Horace Mann Educators Corp (HMN) 2002 Q3 法說會逐字稿

Good morning, and welcome to the Horace Mann sponsored third quarter earnings release conference call. At this time, all participants have been placed on a listen-only mode, and the floor will be opened for questions and comments following the presentation. I would now like to turn the floor over to your host, Mike Henderson. Sir, the floor is yours.

Good morning and welcome to the Horace Mann Educators Corporation's third-quarter earnings conference call. Statements made in the course of this conference call that state the company's or managements intentions, hopes, beliefs, expectation or predictions of the future are forward-looking statements. It is important to not that the company's actual results could differ materially from those projected in such forward-looking statements. Additional information concerning such factors can be found in the company's SEC filings, copies of which can be obtained by contacting the company or the SEC.

We are broadcasting and recording this conference call today. Replays are available as follows. By phone, the number is 973-341-3080. For that you will need a pin number, and that is 3502593. You can do that call through November 12, 2002. The web cast will be available for one month, that will be through December 5, 2002, via link on the Horace Mann homepage, which is, www.horacemann.com.

The speakers in our presentation this morning are Louis Lower, President and Chief Executive Officer; Peter Heckman, Executive Vice President and Chief Financial Officer; Doug Reynolds, Executive Vice President Property and Casualty; George Zock, Executive Vice President, Service and Technology Operations and Financial Services, and Dan Jensen, Executive Vice president and Chief Marketing Officer. We will begin with Louis Lower.

Good morning everyone and thanks for joining us. Let me start by providing some context perhaps for you to think about our third-quarter results. As you may recall our strategy has two major themes, first to serve our target market more deeply and broadly to accelerate revenue growth; second, to improve operational performance and drive margin expansion concurrently with that revenue growth. Although third-quarter results have taken hits from the external environment, specifically the financial markets, we are making solid progress on our overarching strategic objectives.

As you've seen in our results for the quarter, and as we will discuss today, the bond market, through write-downs and write-offs of assets with deteriorating credit quality, continues to adversely impact our net income, albeit at a reduced level from the second quarter. At the same time, the combination of lost investment income on bonds and defaults, and the ongoing fair market in equities, continues to push the margins in both out preferred property casualty and life annuity segments. However, looking at what we control, critical progress continues in our operations as both our growth and profit improvement initiatives gain momentum.

Beginning with marketing and distribution, our agent count at quarter-end was 869; we are on pace to hit 920 agents at year-end, which would be a 15% increase over the low point in August of last year, when we moved to our new agent contract. And as Dan will cover later, both agent productivity and retention continue to improve; we've remained successful in recruiting higher quality agents located in our high priority target markets. Sales in the quarter were up 11%, with Annuity taking a lead at 16% and Auto at 12%.

As you will hear from Doug in his review of Property Casualty, more new business coming in the door is in the better credit tiers, while the in force is improving at the same time. In particularly, more new business is Educator, which typically has better persistency and loss experience, and also has higher potential for cross-selling. However, the impressive new business results at Auto are not currently translating into PIF growth, simply because we are shrinking unprofitable segments of the in force on our business. That process will continue through next year, but once that in force cleansing has been completed, and as our more profitable season book begins to grow again with improved consistency, new business, with it's higher first year commissions and initial higher loss ratios will begin to represent a decrease in percentage of our total premium.

So the future for Horace Mann holds an inflection point, with a combined benefit of adding higher quality new business to a growing higher quality in force block, will pay off in the form of accelerated revenue growth with higher margins. And that's a long-range payoff for much of what we're putting in place today. There's a lot of leverage in that equation, and it's on track.

In the meantime, this quarter's results demonstrate continued loss ration and combined ratio improvements, over last year in both Auto and Home Owner. Early indicators are, 2002 accident year results are particularly encouraging, while we do acknowledge favorable weather results, excluding CATS, are also moving in the right direction. Approved pricing actions continued to earn their way into our results, and we will continue to be just as, if not more aggressive as we prepare our future filings to ensure rate adequacy, including covering future inflationary costs in all of our marketing territories.

Finally, as we described in some detail last quarter, improvements from our claims reorganization will begin to accelerate as we roll out our new organization, new processes and new system.

While Property and Casualty improved by $3.5m after tax in the quarter compared to last year, the annuity line offset two-thirds of that improvement. As George Zock will describe in detail, our Annuity line has been impacted the most by the combination of the bond and equity markets, which have reduced both margins on fixed annuities and fees on variable annuities. Those market forces have also resulted in acceleration of back amortization. And while we don't like the results, we have appropriate financial provisions in place, including carrying a cooperative minimum guaranteed death benefit reserves both on a statutory and on a GAAP basis.

