Hartford Insurance Group Inc (HIG) 2003 Q2 法說會逐字稿

Good morning, ladies and gentlemen and welcome to The Hartford's quarterly earnings conference call. At this time all participants are in a listen-only mode. Later we will conduct a question and answer session and instructions will follow at that time. If anyone should require assistance during the call, please press star followed by the zero on your touch-tone phone.

At this time, ladies and gentlemen, today's conference call is being recorded by Inter Call. This program is propriety to a copyright of The Hartford Financial Services Group Incorporated. No recording or rebroadcast of this call is authorized unless expressly permitted in writing by The Hartford. No other rights to this program are granted to any person or entity without a written agreement with The Hartford. Please drop off the line if you do not agree to those terms.

I would now like to introduce your host for today's conference, Hans Miller, The Hartford's Director of Investor Relations. Please go ahead, sir.

Good morning, thank you for joining us today.

Please note that our 10-Q has been filed and our financial supplement is available on our web site at www.thehartford.com. For today's call, we will be referring to a slide presentation which you will also find on our web site.

Participating in this call will be Ramani Ayer, the Chairman and CEO, David Johnson, CFO, Dave Zwiener, Chief Operating Officer of our PNC company, Tom Marra, Chief Operating Officer of the Life Company and Neal Wolin, General Counsel of The Hartford. After the presentation, we will go right into the question and answer session.

We will make certain statements during this call that should be considered forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. These include statements about our future results of operations. We caution investors that these forward-looking statements are not guarantees of future performance and actual results may differ materially.

Investors should consider the important risks and uncertainties that may cause actual results to differ, including those discussed in our publicly available documents filed with the SEC, including the company's second quarter 10-Q. We assume no obligation to update the forward-looking statements made during this call.

The discussion during this call of The Hartford Financial performance includes financial measures that are not derived from generally accepted accounting principles. Information regarding these non-GAAP financial measures is available for review in the Investor Relations section of The Hartford's web site at www.thehartford.com.

Now moving to our presentation, I would like to turn it over to Ramani Ayer.

Thank you, Hans. Good morning, and thank you all for joining us today.

I will briefly cover the operating highlights of our quarter of which there were many, and then talk about several issues affecting the industries we compete in. I will then turn the call over to our CFO, David Johnson, for some financial comments on the quarter, and our improved outlook for 2003.

Please turn to slide four.

Overall, The Hartford produced year over year double digit growth in top line, bottom line, and assets under management. Diluted operating earnings per share are up 9% from the second quarter of last year.

In the quarter, we successfully completed the primary steps of our capital plan announced to you in May. And although it was a very difficult task for us, we reached our targeted staffing levels by the end of June. As a result, we are on track to reach our ultimate goal of $165 million in annual run rate savings.

We're committed to drive our expense ratios to top tier levels. We have held our AA ratings. We're making solid progress in executing our capital plan, and building a capital cushion by year end 2004. I look forward to updating you on our progress in subsequent quarters.

Now I want to cover the highlights of Hartford Life and the Property and Casualty company so please turn to Slide Five.

Hartford Life successfully executed its strategic plan once again in the quarter. The Individual Annuity segment posted record variable annuity sales of $4.2 billion in the quarter which is up 82% over the second quarter of '02 and 22% over the first quarter of '03. We anticipate at this time to have achieved a market share of over 13.2% in the quarter.

Recall if you will, that first quarter market share was 11.2% and so we have a pickup of 1.4 points of market share in this quarter. I'm proud of Hartford's wholesaling efforts and our product innovation.

Introducing Principal First one year ago and a new suite of annuity products this June. Our new death benefits lower the cost to the consumer and reduce risk to our shareholders.

Page six shows that as impressive as the sales figures were, variable annuity net flows in this segment were an equally impressive $2.5 billion as surrenders declined once again. The lapse rate is at the lowest level since the first quarter of '02, and the dollar amount of surrenders reached its lowest level since the fourth quarter of 1999.

Let me also comment that the margins have been excellent on the annuity business that we have sold.

A little over a year ago, we saw a potential market opportunity to protect the principal of our annuity customers so we devised Principal First, It provides a limited principal guarantee in exchange for limits on policy holder behavior. The withdrawals are capped at 7% a year. We launched the product a year ago with risk management in place through reinsurance.

As you are aware, the take rate of our Principal First has exceeded our expectations. With the Principal First sales during the third quarter, our reinsurance capacity ran out during July.

For several months now, we have been looking at ways to continue meeting demand while managing future potential risk. We have three tools in this risk management process.

First, we are working with re-insurers to explore new sources of capacity. Second, we will have hedging capabilities in place by the end of the third quarter. And finally, we have the option of product design flexibility as a risk management tool.

