? It basically hasn't been going down over time? Is this sort of a $0.5 billion of [staff] surplus in that business for a bit, or is there a sort of visibility of five years from now it could be a lot lower?

No, I think what you see is there's a little over $500 million in it now, like $509 million if I remember correctly, which has been the supplement.

Yes $509 million is the number.

And we do produce a small amount of, you know, consistent earnings in that business, so absent some actions on our part to take it off, I expect it to kind of grow with the earnings and the earnings have been pretty consistent over a few years, so it made a very modest change.

When you see your reported earnings, you're talking about statutory as opposed to GAAP?

Statutory earnings in the Life Company, yes.

Because you reported GAAP lost pretty consistently in that, right?

Right. You'll recall that the Life group segment includes annuities, benefit settlement options (inaudible) deposited and those are all in the Life legal entity. Then the long-term care business, which we also report in the Life group segment, that's actually in the (inaudible) casualty company and legal entity, [in that] different legal entity. So legal entities and the segment aren't 100% aligned.

So the staff picture is better than the GAAP picture for the Life company now and prospectively?

When you separate what businesses they are in there, correct.

Amit Kumar, Macquarie.

Thanks. Just quickly going back sort of to the broader discussion on reinsurance rates, can you refresh us? When does your reinsurance treaty renew, and remind what the limits are?

We renewed -- the cash renew was renewed in January.

What are the limits on that?

We have like $600 million it think. The retention is $300 million, and we bought (inaudible).

Got it, okay. That's helpful. The only other question I have is obviously there has been this broader discussion on the economic recovery and you alluded to it briefly. Maybe just refresh us, obviously you've seen these market conditions for a long time. What are your views on a market turn going forward, and do you think that the increase in reinsurance pricing would sort of filter down to the primary level and could lead to a market turnaround? Thanks.

I think our belief is that what's going to happen on Property Cat reinsurance pricing will affect Property Cat business. We do not see it as being a harbinger of a broad market term, so I think you have to put that kind of on the side.

What we are very encouraged about is that if you look at exposures, exposure continues to improve in Commercial, and in fact that is slightly positive. So that's one of the best things we've seen in quite a few quarters, even probably a few years in Commercial.

If you look at Specialty, we are getting about 1 point in exposure growth, so that's obviously very positive. So I'd say on exposure, which is connected to the economy, at least we insurance peeps look at it, we are feeling that it is stabilized and hopefully moving in a positive direction.

If you look at rates, we've got 2 points of rate in Commercial. That's been -- I guess we've had about six quarters of positive rate. If you go back rapidly over back to 2006, that's the highest rate that we've seen in that time period. So rates in Commercial look good.

On the Specialty side, rates are flat, and that's kind of an improvement as well. So when you look at rate and exposure, which is really your pricing dynamic, we are feeling pretty good with where the market is and where we are. I think you've heard comments similar to that, so I would say this is the glass is half-full. Maybe a year ago, we were saying it was a half-empty glass. So I think we are seeing some improvement, but does that mean there will be a broad turn in rate increases? I can't predict that, and I wouldn't predict it.

That's actually quite helpful. Just related to that, and this is the final question. Do you think the competition sort of agrees with where you are, or are there still some companies which are being aggressive? I guess related to that, if the economy improves, are you sort of seeing a commensurate increase or change in the loss concentration?

I think the first thing is the market appears to be acting rationally. There is always evidence of a rogue trader, but we are seeing less of those out there today than we would have seen six or nine months ago. So I think the market is a more rational market. It still competitive; it's always competitive. But we don't see real craziness out there like we may have seen a while ago. I think people are falling into a comfort zone that they like their book of business, they're trying to retain their book, they're pushing rate a little bit, exposure is helping us all, so I think the market is fairly stable, to use the term.

And on the loss concentration?

