Hanover Insurance Group Inc (THG) 2002 Q4 法說會逐字稿

Please stand by, we're about to begin. Good day and welcome to the Allmerica Financial Corporation fourth-quarter 2002 earnings conference call. This call is being recorded. At this time, for opening remarks and introductions, I would like to turn the call over to the Vice President of Investor Relations, Mr. Henry St. Cyr. Please go ahead, sir.

Thank you. Welcome to the fourth-quarter conference call for Allmerica Financial. I'm Henry St. Cyr, Vice President of Investor Relations. With me this morning are Ed Parry, President of our asset accumulation company, and Allmerica's Chief Financial Officer; Bob Restrepo, President of Allmerica's property and casualty companies, and Mark Huggs, president of Allmerica Financial Services. Also joining us are Jake Huber (ph) , Allmerica's Senior Vice President and General Counsel, Michael Ridden (ph) , Chief Financial Officer of Allmerica Financial Services, and John Kavanaugh, Allmerica's Chief Investment Officer.

After Ed discusses our financial results for the fourth quarter, Bob and Mark will have comments about their respective businesses. Before we get -- excuse me, 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 Financial's inner report on Form 10-K for the year ended December, 2001, formally report on Form 10-Q for the quarter ended September 30, 2002, and in yesterday's press report, which are on file or have been furnished to the SEC.

In particular, we note that Allmerica's future operating results and financial condition will vary materially, depending upon equity and bond market conditions, surrender activities, and rating actions, among other factors. Also, I'd like to mention that Allmerica's quarterly earnings conference calls, including today's call, are on the Internet.

Interested investors and others can listen to the call through the Allmerica Web site, located at www.allmerica.com. And with those opening comments, I'll turn the discussion over to Ed.

Thank you, Henry, and good morning everyone and thank you for joining our call. As you know, we reported solid results in the fourth quarter, and we believe the fourth quarter represents a turning point for Allmerica.

Our goals coming out of the fourth quarter were threefold. First, to solidify the capital base of our life insurance companies; second, convert our agency channel to a successful broker dealer, selling exclusively non-proprietary products; and third, restore our "A" and best rating for Hanover and Citizens to the "A" level.

We think we've made significant progress on these goals during the fourth quarter. The difference between where we were just three months ago and today are significant and meaningful.

During the quarter, we successfully completed four capital enhancement actions that significantly improve the statutory surplus in our life companies. Further, we made good progress in the restructuring of all market financial services into an independent broker dealer. And lastly, we had another solid quarter in our property and casualty business.

Those results, together with the life company capital enhancement actions should put us firmly on the road to having our ratings restored.

Now let me review our quarterly and full-year results. For the quarter, we reported net operating earnings per share of 42 cents, which compares to 64 cents per share a year earlier. For the year, we reported a net operating loss per share of $5.21, versus net operating earnings per share of $3.10 a year ago.

As you're well aware, this year's loss is largely the result of the charges and write-offs associated with the restructuring and end outs for all market financial services in the third quarter.

Our risk management segment reported increased earnings in the fourth quarter with profits of 35.2 million, compared to 29 million a year ago.

For the full year, earnings in this business increased to 184.3 million, almost doubling from 93.5 million for 2001.

Four our asset accumulation business, earnings declined for both the quarter and the year. For the fourth quarter, our asset accumulation net operating earnings were 7.8 million, down from 25.9 million in 2001. For the year, we posted an operating loss in this business of 600.6 million, versus net operating earnings of 163.7 million in 2001.

Now I would like to turn to our segment results for the fourth quarter. First, let's turn to a brief discussion of our property and casualty results. Bob will cover this in more detail later in the call, as well as discuss the strategy for our property and casualty business for 2003.

As I just mentioned, in this segment we reported another quarter of improved results with earnings of 35.2 million, up from 29 million in last year's fourth quarter.

Profits were up to a higher rate increases in commercial lines and lower catastrophe losses. Actually offsetting these items were weaker results in personal auto and lower net investment income.

Our calendar year loss ratio rose slightly in the quarter to 69.5 percent from 68.2 percent last year. In commercial lines, the loss ratio improved by 4.5 percentage points to 59.8 percent from 64.3 percent a year ago. Each of our key commercial reported a lower loss ratio.

The personalized loss ratio increased to 74.8 percent compared to 70.6 percent a year ago, principally due to weaker results in personal auto. Bob will touch on this in his remarks.

During the fourth quarter our underwriting expense ratio increased from 27.5 percent a year ago to 29.5 percent in the current quarter. For the year, our expense ratio increased to 28.7 percent, versus 26.7 percent in the for all of 2001.

As we mentioned in our prior conference calls, a higher underlying expense ratio for 2002 is due to higher assigned risk assessments, particularly in New York. Increased use of outside underwriting reports, higher contingent commission uprules (ph) , and increased premium taxes.

Finally, net catastrophe losses were down for the quarter and the year. They were seven and a half million dollars for the quarter and 31.3 million for the year versus net catastrophe losses of 14.3 million in the fourth quarter of last year and 51 million for the full year last year.

Now let's discuss our asset accumulation business and begin with Allmerica Financial Services, where we reported a loss of 700 thousand dollars for the quarter, down from earnings of last year of 21.7 million. The principle driver of these results was increased amortization of deferred acquisition costs, which was 65 million dollars for the quarter. This higher DAC (ph) amortization of 46 million was partially offset by an increase of 26 million in surrender fees.

The increase in Dac (ph) amortization for the quarter was due to higher surrender activity, and an increase in the rate of the amortization due to lower expected future profitability. Also effecting our results were higher other income, due primarily to increased revenue or [Inaudible] .

