CNA Financial Corp (CNA) 2004 Q4 法說會逐字稿

Welcome to the CNA Financial Corporation's fourth-quarter and full year 2004 earnings conference call. Today's call is being recorded. I'd like to turn the call over to Ms. Dawn Jaffray. Please go ahead.

Good morning. We'd like to welcome you to CNA's fourth-quarter and year end 2004 financial results conference call. My name is Dawn Jaffray and I am the Senior Vice President of Investor Relations. By now all of you should have received our earnings release and financial supplement. If not, you may access these documents at our website www.CNA.com under the investor relations menu. The earnings release is found under the submenu "investor communications financial news" and the financial supplement is located under the submenu "investor communications financial report", and other SEC filings and supplements.

For your reference this call is being web cast and can be accessed again on our website after we have concluded. With us this morning is Steve Lilienthal, our CEO; Craig Mense, our CFO; and Jim Lewis, our President of Property & Casualty Operations. In addition, we have Mike Fusco, our Chief Actuary; and Jon Kantor, our Corporate Counsel, with us. During this call there may be forward-looking statements made and references to non-GAAP financial measures. Please see the section of the earnings release available on our website headed "forward-looking statements" with regard to both.

The forward-looking statements speak only as of today, February 10, 2005. Further, the Company expressly disclaims any obligation to update or revise any forward-looking statements made during this call. There will be time for questions from the investment community following the conclusion of our remarks. Members of the news media may call Charlie Boesel at 312-822-2592, or Katrina Parker at 31-822-5167, and investment analyst questions may be directed to me at 312-822-7757 or Ken De Vries at 312-822-1111. And with that, I will now turn the call over to Steve.

Thank you, Dawn. Good morning to you all and thanks for joining us today. We have no major announcements to make during this call and as with our prior calls, we're happy to be able to say that. 2004 marked CNA's return to a more normalized mode of operation. CNA moved from a transitional state, sort of a wheels and motion condition, to a much more steady operational state in which controlled orderly execution became the order of the day and the focus. Before going any further, I would like to take a moment to introduce our new CFO, Craig Mense. Craig joined us from the St. Paul Travelers early in the fourth-quarter bringing our extensive and exhaustive CFO search to a very successful conclusion. Craig is a key addition to our senior leadership team and we are very, very pleased to have him on board.

From a financial standpoint, CNA rebounded quite well from the charge driven results of 2003 and although year-over-year comparisons are not meaningful due to be enormity of those charges, I'm quite pleased with the performance of the business and the quality of the earnings. CNA reported net income for the fourth-quarter of 305 million or $1.12 a share, a 75 percent improvement over the fourth-quarter of 2003. Net income for the year was 441 million or $6.47 a share compared with a net loss 1.4 billion or $6.58 a share in 2003. Craig will provide more detail on this in a moment.

As indicated in our press release, the fourth-quarter results improved last year primarily due to continued strong results in Property & Casualty operations and improved net realized investment results. Also contributing to better-than-expected results were -- I'm sorry -- also contributing were better-than-expected results from our noncore businesses. With respect to our core business, Property & Casualty operations has now reported 5 consecutive quarters of sub-100 combined ratio, absent the impact of third-quarter catastrophes. Underwriting discipline and claims best practice continues to be our focus.

The impact of 4 major hurricanes in the third quarter was significant, approximately $270 million pretax. But as I mentioned in the third quarter call, it was well below external expectations. Florida is one of our largest markets yet CNA ranked far down the list in terms of size of loss and this was a direct result of 3 years of solid coastal catastrophe driven exposure management. As I mentioned, underwriting discipline is the driver of our Property & Casualty results. Premiums were slightly down for the year due to the impact of midyear underwriting initiatives, most significantly residential construction, silica exclusions and workers compensation reduction.

Retentions dipped midyear and then picked up in the fourth-quarter as underwriting initiatives played out. New business was feathered back in response to increased market competition. Jim Lewis will provide more details on this in his remarks. Overall, Property & Casualty operations are stable and executing quite effectively. The portfolio was balanced and much less volatile. The operating platform has been improved greatly and is very stable. Our system supporting the businesses have been significantly upgraded and are providing solid information to our underwriters. All in all P&C Ops, our core engine, is in a very strong position to compete and deliver going forward. And our runoff unit is running quite smoothly with no surprises.

