Hanover Insurance Group Inc (THG) 2003 Q1 法說會逐字稿

Please stand-by, we are about to begin. Good day, and welcome to the Allmerica Financial Corporation First Quarter 2003 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, and welcome to the first 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 Companies and Allmerica's Chief Financial Officer. Rob Restrepo, President of Allmerica's Property and Causality Companies, and Mark Huggs, President of Allmerica Financial Services. Also joining us are J. Huber, Allmerica's Senior Vice President and General Counsel. Michael Reardon, Chief Financial Officer of Allmerica Financial Services and John Kavanaugh, Allmerica's Chief Investment Officer.

After Ed discusses our financial results for the first quarter, Bob and Mark will comment on 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. In particular, Bob's remarks on our outlook for 2003 and our operating ratio, capital levels and rating, as well as Mark's comments on expense reduction are all forward-looking statements. These forward-looking statements are subject to a number of risks and uncertainties. As discussed in some detail in Allmerica Financial Annual Report on Form 10-K for the year ended December 2002, and in yesterday's press release, which are on file with 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 condition, surrender activities and rating action, among other factors. Also, I would like to mention that Allmerica's quarterly earnings conference call including today's call, and our earnings press release statistical supplement and documents filed or furnished to the SEC are all available under the financial news section of our web site which is located at www.allmerica.com, and with those brief remarks, I would like to 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 first quarter driven by another good quarter in our Property & Casualty business. Further, results in Allmerica Financial Services were down significantly from last year. We are in line with our expectations and guidance.

Now, I'm going to review our quarterly results. Given new rules promulgated by the SEC, so called, Regulation G, we will no longer be discussing operating income. Rather, we will briefly discuss net income for AFC followed by a more extensive discussion of pre-tax segment income. For the quarter, we reported net income of 37.1 million or 70 cents per share, which compares to 47.9 million or 90 cents per share a year ago. Included in this year's net income are the following items. Net realized investment gains of $8 million or 14 cents a share, income from the sale of the fixed universal light business of 3.6 million or 7 cents per share, a gain on the retirement of funding obligations of 3 million or 6 cents per share, a gain on derivative of $1 million or 2 cents per share and restructuring costs of $2.2 million or 4 cents per share. The total amount of all these items is $13.4 million or 25 cents per share. Excluding these items and including the impact of minority interest and taxes, net income would have been $23.7 million or 45 cents per share for the quarter. Now we will turn to a discussion of our segment results. Again, segment income is before taxes and minority interest and excludes the above mentioned items. Total segment income was $32 million for the first quarter of 2003 as compared to $57.4 million for the first quarter of 2002. $25.4 million decrease is due to a $27.3 million decrease at Allmerica Financial Services. The company has discontinued proprietary variable products business.

Now, let's turn to a discussion of each of our segment results starting with our Property & Casualty business. Bob will cover these results in more detail later in the call as well as discuss our Property & Casualty strategy for the remainder of the year. As I mentioned earlier we reported improved results in this segment with income increasing by some 13 percent to $44.2 million and $39 million in last year's first quarter. These increased profits are the result of improved commercial lines result. During the quarter, we reported a 48.4 percent commercialized loss ratio, an improvement of some 12 points from the 60.5 percent loss ratio in the first quarter of last year. Commercial lines continued to benefit the rate increases across all our drivelines. In addition, we experienced stable development of prior year's reserves related to the 2002 accident year. Partially offsetting the strong performance of commercial lines is a weaker performance in our personal lines business, primarily personal auto. We continue to experience adverse trends in our personal auto liability coverages, both in increased loss cost and claim frequency. Additionally, personal lines were adversely impacted by higher non-catastrophe winter weather losses experienced in the first quarter of 2003 impacting both homeowners and personal auto. During the first quarter our underwriting expense ratio increased to 29.3 percent up from 28.5 percent a year ago. This increase is primarily due to higher contingent commission expenses and certain employee-related costs. Finally, net catastrophe losses were $11.2 million in the current quarter, the same amount as reported in the first quarter a year ago.

Now, lets discuss Allmerica Financial results where we reported segment income of $2.4 million for the quarter as compared to $29.7 million for last year's first quarter. Similarly, this quarter's results were consistent with our expectations and the guidance we had previously provided. The decline of profitability in Assets resulted from significantly higher amortization of deferred acquisition cost. A higher DAC amortization reflects our current DAC assumptions, which you'd recall from last quarters discussion now require a higher amortization level due to the company's decision to cease manufacturing variable products.

Also, on our last conference call we mentioned that on a GAAP basis we are no longer defraying expenses because of our shift to non-proprietary sales. This change in effect increases our reported other operating expenses. However, I'm pleased to report that actual operating expenses are lower than those of last year as a result of our expense management efforts. As I said on our last call, we believe these approximately breakeven results for the quarter are somewhat indicative of AFS's expected run-rate until we achieve higher sales volume in our broker/dealer, and further reduce expenses. Mark will discuss this further in his remarks.

