Feb 13, 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, broadcasts, or publication thereof 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. Ladies and gentlemen, thank you for standing by, and welcome to the Fourth Quarter 2012 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, Bonnie and welcome everyone to our year-end conference call. Joining me today is my executive management team, Bill Burke, our President; Brad Irick, our Chief Financial Officer; and Executive Vice Presidents Mike Schell and Mark Callahan.
Brad will follow my initial remarks with financial highlights followed by Bill who will give some commentary on the quarter. HCC had record net earnings and earnings per share in the fourth quarter.
We also achieved record earnings per share for the full year. And net earnings for the quarter were $108 million compared to $78 million in 2011.
Our earnings per share were $1.06 for the quarter versus $0.74 in 2011. Our earnings per share were $1.06 for the quarter versus $0.74 as I said for 2011.
Net earnings were $391 million for 2012 or $3.83 per share compared to $255 million or $2.30 per share for 2011. HCC grew book value per share by 1.4% for the quarter and 11.6% for the year.
We also declared dividends of $0.64 a share. Our combined ratio is 84.5% for the quarter versus 87% for the fourth quarter of 2011.
The combined ratio for the full year was 83.6% which compares to 91.1% for 2011. Our fourth quarter results include pretax accident year net catastrophe losses principally from Sandy of $33 million.
For all of 2012, our catastrophe losses were $53 million for the accident year. We continue to successfully manage our catastrophe exposure as our after tax net loss from 2012 catastrophes was only 1% of our shareholders equity at the beginning of 2012.
Our 2012 paid loss ratio was 56.7% compared to 58.9% for 2011. Net earned premium was up 3% for the quarter and 5% for the year.
Brad will now review with you additional financial highlights.
Brad Irick
Thanks Chris. Net investment income in the quarter was $56 million, up 5% from the prior year as the portfolio continues to benefit from consistent growth and stable yields.
Our investment portfolio grew 15% to $7 billion in 2012 driven by our strong cash flows and increases in unrealized gains. Key investment metrics include a long-term tax equivalent yield of 4.7%, a book yield of 3.9%, a portfolio duration of 4.7 years and an average rating of AA.
Realized gains in the quarter totaled $23 million on sales of about $350 million. We invested the proceeds in tax exempt municipals, bank loans and high dividend equity securities.
We will continue to look for opportunities to realize gains in the future fitting our market conditions and our ability to maintain yields by reinvesting the proceeds consistent with our risk profile. This quarter, we completed scheduled reviews of our reserves in the U.S Surety & Credit and International segments and recorded a net decrease to our loss reserves of $35 million, including $19 million related to favorable development from prior year catastrophes.
The breakdown of the development by segment is as follows: $25 million from U.S. Surety & Credit, with contributions from both surety and credit lines of business and $10 million from International, where favorable development in energy, liability and other lines was partially offset by International Surety & Credit, where we strengthened in reserves related to specific class of Spanish surety bonds, the majority of which were written prior to 2006.
On a consolidated basis, we ended the year with an actuarial indicated redundancy of 5.3% versus 4.2% a year ago. We remain very comfortable with the level of our reserves of both the segment and consolidated basis.
Operating cash flow for 2012 of $661 million is $240 million above 2011, driven by our growth and a favorable paid loss ratio. 2012 represents one of the best cash flow years in our history.
With consistently strong underwriting results, we expect to continue to create strong cash flows in 2013. Liquidity remained strong with $305 million of available capacity under our revolving credit facility and $434 million of short-term investments and cash.
In the fourth quarter, we continued our share purchase program and purchased 1 million shares of our common stock for $37 million at an average cost of $36.27. We expect to remain active, opportunistic buyers of our stock in 2013.
Bill?
Bill Burke
Thanks Brad. As Chris and Brad noted, we had strong results in 2012 as shown by our 5% growth in net earned premium and our combined ratio of 83.6%.
