辛辛納提金融 (CINF) 2009 Q2 法說會逐字稿

Good morning. My name is Amy and I will be your conference operator today. At this time, I would like to welcome everyone to the Cincinnati Financial second-quarter conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator Instructions). Thank you.

Mr. McDaniel, you may begin your conference.

Hello. This is Dennis McDaniel, Cincinnati Financial's Investor Relations Officer. Thank you for joining us for our second-quarter 2009 conference call. This morning we issued the news release on our results along with our supplemental financial guidance. We plan to file our quarterly reports on Form 10-Q early next week. If you need copies of the release or supplements, please visit our investor website, www.cinfin.com/investors. The shortest route to the information is in the far right column via the quarterly results Quick Link.

On the call you will hear from Ken Stecher, President and Chief Executive Officer, and Chief Financial Officer, Steve Johnston. After their prepared remarks, we will open the call for questions. At that time, some responses may be made by others in the room with us including Chairman, Jack Schiff, Jr.; Executive Vice President, J.F. Scherer, Sales and Marketing; Principal Accounting Officer, Eric Mathews; and Senior Vice Presidents, Marty Hollenbeck, Investments , and Marty Mullins, Claims.

First please note that some of the matters to be discussed today are forward-looking. These forward-looking statements involve certain risks and uncertainties. With respect to these risks and uncertainties, we direct your attention to our news release and to our various filings with the SEC. Also a reconciliation of non-GAAP information as required by Regulation G was provided with the release and also is available on our website. Statutory data is prepared in accordance with statutory accounting rules and therefore is not reconciled to GAAP.

With that, let me turn the call over to

Welcome and thanks to all of you for joining us today. As you know, we reported disappointing second-quarter financial results. Record catastrophe losses and ongoing cumulative pricing pressures have taken a toll on us this year. Further, our pretax investment income has not yet resumed a growth trend compared to the year-ago periods. The good news is that the same portfolio rebalancing that reduced our investment income also positioned us for the growth in book value per share that took place over the second quarter.

As a result of higher unrealized gains in our portfolio, policyholder surplus in our main business, property casualty insurance, rose about $135 million between the end of the first quarter and June 30. It is good to see book value and surplus moving in a positive direction again and to see the progress we are making with our strategic initiatives to increase our long-term competitive advantages.

Today I will focus on operations, markets, and status of those initiatives to improve future financial performance. Steve will discuss our second-quarter results and their main drivers including catastrophes, reserve development, and accounting changes.

In February, we said our year 2009 results would likely fall short of our longer-term targets. Despite our dreary results so far this year, we remain confident in our long-term outlook believing that the strengths we bring to the market will position us for strong future performance. Our independent agents' relationships are strong and the many opportunities they give us to quote their best accounts are helping to offset some of the negative effects of the continuing soft markets.

Agents count on us to provide a stable market for their clients' insurance needs and to deliver best-in-class claims service, particularly when widespread storms occur. They highly value our local field team concept.

Our solid reputation among agents is one of the reasons that our new agencies are so quickly embracing Cincinnati-style service. Of the $3 million in premiums our new Texas agencies wrote in the first half of this year, six of these new agencies produced more than $0.25 million each of premium. One agency generated over $0.5 million. Technology clearly is central to maintaining those agent relationships and our high tier position within agencies. We are right on schedule to begin deploying our new commercial administration system for package and auto. It will give agents new processing efficiencies, also allowing us to write more business without proportionate increase in expenses.

Some of our underwriters already are using this system to produce policies for Ohio and Indiana agencies. When we deploy it in October for use in agent offices in the first five states, we will also introduce direct bill capability for package and auto. Our agents are really looking forward to having this capability. The system will be up and running for agents in a total of 11 states before year-end 2009, preparing us for strong, profitable growth when the economy and insurance market pricing begin to improve. And we will go into that market phase with solid reserves, having made no compromises of our reserving practices along the way.

We have proven that we are willing to make difficult decisions to protect our track record of strong reserve adequacy. Steve will discuss this quarter's reserve development in detail. From a strategy level, our intention is to continue having a balance sheet that holds the potential for favorable reserve releases into future earnings. That approach increases stability. We also believe that our diversification efforts in several areas increase stability and will serve shareholders well in the future.

