CNA Financial Corp (CNA) 2012 Q3 法說會逐字稿

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

Thank you, Drew. Good morning and welcome to CNA's discussion of our third-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 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, October 29, 2012. CNA expressly excludes 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.

We reported net operating income of $216 million, much improved over last year's third quarter, and driven primarily by strong results from our Limited Partnership investments. This quarter CNA's results include the Hardy group for the first time. Hardy contributed significantly to our accident year loss ratio improvement.

The third-quarter Property-Casualty non-cat accident your loss ratio was 66.3%, 1 point lower than this year's second quarter.

We continue to achieve meaningful rate increases across our Property-Casualty business with retentions holding firm. The 6% overall rate increase in the third quarter was broad-based, and while consistent in the aggregate with the second quarter, we did achieve improved rates across our Commercial segment.

Our Specialty business delivered solid underwriting results again with a third quarter combined ratio of 93.7%. Specialty achieved a 5% rate increase in the third quarter. Retention remained unchanged. Specialty's non-cat accident year loss ratio was relatively flat as compared to earlier periods.

In the quarter, Specialty's net written premiums decreased 4%, reflecting a lower level of new business as we tightened pricing and underwriting standards.

In Commercial, our third-quarter combined ratio was 106%, which included 2.8 points from catastrophes. Excluding catastrophes and development, Commercial's third-quarter combined ratio was 102.9%.

Our Commercial non-cat accident year loss ratio was 67.4%, relatively consistent with this year's second quarter. Commercial rate increases continued to rise. The 8% rate increase in the third quarter was a 1 point improvement over the second quarter, while retention also improved 1 point to 79%.

Commercial's third-quarter net written premiums decreased 3% for the quarter. Before the impact of last year's fourth-quarter sale of First Insurance Company of Hawaii, Commercial grew 2% in the quarter.

Before turning it over to Craig, I wanted to spend a moment on the Hardy group, our newly acquired Lloyd's operation. Hardy produced net operating income of $3 million on net written premium of $56 million. Premiums were down approximately 17%, reflecting their increased reliance on third-party capital and the re-profiling of Hardy's property treaty portfolio. Hardy's combined ratio was 85.8%. Excluding catastrophes and development, the ratio was 94.7%.

With that, I will turn it over to Craig.

Thanks, Tom. Good morning, everyone. CNA had a solid third quarter from a financial perspective, much improved level of earnings, 4% book value per share growth, and continued improvement in financial stability and flexibility. CNA's third-quarter net operating income was $216 million and operating return on equity of 7.5%.

Our year-to-date operating ROE was 7%. Third-quarter operating income available to common shareholders was $0.80 per share. Period-over-period comparisons were favorable driven by improved results in our Property & Casualty Operations segments. Third-quarter net income also improved from the prior year to $221 million or $0.82 per share. Our Property & Casualty business produced net operating income of $264 million in the third quarter as compared to $130 million in the prior year period. The improvement was driven by strong limited partnership investment results, improved accident year underwriting results and lower catastrophe losses.

We had a modest amount of favorable prior year development in the quarter, $45 million pretax or 2.6 points on the P&C combined ratio. This compares to $90 million pretax or 5 points on a combined ratio in last year's third quarter.

As you heard from Tom, the Hardy Group made a modest but meaningful contribution this quarter. You should be aware that Hardy utilized third-party capital for the 2011 and 2012 years of account. For that reason, the Hardy segment results exclude the external capital provider's proportionate share of syndicate 382's results. The third-party capital percentages are 7.5% and 25% for the 2011 and 2012 years of account respectively.

The 2013 year of account CNA's results will include 100% of the syndicate results.

As a result of the purchase accounting for the acquisition, we recorded $81 million of finite live intangible assets that will be amortized over various lives up to 15 years. So amortization in the third quarter was $24 million, of which $6 million was above normal run-rate DAC amortization.

Our non-core Life & Group segment produced a $22 million third-quarter operating loss, driven by unfavorable claim experience in our individual long-term care business. We continue to pursue rate increases on our long-term care business and to evaluate the overall effectiveness of our runoff operation.

