CNA Financial Corp (CNA) 2002 Q3 法說會逐字稿

Good day, everyone. And welcome to the CNA Financial Corporation's third quarter earnings conference call. Today's call is being recorded. We will now turn the call over to Mr. Don Lofe, Senior Vice President. Mr. Lofe, please go ahead, sir.

Thank you operator, and good morning to everybody. We'd like to welcome you to CNA's third quarter 2002 financial results conference call. My name is Don Lofe, Senior Vice President for Capital Management, [INAUDIBLE] Investor Relations. All of you should have received an earnings release. If not, you may go to our website at cna.com. As a reminder, this call is also being webcast via access into our website. In addition, many of you should have received our financial supplement. If you did not receive it, please call us, or you also may get a copy from our website.

With us this morning for the call are Steve Lilienthal, CEO; Bob Deutsch, CFO; Jim Lewis, President of P&C Operations; and Bob Patin, President of CNA Life Insurance Operations. Before we discuss the results, I'd like to make the necessary disclosures concerning forward-looking statements. Statements will be made during this conference call, using expressions such as "intend", "anticipate," "expect", "believe" or similar terms, and may include financial projections, explanations of the company's plans and objectives, as well as estimates for future performance, and similar statements. These types of statements are forward-looking statements in their nature. The actual results achieved by the company may differ materially from the projections made in these statements.

The information describing factors which may cause the results to differ materially from those in the forward-looking statements are described in the company's various public files with the SEC. These filings are available at the web or on hard copy. The forward-looking statements speak only as of today, November 7th, 2002. Further, the company has no obligation to update or revise any forward-looking statements made during this call. There will be time for questions from the investment community following our remarks. Members of the news media may call Charlie Basil. Follow-up questions from the investment community may be directed to myself, Bob Deutsch. or Don Jaffray. With that I'd like to turn the call over to Steve Lilienthal. Steve?

Thank you, Don. Good morning and thanks for joining us today.

Since this is my first call to you in my new role, I want to start off by saying that there will not be any major announcements during this conference call. We are continuing to work the strategies that we set in place and in motion over a year ago. Continuity of CNA's leadership team operating strategies have and will continue to apply to the very significant operating advance force now and in the future. And by the way, in case you missed it, in addition to my role changing about 60 days ago, we did, in fact, reset the entire leadership team in less than a week without missing a beat. With that, there are four topics I want to cover today. Number one, the consolidated CNA performance for the quarter and year to date. Individual performance of our core business units.

Expense initiatives update and a discussion of a very significant claims initiative that has been under way since the beginning of 2002. Bob Deutsch will follow me with a more detailed financial discussion. Jim Lewis and Bob Patin, DC and Life Group Operations, respectively, will provide detailed discussions of their variations businesses. And we have other people available to amplify on the claims initiative that we will talk about today if you so desire. Anything else you would like to discuss is fair game. If time does not permit, we will handle the questions by follow-up calls throughout the day, as I mentioned. About CNA performance; we achieved net operating income of $38 million from continuing operations, or 17 cent per share for the third quarter.

This compares favorably to the $160 million loss or 86 cents per share reported in the third quarter of 2001, primarily driven by the World Trade Center loss. Excluding the World Trade Center, net operating income from continuing operations declined in the third quarter in 2002 versus 2001. This drop was primarily due to reduced limited partnership income and a double effect of significant reinsurance recoveries in 2001 that we did not benefit in 2002, plus a significant increase in cost of reinsurance in 2002 verse us 2001. We also had a $24 million impact in losses associated with the European floods, which I think are very well documented.

The third quarter of 2002 also includes a $24 million after-tax development, which is the net effect of strengthened specialty and reinsurance reserve with the reserve release in the standard lines. This represents our continued focus on identifying, recognizing, and dealing with any issues that present themselves and maintaining a very, very solid balance sheet.

Net operating income for the first nine months was $289 million or $1.29 per share, which is a significant improvement over the same period in 2001, or slightly down if you exclude the significant 2001 items, as I mentioned earlier. Bob Deutsch will have more to say on this following all of my remarks. I remain very pleased with the 2002 performance in all three of our businesses. Specifically, property casualty operation continues to deliver strong performance on all fronts. Net written premium is up 15% for the quarter, 14% year-to-date. Rates continue strong at about 28%. And retention continues to run in the low 70s.

And this is primarily the result of some strong underlying initiatives that have been under way throughout the out the year, which was included during the fourth quarter. Renewal efficiency, and I think I've been talking to you folks about this consistently over the years, that is the spread between the Payton case and the business that we keep versus the business that we non-renew, also remains very robust. So the issue of adverse of selection is not an issue for us. New business for the quarter was up 19%. Our gross accident year loss ratio, whether of operating or underwriting efficiency, improved 11 points to 72%. And Jim Lewis will provide more detail in a moment.

