Hanover Insurance Group Inc (THG) 2003 Q2 法說會逐字稿

Good day and welcome to the Allmerica Financial Corporation second-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.

Thank you and welcome to the second 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 Hug (ph) President of Allmerica Financial Services. I'm with Ed and Mark in our offices in Worcester, while Bob is participating from another location. Also joining us are Jay 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 discussions our financial results for the 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 the remainder of 2003, as well as our operating ratio, capital level, and ratings, and Mark's comments on expense reductions are all forward-looking statements. These forward-looking statements are subject to a number of risks and uncertainties discussed in some detail in Allmerica Financial's interim report on form 10-K for the year ended December 2002, quarterly report on form 10-Q for the quarter ended March 31 2003, and yesterday's press release which are furnished -- or are on file with the SEC. In particular, we note that Allmerica's future operating results and financial conditions will vary materially, depending upon equity market and bond market conditions. Surrender activities and rating actions, among other factors. Also, I would like to mention that Allmerica's quarterly earnings calls, including today's call, our earnings press release, statistical supplement, and documents filed that were furnished to the SEC are all available under the financial news section of our web site which is located www.allmerica.com. In particular, please note that information to reconcile certain information discussed here to the information that is presented under GAAP, is available and yesterday's press release which is available on this web site. And with those comments I'll turn the discussion over to Ed.

EDWARD PARRY, III: Thank you Henry. Good morning everyone and thank you for joining our call. Overall we're pleased with our results for the quarter and the continued progress we have made in the second quarter. Solid earnings in AFS were due to the improved equity market and our expense management initiatives. What's more, we saw significant improvement in the statutory capital position and risk-based capital ratios in our life companies. In our property and casualty segment, poor segment earnings in the second quarter were out and reflect our efforts to improve underwriting results. As you know, our reported earnings for the quarter were negatively impacted by the arbitration ruling arising from participation in a voluntary pool. We announced this loss earlier in the quarter, which related to a pool we exited in 1996.

Let me review our quarterly results in more detail. For the quarter, we reported net income of 24.4 million or 46 cents per share versus a net loss of 55.5 million or a $1.05 per share in the second quarter a year ago. Included in this year's second-quarter net income are the following items. Net realized investment gains of 6.6 million or 13 cents per share, a gain on the retirement of funding agreement obligations of $300,000, restructuring costs of $800,000 or a penny a share, and the loss on derivatives of $400,000. The total amount of these items is 5.7 million or 11 cents per share. Excluding these items, but including the impact of minority interest in taxes, net income would have been 18.7 million or 35 cents per share. I should also point out that these pro forma results include the charge of 23 million or 40 cents per share, related to the arbitration ruling I just mentioned.

Now I'll turn to a discussion of our segment results. Totals segment income was 23 million for the second quarter of 2003, as compared to a segment loss of 72 million for the second quarter of last year. You'll recall that segment income is before taxes and minority interests and before the pro forma items I just mentioned. In the second quarter, our property and casualty business reported segment income of 20.6 million, versus 51.6 million a year earlier. This overall decline of 31 million was driven by two factors. First, the $23 million charge for the adverse arbitration ruling. And second, pretax catastrophe losses that were 12.6 million higher this year than those in last year's second-quarter. This year's catastrophe losses are more in-line with what we expect, whereas last year's levels were relatively low.

Looking at our lines of business -- commercial lines reported a calendar year statutory loss ratio for the second quarter, including the arbitration ruling of 64.9 percent compared to 60.3 percent a year ago. If we exclude the arbitration charge, the commercial lines statutory loss ratio improved by almost 12 percentage points to 53 percent. Our commercial lines business continues to benefit from overall rate increases and improved underwriting results. We achieved a lower statutory loss ratio in each of our two commercial guidelines. Commercial (indiscernible) workers compensation posted the largest improvements in loss ratios, with commercial auto improving 11 percentage points while workers compensation improved by almost 12 percentage points.

In personal lines, our statutory loss ratio was 71.3 percent compared to 66.7 percent last year. This increase was primarily driven by personal auto, where we experienced approximately $10 million of adverse prior-year development related to personal injury medical costs, principally in our Michigan business. In addition, the current accident year continues to be adversely impacted by the higher frequency of bodily injury claims. Bob will discuss these items in greater detail in his remarks. Additionally, relative to last year, our homeowners results reflect a higher level of catastrophe losses. The statutory loss ratio for the current year's second-quarter was 68.9 percent up from 64.1 percent a year ago.

During the second quarter, our statutory underwriting expense ratio increased 29.4 percent from 28.2 percent a year ago. This increase is primarily to the higher pension costs and contingent commissions. Now, let's move the discussion to Allmerica Financial Services, where we reported segment income of 18.4 million for the quarter versus a loss of 113.8 million a year ago. As you will recall, the second quarter of last year was negatively impacted by 141.9 million pretax write-off of deferred acquisition costs.