We intend to use all of these options to make sure we can maintain our momentum and control the risk profile of our company. By the end of this quarter, we will have finalized this strategy and will share our plan with you in our next quarterly call.

You know that our investment products division also sells mutual funds, 401(k), and institutional products. They all had a great quarter.

Please turn to slide seven.

Total IPD sales and deposits were $7.4 billion, up 35% sequentially, and 37% over the second quarter of '02. This is a new record for us.

In mutual funds, we are seeing a recovery as we generated sales of $1 billion in the quarter which represents a sequential growth of 36%. We have got good momentum now and are optimistic it will continue.

We also showed strong sequential sales growth of 32% in governmental retirement programs, and 52% in 401(k) plans.

Institutional product sales rose from $300 million to over $1 billion. And we're happy with the margins on the business we wrote.

I really believe the diversity and breadth of our product offerings makes The Hartford a real force in the world of asset accumulation and savings products.

In the quarter, total investment products divisions net flows hit $4 billion. Our assets under management and investment products were $125 billion, a record, bringing The Hartford's assets under management to $227 billion at June 30.

I have three other important comments about the Life Company. First, Group Benefits achieved a noteworthy 17% earnings growth. I'm optimistic about top line growth in coming quarters.

Second, individual life earnings are solid. Mortality trends are good so far this year, and we have an early positive view of the market's acceptance of our universal life products.

Finally Hartford Life Japan sales continue to be strong. Assets under management crossed the $3 billion threshold level in the second quarter, and we have just added a new distributor, Noveta Securities, which is the largest securities dealer in Japan with about 6500 financial advisors.

We will be breakeven or better on a U.S. GAAP basis in Japan in the second half of '03.

Let me turn to the Property and Casualty business on slide eight.

It is important to remind investors that last quarter we exited the assumed reinsurance business. A year ago, reinsurance represented about 9% of our Property and Casualty earned premiums. This quarter, earned premiums in the reinsurance segment were 3% of the total, reflecting our exit from this business and with a session of unearned premiums to Endurance Specialty.

Earned premiums in our ongoing segments, business insurance, Personal Lines, and Specialty, grew 14% due to a strong pricing and organic exposure growth environment for us. We are steadily increasing our regional presence and successfully executing our enterprise strategy of becoming a principal market for The Hartford stop independent agents.

As one of five AA rated national players in the property and casualty marketplace, we will continue to see the benefits of the flight to quality.

Slide 9 shows the impact on the company's net written premiums. In Personal Lines where the growth rate is accelerating, we're approaching rate adequacy and our product changes are taking hold.

Our new product has a broader underwriting scope, and it enables us to adapt pricing and underwriting changes quickly. Retention rates are strong. Loss cost trends are favorable and are still negative in Personal Lines.

On Slide 10, we outlined the combined ratios of the Property and Casualty company.

Overall, in the North American Property and Casualty company, a 99.7% combined ratio included 4.7 points of catastrophe loss impact embedded in our results. I do consider this to be higher than normal, but our XCAT combined ratio of 95% has been running very well.

One adjustment we did make in the quarter was reserve development of $59 million in prior years, in the assumed reinsurance business. This represents 2.8 points of combined ratio for Property and Casualty and pushed the reinsurance combined ratio to very high levels.

While we are not writing new business, The Hartford does retain prior liabilities and run-off exposure. Although this result is disappointing, we don't currently expect further leakage from prior years in the remainder of '03.

Business Insurance achieved a combined ratio of 94.4 including caps. This is the lowest combined the unit has had since The Hartford has been a public company. Loss costs are rising at low-single digit levels. In this positive environment, Business Insurance wrote $262 million of new business in the quarter while improving the geographic balance of our book.

On slide 11, we can discuss the current industry environment.

As I look forward to the next one to two years in the property and casualty industry, I am comfortable stating that the market should be a good one. I would say that we are seeing some increase in competitive activity today among the more disciplined companies in the industry.

At the same time, the favorable factors that we have highlighted in previous calls are still in place. Pricing and loss cost spreads remain positive, reinsurance markets remain disciplined. So there is still a lot of distress in many balance sheets of property and casualty companies around the country.

Looking to the asset accumulation business, demographic trends continue to validate consumer preoccupation with retirement needs. They want to maintain their high standard of living throughout their retirement years. Our focus is to serve these needs with our range of products from 401(k) to mutual funds, to annuities.

Although in the last few weeks, interest rates have begun to improve from 50-year lows, many indicators suggest that rates may remain relatively low for now. Across all our products, we will maintain our pricing disciplines to account for these low rates.

The credit cycle is improving. The substantial capital strain over the past few quarters caused by investment losses is behind us and the overall credit quality of our invested assets is excellent. Our portfolio has been fine-tuned and should provide more consistent returns for the foreseeable future.

So now, I am going to turn it over to David Johnson for some comments on our financials.

