CNA Financial Corp (CNA) 2012 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the CNA Financial Corporation's second-quarter 2012 earnings call. Today's call is being recorded. At this time I would like to turn the conference over to Miss Marie Hotza of Investor Relations. Please go ahead.

Thank you, Leah. Good morning and welcome to CNA's discussion of our second-quarter 2012 financial results. With us on this morning's call are Tom Motamed, our Chairman and Chief Executive Officer, and Craig Mense, our Chief Financial Officer. Following Tom's and Craig's remarks about the quarterly 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 on 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, July 30, 2012. CNA expressly disclaims any obligation to update or revise any forward-looking statements made during this call.

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

This call is being recorded and webcast. During the next week the call may be accessed on CNA's website. Now I will turn the call over to CNA's Chairman and CEO, Tom Motamed.

Thank you, Marie. Good morning, everyone, and thank you for joining us today. I would like to start by saying that I am very encouraged by a number of positive trends that we believe are well established across our businesses. We are pleased by the growth momentum across both our property-casualty businesses. Excluding the effect of last year's sale of First Insurance Company of Hawaii, net written premiums increased 5% this quarter, consistent with the level of increase in our first quarter of this year.

We are now achieving rate increases across all lines. The aggregate 6% rate increase in the quarter was up from the 4% we reported in the first quarter and well above the 1% achieved in last year's second quarter.

The second-quarter Property & Casualty non-cat accident year loss ratio of 67.3% improved more than 2 points from last year's second quarter and was 1.5 points lower than where we ended 2011. As you know, catastrophe losses were again a big story for the industry in the second quarter. While CNA incurred significant wind and thunderstorm losses of $68 million, we believe that our 4.4 points of catastrophe losses reflect well on our disciplined approach to catastrophe management.

Our Specialty business continues to deliver solid underwriting results with the second-quarter combined ratio of 94.4%. Specialty sustained its growth momentum with a 5% increase in second-quarter net written premiums. Specialty continues to build upon its positive rate trend. A 5% increase in the second quarter was 2 points better than this year's first quarter while retention held steady at 86%. Specialty's non-cash accident year loss ratio improved modestly this quarter at 67% as rate increases achieved over the last five quarters began to earn into the results.

In Commercial, our second-quarter combined ratio was 108.1% this year. Catastrophes represented 8 points of Commercial's combined ratio in this year's second quarter. Excluding catastrophes and development, commercial second-quarter combined ratio improved to 102.9% from 107.6% last year. We are pleased with Commercial's continued growth. Excluding First Insurance Company of Hawaii, net written premiums increased 5%. Commercial continued a positive rate trend that began in late 2009. The 7% rate increase in the second quarter represented a 2 point improvement over this year's first quarter.

Retention decreased slightly, reflecting rate, account tiering and other underwriting actions geared toward improving profitability. Our efforts to improve Commercial's margins are reflected in the consistently improving non-cat accident year loss ratio which is now 3 points lower than second-quarter 2011 and has sequentially improved more than 2.5 points from where we ended 2011.

With that, I will turn it over to Craig.

Thanks, Tom. Good morning, everyone. The second quarter was marked by meaningful progress toward our longer term objective. Improved underwriting margins across our core P&C businesses, driven by both broad-based rate increases and underwriter risk selection as well as steady revenue growth, were significant positives. In July we completed the acquisition of Hardy Underwriting Bermuda. The acquisition aligned well with our specialized approach to underwriting. The integration work is now well underway and we remain excited about our prospects.

In addition, we trust you saw Moody's recent announcement about CNA. In addition to upgrading our senior unsecured credit rating, Moody's affirmed our financial strength rating and revised the outlook on our financial strength rating to positive from stable.

In the second quarter CNA's net operating income was $152 million, an operating return on equity of 5.4%. Our year-to-date operating ROE is now just under 7%. Operating income available to common shareholders was $0.56 per share. Period over period comparisons were favorable, driven by improved accident year underwriting results in our core P&C operations and lower losses in our runoff businesses.

Second-quarter net income also improved from the prior year to $166 million or $0.62 per share. P&C operations produced net operating income of $163 million in the second quarter as compared to $151 million in the prior year. Lower catastrophe losses and improved non-cat accident year loss experience more than offset a decrease in invested income. We had a modest amount of favorable prior year development in the quarter on a par with last year's second quarter.

Our non-core Life and Group segment produced a small profit this quarter and a loss in the Corporate segment narrowed. The current quarter's results included several favorable items, apart from which our runoff businesses continued to perform as expected.

CNA continues to build on a solid foundation of financial strength and stability. Our capital adequacy metrics remained at or above our targeted levels and our liquidity profile remains very strong. Book value for common share increased to $45.34 per share, up 2% from the end of the first quarter. The increase reflects earnings and improvement in our investment portfolios net unrealized gains addition.