By the way, this is roughly a $7 billion business unit unit for us. Life and Group, a $2 billion segment, contributed $61 million in operating earnings, double the third quarter in 2001 -- and about $30 million better for the first nine months of 2002 versus 2001. Major contributors were the strong results in the group disability and favorable mortality and individual life. Annualized sales were up 37% in the group area with individual life sales up very, very significantly over 2001. Bob will provide you with more detail on this area.

Our reinsurance operation, likewise, is taking advantage of the very robust market conditions that exist on the retail side of the property and casualty world. CNA Re continues to drive rate across the entire portfolio in excessive 25% year-to-date. Gross accident loss ratio has improved to 63%, eight points better than 2001. And we look with great anticipation to the January 1st renewal dates because roughly 50% of CNA's pre-business expires on that date. Deb McClenahan, who is the President of CNA Re, is with us today -- will not formally address you given the fact that this is a relatively small quarter for her. She is here, however, to answer any questions you may have regarding what's going on in the reinsurance operation. From expense standpoint, we are on track to realize the $100 million from last year's restructuring, and this is when we presented the restructuring to you.

We told you we would design it and execute it in a very quick and efficient way. And we are very much on track to realize that $100 million savings and probably a bit more than that. And this is predominantly on the pc sides. Property and casualty operations is down six points on their expense ration to 32%. And we continue to lower the expense structure and life and group reinsurance, and corporate center. We feel very, very good and in fact, we feel very proud of the fact that we were able to design and execute a total replatforming of a $7 billion in addition to reunderwriting the portfolio and disposing of unprofitable business segments in a number of our business areas. In the claims area,, in previous calls, we've talked about our focus of leveraging loss cost management rather than just a pure expense play. But to that end, rate renewal efficiency and underwriting initiatives get only part of it, the front door, so to speak. Our claims department represents the back door, or our cash machine.

Since January, Dean Herring, the leader of our worldwide plants operation and his team had analyzed thousands and thousands of claim files to estimates how much, if any, we overpaid, or to find different ways to handle certain types or sizes of claims. We know there are significant opportunities here. And we have already seen the benefits of it. The major components of this claims initiative are, first and foremost, establishing a very high-level, high-performing claims legal operation. Two, to implement, design and implement, the very aggressive litigation management strategy. Both have been done and are in place. And develop and implement centers of expertise, which has also been done. We reduced the authority of our field claim personnel, and that's my utilization of the centers of expertise.

And then lastly, we have increased and heightened our activities in the area of fraud, segregation, and salvage recovery. This initiative is very, very closely linked with our actual underwriting centers, and there will be more to follow on this. As I mentioned in the press release, I am not totally satisfied with the earnings number that we delivered this quarter. I am, however, very, very positive on the 2002 operating components of all of out businesses. CNA is a large, active, highly diversified, disciplined participant in a very robust market, which we expect that to continue in 2003 and 2004.

Our product portfolio is good, our distribution is strong, our expense structure has improved measurably, and we have no major initiatives underway to distract us from the opportunities at hand, which we think are significant . So a lot has been done. There's a lot going on and much more to do. The right team is in place with the right technical and operational skills, and we are very confident that we will enjoy positive results going forward for the rest of the year and into next year. With that I'd like to turn the call over to Bob Deutsch.

Good morning, everyone. Steve provided you with a good overall discussion of the quarter. I'd like to get a little more into detail before turning it over to Jim Lewis, who will discuss our [INAUDIBLE] goal. Today we reported net operating income from continuing operations of $38 million or 17 cents per share in the third quarter, compared with $144 million or 78 cents per share in the third quarter of 2001, using adjusted 2001 figures from the press release. For the nine-month result, our net operating income from continuing operations was $289 million or $1.29 per share, compared with $305 million or $1.66 per share last year.

Let me explain the difference between our reported results of $38 million and street consensus of $125 million. First, our investment in limited partnerships produced a loss of $47 million versus a gain of, say, $15 million or so in the consensus figures. The majority of the loss results from one limited partnership. Second, the European floods cost us $24 million after tax. These two items caused an adverse swing of roughly $85 million. We offer this to you by way of an explanation.

We do not for one minute consider it an acceptable excuse. On the subject of limited partnerships, on September 30, our investment in roughly 80 limited partnerships totaled $1.3 billion,, the majority of which is invested in market neutral strategies. As more money has followed us into this asset class, the expected rates of returns have decreased in our opinion. Consequently, during the upcoming quarters, we expect to reduce our investments in limited partnerships. Jim Lewis is going to cover the property and casualty operations in some detail. The improvements in 2002 continue to be substantial.