Earlier this year, I said we expected segment earnings in AFS to be flat to slightly positive as we progress throughout the year. This expectation was based on an assumption that are separate accounts would grow at 8 percent evenly over the course of the year or by 2 percent per quarter. As you are aware, the market was up nearly 15 percent in the second quarter, which served to reduce our amortization of deferred acquisition costs and increased earnings, as well as expectations. GAAP amortization expense levels are, as you know, variable from period-to-period, depending upon equity market values. We believe each 1 percent variation from expected market appreciation in a quarter will impact GAAP amortization and earnings by about $1 million on a pretax basis. Accordingly, the difference between equity market increase of 15 percent in the second quarter which is the 2 percent embedded in our expectation accounted for about $13 million of our second-quarter earnings.

Now let's turn to an update on our variable annuity redemption activity. In the second quarter, individual annuity redemptions totaled 553 million, but declined significantly when compared to redemption of 1 billion in the first quarter of this year and 1.3 billion in the fourth quarter of last year. We expect quarterly redemptions to continue in the 5 to $600 million range for the near future. This would result in full-year redemptions for 2003 of approximately 2.6 billion to 2.7 billion.

Briefly, let's turn to an update of our guaranteed minimum debt benefit expense for the quarter, which was 11.4 million on a GAAP basis. Our GNDB (ph) cash loss was 21 million for the quarter. The bulk of our cash costs relate to our mortality reinsurance premiums. At the end of the second quarter, our GAAP GNDB result was 41.4 million down from 55.9 million at the end of the first quarter of this year. The net amount of risk on our variable annuity products decreased significantly to 3.6 billion at the end of the second quarter. This compares favorably to 4.7 billion at the end of this year's first quarter and to 4.6 billion at the end of last year. The lower net amount of risk is due in large part to the increase in equity market values.

Briefly, the asset management segment income was 2.5 million compared to 5.1 million last year. This decrease reflects lower earnings in our (indiscernible) business due to the reduction in the number of outstanding funding agreements. I want to spend a few minutes discussing our statutory capital and risk-based capital positions in our life companies. In the second quarter, the consolidated total adjusted capital for AFLIAC, our lead life insurance company, increased to 536 million up from 472 million at the end of the first quarter of this year. This increase was principally driven by the improvement in equity market values. What is more, the risk-based capital ratio of AFLIAC was 344 percent at quarter-end, representing a significant increase over the 266 percent level we reported just at the end of the first quarter. The improvement in our RBC ratio was due equally to the significant reduction in our high yield investment portfolio and the increase in equity market values.

Now briefly turning to our investment portfolio -- on our last conference call, we said we would act to improve our overall credit quality of our fixed-income portfolio by reducing our holdings of below investment grade bonds. During the second quarter, we sold approximately 270 million of these bonds or approximately 30 percent of our holdings. And we recognized a gain of about $15 million. As a result of this action, we believe our remaining position of below investment-grade bonds is very much in-line with industry averages. The overall percentage of below investment-grade bonds is 6.2 percent of the total fixed income portfolio and 5.7 percent of total invested assets at the end of the quarter. This is down from 10 percent and 9.2 percent respectively at the end of the first quarter. As I just said a moment ago, this action meaningfully improved our life insurance Company's risk-based company capital position during the quarter. At this time, I'd like to turn the call over to Bob, for a review of the property casualty operations. And following Bob's remarks, we'll hear from Mark on AFS. Bob?

Thank you Ed and good morning everyone. Our property and casualty business reported pretax segment profits in the second quarter of $20.6 million versus $51.6 million last year. Second-quarter results included the previously announced charge as, referred to, of $23 million. This charge resulted from an unexpected and unfavorable arbitration ruling, arising from a participation in a voluntary pool. And the claim actually rose in 1995. As indicated, we exited the pool in 1996. In addition, second-quarter results included $21 million in catastrophe losses compared to the relatively mild second quarter of last year where we experienced only $8 million in catastrophe losses. Adjusting for the impact of the arbitration ruling and more normal catastrophe results, our results actually improved in property and casualty. And as we said in an earlier release along with the other pool participants, we were disappointed and surprised by the arbitration ruling. But, we now have this behind us. And we're pleased with the continuing improvements that we see in our property and casualty operation. For the first half of this year, pretax profits are $64.8 million -- our segment profits -- compared to $90.6 million in 2002. Excluding the arbitration decisions, earnings for 2003 are $87.8 million.