We feel very comfortable with where we are on the balance sheet. On the positive side, sales are increasing, persistency is strong, and contracts in force are up. We are seeing a shift from variable to fixed, which over the longer term should be positive for operating income, as fixed annuities per dollar of account value deliver a higher gross margin. As Pete will cover, from a Capital Management perspective, we are on track to reduce our debt levels, debt to the levels that we translated when we issued out comparable notes.

So in summary, we feel great about our target market and remain confident and committed to our strategies. The operating results that we control are moving in a positive direction to realize the company's full potential with long-term profitability. We are keenly aware of the impacts of external forces in the financial markets, we're on top of them, and taking appropriate actions to appropriately reflect them in our financial statements and drive actions to lessen their long-term impact.

And now Pete, Doug, George and Dan will provide greater detail and granularity together, with their perspectives on the quarter, beginning with Pete.

Thanks, Louis. We certainly had a lot going on in the third quarter, but on balance I'd characterize it as a relatively good one. $8.6m in after-tax investment losses, and the property casualty claims restructuring charge were more than offset by 28 cents per share in operating income, which reflected a number of positive underlying factors. Continued increases in agent productivity, both in number of agents and the resulting core lines Annuity and Auto sales increases, were certainly strong points in the quarter. And property casualty results were encouraging. Loss experienced was helped by relatively mild weather during the quarter, but more important was the continued emergence of favorable trends in the current accident year, and Doug will expand on it in just a moment.

These favorable current year trends offset approximately $6m of adverse development in prior year reserves, primarily related to allocated loss adjustment expense, and our professional liability coverage in the 2000 and 2001 accident years. In total, P&C reserves at September 30, 2002 remained adequate to slightly conservative. Based on Ernst & Young's detailed review of the company's actuarial analysis, the degree of conservatism was determined to be consistent with their independent analysis performed at the end of the second quarter, where held reserves were slightly in excess of E&Y's select estimate.

Expenses are being managed effectively. While the year-to-date P&C expense ratio showed a 3.2 percentage point increase over prior year, 1.1 points was related to the claims restructuring charge in the third quarter. One points was due to increased pension and benefits costs, and six-tenths of a point was a result of the reduced level of management incentive compensation expense last year. The remaining 0.5 point was due to underwriting programs and technology investments.

On a company-wide basis, adjusted for the pension benefits and prior year incentive comp items, total GAAP operating expense, September year-to-date are flat compared to prior year. While we're kind of on the subject, pension costs are certainly a hot topic these days. As we've mentioned in prior calls, Horace Mann's pension expense increased considerably in 2002 due to the transition from a defined benefit plan to a defined contribution structure. While we were anticipating these expenses to moderate in 2003, due to declining transition costs, the impact of the financial markets will make that unlikely.

While market performance has created a challenge for us and most other US companies, we are not sticking our heads in the sand. We have adopted realistic assumptions for investment returns, discount rates and mortality. And year-to-date we've contributed $8m to the defined benefit plan, which is more than four times the required minimum amount. All that to say, we are committed to staying ahead of the problem and not letting it build.

On the investment front, we're continuing to work with our money managers to manage through the current credit cycle. In the third quarter we realized $8.6m after tax and losses in impairment. Three-fourths of that related to the communications sector, notably Quest and NTL, with the remaining 25% in the energy sector, [Morant] being the primary name there. After tax, investment income was down about 4% to 4.5% in the third quarter, from both prior year and the previous quarter, reflecting the impact of defaulted securities and lower reinvestment rates. Investment income will continue to be under pressure from those same market forces, as well as from portfolio management actions we're taking to reduce issuer and sector concentration levels.

In terms of our capital structure, you will recall we realized approximately $163m in net proceeds from a convertible bond offering in early May of this year. The registration of which, I might add, became effective yesterday. In the second quarter we retired our existing bank line and $55m of the $100m in senior notes outstanding. At June 30, 2002 our debt to total capital ratio stood at about 32.5%. In the third quarter, we retired an additional $25m of debt, comprised of $6m senior notes and $19m of the converse, which was a cost-effective mix from a relative pricing standpoint. At September 30, 2002 our debt to cap ratio was reduced further to under 28%. And more recently, we've retired another $16m of debt, bringing our leverage ratio, based on September 30, 2002 shareholders' equity, down to the 26% range, which is consistent with our target level and rating agency expectations.

And finally, with regard to our operating earnings outlook, we remain on track relative to the 2002 guidance provided on the last call, which was to the lower end of the existing $1.15 to $1.25 range, with weather - and remember Hurricane Willie was a fourth quarter event - and the financial markets being the biggest wildcards at this point. We had intended to provide preliminary 2003 guidance during this call, however, in light of all the uncertainty in the external environment, we're going to hold off doing so until our next call in February. That will give us a chance to get another quarter under out belt, and complete our more detailed planning process.

And now, I will turn it over to Doug Reynolds to comment on property casualty. Doug.

