CNA Financial Corp (CNA) 2016 Q2 法說會逐字稿

Good day, everyone, and welcome to the CNA Financial Corporation second-quarter 2016 earnings 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, sir.

Thank you, Lori. Good morning and welcome to CNA's discussion of our 2016 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 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 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-Q and 10-K, on file with the SEC.

In addition, these forward-looking statements speak only as of today, Monday, August 1, 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 and other information 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.

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. I am pleased to report what I view as very solid and steady results this quarter.

In the second quarter CNA produced net operating income of $201 million, compared with $132 million in the second quarter of 2015. Operating return on equity was just under 7%. Our property and casualty business had another solid quarter with a combined ratio of 97.4, an improvement of 1 point compared with the prior-year quarter. This was driven by favorable prior-year loss development across all of our property and casualty segments and achieved despite a higher level of catastrophe losses and a higher-than-expected number of large losses in international.

Specialty continues to produce outstanding results in a competitive environment. The second-quarter combined ratio of 85.4, nearly a 6 point improvement compared with the second quarter of 2015, driven by favorable prior-year loss development coupled with a stable accident year loss ratio. The underlying combined ratio was 94%.

Specialty rates increased 1% in the second quarter with retention of 86%. Net written premiums grew 3% in the quarter, aided by healthy retention, positive rate, and a modest level of new business, reflective of our disciplined approach to the market.

Commercial continues to make good progress. The quarter's combined ratio of 103.5 was 4 points better than the second quarter of last year, helped by a modest amount of favorable prior-year loss development. Catastrophes of 8 points were in line with the prior-year quarter.

The underlying combined ratio for commercial was 97.7, with an underlying loss ratio of 61.6, 1 point lower than the prior-year quarter and steady with where we ended the full year 2015. Commercial rates were flat for the quarter. Retention improved 4 points to 83% and net written premium was up 3%, while new business was steady.

We had a challenging quarter in international, with a number of large losses in Europe and Hardy, primarily in political risk, property, and financial institutions. Canada continues to perform very well. Catastrophe losses added 10.6 points to the loss ratio, driven by the Fort McMurray wildfires.

International's second-quarter combined ratio was 118.6, including 7 points of favorable reserve development. The underlying combined ratio was 115.3.

International net written premiums decreased 22% in the quarter, compared with the prior-year quarter. Excluding the effect of foreign currency exchange rates and the timing of reinsurance spend, the decrease was 12% due to lower retention and rate.

With that, I will turn it over to Craig.

Thanks, Tom. Good morning, everyone. CNA produced another quarter of steady results and demonstrated steady overall progress. This characteristic was especially true for all our US-based businesses, as well as for our investment results.

Our international segment results were disappointing. Our core property and casualty operations produced net operating income of $229 million, compared with $237 million in the prior-year quarter. Our second-quarter calendar year property and casualty loss ratio was 63%, nearly a 2 point improvement as compared to the second quarter of 2015, despite a higher level of catastrophe losses. The underlying loss ratio was 63.9%, above where we ended full year 2015 and reflective of the elevated level of large losses in our international segment.

Our US-based commercial and specialty businesses generated significantly improved underwriting profit through stable underwriting loss ratios and favorable prior-year development. Importantly, the underlying loss ratios in both our commercial and specialty segments were consistent with where we ended full-year 2015. The meaningful level of prior-year loss reserve development was relatively broad-based and reflected improvements in more recent accident years. This was especially true in the commercial segment and a reason for optimism as we navigate through today's competitive environment.

Our second-quarter property and casualty expense ratio was 34.2%, a 1 point improvement compared with the first quarter of this year and consistent with our full-year 2015 results. We continue to maintain our long-term focus and to invest in the business. We remain committed to becoming among the very best at selecting, pricing, and managing risk. We also remain mindful of the need to improve our expense competitiveness over time.

Life and group produced a $4 million net operating loss in the quarter, much improved from a $24 million loss in the second quarter of last year. This quarter's modest loss reflects outcomes generally in line with our reset assumptions and was relatively consistent with our first-quarter result this year.

Our corporate segment produced a net operating loss of $24 million.

Net investment income was $502 million in the second quarter, another steady result as compared to the prior year. Income from limited partnership investments was $46 million, a 1.8% return, compared with $48 million, which was a 1.6% return in the prior-year period. Income from our fixed maturity securities in the second quarter was $449 million, consistent with the prior-year period, as modest growth in our invested asset base offset slightly lower book yields.

Our investment portfolio net unrealized gain stood at approximately $4 billion at quarter-end, an increase of $1 billion since the end of the first quarter, reflecting the decrease in market yields.

