Hanover Insurance Group Inc (THG) 2005 Q2 法說會逐字稿

Good day and welcome to the Allmerica Financial Corporation's second quarter 2005 earnings conference call. [OPERATOR INSTRUCTIONS] At this time, for opening remarks and introductions I would like to turn the call over to the VP of IR, Ms. Sujata Mutalik. Please go ahead, ma'am.

Thank you, operator. Good morning and welcome to Allmerica's first quarter earnings conference call. With me on the call today are Fred Eppinger, our President and CEO; Ed Parry, our EVP and CFO; and Marita Zuraitis, President, property and casualty companies. Also here available for questions are Michael Reardon, President of our life companies; and Mark McGivney, CFO of our property and casualty business.

Before I turn the call over to Fred for a discussion of our results and an update on our strategy, there are a few items I need to cover. First, I want to point out that our net income in the current quarter of $72 million or $1.34 per share includes a benefit of $12.9 million or $0.23 per share associated with the reduction in tax reserves related to an ongoing Internal Revenue Service audit.

Like other variable product companies, we have historically taken a tax deduction for equity dividends received by our separate accounts. However, recognizing that these deductions were the subject of some scrutiny by the IRS, we have consistently recorded some related reserves. Since we are nearing the completion of an IRS audit and these deductions have not been challenged, we have appropriately reduced these reserves.

All other items included in net income were pretty standard in nature.

Now for some housekeeping items. Please notice that our earnings press release and a current report on Form 8-K were issued last night. Our press release statistical supplement and a complete slide presentation for today's call are available in the investor's section of our website at www.allmerica.com.

After the presentation we will answer questions in the Q&A session.

Our prepared remarks and responses to your questions today may include forward-looking statements, including statements about our future results of operations. We caution you with respect to reliance on forward-looking statements and, in this respect, refer you to slide 2 of our presentation deck.

Today's discussion will also 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 statistical supplement which are posted on our website, as I mentioned earlier.

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

Good morning and thank you for joining our call. I am very pleased with our strong second quarter results. After tax segment income for the quarter was $58 million. This compares to $29 million for the same period last year and represents an earn increase-- earnings increase of almost 100%.

Our property and casualty segment turned in another strong quarter with segment income of $90 million, which is $41 million higher than the second quarter in 2004. Both our personal lines and commercial lines segments recorded solid earnings growth, driven by improved loss performance.

Our life segment generated a loss of $5 million in the quarter compared to a loss of $6 million in the second quarter of last year. The life segment loss in the second quarter of this year includes a provision of $4 million for an SEC investigation related to market timing. The life company's results from operations were otherwise consistent with expectations, given the equity market performance for the quarter.

Ed and Marita will discuss our financial results and our operating performance in some detail in a few minutes. Before they review the details, I want to reaffirm that the vision and the strategic priorities we established about a year and a half ago now remain unchanged and I will take a few minutes to review some of our achievements for the quarter.

We have worked hard to improve our performance and further our journey to build a top quartile company. Our property and casualty earnings have now improved consistently for the past 8 quarters compared to comparable periods for the prior year. In addition, we continue to generate positive momentum in each of our major property and casualty segments.

In commercial lines, we remain focused on achieving our overall long-term objective. Our goal is to position our company as one of the best in the small business segment, creating an operating model that is distinctive for that $25,000 to $75,000 account and that focuses on partnering with winning agents through a team of seasoned local underwriters. We believe this will enable us to achieve profitable growth throughout the cycle.

We continue to make significant progress on this strategy. We have nearly completed the process of upgrading our underwriting team. Our operating model is settling in and, most importantly, our field leadership team has come together and we are targeting small business opportunities with our partner agents. The financial results reflect this progress with 8% growth overall.

Despite somewhat competitive market conditions, new business flow has remained strong and our retention levels remain in the low 80s. Furthermore, we continue to write high quality new business that is well aligned with our underwriting appetite. The market is certainly impacting the pace of our growth and, as I have said repeatedly, our objective is to profitably grow our commercial lines business and we will do so thoughtfully, maintaining a disciplined underwriting posture.

Let me just comment on the overall market. The market to date has remained rational for most parts of our target segment, $25,000 to $75,000, but we are beginning to see some inappropriate aggressive actions in the larger account segments, say $200-$250-plus. While this is a very small portion of our business, say $20 million or so, we are developing a walk-away price on every account and are tracking the behavior of a handful of national and regional players and working with our agents to ensure underwriting discipline.