Thank you Ramani. I will turn first to slide 13.

Of any measure, we had a good quarter, [INAUDIBLE] delighted to produce operating ROE at 14.5%. Slide 14, shows how our [INAUDIBLE] story continues to improve. Impairments for the quarter held to 4 basis points [INAUDIBLE] pretax.

It is noteworthy that if I exclude the $100 million of targeted net gains that we took in the second quarter as part of the capital plan that we outlined for you in May, we still achieved a net quarterly capital gain. Barring a dramatic change in the credit market we think we have stabilized the capital [INAUDIBLE]. While we still see capital losses in the future, the worst appears to be behind us.

Slide 15 provides some useful detail on our [INAUDIBLE] results which are difficult to read this quarter because of adverse developments and the Endurance transaction. As we reported the underwriting loss for the [INAUDIBLE] was $76 million excluding the strengthening and the impact [INAUDIBLE].

[INAUDIBLE] curtailment of new business activity our underwriting loss would have been about $10 million. That $10 million per quarter underwriting loss is probably a [INAUDIBLE] for what you should expect in the third and fourth quarters [INAUDIBLE].

As we have emphasized before, the value of the Endurance deal was the accelerating of the capital [INAUDIBLE] not PNL --. We'll pause for one moment to see if we can improve our audio quality.

Is it not coming through?

Not well.

Sorry, David. Go ahead.

As we have described before, endurance is about capital release not P&L but there were some P&L positives in the quarter. A positive $15 million for our guaranteed renewal rights commission ran through the PNC other expense line this quarter. That will not be a recurring item.

We will also amortize another portion of our consideration through underwriting income for the next few quarters but it will not be material. Net-net, Endurance is an $8 million non-recurring positive to the total PNC bottom line in the second quarter but the geography surfaces in different places.

I'll conclude with a few comments on our outlook.

We have chosen to express the outlook excluding two items. The effective net realized capital gains and losses and our asbestos charge. Note that two additional items, the $27 million second quarter severance charge, and the $30 million pre-2003 tax benefit that we recorded in the quarter could also be properly excluded. However these two items effectively net to zero.

Slide 16 reconciles our outlook to operating income with the asbestos charge. I'd also like to highlight the -- there's been some -- I would like to highlight how the guidance relates back to the asbestos charge on a full-year basis. There has been some confusion on that item.

As our first quarter weighted average shares denominator is quite different from our full year weighted average shares. So adding back the first quarter asbestos charge per share doesn't get you to the right full year add back. Hopefully slides 16 and 17 will clarify this for our investors.

Our operating guidance for the remainder of the year is not bullish or bearish. It assumes a flat equity market with the S&P 500 or approximately 1,000.

We assume cash at budget at approximately 3 to 3.5 points for the remainder of the year and it does not assume any material adverse loss development. Hopefully we will not deviate below any of these assumptions though the equity market is obviously a complete wild card.

Well, thank you, David. I hope this presentation has been helpful for you. We at the Hartford feel this is a time of great opportunity for us and that we're well positioned to continue building the businesses and strengthening the company. So we, we're ready now for your questions and I'm going to turn it over to the operator.

Okay. At this time, I would like to remind everyone in order to ask a question, please press star, then the number one on your telephone key pad. We will pause for just a moment to compile the Q&A roster. Your first question comes from Nigel Dally with Morgan Stanley.

Great, thank you. First, the competition, there is half a dozen companies we have deemed DMWB products, if you could comment on what impact you expect these new competitors will have on your sales going forward. And second with GMWB re-insurance I am interested in how the cost of [INAUDIBLE] hedging your GMWB compares to your prior costs of purchasing re-insurance. Thanks.

You want to take that?

Hi, Nigel. Let me start with the GMWB. Clearly, the position we're in, we look at as -- and have been working on this for some time. Obviously we look at risk management in this area. We have, with a three pronged approach. The first is re-insurance. And we're still actively in discussion to see if there is capacity.

Second, our hedging, which will be in place in the third quarter. And finally, product design is available to us. As we sit here now, our models we have run indicate that the 35 basis points is in the range. And yes, we are using the rest of this quarter to continue to refine those models, and as Ramani mentioned in his comments, by the end of this quarter we will have our plan in place, again, looking at those three prongs as to how we manage this risk, so right now, we feel comfortable at the 35 but we continue to refine that every day.

In terms of competition, I understand that several of the new entrants to GMWB are making some nice inroads. You know, as you know, our sales continue to be strong. So I am pleased with the position we have. We're certain taking advantage of the flight to quality. To that end interestingly I just saw, the Bards came out last night and the top 25 annuity writers are now 95% of the overall market and the top five are 46% of the overall market.

And that may be as high as it has ever been. So clearly there is a flight to quality going on out there. But my expectation is some of these competitors will continue to pick up share again taking advantage to the flight to quality.

