Cna Financial Corp Q1 FY2020 Earnings Call

Good morning and welcome to the CNA's discussion of its 2020 First Quarter Financial Results. CNA's first quarter earnings release, presentation and financial supplement were released this morning and are available via its website www.cna.com. Speaking today will be Dino Robusto, CNA's Chairman and Chief Executive Officer; and Al Miralles, CNA's Chief Financial Officer. Following their prepared remarks, we will open the lines for questions. Today's call may include forward-looking statements and references to non-GAAP financial measures. Any forward-looking statements involve risks and uncertainties that may cause actual results to differ materially from the statements made during the call. Information concerning those risks is contained in the earnings release and in CNA's most recent SEC filings. In addition, the forward-looking statements speak only as of today, Monday, May 4, 2020. CNA expressly disclaims any obligation to update or revise any forward-looking statements made during this call. Regarding non-GAAP measures, reconciliations to the most comparable GAAP measures and other information have been provided in the financial supplement. This call is being recorded and webcast. During the next week, the call may be accessed on CNA's website. If you are reading a transcript of this call, please note that the transcript may not be reviewed for accuracy, thus it may contain transcription errors that could materially alter the intent or meaning of the statements. With that, I will now turn the call over to CNA's Chairman and CEO, Dino Robusto.

Thank you, Jennifer. Good morning. It is very good to be with you today and I hope you and your families are coping well in this difficult time. As our nation and the world address the challenges brought by COVID-19, I am honored to be a part of an industry that continues to meet its commitments and provide some certainty in these uncertain times. During this crisis, our industry will be resilient and remain a strong factor in the recovery of the U.S. and world economies. On behalf of all of our employees, CNA acknowledges and thanks our first responders and healthcare workers for the selfless and courageous efforts they advance every day, and we are grateful for all essential workers who continue to go to work each day providing key services and goods we all depend upon. I am grateful to CNA employees who have embraced this new work environment and continue to manage our business and operations effectively. I would also like to acknowledge our government leaders across the nation, who are working tirelessly to keep our citizens safe in response to this pandemic. We will now turn to the quarter results, and following that I will add my early thoughts on how the industry issues surrounding COVID-19 relate to our portfolio. Our first quarter results continue to reflect strong underwriting performance, accelerated price increases, and robust growth in our U.S. operations, offsetting the strong underlying underwriting performance where losses are in our investment portfolio due to the economic impacts of COVID-19. Core income for the quarter was $108 million or $0.40 per share. The P&C combined ratio for the quarter was 97.5%, catastrophe losses were $75 million pretax, which included $13 million due to COVID-19. The underlying combined ratio was 93.9% to reflect one point improvement from the first quarter of 2019. The underlying loss ratio was 60.4% in the first quarter, which is a slight improvement from the first quarter of 2019. The expense ratio was 33.1% in the first quarter. This is a little more than a half a point lower than both Q4 and the prior year quarter and is largely due to stronger net earned premium. As we have discussed in prior calls, one tenet of our strategy has been to hold the numerator and the expense ratio flat even while we invest in talent, technology, and analytics and leverage growth to reduce the ratio. The strategy has continued to positively impact our results while positioning us well for the future. Gross written premium growth ex-captives in the U.S. was plus 8% for the quarter. Net written premium growth was plus 6%. For P&C overall, the gross numbers were plus 6% and plus 3% respectively, both of which were impacted by the re-underwriting in international, which as we have mentioned before will be largely completed this year. Gross written premium growth was plus 2% in our Specialty segment ex-captive. Strong growth in financial institutions and management liability was largely offset by underwriting actions in our aging services portfolio. Commercial gross written premium growth was very strong at plus 14%. Our International segment had gross premium decline of 5%. Our rate and retention dynamic is exactly as planned. We are achieving the strongest level of rate increase in parts of our portfolio that are in the most need of rates, and our retention is strongest in the most profitable cohorts of our business. Rate increases were 8% in the quarter, up one point from the fourth quarter. This continues the pattern of stable growth and rate increases over the last two years, and we are very happy to see the continuation of larger rate increases in virtually all segments. Retention was 82% this quarter, two points lower than the fourth quarter largely due to our international aging services strategy, while new business in the quarter grew by 3% year-over-year. I have periodically emphasized our success at recruiting top talent, and this was particularly true in the first quarter. In addition to our new CFO, Al Miralles, who I will introduce shortly, you will have seen our press releases over the past few months because we named Bob Hopper to be our next Chief Actuary and Daniel Franzetti to be our new Chief Claims Officer; both are top industry veterans with deep expertise in their respective fields. We are also pleased to highlight that Mahmood Khan has joined us as our Chief Information Security Officer and brings more than 20 years of experience in cybersecurity within the cloud application security space. Turning back to Al, I want to welcome him to our analyst call. You will recall that we announced that Al Miralles had moved from being our Chief Risk Officer to being our CFO. In addition to his CRO expertise, Al has a strong background in investments and finance, and he's also managed our runoff long-term care business for several years. Having worked with us since I arrived at CNA, I am confident you will value interfacing with him. And with that, Al will provide more detail on our segment results, as well as our investment results.

