辛辛納提金融 (CINF) 2012 Q2 法說會逐字稿

Good morning. My name is Sarah and I will be the conference operator today. At this time, I would like to welcome everyone to the Q2 2012 financial results 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.

I would now like to turn the call over to our host, Mr. Dennis McDaniel. You may begin your conference.

Hello, this is Dennis McDaniel, the Investor Relations Officer for Cincinnati Financial. Thank you for joining us for our second-quarter 2012 earnings conference call.

Late yesterday we issued a news release on our results, along with our supplemental financial package, including the final version of our quarter-end investment portfolio. To find copies of any of these documents, please visit our Investor website, www.cinfin.com/investors. The shortest route to the information is the quarterly results link in the navigation menu on the far left of the screen.

On this call, you will first hear from Steve Johnston, President and Chief Executive Officer, and Chief Financial Officer Mike Sewell. After their prepared remarks, investors participating on the call may ask questions. At that time, some responses may be made by others in the room with us, including Executive Committee Chairman Jack Schiff Jr., Chairman of the Board Ken Stecher, Executive Vice President J.F. Scherer, Principal Accounting Officer Eric Mathews, Chief Investment Officer Marty Hollenbeck, and Chief Claims Officer Marty Mullen.

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 measures was provided with the news release. Statutory accounting data is prepared in accordance with statutory accounting rules and therefore is not reconciled to GAAP.

With that, I will turn the call over to Steve.

Thank you Dennis. Good morning and thank you for joining us today.

My comments on the second quarter parallel several I made at our last earnings call. Investment income remains steady and our investment portfolio continues to grow. Mike will discuss investment details in a few moments.

Underwriting performance before the effects of catastrophes was very much improved compared with a year ago, similar to recent quarters. On the other hand, catastrophe losses continued above historical norms for us and for many in our industry. Previously announced second-quarter catastrophe losses added nearly 18 points to our combined ratio. Improved underwriting performance in part reflected pricing for property casualty policies that continue to increase.

Overall pricing was up a bit from the first quarter. Each of our property casualty segments again had healthy levels of net written premium growth. They each grew at a double-digit pace during the second quarter and our life insurance segments earned premium rose likewise. Factoring out reinsurance effects, property casualty written premiums rose 12% and we're satisfied because more precise and overall higher pricing was a large contributor.

Commercial lines renewal pricing moved somewhat higher in the second quarter compared with the first. Overall average increases were in the mid-single-digit range, including the blending effect of three-year policies. Renewals of workers' compensation and smaller commercial property policies again experienced stronger pricing during second quarter than most of our other lines of business.

Our excess and surplus lines segment had a higher renewal price for the 22nd consecutive month, again in the high single-digit range. Personal lines premiums continue to experience rate increases over successive years with renewal premiums up 11% for the second quarter and first half of 2012. Policy retention for commercial and personal lines continues to remain steady in its contribution to total written premiums.

The contribution of new business is increasing in significance, reflecting benefits from both higher pricing and the cumulative effect of new agency appointments. Property casualty new business premiums in the second quarter were 12% higher than a year ago. Recently appointed agencies again drove that growth. As of June 30, we have appointed 93 new agencies, on pace toward a full-year target of 130.

Our pricing analytics and modeling tools indicate that our new business pricing is adequate and stronger overall than for our renewal business. These tools help us determine when to walk away from business that we believe is underpriced as well as when to have the confidence to compete for good accounts. We are studying our property book of business and identifying opportunities to improve underwriting results for the property lines. Our approach is similar to the multifaceted effort that has been improving our workers' compensation results. We've already put in place some of the pieces and in the future we will further discuss plans in progress.

Over time, we will also benefit from earning the rate increases we've taken on property coverages. On a written premium basis in recent quarters, those property rate increases have outpaced the increases taken on much of our non-property business.

Our total property casualty combined ratio for the first half of 2012 showed good improvement over 2011 on both a current accident year and calendar year basis. That improvement holds up however you analyze it, with or without the effects of catastrophes and the extra reinsurance costs in 2011.

We are continuing to see the benefits of ongoing efforts to improve pricing, underwriting, and claims management. We are confident further benefits will manifest in our operating results. At the same time, we remain steadfast in our approach to service excellence, reserve adequacy, investment management and strong capital.

Now Chief Financial Officer Mike Sewell will comment on several financial items.

Thank you Steve, and thanks to all of you for joining us today.

Our investment portfolio continued its steady contribution to earnings in the second quarter. Investment income again matched the prior year's quarter and both major components, interest income and dividends, were essentially flat. Yields for our bond portfolio were slightly lower than last year as we reported the second quarter of 2012 was even with the first quarter at 5.2% on a pretax basis and 3.8% on an after-tax basis.

