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OPERATOR: This conference call relates to HCC Insurance Holdings
Incorporated. 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 future financial performance are forward-looking statements
made pursuant to the Safe Harbor provision 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, any
recordings, broadcasts or publication thereof by HCC Insurance
Holdings Incorporated are the sole property of HCC Insurance Holdings
and may not be recorded, rebroadcast, published in whole or in part
without the express written consent of HCC Holdings Incorporated.
Your conference call will begin momentarily.
Good morning, ladies and gentlemen, I will be your conference
operator today. At this time, I would like to welcome everyone to the
HCC second quarter earnings conference call. All lines have been
place on mute to prevent any background noise. After the speakers'
remarks, there will be a question-and-answer session. (OPERATOR
INSTRUCTIONS) I would now like to turn today's call over to Frank
Bramanti, CEO of HCC Insurance Holdings. Please go ahead sir.
FRANK BRAMANTI, CEO, HCC INSURANCE HOLDINGS: Good morning, ladies and
gentlemen. Thank you for joining for the HCC second quarter
conference call. As a format, I'm going to make some opening
comments. I will then turn the call over to John Molbeck, our
President and Chief Operating Officer, who will go through our
business in a little more detail. And then we'll open it up for
Q&A. First, I'd like to introduce the people that are will me
here in Houston, John Molbeck, as I mentioned, Ed Ellis, who is our
Chief Financial Officer, Mike Schell, who heads up our property
casualty operations. And we have Craig Kelbel on the line from
Minnesota, who heads up our Life, Accident and Health business. We
have Bob Thomas, who heads up our Assurety operations and Randy
Rinicella, our new General Counsel, who joined us during May is with
us here in Houston.
To get right into the numbers, HCC had another strong quarter during
the second quarter and strong first half of the year. Earnings for
the first -- second quarter, pardon me, were $101.2 million, or $0.86
per share versus $89.1 million or $0.76 per share for the second
quarter of '06. Those are 13% increases year-over-year. For the first
half, net earnings were $197.9 million versus $168.3 million, and
earnings per share were $1.69 for the first half of 2007 versus $1.44
for the same period of '06, 18% and 17% increases respectively. The
return on average equity was 18.8% on an annualized basis, slightly
ahead of our first quarter's number. The combined ratio for the first
six months of 2007 was 84%. Just a couple of other figures, gross
written premium was just under $1.3 billion, and net written premium
was just over $1 billion and net earned premium was just under $1
billion dollars, each up significantly from the same period 2006.
A couple of comments about some of the other line items. Our other
operating income has been pretty consistent over the first two
quarters this year and on target with what it was last year. We will
not be duplicating those numbers during the second half of 2007.
Actually, during the last three or four quarters, we've been
liquidating one of our three publicly-traded strategic investments.
We completed that liquidation during the second quarter and that
effort generated $23 million in gains during the first half of 2007.
That will not be duplicated over the second half of the year. The
remaining two strategic investments we have are treated as trading
securities, and any gains or losses on those for the remainder of our
holding period will run through other income as such. Our investment
income for the quarter was $48.7 million, and for the six months
$98.2 million, both up about 35% over 2006. Our investment assets
continue to grow, interest rates have been up during a lot of this
period, and our investment portfolio has generated very strong
results. That portfolio totaled $4.4 billion. It remains high
quality. The average quality rating is AAA. Predominantly fixed
income, with a duration of 4.9 years, and an average tax equivalent
yield of 5.3%.
Just to go through the numbers on the hot topic of the day, we have
21 million of subprime or alt-A exposure in our investment portfolio.
The average rating is AAA and we have all but about $1 million
dollars is rated AAA. We've had no rating issues with any of these
subprime or alt-A that we own. We own no CDO's or CLO's. And NEM, New
England Asset Management, continues to manage the majority of our
investment portfolio. They have done an excellent job of keeping us
out of any problem areas and we continue to utilize a conservative
approach in investing the assets of HCC. Just a couple of final
general comments. We write no domestic mortgage guarantee business.