Both second-quarter and results to-date for the year, demonstrate continued strong underwriting results in our commercial lines operations. Improving homeowner loss ratios on a precatastrophe basis, stable production despite last year's financial strength ratings downgrade, and expense and loss adjustment expense ratios roughly equal to what we reported last quarter. Although second-quarter current accident year results for personal auto have improved somewhat, calendar year results remain disappointing. For the quarter, we saw adverse development in prior accident years for both bodily injury and personal injury protection, or PIP, primarily in Michigan. In addition, we incurred higher assessments from the residual market facility in Massachusetts. And homeowners' results were somewhat lower in the quarter because of the substantially higher, albeit -- as Ed mentioned -- more normal catastrophe levels, when compared to last year. Our precatastrophe loss ratio results improved almost three points. And we expect continued improvement as we fully earn the significant price increases that we continue to charge and benefit from the underwriting and product changes which we are continuing to implement.

From a production perspective, the personal line story is similar to the first quarter. Production is relatively flat. Attention continues to be good. But new business is down somewhat, primarily as a result of Massachusetts and New Jersey, where profitability is poor. All-in-all our statutory combined ratio for the quarter is 107.3 percent in personal lines. Year-to-date our result is 108.4 percent. Clearly, we have room for improvement in personal lines.

Commercial lines continue to produce excellent results. For the quarter, we produced a statutory combined ratio of 106.5 percent. And when you exclude the impact of the unfavorable arbitration ruling, our statutory combined ratio was 94.1 percent. Year-to-date commercial lines were a 98.8 percent statutory combined ratio and 92.6 percent ratio, excluding the impact of the unfavorable arbitration ruling. Loss ratios continue to be excellent in commercial lines. Premium volumes increased with our activations and we continue to produce good returns throughout our commercial lines portfolio. As I reported last quarter, we see good loss ratios in almost all lines and in all premium segments. In addition, we continue to experience favorable development from prior accident years and excellent results in the current accident year, particularly in commercial multiperil and commercial automobile. In addition, results from workers compensation continue to improve.

From a production perspective, retention is acceptable and new business is up, driven by solid growth with our ongoing agents in the small and middle markets. Year-to-date, direct written premium growth with activations is up 2.5 percent. We're pleased with our production levels, given our current financial strength ratings, and are optimistic that we can hold the fort and experience minimal or no adverse selection until our ratings are restored. From a pricing perspective, we continue to book price increases on renewed business. Year-to-date we've increased premiums by 12 percent on renewed business. Commercial multiperil is up 15 percent. Commercial auto is up 7 percent. And workers compensation increased 8 percent. As I indicated last quarter, commercial lines expense ratios are higher than we would like, but will improve as we resume more normal production levels and eliminate -- eventually eliminate -- the excess costs related to the financial strength ratings downgrade. For the first half of this year, investment income for our property casualty operations is down, as expected, from $102.6 million last year to $91.8 million this year.

Also as we said previously, we expect pretax profits for the year to decline, relative to 2002 results, driven by more normal catastrophe experience, the unfavorable arbitration ruling, lower net investment income, and the higher costs associated with cut-through facilities and contingent -- agency contingent commission programs. These trends will be somewhat offset this year by substantially improved commercial lines results, improving homeowner results, and continued price and underwriting improvements in all lines. Our biggest current challenge remains improving the quality and profitability of our personal auto business. We've made good progress in most of our states, including New York and Florida, where we had poor results last year. Despite our progress, results remain disappointing in three of our largest states Michigan, Massachusetts, and New Jersey. Physical damage results have improved significantly in the second quarter, but liability results and bodily injury and PIP are not good. We've taken several actions to improve results.

In Michigan, we filed for an additional 15 percent rate increase for the PIP coverage. Together with previous rate increases, prices for this coverage have gone up about 76 percent over the past two years. Despite our issues with PIP in Michigan, it is important to remember that our Michigan personal auto book, and the aggregate, remains a profitable line for us. We've carved out our personal auto business in Massachusetts and New Jersey and have established a discrete organization in each state to improve results. In addition, we have recruited a new executive to lead these businesses and improve results. Increasingly, we'll manage our presence in these two states with organizations that act like separate domestic companies.

In Massachusetts, our voluntary results with our traditional independent agency plant are quite good. Our problems in Massachusetts remain with the residual market. Losses from the Commonwealth Auto Reinsurance facility, or CAR, have increased significantly on both a current and prior accident year basis. In addition, we continue to be plagued with increasing losses from the exclusive representative producers, or ERPs, which are a unique feature of the Massachusetts automobile market.

To improve results, we continue to pursue a variety of initiatives to ensure proper risk classification and to enhance the quality of our revenue base. We're also making changes to how we seed risk to the reinsurance facility known as CAR. We anticipate that these changes will tend to reduce our proportional assessment from the reinsurance facility, relative to our experience over the past couple of years. In New Jersey, we've historically produced underwriting profits despite a well-known difficult regulatory environment. Results have deteriorated somewhat this year, as a result of depressed rates and increasing loss trends, primarily involving injury. Similar to our efforts in Massachusetts, we're emphasizing proper risk classification and disciplined agency management. In addition, we're exploring a variety of operational changes which we think will give us a more stable and profitable presence in the State, over the long term.