And we see no signs at all that 2003 that it will produce any letup in this hard market. We and our large competitors are acting sensibly, and that should continue for a long time. Steve mentioned that adverse development in the quarter was $24 million after tax,or $37 million pretax. Standard lines had favorable development of about $125 million, driven principally by the claims initiatives Steve discussed and favorable experience in some residual markets. Specialty lines showed adverse development of $85 million, reflecting reserve strengthening for excess medical malpractice coverage for hospital captives and E&O coverage for long-term care facilities for accident years 1999 and prior.

This is offset partially by reserve releases for some E&O programs involving lawyers, architects, engineers, realtors and small accounting firms, also going back in time to 1998 and prior. CNA Re experienced adverse development this quarter of $70 million for older accident years, relating to dno, eno, and surety. A trend you've seen with other re-insurers this quarter and last. To put these numbers in perspective, total reserve for the P&T segment at September 30th were $13.6 billion. CNA Re is producing very strong 2002 underwriting year results. A lot of the business comes up January 1st. Next quarter, Deb McClenehan will cover her business and give details to you. Life and group had a good quarter and Bob Patin will talk after Jim Lewis. My next topic is net income and capital gains.

Net income for the quarter was $54 million or 24 cents per share, compared with $149 million or 80 cents per share a year ago on an adjusted basis. This quarter's net income reflects $15 million of after-tax realized capital gain. We had net realized gains of $161 million, primarily in bonds, offset by $145 million of impairment losses, principally relating to the communications and energy industries as well as a write-down in our [INAUDIBLE] position.

Lastly, we closed the sale of CNA Re, UK, on October 31. We do not anticipate any additional impairment loss from that transaction. With that, I'll turn it over to Jim.

Thanks, Bob. I'll provide a closer look at CNA's property and casualty operations. I want to underscore Steve's comment on continuity in leadership. That was a major advantage for us in the third quarter. We did not miss a beat and we're not going to. As long as we have a hard market, we want to take advantage of every minute of that hard market. Now let's look at the third quarter results.

My focus is going to be on the operations consolidated results: But I'll also provide information on individual business units and key energy to where it makes sense. I'll also use adjusted figures from the financial supplement. Let's look at net written premium. Net written premium grew 15% from $1.5 billion to $1.7 billion in the quarter and 14% year-to-date, from 4.4 billion to 5 billion.

When you look at standard lines we had 12% growth in the quarter to $1 billion. Year-to-date, 11% growth, $3.2 billion. And our specialty lines, we had 21% growth in the quarter to $673 million. And year-to-date, 19% growth to $1.8 billion. The three major drives for the growth were the continued strong rate, good new business momentum that we have, and lower-seated premium. We also processed our business a little faster this year compared to last year.

When we look at our standard lines growth, it was impacted by our excess strategy for unprofitable lines like peo business, some of our account construction classes, some of our large casualty accounts and some of our ENS programs that were unprofitable. Most of this work has now come to a close. And then we'll be able to fully focus on our attention on profitably growing in the fourth quarter and beyond.

Let's take a look at rates. Our overall rates remain bullish at 28% overall through three quarters. And as we look at standard lines, and that's our small middle ENS in our risk management part of the operation. We ran it 28% rates in the third quarter. Our specialty operations have rates of 30% for the third quarter with very high rates, in our health care operation and also our open brokerage operation. And by the way, our overall October rate numbers are in line with the progress to date. The good news for us is that when you see the consistent rate gains that we get in this stage for next year, where we'll be earning 50% of the 2002 rate, plus 50% of the 2003 rate, which we also expect to be bullish. Retention. Our retention levels have been hovering in the 70's for the entire book.

Our middle markets actually started out earlier in the year in the middle 60s, but it's now also approaching the 70% level. With our exit strategies just about completed, we expect to show progressive improvement on our retention through the rest of this year and also into next year. Our new business is also coming along nicely. In the first quarter, our new business was impacted by our reorganization activities.

We're now hitting on all cylinders, and our new business represented 25% of our growth written for the quarter. Standard lines represented 24% of the gross written premium for the quarter. Specialty lines were 27%. We're also vigilant as we look at adverse selection. And as Steve commented on our renewal efficiency, on the market book where we're looking at the spread of our renewed and nonrenewed business on a paid and pay-reserve basis. That current spread is running a positive 15 to 20 points.

So for the business that we're keeping, we're actually seeing a 15 to 20-point better pay and pay loss ratio than what we're getting off of. And as we look at that loss ratio over a 15-month period of development, we're now seeing that loss ratio run in the low 30s. What this tells us is as we look at renewal efficiency that we're shedding the right business and keeping the right business. The numbers I've covered are on rate retention and new business, but all this really starts with the hard work of our front line on our underwriters. They've learned to deal with the marketplace, flexibility standpoint, added correctly.

