Apr 30, 2014
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 statements, 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 pleased on music hold until the conference begins. Thank you for your patience.
Ladies and gentlemen, thank you for standing by. And welcome to the First Quarter 2014 Earning 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
Good morning, everyone. And welcome to HCC's first quarter earnings call.
With me today is Bill Burke, our President; Brad Irick, our CFO; Mike Schell, Executive Vice President; and Craig Kelbel, President of HCC Life. I'm pleased to announce that after setting an earnings record in 2013, HCC has carried this trend into 2014 with continued excellent results this quarter.
We had net earnings of $108 million or a $1.07 per share, which compares to $106 million or a $1.05 in Q1 2013. Our combined ratio was 83.0% which compares favorably to 83.8% for the first quarter of 2013.
Notably both quarters results included no reserve development. Our accident year loss ratio was 57.2%, down substantially from 59.3% in the first quarter 2013.
A direct result of our focus on improving results in specific lines of business and discontinuing others over the past two years. We had minimal catastrophe losses of $5 million pre-tax or $0.03 per share in both the first quarter of 2014 and 2013.
Our gross written premium grew 4% compared to the first quarter 2013. We once again exceeded our operating ROE goal 10% above the risk-free rate with first quarter operating ROE of 10.8%.
During the quarter, we purchased $31 million of our stock at an average price of $42.66. Our paid loss ratio increased to 63% from 53% in first quarter 2013, principally due to the ongoing settlement of the Spanish Surety bond claims.
We continue to make good progress in settling these claims, which Brad will discuss in more detail. By any measurement it was an outstanding quarter for HCC.
Brad, Bill and Craig will walk through the details and points of interest for the quarter. Brad?
Brad Irick
Thanks, Chris. Net investment income in the quarter was $57 million, an increase of 2% from the prior year.
The increase resulted from growth in invested assets and good performance from our equity portfolio. We also realized gains of $20 million, primarily from sales of equities at the end of the first quarter.
This reduced our equity allocation to 6% at quarter end. There were no significant changes to our fixed income portfolio in the quarter, which maintained a tax equivalent book yield of 4.4% consistent with the fourth quarter of 2013.
With respect to reserves, we recorded net losses of $5 million related to various small cats within the international segment and we made no adjustments to prior year reserves during the quarter. Next, an update on the Spanish Surety matters, we continue to make progress in settling claims with gross payments of approximately $85 million in the first quarter.
Settlements to-date had generally been in line with our existing reserves. With respect to the remaining matters, settlement discussions are active and ongoing.
We remain focused on resolving the vast majority of these matters as soon as possible during 2014. Our current view is that this process will extend into the third quarter.
As expected, during 2014, we received substantial reinsurance recoveries related to the settlements, which largely offset the gross payments, I mentioned previously. We’ll update you further on our second quarter call.
Cash flow from operations of $95 million was strong and we believe we're well-positioned for another strong cash flow year even as we resolve Spanish Surety matters. With respect to liquidity, I'm pleased to announce that we've completed negotiations with our banking partners to amend our revolving loans facility.
The amendment which closes today increases the capacity to $825 million from $600 million and extends the maturity to 2019. The existing favorable pricing terms will not change.
This increase capacity provides us additional flexibility as we look to grow our businesses over the next several years. Operating expenses increased $19 million quarter-over-quarter, $15 million of this change relates to foreign currency movements in our non-U.S.
dollar reserves and 1 million relates to translation of non-U.S. dollar operating expenses.
Both are due to a much stronger pound sterling this quarter compared to the first quarter of 2013. As previously disclosed, we excluded FX movements related to loss reserves from our operating earnings each period, as they are largely offset by corresponding FX movements in our invested assets which are recorded in AOCI.
Before I turn it over to Bill to discuss the segment results, let me address some changes to our line of business presentation within our segments, as many of you have already noticed. The main change is in our U.S.
P&C segment, where we now report liability in sports and entertainment separately. Liability includes small account E&O, employment practices liability and our primary and excess casualty lines.
