Hanover Insurance Group Inc (THG) 2003 Q3 法說會逐字稿

Good day, everyone and welcome to the Allmerica Financial Corporation third quarter 2003 earnings conference call. Today's call is being recorded. At this time for opening remarks and introduction, I'd 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 third quarter conference call for Allmerica Financial. I'm Henry St. Cyr, Vice President of Investor Relations. With me this morning are Fred Eppinger, Allmerica's President and CEO, and Ed Parry, our Chief Financial Officer. Also joining us is Michael Reardon, Chief Financial Officer of Allmerica Financial Services. We're very pleased to have Fred join us on this call, and shortly, he will provide you with some observations based on his first eight weeks with us. Following Fred's comments, Ed will discuss our financial results for the quarter.

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, Fred's remarks about our general strategy and our 100 day plan initiative, as well as our comments about capital levels, ratings, future annuity redemptions, Life (ph) company cash flow, and the impact of the decision about our broker-dealer are all forward-looking statements. These forward-looking statements are subject to a number of risks and uncertainties, discussed in some detail in Allmerica's report on Form 10-K for the year ended December, 2002, quarterly report on Form 10-Q, for the quarter ended June 30th, and yesterday's press release, which has been furnished to or are on file with the SEC. In particular, we note that Allmerica's future operating results and financial condition will vary materially, depending upon equity market and bond market conditions, surrender activities and ratings actions, among other factors. Also, I would like to mention that Allmerica's quarterly earnings call, including today's call, our earnings press release, statistical supplement and documents filed with the SEC are all available under the Financial News section of our website, which is located at www.Allmerica.com. In particular, note that information to reconcile certain information discussed here, (indiscernible) the information that is presented under GAAP is provided under the Financial News section of our Web site, which is located at www.Allmerica.com, and is provided in yesterday's press release, which is available on this website.

And finally before I turn the call over to Fred, I want to note that in the current quarter, we adopted Statement of Financial Accounting Standards No. 150, accounting for certain financial instruments with characteristics of both liabilities and equity. As a result, in the current period, we now include in our corporate segment pretax distributions from mandatorily (ph) redeemable preferred securities of a subsidiary trust of 6.2 million. This amount was previously recorded as after tax minority interest of 4 million. In addition, these securities will now be included as debt on our balance sheet, and our statistical supplement has been revised to reflect this income statement change in prior periods. With those comments, I will turn the discussion over to Fred.

Good morning. I'm very happy to be in the call with you, and I look forward to getting to know each of you over time. I'm pleased to tell you that after almost eight weeks on the job, I'm more excited and enthusiastic than ever. I guess the only thing I'm concerned about is Mr. Weather (ph), but I will get over it.

After conducting my own preliminary analysis of the Company and reviewing its operations, I'm confident that we have the foundation in place that will enable us to create significant value for our shareholders. Of course, we have a lot of work to do. And that is part of what I will talk about today. In just a few minutes, Ed will review our results, which show solid progress in our underlying property and casualty business and continued stabilization of our life business.

But first, I would like to give you a report on what we've been doing since I joined the Company. First of all, we've taken a hard look at our various businesses, with the objective of quickly focusing the organization on what it will take to excel. My first priority was to assess the portfolio of our businesses to ensure we were only investing the effort and capital where we can win. Much work had been done on this before I got here, so we could move relatively quickly. In fact, our decision to cease operation of VeraVest is the result of that assessment. While we regret the loss of jobs in the organization and the impact on many talented and dedicated people, this is the right decision for our organization. We simply could not justify further investment in the business and be confident that it would position us to strengthen the competitive position and enhance future earnings of Allmerica.

Going forward, first and foremost, we will build onto the strengths of our property casualty organization to create greater value for our shareholders and customers. We will also work to capture and monetize the inherent value of our life insurance and asset management business.

Today, we are a strong property and casualty company with solid core underwriting and claims skills and a mix of business focused on personal line (ph) to mains street (ph) commercial accounts, that is predictable and much less influenced by many of the major issues and long-term exposures plaguing (ph) the major players' balance sheets.

On the life side, we've made some very difficult but necessary decisions over the last year. As a result, we now have a block of business that will produce strong cash flow for a number of years. We also have a very strong statutory capital base in the life business with a risk-based capital ratio of nearly 350 percent. In addition, we've taken aggressive steps to reduce our exposure below investment-grade bonds, leaving us with a conservative investment-grade portfolio.

Since I joined company, we've launched a 100-day plan that zeroes in on the critical leverage areas of our businesses. The plan focuses on four areas of opportunity that drive -- improved financial performance, identify strategic priorities, and accelerate our efforts to create a world-class regional property and casualty franchise.

All in all, a new clear business focus, a fundamentally strong property casualty operation, a solid life capital position, and a conservative balance sheet form a good foundation on which to build. However, hot in order to increase our return on capital and create value for our shareholders, we need to have a laser focus on improving our financial performance. We will blend the results of the 100-day initiative with the work on our longer-term strategy to form a plan for 2004. And we will schedule, with all of you, an investor conference in the first quarter of 2004 to share our plan with you.