We are seeing rate increases in all of our segments and we achieved an average rate increase for those lines of business where there measurement is meaningful of just over 4% in the quarter which is a higher rate increase than in previous quarters of 2012. It is worth noting that while rate is important, we are focused on underwriting to achieve a mid-80s combined ratio.
So account selection, deductible and attachment point and coverage terms are equally or more important to us. The retention rate across all segments was 84% which compares to 83% for the fourth quarter of 2011.
Looking at specific segments. In Accident and Health, we continue to have strong premium growth at 9% for the quarter and 10% for the year with a net loss ratio of 72.3%.
Our U.S. Surety team was able to maintain good underwriting discipline and achieved a loss ratio of 16.6% for the year even with a decline in net earned premium year-over-year.
Our U.S. Credit business saw increased levels of submissions in 2012 as economic activity increased.
We had 4% premium growth for the quarter and 8% for the year while also reducing our loss ratio versus 2011. Our US P&C segment includes a broad array of business lines, so naturally we have some variation in the results.
On an overall segment basis, our net earned premium growth was flat for the quarter, but increased by 6% for the full year and the loss ratio showed a slight decrease. If we look at the individual components of this segment, Aviation is a competitive market, but similar to surety, we have maintained good underwriting disciplined and improved the loss ratio by 7.5 percentage points for the year.
The E&O premium results were inline with our plan. We continue to be selective in our writings and while we are seeing rate increases more is needed.
Public risk saw 22 points in CAT losses from sandy in the fourth quarter which contributed to the increased loss ratio year-over-year. As discussed last quarter, we are in the process of re-underwriting portions of this book and while it is early days, we are seeing some progress.
In the components of the U.S. P&C segment marked other we have over 15 lines of business including our Sports and Entertainment contingency business which continue to perform well with net earned premium growth of 5% in the quarter.
The other component also includes the three new lines of business we started in 2011, Primary and Excess casualty along with Technical Property. We wrote $57 million of gross written premium in 2012 for these lines and as we would with any new business, we are proceeding cautiously.
Based on current market conditions, we expect to see continued growth in these lines. Chris?
Chris Williams
Thanks, Bill. The International segment had an excellent year with near record results across almost all lines of business.
Although we had catastrophes in both 2011 and 2012, the segment’s net loss ratio improved from 63.4% in 2011 to 45.9% for 2012. Our energy, property treaty and direct and facultative lines all showed major improvements in the net loss ratios over 2011.
International segment contributed $82 million pretax this year which compares to $3 million in 2011. This was another HCC record for this segment.
I promise to update you on the status of our re-underwriting of our DFP line of business in our professional liability segment. DFP’s 2012 net premium was $56 million down from $82 million in 2011.
33% of the business was non-renewed in 2012 and little new business was written. Premiums on renewed business during the year increased on average 15% and deductibles on average increased more than 40%.
Our policies with our maximum limits decreased 40%. These improvements are impressive and we continue to re-underwrite this book into 2013 and beyond.
The professional liability segment’s gross written premium was down 4% for the year when compared to 2011 which principally relates to the reduction in the DFP business. Other than DFP, the US D&O book was down slightly however we are seeing rate improvements in the mid single-digit range mainly in the prime repricing.
Excess pricing continues to remain competitive. Our international D&O gross premium grew 6% in 2012; rates continue to be competitive in the commercial business with some rate increases in the financial institution sector.
Turning to 2013, we estimate that the company will achieve net earnings of $3.20 to $3.50 per share for the year. The estimated results assume net written premium of $2.3 billion, the combined ratio range of 86% to 88% and average shares outstanding of 97 million.
These assumptions 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. Our 2013 guidance assumes a 1% growth in net written premiums.
As you are aware, we exited certain lines of business in 2012 including our HMO and medical excess reinsurance lines. If we exclude the premium written in these lines of business from our 2012 results, our net premium is projected to grow 3% in 2013 on a like-for-like basis.