Most of you listening today are aware that we maintain a well diversified and highly rated bond portfolio exceeding our insurance reserve liabilities by more than 20%. In recent quarters, we increased our bond holdings and reduced our common stock holdings to 25% of the total portfolio. We are very comfortable with our rebalanced asset classes.

Most significantly, we diversified away from equity concentrations in any single sector or issue. Our portfolio diversification effort is a capital preservation strategy to manage volatility risk. Our new surplus lines operation brings the benefits of diversification to our insurance coverage product offerings. This operation is still very small, but as we said in our news release, it is a significant contributor to new business growth in 2009. The surplus lines products help our agents meet more of their clients needs, also benefiting company performance while offsetting some of the soft pricing in our standard market commercial lines. Our stable life insurance income likewise helps offset some of the market cycle impact of our property casualty business.

Finally, another very important diversification effort is our geographic expansion. The expansion to new states is one of several ways that we are addressing catastrophe risk and especially the destructive effects of that risk on our homeowner results. By entering or expanding our personal lines offerings in seven states in 2008 and 2009, we are setting the stage to gradually increase scale and over time work to dilute our concentration of insured exposures in the Midwest and South. We have confidence that those diversification strategies will produce long-term benefits.

Next, I will comment on commercial lines premium growth, a near-term challenge for us and others in our industry. The commercial lines market remains highly competitive based on what we are seeing. Our second-quarter net written premiums declined 12.2%. We've seen some moderation of average price decreases to low single-digit territory, but those are still price declines and they represent averages. We continue to hear stories about more aggressive competition especially for larger risks.

Whether they are a larger or smaller risks, we walk away from the business we believe is underpriced. For example, we recently lost an account we have had for 20 years to another carrier. It was a school system with annual premiums in the six-figure range that our competitor discounted by over 30%.

You have heard us say many times that nearly 90% of our commercial policy count represents policies with annual premiums of $10,000 or under and that is still the case. But looking just at new business for larger policies with annual premiums of $100,000 and up, we see the effects of intense competition. Our new business written in this size category during the second quarter was $7 million less than we wrote second quarter last year accounting for nearly the $8 million decline in commercial new business.

Commercial premiums also have come under pressure due to economic sensitivity. This year the rate of premium decline for contractor classes in our general liability and workers' compensation business is roughly double that of our non-contractor classes. Many businesses pay estimated premiums based on estimated exposures such as sales or payroll and an audit at the end of the period trues up the premium. Our premiums generated through such premium audits declined $13 million during the first half of 2009 versus 2008.

Before I close the prepared comments on our insurance operations, I will mention that our public parent company is highly liquid at June 30, with more than $1 billion in cash and marketable securities. Strong capital provides the corporation with financial flexibility for dividend-related decisions made by our Board of Directors. To maintain the desired parent company financial flexibility, we recognize that the performance of our commercial and personal insurance segments must improve.

For the reasons I've reviewed today, we believe it will improve. Although our expectations for the remainder of 2009 are modest, we expect to deliver strong financial performance for the longer term.

Now Steve will discuss details of the quarter.

Thank you, Ken. As Ken mentioned, abnormally high catastrophe losses led to a combined ratio of 116.6 for the quarter. Catastrophe losses totaled $118 million or 16.1 loss ratio points. In total, 11 PCS named cats caused damage to our policyholders, most of it arising from three major wind and hail storms across the South and Midwest.

Our total catastrophe losses were higher than the $106 million estimated in our preliminary release due to inclusion in our total estimate of several PCS defined cats that each cost us less than $3 million but in total added up to approximately $12 million.

Our homeowner line of business was most affected with 77.6 points of the 147.8 loss and loss expense ratio coming from these catastrophes.

On the more positive side, our total property-casualty reserves on prior accident years developed favorably, giving us a benefit of approximately $29 million or 3.9 percentage points on the second-quarter combined ratio. While overall reserve development was favorable, there was some variation by line of business. We strengthened reserves to prior years workers' compensation claims by $29 million, while all other lines in total developed favorably by $58 million. The reserve development for workers' compensation was primarily for accident years 2005 and prior.

Nothing has changed in terms of our reserving philosophy, and we continue to target total reserves in the upper half of the actuarial range. For any insurance company, strong reserves are essential to a strong balance sheet. Our track record of favorable reserve development goes back some 20 years and that trend appears to be continuing.