We remain confident in our overall property and casualty business strategy. We firmly believe that we can be the best regional company in industry and have made significant strides in all markets and lines of insurance, with the exception of personal auto. Despite this, we've demonstrated in the past that we know how to make money in this line. And I expect we will return this line to acceptable returns. The fact that we've improved results, stabilized production and expense ratios, and experienced little if any adverse selection despite the ratings downgrade demonstrates the value and the strength of our regional franchises, Hanover and Citizens. The knowledge we have of the local markets, the quality of relationships we have with the agents who represent us, the efficiencies we've introduced with new systems and new business processes, and the perseverance of our people have really paid off when we needed it. Once we get our financial strength ratings restored, I know you'll see the real earnings power of our strong regional company platform. And with that I'll turn you over to Mark Hub (ph).

Thank you, Bob. And good morning everyone. AFS reported positive second-quarter segment earnings of 18.4 million. As Ed said, this is mainly because of lower (indiscernible) amortization associated with an above average market. However, even without the market growth above our expectation, AFS would still have reported segment earnings in the 4 to $5 million range, in large-part because of the success in our expense management efforts. Nonetheless, our earnings remain sensitive to the market in accordance to the guidance that Ed described earlier. The rest of my discussion today will address our progress toward achieving our 2003 critical success factors that support our efforts to maximize the value of the insurance company and build a profitable distribution company.

For the quarter, our assets under management were approximately 14.6 billion dollars up slightly, due to market appreciation. Of the $14.6 billion, approximately 11.5 billion are variable annuities. During the second quarter we saw redemption activity on the variable annuity block decline from 990 million in the first quarter to about 553 million this quarter. In addition, we still see no signs of anti-selection within our redemption. After nine months of experience, we now believe the redemption level we are experiencing in the second quarter represents a reasonable estimate of the redemption rate for the near future. Therefore, we've adjusted our redemption forecast for 2003 down to 2.6 to 2.7 billion dollars. However, with a strong statutory capital base of $536 million, and an RBC ratio of 344 percent, we are in an excellent position to benefit from ongoing revenue from these persisting assets. As such, we can better capture the value of this business.

As discussed in previous calls, our expense strategy is to proportionally manage the expenses associated with the declining closed-block of assets. Continuing our strong positive trend from the first quarter, our actual expenses to support the insurance block were better than our original expectations. These expense reductions are widespread within AFS and stem from our concerted efforts to streamline client and technology services and eliminate non-essential functions across all of AFS.

Let's turn our attention to sales. During the quarter, VeraVest, our new newly generated broker-dealer, generated in excess of $500 million of total annuity, life, mutual fund, and wrap sales. While total sales were flat relative to the first quarter, second-quarter VeraVest revenue of 24.5 million was down 10 percent from the first quarter, because of lower variable annuity sales. Nonetheless, product mix remains strong, as 76 percent of our annuity and life insurance product sales were from our strategic partners. Furthermore, we have finalized our third strategic alliance with MSS Fun Life. Our strategic alliances are now complete, offering our advisors a full complement of quality, variable, and fixed life insurance and annuity products. We continue to make progress in changing VeraVest's infrastructure, by eliminating expenses related to services that are no longer considered valuable or necessary by our VeraVest advisors.

Finally, in previous calls, we have discussed the need to continue to refine the VeraVest organization to improve service and technology capabilities, while garnering expense efficiency. These are necessary steps to make it easier for our advisors to serve their clients and grow their businesses. In an effort to move more quickly on this front, we have signed a letter of intent to contract for services with Linsco Private Ledger Corporation, or LPL, the nation's largest independent broker dealer. LPL is a highly regarded broker-dealer, with what many consider to be the best service and technology platforms in the business. Our discussions with LPL on important strategic steps in refining our VeraVest service and technology platforms to effectively compete in a highly competitive broker-dealer market. What's more, we expect the LPLC service and technology platforms to drive higher net revenue. As such, I will keep you informed about our progress in this regard.

In closing, we continue to focus our efforts on maximizing the value of the insurance company and building our distribution business. During this past quarter, we saw continued progress toward these goals, through our expense management efforts, our adviser growth, and strategic moves. Now I would like to turn the call back over to Henry. Henry?

Mark thank you. And Operator, at this point let's open the call to questions.

