Q2 2006 HCC Insurance Holdings Earnings Conference Call - Final.

Original Source: FD (FAIR DISCLOSURE) WIRE

OPERATOR: Good afternoon. My name is Brooke, and I will be your conference operator today. At this time, I would like to welcome everyone to the HCC Insurance Holdings 2006 second quarter earnings release conference call.

[OPERATOR INSTRUCTIONS]

This telephone conference call relates to HCC Insurance Holdings, Inc.

Before we begin, the Company has requested that I read the following statement which will govern the teleconference 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 these factors could cause our actual results to differ materially from those contained in 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 conference 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..

Thank you. I will now turn the conference over to Stephen L. Way, Chairman and CEO of HCC Insurance Holdings. Please go ahead, sir.

STEPHEN WAY, CHAIRMAN AND CEO, HCC INSURANCE HOLDINGS, INC.: Thank you, operator. Good afternoon and good evening, ladies and gentlemen. Thanks for joining us for the second quarter call. We are a little bit behind schedule. You're probably seen the second press release that we put out this afternoon and that has kept us a little busy here coming down to the wire. We wanted to get our press release out regarding our acquisition of Allianz Health so that we would have an opportunity to discuss this important acquisition during this call.

So I will briefly go over the second quarter results, and we'll have a Q&A, and then I will talk about the acquisition. I'm joined here by Ed Ellis, our CFO; John Molbeck, our President; and Craig Kelbel who is Chief Executive of HCC Life Insurance Company; and Byron Way who is Investor Relations; and Chris Martin; our General Counsel. So we have lot of folks here today.

First, our six months results -- very good. Our business plan is working very well. Business has come through our growth pattern from early in 2000-2001, and like all things, come to an end. Rate increases are not the norm as we end the second quarter. The good news is that most of our business is very stable. Our profit margins are extremely good and there are opportunities within various segments of our business where we can see growth ahead.

Over the past few years, we have been changing the makeup of our Company. Previously, we were predominantly a property and casualty company and we've expanded into other areas, accident and health, property -- surety and credit. And part of the reason for doing this has been to combat softness in the marketplace in any particular segment of our business.

We are not sitting here at HCC waiting for problems to happen. We're trying to understand not only when they will happen but have other things ready to do when that takes place. I am pleased to say that at this particular moment in time our business is strong in all segments. In some segments, it's certainly doing better than others, but our margin is very acceptable in all segments of our business.

And so, really, there are no issues as far as our business plan for 2006 is concerned. But it's very important to plan ahead. To time the planning is not when the issues come forward, it's not when the market changes, it's before it does. And so what we're seeing here now, and certainly with the acquisition that I'm going to talk about, are opportunities that we were looking, perhaps, to offset a softening property and casualty market when, in fact, the property and casualty market is really not softening as far as we are concerned at this point.

We don't expect to get rate increases indefinitely in any line of business. When our profit margin reaches a certain level, we can't expect to keep increasing rates. We are trying to maintain our margins. We're trying to improve our business each quarter. We are constantly re-underwriting and looking at our business from up on high and saying, how can we make it better?

But we know that all things being equal, the market is going to change. We never know exactly when and we never know what catalyst will cause that. In the past two years, we've suffered substantial catastrophe losses as an industry, which have helped the momentum of the industry. But still, notwithstanding the size of these catastrophes, the capital coming into the market has been even bigger, and to a great extent, has offset those catastrophes.

Normally, we would be in a very hard market across the board after such losses. But in fact, we're not and capital is the reason. Companies that should have gone bust didn't go bust. They're still here. They got new capital. So the capacity in general lines didn't go away.

Now specifically, in property and in energy, as you've been hearing, there have been extreme capacity shortages, and obviously, the ensuing rate increases that go along with that. But generally overall, the additional capital that has come into the market in the past two years is causing some pressure in other areas as reinsurers and insurers new to the business with new capital are looking to non-cap premium to balance their accounts.

So HCC is not sitting around waiting for any of these things to happen. And you will see from our results, and I'll go through them now, that although our business is doing extremely well, although we predict that it will continue to do well and our margins are good, we are still always looking for the next opportunity for us to expand our company and go to the next level. And this is what we've built our Company on. This is what we are known to do.

We believe that we understand our business very well. We believe that we can predict the cycles and the issues, both up and down. And in recent years, we've been well capitalized and able to take advantage of that. Obviously, we still are well capitalized today, probably the best in our history. We have an incredibly strong balance sheet. We are very much under-leveraged and yet we are producing substantially larger earnings, record results, but keeping our ability to raise capital or leverage debt to take advantage of situations.

So that's where we find ourselves today. The second quarter ended on a very positive note. Our earnings grew 40% in the second quarter, 31% on a net earnings per diluted share basis. For the six months up 38% on earnings of 27% per diluted share. We are very much on target as far as our business plan is concerned and we've taken a very conservative position as far as maintaining a very conservative lost reserve in IB&R, and I'm pleased to say that we have achieved these results without any material release of IBR on a net basis since the beginning of the year.

Our total revenue is rising and has been rising for several years now, up 22%, driven primarily by our own premium. Obviously, gross premium is still rising, although slower. And our earned premium is growing much faster, as we retain and have been more of our business. Over the past few years, we have developed a substantial book of non-cap business, which we're able to retain without reinsurance, without the volatility of some of our other lines of business. And these lines of businesses have continued to help us grow our own premium.

The GAAP combined ratio at 84% was about what we expected, slightly better than the first six months of last year. But we are working towards the low 80s to the mid 80s as a continuing combined ratio for the Company. The management fees, which we have talked about in several quarters is starting to -- the decrease is starting to slow down. We expected our management fees to go down three years ago when we started to retain more business. And obviously, they have followed that pattern.

But our reinsurance broker in London is doing more non-affiliated business. And they are growing that business, which will help fee and commission income. And with the recent acquisition of Kenrick and other possible acquisitions in the future, it is our intention to grow our fee and commission business over the next couple of years. So we expect certainly by the first quarter of next year to see our revenue to be stable to even starting to increase again.

Our investment income continues to grow very rapidly, up 62% for the first six months of '06, driven primarily by the increase in investment assets. You have all seen our investment assets growing dramatically over the past four years and may continue to do so as our reserves -- our loss reserves continue to grow through for two reasons. One, we are retaining more business. And two, we are writing longer-tail business, not long-tail, not like workers' comp, but longer-tail than we had in the past.

So our reserves are hanging around longer. And therefore, we are increasing our investment assets. So the combination of increased retentions and loss reserves growing through our liability account, our E&O, D&O and our other liability business, has helped growing our investment assets, and, of course, earnings. We don't mention that very often, but we are making an awful lot of money, and that is all contributing both to the shareholders' equity and to our investment assets.

Our total investments increased 10% during the first six months and now stand at about 3.6 billion. We had suggested beginning of the year that we would be somewhere close to 4 billion by the end of the year. And I think that's fairly certain. Our shareholders' equity is rapidly approaching $2 billion. And the good news certainly looking at other competitors that reported here in the last few weeks, we have been able to get more of our earnings to book value, generally speaking, than many of the rest of the insurance industry.

Two reasons for that. We are making a lot of money. But our investment portfolio is relatively short still, and therefore, the impact of higher interest rates has not caused this to impair our equity and our book value. So even with the increased dividends, the 30% increase in dividends that we collected in the first quarter and with the higher interest rates, causing some loss to our fixed income portfolio, we have still been able to grow our book value reaching $16.48, an 8% increase in the first six months. So very much on target for an ROE this year in the mid to high teens.

I am going to turn the call over here briefly to John Molbeck to give …