Hartford Insurance Group Inc (HIG) 2004 Q2 法說會逐字稿

Good morning. My name is Shayla, and I will be your conference facilitator today. At this time, I would like to welcome everyone to the Hartford second quarter conference call. All lines have been placed on mute to prevent any background noise. After the speaker's 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 keypad. If you would like to withdraw your question, press the pound key. Thank you. Mr. Miller, you may begin your conference.

Good morning. Thank you for joining us today. Please note that our quarterly report on form 10-Q was filed with the SEC last night. Our financial supplement and a complete slide presentation for today's call are available on our website at thehartford.com. Participating in this call will be Ramani Ayer, Chairman and CEO, David Johnson, CFO, Dave Zwiener, Chief Operating Officer of our P&C Company, Tom Marra, Chief Operating Officer of our Life Company, and Neal Wolin, General Counsel of The Hartford. After the presentation, we will go right into the question-and-answer session.

As noted on slide two, we will 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 other 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 website at 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 for joining us today. Beginning on slide three, I'm going to briefly cover the operating highlights of our quarter. Then I'll turn the call over to our CFO, David Johnson, for some financial comments on the quarter, our capital position, and guidance for 2004.

I'm very proud of The Hartford's results this quarter. All of our business lines have strong operating performance. Both our Life and Property-Casualty operations grew in the areas we've targeted for growth, and generated very good operating margins. The Hartford reported very solid year-over-year double-digit growth in top line. And fueled by record assets in the management of our Life Company, our total assets under management rose 18% over prior year to $269 billion.

Our results demonstrate that we're building a company that can compete vigorously over the long term, and on our terms, both domestically and internationally. We reported net income of $433 million, or $1.46 per diluted share. Net income was down from $507 million, or $1.88 per diluted share in the second quarter of 2003. Net income EPS included realized gains of 11 cents per share this quarter, versus 65 cents per share last year. Second quarter earnings were also affected by a charge we made for net reinsurance recoverables. I'll discuss the details of this adjustment in a minute. But you should note, that this charge reduced earnings by $118 million after tax, or 40 cents per share. With the reinsurance recoverable charge, operating income still rose from 340 million in last year's second quarter, to 403 million this year. A solid 19% growth rate.

I'm proud to say the Hartford had been able to report a return on equity in excess of 15% over the last 12-month period, even with the reinsurance charge numbers. As you know, operating income is a non-GAAP measure. Naturally excluding the charge, operating income and ROEs were much higher. Including the reinsurance charge, operating income was $521 million, or $1.75 per diluted share. On that operating income, the Hartford's 12-month return on equity excluding AOCI is 17%, well above our 13 to 15% target range. And the Property and Casualty, and Life operations were 18.9% and 16.4% respectively. Stockholders equity, exclusive of AOCI reached $11.8 billion. And book value AOCI now stands at $40.26, up 17% over the second quarter of 2003.

Now, before I turn to the operating highlights for each of our businesses, I would like to take a moment to discuss the adjustment to our Property-Casualty net reinsurance recoverables. Slide four provides some detail. The Hartford has remained attentive to our exposure to legacy issues. In the first quarter of this year, we confirmed that our gross asbestos reserves were appropriate. Although the total gross liabilities were unchanged, the gross liabilities on some accounts were higher, and on others lower than our previous estimates.

Since reinsurance coverage can vary from account to account, we undertook a review of our net reinsurance recoverables. Our focus for this study was the older, long-term casualty liabilities in our other operation segment, which includes asbestos. When we evaluated our reinsurance coverage on an account-by-account basis, we concluded that we had $126 million, less reinsurance available, than was previously estimated. In other words our estimate of retained liabilities increased.

The study also resulted in an increase of $55 million to the allowance for uncollectible reinsurance. Taken together, the results of this study increased our net reserves by $181 million pre-tax, and reduced after tax net income by $118 million. The $55 million additional allowance for uncollectible reinsurance brings our total provision for uncollectible reinsurance, across the entire Property-Casualty Company to $397 million. We believe that our actions this year appropriately addressed the current environment. In the future, we expect to complete both the gross and net reserve analysis concurrently in the second quarter each year.

Now, I want to cover the highlights of The Hartford's Property-Casualty operations. If you go to slide five, you'll see our results this quarter were very strong. Our Property-Casualty Company reported operating income of $188 million, up 18% over last year. Ongoing operations performance was much stronger than Property-Casualty's 18% increase would suggest. I just covered our actions with respect to reinsurance that resulted in a charge of 118, after tax. I should also remind you that in the year-ago quarter we had a $27 million after-tax charge for severance, as we initiated serious cost-cutting measures. Before these items, operating income is $306 million, which is up 64%. An impressive result.