Thanks, Pete. From the total book standpoint we saw a good result in the third quarter, reflecting some improvement over prior years, as well as exceeding our expectations for the quarter. Obviously the third quarter was another good quarter from a weather standpoint, however, in comparison to prior year, we were slightly higher in the third quarter of 2002 for total catastrophe payments.

Total combined ratio after adjusting for the claims restructure charge for the property and casualty group, was below 100, which is a great accomplishment. Mature loss ratio was almost seven points lower than prior year quarter, and year-to-date basis we are 9.3 points lower than prior year. We have also seen a continuing improvement by month in quarter results, as we have moved through the year. The pressure as I stated in our last call, continues to be on loss adjustment expense and expense ratio. In the third quarter, we have achieved a slight improvement versus our year-to-date result. Total loss adjustment expense is 1.2 points over 2001 quarter versus a year-to-date 1.8 point different. Our expense ratio has experienced the same trend of 1.3 points over prior year quarter versus 2.2 points over year-to-date.

As Pete indicated, we have made some changes to our prior year reserve position. However, as a result of the trends we have seen for the 2002 accident year, we are able to stay at our current reserve level. We will obviously continue to monitor our reserve level, but overall we are satisfied with our current reserve position.

Our claims redesign is on target and we have continued to see improvement in a number of areas. We have started the process of closing offices and reorganizing into the six remaining offices. We are 80% complete with our new staffing needs, and will be 100% of target by December 01, 2001. The process of transferring new claims to the new regional offices began in October with our Tennessee office. Our development of a new technology platform also continues on target, with our planned introduction for second quarter 2003. As indicated in prior calls, claims redesign is a major strategic initiative, which will positively impact our ability to more effectively control loss and expense as we move through 2003, and more importantly, into 2004.

In our Automobile business, we have continued to see improved results. Our combined ratio came in at 96.1 after adjusting for claims restructure charges, a 3.3 point improvement over prior year. We are now under a 100 run rate for combined ratio year-to-date. From a pure incurred loss ratio standpoint, our quarter was 6.8 points better than prior year, and on a year-to-date basis 5 points better. This is another strong reflection that the actions we are taking are having a positive effect.

Our expense to loss adjustment expense continues to place upward pressure on our Auto combined ratio. For the quarter we saw a slight improvement in both areas. The expense ratio was 1.7 points higher than prior year quarter versus year-to-date 2.6 points excluding the claims restructuring charges. Our loss adjustment expense, we were 2 points over prior year, versus a year-to-date 2.7 points. In both areas, but especially loss adjustment expense, we have seen improvement on a monthly basis through the quarter.

We will continue to continue to invest in our business, but it's good to see some of the controls we have put in place start to take hold. The underlying trends to continue to strengthen for Auto. Our frequency continues to be about 6% over the prior year. Our severity has continued to have a degree of fluctuation, however, the pure premium trend continues to move downwards. Although CAT losses for Auto make up a small proportion of loss results, we were higher than prior year quarter by 700,000.

We have also experienced improving results and percentage of new Educator business, and placement of business in our better experienced tiers. For the quarter we wrote approximately 60% of our tiered business in the most profitable three tiers, versus a year-to-date result of 54 percent. The profit classification program that we put into place in the second quarter are also showing benefits by ensuring accurate rating of the business. One measure we used is the percentage of new business rated pleasure, which has improved by 5% in the third quarter versus our year-to-date results.

In addition to the underwriting activities we have continued our aggressive pricing action. Year-to-date we continue to receive approvals on filed rate changes of approximately 7%. Overall it is encouraging to see the underwriting changes we have made continue to contribute to the improving loss ratio result.

On top of property business we continue to drive improved results also. For the quarter we are over 18 points better than prior year, and almost 19 points year-to-date. When we adjust for catastrophe losses and reserve changes that were made in 2001 on a year-to-date basis, we are approximately 14 points better than prior year. For the quarter we continue to see frequency improvement, and although severity was still higher than prior years, the increase was substantially lower than prior quarter.

As at Auto, our Property underwriting changes, re-inspection processes and rate activity continue to drive improvement. For the quarter we wrote more than 60% of our tier business in our three-month profitable tiers. This is 5 points better than our year-to-date result. Our rate activity continued over 20% for the year. At the same time, we are leveraging deductible shift opportunities to mitigate losses and generate an improved premium position.

Our average written premium is up over 12.5% for the quarter, and 11% on a 12-month moving basis. For both Auto and Property, we will continue our aggressive rate activity as we move into 2003. Even with all this activity, we are still seeing a reduction of about 3% in policy retention, while our new business units for property are down almost 20%. In key opportunity stakes, such as Florida and Texas, we are down in new business over 41% and 32% respectively. We will also continue to see benefits from all of these changes as we earn the results of our efforts over a 24-month period.