We are more convinced than ever that our market focus on small business and a distinctive operating model is correct and will position us for long-term success.

In personal lines, our strategic actions are also creating positive momentum. As you know, our strategy has been to strengthen our foundation by improving our profitability and mix of business in all our core states while investing in the products and operating model that will allow us to aggressively compete with weakening regional companies and less-agent-focused national companies.

As we've said in previous calls and at our strategic session with you in January, this was the year we should complete most of this foundation work and position ourselves for growth in 2006. I am very pleased with our progress. Obviously, we have improved margins and results in all our core states and, through the use of credit, the budget-rise (ph) product and our better agency management, we have improved our mix and overall quality of business as well. These actions create a very solid foundation for growth in 2006.

As we have discussed, we see the second half of this year as an inflection point. New business began to increase in June and the reduction in PIF count is slowing, as expected. At this rate, we would expect to see PIF count grow in our core business by the end of the year.

On the product front, we are on schedule and on track with the rollout of our new enhanced auto product. This new product, called Connections Auto, provides us with multivariate capabilities and is key-- is a key component to our personalized growth strategy.

We are very encouraged with the results from our launch states, which report a significant increase in quoting and issuing activity. We are scheduled to have this product in place in many of our core states by the end of this year, with rollout complete in 2006.

So while we were late to aggressively reprice and segment our business, we have made up tremendous ground in the last 2 years and we are where we expected to be. And even though the market is more competitive today than it has been, we continue to see a great opportunity to profitably grow our personalized business in our target states in 2006 through our new product and our agency management action.

Turning to the life segment, as a run-off business, the life segment continues to performance as expected. The current quarter segment loss and the net operating cash flow of $25 million were consistent with expectations and given-- and given the performance of the equity market. Our life company surplus remains very strong with adjusted statutory capital of $631 million and a risk-based capital ratio of 575%.

Finally, before I turn the call over to Ed, I'd like to give you an update on our thinking regarding the common stock dividend. As we have said previously, we are committed to reinstituting the dividend this year. Over the last several months we have had discussions with the board on the subject and the board has committed to reinstituting a dividend in the fourth quarter.

Our plan is to take a formal vote of the board in October, with expectations that we will approve the annual dividend at that time. Although the board has not reached the final determination on actual amount to be declared, I expect it will be substantially similar to the $0.25 per share dividend paid out in previous years. Our intention to reinstitute the common stock dividend demonstrates the confidence we have in the solid and improving financial strength of this company and our commitment to deliver value to our shareholders.

Overall, this quarter demonstrated continued progress on our journey toward top-quartile performance. We know, however, that our work is not done and we are focused on our goal and on getting better every day.

I will now turn the call over to Ed for a view of our financial results and, of course, I would be happy to answer questions later in the call. Thanks.

Thank you, Fred, and good morning, everyone, and thanks, again, for joining our call. I'll be using a slide presentation during my remarks and I trust all of you have this available. It's posted on our website, I think, as you know.

Please turn to slide 5 for a review of our consolidated results for the quarter. As Fred said, for the quarter net income was $72 million or $1.34 per share. This is up from $32 million or $0.60 per share in the second quarter of last year. Net income in the second quarter of 2005 includes a benefit of $12.9 million or $0.23 per share associated with the reduction of tax reserves that Sujata discussed.

Now let's look at segment income, which, as you know, is the manner in which management evaluates operating results. As you can see, segment income after taxes was $58 million for the quarter or $1.07 per share versus $29 million or $0.54 per share for the second quarter of last year.

Now let's turn to slide 6 for a more detailed review of these segment results. The increase in segment income after taxes was driven by a substantial increase in our P&C earnings. The life business results remained relatively unchanged with a current quarter loss of $5 million versus a loss of $6 million last year. Federal income taxes were up in the quarter because of the strong P&C earnings.

For the current quarter, P&C segment income of $90 million was $41 million higher than the prior year quarter. These results were driven by improved loss performance, as well as lower catastrophe losses. Both our personal lines segment and our commercial lines segments contributed to the P&C earnings growth for the quarter.

Life company segment results improved by $1 million in the current quarter compared to last year. This increase consists of a $5 million improvement from operations offset by a $4 million provision in the quarter for an ongoing SEC investigation related to market timing.

