CNA Financial Corp (CNA) 2006 Q4 法說會逐字稿

Good day and welcome to the CNA Financial Corporation fourth quarter 2006 conference call. Today's call is being recorded.

At this time, I would like to turn the conference over to Ms. Nancy Bufalino. Ms. Bufalino, please go ahead.

Thank you, Leanna, and good morning. We'd like to welcome you to CNA's fourth quarter and 2006 year-end financial results conference call.

With us this morning is Steve Lilienthal, Chairman and CEO, Craig Mense, CFO, and Jim Lewis, President and CEO of PNC Operations.

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 CNA's Web site headed, "Forward-looking Statements" with regard to both items.

The forward-looking statements speak only as of today, February 12, 2007. Further, CNA expressly disclaims any obligation to update or revise any forward-looking statements made during this call.

This call is being recorded and webcast. During the next few weeks the call may be accessed again on CNA's Web site at www.cna.com.

Following the conclusion of CNA's prepared remarks we will be happy to take questions from the investment community.

And with that, I'll turn the call over to CNA's Chairman and CEO, Steve Lilienthal.

Thanks, Nancy. Good morning, everyone, and thank you for joining us today.

2006 was a very good year for CNA on all fronts and by all measures. All key financial and operating metrics showed market improvement and are very much within targeted objectives. Even the weather cooperated.

Before I turn the call over to Craig and to Jim for a more detailed discussion of the year, the quarter, and even more importantly, what we see going forward, I'd like to highlight a number of key results.

Net operating income for the year was approximately $1.1 billion compared with $253 million in 2005. Obviously the '05 results were heavily impacted by the weather, particularly Hurricane Katrina, but core property/casualty results continued to perform well even viewed ex CAT.

By the way, with respect to our '05 storms, our original loss estimates continue to hold and claim settlements continue to be handled in a very professional, orderly fashion. Net operating income and net income ROEs for the year were 12% and 11.8% respectively, solid, much improved, but more work to do here.

Book value improved by more than 15% growing from $31.26 to $36.03. Net investment income was strong throughout the year. Craig will discuss all of this in more detail in a few moments.

Property and casualty operations continued its steady performance with a full-year combined ratio of 96.4% which includes a 1.4 point impact of catastrophes and significant commutations.

As I mentioned before, 2006 was a very mild year for catastrophe. Even so, the '06 year compares very favorably to '05, normalized for catastrophes and significant commutations in the amount of 11.6 points to the 205 combined ratio come in at 98.4% on the same basis 2006 combined with 95%.

PC ops gross written premiums were up 4% for the year. Rates were relatively stable.

Even with some fourth quarter softening, retentions remained strong and new business at 19% to total production is appropriate and exactly in line with where we said we would be in this type of market. The PC ops expense ratio of 29.8% for the year, quite solid, more to do and more on that in a moment.

A few more comments are in order before turning this call over to Craig and to Jim. During the course of the year, our balance sheet was strengthened by a number of key initiatives including the refinancing in August which allowed us to retire the 8% Series H and replace it with debt with an approximate blended rate of 6.35%.

As for the finites, all but one of the finite reinsurance covers were eliminated reducing our reinsurance cost to $59 million in 2006 and zero in 2007, down from a high of over $300 million in 2003. Commutations had the levered effect of reducing the associated interest expense, reducing reinsurance receivables on the balance sheet, reducing the cost of administration, growing assets and ultimately investment income.

Reinsurance receivables were reduced to approximately $10 billion from $12 billion in 2005 and $16 billion in 2004. This was outstanding work and has significantly reduced our credit risk. Cash flows continued to improve driven by improved underwriting results, processing, billing and collections and investment income.

A.M. Best and Standard & Poor's upgraded CNA to stable from negative during the year making a consistent outlook for CNA for all four rating agencies. We maintained our A writing with A.M. Best and A minus or equivalent with the other three rating agencies.

Overall, I am quite pleased with our 2006 results. CNA performed strongly across the board as the initiatives of recent years emerged in full.

Operating results were positive, the balance sheet was further improved, expense ratios were better, all key initiatives were delivered on time, on budget, the weather was kind, investments were strong, our organization is aligned and survey results show good positioning with our distributors.

Many challenges remain, not the least of which is the deteriorating marketplace, but I am confident that we have the underwriting discipline and skills to continue our progress.

In summary, I feel good about what we have accomplished, and I feel even better about the fact that we can continue to deliver appropriate value to our shareholders in the future.

Craig?

Thanks, Steve, and good morning, everyone.

I'm please to do share our fourth quarter and year-end results which I would describe as solid and sustainable. The fourth quarter net operating income of $248 million we finished a good year on a very solid note.

Operating return on equity was a respectable 11% for the quarter, 12% for the year. Book value at year-end was up 4.6% from the start of the fourth quarter and up 15.3% for the year.

The performance of our core PNC operations was healthy with respect to the fundamentals of underwriting, production, cash flow, investment income, and expense management. We effectively closed the book a former major drag on earnings by commuting all but one remaining finite reinsurance treaty.