Lastly on property, we continue our aggressive action to control more losses. We have implemented [formal] exclusion in 23 States, and strengthened the sudden and accidental language.

In Texas we have removed water damage as a covered peril, which also removes our exposure to [mould]. We implemented this on all new business in the first quarter of 2002, and with renewals beginning in the second quarter. Although we continue to make good progress on our property book-to-business, we need to continue to focus to consistently achieve a mid 90 combined ratio.

For the year, I believe we will exceed our expected results for property, but will be a little shy for our line. This is attributable to the upward pressure on expenses that I've discussed previously. However, as I indicated earlier, the underlying incurred loss ratio trends for both auto and property, are very encouraging.

As we look out to 2003, I would anticipate both Auto and Property would achieve a profitable underwriting combined ratio. As we implement our claim redesign, I would also expect our loss adjustment expense ratio to show improvement, especially as we move through the year. Overall for the year, a realistic target would be a combined ratio in the 96 to 97 range.

And now, let me turn it over to George Zock.

Thanks, Doug. First of all a few comments on the life segment. The pre-tax earnings were pretty much in line with the first two quarters of 2002. The favorable year-to-date variance in pre-tax earnings was primarily due to a favorable preferred acquisition cost unlocking adjustment of $900,000; $400,000 in the third quarter, and $500,000 in the second quarter. The favorable unlocking adjustment resulted from the impact of net realized investment losses in those quarters. There was no unlocking adjustment in the prior year result.

As mentioned in the press release, there was an adjustment to year-to-date operating income reflected in the nine-month results. The adjustment resulted from redundant reserves established in the second quarter of 2002. The adjustment did not impact third quarter earnings.

Now on to the annuities segment. The focus of my annuity comments today would be to fully describe what happened to annuity earnings in the third quarter, and more importantly, to normalize the quarter so you can get a feel for its run rate going forward. I'll wrap up by providing some additional information on the guaranteed minimum death benefit and deferred acquisition cost and value of business-enforced amortization.

First, to explain what happened to annuity earnings, I will comment on the comparison of current quarter pre-tax earnings of $2.2m, to the approximate $7m of earnings in each of this year's previous quarters. Because acquisition cost and valued of business enforced amortization, in the quarter it was $2.1m greater than the average of the two previous 2002 quarters, and was due to the pre-tax charge of $1.8m in the third quarter from unlocking. This unlocking charge stems primarily from [hazards] stock market performance impacting the company's variable annuity.

Net investment income is down $1.3m in the third quarter, compared to the previous two quarters of 2002, primarily driven by the impact of bond default. $400,000 of that decline relates to the write-off of investment income accrued in previous quarters. Compared to the first two quarters of 2002, mortality losses and adjustments during the quarter were unusually high by $700,000. In addition, the guaranteed minimum death benefit reserve was increased $400,000 due to the impact of the equity markets in the third quarter, compared to an average quarterly increase of $100,000 through the first six months of 2002. This brings the total GAAP reserves for guaranteed minimum death benefit to $1m at the end of September. Finally, the variable annuity market declined $400,000 due to the market impact on variable annuities.

Let me go back over that in summary. The $4.8m decrease in the quarter compared to the previous two quarters of 2002 is largely explained by the $2.1m increase in expenses due to the DAC Invest unlocking; the $1.3m decline in investment income; $700,000 of unusual mortality losses; the $300,000 guaranteed minimum death benefit reserve increase in the third quarter over the previous two quarters, and a $400,000 decline in variable margin.

Now looking forward to the fourth quarter results. Given a normal or expected mortality environment, and a normal or expected market performance - and that would equate to a quarterly market appreciation of 2.25%, that's 9% on an annual rate, and no additional bond defaults - only the reduction in investment income and decline in the variable annuity margin would be expect to impact the quarterly run rate in this segment, and that would equate to pre-tax earnings between $5.5m and $6m per quarter.

Now some additional information on the deferred acquisition costs and value of business enforced amortization, and the guaranteed minimum death benefit reserve. First DAC Invest. The company amortizes DAC Invest utilizing a 10% reversion to the mean approach, with a maximum rate of 12%. Our current DAC Invest balances for the annuity line represent 4.4% of account values. While an exact rule of thumb will not work under all market conditions, I want to give you an idea of the sensitivity of the amortization to market decline.

There are a lot of moving parts because of the DAC Invest calculation, including fund performance, persistency, realized investment gains and losses, but generally a 1% deviation from the targeted market performance would impact pre-tax earnings approximately $150,000.

