Hartford Insurance Group Inc (HIG) 2007 Q3 法說會逐字稿

Good morning. My name is Alice and I will be your conference operator today. At this time, I would like to welcome everyone to The Hartford third-quarter earnings 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). I will now turn the call over to Kim Johnson. Ma'am, you may begin your conference.

Thanks so much, Alice. Good morning and thank you for joining us for today's third-quarter 2007 financial results conference call. As you know, our earnings press release was issued yesterday afternoon. To help you follow our discussion, a financial supplement and slide presentation are available on our website at TheHartford.com.

Participating in today's call are Ramani Ayer, Chairman and CEO; David Johnson, CFO; Tom Marra, the President of Hartford and Chief Operating Officer; Neal Wolin, President and Chief Operating Officer of our P&C company; John Walters and Liz Zlatkus, Co-Chief Operating Officers of our Life company and Alan Kreczko, General Counsel of The Hartford.

Following the prepared presentation, we will hold our usual question-and-answer session.

Turning now 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 press release issued yesterday, our quarterly report on Form 10-Q for the quarter ended September 30, 2007, our 2006 annual report on Form 10-K 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 or other financial measures is provided in the investor financial supplement for the third quarter of 2007, in the press release we issued yesterday and in the investor relations section of the Hartford's website at www.TheHartford.com. Now 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. I am going to touch on some highlights for the quarter then I am going to turn the call over to Tom Marra to provide detail on our operating performance and outlook. Before the Q&A discussion, David Johnson, our CFO, will comment on our investment results and capital actions.

Turning to slide 3. The third quarter was another excellent quarter for The Hartford. We saw continued strong profitability from our property and casualty businesses and over 20% growth in life assets under management. Once again, The Hartford extended its track record of delivering significant value to our shareholders.

Since September 2006, book value per share is up 12%, excluding AOCI and our return on equity topped 17%. These strong results were achieved while returning $1.2 billion to shareholders through share buybacks.

Net income rose 12% over the third quarter of 2006 to $851 million. Net income this quarter included the effect of our annual DAC unlock, as well as the impact of widening credit spreads on realized capital losses.

Core earnings rose 14% over the third quarter of 2006 even before the DAC unlock. The unlock added another $230 million to core earnings or $0.72 per diluted share. Now I expect many of you will exclude the effect of the DAC unlock when you analyze the Company's earnings. I do that as well when assessing business trends. That said, I do believe the unlock should be included when evaluating growth in book value and return on equity.

Essentially, the positive DAC unlock means that we have a more favorable view of the future profitability of our life businesses than we did in the fourth quarter of 2006. And that can only be a positive add to our shareholder value.

As you can see on slide 4, The Hartford is effectively managing its businesses in today's dynamic markets. We reported strong growth in core earnings in both our life and property/casualty businesses this quarter.

In life operations, we are generating outstanding growth in assets under management. Since September 30, 2006, total life assets under management are up $65 billion or 21%. We ended the third quarter with $367 billion of life AUM, a great foundation for the future.

I am particularly excited about the success of The Hartford's mutual fund family. So far this year, net sales to our funds are over $4.3 billion. The retail mutual fund business is approaching one of the major goals we set for ourselves, the milestone of $50 billion in assets under management.

The strength of our mutual fund business continues to be our dedicated wholesaling team and excellent fund performance. We now have 23 out of our 28 funds with a five-year track record that rank in the top two quartiles of their Lipper peer groups for the five-year time period.

At The Hartford, the story in property and casualty is one of consistently strong execution. Our results this quarter were excellent with good underwriting profitability and strong net investment income. Again, this quarter, we grew written premium in both personal lines and small commercial. That is good news since these businesses have relatively stable pricing and attractive margins.

Our partnership with AARP continues to set The Hartford apart in personal lines. Written premium in AARP is up 6% over the third quarter of last year. This profitable growing franchise now makes up over 25% of our total property and casualty premiums. With the extension of our agreement until 2020, AARP will continue to serve as the cornerstone of our personal lines business.

At this stage of the property and casualty cycle, investors are beginning to see how various companies walk the walk of underwriting discipline, particularly as you move upmarket to larger commercial risks.

In those markets where discipline and selectivity is key, we are reporting declines in new business and written premium. No doubt we are facing challenges from competitors, volatile financial markets and changing regulations, but our game plan is in tact and the results are encouraging.

Across the franchise, we are aggressively pursuing profitable growth while maintaining our focus on effectively managing risk and returns. So now let me turn it over to Tom to provide some details. Tom?

Thanks, Ramani. I would like to start with a closer look at property/casualty results on slide 5. Total P&C core earnings rose 9% over third quarter last year to $405 million. Good underwriting profitability and strong net investment income contributed to core earnings growth. Our combined ratio for ongoing operations was 91.4%, including 1.5 points of catastrophe losses.