Now let's turn to slide 7 for a review of our P&C results, starting with a discussion on personal lines. Personal lines segment income of $57 million in the quarter was $21 million higher than last year. This increase was driven principally by 2 factors. First, catastrophe losses were $8 million lower in the current quarter and second, we saw more favorable current accident year loss performance in both homeowners and auto. The earned impact of rate increases and continued favorable frequency trends drove these results.

Now let's look at commercial lines on slide 8. Commercial line segment earnings were $31 million in the quarter, representing an increase of $18 million over last year. As you can see from the slide, this increase was driven by the following factors. First, we saw a $12 million improvement in the development of prior year reserves. In the current year quarter, prior year reserves developed favorably by $7 million. This was driven primarily by an improved outlook for commercial multiple [inaudible] in the most recent accident years. In the second quarter of last year, prior year reserves developed unfavorably by $5 million, primarily in workers comp, commercial umbrella and general liability.

Second, in the quarter-- expenses in the quarter were lower compared to a year ago, primarily due to lower contingent commissions and the timing of certain technology costs.

And finally, the current segment income benefited from lower CAT losses and higher investment income.

As you may have noted, the commercial lines expense ratio for the quarter was 36.9%. We believe this to be somewhat lower than normal and expect that the ratio will return to a level approximating our year-to-date ratio.

Finally, let's turn to production, which is on slide 9. Overall, written premium was $558 million for the quarter, down 4% compared to the second quarter of last year. In commercial lines, net written premium increased by about 8% for the quarter, which was offset by a 10% reduction in personal lines.

We're obviously pleased with the increase in commercial lines premium, which is driven by growth in new business and solid retention. The decline in personal lines premium was, in part, the result of our strategies aimed at running off certain sponsored business and reducing our Massachusetts auto book.

However, as we've discussed in the previous quarters, premium has also decreased, to some degree, from declines in our core business, which Marita will discuss in more detail in her remarks.

With that, let's discuss the life company results, which are on slide 10. The life segment reported a loss of $5 million for the quarter, driven by 2 factors. First, the net loss from operations for the quarter was $1 million. This is consistent with our expectations, given equity market returns for the quarter and our expectation of break-even results when we have a 2% equity return in a given quarter.

Second, we recorded a $4 million reserve for an ongoing investigation with the SEC related to market timing. As we've disclosed in prior quarters, we are currently involved in an informal SEC investigation related to market timing in sub-accounts of our variable annuity and life products. This stems from an industry-wide investigation involving many companies and, as you know, a number of these companies have also recorded reserves.

Now let's look at the life company cash flow, which is on slide 11. Life company net operating cash flow, as you know, is a non-GAAP metric intended as a measure of our operating performance and liquidity. It does not represent statutory income or distributable capital from our life business. As you may recall, we discuss and compare this metric on a sequential quarterly basis.

In the second quarter of 2005, the life companies generated net operating cash flow of $25 million, which is $11 million lower than the first quarter of this year. The primary reason for this decrease is related to the impact of the equity market on our hedging program. In the current quarter we incurred a $2 million loss on the GMDB hedge versus a $6 million gain for the first quarter of 2005. The hedge program is designed to generate gains during a falling equity market, as in the first quarter of this year, and losses during a rising equity market as in the current quarter to offset changes in the underlying guaranteed minimum death benefit exposure in our variable annuity product. With the market up slightly in the current quarter, we recognize a loss on our futures contracts of about $2 million.

The current quarter cash flow also includes the $4 million charge related to the ongoing SEC investigation that I just mentioned. And, again, this quarter our hedge program continued to perform as it has been and as we expect it to.

Now let's look at statutory capital, which is on slide 12. Adjusted statutory surplus for the quarter increased by $42 million compared to the first quarter of this year. Capital increased by approximately $28 million resulting from payments by the P&C company to the life companies pursuant to our tax sharing arrangement. The increase in capital also includes $8 million of realized gains, primarily from the disposal of previously impaired bonds.

Income from statutory operations was approximately $6 million for the quarter, which is consistent with our expectations, given the equity market performance.

And, as Fred mentioned, our capital position continues to remain strong with an RBC ratio of 575%.

In closing, we're very pleased with our P&C results, which were strong in relation to the prior year quarter. Our life company results, while generating a GAAP loss, were also in line with expectations when you take into account the equity market performance and this provision for the SEC matter. Life company cash flow also remains in line with our guidance when you consider the equity market levels.

