Hanover Insurance Group Inc (THG) 2004 Q3 法說會逐字稿

Good day, and welcome to the Allmerica Financial Corporation third-quarter 2004 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, Ms. Sujata Mutalik. Please go ahead, ma'am.

Thank you Peter. Good morning everyone and welcome to our third-quarter earnings conference call. With me on the call today are Fred Eppinger, our President and Chief Executive Officer; Ed Parry, our Executive Vice President and Chief Financial Officer; and Marita Zuraitis, President of Property and Casualty Operations. Also here available for questions are Michael Reardon, President of our Life Companies; and Mark McGivney, Chief Financial Officer of our Property and Casualty business.

On today's call we will give you our third-quarter financial results and discuss further progress on our strategic initiatives for the year. Today's discussion will reference certain non-GAAP financial measures such as segment income after taxes and net operating cash flow or what is designated segment income excluding certain non-cash items. A reconciliation of these non-GAAP financial measures to the closest GAAP measure is included in both the press release and the statistical supplements which are posted on our website.

Our prepared remarks and responses to your questions today may include forward-looking statements, in particular remarks about our general strategy, comments on underwriting conditions, expected growth, retention and loss development as well as expectations regarding new product availability and impact, capital levels, ratings, future annuity redemption, life company cash flow and the performance of our GMDB hedging program which should be considered forward-looking statements. These statements are subject to a number of risks and uncertainties that are discussed in some detail and readily available documents, including the Company's annual report on Form 10-K for the year ended December 31, 2003; on second quarter 10-Q and yesterday's press release which have all been furnished or are on file with the SEC.

In particular Allmerica's future operating results and financial conditions may vary materially depending upon weather, equity market and bond market conditions, surrender activities and rating actions, among other factors. Allmerica's quarterly earnings call, including today's call, our press release, statistical supplements and documents filed with the SEC are available on the investor section of our website.

With those comments, I will turn the call over to Fred.

Thank you. Good morning everyone, and thanks for joining us on the call. Marita, Ed and I are pleased to update you on the progress we continue to make on a journey to make Citizens and Hanover world-class regional companies. While we are fully aware that we have a long way to go and much more work to do, we are more confident than ever that we can achieve our goal, the goal of being a top quartile company in our industry.

As I'm sure you can appreciate, we are very pleased with our third-quarter results. We are also very happy to put the third quarter behind us given the financial impact of Charley and Frances and Ivan and Jeanne. These storms caused tremendous disruption and loss for hundreds of thousands of people in the Southeast. Obviously the property casualty industry has estimated these losses at 20 to $28 billion, and these storms clearly had a material impact on our earnings for the quarter.

At the same time, however, the storms served as an important reminder of the role we play in the economy. Helping individuals, families and businesses recover as much and as quickly as possible. I am very proud of the way we responded. Our front-line people worked tirelessly, providing prompt high-quality service to our agents and our customers. And I believe strongly that our response in times like these demonstrates our commitment to our agents and our customers and in fact helps us position Citizens and Hanover among the best companies in our industry.

I am also proud of our agent’s response. Once again they provided invaluable assistance and counsel to their customers helping them to begin the rebuilding process and confirming the value and the critical role played by the independent agency system.

Before I turn to the discussion of results, I want to spend a few minutes on issues and allegations raised by Mr. Elliot Spitzer. We are unaware of any bid-rigging or other activities in our organization such as alleged against Marsh. Any such activity would be a violation of our business practices and would not be tolerated. Our Company's business in general is not very susceptible to those kinds of activities considering the smaller size of our accounts and the limited business we place through brokers. Our business relies almost entirely on relationships with independent agents.

The payment of commissions and profit-sharing to agents is a long-standing industry-wide practice. It is critical to agency relationship and recognizes the role they play in front-line underwriting. However, we are committed to work with our industry to improve the understanding policyholders have of the relationship between the insurance companies, agents and their brokers.

With that, let me turn to the results for the quarter. After tax segment income was 20 million or 37 cents per share consistent with last year. We generated profits in our Property and Casualty segment for the quarter in spite of all the catastrophe losses. And excluding catastrophes, segment income was up significantly compared with prior year quarter.

Followed underwriting results of both Personal and Commercial line segments bolstered our Property and Casualty results for the quarter. Furthermore, our reinsurance program, which includes an aggregate cover to limit exposure from a high frequency of catastrophes in any given year helped us reduce our aggregate catastrophe losses for the quarter. Our gross losses primarily from the four hurricanes were 99 million to the quarter. However, we obtained 36, 37 million in release through reinsurance. And we still have 8 million of aggregate cover available for the fourth-quarter catastrophes, which will substantially lower the impact of any catastrophe losses during the final 3 months of our year. Overall, I could not be more pleased with our Property and Casualty results in light of these catastrophes.

Life results were similar to results a year ago, and also to the prior quarter. Obviously, GAAP results were negatively impacted by the equity markets during the quarter.

Now let me turn to a matter that has been a subject of a lot of discussion lately. I would like to clarify and elaborate on my comments at our last call that we are agnostic about keeping our Life Companies. Here's how I think about it. First, I am pleased with the performance of our Life operation, which as you know has generated good cash flow. Our hedge program has operated as it was designed to and surrender patterns and expenses have been within the range of our expectations and assumptions. However, the future earnings of that business on whatever basis you consider, Stat or GAAP, are heavily dependent on the equity market performance over time.

