Hanover Insurance Group Inc (THG) 2002 Q3 法說會逐字稿

Good day and welcome everyone to the Allmerica Financial Corporation third quarter 2002 earnings conference call. Today's conference is being recorded. At this time for opening remarks and introductions, I would like to turn the call over to Henry St Cyr, Vice President of Investor Relations. Please go ahead sir.

Thank you. Welcome to the third quarter conference call for Allmerica Financial. I am Henry St Cyr, Vice President of Investor Relations.

With me this morning, are Ed Parry, President of our Asset Accumulation business and Chief Financial Officer, Bob Restrepo, President of Allmerica's Property and Casualty companies, Mark Hugg, President of Allmerica Financial Services and Jay Huber, Allmerica Senior Vice President and General Counsel.

Jay has not been on these calls before however he has been with Allmerica for over two and a half years. Before that he was General Counsel of Thomas Hotels Inc., Deputy General Counsel of US F&G and in private practice. Also joining us, is Michael Reardon, Chief Financial Officer of Allmerica Financial Services.

After Jay's opening comments, Ed will discuss our financial results for the third quarter followed by comments from Bob and Mark about their respective businesses.

Before we begin, I want to mention that the primary purpose of this call is to discuss the results of the quarter just ended. However, both our commentary and our responses to your questions may include forward-looking statements. These forward-looking statements are subject to a number of risks and uncertainties discussed in some detail in Allmerica Financials Annual Report on Form 10K for the year ended December 2001 and the quarterly report on Form 10Q for the quarter ended June 30 2002, which are on file with the FDC and in the text of yesterday's press release.

In particular, we note that Allmerica's future operating results and financial position will vary materially, depending upon equity and [bore] market conditions and surrender activities among other factors. Also, I would like to mention that Allmerica's quarterly earnings conference calls, including today's call, are available on the Internet. Interested investors and others can listen to the call through the Allmerica web site located at www.allmerica.com.

With those opening comments, I will turn the discussion over to Jay.

Thank you Henry and good morning. As Henry mentioned, my name is Jay Huber and I am Allmerica's General Counsel.

As you know, on Friday we received the resignation of Jack O'Brien as President and Chief Executive Officer of the company. Following Jack's resignation, the Board elected Michael Angelini, one of Allmerica's current Directors as Chairman of the Board of Directors. Michael is Chairman and Partner of the Worcester law firm of Bowditch & Dewey.

The Board also created a new office for the Chairman which consists of Mr. Angelini, Ed Parry, Bob Restrepo and me.

Ed Parry, as President of our Asset Accumulation business, will assume responsibility for our AFS business unit, Allmerica Asset Management Group and our Corporate Services organization including Allmerica's Corporate Finance functions. Bob Restrepo will continue as President of our Property and Casualty operations.

The Board will retain the services of an executive search firm to begin the process of replacing Jack and this process will include the consideration of certain members of existing management for the position.

I should also tell you that Dick Reilly will be retiring from Allmerica, effective November 15. Dick was formerly President of Allmerica Financial Services until Mark Hugg assumed this role about a year ago. Dick will certainly be missed.

We are saddened by Jack's departure and his presence in our organization will be greatly missed. During his tenure, which began back in 1989, our organization was transformed from a Mutual Life Insurance Company to a Public Company and experienced growth in both our Asset Accumulation and Property Casualty segments.

I will be happy to answer any questions on these matters at the end of this call. Thank you. Ed.

Thanks Jay, good morning everyone and thank you for joining the third quarter call.

As you know, we reported a very poor third quarter due to significant charges related to the re-structuring of Allmerica Financial Services. These charges more than offset the excellent quarter in our Property and Casualty business. In fact, our P&C business earned $58.5mln in the quarter, a significant increase over the third quarter of last year where the earnings were $6.8mln.

In Asset Accumulation, we reported a pre-tax operating loss of $535mln for the quarter. This loss is primarily as a result of the re-structuring announced previously, which triggered $556mln of write-offs in the quarter. As I will comment on later, this charge included adjustments to deferred acquisitions costs and guaranteed minimum death benefit provisions, as well as a write-off of certain technology development costs.

These charges are primarily related to the decision to split life insurance and annuity products in our Life Insurance Companies.

Let me now turn to a brief discussion of our P&C results. Bob will cover these in more detail later in the call. As I said, in this segment, we reported significantly improved results with earnings of $58.5mln up from $6.8mln last year.

The primary story for the quarter were approved losses. These approved losses resulted from last year's implementation of our Agency Management strategy, our re-underwriting actions and rate increases we have initiated over the past two years. Also contributing to the improvement, were lower pre-tax catastrophe losses and favorable development on prior accident year loss reserves.

Our calendar year loss ratio was 62.7% in the quarter, representing an improvement of nearly 11 percentage points over last year's 73.6%. Although both personal and commercial lives reported improved loss ratios, the largest improvement was in commercial lives, which experienced a 27 percentage point drop. In personal lives, the loss ratio improved to 68.1% compared to 69.9% a year ago.