Our P&C earnings are generally tracking well against the guidance we provided at the end of the fourth quarter as we entered this year. However, I would point out that favorable developments this quarter pushed earnings above our expectations.

I'd also like to point out that our 6-month commercial lines growth rate of 8% is probably a better estimate of our expected growth for the remainder of the year than the original double-digit guidance that we provided.

Before I turn the call over to Marita, I'd like to take a few minutes to update you on the status of our discussions with the rating agencies. As you know, each of the rating agencies conducts an annual review of the companies they rate. We recently completed our review with Moody's, the last company-- the last rating agency to meet with us this year.

Undoubtedly you've seen the 2 press releases issued by Best and by S&P earlier this year. In the second quarter, Best upgraded the rating on our senior debt to investment grade. In addition S&P raised the outlook to positive on our debt ratings and on the life company's financial strength rating.

As I said, Moody's has just recently completed their review and we don't anticipate at this point any rating action from them.

Our discussions with the agencies were very positive. Our strong financial position was acknowledged and is believed to be comparable to other A-rated companies. That's A-rated companies.

We remain focused on delivering strong financial results and remain committed to upgrading our P&C company financial strength rating to A and obtaining an investment grade rating for our holding company from both S&P and Moody's.

And with those comments, I'll now turn the call over to Marita.

Thanks, Ed. Good morning and thanks for joining the call. I'm very pleased that our property and casualty business continues to performance well, recording solid earnings in both the personal lines and commercial lines segments.

Ed reviewed the financial results in detail, so I'll elaborate on just a few aspects of our business performance in the quarter. Personal lines results continue to track well, with a combined ratio of 91.5% for the quarter. This represents a 6 point improvement in our margins compared to the same quarter a year ago.

Mild weather in the second quarter was certainly a contributing factor, however loss performance continues to be favorable and our margins remain solid in both personal auto and the homeowners line. We continue to see margin lift from the earned effective rate actions we took last year. Loss trends have remained favorable. While pricing in this market's tight, so far it remains consistent with the expectations we had at the beginning of the year.

While we're very pleased with the earnings momentum in personal lines, we also know that our continued success in personal lines is dependent on our ability to gain market share. For that reason, we continue to strengthen our product portfolio, including a new multivariate auto product that we call Connections Auto, enhancing our homeowners product and leveraging our account rounding strategies. So let me spend a few minutes talking about personal lines written premium where premiums were down 10% compared to the prior year quarter, as we expected.

As you know, our policies in force declined throughout 2004 in personal lines. As we have discussed in previous calls, most of the decline was by design, resulting from our strategies to reduce volume in Massachusetts, from exiting certain sponsored market business and by improving our mix in core states and by implementing multi-tier products and credit.

As you know, we aggressively introduced a multi-tiered product that was used-- that used credit in 2003 and into 2004. This was done to improve the mix of our business in our core states. A significant part of the improvement in our earnings came from pricing and mix improvement and positions us well for the release of our new auto product.

Now that these actions are behind us, we expect to continue to see improvement in our PIF trends during the second half of the year. We believe we've reached that inflection point in new business. New business moved up in June and the loss of PIF continues to improve each month. At this rate, we could expect to see modest growth in PIF in our core business by the end of the year. This sets up next year well as we deploy our new auto product across all 4 states. For example, in Michigan, new business was up 15% in June compared to the same period last year as it is, without the benefit of the-- that we expect from our Connections Auto product.

As I mentioned, last quarter we launched this product in the states of Tennessee, Illinois and Maine in-- on April 23rd, introducing far greater customer segmentation capabilities. We implemented this new product in our smaller states first so we could learn from our experiences in these markets and further improve the product before rolling it out in our larger markets.

We're very pleased with the response to Connections Auto. The increase in new business to date resulting from the new product launch is very encouraging. While these are smaller states with respect to premium, all 3 states recorded growth in new business counts in the range of 40% to 85% or an increase in new business premium of about $2 million.

We have a 2-- we have 2 additional phases of the rollout planned for this year. Wave 2 is currently underway in the states of Indiana, New York and Virginia and wave 3 is scheduled for November and will include Michigan and Florida. We expect to complete the introduction of Connections Auto in 2006.

With the trends in Michigan PIF improving and our new Connections Auto implementation well underway, we remain very optimistic about our ability to compete in personal lines.