Our investment portfolio's pretax net unrealized gains stood at approximately $3.5 billion at quarter end, an increase of approximately $470 million from the end of the first quarter 2012. Approximately $330 million of this quarterly change was generated by the longer term asset supporting our Life and Group segment. The impact of those gains were offset by additional shadow reserve adjustments that were also reflected in other comprehensive income. Our common shareholders equity excluding AOCI was $11.3 billion or $42.12 per common share, up approximately 1% from the end of the first quarter.

Our statutory surplus stood at $10 billion at quarter end, essentially unchanged from the end of the first quarter. During the quarter, our primary insurance operating company repaid the $150 million remaining balance on a surplus note issued in 2008. We continue to maintain more than $800 million of dividend capacity at the insurance operating company level.

Cash and short-term investments at the holding company level were approximately $410 million at quarter end. We continued to target cash at the holding company equal to about one year of our annual net corporate obligations. We have a small amount of corporate debt, $70 million, that matures in August that we intend to retire. Our liquidity profile also includes a $250 million four-year revolving credit facility.

In the second quarter of 2012 operating cash flow excluding trading activities was approximately $340 million, up slightly from this year's first quarter. Additionally, we received approximately $900 million of cash principal repayments through paydowns, bond calls and maturities. Net investment income was $470 million pretax in the second quarter as compared to $517 million in the prior year period. The decrease was driven by our Limited Partnership investments, which produced second-quarter pretax losses of $35 million in 2012 as compared to pretax income of $11 million in 2011.

As a point of reference our LP investments produced a negative return of approximately 1.4% in the second quarter while the S&P 500 total return was a negative 2.8%. Year-to-date, our LP investment return was approximately 4.2% as compared to 9.5% at the S&P 500 total return. Net investment income from our fixed maturity securities in the second quarter was $505 million pretax, essentially flat with the prior year period as a higher level of invested assets offset decreased yields.

We made relatively minor changes to our investment portfolio sector allocation this quarter. Investment grade corporate bonds sector continues to represent the largest component of our invested assets.

Overall, our investment portfolio remains well diversified, liquid, high quality and aligned with our business objectives. The average credit quality of our fixed maturity portfolio remained at A. Fixed income assets which support our long-duration lifelike liabilities as an effective duration of 11.7 years at quarter end, unchanged from the prior quarter and 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 quarter end, down from 4.2 years at the end of this year's first quarter.

With that I will turn it back to Tom.

Thank you, Craig. Before we open it up for questions, I would like to summarize our second-quarter highlights. Rate increases of 6% with increasing rate momentum across all lines. The same growth of net written premiums at 5%, excluding last year's sale of First Insurance Company of Hawaii. Meaningful progress on margin improvement, particularly in our Commercial segment. Increased net operating and net income of $152 million and $166 million, respectively. Increased book value per share of $45.34, up 6% from year-end 2011. Lastly, we declared a quarterly dividend of $0.15.

With that we would be glad to take your questions.

(Operator Instructions). Amit Kumar, Macquarie.

And good morning and congrats on the pricing and margin momentum.

My first question relates -- this is probably a numbers question. In the Life & Group Non-Core, you talked about the gain related to a benefit on life settlement contract. Did you quantify that in the opening remarks, did I miss that, or maybe just expand on that a bit more.

This is Craig. No, I didn't mention the number. But it was approximately $8 million after-tax with the impact.

$8 million. So I guess the related question would be, how is the mortality shaping up? In the third quarter, in the sense that could there be something else like this in the third quarter too? Maybe just expand on the mortality trends in third quarter?

Remember, that was a payout of part of our life settlement business, we haven't talked about that very much, it's relatively small pieces of the runoff business. And to give you some context, I think we have about 500 lives still ensured. Excuse me, more like 800 lives or policies insured in that business, and they've had maybe about a $500 million of face value of life insurance there.

So if you think about it, most of the policies are representing more than $1 million a person when. Now the value of those obviously declines over time as people will live, and that's been a pretty lumpy business running off, so that's not anything particularly material (multiple speakers) future. The other things that affected that, this quarter where we did see improved morbidity as well as improved persistency in the health business.

Now I wouldn't --. You also recall that in the first quarter our morbidity trends were negative in LP. So I wouldn't really draw any conclusion from that, they're pretty steady, we are getting some very small modest improvement because of rate increases and some modest improvement in that business as a result of persistencies, improvements. But very much on the margins.