Also during the quarter, our underwriting expense ratio increased from 26.4% last year to 28.8% in this year's third quarter. This increase resulted from higher assigned risk, particularly in New York, increased use of outside underwriting reports, higher contingent commission accruals and increased premium tax accruals.

A little later in the call, Bob will provide a more in-depth discussion of our results including our assessment of the impact of recent rating agency actions.

Now lets discuss our Asset Accumulation business. Allmerica Asset Management reported pre-tax operating income of $5.7mln, down slightly from $6.1mln last year. At September 30th, 2002, AAM had funding agreements totaling $2.2bln, consisting of $2bln in long-term agreements and $186mln in short-term structures.

As of today, we have no remaining short-term funding agreements in our portfolio. These contracts will all redeem subsequent to the end of the quarter. The remaining $2bln of funding agreement liabilities are longer-term, duration-matched, are non-portable and have no ratings triggers.

Now lets turn to Allmerica Financial Services where, as I mentioned earlier, we reported a pre-tax operating loss of $540mln. This loss was driven primarily by write-offs and other adjustments totaling $556mln. These include a $488mln write-off of Deferred Acquisition Costs or DAC, a $107mln charge related to guaranteed minimum death benefit reserves which were partially offset by a related DAC benefit of $67.6mln and a $30mln write-off of certain technology development costs.

The DAC adjustments reflected several assumption changes, the most significant of which, is an increase in expected future lapse rates. As a result of the recent actions by the rating agencies and our related decision to discontinue the manufacture and sale of proprietary products, we have seen an increase in the rate of surrenders in all of our distribution channels.

Since the end of September, withdrawals have been running approximately three to six times the rate prior to these changes. Although we expect this to moderate over time, we do anticipate higher lapse rates than previously assumed in our DAC model. This expectation of increased lapses reduces expected future profits that resulted in a DAC write-off of $171mln.

In addition, we reset our assumed future equity market return assumption to 8%. This change in estimate reflects the significant continued deterioration of the equity markets and resulted in a DAC write-off of $109mln.

Additionally, the combined effect of these changes led us to evaluate the expected future profitability of each of our distribution channels. That evaluation led to a loss recognition and DAC write-off of an additional $159mln exclusively related to our partner channel.

The guaranteed minimum death benefit charge of $107mln related to a change in our estimate of the long-term cost of this benefit from approximately 18 basis points of account value to about 46 basis points. This change in estimate is due to the combined effects of the equity market decline and the shortened expected life of this business resulting from higher expected lapse rates.

Finally, the $30mln write-off of capitalized technology assets relates to a much lower expected level of business to be administered on our Policy Administration Systems in AFS.

As we continue to re-structure our AFS business during the fourth quarter, we will further evaluate the recoverability of our asset balances. Additionally, we will evaluate the need for a re-structuring charge related to severance, other employee-related charges and other similar items. Although an additional write-off is likely for the fourth quarter, we do not expect the charge will be any more than $25mln.

In our second quarter 10Q, we provided guidance on the estimated impact that moves in the SMP would have on our statutory earnings. Of course, this guidance did not take into account our subsequent decision to cease selling proprietary life and annuity products. Given the extent of the adjustments to DAC and GMDB reserves, future earnings will no longer be as sensitive to short-term moves in the equity market. Accordingly, our previous guidance is outdated and we will be considering new guidance as we prepare the third quarter 10Q.

Now I want to give you an overview of the capital position and liquidity profile of our Life Insurance Companies. At the end of September, the consolidated total adjusted capital of FAFLIC was approximately $326mln. We estimate FAFLIC will have a RBC ratio of approximately 145%. As you probably know, we express RBC ratios as a percentage of the National Association of Insurance Commissioners 100% company action level.

FAFLIC is our lead Life Insurance Company domiciled in Massachusetts and FAFLIC's capital includes its interest in its subsidiary, AFLIAC, which is domiciled in Delaware. We also expect that AFLIAC, on a stand-alone basis, will report total adjusted capital to September 30th, 2002 of approximately $149mln. This is approximately $20mln higher than the level reported at the end of June. AFLIAC will have an estimated RBC ratio of approximately 130%.

I also want to highlight that the RBC for life companies have improved in October from these third quarter levels. As of today, we estimate FAFLIC's RBC at approximately 180% and AFLIAC's at about 145%.

AFLIAC's improvement results in part from the improved equity market in the month of October which had a positive impact on our statutory [GMDB] reserves. AFLIAC's surpluses has also benefited from increased surrender activity and the expense reductions previously mentioned, offset by an expected fourth quarter provision for additional minimum pension liability.

FAFLIC's improvement include the increase in AFLIAC's surplus as well as significant benefit from retiring long-term funding agreements at amounts less than statutory carrying values which has added approximately $65mln in statutory surplus since the end of the quarter.

