CNA Financial Corp (CNA) 2011 Q4 法說會逐字稿

Good day, everyone, and welcome to the CNA Financial Corporation's fourth-quarter and full 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.

Thank you. Good morning and welcome to CNA's discussion of our 2011 fourth-quarter and full-year financial results. With us this morning are Tom Motamed, our Chairman and Chief Executive Officer, and Craig Mense, our Chief Financial Officer. Following Tom and Craig's remarks about the quarter and annual results we will open it up for your questions.

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 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, Monday, February 6, 2012. CNA expressly disclaims any obligation to update or revise any forward-looking statements made during this call.

Regarding non-GAAP measures, reconciliation to the most comparable GAAP measures have also been provided in our most recent 10-K and 10-Q as well as the financial supplement. This call is being recorded and webcast. During the next week, the call may be accessed on CNA's website.

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

Thank you, Nancy. Good morning, everyone, and thank you for joining us. Before Craig reviews our financial results I would like to share a few highlights of the quarter and the year.

CNA's 2011 net operating income was $614 million. That is compared to $660 million in 2010.

Our operating results were influenced by lower net investment income, a higher level of catastrophes, and reserve charges in our Life and Group runoff businesses. Craig will provide more detail in his remarks.

We continue to be pleased and encouraged by our progress on improved underwriting profitability and premium growth in our Core Property-Casualty businesses. In Specialty we continued to produce superior underwriting results with combined ratios on 77.8% in the fourth quarter and 89.9% for the year.

In Commercial we achieved more than 3 points of combined ratio improvement before the effect of catastrophes and development. While there is more work to do on our underwriting margins, we are encouraged by favorable rate trends and premium growth across both of our Property-Casualty segments.

In Specialty, rates increased 1% in the fourth quarter. Commercial rates continued decline, reaching 3% in the fourth quarter, with some lines clearly exceeding that level.

Retention was solid in both segments throughout the year. We are pleased that the market is accepting rate increases after a long period of negative rates. Our Property & Casualty combined ratio continued to benefit from favorable prior-year development, 7 points in 2011 and 10.6 points in 2010. We are also pleased to note that in a year of significant natural catastrophe losses for the industry, CNA's combined ratio included only 3.7 points from catastrophes, which reflects our disciplined cat management strategies.

Excluding the impacts of reserve development and catastrophe losses, our full-year combined ratio improved 1.7 points to 101.7% from 103.4%. This improvement was driven by a decrease of nearly 2 points in Commercial's non-cat accident year loss ratio.

Property & Casualty net written premiums grew 5% in 2011, 7% in Specialty and 4% in Commercial. 2011 is the first year we have grown in both segments since 2006.

Beyond the progress in our Property-Casualty business, we took action on a number of fronts to improve our earnings power, financial stability and shareholder value. We completed the acquisition of the minority shares of CNA Surety, increasing the scale of our profitable Specialty business. We sold our 50% ownership interest in First Insurance Company of Hawaii, continuing our efforts to simplify our organization and focus on core businesses.

Finally, we increased our quarterly dividend to $0.15 from $0.10 per common share. With that, I will now turn it over to Craig.

Thanks, Tom. Good morning, everyone. In the fourth quarter CNA's net operating income was $191 million, an operating return on equity of 7%. Operating income available to common shareholders was $0.71 per common share. Period-over-period comparisons were unfavorable primarily as a result of the reserve charges in our runoff life and group business and lower net investment income.

As you heard from Tom, we are encouraged by the momentum of our core P&C business. The results there reflect our focus on improved margins, scale and financial stability. We continue to sustain our discipline to reserving practices. In the fourth-quarter our core P&C businesses benefited from $250 million of pretax favorable prior-year loss developments.

We now have had 20 consecutive quarters of favorable prior-year reserve development. The major drivers of the favorable development in the fourth quarter were as follows. We recognized favorable development in our Commercial segment general liability line, both primary and umbrella, for accident years 2007 and prior, driven by improved claim outcomes and lower claim frequency.

Specialty segment recognized favorable development in medical professional liability, D&O, E&O and surety in accident years 2008 and prior. This stable development was primarily driven by favorable large claim outcomes as well as lower large loss frequency.

All of these reserving decisions were based on analyses completed in the fourth quarter.