Our bond portfolio's effective duration edged down to 4.3 years from 4.4 years. In our common stock portfolio, we are seeing dividend increases over the past year for most of our holdings, but less funds were at work in that portfolio for much of the past 18 months. Its cost basis is just now approaching its year-end 2010 level following a reduction in the first half of 2011 of almost 8%.

Our fixed maturity portfolio again experienced a valuation gain during the second quarter. For the equity portfolio, unrealized gains were 8% lower at the end of June compared with March. Still, that portfolio's pretax net unrealized gains of $891 million were 12% higher than at the end of 2011.

Consolidated net cash flow from operating activities for the first half of 2012 continued at a healthy pace. That helps fuel our investment income and offset the effects of the low interest rate environment. At $265 million, net cash flow already exceeded the full year 2011 by $18 million. It's on pace to exceed the full year 2010 and 2009, each at roughly $530 million since the second half of the year typically has lower catastrophe loss payments and the bulk of the agency profit-sharing was already paid in the first quarter.

Moving to balance sheet highlights, a consistent approach to loss reserving is one of our hallmarks. Metrics for reserve development our prior accident years demonstrate that consistency. Through the first six months of this year, we benefited from 10.8 percentage points of net favorable reserve development before catastrophe losses. That result came within 0.5 point of 2011's six-month development. Every major line of business contributed to the favorable development for the first half, which totaled $201 million, including catastrophe losses.

Our six-month net favorable development was again spread over several accident years, including 19% for accident year 2011, 30% for accident year 2010, 16% for accident year 2009 and 35% for all older accident years.

We also continue to maintain our consistently low debt leverage with a debt to total capital ratio of 14.8% at June 30. As previously reported, we established a new $225 million line of credit in May. It replaced two credit facilities that totaled the same amount. Six banks participate and it's for a term of five years. Most of the major terms and conditions are similar to the former credit facilities, but we gained some flexibility in terms of borrowing capacity such as raising the debt to total capital covenant to 30% from 20%.

In addition to enhancing our already great financial flexibility with the new credit facility, we once again ended the quarter holding over $1 billion in cash and marketable securities at the parent company level. Our capital remains strong and is available to support additional premium growth in our insurance segments.

I'll conclude my prepared comments as usual, by summarizing the contributions during the second quarter to book value per share. Property casualty underwriting decreased book value by $0.31. Life insurance operations added $0.06. Investment income, other than life insurance and reduced by noninsurance items, contributed $0.44. The change in unrealized gains at June 30 for the fixed income portfolio net of realized gains and losses raised book value per share by $0.20. The change in unrealized gains at June 30 for the equity portfolio net of realized gains and losses lowered book value by $0.40. And we paid $0.4025 per share in dividends to shareholders. The net effect was a book value decrease of $0.41 during the second quarter to $31.66 per share. That result is 2% above the year-end level, contributing to a first-half value creation ratio of 4.6%.

With that I'll turn the call back over to Steve.

Thanks Mike. While we remain encouraged by the trend of strong underwriting performance before the effects of catastrophes, we recognize that there is still plenty of work to be done. Our associates and agents continue to work together to make necessary improvements while maintaining service excellence and creating long-term value for shareholders.

Our primary performance measure is our value creation ratio and the incentive compensation aligned with adding shareholder value keeps every associate in the company focused on what is important. With Mike and me today to answer your questions and further discuss our results and outlooks are Jack Schiff Jr., Ken Stecher, J.F. Scherer, Eric Mathews, Marty Mullen, and Marty Hollenbeck. Sarah, we are ready for you to open up the call for questions.

(Operator Instructions). Mike Zaremski, Credit Suisse.

Good morning. So on pricing, it appears that the pricing rate of change has slowed, and maybe you wouldn't agree with that and us. You used the word "adequate" a couple of times, so does that imply the current rate increase levels are enough and we might fluctuate near current levels, or maybe even move south?

Good questions. I think actually when we look at the first quarter and compare it with the second quarter, the rate increases are actually up just a tic. But flattening is probably a good term, but it is actually -- it did not decline. Overall rate increases are actually up just a bit from where they were in the first quarter. We feel we are getting rate in the areas we need rate, and we are continuing to be able to get rate. I think it's not just the average rate increases that we're taking, but we are using a lot of precision, looking at risks on an individual basis, comparing what we think the exposure is to what the rate that's needed for that individual policy, and we think we are making good progress.

Okay. Okay. So workers' comp specific next, results clearly improved a lot this year. Has that been driven solely by increased prices in some of the new analytics you've talked about, or have broader loss costs also helped out?

It has not been price alone. Price has certainly contributed, and I'm going to turn it over to J.F. Scherer, because he has just produced yeoman effort in terms of an all-around approach to improving our workers' comp results.

