Aug 4, 2010
Operator
Good morning and welcome to the HCC Insurance Holdings Incorporated second quarter earnings 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) This telephone conference call relates to HCC Insurance Holdings Incorporated.
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 of future financial performance are forward-looking statements made pursuant to the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995.
Forward-looking statements involve inherent risk 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. (Inaudible) factors and other risk 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 Incorporated are the sole property of HCC Insurance Holding Incorporated and may not be recorded, rebroadcast or published in whole or in part without the expressed written consent of HCC Insurance Holdings. John Molbeck, President and Chief Executive Officer of HCC Insurance Holdings Incorporated will begin the call shortly.
John Molbeck
Welcome everyone to HCC’s 2010 second quarter conference call. Joining me today is Tobin Whamond, our CFO; Mike Schell, our Chief Underwriting Officer; Brad Irick, Executive Vice President of Finance, Cory Moulton, our EVP of U.S Property and Casualty Operations, Pam Penny, our Chief Accounting Officer and Randy Rinicella, our General Counsel and fresh in from Atlanta Craig Kelbel, who is the CEO of our Life company.
HCC’s performance for the second quarter continued to demonstrate our commitment to underwriting performance while limiting our exposure to catastrophic events despite the continued competitive market and low interest rates. Our net loss for the quarter to weather losses in deepwater horizon totaled significantly less than $1 million.
We are very pleased with our GAAP combined ratio of 85.6% for the second quarter and 88% year-to-date. Our accident year combined ratio for the quarter was also 85.6% and was 87.5% for the year-to-date, including the first quarter catastrophes, which was dominated by the Chilean loss.
Excluding the catastrophes, our year-to-date accident combined ratio is 85.8%. We continue to modestly grow our premium compared to 2009 despite the competitiveness of the market.
Our renewal percentage, or the business that renews annually and that is possible to track, was 87% which is an all time high since we began to track this number. Tobin will now review the financial highlights for the quarter.
Tobin Whamond
Thank you, John. Gross written premium of HCC’s insurance companies increased 2.4% to 1.31 billion in the first six months of 2010, compared to 1.28 billion for the first six months of 2009, and net earned premium was up slightly at 1.05 billion.
For the second quarter of 2010, gross written premium was up 1.5% over the second of quarter of 2009 to 691.6 million. John will discuss the drivers behind the top line in a moment.
Revenue for the first half of 2010, totaling 1.17 billion, was down slightly compared to the first half of 2009, with fee and commission income 16 million lower due to the disposition in 2009 of the operations of HCC’s Commercial Marine Agency business, the sale of our reinsurance for (Barrett) and McKenzie as well as lower other operating income, offsetting these items of the 6% year-over-year increase in net investment income. Operating cash flow for the second quarter increased to 96.5 million up from 42.5 million in the first quarter.
We expect operating cash flow of approximately 100 million per quarter to the remainder of 2010. In the first half of 2010, net investment income increased to 99.5 million, compared to 93.6 million for the first half of 2009, driven primarily by an increase in the size of our long-term fixed income investments, offset by lower short-term yields.
The fair value of our fixed income portfolio and our total investments at June 30 was 5.08 billion and 5.55 billion, respectively. The duration of our fixed income portfolio decreased slightly at the end of the second quarter to 4.8 years from 5.0 years at the end of the first quarter, driven by increased pre-payments fees in our agency MBS portfolio with our overall duration also down slightly to 4.4 years, compared to 4.5 years for the same period.
The quality of portfolio remained consistent at AA+. For the second quarter, average book yield was 4.1% and average tax equivalent yield was 5.0%.
We recognized no OTTI credit losses in the second quarter and none year-to-date, compared to 5 million for the first half of 2009. The net unrealized gain on our fixed income investment portfolio at June 30 increased to 224.9 million from 163.9 million at March 31.from a balanced view perspective, our debt-to-capital ratio declined to 8.5% at June 30, compared to 8.8% of March 31 and 9%at year end 2009.