Total written premium was $2.6 billion in the quarter, 3% below the third quarter of last year. The graphic on this slide highlights the written premium and accident year combined ratio results we are seeing in each of our markets.

Personal lines had an excellent quarter. We reported good growth in written premium and strong underwriting margins. Excluding catastrophes, personal lines reported an accident year combined ratio of 88.7%. Our AARP franchise is our fastest growing business in property and casualty. An expanding membership base, excellent renewal retention and increased marketing efforts all are contributing to profitable growth. With 6% written premium growth that Ramani mentioned earlier, it is commendable in this market.

Agency written premium rose 1% over third quarter of last year largely due to new agency appointments. We are also gaining traction in our dimensions with auto packages product. This flexible product provides agency customers with a choice of price points and options, an important feature in today's marketplace.

Underwriting margins are declining primarily due to rising loss costs. Again, this quarter, higher frequency in auto property damage claims and increased severity in non-cat property pushed loss costs up in the mid-single digit range. We are responding to the trends we see on a very local granular basis. We are tuning our dimensions rate plan and taking actions where needed to maintain overall rate adequacy.

Business insurance written premium was $1.2 billion this quarter, 4% lower than the third quarter of 2006. The lower written premium reflects the fact that we are entering the fourth year of low to mid single-digit pricing declines in middle market. We are also seeing a growing impact from state-mandated rate reductions in workers' compensation.

We are pleased with our growth in small commercial, a business with stable pricing and very attractive margins. Our accident year combined ratio in this business was excellent at 88.5% this quarter, excluding cats.

Small commercial written premium was $664 million this quarter or 1% higher than last year. Small commercial policies in force grew 5% driven by the success of our new commercial auto product. This plan introduced last December incorporates refined pricing and underwriting criteria to target the best risk. We expect to add this product in four new states during the fourth quarter to virtually complete our countrywide rollout.

In middle market, written premiums for the third quarter were $578 million, down 9% from the third quarter of 2006. New business premium is down 20% over the third quarter of 2006 as we saw fewer opportunities to write business at targeted returns, particularly in the larger accounts. We are managing our business mix to target the most attractive industry segment and states. We are also working to retain our profitable in force business.

This underwriting discipline is paying off. Loss costs in middle market are in line with expectations. The accident year combined ratio, excluding cats, was 94.7%.

Specialty written premiums were down 8% in the quarter due to lower pricing and a decline in new business in all lines except property. We are maintaining our underwriting discipline and focusing on protecting the quality and profitability of our book. Accident year combined ratios for the third quarter were 93.1%, excluding cats.

In summary, our property and casualty results in the third quarter were excellent. We are leveraging our experience and expertise to pursue every opportunity we see for profitable growth while maintaining our focus on targeted returns. We have revised our full-year guidance outlook for P&C and reduced top-line guidance. With one quarter to go, we have also narrowed the expected range for combined ratios.

Now turning to slide 6, life operations had excellent results this quarter, a testament to the breadth and strength of our business. We reported strong growth in both earnings and assets under management. Life's core earnings for the quarter were a record $682 million, including $227 million from our DAC unlock. Core earnings would have been up 12% over the third quarter of last year excluding the DAC unlock.

The fundamentals of our business are in great shape. We posted record total deposits of $15 billion in the third quarter and net flows were over $5 billion. As of September 30, year-to-date total net flows topped the strong results we delivered for full year 2006.

US variable annuity deposits were $3.3 billion in the third quarter, up 22% over the same period last year. We are pleased with this level of sales given the volatile equity markets during the quarter. Variable annuity net outflows for the quarter were in line with our guidance at $633 million.

Looking ahead to the fourth quarter, we expect redemptions will be higher. This is primarily due to higher asset values and required minimum withdrawals from qualified plans.

Ramani highlighted the growing success of our mutual fund family. I am pleased to see that our efforts to expand our fund offerings and diversified fund flows are beginning to take hold. Retail mutual funds had an excellent quarter. Deposits were $3.4 billion, a 32% increase over last year. The volatile credit markets this quarter hurt sales in our floating rate bond fund. Consequently, third-quarter total net sales for retail mutual funds came in at $651 million. Now, we expect fourth-quarter net sales will be back on track at a level of $1.2 billion to $1.6 billion. For the full year, we expect total net sales to exceed $5.5 billion, an outstanding result for a young fund family.

Retirement plan deposits were up 12% over the third quarter of 2006 to $1.4 billion. Ongoing contributions from existing plans in the quarter grew 21% over last year. Our growth in adviser-sold 401(k) plans is making this business a bigger part of our franchise.

Assets under management rose 26% from September 2006 to more than $28 billion. Variable annuity deposits in Japan were JPY212 billion in the quarter or $1.8 billion. On a yen basis, this is a 54% increase over last year.