Now I would like to just briefly go over the four areas of the 100-day plan. First area of focus of our 100-day plan is to restore our A ratings. A tremendous amount of work has been done over the last year to address the concerns of the rating agencies. We have restored our capital level in our life business; we have reduced our exposure to volatility (indiscernible) a market movement; and we have upgraded the quality of our investment portfolio. Since joining the Company, I have met with each of the rating agencies, listened to their concerns and shared our initial plans with them. We've made a lot of progress in this progress, and we are committed to working each of them to restore our ratings as soon as possible, particularly those for our property and casualty business. As you know, our current ratings were driven by a severe market decline and the corresponding impact on our life companies. It's time now to demonstrate that we have regained our financial strength to warrant an A rating. We have a strong property and casualty franchise that consistently has performed better than the industry average, and we're now focused on becoming a top quartile performer, with a focused strategy and outstanding execution.

The second area of focus of the 100-day plan has been to identify and capture performance improvement opportunities in our core lines of business. In both personal and commercial lines, we're assessing mix, pricing and underwriting opportunities, as well as setting priorities for improvement in the operating model. I believe there's meaningful opportunity in each area, and we have a dedicated team assigned to identify and capture these opportunities.

The third area of attention is to streamline and focus our organization. Now that we've clarified (ph) our business portfolio, we must streamline our organization and consolidate many of our corporate functions with our (ph) property and casualty functions.

The fourth area of focus is building and aligning our talent. In this execution-based business, aligning business opportunity with talent is critical for our success. We are currently assessing our skills in each of our local markets, and this information will be used to drive people acquisition and development plans as well as our growth plans. In each of these areas, we are moving forward and dedicated teams in every one of these opportunities.

I would now like to briefly share with you some thoughts about the property and casualty industry, and how I see our opportunities going forward. I believe there is a tremendous opportunity in the industry today, as many of the larger players face financial difficulties and many of the smaller players lack the skill to compete. Agents and brokers are looking for financially stable, well-performing regional companies with whom to partner. To become that trusted partner, we will do four things well. First, we will know our agents and markets better than anyone, and we will build lasting partnerships with the best agents. Over the last several weeks, I have already met with more than 300 of our best agents, and it is clear we have a base of outstanding, committed agents to build upon. However, there's an opportunity to improve our distribution management capabilities. We'll build growth plans with each of our best agents that proactively match their market opportunities with our capabilities. In addition, we'll proactively manage our mix and yield by agent partner, which will allow us to manage expense and underwriting results much more effectively.

Second, to be considered a top regional franchise, we will continuously improve our underwriting consistency and effectiveness at the local level. We'll build on our capabilities in both personal and mainstream commercial lines, bringing better and more timely information to the front-line underwriting decision. Given our 100-plus years of experience in both businesses, and our leading position in many of our agencies and markets, we believe we can make significant progress in this area quarterly.

Third, we will focus on building an efficient and effective operating model, a combination of high-tech and high-tech. I looked carefully at our technology capabilities and plans before accepting the job here. And I believe we have a good starting point. But we must focus our current investments on making Allmerica easier to do business with. I believe we can be stronger here, particularly in the main street commercial business area. We have a solid operating model for main street business, and given our technology investment and long-tenured front-line folks, we will turn this into a distinctive advantage.

Finally, we will attract, develop and motivate outstanding people, both in leadership and front-line. This is an execution-based business and employee performance matters. I have met with all employees in recent weeks, many in groups of 50 or less, and I believe our front-line team is as good as any company of our size in the industry. And we will continue to build on this until we are the envy of the industry.

In summary, I believe with a focused strategy and improve execution, we can build a world-class regional company, targeting main street commercial and personal lines. As I said earlier, I'm excited to be here and I look forward to our journey ahead.

With that quick overview, I would like to now go to Ed, who will do our quarterly results and implications of our VeraVest decision. I would be happy to answer any questions later in the call. Thank you.

Thank you, Fred, and good morning, everyone. Thank you for joining our call.

Before I comment on our results, I would like to mention that Henry St. Cyr has recently announced his plans to retire at year-end. As most of you know, Henry's service to Allmerica has spanned some 31 years, during which he has held a number of senior corporate and business unit positions. His contributions have been many over the years, and he will be missed by those of us who worked closely with him. Over the next several weeks, Henry will be introducing all of you to Sujata Butalla (ph), who'll be replacing Henry as Vice President of Investor Relations. Sujata has held a number positions at Allmerica over the last 17 years, including senior analytical positions in our property and casualty business. I'm confident you'll find Sujata knowledgeable, helpful, and a pleasure to work with.

Now let's turn to our third-quarter results, which we are pleased with, overall. For the quarter, we reported net income 11.4 million, or 21 cents per share versus a net loss of 313 million or $5.93 per share in the third quarter a year ago. The current year earnings including an after-tax charge of 7.2 million or 13 cents a share related to the closing of VeraVest.