That's great. Thanks.

Your next question comes from Alain Karaoglan of Deutsche Bank.

Good morning, Alain.

Good morning. I have a couple of questions, then Vanessa has a couple of questions. My two questions, the first one is with respect to the expense savings that we're going to achieve, how much of that have we already achieved? How much do we think we will get in the second half of '03? And how much will be left to -- in 2004? And then the second question is Ramani, you mentioned that the combined ratio in the Business Insurance for example was the best it was since you've been a publicly traded company. How do you keep your underwriters in check to make sure that given this low interest rate environment, it is a great combined ratio but it is not as great as it may seem from a return on equity point of view. So how do you make sure that the loss ratio ought to be lower?

Alan, Ramani. I am going to have David answer the first question. Just on the combined ratio, it is very simple, response to you, as we have often shared with investors, we allocate capital to our product lines, and we always reflect new money yields. So while we are proud of this combined ratio, we continue to feel that pricing loss cost spread is positive and combined ratio targets are established by product line by state so that governs how our underwriters behave at any point in time in the underwriting cycle. But let me have David pick it up, and comment on expenses, over to you David.

Alain, good morning. First, just to be clear, as you know, we took the $27 million of severance costs in the second quarter and that related to the termination that we highlighted to you in the second quarter. We eliminated roughly 1500 jobs corporately. And all the terminations have been notified, many of which have already occurred.

To be clear, none of the savings associated with that are in the second quarter. We are going to begin to see the benefits of that in the second half and into next year. I would estimate the savings that we are going to see on a pretax basis in dollar terms in the second half are somewhere in the 50 to $75 million range and it should be over 100m in '04.

We also, during the course of the road show, during the capital raise in the second quarter, indicated that we're setting some aggressive expense targets, both in Personal Lines and Business Insurance, so there are other actions that we're contemplating that will be coming later next year, which would drive us closer to the targets we'd established, the expense ratios in those two important business.

And on the Personal Lines from a combined ratio point of view, Dave, when do you think you will be reaching be your targets? From a combined ratio not an expense ratio.

The combined ratio in Personal Lines?

Yes.

I got to tell you I am pretty pleased with a 90.8 in the second quarter before tax. You know, I think that right now, we're running at, you know, target combines in our businesses, so I think the variable there is the weather.

I would say in terms of the rate adequacy, really two ways to think about that in Personal Lines, one in total, auto and home, and then state by state. In total, we are above or at rate adequacy on auto in total. And on state by state basis, all but just a couple of states which will be at adequacy by the end of the year.

On the homeowners in total we are very close to adequacy and will be by the end of the year. And in most if not all of our states as well. So I think that given what we've seen in the loss cost and pricing trends, the margin should be at or better than what you saw in the second quarter for the balance of the year and that should keep us at or above our targeted combines and returns in that business.

Thank you. Vanessa?

Vanessa?

Your next question comes from Jason Zucker of Fox-Pitt Kelton.

Good morning. Thank you. Tom, I was hoping you could go back and perhaps if you could just better describe some of the hedging strategies that you are exploring, and similarly, maybe some of the product changes you are exploring, and I was also wondering that just in the meantime, it wasn't prudent to even try to slow down sales until some of these risk management measures were in place.

Yeah, Jason, we have modeling going on all over the place. Let me start with the fact that we are very comfortable with what we will write between now and when our plan is in place by the end of the quarter. In terms of the hedging strategy, it is very similar to what others are doing.

Clearly using options and futures to offset the changes in liability so that effectively, you use the tool to get assets and liabilities moving in place. We haven't been as specific on product changes, obviously, we've got this three-pronged approach, and we're running them all. We are comfortable in the meantime. And we will have a definitive plan for you in the next 60-90 days. All I can say at this point.

That's fine. I understand. And perhaps if you can just give us an idea of how sales looked in July, if they continued at this rate? And then I was also just wondering, you know, were there any specials in the quarter that did help drive sales?

Well, really, the commission specials are almost a thing of the past these days. Since most firms are levelizing commissions so there is nothing special, just strong execution. Clearly, flight to quality. And I just think it is our time right now. And things did continue into July quite well.

Great. Thank you.

Your next question comes from Liz Werner of Sandler O'Neill.

Good morning. I had a couple of questions. First, with respect to the re-insurance market and your appetite to use re-insurance, I was wondering if you could give some specifics as to how you're looking at that market, and how, if you are using that market, the re-insurance markets differently what impact does it have, if any, on your capital, and is it possible at all to quantify the progress made in towards your goal in building capital in just this quarter? I recognize that it is a process that will occur over many quarters but I just wonder if you could quantify that?