Now, the strong results I'm sharing with you today are not simply a reflection of the recent hard market. I believe The Hartford's Property and Casualty growth and success stems from an impressive record of product evolution and performance. And our strategy of combining excellent product with industry leading service and technology, sets us up to win over the long term. Our execution has been great. Ongoing operations written, and earned premiums are up 15% year-over-year. Even in light of slowing price increases, the 3 ongoing segments, business insurance, personal lines, and specialty commercial are all growing well and maintaining margins.

Our combined ratio of 91.4% has improved 4.6 points over 2003. Half of the improvement in combined ratio came from lower catastrophe losses in 2004, than a year ago. The other half reflects underlying improvement in our book business, including some continuing favorable frequency trends. Leading from a position of strength with product and distribution, we can be selective about new business and renewals. We are maintaining our underwriting discipline.

Our sophisticated pricing models allow us to get the right price for the right risk. X cats, our combined ratio is 89%. And we're on track for meeting our 2005 expense goals in business insurance and personal lines. We're continually expanding our product portfolio. New products, such as Dimensions and Expand, position us well for growth in our targeted markets. And we're leveraging our broad distribution reach, to grow both personal lines and business insurance.

We're also competing for leadership in agency technology and service. We recently launched several new front end and back office applications, that make it even easier for agents to do business with us. Two new proprietary applications called QTI and ICON 2, have been well received by our agents.

Slide six shows that our strategies have been successful. Over the last 4 years, property and casualty ongoing operations grew at a 12% compound rate. And as I mentioned earlier, written premiums from ongoing operations rose 15% in the quarter. Written premium of over $2.5 billion in one quarter is a new high for us. While all lines contributed to this growth, we're particularly excited about the results we're seeing in business insurance and personal lines.

Our largest Property-Casualty segment, business insurance, grew 16%. Small commercial is showing impressive growth with written premiums, 26% over the same period last year. I don't expect us to keep up a 26% growth rate, but you will see us gaining share. Small commercial, which includes our Select and Select Expand products, now account for approximately 50% of business insurance revenues. Our products are competitive. At the same time, we deliver outstanding service and technology. I'm committed to see The Hartford continuing to be a leader in these areas.

In personal lines, the AARP program continues to perform well, with written premiums up 10% year-over-year. And I'm proud to report that Purdue University recently awarded The Hartford's AARP call center their prestigious Center of Excellence certification. This award recognizes both exceptional customer satisfaction and operational efficiency. We're the first, and so far the only, property-casualty company to receive this distinction. With this recognition, we join an elite group of prior recipients that include world-class companies such as Dell Computers, Merrill Lynch and IBM.

The real excitement this quarter, though, is the traction we're seeing from our agency strategy. The agency channel has really embraced the new Dimensions class plan, with written premiums up 21% over last year, and 16% sequentially. Our outlook for personal lines is very positive. The Dimensions auto class plan is approved in 36 states, and Dimensions homeowners is rolled out in 17 states. We're now focusing on leveraging our distribution expertise and commercial agency relationships, to power profitable top line growth in personal lines.

On slide seven, we demonstrate that we're growing on a foundation of profitable business. This slide shows continuing improvement in the combined ratios for the ongoing property-casualty operations, x cats. The industry experience low cat losses in the quarter, and we were no exception. Our cat losses this quarter were 2.4 points of combined ratio. versus 4.7 points a year ago. The combined ratio, x cats, for ongoing operation is 89, which compares favorably to last year's 91.3. The personal lines, x cat, combined ratio showed the strongest improvement, dropping 3.2 points to 87.6. The spread between earned pricing and lost cause remains positive. Due in large part to continued negative loss frequency.

We're very bullish about business insurance, too, where the x cat combined ratio was 89.1. A handful of players in the middle market are aggressive, but overall we see competition today as tough, but rational. Loss frequency continues to be favorable in this line as well. In specialty commercial, we are generating very good combined ratios, as we maintain our vigorous underwriting discipline. And finally, we continue to make progress in operating expenses. Our ongoing Property-Casualty expense ratio for the second quarter was 25.6, a full point below prior year. This puts us solidly on track to achieve our full year 2005 goals at 25%.

Please turn to slide eight. Now, I want to cover the highlights of The Hartford's Life operations. Before I do that, though, I would like to set the context. Equity markets were fairly flat during the quarter. Industrywide mutual fund sales came under pressure. And 14 out of 15 of our top competitors in variable annuities, now offer benefits similar to our own withdrawal benefit. Given this environment, Hartford Life executed well and produced very strong results in the quarter. Life operating income was $253 million, up 10% over the same quarter last year. In the second quarter of 2003, the Life company benefited from a tax adjustment of $30 million. So excluding this tax benefit, operating earnings were up 27%, an impressive growth rate.

Assets under management in the Life company reached an all-time high. In almost every line of business, except individual annuities, sales were up by significant double-digit increases over last year. Mutual funds were up 22% year-over-year, despite a drop in industry sales and 401(k) was very strong, up 39%. Our institutional solutions group had a double-digit growth in sales. Group benefits is on track with the CNA integration, and sales are up 13%. And with continued growth in universal life and whole life, individual life sales rose 27%.