EPL and the casualty lines were previously included in the other. Sports and entertainment includes our disability and contingency lines, which were also previously included in other.
Another change relates to the international segment, where the marine line previously in other is now included with energy to form the marine and energy line of business. Finally, we no longer break out our U.S.
and international D&O line separately within the professional liability segment. We believe these changes provide additional transparency and clarity with respect to the performance of our businesses over time.
Comparative schedules by quarter for the past three years reflecting these changes will be available on our website later this week. Bill?
Bill Burke
Thanks, Brad. We had solid performance in the first quarter.
We are continuing to see rate increases in many lines of business across all of our segments. The good rate environment in the U.S.
is offset to an extent by the rate decreases we are seeing from our internationally based lines with rates decreasing in our property treaty business by 8%. On a worldwide basis, rates in our insurance lines of business increased in the low single digits.
The retention rate across all segments continued to be positive at 84%. Looking at specific segments.
In professional liability, we continue to achieve mid-single digit rate increases led by our U.S. business.
We also maintained a favorable 80% combined ratio in the first quarter led by a 60% loss ratio. Our U.S.
Surety & Credit segment maintained flat net earned premium despite competitive markets. Our combined ratio for this segment was also maintained at a favorable level of 84% for the first quarter.
Our U.S. P&C segment had a good start to 2014 with a 28% increase in earnings driven by higher net earned premium and an 8 point reduction in the loss ratio from 56% to 48%.
We achieved mid single digit rate increases for the segment with the rate increases occurring across many of the business lines. If we look at the individual components of this segment, aviation remains a very competitive market.
So the key for us is to continue to be disciplined in what we write and carefully manage our expenses. Our underwriting discipline is shown by our favorable 60% loss ratio, which is down slightly from 2013.
For the first quarter of 2014, we had over 10% premium growth in liability driven by our primary casualty line. We also had strong premium growth in the sports and entertainment lines achieving over 20% growth versus the first quarter of ‘13 led by our disability coverage.
In Public Risk, we continue to implement our re-underwriting strategy and see positive results as reflected in the reduced loss ratio. It should also be noted that we placed quota share reinsurance at the end of 2013, which reduces net written premium on a year-over-year basis.
The other category of U.S. P&C contains approximately 10 lines of business, including our technical and construction property businesses along with residual value and title.
The longer term policies in certain of these lines can create differences between the gross written and net earned premium as you see for this quarter. Turning to the international segment.
We were able to achieve 8% growth in our gross written premium across all of our major lines except property treaty where the impact of increased market capacity reduced the programs that we wanted to write. While property treaty is a valued line for us, it represents less than 5% of our gross written premium on an annual basis, we had strong earnings in this segment with a combined ratio of 79%.
Craig?
Craig Kelbel
Thanks Bill. The A&H segment had a strong performance in the first quarter of 2014 with gross written premium increasing 9% or $20 million.
The rest of my comments reflect key factors in the first quarter for our medical stop loss product, which represents over 90% of the segment's gross written premium. The number of employer groups we received to quote on in the first quarter of 2014 increased 12% as compared to 2013.
The average employee lives per group written was 650 for the first quarter of 2014, which is consistent with 2013. Average specific deductible written in the first quarter of 2014 was $125,000, an increase of 12% over the first quarter of 2013.
Lastly the effective rate increase, which is a measurement of deductible and coverage changes was 18.6% in the first quarter of 2014 as compared to an actual trend needed in that business to keep pace with medical inflation of 16.1%. The market remains competitive but stable.
Most of our competition continues to come from direct writers with no noticeable change in 2014 as compared to 2013. Of the business written in the first quarter of 2014, approximately 80% of the gross written premium comes from our in-force business, which is consistent with prior year results.
We are currently in discussion with a number of brokers and other entities to explore opportunities in the developing market for private exchanges. It is clear to us from these conversations that the flexibility in plan design and cost savings available to self funded plans will be an essential element of this market.
As leaders in this business, we are well positioned to participate in the development of the exchanges, which we believe will provide a new avenue for future growth. Chris?
