Hartford Insurance Group Inc (HIG) 2003 Q3 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the The Hartford third quarter 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 any one should require assistance during the call, please press the star followed by the zero on your touch tone phone.

At this time, ladies and gentlemen, today's conference call is being recorded by InterCall. This program is proprietary to and a copyright of The Hartford Financial Services Group, Inc. 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 these 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 website at www.thehartford.com. For today's call we will be referring to a slide presentation which you will also find on our website.

Participating on the call are Ramani Ayer, the Chairman and CEO, David Johnson CFO, Dave Zwiener, Chief Operating Officer of our P&C Company, Thomas 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 S.E.C., such as the company's third 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's financial performance includes financial measures that are not derived from generally accepted accounting principals. Information regarding these non-GAAP financial measures is available for review in the Investor Relations section of The Hartford's website at www.thehartford.com.

Now, moving to the 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'll briefly cover the operating highlights of our quarter, of which there are many, and then talk about several issues affecting the industries we compete in. Tom Marra of Life will provide an overview of our risk management strategy for our guaranteed withdrawal benefit and then Tom will turn the call over to our CFO, David Johnson for some financial comments on the quarter, our improved outlook for '03 and our initial guidance for '04.

Please turn to slide three. Each of The Hartford's businesses is executing well and is positioned to take advantage of favorable market conditions. The Hartford produced year-over-year double digit growth in top line, net income and assets under management. If one were to adjust our reported net income for DRD, realized gains and losses and the bank core litigation charge, our core operating earnings were up 30% to $375 million, of course, this is a non-GAAP look at our business results. Stockholders equity, exclusive of AOCI, was $10 billion, this is an increase of 4% from year end '02. In spite of our asbestos charge in the first quarter, book value per share excluding AOCI is within 4% of the year-ago level.

This calendar year saw The Hartford take strong steps to insure its continued financial strength through a significant increase to its legacy asbestos reserves. The burden that those reserves put on our earnings is real but strength of our operating companies has come through to almost entirely cover the charge in just a few quarters. Whether or not there is legislative action on asbestos in Washington this year, we remain confident that our recent action has addressed today's asbestos environment.

In the spring, we shared our capital plan with you. I am please to report that we are on track with our goal of building a 500 to $600 million capital cushion by the end of '04.

Now, I want to cover the highlights of The Hartford's Life & Property Casualty operations, so please turn to slide four. Our Life operations successfully executed its strategic plan and capitalized on market conditions in the third quarter. We again, posted record total annuity sales of $4.3 billion, this is up 69% over the third quarter of '02. Variable annuity sales were once again, over $4 billion. This quarter saw our fixed annuity sales surge to $363 million which is 139% higher than last year. This is well above the last quarter's total. This demonstrates that our pricing strategy delivers excellent profitable sales growth for our fixed products when interest rates move up and additionally, our margins are protected when rates are retreating.

Hartford Life's Japan operations contributed over 20% of our worldwide variable annuity sales this quarter. As promised, I am very pleased to announce that we have implemented a risk management strategy for our guaranteed withdrawal benefit. I believe that the program we have in place helps us effectively manage the most volatile risks associated with this benefit. Combined with our reinsurance programs and product design capabilities, this will enable our Life operations to profitably market and sell these products. Tom Marra will cover the program in more detail in a few minutes.

The slide on page 5 shows that annuity sales continue to be outstanding. However, the real story is one of excellent execution on the part of Tom and his team. Throughout this second quarter, several competitors introduced their version of withdrawal guarantees. Many of you wondered what impact these competitive products would have on our sales momentum and market share. With nearly $4 billion in VA sales, I feel we have responded well to that challenge.

This quarter, we once again showed our ability to design, develop and market new products. In June, we introduced a new suite of annuity products with improved death benefit protections. The third quarter represented our first full quarter of sales of these products. I'm pleased to report that these new products, which reduced costs to the consumer and reduced risks to our shareholders, enabled us to maintain our market share leadership. We're certainly proud of our ability to create products that our clients want and need.

Net flows exceeded $2 billion, once again, a remarkable feat that was driven by strong sales volume and surrenders that were lower for the fourth consecutive quarter. Fee revenue on the increasing asset base was up 26% over last year.

Please turn to slide 6. Total investment product sales which includes annuities and deposits grew to $7.4 billion. This is up 56% over the same quarter of 2002 and slightly ahead of the second quarter. This is certainly a new record for us. Mutual fund sales, again, exceeded $1 billion. This is in line with the last quarter and a 20% increase over last year. We expect this momentum to continue.

We also showed strong sequential sales growth in governmental retirement programs to $354 million. This is up from $112 million. Sales growth in 401-K plans was up 22% sequentially. Institutional products which is fundamentally a large account business had some big wins in the quarter, they generated a total of $886 million in sales with healthy margins.

In the quarter, total investment products divisions net flows surpassed $4 billion which is a new record for us. Our assets under management in investment products were $132 billion, also a record. This brings The Hartford's assets under management to $232 billion at September 30. These results show that the diversity and breadth of our product offerings make us a real force in these markets.

Also the following important businesses in the Life operations had solid results. First, Group Benefits achieved a noteworthy 12% earnings growth. Fully insured sales were up 14% year-over-year. I remain optimistic about topline growth in the fourth quarter and certainly, into 2004. Second, Individual Life is beginning to see topline growth again. Earnings are solid, our Universal Life product is gaining traction and delivered $21 million in sales, almost double the second quarter level. We are holding our own in VL sales.