Moving to other items. CNA continues to cooperate with subpoenas and requests for information in connection with the widespread investigation of the industry practices. I touched on his briefly in our last call. Since then, like many other carriers, we have received subpoenas and interrogatories from additional states and the SEC. The areas of inquiry include contingent compensation arrangement, fictitious bidding, high-end reinsurance arrangements, as well as finite insurance and attorney malpractice insurance. This matter is the hands of our attorneys and, therefore, I cannot and will not take any questions about the investigations during this call.

One more item of note is the successful conclusion of our $1.4 billion recapitalization plan in early 2004. We followed up in December of 2004 with a successful bond offering and the repayment of a low surplus note which marks another important milestone in our turnaround story. In summary, CNA has emerged from the whitewater of 2003 and prior, in the best financial operating and underwriting position it has been in years. I continue to be extremely proud of all that has been accomplished here in a very, very short period of time. And while we are certainly not declaring victory, all in all 2004 was a solid gratifying year with much accomplished and much more to get done in 2005. With that, let me turn it over to Craig.

Thank you Steve. Good morning everyone. I'm very pleased to be here, I would say, and Steve I'm very proud to have joined your management team at CNA. I'm doubly pleased and proud to discuss the financial results for the quarter and the year which I believe are reflective of the steady progress that CNA is making in its business evolution. Steve provided you with a summary of the quarter's major events and I would like to give you a bit more detail on the financial results before turning it over to Jim Lewis.

Today we reported fourth-quarter net income of $305 million, or $1.12 per share, a significant improvement over the fourth-quarter of 2003. Full year 2004 net income was $441 million. Full year comparisons with 2003 are really not meaningful since we took such large reserves and bad debt charges last year. Fourth-quarter operating income before realized investment gains was $201 million or 73 cents a share, which is up slightly from 194 million or 75 cents a share in the prior year. For the full year operating income before realized investment gains or losses was $594 million, or $2.07 per share. These per share amounts include the impact of undeclared preferred stock dividends.

Realized investment gains for the quarter were 104 million after-tax, and these are simply a function of our continued focus on a total return philosophy in our investment portfolio. One thing as you point out though, that amount is net of $36 million after-tax impairment on loans to a major national contractor and CNA surety customer which we had disclosed earlier. For the full year realized investment losses were $153 million after-tax, and those include 389 million of after-tax loss related to the sale of our life business earlier this year.

Net investment income for the quarter was $462 million, which is a 6 percent increase over the fourth-quarter of 2003. That number includes 46 million in an interest catch-up adjustment related to our 2001 aggregate finite cover. Absent that adjustment, net investment income increased 17 percent over 2003. Net investment income for the year was $1.674 billion which compares favorably to 1.647 in 2003. Property & Casualty net income -- excuse me. Operating income was $171 million for the quarter which is up 13 percent from the prior year.

The most important thing to talk about here in terms of development is that we had no net prior year premium and loss development in the quarter of any significance. That no news also really goes to our estimate of losses from the 4 third quarter hurricanes, although we did add about $5 million pretax to the number we had disclosed last quarter. The Property & Casualty results and the expense ratio for the quarter were adversely impacted by $36 million of after-tax insurance bad debt charge. This charge relates to premium and loss deductibles owed now or in the future by large risk management account. The primary drivers of the charge were updated projections of ultimate losses on accounts in bankruptcy and a review of all the bill balances that are past due.

The Life & Group segment reported a net operating loss of $9 million for the quarter. That's an improvement over the $13 million operating loss reported in the third quarter and is primarily due to favorable experience on our runoff loss of individual long-term care business and a strong focus on expenses. The Corporate and other Noncore segment reported net operating income of 39 million for the quarter which includes 14 million after-tax of nonrecurring income related to the release of real estate reserves.