Thank you, sir. (CALLER INSTRUCTIONS) Colin Devine, Smith Barney. (ph)

Good morning, gentleman. And I rarely do this. But I will start this off with a congratulations on certainly getting the company turned around. You came a long way back from nine months ago. A couple of questions. You didn't mention the CEO search -- and I guess no conference call today would be complete without that. And also, and again, that's something I thought we would be talking about yet. But, with the RBC ratio, obviously, at 344, where do we stand in terms of getting some capital up to the holding company to address some of these potential liquidity concerns? Obviously, I don't think any of us expect the rating agency -- they're going to do much until next year -- where do we sit on that? And what about, I guess, starting to buy the stock or the debt?

Let me first have Jay Huber, who is our General Counsel, talk about the CEO question. And I'll come back and address the capital question.

Colin, we certainly anticipated that someone would ask that question. And you probably anticipate the response. The committee, as you know, has reiterated that they are committed to finding the right person. The nature of process is one that it takes time. We're not the first or the only or the last company that will take some time in making sure that they make the right selection for our company. Internal and external candidates continue to be under active consideration. The committee has established a practice or policy at the beginning that they would not set a deadline. Nor would they comment on the process, as it went through, until appointed time that they were ready to make an announcement. But, they did not expect it to be extended process from here. I hope that is helpful, without exactly answering your question.

I would hope we're starting to focus on internal candidates, given the turnaround in the company?

Certainly, I think the Board appreciates the work that's been done over the last nine months. Colin, on the question of capital -- we've talked about this in some of our prior quarters. Let me first say that we are very -- here at the company, we feel very good about the capital position of our life companies. In absolute terms, in terms of the risk-based capital percentage, in terms of -- as we think about it -- cash flow and the risk that are inherent in that block of business -- having said that though, we're not going to be in a position to extract capital from the life companies to be used anywhere, whether it's a holding company -- for any purpose or the supporting growth initiatives in the property and casualty businesses -- until we can have further conversations with our principal regulators and until the point where they're as comfortable as we are. We continue to have dialogue with the regulators here in Massachusetts that continue to be very open-minded and very helpful in those discussions. But I think we're going to -- sort of like the comment you made on rating agencies -- when we're going to see some improvement on rating, that a little more time has to go by before we can see any action in that regard. At the very least, in the relative near-term, we would like to see some capital come out of the life business to support the fixed charges of the holding company. And then, we sort of move from there.

Will you be leaving the capital in the P&C businesses this year? That had been the original game plan, I think, and there's been some movement on that. They will be no dividends from the P&C businesses this year? And then your plan is to regularize (indiscernible) address the debt service needs for the holding company out of the life companies?

Tha'ts right, Colin. We don't expect to take a dividend from the property and casualty companies. This year, we have sufficient funds in the holding company to cover our existing fixed charges in the plan about moving capital out of the life company is more prospective.

Bob Glaspiegal (ph), Langen McAlany (ph)

Just a quick follow-up to Mr. Hubert's comments. Has the Board extended an offer yet on the CEO front?

Bob, as I indicated to Collin's question, the search committee established policy that they wouldn't provide comments on the details of the process or what they've done or haven't done. As I said, they have spoken to several external candidates, as well as the internal candidates. But I'm not prepared to comment further than that.

You're still in studying mode? You're not in action mode? Is that a fair summation?

I'm not sure I would characterize it like that. I think that they've done their homework. And, as they said, they don't expected it to be an extended process from here.

But you feel like the Company could continue to operate for the foreseeable future in the current structure? Is that a fair statement?

I think that it's fair to say that the Board is comfortable with the progress that has been made for the past nine months under the current management structure. But, it is not certainly not a management structure that the Board is considering as a permanent basis.

If I can follow-up on some (indiscernible) questions. Bob, you gave -- I believe 10 million is the strengthening for the prior-year personal lines. You didn't give the commercial lines releases --

Bob, as Henry mentioned, I'm a site off site. And there are some folks back there with the numbers on hand. I've got that number, Bob. Very little activity on the reserve development side -- on commercial lines, a couple million dollars -- favorable.

Okay. On your commentary on AFS' sort of run-rate. Is the back positives in the quarter related to the market sort of one-time and we're back to 3 to 4 million earnings power? Or is the number somewhere in between?

If I'm understanding your question correctly, Bob, it's sort of a one-time thing. So, the guidance we've given is, when we look at $18 million of earnings in the quarter what we have said is about 13 million that is owing to the difference between the 15 percent market increase in the quarter and the 2 percent that was embedded in our original expectations. So, the difference is 13 percent -- the difference is 13 million. So, if you take 18 million we reported and take the 13 out, you get sort of a five-ish number which is sort of core earnings under the 8 percent annual and 2 percent per quarter market depreciation section.

Gotcha. Can you update -- I think each one percent was 50 to 70 million in GMDB sensitivity in the market? Where are we today on that?

The 50 to 70 million was the impact on the net amount at risk. And that guidance still stands.

Thank you.

