CNA Financial Corp Earnings Call Nuggets: Hardy Acquisition, Statutory Surplus
On Monday, CNA Financial Corp (NYSE:CNA) reported its first quarter earnings and discussed the following topics in its earnings conference call. Here’s what the C-suite revealed.
Amit Kumar – Macquarie Research: I guess let’s start with a few questions on the Hardy acquisition. I was looking at the premium mix and they have a Property Treaty book, which has been more volatile, and it has reported an underwriting loss for 2010 and 2011. Can you talk about Hardy’s business mix? You mentioned a premium base number of $430 million. How much of that do you think you intend to renew going forward?
Thomas F. Motamed – Chairman and CEO: I think I would start with probably a little bit different look. First of all, if you look at Hardy, excluding the last two years, where natural catastrophes impacted the global insurance industry, this is a highly profitable franchise. So, if you go back and you look at 2007 to 2010, most recent years, combined ratio under 90, probably pretty close to 87. So, the one segment where they encountered some difficulty was the Property Treaty business. They have already scaled that back in their 2012 Lloyd’s plan, and as you know from other calls, reinsureds are getting significant rate increases on Property Treaty business around the globe, whether that’s Japan, Australia, Asia, et cetera. So, they have identified weakness, they are dealing with it, and we are pretty confident that over time they will go back to and start profitability level. So, the other businesses have all done very well through all the years – all the recent years, and if you go back, Hardy’s been around for 35 years, so this is not a bunch of new underwriters getting together. They have a very proven track record in all of their segments, albeit the property cat that got away from the industry the last two years. So, we’re pretty pleased and they’re dealing with it.
Amit Kumar – Macquarie Research: No, I agree with your comments regarding the rest of the book. I’m just wondering, it does introduce a new level of volatility in your results, and are you okay with that?
Thomas F. Motamed – Chairman and CEO: Well, let’s remember two things here. They had cut that back to 50% of where they were, so that’s a significant cutback; and number two, if you look at CNA, 79% of our business is casualty, only 21% is property. They are much short – more short-tail oriented or first-party oriented. So, we kind of like the blend; we think (helpful), and as you know, this is a business of risk and reward, and sometimes you take a little bit more risk and something like property cat reinsurance, but I don’t have to remind you, if you look at CNA’s catastrophe loss ratios over the last few years, they are very low on a percentage basis compared to our competitors. So, it’s introducing a little bit more – I prefer to call it complexity, but we think we got a great group over there at Hardy and they will manage it effectively going forward along with the CNA portfolio that we manage here.
Amit Kumar – Macquarie Research: Got it. And what’s your review on their loss reserves? I mean when you look at their book, do you walk away with a great degree of comfort?
Thomas F. Motamed – Chairman and CEO: I would say we are comfortable, but as – when you look at an acquisition, and you make a offer or you make a price, you build in various assumptions as to loss reserves, expected growth, et cetera. So, we have built that all into our purchase price, and we are very comfortable with what they’re doing and we’re okay.
Amit Kumar – Macquarie Research: And I guess the next question is you mentioned in the opening comments that the senior leadership will remain. Is there some sort of an earn-out period which would result in them sticking around for the next few years? Maybe just expand on that?
Thomas F. Motamed – Chairman and CEO: First of all, they want to stick around. They are a very close group, very loyal. We have built certain things into the transaction and going forward relative to compensation and benefits, which we think will be helpful, but as you also know, in the London market there’s something called garden leave, so when people leave, they don’t go to work for six months or a year, and we believe that these people want to stay onboard and they will be treated well, compensated well, and quite honestly their senior management stays in place, which should give them great comfort that they’re going to be managed and led by the same people that have managed and led them overtime.
Amit Kumar – Macquarie Research: The reason why I am asking is there have been several acquisitions of Lloyd’s entities where the senior management have in fact walked away. And I’m wondering if there is anything specific in the contracts, which would prevent them from moving to another shop down the road? Is there like a specific lockup or some sort of a specific requirement, which would prevent them from moving on apart from the garden leave?
Thomas F. Motamed – Chairman and CEO: They don’t have any contracts. We don’t have any contracts. You either want to work for us or you want to work for Hardy; that’s the way we run the place. So is it conceivable that somebody could leave? Yes, that’s true, but I can tell you a lot of people have CNA too and some of that has been desirable. So the reality is we think we’ve got a good business. They’ve been around for 35 years and we believe they’re committed to continuing to build their business and with our capital they have a lot of room to do things that they were unable to do before and that’s what was attractive about them selling to us.