Mike, we have gotten strong upper single-digit, consistently upper single-digit rate increases on comp. That's been good. The implementation of our -- of the predictive modeling has been a big contributor to guiding us on the pricing. We will be introducing our second generation of that model. We in fact are in the process of doing that right now.

But in addition to that, we've done a lot more in loss control, specifically on accounts greater than $50,000. Every single one of those accounts is going through a more rigorous review by our Loss Control division. They're all scored based on the review. That's resulted in a lot more insight on the accounts that we write.

I think really, and Marty might want to add to this, Marty Mullen, our Chief Claims Officer, but in the Claims area, there has been a tremendous amount more specialization in that, both in terms of putting loss control specialists in the fields, but bill repricing has contributed significantly. We have a call center now where we ask the policyholder to call directly into Cincinnati, which accelerates the lag between when the injury occurs and when we are able to triage the injury, and address how it's going to be handled. So, all of those things have contributed, and we don't think -- pricing continues to be there for us in the comp area. That still remains consistent. I think, in terms of the contribution that loss control and claims will give us, we think there is still some to be gained there.

Okay, that's helpful. Lastly, if I may, so what I am trying to not struggle with, but when I look at the accident year ex-cats for the entire company, it's improved a lot in the last few quarters, which is great. I'm trying to figure out, does any of that come from pricing really? Because pricing just started to improve last year. Has it really been mostly from the analytics and culling of the books and we should expect the pricing increases to come in later in the year and next year?

Mike, I think you've hit it pretty well right on the head. I don't think it is all pricing. I think it is the other elements as well that you've mentioned and agree that I think the pricing will continue to earn as we go forward.

Okay, thank you very much.

Ray Iardella, Macquarie.

Thanks and good morning everyone. I guess first, maybe for J.F. or maybe Steve, as far as the agency appointments this year year-to-date, you guys are obviously tracking above the 130 target, 93 I believe year-to-date. And I think, Steve, your comment was you guys are on pace. But I'm just curious. How do you think about that 130 target? Is it a target that could be moving, and then how do you think about appointing more agents relative to I guess your goal of getting to $5 billion in direct premiums by 2015?

We set that goal of 134 late last year based on the contribution -- the continuous contribution we wanted to see agencies make towards the $5 billion goal. Each one of the 129 field territories analyzed what they needed to do to contribute to the premium growth that we needed, talk to the agencies in those areas, and determine whether or not, based on what the agencies that have already been appointed have committed that they could do in terms of new business and overall written premium, how many more agencies we need to appoint.

We make a point that based on the 134, we wanted to get as many these agencies appointed earlier in the year. I don't think it will change much. I think we will probably come in right at that level at the end of this year. So it's going as planned. We just accelerate the appointments as quickly as we can once we know we are going to make them.

Okay. That's helpful. And when do you guys think you'll be setting a target in terms of agency appointments for next year? Is that something already in the back of your mind, or --?

Yeah, it is. We have -- we are probably -- in the next couple or three weeks, we go into our planning sessions. We will assess where we are, and start putting pencil to paper in that regard here in the next couple of weeks.

All right, fair enough. And then I guess, in terms of the life business, premium is up a little bit there. Has that been a contribution from the new agency appointments, or is that just you're seeing a little bit more interest? I know it's a relatively small part of the business, but just curious what's going on on that side.

This is Steve, I think it's been a combination of both. I think they've been doing a good job in the life company of both appointing new agencies and achieving organic growth, same agent growth, so to speak. Worksite term is another product that we have really focused on in terms of the growth, and I think that's contributing as well. Mike may have a few comments to add as well.

On the universal life policies, collected cash is up about 11.5%. We did have -- each quarter we do unlock interest rates, not to get too technical on you, but when we do that, there is an adjustment on the load upfront which affects the premiums and the deferred acquisition costs. So, you'll see that those kind of offset a little bit, but where we then end up with a bottom-line change this quarter of about $1 million. But we are on pace and doing pretty well with the life company, and it should end up where we planned it to be for the year.

This is J.F. I would just add to it that about 70% of our life insurance premiums come from property and casualty agency appointments. And almost without exception, when we are making some of those 134 appointments, we are visiting with them about the potential to write life insurance at the same time we talk about the P&C.

That's helpful. Last question and I'll re-queue. I think Steve you talked about the price increases in the second quarter, and that being inclusive of three-year policies. Has the attractiveness to consumers to your insured of the three-year policies increased this year, or does that -- have you seen any meaningful shift in that business relative to the one-year policies?

I think it's always been attractive especially to a certain type of clientele who really wants to focus on their business and make their insurance buying decisions once every three years. So I think it's maybe a little bit more important now, but I think it's always throughout our history been an important feature that we offer.

Okay, thanks for your answers.

Josh Shanker, Deutsche Bank.

