Earnings Call Transcript - CNA Q2 2024

Dino Robusto, CEO

Before discussing our second-quarter results, I want to address the upcoming CEO transition announced on June 5, 2024, effective January 1, 2025. Over the past eight years, I have been privileged to lead CNA to record profitability and production. Doug Worman has been key to our success, serving as an exceptional partner in our journey as Global Head of Underwriting. I have complete confidence in his ability to drive CNA forward to maintain our high performance. I am also excited to take on my new role as Executive Chairman of the Board and serve as a strategic advisor to Doug as CEO. Together with the Board, we are optimistic about CNA's future and you can expect our proven underwriting strategies to remain strong. In the second quarter, we achieved impressive results with significant profitability, including our fifth consecutive quarter with a pretax underlying underwriting gain exceeding $200 million, increased investment income, solid revenue growth, and a 1% rise in Commercial rates. Notably, excluding workers' compensation, our written rate change for Commercial stands at 8%, which meets our loss cost trend. For commercial casualty lines like auto and excess casualty, the written rate change remains in the low double-digit range, covering loss costs adequately. Over the years, we have extensively discussed loss cost trends and our methodologies for setting current accident year loss picks and analyzing prior year reserve developments. These factors remain central to our focus, and I will provide further insights based on recent experiences in the quarter and the first half of 2024. Our long-term loss cost trends remain stable at around 6.5% overall. However, as I mentioned last quarter, certain casualty lines like commercial auto and primary general liability have more than doubled over the last five years due to social inflation. Presently, the long-run loss cost trends for commercial auto and excess casualty are in the low double digits, while primary general liability is slightly above the average, property is below, and workers' compensation trends are lower than usual. In our Specialty segment, the loss cost trend averages in the mid-single digits, with medical malpractice rates higher than average and our affinity programs below average. Our International segment similarly has a mid-single-digit average. We have also discussed reserve development in business lines such as medical malpractice and commercial auto, which were significantly affected by social inflation starting as early as 2017. We previously indicated significant reserve strengthening needed for those years, which nearly offset the favorable reserve developments in workers' compensation, surety, and to a lesser extent, our affinity programs. It’s important to highlight that we have not lowered our elevated frequency and severity trends from earlier years; instead, we have taken a conservative approach based on actual data to ensure our reserves are appropriate, anticipating that medical inflation might rise in the future. Although we have seen stable medical costs affecting workers' compensation, we believe our reserving strategy is still valid as higher medical costs may ultimately influence long-run trends. During the pandemic, we observed a reduction in actual loss activity compared to historical figures, yet we maintained our overall property and casualty accident year loss ratio at approximately 60% each year from 2020 to 2023. We favored a conservative stance regarding the implications of earned rates exceeding loss cost trends during those years, as we believed the pandemic clouded the true impact of social inflation. This cautious approach has yielded favorable results for classes heavily influenced by social inflation compared to our original loss ratio selections. As of mid-2024, we strengthened our position in commercial auto, with long-term trends remaining near 6.5%. However, the trend for commercial auto slipped into the low double digits due to recent claims experience. This prompted an increase in underlying loss ratios for commercial auto as we bolstered reserves for the 2022 and 2023 accident years by $24 million, alongside $3 million favorable reserve developments from earlier years. Consequently, the overall underlying loss ratio in Commercial rose by half a point compared to the previous year. In the Specialty segment, our underlying loss ratio increased by one point in the first half of 2024 from last year, even as loss cost trends remained stable. This uptick resulted from written rates falling below long-term trends in several management liability lines. Despite past cumulative rate increases during the hard market period, we are adopting a cautious approach in light of current pricing trends. Now, let's delve into the specifics of our second-quarter results. Core income rose by $18 million year-over-year to $326 million, while the first half recorded a core income of $681 million, marking a record high and reflecting our commitment to underwriting excellence and profitable growth. Net investment income of $618 million rose by $43 million year-on-year, with our fixed income portfolio contributing $30 million to this growth through an increase in both book yield and our invested asset base. The all-in combined ratio for property and casualty was 94.8%, which included catastrophe losses of $82 million, representing 3.5 percentage points of the combined ratio. This is compared to $68 million, or 3.1 points, in the same quarter last year. The catastrophe loss ratio aligns with our average for the last five years. Prior period developments for overall property and casualty were favorable by 0.3 percentage points. The underlying combined ratio was 91.6%, reflecting a 0.5-point increase from the year-ago quarter, with an underlying loss ratio of 60.6% and an expense ratio of 30.7%. We also achieved a strong production performance, with gross written premiums, excluding captives, growing by 7% and net written premiums increasing by 6%. Overall renewal premium changes were 5%, a decline of one point from the first quarter. Rate increases have remained stable at 4% for three sequential quarters, with variations across segments and classes, while exposure dropped one point to 1%. The decline in exposure change is mainly influenced by reduced participation in shared and layered property accounts, as we continuously seek to optimize capacity, pricing, and terms. New business climbed by 7% this quarter, reaching a record high of $595 million, driven by robust growth in our Commercial business units. Overall P&C retention remained high at 85% this quarter, consistent over the last ten quarters, signifying our focus on retaining valuable accounts. In our Commercial segment, the all-in combined ratio stood at 97.0%, with catastrophe losses of $76 million adding 6.1 points to the ratio. The underlying combined ratio improved by 0.6 points to 91.0%. The underlying loss ratio and expense ratio were 62.0% and 28.5%, respectively. Commercial showed a record high underwriting gain of $115 million, with gross written premiums, excluding captives, demonstrating 12% growth, marking nine consecutive quarters of double-digit growth. New business rose by 18%, while retention stood at 84% for the quarter. Rate changes in Commercial escalated to 7%, a rise of one point from last quarter. We observed accelerated rates in construction and small business sectors and consistency in middle market rates. The commercial auto rates alone increased by 14%, with excess casualty rates seeing an 11% increase. In our Specialty segment, the all-in combined ratio was 92.7% in the second quarter, including 0.4 points of favorable prior period development. The underlying combined ratio was 93.1%, with underlying loss and expense ratios at 59.6% and 33.2%, respectively. Gross written premiums, excluding captives, for Specialty grew by 2% this quarter, with net written premiums increasing by 4%. Rate growth within Specialty saw comparisons improving compared to the recent past. In our International segment, the all-in combined ratio was 91.9%, with catastrophe losses amounting to $6 million. The underlying combined ratio was 90.9%, with an underlying loss ratio of 58.1% and an expense ratio of 32.8%. Competition in this segment remains strong, with gross written premiums down 1% and flat growth in net written premiums. Rates were flat this quarter, a decrease of one point from the first quarter, with retention lower by two points. In this competitive environment, we are focused on securing only accounts that meet our terms to maintain the strong profitability in our International portfolio.

