HCC Insurance Holdings' CEO Hosts Investors Conference (Transcript)

HCC Insurance Holdings, Inc. (HCC)

Investors Conference Call

June 07, 2012 09:30 am ET

Executives

John Molbeck - CEO

Bob Rosholt - Chairman

Mark Callahan - EVP & Chief Underwriting Officer

Bill Burke - EVP & COO

Michael Donovan - President, HCC Aviation

Simon Button - Energy Underwriter

Andy Stone - President, HCC Global Financial Products

Craig Kelbel - EVP, A&H

Bill Hubbard - President and CEO, HCC Specialty

Adam Pessin - President and CEO, HCC Surety

Tony O'Connor - Property Treaty Reinsurance

Chris Williams - President

Mike Schell - EVP

Analysts

Presentation

John Molbeck

I am waiting for my queue. In case you haven't figured it out, we are going to be talking about the world not sitting quietly today. Good morning and welcome to HCC’s Investors Conference. My name is John Molbeck and I am the CEO of HCC.

First, I would like to thank you for your commitment of time to participate today; not only the time for the meetings, but the travel time that many of you had to experience getting back and forth to where you really live. We seldom have the opportunity to interface with so many of the owners of our company and we also welcome everybody that’s joining us today by webcast as well as Bob Rosholt the Chairman of the Board. We have a full schedule for you today as you would expect having dealt with me before and we promise you will have a better understanding of both the industry and HCC specifically; you know what that is.

Why a conference and not an Investor Day? An Investor Day is typically a monologue by executive management. What we are going to do today is you will have the opportunity to hear from a number of our underwriters about their individual lines of business. You will be able to ask some questions after each of their presentations. In addition, at the conclusion of the conference there will be general question-and-answer session where you can ask, again you can ask questions on the underwriters or executive management.

To set the stage, I will review for you today the HCC model and then we’ll go part of our strategic plan; the factors which differentiate HCC; our performance versus our peers and our targeted return on equity. Why now; because the market is changing as evidenced by several successive quarters of price increases. Why now; because the market is very fragile. One event, even a psychological event such as an unsuccessful terrorist event could change the market almost overnight.

The world does not sit quietly, Wall Street, Middle East, China, Greece, Hurricanes, Tornadoes, floods and quakes are in news. HCC is well positioned to handle unknown challenges despite any turmoil that may take place whether at the hand of man or God. To demonstrate this, our Chief Underwriting Officer, Mark Callahan will show you how we can handle these challenges. His presentations include the results of the model severe stress scenarios including a dramatic interest rate rise, a three standard deviation underwriting loss and both happening at the same time. And again, you will have the opportunity to ask questions.

Throughout the presentation today, we will be comparing HCC to our peers. We will attempt to contrast, compare and differentiate HCC. We performed well in the past compared to our peers and we believe we will continue to perform well into the future; you of course would be the judge.

As I said before, the market is changing, prices are improving. Through May, preliminary results are, gross written premium was up 6% year-to-date. Net written premium up about 5%, new lines of business which Bill Burke will be addressing later accounted for about 1% of that change. We only have losses through the month of April, but they were consistent with the first quarter.

One thing that differentiates us from the pack is our margins are already good. However, some companies are feeling stressed. We measure stress by what we call the crunch ratio which is a sum of the pay loss ratio and the expense ratio. Once you get to 100%, you begin to take cash out of your coffers to pay your operating expenses.

As you can see by this slide, as of the end of 2011, four companies were already over 100%. If you look at the first quarter results of 2012, of the nine peer companies represented here, six of them presented the information which will allow you to calculate the crunch ratio. Four of those six companies were over 100%. You have to have the cash to pay the bills from somewhere. Most likely, that cash will come from your investment portfolio.

A logical response to the poor crunch ratio is a reallocation of capital to more profitable lines, but more profitable lines for that company. We’re seeing this reallocation of capital, we’re seeing companies exit from certain lines of business and we see a greater opportunity for profit. The beneficiary of this is companies with low expense ratios and we will talk more about that later.

Our goals today are to simplify for you what may appear complex, to demonstrate the strength of our management team and more importantly our underwriters, and to demonstrate the strong position of HCC regardless of the environment. But before we do that, I think it will be helpful for you to understand the HCC model. What is it that we are all about? What's the fabric of our strategic plan?

We target a combined ratio of 85% over any five year period. We forecast this year combined ranging from 85% to 88% but over any five year period, we've been able to achieve an 85% combined ratio. A flat management structure that results in lower costs, quicker decisions, more responsive management while at the same time still maintaining operational control; a decentralized, but skilled subsidiary management; you will see that later today; an expense ratio in the top quartile of our peers; focus on specialty businesses that do not compete during cycles with the admitted market; a focus on businesses that require technical expertise and businesses that are not easy to enter or exit and a focus on businesses that are largely uncorrelated and not dependent upon reinsurance.