As we have said before, we are taking an active approach to managing all our non-core businesses as opposed to simply administering them. We will conduct our annual review of Life through preserves in the fourth quarter of 2012, consistent with prior years.

Our Corporate segment primarily includes corporate expenses, largely interest on corporate debt. The $26 million third-quarter operating loss was consistent with our expectations and included no significant unusual items.

CNA continues to build on a solid foundation of financial strength and stability. Our capital adequacy metrics remain at or above our target levels, and our liquidity profile remains very strong.

Book value per common share was $46.99 at the end of the third quarter, an increase of 4% from the end of the second quarter. The increase reflects earnings and improvement in our investment portfolio's net unrealized gains efficiencies.

Our investment portfolio's pretax net unrealized gains stood approximately $4.4 billion at quarter end, an increase of approximately $900 million from the end of the second-quarter 2012.

Approximately $545 million of this quarterly change was generated by the longer-term assets supporting our Life & Group segments. The impact of those gains was largely offset by additional shadow reserve adjustments that were also reflected in other comprehensive income. Our common shareholders equity, excluding other comprehensive income, was $11.5 billion or $42.80 per common share, up approximately 2% from the end of the second quarter.

Our statutory surplus stood at approximately $10 billion at quarter end, up modestly from the end of the second quarter. We have nearly $700 million of dividend capacity at the insurance operating company level, after having upstreamed a $150 million dividend in the third quarter. Cash and short-term investments at the holding company level were approximately $435 million at quarter end. We continue to target cash at the holding company equal to about one year of our annual net corporate obligations. We retired $70 million of corporate debt that matured in August.

In the third quarter of 2012, operating cash flow, excluding trading activity, was approximately $340 million, in line with this year's second quarter.

Additionally we received approximately $1.1 billion of cash principal repayments through paydowns, bond calls and maturities.

Net investment income was $601 million pretax in the third quarter as compared to $394 million in the prior year period. The increase was driven by our limited partnership investments, which produced third-quarter pretax gains of $89 million in 2012, as compared to pretax losses of $93 million in 2011.

Our LP investments produced a return of approximately 4% into the third quarter. Year-to-date our LP investment return was approximately 8.4%.

Net investment income from our fixed maturity securities in the third quarter was $507 million pretax, a $13 million increase from the prior year period. Higher level of invested assets more than offset the effects of lower new money yields.

We made relatively minor changes to our investment portfolio sector allocations this quarter. The 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 had an effective duration of 11.4 years at quarter end, a decrease from 11.7 at the end of this year's second quarter, and in line with portfolio targets. The effective duration of the fixed income assets which support our traditional P&C liabilities was 3.8 years at quarter end, a slight decrease from 3.9 years at the end of the second quarter.

With that, I'll turn it back to Tom.

Thank you, Craig. Before we open it up for questions, I would like to summarize our third-quarter highlights. Increased net operating and net income of $216 million and $221 million respectively. A combined ratio of 99.7% in our core Property-Casualty business. Rate increases of 8% in Commercial and 5% in Specialty. 1 point of improvement in the Property-Casualty non-cat accident year loss ratio. A combined ratio of 85.8% from the Hardy group, our newly acquired Lloyd's operation. Increased book value per share of $46.99, up 10% from year-end 2011. Lastly, we declared a quarterly dividend of $0.15.

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

Who is on the line?

Amit Kumar.

How's it going? Congrats on the quarter, for a moment I thought maybe Hurricane Sandy is impacting the phone lines. But I'm glad we got in.

Just quickly starting with the Hardy acquisition and I'm not sure if I missed this, but on page 11, if I look at acquisition expense ratio, why is that elevated, and would that normalize going forward? Or is that how we should think about the expense ratio for Hardy going forward?

This is Craig. I think that says nothing unusual in the expenses for the quarter. It was affected by the earned premium declines, as I mentioned in my remarks. Remember, that Hardy was relying on third-party capital for the 2011 and 2012 years of cat. This year about 20% of the earnings -- or this quarter 20% of the earnings went to those third-party capital providers.

