CNA Financial Corp (CNA) 2014 Q2 法說會逐字稿

Good day, and welcome to the CNA Financial Corporation's second-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, Randy. Good morning, and welcome to CNA's discussion of our 2014 second-quarter financial results. By now, hopefully all of you have seen our earnings release, financial supplement, and presentation slides. If not, you may access these documents on our newly designed website, www.CNA.com.

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 and Craig's remarks about our 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 the call. Information concerning these risks is contained in the earnings release and in CNA's most recent 10-Q and 10-K, on file with the SEC.

In addition, the forward-looking statements speak only as of today, Monday, August 4, 2014. CNA expressly disclaims any obligation to update or revise any forward-looking statements made during this call.

Regarding non-GAAP financial measures, reconciliations to the most comparable GAAP measures have also been provided in the financial supplement.

This call is being recorded and webcast. During the next week, the call may be accessed on CNA's website. I'd also like to remind you the presentation slides have been again posted to our 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 second quarter, CNA produced operating income of $272 million compared with $199 million in the second quarter of 2013, a 37% increase.

Our operating return on equity for the quarter was 9%. Our property and casualty combined ratio was 101.3, slightly better than the second quarter last year. Excluding catastrophes and development, the combined ratio was 96.3, more than 1 point better than the second quarter of 2013. This improvement was driven by lower non-cat accident-year loss ratios in specialty and commercial, improved life and group results, and higher net investment income. Results were also positively affected by a post-retirement plan curtailment benefit.

Once again, specialty had a strong quarter, with a combined ratio of 86.4%. Net written premium for the quarter was down 2%, due in part to the termination of a MGA relationship due to unprofitability. Excluding this action, premium was flat. Rates increased 4%.

Commercial's combined ratio was 115% in the quarter, which included 10 points of prior-year unfavorable development. 7 of the 10 points are attributed to runoff programs that we have previously exited. Commercial rates increased 4% overall, and 5% in the US, and retention was 70%.

We continue to work diligently to improve the quality of the book. In addition, we've strengthened reserves in small business this quarter. We continue to take underwriting and pricing actions in certain classes in our effort to improve profitability. These actions have also driven small business retention ratios down, as well as reduced rate achievement, as we non-renewed accounts that would have otherwise provided larger rate increase opportunities.

Finally, as announced last week, we completed the sale of Continental Assurance Company to Wilton Re.

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

Thanks, Tom. Good morning, everyone. As Tom mentioned, second-quarter net operating income was $272 million, or $1 per share; and the operating return on equity was 9%. Our reported net income was $267 million. Our core P&C operations produced net operating income of $236 million compared with $258 million in the second quarter of 2013. The decrease was primarily the result of reserve strengthening in commercial.

The P&C operations loss ratio, excluding catastrophes and development, was 62.8%, an almost 2-point improvement compared with last year's second quarter. The year-to-date loss ratio of 63.4% has now improved nearly 0.5 point compared with our full-year 2013 result.

Our second-quarter expense ratio was 33.3%, essentially flat with the first-quarter and the full-year 2013 result.

We continue to be pleased with the ongoing progress in our specialty business. Specialty's reported second-quarter combined ratio was 86.4%, which included more than 7 points of favorable development. The combined ratio, excluding catastrophes and development, was 93.1%, 2.5 points better than last year's second quarter. The year-to-date result of 93.4% has now improved almost 1 point compared with our full-year 2013 result, driven by improvements in the underlying loss ratio.

The loss ratio, excluding catastrophes and development, was 62.5%, more than 3 points lower than last year's second quarter; and, on a year-to-date basis, almost 1 point lower than where we ended 2013. The improvements were driven by targeted underwriting actions that continued to refine the portfolio mix, as well as rate increases in excess of loss trends. Rate increases for the quarter were 4%, with retention in the low 80s.

As Tom described, our results in commercial are not where we needed them to be. The reported combined ratio of 115% included 5.7 points of catastrophe losses, and almost 10 points of reserve strengthening. The commercial reserve strengthening was driven primarily by exited programs, but also includes small business. Commercial's combined ratio, excluding catastrophes and development, was 99.4%, almost 2 points better than last year's second quarter. The loss ratio, excluding catastrophes and development, was 64.7%, an improvement of more than 1 point compared with the prior-year period.