Chris Williams
Thanks Craig. You heard from my colleagues that all of our different business segments are performing very well.
We believe the franchise value that we have in our various segments is a clear competitive advantage to HCC. As Craig outlined, our Accident & Health business continues to grow and produce very consistent results, which are a testament to the excellent team Craig has built over many years.
Our professional liability business while it's challenging continues to be managed extremely well in a competitive environment. Our U.S.
property and casualty business has seen some excellent growth, particularly in our sports and disability business while we are a market leader, and in our growing primary casualty business. We strive to maximize our shareholder return and we continue to remain opportunistic in our stock repurchases.
Finally, I've been increasingly asked about our views on M&A and the more recent high-profile attempted hostile transaction. First, we have the financial firepower to entertain acquisitions and we will continue to evaluate potential transactions that we believe will build upon our existing franchise.
However, we are of the current view that the disruption that will inevitably occur in other companies will result in opportunities to attract teams of underwriters, looking for a more stable highly rated environment. HCC is certainly open for business to speak to any of those teams.
In any event, the financial strength and profitability allows us to be patient and ready to act on opportunities as they arise. With that operator, we’d like to open up the call to questions.
Operator
Thank you. (Operator Instructions) And your first question comes from Ryan Byrnes of Langen.
Ryan Byrnes
Hi. Good morning, everybody.
I just wanted to get a little quick clarification on the Spanish surety. In the last quarter, you guys mentioned that the majority claims you're looking to getting them sell by the first half of this year.
I just wanted to make sure that I understood the change little bit or the change in telling there. I think you guys may have said in the third quarter now, I just want to make sure I understood that?
Brad Irick
Yeah, this is Brad. You heard it correctly.
First thing, I'd say is we’re, at this point I think a little ahead of where we thought we would be at this point. But as we look at the remaining settlements, we think it’s likely that that's going to continue into the third quarter.
So, I think in the last call, we said by the middle of the year. I think it’s still pretty close but it will probably still have a few things going into third quarter.
Ryan Byrnes
Okay. And then shifting up to the U.S.
PC book, I just wanted to make sure I also understood the new quota share. It looks like it's going through public risk and potentially other as well.
I just wanted to make sure that I understood just from modeling purposes how that worked?
Bill Burke
Sure. It's Bill Burke here.
The quota share that I mentioned had to do with the public risk business.
Ryan Byrnes
Okay. And just the rationale for that was -- were there some issues on that line or just trying to figure out what was happening there?
Chris Williams
Ryan, this is Chris. As you know that was a line of business where we put a lot of attention into the last couple of years.
We were encouraged with the direction that it's going. But we also had an opportunity to buy quota share at terms that we are pleased with.
So, I think it’s just a little bit of a hedge but we are encouraged with the direction it’s going.
Ryan Byrnes
Okay. And then to my last one here, I’ll let other guys hop on.
The Medical Stop Loss again, just wanted from a bigger picture, again as it seems like the defined contribution private exchanges are potentially gaining some popularity and you guys noted how you guys will try to use the medical stop loss product within that. Just wanted to talk about that overall, how you guys see that market developing and how your product and how Medical Stop Loss is used in that environment as well?
Craig Kelbel
This is Craig Kelbel. The private exchanges are still early in its development.
But clearly, in our discussions the self funded concept of a greater flexibility and clearly when you compare to a fully insured is at a much more efficient cost for the employer. We do think as time goes on and the private exchanges develop over the next 12 to 24 months, we think that there is great opportunity for us to grow as that business grows.
Ryan Byrnes
All right. Thanks for the answer, guys.
Craig Kelbel
Thanks.
Operator
(Operator Instructions) And your next question comes from Scott Heleniak of RBC Capital Markets.
Scott Heleniak
Thanks. Good morning.
Just wondering if you could talk about your loss ratio improvement, obviously very good and just wondering if there's anything just kind of generally that you could point to that you're seeing that kind of drove that at any discussion, or any comment on loss cost trends and why you are seeing the significant improvement there?