The composition of our investment portfolio is relatively unchanged. Average credit quality of our fixed maturity portfolio remained at A. Fixed income assets that support our traditional property and casualty liabilities had an effective duration of just over four years at quarter end, in line with portfolio targets. The effective duration of the fixed income assets which support our long-duration life and group liabilities was 8.7 years at quarter end, reflective of the market's low interest rates, expected bond call activity, and our tactical decisions that will continue to be assessed in light of capital market conditions and opportunities.

At June 30, shareholders equity was $11.9 billion and book value per share was $43.94, an increase of 4% since March 31. Book value per share, excluding accumulated other comprehensive income, was $43.16.

Statutory surplus at June 30 was an estimated $10.6 billion for the combined insurance operating companies, relatively consistent to where we ended last year. We continue to maintain ample dividend capacity and significant financial flexibility.

Cash and short-term investments at the holding company were approximately $441 million at quarter end. We continue to target cash at the holding company equal to approximately one year of our annual net corporate obligations.

In the second quarter, operating cash flow was $279 million. Cash principal repayments through paydowns, bond calls, and maturities were approximately $750 million.

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.

With that, I will turn it back to Tom.

Thank you, Craig. In conclusion, the market looks much like it did in the first quarter and our strategy remains unchanged. We will continue to focus on portfolio management and margin improvement, which is evident in our results we shared with you today.

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

(Operator Instructions) Bob Glasspiegel, Janney.

Good morning, CNA. I was wondering -- a couple quick questions on international. Could you quantify how many points you would characterize unusual large losses contributed to the quarter? And also just some commentary on how Brexit is going to impact your strategy there.

Bob, this is Craig. I'll tell you that the unusual level of large losses added about 16 points for the international loss ratio this quarter. I will let Tom answer your question about Brexit.

First of all, our European subsidiary is based in London, so with that we are evaluating what options are out there for us going forward. I would also make the point, Bob, 2% of our premiums are on Continental Europe. It is a very small percentage. Most of our business is UK and Hardy, and then Canada, of course. So we're looking at options and it's a ways off, but we'll figure it out.

Thank you. You said Canada had a good quarter despite the wildfires. Or were you talking ex-wildfires?

No, despite the wildfires.

Okay. So it performed in line, even with the pressure? And how much was the wildfires?

The wildfires was about $20 million total and about half was from Hardy and half was from Canada.

Got it. Last question, could you give us a little color on where the -- you said it was more recent accident year. What drove the reserve releases?

Well, a little bit different in both. What I said, and maybe we want to emphasize it, it was broad-based. In specialty it was across a lot of different products, mostly professional liability products, including medical professional, and it spanned accident years 2008 through 2014.

And the way we -- part of it is how we approach reserving, so we try to be mindful of what the impact on volatility or variability is on specialty. And it just turned out that really the emerging frequency across all those years and we had a few favorable claim outcomes, all those things added up to a pretty significant dollar total.

In commercial, likewise I would say it's several products, but -- over accident years 2010 through 2014, but most of it 2012, 2013, and 2014. I think we'd really give some credit there or kind of reasons there is that we have also been cautious about --.

As you know, we have been investing very heavily in talent and in new tools and improving our execution. And we haven't reflected what we anticipated the positive impact of that to be until we saw those results begin to really manifest themselves in the loss ratios. So what you're seeing now is really a manifestation of a lower frequency, which we would say it is underwriting driven. So underwriting pricing, risk selection, and claim management-driven. And that's the reason for my optimistic remarks as well in the script.

Thanks for the color, Tom and Craig.

Josh Shanker, Deutsche Bank.

Thank you. Just following on Bob's question about international. Can you talk about how many unusual losses were in that 16%? How often you would expect a confluence of a number -- that many large events hitting in one single quarter and whether this has caused you to ask any questions about risk management in the sector?

I think, first of all, if you look at the business at Hardy, where a lot of these losses came from, it's a volatile business. They do have ups and downs. Unfortunately, we got a couple losses in the same quarter. We'd like to think that over time that will balance out, but that's the nature of the business when you're writing trade credit and political risk and some of the other things that they do in Hardy.

So the fact is it was a tough quarter. We would like to think that's not going to be every quarter, but political risk, trade credit is really a pretty small portion of the book, but things are a little tumultuous over there these days. I don't think that changes our attitude about wanting to do business in the Lloyd's marketplace or the continent or the UK.

It is a smaller portion of our business, so it is going to show some fluctuations on the loss ratio side, because it doesn't have the scale of the US business or US specialty or US commercial.

And if I think about -- what is the target combined ratio for the small- and middle-sized attritional loss as part of international's mandate? Is this a business that we should think operates at an 80% combined ratio with standard deviation of 15%, depending on the impact of large losses, or --? How do you guys think about the large loss portfolio versus the attritional loss portfolio?