We're very excited that our sales in Japan hit a new record of $1.6 billion. I'll comment a bit later on our outlook for Japan. First, I would like to address individual annuities in the U.S. As you know, we had a tremendous growth run in individual annuities, since the launch of our very innovative GMWB rider in third quarter, 2002. Over the past several quarters, as the competitive market has changed, we told you that both sales and net flows would moderate. As we predicted, individual annuity sales, this quarter, came in lower than our recent record-breaking pace at $4.2 billion. We reported $3.9 billion of variable annuity sales. This is right at the midpoint of the range we gave you last quarter for second quarter VA sales.

Now, as we look toward the remainder of this year, we expect that variable annuity sales will be somewhat under $3.5 billion. And our best pick today would be $3.3 billion a quarter. Of course the sales guidance reflects our current view of markets today, and could change. Even at these sales levels, we would be reporting another great year in annuities.

Variable annuity net flows in the quarter remain strong at over $1.6 billion. On an annualized basis, variable annuities surrenders of 8.5% of assets, were unchanged from the second quarter of 2003, and remain well within our pricing expectations. We expect positive net cash flows of at least $1 billion a quarter for the remainder of the year. We're the number one writer of variable annuities in the U.S., and we intend to remain number one.

Now, please turn to slide nine. This chart combines the sales for all our asset accumulation businesses, and illustrates a tremendous track record. Over the last 5 years, we leveraged our market position in VA's, our distribution in service expertise, and innovative product leadership to rapidly grow other retail products, such as mutual funds and 401(k). We also launched our Japanese operation. From '99 through 2003, we achieved a very strong 16% compound annual growth in sales. Even in the bear market of 2002, we were able to sustain over $20 billion of annual sales.

This quarter combined sales from our diversified asset accumulation businesses grew 19%, over the second quarter of last year. As you can see, significant growth in mutual funds, 401(k), and Japan more than offset the decline in individual annuities. We're particularly excited about the strength of our Japanese businesses. Our product service and unique wholesaling strategy are keeping us solidly in the number one position in this growing market. We added 3 new distribution partnerships in the quarter, bringing our total to 47. Taken together, we estimate that these distribution partnerships have access to approximately 60% of the personal financial assets in the entire country. We anticipate continued strong sales in this segment. So overall, I'm extremely pleased with the progress we've made in diversifying our asset accumulation businesses.

Now, as you look at slide ten, you'll again see the power of our diversified product portfolio, this time focused on assets into management. We grew assets into management at an 8% compound annual growth rate over the last 4 years. This quarter, assets into management in our combined U.S. and Japanese asset accumulation businesses grew 26%, and reached a record high of almost $191 billion. Approximately half of this growth is due to equity markets and half to favorable net flows.

I'm pleased to report we're leveraging our scale and keeping a tight rein on expenses. In the past year, we added more than 100,000 individual annuity customers, while our operating expenses actually declined 4%. Our annuity expense ratio is now 18.3 basis points, which I believe should be the lowest in the industry. Looking ahead for variable annuities, we anticipate a return on assets in basis points in the low to mid-40s. In Japan, assets into management of $9.3 billion is nearly triple the level just 1 year ago. By 2005, we expect that this business will have reached scale, and will be generating 45 to 50 basis points of operating income annually.

Slide 11 turns the focus to our group benefits business. With the acquisition of CNA's group disability and life business in December of last year, this franchise is contributing strongly to the Life company's growth and profitability. Group benefits is a very consistent track record of growth and operating income. As you can see, operating earnings from '99 to 2003 increased at a compound annual growth rate of 17% per year. And for the second quarter of 2004, group benefits had excellent performance once again. Earned premium up 58%, and operating income up 37%. This reflects both the quality of the block we acquired, and the profitable growth of the core groups benefits business.

I'm very pleased that the management team has maintained business momentum, while integrating the 2 businesses. This requires excellent execution. And we're clearly on track. All field sales offices have been consolidated, and the new sales management team is in place. We retained many of the very best people. Due to sales integration activities and lead times, we've not yet seen the impact of the acquisition on sales growth. But we have maintained sales momentum. Second quarter sales are up 13% compared to prior year.

As we look ahead, we anticipate that sales momentum will increase in the fourth quarter of this year, and into 2005. Transition expenses are on plan, and the loss ratio of 76.2 for the entire group benefits segment is in line with our guidance of 75 to 77%. I believe that customer retention is the true test of a successful integration. And so far customer retention is exceeding our expectations, both at The Hartford book -- in The Hartford book and the CNA business. Bottom line, we're very pleased with progress on the acquisition, and we expect to achieve the targeted 45 to $50 million in incremental operating income in 2004.

So now I'm going to turn it over to David Johnson to discuss some financial issues. David?