That's actually very helpful. The second question relates to -- I guess the broader discussion on capital, and this might be a question for Tom, the Hardy acquisition is done now. We've talked about the dividend, the special dividend, other options. I guess what I'm trying to know think is how do you view putting to use excess capital going forward? You said yourself the pricing is getting better, let me focus on the core book or are you saying that while there are maybe many other properties out there, which I should be looking at, maybe just help us sort of elaborate on that a bit and sort of figure out where you stand on those issues.

I think, Amit, I would start with my -- probably the first conference call that I had when I came to CNA was it's about improving margins in our ongoing operating company business. So clearly, we have been committed to that, we've spent a lot of time, energy, human capital, dollars to make us a better underwriting company and improve margins and, over time, continue to add to surplus.

So the reality is that's first and foremost our goal. At the same time we have our eyes and ears open. So we -- you mentioned Hardy, so just to bring that up again from our perspective, we thought that was a great opportunity that would help us grow our platform around the globe as well as improve profitability. This is a company that's been -- syndicate that's been out there for 35 years, historically combined ratios in the 80s, which is better than CNA. A specialized portfolio predominantly a short tail business, unlike CNA which is much more casualty long tail-driven. So we thought that was a great opportunity to once again contribute to scale and margins.

So -- and what we liked about it was it's what we call a bolt-on. That's basically say okay, you've got new owners and here are the expectations. And go at it. Obviously with lots of direction and control.

So clearly we look for bolt-ons. If there was something like that we would do it, the remainder of CNA Surety, a business that we knew well, and that's contributing to earnings. So clearly that's our first and foremost objective.

Secondly, we did reinstate the dividend, and we have raised it over time. So we will continue to look at that, but no good dividend before its time. When we are ready, we will be prepared to address that.

So other than that, I think we are going to say we are playing this pretty close to the vest, and it's just about building a better company over time.

I agree. Final question and I'll re-queue. This goes back to the discussion on the pricing momentum. Obviously you have good rates in this quarter, there's this bigger debate that the pricing is flattening. If you look at some of the other carriers, Q2 versus Q1 seemed to have flat [and personable then].

I'm curious, as you look towards year end, in the absence of any hurricane losses for the industry or any other capital depleting event, how do you think about pricing for year-end 2012?

We continue to be optimistic about the pricing environment. Quite honestly as we said earlier in the call, we are seeing momentum in some lines, some lines are getting double-digit increases, other are in the high single digits. Some are in the low single digits. But we are getting rate increases in every line, and we see the momentum continuing.

And it has, and you see how the written rate has turned into earned rates, is now starting to help the underlying net accident year combined ratio ex-cat, ex-development. So from our standpoint, we still are pushing out there, we believe we can continue to push. I'd say if you want to say it's flattening, be careful what you wish upon yourself. We are not wishing that on us, we continue to push and we think that if July is any indication, too early to tell, but July was a very good month for us. Relative to rate. So we are not prepared to accept flattening at this time.

Very good, thanks for answers and good luck for the future.

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

Thank you. I guess the first question, more of a numbers question. Can you talk about the difference between new money yields as your portfolio is constructed now, versus your book yields? I just want to get a sense of what kind of the rollover risk here is.

So -- and you'll see when you get the Q, which we expect to file later tomorrow, you'll see the maturity profile in the Q in terms of time forward. We -- in the next -- to give you some context, the next year and a half, we've got a little over $4 billion that we would expect that would mature prepay. And the reinvestment rates are anywhere, 150 to 200 basis points lower than the book yield that's running off. So now, those numbers don't reflect the additional cash flow that's being reinvested which is about $2 billion a year as well.

So generally those are going to be a headwind, but not significant and manageable. We do have the maturity starting at [14 and 15], a little higher rate, more like $4 billion a year so it would be again it would become more of a problem in the outer years.

That's helpful. I guess, related to that, you obviously have a very sizable unrealized gain in the portfolio, and some of that is in the runoff business. But is your strategy regarding recognizing some of these gains changed or realizing some of these gains?

I would say no. I think, as a matter of fact that's one of the things that we've said repeatedly is that we didn't get overly excited. We had unrealized loss on the portfolio in '08, but we were highly unlikely to need to do anything there, nor do we get overly excited about the gain in the portfolio now, because we would be actually welcome rising interest rates as we reinvest the positive cash flows coming out of the business.

Now keep in mind that gains particularly in the life business, you would have to be able to -- if you were going to sell them you would be able to reinvest in that rate that were, that didn't create a premium deficiency. And given the current yield environment, it's very hard to think about where would be a good place to put money at -- money to work to meet those expectations.