Angelo Gracie (ph), Merrill Lynch

Good morning everyone. I have a couple of questions. Just to touch upon the life subsidiary capital again. Given that the regulators reduced the requirement of the RBC maintenance to 100, I'm just trying to get an idea as to what the risk-based capital -- where it is now -- why they wouldn't allow a dividend up to the holding company?

Again, I don't think it's -- what I think it is, is it's sort of a matter of additional discussion and a matter of additional time. We feel very comfortable with the capital position and you point out some statistics that indicate that we should be comfortable. Quite frankly, we are just a brief period of time past the difficulties of last year's third quarter. So, we continue to have very active dialogue with the regulators here in Massachusetts. It continues to be very positive. Over the longer term, I feel very good about our relationship and about the prospect of managing the capital and the life business more effectively for the benefit of our shareholders. It's going to take a little bit of time.

Can you give us some sense as to the dynamics within the RBC ratio? You have provided some guidance regarding the redemption rate. Assuming that redemption rate does hold throughout the year -- and let's just assume that quarterly equity market returns remain in the 0 to 2 percent range -- and I am assuming that you are pretty much done with your high-yield bond sales, as far as a wholesale basis. Given those assumptions, how does that impact the RBC ratio going forward -- should we still continue to see meaningful increases in the ratio? Or are we somewhere around where we would expect to be toward the end of the year?

I would say that the primary change to the RBC ratio that we will see between now and the end of the year will be essentially what are the statutory earnings that we produce in the life companies. So, as you said, assets and other action like the high-yield bond reductions, the denominator is probably not going to change dramatically. I don't know if we've given guidance on statutory earnings -- Well, we haven't. But I think, given our expectation on statutory earnings, we would not expect -- barring significant variation in the equity market -- we would expect the risk-based capital percentage change much between now and the end of the year.

On the P&C side, my follow-up question -- a lot of or a number of competitors have discussed some issues in the workers compensation line. And I was wondering if you could touch upon what you are seeing in workers compensation as far as medical cost trends? And where you see that loss ratio going, going forward?

We see some modest pressure on the medical cost curve. We're not nearly as exposed as some of the other companies that have commented on it, because we have significantly reduced our presence in all loss-sensitive. We have virtually no loss-sensitive programs out there -- by that, I mean retros or large dividend programs. A lot of our largest workers compensation accounts, we have either lost or nonrenewed over the past two to three years. And our focus has been very much on the small workers compensation market. We look back over the past five or six years on an accident basis as actually our most profitable segments. So, workers compensation, at least from our perspective and experience is really a tale of two cities. The larger accounts tend to be very, very price-sensitive, very demanding, and very unprofitable from our perspective at least. We have lost virtually all of that. The small segment, main street business, if you will, has been very profitable for us. And that is what we are emphasizing. We have not done -- because of our mix of business and because of our marketing focus and because of the underwriting actions we have taken over the past two to three years in workers compensation, have not been as exposed. And, as we reported, we have seen steady improvements. Not the dramatic improvements that maybe we've seen in commercial multiperil. But definitely steady improvements over the past couple of years.

Looking at the loss ratio in that line in the late 90's, it was more in the low 60's. Over the past couple of quarters, it has been kind of erratic. I'm wondering what kind of normal run-rate that we should expect (multiple speakers)

We want to get it back into the low 60s. It is running in the mid to high-60s right now. But we feel we can get it back into the low-60s, on a calendar year basis. (indiscernible) the closing point I would make on workers comp, is just it's relative materiality. So, if we look at our premiums through the first six months of some $750 million, our workers comp book is about 50 million of that. It is a -- I guess it's more of a relatively small proportion of our business.

Adam Star, CRM. On the at risk amount -- about how much do you have to reserve for each increase -- for the increase in the at-risk amount? Or does it vary on the age of the policy-holder? But on the aggregate, what you think it is?

I assume you're referring to the statutory reserves? That's correct. Our net statutory reserves at the end of June were up 168 million, which is about 4.7 percent of the net amount at-risk which was 3.6 million. So that relationship should hold as the net amount of risk moves up and down by modest amounts.

On a GAAP basis, it's pretty much pay-as-you-go with the mortality reinsurance?

On a GAAP basis, as we said in the past, we have a reserving methodology. We are contributing about 11 million a quarter to that reserve. And then, we pay the claims out of the reserve. And I think as Ed mentioned, the reserve declined from 56 million to -- at the end of the first quarter -- to 41 million at the end of the second quarter.

And that's largely because of the reinsurance premium you paid?

Right now, the reinsurance premium that we pay, which is in the neighborhood of 20 to $21 million a quarter, exceeds, obviously, the 11 million we are contributing with the reserve. It's declining by that amount. Our expectation is that as our 8-percent market assumption plays out that actual claims will drop to a level at or below that 11 million a quarter, over time.

