CNA Financial Corp (CNA) 2014 Q3 法說會逐字稿

Good day, and welcome to the CNA Financial Corporation's third-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, Noah. Good morning, and welcome to CNA's discussion of our 2014 third-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 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 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, November 3, 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 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 would also like to remind you that presentation slides have again been posted on 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 third quarter, CNA produced net operating income of $182 million, or $216 million, if you exclude the previously announced $34 million charge related to the re-insurance transaction associated with the sale of our payout annuity business. Our operating return on equity for the quarter was 6%; without the re-insurance charge our return on equity would have been 7.1%. Our property casualty combined ratio for the quarter was 96.1%. Excluding catastrophes and development, the combined ratio was 96.2%, slightly higher than last year's third quarter.

We are pleased with the improvement in our specialty and commercial underlying loss ratios. The third-quarter loss ratios improved compared with the third quarter of 2013, and the year-to-date loss ratios improved compared with the full-year 2013 Specialty had a strong quarter, with a combined ratio of 81.6%, which was helped by almost 11 points of favorable loss development. Specialty's combined ratio, excluding catastrophes and development, was 91.8%.

Net written premium for the quarter was down 2%, due to the termination of an MGA relationship as we discussed last quarter. Rates increased 3%, consistent with the second quarter, and retention remains strong in the mid-80%s.

Commercial's combined ratio was 108.3% for the quarter, which included 7.5 points of unfavorable prior-year development, with higher severity in recent accident years for primary general liability being the largest component. Commercial's combined ratio, excluding catastrophes and development was 98.9%. Commercial rates increased 4% overall, and 5% in the US, consistent with the second quarter. Retention improved 3 points from last quarter to the mid-70%s.

With that, I will turn it over to Craig.

Thanks, Tom. Good morning, everyone. As Tom mentioned, the third-quarter net operating income was $182 million, or $0.68 per share. And the operating return on equity was 6%. Our net income was $213 million. Adjusting for the bad annuity re-insurance charge, earnings per share were $0.80. And the operating return on equity was 7.1%.

Our core P&C operations produced net operating income of $241 million, compared with $330 million in the third quarter of 2013. The decrease was a result of lower net investment income, and a reduced amount of favorable reserve development. The P&C loss ratio, excluding catastrophes and development, was 62.9%, essentially flat with last year's third quarter, as non-catastrophe losses at Hardy offset improvements in specialty and commercial. The year-to-date underlying loss ratio of 63.2% is now slightly more than 0.5 point better than our full-year 2013 result. Our third-quarter expense ratio was 33.1%, consistent with full-year 2013 results.

We continue to be pleased with the performance of our specialty business. Specialty's third-quarter combined ratio of 81.6%, which included almost 11 points of favorable development, was more than a 3.5-point improvement as compared with the prior-year quarter. The loss ratio, excluding catastrophes and development, was 61.6%, more than 2 points lower than last year's third quarter. On a year-to-date basis, the current accident year loss ratio is now almost 1.5 points lower than where we ended full-year 2013. The improvements were due to continued refinement of the portfolio mix, as well as earned rate increases in excess of loss cost trends.

Commercial's combined ratio of 108.3% included 1.9 points of catastrophe losses, and 7.5 points of reserve strengthening, as Tom described. Commercial's third-quarter combined ratio, excluding catastrophes and development, was 98.9%, almost 0.5 point better than last year's third quarter. The underlying loss ratio was 64%, slightly better than the prior-year period. On a year-to-date basis, the underlying loss ratio is now almost 1 point better than the full-year 2013. We continue to aggressively manage our commercial book and pursue rate targets that are built upon differentiated pricing, tied to expected profitability of individual accounts. Net written premium was down 7%, compared with the prior-year quarter, reflective of the underwriting actions we have taken.

Hardy had a net operating loss of $15 million in the third quarter, with a combined ratio of 112.9%, including over 4 points of unfavorable premium development. The loss ratio was affected by large aviation losses, which accounted for approximately 13 points, plus higher-than-expected attritional losses in our marine cargo book. Expense ratio increase was driven by the effect of foreign currency exchange rates, as well as by costs related to moving to a service-company operating model, including real estate cost. The life and group segment produced $42 million net operating loss in the quarter, which includes the $34-million charge attributed to a re-insurance transaction tied to the sale of our structured settlement annuities.

