CNA Financial Corp (CNA) 2014 Q1 法說會逐字稿

Good day, and welcome to the CNA Financial Corporation's first-quarter 2014 earnings conference call. Today's call is being recorded. At this time, I would like to turn the conference over to James Anderson. Please go ahead.

Thank you, Greg. Good morning, and welcome to CNA's discussion of our 2014 first-quarter financial results. By now, hopefully all of you have seen our earnings release, financial supplements and presentation slides. If not, you may access these documents on our website, www.CNA.com, under their investor relations menu.

With us in this morning's call are Tom Motamed, our Chairman and Chief Executive Officer; and Craig Mense, our Chief Financial Officer. Following Tom and Craig's remarks about our quarterly results, we will open it up to your questions.

Before turning over to Tom, I would like to advise everyone that during this call there maybe 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 the call. Information concerning those risks is contained in the earnings release and in CNA's most recent 10-K on file with the SEC. In addition, the forward-looking statements speak only as of today, Monday, April 28, 2014. 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 the financial supplements.

This call is being recorded and webcast. During the next week, the call may be accessed on CNA's website. I would also like to remind you that presentation slides have again been posted on the website to provide additional perspective on our financial and operating trends.

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

Thank you, James. Good morning, everyone, and thank you for joining us today. In the first quarter of this year, CNA produced operating income of $190 million, compared with $225 million in the first quarter of 2013. Current accident-year non-catastrophe underwriting results improved over prior year, but were offset by higher winter-related catastrophes and lower limited partnership investment income.

Our property and casualty combined ratio was 101.6 for the quarter, in line with last year's first quarter. Catastrophes affected the loss in combined ratios by 4.5 points, as compared with 2.4 points in the first quarter of 2013. Our property and casualty combined ratio, excluding catastrophes and development, was 97.2. This was almost a 4-point improvement as compared with the first quarter of 2013. This includes just over a 3-point improvement in our loss ratio and a 0.7-point improvement in our expense ratio. Our results in the first quarter are consistent where we ended full-year 2013.

Property and casualty net written premium was flat in the quarter, as rate increases were offset by lower retention in commercial resulting from underwriting actions including exiting classes outside of our appetite as well as continuing to focus on underwriting and pricing actions to improve profitability. We continue to seek and achieve rate increases exceeding loss cost trends. Commercial rates increased 6% in the quarter, with retention in the mid-70s. Specialty rates increased 4%, and retention remains strong in the mid-80s.

With that, I will turn it over to Craig.

Thanks, Tom. Good morning, everyone. As Tom mentioned, first-quarter net operating income was $190 million, or $0.70 per share, and the operating return on equity was 6.3%. Our reported net income of $13 million includes a $214 million impairment charge related to the pending sale of our life subsidiary, Continental Assurance Company, which we announced last quarter. The result of that business as well as the impact of the impairment charge are now being reported as a discontinued operation. We still expect to close this transaction sometime in the second quarter.

The majority of our businesses, as well as our balance sheet strength, reflect our continuous improvement. We are pleased with the ongoing progress in our specialty, Hardy, and long-term care businesses as well as our investment results and capital management activities.

Our results in certain parts of the commercial lines are not what we expected. Continued loss cost pressure on auto and certain classes within our small business segment slowed our overall progress. Our middle-market business and customer segment strategies are taking hold and are making meaningful, positive contributions to our progress.

Our core P&C operations produced net operating income of $219 million in the first quarter, compared with $257 million in the first quarter of 2013. The decrease was primarily the result of lower limited-partnership investment income and winter-related catastrophe losses. Our first-quarter P&C operations loss ratio, excluding catastrophes and development, was 64%, a 3-point improvement as compared with last year's first quarter and consistent with our reported full-year 2013 results.

Our first-quarter expense ratio was 33.1%, a 0.7 point improvement from the prior-year period and, again, consistent with our full-year 2013 results, reflecting our ongoing expense management efforts and a lower level of underwriting expenses.

Specialty's first-quarter combined ratio, excluding catastrophes and development, was 93.9%, 4 points better than last year's first quarter and modestly better than the full-year 2013 results. The reported combined ratio was 94.4%, which included 1.4 points of cap losses and just under 1 point of favorable development. The loss ratio, excluding capacities and development, was 63.7%, 3 points lower than last year's first quarter and slightly below the full-year 2013 results. The improvement was driven by rate increases in excess of loss trends as well as targeted underwriting actions that continue to refine the portfolio mix.

Commercial's first-quarter combined ratio, excluding catastrophes and development, was 101.2%, almost 3 points better than last year's first quarter. The loss ratio excluding catastrophes and development was 66.9%, an improvement of almost 2 points over the prior-year period but 1 point above full-year 2013. Non-cat weather and other large first-party losses added approximately 1.5 points to the reported loss ratio.