Now, lets turn to an update on our redemption activity, where for the second consecutive quarter we experienced high level of redemptions on our individual variable annuities. You would recall these redemptions are positive in terms of statutory capital. Further, they result in cash flows in the form of redemption fees and help to reduce the risk profile of this business. In the first quarter, individual annuity redemptions totaled $1 billion as compared to $1.3 billion in the fourth quarter of 2002. The $2.3 billion of redemptions we have experienced in the last two quarters have reduced our in-force block of annuity assets by 17 percent over that period.

The overall redemption level we experienced is consistent with our expectations. We continue to monitor this redemption activity closely.

Lastly, it is important to reiterate that analysis of redemptions by AAM suggest no anti-selection. Briefly, lets turn to an update of our GMDB expense for the quarter. As you're aware we reinsured the mortality risk associated with GMDB in December of 2002. In the first quarter, we paid the reinsured $25.4 million on the approximately $4.7 billion of net amount of risk. The amount of reinsured's premium will vary as the net amount of risk moves up or down due to equity market movements and redemptions. On a GAAP basis, the GMDB expense for the quarter was $11.6 million. Now, lets review Asset Management's results, where we reported a segment income of $2.5 million compared to $5.1 million a year ago. This decrease reflects lower earnings in our GIT business due to the runoff of the [Inaudible] , and higher borrowing costs for AMGRO, our premium finance business given our lower ratings.

Now I'd like to briefly comment on the statutory capital position and RBC ratios of our life insurance companies. At March 31st, the RBC ratio of AFLIAC, our lead insurance life insurance company was estimated to be 266 percent an increase from the December 31st level of 244 percent. This improvement in our RBC ratio was a result of the improved risk profile of our life company's, Asset portfolio. The reduction in our Asset base due to redemption activity has reduced the RBC charge associated with out Asset portfolio. In addition, during the quarter, we sold certain assets that were carrying a relatively high-required capital charge such as our low income housing properties. The consolidated total adjusted capital for AFLIAC is approximately $472 million at the end of the quarter, slightly lower than the $482 million at the end of last year. The $10 million or 2 percent decline was due primarily to the decline in the equity markets during the first quarter. We continue to be very comfortable with our overall capital position in our life insurance companies.

Before I turn the call over to Bob, let me briefly touch on the status of our rating agency reviews. At this point, we've had annual review meetings with all of the major rating agencies. Although Moody's and S&Ps have not yet finalized their reviews, we're pleased with the recent AM Best release. You will recall, that in the fourth quarter of last year, Best was primarily concerned about two things. First, the potential risks associated with one of our life companies, and second the risk these operations may present to our overall organization, the so-called contagion risk. A recent rating action provides another external verification of the significantly improved capital position and risk profile of our life companies. Our life companies were upgraded to D- from C++, and the outlook for our property and casualty rating, which had been under review with negative implications, was changed to a stable outlook. In their release, Best indicated these actions as they said reflected stabilization in the statutory capital of the life insurance operations. They also noted a significantly diminished risk of regulatory action.

At this time, I'd like to turn the call over to Bob, for review of the P&C operations, to be followed by Mark's comments on Assets. Bob.

Thank you, Ed and good morning everyone. Our Property & Casualty business reported another solid quarter. Year over year results improved despite harsher winter weather in the northeast this year. The first quarter showed significantly better Commercial Lines results, and comparable homeowner results, offset somewhat by weaker personal automobile loss ratios, lower net investment income, and higher expenses primarily resulting from the increased pension costs, contingent commission, and fees paid for the cut through endorsement. Pre-tax first quarter earnings totaled $44.2 million, compared to last year's result of $39 million. A statutory combined ratio of 102.5 percent represents an improvement over the first quarter of last year where we reported a result of a 104.3 percent. Commercial Lines results continued with substantial improvement. In the quarter we produced an excellent statutory combined ratio of 91.1 percent. Loss ratios were down over 10 points. Production is stabilized and we are now producing solid returns on our Commercial Lines portfolio. We see good loss ratios in all lines and in all premium segments, benefiting from favorable development in the quarter and strong current accident year results. Our challenge going forward is to maintain our improved underwriting performance, again to grow the business and reduce our Commercial Line expense ratio.

The Commercial Lines loss ratios look good from both the calendar and an accident year perspective. We're producing excellent results in commercial multi-peril and commercial auto and substantially better results in worker's compensation. From a production perspective, retention levels have improved and new business is up almost 30 percent driven by healthy growth with our ongoing agents in the small and middle markets. Direct rate in premium growth with active agents is up 7.6 percent. We are not only pleased with the increased levels of production but also with the quality of new business. We've seen no indication of adverse selection as a result of the ratings downgrade last year and the mix of new business aligns well, with our underwriting appetite and marketing direction.