Before providing some perspective on the commercial lines business, I'd like to update you briefly on the status of reform in Massachusetts. As you probably know, the Massachusetts Insurance Commissioner had-- approved an order implementing auto insurance residual market reform that I believe would have been beneficial to our business. However, on January 31st, 2005, a Superior Court judge granted a preliminary injunction which placed reform on hold in response to a suit filed by certain carriers and agents in the state who challenged the Commissioner's legal authority to implement changes to the residual market. After trial in June, the same judge made his order permanent.

The Commissioner and the Attorney General have not yet indicated whether they will approve. Massachusetts auto reform has received considerable press this quarter with the court ruling and with legislation proposed by Governor Romney. Despite all the activity, the likelihood of reform is uncertain and the business operates under some ambiguity as the Commissioner has yet to establish the new rules for the redistribution of the residual market deficit.

Despite the absence of significant reform in the Massachusetts auto market, our Massachusetts team has significantly improved our results. We have taken steps to reduce claim frequency, enhance our premium per policy and actively manage our residual business and our cession strategy, with solid results. Regardless of the outcome of reform effect, we remain committed to continue to improve our results in Massachusetts and we are confident in our ability to compete with the best Massachusetts regional companies.

Turning now to our commercial lines segment, our margins remained solid and we generated strong written premium growth of 8%. As Fred pointed out, this growth came from both improving new business and from maintaining solid retention levels. New business premium in the current quarter was $46 million, which is $5 million or about 11% higher than what it was in the second quarter of last year.

We continue to gain new business under challenging market conditions, largely being generated by our preferred agency partners. As you know, developing strong agent partnerships has been and continues to remain a core part of our commercial lines strategy. While total premium grew 8% in the quarter, written premium with those winning agents grew at a 15% growth rate for the quarter.

Growth in our specialty lines continues to be strong. Written premium increased by $12 million or 48% compared to the second quarter of 2004. Developing our specialty lines expertise is another key component of our commercial lines growth strategy. We continue to enhance our bond, umbrella and inland marine capabilities to specifically complement our core product offerings.

Finally, let's look at new business by account size. We have identified the low end of middle market, or policies with account size of $25,000 to $100,000, as our target business. We believe this to be an under-served market and one that we are well suited to serve since it requires strong underwriting skills and benefits from having local market knowledge. Again, we have achieved positive results.

About $14 million or 40% of our new business, excluding specialty, is coming from accounts that fall in this middle market category. Written premium growth of 8% in the quarter is a strong growth rate in this current market. We did not experience this level of growth any time during last year.

Our new operating model that is designed to be responsive to our market space has been implemented and we are now focused on consistent delivery across the network. Further, we have made the necessary investment in the field. The upgrading of our underwriting and field talent is almost complete and we believe we are now positioned well in the market and are encouraged by the growth we can generate.

There's no question that the market is becoming more challenging and that could affect our growth. We are committed to maintaining our underwriting discipline as we grow and will not sacrifice margin at the expense of volume.

As Fred said, our strategy is to grow profitably in the business cycle and we will aggressively leverage our new field leadership, our operating model and our underwriting expertise to gain market advantage without our margins coming under pressure. We're confident that our strategy is sound and we're committed to working hard to achieve profitable growth wherever we can.

And with that, I'll turn the call over to Sujata.

Operator, we'll now take some questions.

Thank you. [OPERATOR INSTRUCTIONS] Dan Farrell, Fox-Pitt Kelton.

I guess, firstly, just with the life RBC at about 575% right now, it's pretty well capitalized. What's-- what's your thought or outlook for a dividend out of the life subsidiary as we move towards the end of the year? And have you been in contact with the Mass. regulators at all on this?

Yes, again, it's interesting. I was thinking about this call beforehand and I was remembering where we were a year ago, which-- we're in a similar position in that we had improved quite a bit the capital position during the first 6 months. And I think the drill, if you will, is going to be pretty much the same as it was a year ago.

We have continued communication. We talk to the regulators on a quarterly basis. We're obviously pleased with where we are. We feel very good about the capital position. But, as I said a year ago, this really becomes an annual event. As we get closer to the end of the year and we close out the year, it's at that point that we really have the substantive conversations about-- about the dividend levels and I expect that that will be the same this year. So I think as we get into the next quarter I can probably reflect more accurately on that than I can now.

OK. And-- and then secondly, can you comment a little bit on what you're seeing in the New Jersey market place and also what your view is of the Supreme Court ruling and the impact that that might have?