We are very pleased with the record breaking results we achieved in 2012 with major contributions from all of our insurance segments. We likewise feel that we have good momentum as we move into 2013 and are encouraged by the positive trends that we are seeing.
Prior to opening the call to questions, I want to acknowledge the outstanding contribution John Molbeck has made to HCC. As you are all aware, John stepped down as our CEO on December 19 last year as part of our succession plan approved by our board.
John is leaving HCC with a wonderful foundation that we will continue to build on. I'm also looking forward to continuing to work with John as one of our directors.
With that Bonnie, I would like to open the call to questions.
Operator
(Operator Instructions) Our first question comes from Ryan Byrnes of Langen McAlenney.
Ryan Byrnes
Just had a question on share repurchases kind of looking into 2013. I want to get your thoughts on maybe what percentage of net income you would look at doing especially in light of the fact that you kind of see, I guess, 1% to 3% or 3% exited lines premium growth?
Brad Irick
This is Brad Irick. I think you would see a continuation of our approach to buybacks in 2013, we are opportunistic buyers.
I think you see in the guidance that we are at 97 million shares which imply some continuation of the guidance and we will continue to be buyers as long as we believe the prices below the intrinsic value of the stock and we believe we have a fair amount of headroom there.
Ryan Byrnes
And then quickly shifting gears, I guess, to the D&O segment, in terms of the re-underwriting, I just want to figure out of the DFP book, is that it will continue kind of going forward. Just trying to figure out when we could kind of maybe start seeing some growth in that segment.
I guess in the overall D&O segment, considering, I guess we're seeing rates up kind of a mid-single digits, especially in the primary layers. Just wanted to see where you guys see that line going into 2013?
Chris Williams
Ryan, this is Chris. As you know, the DFP is part of our overall D&O business and Andy continues to re-underwrite that business with significant insurers in the D&O space.
We continue to be but we cautiously watch what’s going on in that market.
Ryan Byrnes
And I guess what type of loss cost inflation are you guys seeing in that line right now? Obviously, there is some large surveys coming out saying that frequencies have been down the non-DFP book with frequency coming down from lack of M&A claims and reverse merger claims stuff like that?
Mike Schell
This is my Mike Schell. The loss environment is pretty stable over the last six months to 12 months.
Over the last three years we have had pretty similar results on our D&O business. The M&A claims have been the principal frequency driver as you stated and there has been less of it in the last six months than there was before that but whether that’s a continuing trend I think it’s too early to say.
The other factor that’s a trend is our claims professionals brief us on continuing increasing legal expenses on typical claims that are filed on D&O. So those two kinds of claims, the M&A claims and the increased legal expense have had a disproportion like larger effect on the primary policies than the excess policies and when Chris talked about us seeing rate increases on the primary and the excess continuing to be competitive that’s the major reason.
Ryan Byrnes
Great and then last one from me, within the exited line I guess that HMO business, when should we see that to stop running through the numbers, it should be in other two quarters or I guess how long should we expect to see those exist lines premium there?
Chris Williams
We have moved that to discontinued line. So it doesn't appear in the A&H sector anymore, it’s now discontinued lines or exited lines, exited lines.
Ryan Byrnes
Sure, but how much longer should we see exist lines producing premium, I guess I just want to figure out, how much longer that can flow?
Chris Williams
We certainly sold the renewal rights of that business and that will taper off over the course of this year.
Operator
Thank you. Our next question comes from Scott Heleniak of RBC Capital Markets.
Scott Heleniak
Just I had a quick question first on pricing, you mentioned 4% price increases this quarter and I think it was 3% last quarter, so is there any particular area where you are seeing bigger acceleration that stands out, I mean, I would assume most of the pricing has moved up a little bit but is there any one, any line that itself moved up a lot?
Bill Burke
This is Bill Burke, where we do see it kind of different places. Chris mentioned, D&O pricing increased that we saw in the fourth quarter which was up from the third quarter, other lines that we are seeing good increases on would be property, marine, the general liability area, EPL just a kind of name certain lines of business where we are seeing, I'll call it better price increases.