In addition to these positive trends, we continue to charge higher prices. In fact, we are ahead of our plan for this year. Increases remain substantial but more moderate than last year when Commercial Lines' premium on renewed business increased 17 percent. In the first quarter of this year, premiums increased 13 percent. By Line premiums on renewed business were up 17 percent on commercial multi-peril, 7.5 percent on worker's compensation and 8.5 percent on commercial automobile. Commercial Lines expense ratios will benefit overtime as we resume more normal production levels and eventually eliminate expected cost related to last year's ratings downgrade.

Turning to Personal Line, results deteriorated in the first quarter related to the first quarter of last year. A statutory combined ratio of a 109.7 percent was driven by higher loss and loss adjustment expense ratio. Despite lower catastrophe experience in Personal Lines, auto physical damage and homeowner property results were hurt by harsher winter weather this year, particularly in the northeast when compared to the exceptionally mild winter we had last year. In addition, our personal auto results experienced a significant increase in the frequency of personal injury protection or PIP plan in our Michigan auto book. These trends were offset somewhat by modest improvement in other personal auto markets, particularly in Hanover, driven by improved results in New Jersey, New York and in the Southeast.

In Personal Lines Michigan, Massachusetts, New Jersey and New York account for almost 80 percent of our personal auto premium and have a disproportionate effect on our profitability in this line. As I mentioned earlier physical damage results deteriorated New England following a tough winter, particularly with heavy snows in February. Aside from that we see improvement in our Hanover personal auto book. Results improved in New Jersey and New York on both the calendar and accident year basis and we expect continued improvement in both states as we earned price increases and incurred lower residual market assessments in the State of New York. In Massachusetts, liability results were flat, but the only real deterioration is physical damage resulting from bad weather. In Michigan, we experienced a significantly higher level of frequency of PIP claims in January and February. Since February, these types of claims have returned to more normal frequency levels and we expect results to improve when we fully are in the significant price increases that we're charging for this coverage.

Homeowner results were substantially the same as last year with lower catastrophes offset by higher severity related to the harsher winter weather. Personal Lines' production is relatively flat. Retention continues to be good, although new business is down somewhat as we successfully manage production levels and stayed with poor personal auto results. The Personal Lines expense ratio is up moderately due to increased contingent commission accruals. As expected for both Commercial and Personal Lines, net investment income declined from $51.8 million last year to $45.3 million this year. Our outlook for 2003 remains the same. We expect pre-tax profits to decline modestly, relative to our 2002 results.

Key to our success this year will be, first, getting ahead of the medical cost curves affecting our Michigan PIP cost. We have a lot of price that we'll earn out this year but we may need even more price over and above the 55 percent increase that we've already charged since the beginning of last year. Second, continuing to improve results in Massachusetts and New Jersey and producing better personal auto results in New York as a result of better risk classification, aggressive agency management, and lower residual market costs. Third, earning additional price increases in homeowners. Through the first quarter we've already booked another 13.4 percent price increase in this line. Fourth, growing our sponsored Personal Lines business and maintaining our market focus on establishing open groups, penetrating the work site and financial institutional markets and increasing our presence with affinity and association markets and lastly, growing our profitable Commercial Lines business and reducing our expense ratio over time as we resume more normal growth rates.

We remain confident that our underwriting claim, marketing and customer service strategies will pay off with improved loss ratios, better expense ratios, increased statutory capital levels and eventually excellent financial strength ratings from the rating agencies. Successfully executing to these strategies has not only improved our operating and underwriting results but also enabled us to minimize the impact of the rating agencies downgrade on the performance of our two regional companies, Hanover and Citizens. New business is up, retention is improving, and our independent agency relations have never been better.

While we can't predict when our ratings will be upgraded, we can control our own actions in the marketplace. We'll continue to adhere to our underwriting and claims standards, invest in people and technology, use our cut through endorsement facility, and offer enhanced contingent commission programs to agents to grow with us profitably. These actions will not only preserve the franchise value we have in our property and casualty businesses but strengthen the business fundamentals that we can effectively leverage once our ratings are restored. With that, I'll turn you over to Mark Huggs.

Thank you Bob, and good morning everyone. My discussion today will address our progress toward achieving our 2003 critical success factors that I outlined in our last conference call. As I have done in the past, I will split my discussion between the Insurance Company and the broker/dealer that we now follow at VeraVest. Relative to the Insurance Company, for the quarter our ending assets were approximately $14 billion including $10.9 billion of variable annuities. Actual redemption activity for the variable annuity block was about a billion dollars compared to fourth quarter 2002 activity of $1.3 billion. These annuity redemptions are in line with our original expectations. Furthermore, the average age for our annuity redemption activity continues to be consistent with the average age of our in-force block, a continued indication that we are not being selected again with respect to age.

Our expense management strategy is to proportionally manage expenses associated with a declining close block of assets, and we continue to make strong progress in this regard. In the first quarter our actual expenses to support the insurance block were better our original expectation. These expense reductions are widespread and stem from our concerted efforts to eliminate all non-essential functions across AFS. Most importantly, AFS showed positive segment earnings in the first quarter, despite a slowing economy, war worries and a 3.6 percent decline in the S&P. Consequently, we have positive earnings despite having approximately $60 million of DAC amortization for the quarter or 6 percent of our total DAC assets. Relative to VeraVest, our broker/dealer, even in this difficult economic and sales environment our gross revenue per VeraVest increased to $27.1 million for the quarter. This is a 14 percent increase over the fourth quarter of 2002.