Moving on to the guaranteed minimum death benefit reserve. The total GAAP reserve for guaranteed minimum death benefit at September 30, 2002, is $1m. The comparable statutory reserve is $1.9m. The company has a relatively low exposure to guaranteed minimum death benefits, as 25% of contract values have no guarantee; 70% of contract values have only a return of premium guarantee, and 5% of contract values have a guarantee of premium at an annual interest rate of between 3% to 5%. The aggregate in the money death benefits under the GMDB provisions totaled $174m at the end of September.

Again, to give you an idea of the sensitivity for market decline, a rough rule of thumb to the impact on the guaranteed minimum death benefit reserve is that for each one point of negative performance, the guaranteed minimum death benefit reserve will increase approximately $60,000.

And now, Dan Jensen, our CMO.

Thanks, George: 2002 has been a unique year from a marketing perspective. Even with the equity market weakened, significant underwriting and rate actions, and the after effects of September 11, 2001, we continue gain momentum. As Louis has mentioned in the passed, Auto and Annuity are key lead lines for acquiring new customers. As you will recall, 2001 was a strong sales year in both lines of business. Despite these top year-over-year comparisons, we are still seeing good growth in production and productivity.

Auto sales for the third quarter, up 12%, and up 17% year-to-date. Annuity sales for the third quarter are up 16%, and 11% year-to-date. Life sales have slipped, down 17% for the quarter, and 19% year-to-date. By design, property production is down for 2002. Third quarter property sales were down 8% and year-to-date sales were down 10%, compared with the same period in 2001. But these numbers don't tell the whole story.

Florida and Texas are relatively large States for us, and have some unique challenges for the industry. In these two States combined, property production was down 21% for the quarter, and 22% year-to-date, further proof that our overarching strategy for growth is taking hold with the gain in number of agents, agent retention and productivity per agent. We ended the quarter, with 869 agents, an increase of 33 agents since June. September marks the first time in more than three years that we ended the month with more agents than we had 12 months prior. You may recall we reduced the number of less productive agents, mainly through self-selection, bringing it down to 800 agents at August of 2001. We ended last year, 867 agents and project to end this year approximately 920 agents; increases of 6% over the previous year, and 15% over the August 2001 agent count. Surely among the best increases in the industry.

This growth in agent is due to improving agent retention, which is up 6.1 percentage points compared to a year ago, and an increase in the number of recruits, up 20% over last year. Because of better retention, selection, training, and increased recruiting, the number of finance agent - that's agents in their first two years - has grown by 70, more than 24% as compared to the same time last year. Along with the growing number of agents the productivity per agent is up 10% compared to the first nine months of last year. This increase is on top of a 40% increase in productivity in 2001.

With our high priority counties initiative you may recall we are expanding geographically the counties, with large numbers of Educators and minimal Horace Mann presence. In 2002 we added 22 counties to the initial 14 counties from 2001. Our plan was to hire 75 agents in these counties for 2002, and it appears that we will hire approximately 100 agents. Not only are we bringing on agents in significant numbers, the agents retention in these high priority counties is riding notably higher than the retention of agents' population as a whole.

With the success of last year's Cruiser Sweepstake promotion, we have expanded on this marketing campaign to include both Auto and Annuity in our current Get Winning Advice sweepstakes promotion. The number of entrants in these sweepstakes is running more than 10% higher than last year's promotion at the same point. With this, and other marketing initiatives underway, things are looking good for a continued fourth quarter momentum.

And now I will turn it back over to Mike Henderson for questions.

Thank you. Ashley, if you would open the lines for questions.

The floor is now open for questions. If you have a question or a comment, please press the number '1' followed by '4' on your touchtone phone. If at any point your question has been answered, you may remove yourself from the queue by pressing the '#' key. Questions will be taken in the order they are received. We do ask that while you pose your question that you pick up your handset to provide optimum sound quality. Once again, to ask a question, please press the '1' followed by '4' on your touchtone phone at this time. Our first question is coming from Tom Benbuskirk-ph from McMann Securities. Please state your question.

My main question is if you could provide a little bit of balance sheet information. Now that you've done some repurchases, what your debt levels were at the end of the quarter, etc? And if you could update us on cash position as well?

Yes, Tom, the debt position at the end of September was approximately $188m. Let me try to find the cash position for you. Stay on the line, I'll get you that answer momentarily, we have to look it up.

Did you happen to -- are you continuing to buy in the convertible notes, have you made any additional purchases since the end of the quarter?

Yes, as I mentioned in my remarks, we purchased about 6m additional tiering value of convertible notes in the month of October.

And is that going to be kind of an ongoing thing; is it opportunity to yourself?

Well we're continuing to look at opportunities to maintain our leverage ratio, although as I indicated at least current, at the end of October, using September months and equity, our leverage ration is pretty much where we've been targeting it and where the rating agencies want it to be.

And if you could just go back over the breakout of the GMDB reserves. It went by kind of fast, I missed the split there.

