CNA Financial Corp (CNA) 2015 Q4 法說會逐字稿

Good day and welcome to the CNA Financial Corporation fourth-quarter 2015 earnings conference call. Today's conference is being recorded. At this time I would like to turn the conference over to Mr. James Anderson. Please go ahead.

Thank you, Katie. Good morning and welcome to CNA's discussion of our 2015 fourth-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 to 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 in 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, February 8, 2016. 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 for in the financial supplement.

This call is being recorded and webcast. During the next week the call may be accessed on CNA's website. 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 fourth quarter, CNA reported a net operating loss of $52 million, which was significantly affected by a reserve charge in our Long Term Care runoff business, as well as an investment accounting change. Excluding these two items, net operating income was $171 million.

For the full year, CNA produced net operating income of $515 million, compared with $849 million in 2014. The decrease was driven by lower investment income, primarily in our limited partnership investments, and the fourth-quarter Long Term Care charge I previously mentioned.

Our capital position remains very strong and Property & Casualty income continues to be stable. As a result, we are pleased to announce a $2 per share special dividend this quarter. This is the third year in a row that we have declared a special dividend for our shareholders. This is in addition to our regular quarterly dividend of $0.25 per share.

Our Property & Casualty underwriting results continue to show meaningful improvement. Our full-year combined ratio of 95.4% was a 2.3 point improvement compared with the 2014 result. The underlying loss ratio improved 1 point. This marks the fifth year in a row of underlying loss ratio improvement. The expense ratio increased 1.3 points. Craig will say more about this shortly.

Our combined ratio for the fourth quarter was 98.9%. The quarter saw increased activity in natural catastrophes in our International business.

Specialty had another strong year in a challenging market. The combined ratio of 88.7% is slightly higher than the prior year. Specialty's combined ratio, excluding catastrophes and development, was 93.6% for the year.

The fourth quarter combined ratio of 95% was affected by a heightened level of loss activity, primarily in the public management liability and healthcare arenas. Specialty's combined ratio, excluding catastrophes and development, was 95.4%.

Net written premiums grew 2% in the quarter. Rates were essentially flat, while retention improved to 87%.

Turning to Commercial, we continued to make solid progress on underwriting profitability. Our full-year combined ratio of 101.5% reflects an 8 point improvement compared with 2014. The underlying loss ratio improved 3 points.

Additionally, the year benefited from a modest amount of favorable loss development, as compared with unfavorable development in 2014. The combined ratio, excluding catastrophes and development, of 98% was an improvement of 0.6 points.

In the fourth quarter, Commercial had a combined ratio of 99.6%. The underlying loss ratio was almost 4 points lower than the prior year quarter. Excluding catastrophes and development, the combined ratio was 98.3%.

Net written premiums grew 2%. Rates increased 1% and retention improved to 84%.

International produced a combined ratio of 97.6%, as compared with 92.4% in 2014. The combination of higher catastrophe losses, large loss activity and less favorable development than in the prior year resulted in the decline. Excluding catastrophes and development, the combined ratio was 99.8%, compared with 99.2% in 2014.

For the fourth quarter International had a combined ratio of 110%, which included 10.7 points of catastrophe losses, driven by three significant storms in the UK. The combined ratio, excluding catastrophes and development, was 103.1%.

Net written premiums declined 1%; however, premiums grew 8% excluding foreign currency fluctuations. Rates decreased 1% and retention was 73%.

With that I will turn it over to Craig.

Thanks, Tom. Good morning, everyone. Given the number of moving pieces in this quarter's results, I wanted to spend some time to provide you with more insight into the significant items: the Long Term Care unlocking charge, investment income and our expense ratio.

Let's start with Long Term Care. The Life and Group segment reported a net operating loss of $243 million, which reflects the results of the Long Term Care claim and active life reserve reviews.

Our claim reserve review showed actual claim severity -- the combination of claim duration and benefit utilization -- to be favorable to our prior assumptions. However, we strengthened the frequency component of the IBNR claim reserve to better match the incidence rate assumptions that were an outcome of the active life reserve review. This translated to a $9 million increase in claim reserves.

Now let's move to the active life reserve review. Page 14 of our earnings presentation shows the results of our annual gross premium valuation analysis.