Thery're getting the right exposure and also retaining good business. The name of the game for us is writing quality business. And our underwriters are getting the job done every day. Now let's take a look at the loss ratio. And it's very difficult for us to do a period over period comparison as Steve and Bob have discussed when you lock at reinsurance, the European flood and prior year adjustments from the reserves.

To really see the underlying progress, we really need to look at the gross accident year-loss ratios. When we look at the gross accident year-loss ratios, year-to-date we've improved 11 points. That's 83% down to 72% over the prior year. Standard lines improved 10 points, specialty lines improved 12 points. These numbers also include ULAE, which is running five points.

The improvement that we have in the loss ratio is coming from several areas. One, in underwriting. Two, accident unprofitable lines and three, the solid rate gains. Not only that we've gotten in this quarter, but that we've gotten every quarter in the past two years. The expense ratio is also a positive for story us. Our calendar year expense ration improved six points to 32%.

Year-to-date improved five points, also to 32%. This is driven by the expense savings initiative that we put in place in the fourth quarter and we're still continuing to push our overall expense ratio initiative, so we're not done with that yet. I'd also like to take -- provide some information on the longer-term numbers that we're looking at. We talked about balancing our overall book of business, moving the portfolios to a more lower and hazard book of business and more first party coverage. Our focus on this effort has really been in the workers compensation line.

And when you look at the workers compensation as a percentage of our growth written premium, in nine months of 2001, it represented 25%. As you look at that same line of business for nine months of 2002, it represents 18%. We've also rebuilt our small business platform in this less volatile market. We're coming on very strong in the property area, increasing our overall property 9% over prior year with $621 million in premiums year-to-date. These are early indications that we are working on balances in the book.

We're pleased with the progress and we understand there is more work to be done and we're going to stay focused on that. All in all, we had a very solid quarter. When I look at net written premium being up 15% for the quarter, strong rates of 28%. Retention steady in the 70's and should improve. We've got new business momentum, 25% for the quarter. We've improved in gross accident year-loss ratio by 11 points. Renewal efficiency, we have a 15-20 point spread on the business we're keeping versus what we're losing. A 5-point year-to-date improvement on our expense ratio. The underwriting programs we have in place should be completed soon.

So I think all of those issues bode well for us for the future. There's still a lot more to be done, but we're getting it done every day. I'd like to now turn the call over to Bob Patin.

Thank you, Jim. And good morning. It was a very solid quarter for life and group operations. Net income came in at 61 million plus, significantly higher than Q3 of '01. Due not only to the impact of 9/11 and last year's results but also due to several important factors.

First, from operating results, especially in group benefits, particularly in the disability segment, despite economic conditions and while disability claim incidents were, in fact, up, claim terminations more than offset the incidents. We also had favorable mortality versus the previous quarter in individual life with our year-to-date experience now in line with year-to-date '01 without the impact of 9/11. The adverse mortality experience in Q1 of this year seems not to have signaled a trend. We did see some claim volatility in individual long term care claims for the quarter. And although the experience was within acceptable parameters, we are watching it closely as we watched life mortality in the first quarter. On July 1st, we also successfully completed our transaction of the [INAUDIBLE], to sell our federal market division.

This will affect year-over-year comparison premiums, and resulted in a one-time, $9 million after-tax in OI benefits. We also had very strong new sales momentum our core businesses in the quarter. It was an especially good quarter for group benefits, where new sales annualized were 37% higher than last year's third quarter. In annualized new individual life sales we were also up significantly over Q3 of '01. And new individual life -- I'm sorry, long-term care sales -- were also up 4% over the previous year's quarter with a new product launched in the first quarter. We've also totally rebuilt our structured settlement business to better capture the full potential of CNA property and casualty and life connections, and significant new activity is already evident, which makes us very optimistic about the momentum carrying over into '03.

For example, we now see our activity levels at the highest level in four years, with last month's medicals at some 870 with over 800 assignments to brokers, and last month also saw $12 million in paid premiums in the highest month of the year. Our other CNA cross-marketing efforts are also now beginning to deliver some impressive results. As an example, group benefits has just now made some additional $10 million in sales, through support of our property and casualty department. Life sales offices are also reporting new life and long-term care applications, up 8% through property and casualty agency.

Also, our new product development and distribution diversification continues at a rapid pace, as evidenced by three items.

First, new independent marketing operations with more controlled field persons now account for 23% of individual life applications in their very first year of relationship with CNA.

Second, group benefits has now placed a new team of small-case reps in the field to benefit the more profitable segments of this market. And third, six new products are planned for Q4, launched in both diversified portfolio and improved profitability by segmenting out and targeting more attractive initiatives.