In fact during the quarter, VeraVest generated in excess of $300 million of variable annuity sales. Furthermore, VeraVest product mix remains strong as 67 percent of the total sales were from insurance products with 73 percent of those sales going to our strategic partners. Moreover, we are finalizing our third strategic alliance with a major insurance carrier to complement our nationwide AMPAC Life Insurance lineup of strategic partnerships. Once complete, our advisors will have a complete suite of quality variable and fixed life insurance and annuity products. Recall, that these strategic variable product partners complement a broad array of fixed products provided through our newly formed independent marketing organization, VeraVest Insurance Services. We continue to maintain our platform infrastructure that help our advisors generate leads and partnerships to improve their productivity. In particular, we will be introducing enhancements to our practice management platform to our advisors this May. This platform provides our advisors with the tools and best practices associated with managing their business as independent contractors. Additionally, over the quarter we have refined and finalized our advisor list, which included 50 newly hired qualified financial planners. I am pleased to report that we now have 840 signed, VeraVest advisors producing gross dealer concessions for our broker/dealer within our new divisional branch manager field infrastructure. Finally, we've made progress in fine-tuning VeraVest infrastructure by eliminating expenses related to services that are no longer considered valuable by our VeraVest advisors.

In addition, we believe we can further reduce our expense levels by moving to electronic application processing and continuing to garner efficiencies for our platforms. Refining our activities will drive higher net revenue from VeraVest and move us closer to profitability target.

In closing, we continue to focus our efforts on maximizing the value of the insurance company and building a profitable distribution company. During this past quarter, we saw significant progress toward these goals through our expense management efforts, our revenue growth and continued strategic moves. I will continue to keep you informed of our progress throughout the year. Now, I would like to turn the call back over to Henry. Henry?

Mark, thank you. And operator at this time, let's open the call for questions.

Thank you, sir. If you would like to ask a question today, please press the * key followed by the digit 1 on your touch-tone phone. If you are on speaker phone, please be sure your mute function is turned off in order for your signal to reach our equipment. Once again, to ask a question, please press the * key followed by the digit 1. We go first to Colin Devine with Smith Barney.

Good morning gentlemen, and first of all congratulations on what was a solid quarter under obviously difficult circumstances. I was wondering if I'd just get some details on your statutory earnings for that quarter. I noticed there was, I guess, well about a $50 million junk in the stat capital of Hanover, I guess a consolidated PC companies from page one of the stat supplement. I just wonder what was going on. Because the way I crunch it now, period of debt the stat book value of the company is about 25.5 bucks, is that right?

We'll have that number in mind, Colin, I think, you obviously read about the Hanover junk part of that is operating earnings, I think part of it is realized gains as well for the quarter.

Okay. And can we get some details on the investment profile, there's really nothing in the stat supplement as to what the end of the quarter was in terms of junk bond holdings and what the unrealized losses were?

You're looking for dollar amounts or...

Yeah. I'll take dollar amounts.

...or the percentage of portfolio, John Kavanaugh is here with us. John, do you have those?

Colin, I don't have the numbers right on top of my head. First, to say that we have been continuing to lighten up our positions in high yield, probably reduction in assets in the quarter from the sale of [Inaudible] and some further retirements and sundry agreement. I bet our quarter will end in terms of high yield percentage of asset as about the same as yearend, but the trend during the course of the current year continues to reduce our overall holdings of high yield securities.

Okay. And then, I was wondering, by the way going forward, we could get some of those details on the stat supplement?

Yeah, we can look to do that. I'll make one more comment about the high yield portfolio. One of the things that John is working on and that we will probably talk more about in the next quarter is a view or a process to start to reduce that high yield portfolio over time to something less than it is now as a percentage of capital, as a percentage of invested assets. So, I expect we come back to you in the second quarter with more to say about that.

Okay. With respect to the holding company, given that, I was fairly disappointed Best didn't [Inaudible] on the P&C side.

Right.

Does that open the door now then to start taking some capital out of their mid-year when you are allowed to shore up the liquidity of the holding company?

You're taking capital out of the life business?

No, out of the P&C business?

I don't see us doing that. From a holding company perspective, we've got sufficient assets as I think everybody knows at this point to meet obligations in 2003, well into 2004. I do see us therefore retaining capital in our Property & Casualty businesses over the next year or more. What I do see is perhaps starting to think about as we get in to the later part of this year and early next year is a program to start to remove some capital out of our life businesses, that's something that we'll be discussing with rating agencies regularly as we move further into this year.

Okay, then a final quick question. Where do you stand now on continuing to sell off pieces of the life business? Are you still actively marketing some of the blocks or have you stopped that?

