Hartford Insurance Group Inc (HIG) 2003 Q4 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to The Hartford fourth-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 anyone 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 those terms.

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

Good morning, and thank you for joining us today. We're starting just a few minutes late this morning to allow everyone interested to join in after a brief meeting call. Thanks for your patience. Please note that the financial supplement is available on our web site at thehartford.com. And for today's call we will be referring to a slide presentation which you'll also find on our web site.

Participating in this call will be Ramani Ayer, the Chairman and CEO; David Johnson, CFO; Dave Zwiener, our Chief Operating Officer of our P&C 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 the earnings press release issued yesterday, and our publicly-available documents filed with the SEC. 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 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 today. I'll briefly cover the operating highlights of our quarter. I'll then turn the call over to our CFO, David Johnson, for some financial comments on the quarter and our guidance for 2004

Please turn to slide three. Our story this quarter is about strong operating results across all parts of our business. This resulted in strong performance for the enterprise as a whole. In several key areas, our team was able to outpace our main competitors. We're positioned to take advantage of favorable market conditions going forward. The Hartford produced year-over-year double-digit growth in top line net income and assets under management. When you adjust our net income for certain realized gains and losses, core operating earnings were up 44% to $433 million. Both life and property casualty operations had record fourth-quarter operating income. Of course this is a non-GAAP look at our business results.

For the full year on that same basis, and adjusted for other previously-disclosed items in the year, we increased our operating income 25% to 1.5 billion. Earnings per diluted share on this basis increased by 15% to $5.42. This included the addition of 22.4 million shares to our average share outstanding balance as we finance the legacy reserve charge. Stockholders' equity, exclusive of AOCI, was $10.4 billion. This is an increase of 8% from year-end '02. With our strong operating results and favorable equity markets, I'm pleased to report that we are ahead of schedule with our goal of building a $500 million to $600 million capital cushion by the end of 2004.

Our disciplined approach to risk management continues to be a strength at The Hartford. In our property and casualty operations our loss-cost trends continue to run favorably. Our group benefits operation has produced continuous improvements in loss costs over the last several years, despite an economic downturn. Our hedging program for our withdrawal benefit, which we put in place in September, performs very well. Product design, pricing, underwriting and reinsurance continue to play a major role in our operations.

Now, I want to cover the highlights of The Hartford's life and property casualty operations, so please turn to slide four. Our life operations produced record earnings. This was due to an outstanding execution. The favorable market conditions also helped. Across several of its segments, Hartford life produced record top-line growth as well. We again posted outstanding total annuity sales of $4.4 billion. This is up 22% over the fourth quarter of 2002. Variable annuity sales were once again over $4 billion. For the year, annuity sales totaled nearly $16.5 billion. This is 42% over the 2002 total.

Net flows remained very strong. And the hedging program that we put in place last quarter to manage the risks inherent in our GMWB benefit in the variable annuity performed within expectations this quarter. We continue to refine and enhance this program.

This quarter, across the board, all of our life segments executed their business strategies very well. This produced significant top-line growth in most of those businesses. In annuities and in 401(k) products, and in mutual funds, group benefits and individual life, sales were up by significant double-digit increases. And profits increased in each segment. Quality was once again a hallmark of our service, as we won DALBAR awards for customer service in annuities and individual life, as well as for mutual funds and 401(k). A highlight of the quarter that is not reflected in our fourth-quarter earnings was the completed acquisition of CNA's group life and disability business. Integration of the newly-acquired business is on schedule.

Let's go into more detail on some of the results in our other important life businesses. First, Hartford Life Japan. Sales were excellent here, at $1.2 billion in the quarter. Assets under management grew $1.4 billion in the quarter. Outstanding sales and appreciating markets drove the increase. Total assets are now $6.2 billion. We have achieved a profit in Japan for the third straight quarter.

Second, group benefits achieved an excellent 14% earnings growth. Fully-insured sales were up 43% in the fourth quarter over the fourth quarter of '02. I expect the strong top-line momentum to continue through 2004. Now, there are two reasons for this. First, our organic growth is rebounding strongly, and we will benefit from the CNA acquisition.

Finally, individual life reported top-line growth again. Fourth quarter sales were up 46% over prior-year period. For the full year, sales were up 13% over 2002. Earnings accelerated 21% in the quarter. Quarterly results were aided by favorable mortality. Earnings are up a solid 9% for the year. Our universal and whole life products are gaining traction. They have delivered $37 million in quarterly sales, 76% above our third-quarter level. We're holding our own in VL sales, up 15% over last quarter.

Slide five really sums up our investment product segment. Total investment product sales and deposits increased to $7.9 billion. This is up 51% over the same quarter of 2002, and 6% ahead of the third quarter. This is another new record for us. For the year, total sales and deposits exceeded $28 billion, up 36% over last year. We truly believe that our flight to quality has directed many new clients to our investment advisors and our highly-diversified portfolio products. This slide shows how the results by products have changed over the past five quarters. It should be noted that beginning on February 1, we will be increasing the charge for our withdrawal benefit rider from 35 to 50 basis points.

