Hartford Insurance Group Inc (HIG) 2004 Q1 法說會逐字稿

Good morning. My name is Shayla and I'll be your conference facilitator today. At this time, I would like to welcome everyone to the Hartford Financial Services quarterly conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer period. If you would like to ask a question during this time, simply press star then the number 1 on your telephone key pad. If you would like to withdraw your question, press the pound key. I would now like to turn the call over to Mr. Hans Miller. Please go ahead, sir.

Good morning. Thank you for joining us today. Please note that our financial supplement is available on our web site at TheHartford.com. Participating in the call will be Ramani Ayer, the Chairman and CEO, David Johnson, CFO, Dave Zwiener, Chief Operating Officer of our PNC company, and Tom Marra, Chief Operating Officer of our Life Company, and Neal Wolin, General Council of The Hartford. After the presentation, we'll go right into the question and answer session. This quarter we've made some changes, improvements we think to our disclosures. Briefly, I'll highlight the most significant changes.

First, we have reviewed our line of business segments breaking out retail from institutional products on the life side and integrating our assumed reinsurance runoff into the other operations PNC segment. Second, our financial supplement reflects implementation of the life SOP 0301. Finally, with several changes to prior year premium and lost reserves in the quarter, we have introduced expanded disclosure in our supplement to describe these actions. That disclosure is summarized in a slide Ramani will cover shortly. The complete slide presentation for today's call is available on our web site at TheHartford.com.

We'll make certain statements during the 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 10(Q) filed yesterday and our publicly available documents filed with the S.E.C.

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 including financial measures that are not derived from generally-accepted accounting principles. Information regarding these nonGAAP financial measures is available for review in the investor relations section of the Hartford's web site at 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 for joining us today. I'm going to briefly cover the operating highlights of our quarter and then turn the call over to our CFO, David Johnson for some financial comments on the quarter and our guidance for 2004. We had a great quarter. The Hartford has really performed well in what has been a very positive industry environment. Both our life and property casualty companies grew in the areas we have targeted and generated very good operating margins.

In our businesses all continue to strengthen their positions in the marketplace. We're working hard to strengthen our presence in 401(K), personal lines, future funds and Japan. The Hartford reported year-over-year double digit growth in top line in assets in management. Net income reached $568 million. And from our reported loss in the same quarter last year, diluted EPS hit $1.93 on a net income basis this quarter. And operating income EPS hit $1.70.

Our previous record diluted record operating EPS was $1.52 in the fourth quarter of last year. Both our life and property casualty operations produced record first quarter operating income. Operating income, as you know, is a non-GAAP metric. Stockholders' equity exclusive of AOCI increased 9% to $11.4 billion from $10.4 billion at the end of '03. And book value XAOCI now stands at 38.97 up 6% sequentially. Because of our strong operating results, and improving equity markets, I'm pleased to report that we have been successful in achieving a capital cushion of approximately $600 million.

Corresponding to our view a year ago of the potential impact of two external shocks. While we're gratified in achieving this cushion, our task for the balance of the year is to further ensure our capital strength. Assuming our position continues to improve into '05, that would be the time to raise questions about alternative capital use. At the same time, as we're building the cushion, we actively deleveraged the balance sheet while our debt to total cap now -- total cap ratio excluding AOCI dropped from 30.5 to 26.6. And for this calculation, 25% of our outstanding equity units count as debt. Also we prefunded another $300 million to our pension plan last month.

And finally, as we conclude the overview, I want to update you on regulatory activity relating to mutual funds and other investment products. Since you all follow The Hartford closely, you'll see a section in our 10(Q) describing the regulatory requests we've received to date. In addition to the ongoing SEC compliance examination that we have discussed in our filings previously, the SEC has begun an investigation of the company's variable annuity and mutual fund operations.

We're cooperating fully with the regulators. And as you know, we support the efforts of regulators to move toward an industry which provides greater transparency and clarity and ultimately gives investors greater confidence in our products. So, now I want to cover the highlights of The Hartford's life and property casualty operations. If you go to slide 4, I would say that we continue to be very pleased with the outstanding execution at Hartford Life. This quarter, our life operation, again reported record earnings sales -- record earnings and sales in most businesses.

Total annuity sales of $4.7 billion and variable annuity sales of $4.6 billion were records. VA sales were up 12% over strong fourth quarter 2003 sales and 33% over the first quarter of '03. Demand for the product remains strong, despite raising the price on our principal first rider from 35 to 55 basis points. Net flows remain very strong. I'm very proud to report that our individual annuity expenses have dropped below 20 basis points for the first time, coming in at 18 -- 18.5 basis points.

This expense advantage is one of several reasons why we continue to be a strong force in this market. The hedging program that we put in place to reduce the volatility in our annuity products performed within expectations this quarter. As you know, this is a critical part of our overall risk management. Our strategies to maintain our annuity leadership while leveraging the market position to grow our strong life businesses.

We produce significant sales in almost all areas. In annuities, and in 401(K) products and in mutual funds, group benefits and individual life. All of these areas, sales were up in most cases by significant double digit increases. I would like to highlight the nearly $2 billion of mutual fund sales in the quarter. So let's go into more detail on some of the results in our other important businesses. First, in group benefits, revenues exceeded $1 billion for the first time and we achieved an excellent 38% earnings growth.

This was driven both by a double digit increase in our core business and the addition of CNA's group benefit earnings. We remain very pleased with the progress on integration of the two businesses. Second, individual life reported another quarter of sales growth with first quarter sales up 31% over the prior year period. This is really our best first quarter ever. Operating earnings rose 6% over a year ago. Although sequentially profits were down.

Fourth quarter results had been aided by favorable mortality as you know. The first quarter was a bit higher than trend but the two quarters taken together were at a good level. Our universal and whole life products are doing well. They delivered $24 million in quarterly sales. More than twice last year's level. Our new and innovative quantum product is being well-received by our distribution partners. VL sales were steady and we remain number one in the market.