In our property and casualty operation, we reported lower earnings compared to last year, due in large part to higher pretax catastrophe losses in the current year. After adjusting for this, results were down slightly due to an unfavorable comparison of prior-year results, almost entirely offset by premium rate increases and improved current accident-year loss trends. In (indiscernible) excluding the $11.1 -- $11 million VeraVest shutdown charge, earnings were in line with our expectations, given equity market performance for the quarter and our continued focus on expense management. Moreover, our life insurance company saw further improvement in their statutory capital position and risk based capital ratios. Additionally, we continue to see strong positive operating cash flow in line with operation expectations.

Now I will turn to a discussion of our segment results, where total segment income was 14.1 million for the third quarter of 2003, as compared to a segment loss of 500 million for the third quarter of last year. You will recall that segment income includes the AFS charge of 11.1 million, is before a tax benefit of 5.2 million and before a number items, including net realized investment losses, a gain on a retirement of funding agreements, certain restructuring costs, and a gain on derivatives, which all totaled a net loss of 8.3 million or 15 cents per share.

In the quarter, our property and casualty business reported segment income of 38.6 million, down from 58.5 million a year ago. As I just mentioned, this overall decline of 19.9 million was due in large part to an unfavorable comparison in catastrophe losses. Pretax catastrophe losses were 12.9 million higher in 2003, at 16.9 million, compared to the unusually low 4 million a year ago. Adjusting for catastrophe, the earnings decline, quarter-over-quarter, was $7 million. This decline is due to an unfavorable comparison of prior year's reserve development of approximately $23 million, primarily in worker's compensation, and commercial umbrella. Partially offsetting this are improved current accident (ph) year trends as we continue to benefit from rate increases in commercial lines and to a lesser extent, personal lines. More specifically, commercial lines pricing on renewal business is up over 10 percent from last year. What's more, homeowners continued to benefit from increased rate, primarily in the Midwest, as we recognized double-digit price increases in the quarter.

Now let's take a more detailed look at our lines of business beginning with commercial lines, where overall result continue to be solid. Commercial lines statutory loss ratio was 58.2 percent in the current quarter versus 52.9 percent a year ago. The combined ratio was 98.1 percent versus 92.8 in the third quarter of '02. As I mentioned earlier, the primary reason for the increase in the current quarter is due to the unfavorable comparison of prior year development and workers' comp and commercial umbrella. In workers' comp, our statutory loss ratio in the quarter was a high 81.3 percent, up from 45.3 percent a year ago. This year we reported adverse development of 6 million, whereas last year, we reported $15 million of favorable development for the quarter. Last year's favorable development was somewhat unusual, related to a change in the calculation methodology used by the reserving actuaries. This year's adverse development relates primarily to Hanover. While the locality of results in the first quarter were weaker in this line, we continue to see improving results in the current accident year for both Hanover and Citizens. In fact, excluding development, our loss ratio stands at 64 percent in this line.

Looking at our key commercial drive lines, both commercial multi- (indiscernible) and commercial auto continued to deliver very good results, solid returns and lower our statutory loss ratios. Commercial multi- (indiscernible) statutory loss ratio was 53.9 percent versus 56.8 percent a year ago. While commercial auto reported 42.4 percent versus 48.4 percent a year ago. These lines continue to benefit from rate increases we've achieved over the past two years and an improvement in underwriting. On an accident-year basis, results in C&P are relatively flat, with current accident year loss ratios of 48.5. While we continue to see marked improvement in commercial auto, with a current accident-year loss ratio of 50.4 percent.

While we remain pleased with the overall profitability and returns in commercial lines, production remains a challenge. Commercial lines net premiums written decreased by 9.2 percent in the current quarter. Although this decline is primarily due to agent management actions going back to 2001, we need to bring additional focus to growing business with continuing agents. Our retention has improved, but we need to accelerate momentum while attracting a higher volume of new business with our key agents.

Moving on to personal lines, our overall reported statutory loss ratio increased slightly to 68.8 percent from 68.1 percent a year ago. However, these results were negatively affected by higher catastrophe losses in the quarter. When adjusted for catastrophe experience (ph), our personal lines loss ratio improved by 2 points to 65.5, down from 67.5 a year ago. Personal auto statutory loss ratio decreased slightly to 71 percent compared to 71.5 a year ago. You may recall that in our conference calls earlier this year, we discussed adverse trends regarding Michigan personal injury medical protection. During the most recent quarter, we had begun to see a leveling off of this adverse trend. Our substantial rate increases for this coverage appear to be catching up with the loss trend.

Homeowners reported a statutory loss rate ratio of 64.6 percent in the quarter, up 3 percentage points from 61.6 a year ago. However, excluding the impact of catastrophe losses, the loss ratio declined by just over 6.5 points to 52.2 percent in the current quarter.

Our homeowners' line is improving as a result of the significant pricing actions we've taken over the past several years and the enhancements we've made to our underwriting process. Personal lines posted a 2.5 percent increase in net premiums written, led by homeowners' premium increased 12 percent, due to increased pricing, partially offset by a 1 percent decrease in personal auto.

The decline of personal auto premiums was driven by agency management actions going back to 2001, a decrease in new business in Massachusetts, and a reduction in our participation in the mass (indiscernible) of auto reinsurers pool (ph) or car. These declines were mostly offset by increased production from our continuing agents where direct volume (ph) to (ph) our (ph) written premium was up 5 percent.