On the P&C, Bob, would you expect the development to continue at that 10 million rate? Or do you think you have got it all reserved at this point?

That's uncertain, Adam. That's something we look at every quarter and twice the year. I think as you know, we also have a third party come in -- an outside actuarial firm -- to give us a test and evaluation. We can compare our loss trends. And by-and-large, we have been pretty comfortable that we're on top of all the reserve trends. The one thing that has been unique in our business are these PIP trends that are in Michigan. Michigan has a unique personal injury protection facility. And the dynamics of it are causing a lot more development then we had expected. And we have been chasing it for about two years. And as I indicated, are getting significantly higher price increases. But in a nutshell, commercial lines continues to perform better than we expected. And personal auto, particularly in the PIP area, continues to perform more negatively than we had expected.

What is PIP item in Michigan? Is it like an uninsured motorist protection?

It is -- in Michigan they have very favorable benefits related to hospitalization and medical costs. And it's first-dollar coverage. And it's up to a certain amount -- it's increasing right now -- but, up to a certain amount and then you go to reinsurance facility. So, it's very vulnerable to medical cost increases, as it is in most places -- the first dollar of coverage. The benefits in Michigan are unusually attractive for the consumer. So, changes and medical cost in general tend to be exacerbated in Michigan. And that's what we been chasing for the last two years. A lot of what other companies -- (multiple speakers) pardon?

There is also a degree of cost shifting, then to your -- (multiple speakers)

There is, as I've indicated in the past, it's further exacerbated -- generally speaking, across the country. But because of the attractive benefit features in Michigan, it's exacerbated there. Because, as the health insurance companies tighten up their claim adjudication practices -- about two to three years -- a lot of that -- a lot of those costs were shifted to auto insurance carriers. And we are one of the largest in Michigan.

Thanks a lot.

(CALLER INSTRUCTIONS) Sam Kittsten, Blackrock. (ph)

Hi guys. Just circling back to the capital position of the life company. Once you're in a position to dividend out some of that capital, I guess the first step is to cover the fixed charge at the holding company. But then, above and beyond that, what would your preferences be? Pay-down of debt, buy back stock, reinvest in something else?

Right now, the first preference would be to support the capital position of our property and casualty companies. As you know, we're operating currently at a (indiscernible) rating of B++, so we're below the A level. So I think any capital we could contribute to the property casualty company would improve that rating situation. That would be the first priority.

Anything further Mr. Kittsten

No, thank you.

Wayne Archamble, Blackrock. (ph)

(indiscernible)

Mr. Archamble, your line is open. Hearing no response, we'll next go to Jeff Thompson, KBW, Inc.

Hi I had a numbers question, first. Do you have the paid losses for property casualty year-over-year, in the quarter, and year-to-date?

We will look for those Jeff. Did you have another question?

Yes. I guess it's sort of the same question. I'm trying to get to the net loss reserve position for property casualty -- if it has gone up or down, since the end of the year?

We are apparently having difficulty putting our hands on that information. Can we get back you off-line?

Sure, just one follow-up. I just want to make sure my math is right. If I exclude the charge for the pool arbitration decision, and apply, you said, a couple of million of favorable reserve development, it looks like the accident-year loss ratio for total commercial lines is around 53, 54 percent. Does that sound right? That sounds right.

Steve Schapiro, SS Investments. (ph)

Hi. I'm sorry if I missed this. But can you explain why, in the first quarter, statutory capital at the life companies went down, but in this quarter statutory capital went up considerably? I understand how the GAAP accounting works and the differences would be with the market movements. But why the dramatic divergence in the statutory capital levels?

Again, the answer is the equity markets. If you remember, the S&P was actually down in the first quarter which resulted in additional GMDB reserves on a statutory basis. The increasing market --the 15 percent rise in the S&P in the second quarter -- allowed us to reduce our statutory GMDB reserves. And that contributed to the swing in results from the first to the second quarter.

If you -- then, can I ask a follow-up? If you exclude the effect of the GMDB reserve, which I understand, how would just the runoff of the book have impacted statutory capital in both catgut quarters?

I think we have tried to get to this issue in the past, by focusing on cash flow as opposed to some of these reserves that have large accounting swings. And we have indicated in the past that we are significantly positive on a cash flow basis for the closed-block of business.

What does it mean, significant? What does that translate to, in terms of dollars?

Our earlier guidance on this was $200 million positive annually. We're looking at those numbers at this point. We'll probably have more to say on it in the third quarter. Those will be down slightly. Our current expectations have reduced a little, because the redemption activities -- we pointed out -- we expect the redemption activity to be low, which means we'll collect fewer surrender fees. But we still expect it to be well over $100 million positive.

Does that mean I should -- does that imply you are running at about a $25 million a quarter run-rate?