The reported combined ratio of 109.8% included 7.5 points of catastrophe losses in comparison with the prior-year period's 106.8%, which had 4.6 points of catastrophe losses.

Hardy reported net operating income of $7 million in the first quarter, with a combined ratio, excluding catastrophes and development, of 88.6%, as both the underlying loss ratio and expense ratio improved compared with the first quarter of 2013 and the full year. The reported combined ratio was 87.1%, which included a small amount of favorable prior-period development items.

Hardy's first-quarter expense ratio includes almost 4 points of one-time items. The run rate expense ratio is now in the mid-40s. Hardy continued to produce a modest amount of organic net written premium growth and also benefited from a reduced level of reinsurance spend.

The life and group segment produced $2 million of net operating loss in the quarter, slightly better than the first quarter of 2013, primarily driven by higher net investment income due to a higher invested asset base. The results were helped by the ongoing positive impact of our rate increase action. Morbidity was generally favorable, while persistency was unfavorable to recent quarters' results.

Our corporate segment, which primarily includes corporate expenses, reported a $27 million first-quarter net operating loss consistent with the prior year's first quarter. It includes a small $2 million benefit from the recognition of the deferred gain established last quarter related to the NICO retroactive reinsurance transaction.

Our balance sheet continues to reflect CNA's financial strength and stability. Book value per share decreased 1% in the first quarter to $46.61 per share. Excluding accumulated other comprehensive income, book value was $44.05 per share, down 3% from year-end 2013. The decrease was driven by our previously announced $1 a share special dividend and $0.25 a share quarterly dividend as well as the negative impact of the CAC sale.

Our investment portfolio's pretax net unrealized gains stood at approximately $2.5 billion at quarter end, an increase of approximately $600 million from year-end 2013. Our statutory surplus at quarter end was [$11 billion], and we continue to maintain significant dividend capacity at the insurance operating company level.

As previously announced, we completed a $550 million debt offering in February, with the proceeds earmarked to retire senior notes maturing in December of this year. The coupon on the new debt is 3.95%, 190 basis points lower than the existing debt.

Cash and short-term investments at the holding company level were approximately $1 billion at quarter end, up significantly due to the proceeds from the debt offering.

In the first quarter, operating cash flow, excluding trading activity, was approximately $150 million. Cash principal repayments through paydowns, bond calls and maturities were approximately $850 million. Net investment income was $526 million pretax in the first quarter. Limited-partnership income of $73 million was a solid 2.7% return this quarter but lower than the exceptional return in the same period last year. Income from our fixed maturity and other securities, excluding LPs, in the first quarter was $553 million pretax, down slightly from the prior-year period. More importantly, you will note that we generated $324 million of after-tax income from these securities, which is above the level of first-quarter 2013, reflective of the opportunity that we saw and seized last summer and the tax-exempt municipal bond market. Our actions have enabled us to sustain an after-tax book yield of 3.5% on this part of the portfolio.

While our overall portfolio allocations did not change significantly in the first quarter, we did continue to increase our allocation into the tax-exempt municipal bond market. The investment-grade corporate bond sector continues to represent the largest component of our invested assets. The average credit quality of our fixed-maturity portfolio remained at A. Fixed-income assets that support our long-duration, lifelike liabilities had an effective duration of 11.5 years at quarter end. The effective duration of the fixed-income assets, which support our traditional P&C liabilities, was 4.3 years at quarter end. These durations are both in line with portfolio targets. Overall, our investment portfolio remains well-diversified, liquid, high-quality and aligned with our business objectives.

With that, I will turn it back to Tom.

Thanks, Craig. Before we open it up for questions, I would like to make some final comments. As Craig said, our steady progress is evident across the majority of our businesses. We are pleased with our progress in specialty and Hardy and with our capital position and investment income. We know we have to work -- we have work to do in commercial.

We remain focused on the disciplined execution of our articulated business strategy and are committed to driving further improvement in our results. With that, we would be glad to take your questions.

(Operator Instructions) Bob Glasspiegel, Janney Capital.

I was wondering if you could expand on what has changed in commercial auto within the small business segment that is causing some pressures?

I think the industry is acknowledging that commercial auto is a class that's not doing very well. And the fact is, for us, that would be middle-market as well as small, but particularly in the small area.

I think the good news is we are refining our underwriting and pricing strategies there, Bob. We are getting double-digit rate in small on commercial auto. So we believe a combination of strict underwriting guidelines and pricing as well as rate increases is going to have the impact of turning that around over time.

Well, thank you. If I could follow up just with a numbers question for Craig. I see the life and group non-core on page 8. You had a $32 million pretax loss and $30 million of tax benefits. Anything driving the higher tax credit rate this quarter?