Okay, Tom, the GAAP reserve for guaranteed minimum death benefit at the end of September was $1m, and on a statutory basis at the end of September the reserve was $1.9m. Just to repeat, we do have a relatively low exposure to the guaranteed minimum death benefit because 25% of contract values have no guarantee; 70% only have a return of premium, and 5% of the contract values do have an annual interest rate of 3% to 5% accumulating in the death benefit guarantee. The in the money death benefits at the end of September were $174m.

And Tom, we currently are carrying about $10m of cash on the balance sheet.

Our next question is coming from Alain Karaoglan from Deutsche Banc. Please state your question or your comment.

A couple of questions. Do you have any estimates of what is really the impact is so far. You mentioned that it was a fourth-quarter event, but any number?

Right now we're looking at it at about $2.5m to 3.5m as an effect.

And you mentioned the 96% to 97% combined ratio, was that for next year on the total business, or what was it for?

Yes, that was for 2003 for P&C business.

The net investment income on the property casualty side declined meaningfully sequentially from the second quarter, I know the yields are lower, was there any write-offs of bonds within that number, such as the default rate increase? Should that number go back up? How should we think about the decline this quarter, which was I think 10% pre-tax, maybe 6% after tax from the second quarter.

There was about a $400,000 sequential decline in after-tax property casualty investment income. About half of that was due to a default, which occurred in the quarter, one of our communications securities, TeleWest. The other half was a combination of we had kind of an adjustment of investment income from one of our facilities in the state of North Carolina. It looked like a correction of some prior quarters, and that also couple with lower investment rates, as you pointed out.

So if we don't have such a default, then half of which shouldn't be -- we shouldn't have half of that $400,000 in the fourth quarter?

I think that's right, if we have no more defaults.

And what is the spread on the fixed annuity business currently?

Year to date spread line is about 220 basis points.

So you're still maintaining your spreads even with the defaults?

Yes, through the first half of the year we were right about 235, so it dropped 15 points because of the activity in the third quarter.

And have you had any conversation with the rating agencies recently with respect to your ratings or your business? They're putting pressure on various companies. Is there anything you could update us on that front with respect to your capital position?

Well as I think was publicly announced, Fitch changed our ratings outlook from stable to negative. Moody's had done that previously. Again, most of that is triggered by leverage ratio issues as well as property casualty performance, so really anything more than that, I don't have any more current update for you. We are scheduled to meet with S&P in our annual review in a couple of weeks. But there's no, I guess, brand new developments other than the ones I mentioned.

And the leverage concern was it a financial leverage or an operating leverage concern?

It was the financial leverage, the debt to capital ratio, which I indicated once we did the convertibles we retired debt over a period of several months, so over the second quarter end our debt to cap ratio was north of 30% as I mentioned to you. But with the additional repurchases that I've described, that's not gotten down into the 26%, 27% range. And as I mentioned to Tom, that is a ratio we are going to keep our eye on to the extent we have additional pressure there we will take the appropriate action. But right now I think we're pretty much where we wanted to be.

Could you remind us your ROE goals and when do you think you will reach them, by what date?

I think we have been talking about getting ROE in the 13% to 14% range by 2005 or so. Obviously in this interest rate environment and with some of the pressure on the investment side, those targets may be a little bit aggressive, but still I don't think too far out of range.

Our next question is coming from Robert Glasspiegel from Langen McAlenney. Please state your question or your comment.

I've got some follow-ups. By the way, George, I thought your discussion on annuities was particularly helpful, I wish the standalone companies could be as succinct. The one area I lost you on was the -- I heard you say $150,000 on future quarter amortization, is that annual impact per point of the market, or --?

Yes, that's for 1% deviation from the targeted market performance on DAC Invest, that's worth $150,000.

That's an annual figure or a quarterly figure?

Well if we miss by -- on a quarterly basis, if we miss during the quarter we will take a hit, and any time the market under performs by 1% then that's going to be the hit, $150,000.

A one-timer in the quarter?

Right.

And is this a one-way -- I mean we got the market up 11% this quarter, is there positive unlocking or is this just only when the market goes down?

Yes, there can be some positive. The impact on the positive side isn't quite as great as on the negative side.

I mean you said the run rate would be -- you characterized the run rate as $5m to $6m a quarter, that's overall market of up 11%, what does that do to the run rate? If we just froze -- if the market was up 11% for the entire quarter, day one --?

You'd be in the higher end of that range.

It wouldn't take you past $6m though?

No.

Pension costs for '03, you said $8m this year; what does it look like for next year?

Bob I'm sorry, you cut out on the first part of that question?

Pension costs for next year -- you said $8m this year?

Bob, $8 million was the cash contribution to the pension fund. Our actual GAAP pension expenses are running about $6.5 this year, and with the market performance like it is, we probably will be in the same ballpark next year.

Is that allocated to divisions in other -- where do we see that?

