Hartford Insurance Group Inc (HIG) 2006 Q3 法說會逐字稿

At this time, I would like to welcome everyone to the Hartford third-quarter 2006 earnings 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 session. (OPERATOR INSTRUCTIONS) Thank you. I would now like to turn the conference over to Kim Johnson, head of Investor Relations. Please go ahead, ma'am.

Good morning and thank you for joining us for today's third-quarter 2006 financial results conference call. As you know, our earnings press release and Form 10-Q were issued late yesterday afternoon. To help you follow our discussion, a financial supplement and a complete slide presentation are available on our website at TheHartford.com.

Participating in today's call are Ramani Ayer, Chairman and CEO; David Johnson, CFO; Dave Zwiener, Chief Operating Officer of our Property and Casualty Company; Tom Marra, Chief Operating Officer of our Life Company; and Neal Wolin, General Counsel of The Hartford.

Following the prepared presentation, we will hold our usual question-and-answer session. Now turning to the presentation on page 2, please note that we will make certain statements during this call that should be considered forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. These include statements about The Hartford's 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 quarterly report on Form 10-Q for the quarter ended September 30, 2006, our annual report on Form 10-K for the year ended December 31, 2005, and other filings we make with the Securities and Exchange Commission. We assume no obligation to update this presentation, which speaks as of today's date.

The discussion in this presentation of The Hartford's financial performance includes financial measures that are not derived from Generally Accepted Accounting Principles, or GAAP. Information regarding these non-GAAP and other financial measures is provided in the investor financial supplement for the third quarter of 2006, and also on the investor relations section of The Hartford's website at TheHartford.com.

Now moving on to our presentation on page 3, I would like to turn it over to The Hartford's Chairman and CEO, Ramani Ayer.

Thank you, Kim. Good morning, everyone, and thank you for joining us. Last night, The Hartford reported record third-quarter net income of $758 million or $2.39 per diluted share. Core earnings rose 31% over the third quarter of last year to $727 million. Now, this quarter's strong results reflected a quiet storm season, excellent non-cash underwriting results in property and casualty, and double-digit growth in total assets under management.

The Hartford is building shareholder value and our balance sheet is strong. Book value per share excluding AOCI rose to $55.81, 14% higher than the third quarter of last year and up 11% from year-end 2005.

Now in the third quarter of 2006, just as in each of the last 10 quarters, we achieved a 12-month ROE at or above our 13 to 15% target range.

Now as we enter the last quarter of 2006 and look ahead to 2007 and beyond, The Hartford is in great shape. We are among the market leaders in our core businesses. We have been investing for the future with new product and distribution initiatives across the enterprise from agency auto to retail mutual funds and annuities. And we are delivering strong financial performance backed by sound risk management and an excellent capital position.

Last week, we also increased our annual dividend by 25% to $2.00 per share and announced a $300 million stock repurchase that is expected to be completed over the next two to six months. Now these actions affirm our confidence in our businesses and their future.

Now with that broad overview, I'm going to turn it over to David Johnson to discuss third-quarter financial highlights and our updated guidance for 2006. Then before we go to our usual Q&A session, I will make some comments about the industry trends entering 2007. David?

Thank you, Ramani. Turning to page 4 in the slides on our website, I will start with P&C highlights, where core earnings rose 60% over last year's third quarter to $371 million. Relatively light storm season this year and a reserve release from prior-year hurricanes had a significant impact on earnings growth. This was offset a bit by prior-year development in other operations.

After our annual study of environmental liabilities was completed in the third quarter, we increased reserves by $43 million, or $28 million after-tax.

Ongoing operations reported good growth in personal lines and business insurance, written premium, and excellent underwriting results across all segments. Page 4 shows a three-year view of segment performance. Total written premiums rose 3% over the third quarter of 2005 to $2.7 billion. Excluding the impact of reinstatement premiums incurred last year, written premium growth would have been 1%.

A closer look by business shows that we are growing well where margins remain attractive. Our initiatives in products and expanding distribution are driving growth in both business insurance and personal lines. Meanwhile, in specialty, cat management in property, and our exit from a large casualty program resulted in premium declines.

Turning to accident year underwriting results that are shown in the line graph, total ongoing operations reported an ex-cat combined ratio of 89.6 compared to 89.8 in the third quarter of last year. The graph shows some deterioration in combined ratios for both business insurance and personal lines. Underwriting margins are declining slightly as the effect of lower pricing begins to flow through earned premiums. While continued favorable frequency and moderate severity continue, overall loss cost trends thus remain relatively benign.

Page 5 highlights the two changes we made in our full-year '06 guidance for P&C. We lowered our outlook for written premium and specialty, reflecting the drop in specialty property. This in turn reduced our expectation for total written premium growth from mid-single digit to low-single digit increases over '05 levels. Based on our expectation, for the fourth quarter, we believe our full-year combined ratio for ongoing ops will remain in the high 80s, excluding cats and prior-year developments.

Turning to life on page 6, life operations reported core earnings of $407 million in the third quarter of 2006, 12% increase over the prior year. Assets under management also rose 12% to $302 billion, a new milestone for us. Net income by segment is shown on the bar charts. Growth in net income was driven primarily by a lower effective tax rate in some segments, higher assets under management in both the U.S. and Japan, a 9% increase in insurance in-force for individual life, and a 9% increase in premiums for group benefits.