As I explained last quarter, in addition to the sale of our life company, CAC, we reinsured a block of annuities from our Bermuda subsidiary to Wilton Re. The transaction was structured on a funds-withheld basis, meaning that we maintain legal ownership of the assets associated with the transaction, but Wilton Re assumes the economic risk. At the inception of the contract, the market value of the assets was $34 million higher than the $150-million book value, causing us to recognize a $34-million loss. Over time, we would expect the $34-million loss on re-insurance to unwind as the assets are sold or mature, and the gain or loss is recognized.

Excluding the impact of the payout annuity re-insurance transaction, the life and group loss for the quarter was $8 million, compared with the $33-million loss in the third quarter last year. The improvement was driven by improved results in our long-term care business, which was favorably affected by morbidity, rate increase actions, and persistency. Results also benefited from higher net investment income, due to a higher invested asset base.

Our corporate segment, which primarily includes corporate expenses, produced a net operating loss of $17 million, compared with a $26-million loss in the third quarter of 2013. The improvement was driven by a reduction in the allowance for uncollectible re-insurance receivables. Our investment portfolio's pre-tax net unrealized gain stood at approximately $3.2 billion at quarter end, roughly equivalent to the end of the second quarter. Our statutory surplus at quarter end was $11.4 billion. 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 2013 year end, due to the proceeds for the February debt offering to pre-fund our upcoming December maturity.

In the third quarter, operating cash flow, excluding trading activity, improved to approximately $460 million. Cash principle repayments through pay downs, bond calls, and maturities were approximately $950 million. Third-quarter after tax net investment income of $346 million decreased $40 million from the prior-year results, driven by limited partnership income, which returned 1% versus 3.5% in the same period last year.

Overall, portfolio allocations did not change significantly in the third quarter. 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 11.1 years at quarter end. The effective durations of fixed-income assets which support our traditional P&C liabilities was 4.1 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.

Before turning it back to Tom, I want to highlight a pension settlement charge that will flow through our fourth-quarter financial results. We recently offered a lump-sum payment opportunity to about 11,000 vested pension-plan participants who are no longer employed by CNA. The high end of the estimated range of the after-tax charge, which is dependent on the participant acceptance rate of the offer, is approximately $65 million.

The charge will be recognized when the lump-sum payments are made from the pension-plan assets in December. The corresponding charge associated with the settlement will have no effect on shareholders' equity, as the settlement charge represents immediate recognition of the proportional share of prior unrealized actuarial losses already reflected in shareholders' equity.

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 and on our European operations. Since we spoke in August, there has not been a change in our view of the market. We continue to see limited exposure growth and competitive pricing, with some lines of business more aggressive than others.

However, our strategy has not changed. And, more importantly, our underwriting improvement in recent years is not solely based on rate increases. We continue to achieve underlying loss ratio improvement in commercial and specialty, as we shift our book to higher-margin business and exit poor performing accounts and classes. For example, since 2011, we have successfully changed our mix of business in the US from 73% in our focus segments to 80% so far this year. We have also demonstrated discipline in our approach to new business, where our reduced volumes reflect our willingness to avoid inadequately priced opportunities.

Earlier, Craig discussed our transition to a service-company operating model for CNA Europe and Hardy. This was one element of a broader strategy to streamline our international management, which was further enhanced in August by the appointment of David Brosnan as Chief Executive of CNA Europe and Hardy, with oversight of CNA Canada. This new operating model will facilitate our ability to efficiently serve the Lloyds market, the European local markets, and the unique and expanding needs of multi-national customers.

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

Thank you.

(Operator Instructions)

And we'll take our first question from Jay Cohen with Bank of America Merrill Lynch.

Yes. Thank you. A couple of questions.

The first is, I've had several quarters now of adverse development in the Commercial segment. After years of that segment being I guess relatively benign from a loss standpoint, in fact seeing favorable development.

And I was just wondering if you can talk a little bit more about what you're seeing, and did you make an effort to get all this behind you? Was there a concerted effort in this quarter to say, hey, let's try to nip this in the bud?

Jay, the answer to the last question is no. So there's no concerted effort to try to pile on or nip it in the bud. I think a similar question was asked of us last quarter.

And so you can on count us, it hopefully have the reputation that we act on things as we see them. I think what's plagued us here in Commercial has been we've gotten out of a number of businesses that we thought were unprofitable. Those have continued to be even a little worse than we thought they were.

And that bleed, that's been a little slower has continued, and it even contributes a bit to this quarter. This quarter's results in Commercial were driven primarily by general liability severity, which is something that surprised us in terms of the direction it was headed. As we really shifted our book from less of a premises OPS book to things that have more severity.