And finally, Hartford Life Japan sales were excellent at $1.3 billion in the quarter, this is by far our best quarter to date. Driven by the outstanding sales, our assets under management grew $1.7 billion in the quarter. We are now nearing the $5 billion mark in assets and this is remarkable considering we have only been in business in Japan for three years. We showed a slight profit on a U.S. GAAP basis in the third quarter of '03.

Please turn to slide 7. Our Property Casualty operations reported record operating earnings of $193 million. This represents an all-time high and is up nearly 40% from a year ago. Our North American Property Casualty operations turned in a combined ratio of 99.2 before CATs, the combined ratio is 95.8. Also in the quarter, we did have two points of loss development in the Specialty Commercial segment and that development is included in the 95.8. Our three ongoing segments, Business Insurance, Personal Lines and Specialty Commercial are growing well. Earned premium actually grew 14% due to continued strong pricing, I'll cover this in more detail on the next slide.

We are successfully executing our enterprise strategy of becoming a principal market for The Hartford's top independent agents. As one of a select group of AA rated national players in the Property Casualty marketplace, we will see the benefits of the flight to quality. New business growth in middle market commercial was excellent in the third quarter at $157 million. Pricing was again positive with high single digit increases in our fifth year of pricing increases. More importantly, margins continue to expand. Our presence in the professional liability market continues to generate strong growth.

In Personal Lines, the rollout of our new class plan now includes 28 states. Our agency management is focusing production in the most profitable states. I feel this is a positive emerging story for The Hartford. New written premium is up 10% versus prior year. As promised in previous quarters, Personal Lines is achieving profitable growth.

Slight 8 shows you how we have repositioned the company in Property Casualty. It is old news that we exited the reinsurance business which is now running off. Our ongoing businesses include a core portfolio of Business Insurance, Personal Lines and Specialty and we are seeing good growth in each of those.

On slide 9, we outlined a combined ratios of the Property Casualty operations. Business Insurance achieved a combined ratio of 93.3, excluding CATs. We continue to consistently deliver great performance because of the strength of our business model. Personal Lines reported another great quarter, we had a combined ratio of 90.8 before CATs. Overall, our ongoing North American operations delivered a 90.8 combined ratio which included 3.4 points of CAT loss.

One item I would like to address is the $45 million of prior period development we experienced in the quarter. This added 10.4 points to our Specialty Commercial combined ratio and 2 points to the over all P&C combined. About half of the development was related to a few severe 2002 accident year contract shortage claims and the remaining development is related to anticipated settlements of reinsurance obligations. This relates to business acquired at the time of the Reliance transaction.

Now, on slide 10, we discuss the current industry environment and first, I will focus on the insurance sector. As I look forward to the next 1 to 2 years in the Property & Casualty industry, I believe the market should be a good one. We are seeing some increase in competitor activity and this increase is among the more disciplined companies in the industry, particularly in small and middle market commercial. At the same time, many favorable factors are in place, pricing and lost cost spreads remain positive. Reinsurance markets are disciplined.

We have a relatively small market share in California. We expect the devastating wildfires of the past two weeks to have a moderate impact on our fourth quarter CAT losses. Although it's early, we are expecting CAT losses from the fires to come in between 20 and $30 million after tax, this is reflected in our guidance. We are still working diligently toward Federal legislation regarding asbestos and I hope that legislation will be enacted in this session of Congress but if not, we will work on this again next year. I do not see any changes in the asbestos environment since we last spoke to you in the second quarter.

Now, moving to the Life sector, there are two items I would like to address. First, in the asset accumulation business demographic trends continue to work if our favor. Aging baby boomers are focused on their 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 and annuities.

Second, regulatory activity continues in the mutual fund industry. Some of what we all see in the newspapers is troubling; we do not tolerate any fund fiduciary seeking personal gain by abusing their trust. The Hartford, like many others in the industry, has been called on by the S.E.C. and the New York AIG with requests for information and we intend to be fully responsive to their requests. We are committed to the goal of protecting the interest of our customers.

And last, the credit cycle is improving. The substantial capital strain over the past few quarters caused by investment losses is behind us and the over all credit quality of our invested assets is excellent.

I will turn the call over to Tom Marra for an overview of the risk management approach to our guaranteed withdrawal benefit. Tom?

Thank you, Ramani and good morning, everybody. The first thing I would like to do is reinforce Ramani's comments about the Life Company's performance. As we are beginning the fourth quarter, the one thing I can tell you is that our sales are still strong for all of our key products. Now, I'm not signaling that we are going to keep breaking sales records like we have in annuities but we do see continued strong sales performance.

Moving on to GMWB, slide 11, as we promised a quarter ago, we told you we would give you an update on our GMWB risk management strategy in today's call. I want to start by recapping our GMWB exposure. As of September 30, our entire VA block was $77.6 billion broken up in three categories as follows: $65 billion with no GMWB coverage, $9.8 billion with GMWB coverage that is 100% reinsured and $2.8 billion with GMWB coverage that is not reinsured but is now fully hedged.

Turning to slide 12. Also, as we promised in July, we did in fact commence our hedging program at the end of September. It is important for you to note that our hedging program covers all GMWB business written since mid-July 2003, that is, the nonreinsured GMWB business. In order to hedge this liability, we are using derivatives to protect against the adverse market movements. You know, we have a long track record of effectively managing billions of dollars to derivatives to manage risk, so this is very familia territory for us.