Good morning everyone. A couple of questions. One is related to last year's storms. If you look at Travelers or Allstate's numbers, they had some significant reserve releases associated with over-booking last year's storms. You guys didn't. Are you still thinking it's too early to call those reserves? Are you thinking that you got it right the first time? Where do you stand on cat reserves for 2011?

I'll turn it over to Marty Mullen to handle that one, but I think we've been pretty steady, pretty conservative, have seen some favorable development on last year, but I'll turn it over to Marty to see if he'd want to add anything in addition to that.

Yes. We are feeling real confident about our ultimate projections for those 2011 storms, especially cats 46 and 48, those two strong storms of last year. But we are feeling like they are trending in the accurate and positive direction, and feel like those ultimate projections are holding up very well.

So are you saying you got it right the first time or you're confident you were conservative the first time?

I think the ultimate was right about on target the first time. We are still getting some small new claim activity, but it's less than probably five claims a week.

Okay, that's great. And the other question for Marty Hollenbeck, looking at the investment yield, from the beginning of the year, it seems in aggregate -- maybe my number is a little more crude than yours -- it's fallen by about 40 basis points, which is about as much as it's fallen in the last three years combined. Is there something happening right now in the portfolio that's causing acceleration in yield decline, or am I just reading too much into it?

No, we are not really seeing a decline. Actually, it's been fairly steady. Book yield is the metric I'm on, that's kind of the embedded yield in the portfolio. It's down 20 basis points from last year. It has been ranging from, say, 5 to 8 for a number of quarters here. We are seeing a little bit on the embedded yield and the bonds that we lose to maturity or call. That has slowed a little bit but obviously new money rate, as you know with the ten-year down around the 1.4, 1.5 area, we're just not getting any relief on that front. Maybe you're looking -- stocks and bonds, I'm speaking --

Yes, I'm blended here they way I'm looking at it.

We have accelerated a little bit this year our equity purchases. We have been net sellers of common stocks I think every year since just prior to the crisis. So, we are starting to pick that up a little bit this year. I think, in the quarter, we probably averaged around 3.5%, 3.6% pretax yield on new equity purchases, and about 3.7% again pretax on new fixed income money. So the decline, in my opinion, is not accelerating at this point.

Perfect, thank you very much.

This is Steve. I've been thinking about your cat question a little bit here. One thing to keep in mind just for modeling purposes and so forth, and I don't know specifically about other companies, but we did get into our cat reinsurance last year. So to the extent we have a movement in the estimate on a direct basis, if we ceded 95%, say, in the layer that those two big cats hit, any movement will only be, in our estimate now, will only be about 5% of the total if you see what I'm saying.

They'll be the beneficiaries, okay. Very good. Thank you.

Vincent DeAugustino, Stifel Nicolaus.

Good morning. Last quarter, we had talked about personal auto loss cost trends. It's still being rather benign. But if I'm taking a look at the core loss ratio, it ticked up about 11 points year over year, and then in 1Q '12 it ticked up by about 4 or 5 points. So I'm kind of curious if there was maybe some non-cat hail or something along those lines this quarter that would've pushed auto up, or if there was maybe any sort of observable change in loss cost trends more recently.

That's a great question. I have to say as I review our financials and was looking at things, every number in there, that personal auto got my attention as much as anything, especially after we've seen some deterioration in personal auto results for some others in the industry. As we dug into it, there's a lot of moving parts in there as you mentioned. You've got cat, different kinds of weather, so we tried to just drill down with all the noise going on to what we saw in terms of the non-cat paid losses. As we looked at that for the second quarter, the non-cat paid loss ratio was up 1 point from where it was second quarter a year ago. On a six-month basis, it's actually down 0.7 point from the first half of last year. But we're going to continue. We've been taking rates in the low single digits. I think with this new information we are going to continue to analyze and keep a very close eye on that one to make sure we are maintaining price adequacy.

Okay. Perfect. And then sticking within personal lines, if I look at homeowners, or if we think about homeowners, is it easier from a regulatory standpoint and also from an agent and customer standpoint to get tougher on terms and conditions or maybe implementing higher deductible requirements or anything aside from pushing from a rate standpoint. Is it just easier than getting the rate approvals?

I think they're both about the same, to tell you the truth. I think obviously with terms and conditions it's a contract language and you really have to make sure that anything is communicated very clearly to make sure everything is filed appropriately, but I don't see too much of a difference in terms of the regulatory approval process in terms of terms and conditions versus rates with just kind of amplification that you really do need to make sure that everything is properly communicated.

And then one last one, if I may. What was the audit premium benefits of -- to workers' comp in the quarter? I think commercial casualty and work comp together was a favorable $9 million, but just curious if you had the split or would be willing to say what it was.

I've seen it. I know the $9 million in total. We are kind of scrambling around for our numbers here because we've got a couple of notebooks and I think we have it, but I don't have it at my fingertip.