Year-over-year changes in net income by business were impacted by a number of factors as described in the 10-Q. I would like to highlight a few, but would encourage everyone to review our 10-Q for all the details as well as expanded detail on our outlooks.

First, income taxes. Core earnings for the third quarter this year included $19 million of tax benefits related to prior periods. The largest part was $14 million in retail products.

Mortality was another driver. We had a tough compared this quarter and both individual life and institutional solutions due to unusually favorable mortality in the third quarter of '05. Overall, though, growth in earnings tracked well with growth in insurance in-force and assets under management.

On page 7, we've updated our guidance for life operations through year end. In most cases we simply updated and narrowed the ranges for sales and flows. As you can see, we are anticipating continued net outflows in the U.S. VA business. Given the maturity of our block and the competitive market, we don't foresee a substantial change in our redemption rates anytime in the near future. Consequently, unless we get a significant increase in sales we will most likely stay in net redemptions through next year.

We have also increased our ROA guidance for Japan. So far this year, Japan earnings have benefited from several unusual items like tax benefits and surrender charge income. While '06 net income is likely to generate an ROA of 70 to 74 basis points, I still think you should consider a run rate to be in the high 60s.

Individual life sales are up strongly year-to-date; and we're looking at another good quarter ahead. We have increased our guidance on sales growth of 13 to 15% for full-year '06. There are no other changes to guidance in group benefits or individual life.

Turning to capital management. First, a note on modeling our [APF]. I know it is no surprise to the people who follow our Company, but I do want to remind again that our share count continues to go up, as our equity units, which we issued early three or four years ago, mature. We issued 12.1 million shares in August and we will be issuing approximate 5.7 million shares in mid-November. By year end, we estimate we will have 323 million common shares outstanding.

Our recently announced share repurchase will not materially move this meter. At $90.0 per share $300 million only buys you 3.3 million. I would refer you to page C12 of our financial supplement to help you estimate diluted share counts for full-year 2007.

I know you may have questions on our plans for capital in 2007. As we speak, we are in the midst of our annual business planning process. We will share the results with you on December 11 in an extended conference call. That will include views on '07 capital management.

But I can give you some directional thoughts at this time. First, we communicated our plans for the $500 million in excess capital we hope to have at the end of 2006. I believe our Board was very generous in deploying it as they did. In my view, $125 million a year in extra dividends, plus $300 million in share repurchase, adds up to a lot more than $500 million.

While everyone knows that dividends can change over time, if you valued the dividend increase as a perpetuity at, say, 10%, the two actions sum to $1.5 billion.

Second, we are refining our views on the required economic capital we need to protect the enterprise. I do believe we will increase our minimum capital margin somewhat for 2007 above its current target of $1 billion. We will know the new target by December.

Third, we expect to generate capital in excess of our needs in '07 just as we did in '06. That number will likely be greater than the $500 million that we targeted for '06 even after giving effect to the '06 actions and after an increase in our capital margin. We will have that estimate for you also in December.

Overall, our philosophy on capital will not change. We believe our shareholders pay us to maximize the capital and embedded value of our Company, which is best approximated by book value per share plus dividends. As long as we can generate superior ROEs, more book value and more dividends will usually be linked to greater shareholder value.

Now obviously, given that view, we would rather increase dividends than buy stock back at a premium. But as a regulated insurer we need to move cautiously when increasing our regular dividends. And a number of our shareholders have told us they aren't ready to prefer special or variable dividends over buybacks.

We also believe we have to sustain two key strategic assets of our Company, our AA financial strength ratings and the ability to deploy capital at cyclical points in our industries in the future, when others might lack the same flexibility.

Given that view our priorities will remain, one, invest in the business when the returns are there; two, well-priced acquisitions; three, dividends; and four, buybacks. We will seek to deploy '07's excess capital in that order of priority. Ramani?

Thank you, David. We have had a very good year so far. As you can see by the guidance David has provided, we expect more of the same in the fourth quarter.

That said, many of you have been asking about our views in the next 12 to 18 months. Over the next few weeks, I will be reviewing the 2007 plans for each of our businesses. I look forward to sharing our initiatives and outlook with you on December 11.

What I would like to do today, though, is to highlight a few of the major items we see affecting our industry and our business in the coming year.

Page 8 highlights the key trends in property and casualty. I believe that, industrywide, 2006 accident year underwriting results are probably at their peak. In 2007, we are expecting pressure on earnings and return on equity due to three key trends -- competition, increasing loss cost, and higher reinsurance rates.

Now over the first half of this year, the market was largely rational. We saw slowing top-line growth and modest price decreases. Insurers focused on retaining profitable customers while actively seeking new business through expanded distribution, advertising, and producer incentives.

In the latter part of the last quarter, however, we started to see signs of increasing competition, including some pockets of very aggressive pricing. This was particularly evident in the middle of the country. With strong balance sheets and capital generation exceeding revenue growth, pricing pressures are likely to build into 2007.

Now I do not expect to see prices drop as much as in previous cycles, because there are more circuit breakers to support continued underwriting discipline. We have, first, a relatively low interest rate environment, a higher concentration of industry premium among larger, smarter players, far more sophisticated underwriting tools, increase rating agency oversight, and greater transparency of accident year financials.

We believe the property and casualty earnings in 2007 will also be affected by rising loss costs. Severity has been creeping up over the first nine months of 2006. While frequency may still be favorable next year, we're not anticipating it will be as favorable as we have seen in 2006. Of course, we have underestimated the favorable frequency trends for some time now.