Liquidity remains strong with 560 million of cash and short-term investments, and 553 million of available capacity on our revolving credit facility at the end of the second quarter. Share holder’s equity increased to 32 billon; total assets grew to 9 billion and HCC book value per share increased to 27.78 from 26.91 at March 31.
Representing a 12.9% annualized growth rate in book value per share. I would also like to mention that we completed our scheduled goodwill impairment testing during the second quarter.
There was no impairment of goodwill for any of our reporting units based on the annual testing. Our methodology for this testing remains consistent with prior year and there were no changes to our reporting units year-over-year.
Finally, from a capital management perspective, our three priorities continue to be; one, M&A; two, acquiring team’s people; and three, share buyback global value. On June 1, we announced a new 300 million share repurchase program and we out in place the appropriate plans on the 10b-18 and 10b5 to execute our repurchase program at their share price and other conditions (we want).
In the second quarter we repurchased approximately 1.2 million of our common stock at an average price per share of 24.38 With that, I’ll now turn it back over to John.
John Molbeck
Thanks, Tobin. Just a little bit more color to the quarter.
last conference call, the deepwater Horizon loss that just occurred and the impact on the last 90 days has unsettled the energy market and the Fortune 1000 liability market both in terms of rating and the desire for increased limits. As the recognized leader in the Energy business, we continue to be able to write a selective portfolio of business and write as much as we want consistent with the (eye grid) exposure that we want to have with the Gulf of Mexico.
Overall pricing was largely flat with the first half after the quarter with our Directors and officers liability, being increasingly competitive. As the sub-prime appears now appears to the market to be less of a concern.
For the quarter, we’ve had no new sub-prime claims reported. Once again we’ve provide4d this information in our press release.
But as claims activity has been limited over the past several quarters. We will not continue to abide this detail in two press releases.
We’ve achieved price increases in the quarter and our international aviation business or US surety business and a medical staff watch did this, and for the first time increases in a long while in both our miscellaneous and architecture and engineers and (notebooks). You know increases are direct reflection of our continued reunderwriting of these exposures in a very difficult environment.
D&O was down across the board about 5% to 10%. Part of this reduction is recognition that some accounts that we see significant increases during the financial crisis did not and are not likely to have losses and did not require the same amount of premium increase as was previously anticipated.
In all other Lines of Businesses, pricing was down about 5%. We don’t know whether it’s optimism, realism or delusion but competitors continue to write business that generally acknowledge to be an accident year combined ratios over 100%.
And while we recognize the value of relationships, we find it difficult to believe that in this harsh worldwide economic environment, that buyers would pay a higher premium to a team that moved from one company to another simply because of relationships. Recently we made several important organizational changes.
Thibaud Hervy and Philippe Vezio have been promoted to co-CEO’s, leading our international D&O business. They will report to Mike Schell.
Andy Stone who heads our US D&O business will provide consultation and strategic oversize the international D&O business to Mike, Thibaud and Philippe. Andy also reports to Mike Schell.
We’re combining our PIA and ATC Specialty underwriter’s business under the leadership of Bill Hubbard. Bill will be the CEO of ATC Specialty and report to Corey Moulton.
Next week, Tobin will assume the position of EVP and Chief Operating Officer and relieve me of some of my work load. And Brad Irick will become our Executive Vice President and Chief Financial Officer and reports to Tobin.
Brad joins us from PricewaterhouseCoopers and until mid-2007 was our Audit partner. Finally, Mark Callahan will join us Monday as EVP and Chief Actuary.
Mark is returning to his roots in Texas. He previously was with XL insurance where he was Chief Risk Underwriting and Actuarial Services Officer.
So to recap the quarter, we have slight premium growth, we had more that that you should be concerned, we had a great renewal retention, we had a GAAP combined ratio of 85.6%, we had an accident year combined ratio of 85.6%, we had a return in equity of 10.6%, we paid our normal dividend, we had no net losses from deepwater Horizon, minimal of a caps and strengthened our management team and streamlined our structure. With that operator, I’d like to open the call for questions.
Operator
(Operator Instructions) Your fist question comes from the line of Beth Malone of Wunderlich.