And then, I don't want to dwell too much on this hedging of your benefits on your variable annuities but last night, in talking with you guys, it sounded as though when you come to a decision as to what you do want to do, if you want to be more conservative then the 35 basis points you already charge, you can do so on a retroactive basis and I just want to make sure that's correct.

Let me first have Liz, this is Ramani, let me first have Dave Johnson comment on how we are progressing on our capital track. And then I will have Tom address the reinsurance marketing question. And so over to you, David.

Right. I would say that we are at least on track and probably a little bit ahead of our capital cushion development plan that we outlined in May and that we described in some of the slides that we posted on our website. As we've said all along, capital is in the eyes of the beholding rating agency so it is hard to affix a particular point. But I think we had two positive developments versus our expectations in the quarter.

I think vis-à-vis credit losses we're probably looking for less drag from credit than was in our capital plans that we formulated in May. That is a positive.

And I would say that the movement in the equity market is generated positive surplus at variance to our assumptions in the Life company and particularly you saw that in our 10-Q where we had about $500 million increase in statutory surplus in the Life company at the end of the second quarter. So I would say that vis-à-vis the projections that are in the plan, we are probably maybe 100 to 200 ahead of schedule. But we're -- you know, we are still recalcing all the statutory results so I don't have an exact number but we are certainly on plan and probably a little ahead.

Okay, Liz, it's Tom. And on the re-insurance market, it is still out there. I think a lot of you know that our new death benefit structure on our new product that we introduced in June, it is a smart death benefit and as such we have been able to get some re-insurance. We have about 45% of current death benefits that we are selling re-insured so what we're doing with all of these benefits is trying to work with re-insurers, educate them and see if we can find the capacity.

To your question of capital efficiency, yes, re-insurance is desirable because in part it is capital efficient. And I guess finally on the point of the retroactive, actually, the -- if there was a price change it would only apply to business sold after that price change. But I would not get concerned about that. What we're writing in this interim should be no cause for concern.

Okay. Great. And any changes to the use of re-insurance on the Property Casualty side of the business?

You know, as we have communicated for the longest time on this, our Property Casualty re-insurance is from a security standpoint as well as the life and benefits re-insurance from a securities standpoint, we're very disciplined. Short of that we have not had any major changes David, in the Property Casualty re-insurance structure?

No.

No.

Okay. Great. Thank you very much.

Your next question comes from the Michelle Giordano of JP Morgan.

Good morning. On this theme of potentially increasing competition on your withdraw benefit and variable annuities, would I -- it looks to me that it is pretty clear that the competition is going to pick up pretty heavily and you've ruled out some death benefit, interesting death benefit features in June on some of your new products. Does that have enough appeal to potentially combat any competition you have on the withdrawal benefit? And what has the distributor reaction been to these, you know, newer death benefit features you're offering?

Then secondly on universal life, when do you think we might see material momentum in universal life sales? And what has been the reaction from your life insurance producers that were typically offering estate planning products to selling universal life?

Thank you, Michelle. I am going to have Tom take all of these. Tom?

Thank you. First of all, the new product we've introduced has been very well received, we're quite pleased with it. And remember, that reduces our risk so that was one of the driving forces. But we were also able to lower the price of the product a little bit. So I think that combination plays very well in the market and sales continue to be strong and I applaud the team, our team for an excellent transition.

Having said that, I think competition is responding and they want some of our share. So I think to repeat a VA quarter of $4.2 billion is going to be extremely difficult but I still think we will have a good second half of the year. So competition is there, they're good and obviously, they're responding as they should.

In terms of UL, we are getting there. I think the second half of the year, we will see some gains in sales and a lot of that is going to be attributable to UL. We haven't given up on variable life we still think that's a great product it's just a little out of favor in the market.

And our distribution sources are coming around. It has been a little slower than we would have liked. We probably came to the market a little later than we would have liked but I really do think things are on track now.

Just as a follow-up on the employee benefits side can we have some commentary on the competitive environment and what your outlook is for the top line growth for the second half of the year going into the renewal season?

Second half of the year should be much better in terms of where we look. Some of that might be based on the comparison we're making but continues to be a competitive market. But we would look to double digit growth in sales in the second half of the year. Our game plan hasn't changed, it is discipline, it is leads with underwriting. And I think has the results in terms of earnings, are helped by the outstanding claims management. But we should see a little pickup in the second half.

Great. Thank you.

Your next question comes from Tom Gallagher of CSFB.

Good morning. The first question I had was just on the change in the death benefit on your variable annuity product. If memory serves, I believe that was going to be changed in May. Can you just comment on the intra-quarter sales trends and whether you saw any changes after you actually changed that death benefit? That's my first question.

This is Tom Marra. It came June 1, actually. And no discernible difference. And you know, you can't hit the number we did without having a great June, obviously. So we did not see a discernible difference between the months of the quarter.