We will talk about reinsurance later today. But in reality HCC could find no reinsurance in continuing business without any reinsurance. What that would do, is that potentially increase the volatility so we buy reinsurance to reduce the amount of volatility and we will demonstrate the lack of volatility HCC’s had over a long period of time.

We also have highly rated insurance companies; that's part of our fabric. We've always had highly rated insurance companies as long as I have been with the company. A plus by A.M. Best, AA by Fitch, and AA S&P. Different than many, many companies, we don't put out big limits; so our limits control by its very nature limits volatility. And finally, we manage our aggregate exposure closely and we closely monitor it. So that's the fabric of what HCC does, that's part of the model which helps you understand where we are trying to go with our business. We believe HCC is a unique company. One of the characteristics that makes HCC a unique company as I said before, is the highly rated insurance companies.

This slide here shows you our rating and you will notice where A plus rating only one company having higher rating from A.M. Best is HCC. And I have identified for you in this slide in bold red those companies we consider our peer companies. And we define the peer company as a company that we compete for business with in one of our segments or a company that we compete with for talent.

So those are the companies we define as our peer companies. And if you've been following our investor presentations for a long, long time, those are the same peer companies we identify ourselves with each year. So I think you can see lots of other comparisons of peer companies and they compete with. They compare us to companies that we have nothing in common with. We don't compete with, but these really are the people that we compete with.

Just below that is a slide which shows our rating with S&P. We are one of three AA rated S&P companies. You'll note the other two are substantially larger than HCC. Before I go any further, I would like to thank V.J. Dowling. This is a V.J. Dowling slide. He gave us permission to use this slide and a few others in the presentation.

Another characteristic that makes HCC unique is we really are a specialty insurance company. We have strong long-term fundamentals and market leadership. A high percentage of our business is renewal because we are specialty insurance company and as I said before, our businesses not flow back and forth to the admitted market. Renewal book generally produces a better underwriting result than a book we are going out to write new business. I mean logically if you have been writing an account for a number of years you know all the characteristics of that account. You have the information available to you; you know what the loss ratio is.

And if you think about it, it’s a lot easier, it’s a lot less expensive to put a renewal account on the books than to go out and produce some new piece of business that ties back into our expense ratio. Everyday our underwriters exercise independent thought and judgment in order to be successful. There are no manuals. They can’t look it up. These gentlemen will be here to explain that to you in greater detail later. So it takes technical expertise and market knowledge.

But importantly, we are a market leader in a number of our businesses. In the aviation, Michael Donovan leads a significant portion of fixed and rotor wing aircraft in the United States. Internationally, we are a leader of government and military fleets as well as regional fleets where we can avoid US passenger liability.

In the Energy business Simon Button leads 70% of the business we write with an average line of 5%. We are D&O leader; Andy Stone and his European colleagues lead many difficult placements and a one of a handful of underwriters who have the technical expertise rating in reputation to lead primary and first excess layers.

Craig Kelbel leads our A&H segment where we are the leader in the medical stop-loss business and we have been for the last decade. Bill Hubbard will speak to you about our leadership in the sports and entertainment business, leading such events is the NCAA Final Four, The World Baseball Classic, several major studios as well as high profile entertainers and athletes.

Finally we are a leader in the commercial surety business, but with a little bit different twist. We are leader by geography. So we lead in the West Coast, we lead in the Middle Atlantic quarter and Adam Pessin will talk to you about expanding our geographic leadership in this business.

Just to refresh your memory, these are insurance segments, US Property & Casualty, Professional Liability, Accident & Health, US Surety & Credit and International. The speakers that are speaking today as identified by these red circles are responsible for these lines of business. That represents over 80% of the premium volume of HCC.

How well have we done? This slide is a visual display of our performance as an underwriter over the last five years. You can see that we have better than a 10 point advantage in expense ratio and an 8 point advantage in the combined ratio. As to loss ratio, we believe all good underwriters gravitate towards the mean. If you think about it, if we’re all selling the same product, why would somebody pay me a $1.10 and pay somebody else a $1? They are not; when they have perfect information, they’re going to pay a $1, so good underwriter’s results revert to the mean. Bad underwriter’s results don’t revert to the mean.

So if you look at this, why is HCC’s loss ratio slightly higher? Mix of business. Our medical stop-loss business consistently has a loss ratio in the mid-70s, but our expense ratio is significantly lower than the industry average and the combined ratio is excellent. You will hear more about this great franchise from Craig Kelbel later.