Aside from these results, we have some further good news to report on the statutory capital and RBC front. There has been concern among analysts and investors regarding the commitment to maintain a 225% RBC ratio at FAFLIC. I am pleased to report the Insurance Commissioner at Massachusetts has agreed to terminate the related agreement in exchange for a commitment from AFC to indefinitely maintain FAFLIC's RBC ratio at a minimum of 100%, so long as FAFLIC does not write new business. This is consistent with our re-structuring of AFS and the fact that we are no longer writing new business.

We believe the reduction in the level of capital required in FAFLIC from 225% to 100% is significant. Despite the equity markets during the third quarter, we were able to report an RBC ratio for FAFLIC well in excess of this level without any capital contributions from the holding company.

Further, this agreement, taken together with the approval we received from Massachusetts Regulators to allow for a $171mln capital contribution from FAFLIC to AFLIAC, demonstrates the productive working relationship we have developed with our regulators.

Finally, I want to mention that we continue to be very comfortable with liquidity and cashflow positions of both of our Life Insurance Companies. We have a strong portfolio of liquid assets backing our general account obligations. But both of our annuities are separate accounts and surrenders of separate account balances are a positive liquidity event for us, assuming the policies are subject to surrender charges, as most are.

Finally, our decision to cease writing new business has eliminated significant strain on our statutory capital position. The absence of commissions to producers and bonus payments to Policyholders will increase cashflow by approximately $250mln per year. What's more, the cashflow forecast we prepared in consultations with a prominent actuarial consulting firm, show net excess annual operating cash for our Insurance Companies for the foreseeable future in excess of $100mln.

For these and other reasons, we believe we are well positioned to satisfy our Life Company Policyholder obligations. In addition, we continue to maintain a strong liquidity profile on our holding company, as we discussed on our October 7th, call.

With those comments, I would like now to turn the call over to Bob for his remarks on the Property and Casualty business. Bob.

Thank you and good morning. The improvement in our Property and Casualty business which we have seen all year, accelerated during the third quarter. Pre-tax third quarter earnings totaled $58.5mln. In addition, we came close to producing an underwriting profit in the quarter, with a combined ratio of 100%.

Year to date, the Property and Casualty business has earned $149.1mln. representing a combined ratio of 102%. Our results during the quarter and year to date were driven by substantially improved homeowners and commercial lines earnings. We continue to see positive results emanating from the underwriting, pricing and agency management actions that we have implemented over the past two to three years. In addition, we have experienced favorable catastrophe experience in the quarter. Year-to-date results have also benefited from the mild winter back in the first quarter.

Turning to personal lines, we report a combined ratio of 103.4% for the year, which is roughly even with our result of last year, where we reported 103% combined ratio through three quarters.

Year to date personal auto loss ratios improved somewhat relative to last year. We continue to charge higher prices to reflect higher loss costs for bodily injury and Personal Injury Protection or PIP.

In Homeowners, results continue resulting from improved underwriting and pricing, favorable catastrophe experience and better weather during the first quarter.

Our underwriting and pricing actions have improved our catastrophe loss ratio by 7 percentage points relative to 2001.

Pricing, underwriting and insurance de-value programs that we have put into place over the past four years are paying off. We think we are at least two to three years ahead of the industry affecting this historically troubled line.

In fact, we produced an underwriting profit in each of the three-quarters this year in homeowners. Year-to-date we have a combined ratio of 99% for that line.

Production continues to increase in personalized. Year-to-date, net rate in premiums are up 8.2%, driven by healthy sponsor growth and price increases for both auto and homeowners. Year-to-date, prices for autos have increased 7% and homeowner prices are up 14%.

Looking to the future, we think we can maintain this growth as we continue to increase our sponsor business, expand our personalized presence in the South-East and increase prices. These positive production trends will be offset somewhat as we see some run-off resulting from the agency termination actions that we put in place last year.

Although personalized loss ratios are down, expense ratios are up, resulting from higher assigned risk assessment as Ed mentioned, particularly in New York and heavier use of outside underwriting reports, such as [Carter] reports.

In addition, we booked higher contingent commission accruals because of our favorable loss experience, higher premium tax accruals due to a one-time benefit last year and lower loss-adjustment expense reserved for leases in the auto line.

On an accident year basis, auto results deteriorated somewhat in Citizens because of PIP medical and bodily injuries. [Hanover] results are stable. Homeowner results deteriorated slightly in the third quarter relative to the prior two quarters because of higher large loss activity primarily in Citizens.

In commercial lines, counter year results continue to improve at a rapid rate. In fact, they are accelerating. In the third quarter, we produced a combined ratio of 92.8%. Year to date, we have actually produced an underwriting profit in commercial lines with a combined ratio of 99.2%. We see improvement in all our primary commercial lines. Commercial Multi Peril and Commercial Autos continue to produce solid results and we have seen a turnaround in our workers compensation performance.

Our results are better because we are doing a much better job of executing the fundamentals of the business. We continue to get healthy price increases. We have a more disciplined underwriting controls in place, our agency management performance has never been better and we continue to benefit from low cost high quality client handling.