So a little bit the effect of that. It is a little bit the effect of the decline, and then we've changed the accounting and the reporting somewhat so that we really account for all the operating expenses at the Hardy group level in the underwriting and acquisition expenses, which wouldn't be traditional for what they reported in the past or what you usually see at Lloyd's. But that is what you ought to look at going forward at the moment.

Got it. So I guess once we gross up the earned premium, those numbers will obviously fall.

Right.

Got it. The second question is the discussion on pricing, and I guess it is maybe a two-part question. Pricing and margins, pricing was -- it is still strong, but I think it looks like it was relatively flat versus Q2.

And I know we've talked about this in the past, how you were ahead of the curve in terms of pricing entreaties for your book. Maybe just talk about -- and this question is for Tom -- just talk about the sustainability. Do you think these numbers start trending down as we go forward or you think that you'll keep on getting rate on rate into 2013?

We are optimistic about getting rates in the fourth quarter and beyond. I think the industry needs rates, whether it's in the Commercial sector or, in particular, in the Specialty segment. We think there's a lot of rate to be had there. It just hasn't followed the Commercial space.

So we continue to be optimistic. We did improve a bit in Commercial, and when we looked at the individual lines of business, most of them improved, and we did have two that were double-digit and one that was right on the verge of double-digits.

So we are getting rate in the places that we think we need to get rates. So we are pretty confident about that. And Specialty, we are getting rate there. I think if you go back in time, we've been getting rate increases in Commercial now for eight quarters in a row. We've been getting rate increases in Specialty for six quarters in a row.

So the fact is, even if you took that out a little longer in Commercial, we are getting rates beyond eight quarters. Just one quarter we fell behind a little bit.

But we have been building this gradually over time, and I think what the market is showing is nobody is being very aggressive in getting rate. It's much more moderate. And we believe that if it stays moderate, we'll be able to continue to get rate increases. But if you compare third quarter of '11 with third quarter of '12, Commercial has gone from 2% to 8%. And if you look at Specialty, basically slightly positive in the third quarter of '11 to 5 points today.

So it's been moving up. I don't expect that it's going to move up a lot from where it is, but there's certainly areas that will need more rate, worker's comp being one, and we'll see what this storm does to property rates. And that would be not only monoline property, but also the package business, which has a property portion. So we think there's some legs in this market.

That's helpful. And I guess maybe the only other question and I'll requeue after this, can you talk about the contribution of new business in the lines and the pricing the new business is getting versus your renewal business?

If we look at our Specialty business , we believe that the new business is priced much stronger than the renewal business. And quite honestly, as I just said a moment ago, we think the Specialty business needs rate increases. So we'll continue to push in Specialty.

But the good news now is what we are writing on the new side is better priced than our renewal book, and we are becoming more selective in Specialty. And that's why you saw a drop-off in their growth in the quarter because we really cut back on the new business that we were writing. Because there are some problems in employment practices for the industry and certain other professional liability lines. So positive on Specialty.

Commercial, it is pretty flat with the renewal business, slightly negative. But then we are getting more rate increases in Commercial. So 8% is a pretty good number for us. So we're going to keep pushing on that, but we are not giving anything away.

Got it. Okay, I'll stop and requeue. Thanks for the answers.

(Operator Instructions). Jay Cohen.

Thank you. Good morning. I guess several questions.

The first is the review of the life insurance reserves, which you do, I guess, every fourth quarter. Is there anything in the macro environment this year that seems more adverse whether it's lower interest rates --? In other words, as you look at that -- the reserves this quarter, should we be expecting more likely charges given the macro environment?

This is Craig. I would say nothing really changed dramatically in the macro environment. It certainly hasn't gotten better, and I think the two big drivers would be claims. We have seen a slight increase in claim activity this year. This quarter was about $10 million more than we would've expected. Last quarter was actually a very light claim quarter. The first quarter was a bit heavy on the claim. So right now it's tough to see if that's a trend or just some kind of random variability in outcome. So we're looking close at that, although I would say that October looks to be running closer to what the third quarter ran in terms of claims. So that will be a key kind of decision to make and judgment to make about what direction that is going in the future. And then we'll have to wrestle with the low interest rate environment and make some estimate about how long we think that persists or doesn't persist. So those are pretty tough and difficult topics. But that's not that much different. It is just I would say all are a little or slightly worse than they were a year ago.