Sales were strong across our expanded product suite. We have also continued to deepen relationships with our distribution partners. As we noted in our press release, there is a new regulation in Japan called the Financial Instruments Exchange Law or FIEL. This law became effective September 30. Distributors are now requiring extensive customer questionnaires prior to offering many financial products, including annuities. These new practices are extending the sales cycle and are negatively impacting October sales. And we have reflected that in our guidance for the fourth quarter.

Over the long term, we expect the regulation to be positive for the Japanese annuity industry. Distributors will be able to ensure that their recommendations are well-suited for their clients and the questionnaire process opens the door for companies like The Hartford to offer various products designed for consumer needs.

Institutional Solutions had another outstanding quarter with $4.5 billion of deposits. We reported strong sales of structured settlements and institutional mutual funds along with a large corporate-owned life insurance sale. It has been a phenomenal year for Institutional Solutions. Assets under management topped $60 billion at the end of the quarter. This business diversifies our risk while leveraging our investment expertise and strong credit ratings.

Life's protection business also performed well this quarter. Total life insurance for us for individual life was up 10% over third quarter of 2006. Excellent persistency and strong sales in variable life drove in force growth. Individual life mortality can be volatile quarter-to-quarter. This quarter, higher death claims dampened earnings growth, but the DAC unlock was a net positive.

In group benefits, premiums were up 3%. As we anticipated, sales for group products were lower than the record third quarter of 2006. Last year, we sold an unusually large group life case and reported $20 million of medical stop loss sales, a productline we exited last April. We were encouraged by a strong pipeline of activity for January 1 and we'll have a better feel for January sales at our investor call in December.

Group benefits net income grew 22% to a record $90 million in the third quarter. Favorable loss experience in group disability and higher investment income contributed to the strong earnings growth and higher after-tax margin.

In summary, our life operations are having an outstanding year. We have a rapidly growing asset base and leading market positions. Going forward, The Hartford's life operations should continue to deliver solid growth and return on equity north of 15%. And with that, I would like to turn it over to David Johnson. David?

Thanks, Tom. Going to turn first to slide 7. As predicted, this was a complex quarter below the line for The Hartford. All in though, book value per share, including AOCI, rose 3% sequentially and 8% year-over-year. Including AOCI, book value rose 12% in the last 12 months.

I focus on this because we care about all gains and losses, unusual or usual, core/non-core. In the end, all of this hits book value. That being said, there will always be volatility in our P&L given our accounting regimes and the businesses we are in and it will only increase over time.

In the third quarter, we completed our annual review of life estimated gross profits and the result was a good guy DAC unlock. The unlock added $0.72 per diluted share to core earnings. Page L5 of our investor financial supplement details the impact of the unlock and pages 28 and 29 of our 10-Q provide a wealth of additional detail.

Our DAC study is a very detailed, top-to-bottom analysis that takes several months to complete. The majority of the benefit from the study came from favorable market performance in our separate accounts. Bottom line, this is a positive report card on the all-in profitability of our VA business.

A positive unlock means that after incorporating our latest and best views on returns, lapse rates, hedging costs, everything, we found that the total estimated gross profits from these products are higher than we previously projected. That is good news.

The volatility in both the equity and the credit markets this quarter had an impact on our results. We recorded $209 million after tax of net realized capital losses outside of core earnings. That is $0.65 per diluted share. That translates to $359 million pretax pre-DAC. The biggest driver was widening credit spreads that drove down the marks on fixed income and derivative instruments in our portfolio.

Now included in that $359 million was $110 million pretax pre-DAC of other than temporary impairments of the value of fixed income instruments. Of the $42 million of the $110 million, we would classify as credit instruments as these securities have significant spread widening and we think the value is not likely to recover anytime soon.

Now of that $42 million, $37 million was for subprime holdings. So $37 million of the $42 million of what we would classify as credit impairments was subprime. Now the balance of the $110 million reflects market value drops where our traders aren't willing to commit to hold the security until the value is recovered though we do think it will recover. Of those, $17 million was subprime.

So for those of you who want to deep dive on subprime, we have updated the disclosure I provided last month and included it as an exhibit to these slides. It is the last three pages of our slides today.

Now in the quarter, we also lost $100 million pretax pre-DAC on nonqualifying derivatives, primarily credit derivatives. Now these come from some of our investment strategies where we replicate the credit exposure of holding a corporate or asset-backed security by investing in credit derivatives, both single credit and index. A significant portion of the $100 million reflects the impact of credit spread widening.

Now if we'd held that exposure in the form of a bond, you would see it in AOCI as an increase in unrealized loss, but because we did it in derivative form, it comes through realized loss as a mark.

The balance of the $100 million reflects technical pressure on the value of certain credit indices, particularly commercial mortgage-backed indexes. A portion of this index-related loss could prove permanent as those derivatives may mature at a loss before the technical imbalance in these markets resolves itself.