We have a financial products division that has the ability to write
that business but we have none on the books. We have a convert that
is approaching a call date on September 1. We currently have made no
decision as to whether we are going to call those securities or not.
And we're watching the marketplace on what is the best way for us to
structure or capital.
Earlier, I introduced our General Counsel. We also, since the last
call, had our new Vice President of Human Resources begin with us,
Lisa Moore. We're very pleased that both of these people, Lisa and
Randy have joined our team and look forward to their contributions.
In addition, I would like to welcome two new directors who began
their service to HCC during the last quarter, James Oesterreicher,
who's a former chairman and CEO of JC Penny. And Chris Williams,
retired Willis RE National Director of Life, Accident and Health
Business. We thank them for agreeing to serve on HCC's board and we
look forward to their many future contributions. For those that might
not know, we have a Minneapolis office that has a little more than
100 people in it. We're pleased to report that none of our staff or
their families were affected by the catastrophe in Minneapolis. But I
understand some friends of our staff were affected and our thoughts
and prayers go out to all of the people in Minnesota that were
affected by that.
On the acquisition front, we see and continue to see plenty of
opportunities out there. The challenge is to find the right fit at a
price that we can earn our target return on. Sellers expectations
certainly were getting a bit out of hand. We remain busy on the
acquisition front. And we're optimistic that we will be able to
continue to expand the agency footprint. But I think I said earlier
that it will take two or three times the effort, two or three times
the number of deals to look at to find the right kind of mix in this
environment, but we're committed to the process. At this point, I'm
going to turn it over to John Molbeck for a little more detailed
analysis of our business.
JOHN MOLBECK, PRESIDENT & COO, HCC INSURANCE HOLDINGS: Thank you,
Frank. As we're at the end of the chain of the conference calls, it
is a little difficult to tell you anything that you haven't already
heard, but I will try to add a little bit to the overall process. The
competition that is out there remains responsible, which is good
news. The softness that everybody is experiencing in the first
quarter, we continue to experience in the second quarter. And
frankly, we don't see anything on the horizon that is going to
immediately impact the fact that competition will continue. The
international competition is more severe than the domestic
competition, but the international margins have historically been
better than the domestic margins. And all of our margins, both
international and domestic, are acceptable.
Our book of business, as we've talked about before, is largely
specialty. It is not excess in surplus lines. Therefore, we do not
have the same impact of business moving to and from the E&S
market into the standard market. And in addition, our book of
business is dominated by small accounts and not large accounts, which
are less susceptible to competition. 60% of our revenue growth for
the first six months was a result of acquisitions. And the remainder
or organic growth was largely the result of our increased in
ownership in Illium and plus the growth that we continue to
experience in our credit and surety book. For the first six months of
year we've virtually had no development. We had $2.4 million worth of
net development on $2.2 billion of net reserves. We are comfortable
with our loss picks for 2007 with one exception. And that exception
is the medical stop loss component of our life, accident and health
book.
We've increased the loss pick for 2007 by 1.5%. However, to date,
this has been offset by a reduction in our actual expenses by 1.5%.
So the combined ratio for the 2007 book is anticipated to come in as
budgeted. As part of our investment package, we provided net loss
ratios and before you ask the question, I might give you a few
highlights. On the diversified financial products line, last year,
for the full year, we had a 48.2% loss ratio, and now we're looking
at 43%. That is largely the result of one large claim from the 2002
year, which we had reserved for the full amount of our limited
liability, having to do with the dispute with Lloyd's. And it was an
Arizona emission policy. The suit was settled just below our
attachment point and therefore we took that reserve down and that is
a large percentage of the difference between the 48% and the 43%. If
you look at the London market account, last year at this time, it was
43%. Currently, it is at 63%. The 43% is an aberration because that
included 9 points of takedown of hurricanes from the 2004 year. So if
you looked at it on an apples-to-apples basis, that would be about
52%.