Thank you, Dino, and good morning everyone. I am happy to be here today and assume the CFO role at CNA. Clearly, these are interesting times to step into the position, and the experiences I have had overseeing investments in treasury have prepared me for this challenging period. Our Property & Casualty operations produced core income of $122 million in the first quarter. Pretax underlying underwriting profit was $107 million. This was the fourth successive quarter with a pretax underlying underwriting profit mix of $90 million. The P&C combined ratio was 97.5% this quarter, which includes 4.3 points of catastrophe loss and favorable prior period development of 0.7 points. Our catastrophe losses included the impact of COVID-19, which amounted to $13 million pretax or 0.7 points of loss ratio within our catastrophe losses. The underlying combined ratio was 93.9%, marking the sixth consecutive quarter of an underlying combined ratio below 95%. The underlying loss ratio was 60.4% and the expense ratio was 33.1%. In terms of our operating segments, the combined ratio for Specialty was 91.3% this quarter. This is a one point improvement compared to the first quarter of 2019. The combined ratio includes favorable prior period development of 1.5 points and 1.1 points from catastrophe losses. The favorable prior period development is largely driven by favorable outcomes emerging predominantly for accident years 2017 and prior. The underlying combined ratio for Specialty was 91.7% this quarter, 1.8 points of improvement compared to the first quarter of 2019. The underlying loss ratio was 59.5% and the expense ratio was 32%. Expense ratios improved by 0.8 points compared to the first quarter of 2019 largely due to growth in net earned premium. The gross written premium growth ex-captive was 2% in Specialty for the quarter and was negative 1% on a net written basis. Rates continued to increase at 9%, up from 8% last quarter. Retention was 84% this quarter, which was down a point compared to prior quarters and down four points compared to the full year 2019. This is largely due to a drop in retention in our healthcare business relating to aging services. New business volume is down in the quarter and largely due to healthcare. The combined ratio for Commercial was 101.9% this quarter. This is 0.6 points higher than the first quarter of 2019. The combined ratio includes seven points of catastrophe loss and negligible prior period development. The catastrophe losses are largely due to two events, including the Michael Tornado in early March and the storms across Arkansas, Missouri and other states in late March. The underlying results are very strong on multiple fronts for Commercial, as the underlying combined ratio was 94.9% this quarter, 1.6 points of improvement compared to the first quarter of 2019. The underlying loss ratio was 61.1% and the expense ratio was 33.2%. The expense ratio improved by 0.6 points compared to the first quarter of 2019 and the loss ratio improved by four points. Gross written premium growth ex-captives is 14% in Commercial for the quarter and net growth was 12%. The rate change was particularly strong in the quarter at 8%, up about three points from the last quarter. Retention was a healthy 85%. New business growth was quite strong again this quarter at 21%, broadly distributed across our target market segments. The combined ratio for International was 99.9% this quarter, which is a two point improvement compared to the first quarter of 2019. The underlying combined ratio for International was 95.7% this quarter. The underlying loss ratio was 60.3% and the expense ratio was 35.4%. The expense ratio improved by approximately two points compared to the first quarter and full year 2019, largely due to lower acquisition costs. The gross written premium declined by 5% in International for the quarter, while net written premium declined by 15%. The large differential between gross and net change is due to the timing of reinsurance treaty renewal. Rate change was strong again this quarter at 8%. Retention was 72% this quarter, which is consistent with most of 2019 reflecting our re-underwriting strategy. Our Life & Group segment produced $4 