We were very pleased with the performance of our GMWB hedging program in the toughest quarter we have seen since we started hedging in 2003. And as I mentioned last month, the vast majority of our $139 million slippage, that's $70 million after tax after DAC, rose from liability model changes, which are not hedgeable. In general, the actual hedge slippage in a very volatile quarter was quite small.

Turn to slide 8. Here, we remind you that we have raised our core EPS guidance to $10.60 to $10.75 per fully diluted share for the year. That is a fully loaded number and it includes the DAC unlock.

We continue to return capital to shareholders through dividends and share repurchases. We repurchased $373 million of stock in the third quarter. That brings our total repurchases for all of 2007 to $1.2 billion. That is it. Now I believe it is time for question and answers. Tom?

Thanks, David. Alice, please open the call for questions.

(OPERATOR INSTRUCTIONS). Josh Shanker.

Good morning, everyone. My question -- two questions unrelated. The first one is the comment on variable annuity sales despite the choppy market conditions. I am just curious if there were an impact on sales, would that be a lag in the next quarter or would we see it now?

And the second question regards, which may be somewhat a naive question, but when we say you are looking for the most profitable kind of business, what does that mean? How do you assess the most profitable kind of business versus what might be I guess generic business?

Thanks, Josh. Let me have Neal kick it off in reverse order with the property/casualty profitability versus growth assessment we do.

Thanks, Josh. When we look at profitability, we first want to look at our renewals and we have an awfully profitable book of business already on the books, so we are going to be focused on retentions. That is one thing.

Secondly, we really employ very sophisticated modeling and data techniques. We want to look at business opportunities on a very granular basis by geography, by line of business, by segment and so forth. And out of that, we tease out where we think there are profitable opportunities of which we think there are many. So we break it down in that granular sort of way and we go out to those places where we see good opportunities.

And so would it be wrong to say there is a correlation between the long-term profitability of customers and their long-term value, those two things are very much related in your assessment?

Sure, absolutely.

Okay. And the life question?

Yes, John Walters.

Yes, on VA sales across the quarter, clearly they were affected by the market disruptions that we saw in late July and August and our experience in the VA market is that the VA sales, if you compare them to mutual fund sales, they typically lag by 30 to 45 days the mutual fund impact that you see in the market and so we saw that in September.

As we look at the quarter, the market is also, for variable annuities, very competitive today and so a lot of people launch new products over the course of the quarter, which will have an impact on sales over time and that is reflected in our fourth-quarter guidance.

Jimmy Bhullar, JPMorgan.

Hi, thank you. I have a couple of questions. The first one is on the pricing trends in the P&C market. I am looking at your written price increases by line and I just had a question. Is the actual market worse than what your written price increases or declines are showing because those are, I am assuming, positively skewed because your persistency is declining and also you are non-renewing some business? So the first question is on that.

And the second one is on if you can give us some more color on what happened to Japan VA sales in October. Were they down a lot and also the new regulation, is that going to have a short-term impact or could it actually drive some aggressive distributors out of the market if the consumers' (inaudible) requirements are tougher now than before?

Okay, pricing trends, Neal.

Thanks, Jimmy. There is no question that -- I have been out in the field visiting our folks and some of our key partners over the last 60 days or so and it is a substantially competitive environment. There's no question about that. I think that certainly on new business, there has been a meaningful increase in the sort of competitive environment and so we feel that, as you get upmarket, especially in the middle market and you see it in our numbers, there is a fair amount of price competition in the marketplace. So that is the discipline that Tom and Ramani were referring to in their opening remarks.

So would that imply that actual conditions are a little bit worse because your written price increases or declines have been relatively stable the last few quarters?

Jimmy, this is Ramani. I just want to add to Neal's point, which answers this question and one other point that you brought up. One is it is not that we are nonrenewing our business, we are not nonrenewing. It is just that there is more competition and so to some degree, the larger renewals are under pressure.

The second thing is if an account is marketed then the odds of it seeing very aggressive price competition is very high. So the time and account [lands] in the market I would say, by and large, the price movements are more substantial. Liz?

Yes, good morning. First of all, sales for October definitely declined more than usual. October always falls from the September levels and we expect that the Financial Instrument Exchange Law will have an impact through the rest of the quarter and then we expect that industry sales will rebound throughout 2008.

Jimmy, just to add to what Liz just said, obviously we view this [suitability] movement as good, but it has really put a delay in the system and we have seen it in October and we think long term, it is a good thing for the industry.

But you don't expect a long-term sustained impact from this because you think most distributors will adopt the new standards, but it won't drive anybody out of selling variable annuities that normally would be selling them?

Yes, I do not think it will drive variable annuities away. In fact, again, I think that the law over the long term is good for the industry and I think variable annuities really are a very good investment for the Japanese customers. And I think if anything, this law will help ensure that the distributors, as they are working with their customers, ensure that they buy the appropriate investment and we think variable annuities are well-served for that.

Okay. Thank you.

Dan Johnson, Citadel Investment Group.