Now for some details on investments. Our more diversified investment portfolio contributed nicely to book value which grew by 6.7% to $25.49 per share during the quarter. Even after considering the turbulent markets and sales that harvested some capital gains, the equity portfolio once again ended the quarter with over $0.5 billion in net unrealized gains. As a result of the transformation of the portfolio over the past year, pretax investment income decreased by 8.4% quarter over quarter to $119 million.

We also adopted accounting requirements under FSP 115-2. While there is no overall impact on equity or book value, there will be an indirect impact on investment income for comparative purposes. When investment was written down as other than temporarily impaired, the cost of the bond was written down. Then over the remaining life of the bond, the difference between that written down cost and par was amortized into the investment income over the remaining life of the bond.

During the fourth quarter of 2008, this amortization added $3.1 million to investment income and for the first quarter of 2009, it added $2.4 million. Most of the bonds that we previously wrote down as OTTI were written down for noncredit-related issues. Under the new rules, there is not a material amount of this amortization included in second-quarter investment income and we anticipate that there will not be a material amount going forward.

This makes for a tough comparison for the second quarter sequentially to the first quarter of 2009, and it will also make for a tough comparison in the upcoming fourth quarter. Adjusting for this accounting change, we do expect investment income to resume an increasing trend by the end of the second half of the year.

Our liquidity, balance sheet, and financial condition remain very strong, putting us in a good position to grow profitably. At the property-casualty subsidiary group level, we are writing business at a premium to surplus ratio of 0.93 to 1 with statutory surplus of over $3.2 billion at June 30, 2009.

Cash flow from operations for the first half of 2009 was $157 million compared to $334 million in the first half of 2008. As Ken mentioned, we have over $1 billion in cash and marketable securities at the holding company as well and we also have short term used borrowing capacity on two lines of credit of approximately $175 million.

Our debt to total capital ratio is relatively low, 16.8%, and our two nonconvertible non-callable debentures are not due until 2028 and 2034. The value creation ratio we use to measure our long-term success increased nicely during the quarter. Describing our long-term goal more specifically, for the five-year period from 2010 through 2014, we are targeting a 12% to 15% average for the total of our rate of growth and book value per share plus the ratio of dividends per share to beginning book value per share.

2009 remains challenging but our value creation ratio for the second quarter was plus 8.4%, bringing the year-to-date value to approximately 2.0%. This is up from minus 16.6% for the first half and minus 23.3% for the full year of 2008.

A key point is that our investment portfolio changes and other risk management actions have increased financial stability. We believe our risk-adjusted capital indicates exceptional financial strength. Ken?

Thanks, Steve. Steve gave you a good overview of the items that put us in an operating loss position for the quarter. It's been a stormy second quarter with just a few rays of sunshine. We have the capital and strength to grow profitably. We have the ability and intent to outperform. We are making good progress on initiatives that increase our long-term advantages and bring them to the bottom line.

With that, let me open up the call for questions. Just a reminder that Jack Schiff, J. F. Scherer, Eric Mathews, Marty Mullen, and Marty Hollenbeck are here with Steve and me and we are all available to respond. Amy, we are ready for questions.

(Operator Instructions) Michael Phillips, Stifel Nicolaus.

Thank you. Good morning, everybody. A couple questions. First just on topline, the drop in exposure isn't unexpected and the soft market clearly isn't -- hopefully it is getting a little bit better. But a pretty sharp drop here in the quarter. Is there anything that would cause it to fall off so quickly besides the drop in exposure that would make just this second quarter kind of more of an anomaly? Or I guess I would expect this to be more of a gradual thing than what I saw here in the second quarter.

Mike, this is J.F. I think it appeared to us as well kind of an abrupt decrease confluence of both the absence of contribution of audit income as well as the effect -- the double effect of not only are we giving back particularly in the construction area returned premiums to contractors because the premiums -- payrolls themselves, they estimated last year this time are obviously coming in lower. But then also their outlook to the future in terms of the renewal premiums are having a double effect.

As we take a look at our book of business, where we are seeing price pressure are on the larger accounts, as has been described in our release as well as Ken's remarks. But also in our construction book of business. So it appeared to us that just the effects of the economy seem to manifest itself more significantly here in the second quarter.

Thanks, J.F. So as you think about your entry into the new states and the new business that you are getting there, are you consciously thinking about trying to diversify a little bit more away from the construction and contractor type business that you are kind of heavily focused in now?