As you can see from the exhibit, increased morbidity was the driver of the approximate $400 million change in our reserve estimate. This was driven primarily by increased claim frequency assumption, consistent with the experience trend we have observed over a number of recent quarters.

Our discount rate, persistency and premium rate increase assumptions did not change significantly and largely offset one another. After taking into account the $100 million margin at December 31, 2014, the indicated deficiency resulted in a $300 million pretax charge to earnings and a corresponding increase to net GAAP reserves.

As result of recognizing the deficiency, we unlocked our reserve assumptions, which were previously locked in at the time the policies were first written. Our carried active life reserves are now based on our current best estimate assumptions with no margin.

Future periodic income for Long Term Care will reflect any variance between actual experience and the reset assumptions contemplated in our best estimate reserves. While there will undoubtedly be variability in our future periodic results, our reset assumptions should theoretically produce a breakeven underwriting result.

While we were required to recognize a premium deficiency for GAAP reporting, there was no indicated premium deficiency on a statutory basis. We view the GAAP unlocking as an earnings, not a capital event, which coupled with our P&C earnings strength contributed to our Board of Directors' decision to declare the special dividend this quarter.

I also want to remind you of our ongoing efforts to continuously improve our management of the Long Term Care business. We have a number of specific initiatives and actions that have recently been completed and others that we continue to execute upon. These efforts demonstrate our commitment to managing the risks of the business while improving the standard of policyholder service.

Slide 15 provides you with a snapshot of some of these strategic initiatives, including the recent closing of the group Long Term Care block to new entrants, the build out of our new claim and policyholder administration operation centered on an in-house claim team supported by a new vendor, and significant investments in data analytics and talent.

Now let's turn to investments. Net investment income for the quarter was $428 million, down $83 million from the prior year quarter. The decrease was driven by lower income from limited partnership investments, which returned just under 1% this quarter as compared with 2.2% in the prior year quarter.

For the full year, limited partnership investments returned 3% as compared with just under a 10% return in the prior year. These investments continue to perform as we would expect, and over time they have provided diversification to the overall portfolio with less volatility and higher risk-adjusted returns than equities.

An additional driver of the net investment income decrease as compared with prior periods related to the fixed maturity securities portion of the portfolio, where an accounting change to better reflect the yield on securities with call provisions resulted in an approximate $39 million reduction in pretax income in the period.

Going forward we would expect this change to reduce quarterly pretax investment income by a few million dollars compared with our previous run rate.

Our fourth-quarter P&C expense ratio increased just under 4points compared with the prior year quarter to 35.8%. There are a number of components driving this unfavorable comparison. You may remember that 2014's fourth quarter was helped by some favorable recoveries that reduced our expense ratio by 1.5 points.

Conversely, in the fourth quarter of 2015, an increase in loss-based assessment fees related to our prior Defense Based Act workers' compensation program, along with higher contingent commissions as a result of lower loss ratios in Property & Casualty, added over a point to our expense ratio this quarter.

Increased technology and other underwriting investment spend, in addition to lower earned premium, account for the remainder of the difference. We believe our full-year expense ratio of just over 34% is more representative of our current run rate.

Now let's look at additional key financial measures. Our investment portfolio's net unrealized gain stood at $2.3 billion at quarter end, an approximate $300 million decrease from the end of the third quarter due to increased yields.

At December 31, shareholders' equity was $11.8 billion and book value per share was $43.49. Excluding accumulated other comprehensive income; book value per share was $44.66, an increase of 4% from year end 2014, adjusted for dividends.

Statutory surplus at December 31st was an estimated $10.7 billion for the combined insurance operating companies, and we continue to maintain more than adequate dividend capacity.

Cash and short-term investments at the holding Company were $482 million at year end. We continue to target cash at the holding Company equal to approximately one year of our annual net corporate obligations.

In the fourth-quarter operating cash flow was $342 million. Cash principal repayments through pay-downs, bond calls and maturities were approximately $1 billion.

Fixed income assets that support our long-duration Life & Group liabilities had an effective duration of 9.6 years at year end. This duration has drifted slightly lower during the year as a result of declining market yields, which affect the duration of callable bonds in our municipal bond portfolio.