Third, Hartford life Japan. Hartford Life Japan sales were excellent at $1.4 billion in the quarter. Our first quarter is typically strong as it is the fiscal year end of Japan. Driven by the outstanding sales and appreciating markets, our assets in the management grew $1.9 billion in the quarter. We're now $8.1 billion in assets. We continue to diversify our distribution. And service levels remain great. Now, slide five displays strength in our VA sales plus the growing presence of our other retail investment products.

Total sales and deposits rose almost 14% sequentially and 55% year-over-year. This breaks last quarter's record for us. Our VA products were number one in the marketplace. Our share will exceed 13% while total industry VA sales will approach their record first quarter of 2000 levels. We continue to work actively with reinsurers around our variable annuity benefits. During the quarter, we secured additional reinsurance for our GMDB guarantees bringing reinsurance on new business to approximately 50%.

Now, we have told you in the past that we were also exploring reinsurance options for GMWB. At some is point, we expect capacity to emerge in this area but still believe that this is going to take some time. I mentioned that our GMWB hedging performed well in the quarter. For several quarters, we have told you that we don't expect to sustain the pace of VA sales at levels of $4.3 and now $4.7 billion a quarter.

I must tell you that our view still is that we should expect some slowdown as more competitors enter the market. With recently-announced new product launches by our competition, 14 of the top 15 brokers sold retail companies based on sales will offer a withdrawal benefit. Mutual fund sales grew 19% from the prior quarter and more than double last year. With this growing momentum in our targeted national advertising over the past few months, we expect our presence in the mutual funds market should continue to build. First quarter sales in 401(K) were up 50% year-over-year.

We're virtually at our goal of 80 retirement plan specialists up from 50 a year ago and considerably ahead of schedule. We view this as a growth business and we feel we'll get a great return from this investment in human capital. Turning to slide six, let me offer a few thoughts on net flows and retail and institutional products which came in at $3.9 billion. Mutual funds are contributing an increasing proportion of retail products net flows. Adding over a billion dollars in the quarter.

Regarding variable annuity surrenders, although we saw a $2 billion number in the first quarter, that is well within our pricing assumption. Putnam surrenders decreased as expected from last quarter. But they're somewhat above prefourth quarter levels. In addition, in the institutional solutions group, sales were solid in governmental programs and private placement life insurance. In the institutional products line of business, sales tend to be lumpy.

And the relatively flat sales year-over-year did not indicate a trend. Flows are satisfactory at about $200 million. Sales of private placement life were almost double last year's first quarter and up 46% over last quarter. All of this contributed to positive net flow. So, now let me turn to property casualty highlights starting on slide seven. Our property casualty operations, again reported record operating income of $297 million. This is up 42% from a year ago, excluding the asbestos charge. More significantly, it is up 32% sequentially.

Our own going property casualty operations benefited from continued favorable loss trends and strong execution. Ongoing operations delivered a combined ratio of 89.8. This included several items related to prior periods which improve the overall combined ratio by about .8 points. So, we're looking at about 90.6 as representative of current operating performance.

I will go over this in more detail later. Now, the three ongoing segments, business insurance, personal lines and specialty commercial are growing well. A year ago, our North American property casualty book included our assumed reinsurance segment. We have since exited this business. In the first quarter of '03, assumed reinsurance generated $274 million of premiums for us.

Equivalent to almost 11% of our premiums. So, I would say that in one year, we've been able to virtually replace that premium and in subsequent quarters, comparisons will become a lot easier. Turning to our ongoing operations, in business insurance, we had growth of 15% written premiums with price increases of 4%. The state approvals of our select expand product have been completed as of the first quarter. And we have begun to roll out the technology supporting the product which will be completed by the end of this year.

Personal lines premium is up 9% for the segment as a whole. What that number masks is a continued double digit growth at ARP and 13% growth in our agency business. In personal lines, price increases were 4% in auto and 10% in homeowners. Bottom line is we're very excited about our opportunity to profitably grow these businesses. We now have introduced our personal lines dimensions product in 34 states and just began the roll-out of dimensions homeowners in the first quarter.

Our specialty commercials segment, which we have consistently characterized as transactional, grew premiums by 5% with declining premiums in large property accounts offset by 20% growth in professional liability written premiums. Please turn to slide 8. In the first quarter, we completed studies of several developing trends we have monitored for a while. We observed that these trends had positive and negative attributes. Now, the key take away I would like you to have is that these actions reflect no overall change in our reserve strength.

Our detailed disclosure today about these actions reflects our continuing commitment to increasing disclosure. Now, the first and most important of these actions is regarding our reserve for losses suffered in the September 11th attack. In aggregate, we're advising our gross loss estimate to approximately $850 million from $1.1 billion.

The drivers for that reduction include that fact we have recently passed a number of key milestones such as statutes of limitation and a very high participation rate in the September 11th victims fund. Now, while the loss nation suffered on September 11th was massive and while the total loss of The Hartford was substantial, it did develop favorably from our original estimate.

Why? Remember at the time, there was tremendous uncertainty on the number of workers comp injuries both physical injury and stress-related claims. The potential for litigation, general liability exposure and the degree to which the global reinsurance industry would be overwhelmed by catastrophic claims. Now we contemplated each of the possible scenarios in our estimate and tried to conservatively provide for them. Some of the larger potential negative developments did not occur.

Accordingly, we've released $395 million of net reserves. And nonetheless, going forward, our reserves at $430 million, will still include roughly $225 million of gross IBNR for future claims that may arise from this event. We've also been monitoring developments associated with construction defect claims. These claims relate primarily to business we wrote in the early to mid '90s. We've been closely monitoring and evaluating these reserves for some time.

And using our predictive models, we concluded these trends were valid and have booked an increase of $190 million as a result. And combined with a true offer for premium reserve for retro rate of policies, the total impact of prior period development for the quarter is $9 million pretax in our ongoing operations. And finally, we're booking further negative development and assumed reinsurance, now part of our other operations segment. We have commented on the uncertainty and assumed reinsurance for some time now. And with the passage of time, we have been able to better establish the lost position. All of this is displayed clearly on slide 8 for you. Now on slide 9, we outlined the combined ratios of the ongoing property casualty operations. As there were a few moving parts this quarter, we chose to display the combined ratios excluding the impact of prior period and CAT loss development. I've shared with you the impact of WTC development on CATs.