Beth Malone
Thank you. Good morning.
A couple of questions. First in the D&O market and the pricing, you mentioned that you saw it was becoming more competitive and that maybe as a result of we’ve got and passed the credit crisis.
Does that suggest that the pricing coming down is still appropriate that the risk associated with D&O have diminished, therefore, the pricing should also diminish and you should be able to maintain the combined ratios you’ve had in the past?
John Molbeck
Good morning, Beth. I think that’s a pretty good summarization of what the market looks like.
It’s still an underwriting business and you still have to underwrite on account by account. There will be losses that come from the 2007 and 2008 underwriting years from the sub priming credit crisis, but I think the margins that currently exist and your ability to underwriter appropriately will continue to generate acceptable returns and acceptable markets.
Beth Malone
Okay. And do you see markets expanding internationally for D&O?
Is there an increased demand or has that also diminished with the concern about the credit crisis?
John Molbeck
I’m not sure there could too many more players in the international D&O market, to be honest with you. I think there is increased demand for additional limits, and I think as countries like China and India continue to have IPOs and getting to the public securities market there will be increasing demand.
But I also think that you have to be very weary of new IPO placements coming from parts of the world where they don’t have the same legal and capital environment than might be in places with more established laws and history. But it’s funny at Capacity International.
I think the fact that we’re a AA, S&P gives us a competitive advantage and we continue to use that competitive advantage over the opportunities that we have.
Beth Malone
Okay. And then on the Energy market, in the pricing that you’re seeing there.
I was – in looking at your results on gross to net, it’s harder to see the pricing that maybe occurring in the market place. Is that something we’re going to see in the second half on HCCs written premiums and going forward?
John Molbeck
I think a couple of things that take in place. In 2008 we got very, very significant price increases especially on wind storm exposure in the Gulf of Mexico.
The industry is fickle. Without a loss in 2009 and so far without a loss in 2010 I think the pricing for wind exposed business would have dropped dramatically.
Because of the deepwater Horizon loss, it’s created a lot of turmoil in the market. So instead of seeing prices drop dramatically, prices have remained relatively constant, which is a pleasant surprise for us.
It is another business that all other things being equal provides a more than acceptable market. And as you know from our history, we buy a lot of catastrophe coverage, we monitor our D&O very closely and we protect our reinsurance program and effectively we have relative to the industry very small net losses.
And I think that equation remains true today.
Beth Malone
Okay. And then just one other question on deepwater Horizon.
That event was not weather related. Does that expand the demand for coverage from the energy sector?
Because it’s not just wind that they have to worry about?
John Molbeck
Well, I think, every Board of Directors, whether they be in the Energy business or not, have just seen another black swan. And when that black swan, when it walks by or flies by, the directors get very, very nervous.
And I think what we’ve seen, especially in the Energy business, is people looking for additional limits both in terms of liability coverage, someone would respect the D&O coverage. And I think that has spilled over to other certainly Fortune 1000 companies where they ask them a question is there a deepwater Horizon out there that we might have to say we probably insure for those types of events, so I think that have an overhang on the entire industry.
Beth Malone
Okay. Thank you.
John Molbeck
You’re welcome.
Operator
Your next question comes from the line of Dean Evans of KBW.
Dean Evans
Yes, thanks. I was wondering first if you could sort of refresh on your thoughts on the impact of healthcare reform on the medical stop loss business?
Craig Kelbel
This is Craig Kelbel. If present we really have seen not any impact of legislation that’s been put in place really doesn’t impact self-fun.
Self-fun is to continue actually we’ve seen an increase of activity in the last three or four months sent. So we don’t see anything that really impedes our ability to continue on with the business now.
Dean Evans
And you don’t believe standing in that changing thing going forward? It’s kind of the legislation becomes further inactive and grounded?
Craig Kelbel
We don’t. It’s impossible to predict what politicians will do but at the moment, what have been put forth doesn’t seem to have any kind of impact in our business in any way.
It has a bigger impact on the fully insured business than it would have on the medical stop watch saw fun of this.