I'll follow up with Dennis afterwards if that's fine. But thanks for taking the questions and look forward to talking to you next quarter.

Thanks a lot Vince.

Ron Bobman, Capital Returns.

Thanks and good morning. I had a couple of questions. I was curious to know, are you doing anything -- sorry if I missed this -- on homeowners deductibles?

Homeowners deductibles -- we certainly over a period of time have been moving our homeowners deductibles up, and in fact now we have over 40%, probably over 43% of the current force book at $1000 deductible or higher. Virtually everything is over $500, so -- and we are continuing to look at what we might be able to do more and certainly to keep that trend continuing.

Would you hazard a guess, a goal a year from now for it to be specific or a ballpark percentage over 1000?

We do not have a goal at this time. We have been looking at all non-rate, in addition to rate, looking at all non-rate ways that we can improve the results in homeowners and our way we handle catastrophe losses and so forth. But at this point we do not have a specific quantified target.

Okay. Thanks. I don't think you are sort of a licensed player in this business, but as a city folk asking people in the Heartland, do you write any crop insurance? (multiple speakers)

We do not write crop. We are still reading a lot about it because we see our fields -- I've got about 50 acres of beans and it's turning brown, so we read a lot about it but we don't write it.

Good luck with the personal account there. My last question was I think the late June -- the late June storms, June I don't know 27, 28, something like that, running into almost early July, the first day or so of July, were called this derecho. I was wondering if your loss provision for second quarter is going to include -- currently your loss estimate for that event, or will some sort of portion of it be apportioned, or we have a new provision to some degree in the third quarter?

That's a great question, because as soon as I started seeing that storm coming in, I was on the line to Marty. And we only want to provide for losses that occurred up to June 30 in terms of our second-quarter results. Any losses that happened subsequent to June 30 will go into the third-quarter results. So we are tracking that. To this point, I haven't seen that rise to the level of materiality yet, but maybe I don't know if Marty Mullen wanted to comment anymore on that.

Sure. I can just give you an update on -- it was expanded in early July to 10 states. It's actually June 28 through July 2. Our main states involved in the cat are Indiana, Ohio and Virginia. Our claim count kind of breaks down to about 60% of all of our claims are in Ohio, 14% in Virginia. About 80% of those claims are personal lines, and 20% commercial. We've got about 51% of our claims are closed.

I think one thing that's kind of unusual about that claim is most of the claims are wind-related. And about 40% of the claims with incurred on them are under $2500. So although we have our share of commercial losses with wind damage, there's also a lot of personal lines claims with small incurred.

That's -- I appreciate that. That's quite interesting. It's impressive I guess, 51% closed within less than 30 days, that's great from a customer service perspective.

I guess it's a good news/bad news. Ohio is our largest state, so we have a lot of business and premium there, but we also have a lot of our top-notch field claim representatives the majority in Ohio. So we have a lot of feet on the ground to handle those claims.

Okay guys, have a nice day and best of luck.

This is Mike Sewell. Before we go to the next caller, I'd like to go back -- Vincent had asked a question related to the effects of audit premiums. And for the quarter, the effects are the audit premiums for the quarter was almost $15 million, $23.5 million for the six months, which when you look at the six months it's about a $15 million increase over the prior year, $5 million for the quarter. So I just wanted to get that out there.

I think we can move on to the next question.

Scott Heleniak, RBC Capital Markets.

Hi, thanks. I was just wondering if you are seeing any competitors that are rolling back some of the price increases that they had in Q1 because they were too significant. So did you see any of that in Q2 where maybe they had double-digit rate increases in Q1 and they rolled that back to 6% or 7% and that had any kind of impact on your business at all or retentions?

This is Steve. No, I did not see any of that.

Okay. What were the retentions then by segment? Do you have that number at all?

I think we have them. They were stable. They are going to be up close to the 90% range, varying a little bit, slightly lower for commercial lines, slightly higher for personal.

And the only other question I had was you mentioned increase in exposure to equities. Could you talk about how much you deployed either in second quarter or first quarter, and how likely might we be able to see equities at the higher end of the 25% to 30% range that you've talked about before?

Sure. For the second -- for the first quarter, common stocks, we were net sellers of -- this is a very round number -- of around $24 million. For the second quarter, we were net purchasers of around $87 million. I think for us to get to that 30% in the short-term would probably it would take some help from the market obviously, an increase in prices as well as possibly, if interest rates go up, the value of the bond portfolio comes down. We are not being aggressive about this. Obviously with interest rates where they are, we find the types of equities that we buy that you're very familiar with very attractive both on a pretax and after-tax basis. So we are not at all a push. We're still very committed to putting new money into the bond portfolio and building that laddered portfolio over time has kind of been our strategy.

Thanks.