Scott Heleniak
Okay, also I had a couple of questions on guidance for you. You definitely clarified with the 3% growth excluding the exited lines but just wondering if there is any other areas that we see pricing was up and probably getting a better benefit from exposure units now.
Is there any other areas where you expect to shrink, I mean as DFP professional liability would that be kind of holding the growth rate down a little bit.
Chris Williams
Look I think a different answer for different lines, if you look at our medical stop loss business last year we saw a 10% growth in that. We've pulled out some other lines as we’ve mentioned, and remember we are focused on our underwriting profit here, the top line is important, but what we view is more important is achieving that mid-85 combined ratio and that's really what we are aiming for.
Scott Heleniak
And then just on the favorable development, the cat loss release, was that related to one specific catastrophe event from 2011 or was it just kind of a true-up at the end of the year.
Brad Irick
It’s a combination of prior year cats, the largest piece was Irene at about $10 million and there's also some Japan, Chile, it’s a few different cats.
Scott Heleniak
And then my last one is just any changes to reinsurance treaties at more and more renewals. I noticed retentions has been trending down so any changes there.
Chris Williams
No, I think we were pleased with the renewal season. I think we replace the covers that we wanted at basically the pricing that we are after.
So I think on balance we were pleased with how the renewals went.
Operator
Our next question comes from Ray Iardella of Macquarie.
Ray Iardella
I don't know if I maybe touched on this before, I actually hopped on the call a little bit late. But just going back to the guidance in terms of the combined ratio sort of doing an apples-to-apples basis relative to 2012, on my math almost seems like you guys aren't looking for any type of underwriting improvement based on the midpoint.
A, is that correct and then B, can you walk me through the moving pieces in kind of how you are thinking about the business, maybe A&H relative to the P&C business.
Brad Irick
Let me start a little bit, I think with 83.6 combined ratio for the year and 3.1 points of favorable development maybe gets you to the 86 to 87 range adjusted for favorable development, and that includes 2.4 points of cats, if you take that out really a sub 85 combined ratio. So as Chris pointed out, we had some strong underwriting results this year and I think we see the opportunities for some improvements, but that's a pretty good place to start.
Chris Williams
It’s a tough starting point Ray starting at mid-80s, but obviously it’s our goal to stay there and improve on it if we can. Specifically to your question about the A&H business, that is a fantastic franchise for HCC as you know, and if you look at that business we see double digit returns on that business which is extremely well run by Craig Kelbel and his team in Atlanta.
Ray Iardella
That's certainly helpful, I appreciate that additional color. I don't know if you touched on this in the prepared remarks, but the development outside of the cats, maybe what was driving that and was there anything in the surety lines of business that you guys can talk about the trends you are seeing there.
Brad Irick
Ray in my comments I'm not sure if you heard them we talked about the $35 million in the quarter, 25 million of which was in the US Surety and Credit segment and 10 million in International. And you have contributions from energy; the energy liability and other lines of business within that segment; and overall very good performance from our businesses and especially in the international segment.
Ray Iardella
And then lastly just sort of on the portfolio strategy sort of going forward, fixed income duration picked up a little bit. Looks like equities rose a little bit quarter-over-quarter.
Assuming some of that was fair value but changes, could you just talk about kind of where you think the best sort of position for the portfolio and your cash flow going forward would be?
Brad Irick
Yeah, I think we feel pretty good about where we are. You are right, there is a slight uptick in the duration, not significant and some of that is offset by the fact that we did put money into equities, in the years of the growth and the fixed income portfolio was a little lower than what would have been otherwise and so that helps us out a little bit.
Obviously there is no duration on the equities. I also mentioned in my comments that we had some sales within the fixed income portfolio.
Some of that stayed in the fixed income portfolios, some of it went in to equities and bank loans. But I think we continue to feel good about where we are duration wise and we will continue to look for opportunities.
