Jul 31, 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 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 expressed written consent of HCC Insurance Holdings, Inc. Your lines once again will 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 Second Quarter 2013 Earnings Call.
All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session.
I would now like to turn the conference over to Mr. Chris Williams, Chief Executive Officer.
Sir, you may begin your conference.
Chris Williams
Thanks, Christy. Good morning everyone and welcome to HCC’s second quarter conference call.
Joining me today is Bill Burke, our President; Brad Irick, our Chief Financial Officer, Mike Schell, Executive Vice President; and Craig Kelbel, President of HCC Life. As in the past, Brad will provide a financial overview and Bill and Craig will discuss our segment results.
HCC had another strong quarter with continued very consistent results in all of our segments. We produced net earnings of $88 million or $0.87 per share for the second quarter.
This included $21 million of pretax catastrophe losses, $15 million of which related to the European floods. Our net earnings were $93 million or $0.92 per share in the second quarter of 2012, which only included $5 million of pretax catastrophe losses.
Of significance, our earnings per share for 2013 year-to-date is another record for HCC. We generated $1.92 of EPS for the first six months of 2013 compared to $1.71 for 2012.
Our disciplined underwriting and expense management are once again reflected 85.3% combined ratio for Q2, which is consistent with our 85.2% combined ratio in last year’s quarter. Our six month combined ratio of 84.5% compares favorably to 85.3% in 2012 even though 2013 includes higher catastrophe losses.
Our expense ratio continues as one of the lowest of our peers at 24.8% for the quarter and 24.6% year-to-date. This discipline has held in very good stead through soft markets, hard markets and extended low interest rate environment with many of our peers operating at 10 points or 15 points above our combined ratio level.
We expect to maintain this discipline that has served us so well. Our net earned premium decreased 1% for the quarter.
In the first six months, net earned premium increased 1% to $1.1 billion, which is in line with the guidance we provided earlier this year. This was achieved despite our exiting two accident and health lines in 2012 and our continued re-underwriting of the DFP book.
As you know, we selectively write premium that will achieve our targeted loss ratio. We don’t write premium to generate top line growth.
Brad will now review our financial highlights. Brad?
Brad Irick
Thanks, Chris. Net investment income in the quarter was $56 million, an increase of 4% from the prior year.
Key investment metrics include a long-term tax equivalent yield of 4.5%, a book yield of 3.6%, a portfolio duration of 5.5 years and average rating of AA. With the exception of June, the first half of the year was a difficult reinvestment environment.
However, the upward movement of the 10-year U.S. treasury in June has had a positive impact on reinvestment rates.
So, as we mentioned in the past, rising rates are good thing for HCC and we hope this continues. Practically speaking we believe ups and downs are likely to continue.
And we feel that the general direction of rates should be gradually upward through 2015. Accordingly, we expect our book yields will remain near current levels for the rest of the year assuming market rates are stable or improving.
The flip side of the rate rise equation is the impact on the fair value of our fixed income portfolio. Pretax unrealized gains decreased $222 million in the second quarter and $261 million since year end driving both a decrease in total investments and a slight decrease in book value per share from year end 2012 to $35.
Duration also increased to 5.5 years in reaction to the rising rates. Both of these changes were in line with our expectations.
Excluding the impact of after tax, net unrealized gains our strong earnings drove a growth in book value per share of 4.9% for the full year and 2.2% for the quarter. With respect to reserves, we recorded net catastrophe losses of $21 million.
We also recorded a favorable reserve development of $12 million, $2 million related to the 2010 New Zealand earthquake in the International segment. The remainder was in the U.S.
Surety & Credit segment primarily related to a recent settlement of a large 2010 claim. We made no adjustments to prior year reserves in our other segments.
Liquidity remained strong with $254 million of capacity under our revolving credit facility and $256 million of short-term investments in cash. Operating cash flow for the quarter, which excludes $7 million of surety cash outflows was $107 million driven in part by a very positive paid loss ratio of 51.1%.
Through six months, we've purchased 1 million shares of our common stock including 300,000 during the quarter for $41 million at an average cost just below $40. While we continue to be opportunistic buyers of our stock, we have chosen to slow our purchases during periods when our stock is rising significantly as it has throughout 2013.
Bill?
Bill Burke
Thanks, Brad. As Chris and Brad noted, we continue to have strong results in 2013.
In the second quarter, our Underwriting segments showed increased year-over-year pretax earnings ranging from 10% to 70% except for International, which had increased cat losses. All of our segments had strong underwriting margins in the second quarter ranging from 11% to 34%.
We are continuing to see rate increases in many lines of business across 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, which was similar to the first quarter. The overall retention rate in the second quarter was 83%.