Great, thanks. Got a couple of auto-related questions. Specifically, it looks like -- I would like to talk about the new business trends on auto and home and get some feel around your thoughts on the decline there in the third quarter, as well as maybe digging a little bit -- I think I am reading this right that you had a reserve re-estimate for the AARP book and I honestly don't recall whether that was a prior year reserve adjustment or a prior quarter adjustment and what is the thinking around that adjustment? Thank you very much.

Well, thank you, Dan. I guess, first off, on the auto business, it's also obviously a competitive environment for personal lines auto. If you look, we are up both with respect to premium and [pith] count and so we think that is very impressive.

I think with respect to new business, again, a very competitive environment and we are very focused on taking some rate adjustments and competing state-to-state, territory-to-territory.

On the adjustments, they are prior year. They are very small. We look at that every quarter and when we see an adjustment, we make it. This one is really very, very small.

Great, thanks. And then would you mind updating us on where you sit with your agent count metrics and where you hope to be by the end of the year? Thank you.

Sure. On personal lines, agents were up around slightly over 6500, I think about 6800. We are up about 1000 agents over the year, which is where we planned to be and there will be a little more uptick through the fourth quarter and that is right on plan.

And on the outside of personal, wasn't there some folks on the commercial side of the house as well?

A smaller uptick in small commercial and again, on plan. That is about what we are expecting through the year. Less add to the agency count in business insurance, small commercial in particular.

And how is productivity on the new agents coming?

It's good. As Tom mentioned in his opening remarks, a lot of our year-on-year premium increases in the agency line is due to our uptick in agency count.

Great. Thank you very much.

Jay Cohen, Merrill Lynch.

Yes, good morning. I have got a couple and then Ed Spehar is going to have at least one or two as well. You've had some favorable development. It has been I guess relatively modest compared to some of your peers, which had far more significant favorable development. And I guess maybe that means you guys are just smarter, you got it right. But I am wondering if you note any differences between the way you approach the business and some of your peers that have seen again more dramatic favorable development than you have?

I am sure we can't speak for competitors, Jay, but I will let Neal take a crack at it. Obviously, we think we have made the right moves in terms of our own reserve analysis, but -- Neal?

Thanks, Jay. Yes, Tom, nothing much to add other than we look at this every quarter. We look at it carefully. When we see adjustments that are appropriate, we make them. Impossible for us to know exactly what is going on with respect to the competition, but as for ourselves, that's how we do it.

And then one other just quick question. On the investment portfolio, the detail is very helpful by the way in the subprime sec. Do you have any sense, since quarter-end, what has happened to the marks -- to the values of these assets?

Jay, it's David. Not too much net move. I would say that the AA and AAAs are probably slightly better in value and that the As and below are probably slightly worse. As you know, net probably a wash.

Thanks. This is Ed. I have questions for John. I guess the question on VA sales, two things. First, given the importance of the living benefit guarantees now in the market, can you talk about how that might change the historical relationships between what the equity market does and what the sales impacts are and specifically I am thinking there could be an argument to be made that you see more demand for your products and maybe more outflows on mutual funds in a more uncertain environment.

And then related to VA again is I think you guys in the past, recent past, have been talking about how maybe the competitive market and the feature wars aren't quite as bad. I don't know, maybe I am confusing it with someone else. But it sounds like you are suggesting maybe another round of increase in competition. I was wondering if you could clarify that. Thanks.

Thank you, Ed. I am happy to comment on both these issues. First of all, on the uncertain environment and the impact that living benefits have on that, I do think that if we were in a protracted period of equity market challenges that variable annuities would stand to gain marketshare versus other investment vehicles because of the guarantees that they provide. I do think that -- you could say they would grow in sales. It may be that they just don't decline as much as other things, but regardless, I think they stand to do very well in that environment on a relative basis.

However, in a period like we saw in July and August where it was a quick short impact, I think what happens is financial advisors are busy fighting fires with their clients and so the overall velocity of transactions, the overall velocity of people putting money to work just slows down. And so we will get affected in that environment just like other investment products would, but I do think that the living benefits position us well for a range of market environments versus what we were in the past.

Secondly, on product development, a year ago and into the first quarter, we were saying that we saw a slowdown in product development versus the torrid pace that you saw earlier in 2006. That was true. However, over the summer, we have seen a number of people bring a lot of enhancements. They are not as dramatic as what they were doing a year or two ago, but there are certainly a lot of them, enhancements in a whole variety of areas on the existing products that are on the street. So that is going to have an effect on the competitive environment.

We are currently working on new product development here and expect to launch new versions of our living benefits in May of next year. So we are right in the midst of that ourselves and so we will be assessing what everyone has done and how our products stack up and taking appropriate actions to make sure we protect our competitive position.

Thank you.

Bob Glasspiegel, Langen McAlenney.