Both the 2014 combined ratio and loss ratio, excluding catastrophes and development, showed improvement this quarter. The year-to-date ratios are now slightly better than where we ended the full year of 2013. Rate increases for the quarter were 4%; with retention, 70%.

Hardy reported a net operating loss of $5 million in the second quarter, with a combined ratio, excluding catastrophes and development, of 96.4%. The underlying loss and expense ratios compared unfavorably with the second quarter of 2013. The loss ratio was affected by higher-than-expected attritional losses. The impact of FX and integration costs also contributed to the unfavorable comparison. Hardy's reported combined ratio was 102.9%, which included 4.6 points of catastrophe losses compared with no cat losses in the prior-year quarter. The two points of unfavorable development was related to premium shortfalls, and not adverse loss development.

The life and group segment had a good quarter, producing net operating income of $9 million compared with a loss in the second quarter of 2013. Our long-term care business benefited from favorable morbidity and persistency. Rate increases, higher investment income, and a gain on the life settlement contract also contributed to the improved result.

On Friday, we announced the completion of the sale of our life subsidiary, Continental Assurance Company, to Wilton Re. In addition to the sale, we are reinsuring a block of structured settlement annuities out of our Bermuda subsidiary to Wilson. This reinsurance transaction is being done on a funds-withheld basis, meaning that we will maintain legal ownership of the assets associated with the transaction, but Wilton will assume the economic risk.

The market value of the asset is currently $35 million higher than the $150 million book value, causing us to recognize a $35 million loss at the date of inception, August 1. This loss will be reflected on our third-quarter results. Over time, we'd expect the $35 million loss to unwind, as the assets mature and the market value approaches book value. But, until then, we'll have periodic realized gains and losses based on the market value change in these assets.

Our corporate segment, which primarily includes corporate expenses, produced net operating income of $27 million compared with a loss in the second quarter of 2013. This result includes $56 million of after-tax income related to a decision that we made this quarter to eliminate a post-retirement medical benefit subsidy. The benefit elimination reduced the accrual of future benefits for a significant number of plant participants, and triggered the immediate recognition of an unrealized gain in AOCI related to prior negative plan amendments. While increasing current-period income, this change did not affect total stockholders' equity.

Book value per share increased 4% in the second quarter to $48.43 a share. Excluding accumulated other comprehensive income, book value increased 2% in the quarter.

Our investment portfolio's pre-tax net unrealized gain stood at approximately $3.3 billion at quarter end, an increase of over $750 million for the quarter, and $1.3 billion year-to-date. Our statutory surplus a quarter-end was $11.2 billion, and we continue to maintain significant dividend capacity at the insurance operating company level.

Cash and short-term investments at the holding company level were approximately $1 billion at quarter-end, up significantly from year-end due to the proceeds from the debt offering discussed last quarter. In the second quarter, operating cash flow, excluding trading activity, was approximately $400 million. Cash principal repayments through paydown, bond calls, and maturities were approximately $1.1 billion.

Second-quarter after-tax investment income of $391 million exceeded the prior-year result. Both our limited partnership investments and our fixed maturity and other securities contributed to the favorable comparison.

Overall portfolio allocations did not change significantly in the second quarter. The investment-grade corporate bond sector continues to represent the largest components of our invested assets.

The average credit quality of our fixed maturity portfolio remained at A. Fixed income assets that support our long-duration life-like liabilities had an effective duration of 11.4 years at quarter-end. The effective duration of the fixed income assets which support our traditional P&C liabilities was 4.2 years at quarter-end. These durations are both in-line with portfolio targets.

Overall, our investment portfolio remains well diversified, highly liquid, high quality, and aligned with our business objectives.

With that, I will turn it back to Tom.

Thank you, Craig. Before we take your questions, I would like to offer a few comments on the current state of the market. First of all, I believe the market is exercising good discipline when you look at risk selection and pricing. Although rate increases are decelerating, our rates in the US continue to exceed loss cost inflation.

Second, profitable new business opportunities are not widespread. Underwriters are protecting their best accounts after several years of rate increases, and putting them to bed earlier.

Third, we continue to focus on our segment strategy, and avoid expanding our appetite for the sake of growth. The carriers that have expertise in underwriting, risk control, and claims will fare well, even with the deceleration of rate increases.

Let me close with this quarter's highlights. Operating income of $272 million increased 37% compared with the second quarter of 2013. Book value increased 4% compared with the first quarter. We continue to make progress in our core property and casualty operations, with our combined ratio, excluding catastrophes and development, improving over the prior period by 1.3 points.