Finally, we go into 2007 well positioned to sustain this level of performance.

Now I'd like to give you a bit more detail on the financials before turning it over to Jim Lewis. Today we reported fourth quarter net operating income from continuing operations of $248 million, or $0.91 per share compared to a net operating loss of $172 million, or a $0.74 per share loss in the prior year period.

The current period EPS includes an $0.11 per share impact from the commutation. More on this shortly.

Net income for the quarter, which includes the impact of discontinued operations as well as realized investment gains and losses, was $329 million, or $1.22 per diluted share compared to a net loss of $217 million, or $0.92 of loss per share last year.

I'm pleased to be able to say that our fourth quarter results were not reduced by the impact of undeclared stock dividends related to the Series H preferred stock which we retired in August of '06. In the fourth quarter of '05 the impact of the Series H was $0.07 per share.

Significant commutations and catastrophes reduced fourth quarter operating income by $31 million and $12 million respectively. The comparable amounts in the prior year period were $223 million and $37 million. Pages 15 through 18 of the financial supplement summarize the impact of commutations and catastrophes for the quarter and the year.

Property and casualty operations produced fourth quarter net operating income of $275 million compared with a $30 million operating loss in the prior year period. The current period results were reduced by $43 million due to the commutations and catastrophes versus $225 million impact in the prior year period.

In addition to the favorable swing in commutations and catastrophe losses our core business benefited from strong investment income. Prior year development apart from the commutations was not significant in the current period.

With respect to life and group non-core, the fourth quarter net operating loss of $1 million is within our expected range and was driven by unusually favorable investment income and long-term care claims experience.

Period-over-period comparison was favorable for the same reasons. As mentioned in the past, results in this segment can vary.

With respect to the corporate segment, the fourth quarter net operating loss of $26 million was driven by adverse development of $41 million related to mass tort exposures. The period-over-period comparison is favorable due to increased net investment income in the current period and unfavorable development of $141 million in the prior year period.

Pretax net investment income in the fourth quarter was $690 million, up 26% from the prior year period. For the year investment income was approximately $2.4 billion, a 27% increase over 2005. The increase was driven by improved period-over-period yields and continued growth of our invested asset base resulting from improved cash flow.

Our invested assets grew by $500 million in the course of the quarter and $1.8 billion for the full-year. Other drivers of investment income were very strong results from limited partnerships and reduction in interest expense on funds withheld accounts primarily as a result of the reinsurance commutation.

Net realized investment gains were $108 million in the fourth quarter compared with a loss of $54 million in the prior year period. The favorable swing reflects a generally more favorable investment environment as well as a one-time $24 million after-tax payout related to a class action settlement.

On the topic of expense management, the PNC ops fourth quarter expense ratio of 31% came in higher than the past few quarters. This uptick was influenced by some expense seasonality as well as reinsurance reinstatement premiums and seeded reinsurance items that depressed earned premium.

The full-year expense ratio of 29.8% is more reflective of our current expense structure if not a bit on the high side. We are moving into the range of our peer companies and expect to continue to challenge our expense structure and further improve our expense competitiveness in 2007.

One other item of note is the commutation of a finite reinsurance treaty. While relatively small as compared to last year's commutation, it is a milestone. This transaction brings to a close several years of work to strengthen our balance sheet and reduce our dependence on reinsurance.

With this commutation and other balance sheet initiatives we have taken more than $6 billion in reinsurance recoverables off the balance sheet and effectively eliminated an interest rate drag that exceeded [$3] million pretax just three years ago.

With that, I will turn it over to Jim.

Thanks, Craig, and good morning, everyone.

I have been looking forward to this call and I couldn't always say that. But today, property and casualty operation is a leaner, nimbler, more profitable and more focused business than it was just a few years ago.

In 2006 we did well. Not that we're satisfied, but it's nice to be reporting on four quarters of combined ratios under 100, continued strong performance in specialty lines and further improvement in standard lines.

Yes, the wins were favorable, but as Steve said, the 2006 results were anything but accidental. We delivered on the fundamental strategies we have discussed with you before.

We monitor the quality of new and renewal business. We optimized our portfolio taking advantage of attractive growth opportunities across CNA, we leverage the full breadth of our products and services by cross-sell and we invest in our people and infrastructure to drive profitable growth now and in the future.

In 2006 it all came together. Not only was it a banner year, but PNC operations is well positioned for strong performance going forward.

Now let's review our key operating metrics starting with premium. Gross written premiums were up about 3% to $2.2 billion in the fourth quarter and up about 4% to $9.3 billion for the year.

Net written premiums increased at about the same rate. Were up 2% to $1.7 billion for the quarter and 3% to $7 billion for the year.

Standard lines gross written premiums were up 2% for the quarter and 4% for the year while specialty was up 4% for the quarter and 4% for the year. On a net basis standard was virtually flat for the quarter and the year while specialty was up 4% for the quarter and 5% for the year.