Dean Evans
Okay, thank you. My second question, I was just wondering you sort of touched when you talk about capital management.
The top two priorities being M&A and acquiring teams of people. I was wondering if you could sort of give us a little more of color.
Thank you.
Craig Kelbel
I think because of the quality of our balance sheet and a relative performance. We have seen several to join HCC.
As far as the M&A environment itself. It’s probably the best spin in five years.
Pricing we believe has become more realistic. Whether or not we can execute at a price that’s acceptable to the buyer and seller remains to be I think the longer that the market stays in the relatively Soft position that it is now.
Ore, more, more opportunities. Whether or not we can execute at a price that’s acceptable to the buyer and the seller remains to be seen.
And we think the longer that the market stays in the relatively soft position that it is now more, more opportunities will avail themselves. I also would think you’ll some facilities here.
Support for their facilities because to reinsure which will lead people. We seen that in the 1999 to 2001 cycle and we anticipate that would continue through the next 18 months.
Operator
Your next question comes from the line of Doug Mewhirter of RBC Capital Markets.
Doug Mewhirter
Hi, good morning. First of all, there’s the expense ratio seemed a little high.
Was that more of a business mix issue for any onetime seasonality?
John Molbeck
I think it is a business mix issue. I kind of smile when you say that because sometimes we look at – we’re like a 350-hitter that’s got 50 home runs and people want to know why we didn’t have 52 home runs.
I think were the low-cost expense ratio in the business. Some of the moves that we made recently this quarter will continue to keep us in that direction but I think you’re right at the business mix issue.
Doug Mewhirter
Okay. My second question is regarding your credit and surety business that showed some growth.
You did mention you got some price increases there but it would still seem a little surprising considering it’s economically related, for a lack of better term. Are you seeing any sort of knock on effects, if any possible bottom in the economy or proven the economy related to that sort of growth?
John Molbeck
I think a number of people will comment on their conference calls that this is prized. One; the level of claims isn’t any greater than any what would be anticipated based on previous cycles.
But also when you’re looking at our growth, yet, remember that a little over a year ago we bought the Surety Company of the Pacific. And when we bought that bulk of business going to Rome now.
Some of that growth is just a natural evolution for the acquisition that we made at the beginning of 2009.
Doug Mewhirter
Okay. Thanks for that.
And the last is I guess you had some capacity in London. So do you think that your premium volume would sort of keep up for the balance of the year versus the current run rate.
Sometimes it drops off in the third and fourth quarter historically, but if the addition of that took out some of the seasonality.
John Molbeck
I think that our third and fourth quarter will continue to operate as the third and fourth quarters have operated in the past. I think it’s a very competitive marketplace, but we’re in the specialty business.
We’re continuing to renew our high proportion of our business so I think if you were looking at it and forecasting the future I’d say the second half of the year will look like previous second half of the year.
Operator
Your next question comes from the line of Michael Nannizzi of Oppenheimer.
Michael Nannizzi
Thank you. Just a couple of questions if I could, one question about the medical stop-loss business, I know that just kind of heard other players talking about entering that business or looking a little bit more closely at it.
Can you just talk about the competitive environment there and sort of how you protect the business that you currently have?
Tobin Whamond
Well the business, we’ve been doing this for a very long time, HCC really through its acquisitions has had relationships that go back 20 some years. So if you looked at our retention John alluded to before, we had seen the highest retention of our business in the past 12 months than we had seen historically its well over 80%.
So I think because of our long-term nature of being in the business, our long-term relationships with the producers and just our consistency and for new entrants you’d have to have a reason for someone to consider you as a viable market and the market is very competitive, I would – so therefore you have to buy your way in and if you buy your way in, I think that you’re not going to be very profitable in the short run. And there is a lot of less players today than there was four or five years ago.
Michael Nannizzi
All right and so I mean, so for folks that do want entrance, it’s purely enter on price, I mean there is really no other avenue to kind of collect market share early on.