We always look at inflationary trends. Quite honestly, the one that concerns us most because we write workers comp and general liability is medical inflation. Our actuaries have adjusted that a little bit upwards. Overall, we are anticipating there will be some inflation out there, probably good for us on the investment side. On the claims side, you don't like to see claims inflation. But for us, our new arising activity is going down in flames, and we think that's very positive. So with less frequency, hopefully it will have less of an impact should it go up.

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

If you could just clarify something, I think you said there was dividend capacity of $1 billion from the insurance subs up to the Holding Company. That hasn't been paid then yet?

No.

So there's no dividend in the first quarter?

No dividend in the first quarter.

Seasonally, is there a typical time where you do pay a dividend?

Really only when we need the cash, so recall that we still have a $500 million surplus note that the Holding Company owns from the operating sub. So, if we were going to go look for cash to fund that payment and (inaudible) common dividend likely would come first from repayment of the surplus note or a portion of it because that had less of an impact on dividend capacity. So more than likely, sometimes it's in the coming quarter, perhaps a little bit of (inaudible) surplus note and usually then sometime in the fourth quarter of the year. Kind of pattern we'd expect but there's no real pattern to it.

Got it. Okay, thanks.

Ron Bobman, Capital Returns.

I had a question I guess for Tom. When you see the market improving -- you mentioned exposures increasing, reflecting I guess largely the economy improving, and then maybe related to that or unrelated to that, you see some improvement. Maybe it's just stabilization in rate, but you see some improvement in rate. Do you sort of instruct the underwriters any differently, or they should just basically keep doing the same thing they were doing three, six, nine, 12 months ago?

We wouldn't tell them to do what they did 12 months ago, because we kind of push them every quarter to get more rate and write quality new business. So it's not a static plan; it's a dynamic plan. So depending on what the opportunity is in the marketplace by line of business, by geography, we will push them to either write more new business or just push [writing] on the renewal and not write new business. So it changes. That's one thing, by having a pretty robust field operation, we are constantly in conversation with them as to where they see the opportunity or where they don't. So that's kind of always a moving target, but right now we are instructing our underwriters to make sure they are getting the exposure numbers, make sure we are getting that and also to be pushing rate where it's appropriate to push rate by line of business, by account, by geography.

(inaudible) more emboldened -- embolding them to do that more it sounds like. Thanks.

(Operator Instructions). Peter Suess, Surveyor Capital.

Hey guys. I was wondering if you could provide a little bit more color on the improvement potential in the accident year ex-Cat combined ratio in Commercial. Because you are still re-underwriting the book, but now I guess you're also getting 2% rate increases. So I'm wondering if the re-underwriting could actually improve the accident year ratio from here. Thanks.

That's our desire. We are focused on improving our accident year results in Commercial and every line of business within Commercial. When you re-underwrite a book, you do a few things. Number one, you take your renewal book, you decide what you want to keep, what you want to get rid of, and then when you decide what to keep and you decide what should I get in pricing? That's rate. So that's kind of the first step.

But the other thing is when you write new business, you want to be writing new business at adequate rates, and also in the industry that you think can provide better accident year and calendar year results over time. So it's really a mix of business issue as well as industry issue as well as pricing issue, as well as what we call underwriting actions relative to terms and conditions, coverage (inaudible) etc. So there are a lot of moving pieces and all of those are in process. They certainly have not ended.

What inning would you say we are in with the underwriting, re-underwriting?

What's that? I didn't get your question.

What inning would you say that we are in with respect to the re-underwriting of the book?

You're always underwriting the book; you never stop underwriting the book. But I think we are a good ways into the process. But you don't get your achieved objective on every account the first time around. So it takes a while to get the book where you want it, but we are clearly gaining on it as evidenced by the improvement of the accident year loss ratio and the ability to get rates as well as exposure. So we think it's moving along, but I wouldn't give you a percentage.

That concludes the question-and-answer session today. I'll turn the conference back over to our speakers for any additional or closing remarks.

Thank you very much. See you next quarter.

Thank you. Ladies and gentlemen, this does conclude today's presentation. We appreciate your participation. You may now disconnect.