No that's allocated to the segments. I mentioned when I went through in my comments, the reconciliation of the year-to-date property casualty expense ration. One point of that increase, September year-to-date over prior year was due to the increased pension expense.

Just one final thing. Your reluctance to give guidance may have been a signal that you're a little bit more nervous about '03 than you thought you might be. The text of your prepared remarks seems to me that things are really going well, productivity is good, the top line is good, the underwriting is good, we've had an 11% up market this quarter. You had 2 cents of Life that's in the base for the six months that you didn't realize. So there are all these positives, and to me it's a little odd that you're throwing out a yellow flag caution signal, as the world seems to be improving around us and you're operating effectively. Am I misreading this reluctance to give guidance, because you're more nervous or more optimistic, or things are just fuzzy and you don't know which way they're flowing?

Well that was a long one. It was more the latter I think. Our reluctance to give guidance is not so much due to being nervous on the downside, or whatever. As it is just simply wanting to give you as tight a range as possible, and at this point in time with so many things in the flux, we just thought it was more prudent, and we could deliver you a better quality estimate if we waited another quarter.

But I'm correct in reading that you're really pleases at how well you're executing, and you got a little tougher credit markets, but they aren't any worse than they were a quarter ago. So that's not sort of -- the market's higher than it was, and you're executing very well, so it seems to me there's as much reason for optimism growth rate as there is concern, or am I misreading that?

I think you're right, I think we're clearly cautiously optimistic. But again there's the wildcards out there, the market is doing okay, in October relative to the end of September, but again that still is probably our biggest wildcard.

Okay, thank you.

Thank you. Our next question is coming from Stephan Peterson from Cochran Caronia. Please state your question or your comment.

Dan, I was wondering if you might be able to provide us just a little bit of color as to what happened during the key selling season with the independent agency force. Your release indicates that annuity sales were supplemented by the independent agency base that you've worked so hard to establish. Can you give us maybe a little bit of a breakdown in terms of how much of that growth came from the independents and maybe more specifically, how many independent agencies you have appointed right now?

Taking your second question first, we're up to, and we had probably our largest growth in the third quarter, we're up to 145 independent agencies on the books as of to date. We actually have fairly high standards for them, that if they are not producing we won't keep them, so it's not a group of completely unproductive individuals, which some companies do that.

Their impact is still fairly minimal, but it is growing and we're seeing that momentum continue to take a larger and larger role. I would suspect that fourth quarter you will see even a larger impact and we will get more specific on the month to month production of the independent agents. But it is having an impact in a few percentage points of the growth - of the overall growth.

And then just one additional follow-up. You reported some pretty good news going on here in the local Chicago school district. What should we expect from that business specifically? Should we expect sort of a big run up initially, maybe for the first year, and then some moderation, or is that an account that you foresee growing pretty consistently? Maybe not at the current rate, but certainly over time.

Probably the first. You're going to see a big run up in the beginning and then more normal or a lower level of growth. It tends to be very much flex premium business right now, which are small accounts so there is a large amount of small accounts coming on initial, like an opening salvo. That is going to continue, but it won't continue at the rate it did in the beginning.

If I could just add to that. We're not going to stop with Chicago in terms of AFT school districts. There are a lot of other big ones, some of which we actually have payroll slot capability. So we're going to go after other major metropolitan markets on the annuity front only, through independent distribution, and capture that opportunity now that we feel we don't, as you'll recall, need to be the [NEAK-12] company.

One last question. Do you feel pretty comfortable now that you've got most of the home owners problems behind you? I mean I know you were wrestling a little bit with what's going on in Texas and Florid as regards water damage, and obviously excluding those exposures is a huge step forward. But it does seem, from my -- looking at other results, that you seem to be a little bit ahead of the curve compared to some of the other carriers out there. And I'm wondering if you foresee these solid results in home owners continuing, or with the mild weather quarter, we just kind of got lucky?

Well there's no question that the weather has played a beneficial role for us, but I would say the underlying on our business we feel good about the direction that we're going. Are we there yet on the property - no. Property is just a piece that you have to stay continually focused on. You mentioned the [Malden] in Texas is one that you have to stay on top of. I certainly feel good about the rate changes, the underwriting changes that we've put in, the re-inspection processes, tighter re-underwriting controls, and I think all of those things are starting to show up. And as you know, it's also a 24-month tail on the properties, so do I feel good about where it is? Certainly up from where it was a year ago - yes. But we still do have the opportunities, and as I said, I think we will see a positive underwriting result on the property business in 2003.

One quick last question. Most of the ups and downs that we're seeing in annuity are certainly out of your control. I'm wondering if we finally have the P&C reserves where we want the to be. Because it seems that every couple of quarters we seem to be making adjustments there, and I'm wondering how comfortable we are now with the reserves that are up just on the P&C line.