Tobin Whamond
I think it would be a challenge; the contracts are pretty straight forward. We think that we have added value services that are not easy and are consulting of nurses and outside third party’s to control to claim process.
So it’s not something you could decide to get in today without having a lot of other valuable services to protect your guideline (ph).
Michael Nannizzi
So its relationship and infrastructure in it?
Tobin Whamond
Absolutely.
Michael Nannizzi
Okay, and then just one question some way back I remember it, talked about healthcare reform, I think if I remember right maybe this isn’t but it was $1 per covered life tax charge to sponsors of self insured plans and it was in 2013 startup date. Is that still the case and how does that impact your position in these self insured plans?
Tobin Whamond
Well, I think its minimal cost, if you had a 1000 lives you would pay $1000 would be your fee, annual cost of a $1000 for a sponsored healthcare plan it’s insignificant.
Michael Nannizzi
Okay.
John Molbeck
So from a cost standpoint yes, it’s still in the legislation but its far long ways away, not sure whether some changes will be in both in healthcare reform, but it’s still there but it’s a long way to way in, the fees minimal does not impact us, it’s the plan sponsor has to pay not the insurance company.
Michael Nannizzi
Great, thanks. And then just Tobin maybe an investment question, I know that tax exempt income was up about 10% year-over-year.
Just want to understand what drove that, was it a higher allocation towards tax exempts, a shift in assets that rotated towards higher yielding investments or if you could just talk about that?
Tobin Whamond
Sure I think there were few things, one is tax exempts increased slightly on a relative basis and two is our buyers when we looked at value as we sell to short end of the curve was very heavily value and there was some opportunities to really things that we thought were anomalous the types of high yields that existed there and to reposition some of that and slightly longer on the duration curve. (Inaudible) things will work.
Michael Nannizzi
So selling near maturing munis and buying longer duration or further out maturity municipal bonds?
Tobin Whamond
Yes and various likely cases yes.
Michael Nannizzi
Okay. And just on that topic, I mean could you just talk a little bit about your allocation in that portfolio and to GOs and revenue bonds and kind of how you think about exposure in that asset class?
Tobin Whamond
Well I think, I’d say a few things about our municipal portfolio as you know is about 49% of our fixed income portfolio of 45% overall. Our portfolio is not the same as the broad market.
We are underrepresented versus the market in states such as California and New York, Florida, New Jersey and Nevada. We do pay attention to structure and when we do look at special purpose we focus on revenue sources that we consider to be essential, utility type situation.
So I think it’s a continuation of the way in which we’ve invested in muni space historically.
Michael Nannizzi
Okay and then just one last question on M&A and I guess kind of from a different angle I can ask. Do you – when you look out from here, do you think that do you see medical stop-loss and diversified financial as segments of earned premiums continuing to represent the same size, the same representation or do you see if there is M&A activity for it to be in areas other than those two?
Thank you very much.
John Molbeck
I think the simple answer is we love those lines of business. We have to be careful in the medical stop-loss line that we don’t cannibalize ourselves by buying bidders (ph) and producers saying I already have too much with HCC.
So if you looked at the portfolio of business today, it’s probably going to grow over a period of time in a 5% to 10% as far as natural growth, whether that’s buy to acquisition. To that line, we’re also constantly looking to add, I’m talking about the group life and health line of additional products that we can sell to our clients.
If we look at D&O business, I think we have the appropriate team in place, we could actually acquire somebody that has another D&O capability but we could also write as much D&O business as we want by hiring (inaudible) hire people who have different expertise that we have within the company. So I think we’ll write that market, we’ll take advantage of when it’s there to be taken advantage of it.
We’ll pull back when it’s appropriate. So if we would look at the overall structure of HCC and if we looked out in to the future, I think just as a general rule, we would probably grow at a faster pace in other lines of business than we would in those two lines of business.
Michael Nannizzi
Great, thank you very much.
John Molbeck
You’re welcome Mike.
Operator
Your next question comes from the line of Amit Kumar of Macquarie.
Amit Kumar
Thanks and good morning. Three quick questions, first of all just going back to the discussion on muni bonds.
