Feb 12, 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.
Chris Williams
Welcome everyone to our year end conference call. Joining me today is Bill Burke, our President; Brad Irick, our Chief Financial Officer; Craig Kelbel, President of HCC Life; and Executive Vice President, Mike Schell.
Brad will follow my initial remarks with financial highlights, followed by Bill and Craig, who will give some commentary on the quarter and the year. At the beginning of 2013, we indicated that it would be business as usual for HCC as we moved into 2013 and beyond.
I am very pleased to report that we have delivered on this commitment. As we complete our 40th year, the consistency of our various businesses is the very core of our company.
HCC had a terrific quarter and year with all of our businesses performing at or above their expected levels. We had another record net earnings and earnings per share in the fourth quarter as well as for the full year.
Our net earnings for the quarter were $115 million, or $1.14 per share compared to $108 million or $1.06 in 2012. Net earnings were $407 million for 2013 or $4.04 per share compared to $391 million or $3.83 per share for 2012.
Our return on average equity for the year was 11.3%, which compares to 11.5% in 2012. As we have previously mentioned, our goal is 10% above the risk-free rate, which we have once again achieved.
We also declared dividends of $0.78 per share in 2013, up 22% from $0.64 in 2012. Our combined ratio was 81.2% for the quarter versus 84.5% for the fourth quarter of 2012.
Our combined ratio was 83.4% for the year consistent with 83.6% for 2012. These results highlighted our continued focus on underwriting margin and expense management.
Our fourth quarter results include pretax accident year net catastrophe losses of $7 million. Last year, the fourth quarter included $33 million of cat losses mainly from super storm Sandy.
For full year 2013, our net catastrophe losses $52 million pre-tax or $0.34 per share essentially equal to 2012. Our 2013 paid loss ratio was 56.5% compared to 56.7% for 2012.
Brad will now review with you additional financial highlights.
Brad Irick
Thanks Chris. Net investment income in the quarter was $55 million, a decrease of 3% from the prior year.
For the full year, net investment income was $220 million, a decrease of 1%. Key investment metrics included book yield of 3.6% or 4.5% on a tax equivalent basis, which is unchanged from the third quarter.
Our fixed income portfolio remains high quality with an overall rating of AA and the duration of roughly five years. Our equity allocation stands at 8% and delivers a dividend yield of 4.1%.
While we don’t anticipate significant additions to the allocation in 2014, we have been very pleased with this portfolio’s performance since its inception in 2012. The investment markets remain volatile in the wake of tapering and continued concerns over the strength of the U.S.
and world economies. We will continue to follow the markets and invest our cash flow prudently to achieve our long-term objectives to grow operating earnings and book value per share.
This quarter we completed reviews of our reserves of the A&H and U.S. Surety and Credit segments and recorded net favorable development of $18 million for A&H and $28 million for U.S.
Surety and Credit. Based on our review we remain comfortable with the level of reserves on a segment and consolidated basis, which are approximately 4% above the actuarial point estimate at year end 2013.
Before I review reserves, a quick update on the standard surety matters we discussed in our last call. First, we have made no adjustments to our estimates of ultimate losses with respect to these claims.
Second and more importantly, we made substantial progress in November and December in settling claims resulting in gross payments of nearly $140 million. As expected, these payments significantly impacted fourth quarter cash flow, which I will discuss further in a moment.
We are in the process of collecting approximately 60% of these payments from our reinsurers. We expect to finalize additional settlements in the first quarter 2014 and remain focused on resolving majority of these matters in the first half of 2014.
This situation is dynamic, but we are pleased with our progress and believe these matters will be resolved in line with our current expectations. We will update you further on our first quarter call.
Full year cash flow was $263 million, which was reduced by previously disclosed the U.S. Surety collateral repayments of $122 million and the Spanish Surety claims payments mentioned previously.
Liquidity remains strong with $239 million of capacity under our credit facility and $237 million of short-term investments and cash. Overall, we are very pleased with our financial performance for the quarter which included ROE of 12.7% and growth in book value per share excluding AOCI of 2.7% and for the full year with ROE of 11.3% and growth in book value per share excluding AOCI of 10.2%.
Bill?
Bill Burke
Thanks Brad. Our fourth quarter 2013 performance continued in the positive mode that we saw all year as shown by our over 6% growth in net earnings.
For the 2013 year, we achieved a combined ratio of 83.4% maintaining our low expense ratio of 25.8% and achieving a favorable 57.6% loss ratio. On an accident year basis, our loss ratio was also favorable at just under 61%.We are continuing to see rate increases in many lines of business across all of our segments and we achieved an average rate increase in the low single-digits in the quarter, which is relatively consistent with what we achieved for the year.