For this effort, we used several outside advisors to compliment or own internal capabilities in designing the program. We also have a full time team of 10 people focused on the ongoing execution of the hedge program. Our goal obviously, is to mitigate GAAP income volatility by managing our hedge assets to move in like fashion to changes in the value of the GMWB liabilities. By doing so, we also minimize statutory volatility and hedge the economic tail risks. We are confident that our hedge program, now in place, will effectively meet this goal.

Now, on slide 13. we lay out three key market sensitivities that affect the value of the GMWB liabilities and the types of derivatives we are using in the hedging process to address these risks. Those of you who are familiar with hedging will recognize the so-called "Greeks" Delta, Vega and Rho and as you can see, we go beyond Delta hedging which only protects against changes in market levels. Our program also covers Vega and Rho which do protect against changes in volatilities and changes in interest rates.

Different types of derivatives protect against these risks in varying degrees. Our primary hedging instruments are put options but we also use call options, futures and swaps. The best way to think about our approach is this; the GMWB liability, although it looks like an option, our strategy is obviously going to be primarily options based. These techniques also work well with the accounting treatment of these benefits. Our GMWB liability is valued using option pricing techniques and current capital markets assumptions in a manner consistent with the derivatives on the asset side of our balance sheet. The slides and the appendix to this presentation, as well as our 10-Q filing, will give you more information on the accounting treatment.

So, finally on slide 14, I want to summarize and recap some of our key points on GMWB hedging. First, we are very comfortable that our process significantly mitigates GAAP earnings volatility and reduces statutory capital usage, especially under the proposed risk based capital requirements. Second, our process is extremely diligent and robust, we monitor and manage this risk literally, around the clock. To analyze our book of business, we run tens of thousands of scenarios every night and our confidence in this process was boosted even further based on extensive reviews performed for us by a major investment bank firm. That review covered hedging mechanics and strategy, checks and balances on our processes and hedge program risks and controls.

In the conclusion of their review ,it is that our people, systems, processes and infrastructure are leading edge. Hedging is an activity that has been a core part of our asset-liability management practices for many years and our thorough and carefully conceived GMWB hedging process is yet another example of the high standards of financial discipline that are core guiding principals at our company.

At this point, I would like to turn the program over to David Johnson, who will cover operating performance and guidance.

Thank you, Tom. I'll turn first to slide 15. This slide reconciles our reported third quarter net income to our adjusted operating performance, as Ramani and Tom described.

Slide 16 reconciles our outlook for 2003 to the outlook including the asbestos charge. Our operating guidance for the remainder of the year assumes current equity markets are sustained and the CATs are incurred at historical levels. Our current view is that the California fires will not challenge our ability to deliver in this range. Also, please note the guidance on slide 17 regarding the correct denominators to use for EPS forecasts for the full year.

Please turn to slide 18. We currently forecast 2004 operating EPS between $5.65 and $5.95. On the Life side, this assumes roughly 9% equity market growth from current levels. Variable annuity sales are assumed to slow somewhat from the amazing pace of the first nine months of '03 but we firmly expect to maintain our number one position and deliver exceptional sales in '04. But, assuming we match 2003's record levels is probably too high a bar.

In P&C, we have estimated normal CATs and a healthy but clearly moderating P&C pricing environment. Investment income in P&C will grow only slightly in our estimates, again, due to lower interest rates that are largely offset by good cash flow. Certain items will continue to put a drag on growth for us as they do for pretty much all of American industry. For example, we are also budgeting roughly 15% in benefit cost increases in 2004 as medical and pension costs continue to grow even after giving effect of significant actions we took this fall to address and arrest that climb.

That concludes my remarks, Ramani?

So, in closing, I am really proud of my team and all our accomplishments this quarter. Our revenues are growing, execution is really strong across the board. I know you have heard me say this before but I really believe, we have a special franchise. So, this is the time for us to take your questions. Operator?

Yes, sir. At this time, I would like to, if you would like to ask a question, please press star then the number one on your telephone keypad. We will pause for just a moment to compile the Q&A roster. Sir, your first question comes from Michelle Giordano of J.P. Morgan.

Good morning. I had some questions hopefully, Tom can help me out with the first two. Specifically in variable annuities obviously, there are other players offering some form of principal guarantee and there seems to be a lot more competition. Tom, in looking at what the other players are offering, are you expecting a lot more competition coming in the next quarter or two since a lot of them have recently rolled out the product and is there anything in those features that other players are offering that would cause you to want to change the features, the principal first, to make it more appealing or even more competitive?

Secondly, I was hoping you would discuss the surrender activity, there has been such terrific performance in surrender slowing, is this sustainable and if you could just talk about what is driving the improvement in the surrenders and then, I will have a follow up question.

Okay, Michelle, hi, it's Tom. First, on the GMWB, certainly there's some real strong competitors are coming in and I think they are really just starting to gear up and I expect that they are going to be successful, as we have. Having seen their products, I don't see any reason for us to change our offering, we're still happy with them, as you can see, it is still performing quite well.

Regarding surrender activity I think this has been a particularly strong year. I think one aspect of it is, there were a lot of people who got flushed out in the downward market in '02 and those people, obviously, the remaining people are the ones who are more sticking with it. I think the other things, the service and the performance of our products certainly have been helpful as well. But I do need to point that, looking forward as we look at '04, we are going to have some MVA fixed annuities that will hit their window. We also have a higher than normal slug of VA business that reaches the end of their surrender charge period so, while it has been great, I do expect surrenders to pick up a little bit.

Then, can we talk about what is going on in the Variable Life market? It looks like there is some signs that sales are starting to pick up, what is the pipeline looking like for the fourth quarter and are sales starting to remerge in Variable Life?