That's just the reflection of the investment portfolio, which you recall is more heavily weighted to tax-exempt municipals.

Okay. Thank you.

Jay Cohen, Bank of America Merrill Lynch.

One number that looked a little worse than we have been seeing was the favorable development in the specialty segment. And I'm wondering is there -- maybe it's -- (inaudible) it looks like there may be some seasonality there where the first quarter tends to have a lower reserve release. Is that what is going on? Or is there any underlying change in what you're seeing from a claims standpoint in that segment?

I think you are right in what you said, Jay. First quarter typically is lighter. We had a big fourth-quarter reserve release in specialty. It's seasonal. The fact is we don't look at every line, every class, every quarter. And specialty tends to be more towards the end of the year than the beginning of the year.

And I guess on the commercial business, you had a very modest amount of adverse developments, but it was adverse. Can you give us a kind of a glimpse into what is happening with various classes of business from a reserve standpoint? Is that more on the commercial auto side you are seeing some pressure on those reserves?

Jay, I can give you just a little bit of color there. Yes, there was some adverse in commercial auto in the more recent accident years. But that was largely offset by some favorable development we had in property mix with property cats from 2013 as well as general liability in some older years. What you are really seeing there is just the residual of what's left in the workers' comp (inaudible) discount online. So I say -- I would characterize that result as flat for the quarter.

Got it, that's fair. Very good. Thank you very much.

(Operator Instructions) Josh Shanker, Deutsche Bank.

I wanted to dig in a little further on the commercial auto. Can you talk a little about what combined ratio you are running at for that business right now is? And I think it's probably about $300 million, $400 million of premium annually. Can you give us some color on that?

Yes, hold on. On an accident-year basis, it's running about a 121; and 159 on a calendar year.

And how much premium is that?

Hold on. We'd have to get that premium.

Yes. But it's about -- it's less than 10%. It's around 10% (multiple speakers) of our commercial (multiple speakers).

And can we all sort of scale the small business? That's not really a reporting category you have, so I'm not sure exactly what you can tell me there. But I would be interested to know how you guys think about that as well.

Well, you can't see the scale in the earnings slides, as James referred to earlier, Josh. You can see the revenue as well as rate and retention. I might (multiple speakers).

Okay. That categorization -- there are some small commercial in -- there's some commercial auto in the small business -- that's a class as opposed to a line?

Yes.

Yes? So, okay. So in terms of thinking about the pace of improvement, if we're -- where we are today, where given the rate improvements you are at, how quickly do you think it will take to turn this around, given the pricing right now and the trend involved?

Well, we are taking a pretty hard line on rate increases. Like I said, for small it's low double-digit. Retention, we've really dropped a lot of business there. Retention is kind of just under 60%. So a combination of really getting rid of the bad stuff that we don't think we can fix plus applying rate for the remainder of the book will be helpful, and we are extremely cautious on what we are writing new. And really trying to write the new business at profitable levels. So it's going to take some time to get through it, but I couldn't give you an exact time on that.

But would it be incorrect to say even if you could hold loss costs generally flattish, given double-digit rate increases, it would take you a couple years to get to where you want to be on commercial auto?

Well, I certainly think -- to find a couple, 2 to 3, that probably (multiple speakers). Yes.

Well, a couple, two year.

And I think really it's the power of written rate turning to earned rate and exceeding loss costs that will drive the margins more favorably. So we are confident that we will be able to continue to get rate increases in this line.

All right. Well, I appreciate all the color. Thank you very much, and good luck.

(Operator Instructions) Jay Cohen.

Couple of questions -- the first is, Tom, I'm wondering if you can discuss the competitive conditions in the commercial segment. We see what your average rate increases are, but if you could put more color around that. And then separately you talked about non-cat weather and some severe losses affecting the loss ratio. I'm wondering if you could just talk about some of the severe losses. What kind of losses are we talking about?

Okay, on the loss side, obviously it was a tough winter. Some of it gets cataloged as cat, and we have given you the cat numbers. We did have some non-cat large losses; I guess they probably amounted to $15 million, so a couple of fires, et cetera. So you have that. And then there's, in general, the fact that you have weather-related losses that are not cats. So we've had some activity there as well as, I think, most people. So a combination of cats, large loss and weather-related claims from the severe winter.

And your other question, Jay, was?

On competitive conditions, Tom.

Yes. It's always competitive. But I think what we are seeing and probably have seen for the last six months, maybe a little more, is people are very protective of their renewals. They are putting them to bed earlier. They are not letting them get to market, and in fact may be cutting their -- or not applying rate to some of them; renewing them flat.

So I think people are more protective of the renewal book, which creates less new business opportunities. We have seen less new business opportunities here at CNA. And it's not for not trying. It's clearly people are trying to put their stuff to bed much earlier. So we see that.