Matt Rohrmann, KBW.

Gentlemen, good morning. Steve, just kind of most of my questions have been answered, but I wanted to follow up on the continued revisions within the property book. The second quarter I know has been frustrating the last couple of years. In terms of how you view sort of the concentrations in the submarkets within property, has that changed much in terms of how you view it for the book today as it stands versus a year ago? I know it's not exactly apples-to-apples on the weather by a long shot, but just your thoughts thee in terms of handling concentration, and managing it going forward.

Great question. I'll take an early stab and then I want to turn it over to J.F. because he's been doing, again, a lot of great work in that area.

We have been getting good organic growth, as you've seen in the results. We are focusing on increasing our geographic footprint, our diversification by agency in terms of where the business comes from.

I might talk about homeowners just a little bit before I turn it over to J.F. in that we recognize that we have a concentration issue. For example our top six states for homeowners, that would be Ohio, Indiana, Illinois, Kentucky, Alabama and Georgia, they represent over two-thirds, about 67.3%, of our homeowners premium. In those states, we actually saw new business down 4.4%. So, the growth in new business that you see in our published financials came outside of the states where we have the geographic concentration, so that is part of our strategy to spread our footprint and diversify our catastrophe risk. And so I was just trying to put little color on it in terms of numbers on the homeowners side of it, and I'd like to turn it over to J.F. for a second.

Just on the commercial lines side, just give you a little bit of perspective, on commercial property, this would exclude inland marine, our five-year average cat loss ratio on that is about 13.6 points. If you take our ex-cat net underwriting results for property through year-to-date, we are running at, if we were to have average cats, at about a 105 combined ratio for commercial property. That's not horrible considering the kind of cats we've had, but it is certainly not satisfactory.

So we are expanding geographically, but honestly the population of Idaho and Utah and Oregon, that alone is not enough to balance out the kinds of the concentrations we have more in the Midwest. So, we are trying to spend a lot more time here in the Midwest trying to identify ways in addition to rate. And property rates are solidly into -- getting into the upper single-digit range, and they are accelerating. But we've got a lot going on with deductible increases in property, a lot more discussion in the marketplace about percentage deductibles. There is a tolerance on that though in coastal areas. People are used 2% and 5% wind deductibles. In the Midwest, they are not. But there's a lot more discussion there. We're taking on a lot closer look at habitational, habitational risks. Apartments, condos all tend to have asphalt shingles very much susceptible to hail types of claims. Those are areas where we are looking at lot stronger deductibles. Lessors risk only property, you may hear a lot of other carriers talk about that. But in addition to roof exposures there, we are spending a lot more time verifying through inspections and loss control who the tenants are, whether or not during these tougher economic times maintenance might have deteriorated.

Claim specialization is part of what we're doing in the property area as well, and I mentioned loss control. But specifically in terms of inspections, we are doing a lot more in that area and adding a lot more to loss control. So the solution to property in the Commercial Lines side, it's not monumental. We want that combined ratio including cats, to be in the 90 range. We think we are that kind of company. But there are a lot of moving parts to get it there.

Great. Very good answer, guys. I guess just in terms of a lot of what you touched on what sort of more at the micro level which is great. In terms of kind of middle to more macro level, are there any sort of portfolio specifications in terms of you'll only write, say, X amount of business per county or zip code or street or however you define it?

We do have loss tolerances in place. We look at that. It may not be quite as granular as where we are heading, but we are studying that in terms of down to a street level or a ZIP code level. At this point, it's more driven by a state or a marketing territory, more at that level.

Okay, great. Thanks so much guys.

Drew Woodbury, Morningstar.

Hi, thanks. I was wondering if you guys could talk a little bit more about your appetite for new business. Just given where we are in the pricing cycle and looking at your accident year ex-cat ratio above 100%, I was wondering if you could talk a little bit more in detail about how you're adding to your book. Thanks.

Again, to kind of reiterate the comments I made on the homeowners before, we are getting new business, but a lot of that new business is coming from areas that are outside of our traditional footprint. We do feel that in terms of our pricing and looking at our models that we are in a place that we have or will have price adequacy. I think, again, with homeowners as an example, coming up October 1, we have 14 states that I think represent over 80% of our premium volume. We'll be getting double-digit, low double-digit increases on average over those 14 states, and in fact certain segments within there will be getting much more, so we feel this next round will put us in a place that we feel we are adequately priced to cover the expected losses that we'll have.

So again, in terms of the new business, I would not want anybody to think that we are in agencies writing more new business because we are underpriced. It's more that we are expanding out into new agencies, new territories and we feel that the rate levels we have in place are at the appropriate place or will be shortly.