Yeah, we're not actively marketing anything right now, Colin, I think as you're aware, this is not a particularly vibrant M&A market, particularly for variable products businesses. So, that's not to say that we wouldn't consider it, it's more a comment on the current market. I do think, however, though as we continue to stabilize the pace of business we have here, that together with the stabilization of the equity markets, which should occur at some point, should make that a strategic possibility in the future but it's not one that we see right now.

Okay, thanks very much.

Sure.

We go next to Robert Glasspiegel, with Langen McAlenney.

Good Morning, a couple of quick questions. Could you quantify the reserve releases in the quarter for 2002 and maybe give the accident year, define ratios for commercial and personal?

The reserve release was about, in the high 20s I think, $31 million. I got 20 out of $49 million; it was $31 million for the quarter. Virtually all of it in the 2002 accident year is, virtually all Commercial Lines. In terms of...

So, the 91, you haven't done the calc, I can do it. You don't know what that 91 would have been at current year?

The 91 on current year, I don't have that number in my head.

I can do it. But it is something [Inaudible] 100, I mean should we read that maybe you put current accident year up conservatively?

Well, you know, that's good question Glass, I think what we're seeing obviously is conservatives in our picks for 2002. There was a lot of restructuring, as you know in late 2001 and early 2002. I think what we're seeing is our picks were conservative. We need to see another couple of quarters develop here, but it's very possible that our picks continue to be very conservative in 2003.

Because Bob's speech was that the accident year Commercial Lines results were solid. So, we had 30 million back, I mean you're over a hundred?

Right, right, and that's I think Bob's comments reflected the current picks. The question is, are those current picks as conservative as we now see the 2002 PIPS would be. It's a little early to tell, but generally speaking, we pick conservatively.

Bob Restrepo, as I had said, it is early and these things can develop, but we're very optimistic about the quality of the business. Quality of business we're seeing, the trends in our commercial lines but it is early on in the accident year.

It sound like you're saying it will be a mistake to add the $30 million back to...

I think it would be a mistake now to do that, Glass.

Okay. Your $4.6 billion at risk which didn't go down, I assume that's the impact of the down market, which more than offset or which exactly offset the favorable lapses that would have gone down. Did you do a calculation of what that number would have been in a flat market? I know you gave us sensitivities before, but do those still hold in declining asset base?

Yeah the sensitivities still hold, I think we have an estimate of what that amount of risk is at today's market levels. So, Michael, that's about what?

As of today we estimate about $500 million lower net amounted risk versus the end of March, and to your earlier question in the first quarter we probably lost somewhere in the neighborhood of 3 to 350 of net amount of risk due to the surrenders.

Okay, so the market down graph offset that, or were there some other factors?

It was offset by the market going down, exactly.

Got you. Thank you.

We go next to Al Capra with Putnam Lovell.

Good morning. I was just hoping you could give us a sense for the trend in surrenders throughout the first quarter on a monthly basis and perhaps give us any color on what you are experiencing this far in April?

Sure, Michael.

Within the first quarter, surrenders were highest in January. They began to trend down February and March and that continues in April, we are actually seeing a little bit lower level of surrenders than we saw in the first quarter and in the fourth quarter which is not inconsistent with our expectations, we expected there to be a significant spike around the time of the rating agency action, and that gradually it would trend back to more industry-type levels.

This is something, there is significant changes obviously to the business in the third quarter, we made some significant accounting adjustments as you know, we made some significant adjustments associated with that including what we thought surrender activity would be going forward. As I said in my prepared remarks, we continue to monitor that, and so far it's essentially where we thought it would be. But it's impossible to predict ultimately what those surrenders will be, so we'll keep you informed as we progress through the year.

Sure, and just a quick follow up. In terms of your GMDB reserve and your DAC asset, surrender expectation that you are using in those numbers is that sort of unlocked, if you will, on a quarterly basis or is it something that you would reset on any other time frequency?

We look at our experience relative to the assumptions every quarter and we make changes when we feel that there is a margin of variance that the current assumptions are no longer best estimates. There is not any requirement that we make changes every quarter, but we do look at it each quarter.

Particularly in the circumstances that we find ourselves in now. So we will continue to do that.

Okay, that's helpful. Thanks.

Yeah.

We go next to Angelo Gracy with Merrill Lynch.

Good morning everyone. I have a couple of questions focusing on the holding company. The first question is the credit facility that is coming up in May, what are your plans on those?

Given our ratings we don't expect to renew that facility.

Okay, and you mentioned that you don't expect to take up dividends from the P&C subsidiaries and you have enough cash at the holding company for the rest of '03?

Into early 2004, that's correct.

And you said into '04, but maybe you can run through that a little bit because its seems like you have pretty much enough to get through '03?

We have enough to get through '03, I don't have the schedule in front of me, but my recollection is that leaves us with some $15 million or maybe slightly higher as we get into early 2004, which should, if memory serves me correct, it should take us at least through the first quarter of 2004.