Looking at accident-year trends, personal auto is virtually flat, as improvements in our property lines and liability lines at Hanover have offset our deteriorating results at Citizens. Homeowners' accident-year results continued to show improvement.

During the third quarter, our statutory underwriting expense ratio was 29.1 compared to 28.8 a year ago. As we've indicated in our prior calls, the increased expense ratio is consistent with our expectations and has primarily to do with higher pension costs and higher contingent conditions.

Now let's briefly discuss Allmerica Financial Services, where, as I mentioned earlier, we reported a segment loss of 5.8 million for the quarter versus a loss of 540 million a year ago. As you'll recall, it was in the third quarter of last year we made the decision to cease the manufacture and sale of proprietary variable products. This decision triggered several accounting charges, including a $487 million direct pretax write-off of DAC (ph), and $106 million pretax charge to create a guaranteed minimum death benefit reserve. as well as certain other smaller charges. AFS's earnings for the current quarter were in line with our expectations given equity market performance, and the $11.1 million charge related to the decision to cease the broker-deal operation at VeraVest. First, I want to make a few comments on the closing of VeraVest. Over the next several months, we'll be taking the following related actions. We will cease all sales of nonproprietary, variable and fixed insurance products, mutual funds and (indiscernible) business through VeraVest Investments Inc., and its insured agent (indiscernible) affiliate. We will dismantle the VeraVest home office, and field infrastructure. We will close all of our branch offices in the field, and we will sever our registrations with all remaining VeraVest advisers which currently number 850. In addition, the decision will result in the elimination of several hundred jobs at our corporate office and in the field over the next several months. The entire process should be substantially complete by year end. At the end of this process, we'll maintain a limited broker dealer to service our existing variable business. During the fourth quarter of this year, we expect to report an additional charge related to the shutdown. This charge is expected to be in the range of 25 to $30 million on a pretax basis, and relates primarily to severance and lease termination costs.

Now let's look at variable annuity redemption activity. In the third quarter, individual annuity redemptions were approximately 494 million and consistent with our expectations. This compares to 553 million in the second quarter, and 1 billion in the first quarter of this year. At this time, we expect the redemptions for the fourth quarter will be about the same level, about 500 million, and our full-year total will be approximately 2.6 billion. In the fourth quarter of 2002, we began talking about operating cash flow as an important metric in understanding the economics of our life business. With the introduction of Regulation G earlier this year, we are required to reconcile any such non-GAAP measure we discuss to a reported GAAP number. To facilitate this reconciliation, we have developed a measure which we are calling "segment income excluding certain non-cash items." The principal excluded items are DAC (ph) amortization, the change in GMBB (ph) reserves, and certain other small, non-cash amortization charges. Going forward, we will use this measure as a proxy for what we have referred to in the past as operating cash flow. We believe this measure is a reasonable approximation of operating cash flow. In the third quarter, this number was approximately $32 million, and we expect the fourth quarter result to be consistent with this number.

Now let's look quickly at guaranteed minimum death benefits for the quarter, where we saw our expenses of $11.5 million on a GAAP basis. Our GMDB cash costs was almost 21 million for the quarter, the bulk of which related to our mortality reinsurance premium. At the end of the third quarter, our GAAP GMDB reserve was 32 million, down from 41.4 million at the end of the second quarter of this year. Our net amount at risk continued to decline due to the improvement in the equity market and redemption activity. The amount (ph) of our risk in our variable annuity products decreased to 3.3 billion at the end of the third quarter compared to 3.6 billion at the end of the second quarter of this year, and 4.7 billion at the end of last year. Also by way of comparison, a year ago, our net amount at risk was $5.3 billion.

Briefly, the asset management segment income was 5.2 million compared to 5.7 million a year ago. The current quarter's results include 2.9 million of a foreign currency exchange fluctuation. Net of this gain, earnings for the quarter were 2.3 million. This net decrease was due to continued wear off of funding agreements, and the effect of replacing high-yield investments with lower yielding, higher-quality, fixed income securities.

Now a brief comment on our statutory capital, risk-based capital position in our life companies. As the result of higher equity market values during the quarter, we experienced further increases in the capital position and risk-based capital ratios for our life company. The consolidated total adjusted capital for Afliack (ph), our lead life insurance company, increased to 548 million, up from 536 million at the end of the second quarter of this year. All but a risk-based capital ratio of Afliack increased to 349 percent at the end of the quarter, up from 344 percent at the end of the second quarter. We continue to believe we have a very strong capital position in our life insurance company, as evidenced by these amounts, ratios, and very strong income, excluding non-cash items.

Finally, a (indiscernible) comment on (indiscernible) charges, which could effect the fourth quarter of 2003, and possibly to a lesser extent, the first quarter of 2004. As a said a moment ago, we expect to record a charge relating to the shutdown with our decision to exit VeraVest. We estimate, as I said, this charge will be in the range of 25 to $30 million. In addition, as Fred mentioned in his remarks, we have underway a 100-day planned initiative. This initiative includes an extensive review of our operations, and could result in related charges.