While we are very pleased with the success of our hedging capability, we decided to increase our charge to ensure that it covers an even wider array of possible scenarios. Mutual fund sales again exceeded $1 billion in the quarter. This is 44% ahead of the last quarter, and almost double last year. We expected our growing presence in the mutual funds market to build on the success we have achieved in the past several quarters.

Fourth-quarter sales growth in 401(k) plans was up over 60% year-over-year. Full-year sales were 36% higher than 2002, and totaled almost $1.4 billion. Institutional products, which is fundamentally a large account business, had some big wins in the quarter. Once again, they produced sales of over $1 billion and their margins were solid. Sales for the year were $3.4 billion. In the quarter, total investment product division net flows were a significant $3.5 billion. We did, however, experience higher surrenders of our Putnam assets during the quarter. Recently the surrender rate has slowed. In fact, Putnam assets were higher at the end of the quarter than at September 30. Because of our strong brand name, raw distribution, our innovative product offerings and a strong balance sheet, we have the leverage to expand sales and to hold our own and grow our market share in each of our businesses.

Turning to slide six, we address the growth of Hartford Life's investment products assets into management. Assets into management Investment products increased to $146 billion. This is a record for us, and is 33% higher than at the end of 2002. Each of our businesses contributed solid double-digit increases, with 401(k) and mutual funds growing fastest. About one-third of the AUM now comes from products other than annuities. Overall, this growth resulted in the addition of over $36 billion to the assets we earned fees on. These assets will ensure that our investment products operations will produce the kinds of earnings for the company that will help us produce double-digit earnings increases and solid growth in book value in 2004. This excellent performance also helped boost The Hartford's total assets into management to $250 billion on December 31.

Now, please turn to slide seven. Our property and casualty operations supported record operating income of $211 million. This represents another all-time high, and is up nearly 50% from a year ago. Our North American property and casualty operations benefited from strong execution, and delivered a combined ratio of 95.6. In the forecast, the combined ratio is 94.2. Each of our ongoing segments produced combined ratios that were well under 100. And for the full year, NAPC, North American Property and Casualty, before our exited reinsurance operations, turned in a solid combined ratio of 96.5. This is 2.6 points better than last year.

The three ongoing segments, business insurance, personal lines, and specialty commercial, are growing well. Earned premium grew 13% due to positive pricing in most lines and new business growth and business insurance. We are an AA-rated national player in the property and casualty marketplace. And we're successfully executing our enterprise strategy of becoming a principal market for The Hartford's top independent agents.

New business in middle-market commercial was excellent in the fourth quarter, at $169 million. Pricing was again positive, with mid-single-digit increases in our fifth year of pricing increases. More importantly, margins continue to expand. For the full year, middle-market new business contributed over $635 million, up 33% over 2002. We have positive momentum going into 2004, and expect new business growth to be a good story for us. In select, we have a business strategy that will drive new business growth. We will leverage our business model, expanded field presence and solid reputation with our independent agents.

Our presence in the professional liability market generated strong growth, too, with full year up 36% to $324 million. Overall, speciality commercial remains a transactional business, and we're choosing the markets in which we want to write. Margin begin continues to be the number one priority in this segment.

Now, in personal lines, the rollout of our new class plan includes 33 states today. Our agency management is focusing early production in the most profitable states. I feel this is a positive emerging story for The Hartford. I also feel it is important to note that we ended the year by making a significant decision to settle our asbestos litigation with Western MacArthur. The settlement calls for The Hartford to pay $1.15 billion during the first quarter of 2004, in full and final satisfaction of all claims by MacArthur or asbestos claimants against MacArthur. Accepting this agreement, as you know, was very difficult, but absolutely the right thing to do.

Let me turn to slide eight. Business insurance here achieved a combined ratio of 92.4, excluding cats. We continue to consistently deliver a great performance. For the full year, ex-cats, the segment produced an excellent 93 combined, 3.2 points better than 2002. Personal lines reported a solid quarter. We had a combined ratio of 94.2 before cats, for the quarter, and 91.8 for the full year. The turnaround we predicted for 2003 did happen, and we have a solid plan to profitably grow this business in 2004 and beyond.

Specialties, combined at 92.5, excluding cats, was well below last year's fourth quarter. This segment reported a 97.6 combined for the year. Because we carefully choose the business, we're positioned for further success. Now, cats were moderate for us in the quarter, but on the high end of our 2.5 to 3-point guidance for the year.

Our full year expense ratio improved 1.5 points in our overall North American operations. We're really committed to maintain pressure on expenses and to further drive the ratio down. The actions we took in 2003 are an excellent start, but we will not let up until we have our expenses in line with the best in the industry.

Now I'm going to call on David Johnson to discuss some of our financial results.

Thank you, Ramani. I'll turn first to slide nine. This slide reconciles our reported quarterly net income to our operating income. For the fourth quarter, the only adjustment was for real life capital gains, adjusted for the new presentation of coupon income from non-qualifying derivatives.

Turn next to slide ten. This slide reconciles our reported full year net income to our adjusted operating performance. There are a few more items to be adjusted for the full year, but they are pretty much spelled out on this slide.