Waffles (ph) offsetting this increase were higher non-deferrable warper (ph) dealer selling expenses, lower net investment income, and lower fee income on a smaller base of assets under management. We believe these approximately break-even results for the quarter are somewhat indicative of oil (ph) prices expected run-rate until we achieve higher sales volume in our broker-dealer, and further reduce expenses. We expect both of these to occur in 2003, and Mark Huggs will discuss this in his remarks.

As we discussed in our last conference call, we've experienced a significant increase in surrenders on individual verbal (ph) annuities since we ceased the manufacture and sale of these products. If you recall, these surrenders are a positive in terms of statutory capital. They result in cash inflows in the form of surrender fees, and reduce our level of guaranteed minimum debt benefits.

In the fourth quarter individual annuity surrenders totaled 1.2 billion, as compared to 427 million in the third quarter of 2002 and similar amounts in the first and second quarters of that year. What's more, in January we are seeing continued high levels of surrenders, with an annualized surrender rate of 45% for that month. Overall, surrender levels are consistent with our expectations. We monitor this surrender activity closely. It is important to note that analysis by age suggests low anti (ph) selection. In fact, if anything, we are seeing a slightly higher surrender rate for our older age business. More specifically, the average age of our enforced (ph) annuities is 66 years, while the average age of annuities surrendering their policies is about 68 years. In summary, our annuity business is rapidly declining, and doing so in a manner that improves our capital position and decreases our risk profile. Briefly, let's turn to an update of our GNDB claims for the quarter. Parse (ph) expenses for GNDB were about $30 million, while on a GAAP income statement basis, they were about 12 million.

Our remaining GAAP reserve balance was $80 million at the end of the year.

Now let us review Allmerica Asset Management, where we reported pre-tax operating income of 8.5 million, up from 4.2 million last year. This increase was primarily due to increased guaranteed investment contract earnings, which benefited from favorable movements in interest rates and foreign exchange rates. For the year, this business had earnings of 24.4 million as compared to earnings of 20.7 million in 2001. For the year, earnings increased primarily due to the inclusion of the results of AMGRO, the company's property and casualty premium finance business.

Previously, AMGRO had been included as part of the risk management segment. This benefit was partially offset by lower interest margins on guaranteed investment contracts. At the end of 2002, AM had total long-term funding agreements outstanding of 1.4 billion, as compared to 2.7 billion of total funding agreements at the end of 2001, and approximately 2.2 billion at the end of the third quarter.

The fourth-quarter decrease is mostly due to our efforts to retire outstanding long-term funding agreements at a gain during the fourth quarter. The 1.4 billion in remaining outstanding funding agreement liabilities are longer-term, duration based, non-portable, and have no ratings triggers.

Now let me briefly comment on several of the key non-operating items we reported for the quarter. As you know, we retired approximately 550 million par (ph) value of long-term funding agreements through open market repurchases and a successful tender offer that together produced a GAAP net after-tax gain of 67 million.

Partially offsetting this gain were two items, a 20.3 million after-tax loss on the sale of our Universal Life business, principally due to the write-off of the remaining deferred policy acquisition costs for this block. And consistent with our previous guidance, we incurred 14.1 million of restructuring and reorganization costs, net of taxes, both related to our ongoing actions at Allmerica Financial Services.

I want to briefly comment on the improved statutory capital position and the RBC ratios of our life companies and the capital transactions we announced in early January. At year-end, 2002, a consolidated internal (ph) adjusted capital of Appliack (ph) , our lead (ph) insurance company, is approximately $480 million, up significantly from $149 million at September 30th, 2002.

We estimate that at year end Appliack's (ph) RBC ratio is approximately 250 percent, as compared to 133 percent at the end of the third quarter. What's more, Fapplic (ph) , Affliac's (ph) subsidiary, had an estimated RBC ratio at year end of 208 percent, up from 146 percent at the end of the third quarter.

In the news release, we disclosed that this significantly improved capital position was a result of the following capital enhancement actions. First, the sale through reinsurance of our fixed Universal Life Insurance bloc to John Jankhart (ph) Financial that produced an increase in steps during surplus of approximately $109 million. Second, retirement of long-term funding agreements that amounts below face value that resulted in a gain of approximately $84 million and third, the establishment of a new GNDB reinsurance program that resulted in a statutory benefit of approximately 40 million.

Once more, this reinsurance program reduces our surplus sensitivity to equity market volatility; it eliminates the obligation of the holding company to fund annuity death benefits, which could have been as high as $40 million annually.

And fourth, the funding or reorganization of our internal ownership structure of our life insurance companies to best leverage the statutory capital positions of our life companies.

Through these actions, we have stabilized our life insurance statutory capital at levels consistent with those of highly rated companies and significantly enhanced our ability to withstand declines in the equity market. In fact, we have to make the Apuax RBC (ph) level as of December 31, 2002, permit standards decline of approximately 60 percent in the S&P index from the level on that date before reaching the first RBC level for required regulatory action.

Further, we believe that the significant positive capital impact that these actions have eliminated the so-called contagion risk that banner (ph) and ratings agencies were concerned about. This is the risk of the difficulties of our ratings companies could adversely impact our holding company and our property and casualty company.

Lastly, we have been asked from time to time about the status of the informal SEC inquiry, which we mentioned in our most recent from 10-Q. This matter related to the timing of our public disclosures relating to the variable annuity and insurance business. We of course, cooperated with the SEC in our respects. Based upon our discussions with the SEC staff, it is our understanding that this matter, which never developed beyond the informal inquiry stage, has been closed.

At this time, I want to turn the call over to Bob to review the property and casualty operations to be followed by Mark's comments on AFS.

Thank you, Ed, and good morning everyone.

Our property and casualty business finished the year with a solid quarter and significantly improved results for the year. Pre-tax fourth quarter earnings, as Ed mentioned, totaled $35.2 million. Results continue to be very good in commercial lines and improving in homeowners.