Okay. Then my next question is kind of a bigger picture longer-term one about investments, specifically about the equity allocation. So with pricing maybe getting a little bit better, and if that trend continues in the future and we eventually see something that may be a hardening market with robust price increases, will you guys give any thought to lowering the equity allocation or to invest more in policies and writing new business there? And if you could talk a little bit about your thought process and the trade-off between those two type of investments.

I'll start by talking about the equity allocation. We are a little over 25% now. Historically if you follow us for a while, been that number five years ago was probably 54%, 55%. So we are actually at pretty much the low the range of our historical norm. We are not uncomfortable down here. We like it at this level, as it was mentioned earlier. If we went to 30%, that would be okay as well. We are not going to go back to having half the portfolio in common stocks, but we invest consistently over time, and I don't see us selling down below 25%, nor much higher than 30% of the portfolio. So again, we believe in the long-term growth aspects of the type of stocks we have, and, again, the income component of it doesn't get mentioned often, but it's just as important as the growth aspect of it. So, I'll let Steve comment on the underwriting piece.

I guess I would just add right onto everything that Marty said is we have been conservative with our balance sheet. Currently, we are running a premium surplus ratio of just under 0.9-to-1. We have an additional $1 billion plus in cash and marketable securities at the holding company, so we keep that conservative balance sheet so that we are in a place where we can both support our growth goals and our investment in capital management strategies. So I think given where we are in terms of a very strong balance sheet, we are in the position to grow profitably, invest for long-term, and do our capital management dividend paying and so forth.

Great, thanks.

(Operator Instructions). Ian Gutterman, Adage Capital.

Good morning. I had questions on new business and then on cats. I guess on new business first, Steve, the press release said that your new business largely came from agents added in the last 18 months. Can you just put some numbers around it? How much of your new business actually is from the newer agents?

I believe we have that number, and I think J.F. is going through his sheets of paper, so I'll do my best to tap dance here for --

Maybe I can ask the related question while you look up the exact number, which is you said that the new business is, based on your analytics, the new business is priced better than renewal. How do you measure that? I thought new pricing is very hard to sort of have confidence, given you can't see the kind of history you can see on your own businesses as far as claims and so forth.

That price adequacy is very much held by our models, and I think, for both of those questions, J.F. is very well prepared at this point.

Let me just address the new business and the price adequacy. We model our entire book of business. It's on the books as well as every single policy that's written on a monthly basis. So when we write new business, we know based on the models we are using what the price adequacy of those risks should be.

Now, the model doesn't answer 100% of the question in terms of the full quality of the account. It's a huge contributor to it, but there are a lot of other things that you might call non-model attributes. If we take that down to the policy levels, and actually if you can do that, we can take it down to the agency level, to the field territory level, to the state level. The fact of the matter is, in terms of all the new business we've written in 2012 to date, agencies appointed in 2010 and 2011, the business we've written from those folks has been the most price adequate of all the new business we've written throughout the year. So we are pleased with the amount of new business we are getting.

Frankly, we would like to -- we would expect to write slightly more new business based on the new agencies that we have appointed and conversations with agencies we've had. But that is one area where we monitor very granularly the direction that we've gone in terms of the pricing of the new accounts we've written. So -- and we meet monthly on that, so we are comfortable that though new business is up, it's not at the expense of underwriting profitability. Go ahead.

I was going to say, can you sort of explain why that business is in the marketplace, if you will, at that attractive a price? And I guess I'm used to thinking of there being a sort of new business penalty, right, and if business is being shopped, it's probably because it's not priced as well as someone's renewal books. So what's allowing you to see business of such high quality rather than staying where it was?

Well, there is always a possibility for the new business penalty. We understand that and monitor it. I guess there would be a variety of reasons. When you appoint a group of agencies, appoint an agency, we make it very clear in the appointment process that we expect to be a meaningful part of the agency. One way of the agency making that happen is to consolidate the number of carriers they have in the agency, so we may be given an opportunity to look at business simply because they want to cut down the number of carriers they have. Some carriers in the marketplace have announced they are going to take a very, very tough pricing approach, that they are going to get a minimum rate increase on all of their renewals -- translation, agency shops most of that business just to be on guard. So we see some business because of that.

The three-year policy is a significant advantage, I guess, or certainly an important thing for an agency right now. There is an expectation that pricing increases will continue, the market will continue firm for a while, so therefore an agency might want to put the policyholder with us on a three-year guarantee. So, all of those things together give us an opportunity to see very good business in the marketplace.

That makes sense. Great.

I might just add a couple more thoughts on there. One is that we actually have two different models, one for new business, one for renewals. So to the extent you can get different information from a renewal piece of business versus a new piece of business, we have a model for new business that hones in specifically on the pertinent information we can get for new business.

And then I think in terms of the new business that is available to us, and I've kind of tried to touch on it in my opening comments, is the model allows us to really analyze the new business that's presented to us and have confidence to go after the ones that we want to go after, but also have confidence to walk away from the ones that would historically create a new business penalty.