As we have discussed on previous calls, while rate is important we are focused on underwriting to achieve mid-80s combined ratio, so account selection, deductible and attachment point and coverage terms are equally more important to us. The retention rate across all segments remained the same as prior year at 84%.
Looking at specific segments. In professional liability, we have been able to achieve mid single-digit rate increases led by our U.S.
business. At the same time, we are managing our exposure carefully.
We are pleased that we are able to increase our 2013 earnings for this segment driven by a 5 point improvement in loss ratio to 53%. Our U.S.
surety team continued to increase gross written premium achieving 6% growth in the fourth quarter and 4% growth for the full year. In addition, they had a 5 point improvement in loss ratio to a very positive 12% for the full year.
Our U.S. credit business continued to perform well as shown by their 14% loss ratio for 2013.
Our U.S. P&C segment capped off a strong 2013 with a significant increase in net earnings driven by an 11 point reduction in the loss ratio helped by favorable development and lower caps.
If we look at the individual components of this segment, aviation remains a very competitive market, but we continue to maintain good underwriting discipline and achieved a loss ratio of 55% for the year. We continue to be selective in writing E&O and public risk and the premium results were in line with expectations.
In the other components of the U.S. P&C segment, we continue to have strong net earned premium growth driven by primary and excess casualty, sports and entertainment disability and title.
International’s accident year loss ratio for 2013 was very positive at 50%. The loss ratios continued to be particularly good for our energy, UK professional indemnity, and property businesses.
We are pleased with the results of the ongoing businesses within the international segment. For the segment, gross written premium increased by 3% while net earned premium was flat for the year.
Craig?
Craig Kelbel
Thanks, Bill. Overall, A&H segment’s gross written premium for the quarter increased $17 million or 8% over the fourth quarter of 2012.
For the full year, gross written premium increased $47 million or 6% compared to 2012. Our medical stop loss product, which represents over 90% of the segment’s gross written premium, experienced these key results for 2013.
The effective rate increase, which is a measurement of deductible and coverage changes, was 22.9% in the fourth quarter compared to an actual trend needed on that business to keep pace with medical inflation of 14.7%. For the full year, the effective rate increase was 17.2% compared to an actual trend needed of 16.4%.
The A&H segment’s 2013 combined ratio of 86% outperformed our 2013 plans and produced $127 million in pre-tax income, an increase of 12% over 2012. For the full year of 2013, the average employee lives per group was 471 compared to 432 last year.
In addition, the average specific deductible written at 2013 increased 12% to 96,700 compared to 86,100 in 2012. The market remains competitive, but stable.
Most of our competition continues to come from direct writers with no noticeable change in 2013 compared to 2012. Related to business written this year, 78% of the gross written premium comes from our in-force business, which added premium persistency of 82%.
The remaining premium comes from new business, which is consistent with our 2012 results. Early analysis of our one-one 2014 business indicates we are on track with our expectation to grow premium 4% to 5%, employer groups received to quote on for one-one of 2014 effective days, increased 10% over one-one of ‘13.
We have seen no impact on our operations from the Affordable Care Act to-date and we continue to believe it may have a positive impact by increasing the number of self insured lives in 2014. Chris?
Chris Williams
Thanks, Craig. Once again, our non-correlated lines of business, was combined to produce an excellent result for our shareholders.
We remain disappointed with the findings of the Spanish courts regarding the cooperative housing surety bonds, but we are pleased with the progress we have made to-date. Many of the claims are still in litigation and as such we are unable to comment on the details of any specific claims.
We are pleased with our renewal of our various reinsurance treaties at year end. Our panel of long standing reinsurers provides us with competitive terms and we expect similar terms with several programs yet to renew.
We are starting to see the uplift in some lines of business with higher employee counts and higher account activity as the economy appears to be slowly improving. Likewise, we are fortunate to have several non-cyclical lines of business that performed in very acceptable levels regardless of market conditions.
As we mentioned in our third quarter call, we are no longer providing explicit earnings guidance. We believe the consistency of that results and the transparency of our public filings provides sufficient information for investors and analysts to develop projections about future performance.
We remain committed to this transparency and the direct communication our investors have come to expect. We remain opportunistic buyers of our stock and with the recent volatility in the market, we have purchased around 0.5 million shares at an average price of $41.87 since the beginning of the year through the market close last night.
We would now like to open up the lines for questions.