Good morning. On personal auto going into the year, I seem to recall that you had said you were beginning the price declining frequency into your pricing and some of the companies are starting to see frequencies starting to uptick. Maybe you can articulate what you are seeing on pricing and frequency and how it is affecting your pricing and auto.

Thanks, Bob. Neal here. We have, as we said last quarter, Bob, seen some uptick in frequency in the personal auto align, especially compared to last year where it was at sort of record historic lows. We have continued to see that now through the third quarter at about the same rate and so that is a constant for us for the moment. And we are sort of planning for that on into next year.

I think from a price perspective, we have taken some rate adjustment in selective places on account of this and as you see overall, we have taken a little rate in that line, so that is reflected.

And I would guess based on new volume, you are doing it more aggressively than your competition.

Well, again, I don't want to speak about the competition, but we have taken some rate in some places. We have an increase in our policy count and overall an increase in premium.

Okay. David, you mentioned third quarter was an interesting laboratory test through volatile markets and as you have gone through the below-the-line charges, I guess this is more a question for the laypeople, are there any products that you have to change how you approach pricing hedging costs for example perhaps going higher than pricing or credit spreads widening? Meaning we have got to be more careful in spread products that were ready or is it the reverse?

It's Tom, first, Bob. We do recognize the cost of the hedging. Obviously, that is going to vary over the course of a product and you can't reprice your product on a monthly or a daily basis. You file it and so we are still within bounds.

The other thing that I will ask David to talk about is we look for capital market solutions as well and take advantage of those when we can get those within the pricing spectrum.

Yes, Bob, I would say that if the third-quarter market conditions became permanent, we would definitely have to look to adjusting pricing on some of our products if this level of volatility became the norm. Obviously, nobody expects that. I would say if we revert to more normal market conditions that we had over the last two years, that probably would not be something that would require an immediate response in pricing. But you obviously have to be cognizant of market conditions.

I think there has been a long-term increase in the price of long-term volatility over the last two or three years and you definitely see that reflected in some of the model changes we have had in our GMWB liability over time and that is something we watch closely also for its impact on pricing. But I would say in direct answer to your question, only if these conditions became permanent would that necessitate a change in pricing.

We sort of merged the model and the market impact, but when we see a couple of pretty large model impacts, it makes you wonder whether that does have to be reflected in pricing. You are saying not materially?

Well, again, when you make a model change, you are making a one-time reflection in fair value of the impact of whatever the driver of that was on the value of the rider for all time, so it is not necessarily a run rate change. When you see a model change say that produced a $50 million loss in the quarter, that is trying to capture in an NPV basis the impact of that market development or that model change for all time. So it is not a run rate thing that you would have the same 50 every quarter.

That being said though, there was higher volatility in the capital markets, which both increase hedging costs, could also raise the price of volatility, which is one of the drivers of pricing for the liability. If that became permanently higher then you would definitely have to respond to that in pricing.

Thank you. To be continued.

Absolutely.

Nigel Dally, Morgan Stanley.

Great, thank you. I was hoping you could spend a little more time on the higher than expected outflows from variable annuities. You mentioned the higher assets under management, the increased competition, the required withdrawals from qualified plans. It doesn't seem like any of those are temporary items. So should we expect continued elevated outflows in 2008?

Second, it seems like the market for living benefit reinsurance is finally beginning to open up. Can you discuss whether that is something you are particularly looking at? Thanks.

I am going to have John take the second part. Just quickly on the loss rate, the minimum withdrawal -- the minimum withdrawals for qualified plans -- that really is a fourth-quarter item because that is when they come due. So they have to get them done before the end of the year. John, do you want to talk about living benefits?

Yes, and just to put a little more color on that, withdrawal amounts. One of the drivers is if you just look at flat redemption rates, one of the drivers is that assets are up so much that you're just going to have higher withdrawals. But we do see negative net flows continuing into '08 unless you get either a big change in the redemption rate or a big change in top line, which is not part of our current outlook.

As to reinsurance, we are constantly talking to the reinsurance market and also to the capital markets about ways to help us with our risk management and it does appear that the reinsurance market is developing for living benefits. There has been a couple of transactions that have happened. There are certainly active dialogues going on right now. We will continue to pursue that and if it makes sense for us both from a risk standpoint and a price standpoint, then we will take advantage of it. Expect us to be very active in those conversations.

Craig Siegenthaler, Credit Suisse.

Tom Gallagher. I had a couple more questions for John. John, can you elaborate a little bit more about your answer to Ed Spehar's question about a number of enhancements to variable annuity products this summer? What in particular is changing about some of the features?

Yes, Tom, it is a variety of things. In the main, I would say that they are enhancements to existing products. So if you have got an increasing income that you can receive over time, but you don't take the income each year, the amount of additional income you can get in future years is being enhanced. It is what we call a rollup in the industry.