And finally, the new statement of position related to GNP reserves must be adopted by all companies effective 1/1/04, and presented as a cumulative effect of an accounting change. This obviously applies to us. At this point, it is difficult to predict the amount of the related charge. This is in large part due to lack of clarity in the statement of position on how exactly to implement the required changes. Please keep in mind whatever charge we will record will affect our GAAP numbers only. As we learn more about this new SOP and related accounting, we will keep you informed.

With those comments -- all of those comments -- I will turn the call over to Henry.

Thank you. And operator, at this point, let's open the call for questions.

Thank you. (OPERATOR INSTRUCTIONS). Colin Devine with Smith Barney.

My question, I think, this morning -- I just want to focus on the cash flow of the life companies. And now given the very strong RBC (ph) position, when are you going to be able to start taking it our of there, getting it up to the holding company? Obviously, there's debts (indiscernible) obligations next year, but I think more importantly, getting some that cash back to shareholders. I recognize the rating agencies, I'm sure, have a voice in this.

Yes, Collin, as we've said in the past, we continue to work through this with regulators here in Massachusetts and with the rating agencies. And I think we continue to have productive conversations with all of those groups. It's not possible for me to predict, today, on this call, when we might see the ability to remove some of what I view as excess capital from the life companies. But we're working very hard on it.

And as a follow-up, don't you have to be able to do that to service your debt obligations next year? Where is the holding company going to get the cash, since I understand you agreed to leave it in the P&C businesses?

Right now, Colin, the holding company has a sufficient cash position to meet its obligations in '04. For '04, we don't need to do that.

Okay. I assume there's been no change (indiscernible) P&C businesses; that you will continue to just let the cash build up there?

Yes. The plan is to retain the capital in the P&C business to fund the '04 obligations, in part, from existing cash flow. And then as I said, we're working with rating agencies and regulators around moving some cash out of the life company.

Is part of that -- are you considering looking -- given the recovery in the markets, just fully heading it away as best you can, all of the market risk, in the VA (ph) block, so we can get this shutdown and drive on from here?

Yes. That is a good question, Colin. Obviously, a lot has been accomplished in the last year around increasing the capital position. And that, in and of itself, has reduced, significantly, the potential volatility to that capital position. But, hedging that block is a strategy that could obviously be helpful. We've done some work on that over the past number of months. And we think there's some possibility there. And I think that is something we'll be talking more about in the future.

Okay. Thank you.

We will go next to Bob Glasspiegel with Langen McAlenney (ph).

Let me first of all wish Henry well and a lifetime of lower handicaps in the future. Fred, 100-day plan, typical Insurance 101, new CEO of management, which you haven't been a consultant appreciate is, you build the reserve and get the balance sheet right, at first. Can we look at -- have you taken a good, hard look at the reserves, and you're comfortable where they are for now? We can see this modest reserve increase this quarter as having put your stamp on it? Or is there something further that needs be done?

We are actually in the process. One of the initiatives of the 100-day plan is actually taking a look at our reserve positions in all our lines. At this early review, there is nothing that looks surprisingly troublesome. But we have an ocean on a reserve, kind of review of all the lines (indiscernible). So our information should be coming together through the fourth quarter.

Have you hired outside actuaries to do that? Are you doing internally only?

Yes. We actually have got some help to review that. And we have brought a firm to help us.

Okay. It seems like we now have a regional PC company with a life company that is essentially run off -- thrown off, as you say, 130 million in cash flow. Is that the right way to think about the pieces?

Absolutely.

Okay. I was wondering if you can compare and contrast where you think Allmerica is relative to what you had at Hartford, you know, the strengths and weaknesses -- maybe the strengths and weaknesses of Allmerica relative to the Hartford franchise that you saw firsthand. Do you think there are economies to scale the business? Do you have to get a lot larger ultimately? Or you really just want to stay a regional company, and think that there are not economies to scale to the business?

Let me give you some reactions to that. I do think there is economies of scale in the business, and I think that's why the 200 or 300 little regional companies that have very small positions are going to have a hard time to keep up with the automation, expenditures and kind of the connectivity expenditures that a good company is going to have to have working with independent agents in an efficient way. I think we are well beyond those scaled numbers though. And I believe that our concentration will help us on the claim side to capitalize on any scale as well. As far as our current position and my feelings and thoughts about where we would be, I've always been very attractive over the years to the regional company platform, primarily because a lot of the national players have huge legacy issues, as we all know, about the 14-year (ph) soft market, California comp, asbestos, environmental. And I've always felt that the regional platform, if you could get it to the right scale and focus on execution, would be a great platform for kind of consolidating if you will; and I don't mean in acquisitions, but consolidating the market through terrific growth at the agent level. And so, I believe very strongly that we have a platform here to build off of. And in the regions we choose to compete in, I think we're going to have a very viable offering in small commercial and personal lines that can compete with any of the significant players.