That makes sense. And if I can, made one bigger picture question for Tom. So clearly, you're making some progress in your efforts and rates are beginning to help you more and you're pushing for rates seemingly pretty hard. I guess the question is, as you look forward, what is -- maybe it's two questions, Tom. What are the key things on your list, your management team's list of left to do, and then secondly, what do you see as your greatest risks today? As you look at whether it's your income statement or your balance sheet so what's left to do, what the greatest risks? Big, big picture stuff.

I would say things left to do would start with keep doing what we are doing, stay focused on our strategy and our execution. I think the other thing is, we have certain segments of our business that we have identified, call them customer segments, which we think can be built out. Some of them are pretty small compared to our competitors, and we think there's a lot of opportunity there to grow out these segments. What I can tell you is that we are pushing hard in these segments and what we're finding is in the Commercial space where we look at these segments, new business is up 10%, the retention is better. We are just writing better business and more of it.

And I would say as we push harder in these segmented approaches, we have a great opportunity to grow. We've said for a long time that we don't think we have an expense ratio issue, we think we have a scale issue. So we will continue to grow in a very controlled way. Once again, we kind of like where we are at 5%, we think we can grow higher than that but we want to do that as a combination of rate increases and new business in the specific segments where we believe we can develop scale and profitability over time.

So I would say that's always -- or I should say that's kind of the opportunity as well as Hardy. We think Hardy is going to give us some pretty good opportunities and specialties that currently we don't have that they have, such as energy and aviation, a few other things. So from our standpoint, we see that as something that has to grow profitably over time.

As for risk, we kind of look at the glass being half-full rather than half-empty. So I would say all -- you're always worried about what's going to happen on the investment return standpoint, everybody has to deal with that. But I don't think that's an issue, that is a CNA issue. I think that's relative to the insurance industry as a whole. But other than that, we see lots of upside, we don't see a lot of downside.

It sounds like the runoff business isn't presenting any looming risks, if you will. It seems to be running off as expected.

It's been here for a while. This didn't show up last night, we've been managing it through the years, we will continue to manage it, we will continue to look at options and or solutions for it over time. But as you know, timing is everything. The right time is not today. It will be sometime in the future.

But clearly we are managing that business more aggressively, we are very pleased with some of the steps we are taking to do a better job in that area. So we keep working on that, waiting for our moment on the stage to do something.

(Operator Instructions). Ron Bodman, Capital Returns.

Glad to see all the progress that's continuing on rate and retention holding and margin improving maybe most importantly.

I have a question about Hardy. And I just wanted to ask on sort of the cat exposure front, could you give us some metrics, some figures as to what sort of additional cat exposure we are taking on? I don't know if you want, if you can or you are willing or if it's relevant to talk about incremental exposures for one in 100 windstorm in a certain part of the world or a quake or what have you.

But just sort of thinking ahead, there will be a day when there is a storm on the horizon or a quake happens or storm hits and we're all going to be sort of wondering what the addition of Hardy to the portfolio means or doesn't mean. Could you help us there, please? Thanks.

This is Craig. It does add some, and we certainly considered that in the purchase and the diligence, but it doesn't add meaningfully to CNA's one in 100 or one in 250 numbers. We are still well inside tolerances that we've established and the addition of Hardy, which right now we still trade on, we saw a 25% third-party capital but even after that goes away at the end of 2013, at least at the moment in the way their portfolio is constructed it would not add more than $50 million to our one in 100 cat loss. So the volatilities are not meaningful for CNA.

So incremental $50 million, and I assume that's -- that's a high number. So what parallel, what sort of event -- and that's one in 100, Craig?

Yes.

And what peril would that be, and I assume the other peril -- what peril is that? Windstorm, North Atlantic windstorm?

That's all. All and any, but most of there, as of most of us would be US wind.

So that's the bookend, thank you very much, I appreciate the help.

(Operator Instructions). Jay Cohen.

Just wanted to see in the third quarter, obviously you closed on Hardy. Will there be any accounting adjustments that need to get reflected in the financials that are material in any way?

I mean, we are working through the purchase accounting adjustments now, Jay, and again there will be some small amount of that kind of framework detail in the Q when you see it tomorrow. And so, we are finalizing that. I think what I said last quarter, I'll say it again. We will begin reporting Hardy, actually the [separate] operating segment, in the third quarter. I wouldn't expect anything material one way or the other in terms of earnings from Hardy for the second half of this year and that's because of some purchase accounting adjustments related to party in terms of that amortization. I would expect it to be modestly accretive EPS starting at 2013.

Also of course there are costs associated with integration work on the IP, particularly the financial system side that will be underway or already well underway that will happen over the next six months probably into the first half of 2013.

It will be a separate segment that you'll break it out separately from Specialty and the Commercial business.

That's our intention.

Great.

There are no further questions at this time.

Thank you very much. See you next quarter.

Ladies and gentlemen, that will conclude today's presentation.