First lauder results deteriorated resulting from higher frequency of bodily injury claims, unfavorable development in prior accident years for Michigan, personal insurance protection or PIP coverage, and weather related accidents in the Northeast and Southeast primarily in December.

Year to date, our property and casualty business produced pre-tax earnings of $184.3 million on a combined ratio of 103.1 percent.

For the year, we produced an underwriting profit for homeowners and commercial lines. First lauder results deteriorated, primarily due to higher expenses driven by residual market investments in New York, higher premium taxes, guaranteed fund assessments, and higher contingent commission accruals.

Looking at the fourth quarter, results improved from last year driven by substantially better underwriting results in homeowners and commercial lines, offset somewhat by unfavorable developments primarily in personal auto PIP coverage in Michigan and lower net investment income.

Relative to the last two quarters, profits also declined somewhat due to higher weather related claims, lower net investment income, and the unfavorable development I mentioned, again, in Michigan auto pep (ph) . For the year, we're very pleased with the significant progress we made in turning around our commercial lines underwriting results. The pricing, underwriting, and agency management activities that we have taken over the past couple of years really paid off in 2002. Although our production suffered, loss ratios improved significantly, and we're now well positioned for profitable growth once we get our financial strength rating restored.

Homeowners clearly benefited from an unusually mild winter in the fourth quarter, helping us produce an underwriting profit for the year. We're also very pleased with the progress we've made in getting substantial price increases, introducing new credit-scoring systems, and sharing (ph) adequate insurance to value and increasing deductibles. I remain convinced that we're well ahead of the industry in restoring this troubled line to consistent profitability.

One disappointment that we had last year in 2002 was our personal auto results. Generally speaking, Citizen continues to perform well. Over the past few quarters we discussed on these calls our concerns regarding increases in health care costs and the impact on our personal injury protection, or PIP, loss costs, particularly in Michigan. That's where we've had the unfavorable trend, and that's where we strengthened our prior acting year (ph) reserves in the fourth quarter.

We continue to get significant price increases for this line and are beginning to see a very positive impact on our current accident (ph) year results. Also in our current accident (ph) year basis, our personal auto problems reside primarily in Hanover. As I mentioned previously, residual market assessments in New York have increased significantly, hurting our earnings. Residual market results also hurt us in Massachusetts, with significantly higher assessments from the state re-insurance facility, and much poorer results from the exclusive representative producers, or ERPs, which are another part of the residual market mechanism in Massachusetts.

And lastly, we experienced an increase in the frequency and severity of auto bodily injury claims in a number of Hanover states, particularly in the fourth quarter and most particularly in December. We've taken several actions in 2002 to mitigate the impact of these negative trends on our 2003 earnings. We're increasing rates throughout the country for bodily injury. In fact, in many states we'll be charging double-digit rate increases for this coverage. In addition, after several years of rate decreases, or no pricing changes in Massachusetts, the industry did receive a great increase of 2.7 for 2003. The mime (ph) of further reductions of discounts and more aggressive premium pursuit initiatives, we expect to see over a four percent price increase on our Massachusetts auto business in 2003.

We also expect to receive regulatory approval for price increases in New Jersey and New York, where we have increasing levels of bodily injury frequency and severity and deteriorating results. And lastly, this year we'll also complete the implementation of new credit scoring, underwriting, and pricing techniques for states that allow this practice.

For 2003 we expect pre-tax earnings to decline modestly relative to our 2002 results. The expected improvement in personalized performance will be offset somewhat by more normal catastrophe experience, higher expenses, costs related to last years rating downgrade, and continued lower net investment income. We're looking for substantially improved results in personal auto, continued improvement in our homeowner loss ratios, excluding the impact of catastrophes, and another strong performance from commercial life.

We're also hopeful that we'll get our financial strength ratings restored following the significant actions that we've taken to strengthen the capital base of our life insurance businesses, and reduce life insurance earnings volatility. We managed through the downgrade exceptionally well. Retention remains good. Agents and employees are very supportive, and personalized new production is largely unaffected. Having said that, getting our ratings back is critical if we're to restore production momentum, particularly on our commercial line, leveraged the great regional franchises that we have in Citizens & Hanover, and produced earnings growth in 2004 and beyond.

Setting aside the ratings issue for a moment, we plan to stick to our strategy in the property and casualty business and continue improving our ability to execute to it, focusing on the fundamentals of the business, quality underwriting, pricing to an underwriting profit, disciplined agency management, and high-quality, low-cost claim performance.

And we're executing our strategy from a strong regional company platform. We have two strong brand names in Citizens & Hanover, which are well-known and well-respected among independent agents. The agency management actions that we took in 2001 have produced a highly profitable, very productive, and closely aligned agency plan.

Our ability to maintain our profit and production momentum following the ratings downgrade is a real testimony to the quality and strength of our relationships with the independent agents who represent us. We'll also continue our focus on the small commercial and personal lines markets. We see these markets as lower risk, more predictable in their earnings patterns, important to the agents who represent us, and less susceptible to market pricing cycles.

Over the past couple of years, we've made the investments necessary to succeed in these markets. We've implemented a highly automated personal and small commercial product platform, which makes it easier for our agents to do business with us, ensures consistent application of our underwriting and pricing programs, and ultimately will allow us to achieve higher growth and lower expense ratios.

Our plan for 2003 will be to continue implementing this strategy and sharpening our ability to execute to it. Specifically, we expect to improve underwriting results in key northeastern personalized markets, particularly Massachusetts, New Jersey, and New York, continue improving homeowners' results, emphasizing higher prices, higher deductibles, and insurance to values. We expect to grow in the profitable sponsored personal lines niche, where we have a strong and differentiated position.