As a result, it is very hard to get your arms around its ultimate value. Equity market assumptions are embedded in our DAC and thus recoverability of DAC on our balance sheet depends significantly on what happens there. We have seen this over the last 2 quarters as DAC amortization has offset any GAAP profits even as cash flow has been positive. Having said this, the Life business is not integral to the success of our Property and Casualty Company. Therefore, if we have the right opportunity, we would consider disposing of all or part of it.

Now, obviously the next question is what are the considerations in determining what makes the right opportunity. Here are some of the things that I think about. First, the value attributed to the business as reflected in our stock price. The value of eliminating a potential distraction for our core business; the value of eliminating the risk associated with the business, which of course also involves eliminating any upside available if the equity markets and surrender patents equal or exceed our assumptions; the impact of any transaction would have on our policyholders; the realizability of over time of the various tax benefits embedded in our Life business.

The overhead costs covered by the business, which may not be eliminated by the disposition; the availability to the P&C business or to our shareholders of excess capital from this business either as a result of the sale of all or part of the business or through its continued operation. Finally, our outlook at any point in time for the equity market. Beyond this, I really cannot comment. We of course are focused on maximizing long-term shareholder value. Fair market value of the business at any given point of time is not something I can or should comment on. Obviously it cannot be more than any one is actually willing to pay for us at any point in time. I also don't think it is appropriate for us to comment on as to whether at any point in time we are having discussions with other parties that could lead to a sale.

Putting this all aside, as I have said before, and I will say again, we are focused on generating value for our shareholders. And what this means on a day-to-day basis is that we must focus and stay focused on our strategic priorities as a Company. For the Life Companies these priorities are around maximizing value by first maintaining expense margins through expense reductions but by retaining profitable customers. Two, managing capital volatility with an effectively design and executed guaranteed benefit hedging program that protects us against the guaranteed minimum death benefit risk. And three, maximizing our net operating cash flow.

Our Property and Casualty companies are our core business. These day-to-day priorities center around improving our local market and agency management, building strong profitable partnerships with the best agents. Second, enhancing our product pricing and underwriting in every market we are in. And third, improving our services and the efficiency and effectiveness of our operating model. At the same time as we've talked, we remain very focused on the foundational elements that create a winning Company in our industry. First, building and sustaining a strong financial position. Second, attracting and developing world-class talent; and third, creating a strong culture of execution.

As we approach year-end I am confident they we are working on the right priorities and that we have made progress necessary to finish the year strong and build on the success in 2005 and create this world-class Company. In fact we are wrapping up our plans for 2005 and I look forward to sharing them with you on our investor day in December.

With that, I will now turn the call over to Ed and Marita. Ed will review our financial results and Marita will review the progress and our business priority.

Thank you Fred. Good morning everyone and thanks for joining our call. As Fred said, we are pleased with our strong performance in the third quarter, recording solid earnings in the P&C business, despite very high catastrophe losses. The Life Company has generated a loss for the quarter as you know driven primarily by the underperformance of the equity market. However, cash flow was essentially consistent with expectations at $38 million for the quarter, up from $27 million in the second quarter of this year.

We reported net income of 18 million or 33 cents per share in the quarter versus 11 million or 21 cents per share a year ago.

Now let's turn to segment income after taxes which was $20 million for the quarter and consistent with last year's results. As a reminder, after-tax segment income excludes certain items that are included in net income, such as net realized gains and losses, among others. These items total a loss of 2 million or 4 cents per share for the current quarter compared to a loss of 8 million or 16 cents per share in the prior year.

With that said, let's focus on our pre-tax segment results. The P&C segment generated earnings of 37 million in the quarter compared to 32 million in the prior year quarter, an increase of 16 percent. Earnings increased despite catastrophe losses of $62 million in the current period, which are $45 million higher than catastrophes in the prior year. Catastrophes added 11 points to the combined ratio, which stands at 103 for the current quarter.

While the Florida hurricanes had a material impact on our results, the impact of the hurricane losses on our results was significantly reduced by our aggregate reinsurance program. As we have discussed in our catastrophe related press releases this quarter, this reinsurance program protects us against multiple catastrophes within a single year. The treaty provides $50 million of reinsurance coverage in excess of cumulative losses in the year of about $80 million. We currently utilized about $42 million of this aggregate reinsurance cover, which as Fred said, leaves about $8 million in coverage available for any fourth-quarter storms.

On an ex catastrophe basis, the P&C segment contributed $98 million in pre-tax segment income, up from 49 million in the prior year quarter. This increase was primarily driven by Personal Lines, although Commercial Lines results also improved.

Now I will discuss the results of each of the P&C segments. Personal Lines segment income was 42 million for the quarter, up from 12 million in the prior period, a meaningful increase considering that cat losses were $11 million higher than a year ago. Again, excluding catastrophes, segment earnings were 66 million in the quarter, up from 24 million a year ago. This increase was driven by an improvement in Personal Lines loss ratio. The ex cat calendar year loss ratio improved by 12 points in the quarter to 53 percent.

This quarter saw a historically low level of reported loss activity. Several factors contributed to the reduced loss ratio for the quarter. First, favorable development of prior year's reserves benefited the current quarter results by $7 million while the prior period results were adversely impacted by $6 million of development. The current quarter also benefited from the continued impact of rate increases in both Personal Auto and Homeowners. Base rate increases averaged about 7 percent for the quarter.