We also completed our annual fourth-quarter review of GAAP reserve adequacy for the runoff Life & Group business lines. We made two adjustments to our reserves as an outcome of that review. In our Paid Annuity business line, which consists of single premium group and structured settlement annuities, we recorded $115 million after-tax increased reserves, primarily to unlock actuarial assumptions, which have now been revised to current best estimates.

The two main drivers of the increase were our estimates of future mortality improvement as well as the impact of the continued low interest rate environment. One other important matter to note is these charges were GAAP only reserve increases and they did not have any statutory impact.

Total net GAAP reserves for payout annuities at year-end were $2.7 billion.

In our long-term care business line, we strengthened claim reserves by $33 million after-tax. Neither the deferred acquisition cost asset nor the active life reserves in the line needed adjustment at the present time, based on our current best estimate assumptions.

However, our estimate of the level of GAAP margin remaining in the active life preserves was reduced, again, largely because of lower mortality and interest rates. This margin estimate reduction did have a follow-on negative effect on book value per share, which I will discuss further in a minute.

Total net GAAP reserves for long-term care at year-end were approximately $8 billion. These reserve increases were the primary drivers of the $157 million net operating loss from the Life & Group segment in the fourth quarter.

We have added a new page in our financial supplement that provides a summary of net reserves by the major businesses of our Life & Group Non-Core segment. In addition, our 10-K will include new disclosures quantifying the estimated impact of hypothetical changes in key assumptions for both the payout annuity and long-term care blocks of business.

Overall, we continue to build on our financial strength and stability. All our capital adequacy metrics remain at or above our target levels and our liquidity profile remains very strong. Book value per common share at year-end was $42.92, a 2% decrease from the end of the third quarter, driven by adjustments for unfunded pension liability and shadow reserve adjustments related to our Life Group business.

Our investment group portfolio's pretax net unrealized gain stated approximately $2.6 billion at year-end 2011, a slight increase from the end of the third quarter. While net unrealized gains did not change significantly in the fourth quarter, the after-tax amount of Life Group-related shadow reserve adjustments increased approximately $265 million in the quarter.

As discussed last quarter, net unrealized gains on the longer-term assets supporting our Life & Group liability were mostly offset by shadow adjustment that reduced DAC or increased reserves with the offset reflected in accumulated other comprehensive income. The quarterly change was largely driven by the reduction of long-term care margins that I mentioned earlier.

We will adopt the new accounting guidance on deferred acquisition costs as of January 1, 2012. We currently estimate that this change in accounting will reduce book value by approximately $70 million or $0.26 per common share.

Our common shareholders' equity excluding AOCI was $11.1 billion or $41.17 per common share, up 4% for the year. Our statutory surplus at year-end was $9.9 billion. We did not make any repayments on the surplus note this quarter. The outstanding balance on the note remains $250 million at year-end 2011. Our primary insurance operating company continues to maintain approximately $1 billion of dividend capacity.

Cash and short-term investments at the holding company level were approximately $290 million at year-end and the full $250 million of our credit facility also remains available to us.

In the fourth quarter of 2011, operating cash flow excluding trading activity improved to approximately $900 million. Additionally, we received approximately $600 million of cash principal repayments through paydowns, bond calls and maturities.

Net investment income was $523 million pretax in the fourth quarter as compared to $624 million in the prior year period. The decrease was primarily due to our limited partnership investments, which produced fourth-quarter pretax income of $16 million in 2011 as compared to $113 million in 2010.

For the year, pretax LP income was $48 million as compared to $249 million in 2010. These investments produced a fourth-quarter return of slightly under 1%.

On a full-year basis, our LP investment return was approximately 2.1% on par with the S&P 500.

Net investment income from fixed maturity securities declined 1% as compared to the fourth quarter of 2010, reflecting today's lower market yields. We made relatively minor changes to our investment portfolio sector allocations this quarter. The investment grade corporate bond sector continues to have the largest allocation of invested assets. Small increases in the allocations to US treasuries and municipals were offset by reductions in below investment grade corporate bonds and nonagency mortgage securities.

Overall, our investment portfolio remains well diversified, liquid, high-quality and 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 portfolio remained at A.

The fixed income assets, which support our long duration life [line] liabilities had an effective duration of 11.5 years at year-end, up from 11.4 years at the end of this year's third quarter and in line with portfolio targets.