I should also note that nonWTC CATs in the quarter were well below trend at $33 million. And that's before tax. Our ongoing operations continue to improve. The combined ratio X CATs in prior period adjustments is 89.0 which compares favorably to last year's 93.8. In prior calls, we have outlined our 2005 goals of achieving a 30% expense ratio in business insurance and 22% in personal lines.

In the quarter, and before this earned premium adjustment I spoke to for prior years, our overall expense ratio for the quarter is flat at 26.2. We continue to invest in growth initiatives while emphasizing the need to be cost competitive. So, now I'm going to ask David Johnson to discuss some financial issues. David?

Thank you, Ramani. I'll turn first to slide 10. This slide reconciles our reported quarterly net income to our adjusted operating performance. Realized capital gains moved to a pretax gain of $144 million. $95 million after tax from last year's loss position. That is split almost evenly between PNC and life.

The net cumulative effect of accounting changes in the quarter which was from SOP 0301 was a charge of $23 million after tax and that's in line with our previous estimates. EPS was quite strong. At $1.93 net and $1.07 operating which takes me to slide 11. We currently forecast 2004 EPS excluding realized gains and losses in cumulative affected adjustments to be between $6.30 and $6.60 per fully diluted share. At the 50 cent increase at either end of the range from our last estimate at the end of January.

This, of course, makes no assumption about unusual or unanticipated items that may occur during the balance of the year. Why 50 cents? First, we had an outstanding first quarter. These results were ahead of our expectations and they directly boost our estimated year-end results.

Second, our new outlook assumes that some but not all of the positive developments we saw in the first quarter will recur. Let me list some of those things and whether we assume we'll see them again. CATs. Our outlook assumes normal catastrophe levels. In the first quarter as Ramani mentioned, we experienced very low CATs. And we don't assume this will occur.

Variable annuities. Quick pickup in the equity markets and better than expected net flows boosted our first quarter. While we are assuming net flows moderate for the balance of the year, our strong start means results in this line should exceed our expectations for the balance of the year by about the same amount on an absolute basis, not percentage that they did in the first quarter. This, of course, assumes steadily growing equity markets and could change completely with a very sudden market movement.

PNC loss costs. We're assuming that some but not all of the positive underwriting results we saw in the first quarter persist for the balance of the year. Our most important assumption is that favorable lost cost trends we saw in the first quarter trail off through the balance of the year. When we originally forecasted 2004, we assumed '03's favorable lost cost trends would not continue fully this year.

So, thank you, David. Now, as I look forward in the PNC industry, I still believe the market should be a good one. We're seeing some increases in competitive activity around the country. I do want to highlight though that we're able to underwrite our way here in this market and to get the price we need and also grow in the market today. At the same time, many favorable trends are still in place. Pricing and lost cost spreads for us remain positive, for example.

In the asset accumulation business, our products, service and distribution respond to significant demographic trends. Our focus is to serve these needs and grow 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 several quarters caused by investment losses is behind us.

And the overall credit quality of our invested assets is excellent. The interest rate environment for us should improve in the coming year as well. We view rising rates as a positive for our businesses. Our fixed annuity sales will increase significantly if rates rise and at favorable spreads. And our PNC net investment income will increase, too, to name two positives. So, in closing, our outlook for 2004 is cautiously optimistic. 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 want to turn it over to you now and would be delighted to take your questions at this point.

At this time, I would like to remind everyone in order to ask a question, please press star then the number 1 on your telephone key pad. We'll pause for just a moment to compile the Q&A roster. Thank you. Your first question comes from Nigel Dally of Morgan Stanley.

Great. Thank you. Good morning.

Good morning, Nigel.

First, on -- for annuities. You obviously had a great sales quarter. But in the past, I mean the industry has been doing well, it has made competition to heat up and for more aggressive features to be introduced. So I was hoping you could discuss your overall view on the competitor conditions and whether you're seeing irrational product introductions or behavior by your competitors. Second, just on the capital side, now that you've built your capital cushion, hoping you can provide with us guidance on how much excess capital you expect to be generating. Thanks.

I'm going to turn, Nigel -- I'm going to have Tom address the VA question first but I want you to one more time notice that for the first time, our VA expenses, operating expenses are below 20 BBs which I believe is the lowest at the industry, so at 18. Let me turn it over to Tom to address the VA questions then David Johnson is going to talk to the capital issue.

Nigel, thanks. This is Tom. Clearly, we were very pleased with the first quarter. Record $4.6 billion. As Ramani did mention, our success with the withdrawal benefit has attracted just about everybody. As Ramani reported, 14 of the 15 top sellers of VAs will now have that benefit.

So, I know I've done this before but I'm sort of guiding a little bit down from the current sales rate. Although I will say that I think our market position will continue to be very strong. I don't think we're likely to repeat $4.6 billion for the remaining three quarters of the year. But it is a good spot to be in. And both the director product and the leaders product are at full strength.

David -- I mean, Tom, Nigel's other question was about the pricing rationality in the market. How do you see that?

We're seeing a bit of leapfrog development on the GMWB. We raised our price from 35 to 50. That has not materially dampened sales. So, we would like to stay where we are. There have been some new twists to the feature but we're going to stay path.

Dave, do you want to take the capital question?

Sure. Good morning, Nigel. On excess capital, obviously capital is a difficult thing to forecast. Statutory results are more volatile than GAAP. And what is excess capital is very much in the eyes of the rating agencies and they all wear slightly different glasses.

That being said, for the balance of the year, we would hope to be in the position to generate say half a billion dollars of excess capital beyond what is needed to fund our business. There is a lot of variability in that. We plan to use $200 million of that to retire debt in June. Which, you know, should leave us a few hundred million above our needs for the balance of the year. So, you know, it is nice to be in surplus but it is not wildly in surplus.

