May 5, 2010
Operator
Good morning. My name is Tiffany, and I will be your conference operator today.
At this time, I would like to welcome everyone to the first quarter 2010 release conference 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. (Operator instructions) I would now like to turn the call over to John Molbeck, President and COO of HCC Insurance Holdings Incorporated.
Please go ahead sir.
John Molbeck
Welcome everyone to HCC’s first quarter conference call. Joining me today is Tobin Whamond, our CFO; Pam Penny, our Chief Accounting Officer, Mike Schell, our Chief Underwriting Officer and Randy Rinicella, our General Counsel.
HCC’s performance for the first quarter continued to demonstrate our commitment to underwriting performance while at the same time limiting our exposure to catastrophic events despite the continued competitive market and low interest rates. We are very pleased with our GAAP combined ratio of 90.3% including catastrophes and 86.3% excluding the catastrophe.
Our accident year combined ratio remained excellent at 89.3% including catastrophes and 85.3% excluding the catastrophes. Our expense ratio remains low at 26.2% for the quarter, down slightly from the 26.6% for the fourth quarter of last year.
We continue to moderately grow our premium base compared to the first quarter of 2009 despite the competitiveness of the market. Our combined ratio demonstrated this premium growth has not been at the sacrifice of maintaining our underwriting discipline.
Our renewal percentage on our business that renews annually was 83%, which is the highest percentage in the last five quarters. The premium growth has been driven by new teams in our public risk and property treaty lines of business, which is more than offset the loss of business resulted from the sale of our motor business and the non-renewal of our colony quote share treaty in 2008.
We continue to pay claims on these facilities which are in runoff, which has slightly impacted our pay loss ratio for the quarter. Tobin will now review with you our financial highlights for the quarter.
Tobin Whamond
Gross written premium of HCC’s insurance companies increased 3% over the first quarter of 2009 to $622 million for the first quarter of 2010, net earned premium of $510 million was up slightly compared to the same period in 2009. John commented on the drivers behind the topline.
Revenue for the first quarter of 2010 totaling $594 million was down slightly compared to the first quarter of 2009. Our fee and commission income decreased $9 million, mainly due to the sale in 2009 of the operations of CUL and the sale of RML.
Our other operating income also decreased $13 million. The first quarter of 2010 includes an $8 million gain from committing a mortgage derivative contract.
The prior year quarter included $20 million from commuting the magic reinsurance contract. Offsetting these lower revenue items with a 9% increase in net investment income, more on that in a moment.
We had $5 million of adverse prior-year reserve development in the first quarter of 2010, primarily to HMO coverage in the group life, accident and health business that we acquired from Allianz at the end of 2006. This business takes a longer time for losses to develop.
We made corrective actions in 2009 and believe the business will be profitable in 2010. This amount compared to $4.7 million adverse development for the same period in 2009.
Our operating cash flow was $42 million in the first quarter of 2010, compared to $134 million in the same period of 2009, due principally to a $36 million increase in paid losses in the credit, D&O and group life, accident and health lines, a $35 million change in the timing of premium payments to reinsurers, and $12 million lower net earnings in the first quarter of 2010 compared to the first quarter of 2009. We estimate our cash flow will be approximately $100 per quarter for the remainder of the year based on a paid loss ratio, which could range from 55% to 60% for any given quarter.
For subprime related claims for this quarter, we had one full-side D&O, one E&O and no additional side A only claims. As we have said before, based on our current knowledge, we believe that we have adequately provided for the ultimate losses that will be incurred on this business.
In the first quarter of 2010, net investment increased to $49 million, compared to $45 million for the same period in 2009, driven primarily by an increase in the size of our long-term fixed income investment portfolio. Duration of our fixed income portfolio increased slightly from 4.8 years for the first quarter of 2009 to five years for the first quarter of 2010.
With our overall duration at 4.5 years compared to 4.2 years in the comparable period of 2009. The quality of the portfolio remained at AA plus, and had an average tax equivalent yield of 5%.
We recognized no OTTI in the first quarter of 2010. From a balance sheet perspective, our debt-to-capital ratio declined to 8.8% at March 31st, 2010 compared to 9% at December 31st, 2009.
Shareholders’ equity increased to $3.1 billion, total assets grew to $8.9 billion, and HCC’s book value per share increased to $26.91 per share compared to $26.58 at December 31st, 2009. With that, I will now turn it back over to John.
John Molbeck
Thanks Tobin. I neglected to mention that Cory Moulton, our EVP of Property and Casualty is joining us.
He is connected with us by phone from our New York office. A few further comments.
There are some confusion about the magic and the abbey commutation and I just want to point out that the gains from the commutation of the mortgage derivative contract is part of our normal operations. It’s booked other operating income, because it was accounted for as a derivative contract.