And in the second quarter, we had two losses, two large losses come
up which were unanticipated and instead of including those losses in
the IB&R, and looking at them as the normal pattern of attrition
losses, we went ahead and took a hit for those two losses, which
effectively gives you the difference between the hurricane-adjusted
loss ratio and the actual loss ratio. In the other specialty lines,
we increased our ownership last year from roughly 50% to roughly 80%
in Illium and that book of business and Lloyd's runs at a higher loss
ratio than the rest of our other specialty lines, and therefore you
will see that increase in the loss ratio from 56% to 69% and that is
something that roughly will stay in place for the foreseeable future.
Frank and Ed are concentrating on mergers and acquisitions and is a
pretty active environment. Mike Schell and I are focused on new
products and new teams and we anticipate some announcements in the
second half of the year.
On the personnel front, I'm very happy to report that we've extended
the contracts of the people that were instrumental in the acquisition
-- I'm sorry, instrumental in the growth of our D&O business,
with the acquisition of MAG Global. That being Matt Fairfield, Andy
Stone and [Richard Raffay]. And in addition, Andy Stone has hired
Ralph Guglielmo to join his -- Steve Guglielmo, I'm sorry, to join
his team to strengthen our D&O operation in Fairfield
Connecticut. And Mike Schell is actively looking for a number two
person to support him so that we can strengthen our overall domestic
property and casualty team. Thanks, Frank.
FRANK BRAMANTI: Okay. At that point, operator, I would like to throw
the call open for questions.
OPERATOR: Thank you. (OPERATOR INSTRUCTIONS) Your first question is
from Josh Shanker with Citi.
JOSH SHANKER, ANALYST, CITIGROUP: Good morning, everyone.
FRANK BRAMANTI: Good morning, Josh.
JOSH SHANKER: I'm curious about, thinking about the Allianz business
in relationship to the general business. If we look at the legacy
book of HCC stop loss, what percentage of the current in force that
is and how is it different businesses are running in terms of loss
ratio and how we can expect loss ratio to come down over the next six
months, one year, what not?
FRANK BRAMANTI: Josh, I am going to ask Craig to go ahead and answer
that for you.
CRAIG KELBEL, EVP, HCC INSURANCE HOLDINGS: Well, the separation,
you're looking for how much premium, is the old -- the Allianz
acquisition business?
JOSH SHANKER: In terms of contribution to the loss ratio, I assume
that these legacy business is running at a loss ratio typical with
the past and you have some new business that you're integrating. What
kind of color can we give around these --
CRAIG KELBEL: I think the Allianz acquisition business, I will break
it into two pieces. Really the medical stop loss piece which
complemented ours was about $180 million. That is running very
similar to our organic medical stop loss business, so there really is
no difference as it runs into '07, from '06. Clearly when we acquire
the company, the loss ratio was higher and it was booked as part of
the acquisition. The three other lines of business, the HMO,
provider, and medical access, have a natural higher loss ratio,
because their acquisition expenses are less than the medical stop
loss. So in order to get a same combined ratio, you can run them at a
higher gross loss ratio than you can the medical stop loss. As an
example, HMO pays no premium tax to speak of, or assessment, because
it is reinsurance and medical stop loss pays 2.5 points. So as we
reunderwrite the book of business into '07, I think you will see the
blend of the overall A&H loss ratio come down a bit, but it will
still be higher than historically because of the differentials
between the two books of business.
JOSH SHANKER: And if we're thinking about one year into the future,
we're at like a 78% loss ratio for that business, that number should
come down overall?
CRAIG KELBEL: It should come down a bit, I mean it will come down a
bit, not much, because again, the gross loss ratio on the business
acquired by Allianz, the three new lines can run a bit higher than
the medical stop loss. But it will back up a bit, as we go through
the '07 and the '08, I think you will begin to see some change in
that, but it is not dramatic. But you will see some of it come down.
JOSH SHANKER: Okay. Very good. Thank you very much.
CRAIG KELBEL: Sure.
OPERATOR: Your next question comes from Beth Malone with KeyBanc.