Thank you, Ramani. I'll turn first to slide 12. This slide provides a useful reconciliation of our reported quarterly net income to our adjusted operating performance. Now, go to slide 13. Our capital position continues to be very solid. Last quarter we told you that our $600 million capital cushion was in place. I'm pleased that in this quarter, we reduced our debt to total capital ratio below 25%. We retired $200 million of debt, grew equity, and our targeted debt-to-cap ratio which is x AOCI, Plus 75% credit for equity unit, dropped to 24.9%. Our goal now is to move that ratio to the low 20s.

In addition to the general economic and business outlook, there are many factors that influence future capital planning. Given today's environment, our task for the balance of the year is to continue to assess our capital cushion and build capital strength. We are very pleased that our progress was recognized by Moody's, which moved all of our ratings to stable outlooks last night.

Turn to slide 14. With the first half behind us, we've raised our guidance by 20 cents, at both ends of the range. Our current expectation for '04 earnings, is between 650 and 680. This forecast takes into account financial market performance through mid-July, and assumes U.S. equity markets grow roughly 2% a quarter, for the balance of the year. It excludes realized gains and losses, the first quarter catch-up for the SOP, and the Company's second quarter $118 million after-tax charge for reinsurance recoverables. We of course, include no assumptions about any unusual tax benefits or other unusual, or unanticipated benefits or losses, that might occur during the balance of the year.

Our new outlook assumes some, but not all, of the positive developments we saw in the first half continue. In the second quarter, for example, we had very low cap. With hurricane season ahead, our outlook assumes normal levels for the rest of the year. We've also had 2 quarters of positive loss frequency in P&C. We assume some, but not all of that positive underwriting factors persist for the balance of the year. If we maintain second quarter performance on cats and frequency, there's clear upside in the second half. Ramani?

Thank you, David. Now let me open it up for questions.

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 keypad. We'll pause for just a moment to compile the Q&A roster. Thank you. Your first question comes from Jimmy Bhullar of JP Morgan.

Hi. I have a question on your variable annuity business. You've been saying for the past few quarters that VA sales would slow down. Now you're projecting $3.3 billion for the second half of '04. My question is, at what point do you get to a level where sales are sustainable, and then you can start growing off of that base?

Jimmy, it's Tom Marra. Very competitive marketplace. And for that reason, I think guidance will vary from time to time. What we have been telling investors is that, as folks caught up to us with the GMWB, and there are a lot of good competitors out there, we should expect to see the kind of decline that we've seen, and that we expect to see going forward. But for the moment, I'm comfortable with the $3.3 billion per quarter.

Okay. And just to follow-up, if you could give an update on -- you had mentioned last quarter that you planned on introducing fixed annuities in the Japanese market. If you could just give an update on that.

That's right. We should be out in the late third quarter with fixed annuity. It will probably start slow from a distribution perspective. Ramani had mentioned that we have 60% of the universe covered with our variable annuity. We'll start much slower with a fixed annuity. We're really excited about its prospects and putting that on top of the variable annuity story, which is just outstanding for us. Should position us very well.

And what channels are you going to be introducing the fixed annuity product in?

It will be both banks and broker dealers.

Okay. Thank you.

Thank you, Jimmy.

Thank you. Your next question comes from the line of Nigel Dally of Morgan Stanley.

Thank you. Good morning. Just on the variable annuities again. I just wanted to get a little additional color on the competitive landscape. Would you say that competition is continuing to intensify from here, or have we reached a steady state? Also with regard to your guidance. Is it a function of lower expected industrywide sales in the second half, or are you expecting relatively stable there? And also, if you could just comment on what you're doing on the product development side with regard to variable annuity sales, as well.

Nigel, it is Tom again. In reverse order, I won't get specific on product development. But I think you know, as we've seen over and over, innovation is clearly rewarded in this business. So we're really putting a lot of effort into our R & D. I would say the competition is excellent right now. I don't see that industry sales are going to vary much from their current run levels. They've been quite strong. So maybe we might see a slight falloff. But I think for the most part, what we've seen is competitors do a good job of getting to where we've been.

Great. Thank you.

One thing, Tom, I would imagine if interest rates continue to go up, we'll see more fixed annuity sales.

Yeah. I would look -- our fixed annuities, third quarter so far, tracking about like they did in the second quarter. If we see a further increase in rates, obviously we're fast responders, and we would see a pick-up in fixed sales.

Thank you, Nigel.

Thanks.

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

Good morning. Ramani, I wonder if you could frame for us a little more of the small commercial growth in particular, that we saw in the quarter. You mentioned that you didn't expect that to keep going at 26, although you thought it would remain healthy. What factors do you think pushed it above what you would view as trend line in 2Q?

Let me have Zwiener take this one.