We also expect to restore growth in the small commercial market for our multi-peril, commercial auto, and workers' compensation lines, where we now have excellent underwriting results. And lastly, we'll begin reducing our expense ratio as we increase production and maintain a rigorous focus on expense management. We remain convinced that following the restoration of our financial strength ratings, our property and casualty business is well-positioned to produce lower loss ratios, above average growth, and an acceptable return on invested capital.

And with that, I'll turn you all over to Mark Huggs.

Thank you, Bob, and good morning everyone. My discussion today will address two key topics for Allmerica Financial Services, or AFS. First, I will review the fourth-quarter accomplishments of AFS transition. Second, I will review the critical success factors that we will begin focusing on in 2003.

Let's turn to the strategy at hand and discuss the fourth quarter key accomplishments. I'll split my discussion between the insurance company and the broker dealer. In November, we completed our second interval of position eliminations within the AFS division and a variety of corporate departments supporting AFS. In total, approximately 400 employees left the company because of position elimination. These staff reductions and the corresponding expense reduction associated with the stoppage of sales, reduced our annual operating expense level by approximately $60 million.

For the quarter, our ending assets were $15.7 billion, including 12.3 billion of variable annuities. Actual surrender activity on the variable annuity block was $1.2 billion, partially offset by approximately 500 million of appreciated separate account assets.

As Ed said earlier, it is important to note that the average age for our annuity redemption activity in the fourth quarter was 68. This compares to an average age of 66 for the in force block, indicating that we are not being selected against with respect to age. Furthermore, the new GMBB reinsurance agreement protects us against any anti-selection with respect to our clients' health since the mortality risk is now 100 percent reinsured.

Moving to the broker dealer, in January, we formally changed the name of our broker dealer, Allmerica Investments Inc. to VeraVest Investments Inc. This name change is the formal introduction of our broker dealer into the financial services community.

We also completed our efforts to form strategic alliances with two major insurance carriers to deliver high quality products and services to our field force. Nationwide and Pacific Life Insurance companies are now offering variable products through VeraVest Investments Inc. in support of our new strategy.

With these partnerships in place, we have quickly delivered quality variable life and annuity products to our advisors, which are comparable to the proprietary products they previously sold.

By concentrating our distribution capacity on a small number of manufacturers and by internalizing the wholesaler support, we are able to garner significantly higher marketing allowances than typical broker dealer models. We expect to add one or two more carriers in the future.

In three short months, we have secured a broad array of variable and fixed insurance products, mutual funds, and wrap products.

With respect to the fixed products, we were able to move quickly and achieve the highest available payouts because of our ownership of the independent marketing organization, Advantage Insurance Network, or AIN. AIN currently generates more than 40 million of equivalent target premium in the marketplace. In addition, we have built and staffed a proprietary wholesaling team and an internal sales rep in support of these products.

We continue to maintain our platform's infrastructure to help our advisors generate leads and partnerships to improve their productivity. In addition to rolling out the new product line-up, we had to radically restructure our relationship with our advisors. Recall prior to year-end, our advisors were statutory employees, receiving W-2 income, additional benefits in the form of bonuses and pension contributions. As of 2003, our advisors are now independent contractors. We've implemented a new broker dealer compensation grid. It is through this single grid that our distribution system will receive 10-99 income.

In spite of this turmoil and change, we were able to retain almost all of our advisors, and had the best sales month ever in December. Our revenue from VeraVest in the fourth quarter grew from approximately three million dollars in October to approximately 11 and a half million dollars in December.

So let's turn our discussion to the critical success factors for AFS in 2003. 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 focussed broker-dealer. I've organized these elements into three major areas: earnings, revenues and expenses.

As Ed mentioned, we believe that the break-even results for the fourth quarter are somewhat indicative of AFS's earnings power now. Future earnings growth is expected to be driven by a combination of higher net revenue from VeraVest and additional expense savings across the organization.

From a sales perspective, net revenue is generated through market alliances with our strategic partners and gross dealer concessions, net of payout, to the advisors. The margins are largest for insurance products sold through our strategic partners, and are the smallest for mutual funds. We are estimating that close to 60 sales of our sales will be from insurance products, with 75 percent of those sales going to our strategic partners. Furthermore, our broker dealers future growth is dependent on growing our advisor system that now totals close to 750 of the most productive financial planning advisors in the industry. During 2003 we intend to increase our broker dealer by one third, or by a net of 250 advisors.

Operating expenses within AFS are split into two pieces. Ninety million dollars is associated with managing the in force (ph) block, and 85 million is related to infrastructure cost of VeraVest. It is important to manage the in force (ph) block expenses downward as the business runs off. This can be accomplished through the redesign of business processes and through outsourcing both functions that become to expensive to handle inside.

Currently, net revenue of VeraVest is not enough to fully support its 85 million dollars of expense. This is due to the fact that we are early in the transformation process. Therefore, we must rationalize our expenses associated with VeraVest as we push toward significant growth. We believe we can reduce our current expense levels by moving to electronic application processing and continuing to garner efficiencies from our regional platforms.

Finally, any analysis of VeraVest must include the fact that these advisors are responsible for 40 percent of AFS's profitable in force (ph) assets. In closing, we have now been at this transformation for one quarter, and our accomplishments have ranged from re-establishing our capital postion to transforming our advisors into independent contractors. Furthermore, we're off to a great start in 2003 relative to growing VeraVest into a viable broker-dealer. Finally, we know what we need to do during the rest of 2003. By continuing to focus on VeraVest's net revenue, and on our organization's expense management, we will continue the great start that we've already begun. Now I'd like to turn the call back over to Ed Parry. Ed?