Turning to slide 11. We currently forecast 2004 operating EPS between $5.80 and $6.10 per share, a 10-cent increase at either end of the range from our last formal estimate at the beginning of December. What's changed? First, we lost 10 cents in P&C investment income due to the funding of the MacArthur settlement. The largest part of that money has already gone out the door, with the balance being paid this quarter. Second, our life unit continues to perform. This is the source of most of the increase. The most important new information is continued strong sales in December and January, plus nearly 90 points of appreciation in the S&P 500 from levels two months ago. And third, our confidence in our P&C outlook continues to strengthen.

During this period, we also concluded the CNA acquisition and its common stock financing. Now, that we've locked in those terms, one market risk is eliminated. Unfortunately, our common stock price appreciation is not completely good news. Our new estimate also incorporates increased dilution from our equity units, which begins when our stock price above $57. Between options and equity units, you can assume, as a rough rule of thumb, that we lose three cents of EPS for every $5 of stock price appreciation.

The rest of the assumptions that we provided on last quarter's call are still largely intact. A number of investors have suggested that by simply multiplying our fourth-quarter results by four, you establish an interesting baseline for our 2004 outlook. That's both right and wrong. We did gain confidence from the fourth quarter, and you can see that in our revised outlook. But some items in the fourth quarter cannot be assumed to repeat. Life mortality, for example, benefited from three favorable months in a row. And our loss ratio in group benefits was below trend. Together, those probably benefited us $8 to $10 million after tax in the fourth quarter. No actuary would tell you to assume that happens again. Nonetheless, it's great to be starting the year with the wind at our back and an improving outlook. Ramani?

Thank you, David. As I look forward to the next one to two years in the property and casualty industry, I believe the market should be a good one. We're seeing some increase in competitive activity, though. 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 still in place. Pricing and loss-cost spreads remain positive for us. Reinsurance markets are disciplined. In the asset accumulation business, demographic trends continue to work in our favor.

Aging boomers are focused on their retirement needs, and 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. And, finally, the credit cycle is improving. The substantial capital strain over the past few quarters caused by investment losses is mostly behind us, and the overall credit quality of our invested assets is excellent. And the interest rate environment should improve in the coming year as well. So, in closing, our outlook for 2004 is positive, and we're poised for profitable growth. Our market positions are strong, and our capital position has returned to levels at which we have much better operating flexibility than in the recent past.

So, I'm now going to invite Tom and Dave Zwiener and Dave Johnson and Neal Wolin to join me in answering your questions. Over to you, Operator.

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 keypad. We'll pause for just a moment to compile the Q-and-A roster. Your first question comes from Nigel Dally with Morgan Stanley.

Good morning, Nigel.

A couple of questions. First, just hoping to get more data on the rationale for the increase in the GMWB writeoff costs. Whether it's got anything to do with the cost of hedging, or what else was it that led you to that change? And second, the SEC made some comments earlier this week that it's going to aggressively investigate 1035 exchange activity in the variable annuity market. I was hoping just to get your views on what exactly they are investigating, and how it potentially could impact you.

Okay, let me call on Tom to address the GMW pricing.

Yeah, I'll start with the SEC read. I'm about at the same place as you are on this one, Nigel. I've just heard of it myself, so we'll have to wait and see. On the GMWB, we just felt it was prudent. Nothing has changed in our view of what the ultimate cost will be for the hedging. What we've done, essentially, is we just look at the demand for the product, and we feel going to 50 basis points will keep us in good position in the market. And obviously it improves the confidence interval which the scenarios will fully cost the-- cover the benefits provided. So we just thought it was prudent. And it seems to be well received in the market, so far. It's effective February 1, but we've been getting good feedback from our distribution partners.

Okay, great. Thanks. Just one follow-up on that. With the reinsurance, have you had any progress in finding appropriate reinsurance for the GMWB.

No, not yet. I continue to believe there is a market for someone. But it has not really come to light at this point. So, we'll keep talking to the reinsurers,but nothing big has developed yet.

Great. Thanks.

Your next questions comes from Jason Zucker of Fox-Pitt.

Good morning. Thank you.

Good morning, Jason

Just a couple of questions on Putnam. I was hoping you could tell us what the surrender rate on the Putnam assets were versus the other Hartford products. And then I was also hoping you could tell us the percent of Putnam assets that are currently in the surrender period.

Jason, I'm going to have Tom talk to you about that. We don't disclose surrender rates by product, but nevertheless, let me have Tom embellish on the question.

I'll give you, Jason, just a directional. From the Putnam normal run rate, remember it's a bit more of an aged book. It slightly more than doubled in the fourth quarter. And as Ramani mentioned in his comments, it has since come down from there, not back to its original, say, pre-October level, but it seems to be coming down. We just met with the management from Putnam. We feel they really are taking all of the steps necessary. And I expect that it will probably take time, but they are going to be players in a big way, and it's important for us to keep our partnership with them in that light.

Okay, and let me ask something that is somewhat related. Could you just give me a dollar figure for the variable annuity assets that now currently have the GMWB rider?

Yes, I think I can get you that. It's fairly small because, as you know, it's only been in the last couple of years, but we have about $11 billion that's fully reinsured and another $6 billion that's under our hedge program.

Right. Thanks, guys.

Thank you.