Operator
(Operator Instructions) Our first question comes from Mike Nannizzi of Goldman Sachs.
Mike Nannizzi
Thanks. Just I was wondering if we can get a little bit more detail on the development, I have thought maybe I will repeat down along that you said $28 million in medical stop loss, $18 million in the surety business, were those the right numbers and if so what were the other segments if that’s possible?
Hello?
Brad Irick
Within the U.S. Surety and Credit $17 million is surety and $11 million is credit.
The balance of the number to get to $34 million in the press release is various adjustments across multiple line none of which are particularly material.
Mike Nannizzi
Okay. So it was $28 million in Surety and then it was – and then $18 million in medical in the A&H line?
Brad Irick A&H and most of that is as you would expect to the medical stop loss line.
Mike Nannizzi
Got it. And then we had heard from others that there were some raising of recent action in your loss picture in that U.S.
professional liability business. Have you seen any adverse trends or anything of that nature in your book?
Mike Schell
This is Mike Schell we have not seen any adverse trends on our book.
Mike Nannizzi
Okay great and okay that’s all my questions. Thank you.
Operator
Our next question comes from Ryan Byrnes of Langen McAlenney.
Ryan Byrnes
Hi, great thanks. Just had a quick question on the expense ratio uptick, were there any one-timers there, I know FX can be an issue as well just want to see what was going on there?
Chris Williams
Yes. Sure, Ron this is Chris Williams.
Good morning, the increase in queue in the last quarter was principally in regard to compensation and that is tied into the fact that we had such a stellar 2013. And what I would ask you to do is to look at big picture and if you look at the full year expense ratio of 25.8 that’s very consistent with where we've been just really takes into account that we had a very strong year.
Ryan Byrnes
Okay, great. And then I mean can you guys give details on the amount of Spanish surety claims that you guys have in currently and which ones are closed?
Brad Irick
This is Brad. As we said in the last call, we are not giving more details on numbers of claims.
It’s an active litigation environment that we are dealing with. I think the data that we provided in this call gives you a good sense of where we stand today and the best that I can provide you is that we are comfortable with where our reserves are no adjustments.
And as Chris said, we are pleased with the pace of settlement.
Ryan Byrnes
Okay, great. And then just my last one is obviously you guys grew net premium written by under 1% this past year.
And then I look at the buyback or sort of the payout ratio of dividends and buyback and it’s only a 35%. I just want to get your thoughts on how we should think about capital management versus growth going forward?
Chris Williams
Yes, Ryan, this is Chris again. I mean, we obviously continue to look at it.
We would like to think there were some M&A opportunities out there that we can we pounce on, but again we haven’t seen anything that’s going to give us the top of return that you guys have come to expect. I think our endeavors in the new lines of business, has started to bear some fruit.
We are very pleased with those lines of business. The primary casualty as an example is very much going in the right direction.
We did increase the dividend last year as you know. And as you heard in my opening remarks, we have bought back a little bit of stock this year.
So we continue to monitor. We remain opportunistic buyers of that stock and we will revisit the dividend in the Q3 this year, which is where we normally go over that with our board.
Ryan Byrnes
Okay, great. Thanks for the answer guys.
Operator
(Operator Instructions) Our next question comes from Scott Heleniak of RBC Capital Markets.
Scott Heleniak
Good morning. Thanks.
Just wondering the first question, just do you have any earlier read on the January storm loses so far any sense of how those claims are coming in so far?
Chris Williams
Yes, Scott, this is Chris again. What we have seen so far is all within our attritional loss ratio.
So we haven’t seen anything to-date that’s given us any particular pause.
Scott Heleniak
Okay. So nothing significant I guess from the January 3 or the 5 warrant?
Chris Williams
No.
Scott Heleniak
Okay. And then just talking about the international growth, which was up pretty nicely, just wondering if you could touch more on that, you guys mentioned the mix a little bit, it’s in the release, but is that driven – is that geographic expansion or new teams or I don’t know if you can touch on that a little bit more just kind of what’s going on there?
Chris Williams
Yes. Different answers, Scott for different lines of business.
I mean, as you know not all of our businesses match exactly with the cycle. So I think probably the accurate answer is we are opportunistic.
Craig’s business saw some very nice growth last year. As Bill Burke mentioned, our disability business as an example had very good uptick this past year.
So it’s really different pockets of business that are giving us different results. And again, I think it shows the importance of having a non-correlated book of business such as we do, because all of them aren’t going to be going up and all of them aren’t going to be going down.