Okay. And then, can you just comment on if you think re-insurance capacity may be coming back to the market at all, you know, for -- whether it is your -- I presume it is coming back a little bit, given that you are now getting more capacity on the death benefit side. And whether you think there may be an expansion of capacity on the withdrawal benefit side?

We're working every angle. Clearly, we view the developments on the death benefit as encouraging. So we are going to keep working on it. It is a little tough to predict because obviously, each company has got to analyze their own appetite. But I can tell you we're actively in discussion with several.

Okay. And then the last question I had was I know you all have been pretty disciplined on the group, in Group Life and Disability business, any signs of hardening in that market? Or are you still pretty cautious?

Just a little bit. Sort of a moderate improvement. And, but we're going to stay to our game plan and again, we expect to see a little bit of pickup in the second half.

Okay. Thanks.

Your next question comes from Bob Glasspiegel of Langen McAlenney.

Morning, Bob.

Morning. Tom I was wondering, we're going to make you work again on margins and individual annuity. I think you had said high 30s was your outlook for '03. And if you X out the tax gain it looks like it was around 41 in Q2 with still a pretty heavy amortization hit to the quarter that looked surprisingly high in light of the persistent positives and the strong market. I was wondering if you could just walk through your outlook for margins in sort of a non-bear market scenario.

I'm a little conservative but I guess I'm comfortable say at 40-ish at this point, Bob, given what we've seen. And with the tax rate continuing to improving and that's just not the one time but we will receive a benefit on a go forward basis as well. So I am comfortable with 40-ish after tax, obviously.

Are you allowing room for just heavier reinsurance costs? Or just a correction in the market? Or are you expecting that lapses bounce back? It just seems like that is unduly conservative in light of the incredibly positive Q2 fundamentals.

Well, I think it's a number of factors. I just don't want to get too bullish on it. We had originally have always said our goal was to get 35, 40, that's what's in our pricing when we price for 15% return on equity. But it is kind of on a business as usual basis I think. I think 40-ish still is a good number and obviously we are going to work to do better than that.

Bob, Ramani. You know, the assumption for the S&P in our guidance embedded in our guidance is around 1,000 for the balance of the year.

Got it. Just one final thing on amortization, it seemed a bit high. Still 49% of pretax, pre-amortization profits. Is that just a new higher level we should expect?

We had a small true-up that probably put it on the -- up in that range, but actually, we expected to not, you know, 48-ish is a good number to consider going forward. So I don't think it was wildly higher, but so that I think would be what you should expect.

Okay. Thank you.

Your next question comes from Ron Frank of Smith Barney.

Good morning, Ron.

Good morning. I have a few things. First of all and I apologize if I just plain missed this, but you had indicated on an ongoing business you would tell us what the impact of a [DICON] lock would be on earnings and I didn't find that in the material. If you could point me to that if it is there.

Second, Tom, I wanted to clarify you expect to have hedging in place by the end of the third quarter, your re-insurance runs out at the beginning of the third quarter, you are looking into re-insurance, haven't secured it yet. When you say you are comfortable with what you're writing in the meantime, does that mean that that basically you can afford to go naked for a month? Or does that mean you expect to have something in place but you really can't talk about it right now?

And finally, with regard to the guidance, Ramani, if I just, you know, take a look at the facts which are the charge for severance and the tax benefit offset each other, yet about a point and a half of excess caps which you are not assuming will stay in there, in your guidance, you're not assuming a re-insurance charge will recur, just looking at the cost of those two items, if I add those back and make no other changes I come out well above your guidance. So it seems like you're assuming some kind of underlying deterioration most likely in the XCAT PNC results and I was wondering if you could discuss my logic there?

Okay, Ron, this is Ramani. Let me, I'm going to hit the guidance point very swiftly and then turn to Dave Johnson on the impact of DAC and then I will have Tom address the question on re-insurance and hedging.

First on the guidance, you know, we gave you a wide range. We still believe that our range is designed to contemplate most scenarios that we can consider from this point to the balance of the year.

You know, under a set of scenarios where everything fires well, you know, we could clearly be at the upper end of the range or even higher, but what we believe in providing you with the ranges that it should be a reasonable range that contemplates volatility in equity markets and volatility in the CAT environment and I feel that that was a responsible level to guide the street and guide investors on.

But Ramani, did you not say that CATS were assumed to be normal?

We are assuming that CATS in the balance of the year will be at budget or so. But you know, within the range, our range contemplates some variance on all of that.

Okay.

David, you want to address the DAC question?

Ron, it is in the 10-Q in the section on critical accounting estimates deferred policy acquisition costs. If you assume an unlocked and a change, at 9% market tempered account appreciation rate to an 8%, the aggregate after tax impact based on the estimates at June 30, it is 120 to $135 million.