Furthermore, the frequency and to some extent severity of losses was significantly lower in both drivelines compared to both prior year and previous quarters. Current year loss frequency was down about 6 percent in the quarter. These trends are reflected in the ex cat current accident year loss ratios which improved by 3 points in Personal Auto and 5 points in Homeowners.

The operational strategies targeted to improve margins have also yielded benefits in the quarter. These strategies included selectively withdrawing from the unprofitable sponsored business in certain states and remedial action in Massachusetts' Personal Auto. The ex cat current accident year loss ratio for Personal Auto in Massachusetts has improved 5 points over a year ago.

Although our rate and strategic actions have clearly driven a good portion of these favorable results, we do recognize that a meaningful portion of this quarter's favorable loss performance is also related to a generally favorable environment with historically low frequency of losses in the quarter. The Personal lines combined ratio was 96 percent for the quarter which includes 6 points of cat losses and a 7 points better than a year ago. While the margins have clearly improved in this business, net written premium has declined, however.

Personal Lines net written premium was 395 million in the quarter, down from 415 million a year ago. Written premium decreased by 8 percent in Auto and increased by about 3 percent in Homeowners. The rate increases of both Auto and Home have been offset by declines in policy in force. Policy counts in Personal Auto are down about 10 percent while Homeowners policy counts are off by 7 percent from the third quarter of last year.

It's important to point out that a good portion of this decline was intended. The results from our plan to reduce concentration in certain difficult states and to not renew certain sponsored business. However, some portion of the decline is unintended and related to a handful of operational factors which Marita will discuss in her comments.

Now let's review the results of Commercial lines, which produces segment loss of 7 million in the quarter compared to 18 million of income in the prior year quarter. This decrease in earnings is a direct result of catastrophe losses in the quarter of $38 million compared to just 4 million a year ago. On an ex cat basis, segment income was $31 million, which represents an increase of 8 million over last year. Once again, the improvement in segment results was driven by a lower loss ratio, which was partially offset by somewhat higher expenses.

The ex-cat calendar year loss ratio in Commercial lines was 47 percent, down 9 points from the third quarter of last year. The loss ratio improvement is primarily the result of continued rate action and lower adverse development of prior year reserves.

We took rate increases across all drivelines that averaged about 6 percent for the quarter. What's more, the current quarter benefited from approximately 4 million of lower adverse development of prior year reserves. The current quarter saw just over 5 million of adverse development, while the third quarter of last year was affected by 9 million of adverse development. The adverse development in this quarter was once again primarily in Workers Comp where the trends in pain management and attendant care continued to increase our estimates of settlement of pre-2000 workers comp accident year claims.

At the same time, the ex-cat current accident year results remain relatively stable with a 2 point improvement in CMP which is our primary driveline. Offsetting the improvement in loss ratio were higher loss adjustment expenses and operating expenses. The increase in LAE expenses was due to higher cat related activity in the current quarter as well as unusually low loss adjustment expenses in the third quarter of last year, which benefited from favorable development debt.

Operating expenses also increased by 10 million in the quarter, primarily due to increased staffing in technology costs associated with the buildout of our Commercial lines business, as well as higher profit sharing payments. The expense ratio in Commercial lines increased from 35 percent in the prior year quarter to about 38 percent in the third quarter of this year. And the combined ratio for Commercial lines was 117 percent in the quarter, which includes 21 points for cats.

Now let's look at Commercial lines premium growth. Net written premium was 187 million for the quarter or 7 percent higher than the prior year quarter. This increase came primarily from rate increases which averaged 6 percent across all lines. The benefit of rate on top line growth was partially offset by a 2 percent decrease in theft from the end of the third quarter of 2003. However, since the end of last year, theft has been relatively stable as new business counts have increased and our retention rates continue to improve. In fact, year-to-date Commercial lines retention stands at 78 percent versus 73 percent for the first 9 months of 2003.

Now let's focus on the Life Companies. The Life segment reported a loss of 9 million for the quarter versus a loss of 8 million a year ago. The current quarter's earnings were primarily impacted by the higher amortization deferred acquisition cost and by higher GMDB expenses both as a result of lower equity market returns. Partially offsetting this were lower expenses from the shutdown of VeraVest, the absence of asset and impairment charges taken the prior period associated with the VeraVest shutdown and other expense savings.

Let's quickly compare segment results the third quarter of this year to the second quarter of this year. Segment loss was about 2 million higher primarily due to the weaker equity market. Equity markets were down about 2 percent in the current quarter compared to a 1 percent increase in the second quarter. As we've said before, we expect volatility and GAAP segment income due to the impact of the hedge program, the new SOP 0-31 rules on GMDB reserves and DAC accounting. This volatility is due to several factors which principally include equity market movements but could also relate to interest rate changes, surrender activity and any difference between the performance of the underlying mutual funds and the indices associated with the futures contracts related to our hedge program.

With that, let me briefly comment on the hedge program. As you know, we implemented the hedging program in the 2003. Again this quarter the program continues to perform as expected. With the market down in the quarter, we recognized a gain on our futures contract of about $6 million. This gain provides an offset to the increase in the guaranteed minimum death benefit liability from the market decline.