Your next question comes from Andrew Kligerman of UBS Securities

Two questions. First, I believe Ramani commented at the beginning that capital cushion is on track for $500 to $600 million by year end. Given that within your guidance you can earn about 1.7, what does that tell us about your capital position today? And then secondly, I was interested in the premium retention numbers on the business insurance and personal lines. They seem to have dipped down a fair amount in the fourth quarter. Is that a continuing trend? Or where do you expect that to go?

Andrew, Ramani. Let me have David Johnson address the capital cushion, and then I'm going to turn the premium retention issue over to Dave Zwiener.

Great.

As Ramani mentioned, we are doing well versus our goals of that amount of capital cushion by year-end '04. And I would say that if current trends, and assuming no exogenous changes in the markets or otherwise, we might get there by mid-year '04, as opposed to year-end '04. As you know, capital is very much a concept of the rating agencies and what they feel is appropriate, and that that largely arises from statutory earnings as opposed to GAAP. So, there's not an exact match between the earnings power. But, I think we will get there earlier, which indicates going forward we hopefully will have some excess capacity.

And Dave, would that imply a potential slight deficiency at this stage in the game? Or do you feel pretty --?

Andrew, potential what?

A deficiency in capital at this point in time.

No, no. Remember we-- as a matter of fact, one of the things that I've said to investors all along is I want to, given the events of the past three or four years, I want to really maintain a capital position that is able to absorb a couple of shocks. So from a rating agency standpoint, our ratings have been affirmed, as you know. This is really trying to maintain capital at levels that give us the capacity to absorb a couple of shocks. And in the past few years, you've seen shocks in both equity markets, as well as terrorism and other exogenous events.

Point well taken.

Thank you.

Andrew, hi, it's Dave Zwiener. Let me talk to the retention question you had. When you look at the gross numbers that we gave you on the supplement, PC-13, you do see a slight dip in both personal lines and business insurance. Let me break that down a little bit for you. On the personal line, we're still running in the mid to high 90's on the AARP program, and I think that's important. I think what we did see, as we were pushing a lot more pricing through on agency and Omni, a slight dip in the retention there. And that's really reflected in the overall numbers there in the mid- to high 80's. My guess is you're going to see that stabilize there and probably move up during the course of '04. We also-- I think you're aware of the fact we're rolling out our new class plan and agency, which is a six-month premium policy. And so that had some impact on the retention in personal lines as well. In BI, business insurance, generally I think I would probably attribute the slight dip to nothing really more than, again, pushing through some fairly aggressive rate increases. There too, my guess is that we're going to see that stabilize and move up in the first half of '04. Probably again getting back up to where you've traditionally seen that in sort of the mid to higher 80's.

Helpful. Thank you.

Your next question comes from Michelle Giordano of J.P. Morgan .

Good morning. Could you tell us if you've gotten any information back from the SEC or the New York Attorney General's office regarding the information you submitted to them on the market timing in the variable annuities, or if they've asked for any other information?. And then secondly, since the CNA deal has closed, could you give us an update on any kind of disruption that may be occurring and-- just looking at the reserves and the ability to renew the business? Any change in your views or anything positively or negatively surprising you?

Michelle, it's Tom. On the SEC series of questions, I would call that ongoing, and not on or off -- sort of ongoing. Relative to CNA, clearly we're delighted with what has happened so far. The integration teams are, on both sides, coming together well. We've made some key decisions relative to management-- sales management. Even the geographical locations we're going to operate in have already been communicated and are well underway. In terms of its effect on our organic business, both for them and us, we've made it clear that it's a priority to keep the sales engines going. We're not giving anyone a break on their expected sales targets because of this. And they're responding accordingly. So I think we're managing it extremely well. It is coming together extremely well also.

And then just for clarification, a separate new inquiry that the SEC is doing into variable annuities on 1035 exchanges-- is it just simply looking at 1035 exchanges or is it looking at just in general sales practices of variable annuities?

Hey, Michelle, Ramani. As Tom mentioned earlier, this is something we really don't know enough about to give you any clarification on. So, as we understand the issues we should be able to provide more clarification.

Okay, thank you.

Your next question comes from Alain Karaoglan of Deutsche Banc.

Good morning, Alain.

Vanessa and Alain.

Thank you, Vanessa.

First of all, on the life side could you talk a little bit about your outlook for spreads for 2004 and what you are expecting in terms of yield, and what kind of flexibility you have on crediting rates? And then Alain has a question.

Vanessa, you were cutting in and out.

I think I got it, though. Spreads and what flexibility we have on creditor rates. For our market value adjusted annuity, the spreads stay fairly stable because we price for yield to maturity at every two-week cycle. So we keep that relatively flat and we have total control of that. Regarding the fixed accounts generally, we've worked those rates down to pretty much the contract minimums, which is 1.5% in a lot of states now, and 3% in others. So there's probably not a lot of room for us to take those down too much. And where we can we will, but we've taken most of the action where we can. We've also reduced our PCA rate program, and that's going to help. Our six-month rate now is 5%. Our 12-month rate is all the way down to 3%. So that will actually help as we look forward.

And then the yield?

I don't have the yield. Obviously yields are down. I don't have that right in front of me right now.

Why don't we take that one offline?