Chris Williams
I think -- Scott, this is Chris. A couple of comments.
One, if you look at the various segments, they were all performing at very acceptable levels. I think as I mentioned, we spoke about public risk earlier, there were some lines that over recent quarters where we've been putting greater attention into to get them pointed in the right direction.
I think we are having some success there. So, I think as a general comment, all of our segments are performing at where we would expect or hope them to be.
But we do have a diversified book of business and loss costs mean certainly different things to Craig Kelbel's business versus to some of our Property-Casualty business. But I think as a general comment, we are very pleased with where the portfolio is at the moment.
Scott Heleniak
Okay. And then was there a noticeable benefit from some of the lines that you exited over last two years?
What kind of a combined ratio business was that, that some of those lines you exited was there a pretty big impact there?
Chris Williams
I don’t think we’ve ever broken out what those numbers were. I mean, clearly, it is helping, if you look at the improvement in the loss ratio.
But just as a general comment, I think our portfolio is performing better and culling those lines of business certainly didn't hurt.
Scott Heleniak
Okay. In the Accident & Health segment, the other category, the premiums were up 61%.
Could you just talk about what that is composed off or just break that out a little bit, what's in there that driving that growth?
Craig Kelbel
This is Craig Kelbel. Most of that growth is on our short-term medical product, which we've seen increased sales in the first quarter due to, as you’ve read 4 million, 5 million people losing their coverage or having to cancel because the policies didn't conform with the Affordable Care Act or just more awareness of individuals buying insurance coverage.
So we've seen a pretty steady growth in the short-term medical. It'll be interesting to see if that growth continues for the rest of the year with the public exchange is now closed down really until fall.
But that's really what drove it in the first quarter.
Scott Heleniak
Okay. So are you seeing so far in Q2, that same sort of interest or quote activity now that we're beyond the, I guess the initial deadline?
Has there been any drop-off?
Craig Kelbel
Through April, I would say not much drop off, fairly consistent.
Scott Heleniak
Okay. And then just one last question here, just on the investment portfolio, you talked about there, there wasn't a whole lot of change and you noted equity exposure, you sell some equities and that decline a little bit, and there is some shift in short-term investments.
So where are you seeing opportunity now, obviously I wouldn't think you would keep all that money in short-term investments, but where are you seeing the opportunities now in your portfolio?
Brad Irick
Hi. This is Brad.
Pretty much consistent with what we've been doing. I think the muni market has continued to be a good area for us and it will continue to be.
I wouldn't expect the allocation to change significantly. But to address a couple of your comments, sales was about $130 million of equities that was right at the end of the year, so they were sitting in short-term investments.
We will redeploy those into either fixed income -- other fixed income securities or potentially back into other equities if that's where we see the opportunities. But I'd say our expectation is that we are equity investors and we maintain at least a 5% allocation to equities that could go up depending on kind of how we view the equity markets going forward.
But we had a very nice appreciation in the equity portfolio since we started that in 2012 and just decided to take a little risk off the table at the end of the quarter.
Scott Heleniak
Good enough. Appreciate the answers.
Thanks.
Operator
Your next question comes from Ken Billingsley of Compass.
Ken Billingsley
I recall you said that the rate increases across the board were fairly strong. How do you see additional reinsurance capital kind of impacting some of your businesses, especially some of your larger account type businesses and do you see yourself utilizing more reinsurance and how much would you use going forward?
Chris Williams
Ken, this is Chris. I had little trouble hearing your question.
But I think it was in regard to reinsurance and the impact on our portfolio. First of all, as Bill mentioned, on our property cat side of things that represents only about 5% of our premium.
You think about 3 billion approximately, that's only 5%. That market is very competitive.
I think you probably heard from all of our peers that there's an abundance of capacity in the property cat area, so that pricing is down and we anticipate that being down for the year. In regard to our reinsurance purchases, we are, as you know, opportunistic buyers.