Amit Kumar – Macquarie Research: Last question and I will re-queue. Can you talk about some of the expenses apart from the acquisition price, associated with this deal near-term and maybe (expense/benefit) of some sort going forward? Is there any expenses we should be thinking about regarding this deal apart from the deal price?
D. Craig Mense – EVP and CFO: I assume you are asking what sort of earnings impact you might have in the near-term and longer.
Amit Kumar – Macquarie Research: Yes.
D. Craig Mense – EVP and CFO: I would tell you. So, I would expect – nothing material either positive or negative in 2012, so there will be transaction cost and integration cost, and we’re not really even certain yet of exactly the close date and we haven’t settled in on some purchase accounting adjustments. So, I think the best way to think of it, nothing material one way or the other in ’12, and it will be modestly accretive in ’13.
Jay Cohen – Bank of America Merrill Lynch: Just one quick numbers question I missed when you said it on the call, the cash at the holding company level?
D. Craig Mense – EVP and CFO: It’s $270 million.
Jay Cohen – Bank of America Merrill Lynch: Does that include the dividends that were just paid from the P&C sub?
D. Craig Mense – EVP and CFO: Well, it does include it Jay, but actually if you are trying to reconcile where the money that’s been put aside for the Hardy acquisition that’s actually shown in cash and short-term investments on the investment schedule. So that $270 million does not include the $250 million earmarked for Hardy.
Jay Cohen – Bank of America Merrill Lynch: Next, when I look at the statutory surplus, when you break out the surplus from the Life company in run-off. What would be the key differences in the statutory surplus of the Life business and the GAAP equity associated with that business as well?
D. Craig Mense – EVP and CFO: Well, it would just be the – well, let me caution you first. Remember that the Life company houses the majority of the payout annuity and structured settlement reserves, but the Life company does not (have) the liabilities associated with long-term care. So just keep that in mind as a starting point. So, other than – with that starting point, so you’ve got about $2.5 billion of structured settlement, some institutional market and other reserves; $2.5 billion to $3 billion of reserves. Then the key difference would just be the discount rate on the reserves which would be more conservative in the stat results than they would be in the GAAP results.
Jay Cohen – Bank of America Merrill Lynch: Got it. And do we know the amount of statutory surplus associated with the long-term care business? Is that just locked up in the P&C stat surplus?
D. Craig Mense – EVP and CFO: Yes.
Jay Cohen – Bank of America Merrill Lynch: It’s not a separate company is what I’m saying.
D. Craig Mense – EVP and CFO: It is not a separate company, correct.
Jay Cohen – Bank of America Merrill Lynch: Okay. I know in the past you have not given out sort of the GAAP equity associated with the run-off businesses. Is that something you’d consider doing?
D. Craig Mense – EVP and CFO: We haven’t at this point considered doing it, and I know we’ve been asked on several occasions, but we have not disclosed that at this moment.
Jay Cohen – Bank of America Merrill Lynch: It would just – from our standpoint – how from an analytical standpoint to really get a better sense because clearly your ROEs are a lot lower than your comps. This is the big reason why, and even though we know it’s an issue, it’s hard for us to quantify that issue.
D. Craig Mense – EVP and CFO: Understood.
Jay Cohen – Bank of America Merrill Lynch: Just one other question, obviously, you talked about the pricing trends and those are encouraging to see them moving in the right direction. From a claims standpoint, just I guess talk about some of the major lines of business and some of the claims trends you’re seeing, and specifically, if there has been any changes in those trends?
Thomas F. Motamed – Chairman and CEO: Boy, that’s a big question. Yeah, I would say overall…
Jay Cohen – Bank of America Merrill Lynch: Take the big lines of business (though)
Thomas F. Motamed – Chairman and CEO: Yeah, I would say, overall, when we look at claim costs, they are going up 2% to 3%. So, when we look at written rate, clearly, higher in Commercial, and we believe we’re exceeding our loss cost trend in Commercial on an earned basis; that’s starting to come through. On Specialty, the written rate is pretty good; it’s up 3%, but it hasn’t earned through. Once again loss cost kind of 2% to 3%. Paul, I’d say, frequency is down, severity is up a little bit, and Commercial, auto, and workers’ comp, probably if there was two other areas where frequency might be up a little bit, it’s employment practices liability that doesn’t appear to be something strictly occurring at CNA, it seems to be a market issue. And then we have attorneys’ errors and omissions; that has kicked up, and I think those two really relate to the economic woes that are just starting to come through. So, overall, frequency down, severity up a little bit at some places, loss costs are pretty benign; 2% to 3%, and the rate is coming through. So, we don’t think we’re losing ground if that’s what your question is. We think we’re gaining on it.