Got it, that makes perfect sense. Then actually, before I ask other questions, do you have that number on how much of the new business from the newer agents?

We wrote both in commercial and personal lines $21.600 million in agencies that have been appointed in 2011 and 2012.

Got it, okay. Great. And on the cats, I know it's always tricky to use sort of market share to try to estimate people's cats, but I guess I'm sort of wondering what your take is on your cats relative to the industry this quarter. And what I was looking at is if you start with the big picture, ISO I think is using a $6 billion, $7 billion cat number, Aon is at like $8 billion. And if I look at some of your competitors' cats and extrapolate from their state market shares as they come, it starts to move up to maybe $10 billion, $12 billion. But you are basing your market share analysis as playing $20 billion or $25 billion of industry cat losses, which makes it seem like you performed sort of worse than your share would indicate. Do you agree with that, or is it just state market share is obviously a very broad tool and if I -- counting market share you would look more normal, or was this a little bit outsized quarter for you guys relative to what it should have been?

That's a good question, and I have been analyzing this myself. And I think that state market share is broad. Maybe in just kind of describing how the rates are made, we will just take homeowners, it might answer the question a little bit in that the way we provide for the cat provision is we used RMS Version 11, their most recent up-to-date model, one that is pretty conservative, but we used the RMS Version 11 model. We then put in at a very granular level, right down to the street address, our current exposures, what is the coverage A and all the characteristics of the houses that we write that so we have both a current model and a current picture of our exposures. The model is run such that numerous scenarios, thousands of scenarios were generated and we come up with an expected value for catastrophe losses. And that is what we built into our rate level. So it's not our last 20 years of history or our last 10 -- or any years of history; it's what does the most recent model show.

So then we are at a point where we are comparing what actually happens versus what did we build into the models. And I just think, as we look at overall in terms of where these catastrophes happened versus where our footprint is, it just happened to be more in line with where we were and produced outsized losses vis-a-vis what we're building in in terms of expected losses for cats.

Okay. And is there anything -- when I look at sort of your long-term history versus the past two or three years, where there's just been sort of these elevated industry losses, it seems your commercial -- relative to your own history, the commercial has been a little bit more impacted than personal. Historically, is that accurate? Is there anything -- I know you talked about homeowners changes you are making. Are there any changes you're seeing necessary on the commercial property side?

This is Marty Mullen. Actually, on the commercial side, we did have two storms that were kind of outliers on the commercial piece. We got hit pretty hard on the commercial side in Joplin last year, where it hit in the city, the actual city area is where we had some commercial activity and large commercial losses, which is pretty much an outlier for us in a cat situation. And this year in our first cat in April, we had our share of commercial losses in St. Louis from hail damage. That was pretty much more than 50% of losses in St. Louis on an incurred basis from that cat are pretty much related to commercial. So those two were outliers as far as individual storms are concerned.

Okay, so it sounds more like bad luck necessarily than any underwriting change.

We never attribute anything to bad luck. I think it may even be bad luck but we are not going to accept that within the building here that that's the answer. Because it's natural when things don't go your way to say, well, luck was against us and when things go your way it was due to your extreme skill and expertise.

No. Understood. I just wanted to make sure there wasn't anything beyond that that you identify as a concern. So great, I appreciate the time. Thank you guys.

Ron Bobman, Capital Returns.

Thanks. Ian's 19 questions covered mine. Thank you.

We are ready for the next one.

Fred Nelson, Crowell Weedon.

Thank you. My little lady farmer in upstate Minnesota said the other day to me "Pray for rain and a good harvest, but always, always keep on hoeing." And you know the folks in Cincinnati always keep on hoeing. I see it and I hear it and I want you to know I really appreciate all of you.

My question is on the book value, is that an after-tax book value, if you deducted the gains, if you sold everything, or can you explain it in a little more detail?

That is an after-tax book value.

And if you add it back, what would it be, $2 more, $3 more?

The tax impact on investments to unrealized gains? We are taxed at 35% for our realized gains. So --

Correct, but I just wanted to know if you guys have figured what you add back. It must be a pretty good figure.

Yes, it's a pretty good figure, it would be 35% of that unrealized gain that we --

Okay, you didn't have to give it to me. I just wasn't sure if I was correct on my thought process.

You absolutely are and we really appreciate your interest in our Company and your comments.

Been with you all long time and I'm 74 now.

That's hard to believe that you're 74, but --

And still going strong. Thanks for taking the call.

Have a great day.

You guys too.

There are no further questions at this time. I turn the call back over to Mr. Johnston for closing remarks.

Thank you Sarah, and thanks to all of you for joining us. Thanks for the great interest in our company and great questions. We appreciate it and we look forward to talking to you on our next call if not before.

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