So I think that's a bit of a -- that is, was an action to catch up in our perspective going forward. So we're disappointed by having to report these, and we work hard to get our reserves accurate all the time, and we think we have acted appropriately. So we're certainly not holding back on anything.

Yes. I think I would just add to that, Jay, that last quarter we talked about Commercial Auto. And that has popped its ugly head for the industry. So I don't think that was anything unique to us.

But we recognized it, and we're dealing with it. The good news is, it's a small portion of our book today. It gets smaller all the time.

The international work comp which we have exited most of it, we are still paying the price for some of that. But once again, it was one of our exit strategies to get out of that business.

So I think we're dealing with the things in a timely fashion when they come up, but clearly severity has been the issue. It has not been frequency.

And if you look at our claim counts, our claim counts are dropping. Both on the outstanding number of claims, as well as new arising claims. So I think it's a reflection of the changing mix of business, but we are paying for sins of the past.

Got it. And I guess because a lot of the reserve changes you made were in businesses that you've exited. It doesn't have much of an effect on your current year accident pick then?

Well the general liability does, yes. So you're right about the majority in the past, and in the past calls.

But certainly the GL, if we look at GL severity does have an effect on our pick in the current accident year. So, in other words, it would have been proved more if not for the reflection of the severity.

Got it. And then the second question, I guess we're seeing premiums falling now in all of your segments. And part of that is obviously underwriting discipline, which is what we don't want to see.

For many companies when premiums start to fall, which obviously is potentially a negative from a profitability standpoint. The -- one of the options they have is to, well, this will free up capital, we can buy back stock. That's not much of an option for you.

Obviously, you have other capital management leverage you can pull. My question is, does it free up capital for you? As you see premiums going down and your business mix is changing. And that can change your capital needs too, is this affecting your view of how much capital you need?

Yes, obviously that growth or prospects or growth are a significant input to our capital plans and capital perspectives going forward.

Okay. I still had the -- well, that's it for now. I'll circle back if I have other stuff. Thank you.

And we'll take our next question from Amit Kumar with Macquarie.

Hello, good morning. It's Chris Martin today. So the one question that we have is, as we get closer to 1-1, what potential changes might you be thinking about for your re-insurance purchase?

With the current re-insurance pricing where it is and how some of this pressure and some of the more favorable terms have started to show up in Casualty lines. Might you start to be thinking about any changes in how you purchase that moving forward? Thanks.

We are certainly actively engaged in paying attention to what's going on in the re-insurance market. But we don't have any -- no plans at this moment to be buying anything differently.

Our Casualty, you referenced Casualty, you see how profitable our Specialty business is, which is highly causality. So it doesn't seem to make much sense to us to give away that profit. And given the diversification we have in the book, the typical desire of re-insurance purchases is to shed severity and volatility, so no reason to think about doing it.

So, we're in the midst of negotiating or beginning to plan for the negotiation of the renewal of our Property CAT Treaty. And we buy a war comp CAT treaty, and those are underway. But as we look at it, we don't see anything that would be particularly attractive or add to the value of CNA longer term in the re-insurance market.

Got it. Thanks. That's really helpful.

And then just a second thing. In the Hardy business you'd mentioned that I think you had said there were 13 points were attributed to the aviation losses. Can you talk about maybe other lines that you said had higher than average attritional losses?

Well, the other lines that had higher attritional losses, were Marine cargo. So we had quite a few cash in transit type losses over the quarter.

And how many points do you think that would be about?

Well that -- the aviation losses -- in total, both of them were about $20 million worth of losses. So whatever the delta is between the 13 points.

Got it. Thanks. That's all I have today. Good luck.

Thank you.

We'll take our next question from Bob Glasspiegel with Janney Capital.

Good morning, CNA. What was the adjustment in the receivables on collectible re-insurance?

It was about $14 million, less reduction.

Okay. And the Wilton Re, would you have a pretax number for that?

That pretax was $36 million, so pre and after is about the same thing, Bob, because it was Bermuda. And I think if you went back and looked, I think we had a slide detailing it in the last quarter.

Okay. Will do. How would you handicap the likelihood of a special dividend going forward?

Well, maybe the best way to answer it is, that I'm not sure Jay was trying to get at that earlier. That as we sit around and talk about it we recognize that we start with a very strong capital position at the Company.

The earnings, even though they haven't been quite as high as Tom and I would like them to be, they've been consistent and very steady. We'd love to see an opportunity to put that capital that we're continuing to accumulate to work to grow the business.

But I would say there's no potential for that at the moment as we're looking out for it. So at the end of the year, we'll complete our review at the year-end 2014. And what the 2014 results were, we'll add in what our outlook is for 2015, and then we'll decide whether and what to do with the common and or special dividend.