In December we issued $549 million of 5.85 percent senior Notes. The primary use of those funds will be to retire this 6.5 percent senior Notes that mature in April of this year. The funds were also used to retire a $45.6 million surplus Note to Loews. While we will have some negative drag on these funds until the repayment of the April maturities when our future interest run rate will improve modestly over the course of the year, and our overall debt to equity ratio will return to a relatively note low 19 percent in April.

Finally I would like to briefly discuss our expense management process. Our actions in 2004 reduced our total direct expenses by approximately $400 million. That amount, and approximately 300 million was related directly to the Life & Group sales, and 100 million of the reduction was to the cost of our ongoing operations. That is in line with early indications we had made. Our goal for 2005 is to further reduce expenses by an additional $100 million. The success of that effort, coupled with the continued improvement in our billing and collection discipline, should allow us to report meaningful progress in our expense competitiveness over the course of 2005. With that I'll turn it over to Jim.

Good morning everyone. Property & Casualty operations is now in its fifth consecutive quarter of solid underlying performance, 5 quarters of sub-100 combined ratio when you exclude catastrophes. Steve mentioned this already, but it bears repeating. CNA has become a much better underwriting Company. In '04 we were able to do things that we couldn't do a few years ago, such as carry out disciplined underwriting initiatives while holding our book of business together, respond quickly to changes in the market, mitigate hurricane losses, leverage the breadth of CNA product across sales strategy, just to name a few.

You see all these capabilities in our key business indicators. Starting with premium volume, Property & Casualty operations gross written premium was 2.2 billion for the fourth-quarter, down slightly from prior year and 8.8 billion for the year, also down slightly. For the year Standard Lines was down approximately 8 percent, while Specialty Lines was up 7 percent. These changes in our business volume exemplify our strategy of portfolio management. We grew in Specialty where the market remained robust. We pulled back in Standard selectively reducing volatile lines such as workers compensation and accident problem classes, such as residential construction.

Let's look at rate. 2004 was our fourth consecutive year of rate increases, smaller than last year but we did put an additional 3 percent rate on our book in the fourth-quarter and 5 percent for the year. Standard Lines average rate increase is 4 percent for the year, with Specialty at 9 percent. As I mentioned on our last call we pay very close attention to the spread between the rate trends and the loss trends. Overall the spread is telling us we need to maintain our underwriting diligence.

Turning to retention. We continue to emphasize renewal quality more than quantity. Property & Casualty operation retention was flat at 75 percent for the fourth-quarter and down 2 points to 73 percent for the year. When you look at our retention levels quarter by quarter there was a drop-off in the second and third quarter to 70 percent, then a rebound to 75 percent in the fourth-quarter. What you are seeing is the impact of intentional underwriting action, construction defects, silica and others. With much of this work completed we expect retention to continue to improve.

Most of the improvement should be seen in Standard Lines. Our 2004 Standard Lines retention of 70 percent includes a negative 7 point impact into the underwriting (indiscernible). 2004 retention in Specialty remained above 80 percent which reflects our underwriting appetite and the price available in the market. We wrote approximately 1.6 billion of new business in 2004, or 22 percent of the book. This compares with 1.9 billion in 2003 or 25 percent of the book. Our new business production was what you might expect you see in a year of progressively smaller rate increases. CNA was and is very much in the hunt for good new business, but not as much of the new business out there meets our underwriting standards.

As with renewals our new business focus is on quality. For instance we continue to push hard on selling more CNA product to existing customers. This is our cross-sell strategy and it generated approximately 350 million of new business. In other words, 22 percent of our new business production came from customers we already know. Cross-sell is one side of our push for quality new business. The other is underwriting control. For instance we track new business quality by (indiscernible) the spread between paid and case loss ratios for new business and renewal business. So long as the spread remains fairly narrow it's an indicator of underwriting discipline on the front line.

Now let's turn to our loss ratio. The Property & Casualty net calendar year loss ratio for the fourth-quarter was 66 percent, a 2 point improvement from the prior period. For the full year our net calendar year loss ratio was 68 percent which includes 4 points from catastrophe, mainly the third quarter hurricanes. Cat losses had the greatest impact in Standard Lines where our 2004 net calendar year loss ratio came in at 71 percent. Specialty, on the other hand, came in at 63 percent.