This is similar to last year’s MGIC contract which was booked similarly, but it was booked under deposit accounting. Additionally, we have had had several questions, many questions about our participation in the deepwater Horizon loss or some people refer to as a Transocean loss, I am not sure that Transocean refers to it that way.
We estimate the Transocean insured loss is at least $800 million, $560 million of that is going to be paid within a few days. The insured loss could be substantially greater than that once the cause of loss is determined.
If you followed in the press, the number of parties have been mentioned, Halliburton, who cemented the well, Cameron who had the blow-out preventer, BP the operator, and Transocean, who owned the rig. The event, the cause of the loss probably won’t be determined for some time.
However, the insured loss can be substantially greater than the $800 million depending on how is ultimately responsible. This event should improve – should result in improved terms in the energy market at least on the short term, as well as the excess liability market.
Excess liability premiums for a $100 million over a $500 million might have been going for $15,000 a $1 million as underweighted and truly appreciate the exposure that you might have for the potential seepage claim which they are recognizing now. Drilling contractors, service companies, manufacturers of related equipment, operators and their partners will all consider buying additional limits as they recognize the magnitude for the potential loss and the impact that such a loss could have on their balance sheet or their ability to continue to operate.
On the other hand, liability underwriters have now recognized the significant pollution exposure and their quote to reflect this recognition. Additionally, insurance in the energy industry may well buy more limits as they recognize that the limits they currently have purchased are not adequate for the potential exposure offshore.
And this offshore concern may not just be Gulf of Mexico, but it could be worldwide. We also understand that a number of underwriters in the market now buying additional excess of loss protection in advance of the pending windstorm season, as the Transocean loss and/or the first catastrophes may have left them on the inadequate protection for the remainder of the year.
All these are signs that could indicate some positive directions to the pricing and insurance markets. As for pricing with respect to HCC, we continue to generate price increasing in our international aviation, credit, marine hull, and London A&H business.
Medical stop-loss is about even with trend, property, energy, and US surety is flat. The average decline on the remainder of the business is slightly less than 5%.
Competition stems primarily from the traditional surplus line carriers in the Bermuda market, both of whom had seen their premium income dropped significantly over the past three years. And you were trained to enter into new lines of business to bolster premium writings with what we believe will be a predictable and unprofitable result.
Bill Foley the Chairman of title insurer Fidelity National when discussing competitors recently stated that the industry is always only as strong as its dumbest competitors. An interesting observation.
In closing, the economy appears to be improving which should result in increased demand for insurance products, but the market remains difficult, it may remain difficult for sometime. HCC’s morale is excellent.
And rather than predicting when the market will change, our focus remains on underwriting for profit. With those comments, operator, I would like to turn the call over for questions.
Operator
(Operator Instructions). Your first question is from the line of Beth Malone with Wunderlich Securities.
Beth Malone
Okay, thank you. Good morning.
I have a couple of questions. On the Transocean and that energy, is there any movement like from a regulatory standpoint that’s going to require these rig owners or the energy market to get more insurance coverage as a result of this?
John Molbeck
There is certainly some bills being considered immediately in Congress right now. The indirect implications of which we believe will generating to the purchase of increase covered by the people that are operating offshore.
I don’t know of any specifics as of this moment and time.
Beth Malone
Okay. And then do you – with the catastrophes in the first quarter, and as well as Transocean, you mentioned there might be more demand for cover.
How much more claims would the industry have to endure in order to see some real price improvement do you think?
John Molbeck
I was not good at estimating, I probably have different job even. I think the market is somewhat fragile right now.
And so I don’t think it’s going to take much but another major catastrophe could generate some additional movement in pricing, but I think we are not there yet.
Beth Malone
Okay, and then just two more questions. On the net written premiums, the property treaty business, you showed $35 million on the London market.
What’s that related?
John Molbeck
It’s the – we are writing a book of property treaty business in the London and it’s directly related to – we are protecting people on an excess of loss basis for catastrophes such as Chilean loss. That would be an example.
Beth Malone
Is that a new coverage then?
John Molbeck
We started writing that in the fourth quarter of 2009 but really didn’t start writing it in any significant until the first quarter of 2010. There was a team of people that we acquired in the second half of last year that we have been trying to acquire for three years.
Beth Malone
And so on your loss ratio for that same line was 177, I assume that’s the earthquake cost.
John Molbeck
That’s correct.
Beth Malone
So this was a new line you wrote and did that make you exposed to the earthquake in Chile or would you have already had exposure through other writings?
John Molbeck
As a combination of both we had energy loss, we had a property loss, we probably had a very small marine (call) loss that we have had regardless of whether we were in the property treaty business. And then we picked up a loss through the property treaty accounts level.
Beth Malone
Okay. And then finally, on Goldman Sachs current – the investigation that is going on there.
