May 1, 2013
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 would 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 recordings, 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 expressed 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 standing by and welcome to the first quarter, 2013 earnings 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.
I would now like to turn the conference over to Mr. Chris Williams, Chief Executive Officer.
Sir, you may begin your conference.
Chris Williams
Thank you Christy. Good morning everyone and welcome to HCC’s 2013 first quarter earnings call.
Before getting started we wanted to pass on our sympathy to all of those that have been affected by the most recent tragedies, both here in the U.S. and abroad.
We are sadly reminded everyday of the perils that are out there caused by both man and Mother Nature. To our friends in Boston and those affected by the events in West Texas and those impacted by the recent Chinese earthquake and the events in Bangladesh, know that you’re in our thoughts and prayers.
Joining me today is Bill Burke, our President; Brad Irick, our CFO, Mike Schell, our Executive Vice President and Craig Kelbel, President and CEO of HCC Life. Brad will follow my initial remarks with his financial highlights and Bill will comment on our business segments.
Craig will summarize our excellent medical stop loss results, as well as provide some commentary about that Accident & Health market in general. First a few highlights for the quarter.
We had another record quarter with earnings per share of $1.05 and net earnings of $106 million. Annualized return on equity was 11.
9% and gross written premium increased 5% to $720 million. With a net loss ratio of 59.3 and the expense ratio of 24.5, we continue to lead our peers with a GAAP combined ratio of 83.8.
Now paid loss ratio was also very favorable at 53.4. Brad will now review with you our financial results.
Brad Irick
Thanks Chris. Net investment income in the quarter was $56 million, a decrease from the prior year of 2% and in line with the fourth quarter 2012.
Key investment metrics include a long-term tax equivalent yield of 4.6%, a book yield of 3.7%, a portfolio duration of 4.9 years and an average rating of AA. Lower investment yields are a result of reinvestment of portfolio cash flows into the prevailing low interest rate environment.
We expect yields near current levels for the remainder of the year, assuming market rates are stable or improve. Duration increased to 4.9 years, reflecting continued investment in medium term municipals and interest rate increases during the quarter.
These rate increases also drove the decrease in unrealized gains of $39 million, which was net of appreciation in our equity portfolio of $20 million. We recorded net losses of $5 million relates to various small cats during the quarter within the international segment.
We made no adjustments to prior year reserves during the quarter. Operating cash flow for the quarter was $69 million, which excludes $67 million of surety collateral outflows.
Operating cash flow is less than the prior year, primarily due to timing related to various receivables and payables. Surety collateral cash flows on average add approximately $5 million each year to our pretax income from the spread we earned on these funds.
Liquidity remained strong with $271 million of available capacity under our revolving credit facility and $343 million of short-term investments in cash. I’m also pleased to report that we recently renewed the credit facility, extending the term two years to April 2017 and improving the pricing.
Our banking partners remain very supportive of HCC, given our consistent performance and strong balance sheet. Finally, we continued our share purchase program and purchased 700,000 shares of our common stock for $29 million, at an average cost of $39.18.
We still consider the current market price to be below the intrinsic value of our stock and continue to be opportunistic buyers. Bill.
Bill Burke
Thanks Brad. As Chris and Brad noted, we had strong results in the first quarter 2013.
All of our segments provided meaningful underwriting profits with margins ranging from 12% to over 22%. We are continuing to see rate increases in all of our segments and we achieved an average rate increase for those lines of business where the measurement is meaningful of just under 3% in the quarter.
The retention rate across all segments was 85%, which compares to 84% for the first-quarter of 2012. Looking at specific segments; in the professional liability segment the overall pricing environment for U.S.
D&O continued to be positive. In international D&O, pricing on financial institution business remains firm.
For the overall segment, we had rate increases in the mid single digits and a 3% increase in gross written premium, despite a 21% reduction year-on-year on the DFP portion of our U.S. D&O business.