You also see people revising how their step-ups work to make the step-ups more frequent. In some cases, people are now coming out with quarterly step-ups, things of that nature. You see other people changing their withdrawal provisions. If you have not taken withdrawals for a period of time, so if you wait five years or wait 10 years, you may be able to take out a bigger chunk of money rather than just the periodic payments that were standard in the various living benefits.

Each of these independently isn't a big deal in my view, but collectively, you look at how they are changing the face of the industry. They add up to a meaningful set of product changes and in the main, they also add up to people taking somewhat more risk on their various products and so we are assessing that and incorporating that into thinking about what we want to do in the future.

So is it fair to say then, John, that, as of right now, you are not participating in this round of the feature wars at least in terms of the stuff that's maybe a little bit more on the edge?

That's correct.

Okay. The other question I had was just on whether you have seen any change in the industry as it relates to the percent of sales that you have that come from 1035 exchanges versus net new money from outside of the industry.

Yes, for us specifically, it is somewhat over 50% of our business that is from 1035 exchanges and that has been pretty steady over the last several years. It has increased in the industry at large over the last several years, but ours seems to have stabilized in that range.

I am actually hopeful that as the industry continues to grow that more and more of the growth will come from new money rather than just a continued churn. As we work through kind of the older vintage business, they get the updated features and then people are more focused on where new money is. We haven't seen that come to complete fruition yet, but we are anticipating that that is the direction that things will go.

Darin Arita, Deutsche Bank.

Hi, good morning. A couple of questions here. I guess first on the DAC unlocking, the [Sanyo] study here. Can you talk about how this affects your DAC amortization going forward?

It's David Johnson. Actually, we will have a slight benefit next year. We are still calculating the exact amount and then going forward, as you know, the whole point of an unlock is to say that there is going to be more gross profits in the future than you heretofore thought and in order to maintain the matching concept of amortizing your acquisition costs in line with profit, you are saying that some of those expenses, which have previously been amortized, have to be put back on the balance sheet. That is the positive unlock you saw this quarter. So they can be amortized in the future.

So then over the balance of the 10-year or 10, 20-year life of these cohorts, that $230 million would be amortized in the future so you would see slightly higher amortization rates there. But it is not something you are going to discern a material impact from in the near future.

Great. And on the dividend received reduction, the company has been benefiting lately from that in the past, but it has turned this quarter. Can you talk about what is happening there and what caused the change?

Yes, we made a slight true-up to our rate of accrued benefit from that in the third quarter of, I think, $17 million of which about $12 million was just trueing up the first and second quarter to our now run rate for the year and then the $5 million is kind of the reduction in the quarterly run rate.

As a result of a technical calculation that we have to make in terms of what the Company's benefit from dividend received in the separate account is, we got some data from the mutual funds inside the separate accounts as to the relative mix of dividends, short and long-term capital gains and it made a slight change in the formula, so we adjusted for that.

Eric Berg.

Thanks very much. David, just one question about the change in the model refinements and the assumption updates. My question is why do you take that below the line? My thinking is this and tell me why you clearly disagree, but my initial thought would have been this is The Hartford saying that it has a robust model, but not as robust as it could have been, it needs to be better, it is not as good as it could be given our current knowledge of the world. Therefore, we are going to sort of change this model. We are going to acknowledge from a financial reporting perspective that our liability to our customers is greater than we thought it was. Why isn't that an operating item?

Eric, let's say -- well, just to draw back from -- as far as I am concerned, all my book value is precious. Whether that which comes from core earnings or from non-core earnings or below or above the line, so we care about contributions to book value wherever they are. So whether something is in core or not core is really a reporting convention in order to benefit our investors and probably the most important thing there is consistency. And as you know, the rule of thumb for core earnings is that if it is a -- generally, it is going be in core if it is not a realized gain or loss and it is going to be below the line if it is a realized gain or loss.

And we have only made a slight change on that to take some aspects of recurring derivative flows that really are akin to investment income and put those above the lines because that was very, very much in the spirit of what investors were expecting to see as operating earnings.

So the biggest reason it is below the line is because under accounting it is and must be a realized loss when we make a change in the FAS 133 liability there.

Now you can get back to more conceptual questions of, well, what were investors wanting to see in core and non-core for purposes of useful presentation and I think the most important thing that they are looking for there is core is what is supposed to be modelable and reflective of kind of a recurring run rate. Obviously hurricanes are an example of something that doesn't quite rise to that level.

But in general, I think that is the convention that you are trying to talk to in terms of how you present this stuff. Model changes like this are not recurring. They certainly don't represent a run rate as we talked about in a previous answer. They reflect an NPVing of the all-time impact of that model change for the end of time, but we definitely look at this as part of the overall profitability of the product. We disclose it and we think about it all the time and we encourage our investors to think about it all the time.

That being said, putting it in core I think would just confuse more people than it would help given that it violates some of the two or three kind of core rules of thumb -- no pun intended -- as to what goes above and below the line.

I understand your answer. It's very clear to me. Thank you.