million of core income in the quarter. These results and the underlying drivers were consistent with our breakeven expectations. Finally, our Corporate segment produced a core loss of $18 million in the first quarter. Pretax net investment income was $329 million in the first quarter compared to $571 million in the prior year quarter. The change was primarily driven by our limited partnership and common equity portfolios, which produced pretax losses of $125 million compared to pretax income of $96 million during the same period last year. Pretax net investment income from our fixed income portfolio was $449 million for the quarter compared to $465 million in the prior year quarter. The pretax effective yield on our fixed income holders was 4.6%, and this portfolio continues to provide stable earnings. Additionally, pretax investment losses for the quarter were $260 million compared to a $31 million gain for the prior year quarter. These losses were primarily driven by the mark-to-market of our non-redeemable preferred stock investments in addition to credit impairments of certain fixed income holdings. Our unrealized gain position on our fixed income portfolio stood at $2.1 billion at the end of the quarter, down from $4.1 billion at year-end. The change in unrealized gains was primarily driven by the broad increase in credit spreads across the market, predominantly impacting the value of our corporate bond holdings. While we hold a diversified fixed income portfolio with an overall A credit rating, the significant deterioration across markets adversely impacted our portfolio value during the month of March. As these markets have shown signs of stability in April, credit spreads have broadly declined, positively impacting the value of our fixed income portfolio. As of the end of April, the unrealized gain on our fixed income portfolio increased by approximately $900 million on a pretax basis to nearly $3 billion. Likewise, rebound in the broader market has increased the value of our limited partnership, common equity, and non-redeemable preferred stock investments. Fixed income supports our P&C liabilities with an effective duration of 4.1 years at quarter end in line with our portfolio targets. The effective duration of the fixed income assets that support our Life & Group liabilities was 8.7 years at quarter end. Slides 14 and 15 in the earnings presentation will provide you additional details of the investment results and the composition of the investment portfolio. Our balance sheet continues to be extremely strong. At quarter end, shareholders' equity was $10.4 billion or $38.18 per share. It reflects both a decrease in our unrealized gain position and the payment of a special dividend during the quarter. Shareholders' equity, excluding accumulated other comprehensive income, was $11.4 billion or $42.12 per share, a decrease of 1% from year-end 2019, adjusted for the $2.37 in dividends per share paid during the quarter. We continue to maintain a very conservative capital structure and a low leverage ratio with a well-balanced debt maturity schedule. At quarter end, all of our capital adequacy and credit metrics remain above target levels supporting our credit ratings. Slide 12 of the earnings presentation provides additional information on our balance sheet metrics. In the first quarter, operating cash flow was $212 million. In addition to our positive operating cash flow, we continue to maintain liquidity in the form of cash and short-term investments, and we also maintain ample liquidity within our investment portfolio and have access to both our revolving credit facility and an FHLB line of credit. I will remind you that our long-term care policies should not have any cash value and thus policy surrenders do not constrain our liquidity position. Overall, our liquidity position remained strong, with positive operating cash flow and sufficient liquidity holdings to meet obligations and withstand significant business variability. Slide 13 of the earnings presentation provides additional detail with respect to our liquidity profile. I am pleased to announce our regular quarterly dividend of $0.37 per share. With that, I will turn it back to Dino.