Overall our premium volume reflects a disciplined healthy appetite for profitable growth. Our diversified portfolio continues to provide a major growth advantage.

On the specialty side we did not have to [build] new product to distribution to go after good opportunities in private company D&O and healthcare liability. We could grow these businesses in '06 because all the pieces were in place.

It's the same story in standard lines. The property market became very attractive in '06, and we had the people, product and distribution in place growing the right way. Selective growth like this will only become more important in a softening market.

Now let's turn to rate and retention. For PNC operations as a whole, average rates were down by a little more than 1 point in the fourth quarter and virtually flat for the year. So in an environment of softening rates, we held our own.

In standard lines, average rates tracked with PNC operations as a whole, down about a point for the quarter, flat for the year. In specialty lines we were off about 2 points in the quarter and flat for the year.

In general we have enjoyed a relatively benign rate environment with rates trailing off modestly for the past two years. We took advantage of this window of opportunity to build and improve the capability to position us well in any rate environment.

For example, predictive modeling tools, infrastructure for growth segments like small business, strong distribution relationships, and a relentless approach to managing expenses. As for retention, property and casualty operations came in at 83% in the fourth quarter.

For the year standard lines ran in the low 80s while specialty ran in the mid-to high 80s. These figures are consistent with the normal level of turnover in a quality book of business. Overall our rate and retention metrics speak volumes.

We like our book of business. We monitor its quality continuously and our underwriters are retaining profitable accounts. Meanwhile, we continue to optimized our portfolio shifting more of our mix towards specialty and improving the economics of our standard book by [a] segmentation and targeted growth.

Now let's turn to new business in cross-sell. We wrote approximately $315 million of new business in the fourth quarter, $1.4 billion for the year. This represents approximately 18% of total production for the quarter and 19% for the year.

We eased up a bit on new business during the fourth quarter as rates trailed out. Exactly what we said we'd do under these circumstances.

Cross-sell continues to provide a nice lift for new business. The mindset of our frontline underwriters is defined as par and quote every good opportunity to sell additional CNA products to our customers.

New cross-sell premium amounted to $144 million in the fourth quarter, or approximately 46% of new business. For the year cross-sell premium amounted to $562 million, approximately 40% of new. That makes more than $1 billion of cross-sell business in the last two years.

I've talked about the advantages of cross-sell on previous calls. Rather than repeating myself, I will simply say there is more cross-sell opportunity embedded in our portfolio and a cross-sell is only one element of our control, selective new business strategy.

We continue to track new business quality by monitoring the spread between [inaudible] and case loss ratios for new business and renewal business. We also monitor the spread between new versus renewal pricing. Metrics like this helped us optimized our portfolio in the past few years, and they're equally important going forward.

Next loss ratio. Our fourth quarter 2006 net calendar year loss in LAE ratio of 68% was on the high-end of the mid-60s range we have been in all year. Included in this ratio are approximately 4 points from significant commutation and catastrophe.

The impact of these items is detailed in our press release and financial supplement. Standard lines came in on the high-end in the fourth quarter at 72% due to the aforementioned items. Specialty lines continue to impress with a 61.

On a full-year basis the PNC operations net calendar year loss ratio came in at approximately 67% including 2 points from a significant commutations and catastrophes. The standard lines ratio was 70% specialty, 61%.

The net accident year loss ratios were similar. Property and casualty operations was approximately 65%, standard lines was 68%, specialty lines was 60%. These ratios are all evaluated as of 12/31/06.

Finally, combined ratio. In the fourth quarter we continued our run of sub 100 quarters. The property and casualty operation combined ratio was 99% which includes approximately 4 points from significant commutations and catastrophes.

Standard lines came in as 105% while specialty delivered at 89%. For the year our combined ratio was approximately 96% including a 1 point impact from commutations and catastrophe.

Standard lines was 102% including more than 2 points from a commutation and CAT. Specialty came in at 87%.

Further improvement on the standard lines side is the key priority for 2007. We're shifting our standard portfolio towards small business, property, small end of middle market, and other attractive segments. As Craig mentioned, we will continue to squeeze out expenses.

The process and IT efficiencies are key drivers of our small and middle market strategy. On the claims side we're focused on further improvement in service and efficiency.

Before wrapping up I'd like to comment briefly on the outlook for 2007. It is competitive out there. Constant pressure on price and terms and condition is the new norm.

Be that as it may, the current market environment is neither unexpected nor unmanageable. Our frontline underwriters stay very close to our agents and stewards. They know when to fight for an account and when to walk away.

Relations with our agents have never been better. Predictive modeling is a powerful tool in managing our portfolio. Our risk control services improve retention for customers who care about reducing losses.

Cross-sell differentiates us. We have invested in staff, product development and infrastructure for our targeted growth areas. For all of this reasons we are well positioned to manage through the market cycle.

In summary, property and casualty operations had a very good year. We feel good about our performance, we think it is sustainable and we expect another solid year in 2007.

Operator, we're now available for our Q&A.

[OPERATOR INSTRUCTIONS] Our first question comes from Jay Cohen with Merrill Lynch.