Got it. Thank you. Second question, I guess, really just given the storm activity, going on right now as we speak, could you just remind us what your cat program looks like? I would normally look it up, but I don't have my files here, and if you could give us that, that would be helpful.

Yes. We buy -- our retention at our cat is $300 million, and we buy $600 million of protection over that $300 million.

Is that fully placed, the $600 million?

No, the first $100 million layer is 50% placed, and the rest is fully placed as I remember.

Okay. And then lastly, when I look at Hardy, when I look at the net gross, that difference, that reflects I'm assuming the third-party capital as well as reinsurance purchases?

Yes. So I guess you've really got to make a couple of steps. First, a portion of the third-party capital actually gets deducted from the growth before you even see it -- like 10%. And then the other 15% is deducted from the growth in that, and then they buy third-party reinsurance somewhere between 20% to 25% reduction of the gross.

And yielding that goes away next year as you have it modeled now would be the third-party capital?

That's correct.

Okay.

And do remember, though, Jay, because that's a year of account trading basis, that will kind of gradually change over the course of the next couple of years. So as premiums continue to be collected for the '11 and '12 years of account, it will only be the premiums on the '13 year of account and then the earned premium on '13 that will be 100%. So that will be a pretty gradual transition over the next couple of years.

It has to be earned in, okay. That's helpful. And then lastly on Hardy, again, I am sure you've talked about this before, but I don't have notes in front of me. The seasonality of that business, how should we think about that?

I think it's really more the property treaty that's a little more seasonal, so -- and that business has been pretty significantly curtailed. And we are in the process really of rebuilding and reprofiling that business. So in the future, you should expect that to kind of follow the seasonality you would see in any other kind of property treaty reinsurer.

So, if we look at the third-quarter gross premiums, obviously some of that will get moved up because of that gradually the third-party reinsurance goes away, but is that a decent run rate for us to look at as far as modeling purposes going forward?

I think that's a bit depressed in terms of the written, but not significantly. I think it's reasonable enough as a starting point, and you will have a better view of that when you see the fourth quarter year-end, I think.

Got it. That's helpful. That's all I have. Thank you.

Amit Kumar.

Thanks. Just very quickly, going back to the discussion on your cat program, can you remind us what your Hurricane Irene losses were? Is that number handy?

Yes, it's top of mine unfortunately. So we reported $44 million of losses from Hurricane Irene. Now this (multiple speakers) storm looks to be a bit broader based and slow-moving, so.

And I guess maybe to expand on that, and I'm sure you're getting some reports, do you have any view what Hurricane Sandy will look like, or are you hearing anything from the people on ground?

No, not really. We won't get our really first model of output until late this afternoon or tomorrow morning until we have a better sense of storm track from our RMS and some others. So really the only measures we have to look at is kind of our own judgments of path like you're asking about. So what was Irene and what were Irene's losses? We know our market share is between 0.5% to 1%. So depending on where the industry loss is, maybe that's another little marker. Those are pretty -- I don't know how helpful those are necessarily, but that's about as far as we can take it at the moment.

That's very hopeful. And what are the split in your Hurricane Irene loss between Commercial and Specialty? Can you remind us of that?

It was almost all Commercial. There is very little Specialty losses. If you look back, you'll see the Specialty cat losses over and any of the number of the last years have been relatively modest.

Modest.

And fairly insignificant. So less than 0.5 point. I don't think it's been more than 1 point in any quarter. Actually our overall cat losses have been, we think, stacked up really well relative to industry comparisons.

Got it. I guess if the losses turn out to be a much bigger deal, then definitely some of those will start flowing through Hardy, right?

Some do, but as we've said in earlier calls, the PML impact of Hardy is not that significant.

Okay. And the only other question I guess I had was, I know we talk about this every quarter and probably even the same answer. But just in terms of the impending fiscal cliff, any thoughts or any sort of revisitation on the possibility of a special dividend?