Well, we've been trying to do that for some time really across the board for us. In Texas for example, the economy actually what we've found in working with our agencies down there, the economy is not as bad. The construction accounts that we are writing down there are clearly survivors of what are out there. We are not targeting construction. We are continuing to write a balanced book of business, part of which would be construction. So there's no effort to steer away from that particular line of business in places like Texas or Colorado. But certainly we are anxious to write a balanced book of business.

Okay, thanks. I switch over to the reserve development on the workers' compensation for Steve. Now we've got the second quarter of that and I guess the same reason is a slight change in the inflation assumption had such a dramatic ripple effect. But I guess given that we've seen now two in a row, is there any reason for us not to think that maybe on the inside of the house there that you are sort of cautiously taking baby steps and that we can therefore expect more of the same going forward? Or do you think you've taken what you need to take on that line?

Mike, that's a good and fair question. The short answer is we do feel that we have taken what we need for workers' compensation, but I think it's again a good and fair question. I think as we looked at the second quarter just more evidence materialized on these prior years and our actuarial department, as most do, use multiple models to review the data. And as they look at it over the second quarter, more -- all of the models started converging to a higher result than they had at the first quarter. We had one, maybe one model then that they all started to converge to the same number, which gave us more confidence in the need to add reserves to workers' comp. But again back to answer the question, we do feel we have it at this point.

I'll hop off, just one quick numbers question. If you could give the operating cash flow for the quarter. Then I'll hop off.

Yes, it was one hundred... -- for the quarter, I have it for the half year that I gave in my prepared remarks. I think we can get to you for the quarter here before the call ends, Mike.

Okay. Thanks.

Beth Malone, Wunderlich.

Just talking about the weather-related losses, I know that's always been a part of the business that you write. Do you think there's any -- is it being impacted as well by your new agencies or new markets that you are going into exposing you more to weather than in the past?

Beth, this is Ken Stecher. I don't think -- I will let J.F. respond in addition if he would like -- but I don't think it's that so much as just the weather patterns the last two years have focused very much on the Midwest. And I think this year is an example and the Midwest to the Eastern part of the country, it's been so much cooler and that has just kept the thunderstorms and the hail storms going much longer than they normally would.

And it's focused in an area where we have the largest part of our homeowner line in the Ohio, Indiana, Illinois area. So I think that has kept the size of the catastrophes at a higher level than we have experienced in many years in the past. I don't think it is an effect of just the agencies that we're appointing or the business that they are giving us. I think it is just that what I believe is a temporary weather pattern change. But I don't know if J.F. would like to add anything to that or not.

No, Beth, I can't add anything to it. The newer areas we are in, North Carolina, South Carolina, Maryland, very little business from those areas. We did enter Arizona, Idaho, Montana, and Utah. Of course once again, very little business so far in those areas and no losses from cats in those areas. So it's -- where we are having the impact or the weather is having the impact is our traditional areas.

Well, do you feel -- since it seemed somewhat random obviously, acts of God kind of thing, but is it possible that you are getting adequate rate or rate increases now on those books to make you feel more comfortable going into 2010?

I think that if they continue at this level, Beth, I think the obvious answer is no. These are abnormally -- at least we feel to be abnormally high levels and the pricing is more aligned for a longer-term approach. Having said that, particularly in the homeowners line, there is a lot of work being done on the pricing side in terms of pricing segmentation and more pricing points. They are working to get geographic diversification by going into other states and then also working on things that they can do to reduce the cat exposure.

Okay, and then on the workers' comp, how much of that -- the experience you are having do you think is reflective of changes in the regulatory environment in those markets or legislative issues or is it just market conditions among competitors?

That's a good question. I guess I would take the first stab at it and Marty Mullen probably has some comments as well. The way I look at it, it's a tough line in terms of it being cyclical in nature. That makes it difficult over time and we've seen big swings in results in workers' compensation. I think also the long-tailed nature of it makes it difficult to always get an accurate handle on right away.

But we are doing what we can in terms of pricing the product as appropriately as we can. Our underwriters are using our predictive modeling now as a tool in their decisions on pricing and working hard on what we can in terms of the underwriting. Marty?

Thank you, Beth. This is Marty Mullen. I would just mention the regulatory environment. There certainly are specific venues that make a successful writing of workers' comp profitable and challenged based on some revelatory issues, favorable or unfavorable work comp boards or decisions and make it difficult to proceed -- to anticipate successful resolutions of those workers' comp claims for the employee and the company.