I have a bunch of questions. If I go on too long, just tell me to shut up.

Just one quick numbers question, and that is within the standard segment, you look at two line items, other revenue, other expenses. The difference typically is right around zero.

This quarter was negative $23 million. And I'm wondering what is causing that? Is there anything unusual?

This is Craig, Jay.

We did, we actually took a charge in standard lines really in our claim services revenue. We took a charge for a deferred service liability, and we also reclassed some of the revenues expenses coming through the claims services we sell to third parties which had no impact on the net. The change in the net is the deferred service liability charge.

What exactly is that, a deferred service liability charge?

We're delivering claimed services to large risk management customers.

What is the charge related to?

Claim service.

I'm not quite sure what gave rise to a charge, though. Why are you taking a charge in that business?

It's future service liability related to obligations to deliver claim services to large risk management accounts.

I can always follow-up on that one.

The impairment that you talked about in the press release, I think it was $29 million. Is that an impact to continuing operations or is that in the discontinued business already?

The discontinued business, so no impact on the continuing operations.

Okay. Next question.

Prior year reserve development. You mentioned in the quarter that it was basically nothing, but I'm wondering if you can, I guess, two questions.

One, was there still some movement in the older years offset by favorable development in the more recent years within that number, and if there is, I'm not sure if you can quantify it or not, but give us a sense if it was material.

This is Mike Fusco, Jay.

We constantly review our reserves by product, by accident year, so there's always some movement between years. I think you'd be able to see in the supplement at 2005 as an accident year performed favorably and 2004 absorbed some of that charge. 2004 and prior absorbed some of that.

Okay. And then can you just give us the number for the full-year, prior year reserve development?

For standard it was favorable in the order of $50 million pretax. For specialty about $15 million unfavorable and corporate was the [inaudible] charge that Craig alluded to in the fourth quarter.

Okay.

And then I guess the last point is on capital. You obviously had a good year, improved equity, surplus is up, and I'm just looking at the mass, and I look at the premiums to surplus ratio of .86 to 1 as of year-end.

Your competitors, and I just looked the Chubb, Hartford, St. Paul Travelers are averaging about 1.13 premiums to surplus and I would assume that they feel they're over capitalized but they're all buying back stock pretty aggressively.

So you're better capitalized than they are. Your business mix isn't that much different. Your balance sheet's better. Why are you sitting on all this capital?

Jay, it's Craig again.

I think it's, I mean know this is a return of the question you asked last quarter, and really it's the same -- the answer's the same.

It's gotten even worse, though. You have even more capital now.

We agree that, well first of all, I think you would agree, too, that your measure is a very crude measure of capitalization.

Agreed.

And it does have something to do with relative to ongoing operations but not some of the capital needed for some of the run-off obligations as well.

Second, we agree that we're very well capitalized. And then as I said last quarter, as I think you paraphrased my response as saying if '07 repeats in terms of the levels of profitability and earnings, then we'd have much more capital management flexibility as we move forward in '07 as we had in '06.

I guess I'm not sure why you don't have it now. I mean I did look at when the S&P moved you to a stable outcome, I guess they were concerned about still prior year development, they felt it would still hurt your earnings, and I think in their release it's just that they thought your combined ratio for the year would be 103 to 105. It was nowhere near that.

I don't understand -- I guess the question is this. What is different about your business that you perceive, that you have to have, you know, demonstrably more capital than other companies when they're buying back stock and you are still gaining flexibility when it looks to me like you've got more capital than they do?

What's the difference? How come they're doing it and you're not do you think?

I think it goes to the point I had made about the consistent demonstration of capitals earning [inaudible] so to the extent we consistently generate the level of earnings we did this year, we would have more flexibility. I think that's the important -- the important point is the not the absolute level of capital, it's the ability to consistently generate new capital.

I guess I look at the last two years, and your earnings, except for the hurricanes, which everybody had that problem, have been pretty consistent.

I mean, again, maybe a follow-up question, the last one, and I'll get off the call. What you're telling us is you're constrained by rating agencies at this point. Is that a fair statement?

Jay, this is Steve.

I don't think that we're constrained by rating agency requirements but we're looking with great interest as to what the new capital models that they've come out with would require of us and so we look with great interest at that.

When's the next board meeting?

I beg your pardon? Do you know when the next board meeting is? Well we just had one last week and obviously our next one will be after the first quarter.

Okay. Well I guess overall nice to see a year where you guys made an underwriting profit. I went through my model, I couldn't find one in there. So nice milestone. Congratulations.

Thanks, Jay.

Question goes to Bob Glasspiegel with Langen McAlenney.

Good morning.

Could you quantify the charge on that other revenue/other expenses to Jay's question?

$22 million.

That's a pretax number?

Yes.

Okay. I didn't get on the expense ratio what juked it up this quarter.

I said some seasonality in spending, and we also had some impacts on the revenue line on reinstatement premiums, reinsurance it's related to a individual large property loss and some increase in the seeded premiums in specialty, really for prior years.