Finally on the reinsurance front, we have started the negotiations for our January 1 renewal. Early indications are that reinsurance market costs will rise again in 2007. We were fortunate to have a light hurricane season this year but we don't expect to have that one good year will result in lower reinsurance rates.

So the collective effect of pricing, loss costs, and reinsurance trends suggests to us that industrywide accident year underwriting margins are just not sustainable at the current levels through '07. That said, in property and casualty we will seek to grow our business wherever margins remain attractive.

Now across our property and casualty business, we are working to appoint new agencies in personal lives and small commercial. This work will continue into 2007. We will also increase marketing to AARP members. Our efforts to refine our pricing and underwriting technologies will continue, building on our success with Dimensions. Lastly, we will invest in enhanced service capabilities to ensure that we make every effort to retain our most profitable customers.

Moving on to life operations, page 9 summarizes the key trends. The U.S. variable annuity market has seen strong sales in 2006, but industry net flows remain under pressure. As we look to next year we expect industry sales growth to moderate, with continued pressure on net flows as older annuities are surrendered. Now that all major competitors have some form of lifetime income benefits, we do expect the pace of new product introductions to slow somewhat next year. This should allow financial advisers to focus on serving their customers and building their expertise in retirement and longevity planning.

The Hartford can compete very effectively in this market. We have a strong array of living benefits, great money management, and some of the best fee structures in the industry that provide great consumer value.

2007 should be another fine year for The Hartford's young retail mutual fund and retirement plans business. While we have generated strong double-digit growth in assets under management, we have only begun to tap the opportunity in these markets.

Moving to Japan, The Hartford remains very optimistic about the long-term opportunities for retirement solutions in Japan. We have seen more competition from both domestic and foreign companies; but that is to be expected in a growing, profitable market. The Hartford recently introduced an updated annuity product with an enhanced liquidity feature. Our plans for the coming year call for expanding sales in both new and existing distributors and building out our product suite in order to maintain our leadership position.

In individual life insurance, the key trends we have seen in 2006 are likely to continue next year. Universal life insurance will probably dominate industry sales, but good equity markets could generate a comeback for variable life. Product and distribution expansion will continue to be the key themes for The Hartford's individual life insurance business next year, and we already have many of the building blocks in place.

We are expanding distribution in financial institutions, the fastest-growing channel in the industry. We recently introduced a new term portfolio that should position us well for sales growth next year.

Group benefits continues to face a challenging business environment. As always, you can expect us to maintain our pricing and risk discipline and deliver strong results in 2007.

So to summarize, 2007 will be a challenging year in both the life and property casualty industry. The Hartford is operating from a position of strength. We like the mix and diversity of our businesses. We have leading positions in our markets, a sound balance sheet, and strong risk management. So while the industry may slow a bit into 2007, we should be able to outperform in our targeted markets. I would like to open the floor now for your questions.

(OPERATOR INSTRUCTIONS) Jimmy Bhullar of JPMorgan.

I just have a couple questions. First, if you can give us some sort of more clarity on the loss development in the P&C side. I think you had favorables, and in personal lines and in business insurance. If you can just give us some detail on which accident years are developing favorably and perhaps which ones are not. Then I have a follow-up on Japan annuities.

Jimmy, good morning. Dave Zwiener. On the loss costs in the third quarter, I think a continuation of the sorts of trends reported in the prior quarters.

But just to give a little more detail, I think turning to business insurance first, what we saw in the quarter, as you would expect, is a continuation of favorable frequency in sort of a favorable low-single digits.

On the severity side, it was well contained. There too, I think that what we saw was a little bit of an uptick in the severity, but still in total for business insurance positive low single digits.

So I think on the total loss costs, a very similar profile to what we have seen on average for the last couple of quarters. But if anything we are seeing a little bit of a pickup in the severity numbers, as Ramani talked about.

I think on personal lines, too, I would say not a big change. Looking at the auto line, I think, on the frequency side it continues to be favorable in the third quarter. On the severity side, there too, well contained, low single digits on the severity side. So total loss costs on the auto line has been well contained. I would say just about flat in the quarter.

On the homeowners side, the severity was probably ticking up a little bit there as it did in the second quarter. So it is something that we are watching, as I think others are in this space. But I think in total, just to remind you and others, homeowners is probably a lower portion of our personal lines book, probably closer to 25 to 28%. So when you look at the total personal lines loss costs, you are looking at something that is actually quite favorable. We are probably in the very low single digits in total home and auto frequency and severity. So that is the way it looks right now in the third quarter.

Have you seen any uptick in frequency in the auto side with the decline in fuel prices?

The frequency, I have to tell you, on the auto side has been fairly consistent. Sort of that negative low single digit number. We saw that again in the third quarter. So really, no impact from that or any other phenomenon, as yet.

Okay. Then just a question for Tom Marra on the Japan variable annuities. I read through the new product you had, (indiscernible) [Equity40] with the 10-year deferral period. If you look across other companies that you're competing against in Japan, especially the domestic insurers, even with the revision to your product, their products are much more aggressive than yours is.

So what is your outlook for sales just in general terms next year? Can you stem the decline in sales? Or are you going to keep losing market share for the foreseeable future as competition increases?