Lastly, we declared a quarterly dividend of $0.25. The entire team here is focused on execution and improvement, and there is confidence about our strategy and our future.

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

(Operator Instructions)

Jay Cohen, BoA ML.

Thank you. A couple of questions. I guess I was a little surprised to see the adverse development in small commercial. And I'm wondering if you can go into more detail on what drove that, and what lines of business drove that.

And then, separately, while the US seems to be holding up reasonably well, as you guys described it, from a competitive standpoint, it sounds like London is getting quite competitive and prices are down there quite a bit. So the second question is, what's the strategy in London given what appears to be more intense pricing pressure?

This is Craig, Jay. Why don't I try to give you the answer on small business, and then let Tom describe what is happening in London? But the small business adverse development is really driven by package and the liability portion of package. And that's really where we've been focusing our attention, as we are working to correct by taking down some general liability limits, exiting some classes, and reducing the unanticipated severity that we're seeing in that business line.

Particular accident years? Sorry -- the last question, any particular accident years?

That was 2013.

Okay.

Switching to Europe, you know we have two businesses there. We have Hardy, a syndicate at Lloyd's; and we have our regular business in the UK and the continent. The Lloyd's market is extremely competitive, as you know, and as you have suggested, Jay. So our strategy at Lloyd's is basically to walk away from business when the pricing just becomes ridiculous.

And we are very satisfied that they are maintaining the right kind of discipline, and it's affecting their retention; and, once again, new business is very cheap there. So I think London -- the London, Lloyd's market is, as you said, extremely competitive. What we call the company market -- our UK and European operation -- it's competitive, but it's not as competitive as Lloyd's. So I think we're holding our own there. We are happy with what we're seeing. Once again, this is about walking away when the price gets ridiculous.

Just one follow-up on that, if you don't mind. If part of the story there has been the expense ratio has been coming down -- that, I assume, is going to get a little tougher if you are obviously willing to walk away from businesses to protect the loss ratio. But then, the expense ratio -- could that feel some upward pressure?

I think, Jay, yes, it could. And we are also in the -- remember, we're investing there, and we're investing there for the long term. So we're not going to let this short-term softening distract us from adding and building the right foundational elements to grow over the long-term there.

So we are actually relocating offices of Hardy and our other European operations -- co-locating them in the fourth quarter, so there will be some expense, one-time expense charges there. And it will make improving that expense ratio -- which I think we had told you before, we had an objective of getting it down into the low 40s -- more challenging, and take us a little longer to get there.

We thing I would add there also, Jay, is we have added people at Hardy. We have brought in a group of people in what they call casualty. But think of that as a little bit of professional liability. And also we are looking to inject some of our current capabilities in healthcare et cetera, into Hardy. That's one of the reasons behind putting everybody in one place.

Like Craig said, it's to get the best of both worlds and create an additive situation, rather than just follow the market down.

Got it. Thank you.

Josh Shanker, Deutsche Bank.

Given the reserve charge, I just want to talk about thinking about a situation in the future where you would call CNA a business that has a higher probability that reserves are redundant, as opposed to being deficient. Are you still putting out fires? Or do you believe that you are already in that position?

I think we've identified all the fires, and we have firemen surrounding them. We don't think there are any more surprises. We kind of call it the whack-a-mole phenomenon, if you recall that game at an arcade where things pop up their ugly head. But we think we've got our handle on all of that.

So our objective is to drive more of our business into the segments, as you are probably familiar with. But the segments today are 70% of the book; that's gone up from the prior quarter. The loss ratio on the segment business is 4 points better than the overall loss ratio. And that's an area that we think our specialization will continue to sell in the marketplace.

So we keep pushing the business towards the segments. And think of it this way: of that 70% of the business, we've got 30% of the business. And if you look at the pieces that are kind of what we are focused on, it's 18% of fixing to do, if you will. So we think we're moving in the right direction, and we have good traction. But we have identified what we would call all the fires.

To the extent that to which -- when you use the term for yourself whack-a-mole as kind of a pejorative term, and that things are popping up and surprising -- why do have more confidence after this quarter that you are not going to be surprised, and why do you think you got surprised this quarter?

I think we got under the machine, and we saw the moles before they popped up. So we've kind of identified the outliers that fit that have been outside the business -- outside the segment business. So if you think of long-haul trucking, and international work comp, and things that just didn't fit our strategy, we've got a very good handle about that today.