Okay.

The mass tort, the charge. What drove that?

Hi. This is Jon Kantor.

Nothing meaningful, no meaningful changes relating claims patterns, just a lot of adjustments in the context of our account by account review.

Okay.

Final question is -- and I share Jay's overall respect for the terrific progress you've made on a lot of fronts as a company, but even so, there's a [inaudible] in the standard combined ratio ex CATS and ex commutations a 99.4 is I would say bottom quartile relative to universe I look at.

What should we be thinking about where you think you are on a relative to the industry basis and standard lines and how long do you think it is before we could start seeing sort of industry numbers in that important segment?

This is Jim Lewis.

On the standard lines combined we said, you know, we're happy to be under 100, but obviously there are opportunities for improvement, and we clearly think there's opportunities to improve that overall combined ratio. As we go into the markets and the rates being softened at this point our emphasis is going to be are retaining our profitable business and selectively writing new business, and the focus is going to be on small and middle market business across the whole portfolio.

What I'm looking at standard lines are if I look at our specialty, what we see is that the small and middle part of the portfolio is much more profitable than whether I'm looking at large [incomes], large lawyers, large risk management casualty type business or even large middle market business in excess of $500,000. In this soft market we have much better data quality than we had in the 90's.

We've got metrics on every segment within our book of business. We've segmented our book of business. This allows us to react a lot quicker to the overall marketplace.

As I look at the improvement in our overall bottom line, in our specialty lines I've got to remind you that we've got a broad portfolio that's roughly 37% of our book. We've got combined ratios in the 80s.

A lot of those businesses are mature businesses, and our focus is going to be as we go forward on retention, and there's significant opportunities to cross-sell in that book of business. We had $562 million from cross-sell this year, $2 billion over the last two years, and there's even still more opportunities.

In our standard lines portfolio we've made a huge investment in small business. We do about $600 million in small business. The investments that we've made are now starting to pay off.

We [added] a new product with significant flexibility. We've got state of the art technology. As a matter of fact, we were recently awarded an award by Applied for leadership in innovation in our real-time quota capability which makes it much easier for the agent to do business with us.

We've invested in significantly much stronger people at the point-of-sale. We've got a very talented salesforce. And as a result in small business we grew 15% in the fourth quarter, 19% in December, and the potential for growth is now just really taken hold, and we see significant profitable growth in this segment and in '07.

On our property side of our business, property we took advantage of the overall property marketplace. We've got strong expertise from a claims underwriting and risk control standpoint.

We grew property 20% this past year. Property is one of our more profitable segments, so there's opportunities to continue to grow that segment.

In middle market where rates are moderating, and rates are down about 3% for the year in our middle market portfolio, we're using predictive modeling. We've got predictive modeling that is a tool for our underwriters to use in pricing their business so we get a lot more consistency for a similar type of risk across the overall country. We didn't have that in the 90's.

We've also got retention measures and pricing as we really look at the scores that come out of our predictive models to make sure that we're using the most competitive pricing on the better performing lower scored business, and the higher pricing on the higher scored business itself.

We've segmented our middle market book, and what we've seen is that the most profitable part of that book, whether I look at it from a geographical standpoint, whether I look at it overall within that book, it is a small segment of that book. It's the accounts that are under $150,000.

Four-year loss ratio on that business is under 50%, and that represents only about $260 million of our book where we estimate the whole industry is about $18 billion in that particular segment.

What we're going to be able to do we look to go after that segment is to utilize the product and the technology that we now have in small business. The product that we have there is flexible enough.

The technology that now allows the agent to upload and reduce double entry we're going to use that to go after the lower end of our middle market book, move our best middle market underwriters, the most talented onto that particular segment, and along with the predictive modeling we think this will allow us to right [business] very profitably while at the same time transform our middle market book where we can become a lot more efficient and a lot more effective in driving our overall costs down.

On the claims side of our business, now, we're taking a closer analysis of our claims expenses. We think there's opportunities in our ULEE and ALAE. We do have strong metrics in place to really help drive down those expenses.

As we continue to grow our small business, we do have an express center set up in Redding for low severity, high frequency claims, and that's going to allow to us drive down our overall costs, especially for the claims that are under $10,000.

And then the last piece is just continue our aggressive expense management. We've made very good headway over the last three years.

We focus on everything we do, and when we look at the expenses we focus on it based on what's the bottom line impact we're going to get from that particular change. So we think we're extremely well positioned in our standard and our specialty overall portfolio to compete in the soft market.

That's a thoughtful answer, and I can't disagree with anything you said as to what you're trying to do and what you've accomplished to date.

You're still left with sort of where you are, and, Jim, when do you think you can get the standard combined ratio to where the industry is? Are we a couple years away?

It depends on where the marketplace goes, and I think as we obviously do not drive pricing in the overall marketplace. We're just one of the competitors, and depending on, you know, at this point rates have not really fallen off the cliff, they've just slowly moderated.

If they continue to slowly moderate then, sure, in the next two to three years we could be there. If they do not and rates all of a sudden cliff, then I think it's a different ball game, different story for us and the whole industry.