BETH MALONE, ANALYST, KEYBANC CAPITAL MARKETS: Thank you. Good
morning. A couple of questions. I know you said you don't invest in
any of the subprime, but is there any exposure in your directors and
officers liability lines to some of these companies that have got in
trouble in the subprime market?
FRANK BRAMANTI: I'll have Mike Schell answer that, because he has
looked at that in detail.
MIKE SCHELL, EVP, HCC INSURANCE HOLDINGS: Beth, in our public company
D&O businesses, we've received notices -- we've received notices
of circumstances and claim notices. Of what we received, there are
two claims of significance that we think might develop. If they do
develop, the loss incurred will be within our expected loss
development amounts. The background is that claim activity on public
company D&O business has been low for the past one-and-a-half
years. And our incurred loss levels have continued to be good for
that time frame. Besides the public company D&O businesses, we've
also got some additional exposure, at least potentially on our $90
million miscellaneous E&O, small account business. Out of that
$90 million, we only write $600,000 of mortgage brokerage E&O and
that would be the principal area of exposure and on that business we
typically have limits of $1 million dollars. We might have claims in
the book. If they do, I expect the incurred loss levels to be
manageable within the book's ultimate loss ratios.
FRANK BRAMANTI: Ever since the subprime issue came up, we've been
looking at our exposure from an insurance standpoint. We didn't have
any of the big names, the initial subprime originators, and we don't
think we're go have anything significant that is going to change any
of our numbers across the board.
BETH MALONE: Okay. Thank you. And then the interest expense in the
quarter was lower than it was in the first quarter. Could you explain
that?
ED ELLIS, CFO, HCC INSURANCE HOLDINGS: Yeah, we had a minor
correction, I guess, an adjustment in there, and less than $1 million
dollars from the first quarter, and it is going into the second
quarter, and so it lowered the interest expense in the second
quarter.
BETH MALONE: What is the right amount that we should be assuming for
interest expense going forward? Is it more like $2.5 million?
ED ELLIS: I don't have that number exactly. But I can get that for
you. It depends upon of course how much short-term borrowings we have
out there, which we have some at the end of the second quarter.
FRANK BRAMANTI: It is going to fluctuate based upon our fundings on
our line of credit, which we use, acquisitions, we've used it to fund
some of the earn-outs that we've had so I think that will fluctuate.
But we will have Ed get back to you with what the run rates is on the
converts and kind of average expected amount under that line.
BETH MALONE: Okay. And then just one other question, on the operating
expense line, it was also lower than it had been in the previous
three quarters. And is there -- what was driving that?
ED ELLIS: Beth, I will have to get back to you on that. I'm not --
there are aberrations in there.
BETH MALONE: Okay.
FRANK BRAMANTI: I mean our expenses, we think we're pretty close to
budget on our expenses, so -- we will come back to that.
ED ELLIS: We did have some acquisitions that would have driven it up
somewhat, okay?
BETH MALONE: In the previous quarters?
ED ELLIS: Correct. Well, in these quarters. But I will have to get
back to you on the difference, okay?
BETH MALONE: Okay. And then one last question, with the stock having
pulled back here, I know you don't often consider this, but what
about share repurchase at these levels with the excess capital that
you appear to have at the holding company?
FRANK BRAMANTI: Well, people keep talking about this excess capital
we have at the holding company. I'm not sure that our rating agencies
necessarily agree with that. As I stated before, we are looking at
and continue to look at what the proper level of capital is and what
the proper structure of our capital account needs to be. When our
stock gets down, we've always looked at it, and analyzed it and seen
whether it made sense, which we're continuing to do. I would hope
that the decline in our stock is a short-term blip and therefore
there isn't any great opportunity for us to pick up stock at these
levels. We continue to be committed to expanding HCC, and therefore
think that we will utilize the excess capital that we generate.
BETH MALONE: Okay. Thank you.