On new business, I'd say people -- when a piece comes out there, people are competitive and writing some of the business in commercial probably below expiring, in many cases. And everybody has different analytics to predict one account is better than the other. So I think you have some trading when business comes out to the market on a new business standpoint. But that has been going on for a while. I'll think it's anything new.

Kind of interesting, though, when we look at commercial, the month of March had the highest rate increases in the first quarter compared to January and February. So it's a little lumpy out there, but that's how I would describe it.

That's great. Thank you.

Adam Klauber, William Blair.

So when you look through some of the weather noise, it looked like the accident year loss ratio in first quarter was better than the first quarter last year. Do you think we will continue to see accident year improvement throughout this year?

That's the goal.

Okay. Next question -- workers' comp. How is that trending? And again, do you think the accident-year workers' comp this year will be better than last year?

I think there are a couple things going on in workers' comp here. Number one, we are getting rate increases in excess of loss cost trends, so that will improve margin. We are moving the mix much more into what we would call white-collar, which I would probably describe as companies that have people that really want to go back to work because they are high-wage earners. So we are managing the mix. We are pretty careful on what states we are growing in or not growing in. So it's a multi-faceted strategy -- get the rate increases, manage the mix, manage the jurisdictions. But we think we are going to gain on workers' comp; we are seeing improvement there.

Okay. Thank you very much.

Ron Bobman, Capital Returns.

I got on the call late, so I apologize if this is ground you covered. I was curious to hear your thoughts about what is going on in the cyber market, Tom. Sort of broadly. And then any actions or plans for CNA's participation?

And then switching to Hardy, if there's any description as far as does Hardy have a broadening underwriting appetite, whether it's geography or lines of business? If you would describe any of that, I would appreciate it. Thanks, and hope all is well.

To start with Hardy, I think Hardy is in a competitive environment in the Lloyd's marketplace. It is quite competitive on pricing, whether that be new and renewal. They give up about 3 points of rate in the quarter. But I would describe them as sticking to their strategy of areas that they want to underwrite in. And I think they really have a great attitude about keeping their powder dry. They are not going to chase the market down. We are constantly talking to them, but they are pretty disciplined. And I think they are not going to chase the market down. They're going to wait for the opportunities, and we are pretty happy with what's going on at Hardy. And they obviously contributed to the results in the first quarter.

As far as cyber, we do offer cyber liability. We have been doing that for a while. It is a hot topic -- obviously, what you read in the papers, and I think for yourselves. Right? So companies are buying this product. They are not sure if they are going to have a breach or not, but clearly it is a hot product. And there's a lot of competition for it. There's a lot of people writing cyber, and we would expect that to continue.

To me, it's a little bit reminiscent of public D&O back in the early 80s, that we were selling the product and nobody really knew what the coverage was and there weren't many claims. And then all of a sudden there were claims and people started adjusting terms and conditions and policy language. So I think cyber, quite honestly, is going to develop over time until we really know what it's all about, et cetera. But it's here to stay.

Thanks. Can I just go back to Hardy (inaudible) make sure because you didn't say so I assume the answer is no -- I didn't think you said. As far as Hardy broadening its geographic risk profile or lines of business, no great -- no meaningful changes planned there or currently being undertaken. But you said sticking to their knitting, the same lines that they had been writing historically and largely in the same geographies?

Yes, that's true. Now, the only thing I would give you -- there's one caveat, and that is Lloyd's is expanding their network. They operate out of Singapore now. And the fact is we have to figure out how we are going to -- if we did go to Singapore for Lloyd's, we have got to figure out how we're going to do that and what product lines. But we are not going to do something we don't know anything about. I can assure you that's the case. So we're going to stick to our core competency, our expertise. If there's business that fits that coming out of the Singapore Lloyd's facility, we will be interested in entertaining it if it's the right price. This is not about going like a barn burner here. This is cautious.

Good. We don't want any barn burners.

No, we don't like barns that burn.

John Thomas, William Blair.

Some of my questions have already been asked. But could you break down the growth in specialty because that came in at 10% this quarter? And I'm just wondering what lines of business are driving that.

Yes, that's gross. The net was, let's see, minus [1].

And so why were those so different?

It's the Asurion cell phone captive. I think we've talked about it before, but it's probably been a while since we've described it.

That's gross, but it does not contribute to the net.

Okay. And then your exposure growth this year compared to last year -- are you seeing increased business activity, lower?

Slightly higher, but I'm telling you slightly; less than a point.

All right. Thanks.

And it appears there are no further questions at this time. Mr. Motamed, I would like to turn the conference back over to you for any additional or closing remarks.

Thank you very much. See you next quarter.

Once again, that does conclude today's conference. We appreciate your participation.