Okay, maybe we can take that off-line because I think I have different numbers.

Okay. We'll be happy to do that.

Okay, great. Can you also mention go over cash flow, operating cash flow on the P&C side and in the life subsidiaries during the quarter?

Maybe we'll hit the life first.

On the life side we had given guidance, and we expected roughly a $175 to $200 million of positive cash flow out of the life companies and in the first quarter, our actual results were consistent with that guidance.

On the property and casualty side we don't watch cash flow as closely as we do on the life side. It was obviously positive, we can get back to you with a specific number on that if you like.

Okay, and just one more question. You did mention that your outlook for 2002 in P&C was, let me see if I can get this correct, modest decrease?

Right.

In pre-tax profit?

Right.

If I'm correct, on the fourth quarter conference call, I believe the guidance was for flat results on year to year basis. Can you clarify if there has been a change in your expectation?

No, that's right. There is no change.

Yeah, there is no change, if my memory serves right, we did talk about, we may have said flat to modest decline but the indication was for a modest decline primarily resulting from more normalized catastrophe experience and we didn't see that in the first quarter but we've got three quarters to go, I think it will kind of work out over time.

Okay. So, there's no change in that previous guidance?

That's correct.

Okay. And worker's comp, what was that rate increase, I am sorry, I didn't catch that when you mentioned it.

7.5 percent.

7?

7.5, correct.

Thank you.

We go next to Sam Kidston (ph) with BlackRock.

My questions have been answered, thank you.

We go next to Jeff Thompson with KBW Inc.

Hi. First question on that prior year reserve release. That was $31 million pre-tax?

That's correct.

In what lines was that release for?

Primarily, CMP with some worker's comp.

Yeah, and little bit of commercial line, primarily Commercial Lines.

Yeah, it was all Commercial Lines.

So it's mostly P&C and worker's comp? CMP and workers comp, right?

CMP and workers comp, right.

You mentioned that the cash flow for Property & Casualty was positive but the investment income was down I think 17 percent. What's driving that?

I'll have to get back on that. I must tell you that quarterly cash flow in our Property & Casualty business is not something that I have to [Inaudible] memory so, what's that John?

lower investment rates.

Yeah, lower investment rates. So let me give, I know a couple of people who've asked that question. We'll get back to you individually with the answer to that.

Was the cash flow in 2002 positive for Property & Casualty?

Yeah, I'm sure it was.

Okay, and when you talked about overall Commercial Lines rate increases, I want to make sure I heard the number right. You said they were up 17 percent last year and 13 percent in the first quarter?

That's correct.

Okay. On the expense ratio, where do you see that heading? Seems like it's moving up and you mentioned some items. What do you think that's going to bottom out or balance up?

We expected there might be a slight increase, but talking about a couple of sensible point, it is most this year and then beginning to decline on a run-rate basis the second half of this year and obviously through next year. Over time, we would like to get back to more of a 27.5 to 28 percent expense ratio what we're targeting and we think we'll get there with, again as I mentioned, more normal levels of production as well as some of the one-time cost associated with the downgrade. Primarily, increased contingent commissions and obviously the cost of these cut through endorsements.

Okay. And then, one last question related to VeraVest, did you talk about what you think is the revenue target you need to hit in order to breakeven in that operation?

Our revenue continues to increase, as you know, we basically just started this operation. Our revenue targets are actually need to probably increase, I would say, a good 25 percent depending on how well we refine the expense of the operation.

So they need to increase 25 percent this year?

Well, it's ...

It's over time?

... yeah, it's a good question and right how it's one that's a little bit difficult for us to answer mostly because we're still working on and studying and attempting to break our expenses in the life side of our business between insurance operations and the VeraVest operations.

Okay. Thank you.

And, until we can get a better answer to that question, it's hard for me to exactly answer the top line question.

Yeah, I understand. Thank you.

Welcome.

We go next to Patrick Megan with Hotchkis & Wiley.

Hi, guys. How are you doing?

Good Patrick, how are you?

Good. Just a quick question on statutory capital at AFLIAC. You guys had made a comment that you were cash flow positive for the quarter but statutory capital for AFLIAC went down. Can you kind of reconcile those two statements?

Yeah, the biggest difference would be changes in the statutory reserve levels, which are non-cash items. So one of the things that you'll see in our results is that GMDB reserves, for example on a statutory basis were slightly off over the course of the first quarter and that even though we had a billion dollars of surrender, so that represents an increase in reserves for the business that remained consistent with the market being down for the quarter. Secondly, every quarter there is a significant amount of surrendered charges amortization that runs through the reserve calculation. So as you know, in the statutory reserve calculation, we take credit for existing surrender charges and the contracts are designed so that those surrender charges round off over time and that comes through as a non-cash charged expense for the earnings.

Okay. And then one quick follow up. You made the comment about the cash payment for around $25 million for the GMDB reinsurance. Is that included in your calculation of cash flow for the life company, or is that excluded?

No, that's included.

So the positive cash flow includes the ...?