Hey, Ron, good morning. Obviously we're pleased with the second quarter numbers, not only with small commercial, but I think all of the flow businesses. I think in small commercial in particular. Obviously we've talked about the growing importance of the new Expand product. And although it didn't have a tremendous impact on the quarter, it did have a positive impact. And I think that that will continue to play out.

Secondly, I think, like with all the flow businesses, our real strategy here, that we've been talking about for the last couple of years is , we want to be competitive on price. But we want to be distinctive on the technology and on the service. And we also want to be distinctive on the sales management. And I think that we're starting to see some traction in all of those areas, as this market gets to a very stable point in the cycle. Having said that, I think our guidance would continue to be mid-teens kind of growth in that business. We hope that will be continued -- pleasant surprises above that trend line. But I think we're very optimistic we'll be able to maintain it above industry growth rates, for the reasons I've mentioned.

So, aside from it being just a good growth quarter or great growth quarter, and they happen once in a while, you wouldn't attribute the extra, if you will, above what you consider trend to any 1 or 2 factors?

No. I think it is an accumulation. All of which would cause me to caution you not to draw a trend line off that quarterly number. But I think that the trend line we talked about before, above industry growth, mid-teens growth, is something we feel very confident about.

Thanks a lot. And a follow-up for Tom. Tom, with regard to market discipline, as the competitors catch up, are they in your estimation, doing anything foolish in the way of features or pricing, et cetera?

Ron, I would say we're starting to see a little bit more aggressiveness than we had in the past. I wouldn't say it is rampant. But I think we've seen a couple of annual resets, as one example on a withdrawal benefit. Just things at the edge that are cause for a little concern, but not overwhelmingly so.

Okay. Thanks very much.

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

Good morning, Jay.

Good morning. I've got a couple of questions, and I think Ed is going to have a couple as well. First, is a numbers question. In the other business, a runoff business, what kind of number should we be thinking about as far as an ongoing loss in that business, assuming no major adverse development.

As I mentioned last quarter, Jay, somewhere in 35 - $40 million a quarter is what I've been guiding. Most of that is the cost of running the operation. So closer to the upper end of that range is what I would say.

After tax, right?

No. That was the underwriting loss.

Okay. Fair enough. Good. Second question, you've mentioned Ramani, that on an earned basis, you felt that your premium increases were still keeping pace, or exceeding claims inflation.

That's true.

On a written basis, however, just in fact to let you know in the St. Paul Traveler's call, Jay Fishman suggested that on a written basis, that really wasn't the case. Do you have any comments what's happening on a written basis?

Even on a written basis, the spread is marginly positive, Jay.

Great, thanks. Here's Ed.

And a lot of it is driven, as I mentioned, by the frequency gains. You know, we are really very pleased. And David and the team are really pleased with the frequency gains that we've seen.

Good morning. It's Ed. Just one question. Tom, if you look back -- I believe it was 1994, you wrote almost $3 billion of fixed annuity sales. And I'm wondering, where do you think rates have to go to, for there to be a substantial ramp-up in your fixed annuity sales, and what do you think -- just looking at your distribution relationships, what the capacity could be today, if we do get into an environment of higher rates?

Ed, Tom, yes, '94 we wrote a lot of business in a short period of time. You recall, that was the rate -- market rates back then were a lot higher than they are now. Our 10-year is currently a 485. We think 5 is certainly a point where we would see accelerated activity. But, still, we're not in the ballpark that we were back in '94. Other things, there are more players in the fixed -- particularly the longer duration, 5 and 10 year, where we specialize. But having said all of that, we love to opportunistically attack that business. And with potential rising rates, we'll see some pretty good numbers. I don't know if we'll -- rates will have to go up quite a bit till we saw '94 levels. But I think we'll do all right.

Thank you.

Thank you. Your next question comes from the line of Liz Werner from Sandler O' Neil.

Good morning. I had a couple of questions. First, I was wondering if you might just let us know, when you see the shift in sales to some competitors on the variable annuity side, is it the more aggressive features that drives the sales, or is there anyone out there with more aggressive commission structures in the variable annuity market? Secondly, I wonder if you could give us just a quick update on the DRD outlook, when we might learn more about what is coming out of that review, and I'm assuming that is not in your earnings guidance. And lastly, is it possible to talk about capital generation going forward? I know that this year your excess capital is being used to do things like currently pay down the debt. But I want to get a feel for future excess capital. And if it helps, maybe we could just look at statutory earnings for the Life and the P&C operations, year-to-date.

Liz, this is Ramani. The DRD and capital generation, let me have Johnson give you a little feel for how we see DRD.

Right. On DRD, Liz, it is not in the guidance. So if we had an unusual benefit there, that would be in excess. As we've indicated in our Q, for 2 quarters, we're currently in audit on the '99 through '01 tax years. And we think it is highly likely that will be resolved in the second half. We think hopefully, there is some good upside there.