Thanks, Al. Before we move to the question-and-answer portion of the call, let me provide some perspective on the pandemic and our portfolio. The claim notices we have received to date are mainly business interruption notices related to our property forms. Let me start here. Our property policies require direct physical damage to the property from a covered peril for coverage to attach, and our property policies, whether issued in the U.S. or international, all have exclusions barring coverage for viruses. There are a very few policies where coverage may exist on small participation in our Lloyd's operation, but the total limit exposed is de minimis. With respect to business interruption, the property policy exclusionary language does not provide coverage for COVID-19, and as such we never collected a premium for it. Now, let me turn to an area that I have commented on during several of these calls, aging services. I want to first remind you of the composition of our book. Our aging services portfolio is predominantly a medical malpractice professional liability book with some property coverage and a small amount of auto. Importantly, we write essentially no workers' comp coverage. It is less than 1% of our work comp premium volume and it is written over a very large deductible. This is also true for our broader healthcare business beyond aging services, which is also a professional liability portfolio with minimal workers' comp exposure to frontline healthcare providers. Additionally, we don't write coverage for first responders. Moreover, regarding aging services, as I have said on prior calls, we have been working for some time to obtain the right terms and conditions for the exposures, and we have walked away from accounts when we could not achieve them. Our current professional liability exposure is 26% lower than a year ago and 40% lower since we started to take significant underwriting action. On the policies we do retain, we have been achieving significant rate increases, raising deductibles, and tightening other terms and conditions. We expect these actions to mitigate our exposure to COVID-19 claims in this portfolio. To date, we have received relatively few notices from our aging services insured, but these are early days, and we are monitoring the situation closely. Importantly, a number of these notices are in states that have enacted immunity for healthcare professionals and facilities, which should limit unwarranted liability claims against this critical industry. With regards to other healthcare professional liability segments within our book, a large component of our premium volume comes from non-frontline healthcare professionals, such as physical therapists, counselors, pharmacists, and similar classes. We also have a meaningful dentist program. It is important to note that across all other healthcare professional liability segments, we have seen a significant reduction in reported claims due to shelter-in-place restrictions. Switching to surety now, we are a large successful surety writer with a balanced portfolio of both commercial and construction risks. Our commercial book includes a sizable portion of smaller compliance-type surety bonds that have historically performed steadily throughout any economic conditions. Our construction portfolio largely consists of a diversified group of financially sound contractors that have long-term relationships with us. To a great extent, most of the contractor accounts in the portfolio participate in parts of the economy that have been deemed essential, so operations have continued, and many of the accounts have expressed having a meaningful backlog of work orders. Given the historical success of our bond theme, we believe we are well-positioned to withstand the current environment. Of course, the length of the recovery is still difficult to predict, so we should have much more clarity by the time of our second-quarter call with respect to any longer-term potential impacts. The final coverage area I wanted to highlight is trade credit. As I have mentioned on prior calls, this has been a small part of our Lloyd's syndicate portfolio, and this book was placed into runoff in 2018. We now have less than $7 million in premium remaining. Nevertheless, we expect to see some claim activity from that portion that still remains. Our first-quarter charge includes some potential trade credit losses, as well as provisions for legal and other experts retained by our claims department as we work through this pandemic. A few last comments. From a rate perspective, although there are a number of unknowns with COVID-19, I do not believe the dynamics that underpinned the hardening market over the past 18 months have fundamentally changed. If anything, the outlook for the protracted low interest environment has deteriorated. So, I think rate movement should continue at the current pace throughout 2020, and we have seen that in April. Now, premiums overall will be impacted by the lockdown and economic slowdown, which will likely hurt our top-line growth rate later in the year and this will also put pressure on our expense ratio. Thus, we will focus on managing every dollar of discretionary expense. However, we do expect to continue to make necessary investments in talent, technology, and analytics as we work through this pandemic. In addition to updating you on loss reserve impacts at the end of the second quarter, we expect to have much more clarity on the top-line premium impact and expense impacts, which we will provide. With that, we'll be glad to take your questions.