ED ELLIS: Beth, on the operating expenses, they increased. I
misunderstood, I think. Your question was they increased, and it was
mostly due to acquisitions. And also we had in the six months we had
-- in the six months, we had $3.6 million of professional fees
related to the option review issue that we didn't have in obviously
the first six months of last year.
BETH MALONE: Okay. All right. Thank you.
OPERATOR: (OPERATOR INSTRUCTIONS) Your next question comes from David
Lewis with Raymond James.
DAVID LEWIS, ANALYST, RAYMOND JAMES: Good morning. And thank you. On
the other income, you can provide us any guidance if you assume you
had $23 million in the first half, is maybe a good guesstimate,
somewhere in the $8 million to $10 million quarterly range? I know it
is going to bounce around a little bit, but any feedback would be
helpful.
FRANK BRAMANTI: Well, I think originally, we had a kind of a budget
of about $40 million for the year, which is about where we're at
right now. I think going forward, if we had to reforecast, we would
say it could come in somewhere between $40 million and $50 million
and it looks like we have about $2 million to$ 4 million any given
quarter on kind of regular recurring income that is running through
there. We do have two investments that are being treated as trading
securities, although they're viewed differently by us, but they're
being marked to market, so any change in the market value of those is
going to run through that line of business, but my best shot is to
say that it will probably end up between $40 million and $50 million,
$45 million to $50 million by year end.
DAVID LEWIS: Which is $2 million to $4 million a quarter.
FRANK BRAMANTI: Yes. Something like that.
DAVID LEWIS: In the second half. Okay. And on the stop loss business,
can you give us what the Allianz premiums were in the first quarter
and first half, please?
FRANK BRAMANTI: Craig, are we even tracking that at this point?
CRAIG KELBEL: Effective '07, we rolled the premium together. All I
can tell you is that it is pretty much on budget of what we would
have expected to keep of our total medical stop loss line of
business.
FRANK BRAMANTI: I mean when we -- David, just for your information,
when we got to 1/1/07 and we had had the acquisition close for about
90 days at that point, we rolled everything onto our system, and so
as the business renews, it just kind of gets blended into the same.
We were -- we've looked at it each quarter, and we're approaching a
full year here at the end of this third quarter. But we were on
target with what our retention levels were expected to be, and really
kind of, at this point, declare the acquisition a success. And really
have moved past having it being treated separately and now it is just
HCC Life's business, just like any other part of the business.
DAVID LEWIS: Okay. And another way to kind of go at that, do you
think you're getting any organic growth out of that book of business?
And maybe a little bit of commentary on kind of the pricing trends? A
lot of folks have talked about the markets pricing bottoming and
potentially turning up here over the next 12 months. Your thoughts
would be helpful.
FRANK BRAMANTI: Craig?
CRAIG KELBEL: Well, I think the market, my view would be that it is
no worse, no better, it is responsible, it is consistent. Our
competition does not necessarily come from the other self-funded in
people who are in the business, it is generally the fully insureds,
the United Health Cares, the Blue Cross, Blue Shield plans, those,
and we have seen some slight change in the upward direction of the
pricing, but it is too early to really say is there going to be a
significant change. I think the good news is the market is pretty
much consistent now, it is much more predictable than it was six
months ago, and we're able to keep our margins where they're at. And
we're happy with that, considering the market conditions.
DAVID LEWIS: Great. Thanks very much.
CRAIG KELBEL: Thank you, David.
OPERATOR: At this time, there are no further questions. I would like
to turn the call back over to management for closing remarks.
FRANK BRAMANTI: Thank you, operator. Ladies and gentlemen, thank you
for participating. I just want to leave you with our closing thought
here. The market is getting softer. HCC is well-positioned to
continue to perform at the levels that we have. We are -- we have a
solid team of underwriters who are specialists in their field, some
of the top people on a line by line basis, who are running some very
good businesses for us, and we are optimistic that HCC will be able
to continue to outperform. Thank you very much. And we look forward
to talking to you next quarter.
OPERATOR: Ladies and gentlemen, this concludes today's conference
call. You may now disconnect.
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