The other point, Nigel, I would add, is that, you know, our strategy is to continually delever the company some more. This helps us think conservatively about both correlated terrorism and equity market risks and, you know, I'm very proud of where we have gotten to with the capital cushion but I believe that is an important attribute to how we want to think about capital going forward.

So, I guess when we look at the excess capital, it is going to be deleveraging the balance sheet as a first priority. Would the second priority be stock repurchase or would it be acquisitions?

This would be a question for 2005. Anything related to deployment away from the business should be a question for 2005, Nigel. That's what we have said consistently to shareholders.

That's great. Thank you.

You next question comes from Eric Bert of Lehman Brothers.

Good morning and thank you. Good morning to everyone. I have a question about your mutual fund business which also seems to be doing just great. You have had a mutual fund business for several years, indeed for as long as I can remember. You've had had deep and broad distribution for as long as I can remember. Yet the business is taking off. My question, what are you doing different?

There are a lot of things that we're doing different and exciting. I want to have Tom address it. I just want to point out one thing. Our mutual fund business commenced substantially later than our annuity business. I hope you have that understanding. We started sometime in '97. Let me have Tom cover all of the exciting things that are going on in the mutual fund business.

Thanks, Eric. Yeah, our mutual fund business did start in the summer of '96. So, in the big scheme of things, we're relatively new player. But we made a determination about a year ago that it was time that we put more resources to it. Add wholesalers, in fact, wire house wholesalers are specifically dedicated to just mutual funds so they don't carry the variable annuities anymore. We've put a lot of our advertising dollars into our mutual fund effort. In a partnership with the NCAA. And we've just been expanding the products. We have great fixed income product as well as equity. And a few of our offerings are doing well, performance across the board has been much better than average. And we've now got a depth and breadth of the portfolio so we can really fill out the "Morningstar" boxes. So, I think as we put more emphasis on it and have built the product out, we're becoming accepted as a credible player and I think the results speak for themselves there.

Ok. If I could follow up with a quick question on the GMWB and it is why are you, you know, given the losses that have been suffered by others in GMWB and the absence of reinsurance capacity or the withdrawal of reinsurance capacity, why are you so hopeful that it is going to emerge? I mean, isn't it possible that the reason we don't have reinsurance at present is that reinsurers view this as a very difficult to hedge and just sort of menacing risk? Isn't the market making comment to us about the GMWB?

Eric, this is Tom. I think the hedging is emerging. You recall, we started our program late summer, early fall of last year. And it is pretty robust and I think it is just emerging to the point where people are realizing how effective it can be. In terms of reinsurers' appetite, it is true it has not emerged quite yet but we have active discussions going with many where they're seeing the strength of the hedging and I am not going to predict it will open up any time soon. We'll keep those communication lines open. In the meantime, we're happy with the protection it affords us in terms of our own book and particularly moving the price we charge up to 50 basis points. It is working quite well for us in the 50 basis points obviously enhances our margin. So, we're pleased with it. But we'll continue to work with the reinsurers and hopefully we'll see something open up sometime.

I'm not sure what he is referring to. What you're referring to, Eric, in terms of losses.

The losses incurred in the guaranteed VA were really on the death benefit side. Not really the withdrawal benefit side.

I don't know if you recall, GMWB as it is presently structured, was really an innovation that came out from Hartford life's product design.

No. You're absolutely right. I should have clarified that it was indeed on the GMDB where the losses were, the margins, they were. My point was one would think that given all of the demand by the public for GMWB that there would be an opportunity for reinsurers to make money and if they would have responded by offering a product, and it is just curious that no one or hardly anyone is offering it. I wanted to get your sense as to why that might be.

I got it. As Tom said, our education of our reinsurers continues. And, you know, what we've develop the here by way of hedging competency under Tom's management here, we have some real good expertise and we want to continue to convey that to reach those markets - broaden the market availability here. Which we're working to do.

Thank you, Ramani.

Yep.

Thank you. Your next question comes from Alan Karaoglan from Deutsche Banc.

Good morning. I have a couple of questions then Vanessa Wilson has questions as well. With respect to lost cost trend, Ramani, the past clearly the price increases have been above lost cost trend but this quarter in the business insurance segment, price increases are 4%. Could you comment on expected lost cost trends going forward? It seems that at 4%, we're below the trends. And the second question relates to the reinsurance runoff business. What is assume the your guidance, or not just reinsurance, all the runoff business, what is assumed in terms of underwriting losses for the next three quarters?

Let me address the runoff piece and I'm going to -- David would be excited to comment about the lost cause pricing spread. On runoff, we've seen volatility there, as you have noticed. You know, we think it is still somewhere between $40 to $50 million a quarter. In terms of underwriting losses that we're thinking. I'm not sure -- closer to $40 million a quarter is what I'm thinking.

I'm not sure yet. I'm ready to declare the volatility has seized yet in that area. So, it is one that, as we learn more about the developments there, we'll be able to fine tune that a little better but I have seen comparative prior indications a little more volatility than what we have actually -- what we actually thought we should expect in this area. So, let me have Dave Zwiener really take the question on pricing lost cost spreads in the insurance area.

Good morning, Alan. This is Dave. You're correct. The written pricing in the first quarter up 4% roughly. In business insurance. Relative to the lost costs that we're seeing, that's still a substantial spread.

In fact, the story continues to be in business insurance and in personal life, the frequency which has been very favorable for an extended period of time here. And frankly, longer than we and I think others would have expected. And I think that our guidance going forward assumes that that is going to gradually move to a more normal relationship throughout the course of the year. But right now, with sort of a mid single digit pricing increase environment which I think will continue in business insurance relative to the lost cost, we now have and expect to have -- we expect to have positive spreads in all of our business insurance businesses.

So, the margin should continue to go -- to improve if we still have that positive --

We think the margins are sustainable, yes.

Ok.