As for the net accident year loss ratio, Property & Casualty operation was approximately 67 percent in '04 versus 64 percent in '03, both evaluated as of 12/31/04. These ratios include cat losses, 4 points for '04 and 2 points for '03. Turning to our combined ratios. Property & Casualty operations finished the year well. We ran at 97 percent for the fourth-quarter, 2 points better than '03. Standard was essentially flat at 102 percent and Specialty came in with a stellar 88 percent.

For the entire year Property & Casualty operations had a combined ratio of 101 percent, Standard was 106 percent and Specialty was 90 percent. The combined ratios were impacted by factors that have already been discussed today and in prior calls. Cat losses and bad debt charges added 6 points to the '04 combined for the P&C operations and 9 points to the Standard Lines combined ratio. Before wrapping up, I would like to comment briefly on our outlook for '05. Even with the market moderating we like our prospects quite a bit. In Standard Lines our size, the breadth of our product portfolio, our geographic diversity put us in a strong position.

We intend to grow in our profitable lines which include property, in the marine, umbrella, small business and casualty lines other than workers compensation. In middle markets, our bread and butter business, we are targeting manufacturing and commercial construction. For the most part these are lines of business in customer segments where CNA is already well-positioned with product, distribution relationships and underwriting expertise. As for Specialty Lines we should be able to write profitable business across our entire portfolio with very few exceptions.

In summary, in 2004 we translated the hard work of a few years into bottom-line results, excellence in underwriting and claims, portfolio optimization and distribution management have served as well. Now it is up to us to stay focused and keep it going in 2005. With that, I will turn it back to Dawn.

I would now like to open the lines for questions. Operator, please proceed.

(OPERATOR INSTRUCTIONS) Bill Wilt with Morgan Stanley.

A couple of questions. I guess the first one is numbers related. Craig I missed in your comments, you mentioned something on the finite cover, the cost of which increased this quarter. I believe you referred to a catch-up, but I wasn't sure of the dynamics underlying that.

Bill, it was related to the 2001 aggregate cover and would've been a charge of about 50 million, a little less than 50 million, of interest expense which would have reduced our net investment income by that amount. We tripped a loss ratio trigger in that cover which cost us additional 2 points of catch-up interest, as well as really for the number of years since 2001. So our total maybe the number you'd like to note Bill, is that our total interest charge for the finite in '04 were 267 million. I think you didn't really ask this question, but you probably want to know where we are headed next year. I think we've given some guidance before. The updated guidance on the finite charge in '05 would be 190 million, down from the 267. And our expectations of finite interest charges in '06 would be 140.

That is helpful. Thank you. I'll loop back to that. This loss ratio trigger that you tripped, was that on a paid basis because of an exhilaration on the paid, or was that on an incurred basis where you would have raised estimates for the loss ratio from 2001?

It was a 2001 incurred loss ratio trigger and we tripped the interest rate from 8 percent to 10 percent going back. It was a small of amount development in '01 that tripped that.

Thanks very much. Part 2, if I could. I notice the reserve releases on accident year 2003, I think around about 4 points released in '04 on accident year '03. I guess a 2 part question. One is, comments on the sources out of that reserve release. And then part 2 is, noticing then that the accident year 2004 accrual is maybe up close to 5 points, or a bit over 5 points higher than the accident year 2003. I realize part of that would be for catastrophes. I was actually planning to go back and do the math, don't think I was successful.

But maybe you all know, off the top of your heads, how much of that incremental increase from the newly revised accident year '03, upped the accident year '04 accrual. I'm thinking of Standard Lines. How much of that was for cats? And then stripping that out what's your view on the delta or the change from your accrual to accident year '03 to accident year '04, which I guess translates into rate change and loss ratio -- loss cost trend dynamics.

Bill, could you repeat that question please.

I don't think so.

I don't think we could either.

We'll try to dissect that question, Bill. I think part of your question was '03 -- for calendar year '04 we did release dollars of reserve for accident year '03. Where was the source of that, I think was one of your questions. Primarily property, which somebody took a look at all of our lines of business. Certainly as part of our process, they're reviewing reserves every quarter for a whole medley of our products, Standard and Specialty Lines, and there will always be movement by product, by accident year throughout each calendar year.