Okay. That's a thoughtful answer. Finally on long-term care.

You do a great job in the K and Q of sizing up the various sensitivity analysis. I can't remember if you do a year-end review or it comes up periodically.

But it seems like you got interest rates lower, but experience and pricing improved. If you had to weigh the battle of those two countervailing forces, does it come out more positive, more negative, or stay tuned?

Well, we do, well, first, you're right. We do a -- our gross premium evaluation review in long-term care in the fourth quarter. We did complete the claim review of long-term care in the third quarter, and the outcome of that was actually a slight positive change on about $2 billion of reserves.

The gross premium review was underway. As you said, the big components are morbidity. I wouldn't, given our results over the last year, I wouldn't expect any adverse for morbidity. Persistency, even though it's been better this year than last, is still running a little worse than what our expectations would be.

And interest rates, as you said, will be the biggest driver. So you can look up and you can see a difference in the spot rate on the [$30 million] is almost 50 basis point lower September 30th this year, against September 30th a year ago. But we're really looking at the forward curves that we're thinking about, which would be a bigger delta.

So that will be the bigger driver of the outcome. And I think all things being equal, we'd expect some pressure on margin coming out of that interest rate review. But I can't tell you what the outcome is exactly.

I thought there was a fourth factor, which is that price increases that you're able to get. (multiple speakers)

Yes, that's true, and those are slightly better than we expected.

Okay. Appreciate it.

Thank you, Bob.

We'll take our next question from Josh Shanker with Deutsche Bank.

Yes, good morning, everyone. Over the last couple of years, you've obviously focused on weeding out businesses that you CNA didn't have a necessarily a value added edge on. When you look at the portfolio today, how far are you in terms of weeding out those businesses do you think that you are?

Is the CNA portfolio a enviable collection of businesses? And if so, why do think that the gap is so persistent between your pricing and peers profitability on underwriting at this point?

I think we still believe in the focus segments. We think they are the right places to be, and we're not going to change any direction on that at this time. I would say this, that the industry has gotten rate, and that rate has probably helped everybody to a large degree.

But as I said in my remarks, and I believe Craig said the same thing, we're really trying to manage the mix of business or think of lines of business within a segment. We're really trying to do a much better job tiering the best customers from the least profitable customers.

So, it is work in progress. But we think we're getting more sophisticated at it. And as we put more analytics in place to really analyze what the exposures are for these customers, we think it's moving in the right direction.

As Craig mentioned, the loss-ratio improvement is a little slower that we would like, but it still is improving and we are throwing out this legacy business which has hurt us. But we expect we'll continue to push into the segments, and we will do better over time. We think we have the expertise to do that.

Do you think, just with that analytics set up there, if the markets generally stayed stable. With what you have in place right now, there is margin improvement to be found just in letting things play out as you set them up today?

Yes. I think we told you about rates for the quarter. Rates are still pretty good. Actually, in Commercial, September was the best month of the third quarter. And if we looked at October, October looks pretty good.

And what about the (inaudible) rates?

I didn't hear you.

I'm sorry, without rate. Can you achieve margin without rate -- ?

Yes. That's the whole issue of tiering. In other words, figuring out which are the best accounts and how you keep them. And the ones that aren't that good, you get rid of. That's what you call loss business.

So we think there's room there, and also managing the mix. So we have accounts that may have hurt us from worker's comp or auto perspective, and we find ways to try to keep the best pieces of the account and throw out the worst. So all work in progress would be pretty consistent with what other markets do with their business and how they manage their portfolio.

But mix of business is a big deal. One example is, less blue collar work camp and more white collar work comp. Which affects the proportion of business we write in some white collar industries, whether that be law firms, financial institutions, et cetera. So that's a lot of behind the scenes stuff, but yes, we think that's all going to help and continues to help. We get better at it.

Well, thank you and good luck.

Thanks.

We'll take out next question from Adam Klauber with William Blair.

Thanks. Good morning, everyone. A follow-up on data and analytics. What are some of the next steps in 2015, 2016 as far as rolling out better data and analytics?

As you know, it's a very big area. People talk about big data, you've got distill that down to the ground. But we are looking at data and analytics that helps us assess risk, so that's on the underwriting side as well as on the claims side.

How can we get people back to work sooner? Or what can we see relative to claims that can be helpful? We do have some pretty good analytics in Specialty, and our Specialty results we're pretty proud of.