Net earned premium declined 9% from the prior year, driven again by the DFP book, and our loss ratio for the segment for the first quarter improved from 68.2% in 2012 to roughly 61% in 2013. In our U.S.
surety and credit segment, our surety business maintained a good margin by achieving a loss ratio of 25%. Credit had a significant increase in net earned premium and a satisfactory loss ratio of 37.4%.
Our USP and C-segment had net earned premium growth of 5% for the quarter and the loss ratio was roughly flat with 2012 at just under 56%. If we look at the individual components of the segment, aviation continues to be a competitive market, particularly in the international arena.
We are pleased with the 61.7% loss ratio we achieved with the first quarter, which was better than our expectation. In public risk we had an 8% increase in net earned premium versus prior year.
The loss ratio improved from 93% for the first quarter of 2012, to 78.2% in 2013 and last year’s first quarter was adversely impacted by Midwest storm losses. In the component of the U.S.
P&C segment marked other, we achieved a 26% increase in net earned premium for the first quarter of 2013 versus prior year. This category has over 15 lines of business.
The net earned premium growth was driven by our Sports and Entertainment Disability business, along with three new lines of business we started in 2011, primary casualty, excess casualty and technical property. The international segment had 15% growth in net earned premium over the prior-year, while achieving a very favorable 43.7% loss ratio.
The premium growth was driven by energy and property. We are a leader in energy and with strong industry growth we are able to increase premiums in 2012 and in the first quarter of 2013.
Property treaty net earned premium increased from the prior year due to rate increases on business written in 2012, principally related to Japanese renewals. Craig.
Craig Kelbel
Thanks Bill. Overall the A&H segments gross written premium for the first quarter of 2013 increased by $10 million or 5% as compared to the first quarter of 2012.
Specific to the medical stop loss product, which represents over 94% of the segment’s total gross written premium, the following are key results for the first quarter. The effective rate increase, which is a measurement of deductible and coverage changes was 17% in the first quarter, as compared to an actual trend needed on that business to keep pace with medical inflation of 16.9%.
This will suggest that the loss ratio for our renewing medical stop loss business should continue to perform this year at similar levels to past years. Having completed our largest premium quarter of the year, the A&H segments combined ratio and pretax earnings are performing as planned.
For the first quarter of 2013, the average employee lives per group was 642, as compared to last year first quarter of 604 and full year of 431. We continue to see a trend of writing larger employer groups.
The market remains competitive, but stable. Most of our competition continues to come from direct writers with no noticeable change in 2013 as compared to 2012.
On the business written in the first quarter, approximately 80% of the gross written premium comes from our in-force business, which had a premium persistency of 83%. Premium persistency is renewal premium of HCC’s in-force accounts, plus rate increases on those accounts.
The remaining premium comes from new business, which is consistent with prior year results. Currently there is considerable debate in a number of states regarding the small group market, meaning 50 lives and less and how self-insurance may impact the federal or state exchanges.
It’s important to understand in the first quarter of 2013, HCC’s number of covered employee lives for the medical stop loss attributed groups of 50 lives or less is less than 1% of the total covered employee lives. Regardless how one views this debate, it does not have a meaningful effect on our medical stop loss business.
Chris.
Chris Williams
Thanks Craig. As you’ve heard from Brad, Bill and Craig, we’ve continued to build on the momentum we had in 2012, with a very strong start to 2013.
This is the fourth consecutive quarter, where we’ve produced record earnings per share for the quarter. Our book of mainly non-correlated businesses continues to perform at a very acceptable level.
Each of our segments produced strong increased earnings this quarter compared to the first quarter of 2012, with overall net earned premium growth of 3%. We were the beneficiaries of continued disciplined underwriting and expense management, as well as benign first quarter catastrophes.
Putting this quarter’s results in perspective versus our guidance, you will recall that we include a catastrophe estimate in our loss ratio of 2.7% and do not include any provision for reserve development, OTTI credit losses, currency fluctuation or investment gains or losses. These record results are well positioned for the balance of the year.