Thanks, Jimmy. It's Tom. Certainly our intent is to begin to increase sales a little bit, although now that the market is full of competitors, we think that will be more slow growth.

Keep in mind, fourth quarter is a little affected because the third quarter is the end of the fiscal half-year. So there is a little bit of rush, particularly at the end of September. So that is why our guidance is somewhat in line with third quarter for fourth.

But our product development isn't going to stop with Equity40. We plan on having yet another product out in the first half of '07, and that will be part of the game plan. So it is kind of good to see that this is really now a market that has arrived. So we still expect total growth for the industry. Now our job is to claw some share back, and I think we are up to it.

Thank you.

Andrew Kligerman of UBS.

Just wanted to get a sense of the new riders that came out within September in the U.S. How that is playing out in the different distribution channels, and whether you think maybe -- it looks like your guidance isn't up too much in the fourth quarter. But do you think that might play out a little better next year?

Thanks, Andrew; Tom. Yes, I hope so. We are very pleased with the new riders. The LI, Lifetime Income Builder II is now our number-one seller. So that is a product that is brand-new, already our number-one seller, which is very good for a new introduction.

I would say, early on, I would have to call most of its sales a substitution for what would have been in the Principal First rider. But momentum is good, the spirits are good, and I think it may take a little while. Again, like Japan, this is a very competitive market that has got a lot of good players in it. But we are real pleased with the early success of the riders.

Just in terms of your wholesalers and so forth, are you seeing a lot of competition for your wholesalers? Or are you able to retain them and grow them in the variable annuity area?

Yes, we are pretty pleased with the maturity of the wholesalers. Remember we are coming up on the full second year of when we made the split between mutual fund-only wholesalers and then the two variable annuity teams. So I think they're jelling quite nicely. We do get them picked off from time to time, because folks are willing to pay a lot for good wholesalers. But I think, overall, the teams are jelling nicely.

Lastly, Tom, just on the group benefits competition. It is increasing. Could you just talk a little bit about group disability, group life? Just a little color around that, and whether you're going to be able to grow the top line in '07.

Yes, we think so. First of all, we have had great persistency. The other thing I would say, in terms of sales this year, over a third of our sales were to existing customers, where we actually offer a new line of coverage. So we think that has been a nice way to get growth, along with the good persistency and of course new sales.

Competition is tough. Certainly we are seeing it especially keen on the small group side. But as Ramani said in his comments, this has been an incredibly consistent business. So I think we will be able to get some nice premium growth and still turn in good results, good returns.

Excellent, thank you.

Eric Berg with Lehman Brothers.

What I am trying to reconcile on the life side of the business is what clearly seems to be, on the one hand, really strong flows, which in turn are sending assets higher, or in the case of traditional insurance products, premium higher. But when I look at the summary of your life results, sort of the trend over time in the various businesses, whether it is individual life, institutional solutions, or retirement plans, it doesn't look like the earnings are really moving up. They sort of seem to be sort of flat-lining.

While I certainly heard Dave's comments that we need to really scrutinize and understand the special items that were discussed in the 10-Q, I'm really referencing what has been happening for like the last six quarters. My question, should I be looking at the data differently from how I am? Or in fact, is the trend that I am seeing the real trend, flatness in earnings?

Eric, I am going to have Tom answer this. One thing that you should be aware of, as I turn this over to Tom, is we are investing in the growth of our 401(k), which is our retirement businesses, as well as our retail mutual fund businesses. So there are some real exciting possibilities here for us from that perspective. But let me turn it over to Tom.

Yes, Eric, if I don't completely catch this, I will turn it over to Dave Johnson who might be able to add more color. I think generally speaking, each quarter seems to have a little bit of noise. Things like tax rates, or DAC true-ups, those kind of things emerge.

But overall, I think the earnings will track the general growth of the business. I don't see huge swings in margin. So individual life is a 9% growth in account value or face amount; and a similar growth in account value. That should be a general guide.

Every quarter you'll see a little swing from within that broad range. But overall, as I look at it, I do see the results in terms of earnings generally growing with the business. David, did you --?

Yes, life core earnings were up 12% year-over-year and that pretty much exactly tracks with the increase in assets.

Thank you.

Joshua Shanker with Citigroup.

My first question involves the $350 million share repurchase. You mentioned in the press release that you would be completing that within two to six months. Can you talk about your thoughts about when you come to the market to buy shares over the near term?

Let me turn it over to David.

I think we will probably be tactical there. Beyond that, you know --.

What does that mean, tactical?

Lots of good tactics. Well, I think we will look at what availability there is, and block flow. We will look at the stock price. We will look at timing of other things that we could be doing in the market.

It is not a large amount to get done, as some shareholders have pointed out to me. So I think we will probably easily get it done within that six-month period. We could easily get it done in the first two months.

Joshua, we have done this in the past. We know how to do this. We really to a very good job of executing it, so the two- to six-month guidance is to help you all visualize how this might happen in time.

Very good. My second question involves an issue of life insurance suitability. I am wondering if it is an issue. You have been training your sellers in both variable annuity products as well as mutual fund products. Is there potentially an issue somewhere down the line for regulators to suggest that some insurance sellers have been selling unsuitable expensive variable annuity products to customers who might well be suited to buying mutual fund or whatnot?