We also deal with future issues concerning Medicare, a secondary payer fund, which is an issue that we are all dealing with in the future and as it pertains to future work comp claims and payouts, which is also a factor to be considered moving forward.

Okay. All right, thank you.

Thank you, Beth. Amy, before we take the next question, I would just like to get back with an answer that our operating cash flow for the second quarter was $118 million and that compares to $156 million in operating cash flow for the second quarter of 2008. Thank you and on to the next question, please.

Paul Newsome, Sandler O'Neill.

Good morning, folks. I guess big picture we have had a pretty long series of cat losses every quarter -- or close to every quarter for almost two years now. At what point do you think you can go back to the regulators and just say, you know, the world has changed and this is the way that cat losses are going to be and we've got to put rate in [for us]?

Paul, this is Ken Stecher. I'll start off. I think in some cases, you know, the big thing I think is really the competition. We can go do that probably with some of the data we have currently. But if the other companies don't do that, it could put us at a price disadvantage. So we do have to weigh that factor.

Secondly, and maybe Steve would be better to comment on this, as he mentioned in his previous comments, when we factor in the rates, we look at a longer cat exposure trends and not short-term trends. And I'm not sure how regulators would feel about -- as you said, the last year and a half definitely cats have been much heavier than normal for us and you weigh against the 2007 year where they almost didn't exist in the states we were in. Regulators are going to look at, A, trying to give us adequate rates to protect her solvency, but they're also going to want to keep rates down to protect the consumer.

So we have that balance along with the balance of what -- we want to try to stay competitive. But we do have to make money in the long run and that's the point that you are trying to make, and that's one of the things that we have to try to balance.

I would just add to that, Paul -- this is Steve -- that clearly rate is an issue. You just can't look at the results we've had and not come to the conclusion that rate is an issue, so we are filing for rate increases that will be effective in October. They will be in the 5% to 7% range. They won't be across the board. They will be addressing various pricing points, increasing our pricing points. And we've seen a shift through this pricing effort that we have been making towards what we feel to be higher-quality business.

The geographic diversification is moving into full swing as well. We have opened up four new states for personal lines. That would be Arizona, Idaho, non-coastal South Carolina, and Utah. We are introducing personal auto -- that speaks more to the account than homeowners or property in particular but we are introducing personal auto in Maryland and North Carolina. And so the effort to gain more premium over a wider geography would make the impact of the various cat losses smaller to the total.

And then we're working also in taking underwriting action in reducing our hurricane exposure. So your point is a good one and getting right down to it, price is an issue and we do need to get more rate.

You know, I guess given -- I guess I also like to push back to see on the amounts of rates you're trying to get a hold of. You know, 5% doesn't seem like it's quite enough to get you to an underwriting profit. I mean, you may get some benefit from geographic distribution and I apologize, I had to jump off here. But the numbers don't seem to quite work up for me unless you meet or achieve a second or third or fourth round worth of price increases to get you back to an underwriting profit.

You know, that's a good point and it's hard to argue with, Paul. The point that I want to make though is that 5% to 7% is an average and there is a distribution in terms of the rate increase with much higher percentages of rate increase being planned for what we consider to be the pricing points that are causing the majority of the losses or where we need to get more rate. But it is -- I think as Ken pointed out -- a process that we have -- an ongoing process.

As we mentioned in prior calls, Paul, I think we have many more pricing tiers than we had previously and we're still trying to adjust those rates on the lower insurance scores, you know, the lines that would warrant more rate. So we're working on that also. So it's a combination of both of those things. But as Steve said, we agree. We have to continue to work very aggressively on this issue.

Great, thank you very much.

Dan Schlemmer, FPK.

Good morning. Another question I guess on the cats and it was -- rounding it was basically $100 million in cats this quarter, which is pretty comparable to what you had Q2 '08. They are fairly close. And sort of what we are seeing overall market I think if Q2 '08 was bad for everybody, but I think this quarter Cincinnati is more of the anomaly, worse than maybe what we would expect based on just market share or whatever.

Is there -- do you have anything that can maybe -- do you have any sense that you were hit particularly hard due to a lot of it being in Ohio or some other issue that caused your cats to be worse than industry this quarter? Or was there anything -- any specific drivers that you saw?