If we gather our capital management, we still see considerable deal flow of M&A opportunities. For various reasons it has not been attractive to us.
As Brad mentioned, we remain opportunistic buyers of our stock, as well as considering potential new teams to add to our excellent portfolio of businesses. With our superior ratings and consistent low combined ratio, the dialogue between potential new teams continues to increase.
With that Christie, we’d like to open up the call to questions.
Operator
(Operator Instructions). Your first question comes from the line of Michael Nannizzi with Goldman Sachs.
Michael Nannizzi
Thank you. I had a couple of questions if I could.
On the expense line, it looked like other operating expenses ticked down in the quarter when compared to last year. Is there anything in there that was one time or can we get a little bit more color on that trend?
Thanks.
Brad Irick
Mike hi. This is Brad Irick.
Michael Nannizzi
Hey Brad.
Brad Irick
A couple of things; when you look at operating expenses on the income statement you’ll notice that that does include FX which had a again in it. So again, depending on how you’re looking at operating expenses and expense ratio that would have an impact and then largely the rest you would say is really business mix and we’re happy with the expense ratio and how it’s performed.
We can expect to be in the mid-20’s, continuing on through the year.
Michael Nannizzi
Great, thank you. Yes, that makes sense, okay.
And then Brad maybe if I could ask you too about investment income. I mean obviously you have a long duration portfolio that helped keep investment income really through a period of declines we’re seeing in lots of places, but obviously there’s another side to that equation in terms of building interest rate sensitivity as the portfolio rolls off down the road.
How should we think about investment income in the near term?
Brad Irick
I think we’ll continue to look for opportunities to get rate, but the reality is that the portfolio will roll off as the year goes on and the reinvestment is going to be lower and where that’s going to be is going to depend on where rates end up. Going this year and next year, we expect its going to be a continued low rate environment.
That’s one of the reasons why we decided to keep the portfolio a bit longer. I think that served us very well.
When we did our investor conference in the summer last year, we did a sensitivity around this, which still I think is a relevant data point to share, that with the strong cash flow the company puts out each year, that you’d expect that over time you’re going to have a natural roll off of the portfolio, a reinvestment at current yields as time goes on and I think so basically we’re very comfortable with where we are from a duration perspective. It picked up a little bit this period and a lot of that’s rate and also there is good value in mid-term municipals and that’s really what drove it.
Michael Nannizzi
Okay, and you expect to continue to keep the duration on the long side, I mean as opposed to reinvesting shorter. Is that kind of…
Brad Irick
Well, in the last year we did a couple of things. We invested in bank loans, about $150 million in bank loans, which is kind of a zero duration type product.
We also have a little over $300 million in equities where there is no duration. So that’s been some areas where we found good yield, but also didn’t add to duration.
So we are not trying to add to duration, but we are also not trying to pull back significantly.
Michael Nannizzi
Really helpful, thank you soo much. And then in professional liability, could you talk a bit about rate versus loss trend in that.
I mean, I appreciate Chris’s comments upfront about and (inaudible) Bill’s upfront about what you are seeing in terms of the U.S. and internationally, but maybe a little more on what drove the 9.0 year-over-year loss ratio improvement contributors of rate, mix shift, the DFP book and maybe new business?
Mike Schell
Mike, this is Mike Schell and I’ll start on what drove the loss ratio improvement. And it was actually seven points from 68 or so to 61 or so.
The DFP that you talked about has a higher loss ratio than any other part of the professional liability segment book. The net earned premium on diversified financial products the DFP book is 28% less than it was a year ago.
So the mix caused a better loss ratio from having less DFP business at a higher loss ratio. Besides that it was compounded a bit, because the loss ratio in DFP is improving.
We had a better loss ratio on DFP in the first quarter of 2013 than we did in 2012. So those two factors that resulted in a 61% loss ratio or so versus the 68% loss ratio or so.