Now let's turn to cash flow. As you know, last year we introduced the concept of net operating cash flow. This non-GAAP metric was intended as a measure of operating performance and liquidity. It represents GAAP segment income adjusted for certain non-cash items such as DAC amortization and GMDB reserves. We provided a reconciliation of this non-GAAP measure to our GAAP earnings in our press release and Stat supplement.

As I've said repeatedly, this cash flow measure does not represent statutory income or distributable about capital from our Life Companies. The distribution of capital is directly related to Stat earnings and statutory capital levels and of course is dependent on regulatory approval.

In the quarter the Life Companies generated net operating cash flow of $38 million, which was in line with our expectations given the current equity market performance and was $11 million higher than the second quarter of this year. The primary reason for the increase in cash flow between the two quarters is the $6 million of gain on the GMDB hedge program in the current quarter versus $6 million of loss in the previous quarter.

With year-to-date cash flow currently at 105 million, we believe we are on track to meet our cash flow guidance of about 120 million for the year.

Now let’s look at Stat capital. In the first 9 months of the year, STAT surplus increased by $58 million bringing our total adjusted capital to $611 million, up from 553 at the end of last year. Statutory surplus increased by 19 million in the quarter, due almost entirely to a tax benefit resulting from the utilization of our now operating loss carryforward. As you know, we have about $150 million in statutory net operating loss carryforwards that were generated over time by our Life Companies. According to statutory accounting rules, only a portion of these NOLs are recorded in our surplus. However, as we've said before, these NOLs could be applied against taxable income generated by either our Life or our P&C companies.

Strong earnings in our P&C companies have led to a higher utilization of these NOLs in the quarter with a consequent increase to Life surplus due to an intercompany tax payment to the Life Company from the Property and Casualty Company.

Although we generated strong net operating cash flow in the second quarter, statutory surplus did not increase quarter-over-quarter other than for the tax benefit. This is because cash flow excludes certain non-cash charges that are included in statutory surplus. The most material of these items is the charge to statutory surplus related to changes in the so-called Carbon (ph) Reserve Credit. This charge which was approximately $38 million in the quarter reflects the amortization of surrender charges and the changes in our statutory GMDB reserves.

Now briefly comment on a few other transfer from the Life business. First our operating expenses were lower by about $32 million or about 53 percent compared to a year ago and reflect the shutdown of the broker-dealer business, VeraVest last year as well as our ongoing expense management efforts.

Second, variable (ph) renewable annuity redemptions were 492 million for the quarter compared to 556 million in the second quarter. Redemption rates were 19 percent for the current quarter compared to 20 percent in the second quarter. And our Risk Based Capital ratio also approved to 465 percent at quarter end compared to 365 percent at year end.

Before I close and turn the call over to Marita, I would like to respond to some recent requests from several investors to share the tax basis of our Life Insurance Companies. I'd like to start by making the point that the tax basis of an entity is obviously different than both the GAAP and statutory carrying value. Each one is calculated based on different rules, and therefore a reconciliation for tax basis to Stat or GAAP values cannot be readily provided.

That said, the tax basis of our 2 Life Companies on a consolidated basis currently stands at just over $1 billion. This tax basis results from many years of accumulated taxable earnings and profits from these companies, as well as the effect of a number of corporate reorganizations done in the past that affect the basis.

With those comments, I'll turn the call now to Marita.

Thanks, Ed. Good morning. Like Fred I am very pleased with the progress we've made so far, and I am confident that we can and will position Citizens and Hanover among the very best companies in the industry. Our Property and Casualty business clearly generated strong results for the quarter, showing significantly improved core underwriting results. Our Personal lines business has been the primary driver of earnings improvement in both the quarter and the year, although Commercial lines continues to also produce strong results.

Our results this quarter reflect a significant improvement in Personal lines margins. We recognize that a good part of this improvement is the result of environmental factors influencing claim trends that are also benefiting the entire industry. At the same time, our strategies have also improved the quality of our book. At the end of the day, success in our business is all about execution. With that in mind I'd like to take a few minutes to talk about the progress we've made on our operational priorities, the successes we have achieved and the work that we still have to do.

In Personal lines, we began the year with the objective of improving margins in this segment. Accordingly, we developed what could be termed a defensive strategy. To maintain profitability and market share in states that offer a favorable business climate such as Michigan, while implementing an improvement strategy in highly regulated states that are difficult to do business and, such as Massachusetts and New Jersey. You will recall that we also made the decision to terminate less profitable segments of our sponsored book, and we've made good progress. We have taken discipline rate action in both Personal Auto and Homeowners in all of the states in which we do business, with base rate increases averaging about 7 percent in the quarter, and on a year-to-date basis.

We continue to benefit from the introduction of our insurance score queuing (ph) product budget-wise, which enables us to better differentiate among risks and to price each risk accordingly, while budget-wise enhances our segmentation capabilities and our competitive position, we view it as a transitional product. In fact, we have already started developing a multivariate Auto product that we expect will be competitive with those offered by the best Personal lines companies. This rules driven product will use many more variables and exponentially increase both price points and segmentation capabilities.

Scheduled to begin deployment of the first half of 2005, this product will help us achieve both greater adequacy per risk and support our efforts for growth. In the meantime, we are fully deploying the budget-wise product. This product was launched in Michigan at the beginning of the year and is currently being used for both new and renewal business in this key state. We have successfully ruled out our insurance score tearing for new business in the majority of the 9 states targeted for implementation this year.