The effective duration of the fixed income assets that support our traditional P&C liabilities was 4.3 years at year end. We continue to manage the assets to match the characteristics of the underlying liabilities. The portfolio durations remain in line with the portfolio targets.

We continue to maintain a very conservative capital structure. All our capital adequacy and credit metrics are well above our internal targets and current ratings. As I said earlier, this sustained capital strength was a significant factor in the Board's decision to declare the $2 per share special dividend and the $0.25 per share quarterly common shareholder dividend.

With that, I will turn it back to Tom.

Thank you, Craig. Before we take your questions I would like to make several closing comments.

Once again we are pleased to return excess capital to our shareholders. This is the third consecutive year of a special dividend.

The combined ratio in our Property Casualty business of 95.4% in 2015 is the lowest it has been in five years.

Specialty continues to be a profitable and resilient business in a challenging environment.

Commercial continues to show improvement in the underlying loss ratio.

Commercial retention showed considerable improvement, reflecting less churn in our existing portfolio due to underwriting actions.

Finally, we continue to invest in people, technology, process and tools for the future.

With that we will take your questions.

(Operator Instructions). Josh Shanker, Deutsche Bank.

I wanted to talk a little bit about the Long Term Care charge. To what extent was the charge the result of changing assumptions and to what extent was it the result of the new methodology or new process that you have in place?

Josh, it was 100% due to changing assumptions and had nothing to do with changing methodologies or the new reserving processes we put in place.

So what did the new processes tell you? What did you learn?

What did we learn? I think if you are referring to the processes or the assumption changes, the assumption changes were driven by morbidity, really claim frequency increase, which is something that we have been mentioning and reporting on that we really noticed over the last five quarters.

So, the real driver after reserve charge was a change to our assumption about claim frequency, which affected morbidity outcomes.

But there was nothing incremental to learn out of the new granular approach?

Well, yes, I think we have better -- it did enable us and was helpful in determining what those assumptions were. And we've been, because we have much more granule information, really moved to -- away from what had been a dependence on industry and historical factors and some statutory or actuarial studies about morbidity, as well as mortality. And able to be much more dependent upon our own results and the trends we saw in our results.

So, that is what gave us the confidence to change as well as gives us the confidence going forward that we have appropriately accounted for what we would expect the results to be.

And in terms of your recommendation and the Board's decision on the $2 per share special dividend, what impact did the Long Term Care charge have on those discussions? And could it have been a bigger special had the charge not occurred? Or it really was not an important part of the discussion?

I would say that the more accurate reflection, it was not an important part of the discussion. And I think what we've said in prior and what I would suggest going forward is that we have more than adequate capital and strength in the balance sheet. And that earnings going forward is what we would look at as being available for a dividend if we didn't have a better use for them.

Essentially we dividended more this year than -- it was 150% of earnings. So the reserve charge really has essentially been accounted for in the excess capital that we had accumulated over time. So, therefore, it became something we could kind of exclude from our thinking and just think about the earnings excluding that reserve charge when we talk to the Board about the special dividend.

And final question, when thinking about that gap between your property and casualty combined ratios and best-in-class peers, it looks like the industry is having some tough pricing issues right now. And I expect, and I hope, that CNA will narrow the gap between itself and the best-in-class peers.

Does that mean going forward -- do you think that there is a lot of room to improve your combined ratio or that gap will be narrowed as the pricing environment takes its toll on peers' very excellent origins? Where do you think the trend is in CNA relative to peers and where will that gap go?

Well, I think I would answer it a couple of ways, Josh. One, if you look at the accident year loss ratios and you look at the information that we have shown you in the earnings presentation slides, you can see that we have consistently improved the accident year underwriting.

And I would say that if you look at our very best peers we are still -- on an all-in basis now, property-casualty total -- we have narrowed the gap to probably 2 or 3 points on the loss ratio component. We actually think we have closed, almost completely, the gap into most of the -- our other peers, better peers on the loss ratio side.

We do think that despite the ongoing -- really the softening of the market relative to rates, so we will see some margin pressure coming from turn rate and written being slightly less than trend. But remember, we are still improving our execution, improving our risk selection, improving our pricing differentiation.

And we would expect -- and improving really our portfolio composition as we move away from poor performing business to business where we have more confidence. So all of those -- we think all of those factors will enable us to continue to show some modest level of improvement in the loss ratio over the course of 2016.