The thought I wanted to express there in addition to what David just said is, you know, we have really have timed this quarterly conference call to have our investor supplement and our Q converge at the same time so hopefully that was helpful. Tom, you want to address the question that Ron raised?

The question is why we're comfortable with what we will write in the interim period as our three prong plan comes to together at the end of the quarter. Two things, Ron, one, we're not going to -- the amount we're going to write in this period is going to be relatively small in the big scheme of things, and secondly probably more importantly, we can apply the hedges to what we've written on an in-force basis on a go-forward basis so it's not that that business will never be hedged, it can be hedged once we get the program fully in place.

All very helpful. Thank you.

Your next question comes from Jody Hansen of CSAM.

Hi, good morning. On a different topic on re-insurance, the re-insurance adverse development, you had said you don't expect any more adverse development in 2003 which begs the question about 2004 and beyond. How should we think about this run-off business? Because my experience is that run-off businesses don't run-off cleanly or without things that go bump in the night.

I'm going to have, Jody this is Ramani, I'm going to have David Zwiener take that question. David, you want to take that?

Sure, as you know on the Endurance transaction we kept the tail of that business and I think that post the transaction we took another look at the reserve position and we felt it was prudent to strengthen those reserves for a prior year by the $59 million that's included in the second quarter.

Our view is that at this point in time we have, you know, certainly reduced the risk of any further adverse developments in that book, and secondly, it would be our intention right now to continue to break that out as we have in the past as an ongoing operation for the remainder of this year. But more than likely, 1/1/04 we would include that into the run-off operations which as you know is a much larger pool of assets and liabilities will be managed from that point of view.

So I think that we've done our very best job here to -- as conservatively as possible, put this issue behind us and hopefully we're not going to have any additional impact on earnings in the second half of '03.

But going forward, maybe looking into '04, should we budget some sort of a drag from the run-off operation?

Run off in total or run off --

Well let's look at re-insurance and then in total. Just the reinsurance piece first and then in total.

I can tell you we're not budgeting anything for re-insurance, you know, we try to make our best call and it's a call within our range of estimates, so we're not budgeting for anything. But it is a volatile line and has displayed more volatility that we liked.

I guess I can't ask for any more assurance than that. Thank you.

Your next question comes from Jeff Thompson of KBW.

Thanks, I had a couple of questions. First on this specialty net written premium growth in the quarter, on property casualty, it was not what I had expected and down from the first quarter. Is there something lumpy in there? Or how should we think about that?

You know, I would say that we're not displeased with that kind of growth. I mean the 16% growth is about what we would have expected. And I think that, you know, as you look at, you know, the property line was up 10%, you know the casualty line was about flat, and professional liability is where we really saw the strongest growth, that was driven primarily on the rate side, so I really am not displeased with that. I think on a go-forward basis, that sort of teens growth is probably what you're going to see for the rest of the year.

You know, we continue to view this as a transactional business we write the business when we get the returns, we're not driving it for growth. And given our mix of businesses, I know it is -- you're probably comparing it to some of the other specialty players who have shown growth in the 20s, I think our mix is a little different and as a result that sort of mid-teens growth with the kind of profitability we have is just about where we wanted.

So in the first quarter then, that was an anomaly because I think through six months it is up 25 or 26%.

The other thing is specially is more, you know, that kind of business has January 1 and July 1 fiscal dates, you know, the April and October fiscal dates are not as huge.

Okay. On the investment income for property casualty, can you tell us what the yields and the duration is right now and is there a lot of money in cash that may be invested over the next couple of months?

The duration of the PNC portfolio we typically run in the 4.5 to 5-year range, right now it is at about 4.9. The yield, current yield on the total portfolio after tax is about 4.4. The new money rate as we're putting money to work right now, it's probably the best [INAUDIBLE] would be a AA corporate a little bitter, that's about 3.8 to 4.

There is some money that will be moving, you know, out of short term into a longer duration but we're at the higher end of our duration range right now but if we want to maintain a right about that 4.9 and so that's where both maturities and new money will be going.

And then with the expense ratio, I know this was sort of asked before but maybe to ask it in a different way, is it safe to assume something between a 26 and 27% expense ratio going forward?

Yeah, I think that would be a safe assumption. You know, we ended last year '02 at about 28.3% for the whole corporation. We certainly want to get at least a point off of that for this year and continue to whack at it probably as much as a point or more next year.

And one last question following up on Jody's question, just the second half of his question, if you exclude re-insurance, what you do you think that discontinued operations are going to show as sort of a loss as we go forward from here? What's a decent run rate assumption?

Well, as far as discontinued operations from an underwriting loss standpoint, there is very little development that we see as we talked a few seconds ago. But what we will show going forward is given our exit from reinsurance business, really all the major product lines will all be consolidated under either Business Insurance, Personal Lines, Specialty I or other. And the other piece of it will be consolidated to reflect all the items that we have under run-off -- in run-off, right now.