Thank you very much.

We'll move on to Charlie Gates with Credit Suisse.

Hi. Good morning. Two questions.

My first question, maybe I'm misreading your news release, but the cost of this commutation, I understand was, and once again maybe I got this wrong, $31 million post tax. Is there any way you can opine as to what the benefit of that commutation is for company?

In terms of going forward basis?

Sure, or what on that program you lost, I guess, all other things being equal for the last two years, if you feel more comfortable with that.

I think that we talked before about projected finite interest expense in '07. What this does is effectively the series of commutations effectively eliminates that entirely.

Now we do, if you look in the supplement, and you look at the interest expense, really, if you look at Page 12 of the supplement that's got a breakdown of all the investment income, and you also gives you a breakdown of expenses on finite and other funds withheld, I think you'll find the answer there. And you'll see that we effectively eliminated the finite.

We still do have some customer deposits we hold and we face some interest on, which runs about $3 million or so a quarter right now, so going forward you could expect us to have that and you could compare the 25 to 40 or this year we had over close to $70 million of expense on similar items. I think that's the right context to think of it, Charlie.

My second question, in your prepared remarks I think one of you opined that basically your expense ratios were moving so that, and maybe I got this wrong, to be in line with your peer companies. When you made this comment, what that companies were you thinking of as your peers?

I was looking at Travelers, Hartford and Chubb.

Okay. That's great. Then my third and final question.

One of you opined, and maybe I got this wrong also, that pricing was off 2% in fourth quarter. What area of your book of business were you referring to? And seemingly 2% doesn't seem like much and so therefore basically if you could elaborate on how you see the underwriting cycle evolving, that would be wonderful.

As you looked at the price and we were actually only down 1% for all of PNC operations for the quarter, we were down 1% in standard lines, we were down 2% in standard lines, in specialty lines for the quarter and we were only down or flat overall for all of PNC.

Now within specialty lines I remind you this is the business that's producing combined ratios in the 80s. And so it's not unexpected that we would see a little more pricing pressure in that book, and it was primarily driven in our excess institution, our hospital business, in health pro, our health pro business is performing with combined ratios in the 70s, and it was also on some of our financial institution D&O.

But nothing unexpected as we looked at where our overall pricing and results were. We're very comfortable with the retention versus rate trade-off for this particular book of business.

I guess the only problem with what you said, sir, is the fact that with pricing off in your special lines 2% and with combined ratios in the, II think you said 75% area --

80s.

Okay. In the 80s. You wonder basically whether or not it's 1987. And with regard to 1987 basically perhaps you know '87 better than I do, pricing started to go the wrong way and it continued for a long time.

I was around in '87 and this is not like in the 80s because if you kind of look at our whole book of business, [our] PNC book, our rates have been flat over the last two years. We obviously got double-digit rate increase for three years, three solid years leading up to that, but all we've seen at this point is a graduate moderation in the book.

What you saw the last time around was all of a sudden rates were down 1, 2, then went down minus 5, minus 20, minus 30, minus 40, and continued. This environment rates are moderating very, very gradually, and it's an environment where we can compete, we function extremely well in.

So that's what I see still on the horizon is rates at this point gradually moderating as opposed to cliffing.

Thank you.

We'll move on to Bill Wilt with Morgan Stanley.

Good morning. I guess a related question for Jim.

I know you all track new and renewal pricing trends very closely. Could you comment on the current gap new versus renewal pricing I guess split by standard specialty and how that gap has trended over the last handful of quarters?

If you kind of look at we track discretionary mods, and these are scheduled modifications that are being used on this book, and when you look at new and renewal, what we see is a slippage at the same pace. So new and renewal both slipping at the 1to 2 point pace, and that really doesn't vary much between standard and specialty.

The other thing that we really look at is another critical means for us is looking to see what's really happening on the new business pricing versus our renewal, and so we track the new and renewal [paid] case loss ratio, evaluated at nine months, and there what we only see between new and renewal is still again a 2 point difference, loss ratio is 38% versus 28%.

We also track renewal efficiency just to make sure that the underwriters are making the right decisions and are staying on the better performing business and getting off the worst performing. And we track the incurred loss in ALAE rated loss ratio developed at 15 months, and the business that we got off of in the most recent quarter was an 88% loss ratio. Business we kept was 40%.

That's helpful.

The numbers you mentioned I guess just prior to this last set I picked up 38% and 28%. Is that the difference between the case loss ratio and the paid loss ratio?

Paid and case loss ratio for new and renewal with new being at 30, renewal being at 28.

30%.

And evaluated at nine months.

Helpful. Thanks.

I guess the question for Jim or Steve, really, but, Jim, a lot of the answer to my question I guess is interwoven into one of your previous answers.

Just under the assumption that the market continues kind of sort of as it is now, where it just gradually grinds down and we're looking at, say, a couple of years of this process, top managerial objectives over the next, say year, eighteen months, two years, I jotted down cross-selling, expense initiatives, small business, but I wanted to throw out the question and see if you could just summarize your top objectives under that assumption for the market over the next couple of years.