And finally, our '02 operation investment is designed to drive new revenue or operational savings are actually ahead of the schedule in only a small but accelerating contribution to NOI in '02, after payback of GAAP expense income. So all in all, a strong quarter contributing to a strong year-to-date with excellent momentum. I'll now turn it over to Don Lofe and look forward to your questions.

Thank you, Bob. Operator, we're ready for questions at this point.

Thank you Mr. Lofe. Today's question-and-answer session will be conducted electronically. If you would like to ask a question, please press the star key followed by the digit 1 on your touch-tone telephone. We will proceed by the order you signal. If you are using a speakerphone, please make sure that your mute function is turned off to allow your signal to reach our equipment. Once again, if you would like to ask a question, please star 1. We will pause a moment to give everyone an opportunity to signal. We will take our first question from Marie Harrington from Salomon Smith Barney. Please go ahead.

Hi, it's actually Ron Sike with Salomon Smith Barney. How are you?

Hi, Ron.

I have two questions related to the reserve issue or reserve strengthening. Maybe "Issue" is too big a word. When you did the June strengthening back when -- in '01. It was clear it wasn't just for a need, but a substantial chunk was for the recent prior accident years. It would seem that at least with respect to the professional liability and other lines that were affected in CNA Re and the specialty ops, something worsened significantly over the last 12 to 15 months. Now, obviously we know what's happening in corporate America, but I was wondering if you could given any additional color on that. And related to that, the fee to incur of 133, pricing is clearly going up, but you had growth in the business. You have the reserve strengthening. Yet the reserves came down. Is that mainly a function of runoff business and the lower-gross accident year picks?

Ron, it's Bob Deutsch. Thanks for the question. You're certainly right, in June of '01, at the time at the time we took that reserve charge, we absolutely thought we had all of this, but a lot has changed since then. Bear in mind, you have to put this in the context of over $13 billion of reserve so that these are not in aggregate all that significant. Having said that, in the dno and eno area and surety, CNA Re is not immune to what is going on in the economy. We've seen more dno claims come up as the stock market continues to perform poorly.

Attorneys are filing claims. We are also seeing more spinoff on multiyear policy where there's more claims coming from that. Bear in mind, we're not writing a lot of multiyear policies, if any, but we are still seeing some claims from there. While this is all negative news in the sense of reserve strengthening, it really is positive news. One of you guys says bad news is good news in the insurance business. In the dno market, rates are up substantially.

We are writing a fair amount of that business in Jim Lewis's area. Terms are tightening. We're focusing more on private market than midsized public companies. There's the -- terms and conditions are improving considerably. I could get into details with you. But let's just say that some of this bad news, is in fact a good harbinger for making sure the markets stay firm going forward. In terms of the paid to incur, you're right. It's simply just a runoff of other business.

And Ron, by the way, in some of the specialty areas where we talked about the capital business, that business that we have exited, we basically are out of that business. This relates to earlier accident years. We don't expect it to bite us again. We think we've got it all at this point in time. I recognize we said that a year ago, but we do feel that we have run off this business and feel good about our reserve position.

Okay, thanks a lot, Bob.

Hey Ron, this is Steve Lilienthal, I just want to amplify that a little bit. On a couple of previous conference calls, I think I mentioned to you that we had consolidated our actual [INAUDIBLE] at an enterprise level. And what we have in place is a process and a control that the regular reviews all of our reserve positions and emerging issues.

And we have strong linkages across not just the actual functions of the enerprise, but our claims and our underwriting functions. So our determination is to provide the strongest and most pristine balance sheet that we possibly can. And this is simply a reflection of that. I think in the world where we're a little more fractured, some of these things might tend to go and extend out and would not be discovered for a longer period of time. This way we find these things and deal with them.

Actually, Steve, following up on that one. What years did the standard lines release come from?

Standard lines release for -- for example in the residual market was really 1998 and prior.

Okay. Thanks again.

We will take our next question from Chris Winan from Williams Capital. Please go ahead.

Yes. I just wanted to find out what particular niches are you targeting? That you find particularly attractive?

We have been a very strong player in the large disability group for some time where we now identify core market resources. If there are sub-segments in the small and middle market with certain areas of construction and education that are actually quite attractive, as well as the number of other segments, we'll be pursuing. As we can identify business that both will emerge from better experience and also that we can target to our relationship across CNA.

What's the price environment like in that market?

It varies. Group life market continues to be a competitive -- we've raised prices fairly significantly. Our average price increase on the disability side is around 5%, which is right around the top of the band that we're seeing in the market. So we're getting rate, but it continues to be competitive. The accident market is extremely competitive these days, and we're not writing much of that business because of that.

Okay. Thanks a lot.

If you would like to ask a question at this time, please press star 1 now on your touch tone telephone.

We will now go to Angel Rocky with Merrill Lynch. Please go ahead.