On loss trends, the loss trends are then fairly normalized in the minority part of the book that we write on professional liability, with the minority parts being large account E&O and fiduciary and some flattening I guess I’d call it from an accelerating trend on EPLI. EPLI is the least significant portion of the minority portion of our business and when you look at the rate increases that we have, Bill talked about mid digit rate increases on U.S.
D&O, the strongest area of rate increases in the business has been the employment practices liability, EPLI, because its been the most unprofitable. So there’s other companies that have reported higher rate increases that we have and it has to do with them having a different book of business with substantially more EPLI to the secondary degree, probably E&O.
On that D&O and loss cost trends, D&O is a great business. It’s a punishing, unforgiving business, but it’s a great business and one of the reasons is that nobody knows – this is just my personal opinion, any one here who was at a loss cost trend is going to be plus-20 or minus-20, and you underwrite with thought and reason and skill, knowing that anyone here depending on stock market developments, investigation developments and the like that there is a wide range in the loss cost trend.
All we can say on the D&O loss cost trend from a positive standpoint is that we’ve got a strong stock market and we have fewer securities cases that keep being filed year-after-year and the types of security cases that are filed are relatively less severity being the M&A and other similar, and a lot of that’s due to having a good stock market.
Chris Williams
Mike, does that give you everything you need?
Michael Nannizzi
No, it’s very, very, helpful. I have a couple more.
I’ll re-queue. I just don’t want to take up too much space.
Thank you.
Chris Williams
Okay.
Operator
Your next question comes from the line of Ryan Byrnes with Langen McAlenney
Ryan Byrnes
Hi, good morning everybody.
Chris Williams
Good morning Ryan.
Ryan Byrnes
Just wanted to dig in a little further on the A&H segment. You guys gave some nice color there, but there’s one other, I guess large competitor last week who came out and said that I guess there was a little more competition at the market at 1/1 and that kind of pushed pricing down, but I just want to see how that jives with what you guys are saying, that 17%.
And I guess they did also mention that they did see an increase in frequency of time in the first quarter. I just wanted to see how you guys view that.
Chris Williams
Craig?
Craig Kelbel
Yes, I would say that we are happy with our development of our 12 business and 13. We were happy with our 1/1-renewal season.
As you can see from our previous numbers we kept up with inflation. So we are right on plan, right on queue from what we expected our loss ratio and our trend to be.
Ryan Byrnes
Okay, and then just my last question. Obviously the overall, I guess net reserve releases were zero for the quarter.
Just wanted to see, were there any, I guess meaningful moving parts. Did something offset the other or is it basically kind of flat all-around?
Brad Irick
Yes Ryan, this is Brad. There were no adjustments to prior year reserves across any of the segments or even within the lines of business, and our practice would be to let you know if there was something significant like that, but no, there are no changes across those segments.
Ryan Byrnes
Great. Thanks for the answers guys.
Chris Williams
Thanks Ryan.
Operator
Your next question comes from the line of Ray Iardella with Macquarie Research.
Chris Maimone
Hi, good morning. This is Chris Maimone calling for Ray.
Thanks for taking the question. A few of my questions have been answered already, but I hoping that maybe you guys could just touch a little bit more – into more detail on the expense ratio.
I know that you mentioned there was a change in business mix, as well as some FX that impacted the expense ratio this quarter. I was wondering if you could maybe just provide any more detail on which businesses perhaps are making the expense ratio lower year-over-year.
Chris Williams
Chris, you’ve actually summarized it very well. It simply was FX and different business mixes.
Some of that businesses carry higher expense loads than others and it’s simply the mixes as to how it played out this quarter.
Chris Maimone
All right, that’s fine. And then I guess in addition to that, I was wondering if you could touch on the loss ratio and public entity.
I just noticed that it improved significantly from 2012 to first quarter. I’m just wondering if there was anything specific you could mention there that was driving that improvement.