And I think, Josh, just take it -- listen, you can never be absolutely sure of anything, right? But what we would like to have the reputation, and believe we have earned, is that when we see something we don't delay it; and we don't put it off, thinking it's going to get better.

So we act on what we, see when we saw it. So these are primarily businesses that we exited more than two years ago where the severity trend has been even worse than we anticipated when we decided getting out. So, count on us to act on things when we see things, and not delay things.

I appreciate the candor there. The other question I'm keen to discuss: the last three months of rate approval trend in long-term care, and then what progress you've made there.

Well the rate approvals are now slightly over half of what we filed for, at least the most recent filings. Remember, we had really two series of rate increase filings -- one starting 2010, one starting in 2012. The 2010 one is largely completed; 2012 is about halfway through, although we are not seeing all of in the -- yet flow through.

The incremental increase from rate this quarter was an additional $5 million. And actually from both programs, if you think of it starting at 12 -- so an additional $12 million in rate coming through the segment this quarter.

And in the states where you haven't gotten as much approval as you've asked for, knowing as much as you know about the political process, what do you think the odds are of you getting rate on rate in the coming year? And the regulators trying to just slow your pace of you getting what you think you need, versus trying to put a restriction on you achieving that rate?

Well, it is different in every state, as I'm sure you appreciate and know. Regulators have largely worked with us through this. They appreciate the circumstances of the situation and they've been reasonable in most respects. They've certainly been sympathetic to where we are, and what we need. Not all of them -- some move a lot slower than others. Some states have been reluctant to do anything at all. But in the main, we haven't really seen any change in their attitude towards working with us to get rate increases which are actuarially justified.

Do they come back and tell you, look, you asked for too much rate this year, but come back next year; we might give you some more? What sort of color do they give you in those cases?

That is one of the responses we might get. We might get no response -- we're working on it. We might get a yes, it's approved. We might get a yes, it's approved, but we want you to take it in three year different annual increases. We might get it in, here's a small amount; come back next year, and we will work with you to get it. So it kind of goes across the board, as you were describing.

Okay. Thank you very much, and good luck with it.

Bob Glasspiegel, Janney Capital.

Good morning, CNA. With the Wilton Re transaction, you've showed, Tom, that you're willing to make some tough decisions where businesses can't get to your targeted ROE. On the standard commercial business, which seems like it's -- for a long time, has been obscuring much better results from specialty, what is the glide path to get that to an acceptable ROE? How much patience do have to work through it? You have shown a lot of patience to date, for sure. And in an environment where you are getting less rate, do we really have to wait to the next up cycle to get to sort of attractive returns in that business? Or is there a path that you can get there sooner?

I think a couple of things. I think you had about 12 questions there, Bob. So I will try to remember a couple of them.

I think, first of all, we believe that the segment strategy has legs, and will help commercial going forward. When I came here, I would say the commercial book was a very generic -- we just would write anything if it had premium dollars connected to it. We have moved much more into specialization, if you will.

So although it's commercial business, we are trying to be more specialized -- whether that be technology, or it's manufacturing or construction, professional firms, healthcare -- whatever it might be. So the book is changing dramatically, if you look the mix of types of customers, as well as the mix of product lines. So less workers' comp -- workers' comp is more white-collar today than it was years ago. But this takes a lot of time to churn through it.

Yes, we may appear to be patient, but I can tell you, we are pretty impatient. We are looking at this stuff all the time and constantly putting more tools to work to improve this, and improving our pricing and predictive analytics. So it's all a work in process. But you know the commercial industry -- commercial, for the industry historically, is not a business that makes a lot of money. Specialty is where all the gravy is.

But we think we can improve commercial. And the first goal is to get it clearly under 100 from a calendar-year perspective, and then keep driving it down towards 90, and we showed improvement this quarter. We've showed improvement for the last few years. And the legacy is these runoff things that are adding to reserves, as well as some severity that we've seen in commercial auto, for example. So the fact is, we keep fine-tuning the book, but we think we're going to get there.

And we do have the support of the agency force. They like the strategy and are working with us. So we'll get there, but it takes a long time when you have these legacy things that pop their head up. We have been -- as you've pointed out -- whether it's the transaction with Wilton Re; or the asbestos; or the sale of Argentina work comp business, which is not good business; FICOH, when we sold our interest. We have been cleaning up a lot of stuff. So we just now are really -- have our attention turned to getting commercial fixed in a big way. And even long-term care made a little money this quarter. So the fact is if we keep hunkering down, we are going to get it done.