I have a couple of questions. One is the balance sheet. Can you give us an idea as to what you're looking to do with debt maturities coming up in '03. The credit facility, which is maturing in '03. What are your plans for either extending that out or taking it down?

Right. We -- you're right. We have money coming due in '03. 634 million dollars. And we are undertaking an analysis now as to what to do with it. But nothing to report today, but expect to hear more comments from us next quarter on that.

Okay. Looking at the investment portfolio, there were 145 million in impairments. What are the investments in CDO's if any?

It's not significant. I don't have the exact number here. But if you want, we can follow up with you after the call.

So most of these were in bonds?

Yes.

Do you have any idea as to what trouble credits look like at this point? You know, kind of sifting through the bond portfolio?

Well, as of September 30, we can talk about some of those numbers. We've marked these things to a net realizable valuable that comfortable with. Some of the net write downs. We mentioned trend wick and satellite company and energy company. You know, we continue to -- who knows what the economy does, but if it continues to be in this state of malaise in the fourth quarter, we may very well have some additional impairment losses in the fourth quarter. We continually monitor these portfolio issues. And as Bob said, deteriorating conditions are going to warrant closer look.

I guess the point I was trying to make was you've taken some impairments, but is there, I guess, a separate credit watch list where you haven't taken any impairments yet but you're closely watching?

The short answer is yes. We have a sort of watch list, as referred to by you. And that's just part of the normal impairment analysis process that we go through on a routine basis. Keep in mind, we're sitting on over 600 million of unrealized gains and to the extent there were additional impairments on some of these credits in the fourth quarter. Some of that is already reflected in our net unrealized gain position. So you know, we do watch this regularly. Continually, you could say.

Okay. Thanks. Okay. Last question. What is the size of the dno book, premium-wise?

We're checking on that.

And while Bob is checking that, too, just a quick follow-up, you should know our balance sheet is marked market on a GAAP basis, not only in the overall portfolio reflected in the balance sheet position at 9/30.

The overall dno is $300 to $400 million. And it's growing based on the rate that we're getting on the rate of that book of business that we're getting right now.

Okay. Great. And the point I was trying to get at before, some companies have given the indication of 20, 30 basis points. The bond portfolio is currently under surveillance, potentially trouble.

I was trying to get an understanding of whether there is any guidance you can provide as to how large that credit watch list may be?

No. Nothing more to say on it. And we will keep watching it.

Great. Thank you.

Jim, this is Steve Lilienthal. Jim Lewis, if you want to pick up a little on the strategy in the dno portfolio. Because that is material in where we've taken this book.

Our overall strategy in dno is we look at dno as to really emphasize the private entities as well as public entities. And so we're moving the book in that direction. We are obviously reduced in our overall limits. We're getting significant returns and conditions reductions in this book. We're getting significant price across this total portfolio. And so as we look at this, it is an opportune time to stay in the dno market because of the current conditions that are in place.

Great.

We will take our next question from Bob Blacksegal with Lingham McGinnelly. Please go ahead.

Good morning.

If we could go through page 15 of your supplement, as you blow apart your investment income, the two pieces I want to address is your, quote, other investment income, which is down 22 million sequentially, and despite the pretty impressive operating cash flow you had in the quarter, is that just getting crushed by decline in yields? Have you shortened your portfolio, or is this I mean, is 260 sort of the rate, sort of core run rate? Extrapolate?

It not a sure thing the portfolio. It is the decrease in yield. Plain and simple, you know, the market yielded June 30 on bonds was about 6%. It was about 5.75% as of September 30th. The maturity on bonds was basically unchanged at just under 6 years since June 30. So it is a decline in rates.

Okay. And as you redeploy the sort of -- I assume it's going to take some time. You're going to have to figure out in this limited partnership income, and over time, some of that is going to go into quote, other investment income. You said the run rate of 15 million a quarter is no longer valid. Are you willing to give a better guidance number? Or are we just flying blind on that specific piece over the near term until it gets to position?

When you said 15 million a quarter, what are you referring to?

We talked about normalized limited partnership income.

Right. At the call we had talked about that. That's right. I would expect that in the fourth quarter that would be down. I could see that actually being a small loss.

Small loss.

Not what it was this quarter.

Right.

But if you had a 10 million lp loss in the fourth quarter, I think that's reasonable.

And then going into next year, the billion three is going to -- how long will it take you to redeploy into bonds?

Bob, it's not going to take very long at all. We would expect some going into fourth quarter and next quarter.

New money rates are about what?

New money rates -- about two-ish, three-ish, but we're not going to comment where we're investing it.

Reserves -- all your commentary on reserve development was exit 9/11, right?

Correct.

And 9/11 was where? In which lines?

In terms of development?

Right.