You are correct in that '03 versus '04, you were looking at it I think on an including cat basis. As Jim Lewis said, they were about for points of cat in '04, about 2 points of cat in '03. I think when you factor that out we are currently booking '04 a little bit higher than '03 but not significantly higher. '04 is an early look, it's a 12 month look at '04. It's pretty premature and we tend to wait and see what happens on '04. In terms of low cost trend versus rate trends, Jim commented, we're keeping a careful eye on that for the year '04. Certainly on an earned rate basis we exceeded loss cost trend for both Specialty and Standard.

Bill, if I could go back for a second too. This is Craig, again. Just to make clear on the finite interest charge. That was not a cash payment. So all we have really done and (indiscernible) accelerate that, is to accelerate the total repayment of all the interest charges on the finite. The future years will be less as a result of us catching up in '04.

Very good. Very helpful, thank you.

Arun Kumar with JP Morgan.

You made some comments on the Standard lines about workers comp and the rate environment. Could you tell us what those comps, in terms of percent, what does that represents of your Standard Lines or your overall book of business? And the second question is to do with the numbers question on the statutory capital that you have, the 7+ billion. In terms of dividend capacity from the insurance companies, if you could tell us what that is for all of 2004? Thank you.

On the workers comp mix, we have been working very diligently since 2001 to reduce the mix of workers comp on the total portfolio. And in 2001 workers comp was 20 percent of the book. As of year and '04 it's down to 15 percent of the book. There are some other interesting things that we have done within the work comp. Our overall policy count over 2000 to 2004 is down 39 percent. At the same timeframe, exposures are down 49 percent. We also had a high hazard book of business and the high hazards policy count is down 69 percent. During that same 4 year timeframe rates actually increased 47 percent. And so even though we're showing 15 percent if our total mix, it's actually better than that because 315 million of that really came from rate. So we are pleased with the progress we've made in reducing the comp line.

With respect to the capital position, we have at the holding company approximately $720 million as of the end of December. And with respect specifically to dividend capacity, we have received preapproval for 125 million, which is the needs that we have for the balance of the debt service.

Terrific, thank you.

Bob Glasspiegel with Langen McAlenney.

Bob Deutsch (ph) got tired of hearing these questions I'm about to ask and, Craig, you will soon too, as well. It relates to sort of the finite cover discussion with Bill. Does it make sense to still have these finite covers in place in today's world, is question 1. Do you have the financial strength to remove them if you want to, is question 2. And is it a significant part of your game plan going forward for new business?

Let me answer the question, Bob, with respect to how it stands as part of our business going forward. We put in a prohibition companywide against buying them at a business level or at a business unit level or at a corporate level a couple of years ago. So we do not buy that. There was a contingent cover in place where we had a reservation on 1 for '03 which we commuted, did not use. We did not have one for '04. And we will not buy any of these things going forward and that is not new news for CNA. It is not part of our plans. We are not dependent upon it. And right now we're just working our way out of the old covers. In terms of ceding for those covers, these were mandatory sessions. There is no options on it. So if we hit them, we had to cede to them. But going forward, and actually for the last couple of years, finite, other than paying the bill off, has not been part of our plans and will not be part of our plans going forward.

Questions 1 and 2, does it make sense to pay out and dig out of where you are now and just close them out? And 2, you have the financial strength to do it if you wanted to.

I think the answer to that is that -- (indiscernible) your three questions, where that it doesn't make sense to go forward or we're not interested in going forward. Second, it does not make -- we look at the capital charge, on our ability to take it, and the economics underneath each and every one of these finite covers to make those kinds of decisions. I think that you have to remember there is real economic value in a number of these covers.

So it would not make any sense to commute (indiscernible) that have economic value unless we were able to get the right economic value today. We're going to make individual decisions. We look at them all the time and we do it within the context of our ability to manage it within the capital structure that we have, when we made those decisions. But we'd be driven by the economics of the deal.

One last question on the subject, I promise. Is there any move to make analysis of reserves in the financials more transparent? In the past you used to give a Schedule P on a gross and net basis. I guess you discontinued that a few years ago. But it make sense maybe to provide more information?