We continue to feel comfortable with the total reserve level, Stephan, as I indicated. We've made good progress both internally and with E&Y and really we think getting our analysis to a much better point an so on. And E&Y's independent analysis both at December 30, 2001 and June 30, 2002, indicated that our reserves were slightly above their select estimate in total. What you saw this quarter was a favorable development in the current accident year, offset to some degree by some adverse development in prior years, which many companies in the industry are experiencing. So our intent is to continue to keep our reserves slightly conservative. Accident years may develop differently, as they always do, but on balance we're comfortable with where we are.

Our next question is coming from Seth Bower from Banc of America. Please state your question or your comment.

A couple of quick questions. The first is, on the expense ratio you provided a breakdown on those 3.2 additional points of expense. I'm just trying to get a better sense of what we could expect to see over the next several quarters in terms of the run rate and in particular on the claims, 1.1 point of claims restructuring expenses. Is that something we should expect to see going forward, or is that more of a one-time?

If I understand the question, as far as the restructuring charge, that would be a one-time situation. As far as our run rate for the business for loss adjustment expense, we would expect to see the actions that we're taking as part of the claim redesign process to improve our loss adjustment expense ratio. So we would expect that to be trending down as we move through 2003. On our expense ration, for the P&C business we would expect that in 2003, as we're moving forward here, to be in the mid 20s. As I said, we still want to make sure that we're investing - mid 22s, I'm sorry. The mid 22 range; as I said, we're still investing in our business, so we still have a few issues that we will be addressing in that area.

And the second question I have is on rate actions. I think you indicated that you were currently at about 7.7%, and I believe last quarter you spoke -- the last quarter you were at 7.7 and the current you were closer to 7%. Is the trend on that would you say ticking down or mostly flat?

Yes. Some of that is stakes that you put into place at certain points in time. North Carolina is a good example, with some of the bureau changes and commissioner involvement. So our trend or our intent is to continue to drive the rate changes on the Auto at least that 7.5 and even higher where possible.

On the investment portfolio I think you'd indicated that you were going to -- you're reducing your single issue cap from 4% down to 2%, has that rebalancing process been completed or is that just underway. And when do you expect to complete that?

Seth, that's not been completed, it's still under way. As I mentioned during the last call, we're probably looking at a 12 to 18 months horizon to deal with our existing portfolio and to get into those revised guidelines. Obviously in terms of new purchases or new issues, it's already in effect.

Our next question is a follow up question coming from Tom Benbuskirk-ph from McMann Securities. Please state your question or your comment.

Actually the last caller addressed a piece of it on the investments because I did want to check the progress of how you were going with those changes. Since it's going to be something that's going to be worked through over time, are there any remaining outsized exposures that we're going to have to worry about that might lead to future charges, particularly in the telecom area? And also if you could tell us what percentage of the portfolio is below investment grade at this point?

We will be working through some of the concentration reduction over time. We do have issues that are ahead of our guidelines. I guess to be specific to your question on telecom, our larges holding currently is Verizon Wireless, book value of about $27m, that currently reset the end of the September and had of unrealized loss of a little under $1mln. The second largest in that sector is AOL Time Warner at $23m, which is about a $3m unrealized loss. Others in the top five, they're around the $20m book value each, are [Comcast] Cable, Viacom, and News America. So that gives you some sense of at least the size holdings in the communications sector. I guess further elaboration on our communications holdings, total in that sector, which really is a combination of telecom and cable, and some media and publishing, book value of about $258m with a pre-tax unrealized loss in total of about $22m spread across 36 issues. The number of issues in the holdings and the unrealized loss is down from where it was in June.

With regard to your follow-on question in terms of lower than investment grade, we're about a little over 4% of our portfolio is below investment grade.

And just one other quick follow up to that. If you could talk for a moment about energy exposures. I know you mentioned Morant as one of the credits where you took a hit. And then I had a very quick follow up on the pension issue as well.

Our energy holdings at the end of September had a book value of $282m, and a market value of $290m, so for the total sector we had an unrealized gain of $8m. Largest holdings are Norsk Hydro and [Conico], both at around $20m and both have unrealized gains.

The question on the pensions was just was there an unrecognized pension and liability; did shareholders' equity take a hit as a result of the market performance that we've seen that's affected a lot of companies?

Yes. We took I guess it's referred to as accumulated other comprehensive income. Hit to equity after tax was about $10m at the end of last year, and we have not booked anything so far this year, but our current estimates would say we'd be looking at a reduction to equity of about $6m to $7m at the end of this year.

Once again, if you do have a question or a comment, please press the number '1' followed by '4' on your touchtone phone at this time. Gentlemen, we have no further questions at this time. We would like to thank everyone for their participation in today's teleconference, you may disconnect your lines at this time and have a wonderful day.