HCC Insurance Holdings' (HCC) CEO Chris Williams On Q2 2014 Results - Earnings Call Transcript

Jul.30.14 | About: HCC Insurance (HCC)

HCC Insurance Holdings, Inc. (NYSE:HCC)

Q2 2014 Results Earnings Conference Call

July 30, 2014 9:00 a.m. ET

Executives

Chris Williams - Chief Executive Officer

Bill Burke - President and Chief Operating Officer

Brad Irick - Executive Vice President and Chief Financial Officer

Mike Schell - Executive Vice President

Analysts

Ryan Byrnes - Janney Capital Markets

Mark Dwelle - RBC Capital Markets

Bob Farnam - KBW

Presentation

Operator

Ladies and gentlemen, this telephone conference call relates to HCC Insurance Holdings Inc. Before we begin, the company has requested that I read the following statement which will govern the telephone conference today.

Statements made in this telephone conference that are not historical facts, including statements of our expectations, of future events, or our future financial performance, are forward-looking statements made pursuant to the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995.

Forward-looking statements involve inherent risks and uncertainties and we caution investors that a number of factors could cause our actual results to differ materially from those contained in any such forward-looking statements. These factors and other risks and uncertainties are described in detail from time-to-time in our filings with the Securities and Exchange Commission.

This conference call and the contents thereof, and any recording, broadcast, or publication thereof by HCC Insurance Holdings, Inc. are the sole property of HCC Insurance Holdings, Inc. and may not be recorded, rebroadcast or published in whole or in part without the express written consent of HCC Insurance Holdings, Inc. Your lines will again be placed on music hold until the conference begins. Thank you for your patience.

Ladies and gentlemen, thank you for standing by and welcome to the Second Quarter 2014 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session.

I would now like to turn the conference over to Mr. Chris Williams, Chief Executive Officer. Sir, you may begin the conference.

Chris Williams

Good morning, everyone and welcome to HCC's second quarter earnings call. Joining me today is Bill Burke, our President; Brad Irick, our CFO; and Mike Schell, Executive Vice President.

HCC's record earnings trend has continued setting another six months net earnings record of $205 million compared to $194 million in 2013. Our net earnings for the quarter were $97 million or $0.97 per share, compared to $88 million or $0.87 for Q2 2013.

We successfully grew gross written premium by 3% for both about the quarter and year-to-date to $1.6 billion for the first half of 2014. Our combined ratio continues as a market leader at 83.5% for the quarter and 83.2% year-to-date. There were no reserve developments in 2014 versus favorable development of $12 million in 2013.

We have been the beneficiary of very modest catastrophes which is reflected in our results, with only $5 million of cat losses for the quarter or $0.03 per share and $10 million through the first six months of 2014 or $0.06 per share. This compares to $21 million or $0.14 per share for Q2 2013 and $27 million or $0.17 per share in the first half of 2013.

Book value per share increased 7% for the first half of 2014 to $39.12 and we once again exceeded our OE target achieving 10.75% year-to-date. Brad will now walk you through the financial results.

Brad Irick

Thanks, Chris. Net investment income in the quarter was $56 million, an increase of 1% from the prior year. Our fixed maturity portfolio maintained a tax equivalent book yield of 4.4%, unchanged from the first quarter. Duration decreased to 4.7 years, largely due to the decrease in interest rates during the quarter.

While there were no significant changes to the portfolio in the second quarter, in mid-July we sold a portion of our equity portfolio realizing gains of $35 million. Given the recent increased valuations, we made the decision to reduce our overall equity exposure and lock-in realized gains. These gains will be reflected in our third quarter results.

As Chris mentioned, we made no adjustments to prior year reserves during the quarter. We will complete detailed reviews of our U.S. P&C, professional liability and international reserves in the third quarter. We continue to make progress in settling claims with respect to Spanish cooperative housing bonds and believe we will resolve the vast majority of these matters during the third quarter.

Cash flow from operations of $195 million through six months was strong, in line with our expectations and well above the prior year. With respect to liquidity, we have approximately $800 million in short term funds and available capacity under our credit facility. We have also continued our opportunistic share buybacks with 1 million shares purchased in the first six months at an average cost of $43.21 per share.

Finally, we completed our annual goodwill assessment this quarter. As expected, we continue to maintain a significant margin in each of our segments driven by our favorable underwriting performance. As a result, no adjustments to goodwill have been made. Bill?