I think you have to look at it in different pieces. If you look at the UK business, we think that's usually pretty stable. We like that business. It doesn't have the volatility that Lloyd's has, so I think if we look at the Lloyd's business we think that's going to trade at a higher combined ratio at this point in time.

Continental Europe pretty stable, although they did have the financial institution loss on the continent. So I think we realized they're three very different businesses and our objective is, over time, to make them all more profitable and get a little more scale. I don't know that I can answer your question exactly, Josh.

That's all right. I guess I'm trying to gerrymander into my own answer I guess. Is it possible (multiple speakers)?

Think of it this way: if you look at the markets that trade in Lloyd's, it has been a market that has suffered from rate decreases for probably two years now. So rates have been going down there. It's extremely competitive. There are new entrants. It's a tough market.

The Lloyd's market is very tough; doesn't look like it's getting better, so I think that's the reality. It's not a CNA issue; I think it's a Lloyd's issue. And I think that is probably going to continue with what's going on over there. So --.

I guess, in terms of thinking about -- if the possibility of hitting a 115, 120 is a reality in this market, can we envision that there's also quarters where we will see, even in this kind of market, combined ratios in the 80s given the volatility? There should be a trade-off there. So if a 120 is possible, then maybe an 80 or 85 should be possible, too, but in this market maybe that's not possible.

I don't think you're going to see 80 combined ratios coming out of the Lloyd's marketplace. I just don't see that. Now what you hope is you don't have three or four 115s. Maybe you have 115 one quarter and you can get things down to 100 or in the 90s, but I think you are kidding yourself if you're thinking it's a 80s business with an occasional 110, 115. I don't see that.

No, no, no. I'm saying that the volatility -- that I'm just as likely maybe to show up with a 120 as I am an 80 in an unusual quarter, I guess is how I'm sort of thinking about it. But maybe that's too much. The market is tough, I understand.

Let's hope it's not like an EKG where it's up and down. I think we'd like to see it get closer to 100 overall, but 115, we are not happy with that.

In terms of the business that you are going to leave in about six months, a little less than that actually, can we conceive of the reserve situation getting to a point where you're looking to have the reserves have a steady trend, depending on where the market is going?

It seems like if I try and forecast reserve release for CNA, good luck to me. Good luck for any company, but they are pretty volatile. And that's a result of trying to get the book in order, which there's a number of things changing all the time. Should it be less volatile in time or is this sort of normal volatility?

I would say we are comfortable with reserves and we are comfortable that we have had now a couple quarters of reserve releases in commercial. Specialty has been consistent in that regard. This is not the serial reserve company that somebody knew in the past. This is a much different place.

We are very comfortable with the reserve. Sure, there are ups and downs periodically, but we think we are really doing a nice job on the reserve side. We are comfortable.

Josh, this is Craig. I would say over the last 10 years our reserve history has been remarkably consistent, in terms of favorability, most of the time. We don't get it right all the time, but pretty remarkably consistent in that we do see some small amount of favorable reserve develop because of the approach we've taken.

I think the point that Craig made a little earlier, you are seeing reserve releases now from more current accident years. If you go back a few years ago, it was the older accident years. It's more consistent now, so we are pleased.

All right. Well, good luck with the rest of the year and I'll talk to you soon.

Jay Cohen, Bank of America.

Thank you. I guess starting on the international side, can you maybe put a little color around one or two of these large losses? When you say trade credit political risk, what exactly happened that gave rise to the loss?

I don't know if you understand the trade credit business, but essentially we are -- what's giving rise to the loss is the commodity-depressed prices, guarantees made about deliveries or prices of those commodities, and failures of the companies to transact or complete those businesses. So that's really a function of the currency in emerging markets and commodity pricing and the impact of that business and the guarantees made in that business.

Got it. And on the financial institutions loss, this is a liability-type product?

Actually, there are several there, Jay, so it is financial institutions. Some are directors and officers liability and there also is one large Fidelity crime loss. So it was relatively -- there are a handful of large losses with different characteristics across that portfolio.

Got it. Then on the international premiums, it makes sense that you would see the shrinkage given the market conditions. It did seem to really step down this quarter versus the last several. Are you reacting more aggressively to the competitive environment?

I think remember also, and you want to be able to see that some in the commentary and in the press release, that there is a bit of the timing difference in the reinsurance spend at Hardy, which reduced net written premium by about 10% this quarter. You might remember that last quarter we were explaining that it wasn't quite as high as it looked, so some of it is that.