Yeah.

Thank you. And then Alain has a question.

Good morning. A couple of questions. Could you discuss loss-cost trends by each of the segments? And business insurance rating is going to run 6% now. We're getting very close to-- I assume being very close to loss-cost trends. How should we look at that business going forward? What should we watch out for? And what are you watching out for to make sure that you're going to be disciplined? And will you be shrinking that business in the next year or two if the price increases remain on this trend? And then the second question is for Neal with respect to the ACNS recent decision with Travelers. Does that have any impact on other asbestos bankruptcy situations?

Alain, let me call on Neal to address the ACNS trend, and then David to talk about the business insurance pricing loss-cost spreads.

Alain, I think the ACNS decision is a hopeful signal for us and for other insurers, calling into question some of the arrangements that we've been talking about as being collusive and sort of not consistent with a clear understanding of the bankruptcy code. So I do think it has the potential to be something that will arrest the development of some of these more abusive asbestos bankruptcies, But, obviously it's just one opinion and we'll have to see how that plays out over time.

And on business insurance loss-cost pricing and our outlook going forward, I would say in general, we are more optimistic by the environment for business insurance, specifically in '04 than probably we were even two to four weeks ago. And I think that it reflects a couple of things. One, loss-cost trends which you mentioned have been favorable in '03, and looking at the fourth-quarter numbers, continue to be favorable. So that gives us a lot of confidence to reassert that the environment we expect to be in at least '04 and maybe beyond is where earned pricing in this business and all of our businesses will exceed the loss cost. That would be one comment. Secondly, to your question about remaining disciplined, obviously that's the core of what we do. But I would tell you our plans in '04 assume that we'll be growing at a pretty healthy clip. It would be, I would say, probably north of 15% in business insurance in total. And I think that what we see as an opportunity, in addition to extending our select product up into a larger capability there, we are also going to get true growth. In other words, I think that a lot of our growth has been pricing in business insurance over the past couple of years. We're seeing unit growth in both small and mid-market, and I think that that will be a bigger part of how we grow as we penetrate deeper into the agencies where we can bring the multi-product capability of not only business insurance, but personal lines. So I think I would give you a little more confidence in the environment we're going to be in for business insurance and personal lines because business insurance specifically is going to be a good one in '04 and maybe beyond.

Thank you.

Your next question comes from Jay Cohen of Merrill Lynch.

Yeah, thanks. Both Ed and I have some questions. I just have two pretty shorts ones. The first is the loss on the corporate side has jumped around a lot the last several quarters. What's a good run rate to use going forward? Was this quarter understated and the past couple of quarters overstated?

About $11 million a quarter would be a good run rate.

$11 million? Okay. And then more specifically, on the property and casualty side. Ramani, you had mentioned working on getting the expense ratio down. Are there any particular programs that you're pursuing at this point to do that?

Let me ask David to comment on that. As you know, David has really been communicating a consistent story here to the market. David do you want to--

Jay, just to reassert, we've committed ourselves to reducing the expense ratio, and I think you know the targets we set by the end of '05. We want to be below 26 for the total property and casualty company, and below 30 in commercial, and below 22 in personal lines. And I feel like we've made very good on-track progress in '03. So we're down three points over the last three years. And I think that we're very confident in getting down to the targets we set. I think what we're doing is a couple of things, one of which you'll see-- the actions we took in the second quarter of '03 in terms of headcount and some other things had a direct impact. Some of the things you don't see, which is really a shifting of costs, so although the cost doesn't move we're shifting more of our cost structure into the field, into the service, into the distribution. And so there's a lot of active movement within our cost structure. We're trying to variablize the costs a great deal more than we have in the past so that as we penetrate these markets, we can add costs. To the extent we don't see the opportunity or it moves away from us, we can take down the costs much more quickly without causing sort of the seismic effect that the second quarter had on the organization in '03. Also specifically we're taking a hard look at our claims operation. I think that we've got some real technology scale opportunities there over the next two years that are going to impact our cost numbers. So more than anything else, we're trying to build in a culture of always improving. But also looking at where we spend our money is in the right place. And that increasingly for us is going to be on the sales and service and distribution side.

This is Ed. I just have a couple quick questions. First, Tom, I was wondering if you could comment on what type of impact you think you're going to see from the price increase on the withdrawal benefit on VA sales? Do you think you could-- do you think production could be as high as we saw in '03? Or would you expect some decline? And then also, the impact of any new competition in Japan. You know, Manulife put out a release the other day about a relationship they've entered into with Bank of Tokyo Mitsubishi to sell individual annuities. And I'm just wondering, what are you seeing in terms of the competitive environment? Obviously that business has grown extremely rapidly here recently.

Clearly, the Japanese market is going to attract players. Manulife has been there, obviously, but they see the opportunity and that's a good account to land. BOTM is obviously a big seller already of variable annuities. In fact , we continue to list them as our number-one seller, and we expect that others are coming on, but there's a lot of great distribution opportunities. We think that market is going to grow in total. And so our 25% share that we currently have will obviously go down. But we think overall our sales will continue to increase nicely. Regarding the price increase in VA. Not so much because of that, but also-- I think competitors really playing much at the top of their game, we can't expect, as I've said before, to continue the torrid pace of '03. I will say-- remember the price change doesn't-- is not effective until February 1. So we are seeing a little bit of opportunistic buying to try to get in at the 35 basis points. So modestly, we're seeing some-- I call it front-loading of our first-quarter sales. But we're going to do fine. We are going to, I think, continue to have a solid market share. And we like the pricing change that we made. It's been well received. And I think we're going to do fine. But I don't think we'll keep at the levels of '03.