Production continues to decline, resulting from our underwriting and agency actions, but at a slower rate. Year-to-date, commercial lines net written premiums are down 13.8%. For the third quarter though, net written premiums results declined by a more modest 7.5%.

Although commercial lines loss ratios are down substantially, expense ratios are up somewhat. Commission ratios are higher as we exit the heavily re-insured specialty line and reduce the mix of workers compensation relative to package and commercial auto business. Expense ratio on commercial lines has also increased relative to last year due to one-time premium tax benefits in 2001 and lower premium volumes that we have experienced this year.

Looking at our commercial results by line, we continue to produce excellent results in commercial auto and commercial multi perils. In the commercial autos line, we produced an underwriting profit with a combined ratio of 97.3% which is almost a 10 percentage point improvement over our year-to-date results in 2001. Accident year results continue to be quite good and premium is up 16.5% on renewed business.

Commercial multi peril results continued a significant improvement. Year-to-date, we almost produced a break-even underwriting result with a combined ratio of 100.2%. After adjusting for the impact of the tragedy of 9/11, this represents almost a 10 percentage point improvement over last year. Commercial multi peril continues to be our lead line. Premiums are up over 20% on renewed business, producing substantially better results for both our top line which includes the new Dimension 2000+ product and other commercial multi peril. Accident year results continue their very favorable trend.

In the third quarter, we also saw improvement in workers compensation. Better counter year loss ratios resulted from both continued improvement in the current accident year and favorable development in prior accident years. All in all, we are very pleased with our third quarter performance.

Looking to next year, it is clear that the difficulties in our Life business and the recent ratings downgrade, present challenges to the positive momentum that we have built in our Property and Casualty business. Although we are still assessing the impact, it is clear that the ratings downgrade will affect production, primarily in commercial lines. We are working with our re-insurers to provide cut-through coverage for commercial package business where necessary and expanded coverage for commercial umbrellas. These are the two areas that are most vulnerable to the recent ratings downgrades.

As background, these so-called cut-through endorsements are financial guarantees, that are provided by A-rated third parties.

In addition, our ability to maintain our current new business momentum on personal lines and return to more normal new business run-rates in commercial lines, will be effective. Our immediate priority is retention, retaining the best business, the best agents and our best people.

We have had a series of conference calls open to all of our agents and I can tell you that they are hanging with us. But I can also tell you that they don't view us as the most attractive market for new customers right now, particularly for larger commercial accounts. Although the most immediate financial impact will be on our production and expense ratio, we think the positive impact of our pricing and underwriting actions should continue to produce good loss ratios.

Despite the challenges posed by the rating actions, we remain focussed on the fundamentals of our business, namely disciplined underwriting, continued price increases, quality claim handling and better agency management.

We have already invested in underwriting and claims systems to improve our effectiveness and productivity. We are now investing in management information systems to help us better forecast loss trends and manage our day-to-day underwriting, marketing and claim operations.

We think we are very well positioned for continued success in the Property and Casualty business and with that, I will turn you over to Mark Hugg.

Thank you Bob and good morning. In our last conference call, I outlined the new Allmerica Financial Services strategy. My purpose today will be to further describe the strategy and report on the progress we have made to date.

To recall the heart of our strategy is two-fold. First, manage our existing book of business from a capital, liquidity and expense standpoint and second, transform Allmerica Financial Services into a focused broker dealer, a term that I will elaborate on later in my remarks.

Now lets turn to the strategy at hand and discuss the progress made to date in Allmerica Financial Services. I will first discuss those initiatives relative to the Insurance Company and then discuss our approach to the broker dealer.

Fourteen project teams to reorganize AFS are well under way, co-ordinated under the direction of a single Project Manager. A Steering Committee of senior management personnel monitors weekly progress to ensure successful execution of this complex strategy.

We expect the most significant elements of our plan to be executed between now and year end. During that time, we anticipate that 400 or more employees will leave the company due to position eliminations. These positions include those from within the AFS Division and those from a variety of corporate departments currently supporting AFS.

Our first interval of affected employees occurred on October 15th. These staff reductions and the corresponding expense reductions associated with the stoppage of sales have already reduced our annual operating expense level by $40mln. This activity is the first step in achieving annual operating expense savings of $100mln. This saving is in addition to the $250mln annual commission and bonus savings associated with the stoppage of new business.

With the focus on expense savings, also comes the focus on our enforced block of business. Therefore, we continue to take the necessary action to manage and retain this $17bln block of business. We still maintain a customer service organization who's only objective is to ensure quality servicing of our existing Policyholders.

Now lets turn to the broker dealer. As I mentioned earlier, our objective is to build a unique broker dealer with key value added services. That broker dealer is made up of a growing advisor system that now totals 750 of the most productive financial planning advisors in the industry. During the month of September, we added ten additional advisors to our distribution system and have not lost any advisors since our re-structuring announcement on September 27th. In fact, we have added seven advisors since September 27th on the very basis of building an independent broker dealer with full value added services.