We have a tool now that we've rolled out on Automobile, which is a troubled line for us. So we expect to see more improvement in Auto. Although, it is a small line for us as an overall percentage.

So, Auto and Work Comp are two areas that seem to be as well as some of the Specialty lines, whether you look at lawyers or some other areas. The fact is, these are all things that are going to help us make better decisions as to what business we keep and how we price it.

Adam, this is Craig. So it is an ongoing -- think of it as more ongoing than some fundamental add and replace. So we're probably in second generation of both predictive tools and pricing mechanisms, and this has now become an annual updating and prospective and improvement.

So there are some fundamental we're always building and improving. Like we introduced a new property product, and new property pricing a year ago, and a new GL pricing this year, and a new GL product that goes with the property product next year together. We'll do the same with Auto.

But I think of it really more in terms of the continuous iterative improvement that Tom was referring to. So we're generation two, and we're actively working on generation three and making sure that's something that's built into the fabric of the place that we do as part of the regular rhythm, rather than as an event.

Okay thank you. And then, do acquisitions become more likely given two things. One, within P&C, there's really very little growth out there. And two, you continue to do a good job of narrowing your focus, so does that give you more room to do acquisitions more on your focus. Obviously it's probably not out of your focus, but in your focus?

Yes, I would say we always have our eyes open as to what might be out there. We have said for a long time that we prefer to do something that is a bolt-on, which we define as less integration risk. So whether was CNA surety or that was Hardy.

But there really was not chaos around making those acquisitions. So we like things like that. And we've gotten rid of things that didn't fit the strategy going forward.

So we keep our eyes open. We have to assess the risk of buying anything. But quite honestly, the first and foremost objective is we want to do a better job with our portfolio.

And that's where we're focused. And if something meets our eye and we like it and we think it will help the profitability of the firm, we will make a decision.

Is there a pipeline of potential deals out there that would make sense, or are they're just not a good group? There's always deals out there, but is there just not a reasonable pipeline out there?

Let's put it this way, we got lists. Everybody has a list. We have lists.

And the question is, do they want to sell? Is it the right fit? What is it going to cost?

Is it going to increase the shareholder value over time? All of those questions have to be answered.

But we have a pretty good idea what's going on out there. And I think as the market continues to become less driven by rate and more driven by rate and margins maybe become compressed for some. Some companies may think about their future differently, and we're willing to talk to people.

But I think in this low growth environment you are going to see more M&A going forward. I think that's true unless all of a sudden rates go up, and the economy booms, and exposure goes up, and all of that kind of stuff. But I don't see that myself.

Right. Thanks. And then just one follow-up. I think you said the competitive conditions really haven't changed.

I think you said you're having a good September. Would you say that is the Commercial more competitive than the Specialty, or you're not seeing really a differential on that? I know each line is different, but just in general?

Well you said it, each line is different. Everybody wants to be in the specialty business. It's got a nice ring to it.

So you -- there is a lot of competition in specialty. And somebody nipping on your feet on lawyers, professional or something else. But I don't think it's really changed much. And the one thing I look at is, everybody's trying to retain their business.

There's very little good new business opportunities out there. At least from our standpoint, what we see coming out is fairly distressed. There really isn't a lot of good stuff.

So people are putting their renewals to bed earlier, and trying to keep their retentions up and get some rate. And I think that's what we saw in the third quarter, and we saw it in the second quarter. And I expect the fourth quarter will look much like the prior two quarters.

Great. That's very helpful. Thanks a lot.

Yes.

(Operator Instructions)

We'll take our next question from Jay Cohen with Bank of America, Merrill Lynch.

Yes, just from a modeling standpoint, the -- obviously you made a lot of changes at Hardy from an expense standpoint. And, in fact, the underwriting expenses, the overhead expenses there have come down quite a bit. The question I have is, is the number we're seeing in the third quarter, is that in your view a reasonable run rate to look at going forward, or will there still be a downward trend?

Jay, there will still be a downward trend. But not -- we haven't completed the real estate moves and some other people related moves that would add some expense to the fourth quarter. But in 2015, that expense ratio should start coming down pretty considerably.

It was about, there's an FX impact in that number right now, which is pretty meaningful. And there's about 1.5 points, little less than 1.5 points of those integration combination costs in there this quarter. But that's -- we would expect that to improve considerably, but not until 2015.

Got it. That's helpful. Thanks so much.

You're welcome.

(Operator Instructions)

With no further questions at this time, I'd like to return the call back over to Tom Motamed for any additional closing remarks.

See you in 2015. Thank you.

This does conclude today's conference. Thank you for your participation.