This is Steve.

I would say that the top four or five objectives that I would pick for CNA over the next couple of years number one would be moving our ROEs up into the quartiles would be in line with our competitors, maintaining the sub 100 combined ratios, you know, for the next four to eight quarters. I would see 2 to 3 points of opportunity within the standard book in the areas of both a combining a loss, manage expense and then ULEE, I think, there's 2 to 3 points there which gets that thing down.

I'd like to see our specialty business move to more than the level, you know, percentage of the portfolio than it is right now, and we're placing a high degree of dependency on some of the key markets so our key targeted market areas that we're rolling out to drive that.

A couple of things that I'd like to emphasize that Jim said, is that historically CNA has taken the approach of choosing rate over retention and retention over new business. We talked during our initial reunderwriting story about the renewal efficiency report that we track.

You hadn't heard too much about that over the past couple years as the portfolio stabilized, and you're going to hear more and more about that from Jim and Mike Fusco as we go forward because that will be our navigating tool through the soft market.

I would want to remind you that we gave you an indication several years ago as to what new business levels would be, and we said in the height of a very firm and favorable market for those of us on the supply side that we would be in the 24 to 5 range if the market stabilized we'd drop into the low 20s, and then as the market got soft we'd be in the high teens which is exactly where we are right now.

And then the emphasis that we've, you know, on cross-selling new business so that 19% is heavily comprised or composed of cross-sold new business we think is also a major advantage to us. And I guess I'd also want to say that I think we're one of the few if not the only company that has ever pulled off a cross-selling strategy, and it's great credit to Jim and his team, but to see that much of our new business being sold to existing customers, which intuitively has to have less volatility, we think is a major advantage to us. So those are the things that I would be focusing on going forward.

That's extraordinarily helpful.

The only point of clarification I wanted to ask if you could revisit the, your comments on expense ratio or are you [commenting] on 2 to 3 points of opportunity. And then I perhaps folded together expense and claims. If you could just revisit that, that'd be helpful.

Let's take absent [ULA], which is the claims expense that's kind of held off to the side there, and we're going through a major reevaluation of our entire claims structure and strategy.

But we believe in the standard lines business alone that there is at least 2 to 3 points of loss and expense. And if you want to say, could you break that out, I could say I'm looking for, I'm hunting right now for probably anywhere from a half a point to a point on the expense side, and I would leave you maybe 2 on the loss side, 1.5 to 2 on the loss side.

So that's what I am hunting on the standard side, and we believe we can do that with a combination of the initiatives that Jim talked about, our small business strategy. We've got the customer express strategy going in our middle market business, and some other areas that we're growing out.

So I think that's very doable over a couple of year period of time, and I think building on our already robust specialty operations I think we can shift the mix on that to higher than what it is right now.

Very helpful. Thanks a lot.

We'll move on to Tom Cholnoky with Goldman Sachs.

I have a couple of questions.

Jim, I'm just curious. We've heard from Hartford, Chubb, St. Paul Travelers, all complaining, I guess, about pricing in the large market area and how everybody's shifting into the small and middle markets. If the four largest writers, or four of the largest writers in the industry are not writing the large national account business, who the heck is writing it?

We didn't say we're not writing it. What we're saying is we're shifting our book into more of the small and middle.

We see the large account business as being the more opportunistic, and so obviously if we can get rate turns and conditions, then we're in the market for also doing large accounts, and that's across the total portfolio where there's large property, large casualty, large D&O, large E&O.

There clearly are some competitors that I've given names that are much more focused on the large account business itself that are pretty aggressive in that arena, and when we come across the [inaudible] situations where we look at it and we can't get rate turns or we just look and say we can't make money, then we will back away from those particular accounts which is why our focus right now is retaining our good profitable business that we already know and understand, and also to selectively write new business.

Okay.

But it does seems to me that everybody else is moving into that sector of the market, too, so my guess is that we'll slowly become more and more competitive.

Well even, well let's say people are moving into that market today, and let's take small business where we have a $600 million book overall, and we were not known three years ago as a small business key player, but with the investments that we've made and you hear everyone talking about really wanting to grow small business whether it's a national carrier or a regional carrier.

And even with that being the case, our reach in small business are flat. We grew 15% in the quarter and 19% in December with more opportunities even with the competitive marketplace.

Craig, can you talk a little bit about the limited partnership portfolio? If I calculated the return it looks like about a 20% return for the year. Is that kind of what your expectations are or how do you expect that portfolio to deliver returns in a normal year?

I don't know that we said, I would not expect 20% returns every year. But you're right to calculate that's about what we got this year.

What is more normalized? What would you think is a more normalized return?

We don't really set that. I would say probably somewhere like half of that.

Okay.

And then, Steve, I guess I'm a little bit -- I want to just pursue your ROE goals. I don't know if in the past you've discussed at all what you think is a reasonable ROE over a cycle or how you look at that. Do you have any thoughts on that point?