But even when you take currency impacts away and you take that reinsurance timing away, the top line, on a local basis, would be down about 10 points, 10 points or 12 points. And that is a function of the market rates and the market and retention in the market and our reaction to the rationality or lack of rationality in the market.

I think also remember that at Lloyd's one of our bigger sectors was energy and energy has been under significant pressure, both from just the assets that are being insured declining, less purchasing from those eventual customers, and then the kind of competitive environment of that. So there's a lot of different things going on, which are why Tom was saying what we was saying about the relative stress now ongoing at Lloyd's.

You are not alone there, certainly. Then the last question, given the ongoing favorable development, how are you adjusting your current accident-year loss ratio picks? Has that allowed you to use a somewhat lower pick, maybe not as low as the reserves might indicate, but a somewhat lower pick anyway?

We do adjust our current picks based on how we see the base loss ratio improve, so that is a factor in how we look at things. I wouldn't say that we adjusted anything this quarter. If we take it into consideration and as we go along we try not to act too quickly on the current accident year, particularly in this rate environment, until we are a little further in the year and then we can see how all the different components that might drive the outcome is a little more settled in.

But certainly that is a positive factor and will be a positive factor as we are going forward.

Got it. Thanks for the answers, Craig.

(Operator Instructions) Jeff Schmidt, William Blair.

Good morning, everyone. Question on the commercial book. It looks like small business rates are holding up well. The middle-market book is down; for the second straight quarter it went negative. Could we get a sense on how much of the book is broken between the two, small business and middle-market?

Small is about 20% of the total, of the total commercial line segment.

Okay. And are you seeing rate pressure there kind of across the board or are you seeing any lines deteriorating more?

No, rates are up in small business. We tier our business 1 to 5 and all of the tiers are up. Some are high single digits; some are low single digits, but small business we're seeing good rate increases.

I meant for middle-market there. I'm sorry.

Oh. What's the question on middle-market?

Well, it's gone negative here now for the second straight quarter and I was just wondering if that's kind of broad across business lines or is there any --.

The package business is off low single digits and that would be a big driver of the middle-market.

And then the expense ratio for that book is up, I think it's like for the seventh straight quarter. Is that mainly being driven by investments in the business? Where does that top out at?

Yes, investments in the business.

Is this at 38%, 39%? I mean is there much more?

I think what you saw is that it's actually down this quarter from last. So it has been up year over year, but down this quarter a little bit from last and a little bit more consistent.

As I said, overall, we think the expense ratio -- we're going to continue to invest in the business because we think, long term, this is a game of how well are you -- how good are you at quantifying, selecting, and managing risk. And we are very mindful of where our competitive position is, as compared by the accident year loss ratio, to peers. And I see -- and I think you'll see, if you look at it, how much we've closed that gap, if not completely closed that gap.

So that is a significant positive factor for the business trading forward and you expect us to be mindful of that expense ratio on competitiveness, which is about 2 or 3 points now. But essentially we arrested any increase this quarter from last and what I said in my remarks is we expect it to be closer to that -- where we began the year; around 34, 34.5 when we end the year.

Okay, thank you.

Meyer Shields, KBW.

Thanks, good morning. Is there any useful rule of thumb in terms of saying that when you've got loss ratio improvement of x points there's an offsetting expense in terms of incentive compensation within the expense ratio? Is there any -- is that a driver at all in this quarter?

I'm sorry, we're having a hard time -- I'm having a hard time hearing you or understanding the question.

Okay. I'm wondering whether the successes that you are showing on the loss ratio in commercial and in specialty, does that come -- does that imply a higher expense ratio for incentive compensation at all.

No, not necessarily. Depending on how well we do, we could have some impacts there, but if it is, it would be one time and it would be incremental. I don't think it would be particularly noticeable and I wouldn't --. But we do, certainly do reward our underwriters for their performance or outperformance against expectations.

Okay, that helps. I think, Tom, you mentioned the improvement in frequency as a function of underwriting -- internal underwriting. Is there anything changing in the external environment in terms of frequency or severity, particularly on the liability side, getting worse?

I think the only thing is management liability looks pretty bleak to me from a claim standpoint and the market continues to push rates down. It doesn't make any sense at all. But I think management liability is a bit troubled, particularly the large public stuff, so that would be the only other thing.

We look at our claim accounts and new claims were down 5%. Our outstanding claims are down 5%. That's been going on for a while and that's part of the portfolio of management. I think we're doing a good job managing frequency.

Okay, that covers me. Thanks so much.

That will conclude the question-and-answer session. I would like to turn the conference over to Mr. Tom Motamed for any additional or closing remarks.

Thank you, everybody. We will see you next quarter.

That will conclude today's conference. Thank you all for your participation.