The effective duration of the fixed income assets, which support our traditional P&C liabilities was 3.9 years at year-end, down from 4.0 years at the end of this year's third quarter. The increase in our common stock dividend reflects our measured approach to capital management.

With that I will turn it back to Tom.

Thanks, Craig. Before we open it up for questions, I would like to close with some observations. A year ago at this time we said we would continue to focus on underwriting and pricing discipline, while continuing to build the balance sheet. Our progress on these priorities is evident on many fronts. Margin improvement across the portfolio, driven by more than 3 points of combined ratio improvement in commercial before catastrophes and development, positive rate and solid retention across our Property-Casualty businesses. Net written premium growth of 5%. Favorable prior-year loss development for a fifth straight year. Improvement in our capital position reflected in a 4% increase in common shareholders equity, excluding AOCI. The acquisition of the minority shares of CNA Surety and the sale of our 50% ownership interest in First Insurance Company of Hawaii. Lastly, a $0.05 per common share increase in our quarterly dividend to $0.15.

Looking ahead, we expect that market conditions will be similar to the past few years with no letup in the competition for good business. We also expect overall rates to continue to rise. Clearly the most significant increases will be in lines affected by catastrophes as well as in workers compensation.

Although specialty rates have begun to improve, they have a long way to go. At CNA we will continue to focus on the fundamentals which we believe will drive improved earnings and shareholder value in 2012 and beyond.

Now we would be happy to take your questions.

(Operator Instructions). Amit Kumar, Macquarie.

Just a question on the capital. You have had good underlying trends in P&C. You also raised the dividend, which is a good first step. But if I look at your premium to surplus it's at a much lower level than others. And the undeployed capital pressures, ROEs, compared to other commercial players, I am wondering what specific steps on your capital do you anticipate to get the ROEs to let's say high single digits or even low double digits?

I'm not sure I am following the question. Are you asking what the next steps would be?

Yes, to get the ROEs to go up further. I'm talking about the undeployed capital versus other larger commercial players.

We have -- don't know if I'm as to your question answering it exactly, but I think that we have been pretty consistent in both our answer and our behavior relative to capital. That we have taken a very measured approach, although we have been active, we didn't use excess capital to buy in minority shares as surety. You know we built our 50% interest in the Hawaiian company to further simplify the place.

We just established -- reestablished a common shareholder dividend a year ago. We just raised it 50% this quarter. And when we talk at the Board level and at management, among the things we would like to be -- that we really focus on in the capital side -- is just creating a company that is known for creating a common shareholder dividend that is sustainable and consistently increasing. So that has really been the focus and really the extent of the discussion on the capital side.

Got it. I guess there is no near-term thought process that we should try to get the ROEs higher. That is what I'm trying to get to. If you look at Travelers or Chubb's, is there some sort of a comparative thought process, what you are saying that we do have this undeployed capacity maybe we should look at acquisitions, special dividend or things of that nature. Or is it more about let just fix the balance sheet? Let's keep on slowly, yet incrementally improving the operation. Is that what the thought process is?

I would say this. We look at everything. We also believe timing is everything, relative to what you try to achieve when you try to achieve it. But we have a clear focus on improving the underwriting results, improving the loss ratio, improving the returns on the P&C business in a low investment yield environment. So, clearly this is about improving our margins and creating better returns that way.

If you look at our ROE you are correct, we are behind some of the other competitors that we see in the market. But I can at least as I read the data, as their combined ratios take some hits, their ROEs are going down as well. So it is about underwriting margins these days and we got to get that fixed. That is our priority.

But we look at everything and if there is something out there that make sense, we will do it. But at the same time, remember a year, year and a half ago, we had no dividend. So that is a start and we will keep looking at other opportunities.

And is there a specific ROE target that you have?

Clearly in this environment where rates have been pressured it would be hard to deliver those kind of returns. However, we believe as the rate environment improves and we improve our underwriting margins, our ROE will eventually start moving up.

Into the double-digit range?

I would love to see that happen.

Just -- I guess just one more question then I will requeue. Can you just talk about -- you talked about pricing. You talked about margin. Maybe just talk about the loss costs trends. I am looking for some sort of specific numbers. Are you seeing loss costs go up by 3% or 4% in Specialty or Commercial? Maybe just expand on the difference between pricing versus loss cost increases.