Let me spend a second on Massachusetts where the results have improved significantly this year. Our current accident year personal auto loss ratio in Massachusetts is about 5 points lower than a year ago. Fewer weather-related losses and the continued success of our efforts to better control this difficult market have improved claim frequency. Our Massachusetts operation has also benefited from our actions around both premium pursuit and improved session strategy developed to minimize the adverse impact of this state's unique, high-risk driver pool.

We are not alone, however, in our Massachusetts experience. This quarter several companies have reported improved results in Massachusetts auto. We continue to support the Massachusetts auto reform process and still expect that the first phase of reform will be effective at the beginning of 2005. We remain encouraged that the progress on reform should result in a more rational and improved business environment in Massachusetts.

While we continue to improve margins in Personal lines, the number of policies in force did decline by about 8 percent in the quarter. As you may recall, a good portion of this decline of policies in force was by design, and a part of our strategy to improve margins. Specifically, we targeted the withdrawal from sponsored business in certain states. In addition we had planned to reduce our presence in states with a difficult business environment, such as Massachusetts. Furthermore, we implemented an aggressive rollout of the budget-wise product and introduced greater segmentation.

In Michigan, the budget-wise introduction occurred together with rate increases on both new and renewal business. Most of the policies in force decline is directly related to these aggressive actions and have yielded the results we expected, an improvement in the loss ratio. However, the number of policies in force in other states has also declined. When you take aggressive action like we did, it is difficult to simultaneously build the business. And we believe we must now focus on refining our direction in our core states.

In Michigan for example, with the needed margin improvement now obtained, we are focusing on growing our business. Our strategy with the budget-wise product was to achieve rate adequacy across all risk tiers in Michigan at the risk of losing the less profitable business while capturing an increased flow of more attractive tiers of business at competitive rates.

While we are confident that the quality of the book has improved, as evidenced by the improvement in the Michigan loss ratio, we are generating less business than we expected. We attribute some of this to the disruption caused by an aggressive rollout of budget-wise for both new and renewal business, which impacted the flow more significantly than we anticipated. At the same time, we are taking a look at our rates to make sure we are striking that optimal balance between business generation and margin improvement. Clearly our focus this year in Personal lines has been margin improvement, and we have demonstrated improvement here. Our focus is now turning to growth while continuing to improve our margins. As a result, we should begin to see an improvement in the policies in force trends as we manage this balance between margin improvement and growth.

Now turning to Commercial lines, our Commercial lines results were also strong in the quarter on an ex-cat basis. Top line growth continued in the quarter and was approximately 7 percent. While this primarily was driven by average rate increases of approximately 6 percent, the underlying trends for positive future growth remain. For example, both retention in new business have improved. Retention for the first 9 months of the year is up 5 points compared to the first 3 quarters of last year. This represents good progress and is critical to our achieving our growth objectives.

Our retention rate has clearly benefited from our ratings upgrade earlier this year. However, it is also improving due to changes we have made in our front-line workflows where we have leveraged technology to automate more of our small renewal and endorsement processes. As a result of the changes that include automation, more than 80 percent of our small renewals are now processed without an underwriter’s involvement. Previously only about 50 percent of our small renewals were processed without that same involvement of the underwriter. We believe there is also some room for improvement in this area, and will continue to work to reduce the number of renewals that our underwriters handle.

These same workflow enhancements have improved our ability to generate new business as well. As our underwriters have been relieved of routine processing responsibilities, they've been able to spend more time working with our agents and prospecting new business. In the quarter, new business production increased to 41 million, that is up approximately 22 percent from the third quarter in 2003 and is now in line with our targets.

The line we most want to grow, our standard package business, was up 4 points through the first 9 months of the year. At the close of the quarter, standard package business represented almost 22 percent of our new business. At the same time, we have been successfully managing growth in other lines in keeping with our plans, increasing manufacturing in retail while reducing our contractor segment. Similarly, we have improved new business flow in our middle market segment. We believe that this segment, which we define as accounts with premiums between 25 to $100,000 is a sweet spot for us. Our product offerings, our field structure, our agency mix, are all well-suited to this market segment.

Through the third quarter, first-tier middle market accounts represented almost 24 percent of new business, and we have significant growth opportunities in this market.

Along with gaining efficiencies in workflow and shifting our product mix, we also have substantially improved our service capabilities, something we believe is a critical value lever for our agents and is a key element in our middle market operating model. In the third quarter we launched our new agency portal, providing our network of independent agents with centralized access to all of the information and tools they need to conduct business in the most efficient way possible. This tool increases agent productivity and profitability by consolidating several resources into one easy-to-use interface.

The agency portal adds value, not complexity to the work process and reinforces the commitments we have made to our agency partners to be even easier to do business with. The portal, which is in the initial rollout phase has been very well received by our agents and their customers' service representatives as well. It takes significant investments in people, product and technology to drive improvements in the mix and flow of business and to improve the service capabilities needed for future growth and profitability. I want to ensure you that we are thoughtfully managing the expenses related to each one of these initiatives.

And with that, we are happy to respond to any questions you might have.

(OPERATOR INSTRUCTIONS) Ira Zuckerman, Nutmeg Securities.