Thank you, Dan. This is Marty Mullen. I will just give you some more color on the three major claims or storms that we had which really centralized in our Midwest and in some southern states. The main driver is hail and extensive wind claims and I think what you're driving at is why it's greater for Cincinnati than some others that are reporting. And I think it touches on an earlier comments that mainly hit us in the areas where we have our consistently historical business.

For instance the April 9-11 storm South Midwest is mainly driven by a tornado in Nashville and subsequent hail in Alabama and Georgia, all states that we do a fairly amount of commercial and personal lines business. And subsequent two storms of that followed the same pattern of Midwestern states involving hail and significant wind claims.

Our past experience with these types of exposures in our areas leads us to develop -- can develop adversely and have to be handled cautiously because of that long tail. Consequently, we think it's best to proceed with a cautious approach to these is the best practice.

Great, thank you. Separate question just on the surplus lines and you've sort of been a little more than a year going on this now in this business. Do you have a long-term target at this point? Do you think this three, five years out, is it a $10 million business? Is it a $100 million business? Or what is -- what are you guys thinking of in terms of a longer-term target for the surplus line specifically?

Dan, this is Ken Stecher. I will start and J.F has given numbers before in the past about the amount of business that is written by our agencies in this excess and surplus line. So I think it's a great opportunity for our company. We believe it can be a fairly meaningful line of business for us in the long term.

We have a plan, business plan, but we haven't disclosed any of those production numbers. So I'm not going to give those at this point in time. But I think it really what it does is it matches up well with our strategy of trying to provide the products for our agent customer that they need for their success. And I think when you look at where we started a year and a half ago and the written premium for the first six months is about $17 million, we are making some strides in that area.

But I think J.F. can explain a little more about the real benefit that it provides between us and our agency customer.

Dan, we wrote $15 million in new business in the first six months. Just to give you a little color on it, as has been mentioned in the past, our agencies write about $2.7 billion in excess and surplus lines business. We are not a market for all of it. We like to feel that our appetite range has been relatively modest. Just to put it into context, as far as new issues so far this year, the average premium has been $5,300. The medium-size premium is $2,000. So I would like to say that we are trying to grow this company hitting singles maybe doubles, not trying to hit a home run. Though from time to time we do have agencies that are allowing us to write a very important account that would have some size to it.

So far this year we have had 10,000 quotes, just to give you an idea, and converted about 3,700 of those. Retention so far on those accounts that weren't short term is 87%. So we are measuring a lot of things. As Ken said, this is an important segment of what our independent agencies do. There are a lot of standard accounts that have E&S exposure to them and that's allowed us to write some of those. So in terms of long-term, given the potential we have within our own agencies, we think there's a lot of opportunity for us.

Sort of follow up on that, you said I think 3,700 conversions. Is that -- do you find a particular -- is there a particular niche that you are finding particular success in or is it more across the board? Is there anything identifiable that is whatever -- where you are hitting the most?

Special events obviously are a big deal with July 4th coming and gone for example. We wrote a lot of that type of thing. Summer festivals would be a good example, church festivals, vacant property. Now that we are writing to property, we're writing a lot of vacant buildings, vacant houses. I think probably a line of business would be fire suppression installation. That seems to be a fairly large segment of this particular class of business. We are getting our opportunities in that area.

But some products liability on light manufacturers. I think as a general statement though, given our agencies, the towns they operate in, an awful lot of special event types of things would be reflected in our book.

Great, thanks. Last question just on the dividend, you made a decision earlier this year not to increase the dividend. Is that something you intend to revisit during the year? Have you given any further consideration to that or is that something you really only will consider again sort of on an annual basis?

Dan, this is Ken Stecher. We discuss a dividend in every Board meeting that we have. So this is something that will be discussed at our next Board meeting just like it always is. It is a Board decision, as you know. But we have the capital right now to support the dividend policy that we have. But as I said in my prepared comments, when you look at a long-term view, the operating results have to come into play and we must improve on the first six month earnings per share numbers. We have to do that just to provide the capital, to grow the company and give us the ability to pay the dividends going forward.

Great. Thank you.

(Operator Instructions) Mark Dwelle, RBC Capital Markets.

Good morning. One area we haven't touched on much, there is a huge rate of growth in the life insurance operations. Could we talk about that in a little bit more detail?

Sure, Mark, this is Ken Stecher. I think what we are doing is we are -- we have always stayed out of the variable markets for insurance. We've always sold on mortality products. We worked very hard to make sure that we have competitive term insurance products. We are building our book of worksite marketing. We have a universal life product. And in this past quarter, what we're starting to see is some of the benefits of the renewal rates of those types of policies.