Thank you, Mark. Just a few remaining comments before we open this up for questions. Pardon me. As we look ahead to 2003, Bob has already discussed the outlook for the property and casualty business. I want to discuss some items which may be helpful as you analyze our life insurance business. Obviously, the earnings picture in this segment has changed, and in many respects, is still evolving. Our GAAP amortization (ph) has increased significantly as the result of much higher surrender activity, and increased conservatism in the assumptions underlying our amortization ratio.

We have also stopped deferring our expenses, as was our practice in the past. Now, all of our operating and sales-related expenses go through our income statement in the period they are incurred. All of these changes have reduced the current run rate of earnings in AFS to essentially breakeven. As we've said, in order to improve this result, we need to continue to reduce expenses and increase the revenue from our broker-dealer, both of which we expect to do.

Accordingly, we expect to begin 2003 with breakeven results with profits increasing as the year progresses. Why don't we spend a couple of minutes discussing factors I believe you should consider as you think about our life companies. Let me start by highlighting some key tracts.

As Mark mentioned earlier, at the end of 2002, we had a fee earning base totally $15.7 billion. Our life insurance companies had total adjusted statutory capital of approximately $480 million year-end, 2002. GAAP book value for these companies was 1.2 billion at year end, and lastly, our life business is expected to generate over $200 million in positive cash flow in 2003, as well as significant statutory earnings for the year.

Let me take a few moments to briefly comment on some of these items. As I've said, statutory capital from our life companies at year end, 2002, was approximately $480 million. As you are aware, statutory capital is generally viewed as a conservative measure of a life insurance company's book value. There are a number of accounting principals in statutory accounting, which are designed to be conservative. First, by statutory accounting, there is no DACT (ph) . Expenses are recognized immediately and are not deferred. Accordingly, all cost associated with acquiring business is expressed immediately, although revenue is earned over time.

Second, actuarial guidelines require the application of conservative reserving methodologies for all product features, including reserves for GNDB costs. These required GNDB reserves reflect a company's unique product features, including age mix and members (ph) that are not at risk. In our case, these reserves totaled approximately 290 million before reinsurance at December 31st, 2002.

Third, there is a diminimous recognition of net operating loss carry-forward and other tax credits for statutory accounting purposes. For us, these total about $130 million at the end of the year. These tax attributes can be used to offset taxes from earnings in our property and casualty business, as well as our life business.

As I mentioned earlier, our life companies had total GAAP book value of 1.2 billion at the end of the year. Almost a half of this balance consists of balance sheet items that would be found in the capital of virtually any company. Items such as the value of the tax attributes I just mentioned, investment assets, or other typical assets.

The book value also includes GAC (ph) , which totals approximately $780 million on a pre-tax basis for our variable annuities.

We believe the assumptions underlying this GAC (ph) balance are reasonable and conservative and the level of GAC (ph) is supported by expected future profitability. Our assumptions include, for example, a lapse rate of 30 to 40 percent for 2003. We also assume, despite the rapid pace of surrenders, we will accrue 310 million of GNDP claims as the block runs off.

Another measure of GAC (ph) realized ability noted by various interests, is the level of aggregate surrender fee income, assuming the entire block were to surrender. It is generally believe that this amount will be less than the net cash flow over the life of the block under normal surrender activity.

For Allmerica, if all of our annuity business were to surrender at once, we would generate approximately 500 million in surrender fee income in cash.

Now let's spend a moment discussing cash flow for our life companies. In November and December, since the significant changes in our business, our life companies have generated positive cash flow averaging in excess of $20 million per month. We are currently forecasting positive operating cash flow for 2003 from our life companies of at least $200 million. This includes an expectation of $90 million of GNDB claims, reflective of the current equity market level and rate of claims.

These cash flows are obviously sensitive to equity market volatility. However, our analysis suggests that we could withstand an approximate 50 percent decline in the equity market from year-end levels and still generate positive operating cash flows in 2003 and beyond.

This analysis includes, as you would expect, funding for the higher GNDB expenses associated with lower equity market levels. We expect to maintain strong, positive cash flows in our life operations beyond 2003, but obviously in decreasing amounts as the business runs off.

One final point, as you think about or attempt to quantify our potential GNDB exposure, and the sufficiency of our reserves, please keep the following in mind. While changes in equity market returns or other factors will impede impact GNDB costs, there is also a significant impact from the related assets. That is to say, any estimate on the sufficiency of statutory capital must include an estimate of future earnings and cash flow from MNE fees on retained assets or surrender fees on assets that run off.

As I said earlier, our analysis suggests our net cash flows are significantly positive and would remain positive even under an assumed 50 percent market decline.

Once more, remember that our annuity business is running off at a rapid rate, taking net amount at risk and future GNDB liability with it. Hopefully these items I've discussed our helpful as you think about our life insurance companies. Overall our life companies are generating strong, postive cash -flow (ph) , are self-funding, and our not expected to need further capital in the holding company.

We believe our in-force (ph) insurance blocks and associated capital royv (ph) companies represents positive value for our shareholders. We're excited about the prospects of our broker dealer strategy for the future. And with all of those comments, I'd like to turn the call back to Henry.

Thanks Ed, and, operator, let's now open the call to questions.

Thank you. Today's question and answer section will be conducted electronically. If you would like to ask a question on today's conference, press the star key followed by the digit 1 on your touchtone phone. We will come to you in the order that you signal. We'll pause for one moment to assemble our roster.

Once again, star one. We'll take our first question from Len Savage with Fox-Pitt, Kelton.

Good morning everyone and Ed, thanks for the additional disclosure. Just a couple of questions. First, Ed, could you give a net amount at risk at the end of the year on the variable annuity business?

It's roughly 4.6 million?

4.6.

4.6 million.

OK, thank you, and the past quarter you gave us a sensitivity to statutary (ph) capital or the GNDB reserve for every one percent?

Right, and that was about 6 to 8 million dollars for one percent. It's now four to five million.