Looking at specific segments. For the Professional Liability segment, the second quarter continued the favorable trends we experienced in the first quarter.
The overall pricing environment for U.S. D&O continued to be positive and in International D&O pricing on financial institution business remains firm.
For the overall segment, we had rate increases in the mid single digits, however, our net earned premium declined by 7% in the second quarter versus prior year led by a reduction in the DFP portion of the book. Our loss ratio for Professional Liability continued to improve.
We had a loss ratio of just over 60% for the first half of 2013 versus almost 67% for 2012. In the U.S.
Surety & Credit segment, we achieved low to mid single digit increases in our gross ands net written premiums for both the second quarter and first half of 2013 versus prior year. Our loss ratios for this segment continue to be very positive at 19% for the first half of the year versus 27% last year.
Our 2013 year to-date loss ratio includes the favorable development that Brad mentioned previously. The accident year loss ratio of 29% for the segment is also very positive.
Our U.S Property & Causality segment had net earned premium growth of 3% in the quarter and 4% for the first half versus prior year. This growth was driven by our Sports and Entertainment Disability business, title reinsurance and primary causality which are included in the other category.
On an overall basis for this segment we were able to achieve rate increases of mid single-digits and our loss ratio continued as expected at roughly 58% for the first half of the year. As you may have seen in our press release, we started a new line of business in this segment construction property.
With a growing economy we felt this was an opportunity time to get into this business and we were pleased when we were able to hire an experienced team. Despite catastrophe losses from European floods and other smaller catastrophes the International segment had a favorable 56% loss ratio for the second quarter.
Year to-date, international’s loss ratio is just under 50%. Many of our international lines of business continue to have excellent profitability.
Our loss ratios in the first half of 2013 are particularly good for our energy U.K. professional indemnity and general property businesses.
For the segment net earned premium was flat in the second quarter and 7% ahead of 2012 for the year to-date. This includes property treaty which although we were impacted by the recent market rate reductions had gross written premium for the first half that was flat compared with 2012.
Craig?
Craig Kelbel
Thanks, Bill. Overall the A&H segments gross written premium for the second quarter of 2013 increased by 4% and $7 million over the second quarter of 2012.
Year to-date for 2013, gross written premium has increased by 4% or $18 million as compared to 2012. Specific to the medical stop loss product, which represents approximately 90% of the total of gross written premium for the A&H segment, the following are some key results for the second quarter and year to-date.
The effective rate increase in the second quarter, which is a measurement of deductible and coverage changes, was 16.6% as compared to an actual trend needed on that business to keep pace with medical inflation of 15.4%. On a year to-date basis, the effective rate increase is 16.9% compared to actual trend needed of 16.7%.
This would suggest that the loss ratio for our renewing medical stop loss business should continue to perform this year at similar levels to past years. The A&H segment's combined ratio and pretax earnings are performing as planned.
Through the first six months of 2013 the average employee lives per group was 537 as compared to 507 last year. We continue to see the trend of writing larger employer groups within our portfolio.
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.
Of the business written in the first six months, approximately 80% of the gross written premium comes from our in-force business, which is at a premium persistency of 83%. The remaining premium comes from new business, which is consistent with prior year results.
We have seen no meaningful change regarding the small group market, meaning 50 lives and less in the second quarter from our comments in the first quarter call. HCC’s number of covered lives for the medical stop loss attributed to groups of 50 lives continues to be less than 1% of the total covered employee lives in the first half of 2013.
Even with the President’s decision to delay implementation of the employer mandate until 2015, we continue to do the Affordable Care Act as having no negative impact on our medical stop loss business. In fact, the Affordable Care Act may have a positive impact by increasing the number of self-insured lives.
Chris?
Chris Williams
Thanks, Craig. Thanks for another great six months.
The pretax earnings and gain exceeding $50 million year to-date. For those of you that have read our 2012 annual report, we referenced business as usual as a mantra for this year.
As you have heard today a book of non-correlated businesses continues to generate consistent underwriting results over time and through market cycles. Based on the first six months results and with some help from Mother Nature we remain opportunistic that we will once again be able to achieve double-digit operating return on equity.
A strong underwriting platform and liquidity position enable us to be nimble and acquisitive should the right acquisition opportunity present itself. As Bill mentioned, we recently hired a new team of seasoned underwriters to build a construction property book of business in the U.S.
We are actively pursuing other new teams and lines of business and expect to announce more additions later in 2013. Finally, we are pleased to have S&P reaffirm at AA rating this quarter.
This reaffirmation issued another endorsement to the consistency and stability of HCC. Christy, with that, we’d like to open up the call to question.