Our operating platform, our automation here -- is something the last 15 years with, and worked with many of the leading players in this industry -- not all. And I feel we have a great starting point. There are a lot of things that the large players have and we can build off that. So I'm comfortable that if we're focused and we have a lot of intensity around execution that we can compete very effectively in the segments ages. I don't think you'll see us going into the national account market or large middle market. I don't think that fits our skill set or our capabilities. But I think in small commercial and persona lines, we could be effective in the states we choose (ph).

Okay. Great answers. Next question, GMDB, in the money, death benefits as of today?

We reported 3.3 billion at the end of September as Ed mentioned. As of yesterday, the S&P was up about 3.5 percent, which would knock another, approximately, 250 million off of that.

Thank you.

Adam Star with Cramer Rosenthal.

Thank you, and good luck to you, Fred. With your determination to emphasize the regional PC business, is there any potential for accelerating the realization or the value in the other businesses? Can the agency relationships and plant and VeraVest be sold to anyone? Is there any way of selling or monetizing at least some of the run off variable annuity business, either one of the three blocks or possibly more of it? And, so that you can really focus your management efforts and your capital in your future businesses?

Good question, Adam. Our goal, obviously, is to maximize the economic value of our life business and our life block. At this time, given the markets, we believe the best way to do that is to manage internally, and then maximize the value to our shareholders by running them and managing them. I think we will constantly be thoughtful that and look at the market and see if there's an opportunity to do something else that would maximize the value. But right now, that is the decision we've made based on our assessment. (multiple speakers).

That is exactly right.

So in other words, you don't think you could get fair value, even for, say, the partner piece or something like that.

We think it's worth more to us right now, in terms of the present value of future cash flows than it would be in any kind of a transaction. But as Fred points out, we will continue to monitor that, and that could change over time.

I (indiscernible) to think that somebody else who has the infrastructure in place to get some cost out. You guys could split the difference or something.

Yes, theoretically. But when you get right down to the dollars and cents, it's as much a function of appetite and priorities of fires (ph) as it is the pure economics. I think we know the market pretty well out there from an M&A standpoint. And we're not married to one strategy versus another. What we are married to is the objective, and that is to maximize the value of that block of assets.

I understand. And is it getting some of the capital out would not get a higher return by improving the P&C position and eliminating some distraction?

Right.

Also, was there any value that could be realized from the VeraVest plant?

As we thought about this decision, and started to execute to it, we obviously thought about whether it would be beneficial financially to us to see if we couldn't structure a deal with somebody around that distribution channel. In fact, we had conversations with a number of companies. But the final analysis became clear to us that as we think about the overall objectives from AMC and clarifying the organization, and what we're trying to do with our capital, human and otherwise, that it made best sense for our shareholders to exit, shut it down and move forward.

Just to be expeditious about it.

And to get focused, as Fred pointed out.

I understand. Has the rating agencies issue been that much of a handicap, still in the property, casualty business? Or have you been able to work around it fairly well?

In terms of in the marketplace?

Yes.

I think it's -- our agents have been very loyal. And the flow of business and the type and quality of the business has been fine. We watch that, obviously, really carefully. I do think it hinders us on new business. I have had a lot of conversations with folks. Particularly when you get to the mid to upper size broker that has small commercial that would like to get a regional player in there, they are more cautious about putting (ph) new business. What is interesting about it is that I've had, oh God, dozens of phone calls from folks that want (indiscernible) relationships with us, and are starting to have conversations with us, and are poised to move as the rating comes back. So it hasn't affected, really, our current business. But it has affected, I would say, new business opportunities.

So ideally you would like to be able to get the rating -- to get more agency appointments over the next --

Yes and change the level. We have a number of the right (indiscernible) of these territories. But there are people that we haven't had deep relationships in the past that are terrific agents, that aren't going to change their position dramatically as we are in this spot. So it is both new appointments and it is deepening penetration with folks that want to really deepen their relationships with us, given all the turmoil in the marketplace.

What about the endorsed personal lines business? Has the ratings been an issue there?

On the sponsored side, Adam, it's been more of an issue there than it has been in other parts of our personal lines business. But the segment that it's impacted is the infinity segment. It has not affected our open group business, which is where we have the vast majority of our sponsored business (indiscernible) state of Michigan.

How much premium do you think that it has cost you?

Well, you know, in the infinity business, in terms of new business, it's probably cost us 15 or $20 million in premium, would be my guess. That’s a block that’s got about $100 million in premium.

That's a block that's got about 100 million in premium.

So, it (indiscernible) if you could grow it again.

Yes.

Okay. Thanks a lot. I will let some other guys throw you some softballs.

We will go now to Angelo Gracey (ph) with Merrill Lynch.

Good morning, everyone. Thanks for the call. A couple of questions on the P&C side and then on the life side. On the P&N side, looking at the combined ratio, looks like for the most part, some of the increase in the combined is really coming on the expense side. I want to get your view on how you think getting the ratings back to A from AM Best would impact the expense ratio going forward?

I think where it is impacting the expense ratio is in the commission area, where we spent some money to maintain the relationships that we had. I think the final answer or the bigger answer, I should say, on the expense ratio, is not so much related to ratings; but as Fred pointed out in his opening remarks, clarifying the organizational structure here at Allmerica as we moved from a company that was in two businesses, life on the one side P&C on the other side, to a more efficient, regional P&C platform.