Includes the $25 million, yes it does.

Okay, thanks.

We will go next to Dave McDollen (ph) with Citigroup.

Good morning Ed and guys, how are you doing?

Hi Dave, how are you?

Good. Thanks. A couple of clarifications and a couple of real questions. First of all, I want to make sure I got the number right on the impact of surrenders and on net amount of risk. Was that $350 million in the quarter?

That was the estimate that I made, yes.

Okay, thank you. On holding company liquidity, just to make sure I have the right number there. In the supplement you've got corporate cash and investment $33.8 million. I think that's different than what the whole liquidity is. Can you give us that number?

Yeah, I don't, Dave, I don't have that number in front of me. My recollection is we have, I guess, I could do the math work... we are going to end the year with some $15 to $20 million of positive cash. On an after-tax basis our annual obligations are $25 million. So, we are starting the year with essentially the difference, which would be, about $50 or $60 million, which is a little bit different in the holding company cash item that is shown in the statistical supplement.

Okay.

If you are interested in top line, we can reconcile those.

Yeah, I just wanted to make sure I have that number to get that as close as possible. I too was a little disappointed that the Best rating was only an affirmation of P&C companies. Given there is a discussion of rationale about the stabilization of life?

Yeah.

I think it was in your K, where you guys made a statement I'm paraphrasing obviously, that the longer you don't have any [Inaudible] the better, the more of an impact it has on the company. Yet your outlook for P&C and Bob's statement in particular, seems to be relatively sanguine despite the B++. Can you be a little bit more specific about some of the things you are doing there besides the cut through to offset the impact?

Yes, Dave, and obviously our comments in the 10-K will reflect as a real risk to the business, but we have been able to manage that risk well, partly through the cut through programs that we have discussed in the past, partly through enhanced contingent commission programs to recognize and reward agents that continue to do business with us and grow with us profitably. And we've, I think it is a sign of the fact that we have got excellent agency relationships on a local basis with our field folks and we have made concerted efforts since the end of the third quarter to maintain very open and candid communications about where we are corporately in general and specifically as it relates to our Property & Casualty business. So, agents seem to have a high degree of confidence not only in our ability to continue to be a responsive market for them, but also I'm pretty positive about the inevitability of getting the ratings restored. So they are hanging with us. It costs agents money to switch customers, customers that we have gone out and actually spent a lot of time individually with customers, explaining our financial strengths and our outlook for the future, and those communication efforts seem to be paying off so far and I'm reasonably optimistic that from an earnings standpoint, that we will be able to insulate ourselves from the downgrade for the balance of the year by sticking, as I mentioned to the fundamentals and by sticking to those fundamental, we remain optimistic that we will get those ratings restored, which is still obviously our number one priority.

Bob, I know you might be somewhat careful about this one, but have you made representations to the agent? I'm thinking about this from a risk perspective. Have you made representations to your field force about getting the best rating back and I'm asking the question from a perspective as is there some sort of time frame where the agents might say, well, the rating has not come through yet and it expects to have more of an impact?

No, no, we have not set specific dates. We had discussed, some assumptions we have made that something would happen this year, but we have not committed to specific dates. Obviously, that is not something that we are smart enough to figure out we are not in control of that process.

I guess, then when...

...obviously, but we did indicate that we felt that our results in capital levels gave us some room for optimism.

I guess, I'm with you on not being able to figure out what it is. Last question, Ed, you talked about some preliminary indications about being able to take some capital out of the life companies and this goes right back to the best rating. My read of their rationale is that they have some concern about P&C remaining because they are expecting that that is going to be a predominant source of capital for the holding company. Can you give us anything further on the life company capital, maybe magnitude, ability to paying capital in P&C [Inaudible] ?

It's premature to do that. Let me make sure I'm clear. I didn't mean to convey an indication, its, what I was trying to convey was a desire on our part...

Okay.

... to ultimately get to that position as I said, we'll, we think we will be in a position to start to have dialog with rating agencies and regulators in particular, as we get to the tail-end of this year.

Okay, thank you.

Yep.

We will go next to Jim Wolf with RBC Capital Markets.

Yes, my questions have been answered. Thank you.

We go to Robert Glasspeigel, Langen McAlenney.

Two quick follow ups. Just the reconciliation between what you pay your re-insurer and the GAAP charges, is that adjustments to reserves or...

That's exactly right, the redemption in the GAAP reserve.

But the reserves you said didn't go down or did I miss...

That was statutory reserves that I mentioned.

glasspeigel Okay the GAAP reserves went down from what to what?

They went down from $81 million at the end of 2002 to $56 million at the end of 2003. That will reconcile the difference between the $25 million and the ...

Eleven.

And the $11 million and that's because we had at the beginning of the reinsurance program, we had an adjustment to essentially establish an idea in our reserve that would have run through the GAAP reserve, so that's the disconnect. But going forward the difference should be, as you expect, the difference between what we pay the re-insurer and the GAAP charge.

We shouldn't expect the, or should we expect the GAAP reserve to go down going forward or...