Four to five million. OK. And just on the cash flow as you mentioned for the life companies. Is that an after tax number or a pretax number?

We're not in a tax paying position.

It'll-

Gotcha.

-utilize tax benefits.

OK. And, is that statutory (ph) earnings pretty close to that amount?

Pretty close, yeah.

If I wanted to sort of track that, if I looked at the, AFS this quarter and just add back the Dak (ph) amortization, is that a good sense of what the cash flow is?

Yeah, let me give you our estimate, let me give you the estimate of our statutory earnings for the year. It's roughly, we're expecting cash-flow, a positive net cash-flow of 200 million, our statutory earnings are estimated between 75 and 100 million for the year.

For next year.

For next year, yeah, I'm sorry.

OK, great. And then, just give an update as to what your talks with the raid (ph) agencies, when are you sitting down with them, when are you expecting them to react?

The conversations have been positive, we've had meetings coming up with all the rating agencies within, probably within the next six weeks, starting with AM vest (ph) in a couple of weeks. You know, we plan to go through a lot of the things we went through on the call here today probably in some greater depth, and the conversations we've been having are postiive. It's hard for me to predict, obviously, when they might change their outlook or their ratings, but we're going to work hard with our analysis and with them to see that that happens.

OK, thanks very much.

Yeah.

We'll take our next question from Colin Devine with Solomon Smith Barney.

Good morning. A couple questions. First of all, could you just review the re-insurance treaty (ph) again and explain why that's take the redibblus level down here (ph) ?

Sure, let me, I'll have Michael Reardon, (ph) who was the architect of this, describe that.

OK.

The re-insurance treaty that we entered into in December essentially transferred all of the mortality risks to the re-insurers, while we retained the market risk that the net amount of risk will grow if the market declines or decrease if the market increases. The actual mortality risk is borne by the reinsurer, and that has benefited our statutory capital, because for purposes of statutory reserves, we are now able to reflect the cost of the reinsurance in place of the GNDB table that's part of the Guideline 34 calculation. And that cost is 25 to 30 percent lower.

OK. All right, the second one is, in terms of sort of where we stand, obviously, in kudos to Bob for getting the P&C business turned around this year, but where do we stand in terms of the next steps. You've obviously got some wasting assets here with the variable annuity block, the variable life piece. You're not in the manufacturing business anymore. Is the plan to sell those, which was my understanding of what it was before, or are you now just going to run them off. Where are we going from here?

The plan would be to monetize the value that we'd have on the life business, and that can be done in any number of ways. Part of it will be accomplished, quite frankly, through run off of business that's not saleable and is that inherently, some of it, inherently unprofitable, given the amount of risk. Others of the strategies will be to reduce expenses continuously, so that as we run things off, we generate profits. Another part will be generating more favorable results [Inaudible] you're dealing with profit there.

And then for other blocks of business, we would entertain the sale of those blocks if it made sense to do that versus the alternatives. And I think in the case of certain of our blocks of the business, that could make sense.

Could you perhaps be a little more specific on which blocks? I presume you're starting to carve up the VA block. Obviously, you've got different -- I guess, four major products in there. Talk about the profitability characteristics of each in terms of sort of what can we expect to happen as we go forward, and then maybe to talk a little bit more about what the last experience has been on the AFC product versus the stuff you wrapped.

Yes, we think about the profitability of our variable annuity business probably more by distribution channel than we do by product line, and certainly our advisors sold variable annuity businesses, relatively speaking, more profitable, quite frankly, is quite profitable.

So we value will [Inaudible] to our shareholders either from retaining those assets, together with a successful broker-dealer strategy, therefore earning profits in the future as on that block, or arguably through disposition. The other of our variable annuity blocks that are separate, the Select block. This is the Allmerica branded that we sold through independent broker-dealers, is running up very quickly. Our annual surrender rates on that block exceed 50 percent.

Our third distribution channel, our partner channel, the surrenders there are lagging somewhat. We believe it's largely because our partners don't have a replacement product in place at the moment. I think that they expect to, and once that does, I expect to see the surrenders for that block to be like the Select surrender rate that I just mentioned.

Could you give us some idea of the split? Just a rough split of the 13 billion of VAs that you've got? How much is now left in each sort of bucket, just so we have an idea what we're talking about?

Michael's got those numbers. Mike?

There's about 4.6 billion of the 12 billion is in the advisor channel. Select is roughly 3 billion, with the balance being in the in the wrap channel.

Or the partner, partner channel.

Or the partner channel.

OK. So in terms of profitability, are you saying the advisor stuff is profitable.

Yes.

The select, it's not clear to me, is or is not? And the partner is not clear to me, is or is not?

The fourth is slightly profitable the partner business is not profitable at this point.

OK. So it's unlikely you're going to have a sale to partner stuff.

I think that's right. I think that's ...

Unlikely on the select and maybe on the advisor.

I think that's a fair characterization of how the market might view the blocks.

OK. And what about the VUL piece? Are you looking to sell off that block as well?

Yes that is a discreet block of business. It's largely advisor sold business. It's profitable business and value could renew order the shareholders on that just like the variable annuity, either through maintaining the block in earnings - with earnings over time or through a disposition. And as I said, you know, we would consider as we restructure that part of our business to solely a distribution strategy, the disposition of those blocks of business.

OK. All right, then, thank you very much.

We'll take our next question from Robert Glasspegle (ph) with CFA Langen McAlenney (ph) .