On the expense side, because we -- and you know that we have said before we would have been focused on improving our underwriting capability as measured by loss ratio and loss ratio competitiveness.

And we have been making, trying to be mindful of the long-term gain and making important investments in technology and other underwriting capabilities, which has meant that we still -- we now have probably another 2 or 3 point difference in the expense ratio to peers.

I wouldn't expect -- we do think that we can maintain the expense ratio where it is. And as I pointed you all to looking really at the full-year expense ratio as more representative, we think we can maintain it that there. And don't have any current intentions of doing anything or plans to be able to reduce that margin. And we will need to turn to that at some point in time, but we are not -- no near-term plans to do that.

And one more question if I can, typically there is not so many questions on these calls, so I will take some liberty. Before Dino comes to work for CNA, are there any risks or issues precluding ACE and Chubb employees looking for a new home from coming to CNA?

This is Tom. There probably are some restrictions on certain people at Chubb relative to what level they were in the organization. But that is between them and the new Chubb, that has nothing to do with us. So, I think that is really the short answer.

Okay, thank you. I appreciate it and good luck in 2016.

Jay Cohen, Bank of America.

a couple questions. First is the higher contingent commissions. Given the higher level of profitability you have been able to achieve, is that something that will continue going forward or was there some sort of catch-up in the fourth quarter?

That was more of a catch-up effect in the fourth quarter, Jay, than a go-forward expense issue.

Got it. And then you had, I guess in the press release talked about in the call healthcare reserves adding to those from prior years, maybe it was current year. But we have had one other company talk about med mal or healthcare in general being an issue. Can you talk about what has happened there from a claim standpoint, what gave rise to that strengthening?

Well, I think it's something -- this is Craig, Jay -- that we really started noticing back in probably 2011 that medical severities have been up across our healthcare books. So whether that was hospitals or nursing homes or nurses or dentists caused by just an increasing really just outcome, claim severity outcome.

And I think what we have also mentioned that over particularly the last couple of years, maybe heightened sensitivity to we thought a lot of people chasing -- making it a more competitive market. And to a certain degree chasing yesterday's returns in that. So healthcare has also been affected by rate declines or competitive pressures over that time.

But as to the losses, it is really medical severity and it is pretty much across -- has been across the book of business. And we think we have reacted appropriately to it in terms of our underwriting posture as well as how we have set current loss ratios and reserves.

Got it. And then lastly, you had talked about some large loss activity, I think it was certainly in the international side, maybe in specialty as well. Is that something you can quantify? In other words, the type of large loss activity you saw this quarter relative to what you would normally expect to see?

Well, it was -- I don't know if I can quantify it for you -- well I can quantify it in terms of what the impact was on the Specialty loss ratio. So, we have seen a heightened level of losses in the public D&O book and, as we said, in our healthcare book.

So it is kind of by definition losses in public D&O [or at large, right]. So we just keep seeing increased really frequency of large losses across public D&O and the other. So that caused us to both add to prior reserves in Specialty. Now those were offset by other good news, so we didn't have any adverse development in Specialty.

But it did cause us to increase the full-year specialty loss ratio by just a little less than half a point. And then that is reflected in -- as you understand, when you do a re-estimation fourth quarter, you do four quarters of catch-up, so it elevated the Specialty loss ratio this quarter by a little over 1.5 points.

That is great. Thanks a lot.

Jeff Schmidt, William Blair.

A question about the limited partnership investments. It sounds like maybe 65% or 70% are in hedge funds. Is that -- pretty much all of that marked-to-market immediately? I am trying to get a sense on how much of the total portfolio has a lag in the mark-to-market.

You are correct in that about 70% of that limited partnership portfolio are hedge funds. And it is about the same amount that is current mark-to-market.

And is the remaining amount more -- is it basically private equity funds?

It is private equity and some real estate.

Okay. And there may be a lag there?

There is a -- well, the longest lag you would see is three months and that is only about 15% of that portfolio. The other is just a one-month lag. But I think you should -- I would encourage you to view those LB results as very much a market in back timing.

Yes, okay. That is helpful. And then could you maybe discuss some of the loss trends in some of your key lines, workers' comp or professional liability?