Yes. I've got a couple of questions. One, just a numbers question. You gave us a number that you've used $42 million of your aggregate loss treaty, and you said also previously that you recovered 36.7 million in reinsurance. I assume the difference is a reinstated premium. Am I correct on that?

The difference is retention. There is some retention.

Okay. The second question following up on that is do you have an idea what the treaty is going to cost you on renewal?

Not exactly, although we believe it might be slightly more costly than it has been in the past partly because of sort of the fundamental underlying factors affecting pricing in the market. And secondly, this coverage is pretty unique or it was anyway -- we think perhaps there are going to be others that are going to be in the market for a similar product which could have some impact on price.

Can you tell us who the carrier was?

It's a number of carriers. Ira, I don't have it off the top of my head.

The other question I've got is what are you guys saying in terms of January 1 renewals, in terms of pricing?

Specifically to Commercial lines?

Commercial lines -- I've got a follow-up question on Personal lines as well.

What I would say clearly in Commercial lines is our target market is obviously less volatile to pricing swings. We are seeing a good flow of 1-1 new business.

And the pricing this year we've achieved is that roughly 7 percent, and we see -- we believe we can continue to see that kind of level in our segment.

The middle market seems to be however, getting a little bit more competitive -- it has always been so.

No question, Ira. That's exactly what we're seeing as well and Property and Liability has been softening in the market. But we've seen in the smaller accounts some stability around that kind of mid to high single digits.

And on Personal lines pricing, again, Auto has gotten more competitive. Homeowners may be less so. If you are targeting rate increases when State Farm is cutting prices, how do you feel you're going to be able to remain competitive?

The key for us was obviously to get the right price for the right risk. To have the right amount of tiers and to be able to price many different types of risks in this segment. So the key for us was to get the segmentation and those options right from a base perspective. And we think we have that now.

So from now on I think we're going to be -- it is much more surgical by territory and by state, Ira. So we played catch-up a little bit the last 14, 15 months. We got behind a little bit on both features that Marita talked about. And I feel now we can be much more surgical and thoughtful, particularly in our target states. Michigan, we have as good a segmentation now as anybody in the industry. So we can be very thoughtful about rate movement or lack thereof of rate movement because we are happy with the rate themselves. And that's what we've done we took some small adjustments that are going to happen in the next couple of weeks to kind of tweak small territories themselves. So I actually feel we are in relatively in good shape now that we're kind of with other people.

I've got more questions but I'll give somebody else a chance for now. Thanks.

Bob Glasspiegel, Langen McAlenney.

Good morning. I was wondering if I could ask you to reput your McKenzie consulting hat back on and remember your days at Hartford trying to build the brokerage distribution there and maybe give us your crystal ball on how the post-Spitzer PSA contingent world shakes through the brokerage and Commercial lines marketplace first of all. How much ramifications does it have to the agency market for contingents, which Spitzer is concerned about both the volume and profitability bonuses. And you hinted there may be some changes ahead. And what risks and opportunities are there for Allmerica in the new world that you envision?

From our point of view, obviously this is less of an agency issue. The current issue is much less of an agency issue given the fact that agents obviously work for the insurance companies, versus the brokers. And as you look at it, we have historically always used commissions and profit-sharing in some form to make sure that there is a partnership around underwriting. Frankly a good matching of the right risk to the right company, which is really the difficult thing in our industry. So my view is that that will probably stay the same at some level. However, I think the transparency that people are going to push for and I think its appropriate is the transparency of these arrangements with the consumers, and the purchasers of the insurance, which to us is fine. I think that is a good evolution and a good movement.

One of the things that has always been perplexing in this industry is when you serve individuals and you ask them are they going to an independent agent, there is a good 50 percent that go through captive agents that think they are independent. So the transparency to us could actually help us because we obviously believe very strongly in the value of the independent agency system and the value they bring to the consumers and the strength they bring from being independent. But I a lot of the trends you are seeing on -- or discussions you are seeing in my view are really very much focused on the high-end broker, which really in a lot of cases lost sight of their role by thinking about commissions in addition to the fees they got from their customers. And I think you're going to see that stop pretty quickly in many, many of the businesses.

I'm not sure that Elliot Spitzer's primary goal in life is to save the GM risk manager some money. I think there's more votes in going after the consumer ends of the market, which I don't think he has found a way to get at it yet. But I hope you're right, that it just narrowed in that segment.

Again, as I said, I do think has ramifications down the system -- I just think what will happen is it will be very focused on transparency, the role of the agent will get clearer. And again, from us, we are -- to me as long as the whole industry moves together, you're going to compete on the basics of adding value to your customer and your agent. And it's going to be that way hopefully going forward. And that transparency should help good companies.

One quick follow-up maybe for Marita. It looks like your ex-cat combined ratio was around 92. And if we throw in 3 points of normalized cat, it would have been a 95. I'm thinking about run rate for the future. I guess there's probably some seasonality maybe in the third quarter being better than the fourth, but is a sub 100 combined ratio attainable?

I definitely think so. We have talked about the expense ratio before. We're making some clear investments in Commercial lines, and there could be a couple of points there that I'd like to see improve as we take advantage of the investments that we've made in '05 and beyond. But I certainly think it is obtainable.