Scott Heleniak
Sure, okay. And then just had a question just on pricing, you mentioned there is positive request, but is there any lines where pricing is actually flat or declining, I mean, assuming property is a little bit weaker, but you are actually seeing declines on that part of the book?
Bill Burke
This is Bill Burke. There are certainly lines, where we see pricing under pressure.
And on a quarter-over-quarter basis, we would have seen some rate reductions. Some of the international lines, property treaty certainly would be an example of that, where we saw some reductions, so yes.
Scott Heleniak
Okay. And then just one follow-up on that, the A&H, it looks like the rate increases, the effective rate increases ticked up a little bit throughout the year and is that just a function of improving demand you are able to get to higher rate increases or I don’t know if you can talk about why that’s trending up compared to beginning of the year?
Craig Kelbel
This is Craig Kelbel. I think you see the effective rate being increasing a little bit more rapidly in the last part of the year and employers are choosing to buy higher deductibles, therefore it actually makes the risk, a better risk from our perspective.
So it drives the effective a bit higher rather than them accepting a rate increase.
Scott Heleniak
Okay. Yes.
Thanks, guys. Alright.
Thanks for the answers.
Chris Williams
Thank you.
Operator
Our next question comes from Bob Farnam of KBW.
Bob Farnam
Hi there, most of my questions have been answered. I guess the one I had was the minimum amount of catastrophe losses during the quarter.
Was that in the International segment?
Chris Williams
It was across the board, Bob. We have a little bit of CAT exposure obviously in some of the business that we write in the U.S.
but it was international and domestic.
Bob Farnam
A pretty even split between the two?
Chris Williams
Yes.
Brad Irick
Mostly international.
Chris Williams
Mostly international, I think probably of the $7 million about $5 million international and about $2 million domestic.
Bob Farnam
Okay, very good. That’s it from me.
Thanks.
Chris Williams
Thank you.
Operator
Our next question comes from John Thomas of William Blair.
John Thomas
Hey everyone. The U.S.
property casualty other segment, the profitability has been very strong for many years now and you’ve had great growth, but the net written premium retention keeps declining. Is there any plans to increase the retention in the future given the strong profitability in that segment?
Bill Burke
This is Bill Burke. That segment has a fair number of lines and it’s got about 15 plus lines of business in it.
It does have our new lines of business that we started back in 2011 and 2012 and where we saw growth in this past year was coming out of the primary casualty. I think as we’ve discussed in years past our plan with new lines of business would be to buy a fair amount of reinsurance at the beginning of those lines and then once we get comfortable with them to start to cut back on that.
So it just depends on where the business growth is coming from, some lines of business we will always continue to buy a fair amount of reinsurance and so you’ll see a big difference between the gross and the net, other lines will – like our – some of our new lines you will see us change that over time.
John Thomas
Alright, thanks. And then in the public risk segment, what has been the driver of the elevated loss ratios in the past three years?
Bill Burke
Again, this is Bill Burke. The public risk business as we went through the economy, economic problems over the last few years, municipalities clearly were struggling with their own budgets which were then causing some of the exposures to potentially expand.
So we’ve been addressing that in our book of business and we’re going in the right direction I believe.
John Thomas
Thank you very much.
Operator
Our next question comes from Brian Pirie of Sansome Partners.
Brian Pirie
Good morning gentlemen. Congratulations on a great quarter.
Chris Williams
Thanks, Brian.
Brian Pirie
I’m wondering if you could comment on the international others segment and where you may have been cutting back in that segment?
Chris Williams
International other, that’s a bucket of various lines of business, some of them have been growing, some are shrinking. I think A&H is in the other there that is grown slightly.
We had a direct and facultative book which we’ve been reducing as that market has been fairly competitive. We had a small book of casualty business there that that’s also reduced.
So it’s a bit of a mixed bucket as we continue to track each of those different lines.
Brian Pirie
Okay. And I understand you’re not giving CAT loss guidance anymore.
It’s not a huge number for you, but can you say directionally is your appetite for writing catastrophe exposed business increasing about the same, increasing..
Chris Williams
You probably extract this out of me, Brian is what I tell you is directionally it is going to be very consistent with where we’ve been over the last few years. You shouldn’t think there is going to be any major variation from that.
Brian Pirie
Okay. And last question policy acquisition costs were a little higher than I expected just on a percentage basis.
Do you have any comments on policy acquisition cost in the fourth quarter?
Chris Williams
Just mix of business, there was nothing there that gave us any particular pause, it’s just this –the particular lines, we run more often in that particular quarter.