I think the other place is, obviously, we have a cut through arrangement -- reinsurance arrangement that was costly as well. So it is the contingent commission, the cut through in the reinsurance contracts. And as Ed said, we believe there's lots of opportunity to focus the organization. So I think that's an area where you will see improvement in the future.

Do have any targets -- let's say maybe a year or two down the line where you would like to see that expense ratio?

We obviously will be developing that as far as (indiscernible) as well and with a lot of other targets as we develop the 100-day plan. So right now, it is a little premature to (indiscernible) lay out the targets because they are being developed as we speak.

On the life side, I'm trying to get a handle as to what -- what can happen here with the business. And you know, just moving away from a sale, because clearly we don't what can happen there. But if we assume that no sale happens, and we're running this business down over time, I'm just trying to follow the logic here. You know, you are winding down the broker-dealer operations, and it certainly appears like there's going to be a reduction in the service of the accounts to some extent. I'm wondering to what extent that could increase or accelerate redemptions in the variable annuity block. And from that, where do you see DAC recoverability in the variable annuity business, both from your view of your communication of 4Q redemptions probably staying flat relative to 4Q? And how it would change if you saw an acceleration of redemptions going forward?

Let me first say we don't have an objective of reducing our service levels to the point where it impacts retention. We do expect to be a lot smarter and more efficient around our service operations. And we think now that we're moving to get out of distribution business, that will make it much easier for us to accomplish. So and I think that we know over the longer term, assuming reasonable market levels, this business is worth more to us in future cash flows than it is in near-term surrender charges. We talked about the 30 to $40 million a quarter of positive cash flow. So, I think the way to think about it is, as we mentioned earlier, it is a run off block of business that we're going to manage very efficiency from an expense-based standpoint. We're going to maximize our cash flow. We're going to maintain our customer relationships in an effort to retain the assets so that we can reap the benefits of that, either through cash flow that we get by retaining it, or cash flow we get by disposing of it. That is the game plan.

You will have to come to your view on value. We give these cash flow dollar amounts in order to be helpful. We also talk about the statutory capital base as another thing that we think is helpless as people think about value. And of course we have GAAP book value, which is still roughly $1 billion. And if you think that we well generate sufficient profitability to earn in the DAC, that's another applicable benchmark as you think about value. So when we think about it, we sort of think about all those factors.

I guess it's not entirely clear what the plan is going forward -- because this is a runoff operation, but at the same time, it does make sense to maximize the value in that business. But there are kind of conflicting messages as to, you now, would you prefer to wind this down as quickly as possible, or to retain and suck out as much value as you can? It seems like the latter answer is what you're saying.

Yes, it's the latter, because we know under the vast majority of market scenarios, it's worth more to us retaining it than it is watching it surrender away. So long as we manage it properly, which we have every confidence we can do. Although it is possible, at some future point in time, that there is a buyer that sees more value in it, or as much value in it as we do. At that point, we would think about a transaction. But as we stand, the market is not at that point. The M&A market is not there at this point. So as we think about it, we'd much rather retain it and manage it.

So what you are also saying is, you're not overly concerned about the GMDB exposure?

We're really not. You know, we've got the capital; we've got our RBC at 350 percent. Our statutory capital is well over $0.5 billion. We can withstand a shock equity market decrease of, at this point, over 60 percent.

And Colin asked a question early on about potential hedging strategies, which are starting to be developed in the marketplace which we are actively looking at. So, I feel very good about it.

Great. I'm sorry, but just one more thing. You did mention before that you have enough cash at the holding company to support interest expense through all of '04. Last quarter, it was through the first quarter of '04.

Yes. I think -- Henry was just giving me some numbers. I think on an after-tax basis, our expected beginning cash flow is just about sufficient to pay those obligations for '04.

For all of '04?

All of '04.

Wayne Archambough (ph) with Blaylock (ph) Capital.

Good morning. Just for Mr. Eppinger, can you give us some sense as shareholders how your interests are aligned with ours in terms of how your compensation is structured, options, and how your bonus is derived? Thank you.

We will release in our public statement. It's obviously the options that I was given are tied to the performance of the company as well as my bonus, long-term bonus, is going to be tied to the performance of the institution. So the vast majority of my compensation is tied to the overall performance and financial performance of the institution.

Thank you.

Aaron Tone (ph) with Carsh (ph).

Two questions, gentlemen. Thanks to taking the call. The first one is, closing on VeraVest, do you have an estimate of the cash flow impact in terms of cost savings you would get for '04? And then the second question is, you mentioned an A rating; I assume that's at the operating subsidiaries? What would be a target for the holding company in terms of credit ratings?

The question on VeraVest and its impact on '04 -- let me beg off on that a little bit. As Fred mentioned, we're going to be having an analyst meeting in early '04, in Q1, and talk about our plans. Although I will say that were sustaining losses with VeraVest, both on a cash and non-cash basis. So once we get through these charges here in '03, it will have a positive impact on cash flow and on earnings. But we will quantify that for you going forward. I'm sorry; your second question was around?