Unless we get surprised on the frequency side, Alan. So, for now, what this shows is a reflection of the underwriting quality as well as, you know, what's happening economically.

Ramani, it is Vanessa Wilson.

Good morning, Vanessa.

You talk about reaching your capital cushion target this quarter and you've also delivered a 16% ROE this quarter. By my calculation. And then you mentioned you're planning to delever. Do you see that ROE going down as you delever or is there more lift in the business? From here?

Go ahead, David.

No, we don't see that as having a material impact on ROE in the near term. I don't think any of the plans that we have for the next six to 12 months on delevering should materially impact our goals there or delivering them.

Ok. Then on the SOP 0301, could you just give us a little more color? Is there any change that you'll need to make in any of your products, your annuities or life products that would be driven by this accounting change?

Vanessa, it is Tom. I'll ask Liz Zalackas to jump in also. No, we're not going to change any of our game plan. You know, our CRC product or market value adjusted annuity is one we love and particularly if rates rise, we plan to really exploit that opportunity. So, rising rates or even the rates we're at now are ten-year rate just hit 5%. Five are still at 3.60. So we see that the accounting changes aren't going to change our game plan and I expect we'll actually write some increased levels of that fixed annuity business starting almost right now. Liz?

Vanessa, I would concur with Tom. Economically, nothing changed. The only slight difference would be on the CRC portfolio. We won't trade the portfolio as much as we did before under market value accounting. But we don't think there is going to be any real impact from that on an economic basis. So, things will be as Tom mentioned.

Thank you.

Thank you. Our next question comes from Jason Zucker of Fox-Pitt.

Great. Good morning. Thank you. Wanted to ask just a couple of questions on annuities. And Tom, real quick, any fire sales of the old GMWB pricing that would have helped sales for the quarter? Any commission bonuses during the quarter?

No. Jason, not anything material. Sales month per month were relatively flat. March, if you look at average daily sales was down slightly and that was the first full month with no noise. Everything virtually sold. March was at 50 basis points but really, not down much. On an average daily basis. And from just a dollar basis, it was pretty flat from month to month.

Ok. And then I wanted to react just to Ramani's comment. He mentioned the expense ratio dipping down to 18.5 basis points for the quarter and I was hoping you could just describe to us how that advantage is passed along to either brokers or consumers and give you that much more of an advantage in the marketplace. And then a last very quick question. Have you thought of introducing indexed annuities now that you have an internal hedging program that you could utilize?

Answer to the last one is as of yet now, in fact, we're taking a step back on product development generally and I think trying to figure out where we're going to go. We had given indications that later this year, we definitely have a product out. It won't be an indexed annuity. In fact, we're even re-evaluating what our new product strategy should be. So we'll keep you posted probably at the second quarter call as to where we're going with the product. But what was the other -- 18 beeps getting passed on to customers.

It gives us the potential in new pricing, obviously, to work through it. In terms of -- those are our operating costs. Those are not expenses of the funds. Although our expenses of the variable funds clearly are at the low end of the spectrum. But clearly, when we go into price new products, it is a leg up we have in that our operating costs are lower than what we think our competitors are.

Tom, last year though, when you launched the APB, you did lower the cost to the customer.

That's correct. On the death benefit product with the APB, the core cost to the customer did go down a few basis points. As we price new business, we take a look at what our run rate expense ratio is and extend -- if it's down, we can reflect that in our pricing.

Do you think always perhaps you spend more than your competitors on service and infrastructure?

Oh, absolutely not. Per unit we spend a lot less obviously given the expense ratio. We don't skimp on service. We won eight Dalbar awards in a row. I attribute it to the outstanding team we have but also we got early on the technology and I think technology is one of our absolute strengths in the business.

All right. Great. Thank you very much.

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

Good morning and thank you. I had a couple of questions. First on the universal life product. Do you offer a secondary guarantee benefit and are you reinsuring that benefit? And if it's meaningful, can you just remind us what the SOP 0301 implications are on that feature then I had a follow-up.

It's Tom. Yes, we do offer secondary guarantee UL and the secondary guarantee portion of it is 90% reinsured. So, we have made available reinsurance on that and the SOP impact on universal life is negligible.

Okay, great. And then on the -- I believe you said you're reinsuring 50% of your death benefit on new sales now?

That's right. That's the variable annuity death benefit.

Ok. So, is there any earnings or capital impact from the reinsurance relationship or should we view this solely as a risk management technique?

You should pretty much look at it as a risk management technique and essentially, it is a pass through.

Ok. All right. Thank you very much.

Thank you.

Your next question comes from Andrew Kligerman of UBS securities.

Good morning, Andrew.

Good morning. Questions on your PNC business. A while back, I recall hearing, you know, objectives on combined ratios. Maybe you could look two or three years out. Tell us what your objectives long-term might be for combined ratio. Secondly, I'm hearing about pressures in the D&O line of business on pricing recently. Could you comment on what your specialty operations are seeing there? And then lastly, just in case I missed it, did you specify what SOP 31 impact on operating EPS was this quarter?

Ok. Let me have David comment on combined ratio outlook which is really the way I take your question, Andrew, am I correct?

An objective for the long-term. Long-term. Not what you're seeing now but long-term.

Andrew, Dave Zwiener. Good morning. If I understand your question correctly, you want us to look into the future and sort of pick a target and as you know, the way we price our business is to get, you know, a 15% ROE. That's dependent on the current interest rate environment we find ourselves in. So you're asking me to make a bit of an interest rate forecast here. Assuming the rates do move up over the next couple of years by a modest amount, I think you could see the targets for our businesses in total to be somewhere in the low to mid 90s.

Obviously, we can do a little better on the personal lines and right about that level on to business insurance. On the D&O question you asked, you're hearing comments from others regarding pricing pressure and competitive environment. I think that we would probably echo that. I think looking at the pricing year-over-year in our financial products area, it is probably down slightly but obviously, that's on top of some fairly huge increases that have compounded over a period of time.