Yes, Michelle. We had a good quarter in Variable Life but we had an even better quarter if Universal Life. I think our team now, is really poised to take advantage, I think we're back on track to grow sales again and I do expect fourth quarter sales in Individual Life to be quite strong, particularly when you look year-over-year. So, right now I'm looking at it as a mixed approach. We're still, we do hold the number one position in Variable Life, I would like to hold that but now, we have a nice compliment of UL products to go with it.

What are you expecting for overall Life sales in 2004?

Better than '03.

Much better than '03. I don't have a specific number to give you but we're going to see nice gains, particularly, I would expect fourth quarter to be some where in the 54 to $60 million range. So, I think that will be a healthy growth off of '02 which was $48 million and then we will go from there.

Thank you.

Thank you, Michele.

Your next question comes from Bob Glasspiegel of Langen McAlenney.

Good morning and Tom, I want to congratulate you at getting to the unreachable 45 basis point margin level this quarter. A quick question on your hedging strategy, to what extent did it influence how fast your foot was on the accelerator in sales in the third quarter, if any?

The hedging strategy itself was, well, obviously the hedging strategy is a program we use to back up the business we have been writing. I think the business we have been writing has been selling well due to a number of reasons. I think the both the leaders and director programs execution is particularly strong but clearly, the withdrawal benefit is very popular as well.

I was actually asking a different question, I was just saying that given that you were rolling out your risk management program, was there any sort of concern to go slower than you might otherwise, as you were beginning to execute this?

No, we are very comfortable with the hedging program and, you know, as we stress tested it and run it through we think it very effectively matches changes in the GAAP liabilities so, we are very comfortable with it and knew we were going to be able to get there by the end of the quarter and that is why we kept business at the robust pace.

So, there is no constraint for growth as far as risk management from your perspective?

Well, there is a couple of things. One, we still are talking to several reinsurers and we think, you know, in large part because of the robustness of the hedging program that the reinsurers may come back to the market but even without that, for the business we're writing now for the foreseeable future we are comfortable with that the hedging program will meet our risk management needs as we see the next, you know, several quarters.

Thank you and the Property Casualty question, let me applaud you for consolidating other runoff into Property Casualty and aligning your reporting with how others in the industry do, I was wondering if you guys could give us rough guidance on what we should think for reinsurance and runoff underwriting losses in '04?

Well, this is Dave. We, as you know, are consolidating what is left of the reinsurance operation into runoff on 1/1/04 and so, you know, if we are going to break reinsurance out for the remainder of this year, when you get to 1/1/04, we are going to consolidate to that. Going forward, what you are going to see in the other line then, which would incorporate both our existing runoff plus the reinsurance, is a run rate, I think, probably in the positive range of probably in about 30 to 40 million. Is that right, David?

You're talking underwriting only?

No, not underwriting only.

I was talking underwriting.

The underwriting, all right, let me see, what would the underwriting be?

I would say about, Bob, somewhere in the $20 million or so before tack impact on AUI loss

Okay, and then 50 to 60 million of invested net income associated with that block?

As you have seen,

Right.

we have consolidated all the investment income and the reason for that consolidation is that we are not breaking out the capital anymore between those operations so, we felt it was a more logical presentation for everybody at the street level so, that is the reason why we did it that way.

And the fact that you have modest underwriting losses, you still have some earned premiums running off, I mean, this is actually the adverse reserve development that...

Exactly.

In the analysis, just your earned premiums are there and you do have some loss adjustment expenses?

That is one reason, Bob, the other reason, too, is that we have expenses matching the claims activity et cetera and so there will be, you know, the cost of running that facility we are going to be administering close to $5 billion or so of reserves so you will definitely see costs involved in administering all that.

Right, gotcha, thank you, that's very helpful, thank you.

Thank you, Bob.

Your next question from Liz Warner of Sandler O'Neill.

Good morning, I had a question about Japan, I recognize that it's a small but a very quickly growing part of your business but I wanted to know if you had any, I guess, goals for what what you could achieve in in that marketplace both in terms of magnitude and also, if any type of product extension or broader distribution or something that you are looking at to getting to those goals and also, thank you for the disclosure on all the GMWB hedging, that was very helpful.

Thank you, Liz, this is Tom. We have obviously been very pleased with the Japanese Variable Annuity market. It will grow, we are looking at achieving, we are making money now and we should have, say 12 to $13 billion in assets, we are now about 5. We will get up to our 15% ROE in the 40 plus range so, that is plan A which is to just keep describing that VA business and we have lots of distribution outlets to work on that and we are up and running and established. The other thing though, we do intend next year to introduce a MVA product, much like we offer here, we think that will be a nice tandem product to the VA, so that's are most immediate plan to expand in Japan.

Okay, great and just a quick follow up, you had talked about the portion of the portfolio that is coming out in the U.S. it is coming out of the surrender charge period and I was wondering if there is any type of conservation strategy to go after that book or is that kind of a wait and see type of?

No, actually, we have a very successful conservation program, I think that is one thing that has helped a little bit with the success we have had this year and we are gong to continue to play that out but I just think the laws of nature are that you lose a certain percentage of that and that is why we expect to have it tick up but we are going to even enhance those programs and hopefully keep as much as we can of it.

Great, thank you very much.

One other point I just want to make on Japan as Tom and the rest of our team as well as our Board of Directors were in Japan last month and we met with distributors, about 400 or so of them, and had a phenomenal reaction to our position in Japan and appreciation for the marketing efforts we have undertaken, so, we are very positive about Japan.