Yes. And we'll go first to Jeff Smith with William Blair.

Hi. Good morning. I may have missed it, but did you say if you have any event cancellation policies at all?

No. That's not a coverage we have. There may be some small little freebies on some International, but we've looked at all of those and those limits are totally de minimis.

Okay. And then in the Specialty book, about how much of that is D&O, and do you see much risk there for COVID-19?

As we've indicated in the past, Jeff, it's not a large portfolio of D&O for us, but it is an area that we have been focused on and we have been growing. It is clear that there have been tremendous stock price drops, and whenever you see that, you know you're going to see some elevated class action activity. However, I think this is going to end up being much more of a defense cost scenario. The stock drops were very broad-based due to the pandemic, and I think it's difficult to establish Director & Officer accountability for the drop.

Right. Okay. And then just the warranty business, are you seeing a pretty big drop-off in demand there? Is that mainly vehicle warranties?

Yes. It's mainly vehicle warranties. We have, as you know, the large electronic cell phone programs, but those are all captive, reinsured to captive. You're seeing obviously some drop-off in the warranty along with the drop-off in sales and new cars, etc.

Okay. Thank you.

Thank you.

We will go next to Meyer Shields with KBW.

Great. Thanks. Good morning and thank you very much for sharing details about your business. Can you clarify which lines of business the $15 million charge applies to?

I'm sorry, say it again.

The $15 million virus-related charge in the first quarter, can you detail which lines of business that was for?

Yeah. The line of business that we put the actual charge for was trade credit, even though it is in runoff, you still have, as I said, $7 million. As we did our reserve reviews of all lines, the dropping of commodity prices, especially on the oil side, the drop in the oil prices will put a strain on trade credit until we put our money for trade credit losses. The rest is just the legal and expert costs that the claims department incurs, as we typically do during a catastrophe, but clearly in something of this magnitude. The estimation for those costs as we assess the pandemic are also included within that amount. It's not any sum of like ultimate defense costs for the future. We hope to have a much better picture, Meyer, as we get through the second quarter to put together some other projections for defense costs.

Okay. Fantastic. That's helpful. I was hoping you could sort of wrap up all your thoughts on workers' compensation. In general, I'm wondering, first of all, what do you expect reinsurance to come into play? And second of all, what is CNA's stance on states that are expanding presumptions considerably?

Yeah. Okay. I appreciate the question, and it's obviously complicated at many different levels. Let's start with reinsurance, if I may. We do have workers' comp reinsurance protection for large events. It provides, Meyer, perception on a fall of the fortune status, by the way. It provides around $275 million protection excess of $25 million retention. We get to determine what constitutes an event, and we can then select the consecutive 160 hours time period for combining the losses. So, there is strong reinsurance protection. Now, regarding the presumption doctrines, as you know, in some states, officials have supported the coverage for – for coverage presumption for both first responders and healthcare workers. As I said, frontline healthcare workers make up a very small part of our workers' compensation portfolio. I went through that in detail because we do write medical malpractice, but I want to be clear that it's not a workers' comp portfolio. We also have no workers' comp for first responders. Fortunately, there are relatively few other states where a broader presumption for essential workers is being proposed. This would add, in my opinion, significant unpredicted costs to the system overall, because those exposures were not underwritten and were not priced, and ultimately are going to be shouldered by already struggling businesses. So, we, together with many of the other member companies of the APCIA, are working with policyholder groups, which is very important because the policyholder groups themselves are pushing back for the obvious reason of the subsequent consequences and availability. They're pushing back on broad extra contractual retroactive claims. We will need to see how that plays out, which is why I suggested we wait for the second quarter to better understand the situation. We have seen a drop in claim counts from workers' compensation due to the lockdown. Therefore, you've got to see that as a net-net basis, and factor in the prospect of exposure that's going to come into play. In the meantime, we are going to fight tooth and nail to avoid a very broad assumption because, in the end, we risk hurting our own interests. We really need to wait to see how this shakes out.

Okay. Thank you. That was very thorough.

Yeah. Meyer, thanks for the question.

And at this time, there are no further questions.

Okay. Thank you everyone. I appreciate your time, and please be safe and be healthy.

This does conclude today's conference. We thank you for your participation.