Having said that, I think you see in our disclosure we did grow in that line. And one of the important things I want to remind you and others of is why we found the business so attractive when we got into it is not only one that we had a fresh start in effect, not buying the tail end of the business but the real focus of that practice has been the private and sort of below the fortune 500 which played nicely with our distribution in the middle market area and in the quarter, new business coming from that middle market penetration was up 45%. So, we feel like it is starting to drive another product capability into the market that is very important to us and that's going to add some level of growth. Your last question was on SOP.

Yes. 3-1. What was the impact on the quarter?

Hey, Andrew, Ramani. Are we coming through clearly because you're coming in very choppy.

I'm sorry. Yea, can you hear me a little better? I just want to know what the impact on operating earnings was in the quarter if I hadn't -- I know it has been touched on but I didn't hear operating earnings impact this quarter.

Andrew, this is Liz Zalackas. Good morning.

Good morning.

On the individual annuity side, it's about $5 million after tax. That's primarily due to the CRC product needing to be reclassed from a separate account to a general account. Some of the other items kind of wash out. Some of the other lines, it is fairly minimal.

Would you stay with that $5 million a quarter is a run rate?

That will decline over the proceeding quarters.

Thanks a lot.

Thank you.

Your next question comes from Jamie Bueller of J.P. Morgan.

Hi, I have two questions. First, could you talk about the growth potential of your Japanese business, do you think your growth could actually slow down as other companies enter the VA business in Japan? I know AIG has been selling fixed annuities in Japan for a long time but they're rolling out a VA product also. And the second, if you could talk about -- you mentioned that fixed annuity sales should be held if rates go up. Would you be able to write new business at the same level of spreads if the yield curb flattens with the rise in rates? That's it.

Go ahead, Tom.

Tom Marra. Clearly, the way we do our fixed annuity, we take a fixed spread on new money rates every two weeks. We price it every two weeks. So, our spread is going to be quite level. As I said earlier, with rates rising and our ten year rate at 5%, I think it will be a good time for our fixed business and we'll get our margins. In terms of the Japanese VA market, a couple of things. There will be more competition.

My outlook is the overall markets going to see rapid growth. So, while our market share is in the 20 plus percent range, that will probably go down but if the overall market continues to increase, we'll do just fine there. We're pleased we're making money and, you know, moving up on our -- we have $8 billion in assets now. I think we've guided to 12 to $14 billion we'll be making our 15% return. So, we're right on a good path there.

We've also announced that we'll introduce a fixed annuity in the third quarter to compete with the success AIG has had. That's a -- an extension of our portfolio there. So, all in, I think we'll see more competition. But we'll continue to do good -- we'll continue to do well.

The one caveat with the second quarter being the end of their fiscal year, we think the $1.4 plus billion for the second quarter was good and might not be repeated immediately in the third. Or in the second. Our second. So, it was $1.4 in our first. And that was the end of their fiscal year. So, a little concern for the second. Sorry I got you all confused there.

Just to follow up on fixed annuities. Is that going to be in the VA product also and what channel are you going to sell that through? Wire houses or mostly banks?

It will be an MVA product like we sell here in the U.S. and it will be both broker dealer and bank.

Ok. Thank you.

Your next question comes from Dan Johnson of Citadel.

Great. Thank you very much. Question goes to the reserve additions you that made in the quarter. Could you go through some of the thinking you had on the construction defect as well as the runoff from specifically in construction defect, many people have been talking about this for good part of a year.

Can you talk about what is it that you saw this quarter that made you rethink your reserves and could you talk a little bit about the size of that book and then just put a little more color on the other operations runoffs -- or the runoff reserve editions. Thank you.

First of all on construction defect, the way I characterize it is on cases being reported to us, we're starting to see 20% to 30% severity increases. In -- this is -- by in large, California, although some of the peripheral states surrounding California are starting to see some activity. Second thing in the past, we've had construction defect as part of our overall specialty IBNR. We strengthened our IBNR by $190 million related to this. What we believe is you know, when it comes to construction defect, you know, we have introduced some extensive modeling in trying to model all of those and that's -- that is related to what we did in this quarter.

On the assumed reinsurance side, you know, as we look at our assumed operation, two comments I would make. One is, you know, we have been noticing and observing that we have had an adverse -- adverse trends in casualty while at the same time, suspecting we'll have more favorable trends related to the WTC and so if you think about it within the segment, we had a positive development in WTC of '97 but we also had with respect to casualty an unfavorable development.

Our belief, you know, is in seating company delays in reporting continue to be a challenge in the assumed reinsurance arena but, you know, we keep adding here and what we have added is by in large to our IBNR, it is really not case activity propelled, if you will. So, those are the two things. Net net in the other operations impact of all of this is a negative 48 and net net in the ongoing operations with respect to the changes we made all in is a positive 9.

If I can just drill in a little further because certainly if we had not had the WTC this would have been --

I'm sorry?

Can you hear me a little better now?

Yes.

Just drilling in further. You said that assumed re has issues related to reporting delays, but you added the IBNR. These were not specific cases you've been receiving notice of. Is this your just kind of general feel that you're going to get more?

As we look at the curves on assumed reinsurance, we continue to believe that that area is not continues to develop and our feeling is that a conservative IBNR here would probably be the right thing to hold for assumed reinsurance.

And last detail on the construction defect, is roughly how big is that book either from a --

Well, this book is actually '95 and prior. We've been out of the construction business related to California and these were actually contractors who had incidental -- if my recollection, and this goes back a ways. My recollection was incidental residential construction exposures but what we're noticing which is -- which was a disturbing trend is the -- the number of defendants -- the circle of defendants keeps increasing and the circle is getting widened. And that is a concern for us and we have seen more recent case emergence and severity changes that are a source of concern for us, too. Those are the two things that drove us to strengthen the IBNR and construction defect claims.

And did you not -- was this not an issue last year when CNA added materially to reserves and I think Ohio casualty as well. I'm just trying to understand what your thought process was.