Bob, Mike is going to answer that question for you but the point we're at right now, we've got a 212 page K coming out and I'm not sure whether the world could stand any more information from us. Mike, did you want to take that question?

I'm not sure I understood everything, Bob, on your question but certainly Schedule P will be out soon and maybe that will be what answers your question.

I find analysis of your Schedule P increasingly challenging with the use of the finites on top of a bunch of other factors. Any analysis that we can get from you guys, and obviously you'd have to give it to the whole world, not just to me, would be very helpful. I would be glad to discuss that with you off-line.

We'd be happy to consider things like that, Bob.

Thank you.

Si Lund (ph) with Morgan Stanley.

Just a follow-up question from one of the earlier ones on statutory position of the Op Cos (ph). What were consolidated statutory net earnings in '04 for the P&C companies? And then just a quick follow-up, where you guys stand with the rating agencies right now? I think both of them have a negative outlook on the ratings right now.

With respect to the rating agencies, we continue to remain on the negative outlook as it was assigned back, after the third quarter. Certainly the continual demonstration of consistent earnings is what the rating agencies are looking and this is our fifth quarter. Certainly we continue to have a good relationship with them and we will hopefully have that negative outlook removed as have more quarters of earnings. With respect to the statutory number, we will have to get back to you on that. We will have to pull out the blank.

Thank you.

Donna Halverstat (ph) with Goldman Sachs.

By question was already asked and answered, thank you.

Bill Wilt with Morgan Stanley.

Just wanted to check in on the status of a couple of items' timing. First, the arbitration hearings or the arbitrations with John Hancock. And then secondly, any timing or color on the reserve reviews that were initiated as part of the statutory realignment?

The Hancock arbitration is for ceding. We don't expect to have any actual hearings until '06 or there about. So it's a little ways off.

As part of the statutory comment, the exam is still underway. So we really don't have anything to report to you right now.

No estimates as to the timing at that or color?

It's really difficult to say.

And very much not within our control.

Understood. Thank you.

Louis Supere (ph) with Oppenheimer.

Could you currently give some idea, after all the adjustments have been made, what your adjusted book value is, that is the first question. And the second question, how are you managing your investments? Who is doing it and what are the ratios?

What sort of ratios are you looking for?

Between debt and equity and how they are divided.

Our current debt to equity ratio is about 24.5 percent. That is because we issued the debt in December, the $549 million, and we won't pay off a little under 500 million, until April. So we expect to be down to about 19 percent in April, return to about the number it was before we made the debt offering. So I think that's a pretty conservative number. Now the investments are managed consistently with the past and they are managed internally. And then you had a question about adjusted book value.

Correct.

Could you repeat that question?

What is the adjusted book value after you have made all of your calculations?

I don't think we're really clear at to what you are asking here. Obviously we know what are current book value is. Did you want us to do some adjustments to --.

If you have made all of your adjustments, what is the value?

Putting things in and backing things out, is that what you are saying?

Correct.

Would you mind if we didn't do the mathematics on the phone. We could come back to you on that and figure out exactly what you're looking for and try to work it through with you.

Okay.

The book value per common share has gone up from 31.42 at the beginning to 32.55 at the end of the quarter.

Thank you.

(OPERATOR INSTRUCTIONS). Scott Frost with HSBC.

Could you describe what you are seeing in terms of the rate environment right now?

On the rate side, as I indicated, we got 3 points of rate for our whole P&C book in the fourth quarter. We've seen rates moderate each quarter of the year as you looked at '04. We started out for total P&C at 8 points of rate, and then as we got into the fourth quarter we had 3 points of rate. Rates haven't fallen off the cliff. We see them kind of moderating at roughly a point or so each quarter. It's varying by individual business segments. But it's really exactly what we have expected after 4 years of rate increases. On our whole P&C book, we've got 17, 27, 19, and 5 points of rate for last year.