Joshua, it's Tom. I guess anything is possible. I would just note that we are among the lowest in terms of our variable annuity expense ratios. I think variable annuities, particularly with the expansion of benefits that have really just -- I think are really valuable to customers right now. Certainly, as you know, to be able to provide the robustness of the benefits, they do require charges, particularly on the riders.

So I don't know. I haven't had any signal that there's issues brewing. I think in our marketing, these are [in ASD] sold products, so require that a broker sign off on suitability. Like I said, in terms of our fees, they're at the low end of the industry.

Very good. My final question involves the P&C business. According to the survey data that comes out, it seems like the downtick in rates is pretty similar in the small market businesses to the large market businesses. Which is kind of counterintuitive.

I tend to think, according to what my study is, that the small market business is less price sensitive in the downcycle. What are you seeing in this? (indiscernible) the survey data at this point?

We would agree with your observations. This is Dave. I think in the small commercial space, we have seen flat to slightly up pricing. But in the middle market, we have seen down low single digits. So we would agree with you.

I think as others have suggested, some of the pricing survey data is suspect. I think that it is a lot of anecdotes versus I think what we are seeing live in the market. So that is exactly what we are seeing.

Thank you very much.

John Hall with Wachovia.

I have got some questions about Japan. David in your comments, you indicated that the run rate margins there were going to be in the 60s, while you put the guidance up into the low 70s. I wonder if you can offer an explanation of that.

Well, I think the reason why it is a little bit higher this year is because we had some unusual tax benefits; and we also some an unusual surrender income. We don't believe either of those will persist in the long term and probably not even in '07. So I think high 60s is the more sustainable run rate.

Why would you think that surrenders would go down as the book becomes more mature in Japan?

Well, I think that I will yield to Tom on this one, after my first answer. But we have a very young, immature book. You know, pockets of surrender activity as people get to know the variable annuity and their rights and opportunities under that product can have a disproportionate impact on surrender rates in the early part of the product lifecycle. Over time we think that that will probably stabilize.

What happened, particularly at a couple of distributors, John, is when the gains were -- they haven't had good returns. Of course you know the Nikkei was way up in '05; and that created sort of a heightened level of surrenders as people just wanted to protect their gains.

So we don't -- we think that the run rate will be higher than we had first anticipated. Certainly, well within pricing, but slightly lower from what it has been this year.

Okay, great. Just on the Japanese VA sales as well. I was wondering if you could offer an opinion as to how big a factor mutual funds as a substitute product has been in the shortfall; and whether the changes in leadership over there, given it is a relationship-type market, had any impact.

Well, clearly the domestic players jumping in, in full force, was the driver of the share shift. I don't -- the mutual fund industry is still relatively small in Japan, something we are interested in, by the way. But I don't think that has been a major factor in competing for share with variable annuities.

I think VA seemed to be the product of choice given their retirement and tax benefits and some of the protection features. So I think things will go well for VA. But the major phenomenon that we have seen is the domestic competitors really making an entry with some force; and that did affect us.

Great. My final question has to do with the capital cushion. David, you mentioned that it was biased up. You will give the new target in the future. But I was wondering if you could just discuss what is driving up the basic bias for that going up?

I am going to transfer to David; but we call it capital margin, not capital cushion, just to correct you. I will turn it over to David.

Cushion gave the implication that it wasn't needed to protect our businesses over the longer term, and we really do look at it as economic capital needed to protect us.

Well, I think a number of things. One, we do continue to see a trend towards principal-based capital margining, both in the rating agencies and the regulators. We had our capital -- required capital is going to go up by somewhere between $0.5 billion and $1 billion, for [F&P] for example, into next year. That is as a result of them moving from a factor-based approach to capital margining to a principals-based one, based on risk modeling of catastrophe charges.

Similarly, on the life side, you see the regulators -- and their approach is embraced by the rating agencies -- moving to a modeled [CTE], a stochastic exposure-based approach to required capital, and ultimately reserves, for life benefits, particularly associated with a variable annuity.

What both of those have the advantage of doing is that they reward more sophisticated granular risk management, particularly in stable times. But they also both have the disadvantage of increasing the volatility of the capital call in stress events.

So over time, as those approaches come onboard, and as everyone analyzes their risks better, it takes up your view of the need for capital in the tail events. As we continue to do that modeling and it continues to be embraced by the people who matter to us for capital management, that is leading us to increase the required capital margin.

So that is what is driving it, and we are not looking at tectonic changes, but it is going to go up a little bit as our business grows up.

All right, thank you very much.

Gary Ransom with Fox-Pitt, Kelton.

I had a couple questions on the property casualty side. One on the environmental charge. Could you tell us what it was that emerged or what new information came about that triggered the additional charge?

Thank you, Gary, I am going to have Neal Wolin address that.

Gary, there really was not any secular trend. We looked at all of our -- every one of our environmental accounts; and some were up a little, some down. The net of it is what you see in that charge, rather than anything going on in the marketplace or in the litigation environment that was sort of a secular trend.

Okay, thanks. Then one other question on prior-year loss development. I noticed that actually in the auto segment, you had no prior-year favorable development. I guess there is a little tiny bit of adverse.

But that is very different from what the other competitors are seeing. I guess in an environment when loss trends are going favorably, and in particular when frequency is declining, I would expect there to be a little bit fewer claims coming in than you expect, and that there would be naturally a little bit of favorable development.

I just wondered if you could comment, and maybe this is for Dave Zwiener. But if you could comment on what is going on there or why you think you are different; or if you can speculate why you might be different. Or maybe, to put it more positively, why are you so accurate?