Scott Lindquist, CFO

CNA's core income of $326 million is up 6% compared to the prior year quarter, leading to a core return on equity of 10.6%, and reflects another quarter of great underwriting and investment results. Our P&C expense ratio for the second quarter was 30.7% compared to 30.9% in the prior year quarter reflecting higher net earned premium. As we have noted previously, while we tend to have a certain amount of variability quarter to quarter in this ratio, we do expect the expense ratio to be at about this level for the full year. The P&C net prior period development impact on the combined ratio was 0.3 points favorable in the current quarter. In the Specialty segment, favorable development in surety and in casualty coverages associated with healthcare products was partially offset by unfavorable development in other professional liability and management liability. In the Commercial segment, favorable development in workers' compensation was largely offset by unfavorable development in commercial auto and general liability. The unfavorable development in commercial auto of $21 million was concentrated in the most recent accident years as Dino alluded to and the unfavorable development of $19 million in general liability was across multiple accident years going back to 2014 and prior. In the International segment, favorable development in specialty coverages was partially offset by unfavorable development in commercial coverages. During the first quarter earnings call, we explained certain factors impacting our auto warranty business, namely, higher labor rates and car part costs are driving an increase in severity, and lengthier durations of car ownership resulting from higher car prices and interest rates are driving higher frequency of warranty claims. This same dynamic is continuing to impact claim costs in our non-insurance auto warranty business where pretax earnings before investment income of $16 million this quarter is down from $23 million in the prior year quarter, and year-to-date pretax earnings before investment income of $29 million is down from $46 million for the prior year six-month results. Please refer to the Specialty - Results of Operations page in our Financial Supplement for the detail on the non-insurance warranty revenue and expense line items that comprise pretax earnings before investment income. For Life & Group, we recorded a core loss of $1 million for the second quarter compared to a $20 million core loss for the prior year quarter, reflecting the reduced impact from long-term care policy buyouts and $10 million in higher investment income. Active inforce management risk mitigation activities are ongoing in our long-term care book, including rate filings, benefit reduction offers and policy buyouts. The current quarter results include a $2 million pretax loss related to $15 million of cash policy buyouts compared to a $13 million pretax loss on $67 million of buyouts in the prior year quarter. We expect to continue offering buyouts with the impact to earnings from such activities varying quarter to quarter depending on timing and mix of buyout elections. Also, a reminder that we will perform our annual assumption updates for our Life & Group segment during the third quarter, which is consistent with historical practice. Our Corporate segment produced a core loss of $53 million in the second quarter, compared to a $46 million loss in the prior year quarter. We conduct a comprehensive review of mass tort reserves in the second quarter of each year and will also react to developing facts and circumstances in other quarters. As a result of this quarter's comprehensive review, the Corporate segment results include a $28 million after-tax charge related to unfavorable prior period development largely associated with legacy mass tort abuse claims. In addition to the foregoing, the second quarter results for the Corporate segment include a $5 million after-tax charge related to ongoing office consolidation. Looking forward, we expect another real estate consolidation charge of similar magnitude in the third quarter. Also, a reminder that our asbestos & environmental reserves within the Corporate segment are reviewed in the fourth quarter each year.