Great, thank you.

Your next question comes from Michael Lewis of UBS.

Hi, good morning. Should I read anything to the fact that Dave Zwiener didn't take part into the original presentation? But I will let that one go.

Michael, I'm here.

Okay, okay, I just want to make sure. Could you give me some details on two things, on the...

The risks are perfectly hedged, what are you talking about?

I take it back. Can you give me some detail on the Personal Lines, Auto Business? You are running about a 90 combined ex account losses, can you give me some details on what the new auto rate plan is and what you view the competitive environment in the Personal Lines being since you and most other companies are getting to rate adequacy in all states. Are you factoring in a more competitive environment, going forward? Thank you.

Michael, this is Dave Zweiner, I am here, I think as we talked about the last last couple of quarters, really we are driving for is rate adequacy and, as you said, we and others are starting to achieve that and so what you're starting to see now, is some real growth in the business and, I think, specifically for us, we disclosed some of the growth numbers in the supplement but this is the first quarter in five quarters that we had positive growth in Personal Lines so, I think that reflects the rate adequacy.

On the new class plan, which we've talked about, I think it's still early days but we've got it out now in 29 states which represents about 59, 60% of our total written premiums, we are getting some very positive feedback and I think what we are measuring as early indicators there are both the number of quotes as well as the issues and we have seen dramatic improvement where we've rolled out the new plan. We are going to continue to roll that out and should have it in all of our states by the end of this year, so, I think that the combination of rate adequacy and the new plan gives us a lot of confidence about growth next year. On the pricing side, I know others have commented and I guess we would echo, there is some moderation in pricing but at this point, pricing continues to be in excess of loss costs and I think, from what we can see, that trend is going to extend well into next year so, we feel good about the Personal Lines story.

Okay and just one quick follow-up. Again, Ramani mentioned competition also on the small and middle sized commercial marketplace is there a distinct difference in the competitive environment in the small commercial marketplace versus the middle market and could you go into a little detail on what is going on there because obviously, your growth rates aren't as good there in that marketplace as it is in the middle market?

Growth rates I think we are pleased with. I think when you look at the quarter, for total business insurance which includes mid-market and select, up 14%. We are confident in total we are going to get to a billion dollars in the combined business in the fourth quarter. I think the other thing is in total, again and I will get to your question on small commercial, third quarter is the third quarter that we did a quarter of a billion or more in combined new business so I think it is a good story there.

On the growth rate specifically, what you're seeing is the middle markets, probably growing closer to 20% and the small, closer to 10%. I think that that for us, reflects some degree of competition but probably much more being impacted by state management and I think where we are seeing a few states that we are, I think, moving back from. While we we are' pushing hard into the middle part of the country which I think is going to bear some fruit for us the early part of next year so I'm pleased at this point what we are seeing with the growth.

Thank you very much, excellent results.

Thanks.

Your next question comes from Jody Hanson of Credit Suisse Assets.

Hi there, yeah, good morning. Wondered, I have got three questions that relate to the GMWB hedging. One on the, on page 14, you say that this is going to impact your, will reduce the capital usage for the NAI-3 Phase II implementation of the RBC standards. Can you quantify that?

Jody, I am going to turn it over to Tom.

Thanks, Jody. We looked at it both under the interim and the proposed and in both cases, we think the capital attributable to the GMWB will be under 1%.

Under 100 basis points??

That's right.

On the RBC ratio?

The, no, the incremental capital that we will have to put will be under 1% of account value.

I got you.

Okay.

I can back into that. On page 21 of your slide presentation on the GMWBs, you have the gross fees collected, this is in the appendix, and then less fees attributed to the hedge GMWB. Is that, am I interpreting it correctly that that is your cost of hedging?

I'm going have Liz Zlatkus, who is the Hartford Life's CFO, take that one.

Good morning, Jody, the 15 basis points that you see that is deducted from the 35 that we collect for the writer, that is essentially at the end of the quarter, our best estimate of the present value of the future cash flows we would expect to pay out and again, that is value in the liability under options pricing technique similar to derivatives so, under a wide range of scenarios, using current volatility, et cetera, that is our number.

As you know, we are hedging this product. To the extent that the hedge doesn't quite match the asset hedge doesn't quite match the changes in liability, any changes in that would fall through realized capital gains or losses which is is what you see down at the bottom in that $600,000 number.

Right, so, that is your present value of what based on what your hedging strategy, what the payout will be?

Yes. In other words at the end of the third quarter our best estimate of the present values of the future cash flows will be about 15 basis points.

And that goes lots of years into the future, that is your present value discounted back to today?

That's right, using risk free rates.

Okay and then the last question is in the 10-Q you mentioned that the company has entered into an offsetting reinsurance arrangement which is recognized as a derivative asset, this is under the GMWB discussion in the derivatives. What is that? That appears to be new?

No, that is actually what Tom was talking about earlier that a large portion of our GMWB was reinsured and it is just the DOA that is accounted for but essentially most of the book is reinsured and then the remaining book, as we said, the remaining $2.8 billion is hedged.

Terrific. Thank you very much for the questions.

Thank you.

Thank you, Jody.

Your next question comes from Vanessa Wilson of Deutsche Banc.

Good morning, Vanessa.

Hi, good morning, I have two questions and then Alain Karaoglan has a question

Could you speak up, Vanessa?

Yes. Can can you hear me now?

Barely, it feels like a Verizon ad to me here.

How is this, can you hear me now?

Perfect.