I'm going to stop short of admitting we are so accurate. But I think that a couple of things. One, we did flow through some benefits last year, as you know. I would say that net for the nine months this year we have flowed through a net benefit.

I would characterize it more as timing, and two, the trends that we see continue to be intact, favorable trends. So, for this quarter, this is where we landed.

Essentially, the only issue there in the quarter was the release of some of the cat reserves that we had from '04 to '05, flowing through personal lines. But I think as we look at the trends, the bias would be for continued favorable development in the future. But in this quarter, this is where we landed. I think this is the right place to be.

Okay, thank you very much.

Tom Gallagher with Credit Suisse.

I have a question and Charlie Gates is going to have one on the P&C side. Ramani, I guess just in terms of the outlook you talked about in terms of U.S. VA, you had mentioned that you expect industry sales to moderate, pressure on surrenders. I guess, it sort of struck me that it sounds like -- I don't know if you can comment, you or Tom can comment on directionally where this is going. But it sounded to me like you were expecting net flows to actually get worse from where they are right now, even though they are running at a pretty large net outflow number. Can you elaborate on that at all?

Well, Tom, it is more a general statement about the fact that the net to gross sales in the industry have been fairly low in the last year, and we don't see that improving. By and large, that is the area where we focus on to a great degree.

We would love for the industry to relate expand its pie; but it is really annuities trading between companies was where predominant percentage of the gross sales are. That was all we were trying to suggest to you there.

Tom, I think the what-for with our numbers, as we said, unless sales find a major uplift, we will stay in net redemptions. One thing to consider on the surrenders that go out, with the recent run-up our account values are up yet again even in this quarter. So even if you applied the normal surrender rate to a higher number, that is going to affect the amount going out, which is really a good news item. But I just wanted to point that out. I am sure you are aware of it.

Generally, industry-wise, I think there's a lot of good things going on. Ramani did mention that maybe some of the product arms race is subsiding. I think one of the things I think we will see is continued emphasis on some longevity benefits, in addition to the performance guarantees. I would -- the [5 for Life] is a concept that started it. Now with LIB II, we actually can go higher; it goes up a 0.5% for each -- if you defer to 65 instead of 60 it goes to 5.5% and so on.

I think you're going to see more of those kinds of innovations. So I wouldn't be too conclusive one way or the other how this is all going to play out. I think it is a good industry and there is some good innovation that I think is going on here and elsewhere.

Got it, okay. Then just one other one for me before I turn it over to Charlie. We just got off a conference call with Genworth, where they discussed the SOP05-1 that is going to be implemented in the first quarter of '07. Aside from just the internal replacement DAC write-off for individual products, they were talking about also writing off their group life and disability DAC.

Can you --? I realize; I don't think you guys are ready to comment on any numbers related to this. But can you comment on the product types or DAC types that you're looking at, potentially related to this?

We have not identified an exposure such as Genworth was talking about in group. But I would say that on SOP05-1, that came out a fair amount of time ago and has generated immense confusion ever since. When the industry turned to actually try to develop implementation approaches to it, it was readily apparent that there were deep complexities where a lot of guidance was needed.

So we are all currently awaiting a technical practice aid that the AICPA is going to hopefully put out before year end, that is going to address eight different practice issues of these sorts of complexities. Even that is not expected to be enough to eliminate all confusion.

I would say that the place where The Hartford would potentially have exposure to this is in the VA area where obviously that is where a huge amount of exchange activity happens for us. But we do not currently compensate for a VA to VA exchange. So that is a relatively small exposure for us. Because it really would have to be an exchange from VA to an unrelated product inside our apparatus. As far as we can tell, that is not going to create a material exposure.

But there is a lot of confusion on this one. We are all awaiting some of the technical guidance. But our preliminary evaluation is that this is not a big issue for The Hartford.

Okay, thanks. Now I think Charlie has a question.

My first question, I think one of you opined that there was greater competition in the middle market than with small commercial lines cases. How do you define the middle market?

Charlie, for us middle market is the level of customer right above our select customer and below national accounts. So it is usually above $75,000 or so in premium, up to about $1 million.

Charlie, this is Dave. I think where we are particularly seeing scene that competition -- although it is, I would say, a national competition that is heating up -- the middle part of the country is particularly where we are seeing it.

I think that as you have heard others talk about and we have talked about on prior calls, I think with folks paring back on some of the cat-prone business, moving very aggressively to the non-cat or center of the country, we are seeing an awful lot of competition with some of the entrenched players in that part of the country.

So there has been, I would say, probably the biggest gapping of new and renewal pricing in that line in that part of the country that we have experienced.

My second question, if you were to step back, you talked in your 10-Q at length about giving up this one captive program in your specialty commercial lines business. What are, say, the two most important trends in your specialty commercial lines business as you currently assess them? That is my final question.

Sure, Charlie. I think probably the most important trends within the total specialty operation would be within the property category. I think you pointed out the nonrenewal of the one single captive insurance program. That affected the casualty line. But I think when you adjust for that, you get a pretty understandable comparison year-over-year and sequentially.

It is on the property side where I think there are a number of things going on particularly on the year-over-year comparison. First of all, when you adjust for the reinstatement premiums that occurred in the third quarter of last year, rather than showing property up 29% year-over-year you actually get a profile of property being down 23%.