Over the last several weeks, we have outlined our new operating plans to our advisors and field management in a series of meetings and conference calls. Our advisors are excited about the concept of providing additional product choice to their client and the independence that this new strategy affords them.

This broker dealer will use our existing hub-and-spoke infrastructure to ensure the successful execution of our platform strategy. Recall that these platforms are full-support resources, that includes technology, process and people, that help our advisors generate leads and partnerships to improve their productivity.

Furthermore, our hub-and-spoke infrastructure will have its own proprietary wholesalers, training and educating our advisors on our strategic partner's product. Also, as we discussed in our previous call, if this channels historical volumes were expressed in terms of Gross Dealer Concessions (GDC), it would already be a top twenty broker dealer, excluding the wire houses and in the top five when measuring broker dealer's variable annuity business.

We continue our efforts to form alliances with three or four major insurance carriers to deliver high quality products to our field. We are finalizing our first major insurance carrier partnership and expect to announce it formally shortly.

Our proprietary wholesalers have already begun training the advisors on the new products and our sales desk is currently providing marketing materials, applications and illustrations to support the sale of their products. We expect additional partnerships to be finalized over the next several weeks. By concentrating our proven distribution capacity and support on a small number of manufacturers, we are creating broad and mutually beneficial partnerships with these companies. This is what we mean by a focused broker dealer. From the prospective of the advisor and their client, these new partnerships allow greater independence for the advisor and a broader array of product choice for their client.

In closing, the strategy that I described to you a few weeks ago, was already working. We have stopped the sale of our own products and have already removed a significant amount of expense as a result of this change. In all, the stoppage has improved our cashflow by almost $300mln on an annualized basis and is definitely having a positive impact on statutory capital.

We have retained all of our advisors and they are enthusiastic about the new broker dealer model. From their perspective, they will have product flexibility to meet the financial needs of their clients and a full complement of value added services to help support these clients.

In a matter of a few short weeks, the marketplace has responded to the strength of our advisor distribution channel and our first product partnership will prove that we can in-source high quality product in a mutually beneficial relationship.

We regard this joint venture as a strong endorsement of our new strategy. As we continue to implement this strategy, I will keep you informed of new developments. Now I would like to turn the call back over to Ed Parry.

Thank you Mark. Before we take questions, I wanted to take this opportunity to close our prepared remarks by reinforcing some of the positive news we have discussed today.

Our Property and Casualty business, which will be our largest source of earnings going forward, posted another solid quarter of improvements. The strategies we have implemented to improve our earnings in that business, have taken hold.

In terms of our Allmerica Financial Services re-structuring, we have made progress on a number of fronts. We have taken significant action to increase the statutory capital and RBC positions of our Life Insurance Companies through ceasing new sales of proprietary products, eliminating the statutory capital strain associated with such sales, significantly reducing expenses and opportunistically re-purchasing bonds, back our [funding] agreements.

We have analyzed and are comfortable with liquidity and cashflow positions of our Life Insurance Companies, providing us confidence we can meet our Policyholder obligations.

The new agreement with the Massachusetts division of insurance, reduces the capital maintenance level at FAFLIC and demonstrates the positive working relationship we have with our Regulators. And finally, our advisor-led broker dealer strategy is well under way.

As we move forward, our highest priority is restoring the A-rating for our Property and Casualty Companies. In addition, we will continue to further solidify the capital base of our Life Insurance subsidiaries in order to restore the confidence in their strength. Further, we will maintain the solid momentum in our Property and Casualty business through continued disciplined execution. And lastly, we will continue to execute our advisor-led broker dealer strategy.

I look forward to updating you on our progress at the end of the fourth quarter and with that, we'll turn the call over to questions.

Thank you. our question and answer session will be connected electronically. Anyone wishing to ask a question may do so by simply pressing the '*' key followed by the digit '1' on your touch tone telephone. We will take the questions in the order that you signal us and will take as many questions as time permits. Just a reminder if you are on a speakerphone, you must depress the [relieve function] in order for your signal to meet our equipment. Again, if you would like to ask a question, you may do so by pressing '* 1' now. And we will pause briefly so that we may assemble our roster.

And we will go first to Liz Warner from Goldman Sachs.

Good morning, I had a couple of questions. First, I wanted to hear how you thought the progress that you have made on the statutory capital front on the Life Companies, how that affects your view of your strategic alternatives going forward and if it does have an effect, particularly given the focus on improving the rating at the [TNC] Company, is it possible to achieve that rating while keeping the latest companies and slowly continuing to build the capital base in those life companies over time or is there some value to the operations being separate? That is my first question.

The main part of your question, I will try to answer it this way, Liz. First, they are related, that is to say, stabilizing the capital position in our Life Companies is very much related to our current structure to obtaining an increase in our ratings for our Property and Casualty company. We are very much focussed on that and as I said, we think we have made some significant progress on that front, both numerically as well as the agreement we have reached with the Regulators.