It's not showing in the earned premium as much, but in the written premium, there is a little bit of availability to -- we have increased our annuity writings, but it's fixed annuities, not variable. And we believe that with the products that we have we are well protected in that area. So again, mostly standard. The old type life insurance products are what we really focus on.

Okay.

And I would add -- this is J.F. -- I would add our strategy has continued to be -- we get about 70% of our Life premiums from our property and casualty distribution and we continue to exploit that. Our property and casualty agencies continue to make it more a part of their operations to sell life insurance. They have a very good relationship with their property and casualty accounts. We do our best to cross-sell. We have a field force that calls on those property and casualty agencies.

And so I think Dave Popplewell, President of our life company, would tell you that having been involved in other distribution systems, the stability of using a property and casualty distribution system has really paid off for us when right now in the life insurance industry it has not been so good.

Okay, that's helpful. Moving back over to the commercial lines business, somebody earlier kind of generally asked this question. I'd like to ask it a little more specific. In terms of the 12% decline in net written premium in the quarter, how would you -- what portion of that is -- would simply have been price? What portion of that would have been volume declines, whether that be existing business or reduced policy count or anything else? Then what portion would be the things you described such as payroll audits and kind of things that are something -- something that's in the nature of one-time or at least hard to predict or track?

Well, I guess -- this is J.F., Mark. Our persistency, our retention rate in commercial lines remains pretty strong at 91%. In the second and third year of a three-year policy, it continues to be in the mid-90s. So we are retaining the policies. So we are comfortable that we are not losing an inordinate number of policies. Pricing changes, as was mentioned, although pricing changes that have occurred up until this quarter where we've seen an improvement to the low single-digit declines on average at renewal. Obviously we have some policies that are earning their way through right now that are affecting things.

I would say that the largest effect that we are seeing though is the effect of the economy, payrolls and the sales. For example in 2009 just on a quarterly basis, a year-over-year decline for our contractor book of business on premium is 17.4%. For our general liability book of business in total, it was 8.4%. So you can see the effect that the construction book has had and the effect that the economy in general is having on things. I think that's really the best description I could give.

Would it be fair -- saying this a different way -- would it be fair to say had there not been any rate decreases across your policy book, had rate been flat or out of the equation, you would have still had a net premium decline in the neighborhood of 10%?

I would say that's fair. We're getting some nods in the room here, just some quick math. But yes, that's what we're seeing.

Okay, thank you. That's all my questions.

Michael Phillips, Stifel Nicolaus.

Thanks. You guys -- in personal lines you mentioned the large losses in personal lines, not the first time and certainly not alone in mentioning that. You are also not alone in a lot of what other companies are doing in raising your retentions. How much comfort do you have in your pricing -- I guess adequacy or the confidence you have in these upper layers that are kind of new for you that might be part of large losses there? Or maybe they are not. Just comment on that.

Mike, are you talking about on the personal lines?

Yes, (multiple speakers)

-- which upper layers?

I guess across the board. You specifically mentioned personal lines but really anywhere across the board.

I think, Mike -- this is Ken Stecher. Maybe what you are referring to is when I was mentioning, pricing tiers, the fact that we've instituted more pricing different rates for different insurance scores. And for the people that have the lesser or the higher insurance scores, however you want to look at it, if you want to look at it from one to 12, six, seven, or eight would be a higher score and therefore the rate would be greater for those types of risk. Is that what you are referring --?

Actually what I am referring to is as you are taking higher -- taking on higher retentions and so it's kind of a reinsurance question, therefore you're exposed to this higher losses and are your pricing upper limits adequately?

We feel we are. I mean that's a tough question and you just have to -- because it's harder to get the law of large numbers to work for you, because you are -- you have fewer that go into those upper layers. But for our underwriting guidelines and so forth, they are reviewed carefully and reinsurance is utilized. So we feel that we are.

Okay, thank you.

Beth Malone, Wunderlich.

Okay, thank you. Two follow-up questions. One is on the reserving development in the workers' comp. That was based on a new assumption on inflation, inflation trends. Would that assumption have impact on reserves on your other lines of business or because of the nature -- the length of the workers' comp, you wouldn't see it elsewhere in your book?