With regard to capital generation, you are correct. We've had good statutory generation this year, so far. But we've taken out about half a billion to pay down debt, and to further fund the pension. And I would expect that the capital generation for the balance of the year will again go into strengthening the balance sheet. Very difficult to forecast that, generation. Difficult to come up with a run rate. And it's a function of how we're growing the business.

But I would say, we should definitely have capital generation in the hundreds of millions level next year, that could be used either to strengthen the balance sheet further, for external purposes, or for return to shareholders. We'll have a lot more visibility on that as we go through our operating cycle.

Liz, this is Ramani. The way I think about this, as David and I have shared with investors, we continue on the track to delever the company. The capital cushion that we had committed to last year, we have achieved that. But we are continuing to delever the company, as we believe that it sound capital management, from the standpoint of shareholders. On the statutory income year-to-date, I'm going to have David comment on the Property-Casualty. That was basically a pension [inaudible] that we had. So that was really the basic reason for the statutory income on the first 6 months. Going to features and benefits on the variable annuity, I would like to have Tom comment on that.

Hi, Liz. I guess the way I look at it is, other than in the independent channel, commissions are really levelized in most of the major firms. So, in the independent channel, I think commission is still a competitive tool. Not in the wirehouses, regionals and at most banks. And I think it really comes down to performance of the funds. But this is a feature-driven market right now. And I think everyone seems to be leading with the withdrawal benefits, or the income benefits.

So clearly, that has been the focus of where there has been competition. I think that may change. Certainly as the markets firm up, I would think people are going to start to look at long-term performance and a little bit less of features. But I think right now, features seem to be, competitively, the game.

Okay. Great. Thank you.

Thank you.

Thank you. Your next question comes from Bob Glasspiegel of Langen McAlenney.

Good morning. Tom, I'm going to make you work a little more on the annuity question. Margin outlook, you say the 40 to low 40s, which implies going down. We went down in this quarter. What is driving margins down, first question. The second question, it looks like your amortization is -- as a percentage of pre-tax, pre-amortization, is running at 50% this quarter. It has been trending higher. But in prior years had been 45, 46. Is that a new plateau we should look at? Is there some conservativism early in the year given that the margins were running well? What is driving that number?

First, Bob, for the quarter, 50% is about what we're looking for, going forward. So I think we've reached that new level. There was a slight negative true-up, just the quarterly update. And in terms of the margin, I'm now quite comfortable in the low to mid-40 range. I think we can do that for the foreseeable future. Obviously the good part of that story is the expense leverage we've been able to get through our technology and operating success. So getting that down to 18 basis points, I think, gives me confidence that we should be in that low to mid-40 range going forward.

But, it seems as you're driving your expense ratio down lower, you're not looking for better margins. So you're passing that on to customers in the form of better features or -- is that how you're using that weapon?

I think there is a lot. That is a very involved issue. There are a lot of moving parts, as you know. Competitive forces are a little part of the game. I think the amortization rate is another big piece of it. So I'll just stay with, we're comfortable in that range. I think we can keep going and operate quite well.

And finally, Japan, you were saying 45 to 50 basis points on 10 billion a year out. So we're looking at, sort of, 45 million of incremental earnings over the next 12 to 18 months to flow through?

I think we'll hit the 45 to 50 more at the -- we've been saying 12, 13 billion. You're directionally right. And it is going to start to -- as you can obviously see, be a meaningful contributor to earnings. So we're very excited with that story.

You're sort of breaking even now.

Bob, we're making money now. We're just not at full margin yet.

I couldn't find them yet. Still looking for it. I'll trust you on that one.

Bob, the way we're thinking about it, as the operation gains a little more mass, at that point in time we should be ready to position that, and consider whether we should break that out as a segment or not.

I'm in favor. Thank you.

Thank you. Your next question comes from Andrew Kligerman of UBS.

Good morning, Andrew. Andrew? I think we lost him, operator.

Mr. Kligerman, your line is open. You may state your question, sir. Thank you. Your next question comes from Tom Gallagher of CSFB.

Good morning. I have a question and then Charlie Gates has a question on the Property-Casualty side. If I look at quarter-over-quarter individual annuity earnings, they were flat. If I just look at the disclosure in your supplement -- Tom, I know you mentioned the amortization. But it looks like fixed annuity spreads tightened a bit. Can you just comment on if that's just a quarter-over-quarter,kind of one quarter blitz. Or maybe flexibility to widen that back out. And should we[inaudible] in the outlook.

I would stay somewhere in the middle on those fixed annuity spreads. Just some noise. But I would say somewhere in the middle of that range. The other thing to point out on the variable annuities, if you look point to point, the S&P did go up. If you actually take the daily average of the S&P, it is actually down a percent. So, obviously our account values would fluctuate accordingly. So that's a little bit of the reason, the amortization up, on an average basis. Our accounts were just a teeny bit smaller, which would explain the flatness of the results.

Okay. But I was looking at -- I think you had a 3% sequential increase in variable annuity fees.