The rating agencies what they said publicly with regard to the downgrades and when they talk about the Property and Casualty Company is they focused on the difficulties in the Life business. They focused on the statutory capital there. They particularly cited the 225% agreement with the State of Massachusetts. I think that they were concerned about with some risk that we might have in maintaining that level and what impact it could have on the entire empire. Now with the improvements in that area, after reiterating everything that we have gone over already, about the improved capital and our perceived position, the change in the agreement to 100%. $171mln of capital went from the Massachusetts company to the Delaware company. We are going to go back to the rating agencies and have a whole discussion about that and hopefully have something to report and some progress to report in the fourth quarter with regard to that.

Ok. With respect to the future DAC amortization levels, given the current lapse rate and your 8% mark on return assumption, what would the amortization look like? What is the risk of any future DAC write-offs? If the lapse rates continue to climb, we can expect additional write-offs there?

I think I will take the second one first. We currently do not expect any additional DAC write-offs of course, we have made estimates about lapse rates etc. and actual experience I am sure will be different than what we have assumed, but we think we have been reasonably conservative.

With regard to amortization going forward, I cannot tell you exactly what that will be, some questions were asked of us last evening as we did some calls and they were around that. They were around what your GNDB expense be. What is the core earning power in the life business. These changes are fairly significant and fairly reasonable and what we would like to do is to spend some time here over the next month or so, thinking about that and then getting back to the street about what that core earnings power is and what the pieces are.

Ok, now my last question for Bob is given managing these new ratings for the Property and Casualty business, how do you prevent yourself from being in the position of adverse selection with your agents?

I think that short-term, Liz, we really have not seen any impact on retention. As I mentioned, we expect and have already seen an impact on our new business flow. Primarily with the larger accounts which represent just about 11% of our current volume. It is also going to affect our ability to develop new sponsored accounts or at least most particularly with financial institutions, banks in particular. Beyond that though, our retention looks very good. We're just a month into it but what we have seen in our numbers and what we have seen [...], it is holding up. As I mentioned the feedback I got, from conference calls and calls I have made to scores of agents around the country is that they are going to hang with us, they are hopeful that this rating situation will be short-lived and they are hanging with us. So short-term definitely through to the end of the year, I think even into next year, we do not expect to see much impact on retention for the vast majority of our business.

Ok, great, thank you.

And next, we will go to Wayne Savage with Fox-Pitt Kelton.

A few questions here. Firstly Ed, if the rating agency said to you, you are not going to get the rating back unless you separate the PNC company. What are your restrictions there? Could you spin that today with some covenants or some state restrictions? Can you do that?

I think we are not there yet and I think what we are going to first work on is obtaining a higher rating in our current structure. We think that that is possible, we are very much focused on that.

Getting back to the question, can the State restrict you from doing that, or do some DAC covenants restrict you from doing that?

I think, Jay perhaps you can comment on that, but I think there are some level of restrictions on that.

Well, certainly in terms of spinning off the Property and Casualty Company, the State of New Hampshire and the State of Michigan as the domiciliary states, we would require their approval. We would certainly work with the State of Massachusetts in light of the 100% commitment that we have. In terms of the bond restrictions, there are restrictions on at least one of the bond covenants if we were talking about a dividend for value, that would be, I believe, permitted under the bond document.

Ok. Turning to surrenders, if the whole book surrendered Ed, what surrender fee would you collect? Or to ask another way, what is the average surrender charge against the book?

Michael Reardon, do you want to answer this?

We probably have somewhere between $500mln-$600mln of total surrender charges on just the variable annuity levels.

Ok, and can you give us any color, would you call them good versus bad surrenders, i.e. with the guaranteed minimum death benefit. Are you seeing surrenders from accounts that are under water?

Yes the mix of surrenders looks very much like the mix of the enforce business both in terms of the age of the client and the level of those that are at risk.

Do you not get into any adverse selection where only those surrendering who have a death benefit equal to or below their account value?

No. Not at all.

Ok. And just on the level of surrenders, can you give us a dollar amount of the weekly run-rate you have been seeing? You had $350mln roughly of surrenders in this quarter, I think 3-6 times that number, it implies $2mln, is that a number you would expect for the fourth quarter, or am I off base there?

We are running probably, it has continued to increase since the announcement, I would say $80-$100 a week.

Ok, is there any increase in this week, is it higher than last week?

Yes, we have seen modest increases each week since the end of September.

It has sort have gone from mid 20's mid 30's, mid 40's, 60's and we're kind of in the mid 70's right now.

Ok..

Just to make it clear to everybody about that. If we are focusing here on a lot of this, which of course is what we are doing, surrenders are a positive event for us.

Absolutely.

It is a positive cashflow event, it is a positive sketch to our capital event and it is very positive in reducing our net amount of risk related to these guaranteed minimum death benefits, so it is a good thing, not a bad thing.

Sure. And that's your point about asset charges being $25mln in the fourth quarter. I was not even sure what that encompassed. Was that just a re-structuring charge or does that include DAC and?