I'm impressed with the strategy. It just seems like the challenge may be tougher in an environment where rates aren't going up as much. So what you are saying is, you do (multiple speakers). Go ahead, I'm sorry.

What I would tell you, Bob, is it's about risk selection and the quality of your pricing. We're spending a lot of time working on pricing, whether that be for small or for middle-market -- whatever it might be. So as I said in my comments, this is not a period of time that you are going to see the industry grow like crazy. I mean, people are protecting their best business. But if we can have a superior offering to our competitors, we'll see the better risks, and we will write them. And that's our plan.

Just like I said to the question about Europe, if we don't get the price we write, we are not going to write it. So that stands true in the US, too. But we think there's upside with the segment strategy, and we will keep pushing it, and hopefully these legacy things are going to be gone forever.

Good luck, Tom.

Adam Klauber, William Blair.

With new business opportunities slowing down, how does that impact your view on capital return and acquisitions? Thanks.

Adam, maybe just to make the obvious point that you can see where we are -- stat surplus; and we are certainly generating more capital that we need to support the business and the business growth. So at the appropriate time, we will be making decisions about that.

Okay. And as far as workers' comp, how are the workers' comp loss picks this year compared to last year and the year before?

They are lower, and have been behaving -- at least at this point, we are going to do comp review again next quarter, which will be the second time we've done it this year. Early indications are things are pretty stable in terms of the improvements that we had baked in and anticipated.

Okay. Great. Thank you.

Jay Cohen, Bank of America Merrill Lynch.

Yes. Thank you. I guess two questions: one is a follow-up on the reserve addition. The bigger piece was the businesses you are no longer in. I'm wondering if you could specify what lines we are talking about there.

So there's really three lines, Jay. One is the overseas workers' comp, which we had exited a while ago. There were a number of programs there, and there's actually one last program that runs through December of this year. So we're not entirely out of that. And these are roughly one-third of each of them. So one-third is overseas comp; one-third was this transportation; E&S -- all these are excess and surplus lines -- E&S transportation book, and an E&S habitational book, which really the losses came from GL.

Got it. Okay. And then, secondly, I guess a follow-up on the last question on capital. Because not only is the growth is not there; you are generating more than you need. And you may have talked about this before, and I just probably forgot, but the sale of Continental Assurance to Wilton Re -- how much capital does that sale free up?

It frees up a little north of $200 million.

So between that, the excess capital, you say you will kind of get to it when you get to it. But what are some of the -- can you share with us some of the thinking of what you might be doing with this excess capital, which is only growing at this point?

We would, of course -- we'd love to be able to put it to work in the business. If we can't put it to work in the business, then we consider the other options that we've had. And we've told you before, share buyback is really not an option for us, and we focused primarily on the common dividend. And then of course, last year we did declare a special dividend.

So this is the middle of the year. We didn't think it was an appropriate time, particularly facing wind season. Later in the year, we would have a better of how the full year is going to play out, earnings-wise. And that's when we sit with the Board and come up with a recommendation to have those conversations.

Got it. All right. Thank you.

Ron Bobman, Capital Returns.

Just because Jay Cohen is a lot older than me, I don't see why he gets to ask two sets of questions before me. I had a question about -- you made mention of a life settlement gain -- I think you said gain, not sale -- but can you describe that? I didn't realize that either the investment portfolio or underwriting ops was in that business. Could you describe that?

So just let me bring it back to you. It's in the life and group segment. Now that we've sold the life company -- and that is in discontinued ops -- what is left is the long-term care business, a small amount of group business, and viatical settlements -- a life settlements business. So we had insured, or bought the life insurance on a high-net-worth individual who passed away -- died last quarter, and we received the proceeds of that. So you will see it if you look in the P&L, Ron, in other income.

So I guess in some date past we were in the business of buying these policies, I guess. But when did that stop? How far back were we active doing that?

In the early 2000 --

Roughly.

So, 10 years, 12 years ago.

Okay. Thanks a lot. You had answered my other questions that I had about the adverse development and runoffs. Thanks again. All the best.

(Operator Instructions) At this time, there are no questions in the queue.

I'd like to turn to call back over to Tom Motamed.

Thank you very much. Have a good day.

That does conclude our conference. Thank you for your participation.