Okay, I have two questions and Alain Karaoglan has a question as well. First of all, I'm just looking at your statistical supplement on the page that shows the ROEs for the Life segment is L1 and it shows this quarter that you're at a latest 12 month ROE for the segment of below 14%, it's 13.6. If I annualize the quarter, as opposed to the doing latest 12 months, I get 15.8 as the ROE for the segment. Should we think of that as a normalized sustainable ROE and I'm wondering, given that higher capital requirements that go into effect next year, how will all that interplay affect the ROE?

Yeah, I'll try to take it and I might ask Liz to come back again. That capital that you refer to is really already there. In terms of the guide for ROE I would think that, I would hedge it into the 14 to 15% range as a better indication of the run rate we are shooting for.

Okay and Tom, in terms of the hedge, what could cause the hedging program to be ineffective, what are the scenarios we should think about that would make the hedge, you know, not do what you want it to do?

It really is quite robust, Vanessa, we stress tested it under a variety of different scenarios . Now, the cost of the hedge might vary at times but in terms of its ability to cover the tails, it is quite effective. The things we look at that might shift it are policy owner behavior changes, we have modeled this with conservative policy behavior, we even added dynamic policy holder behavior meaning the models will adjust assumptions depending on the scenario so if the market is down and benefit comes into the money we will assume a lot more people will exercise their right to begin withdrawing so, we covered a lot of that just in the way the model works but, clearly, it is not perfect but we have been quite impressed with its robustness.

And you gave us a lot of detail on this already but I want to be absolutely sure I get it. The page 21 that Jody Hanson referred to, the .7 of variable annuity and life fees is profits that go above the line this quarter and the .6 loss is a realized capital loss that goes below the line so, economically you were neutral but the accounting makes you split it this way?

That's right.

Okay, thank you, and Alain has a question.

Good morning, a question with respect to expenses and the the guidance. How are you doing on your expense savings program and I did notice that the business insurance expense ratio had an uptick this quarter from 31% in the second quarter to 32.7. Could you discuss a little bit where are you on the expense side, why we had the uptick and what is in your guidance for next year in terms of expense savings and what is your catastrophe load embedded on a combined ratio basis for next year?

Alain, hi, it is Dave Zwiener. Let me take the CAT load, I think, as we have in the past, we would probably guide to about 3 percentage points plus or minus a half, so that would be our expectation for next year, the same as it was this year. Talking to expenses, we have implemented all of the expense actions we have described with you and others during the second and third quarters and we are starting to get the benefit of that.

With regard to this quarter's expense ratio, specifically in Business Insurance, we really don't focus as much on the sequential as we do the year-over-year and let me just point to where we are going and give some guidance for the next couple of years. Each of the three ongoing businesses, Personal Lines, Business Insurance, Specialty, have all seen expense ratio improvements both year-over-year in the third quarter and year-to-date '03 versus '02 so, I think we are heading in the right direction to achieve what we want to get. Relative to where we have been, I think the total company expense ratio was about 29.1 at '01 and we are hoping to get a full two points by the end of this year so, get it down to the 27.1 range and going forward over the next couple of years we want to get another point and a half out of the total and we are on track to do that.

Specific to Business Insurance and Personal Lines during the second quarter we did give targets that we are still on track for which would be we want to get the Business Insurance expense ratio down below 30, we want to get the Personal Lines down below 22 and I think within the next couple of years, we are on track to achieve that. So, I think the quarter just sequentially is more of a timing issue but the trends are still intact for us to get where we committed to going.

And so, if over the next couple of years we want to achieve a 2.5 points of additional expense savings would it be fair to assume that it is going to be linear over the next two years?

Well, first, it was a point and a half more over the next couple of years but I think in terms of getting an equal amount in every quarter, no, I don't expect it to be linear. It will come I think it, most of it will come next year will a little bit more coming in the '05, '06 area and I think what you are seeing then is sort of the effect of the cuts we took. The 1,500 jobs we eliminated the second quarter, obviously the severance period plays out and you see the real benefit of that as we get into next year.

Thank you very much, very nice quarter.

Thank you.

Your next question comes from Ron Frank of the Smith Barney.

Good morning, Ron.

I had a couple of questions for Tom on the hedging. Tom, you had indicated in a previous call, I believe, that while you were comfortable with hedging you had a limited appetite for it as a risk management strategy in the aggregate and I was wondering if you could put that in some context and maybe give us some color on what that limit might be and, assuming you can't get reinsurance and it doesn't seem that has happened as of yet, what the full backup or plan B would be presumably, in terms of product design? And then, I have a follow up.

Okay, one thing Ron, now that the program is up and running, we do feel better with the capacity. Having said that, you know, I still think our plan now is really to work with reinsurers because we think that is one of the approaches we ought to be looking at, is using reinsurance and we will in fact, make the technology available to reinsurers if they want to employ it and if their capital is suited to go against this kind of risk with the hedging.

So, that is the way we are looking at it. We are certainly comfortable for now, we are always looking at our risk management across the company but for now, I think the hedging has proved to work quite effectively and we will continue to proceed down that path while continuing to look for reinsurance.

That's interesting, so you think you can cultivate an appetite on the part of the reinsurers by teaching them to hedge the way you're doing it?

I believe that's very possible.

Okay, and second, I just want to confirm something and think this is correct. Is it correct to assume that the hedging while attempting to neutralize the net income impact that there is no consequence to operating earnings for the mark to market of those liabilities?

Yeah, effectively the way the hedging works is the assets liable move changes and closely in the liability side. So in both on both sides you are really marking the market.