Oh you mean if I estimate what we might have in the fourth quarter, I don't expect any DAC in there. I think we will have some severance and other employee type costs. I think we could have some more hardware/software-type write-offs that we just might have missed in the most recent analysis.

So it sounds like the lapse that you are seeing then, the surrender fee is offsetting the DAC, recovering the DAC?

Ed mentioned a big piece of the DAC write-off related to increases in the expected lapses in the [...] to what we now expect to see.

Ed, I am wondering if you have done any back-of-an-envelope math. What level does the S&P have to go to where you would pierce the 100%?

The mark that it would have to go down is about 25% from where it is today.

Ok, thanks very much.

And we will go next to Andrew Capper of Putnam Lovell.

Good morning, I was just hoping you could help clarify something and that is, after the lapse conference call where you announced a lot of your initiatives, I guess I kind of walked away with the sense that there was some level of frustration over the downgrade of the Property and Casualty ratings, given the capital structure. And that was that the Life Company couldn't directly assets of the property cash company and in turn, perhaps with the ratings downgraded and specifically with the life piece it was sort of unwarranted. But I kind of think that you are looking at that a little differently and I was wondering if I am right in where I am leading here and if anything has changed.

Well, I think in part which you might have heard from us on our last call, is that we felt pretty strongly about the capital position of our Property and Casualty Company and the trends that we have there and the conservative reserving policies, the very positive trends that we have. So we are clearly disappointed with the downgrade and by the way, we continue to be disappointed with that. I think there has been, as I said earlier, some concern and some confusion over this so-called 225% agreement. It is absolutely clear now that that has been reduced to 100%. So I think that clears up some of the items that were unclear and as I said, with respect to the high authority of operating the P&C rating, we are going to be continued to be focussed on solidifying and stabilizing the capital position of the Life business and continue to execute well as we have in the P&C business and then have discussions with the ratings agency about upgrading that rating.

Ok and do you have the book value on the Property and Casualty business?

Book value on the Property and Casualty business is about $13 to $14 a share, about $1.4bln, $1.3bln, $1.4bln we've got booked on it.

Ok, thank you.

Next, we will go to Adam Star from CRN.

My question has been asked already, thank you.

Thank you. Once again, if you would like to ask a question, you may do so by pressing '* 1' and if you would like to remove yourself from the queue, you may do so by pressing the '£' sign. We will go next to Angelo Graffy with Merrill Lynch.

Good morning everyone, I have a couple of questions. I would like to address the capital and liquidity position. Looking at the Life city areas, you mention that FAFLIC has had surplus of about $326mln, is that correct?

Yes.

How does that conform with the $265mln that is in the financial supplement?

The supplement does not include ABR and the apportionment of the dividend. It just includes capital and surplus. So the capital surplus is the $265mln and then you need to add those other items which are considered when you talk about total adjusted surplus, the total adjusted capital which brings you to the $326mln.

Ok, and I want to address the previous question about the impact on the S&T. If you look at the current estimate that you gave for the RBC on FAFLIC, you said it was around $180mln now from $145mln, how much of that was from the increase in the equity markets?

Probably about $50mln or $60mln of that capital. Then we had some additional capital from the re-purchase of the bonds. We had stable statutory earnings, otherwise and then there is a provision which will not be booked until the fourth quarter for the capital, the negative, for the increase in the under-funded position of our pension plan. And that's an item that unfortunately for us and unfortunately for most companies, companies are seeing these days.

And so it looks like 15 points out of that 35 came from the equity markets? Are you saying $50mln?

Yes, I don't have the numbers in my head.

Ok. On the last conference call, management made a comment about potentially paying $40mln on re-insurance. Can you elaborate on that? Is that re-insurance for the Life city areas?

Yes, we have disclosed in our figures, I think we probably talked in the last couple of calls about a re-insurance arrangement where a Life Insurance Company has with a third party re-insurer. Although as part of that agreement there is an arrangement whereby the holding company under certain circumstances will fund some portion of what the re-insurance company has re-insured. There is a limit to that. There is a limit of $40mln annually and it is a three year contract and we are one year into it. So we expect about $35mln payment, probably a little less than that, low 30's in the fourth quarter from our holding company pursuant to that. We didn't talk about it in this call but we talked about it in our October 7th call, we talked about our holding company cash position entering the quarter which totaled about $85mln and we talked about our obligations including that. We have a more than sufficient cash position to meet our obligations for our debt etc. through the middle of next year, at which point we will take another ordinary dividend from our Property and Casualty Company.

So capital at the holding company right now is still around $85mln?

Yes, about $85mln, coming into the quarter.

Good grief! I just want to clear something up. Before you mentioned something about retaining business. I am assuming that is on the P&C side. Are you focussing on retaining the annuities on the life side?

On the life side, this is consistent with our broker dealer strategy, we are focussed on maintaining the variable annuity and other businesses sold over the years by our advisor channel. That business has historically been and continues to be a very profitable business for us, so we are focussed on retaining that business.