And if you think about what we've said the kind of cost of capital we want to achieve and sustain top performance, obviously mid-90s is where a company needs to be in this kind of investment returns. But I would just be clear that one of the things we continue to do and will continue to do through next year is invest in our business to create a distinctive position in growth capabilities in our Company. We still are investing dramatically or significantly is a better word, in creating an operating model that is a bit more efficient than what we have. So we've got some automation expenses in there. We also have friction costs from turning over roughly a third of our top 300 folks which are working through its system to build the capabilities and distinctive skills we need to have profitable growth. And I use that as one word, not two.

And so while this was a good quarter, I think there is some seasonality in it. I don't want to think we're there, because we're not. We are still very focused on improving and focused on being a Company that can sustain those kind of margins through the cycle. We are very pleased -- I mean in a lot of ways, a lot of the aggressive actions we took over the last year and the people we brought in are starting to really pay off.

Thank you.

Jeff Thompson, Keefe, Bruyette & Woods.

Very good quarter, guys. I had a question on the expense ratio, and I'm trying to look at it on a GAAP basis and maybe my numbers aren't quite clear. But I just taken on the GAAP income statement the policy acquisition expense, other expenses, added them and divided by earned premium. I get a number like 32.6 this quarter, and it is down from 33.6 and almost a point higher in prior quarters. Am I looking at it the right way and can you sort of let me know what's going on here?

Jeff Thompson said. We should probably spend some time with you. We don't report our expense ratios on a GAAP basis and quite frankly, we tend to look at them internally the way we report them externally, which is on a statutory basis. So if you looking at them on a GAAP basis, you bring into the equation amortization of intangibles and any volatility having to do with that. So maybe what we should do is just review those numbers with you.

We'll do it off line. Second question, as we move into higher profitability for the P&C business, what can we expect on the tax rate? How should we model that for the future?

I think that all the forward-looking comments -- what I'd like to do is spend some time in our early December investor conference thinking about those. But having said that, specifically around taxes what we said is that we should expect over time an effective tax GAAP for our P&C business in the low 20s, low 20 percent 23, 24, 22 percent.

And one more and I will turn it over Yuka (ph). The Commercial lines tiered pricing, you haven't touched on that today. Do you still believe that is a viable way to look at that business and when might that begin to roll out?

Obviously we've done a lot this year around mixed management and on renewals as Marita referred to on automating our renewals actually using data to kind of determine which ones we touch and which ones we don't. We have an initiative in our strategic plan around predictive modeling. And we are still working -- we are focused on that and working on it. Whereas in Personal lines, we see it being rolled out next year. I think Marita might have mentioned that in kind of a broad way. Commercial we haven't really decided exactly beyond renewals how we would use it on new business and when. But we have a team actually working on that now in trying to decide what the timing would be beyond the renewals.

But you still think it's a viable way to look at that business?

Absolutely. Again, having worked on this before and worked on it here for our type of business, that segmentation is going to allow us to make much better surgical strikes around our pricing and our growth. And so we, as I said, we've done some rudimentary things but nothing that I would consider cutting edge. We've been very aggressive to Marita's point on mixed management and by agent. On a monthly basis we manage that; we manage flow and mix. And you are going to continue to see ourselves evolve based on use of data but to take it to the point of a multivariant like Personal lines -- it is not as well developed yet.

Okay. Here's Yuka.

A couple of questions on the Life side. First of all if I look at your cash earnings excluding hedging gains and losses, second and third quarters of last year were at 23 million each. This year you are at 32 to 33 million, second and third quarter. What is the difference with the much better cash earnings this year?

It is primarily around two things and they are related. One is sort of general expense levels and expenses are clearly down. Secondly, the VeraVest distribution system was in line down, and that was unprofitable for us on a cash basis last year and of course it is gone at this point. So that's no longer a drag.

And in terms of the swing in the hedging results, can you give us a little more color? I would assume that with the markets having been down and the market volatility having been somewhat less this quarter than it was in the second quarter, were the primary factors and so am I thinking about it correctly? Are there any other factors that played into it?

No, Yuka, that's exactly right. The market was down which obviously translated to gains in the future, and volatility was lower than in the previous quarter. Also if you remember in the second quarter we had a rise in interest rates, which created a disconnect between the reserve and the hedge gain, which we didn't see return in the third quarter.

Last quick one for Fred. You said in your comments, opening comments that one of the factors when you think about the Life business whether to sell it or not or keep it is you're looking at the value that is attributed to it in your share price. With the shares trading at roughly $29, how much value do you see is being attributed to your Life business?

It is anybody's guess. Really, the way the map works or the way the calculation works is people have a point of view on the value of our P&C business and I think what we said before is that we think conventional valuation methodologies are appropriate there in terms of ROE, regression, earnings, growth prospects, etc. And I think people run that math, and you compare that number on a levered basis to what the stock is trading at and at any given point in time you get a point of view on what is in the Life business. The stock is clearly down from sort of the mid 30s where it was at some point. And that is either because there is less perceived value in the Life business in our stock or some other factors. But I think that is the way that people think about it.

Thank you.

Charles Gates, Credit Suisse First Boston.

I have one question. It has two parts. What is your current strategy with regard to writing Personal Auto insurance in the Bay State? That is the first part. Two, how do you see the environment, the regulatory environment changing in the coming months?