So within that, I would tell you that the trends would be, one, most importantly, we have been working very hard to manage down some of our aggregate exposures, cat exposures within that line. You are seeing the effect of that. Then, two, the effect of the higher reinsurance that has rolled through that line as well.

So I think that that is really the trend that has been in place for the last year and probably will be here for a little while longer.

Thank you.

Alain Karaoglan.

I have a few questions. In terms of the competition in the Midwest or around the country, can you describe maybe the nature of the competitors? Are these national companies? Are they mutual companies? Regional companies? Or it really depends on the line of business or the case in particular? Is there any sort of characterization of the competitors that are being extremely aggressive?

I would say all of the above, but with a bias to the regionals. I think that there has been an increased presence of the nationals, The Hartford included. I think that this is bread-and-butter business for many of those companies that have been there. They are feeling the competition from bigger, in some cases more sophisticated, companies coming into their markets.

So I think that we are feeling that competition coming most from the regionals. But I would come back to my original answer. I think everybody is being very competitive in that market at the present time.

Okay. In terms of the discontinued business or the runoff business, any thoughts on when that business can really runoff without underwriting losses? Any expectations of being better going forward?

You know, I think, we look at our accounts in this business on a very careful basis as you know. I think we feel like we have got a good handle on where we are and what we have. But this remains a challenging segment. The external conditions are challenging.

I think there are some favorable things we see out there in the environment which give us some hope. But we continue to be mindful of the fact that this has historically been a challenge for the industry. That is how I would describe it.

I think we will continue to make progress resolving our most volatile and most problematic accounts. We have done an awful lot of that over the past few years. I think you see that to some extent in the number of accounts that are big ones that we report. But we look forward to more favorable developments.

Thank you very much.

Tamara Kravec with Banc of America Securities.

I have two questions. One is, I was interested in your comment that you said universal life would dominate sales in 2007. Essentially you have been more of a VL writer. So I am curious as to your thoughts on how well you're positioned in the UL market; and particularly with competitors doing [a] Triple-X securitizations and the disarray of the market this year.

My second question is, your fixed annuity sales were up considerably this quarter. I was just wondering if there was anything particular in that number.

It's Tom. Yes, the fixed annuities are going to be lumpy, and particularly when you get -- short-term rates spikes will kind of explode on the scene. That is what you saw in the third quarter. Rates did retreat; they picked back up slightly in the last couple weeks. But it will be down considerably from that number in the fourth quarter.

You'll see that we will just from time to time hit these spurts where we can quickly burst onto the scene and write some business at full margin.

We are a UL player. We don't want to mischaracterize our VL leadership to say that we are not also interested in the UL business. So I think we are well positioned there. In fact, the sales this year are up more for UL than VL, certainly. We are, I think, positioned in good shape to play in that market as well.

Okay, thanks.

Jay Cohen, Merrill Lynch.

Two questions. The first is, FAS 150-a, you mentioned in your Q that you will be taking a charge for that in the fourth quarter. Maybe not a charge, but you're making that addition. It didn't seem like a very big number relative to what one might have expected looking at your disclosure in the past. I am wondering why that number is relatively small.

Well, we benefited from a number of actions. We have made continuing contributions to our pension fund. That have significantly improved the capital position there. We have benefited from good investment performance. Interest rates have moved up, decreasing the net present value of the liability.

All of those things together have brought us down to a very nominal impact. So it is a happy place to be, and we expect to continue funding our pension plan on a regular basis going forward despite the fact that we are in relatively good position, because I think that is the prudent thing to do.

Yes, that was good news. Second question, I guess it is either for Ramani or Dave Zwiener. That is, the outlook that you described on the property casualty business, looking out into '07, was -- one would just probably describe it as somewhat subdued. But from my standpoint, not all that surprising.

I am just wondering how you feel about it. In other words, if I asked you six months ago what kind of comments might you be making at this point, would you have guessed they would be much different than what you said?

Well, Jay, it is hard for me to go back to six months and just precisely describe how I might have characterized '07. But you know, one noticeable observation here is industry capital is growing faster than industry revenue. Second, industry balance sheets are about the best they have ever been.

Third, industry accident year performance is absolutely outstanding. Fourth, industry handle on legacy issues is the best we have ever seen.

So when you put it all together, you know, you have to assume that the search for growth and hence the competitive trends will be more acute in '07 versus '06.

On the favorable side, if loss costs stay very moderate, you should see a good year continue, but I suspect '06 is probably for the industry the peak from an accident year performance standpoint.

I also believe today, which is a point I made earlier, the concentration in the -- concentration may be the wrong word. But there are larger, smarter players in the business and there is greater discipline; so I don't expect this market to become irrational. But I do expect this market to turn more competitive.

Great, thank you.

Paul Newsome with A.G. Edwards.

I want to beat the Midwest competition dead horse just one more time. My apologies. A number of your midwestern regional competitors have reported more than just a creeping up of severity. They said that, in particular, the number of very large claims had spiked up in the quarter. I was wondering if you had seen this; or if it was just more a general increase in severity in the Midwest. And if this could be tied to any loosening of terms and conditions above the rate competition which seems to be there.

This is Zwiener. The answer is no. We have not seen that same trend. I think the only thing we had seen, and it is national, would be -- as Ramani and I both have said -- there is a slight uptick in severity, but by no means any spiking that we have seen. I think the one area that we have reported on and continue to watch would be the homeowners line. But otherwise, thinking more broadly and certainly within the commercial space, we have not seen that.