Bill Burke

Thanks, Brad. We continued to have solid performance in the second quarter as highlighted by our 3% increase in gross and net written premium along with a low combined ratio. We are continuing to see rate increases in a number of lines of business across all of our segments except international.

For our U.S. based businesses overall, we achieve a low single-digit rate increase while our internationally based lines had a high single-digit rate decrease led by our property treaty reinsurance business, which saw rates decrease by 10%. The retention rate across all segments continued to be positive at 84%.

Looking at specific segments. In professional liability, we had continued strong results with a combined ratio of 79% for the quarter and first half. Our U.S. Surety and Credit segment achieved a 4% increase in gross written premium for the quarter led by our credit business which saw the impact of an improving economy.

Our combined ratio for this segment was a satisfactory 84% from both the quarter and year-to-date. Our U.S. P&C segment continued to have good results driven by increased net earned premium excluding public risk of 2% for the quarter and 6% year-to-date, along with a combined ratio of 84% for the quarter and 80% for the first half.

As I mentioned on our last call, we placed quota share reinsurance for our public risk business at the end of 2013, which reduces net written premium on a year-over-year basis. If you look at the individual components of this segment, aviation is a good example of our underwriting discipline and ability to maintain margins even in a soft market. Aviation insurance has been very competitive for a number of years but we have been able to continue to write profitable business as see by our 61% loss ratio for the first half.

We are expecting improved pricing in the aviation market as a result of the string of large aviation losses over the last several months.

Our liability continues to grow led by our primary, general liability and excess casualty lines as can be seen with the over 20% increase in gross written premium for the first half. We continue to see opportunities in these lines and added a new team of underwriters in Ohio this quarter.

Our sports and entertainment lines on a gross premium basis can show significant variation due to large event related coverages as shown by this quarter when the prior year results were materially higher. Competition continues to increase across a number of lines in the international segment.

As you are no doubt aware, the property treaty business has been the most competitive and while this is positive when we are buying reinsurance, we are seeing reduced premiums writings in our assumed reinsurance lines. As a reminder, while property treaty is a valued line for us, it represents less than 5% of our gross written premium on an annual basis.

The international segment has over 15 lines of business and we saw a good growth in a number of lines including surety and credit along with our small account liability business which helped offset some of the more competitive lines. We maintained good underwriting discipline and achieved a very positive 78% combined ratio for the quarter. Chris?

Chris Williams

Thanks, Bill. The A&H segment continues to perform extremely well with gross written premium increasing $36 million or 17% for the quarter-over-quarter and $56 million or 13% year-to-date. Our Medical Stop Loss product achieved excellent results in the first six months including the number of employee groups we received to quote on increased 5%, showing continued interest in Medical Stop Loss. The average employee lives per group written was 557 lives consistent with 2013. The average specific deductible increased 13%.

Importantly, the effective rate increase continued to outpace the impact of medical inflation on our book. We achieved increases of 15.6% for the quarter and 18.1% year-to-date, compared to adjusted trend of 14.4% for the quarter and 15.8% year-to-date. The market remains competitive but stable and most of our competition continues to come from direct writers.

Our retention rate of 78% in the second quarter is consistent with the prior year. We are continuing discussions with brokers and other entities to enhance our strategy for private exchanges. This market is in its early development but it's clear to us from our conversations that self-funded plans still offer flexibility in plan design and cost savings that employers have come to appreciate. The Medical Stop Loss group continues to be one of HCC's many great franchises.

2014 is off to a very good start for HCC in several aspects. As a specialty insurer with a successful and profitable track record, our reinsurance partners continue to provide broad, competitive coverage for us with the majority of our 2014 treaties now renewed. Our double A rating was reaffirmed by Standard & Poor's.

As Bill mentioned, we have grown our casualty business with the addition of a Midwest team and we have also expanded our surety platform. Our diversified, non-correlated businesses are all performing at very acceptable levels. We remain acquisitive should the right opportunity present itself, be it companies or teams with people that will enhance our business and shareholder value.

Finally, we will be holding an investor conference on June 11, 2015 in Houston providing you an opportunity to interact with our senior leadership. We will be providing further details nearer the date. We would now like to open up the lines for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Ryan Byrnes with Janney Capital.

Ryan Byrnes - Janney Capital Markets

The first question. It's been a pretty active third quarter for the aviation market, just wanted to see if you guys had any exposure to any of those recent issues.

Chris Williams

Hi, Ryan. This is Chris Williams. I am pleased to report very very minimal exposure to all of the tragedies there. As Bill mentioned, our expectation is it's going to have an impact on the aviation pricing but thankfully we have got very minor exposure.