Clearly what we've stated in math about Massachusetts is that we have attacked it really at three levels, and I continue to believe that this is the right way to think about it. First of all, it is absolutely one of the most difficult places to do business in Auto than in any place in the country. It is unique and it is incredibly difficult because of the regulatory environment. And so we have been very intent to have a dedicated management team that is all over this from a tactical point of view so some of the seeding things and I think believe very good things have happened this year as far as our modeling and the way we've seeded things in the residual market etc. The second part of this is we've said, and I'll consistently say it, I believe this Company got too heavily exposed in Massachusetts. So even though I believe there's some good trends right now, it is very hard to anticipate Massachusetts behavior if you look at historically and how many companies have exited and the risk of that.

So as part of our strategy we are shrinking our number of policies in Mass Auto within the rules of Massachusetts, which has limits. But we're trying to shrink your exposure to mass in percentage of the rest of our business and we're going to continue to do that as part of the portfolio.

As far as the questions for the outlook, I actually feel pretty good about it. We have worked very aggressively as has most of the reform minded companies and made very good progress particularly about how the residual market is allocated the companies and how transparent it is. There is now talk about some of the subsidies and the extreme subsidies we have for the bad drivers in our state and addressing that. So I actually feel relatively confident we will get some -- we will absolutely make progress on the residual market at the beginning of the year, and I am pretty hopeful that people are being more thoughtful about continued reform.

The biggest concern we have is over the last 12 or 13 years we've lost 50 companies. So the issue for us is obviously it is an environment that most of the big companies have run from. And having this little or this few a number of companies is not good for competition. And so our belief is that this reform is required and necessary to have it to be a more sane place to do business.

As I step back from all of it, I feel great about the three things we've done, and I think about our performance improvement, and I look forward, and I think this year is going to be continued good performance or better performance because of the reform and because of our focus. But it is a difficult -- there's no way to say it -- it is a difficult state, and that's why there's so few companies in and so many companies left.

Do you ever see an environment on a near-term basis where the Progressives, the GEICOs of the world come back?

Well, I mean again, what we talk about with the regulators and the governor and the Legislature and the Attorney General -- and actually I give a lot of those guys credit for working together. And, frankly, they've done interview with many of those companies and if you look at what's happened in New Jersey and I have encouraged them personally very aggressively to have those interviews and to talk to New Jersey because New Jersey which had a lot of the same traits has now got GEICO to go back in. And so I look at them as a model that if we could be thoughtful about going toward a more competitive environment maybe we could get some of them to come in and ultimately, for me, that is the thing that's going to make Massachusetts a more sane, long-term place for top quartile companies to play.

Thank you.

Dan Farrel (ph), Fox-Pitt, Kelton.

Congratulations on a good quarter. Just a couple of questions. First on the Personal lines segment, you've talked around this a little bit, but just roughly speaking in terms of the frequency numbers, how much of the combined ratio improvement do you feel is due to pure industry trends and the frequency versus how much that the efforts that you have put in to turn around the specific things in your Personal lines business? Because frequency trends have been great for a while in this really is the first quarter where we are seeing some really great numbers out of your Personal lines segment.

And then second question, just with regard to the increase in the Workers Comp reserves -- there's not a large increase, but you have increased reserves on this in the past. How do you feel about the current reserve levels now in the Workers Comp business?

On the frequency question, here is how we think about it. We think that to a great degree we have been experiencing the same results in decreased frequency that the rest of the industry have. It hasn't come through our P&L because of other difficulties in Personal Auto. And what we think is that the actions that we've taken this year which we've spent a lot of time talking about here today and in previous discussions have started to let those trends that everybody else is seeing emerge into our P&L. So I don't know if that means that we are seeing this in our P&L because of all the things that we're doing or if we're seeing this in our P&L because we are like everybody else, but clearly we're starting to experience what everybody else has and it's really emerging. I think because we've gotten a lot of the other problems out of the way.

And again, because we are so skewed in some states that crowded it, for instance Michigan -- where we put in a deductible, which for Michigan made a heck of a lot of sense, and let that frequency, that trend come through. I also think that because we didn't have the credit in our products we got a little bit of our mix. What you see, particularly with high credit scoring, you often kind of got some of these good trends in the industry kind of mass by having underpriced business in some of the segments. So I think a lot of the actions we've taken at Ed's point have allowed us to be back in the game and emerge as one of the players that can take advantage of some of the trends you are seeing.

One way we get a sense for that is we've certainly seemed claim counts (indiscernible). If you look at claim counts and you look at that as a barometer for frequency, we've certainly been seeing that but we haven't in the emergence in the P&L as much as we like. So I think that is fair.

I think your other, your other comment was about reserves and Workers Comp. You know, I'll say what we've said, is we think in general the reserves are very solid. But we've had some de minimus adverse development. I think we had 4 or $5 million this quarter on a total reserve position for Workers Comp which I want to say is 150 or $160 million, so it is not particularly material. We feel good about the overall level and quite frankly we're trying to be a little bit conservative in our Workers Comp reserves and clearly overall from an overall reserve position, we feel very good where our reserves are. I think we talked to the street a year ago about the reserve studies that we did shortly after Fred arrived, which gave us -- made us feel very comfortable, and we're clearly even more comfortable from an overall position today than we were a year ago.

That's great. Thanks, guys.

Angelo Graci, Merrill Lynch.

There is no one else in the queue at this time.

Thank you very much everyone and we will talk to you next quarter -- in December. Thank you.

This does conclude today's conference. Thank you for your participation. You may now disconnect.