Well, in earlier calls, and let's say earlier calls being anywhere from, say, one to two years ago, we really didn't emphasize or discuss much about ROE because the numbers were relatively modest and it didn't make a whole lot of sense to talk about it and have that compare to what was going on in the industry.

And in the last two years, or '05 and now into this year, you know, we've actually on a normalized or however you want to look at it basis, we've made a lot of progress on that and to show at 12%, you know, ROE for the year, we're now within range of what we feel would be our competitors, and I would like to see us be in a sustainable mid double-digit ROE for this company over time. I think that's a fair level, I think it's doable and I think it's sustainable.

And I think we've got a, now having, you know, we've gotten rid of a lot of the baggage and legacy issues, and I think the results of all the hard work and all the initiatives that we put in place over the last several years are showing through, so we believe that the business has got earnings power.

We believe it will generate solid ROEs, we believe it will generate ROEs that will compare favorably with competitors which I think is what you folks are looking for. That's the best I can tell you and the proof will be in what we do.

Okay.

I'm just -- I guess what I'm struggling with is that, you know, '06 will probably prove to be the best year for the industry in terms of returns, and if you simply look at consensus numbers for '07, most numbers are for down earnings in '07 versus '06, and, you know, you could -- I just kind of find it difficult to see how given going back to Jay's question the amount of capital that you're generating that you can actually improve ROEs from these levels without significant capital management. It would defy what is going on in the rest of the industry.

I think that's a fair point, and I think that's something that we're going to have to look at going forward.

Okay. All right. Great. Thank you.

Your next question comes from Gary Ransom with Fox-Pitt Kelton.

Good morning. I had a question on the asbestos and run-off reserves.

We've heard from the outside a lot of things from various courts, Corpus Christi, Ohio, judges putting more scrutiny on the plaintiffs bar. Has any of that activity at all shown up in what you've seen inside with either new claim reports or any other measures that you might use?

This is Jon.

Definitely. We have a distinct decrease in our frequency, 48% decrease year-over-year in new claimants which confirms what you just said, the mass screenings have been shut down, and the last three years our survival ratio's been pretty constant, in the 11 to 12 range, and our percentage of the IB&R to reserves has been pretty constant. So we're looking at a fairly, I'd say a stabilizing to stable run-off book here of asbestos claims.

Okay. That's helpful. Another question on a different subject.

You've mentioned predictive modeling on the commercial lines side. Can you talk about that a little bit as to what data you're using inside information, external information, with the real question being how much of this is different from what other competitors might be talking about when they're talking about predictive modeling for commercial lines?

I'm not sure how they've done it, designed their system, but ours actually includes internal and external data. Obviously have a lot of information on our total book of business loaded into the model.

We have invest data, [DMB] financial-type data built into the model versus other external information, and we feel now after taking our whole book of business, getting it loaded into the model itself that the model is very credible, and so we're using this as a tool to really help price our middle market business.

We already had this type of model in our small business arena. We've had it there for numerous years. The most recent add has really have been over the last couple of years to incorporate that into middle market.

And do you have actual examples of how that has proven to allow growth because you've focused your pricing in a more efficient way and therefore you get growth with the profits? Is that, I mean do you have, I'm trying to think about where it is that this is working best.

Too early to tell in regards to the growth side, but clearly, that's one of our expectations that it will help us in really pinpointing the type of business that has the best overall return for us across the country we'll get the consistency on how our underwriters are pricing that new business. But equally where we've [inaudible] seen is it's helped us more in our retention and making sure that we're pricing our business on the retained business.

If it's the better performing business, then we're willing to give up a little more rate for that particular business. If it's not, then we obviously need to get more rate or we're willing to walk away from it. It's helped more on the retention side, but clearly, we've got a position now as we're into the soft market to help on our new business.

Just one last question on the market.

If rates do go off a cliff, as you said was possible, it would be fair to assume that your top line would shrink meaningfully at that point. Is that correct?

Our philosophy is to really grow the bottom line versus the top line, grow the top line where we can do it and still make money. If the market were to cliff, then [inaudible] we would take a look at our total portfolio and I think the fact of having a $9 billion portfolio that's very diverse and knowing that within that portfolio we've got numerous businesses that are producing ROEs in excess of 15%, we would focus on those particular businesses.

We'd focus our resources on it. We'd focus the growth on those particular businesses, and there'd be others where we would actually shrink or withdraw from the market until the market changed.

Thank you for the calls -- for the questions and answers today. That will conclude our call.

I did want to thank you all for joining us and once again call your attention to the disclosures concerning forward-looking statements and non-GAAP measures in the earnings release. If you have further questions, feel free to contact any of us that are listed on the press release or Investor Relations.

I also want to note that the taped relay of today's call will be available for one week immediately following this call until February 19th. You can access the replay by dialing 888-203-1112 utilizing passcode 3604225. The call will also be archived later in the day for replay on the Investor Relations section of CNA's Web site.

Thank you again for joining us and we appreciate your participation in today's call.