Good morning. I thought your discussion was very helpful in your outlook for '03. The one thing that struck was Bob Restrepo's outlook for '03. It seems like, you know, I would think at a 103 combined with your business mix and with interest rates where you were, you're not earning an adequate return and it seems like you're looking for next year, for '03, to deteriorate. Obviously we've got first quarter weather in the picture as an issue, I'd like for you to expand on that, but it seems like you're pawning on '03 ROE's already before the year is started and maybe what I'm missing is that you get the benefit of NOL's blowing through and your comment that's acceptable ROE factors and the benefits of that, but I was wondering, Bob, if you could just flush through where you think you are in '03 ROE. And as the company gets successful, peeling the company back to be more and more your operation. We got to come to grips to where you are and where you're going to be.

Yes, in terms of NOL, our expectation really, I don't - I don't see much of an impact on our ROE. I mean we're targeting in the eight to 10 percent range, which is roughly equal on a GAAP basis what we - what we produced in 2002.

The reason that we're maybe a little pessimistic, and again I did mention about a modest downturn, I'm not talking about anything ...

Right.

... significant. But we continue to see very strong improvement in our underwriting results in commercial lines and homeowners, as I mentioned, and a big turn around in our personal auto.

Offsetting that, we, I think as you know, routinely budget two point nine or three percent of our premiums, earned premiums, for catastrophes. We were well below that this year and also below it last year. So when we - traditionally our outlook is to take a conservative view regarding catastrophes and we're looking for roughly three percent of our premiums to be incurred in catastrophes, that's a significant, almost double what we experienced in 2001.

And lastly, we expect an increase in expenses for a couple of reasons, most of which are one timers that we expect, early hassles, which we expect to be one timers in 2003. Specifically we expect to pay additional dollars in commissions to our agents as a result of the downgrade. We also are incurring an additional fee, reinsurance costs, if you will, as a result of the cut-through facilities that we were able to put in place during the fourth quarter of last year. Once the ratings are restored, those costs go away, and as we indicated, or as Ed indicated, we can't time when the ratings will be restored, but we're hopeful given everything we've done in both the life business and the property and casualty business. That restoration is forthcoming. Those costs drop away pretty much immediately when we get those ratings restored, but it's a hurt for us in 2003 relative to our expenses in 2002.

And our production levels, have also, because of the ratings downgrade, a flat production with normal increases in costs, employee related costs, as well as additional pension costs in 2003 also hurt our earnings. So it's down modestly, flattish, but it's definitely, we're projecting down, primarily because of castrophes and increase costs, partly running the business and partly as a result of downgrade.

I appreciate the answer and I think I understood the '03 guidance. What I was quibblin' with was that an 8-10 percent ROE was acceptable. I thought you said a generally acceptable ROE in '03, and I'm not sure as what you're going to want to get to as a standalone C (ph) company.

I've got to go back, but if I did, I want to put it in the context of following the restoration or financial strength ratings. We expect these costs to drop off, the underwriting improvements to continue, and that puts us on a path to acceptable ROE, and we're targetting 12 percent on a GAAP basis, and again, accept for these one-time expenses, we think we've got the loss ratio improvement already under way in our commercial and personalized business to achieve that, but not this year.

Could you qualify the fourth quarter one-timers? Specifically the reserve increase and the assessments from the state funds, which I assume are not one-timers, they'll be with you in '03.

Well, we expect them to be less, and let me deal with the assessments. We expect them to be several million dollars less for New York, partly because our market share has declined, we've been trying to contain our production there, and partly because we expect that the overall assessment to the industry from the New York assingner's plan (ph) will be less in 2003 than it was last year. Last year was a peak year. We also expect to do a much better job managing our sessions (ph) to the reinsurance facility here in Massachusetts, which also will reduce our residual market cost for operating in the state here. In terms of the fourth quarter, the two most significant changes were, even though our catastrophe experience was less relative the fourth quarter 2001, weather-related expenses, or loss costs (ph) were up significantly, particularly in December, and I know you're down in the Hartford area. All that snow and ice that we had in December really effected our results throughout New England. We also had a fair amount of ice and bad weather the couldn't be classified as a catastrophe, but down to Carolinas, and Virginia and Tennessee, also caused an increase in bodily injury and physical damage claims. Again, fell outside the catastrophe bucket, but very much were result of weather-related claims.

The second big thing was, as I mentioned in my prepared remarks, strengthening our Pitt (ph) reserves, Michigan Pitt (ph) reserves from prior accident years. We've seen a real cost shifting in Michigan, really beginning back in 1998, peaking in 1999 and 2000. And we've been watching these trends for really about 18 months, strengthening it, but we took additional strengthening in the fourth quarter, we thought it was the prudent thing to do to as best as we could put it behind us.

The pricing actions we've taken, which have -- over the last 18 months, we've increased our Pitt (ph) rates by a little over 15 percent, and we're really beginning to see the positive benefits of that on the current accident year results. So we think going forward we're in reasonably good shape there. But that had a significant impact on our fourth-quarter first loaner results.

Thank you.

Your next question comes from Adam Star (ph) with Kramer, Rosenthal, McGrinn (ph) .

I stayed on and off, so I may have missed this, but did you discuss the capital and reserve position of the property casualty company, and how comfortable you are with it now and what points you expect to bring up in your discussions with the rating agencies?

Yes, when you're referring to capital, I assume you're asking for statutory capital on the on the property and casualty company. It's about $835 million, I believe, at the end of the year. And with regard to the reserves, if you were to expect, we look at our reserves internally every quarter. Certainly scrutinize quite a bit by year end, not only by us, but by our operators. We also have a separate study done by an outside actuary. All of that analysis suggests that our reserving practices have been consistently applied and that our reserves are at conservative levels. That is to say the indicateds are -- the recorded reserve levels are at levels above the indicated reserves.