Beth, this is Steve, and we think it was most pronounced in the workers' comp. We've actually seen pretty nice favorable development in the other commercial casualty lines and we think that the ability to get there, get our mediation process in place, and get those claims closed more quickly and more favorably is helpful. So I guess in answer to the question, we do see it impacting the workers' comp more.

Okay. So it's really not an assumption about where you think inflation is going to go on these claims. It's more that your actual experience on the claims has been greater because of the inflated costs of settling them?

I guess for workers' compensation, as we -- as the actuarial models regress really in three dimensions, we are seeing the paid losses over the calendar years increasing, which would indicate calendar year inflation. So we are seeing that on the workers' compensation line, but we just aren't seeing it as much on the other casualty lines.

Okay and then a question on the dividend. You haven't -- you are not going to -- it doesn't look like you are going to earn your dividend this year. I don't know about second half. I'm not going to make an assumption at this point. But what -- when you talk about the need for improving your operating results in order to -- is that to support your existing dividend or is that to justify increasing your existing dividend?

Beth, this is Ken Stecher. I think it's basically to continue the policy that we have. And I think that's the fact that we really do like the policy, the fact that we pay a fairly sizable dividend, the fact that we have been able to grow it, and we definitely want to maintain it. When you look at -- when I said before that we do need to improve results, yes, the economy is very trying. The commercial lines pricing is still very soft. But if we -- and I know this -- there is always anif to the question, so here it comes -- if catastrophes for the next quarter would be along the lines of say that 5% or 4 to 5 points of guidance that we normally would give for the year, I mean that could deliver like cats I believe Steve this quarter about $0.48 impact, I believe. And that was about 15 to 16 points. If the cats -- that number would be decreased to 5 points, you can pick up about $0.30 of earnings.

As the question was asked previously on the workers' comp reserve increase that we took, we believe we are where we need to be. If that does not occur again, you get another X number of cents.

So your point is well taken. Where we are sitting here right now, the operating earnings did not cover the $0.78 that the Board has declared in the first half of the year. Is it possible that we could earn over $0.78 in the last half of the year? I think if the weather improves, I think the possibility is there. The capital position for the quarter increased on a consolidated basis from about $3.9 billion to $4.1 billion. So, you know, the potential would be there for the Board to consider following the dividend policy that we have had in the past.

So those are the kind of factors I was trying to refer to as to what we're looking at. The other thing that I will just clarify is that on a year-over-year basis in our past history, there have been occasions where the Board has declared a dividend in excess of the current earnings. But they were looking at long-term. There were unusual circumstances from their view that caused the operating earnings for the year to be less and so they felt comfortable taking the dividend policy forward.

That's what I was kind of referring to before is that potentially this year, it could be done, but if next year would be below the $1.56 current level, you just can't do that indefinitely.

Okay, thank you.

Paul Newsome, Sandler O'Neill.

No, you actually -- you covered the question. Thank you.

(Operator Instructions) [Fred Nelson], Crowell, Weedon.

Thank you, a lot of congratulations goes to your investment department and the philosophy which allowed Marty and his staff to do to turn the book value up and to build the income. And a lot of us as shareholders are of course concerned about the fact that if you reduce the dividend that money can be put back in the portfolio to build the long-term wealth of the company. So I haven't heard much talk about that, but I do want to say congratulations. It's a tough period for all of us. And thank you, guys and gals.

Thanks, Fred. This is Ken. I will let Marty talk a little bit about some of the portfolio reallocations we've done. I think he and his team have done an excellent job going through this economic environment that we have and positioning us, which I believe in good position for the future.

Yes, Fred, there have been a lot of changes. Certainly our core philosophy of focusing on common stocks to a degree is probably a little higher than most P&C companies is still intact, albeit in a smaller fashion. We finished the quarter with about 25% of the overall portfolio in common stocks, virtually unchanged from the first quarter. We still like companies that pay and grow dividends. It's a little more challenging in this environment certainly. We had a couple -- three in the first quarter that cut their dividends.

So it's still a tough landscape out there, but we think in the long-term, putting a little more money into the bond portfolio, increasing yields there will give us some additional flexibility in the common portfolio. So as Ken said, I think we are well-positioned going forward.

Thank you.

(Operator Instructions) There are no further questions at this time. Mr. McDaniel, you may continue.

Thank you all for joining us today. We look forward to speaking with you again on our third-quarter call. Have a great afternoon. Thank you.

This concludes today's conference call. You may now disconnect.