Tom, just to follow up on the Bank of Tokyo Mitsubishi, how much of your sales right now would be coming from that relationship?

I don't have that right in front of me. We don't have any real lopsided distribution of sales in Japan. We operate through broad distribution. So I don't have that, but it's not huge.

Thank you.

Your next question comes from Charles Gates of CSFB.

Good morning, Charles .

Hey, good morning. I think Tom Gallagher is going to ask questions after I. The bottom line-- I have two questions. My first question, could you-- one of you made reference to the fact that I think you saw increased competition in small and medium-size commercial lines risk. If you could elaborate on that. That's my first question. And then if I just give you the second one. My second one was, I think, Mr. Ayer in your opening comments, you made reference to the fact that it was your plan to-- or you were outpacing the competition in various areas. If you could speak to that with regard to the property and casualty business. So, those are my two questions.

Let me-- on the property and casualty, very specifically the areas where we are outpacing is principally in the middle market business that I commented on in terms of numbers. But let me have David expand on the issue of where we see competition emerging. We don't take competitors' names on the call. But I want David to give you some color on what is going on in the small business and middle market business in the marketplace.

Charles,just to make sure, that was your question-- you really wanted some color on the competitive environment?

Yes sir. Just elaborate. You had the guys at Gallagher saying yesterday in the small commercial lines market that it was flattening out. I believe that was their expression. Simply if you could elaborate on what you see, given the comment that one of you made.

Yeah, fine. I think if I had to characterize it, separating small to medium, we're seeing more competition in the small area. And not only from all the recognized national players but some of the strong regional players. Having said that, I think that we're seeing a real opportunity for a company like The Hartford to get an increased share over the next 12 to 24 months. Because the gain, as we've talked about before, is shifting very much to a technology-based product and very much to a service-oriented product, which is really what we compete on. Two, I think, to the Gallagher comment and maybe some others about the slowing growth, organic growth among the distribution-- that gives us an advantage because we penetrate some of the larger brokers and agents in the U.S. much more deeply than others. And it gives us the opportunity, really, to grow more rapidly with them. So I feel, although there is increased competition, the basis on which competition will occur actually favors our business model going into this next 12 to 24-month period. Probably echo those comments on the mid-market side, although we see less of the regionals there, more of the national players. There, too, I think where we're really levering is not only the product capability we've already demonstrated with the results we have, but the ability to grow and the ability to penetrate more deeply into these big agents and brokers who we see as probably entering a period of consolidation. I think that, particularly those of them that are publicly traded and looking to drive growth and organic growth slowing. I think you're going to see them move more aggressively into some consolidation activities, which again plays to our business model very favorably.

A few other things, Charles. David, you may want to comment on how you're expanding the small business product, too.

Well, I think we've mentioned on previous calls that we are expanding our select offering into a larger underwriting up to a larger size capability And really what it does is it provides a seamless proposition from small through this upper end of small, which we're calling select expand. Up into the mid-market. And so it really-- you should think about the standard commercial market in the U.S. it is roughly about $100 billion market, we'd estimate. The small end or the select end would be about 30, and the mid-market maybe 40. But in the middle there is something that we've really not actively attacked. That market represents about a $30 billion market. So we think that you're going to see a lot of growth, at least in our business insurance, as we now have the product capability and underwriting capability to attack that sort of middle part of the standard commercial market in the U.S.

Tom Gallagher has some questions I believe.

Yeah, two annuity-related questions. The first is the increased GMWB charge. Can you just comment on where some of your peers are right now from a pricing standpoint? Are there a number of peers currently below the 50 basis points?

There are. But this won't make us the highest. So I think we'll be right in the pack with this change. Then you have to look at-- the benefits vary. So you really need to look at it as the package, the benefit and the price. We believe that at $50, given the demand we've seen, we're going to do fine. With the combination of the benefit and the price, we think it's where it will play well in the market.

Okay, and then just a question on your [inaudible]. I notice it went down considerably, about 40%. Yet the S&P was only up about 11.5%. Was this related to the surrenders, particularly in the Putnam product, or was there something else at work there?

No, it's not going to be linear the way it goes down. Obviously it's a function of the market. The surrenders really didn't materially impact it. So it was just good markets meant more of the death benefits went-- they either were reduced or some went to the point where they are out of the money.

As a matter of fact, as markets improve you're going to see that the amount of risk will keep declining. Which is the whole nature of this product.

Okay. Thanks.

Your next question comes from Liz Werner of Sandler O'Neill. Ma'am, if you are on a speakerphone, please pick up the handset before asking your question.