Just to add to that, too, I know there's been a lot of headlines on commercial-related reserve positions. We feel particularly comfortable right now -- you never know, there's always a certain amount of uncertainty, but feel very good about it, primarily for two reasons. We've been strengthening our commercial reserves, which hurt our earnings in 2001, but the agency actions that we took, and the write-off that we took in 2001 makes us feel very good about the quality of our commercial lines results going forward, and we've been seeing that for two years in commercial RO from an accident year perspective, saw a tremendous improvement this year in commercial multi-peril, and beginning in the third quarter, saw significant improvement in our workers' compensation results.

The other point I'll mention, as I think you know, is we have a very small, diminimous, if you will, exposure to asbestos, which is obviously a reserve issue. We feel we're more than adequately reserved there. So net-net, we feel very good about our reserve position.

The only area that might be at all of alarm then would be auto-bodily injury?

Bodily injury in Hanover is where we've seen some deterioration in the current accident year, that's correct.

And there is no professional classes, no D&O, none of that stuff?

That's correct.

And the surplus ratio, given your short tail, that meant that's within the comfort ranges of the rating agencies?

Yes, I believe it is, but I would say that it's probably at the higher end for an "A" rated company, but it's, in my view, it's within the range. Let me make that comment, an additional comment on capital that's related to that.

Our forecasts show that our property and casualty business next year will earn about $100 million on a statutory basis. And with all of the capital improvements that have been made in the fourth quarter, we start next year, we start 2003, with about 40 to $45 million in cash at our holding company, which is an amount that exceeds the expected holding company obligations.

So while we may see some dividend from our property and casualty company to our holding company, we may see none at all. If we see some it's going to be much less than it has been in the past, which means that the property and casualty company should retain all or most of the its statutory earnings and general rates during the year next year which would obviously materially affect those ratios by the end of the year.

And in the fourth quarter there were some unfavorable marks in the investment portfolio and the pension expense.

Yes. Yes. The pension expense, in particular, affected the capital position of our - of our PNC business significantly by about $70 million. And unless we see further deterioration in equity market valuations, we're not likely to see, you know, an amount next year anywhere near - anywhere near that amount.

Thank you very much and really good work getting this life company under control.

Thanks, Adam.

Our next question comes from Angela Gracie (ph) with Merrill Lynch.

Good morning. One of my questions has been answered, but I have a couple more. Looking at the life subsidiaries, is there any possibility or any view of actually freeing up capital sometime during or towards the end of 2003 considering the quick run-off business and the RBC ratio jumping up substantially?

Well let me - let me say first that I'm pleased to have somebody ask me that question versus the nature of the questions we're asked just a few short months ago. Yes, I think over time we'll have to consider that but I think, at least in the near term here, it's not going to be likely. What we'd like to do as I said earlier, is monetize that capital. It'll probably reside in those life companies for some time, but as the liabilities run off with surrenders, you know, I can see at some point wanting to move that capital obviously out of our life businesses and use it for other purposes. But I certainly don't see that occurring in 2003.

OK. Maybe I can pose that question a little differently. At what RBC ratio would you - would you kind of look at the capital level and say, you know, there's just - there's too much here?

Yes, I think we're very well capitalized right now. And I believe you know, under reasonable assumptions it should improve and even get better. But it really is going to be a matter of, I think, watching not only for us, regulators and others within ratings agencies when you watch this business develop during 2003 and watch us execute and things that we said we're going to execute to. And I think, you know, maybe as we get - if we're successful in our old opposes, we get to the end of next year, I can envision starting to have some discussions about that. But I don't see it affecting - I don't see it happening in 2003.

OK. You mentioned before a holding company.

Yes.

I believe cash was about, did you say 40 to 45 million?

Yes.

In the supplement it says 63.4, just want to clear up.

Yeah, there's an obligation to the insurance companies for about 20 million dollars that I've netted against that 60 million dollars. It will be funded here in the first quarter. This is-

Oh that's the capital contributions?

the capital contributions that we talked about, which gives rise to the 40 million dollars improvement for the reorganization of our guaranteed minimum debt benefit reinsurance program. So I've taken that out because I know that that's a negative as we begin the year. So net of that we start with 40-45 million dollars and we estimate that our after tax funding obligation out of the holding company is about 30 million dollars for all of 2003.

OK, and very quickly, the other assets, the negative 72 million, could you just explain everything that's in there? In the corporate?

Uh, that doesn't come to mind, could we follow up with you offline on that?

Sure.

It's just that, that doesn't pop into my head. I think we'd have to spend some time on that.

OK, thank you.

Yup.

Operator, I think we'll take one additional question.

Our last question comes from Caleb Piper (ph) with Morgan Stanley.

Hi thanks. Just to sort of follow up on the last question, could you sort of go over an RBC (ph) ratio which you would be comfortable operating in the live company, given you've gone quickly to 250, the life companies running off and you've got 200 plus million in capital expected to generate. To me, that seems like you're going to shoot, you're going to break through 300 pretty quick-

Yeah, I mean, that's a very good question, and pleased again to be asked a question. But I think that at our current RBC level, given the business profile, that's to say, given the fact that we're not actively manufacturing and distributing proprietary products, this is running off, the crook is running off (ph) , I feel very comfortable where we are, and I think it will improve over time. But the question of taking capital out of the life companies, again, I don't think it's one that we're going to be in a position to entertain until at the very earliest we get through the end of 2003. But I, we're comfortable with our capital position today.

: Have you forecast where you think the RBC (ph) ratio is going to end up at the end of 2003? Could you give us a range?

Yeah, we haven't, I mean, I'm sure I've had models we've looked at but it's going to be at or slightly over that level I think.

OK, thank you very much.

Operator?

Yes?

I think we're all set, should we turn the call over to... turn the call over to Henry, you going to make some concluding remarks?

Yes, thank you Ed and thank you operator, I want to thank our conference call participants for being with us today. We're pleased to have this opportunity to discuss with you our quarterly results, and we look forward to talking with you very soon and thank you very much.

That concludes today's conference call. You may disconnect.