No. It wasn't affected. Our World Trade Center net losses of 468 is the number we stuck with since the first time we gave it out. We see no reason to change it.

I misread your press release. I apologize. Just a general comment on reserve development. Steve, you're the sort of pitcher of record now.

And it's sort of a honeymoon period, I think with analysts in the investment world to look at the reserves. At what point should we sort of look at adverse development from prior years as your record as opposed to prior management team?

Bob, the point I made earlier about this is I didn't really look at this as a honeymoon period or a quarter that I would use to clean up anything. We have had in place a very high-level, disciplined process on an enterprise level to review all of our reserve positions on a regular basis. And we do this. And what took place in the third quarter was the result of having done that and identified issues.

And some opportunities, and we felt the right thing to do was to recognize them, identify them, and deal with them and be done with it. At the end of the day, I don't really look at this as the one-time deal, the honeymoon deal. I've been doing this since I got here last year. And this is just an extension of that process. And it's actually getting better. What comes out of this is whatever volatility we have in our reserve, we get it back. That's sort of the good news and the bad news.

And the better news from your perspective is whatever we've got, we're going to deal with. That's how it is. We look at this, it is what it is. And the issues emerge at the ball of the business, and stuff happens and we're going to take a straight-ahead approach. And folks, we do feel that we have excellent controls and a prophecy place to let us get at this stuff in a very disciplined way.

I guess what I'm asking is, the degree of confidence you have on the current adequacy of prior year reserves at this point. High, medium, still get your arms around it, going to have a review, expect volatility, buzz, you're somewhere in between.

Bob, I am by nature a cynic.

Right.

And I believe it when I see it and I can touch it.

And the only thing I can tell you is that for the fourth quarter, there are scheduled line reviews and business reviews scheduled throughout the fourth quarter. And I have a schedule of business segments and lines of business within those business segments scheduled throughout 2003. This is a regular process. This is nothing unusual. And so whatever we look at in the fourth quarter, we have an initial meeting. An initial meeting early in the quarter to sort of talk about what we're discussing and then, you know, issues that we see emerging.

And later in the fourth quarter, we will have a hard meeting with all the business units claims and underwriting folks to say, okay, this is what it yielded. And the same process will take place in the third quarter of '03, and I can tell you the same process will take place in the third quarter of '04. So this is just a regular way to deal with the issues that are germane or endemic to our business.

Okay.

I feel as comfortable as anyone can feel after being in this business for 30 years if you know what I mean.

I guess I understand your answer. Thanks.

Thanks, Bob.

Once again if you have a question or follow-up question, please press star one on your phone. We'll go next to Rob Mate with Scneider Capital. Please go ahead.

I just had a question on the loss ratio exhibit on the last page of the supplement. For the pnc operations, re-insurance has been about a 2.2% drag in the year. Which, I guess, is five or six points worse than last year. And I'm just wondering if you have any feel now for going forward into '03? Does that continue to get worse as the higher-rated re-insurance earns out? Or is that, you know, starting to stabilize?

Rob, which numbers are you referring to?

I'm looking at page 28, the pnc operations, I guess the -- excluding the re-insurance division. -And the impact of other re-insurance as a 2.2% increase going from gross to net.

Right. It went from -- 2.2 is the cost of reinsurance. Right. And how much longer do we expect that to continue?

Yeah. Is that still going up as higher treaties go out? Or is that stabilizing now? I guess it partly depends on the '03 re-insurance renewals go.

I don't expect it to go up, but I actually think it's a good sign that it's a positive number because it means the underlying quality of business has improved. If you look at last year, look at pc ops. It's a good thing, the reason we give that page to point these things out. But it's about a 13-point swing from one year to the next.

Last year between WTC and the reserve strengthening, we were a huge beneficiary of having purchased a lot of re-insurance. Costs of re-insurance has gone up significantly, we've raised our retention. But even with the re-insurance we purchased, the re-insurers, knock on wood, are actually making money. Which we think is good. It means the underlying growth business is profitable.

So we actually are not troubled by the 2.2 because it means that 72% number that you see there is a good number. And that's where Steve and Jim are focusing is getting that 11-point differential to be even greater, if possible.

Okay. So basically, then, that means you should start to see more of the rate increase benefit drop to the net and bottom line as less of it is eaten up by re-insurance costs?

Sure. The rate increases Jim talked about, 50% of them get earned in a year. 50% the next year. And hopefully we share the majority of that and not our re-insurers. So I think that's right.

Okay.

And the other side of that, Steve, is on our reinsurance operation, obviously what we had to supposedly eat on the retail side, we harvested on the re-insurance side. So we are actually getting the benefit, one of the things that we had to deal with on the retail side. So that bodes very well and actually makes us feel very, very robust about what we can expect to make for January 1st. And I guess one other point I want to make is that the little bit of loss on this page is the fact that in the prior year, we showed significant impact from finite r-insurance. And the fact of the matter is we have moved away from that. In fact, did not have any dependents on finite reinsurance in '02.