How do you see that affecting the financial D&O market or your exposures there?
John Molbeck
Well, from my recollection, Goldman Sachs buys A side only coverage. I don’t think anybody believes regardless of what’s going to happen at Goldman Sachs but they are going to be bankrupt as a result of the process.
Beth Malone
Okay. And any concerns that this might spread to other companies that might have exposure or you might have exposure to?
John Molbeck
Well, I would think that and I don’t know anything about what I am saying but I would think Goldman Sachs is not the only person that if everybody looked at every single thing they did in subpriming credit, they might find a transaction that somebody will find unusual. Having said that, most of the financial institutions buy A side only and I suspect the cost are going to be incurred are probably going to be the cost of defending themselves to legal actions and will not be picked up by A side only coverage.
Beth Malone
Okay, then I do have one last question. The stuff that is going on in Europe, Greece, and that; with your international exposure, are you concerned about what’s going on over there in terms of your own exposure to potential loss?
John Molbeck
We are always concerned about everything but there is nothing that’s going on with Greece or Spain or Portugal that has any direct implication that we didn’t already appreciate and the fact that we had subpriming credit issues in Europe beginning in 2007. So I just think it’s a continued contagion from what had already started.
Operator
Your next question is from the line of Michael Nannizzi with Oppenheimer & Co.
Michael Nannizzi
Just to follow up on the Greece comment. In terms of your portfolio, Tobin, could you comment – do you have any sovereign bonds in Greece, Portugal or any of the European nations there?
Tobin Whamond
Mike, good morning. In Greece, the answer is no.
In some other sovereigns we have a de minimis Spanish exposure but not a fair exposure in any those types of countries.
Michael Nannizzi
And then just wanted to talk a little bit about the D&O market. Your premiums were down a little bit year- over-year.
Is that the result of maybe you moving higher in a tower or other people coming in, rates declining more than you are comfortable with? Can you kind of talk about the dynamics in that line of business, please?
Mike Schell
This is Mike Schell. The first quarter’s light premium for large D&O accounts activity to begin with, so it’s hard to draw any conclusions from what happens or doesn’t happen in the first quarter.
On our specific book, we actually had a very strong renewal percentage of premium for the quarter. But there were limited new business opportunities, that at least, the way we saw things.
And we wrote quite a bit less in business in the first quarter of 2010 than the first quarter of 2009. Also on the business that we write, we typically generate about $5 million to $10 million a quarter on what’s called endorsement premium where it’s extended reporting provisions that are exercised or other kinds of activity related to changed in an insureds operation and we actually had a light endorsement premium quarter.
That again is difficult to draw any conclusions with because there is so much variability from quarter to quarter. Answering your question about any kind of change in the market, like I said it’s hard to draw a conclusion from first quarter activity each year but if there was anything, we would say that the market was a little tougher for non-financial institution commercial business.
When you read all the reports that come outside of the various institutions that track security suits, you will see that there has been a trend for a couple of years that even with the securities activity in the credit related suits against financial institutions, there has been a trend for several years that securities actions on nonfinancial institution commercial accounts have been below average and I think that’s reflected in how the renewals and account activity is tougher for that. So that’s what I would say.
Michael Nannizzi
Thank you so much Mike. And then on the financial side, John, you had mentioned this side A profile of most financial institution policies and the concept of legal fees.
Do insurers not pay those fees in suits like this if the company is still going concern or how does that dynamic exactly work?
John Molbeck
It only indemnifies the directors when the directors are not able to pay for the company is not able to pay for some reason. The only aberration to that is potentially in a derivative lawsuit and there’s been a couple of famous ones but the ones that come to mind were derivative lawsuits because the founder of the company or some significant shareholder in the company who is also an officer was significantly enriched by whatever the transaction was, and therefore the company did not indemnify him and therefore the side A coverage did indemnify him.
But those are very, very unusual things and I haven’t seen any allegations of that type on Goldman Sachs or any of those related accounts.
Michael Nannizzi
Great and then just one last one if I could. It looks like you took a – or actually, I’m sorry, the Polish plane crash, I know that you didn’t disclose any exposure there.
Is that the type of business you write a government movement or personal movement? And do you think that what happened there will change the market or rate in that business?
John Molbeck
As we’ve been saying for, going on two years now that we’ve been getting increased rates on the international aviation book of business and last year we were in the mid 20s. This year in the first quarter I think our increase on a year-on-year basis was around 6%.
So what we had is a compound rating in terms of 26 on top of 6 if you’re looking at just kind of a ballpark number. And so the international aviation market continues to be attractive.
We would write that type of account, we did not write that particular account.
Operator
(Operator Instructions) Your next question is from the line of Mark Dwelle with RBC Capital Markets.