Could you speak up, we couldn't hear that question.

I'm sorry. Could you discuss some of the loss trends in some of your key lines like workers' comp and professional liability?

Yes, workers' comp I think the loss trends are improving, it is getting better. And if we look at pricing we have had the benefit of some good rate increases in workers' comp over the past few years. It is kind of slightly negative on the rate site but loss trends are improving.

Part of that is also due to the mix; we are writing more white-collar work comp and getting out of the industrial or blue-collar typical work comp, which tends to have more catastrophic claims. So, yes, moving in the right direction in work comp. What was the other line you asked about?

Professional liability.

Yes, as Craig mentioned, public D&O, you write pretty big limits and many of these losses follow limits. So we just had a situation that we had a couple of them in the fourth quarter, that is the nature of that business, it is lumpy. But I would not say it is a trend that is really affecting the whole portfolio.

Okay, thank you.

Ron Bobman, Capital Returns.

I had a question -- Craig, you mentioned briefly in some of the LTC actions, something to the effect that limiting or stopping the addition of new lives or new accounts moving into the closed block. And I didn't understand what you meant by that, if I am close to sort of repeating what you said.

Yes, you are. Ron, good morning. What I said and hopefully it wasn't confusing. We closed the group business to new customer, meaning sponsoring company entrants, a long time ago. But we have allowed new employees of existing groups to continue to buy coverage. So that has meant that the number of lives in the group business has remained relatively stable over the last 10 years.

So, the action that we have taken over the last year is to really go back through all of those group sponsors. And as -- effective February 1 of this year we have closed that book to any new entrants. So then that book will just kind of naturally decline over time. So if you are a new employee of one of our sponsoring organizations you can no longer buy group Long Term Care.

Got you, okay, thanks. And so then is it sort of safe to assume that you are writing no new Long Term Care group or individual?

That is correct.

Okay, I understand now. Thanks a lot, gentlemen. Best of luck.

(Operator Instructions). Bob Glasspiegel, Janney.

Statutory earnings for 2015 and likely dividend capabilities for 2016?

Statutory earnings were a little north of $1 billion, so $1.1 billion. So dividend capacity would be -- approximately 10% would be that or 10% of stat surplus, which is as I said $10.7 billion. And then you understand the calculation is kind of a running calculation less whatever amount of dividends you've made over the prior 12 months.

Right. Given that your overall risks seem to be shrinking in 2016, there is no reason why you wouldn't have the capability to take that if you wanted to. Is that a valid assumption?

That is correct. I mean I think you should think of it -- our dividend capacity is over the course of the whole 12 months is being roughly equal to -- that earnings are 10% of surplus.

Right. Your partnerships didn't return quite as much as I had modeled in light of where the markets were. Were there any impairments notably that held back real estate maybe or --?

No, not at all, Bob. So, there are no impairments or nothing unusual in the partnership. That is just a reflection of the market. And remember that the way we have constructed that portfolio is to give us what we presume to be or intend to be better returns but less volatile returns than what you see in the S&P.

So when you have a big spike up in the S&P we don't get the immediate response. But if you look at over the course of the full year our LT returns were 3%, which is twice what the S&P 500 index would have performed.

So it is just a reflection of the responsiveness and immediacy of the reaction to S&P. And we are not -- remember that we have a bit of a long equity bias, but it is not just a long equity portfolio.

And just the choppiness of the last -- I asked Loews this question as well -- but the choppiness of the first quarter, does that make you want to increase your commitments, decrease or you are just staying the course in a very choppy market than change how you think about things?

Well, I think actually if you -- that is a good question. And if you -- once you dig into our published material you will notice that we have actually taken money off the table and LP has [already] reacted given our outlook for the market, we have reduced our allocation to that asset class. And likely [it will] continue to perhaps reduce it further as we are going forward.

Selling the weakness. Got you.

No, I think we sold -- yes, well --.

I meant this quarter.

(Multiple speakers).

No, no, that was a great sell before.

Thank you.

Appreciate the answers. Thank you.

At this time there are no additional questions in the queue. I would like to turn it back over to management for any additional or closing remarks.

Thank you very much. See you next quarter.

That concludes today's conference. We appreciate your participation.