Let’s look at the combined ratios both in an accident year and a GAAP basis for 2011. None of our competitors had a better accident year combined ratio than HCC and only ROI had a better GAAP combined ratio.

We often talk about the lowest expense ratio among industry peers and yes, how do you do it, I mean, how are you 10 points better than everybody else in the business. Its not accident, it’s by design. We avoid businesses with inherently high commissions and other expenses, so you haven’t seen us in the commercial auto business; you haven’t seen us in the workers’ comp business. If we are to be in these businesses or if we were to give our pen away to others where we would have to pay them and overwrite commission of 7.5% to 15% plus a percentage of the profits by virtue of a profit commission, we would not be able to achieve one of the [tenants] that's in our model.

There's no way we would be able to achieve an 85% combined ratio over any five year period of time. We employ highly qualified underwriters which allows underwriting decisions to be made at the business level; therefore we don't need a branch office system. We do not need a regional office system. We don't have to invest in all that bureaucracy because we allow the underwriting decision to be made at the lowest possible level where we have the expertise.

So nothing is submitted to the branch office or regional office. If there is something submitted, there's a very flat home office management structure especially it's insurance. So you have Mike Schell sitting over here, you have Chris Williams to my right, myself, Mark Callahan and Bill Burke. That's the insurance management structure. We have less than 1% of the businesses submitted for home office approval and the only time that it is if it’s a political issue.

So it’s a highly sensitive account like writing the D&O for AIG after the government took them over, probably a good thing to check with us to see if we want to do that or if somebody wanted to exceed the authority that they had for either a limit or an aggregate exposure in an earthquake zone for example.

We are headquartered here in Texas. You probably don't know a lot about Texas if you don't live here but you do probably realize it’s a very good tax jurisdiction both personally and corporately. Salaries are a lot less than they are across the country; expenses for running operation are a lot less. It’s a very, very good legal environment. So if our operation which we have roughly 400 people headquartered well, more accounting Dallas we would probably be closer to 500 people located in Texas.

If we were to move those people into New York, Connecticut, Boston, Chicago the expenses running our business would be significantly greater. And lastly, we access our international business through our London office and I can’t over stress this. You will see a number of the peer companies setting up offices in Dubai, Singapore, Hong Kong, Rio.

We can access that same business out of the UK operation. We are specialty insurance company, if somebody wants to play specialty business they are going to go to a double AA rated S&P company and they are going to come into London market, if they are looking for capacity on a difficult risk they are going to come to the London market. We don’t have to set up our business all across the globe to see this business.

It’s not that we don’t get a big thrill out of having HCC in 55 jurisdictions, it doesn’t do anything for you to shareholders and it really doesn’t do anything for us, it allows us to have management control over the underwriting in the business. So we have avoided that structure.

The other problem you have with setting up offices in all these third world countries is that you have to deal with the legal jurisdiction, you have to deal with OFAC, you have to deal with all the attended problems and you have to deal with the court system in all those countries.

The UK well it might not be perfect, it’s pretty damn good place to operate. Most importantly, the characteristics that makes us different is our underwriting talent. This slide reflects our executive and underwriting management. The executive management’s job is to stay out of the way of the underwriters. And I think we are trying to do a good job of that but the underwriters might disagree with you from time to time.

I would like to point out two people on the slide, Craig Kelbel, 35 years in the industry, 13 years with HCC; Michael Donovan also 35 years in the industry and 29 years with HCC. One of the reasons I want you to think about this slide is when our underwriters present today, you’re going to see similar slides about their operations.

You will note the stability of our underwriting talent. We’re virtually no turnover in underwriting talent. It’s one thing to have a stable underwriting team when your combined ratio is a 100. It’s quite difficult to have a stable underwriting team when your combined ratio is in the mid-80s. Mid-80 underwriters can move, mid-100 underwriters keep their head down and try and keep their job.

How we’re able to attract the underwriters is because of our compensation policy. It’s important that our compensation policy be understood, be fair, be communicated and consistent. So how do we pay for our underwriters, we pay for performance. We don’t pay for premium volume. If you are running your company and you wanted to pay somebody big for their results, you want to pay them, you want to make money and let them make money when you make money. That’s the basic premise of our compensation policy.

Underwriters receive a bonus which is a percentage of pretax underwriting profit. Generally, a pool for the underwriters is 10% for that individual unit’s pretax underwriting profit. Investment income is excluded. So there is no benefit to go out and write a lot of premium so that you can generate the investment income on that book of business. So it’s pure, pure underwriting profit. There is no benefit of increasing your gross written premiums for the sake of writing more premium. Two-thirds of their bonus is paid in cash, one-third is paid in cliff vest and restricted stock.

Read the rest of this transcript for free on seekingalpha.com

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