Yes, what I would say is on an overall basis we look at loss costs running anywhere from 2% to 4% depending on the line of business or industry segment. We would believe that we're getting in the fourth quarter 3 points of rate, in Commercial that that is exceeding our lost cost trends and commercial.

In specialty, we're at about 1% rate. We are lagging on loss costs trends in Specialty, but I would say we are moving up. If January is any indication of the future, rates continue to improve. So we think we're on the cusp in Specialty and Commercial, we think we are doing just fine.

Got it, thanks. I will stop now. I will requeue. Thanks for your answers.

(Operator Instructions). Bob Glasspiegel, Langen McAlenney.

I think I was with you for most of the long-term care discussion, Craig. But I lost you at the end on the balance sheet. Did you save that the $254 million balance sheet adjustment was for the lower margin or in long-term care -- or did I misunderstand the number?

No, I think I said $265 million.

$265 million?

Yes, after tax. Was the -- which was the increase in shadow reserves.

For long-term care you said primarily?

Primarily.

Do you have the pretax number or is it 35%?

You can use 35%.

Was there any pension adjustment on your book value at year-end?

Yes, we did adjust the minimum pension liability and that had a $211 million after-tax impact on book value per share, so about $0.78.

Okay. Is there an interest rate number used for either of those two things that would be helpful?

I can tell you, it is going to be -- you will see it in the 10-K and we will be -- expect to be filing that in the next couple of weeks. But the discount rate assumption we used on the benefit obligations for pension was 4.6%.

And the long term care, just what sort of discount rates are we using now?

We are using -- and you will see this as well in the K when you get it, so you need to parse and I would say pay attention to the detail of the reserves and the makeup of the Life Group segment. So the payout annuities and structured settlement reserves have discount rates based on 2012 cash flows of about 7.4%. That will be, then, declining down to about 5.5% over time. And the discount rate in the long-term care is something around 6.4%, 6.5%.

Not to belabor this, but you are [sort of] matched on your asset and liability duration as I understand it. Is that a fair statement?

That is a fair statement, but remember, we attempt to match the best we can in terms of assets and liabilities, but recall that the durations of these liabilities would exceed that asset duration we have of 11.5 years.

11.5 years versus what?

Our asset duration is 11.5 and liability duration and payout annuities is a little over 10. I think long-term care is 16.

Getting to a more pleasant conversation, Tom, do you think that on the P&C side, rate increases now are keeping up with underlying loss costs. Where are underlying margins heading, trendline based on current pricing?

On the Commercial side we think that our overall rate achievements is exceeding loss costs trends. On Specialty we are just moving into positive territory on rate increases 1 point in the quarter, so we're behind in Specialty. But we like the momentum we are seeing. January was both good on rates for Commercial and Specialty. So we think that is going in the right direction.

Thank you very much.

(Operator Instructions). Amit Kumar, Macquarie.

Just cleanup questions. First of all, can you talk about what sort of pressure do you expect on retentions going forward as you try to raise rates? Some other companies have talked about experiencing near-term pressure on retentions as they try to charge higher rates on the business.

I guess you have to go back to 2009. We started pushing rate increases in Commercial back in 2009. So in 2009 and 2010, we did suffer some drop-off in retention, particularly in Commercial, not in Specialty. But I would tell you this, in the fourth quarter, retention actually improved slightly. So we have been at this a while. We have been reprofiling the book, so I think the longer you are in this you get a stabilization of retention. We are seeing that in Commercial.

We're going to continue to push hard, not only in Commercial, but Specialty for rate increases, so it is foreseeable there may be a slight dropoff on the Specialty side, relative to retention. But we have had some quarters going back a year or two where the retention would have been 5 points last than what it is in the fourth quarter today. So, yes.

That is good to know. The second question is you talked about pricing in Q4. I'm wondering what sort of prices did you see in the first two months of 2012.

Considering it is only early February, I can only give you one month and I won't give you an exact number, but if we look at the month of December, which was a good month for us on rate, it was higher than November and October. So we gained momentum in the month of December and January is higher than December.

And then final question on the reinsurance treaty. I think there was a mention that reinsurance costs fell. Can you just expand on that and I know that your reinsurance treaty renews on 1/1. Is it the same? Is it different? Did you pay less or did something change on that? Thanks.