Sorry about that. I had a couple of quick questions. On the group benefits area, I was wondering if you saw anything in the quarter that would lead you to believe that the benefits ratio might be at the low end. I think your targeted range is 78 to 80%. Or if you still feel comfortable with that range? I didn't know if there is anything in particular that was unusual in the quarter or if you just feel that the maybe the claims trends are improving overall. And then, secondly, I was hoping Tom might comment just on his view of the variable annuity market growth for this year. And just for the industry overall. Because I obviously see a lot of growth coming from withdrawal benefit and everybody has a withdrawal benefit. But it just seems as though that's something that could continue to capture assets. I just wondered if you had a view on growth. And I also wanted to know what percentage of variable assets are coming from things like 401(k) and IRA rollovers.

We're getting about 60% coming in from the qualified market. Now, Liz, on the GBD loss cost, I think it was a good quarter obviously. And I think we've said 78 to 80. Maybe now we might say 77 to 79. But it was a good quarter. And I think you had one other-- oh, just the market. VA, what it will do? Yeah, we expect it to grow. I think the industry is poised to do well in these market conditions. I think the benefits that have been provided are attractive. I think the whole industry is going to have a good year.

Okay. Thank you.

Your next question comes from Ron Frank of Smith Barney.

Good morning. My question related to, one to the P&C business, really primarily-- it looks like, and we saw this pattern at other companies too, that you eased off on adding to reserves for the business insurance and speciality commercial segments in the fourth quarter. Is that a function of basically having held the reserves for most of the year and then seeing favorable development on some of the short-tail business? Or is there something else at work there?

Eased off on adding to reserves?

Well the paid-to-incurred was for both--was considerably higher than it was for the full year, Ramani, and it didn't look like anything ominous. I was just curious as to whether in fourth quarter there was a reassess on the accident year and an adjustment of the pick.

All I can say to you is from an accident-year standpoint, we continue to be doing very well. So, I don't see any fundamental issues here.

There may be seasonality there as well, Ron, that normally you've got some heavier than the fourth quarter. But there's nothing else going on there.

Okay, I wasn't suggesting an issue so much as a suggestion that perhaps your view of the accident year changed for the good in the quarter. But it seems like the answer is no.

No significant change. No, sir.

Okay, thanks.

Your next question comes from Joan Zief of Goldman Sachs.

Thank you. Good morning. I have two questions. First,,on the variable annuity market, do you think that we're seeing a shift in the balance of power to product features rather than broad distribution reach? So that's my first question. And my second question is about price sensitivity in your mutual funds, or for your mutual fund and variable annuity. We see talk about these mutual fund companies lowering fees. And do you think that pricing is going to be more of an issue in selling your product. Or is this just something that policyholders continue to ignore?

Hi, Joan. This is Tom Marra. First on the annuity market. Obviously the features are gaining attraction. But they're not running the market. You really have to have the scale, the distribution, the technology investments to make a market. It's not one that you can have one piece of the puzzle and run the table. You need to have everything. And I continue to rank distribution as probably the number one most-important thing in terms of success there. In terms of price sensitivity, we've seen a couple of mutual funds that have reduced fees. I don't think that is going to be followed by the masses. I think price will continue to be important and both of these markets will continue to play in the range where we're priced attractively. But I don't think that we're seeing the beginnings of a price war.

Okay. Thanks.

Your next question comes from Michael Lewis of UBS.

Good morning. This is basically a more philosophical question, Ramani. What do you think the Travelers/St. Paul ramifications are going to be on your property and casualty book of business, either positive or negative? And does it change your thinking towards the business going forward in any way?

You know, I'll invite David to comments on this too. My own view is it takes one competitor out. And so we believe that it naturally benefits us. Simultaneously, you should also be thinking that there's a lot of regional players who are in financial straits and it continues to give us an opportunity to consolidate. The stronger are getting stronger and we certainly believe this is a trend in that direction. They will be a great competitor. We respect Travelers a great deal. And we look forward to competing with them.

I would second all of that. I think from my perspective, Michael, obviously it's not an issue with regard to the personal lines business. I think the real action in the marketplace from our perspective is going to more in the business insurance. And I think in the near term it presents an opportunity for us, as I think, as Ramani said, we have a lot of respect for not only who they are, but how I'm sure they'll move through this difficult transition. But it does distract their attention. And, too, it will force them to really think about concentrations they have which presents some opportunities for us. At the same time, I think distribution is thinking about concentration. So obviously we're focused on that short-term opportunity. Longer term, I think the jury is out as to whether or not this provides any increment of advantage for them from a scaled perspective or a national distribution perspective that would put us at any sort of disadvantage. I do think, talking to our distribution partners, many of whom are partners with Travelers and St. Paul, that it has created some concern about-- obviously it's one less quality provider out there. And so I think that it may be a net-net positive for both institutions where the flight to quality or the flight to size is happening inevitably. And it is forcing more of the business to go into the larger hands. Which I think long-term is an advantage for both of us.

Thanks very much.

Yeah, you bet.

Your next question comes from Ira Zuckerman of Nutmeg Securities.

Ramani, you said that you're trying to build up a $500 million cushion this year. What does that say as to your appetite for acquisitions, either with books of business or companies? And what would you be looking at at this juncture.