Yeah, that's right. But you would expect the normal increase to be even higher than that. Given what you would expect for the [inaudible] base. So I was just trying to point out directionally that some probably expect -- if they just look point-to-point, would expect us to do even better than that 3%.

Gotcha. And then just one follow-up on the annuity business. Can you just comment on whether you're seeing increased competition for wholesalers, and how your retention has been?

Our retention is excellent for wholesalers. A few years ago, you saw some crazy guarantees that lured some good wholesalers from us and others. But those are pretty much dried up. So I feel very confident with the stability of that group.

Okay. Thanks. I think Charlie has some Property-Casualty questions.

Good morning. 2 questions. I'm working from page PC 13 in your supplement. Could you elaborate on how you see pricing in what you call business insurance, and then the 2 personal lines categories evolving in the coming months.

Charlie, hi, Dave Zweiner. I think that where we are is the pricing cycle in those 2 areas, is a period of stability. Which is where we're going to see low single-digit increases for the balance of the year. Obviously on the personal end side, we've seen a lower end of the range there on auto, and a higher end of the range for homeowners. But I think we've hit a point where the competition is in a fairly stability pattern. And as I've said before, that's what we like about first lines and business insurance strategically, and why we put 82% of our premium in those 2 businesses. We think those are businesses you can be competitive on price, and be distinctive on other non-price features, that being the service, the technology, the distribution areas.

I think the other important thing is, although the price increases are something you, and others, I think, study with a great deal of attention, the technology of pricing has really changed and gotten better with the big players. Certainly in personal lines, but also for us in the business insurance area, allowing us the segment and get the right price in place much more quickly, on a very granular basis. I think for those reasons and others, we like where we are. We think the market is going to be fairly stable and attractive one for us.

What is the Expand product?

The Expand product is, essentially a product we introduced this year that fits between our Select product, which really covers companies that up to 5 million in revenues, and our mid-market, or key product, which is really more of a 20 million and up revenue. So the Expand product fits right in the middle there. It is, as we estimate it, a 20 to $30 billion market in the U.S. It is an opportunity we really had not gone after. What we've done is, we've come in with a product that feels, to agents and brokers, very much like our Select, in terms of ease of doing business and ability to get a quick quote very easily. And so we think that it is going to do very well. We're getting very good feedback from the agents we rolled it out with. We just started in the first quarter rolling that out.

I'm sorry. What is the typical premium on that product?

Well, the target, I mentioned to you is, the size of company, is more of the 5 to 20 million in revenue. The typical premium is somewhere in the 10 to $15,000 range.

And my final question, how would you -- if you were going to speak to a group of agents, how would you compare Dimensions to those of other segmented offerings by other companies?

Well, I obviously, would speak very highly of its capabilities.

No, but what are the 2 reasons why I care. If I was an agent.

Why you care, I think, if you went to sort of a third-party evaluation as a starting point and you looked at -- I think the study you and others have looked at, which McKenzie and Insure Quo (ph) came out earlier this year, looked at auto pricing technology in Illinois, and based upon their analysis, Progressive was the number one position. But tied in the number two position was The Hartford and Geico, with everybody else trailing behind that. And so, when you look at us in terms of our granularity, the ability to segment, and price, and you look at our ability to add the homeowners product, the commercial capabilities, the integrated technology and so forth, I think we've got a fairly distinct position with regard to personal line as well as all the other things we can bring to the agency plant.

Thank you.

I think, Charlie, the important thing that David mentioned here, is really it's validated externally. It is not a Hartford validation. And the granularity really proposes the notion that we can do a much better job of pricing individual risk, than a lot of others. David has found that to be remarkably appealing to agents.

Thank you.

Thank you. Your next question comes from the line of Michael Lewis of UBS.

Wondering where you were Michael.

Very nice to hear from you. Nice to hear great numbers from the P&C side. Andrew Kligerman has a follow-up question after I go. My questions are two-fold. What seems to be the difference going on between the small commercial and the middle commercial marketplace right now. Again, you're getting much better production growth, at least in the latest quarter, in the small commercial market. And also, didn't really spend that much time on specialty commercial. I saw there was a big kick-up on the casualty book of business. At this stage of the marketplace, what are you finding very attractive, and you're pushing in that sector? Thank you.

Michael, hi. Dave Zwiener. The Select, or the small commercial for us, has been a growth area for a long time. I think that what is happening right now, importantly, is the expand capability we've talked about, which is in that small commercial line. And I think also -- I hate to sound like a broken record. but, it is true, and it is getting traction in the marketplace. The service elements and the distribution and so forth, is really allowing us to take share. One of the things we look at, as I'm sure many other companies do, is not just the pricing, but what we consider to be true growth. True growth measuring really unit count or share gain.