Operator
(Operator Instructions). Your first question comes from the line of Ryan Byrnes with Langen McAlenney.
Ryan Byrnes
Hi, good morning, everybody. Quickly, I just want to touch on the investment portfolio.
I guess you guys noted that the expected book yields should remain flat to the back half of the year. Just trying to back into I guess what kind of new money rate you are getting versus I guess the bonds are maturing right now.
Just want to see how that matches up?
Brad Irick
Ryan, this is Brad Irick. It continues to be what’s rolling off is higher than what you are putting on but that’s improved from where we would have talked at the end of last quarter.
That is in the range of 100 basis points and you’ll see the short fall between what rolls off and what comes on and this is about where we sit right now.
Ryan Byrnes
And then, secondly, you guys also noted that you may have slowed down your share repurchase a little as the stock has risen a little bit. Did that change your philosophy there versus maybe special dividend versus share repurchase or is that or the share repurchase still your main vehicle for returning capital?
Chris Williams
No, we remain opportunistic. As Brad said, we have slowed down a little bit with the stock price increasing.
We are deploying capital in other areas. As Bill mentioned, we put on some new lines of business.
We are actively looking at some others but we remain opportunistic. We’d like to buy more back and we’ll let the -- in the future but at the moment we think the best way to use our capital is expanding in lines of business sitting and generate a return in excess of our cost of capital.
Ryan Byrnes
And then, quickly my last one here is, I just noticed that I’ve seen international lines the net written premium fell back a little bit. Just trying to figure out why that was and maybe just also why the retention fell a little bit as well?
Thanks.
Bill Burke
Sure, this is Bill Burke. Some of our -- we’ve got a lot of different lines of business and we obtained different levels of reinsurance depending upon the business.
And so, some of the growth that we had in our international lines was into lines of business where we buy more reinsurance which then causes obviously the net to written premium to drop down. So, it was in line with where we saw it coming.
Ryan Byrnes
Thank you.
Operator
Your next question comes from the line of Scott Heleniak with RBC Capital Markets.
Scott Heleniak
Hi, good morning. I just had a quick question you mentioned in the release then you mentioned later on in the call about new team additions later in the year obviously you can’t talk about that too much but can you talk about where acquisitions may fall and is it -- so the preference continues to be hiring new teams versus acquisitions and if you can touch on that how you are feeling about those two?
Chris Williams
Yeah, Scott, clearly we are more focused on new teams and lines of business. I mean, we have an appetite for M&A but as I think I’ve said in the past we just haven’t seen anything that fits for us it gives us the appropriate return we want.
So, we’ve added this construction team earlier this year. And I think it’s reasonable to assume you’ll hear some announcements about some others coming on board.
So that’s been more our focus but we continue to look at M&A opportunities as they come along.
Scott Heleniak
Okay. Then I had a changed question about rate increases you guys are getting 3%.
I was juts wondering if you could touch on what you think your loss cost trends are and whether you are getting margin expansion whether the pricing is outpacing the loss cost you are seeing right now?
Bill Burke
Sure. Many of our lines of business, we don’t have what I’ll call traditional loss cost trends.
We don’t have a lot of medical type of coverage or exposure. Craig went through the trends in the accident and health business.
Scott Heleniak
Right. Bill Burke In other lines of business, we don’t have the worker’s comp and the automobile type of exposures that, where you track the medical and different loss trends very closely.
We’re continuing to see as you can - our margin expansion as you could see from our combined ratio and so if we see a line, where we’re not getting a sufficient margin then we push higher rate or we push selection within that particular line. But we continue to be positive about where the, where the market is at the moment.
Scott Heleniak
Okay. And you mentioned so you really saw no big difference in rate changes Q2 versus Q1 any areas that come out that stick out at all?
Chris Williams
No it’s got - its tracking pretty much where we had given the guidance. At the start of the year, we anticipated relatively modest net premium growth when you backout the lines we exited.
We’re pretty much right, where we told we would be.
Scott Heleniak
Okay. Just one last question now the, I guess saw some growth in Surety & Credit, I wonder if you could talk about some of the opportunities you are seeing there maybe by class I guess as far as new business and is the economy driving much of that increase there?
Bill Burke Yes. I think the economy is driving some of our increase there.
We see increased project development, which obviously on the surety side could lead to additional bonding activity. On the credit side, you see increased transactions exports taking place, where which then also drives our credit business.
Scott Heleniak
All right. Thanks for the answer.
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
Thanks, Christy. Thanks everyone for joining us on today’s call.
We look forward to reporting the third quarter results due in October and everyone have a great day. Many thanks.
Operator
This does conclude today’s conference call. You may now disconnect.