First, remember, we have several treaties out there. So is there anything specific you're looking for, which treaty?

There was some discussion on the last call that one part of the treaty renews on 1/1 and I don't have those notes with me, but something did renew on 1/1. Is that right?

This is Craig. So we did renew our property cat treaty 1/1. And we renewed it on the same terms, both same coverage, same retention and the prices were up slightly. I would say actually about something like -- and this is going forward in 2012 -- about 9%. Some exposure and some rate.

But I think what you are referring to was an earlier call. We had said that part of the increase in net written was lower reinsurance costs. And that was really -- that was a function of the property for risk and the property cat last year in 2011, because we had lower cost as we improved the portfolio and as our results improved.

So that helped the net written, which was growing at a faster rate than the gross written, which is what we're trying to describe in some of the earlier conversations and calls.

That is all. Thanks so much for your answers.

(Operator Instructions). [Peter Suse], Surveyor Capital.

Just a question on commercial lines, underwriting. It looked like the accident year ex-cat combined ratio or loss ratio, I guess, improved by a couple of points this year and I assume most of that is due to the reunderwriting of the book. Just wondering if you'd provide some color as to how much improvement remains from the reunderwriting initiative.

Sure. We continue to press. We continue to improve our metrics and tools so that we can get more granular relative to pricing of any particular risk, whether it be by industry segment or line. But clearly, we don't retain 100% of the book. We retain roughly 80%, high 70s, so we're always turning the book looking for better business and we are pushing rate pretty hard.

The other thing is there is really very little exposure growth in Commercial these days. It is less than 1 point, which is a reflection of the economy still being fairly flat. But you always underwrite the book or re-underwrite the book, but we're making good progress and we are very pleased with the new business we are writing is going into the segments we really want to be in. And the other thing is, actually, in the fourth quarter where we saw a lot of competition for new business, our new business writings went down a little bit.

So the fact is we're only writing the business at the right price to bring it in the door the first time, and then we are constantly looking to push rate once it is in the door.

Would you say that a lot of the low hanging fruit from the re-underwriting has been accomplished or can you continue to sustain these types of improvements going forward?

Our expectation is we will continue to see these kinds of improvements over time.

Then, finally, just on the expense ratio. About 33% this year. What kind of growth do you think you need in order to see improvements in that ratio?

I think 6 points would be a good number to keep in mind. But clearly, you mentioned 33, we look at it as being 33.5, it has been bumpy for various one-time events. But we need to grow the business 6% a year. That would be a good number. 6%, 8% would be helpful. And, of course, keeping our controllable expenses pretty flat, which we have done. We have really done a good job on expense management from a controllable perspective.

So 6% to 8% would result in improvement. And do you think that that type of growth is achievable in this rate environment?

Yes, I think it is clearly achievable.

Okay, great. Well, thank you.

Ron Bobman, Capital Returns.

Craig, you mentioned, I think, $1 billion of dividend capacity. I assume that is from the main underwriting entity. I was curious. Is that entity paying any ordinary dividends or is that a going forward capacity and you have not been pulling dividends on a regular basis, ordinary dividends, out on a regular basis? And then, also, what are your thoughts about dividend eating the maximum amount of ordinary dividends or choosing not to.

Well, first, you are correct. That is the dividend capacity. It is the dividend capacity in our operating company. So Continental Casualty. We have not been distributing dividends from the operating company to the holdco. Over the past year we have been holdco cash needs have been met, more than that, by repayment of the surplus note that we had established. We still have $250 million of the surplus note. So the uses for cash we would have at holdco are debt service payments and common shareholder dividends, out (multiple speakers) which as we look at it will be met by -- first by continued repayment of the surplus note and then, likely later in the year, begin to take some dividends from the operating company.

But there is no particular advantage for us that we see and taking surplus from the operating company and putting it -- holding it at holdco. Actually, it would probably be a hurt to investment income if we increased the amount of short-term assets.

I'm sorry, the holder of the surplus note, is that the holding company or is it --?

That is the holding company.

Thanks a lot for the help on that.

There are no further questions at this time.

Thank you very much. See you next time.

Again, that does conclude today's presentation. We thank you for your participation.