The second question was around ratings. You mentioned you're looking for an A; I assume that is at the subsidiaries. I was wondering if you got an A at your subsidiaries, what would be sort of your target for the holding company?

We're very focused on -- first and foremost, we're very focused on the P&C ratings, and in particular, on AM Best, but S&P as well. At the holding company, I think we have an objective to get them back to investment grade levels, but we recognize that the journey to getting those there will probably be a little bit longer, in large part because they are dependent on the ratings of the life company and the notching process that is used by the rating agencies. We are very actively pursuing A ratings at the property and casualty business. And we believe that our capital position is sufficient, currently, to support that. I think at the holding company, it will be a little bit longer.

Thank you.

Richard Diamond (ph) with Inwood (ph) Capital Partners.

Following up on the rating agencies, at the P&C companies, to achieve and A rating, could you provide us with a potential time line please?

It is difficult for me to do that because we don't have a time line that's been agreed to with the rating agencies. So what I can tell you is what I've already told you, which is, we believe we've made a lot of progress. We feel very good about the capital position in all of our companies. We are having active and what we think are productive conversations with the rating agencies. We're going to continue to have -- we're going to have additional dialogue with the rating agencies in December around the 100-day initiative and around our thoughts for the plans for '04. And we're hopeful that all this comes together with a favorable outcome from the rating agencies. But I can't, obviously, predict when that might happen.

But it's fair to say that I won't be aggressive in assuming a move to A within the next twelve months?

Yes. I wouldn't say within the next twelve months that that is aggressive at all. But again, since we don't make the decision here, it is hard -- it's really very difficult for me to say.

Secondly, what was the impact from Hurricane Isabel on the quarter in your catastrophe losses?

$9.5 million, pretax.

Third, on VeraVest, are there potential annual savings at the corporate level that we should begin to factor in, as you slim down the corporate staff?

Yes, as Fred mentioned, he's asked a number of us to look at this question. There are a number of teams looking at it. That will get folded into the results of the 100-day initiative, and it will get folded into our '04 plan, which we will talk to you about in early '04. But there is savings that we expect, yes.

Last but not least, in workers' comp in the adverse development, is that something we should expect going forward? Or do you think you've -- by increasing reserves at least for the near-term, you've resolved the problem?

Yes. The adverse development that we have seen in workers' comp, we are really foreseeing in this quarter. And so we're taking a hard look at it. It's a little premature, given the fact that we've just seen it, for me to make prognostications about whether we will see it recur. Although I will point out, this is a very small line for us. Our annual premium at workers' comp is just over $100 million. So, even if we find we have a bit of an issue there, I wouldn't expect it to be particularly material going forward.

Okay. Thank you, very much.

The other comment I would make on that is, Fred pointed out in response to a question earlier, we are taking a hard look at all of our reserves including workers' comp. And we will talk about the outcome of that, no doubt, in the fourth quarter.

Thank you, very much.

Juddd Nustorf (ph) with Forest (ph) Capital.

Good morning, guys. Henry, best of luck. Are you guys seeing anything, as long as your ratings stay low in the life business, of sort of buying back some of your gicks (ph) like you did in the first quarter. Are you guys seeing any more? Are you guys still actively doing that? Ed, I guess that's for you.

We are actively doing it, although there aren't very many sellers. I think we bought back about 13 million of face in the third quarter. So we are very active in the market. It's just the market, given the strength in the capital position in the market is not very broad (ph) at this point.

Okay. And Fred, I think a lot of us down here in New York are (indiscernible) meet you; and we are just curious in terms of when you think you'll be able to sort of get on the road and start to meet investors.

It will probably be relatively quickly. As I said, we've been relatively busy trying to get some of these decisions made and get the 100-day plan put together. But we are now in the process of scheduling some meetings in the next quarter, as well as we are setting that investor conference, as I said, in the first quarter so that we can get focused in and kind of review our plans as well. Both will happen relatively quickly.

All right. Great guys. Keep up the good work. Thanks.

Operator, we will take one more question if we have one.

And our final question will come as a follow-up question from Bob Glasspiegel with Langen McAlenney.

One last question. Fred, I assume that we're not going to replace Mr. Restrepo, and that you're going to be heading up the PC operation? Or is that an incorrect assumption?

That is absolutely correct. What you'll see is an operating committee that handles more like a traditional P&C company. I believe very strongly that we all need to be a lot closer to the market in this kind of execution-based business.

So there will be a leader corporate holding structure, if you will.

Absolutely. And we will have a head of personal commercial that will join our operating committee to go forward.

Is that outside, or is it --?

Right now, I'm assessing candidates in commercial. I feel fantastic about our team. In personal lines, I'm assessing candidates right now to run the personal lines business, so that we can bring in some additional capabilities.

Okay. Thank you.

And we're standing by with no further questions.

Operator, thank you. 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 third-quarter results, and we look forward to speaking with many of you very soon. Thank you.

Once again, that does conclude today's conference call. Thank you for your participation. You may disconnect at this time.