Eric, one other point I wanted to add is what Johnson has been saying and has said, which is some of these model inputs -- we are getting longer dated [vols], etc. determined more clearly by the market and so that adds to why model changes are being made.

Actually, David, one other question that I wanted to ask. One of the things that we hear a lot, I suspect many people who call on investors like I hear a lot, is questions that relate to the problems that arose many years ago on portfolio insurance. I don't know if you remember, but there was this situation in which sort of everyone pursued the same strategy at the same time and it was revealed that that was sort of a fundamental flaw. I am sure you have given some thought to that. Can you go over why that wouldn't be an issue in a time of market dislocation?

Well, the old portfolio insurance problem, particularly as we saw in the '87 crash, was the result of people pursuing delta hedging strategies. At least at its most simplistic was people pursuing delta hedging strategies where they were investing in stock futures, which required significant dynamic rebalancing as the market changed. So that was at least the first-level reason why that was such a catastrophe because it required you to just increasingly short the market to preserve your position because in the end, you were not -- you weren't hedging against increases in the market volatility, you were only hedging against increases -- absolute changes in the market using futures.

So that is the reason why we and I think most firms now use a three Greek as we call it hedging strategy where you don't just use futures, but you also use options, which gives you protection not just in absolute changes in the market, but changes in the price of protection.

Now there is a second-level issue, which is that even that strategy cannot protect you from some need for rebalancing because the convexity of our liabilities doesn't match the convexity of the assets, but that is a much further removed and not as immediate trading necessitating strategy in the case of a significant down day such as we saw October 20 years ago.

You and I have been around too long I guess. But the -- so that we do worry about. And as John mentioned, some of the new strategies that are becoming available to variable annuity writers, including The Hartford either in the capital markets or in reinsurance, gives us protection from that feature too and we have done some trades of that type and like to do more in the future.

Thank you. Helpful.

Jeff Schuman, KBW.

Good morning. I was wanting to come back to the DRD issue, but more specifically your disclosure in the Q that the IRS is apparently going to rewrite the rules or consider rewriting the rules for variable annuity contracts. And you concede that this could result in the elimination of some or all of the DRD tax benefits that you have been enjoying. It's a huge issue, I think it was almost $200 million last year. Can you give us a little perspective on what the battle is about? Is this just a technical battle that will be decided by technocrats in the IRS or is this more of a political battle between financial industries and how concerned should we be here?

It's David Johnson. I certainly wouldn't characterize it as a political battle between financial industries. We have had obviously significant interaction with the IRS with regards to the tax benefit we get from the dividends received deduction, gosh, for over 10 years. And to date in that technical interaction, we have generally prevailed and continue to receive the tax benefit.

The IRS has indicated that they are going to put out a new -- or at least that they would seek to put out new regulations, which could have the impact of reducing the benefit of the DRD. Obviously, difficult to judge until you see the regulations. That process would take time and would obviously be subject to significant comment and dialogue with the industry and other parts of the tax practitioner lobby or community I guess would be a better way to put it. So we think that the foundation for the DRD is in statute and we look forward to a dialogue with the IRS on this.

Given that you've been in dialogue with them for 10 years, as you said, any perspective -- are they concerned just that maybe you don't have a consistency across the industry and they want to kind of tighten that up or are there still people just that conceptually just think you shouldn't be entitled to the deduction or what is the debate here?

Well, it is -- I think it's -- not taking any particular angle to say that generally the IRS likes to increase the taxes people pay and that taxpayers generally like to not pay as much and there is plenty of legitimate grounds for dialogue on that. We have -- I would say that this is of that ilk.

Okay. And any guess at all in terms of timeframe? Is this something that will be decided in months or years or what do you think?

I think it is most likely some time in 2008.

Okay. Thanks a lot, David.

Alice, one more question, please.

[Josh Smith], [Piacrav].

Great. Thanks for taking the call. This will be quick. Just a question on the DAC. The biggest move was in the VA biz. What are the most critical factors that we can gauge the likely future positive or negative unlocking? Is it persistency, is it market levels being higher, does market volatility come into play and if it is not a simple answer, we can take it off-line?

It is actually not a simple answer, but I would refer you to page 29 and 30 -- well, actually 28, 29 and 30 of our 10-Q not only provide significant detail as to what generated this unlock, but as to the sensitivities going forward that could benefit, cause a negative or positive unlock in the future and you will see that most of the principal ones have to do with the performance of the separate account and that was by far the largest generator of the positive unlock this year.

Thanks a lot.

Thank you all for actually joining us on this call as I want to reinforce with you The Hartford really had an excellent quarter. We delivered good growth in book value, strong returns. We also continued and did a good job on our capital return to shareholders. So all in, it was a terrific quarter.

I want to remind you that we will host an investor conference call at 10 a.m. on December 10 and during that call, we will discuss our plans and outlook for 2008 in some detail. We are looking forward to speaking with you then. So until then, thank you very much.

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