Few Underachievers Disturb First Qtr. PartyAtmosphere

While most property-casualty insurers were invited to thefirst-quarter party celebrating higher earnings, lower combinedratios and double-digit premium increases, investors and analystswere impatient with those few that did not make the “A” list.

“If you dont start making hay while the sun shines, then theboard of directors should look for management changes,” an investortold CNA executives in Chicago during a conference call heldearlier this month.

“Why should shareholders entrust all this capital to managementif were not making good money in a really good environment? [Its]not going to last forever,” he said, after CNA leaders informedlisteners that the company is ultimately capable of being a“top-quartile earner,” but that a 10 percent return-on-equity wasntnecessarily forthcoming for any quarter in 2002.

CNA was one of only four companies among 27 whose operatingearnings were tracked by National Underwriter to reportlower operating earnings in first-quarter 2002 than infirst-quarter 2001. Vesta Insurance Group in Birmingham, Ala., wasanother laggard.

During Vestas conference call, a man identifying himself as along-term shareholder was also losing patience. “What are somethings–especially the way this market is, with Enron and othercompanies–that you can tell individual investors to keep our trustin the management [and] your ability, once you get the earningsgrowing again, to keep them growing?” he asked.

“Can you say with any assurance that this [second] quarter willbe any better than the first quarter?” a different caller asked,after executives said they were doing everything they could “to cutoff the drain and drag of standard auto,” which hurt first-quarterresults. President Norman Gayle responded that the companys goal isto improve earnings over the next four-to-six quarters.

Negatively-worded questions and comments, however, were atypicalin a quarter that was, for the most part, uneventful. “Nosurprises” was the theme of several calls hosted by p-cexecutives.

“The good news is that theres no bad news,” said Steven Markel,vice chairman of Richmond, Va.-based Markel Corp. “After severalquarters of this not being true, [Markels] business is on track andon budget. Were participating in this marketplace and enjoying itat last,” he added, referring to the fact that underwriting lossesand reserve boosts needed for Markels international operations haveplagued the company in recent years.

At Seattle-based SAFECO, President and Chief Executive OfficerMike McGavick said: “What is remarkable is theres really nothingremarkable to report,” reporting the companys best quarter in threeyears. In contrast, last years quarterly reports had Mr. McGavickdetailing job cuts, a third-quarter $240 million pre-tax reservecharge, and a first-quarter charge of more than $900 million forthe writeoff of the goodwill asset associated with prioracquisitions.

This year, the net income figures of several insurers tracked byNU were impacted by the adoption of new accountingstandards relating to goodwill–the difference between the purchaseprice and the fair value of an acquired company. A new accountingstandard approved by the Financial Accounting Standards Board lastyear (Statement No. 142) changed the accounting for goodwill froman amortization method to an impairment-only approach, requiringcompanies to annually test if there has been a decline in the valueof goodwill.

The accounting change generated some notable differences betweennet income and operating earnings in first-quarter 2002. TravelersInsurance, for example, took a $242.6 million charge to write offgoodwill related to its 2000 acquisition of Northland, causing a 79percent drop in first-quarter net income, compared to only a 6percent decline in operating earnings. Travelers said its operatingearnings drop was the result of an expected decline in investmentincome.

Northbrook, Ill.-based Allstate, the final company onNUs list to report an operating earnings decline, boostedreserves by $148 million as it continued to battle homeownersissues in the quarter.

In the aggregate, operating earnings, net income and netpremiums written all grew around 20 percent for the group trackedby NU. Individual combined ratios improved for 27 of the30 companies that disclosed them, with more than half of theseinsurers reporting underwriting profits. Roughly one-third sawcombined ratio drops of more than five points, while some largecompanies (like Allstate and Travelers) reported worse combinedratios in first-quarter 2002.

“Overall, property-casualty insurers did better than most peopleanticipated in the first quarter,” according to Michael Paisan, ananalyst for The Williams Capital Group in New York. One of thereasons was because this was a mild catastrophe quarter, hesaid.

Indeed, it was the mildest in a decade, according to theProperty Claims Services unit of the Insurance Services Office Inc.in Jersey City, N.J., which said insurers will pay $580 million forthree catastrophe events for first-quarter 2002, besting last years$705 million figure.

Predicting increased “earnings momentum” for the remainder ofthe year, Mr. Paisan said, “were beginning to see the benefits ofrate increases taken last year filtering down to the bottom line.The fundamentals began to show” in the quarter, he said–adding,however, that another reason that most companies beat analystsexpectations was that “expectations were fairly low.”

ACE Ltd. in Bermuda was a glaring exception. “ACE doesnt usuallymiss by a penny one way or the other,” he said. With operatingearnings-per-share falling five cents short of analystsexpectations, ACE proved that you could report the best quarter inyour history and still face the wrath of analysts.

ACE executives spent the better part of an agonizing conferencecall explaining why the companys growth (in the mid-teens on a netbasis) didnt measure up to 30-to-40 percent rates reported by whatanalysts identified as comparable top-tier companies, such as XLCapital and Chubb. ACE Chairman and CEO Brian Duperreault noted thedistorting impact of loss portfolio transfers, explaining thatwhile ACE wrote three LPT contracts for $250 million in premium infirst-quarter 2001, it wrote none in first-quarter 2002.

At one point, the call even had an analyst take up ACEs defenseto convince doubters of ACEs earnings power, citing “prettyfantastic” 13.5 percent return and growth rates that soared overthose of competitors in past years.

During The St. Paul conference call, a similar phenomenon wasrepeated, but in the latter case an analyst felt the need toconfirm the Minnesota-based companys prior-year disclosure of a$100 million reserve release. The defense came after anotherpreached about the need to disclose all positive and negativematerial items to analysts, a commentary that might have had moreto do with post-Enron skittishness about financial reporting thanSt. Pauls first quarter.

While Mr. Paisan identified The St. Paul as one insurer thathasnt yet joined the 2002 party, the company still managed toreport 5 percent growth in its operating earnings.

The St. Paul is “in the midst of a major overhaul,” Mr. Paisannoted. That restructuring continued in the quarter, with thecompany announcing plans to transfer its ongoing reinsuranceoperation to a new Bermuda company. More recently, The St. Paulsaid it plans to form a new underwriting operation to target largeU.S. property risks.

At Ohio Casualty in Fairfield, a strategic restructuring set inmotion last year to cut staff, exit some personal lines markets,and achieve specific growth and combined ratio targets is on trackbased on first-quarter results. Still, one analyst displayed adifferent sort of impatience. With everything going so well, whydoesnt the company revise its outlook to be more optimistic, heasked.

“The second quarter is always a higher catastrophe quarter thanthe first,” CEO Dan Carmichael warned.

Similarly, at Chubb, a usually optimistic Chairman Dean OHaretold an analyst that hes learned to err on the conservative side,when asked why the company had predicted commercial lines growth somuch lower than it achieved.

Reproduced from National Underwriter Property &Casualty/Risk & Benefits Management Edition, May 27 2002.Copyright 2002 by The National Underwriter Company in the serialpublication. All rights reserved.Copyright in this article as anindependent work may be held by the author.