Ryan Byrnes - Janney Capital Markets

Okay. Great. And then another recent little headline is the cost of the new hepatitis C drug. I just wanted to see if that’s going to impact, I guess, your loss ratio this year or into next year because I know that’s a pretty expensive drug.

Chris Williams

Bear in mind, our medical stop loss business doesn’t attach until an average deductible of just over 80,000 in any one life. So it really shouldn’t impact the specific side. And on the aggregate side of the business, less than 5% of them buys aggregate coverage. So there should be minimal impact there.

Ryan Byrnes - Janney Capital Markets

Okay. Great. And then a last on and I will turn it over to other guys. The improvement in the loss ratio in both the U.S. property and casualty book as well as the international segment. Just want to see where that loss ratio improvement is coming from. It is from business mix, fewer losses or rate increases. Just want to see where that is coming from.

Mike Schell

This is Mike Schell. On the U.S. P&C side, it's much improved results in public risk and improved results in our small account, professional liability which is errors and omissions and employment practices liability. On international, all the areas are solid and we had a low cat quarter in the year-to-date, and remember this is where most of our cat exposure is.

Operator

(Operator Instructions) Our next question comes from the line of Mark Dwelle with RBC Capital Markets.

Mark Dwelle - RBC Capital Markets

Couple of questions. Following up on that first question about any exposure to aviation losses. I was under the impression that you guys didn’t really write major carriers, that is was really, primarily smaller and corporate aircraft and things of that nature. Is that the right impression and if so, I guess if you can say, on what dimension do you have exposure to some of the larger loss events?

Chris Williams

First of all, Mark, your understanding is correct. We are not a writer of the big flagship carriers, which sadly a couple of those tragedies centered around. There could be some small miscellaneous coverage that we are writing in different part of the world. So we really don’t, as I said, have any material exposure to these things at all.

Mark Dwelle - RBC Capital Markets

In international book, do you write any political risk at all?

Chris Williams

We do write some surety and some credit business. We write that in the U.S., well we do write it out of the U.K. as well. So, yes, we do write some of that business.

Mark Dwelle - RBC Capital Markets

Okay. And then in the A&H sector segment, you have a line called other and it's grown quite nicely this year. And I was just curious what exactly that was that is growing so dramatically over the last year.

Chris Williams

Sure. We write a short-term medical product and have done for the last six years. And we have been the beneficiary of a lot of the confusion that’s surrounded Obama Care where a lot of people have been waiting to get enrolled in various programs. So what's been happening is people have been buying this as an interim coverage. Of interest, less than 80% of the coverages only runs for about 60 days. So it is very very short tail business. The one comment I would caution you on is, that I don’t think you should assume it is a run rate just yet. I think there is still a lot to unfold and this may reduce back to more its custom level which if you remember, was more around the $20 million area whereas we have already written $30 million this year.

So we like the business very much. We would like to write more if we could but I wouldn’t assume it is a run rate just yet.

Operator

Our next question comes from the line of Bob Farnam with KBW.

Bob Farnam - KBW

A couple of questions. In terms of the Supreme Court's ruling on the Halliburton case, do you see any impact on your D&O book, like increased defense cost, things like that?

Mike Schell

This is Mike Schell. The answer is, yes. It seems to be pretty clear that there will be more defense cost incurred in the first couple of years of a case because there is more opportunity for upside if the positive aspects of the ruling result in more motions to dismiss. As that occurs of course, down the road four to five years, that could moderate severity but we will have to see if that happens or not over the next four to five years.

Bob Farnam - KBW

Is this changing your opinion on writing the book right now or changing premium rates or what not?

Mike Schell

No.

Bob Farnam - KBW

Not at this point at least, okay. And the new team in Ohio, what business are they writing?

Bill Burke

This is Bill Burke. They are writing both primary general liability and excess liability.

Chris Williams

Bob, you will recall that we started a new team with that in 2011. So this is an addition to the team that we already had in place in Chicago, so we are just building out the footprint a little bit.

Operator

(Operator Instructions) And at this time it appears that we have no further questions. I would like to turn the floor back over to Mr. Chris Williams for any additional or closing remarks.

Chris Williams

Thanks everyone for participating on today's call and we look forward to speaking to you again at the end of October. Everyone enjoy the balance of your summer. Thank you.

Operator

Thank you. This concludes today's conference call, you may now disconnect.

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