I am just wondering of the potentially enormous capital relief you would get if, lets just say, if just all the variable annuities went away, that capital release would be very large. I am just wondering why you wouldn't have more of an incentive to wind that down at a quicker pace.

Well there's much more capital relief associated with the non-advisor sole business. So with the business that's been sold over the years in our other two distribution channels, namely the partner channel and the select broker dealer channel. About half of our variable annuity business was sold by our advisor channel, but only about a quarter of the GNDB guidelines 34 reserves, which are made for statutory purposes, relates to that business. So relatively speaking it's very profitable business.

What was that percentage gap for GNDB?

About 25% of the GNDP reserves for the variable Moody business although it represents about half of our overall [...].

Okay great. Thank you.

You're welcome.

Our next caller is Robin Abernee with Stephen Brothers.

Hi. I was wondering if you could review with us the reserve development, the favorable reserve development? And with that all in workers comp what was the magnitude of that reserve development?

I'm not sure I follow your question Robin. You're referring to some comments perhaps that Bob made about the workers comp business?

Yes. I believe he commented that you benefited from some favorable development in the workers comp.

Yes over the prior couple of accident years we've been strengthening reserves for accident year '99, 2000, a little bit in 2001 and based on our most recent review we saw about $7mln of favorable development coming out of those accident years. So that benefited our calendar year results in the third quarter.

Okay. Also with the auto results in citizens. There was a little bit of a deterioration in the business and I was wondering if you could just elaborate on that a little bit.

Yes it's almost, we've seen some increase in bodily injury losses. But what's really driving it is the significant increase in medical costs related to personal injury protection. And two things are affecting it. Number one, the health insurance companies have gotten a lot tougher in adjudicating claims and claims that they have traditionally paid in the past, they're now referring to us. So we got a benefit there for a couple of years that we have not seen over the last year or so. And we saw this trend evolving particularly in Michigan about 18 months ago and since that time we've actually increased our prices by over 50% for that coverage and we another increase scheduled for the first of the year. So we're confident that as those price increases spurn out, we'll be able to absorb the increase.

The second thing is there is a reinsurance facility in Michigan. We used to see up to, any loss in excess of $250,000. It's now up to $300,000. We got a rate increase that reflected the increase in benefits but of course the benefit goes up immediately. It takes 12 months, the full year, in the price increase. So there's a bit of a lag effect there. But again we're confident that we've got the price increases in place that once they fully are announced, will be able to absorb those increases in medical costs.

Excellent. One more question. The [...] endorsement on your promotional line business with reinsurers, is there a cost associated with that?

Yes there is and we haven't finalized it yet. But there will be a cost actually to put the facility in place if we ever use it and we expect to use it sparingly primarily for a larger account. But the cost can be anywhere between, can be 5%-8% of premium when we use it.

Great. Thank you very much.

Again we expect to use it on a very, very small portion of our book but we need to have a facility in place.

Okay. Good. Thanks.

Operator are there any further questions?

Yes we have a question from David Havis.

Okay why don't we make this our last question.

David is with UBS Warburg. Go ahead David.

Right thank you. Just following up on one of the questions asked earlier. The cash position of the holding company was $85mln, is that correct?

That's correct.

Okay. Just wanted to make sure about that. Is there a keep well between FAFLIC and AFLIAC like a network maintenance agreement or anything of that nature?

No.

No.

No.

Okay then in your discussions with the regulators and I know that there are obviously sensitivities in discussing this, but are Massachusetts and Delaware in alignment because it seems as though there could easily be grounds for you know conflicts of interest between the Delaware company and the Massachusetts company at this point?

Yes I mean certainly as you will expect I can't speak for the regulators and Walt. I observed that, and I have observed earlier on the call, the $171mln capital contribution that FAFLIC made to its subsidiary AFLIAC at the end of the third quarter, which was obviously in support of AFLIAC's capital. And I think it's fair to say that the appropriate support would be there for AFLIAC so long as that was consistent with the interest of the FAFLIC policyholders and of course it would be facts and circumstances dependent at the time.

Right and then just a final question sort of along these lines is that in the event that you breach that 100% agreement, which you know hopefully won't happen. But in the event that that does occur, the funding mechanism would be to dividend funds up from the non-life companies, the holding company, and then down to FAFLIC?

Well it's an obligation of AFC and if that were to occur, that is to say the 100% were pierced, AFC would have to make good on that. But again that would be fact specific at the time.

Okay and where is the RBC ratio of the non-life companies?

The property and casualty RBC ratios are in the mid 200s. 250, 260.

Okay. Alright. Thanks very much.

245. Okay. 250. 250, 245.

Okay.

Okay.

Alright thank you.

You're welcome.

And that concludes our question and answer session. Mr St Cyr I'll turn it back over to you for any closing remarks.

Thank you operator and I want to thank our conference call participants for being with us today. We're pleased that we had this opportunity to discuss with you our quarterly operating results and we look forward to speaking with many of you soon. Thank you.

That concludes today's conference. We thank you all for joining us. Have a great day.