Mark Dwelle
Yes, good morning, a few questions. First, following up on that last D&O question, if I’m hearing your response correctly and it sounds like there were some modest decline in endorsement premium and then some modest decline in rates on the balance of the renewal book.
Is that a fair overall assessment?
John Molbeck
I think that’s a fair assessment yes. I would also say as Mike said, the first quarter is our smallest quarter for premium during the year.
So I wouldn’t read a whole bunch into the first quarter but what you said is accurate.
Mark Dwelle
The second question I had was related to the property treaty book. Obviously you had a substantial amount of premium in the first quarter.
I would presume that by the nature of that business that that’s going to be somewhat frontloaded across the year, which is to say probably first and second quarter will be relatively stronger than third and fourth, is that a fair outlook?
John Molbeck
It’s probably first and third quarter and will probably write ballpark between $70 million and $80 million in that class; half of it is going to be January 1, probably 35% will be July 1, the rest will be spread throughout the year. It’s not a US focused book, it’s truly an international property treaty book.
Mark Dwelle
Okay, that’s very helpful thank you.
John Molbeck
(Inaudible) US, but it’s not a US book.
Mark Dwelle
Okay. And then in the group life accident and health, there didn’t seem to be any real – anything unusual in the medical stop loss but the other two lines of business experienced a fairly steep decline.
So I was just wondering if you could describe what was happening there, if it was just timing or something rather unusual.
John Molbeck
We bought the remainder of that book from Allianz in 2006. The provider excess, the HMO excess and the medical excess, those lines of business have longer tails in medical stop loss.
The tail in medical stop loss is about 24 months but it takes a little longer to get a handle on those other lines which we call risk management. We decided in the second half of 2009 excess to provider excess business.
So that premium is gone from the book of business. And we completely re-underwrote the HMO and medical excess and therefore you’ll see a reduction in premium.
So that was a planned reduction.
Operator
Your next question is from the line of Amit Kumar with Macquarie.
Amit Kumar
Thanks. Maybe just going back to that HMO book, what sort of gives you comfort that business would be profitable in 2011 in terms of specific actions which you have taken?
John Molbeck
Well, we did a couple of things. One, we non-renewed a number of accounts, which we thought we were problematic and we got significant increases.
I don’t remember exactly, Craig is not here today; he’s with some clients. But I think our average increase is over 30% on the book of business that we did keep.
So we did two actions. We non-renewed business that we didn’t think we could ultimately make a profit and we had premium increases on the remainder of the books.
Amit Kumar
Okay, that’s helpful. Then maybe just very quickly going back to the D&O issue, if I’m understanding this correctly, would it be fair to say that your claim count Q2 to date isn’t much different from what you reported at Q1 end?
John Molbeck
It’s two claims different and it’s not that materially different than we almost if you looked at it a year ago. It’s probably 10% more claims that have been reported in the last year, maybe slightly more.
Amit Kumar
And that was in the second quarter to date?
John Molbeck
No, if we took year end of 2008 and compared it to now, it’s not – how many claims we had Mike?
Mike Schell
03/31/2009, we had 62 claims, now we have 77. So it’s about 20% more.
But each of the last two quarters we’ve only had two new claims reported in each of the last two quarters.
Operator
You have a follow-up question from the line of Beth Malone.
Beth Malone
I just wanted to ask a little bit more on the energy market and the consequences of the rig accident. In the past, you’ve been pretty opportunistic about going into the energy market when pricing is more than adequate.
Is that a strategy that you’ll probably employ here as well, are you exploring the opportunities to write more business in that market now?
John Molbeck
We’re definitely doing that. I think the weather the losses actually ultimately are being paid, in other words, the people who actually end up paying these losses are going to surprise some of the managements of both Lloyd’s Syndicate and insurance companies and they may to a certain degree lose their appetite for writing some of this business.
On the other hand we will continue to be opportunistic. I think what we’ve done, we’ve told the shareholders we were going to do.
We were relatively a significant player writing about 3.5% line on the Transocean package and we wrote a line in one of these partners on that and we substantially reinsured ourselves out because we were concerned about the potential for pollution and liability in the Gulf of Mexico. So we were opportunistic at that point in time, still was able to provide the broker service.
We still did retain some of the business and we reinsured ourselves out but very effectively. I think there’ll continue to be opportunities.
If you look at the total – we can’t imagine a situation where our gross loss would be more than in the $35 million to $40 million range with a minimal net loss to the company. So we’re pretty pleased with our London team’s performance with respect to this terrible loss.
Operator
There are no further questions at this time. I would now like to turn the call back over the presenters for any closing remarks.
John Molbeck
Well, thank you everybody, thank you for joining us on the call and we look forward to presenting the second quarter numbers in about three months. Have a great day, thanks.
Operator
This concludes today’s conference call. You may now disconnect.