We do have a panel of reinsurers that have been longtime supporters of HCC and depending on where our appetite is and where the market is we flex that buy. We sometimes buy a little more or a little less, but I would not anticipate any major change in our buying habits.
Ken Billingsley
And you kind of extracting that to be M&A comment that you made about looking at maybe teams that maybe disenfranchised for one reason or another. If you brought them in, would you follow a prior history of using reinsurance or other capital as you were understanding that book of business, or do you think you guys would put your own capital in there to grow from day one?
Chris Williams
Again, depending on the line, but I think it would be very much -- and you've heard me say this before, it’s business as usual. We generally, as we do undertake new endeavors like to buy a little bit more reinsurance.
It's not to say we disband those reinsurers once the program is going, we simply will restructure it. So I think it would be pretty much business as usual to the extent that we are able to get some of these terms.
Ken Billingsley
The last question I have is and this is regarding the A&H business. I believe you said that the effective rate increases were approximately 18.6% and this was over the needed rate increase of 16% to keep up with medical inflation.
First off, did I have my numbers correct?
Craig Kelbel
This is Craig. Yeah, pretty close.
Ken Billingsley
Could you just talk about what's driving that 16% and what changes you may -- maybe seeing positive or negative over the next 12, 24 months?
Craig Kelbel
Well, I think the biggest changes seen which drives the effective rate increases is the increase in deductibles. So we are up to 125,000, which is an increase of 12%.
So people rather than buying rate increase are taking more of the risk-on which actually improves the risk from our perspective. So I think that's really the driver of why we are at 18.6 versus a needed of 16, because the employer groups we insure are increasing their deductibles or retentions.
Ken Billingsley
Great. And what about from the actual medical inflation site itself, like what's driving the 16%.
Craig Kelbel
Well, the 16% really is leverage depending upon the deductible you signed. If you wanted to ask a question of first dollar deductible which is a common question that I think most people are looking for an answer, it’s some place between 5% and 6%.
The rest of it is a leveraging as a deductible goes up.
Ken Billingsley
Great. Congratulations.
Nice quarter.
Craig Kelbel
Thanks.
Operator
(Operator Instructions) And your next question comes from Bob Farnam of KBW.
Bob Farnam
Hi there. Good morning.
Couple questions, one -- actually one quick one, did I hear right that the catastrophe losses were allocated to the international segment this quarter?
Chris Williams
That's correct.
Bob Farnam
Okay. The international surety and credit line, it probably more growth there than I expected and the loss ratio improved more than I would have thought.
So, can you just kind maybe add more color as what's going on there?
Chris Williams
Yeah. They are too very good lines of ours, Bob, I mean, a lot of that is written out of the U.K.
As you are aware the U.K. has got seemingly a little bit better improving economy than the rest of Continental Europe.
So I think we’re seeing some more opportunities there. And indeed, the loss ratios are fairly consistent.
I mean, that's been plus, plus, those lines of business have been very good for us.
Bob Farnam
Okay, good. And I guess, maybe the last question for me, any exposure to the suffering, sinking or the Malaysian aircraft disappearance?
Chris Williams
Very, very minor in both situations.
Bob Farnam
Both situations? Okay.
Very good. Thanks.
Chris Williams
Thank you.
Operator
Your next question comes from John Thomas of William Blair.
John Thomas
Hi. Maybe I miss heard, but you mentioned that the professional liability environment is still challenging.
I was curious given the combined ratio running at 80, and the last two actions here is having a very good results in the U.S. business.
I guess, how much more improvement do think you can get there?
Mike Schell
This is Mike Schell, and it's a challenge to get improvements. We’re still continuing and did in the first quarter in the U.S., but it's a challenge.
John Thomas
All right. Thanks.
Operator
(Operator Instructions) And at this time, we have no further questions. I will hand the floor back over to Chris Williams for any closing remarks.
Chris Williams
Thank you, everyone. Thanks for joining us on today's call.
I look forward to reporting our second quarter results in late July and everyone have a great day. Thank you very much.
Operator
Thank you. This does conclude today's conference call.
You may now disconnect.