In the second quarter, our total business insurance had a true growth of 8%. So we're gaining share. And I think that that's really what was very important for us, as we were pushing the product. The other thing I'd mentioned, this is the first quarter, second quarter, that the small commercial premium actually exceeded the mid-market premium. You can see the acceleration is driving a portfolio shift, where it's becoming much more of a small commercial portfolio. And I think that will likely continue in the quarters ahead.

On the specialty question, I think the one thing I would highlight there, you're looking I think probably on PC 12, looking at the casualty growth line. Up 22%. Included in there is our alternative markets captive program, which is exclusively agency cap to programs we set up for our VIP, best agents. And we're seeing some growth there. And that's really what is driving that.

No real change in the specialty commercial markets. It's really your personal lines and business insurance is getting all the major attention.

I'm very pleased with the results. I'd just call your attention and others to the property line up, 5. Those are transactional businesses that we write when we can get our profits. I think that what you're seeing is some of those markets is some negative pricing trends. And we're being disciplined there. So we're getting our pricing, or we're not writing the business. 82% of our portfolio are in the business insurance and the personal lines, where we think we can continue to grow, and gain share, and maintain profitability. I like the discipline I'm that seeing in our businesses there.

Thank you very much. Andrew has some follow-up.

Real quickly. Sorry for the problem on my line before. But with regard to the group business, it looks like your benefits ratio at 76 was real solid. Can you give us a sense of the color? A little color on your business? What does the mix look like in terms of large case, mid case, small. What's the competitive landscape? And I have a quick follow-up on something else.

Andrew, Tom. I'll give you -- I don't have the large breakout right, versus small. We picked up some strength in small, because CNA was real strong there. And in terms of the competitive flavor, I would say disability right now seems to be -- these are always competitive markets. Disability, probably slightly more competitive than the life side at this moment. And probably, as you trend up in size, again, it just gets to be quite competitive. This is, you know, season for the 1-1 cycle. So we're getting a taste of some real competition. I think we're going to do well. But it continues to be a quite competitive market.

But not excessively competitive?

No. I think we -- you know us. We'll continue to underwrite as we always have, and continue to make sure we're going to get our margins.

And if you had to assess small case, would you say that's close -- what percent of your book would be small case group life --

I don't have that right in front of me. We'll have to get back to you. That changed. Obviously, it grew with the CNA acquisition.

We'll come back.

Why don't I have Hans get back to you. Operator, we have time for 1 last question. Because I believe another conference call is expected to start in another 2 or 3 minutes. So I want to be fair to that party.

Thank you. Your final question comes from the line of Ira Zuckerman of Nutmeg Securities.

Alphabetical again. First of all, on the personal lines, especially the homeowners. The kind of underwriting results you and the industry are reporting don't seem to be really sustainable over a long period of time, just from a competitive viewpoint, if not regulatory. How do you see the resolving of that problem? And following on that, it looks like we are at the peak of the underwriting cycle on the property-casualty side. What are your plans for dealing with the down-leg of the cycle, and how do you see that developing?

Let me have David answer the second half of the question. This is Ramani. On the first half, I believe it is a combination of 2 things. One is, you have seen a period of very, very light cats. And Johnson mentioned that in his opening comments. And that contributes partially to why the profitability is excellent.

The second reason is, the industry has seen a meaningful amount of rate increases. And there is far greater discipline being exercised in the industry, to recognize the fact that cats come infrequently. But when they do, they cost the business a lot. And so there is more discipline in the pricing the of homeowners product, which is also being recognized by regulators. I would have David answer the second half of your question.

Ira, I guess we'll end with the Zs on both sides. I think we can debate where we are on the cycle, and whether it is soft. And clearly we have seen rates come down, though still positive. And again, where we're really focused, are on the flow businesses where we can rapidly respond in a very segmented basis and get the right price, and also bring to some distinctive capabilities around those that are appealing to our independent distribution. And I think that we've been working on all of those things very hard for the last few years. We're certainly not going to declare success, or say we're bulletproof from a very soft market.

I would only say 2 things. One, we do think those portions of property-casualty market will act in a more disciplined fashion. And two, we do think that the things we talked about, in terms of service and technology and sales distribution, and the AA rating of the corporation, and the brand name, are going to have a lot more traction at this point in the market, than they have any time I've been here. So I think we're cautiously optimistic that we're going to grow faster than the industry. But we're going to be able to maintain our margins, and we're going be able to take profitable share from some of other the other carriers out there in this environment.

Thank you, David. So let me bring this call to a close. I would like to quickly sum up by saying that as we look back on the quarter, we're encouraged. Our business is performing well at all levels, despite slower equity market and competitive P-C market. As I look ahead, we have in place strategies to continue to do very well in these markets, because we have a very diversified and balanced portfolio business. We are continually bringing new products and services to the market. And our execution and pricing and discipline is also well anchored. And so I believe The Hartford ought to continue to do well over the next several quarters. And I thank you for participating on this call.

Thank you. This concludes The Hartford second quarter conference call. You may now disconnect.