We had overall -- you know, specialty IBNR and specialty reserves and we had not segregated construction defect but we did a lot more extensive modeling in the first quarter and that's really what drove us to set this up.

Great. Thanks a lot. Best of luck.

Thank you.

Your next question comes from Ron Frank of Smith Barney.

Good morning to you, Ron.

Good morning. I wanted to ask you a question first about two of the assumptions behind the guidance to clarify and then one about capital. Did I hear correctly first of all that you're assuming that personal lines claims frequency deteriorates gradually over the balance of the year?

Becomes less favorable, correct.

Ok. Your correction of my statement by saying less favorable. I assume that means you expect it will continue to decline but at a slower rate?

Ron, one thing on personal lines frequency, last year first quarter was an outstanding quarter. David reminded you of that. It was a terrific quarter. So, this -- you know, as we look to the balance of the year, we don't see that kind of great comparisons available to us.

Ok. And the assumption that the equity markets will be up about 9% for the year. Since they're flat year to date, I assume that basically means up about 9% from where we are today. Is that a correct statement?

Yes.

Ok.

But it is again, as you know, Ron, it is not a question of where they end up. It is a question of where they go throughout the year.

Of course. I assume it doesn't mean up 9% on the last day.

So, for example, because we banked a fair amount of time above a straight line 9% trend in the first quarter, we actually would not have to end the year up 9% could be consistent with our guidance.

So, the average level of the market, if you will --

Basically, if you took the weighted average level of the markets that consistent with the same number as the straight line 9% through the year, you get to the same thing. Obviously it is Serpentine to get to the same number.

David, this is 9% annualized.

Yea, 9% annualized.

On the capital question, I want to understand how the definition of excess capital interacts with the needs of the life company because obviously you're growing explosively there. Does the $600 million in excess capital, does that mean that that's capital that you do not expect to call upon near or intermediate term to fund but the anticipated growth of the life company?

Well, with about 5 or -- with about five or six caveats, yes. IE, the growth of the life company will put on more equity linked assets which have a volatility associated with them and that capital cushion is there to support us against that volatility. But assuming that we're within a normal trend of volatility, we would not need that. That's cushion.

Ok. Is all of that money at the parent now?

No. Our policy is to keep substantially all of our capital cushion at the operating companies.

Ok. All right. Thanks very much.

Thank you, Ron.

Your next question comes from Michael Lewis of UBS.

Good morning. I have two quick questions. Most have been answered already. On the business insurance, can you define a little better what's happening, the difference in the market conditions between small commercial and middle market commercial? It seems middle market commercial's magnitude of growth is slowing while small commercial is taking off.

Is there a dramatic difference in the competitive market? Number two, with the economy starting to come back, are you seeing any changes in the -- lost cost trends regarding severity patterns? Are you factoring in any changes there? And quickly, pick up in the agency business on the personal line side, now that you have your market segmentation rolled out pretty much, is your appetite changed? Where are you getting the traction there? Is it that you're changing comps to the agent? Are you advertising more or do they just like the segmentation model that you're presenting them? Thanks.

MIchael, I hope we remember all of the questions. Many parts to your question. But David, do you want to take a shot?

Thanks, Michael. It's Zwiener. And I've got a crew here to remind me of anything I forget so we'll try and keep track here. Let me start with your last question on the new first lines dimension product which is both auto as you know we rolled out last year and into this year and now the home product. I'm glad you asked the question because I think that the numbers we reported in personal lines up 9% of the top line really belies some of the real growth that's going on there. Particularly in the agency numbers. Agencies up 13%.

A reminder to others listening is that the new policy is a six-month policy so if you're adjusting for the six versus 12 month policy, agency growth is 17. I think we're really seeing the kind of growth we would have expected there. What it allows us to do is really price more segments of business and so it is getting exactly the kind of lift where we wanted it. And I think it is exactly the kind of product that we needed. You asked -- I think on -- was it comps or commissions?

Comps.

Basically do you step up your advertising, you changed your commission structure or any other thing to kind of produce this business besides just roll out the segmentation?

Actually, you look at the expense ratio and lines, it picked up a little year-over-year. That really speaks to the roll on the product and some of the marketing expenses associated with that training and so forth. I think that that in no way affects our commitment to get down to the 22 that we committed to by the end of '05. I think that reflects the activity we had surrounding the new product introduction.

In terms of the commissions, we're actually in the process of revising the commission schedule related to this project which will move them down a bit from what has been out in the market and our older product. And frankly, I'm being very candid about it, I think we needed a higher commission structure on the older product because it wasn't as competitive. With the newer product, we're able to renew the commissions to a more competitive level. So that's in motion now on a day by day basis. On BI, business insurance, small versus mid market. When you look at the numbers in terms of the growth and if you're looking at the growth for the quarter, the small commercial is up 17.

Versus the mid market 13. I think reminder we are in the process of rolling out our new -- what we call our expand product which is included in the small commercial category. This is really filling a gap in our underwriting ability that was evident to us about a year and a half ago. The small commercial product really is targeted to companies roughly $5 million and under in revenues.

And the mid market product was more in the $15 million and up. This new product expand hits right in the middle there will between the 5 to 15. Which we estimate is about $25 billion plus market. So, it presents some real opportunity for us to grow and I think you're going to see that come through this line. Some small numbers in the first quarter building for the rest of the year and probably having more significant impact in the top line as we reported small commercial in the second half of the year.

As I said earlier, on another question in terms of pricing lost cost trends, think we're still seeing favorable and positive spreads there. Both in small and mid market. And so I think that we feel very good about able to maintain not just the profitability but continue to drive the growth over the course of that next year. In terms of loss costs, you asked any trends of in lost costs that we see. Again --

Basically, severity. If you see -- if you expect any pickup in severity, and the other thing I meant to point out is we're hearing from other companies the middle market commercial business is getting a lot more competitive. Those are the only two things I wanted to comment on.

No great changes in severity we're seeing. Surprise continues to be the frequency. We've talked about it which has been very favorable for an extended period of time. It continues to be in the first quarter of this year. So, I wouldn't say we see anything surprising in the severity trends.