Dino Robusto, CEO

CNA had a very strong second quarter, following up on an excellent first quarter, and has generated record core income for the first half of the year. Record levels of core income are reflective of disciplined underwriting, profitable growth, and high levels of net investment income. We achieved 7% growth in gross written premiums excluding captives, 6% growth in net written premiums and our retention remains very strong at 85%. Our loss cost trends remain unchanged in the aggregate, but commercial auto continues to see elevated claim activity. We believe the double-digit rate increases in commercial auto and excess casualty, and meaningful high single-digits in medical malpractice will persist, thereby covering loss cost trends for these three classes of business most unfavorably impacted by social inflation. We remain optimistic about our ability to successfully navigate the current favorable market dynamics and to further the Company's profitable growth. We look forward to providing comments to you next quarter.

Operator, Operator

We invite shareholders and analysts to submit questions for management in advance of each quarter's earnings release. Below we address some questions we have received as well as some timely and topical focus areas for CNA and our industry.

Unknown Analyst, Analyst

What do you expect the loss impact to be from the CrowdStrike event?

Unknown Executive, Executive

It is still very early; however, we do not expect this to be a major claims event for us.

Unknown Analyst, Analyst

Where is pricing going? What do you expect?

Unknown Executive, Executive

Based on what we can see right now, in the financial lines there is a little bit of variability month to month, but we expect to see a little bit of moderation in the rate decreases in this area. In workers' compensation, we anticipate it remaining in the mid-single-digit negative range. On property, rate has come down from where it was late last year; absent any significant catastrophe experience that this line tends to respond quickly to, we do not expect rate to re-accelerate and expect it to be in the low to mid-single-digit range in total. On the casualty lines pressured by social inflation, as we indicated in our prepared remarks, commercial auto and excess casualty are in the low double-digits and rates need to continue to increase. In International, we expect rate in the aggregate to stay roughly flat as margins are still favorable.

Unknown Analyst, Analyst

Do you think loss cost trends could increase?

Unknown Executive, Executive

As we said in our prepared remarks, loss cost trends are unchanged in aggregate, but are up over a point in commercial auto even with reduced backlogs in our court system today. We are taking into consideration everything that we see right now for each class of business. Is there a possibility loss cost trends could continue to go higher? It is certainly possible. So we will continue to watch it and react accordingly.

Unknown Analyst, Analyst

Can you please remind us of your investment portfolio exposure to the commercial real estate sector, in particular office properties?

Unknown Executive, Executive

Our direct exposure to commercial real estate is through fixed income securities, in the form of commercial mortgage-backed securities and debt issued by real estate investment trusts, as well as through our direct mortgage loan portfolio. Together these three portfolios comprise about 8% of our total investment portfolio. Our commercial real estate holdings are high quality and well diversified as to underlying property type and geography, with a modest exposure to central business district office properties. Taken together, our CMBS and REIT portfolios are over 95% investment grade with about 60% rated A or higher. Finally, we are limited in exposure to commercial real estate in our limited partnership portfolio as this is not one of our core alternative strategies. Please refer to our 2023 Annual Report on Form 10-K for additional detail on our commercial real estate holdings.