The extent that the amount paid to the re-insurer exceeds the amount that go through our GAAP PNL, that difference will be the amount of the reserve we will go down by.

Okay, mathematically I understand that. I was just looking for some guidance on...

Yeah, right now the cost of the reinsurance exceeds the long term assumption and that is in the GAAP reserve as I think we've just learned.

Right.

We believe that over the course of the next 12 to 18 months based on our market assumption of 8 percent that the actual cost will drop to a level at or below the long term GAAP assumption.

Yeah, so let me just make sure we are clear on this, I think we talked, may be, I think we gave some detail on this when we established the reserve. Our expectation is that our long-term cost per GMDB is, I don't know, 45 to 46 basis points, so that was the basis for setting up the reserve. Right now, under the current market level and that is long-term, that's obviously over many years.

Right.

Right now, the current market levels cost is somewhere in the lower to mid 80s, I think in terms of basis point. So, if the market stays where it is, we will continue to work that reserve down.

Right. And then we you get a quarter with the markets up, lets say 10 percent, would you pay the re-insurer or --

It is the other way.

...or the things go down.

Yep.

You don't have any guidance of what it might be in this quarter, if you just [Inaudible] the market where it is, right now or...

Well, as we said earlier the market in April has probably not $500 million or so of net amount of risk that represents $10 or $11 million dollars of annual reinsurance cost.

[Inaudible] do it this way...

I got you.

I think we said our cost for this quarter for reinsurance was around $25 or $26 million and that was around $4.7 billion net amount of risk. So you can calculate a rate there and then apply that towards a...

If the average balance was 4.1...

And that's what's the moving net amount of risk given the, guidance on that we have given you.

Okay, that's very helpful. Finally, we took the end date for the search away from the annual meeting and it sort of left ambiguous if you could go through this thoughtfully. I don't know who the right person us to address this, to represent the boards point of view on this, but is there a sort of drop dead date where the board makes a decision or we've [Inaudible] intimation here.

Glass, J. Huber is here and he can respond to that question.

I don't think we are prepared to indicate any drop dead date. Perhaps the board got a little ahead of itself by saying probably what it's own internal deadline was. But I think that you're now looking at an extended search (ph) . They understand that it's important to identify the CEO but they also want to make sure that they've gone through their process properly and reached the decision that they are very comfortable with.

Is that fair to say that, I mean, we are comfortable with the current, sort of, operating management structure of the company that there is no, sort of, sense of urgency from either a rating agency, financial lenders, ..

.... [Inaudible] it is the lower hazard classes which relate to more service related industry. But by and large, we are not over concentrated in any one segment.

Great. And you are pretty much run down the large program book, is there any more business?

We are very, we've definitely run down the loss ratio. We have got smaller but there are large account books, which tend to be positive sizes above a 100 or 150,000, its gone for maybe for 12 or 13 percent of our total cost of that 10 percent of our total Property & Casualty book, but the loss ratio has been dropped significantly. So, we are very comfortable with the business we have on the books right now. We have not been writing a lot of new business in that segment, but we are open to new business opportunities. But again, it has to align with our underwriting standards and our underwriting appetite.

You are saying the large programs are about 10 percent off the worker's comp book?

No, I am sorry, 10 percent of our total Property & Casualty volume is large. It's larger than that in Worker's Comp Line, but it used to be 25 to 30 percent, I don't have the number in front of me but I know it is substantially smaller than that now.

The 10 percent is across all lines.

Yeah. That's all lines.

So all Commercial Lines is a percentage of the total.

Right. So all commercial, not the paracommercial, auto and worker's compensation, all the other Commercial Lines represent 10 percent of our total Property & Casualty.

So, a limited number of accounts.

Yeah. It's couple of hundreds.

Okay. Great. It looks like on the GIG program, are you continuing to buy back outstanding GIGS? It looks like it has been running down?

Little bit. John can respond to that.

Yeah. In the first quarter, I think we reported just about $50 million of base amount at discounts and then recognized gains and [Inaudible] surplus and we are always open in the market to opportunities to do that. We have a modest amount of scheduled maturities in calendar 2003 and otherwise, yeah, the books remains nonportable, noncallable but we continue to be interested in buying back paper that's available (ph) .

Yeah. Of course unfortunately for us with regard to buying back GIGS as Best points out which stabilize the life capital position, so that makes it difficult for us obviously to buy that paper back at a discount because holders barely have confidence in getting paid.

Right. And what was the average discount in the first quarter?

I won't get into any details on that. It is a pretty much, item-by-item opportunity.

Okay, great. Thank you.

Yep.

That concludes today's question and answer session. I would like to turn the call back over to Mr. St. Cyr for any additional or closing comments.

Thank you operator and I want to thank our conference call participants for being with us today. We are pleased to have this opportunity to discuss with you our quarterly operating results and we look forward to speaking with you very soon and thanks for being with us.

That concludes today's conference call. Thank you for your participation. You may now disconnect.