Okay. Okay. Just one other quick question on page 23 of the supplement. Year-to-date, the net written and net earn premium on an adjusted basis for the pnc companies overall is pretty flat. I guess up four and one percent. So with the rates you're achieving, is it a reasonable calculation that your exposures you're rating or earning this year are actually down, you know, 25 to 30% over the prior year and how does that relate to the paid to incurred ratio.

I don't think you should focus on pc companies. Look at pc segments. Because they have a lot of the mail handlers business, which is a huge premium number, about $10 million of NOI. And there's other life and group business in pc companies. So you really should focus on pc segments. And there you see the increase in writings is just 15% growth -- net. And 11% on an earned basis.

That's so far less than the rates that you're achieving, right? So your exposure is actually down year-over-year?

This is Steve. And maybe Jim you want to comment on this a little bit. We have undertaken some very significant underwriting programs throughout 2002, particularly at the front end. This is, I think, things we talked about. We had programs we didn't like and then we had significant portfolios which we have been driving out or non-renewing for the year. This is the net of all of that. You start out with x and take out less than 30% of it and then put back on to that rate on the remaining portfolio and then some new business. And that's really how you get to that number. We would expect in '03 that retention levels will rise. And also our new business will stay -- if not steady, pretty much around where we're at right now, which is, I think, Jim, what? In the 23%, 24% range?

Right, and I think Steve indicated we did undertake a profit improvement initiative in our standard lines operations. And even in the peo business, some of our construction business, some of our large risk management casualty accounts, where we also looked at mono line worker's comp, where we couldn't pick up the rest of the account. But we also were exited. And we'll have that completed in the fourth quarter. And as a result of that, our retention has gone up in the fourth quarter and also into next year.

Thanks.

Thank you.

We will take our next question from Sean Reed with Salomon Smith Barney. Please go ahead.

Yes. Good morning. Just wanted to ask you some questions on the asbestos front. Number one, could you please comment on what you see that's going on in the general environment now. And do you think the situation has worsened over the last six months or so.

And the second question would be related to, one of your competitors recently announcing this call into last month. And it's getting sued for non-product exposure for a company that it covered up, in California. Could you comment on your exposure as to McArthur or any of its subsidiaries?

No exposure to Western McArthur. In terms of the environment. It's steady to slightly better, I'd say. The rate of increase in claims volumes has slightly decreased. Which is to say it's still increasing, but not at the same rate as seen in prior years. The courts are beginning to become less tolerant of the so-called unimpaired claims.

You may have seen the RAM study, which recently was released, which said that up to 90% of the currently filed claims don't meet the American Medical Association criteria for lung impairment. And there are a number of courts, including the federal courts, which are no longer trying these cases and in fact putting them in so-called plural registries, which is to say they're on permanent hold. From our own point of view, we're having a pretty good year in asbestos.

I think we're going to to -- we will in our third quarter filings, show that our asbestos calendar year payments to date are down significantly, due to very significant management initiatives and also some -- some -- we closed off some of the bleeders that were feeding into the prior three years of calendar payments on asbestos. So I hope that answers your question.

And there will be more disclosure in our third quarter, too.

Sean, just add to that. That was, by the way, John Cantor, our General Counsel. Just to add to that, I think the election results are all very positive with respect to the litigation debt in the insurance industry. Operator, we have time for one more question.

We will take our last question from Ira Zuckerman with Nutmeg Security. Please go ahead.

Is this alphabetically again? Just following up on the last question on asbestos, I won't take too much time. Can you give us an idea first of all what the amount you have in reserves for asbestos at this point? And how much of it is tied up with the fiber board settlement?

We've got 1.2 billion in asbestos reserves. And I think less than 100 million is net for fiber board. I think it's significantly less than 100 million. I think it's more in the 40 to 50 million range.

Okay. Thanks. I've got more questions. I'll give you a call.

All right. Feel free to call us.

This does conclude the question-and-answer session for today. I will now turn the call back over to Mr. Lofe for closing comments.

Again, thank you operator. We would like to thank everybody for joining us. Once again, I would like to call your attention to the forward-looking statements in the earnings release as well as my previously read statements the beginning of this call. A reminder, a taped replay of this call will be available immediately after the call today, until 11:59 p.m. eastern standard time on November 14th.

You may dial 1-888-203-1112. Or for international, 719-457-0820. And utilizing task code 360508. It will also be archived for replay later today in the investor relations pages on our website. Once again, thank you for your participation.

This does conclude today's CNA Financial Corporation third quarter conference call. We thank you for your participation and you may disconnect at this time.