I think a couple of companies that that you reference I think are reporting on some very local phenomena. Maybe company-specific phenomena. But it is nothing that we have seen in that part of the country or in our book.

Thank you. That is very helpful.

Operator, we have time for two more questions.

Mark Finkelstein with Cochran and Caronia.

A couple of quick questions here. In Japan annuities, it sounds like the product is there with the enhancement, the 10-year product. I am just curious about kind of the distribution side, with the product being a little bit less competitive over the last couple of quarters. Domestic is obviously getting more aggressive. Have there been any major gains, losses?

When you go back to your prior commentary you talked about continuing to expand distribution. How is that tracking?

Mark, it's Tom. Obviously in our decline, we were displaced as number one at several places. In particular, Tokyo Marine, a domestic company, took the number one spot while we for the most partway remain in there as a number two. So it is going to be claw back.

There are a couple of accounts where we are going to have to win prime space back. But for the most part, the distribution is there; it is a question of execution and getting management and brokers to see us as the superior alternative. But we don't have the market to ourselves anymore. That is for sure.

Right, okay. Then just a quick question on the P&C side. I guess just given comments on that business and where pricing is, can you just talk a little bit about your outlook on the specialty commercial business? Which is obviously very transactional in nature, shows much kind of broader spikes in terms of written premium levels. Casualty, obviously, with pricing down a fair bit this quarter. Property a little bit up but still kind of well below the highs of '04. I am just kind of curious about where we could see these businesses going in '07.

Sure, just some general comments. I think that the way we approach these businesses, as we reported in the past, are really transactional businesses. So you're going to see more volatility of the top line. I think this is a quarter when you certainly have seen that.

I think we're reacting to the market conditions and we are pricing to get the business at the returns we need. Where we can't, we're cutting back. Obviously too, on the property line we have the cat exposure issue that we are managing aggressively as well.

That said, I think we have put a lot of attention over the last several quarters in terms of developing product capabilities that could be distributed to our middle market and small commercial customers. So I think what you are seeing is some good trends within financial products on D&O and E&O, and also on the bond business.

So I think that we have seen some good, stable growth rates there. I think that you probably should continue to see that as we penetrate our distribution into the middle markets and, to a lesser extent, some of the smaller commercial customers as well.

Okay, so I guess just thinking about '07, is it a little bit early to say where we think that top line could go?

Absolutely, yes.

Fair enough. All right, thanks.

Last question, operator?

Jeff Schuman with KBW.

A question for David Johnson. We have seen your capital margins built over the last couple years, and now you're talking about feeling a need to increase it further. I am wondering what the bottom line is, I guess, both in the near term and the long term. Does increased capital costs --? Are you optimistic that the industry will follow you in this direction, until you will eventually be able to price for it?

I guess, first of all, I am wondering, first of all in the context of the current environment of very rich capital environment, and then maybe longer-term when capital is not so plentiful.

Okay, well there is always going to be some -- given a view as to how much capital is needed for a given level of risk and a given level of premium -- a growing company, which we of course always aspire to be, is going to always have a little bit of an increase in economic capital required. That being said, obviously, we have increased the margins more than just would be tracked by the growth in our premium over the last two or three years.

I think it is informed by two or three things. First, we will never hold so much capital that it impairs our ability to achieve appropriate returns. If you're holding capital in excess to an extent that it hits your ROEs, that means that you're not writing the right business. While there can be periods of dislocation, you need to rescale your company and your operations if capital and return are out of whack in the intermediate to long term.

That being said, I think we are responding to a couple of things that might distinguish us a little bit from our competitors, maybe not. One is that obviously over the last six years, we saw what it meant to not have shock capacity in capital when bad things happen to you as an insurance company.

I think as stewards of our shareholder value, that means that we don't want to have to go to the capital markets in relative weakness and at relatively poor pricing to raise capital in ways that create dilution to them, that is particularly disadvantageous. So that does inform probably a slightly higher view of the value of a margin than a company that had not had to go through that experience.

Second, we do believe it is strategically important to have capital in situations where other folks don't. These are cyclical businesses. This is obviously not a time in the cycle when other folks don't have capital. But fortunes change, and having a little bit more resources when cyclical opportunities arise is a great way to create shareholder value over the course of a cycle. And we are informed by that insight also.

Finally, I would say that our views on economic capital required are not just driven by ourselves, but again by the growth in the principles-based and model-based capital requirements that are emerging amongst regulators and rating agencies. I think they will enforce some aspect of this discipline across the industry. But that is going to be a multiyear process.

So as a fair summation, is it fair to say that your evolving views on capital are not changing your long-term return expectation?

Not at all.

Okay, thank you.

That is very core, Jeff, to everything we do here. Because ROE comes first, and we have been very consistent in letting shareholders know that we want to grow book value per share including dividends distributed, and how our ROEs be in the 13 to 15 range. That is a discipline that is very fundamental to how we do business at The Hartford.

So let me bring this conference call to a close. We want to remind you of our excellent year-to-date results as well as the good performance in the quarter. We look forward to meeting with you on December 11 at 10 AM. At that point, we will be sharing our 2007 outlook with you, as well as any questions or answers you might have then. Thank you again for attending this conference call.

Ladies and gentlemen, this concludes today's conference. You may now disconnect.