Bill Burke
Sure, this is Bill Burke. In the 2012 first quarter there was storms in the Midwest and we had losses in our public entity book coming out of that and in the first quarter of ‘13 we were cat loss free in our public entity book.
Chris Maimone
I got it fine. That’s great, thank you.
And then lastly, if you could, I was just wondering if there was any update on the Spanish surety bond reserves and how big that is currently and if there’s any exposure to any other countries in the surety book.
Brad Irick
I’m sorry, this is Brad Irick. No updates with regard to that.
I think we reported in the fourth quarter that was a specific class of Spanish surety bonds. No adjustments to those reserves since then and really nothing to report different on that.
We do have exposures to various other countries in the surety book, primarily the U.K. and the U.S.
but nothing to report further.
Chris Maimone
Okay and is it possible to give maybe just like a rough percentage of what the allocation or the exposure to Europe as a whole is, if you can’t do it by country within that?
Chris Williams
I don’t think we have that information handy, Chris. We can certainly do some homework for you on that.
But as Brad said, this is the book of business that we write out of the U.K. and out of Spain, so we haven’t historically disclosed that information, but let’s have a look at that?
Bill Burke
The only other comment I would add to that is we reported on our international segments with our premium writings there, but an awful lot of our premium writings coming out of our international segment are written back here for exposures back here in the U.S. and/or exposures elsewhere around the globe.
So from a European perspective, we are relatively light.
Chris Maimone
Understood. Okay, thanks very much for your time.
Chris Williams
Thanks Chris.
Operator
Your next question comes from the line of Scott Heleniak with RBC Capital Markets.
Scott Heleniak
Hi, good morning. I was just wondering if you could touch on the – you had mentioned coming here, your full year gross of premium guidance had been 1% for the year, you guys grew 5% in the quarter.
So obviously you are on track to be beat that. Was there any particular areas where you saw more opportunity than you originally thought, I guess coming into the year?
Chris Williams
Scott, I think that was net premium estimate; we’ve given one, and you may recall that if you backed out the discontinued lines that we exited last year, which were principally the HMO business and the medical excess business that brought that projected growth back to 3%. So if you look at really where we performed this quarter, we are pretty much right on where we’d estimated, again when you back out those discontinued lines.
Scott Heleniak
Okay. On the DFP book, that was down again pretty significantly and I guess you guys have been tweaking that for a couple years now.
So do you think the rate of decline slows during the rest of the year compared to what you are seeing this year and last year and are you still getting significant price increase and good terms and conditions or are those changing significantly?
Chris Williams
Yes, Scott look, we continue to work our way through that book. I mean as you know, we’ve historically gone into rate increases, deductible increases, limit reductions, and we continue to do all of those things.
Andy Stone in which his business for us has done a wonderful job re-underwriting it. So it just continues as a work in motion.
Scott Heleniak
Okay. The only other question I had was the net to gross premium retention ratio was down in Q1 and it had been down a bit in ‘12 too.
I think you said last quarter no major changes in reinsurance treaties. So should we expect a similar number for the rest of the year, kind of 80% range, down somewhere in the line?
Chris Williams
As you know, in the first-quarter, excess of loss premiums are generally payable, but it will move around a little bit, but it should be relatively consistent with what you are seeing.
Scott Heleniak
All right. Thank you.
Operator
Your next question is a follow up from Michael Nannizzi with Goldman Sachs.
Michael Nannizzi
Thank you so much for taking the follow-up. Just a couple of numbers questions I guess if I could.
As far as the A&H business, I think you had mentioned that you kind of expected ‘13 to look kind of like ‘12, but in ‘12 we had a big tick down in the third quarter in the underlying loss ratio, which kind of brought the average down for the year or brought a year down a couple of points. Is there seasonality in that number or how should we think about that?
Chris Williams
Well Mike, it’s Chris. As you know we have a calendar of when we do the detailed reserve reviews of all of our segments.