When you look at this, Mike indicated, as we manage and look at our overall loss cost and what is really happening with rates, on an earned basis we're still getting rate in excess of loss cost trends. And even when I look at the total book of business for last year for Standard Lines and P&C on a written basis for Specialty, we were actually just slightly under loss cost on our written for Standard Lines, well in excess as I looked at our overall Specialty Lines portfolio. So rates are moderating. We still see this as a healthy market for us to do business in.

There are new business opportunities that we're actually selectively picking and choosing where we see those opportunities. But I think this is a marketplace now where we continue to show the discipline that we've really done over the last couple of years of managing our book and continue to monitor what we see as far as our renewal efficiency that we talked about over the previous years, and also our paid in case loss ratio.

(OPERATOR INSTRUCTIONS). Gary Ransom with Fox-Pitt Kelton.

I had a question on the Standard commercial lines. Looking at the combined ratio it's been running over 100 and assuming that that's not where you want to be ultimately, where is your target for that business? And I think you mentioned expense cuts as part of the potential improvement in the future and perhaps business mix changes that would help that number. Where do you get satisfied on that number? And what are you looking to do, a little more specifically, to work that number down further?

Just one comment so that you know that one of the biggest points of emphasis, and we've been working on it for a while here, is just improving the disciplines around billing and collection. So our bad debt expense adds over 3 points to the combined ratio there which is significant, obviously a strategic disadvantage. One of the big improvements we're looking for and you should expect is in that net allowance. The other expense initiatives allow us to make some marginal and modest improvement over the course of the year. I think that would be one of the bigger numbers having a big impact. I will let Jim or someone else comment on where our target is.

When you look at the overall book for Standard Lines, as I indicated, we ended the year with a combined 106 percent. Within that 106 percent within Standard Lines, you actually had 9 points that really came from the bad debt and also the cat losses that we had. If you take that 9 points out that is really where we would really expect to be within our Standard Lines portfolio.

I guess I'd like to add, as you would know the impact of underwriting initiatives I think which has shown itself pretty self-evidently since we have been here, since we started this stuff in 2001, as we continue to put additional underwriting activities in-place or underwriting restrictions, it takes a while for this stuff to play out. Your question was, what is the target? And I think that would be a function of what kind of investment income we can make on this business too. That will play into it. But in a perfect world I'd like to see the Standard book run between 95 and 100 on a pretty steady basis. If it ran a little over that in a more robust investment or return environment, that might be okay.

As a purist on the underwriting side, I would like to see it stay below 100 and then work it from there. But the initiatives that Jim and the team have put in place with respect to workers compensation takes a while to play out, as you know because of the tail on the business. And we don't like to get overly optimistic just because we've taken an action and assumed that we'll have immediate impact. We've taken a lot of the initiatives with respect to our general liability book, specifically in the area of residential construction. That takes a little bit of time to play out.

Our E&S portfolio was pretty a heavy-duty book of business and we took that down. And it just takes a while for that stuff to play in. You can declare victory, but we've got to have the numbers to back it up before we start moving our numbers around and taking an overly optimistic view. There is a lot of stuff that is sort of the nature of our business that doesn't allow you to claim the number just because you initiated an activity.

With respect to expense, it's also a similar situation. We went through a radical transformation and replatforming of this Company between 2003 and 2004. We had expense that was stranded which was very much a function of the disposition of these businesses. We had commitments going forward as part of the sale. We had expense that was left in place to service the remains of these businesses. And it takes a while to get that stuff out in an orderly rational fashion without breaking something, or breaking an agreement that we have made to any of the people that we have disclosed this stuff to. That is sort of both on the loss side and on the expense side, what were about. And we are trying to do this in an orderly, rational fashion rather than just slash and trash and possibly break something.

If you think about where you are in Standard Lines and make whatever adjustments you want for bad debt and the like and think about what your competitors are doing in the similar classes of business, do you view how you're performing as average, better than average, less than average?

I will let Jim Lewis comment on that too, but I would say that I would not position us as best-in-class, but I would position us as right up there with the best-in-class. Certainly if you wanted to be conservative you could say in the average to a little bit above that category. But if you consider where we were and how much ground we've taken back on that Standard Lines portfolio in a very, very short period of time, you know how the accounting goes, you know what the drag on this stuff is. I think it's nothing short of phenomenal to take it from numbers that were north of 120 across this entire portfolio with a very volatile book to get to where it is today.