Brian Pirie
Okay, thanks gentlemen. Congratulations again.
Chris Williams
Thank you very much.
Operator
Our next question comes from Kenneth Billingsley of Compass Point.
Kenneth Billingsley
Good morning.
Chris Williams
Hey, Ken.
Kenneth Billingsley
I wanted to just follow-up and I believe your comments on that the ACA has not presented any business opportunities for you? And just a follow-up from that if that is correct with the uncertainty that continues to surround if you see opportunities expanding your customer base even in the smaller account.
Craig Kelbel
This is Craig Kelbel. I would say the ACA doesn’t impact us in a negative way.
There is opportunity as more employers consider self funding is a good financial tool for their healthcare cost and expenses. So, we actually think that will be more employers which will look to it because of some of the taxes that are associated with the Affordable Care Act for fully insured plan.
So, as we – as I pointed out in my remarks, we’ve seen our activity increased by 10% January over January. So, we would expect that kind of activity to continue throughout the year.
Kenneth Billingsley
And are you getting any commentary back from your customers regarding the fact the uncertainty with regulations and the fear they could be changing at the last minute is helping to keep customer retention or is it really having no effect.
Craig Kelbel
I think at the moment it really has very little effect on decisions that employers are making most employers continue to believe that providing sponsored healthcare benefits to employees is important to them and so, they continue to look for other ways and which to financially fund that liability and self funding clearly represents an advantage over the fully insured.
Kenneth Billingsley
Great, thanks for taking my questions. Congratulations on the quarter.
Craig Kelbel
Thanks, Ken.
Operator
(Operator Instructions) Our next question is a follow-up from Mike Nannizzi of Goldman Sachs.
Mike Nannizzi
Just a quick one on the product, did you utilize a credit line to fund the buybacks so far year-to-date.
Brad Irick
Mike, this is Brad. Yes, that’s been our practice in the past and we expect to continue that.
Mike Nannizzi
And any thought about, because I know in the past you built up the credit line and then termed it out, any thought on if or when or what size of outstanding credit line you might consider terming out that credit line?
Brad Irick
Absolutely. We look at the lot of different things I’d say that right now, we don’t think that’s the right mix, but we look at those things and watch the markets and make their decisions as we go on.
Mike Nannizzi
Got it. And then just one question on reinsurance, so it looks like the ceding percentage is higher and not just international, but, like U.S.
P&C for example and a pretty decent amount, is it your – is that just a reflection of your ability to secure more economic reinsurance costs or the business you’re riding and just kind of locking your results and with the little bit more specificity or if so, I mean should we expect you to run it at a higher ceding level if reinsurance cost remain kind of where they are or is that just more of a kind of back half of the year situation? Thanks.
Chris Williams
Mike, this is Chris. Look it’s mix of business.
I mean, we have got some lines of business that we buy significant amounts of reinsurance, others we buy lesser amounts. As Bill Burke mentioned when we start new lines of business we generally fairly large buyers of reinsurance that we then ease back on as our comfort level of the business growth so, it’s really mix of business that we are opportunistic clearly, but it really depends on the line of business is to what our plans are with the individual lines.
Mike Nannizzi
Got it, great. Thank you.
Chris Williams
Thank you.
Operator
Our next question comes from Robert Paun of Sidoti & Company.
Robert Paun
Good morning.
Chris Williams
Good morning, Robert.
Robert Paun
Can you just talk about the investment strategy going forward? Were there any changes as far as asset allocation or duration in the bond portfolio and where you’re seeing opportunities to invest the new cash flow?
Brad Irick
Hi, this is Brad. No significant changes from what we talked about in the third quarter.
I think in the third quarter, I mentioned that there were on the margins we were looking for opportunities to find floating rate securities low to no duration security. So, we have done that in anticipation of higher rates.
You have seen that our equity portfolio that we initiated in 2012, we have grown that sum to about 8% of the portfolio. We are pretty comfortable at that level and probably we keep it at that level for now.
The muni space generally performs well on a rising rate environment. We have continued to find good value in the – for the muni space.
Robert Paun
Okay, thanks that’s helpful. That’s all I have.
Operator
At this time, there are no further questions. I will now turn the call back over to Mr.
Williams.
Chris Williams
Thanks, Bonnie. HCC, we had a wonderful quarter in a year and I want to thank our almost 2,000 employees around the world for making it a record for us.
We look forward to reporting the next quarter’s earnings and your participation on the call. Everyone, have a great day.
Thank you.
Operator
This concludes today’s conference call. You may now disconnect.