I do see that revenue bonds are bigger percentage, can you just remind us what exactly is in these revenue bonds, are these bridges, roads, filtration plans, what is that mix?
John Molbeck
I’d say combination of all the things you mentioned. We don’t really go into beyond what’s disclosed in our financials specifics, but it’s obviously bonds that are backed by the revenues from specific sources and we’ve set on a number of these, there were utilities, things of that nature.
Amit Kumar
And then how do you see that issue playing out, there has been obviously a lot of discussion on defaults going forward, there had been a number of stories. What is your view on that issue?
John Molbeck
Well I think historically clearly the tactics (ph) sector has had lower defaults and lower loss given default rates than constantly rated, historically, than you’re seen in other classes. We have always taken a fundamental approach to invest in the municipal space, so irrespective of wrappers we’ve looked at the fundamental underlying credit.
We think that it is something that we have to continue to do. We’re very comfortable with our portfolio, its AA plus portfolio.
It’s something that we monitor regularly, all of our asset classes.
Amit Kumar
Okay, that’s very helpful. Just moving on and going back to the discussion on Transocean and Deepwater Horizon.
We have discussed the sort of the property issue, the rig issue. What are your views on the D&O and E&O issues surrounding the distinguishing (ph) of the rig.
How do you expect that to play out going forward?
John Molbeck
Well I certainly believe that there will be point of some attorneys that create class actions that will follow us against everybody and anybody they can because that’s what point of attorneys does or do and I don’t think Deepwater Horizon is going to be any difference in that. I think there will be cost incurred by people defending themselves and probably at the end of the day, if anybody, if any board is held to have violated their feudatory responsibility to its shareholders and in doing so call it a loss of the company that some board with marginally one board unless they’re going to say there is a complicity between several companies will ultimately be held responsible for that.
We have the administration saying who they think caused the loss, we have other people saying who thought caused the loss and I’m sure the point of attorneys will say everybody caused a loss. So it’s just another event in the D&O market on a day-to-day basis but it’s not a systemic event and I don’t think it’s going to be a major event for the industry.
Amit Kumar
Okay, that’s very helpful. And then just finally going back to the capital management.
In the opening remarks you mentioned that have attracted to buy it, buy the stock below book, I’m just wondering did – was an accelerated share repurchase, was that option thought about or you feel that a modest amount of buyback every quarter is the better route to go through?
John Molbeck
I think as Tobin told you we have three priorities the third of which is buying our stock back and the first of which is M&A and second of which is team. So it’s part of an overall process and we evaluate it just as we operate in insurance space, we’re very opportunistic when we buy our stock back and when we see the opportunity to buy our stock back and attractive price will continue to do that.
Our previous $100 million share offering we bought in the $21 range and today our stock is trading at $26 and our recent purchase was in the $24 range. So I think you’ll continue to see us operate on that basis.
Amit Kumar
Okay, that’s very helpful. Thanks so much.
John Molbeck
You’re welcome.
Operator
We have a follow-up question from the line of Beth Malone of Wunderlich.
Beth Malone
Thank you. I just wanted to ask on the pricing environment that you’re seeing in general in the marketplace.
Some of your competitors have suggested that conditions are improving to the point where we may start to see some price increases as the losses in the industry continue to build and just – what’s your perspective on that?
John Molbeck
Well I just – I don’t know what they’re writing but I do think there is opportunistic buys on certain I mean, opportunistic pricing in certain lines of business because of certain circumstances in the energy business would be one for example, where there is capacity needs. But I don’t see, maybe pricing is bouncing along the bottom right now but I don’t see other than special situations any movement to increase pricing.
Beth Malone
Okay, thank you.
John Molbeck
You’re welcome.
Operator
At this time, there are no further questions from participants. So I’ll now turn the call to management for any final remarks.
John Molbeck
Well thanks everybody for joining us on the second quarter conference call and we look forward to talking to you again in a couple of months. Have a great day.
Thanks.
Operator
Thank you participating in the HCC Insurance Holdings Incorporated second quarter earnings conference call. You may now disconnect.