Thank you, Ira. As always, we have commented in terms of acquisitions. It has to meet our internal rate of returns targets. Secondly, it's got to be accretive in the first full year. We're very committed to that. And as our latest with CNA, I think Tom commented that at one point we expected to be about three cents accretive in '04 and probably twice that in '05. That's a standard I just want to hold in terms of accretion. The second thing I would also say is we continue to look at opportunities. There are opportunities. Smaller to midsized players. But invariably where we feel reluctant is balance sheet issues or the nature and the quality of the book of business. We have seen several of those. As long as the book is appealing, we're willing to consider acquisitions, because in the long run we believe there is an opportunity to grow this franchise, not only organically but selectively from an acquisition standpoint. The capital cushion-- I just want to keep reinforcing a point. The last three years has really caused us to consider building capital strength in the direction of not only supporting our growth, but making sure that we have an ability to absorb a couple of shocks. And that's something we have leveled with the rating agencies on and that's one I'm very committed to.

What areas do you think are most attractive at this juncture that you would be focusing on?

We believe in the investment products arena, we just have enormous organic growth capability. We don't really see the need to do anything there. You saw us adding in group benefits. We also believe in property and casualty and the personal small business. And we're willing consolidaters in the right markets.

Okay. Thank you, Ramani.

Our next questions comes from Eric Berg of Lehman Brothers.

Thanks, and good morning. I have a couple of questions regarding the GMWB of Principal First. My first question is, what is the basis for your comment that the hedge is working? Because after all, the stock market went up pretty much straight in the December quarter. So I don't think there was a chance for these options-- certainly for the options to go deeply into the money, I don't think, if I understand the hedging strategy correctly. And relatedly, my second question is-- it just strikes me as curious -- I've certainly heard the answer before. But it just me as curious that as recently as five weeks ago, you thought Principal First was properly priced. Now, let's call it six or seven weeks, I should say, after your investor day, you're raising the price 50%. I'm saying to myself, something must have happened. Someone must have woken up and said we need to charge a lot more. I'm done.

Okay, I'm going to turn it over to Liz [inaudible] in a minute, because she can dig deeper into the GMWB hedge costs . But no, nothing's changed. Our view of what the hedging costs will be have not changed. Just as we look at the demand out there, and the take rates that we've been getting, we think we made a good move. We can go to 50 basis points, cover more scenarios, and the market will like it. Relative to what happens in an up market, remember, we're trying to have the assets, meaning the derivative instruments, change in the same direction that the liabilities change. And I'll have Liz give you more color on that.

Eric, I would second Tom's comment. The whole point of hedging is that as the assets move, whether they go up or down. As the liability moves up or down, the assets move in correlation to that. We look at our hedging program and say it's effective when the difference between those two changes is minimal. In the fourth quarter, the difference for the hedge piece was about a $.5 million. Admittedly, had we not been hedged we would have made money, because the markets went up. But we're not in here to make money on a hedged portfolio. We're in here to make the hedge work effectively. We think it is showing that it is doing that. We talked last night about some of the other changes related to the fact that we weren't hedging the international markets, and we're all set and are hedging that now.

Indeed. I understand your answer. I'll certainly circle back to you. But thank you, that's very helpful.

Eric, one other thought-- I just want to keep reminding investors, as Tom was saying, the increased price actually covers a wider universe of scenarios. And that is something we care deeply about.

Thank you.

Your next question comes from Bob Glasspiegel of Langen McAlenney.

Good morning. Tom, again congratulations on getting the 48 basis points of margin in your annuity business. I'm sure you're going to say that's too high for '04. But just some general guidance on what you're thinking in terms of '04 in a more favorable market.

I thought you'd have a Different question, Bob.

Is that right?

Just kidding. This is Ramani.

Thank you. Two, the second question is Japan. Was that the $6 million swing in other life in the quarter? I know you're going to start breaking that out soon. I guess I've asked that questions a few times as well.

It was a big part of it, Bob. This is Tom. But no, we're not yet ready to break it out. If we keep growing the way we will, it will come soon enough. But, obviously we're making money, and that obviously helped that segment. I'm now in the 45 range. I just looked at the last few quarters. This is the return on assets expectation for our annuity book. And I think we've gotten the expense ratio down well enough. We see a pretty good run rate in terms of the net flows. And the expenses are being managed appropriately. So now, I'm kind of thinking 45 is a pretty good range to look at.

Tom, you might just want to add a comment on how you held staffing fairly level. It was a very good story.

I think John Walters and his team have done an extraordinary job of just-- while the market was growing, our business was booming. Transaction counts were up well into double digits. We actually ended the year with three fewer people in the division than we started. Which is pretty impressive. Obviously the technology has been employed very well. And is very powerful in allowing us to keep our manpower at these low levels.

Thank you.

Operator, I'm going to have to bring the call to a close. I believe we have overstayed our visit here. I really want to thank you all for joining us today. I'm really proud of my team and all of our accomplishments this quarter and throughout the year. Our revenues are growing and execution is strong across the board. This is a time of great opportunity for us, and our position is well thought out. And the outlook for The Hartford in 2004 is bright. I know you've heard me say this before, but I really believe we have a special franchise. I want to thank you again and have a good year.

This concludes today's conference call. You may now disconnect.