25 quarter would be 100. And I said we expected it to be well over 100, so it would be more than that. One of issues that we're having, quite frankly, with giving updated cash flow numbers is that with the SEC's new rules under so-called Regulation G, any non-GAAP financial information we provide, we have to reconcile back to GAAP numbers. And so the accountants are doing a lot of work trying to figure out how to reconcile these cash flow fargoptications (ph) and actual results back to GAAP numbers that are understandable and meaningful.

I guess what I'm trying to do is figure out what portion of the statutory capital is coming from the good amortization in the back asset, versus what portion is coming from a reversal of GMDB reserve? There's no back assets for statutory purposes --(multiple speakers) I understand that.

It relates to the reserves that are put up for the business, as Michael has pointed out. And basically -- essentially I should say, our statutory capital varies from quarter-to-quarter -- has varied from quarter-to-quarter in recent tests, largely because of the movements in the equity market. So, but for those, it would remain relatively stable at the amounts that we began the year with.

Shouldn't the runoff of the book be providing statutory capital?

It is providing positive cash flow, as we have said. Against that on a statutory basis, we still have some surrender charges to amortize which is somewhat analogous to the DAC (ph), although a much lower number than the DAC basis. Our expectation would be that we would generate positive statutory earnings, excluding the impact of the GMDB reserve. In amounts lesser than the cash flow. We probably should do this off-line, but there is a -- I don't know how familiar you are with statutory accounting. There's a contest in statutory accounting that's not DAC -- but it's like DAC -- called CARBON (ph), which is an amortization of a balance sheet item which serves to defer statutory earnings -- which is not cash flow related.

Understood.

It's relatively, quite frankly, arcane and complicated. If you'd like, we can spend some time off-line going through that.

I appreciate your patience. Thank you.

Al Capra (ph), Putnam Wible NBF.

Good morning everybody. Just a follow-up to your comments on lapses. It looks like you are assuming about a 17 percent lapse rate going forward. And I was just wondering if you have done any sensitivity analysis? If should the lapses not come in-line with expectations. Let's say they came in at 10 percent. What impact would that have, for example, on your statutory capital -- your GMDB reserves for example?

I would agree, where roughly 20 percent is a guidance that we've laid out. From a statutory standpoint -- surrenders in the near term, tend to generate a little bit of statutory capital, as we are able to release the GMDB reserves. But from an economic basis, we believe we're better off having the business persist. Because overtime, the fees we collect from the separate accounts are even better than GMDB claims that we expect to pay are more valuable to us than the one-time surrender fees. This is just as a follow-up. If your -- because the financial standing of the Company is improving -- if your lapses were to subside and go to -- say, 10 percent of beginning of period balances -- do you feel that it wouldn't have a material impact on the financial standing of the company? Is that a fair statement? What Michael's saying, from an economic standpoint, if you think of it in terms of the present value of cash flows -- assuming a reasonable market going forward -- growing at 5, 6, 7, 8 percent. We would rather see the business persist. Because the value of future cash flows, where the efforts persist, is greater than the value it surrenders and we just collect the surrender fee.

Okay. Just one additional question. I was just wondering if there are any potential asset divestitures in the life business? Or are the pieces that you have -- for example VUL (ph) important, in terms of funding your turnaround in the life and asset accumulation line?

I think we've talked about that in the past. It hasn't come up so far this morning. The question around can we or are we or should we divest some or all of the businesses or assets on the life side of our business, in the interest of creating shareholder value. It is something that we continually think about as we manage this business in a run-off. We think about it by block of business as well as by -- in total. What I would say right now is, we don't have any current plans to do that -- for any number of reasons, not the least of which is currently a very vibrant M&A market.

That is helpful thank you.

Our final question is a follow-up from Bob Laspiegel (ph) Langlan McClenney (ph)

Just a quick question. How much capital do you think you would need to contribute to the P&C subsidiary, to get an upgrade to A level? What's A&Best telling you?

We've touched on that in the past, Bob. They don't have a per-se or specific answer for that question.

What is your sense -- how much would make it a no-brainer that they would have to do it?

If I could, let me beg-off on that question. It's very difficult for me to say, given the -- right now -- given where our conversations are right now with Best.

So, you're in negotiations with them on that point?

I wouldn't say that, Bob. But, we continue to have dialogue with Best and the other rating agencies around all these questions. So, what I'd like to do is beg-off -- maybe touch on that next quarter as we sort of progress through the year here a little bit.

I'll be back with the question then. Thanks.

We'll be waiting Bob. Thank you.

That concludes our question-and-answer session today. At this time, I'll turn the conference back over to Mr. Henry St. Cyr.

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

That concludes today's conference. We thank you for your participation. (CONFERENCE CALL CONCLUDED)