What I mean is, were you not to hedge, would it be an operating income volatility or a net income volatility?

It would be net income.

Okay, and finally a question for Dave, since Mike gave you a hard time, I don't want to leave you out. I just wanted to ask on net investment income growth, you mentioned your expectation, your continued expectation that it would be fairly de minimus next year and I'm curious about that. It would seem to me that that the impact of the interest rate comparisons would be worse in '03 and that in '04, cash flow would start to move NOI in a more positive direction. What am I missing in that assessment?

I think, you know, the guidance we've given for next year is low single digits for net investment income growth and I think that there are probably three variables: One, there is strong positive cash flow which has certainly offset the falling interest rates this year and will continue to to so next year. Two, the portfolio reprices, as you would expect, so in terms of new cash flow and specific cash flows are reinvested at lower rates and so that is one impact and three, as you can just see in the supplement, I think we have fine tuned the portfolio relative to the tax position, muni's and others have come down, we have reduced our exposure to the partnerships that we have had in the past and, I think all of that plays through a little bit, some of the after tax yield that we would be getting, so, the combination of those three would guide us to something like low single digit growth in invested income.

Okay, David, just

Ron, I just wanted to add one more thing the second quarter capital raising activity we restructured the portfolio.

That is exactly the points that David spoke to that effectively because of change in our tax position, we are less able to avail ourselves in the municipal bond market and as we exited equities and partnerships that was, you know, a higher volatility but higher return component middle to small investment portfolio and that puts on small drags so, it is the same thing.

And is there a ballooning of maturities next year in the portfolio or are you referring to the normal.

Just the normal repricing of maturities. No ballooning in '04 or 2005.

Great, that is all helpful, thank you very much.

Thank you, Ron.

Your next question comes from Eric Berg of Lehman Brothers.

Thanks very much and good morning.

Good morning.

A couple of questions. First, two questions. First, very much appreciate the ongoing disclosure regarding embedded value and I would like to know, let me pick up the phone, I would like to know the assets under management your reserve balances in the variable annuity business are reflecting the exceptionally strong sales, up dramatically from a year ago I think it's about 30% in terms of account value growth yet, the growth in the value of the business, the embedded value, has been far less than that. Why is there such a difference? And I will have one follow up.

Thank you, Eric, I will have Tom pick up the answer on that one. Tom, do you want to take that one?

I think I'm going to have to ask Liz to do it, I guess I'm --

And if you want to noodle on a little bit, too, we can talk offline.

That might be better. We are trying to account for it but we will get back to you, Eric.

Okay and the other question, Tom, that I think you will be able to field immediately is this; you obviously have spent a tremendous amount of time and resources, human resources in developing the hedging program, you are very proud of it, you say it's working, you say it will work and you are making money off of it on the operating basis; if it is such a good idea that is working so well, why not continue to use it unlimitedly, why give it to reinsurers, why share it with anybody?

I think it is part of an overall risk management practice and it is working effectively and it does have capabilities, particularly the choice we made to hedge GAAP volatility, not just standard economics, I think that proves to work well for us but I think it is only one of several tools that would need to be used. Reinsurance is an outlet that we had great success with and I think should be a big part of our overall risk management strategy and, like anything we have said, I hope we conveyed the hedge works very, very well but it is not perfect. Liz explained, there's going to be accounting noise from time to time so, I think we will look to combine our efforts between hedging and hopefully, more reinsurance will emerge.

Thank you.

Your next question comes from Al Cupersino of Columbia Management.

Hi, good morning.

Good morning Al, could you speak up? This is Ramani.

Can you hear me now.

Barely?

Okay.

Great.

It is probably too early to comment on these sorts of things but I wonder if perhaps you could, the recent article this week about the administration attempting again, to put forward lifetime savings accounts and things like that; any thought either on the odds of passage or a very early read on the potential impact to The Hartford?

I will have Neal Wolin comment on that, Neal?

I think it is very early to tell on passage. I think obviously, this session is winding to a close. Next year election year, very hard to know what is going to happen in that context. I think Tom has spoken to the past to the implication of this to our business and I think, you know, he has expressed a view that we don't view this as terribly problematic.

One thing the annuity industry is doing on the offensive that I'm quite involved in is we do have a coalition forum where we want annuities to get more favorable tax treatments and specifically, what we are looking for is that annuities that go out in some type of lifetime payout would not get ordinary income taxed, as they are treated now, but would have a portion of those pay outs excluded from taxation and we are working that as an '04 agenda item and think really that would be a great boost to the annuity business if we can get it through. Meanwhile, we will keep looking at what will be proposed by the President and others.

Great, thank you.

Your next question comes from Jay Cohen of Merrill Lynch.

Good morning, Jay.

Good morning. I have got a couple quick ones and think Ed has question as well. Ed Spehar.

Related to the asbestos legislation, Ramani, has there been any talk about maybe taking a step back with this and taking an approach that is a little less aggressive than setting up a whole fund, simply putting in medical constraints and taking a stab at it which it passible but not as dramatic as setting up the fund?

I don't believe so, Jay, this is Ramani, and there is a lot of energy that has gone into the design of this and Senator Frisk personally extending a lot of capital trying to hammer out a consensus between Democrats and labor as well as the business community. I feel, for now and for the foreseeable future the bet is on trying to find a way to make this approach work before you pivot on to something else.

Great. Next question would be, the amount of underwriting loss in the other income you said $20 million and I assume that is annually and not quarterly?

Pretax it would be about 20 a quarter, next year.

Thanks, Ed?