We, again, appreciate you asking the question, but as we said, we made a practice of not talking about or telling what capital actions we might take in the future. So we'll naturally look at everything. We talk about it every quarter. We'll discuss capital plans again at the end of the year after we look at the full year's earnings and earnings estimate and reconsider our outlook for '13, and all those things that we talk about in the past are certainly on the board as far as uses for our capital.

But it's not off the table.

Same answer as last quarter and the quarter before that. You said it correctly right at the beginning of it. (multiple speakers)

Okay. I'll keep on trying. One of these days. Thanks for all the answers. Much appreciated.

You're very welcome.

Ron Bobman, Capital Returns.

Good morning, gentlemen. Calling in from an undisclosed location on the storm-battered East Coast.

I just had a question about loss pic in Commercial and maybe Specialty as well. As rates declined in the last five, six years, maybe '07, '08, '09, '10 and '11, just curious for those years how the loss pic is holding up?

And you want to know for '09, '10, '11? I think that when we think about it, maybe start with Commercial. '09 actually has held up pretty well. '10 and '11, what we have seen and you kind of see it in the reserve reviews and the reserve outcomes is that largely property and general liability lines have performed slightly better than we expected, and auto and comp have been a little bit worse than we've expected. But those have been kind of on the margins. I think that as an example, comp over the last two -- for the last two accident years this quarter we added less than $20 million to comp reserves.

In Specialty, those pics have moved up because we've seen pretty significant increases, as Tom was saying, in frequency, in employment practices, liability and a number of professional liability lines that we think were generated by the economic crisis and the outcomes from that. So we've seen a pickup in frequency as an example in the lawyer's books. But on the pics, if they have moved, they've moved pretty modestly and on the margin. I think you can kind of see those in the numbers they report over time.

And, Craig, you answered it by focusing on '09, '10 and '11. I asked for a broader window. Did you focus on '09, '10, '11 because those are the only ones that are really noteworthy?

I thought you were asking '09, '10, '11. You wanted something larger than that?

No, I was just curious. Since you focused on '09, '10, '11 because of the miscommunication, sorry, anything noteworthy about '06, '07 '08 where rates were declining, but maybe they were still well more than adequate so it's less of an issue or (multiple speakers)?

Those are all continuing to develop favorably all those years.

Okay. Thanks. So '09, '10 and '11 are really the ones worth noting. (multiple speakers) Thanks. I appreciate it.

Jay Cohen.

Just to move, I guess, more towards a bigger picture view, can you talk about what your eventual ROE target is for the Company?

I think right now, Jay, in this kind of interest rate environment, we would like to do better than where we are today. And the name of the game is improving the underwriting contributions. That is key.

So I would say we are at -- I guess we're at 7.5% this quarter. In the near future, we would like to get close to 10%. We think that would be a reasonable, all things considered, so.

But the underwriting side is going to have to contribute, and Hardy has helped. Buying the rest of Surety has been a good deal for us. We are seeing improvement in Commercial. We are tightening the hatches in Specialty. Specialty had very good ROEs until recently. So I think that's probably get to double digit before you declare you want to go up in the cloud. So I think that's where we want to try to get to right now.

Do think you can get to 10% without doing some sort of restructuring on the runoff business? Does that have to be part of it to get to that kind of ROE?

No, I think if we can really get the underwriting stuff much improved, I think we can get there. Since you brought it up, we are always thinking about these runoff businesses and what we can do. And you know we came up with a solution on asbestos.

So these things take a lot of time. They take a lot of diligence. We continue to look for solutions in that business. But at the same time, we are an underwriting company, and we have to improve our results. And we think we could certainly get to those or get to 10% if we get loss ratios down from where they are today, and we're working on that, and it's getting there. We see the results.

So we're pleased. I can't tell you when it's going to happen, but if you said short-term what am I looking at, I think that would be a number that we would be happy with today in this environment.

Got it. Thank you.

It appears we have no further questions at this time. I would like to turn the conference back over to our speakers for any additional or closing remarks.

Thank you.

That concludes today's conference, ladies and gentlemen. We appreciate your participation.