I think that is incredible and I think that is sustainable. We have repeatedly said that we would accept a smaller company in exchange for profit. As we have said repeatedly to our employees, to our shareholders, to our Board, what we're after is money you can keep, not many you can run through the place. I think that has been a very, very consistent message. Our compensation plans for the organization are geared that way and we feel that that is embedded in the culture now. We will find out whether we're walking the talk as we go through the softer conditions. But I would also tell you that our retentions are lower than what our competitors are. Our new business is lower than what our competitors are. So you may draw some conclusions from that as to who is competing in the marketplace a little more aggressively than we are.

Thank you.

We dropped our new business writings as a percentage of the overall portfolio, I wouldn't say dramatically but very noticeably, and somebody is out there eating it because our retentions are still lower than what you would expect a company in a position that we would at. We have let this stuff go and it's a very circular game out there. I mean it's going someplace. Our workers compensation has dropped from 27 percent when we got here 3 years ago down to a little over 15. It didn't go away and the involuntary market didn't eat it all up. People have entered the large account marketplace that we abandoned, people have entered the excess workers compensation market that we dialed back very, very dramatically. And it has gone someplace.

Right.

But take your own conclusions from that.

Thank you. My questions are not meant to take away from the phenomenal success you have had. I'm just trying to look -- looking at head.

I think it's nothing short of phenomenal what has taken place and we are very proud of it. We are not declaring victory. We are not saying that is where we want to be. I would challenge you to point out another company on the street that has come as far and as fast and executed so many different things as well as we have in the amount of time that we've done. I feel very good about that.

I'd say that as good as anybody has done and maybe even better than that. And in respect to where we are in an absolute basis, I like to see us do more. I don't want our underwriters to lay back and say that this is good enough. I think there is more ground to take. I think we've got it. I think we got the controls in place. I think we've got underwriting discipline in place. We've made major progress with respect to our claims restructuring.

If you look at the amount of just the sensitivity on both income coming in -- I know you say the two core transactions of this place are taking the money in for risk. If we're 1 point off on that and you figure we are whatever you want to call us on gross net, written, whatever, that 1 percent is a huge amount of money. And the same thing on the claims side. If you look at what we pay on the PC claims, 1 percent move is real-live money. You add two of those together and you say add 1 percent of anything, that is a huge amount. And that is what we are after. That is what we have said to employees, that's what we have said to shareholders, that is what we have said to the Board, the money at the bottom line that we get to keep what we are after.

My follow-up question is to tell us how you really feel, Steve.

Can I get back to you on that. I appreciate the opportunity to talk about it. That is a fair question. Where are you and how do you feel about where you relative to the rest of the world, and in light of the conditions that we are going to go into going forward. There are a lot of people that have talked about underwriting discipline but they did it when rates were at 20, 25 percent. I think it's going to be very, very interesting to see a year from now, or a year and a half from now, who stuck to their underwriting and claims gun.

Thank you.

Brett Reece (ph) with Wachovia Securities.

If the yield curve continues to flatten and stay flat, does that help or hurt your investment income based on the duration of your fixed income portfolios?

That would be a good thing because the strategy we have in place is a barbell and it's been that way for a while. We are continuing it, so that would be a positive for us.

Thank you.

We have no further questions at this time. I would like to turn the conference back over for any additional or closing remarks.

Thank you operator. I will make one closing statement before I close the call. The question regarding the preliminary statutory net income for the P&C Company, this is not finalized and it is preliminary, but the number is about 565 million. In conclusion, I call your attention to our disclosures concerning forward-looking statements in the earnings release and as previously stated at the start of today's call. Please note that a taped replay of today's conference call will be available for 1 week immediately following this call until February 17th. You can access the replay by dialing 888-203-1112 or 719-457-0820 for international callers, both utilizing pass code 227455. The call will also be archived later in the day for replay on the Investor Relations pages on our website. Thank you for joining us this morning. We appreciate your participation in today's call.

Thanks everyone. That include today's conference and you may disconnect at this time.