A couple quick questions. First, Tom, I was wondering if you could comment at all, on how you think the competitor GMWB products are priced, do you feel they are being priced a appropriately from what you can tell? And then, digging deeper on the whole hedging versus reinsurance given the comments that you made on the additional capital that you think would be required for the C3. Phase II, it seems like the incremental ROE to you, from the GMWB product offering just the incremental ROE is maybe 11-12% so, below the kind of return you look for in the variable annuity business. So, I am wondering, is the look for reinsurance not so much related to the concern of the effectiveness of the hedging program but is it really more driven by the idea that maybe this could boost your returns because of the kind of capital arbitrage we might see as a result of reinsurance and also, is it because of the GAAP implications maybe of using reinsurance rather than hedging it yourself?

Let me start with the competitors, they're good companies and I think well run and I can't comment specifically on their pricing, in large part because I haven't scoured that but I have respect for those companies and I think they will make inroads in the market. But our hedging and reinsurance, this is more a risk management than really a return view that we are looking at.

One thing I will point out, is that we still when you basket in the hedging with the other parts of our pricing, still very comfortable that we will, or pricing as we speak in the 13 to 15% ROE range which is as you know is our target there is some things in the VA that have actually helped to expand margins, you know, going the other way that fix account utilization is way down, we have dropped the guarantees down to as low as one and a half in the 40 states where we can which represents 75% of our business. Our DCA rates are way down, 3% for the 12 months and 5% for the 6 months so, we have done other things within the product that I think have actually helped the margin and returns.

I guess I'm still a little bit confused, though, because I'm wondering is the use of reinsurance, though, if we are sharing, to follow up on a previous question, if we are sharing sort of the technology with the reinsurers and that is going to be sort of the pitch to get them to consider taking on the risk, doesn't there have to be some sort of a capital issue that maybe they can show a better return than what you can?

Well, we haven't seen how they are going to price the reinsurance and that certainly, will factor in. I think there are, you know, certainly there are reinsurers who operate outside of the U.S. and sometimes there are capital advantages to that so, we are only in the early stages of talking to these reinsurers but you're right, there may be some advantages that they would have that we would not and we would, you know, work with them to pursue a strategy that we could work together on, if possible.

You know, Ed, one last thing I want to say is that our confidence in our ability to access this and to be able to continue to maintain our momentum is very strong and we believe, as Tom mentioned, this is our approach and Tom has always said, you know, our risk management strategy relies on product and reinsurance and hedging and the combination of all of this and that is the approach we continue to believe is the smartest way to run this business.

Okay, just because I want to try to make this call go to 11:30, one more follow-up if we look for clarification on the page where you show that the impact from the hedge program and show the mark to market on both the asset or the derivative and the hedge assets. The .6 million realized loss, is that in any way representative of the economics or is that just sort of the FAS 133 or whatever accounting for this and really, economics of it that that is really zero over the life of the hedge? Thanks.

I'll have Liz take that.

First of all the $600,000, we started the hedging program towards the end of the quarter so actually had a little more slippage between the hedge assets and liability than we normally think we would have had on the cohort. But essentially, you are not going to know the true economic cost of the hedging programs, really, you know, cash payments out for many years, so you mark the liability to market under FAS 133 and that is our best estimate and we will really find out what the ultimate payout will be over time. So, part of it, the economic costs won't really emerge until over time. What this really represents though, is the difference in the valuation of the liability and the assets and that is what you have to record under GAAP accounting. Does that help?

Yes, so it might be economic or it might not?

Right, over time we will find out. Actual hedge costs to the extent that there are bid ask spreads, some of that would come through this also and that would be an economic cost.

Thank you.

Operator we just have time for one more question.

Your final question comes from Brian Meredith of Bank of America.

Good morning, Brian.

Good morning, everybody. Just a couple of quick questions here. Two on the PC side and then one on the Life. On the Property Casualty side, could you give us a sense if you are seeing any of the reinsurance claims issues that some of the other companies are seeing in the runoff business increasing in case frequency?

Brian, elaborate on that question?

A couple of the reinsurers out there have seen an increase in case frequency on the reinsurance and the assumed reinsurance book of business from the '97 through 2000 accident years?

Well, Brian, that is what we have been doing for the last several years and so the answer is, no.

So, nothing unusual this quarter?

No.

All right, perfect. The second question is on your D&O book of business, any exposure to the mutual fund situation?

On the D&O, you know, by and large the thing to remember for us, The Hartford, as a player in the D&O business we are usually in the higher layers of insurance and really an excess player on most of these insurance programs so, we do have exposure to financial institutions but it is at much higher layers and it is heavily reinsured.

Terrific. On the life insurance side, I think the way my model sees this, your DAC amortization rate on individual annuity businesses seems to be trending up a little bit the last couple quarters, is there anything to that?

This is Liz Zlatkus. No, you know, we have higher profit margins so, yeah, it did tick up to 51% but that there is nothing unusual there.

Great, thank you.

Thank you, Brian, sorry, Tom were you going to say something?

No.

Thank you again, I want to thank everybody for the participation on this call. As I mentioned at the end of my comments, you know, our exciting times over the next couple of years, I continue to believe we will see a positive environment for all our businesses, Life and Property Casualty. Our execution is very strong so, we are very committed to shooting for double digit growth in EPS as well as our ROEs in our range so, I'm terribly excited over the next 24 months as to what we are able to accomplish in our company. Thanks a lot.

Thank you for joining on today's Hartford's third earnings conference call. At this time, you may disconnect.