The A&H 1 historically we’ve done in the fourth quarter. The reason we accelerated that last year was because of the discontinued lines that was more relative to do then, so...
I mean we look at all of the businesses every quarter and obviously if something jumped out at us, we’d adjust accordingly. But the deep dive for A&H would be in the fourth quarter.
So I think we’ll see how it plays out then. But as Craig mentioned, it is tracking consistently with where we were last year.
Michael Nannizzi
Got it, great. And so that implies that in the third quarter ‘12, the reserve review was reflected in the accident year?
Chris Williams
That is correct.
Michael Nannizzi
Okay, got it. And then is there any way that you might consider breaking out.
I realize other in P&C is a conglomeration of a lot of different individually small lines of business. Is there a way to break that out some more, because it’s actually the biggest sub-segment of U.S.
P&C and we just don’t have a lot of granularity there? I don’t know, if that’s possible you might consider that.
I’ll leave that as an open question. And then also on that A&H business, I mean now when we have this move to exit it, it still a little tough to look at the year-over-year, just given that we don’t have the reclassifications for 2Q and 3Q of ‘12, another just open question if you might consider providing that as well.
Chris Williams
Okay. First of all in regard to the P&C 1, obviously when we start these lines of business, new lines of business they felt relatively modest.
As they start to grow it may make more sense to be a little more transparent on that. So that’s actually something we’ve been bouncing around a little bit.
In regard to the A&H 1, I thought we’d actually restated that backing those out.
Brad Irick
What we are saying is that we’ll restate those as we file new quarters, so you won’t have the 2Q and 3Q. So Mike will you give you some thought to if there’s a way to get that information out there and I’d also say, in the 10-Q we do try, and the 10-K we do try if there’s something significant driving results in the other piece of US P&C or any other segments, you can try to provide some color around that.
So I think all in all we’ve given quite a bit of transparency across that segment, but I think that may be a source to find some additional color.
Michael Nannizzi
I appreciate that, thank you. And just one last one, sorry to be a pain, but do you have underwriting income by segment.
Just that it would help us or me at least to try and calibrate my model just until we have the Q.
Brad Irick
Not until you have the Q. Yes, we have the numbers obviously, but that’s going to be in Q.
You are just asking if that’s something we can provide easier in the press release?
Michael Nannizzi
Yes. I mean you provide a lot of information in the press release and as analysts we always want more I guess, but I’ll just leave that there.
Thank you so much.
Chris Williams
Thanks Mark.
Michael Nannizzi
Okay. Take care.
Operator
Your next question comes from the line of Brian Pirie with Sansome Partners.
Brian Pirie
Good morning Chris, good morning everyone.
Chris Williams
Good morning.
Brian Pirie
I have a question for Brad on the foreign currency benefit. Is that primarily driven by changes in the value of loss reserves that are denominated in foreign currencies?
Brad Irick
That’s correct and the thing I would point out, the U.S. dollars strengthened towards the end of the quarter.
That’s really reversed, but the offset of that is we match those liabilities with investment assets. Those investment assets, the FX goes through the OCI or equity.
So that’s the reason why we show that as a separate item outside of operating earnings. But you are right, that’s the primary driver.
Brian Pirie
Okay, but the $7 million after tax, that is not the net of the assets and liabilities?
Brad Irick
That is not.
Brian Pirie
That’s the liability note.
Brad Irick
Liabilities, there are other assets and other liabilities outside the reserves that relate to those businesses that go through the income statement and then the offset of that from the assets is an equity.
Brian Pirie
Okay. That’s what I thought.
Thanks very much.
Operator
(Operator Instructions). And there are no further questions at this time.
I hand the program back over to management for any further comments or closing remarks.
Chris Williams
Thank you, Christy. We had a great quarter.
We look forward to the next and you participating on our earnings call. Everyone have a great day and thank you very much.
Operator
Thank you. This does conclude today’s conference call.
You may now disconnect.