Is it getting more competitive? Yes, it is. But again, you know, we're growing. We're opening new offices. We're pushing a new product. So I think we feel pretty good about our ability to compete in this type of a market and maintain the profitability.

Thanks.

Thank you, Michael. Operator, I can take two more. I feel we're encroaching on another company's call. So, let's keep it to two more questions then we should concede the floor to our friendly competitors.

Ok. Your next question comes from Paul Newsom of A.G. Edwards.

Good morning, Paul.

Good morning. Was hoping you could focus a little bit more on the property casualty side.

Ok.

Just any comments to update us on personalizing on whether or not you're still concerned about reaching scale and there have been a fair amount of conversation about whether or not you buy or divest and then a broader conversation on the personal line side. We're hearing lots of your publicly traded competitors talking about continued growth in middle market and small commercial as well as personal lines. This is a pretty mature business. I don't expect everybody will be able to grow. Where do you think the ones who lose share will come from?

Let me make a general statement and then I can get specific. Three years ago, we said we wanted to change the mix of our portfolio to focus on those areas, the business insurance and personal lines. So we've been doing an awful lot over the last three years to position ourselves to be winners in those areas.

That's now 82% of our premium in the -- at the end of the first quarter. So, others now coming to the conclusion that it is going to be difficult to grow in some of the larger account business or specialty are now declaring they're going into middle market or small commercial is interesting but I think late. Because there is an awful lot of investment that's required in terms of technology product, opening offices, service and so forth that we think are table stakes to being competitive there. So, I think is it getting more competitive? Are people making noises? Do they think it is a great business?

Yes to all of that, but are they going to be able to take share away from The Hartford or a handful of entrenched players who are able to compete, I think, very aggressively and have scale, I think it is going to be difficult. So, I feel very good about where we're positioned. I would also say we view this as a long-term strategy.

And you know, we've been putting up, I think what you and others would hopefully agree is fairly consistent results in the small commercial with, you know, underwriting profits and combined flow 100 for an extended period of time. That's the sort of consistently we're trying to drive through personal lines and we think we've achieved it with dimension and mid market. What we're trying to do is have the majority of our premium, 82% or more in businesses that we can quickly react to changes in the business. Price and hold our margins and grow profitably regardless of where we are in the cycle.

Thank you, Paul.

Thank you. Your next question comes from Jay Cohen of Merrill Lynch.

Hey, Jay, good morning.

Hitting cleanup today. I have two relatively quick questions I think in the property casualty side and then we'll have on the life side. On the World Trade Center change, I'm assuming most of the reduction was in the kind of liability lines. Is that fair? That's where most of the uncertainty was initially?

I believe that reasonable chunk of it, Jay, was in the liability lines. Yes.

I guess the second question is on the personal line side, it wasn't terribly surprising you had the resultless you did in the quarter. What surprised us was that they weren't as good in the second half of last year. We've seen Allstate, Progressive, Safeco show very good results in personal lines the last two or three quarters. You seem to recognize it all in one quarter. I'm wondering if something changed for you in this quarter.

David, you want?

No, is this you rebidding your question for the fourth quarter call? No, you know. Candidly, we're a little better in the first quarter. We had assumed a lot of that is weather-related. Also, I think a continued pleasant surprise on the frequency side. In terms of getting two or better than target profitability, we had assumed it was going to be an '04, you know, event that we were really going to break through across the board and deliver this kind of performance.

An awful lot over the last 18 months for us, it was driving pricing. Getting to the target margins that we needed to be at in all of our lines. And I think that that was most of the news that you heard us talking about in personal lines last year. With dimensions out, with dimensions being successful and with the benefit of good weather, with the benefit of the frequency, I think most of the industry is benefiting by, I think that's what's really causing the big delta in the first quarter of '04.

The homeowners experience, Jay, in the first quarter is outstanding as we have just had terrific results at homeowners. David has been putting rates through for quite some time. Homeowners, we have been reporting fairly good experience. Now the auto is catching up, too.

Ok. This is Ed. I just had two really quick questions. First of all, Tom, wondering is it fair to say that you're backing away from the $1 billion per month in the VA side? It sounds like you're willing to concede that it is going to be probably a little higher than that. At least a little higher than that going forward?

Yes, it will.

Ok. Then the second question is on the 401(K) sales, I'm assuming that if you're like other companies in this business, probably 2/3 or more of it would be takeover business. Can you give us any indication of where you're getting that business from? Is it other insurers? Is it regional banks, et cetera?

It is all over and even more, I mean it is a takeover market. These are small plans. So the typical plan would have say $2 million in account values to take over then maybe ongoing for $400 or $500,000. We use our financial adviser base so the broker dealers and the banks and the planners that we work with and it is a tag team between Polanco and the 80 retirement plan specialists so it is not a real crowded field, the way we operate it.

We've got good on-site field service that it is just sort of a natural add-on for us. A business where we can help our financial advisers to branch out into yet another business activity. So, we're going to continue to invest in it. I think it will be a real winning business for us going forward.

Ok. Thank you.

Ed, one of the things Tom mentioned or I mentioned earlier is we have really increased our field sales in the 401(K) sales specialists from 50 to 80 now. We're almost at 80. So, it is quite an addition. 60% addition in our sales feet on the street if you will. Operator, I'm just going to have to close the call now. I would like to really say that we're in a period of some risks but far greater opportunities in our estimation.

We're leveraging the strength of variable annuities across investment products like we just spoke to such as mutual funds and 401(K). Our group benefits division is 50% bigger than it was a year ago and is very well-positioned in property casualty, we have significantly increased our regional presence and have invested wisely in customer and agent phasing technology. New product introductions in both personal lines and business insurance will round out our competitive strengths.

So, we're well positioned to deliver double digit earnings growth and are 13 to 15 ROE commitments to you. With that, I would like to close the call and yield the floor to our friendly competitors. Thank you again.

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