Right, but how should we think about that? Is it a $20 million loss per quarter going forward? What kind of number should we put there?

I don't want to make any specific forecast for you, but I would imagine that we're reflecting from an underwriting standpoint as best as we can see, reserves at a level that we feel comfortable with. Dave Johnson do you want to add anything?

Yeah the only thing that is for certain is there is a very small negative development for asbestos that you will see every quarter which is just the unwind of the one discounted loss reserve position and that will flow through the underwriting income for the run-off operations but that's single digit per quarter.

Okay. Thank you.

Your next question comes from Brian Meredith of Banc of America.

Good morning, Brian.

Good morning. Couple quick questions. First on the life insurance side, I noticed that your reinsurance recoverable analysis you've had some continued deterioration in the quality of your reinsurance recoverables in the quarter. I'm curious, what is your bad debt that you have assigned to that? And does that concern you at all that you continue to see deterioration there?

You know, on reinsurance, on the life side we don't expect any real deterioration. The only issue we had was we commuted a cover in the second quarter, but outside of that, we feel pretty comfortable with our reinsurance profile on the life side.

Okay. I was just looking at the ratings have you listed, percentage, it looks like there is significantly more that kind of dropped below the A level and then just deterioration from the A plus, plus and A plus levels.

Well, you know, as far as our selection of reinsurance, A or better is pretty good for us.

Okay. Next question, with respect to pricing, Ramani, you said pricing is exceeding loss cost inflation, is that true when we kind of segment the lines property versus casualty, a discussion where you're seeing the pricing better.

The answer is yes, Brian, the straightforward answer but I'm going to have David Zwiener comment on that a little more expansively. Dave?

I would agree. I think we've seen the same sort of moderation in pricing that I think other the thoughtful players have reported in their calls but we have not seen a moderation in margins. So I think that, you know, that the spread between loss cost and pricing continues to be a very positive one.

The only area where we see some frustrating, you know, environment is workers compensation in California, and workers comp in Florida, but outside of that, I don't see the property casualty pricing environment from a net spread standpoint as being unattractive. It is actually very attractive for us.

Okay. Great and two other quick questions. One, Ramani, could you give us your outlook for something being done on the asbestos front, the second half of this year? And then I have one more quick one.

You mean the asbestos --

The asbestos legislation.

You know, as the industry has really weighed in several of my colleagues along with me, we're all very heavily involved in this. We feel the bill as it is presently situated is very bad for the industry. It is -- it has got several, several problems. One is the funding level now being contemplated in the bill is -- shifts a disproportionate amount of the burden to insurers, which we vehemently oppose.

The second issue is there is still a lot of holes in the bucket, you know, with the Biden and Feinstein amendments, a lot of stuff is still left in the tort system, so the insurance industry is very actively campaigning to have Senators and Congressmen understand that the present bill doesn't work as it is set up. Now, going to the outlook, we all believe that asbestos legislation is still absolutely key and we really need a good, sound proper way to address asbestos costs. And clearly, we are eager to have something happen there and we're working with Congress on that. But we cannot accept the bill that we have today.

Okay. Great. And last question, looking at the fundamentals in the Life Insurance business and the fundamentals of the Property Casualty business right now, Ramani, where would you be allocating more of your capital, life versus property casualty and then maybe dissect within each of those two units any businesses that look more attractive than others.

First thing I have to tell is having exited the reinsurance business, all our businesses are performing at or above our expected rates of return. So there is no area in the company right now we're unhappy with in terms of rates of return on allocated capital, so we feel very, very good about it.

Secondly, we're also very focused on making sure that we build our capital cushion and we're working very hard to do that. And still, as John mentioned I am still very confident that by the end of '04 we will have positioned our company to be able to absorb two risks of reasonable magnitude, which is important to us.

Thirdly, we are stressing all our people to make sure that our internal capital generation is good and attractive and we're working to do that.

And the last thing, you know, managing risk. We are clearly making sure that the areas where there is risk embedded in our products, we are properly addressing it.

And so I feel that the portfolio as it is presently constituted is an attractive portfolio, is an exciting portfolio, and the outlook for us is actually outstanding over the next 24 to 36 months as a company.

Okay. So I guess your answer is you're going to allocate capital equally to Life and Property Casualty?

At the present time we're allocating capital across the board to the areas we're currently involved in because they are all generating very attractive rates of return.

Thank you.

Operator, this is Hans Miller coming back on. Thank you very much for joining us. We know that there is another company whose call is scheduled for 10:00 a.m. so we would like to free up the line. Thanks again for joining us and feel free to call with other questions. This ends our call.

Okay. Thank you. At this time, you may now disconnect.