I think we’ll expect to have some more investments in equities in the future, but feel pretty good about where we are.
Operator
(Operator Instructions) Our next question comes from Michael Nannizzi of Goldman Sachs
Michael Nannizzi
Just wanted to ask quickly on the medical stop loss business, can you just give us some context on what’s happening in that line changes on the healthcare side, impact positive or negative, just some flavor on the risk and opportunities there for 2013 and then just one follow up if I could thanks.
Chris Williams
Sure. As you know it’s not part of the affordable healthcare act as it sits and so we have seen some great opportunity in this line of business.
I think to give you some color for that at 1-1 that’s a major renewal date as a lot of employers’ health plans renew then. And our renewal retention to new business was just about right on the mark.
So we are guardedly optimistic, I think it’s a great line of business for us, it’s very well ran and we continue to monitor the space.
Michael Nannizzi
Some notes payable lifted a bit in the quarter, I didn’t see any specific mention of buybacks. Do you repurchase some shares in the fourth quarter and then kind of put those on the credit line or.
Brad Irick
Yeah that’s right. We did have about 1 million shares that we purchased about $37 million in that.
We are continuing to use the revolver to fund that.
Michael Nannizzi
And do you anticipate at some point just given the rate environment that you will some turn some of that out. I know you guys have done that in the past.
Brad Irick
Decision to be made in the future. Certainly it would be one of the things we consider.
Operator
Our next question comes from Brian Pirie of Sansome Partners.
Brian Pirie
I wanted to ask about the public risk segment, could you give us more color on what you feel was going wrong in that segment and what you are hoping to accomplish with the underwriting and re-underwriting?
Bill Burke
Sure. We write a cross section of business there, we write business in the Midwest in a couple of different areas.
I know we write some east coast business. Obviously, as I mentioned this particular this past year, the fourth quarter was impacted by the cats that we had from Sandy.
The business has been - the municipality environment has been challenging, I suppose is the right word from an economic perspective over the last few years, based upon just the tax base and the economic problems, and so that's caused I think some of the issues that we have in that area. We are in the process of looking at the areas of that business that we are not getting the return, that we would we like, and we are pushing rates, we are pushing deductible increases, if there are certain areas, and certain types of public entities that we may find ourselves not seeing that we can get the rate and we will move up off of those and look for the areas where we can get the rate.
Brian Pirie
And so it doesn't sound like it’s an issue of more competition getting into those lines, it’s just something in the environment; something in economic environment has changed the risk return of the underlying exposure?
Bill Burke
Well, I think it is the combination of insurance business is a competitive business, and there is competitors others competitors that write the public entity space, and so that certainly is a factor in certain of those classes of public entity business.
Brian Pirie
Okay and I ask you some more question about the HMO reinsurance. I was wondering for both the exit lines, could you just talk about what changed in your view of those lines and what caused you to move them to exit lines and sell off the renewal rates.
Chris Williams
I mean they are lumpy businesses. I think Craig and his team did a great job on the Medical Stop Loss side.
What we found the HMO experience bounced around significantly. They are very good buyers of reinsurance, and that wasn’t something that we felt was scalable and more importantly give us the consistent returns that we want.
As you know we are underwriting focused and we are trying to hit that mid-85 combined ratio, and some of these businesses don't allow us to do it. So we exited the medical excess is very small and quite a similar comment and that was very lumpy as well, could jog along, I am going to be fine and then all of a sudden there’d be some sharp losses and the experience that goes sideways.
So we elected to move out of those.
Operator
At this time there are no further questions. I will turn the call back over to management.
Chris Williams
Thank you, Bonnie. We had a great quarter and a great year, and I want to thank all of the HCC staff for the wonderful contribution they made in 2012.
We are looking forward to the next quarter and to your participation on the call. Everybody have a great day.
Thank you.
Operator
Thank you. This concludes today's conference call.
You may now disconnect.