We're obviously-- it's Marita. We're obviously seeing some increased competition in New Jersey. We have spent a lot of time reviewing the state and putting together strong strategies similar to the way we approach the Massachusetts market place. We have a strong presence there.

We are keeping track of the effect of all changes, including the new ruling, on our book. It certainly makes it a more difficult market place and we'll respond to this as we have all the changes in this market place. We're close to it. We understand it. We constantly evaluate it and react accordingly.

Yes, one of the things, Dan, New Jersey, just like Massachusetts, no matter what the reform is, it's always going to be a difficult state and one of the things that I think that the Supreme Court ruling does it just-- it really emphasizes the fact that you have to have a very targeted claim strategy, particular-- particularly fraud in certain geographies. Because it really is where the losses will be driven.

The other thing I would just comment on, we-- a year ago we introduced a new product and we're doing it again in the next month. We've upgraded our product again to create more tiering and more distinctiveness in our pricing, because in New Jersey one of the biggest issues always is the liability-only policies, in particular. And so we continue to refine our product and refine our strategies and claims.

So we are actually-- it's one of the states that I watch very, very carefully and we do not have at all aggressive growth goals in that state compared to what others are talking about. Because I'm just watching this ruling and, again, we have a great agency plan. I'm comfortable where we are. I'm comfortable with the new product. But it's a place that we are, essentially, keeping a close eye on, given the changes there.

Angelo Graci, Merrill Lynch.

A couple questions. Moving over to the commercial line, could you provide a little more color regarding the retention rates and how they've moved up over the past year and what do you think is driving that as far as the rate environment, the-- I guess, the push for insurers to retain accounts as opposed to push for new accounts?

Yes, the retention rates have moved up slightly, but remain solid in the low 80s and, like we said last quarter, it's obvious that this really has been a retention market where people are holding on to their renewals and working hard to maintain those renewals with good margins and we're seeing that same benefit. No significant changes -- more of that slight upward trend in retention as people work hard to retain-- retain those best renewals.

And one of the things I would comment on and I mentioned it in my early comments, the retention that we're seeing in our large accounts, say over $250, is about 68%. So in our core business, in the smaller business, it is very solidly where we expect it to be and where we want it to be. But what I'm seeing in this small segment for us -- it's a big segment for many others -- is you're starting to see more aggressive behavior. And, again, it's not everybody. It's some large players and it's a couple of the regional players and I expect that to not get better in the end of the year.

And so, as I said earlier, we're creating a walk-away price because I can see some people being more aggressive in some of the large accounts. Again, it's isolated to a few competitors to date, but it's real and we keep track of it.

And you're not really seeing that in accounts that are $100 or less?

No and, again, I don't expect it to be. I mean, I think that so much of what's happening right now in that is it's about service and responsiveness and operating models and I don't see that. We'll see, maybe, a little pressure coming down to that segment, but I'm pretty optimistic because, as you know, that segment is somewhat more consolidated than the rest of the segments and I feel that people are being a lot more disciplined. Or at least that's what we're seeing.

And as we said in the last call, that smaller segment of the commercial lines business is the segment that saw less price increase in the harder market, so it stands to reason that it would show-- it would show less decrease in a softer market.

OK, great. And you're comfortable with the retention rates where they are right now or do you think they should be a little higher over the next--?

Well, one of the things for us, they should get-- we should see some increase because one of the things we've been doing -- it's less noticeable here than personal lines -- but we have been very aggressive on mix. So when Marita and I started this, we had too many-- in BOP, for instance, there was a little bit too much habitational risk and a little bit too much contractor. We're still kind of-- there's a little bit of that working through the system and in comp we're being very thoughtful about comp in some of the states, given what we're seeing with medical costs and the outlook.

So there's a little bit of mix work we're doing there, as well. So I would expect that, while I feel very good about our retentions in our core business, the overall number is seeing the results of some of that continued action. It'll finish up in the next couple of quarters, but there's still some pretty aggressive action in both comp and BOP going through the numbers.

Jeff Thompson, KBW.

I have, I think, 2 questions. The New Jersey auto, can you quantify how much premium you have and have you set up the reserves differently there as a result of the recent ruling?

The New Jersey book is about $100 million for us, Jeff.

And that's personal auto or is that homeowners, too?

That's $100 million in auto, Jeff. That's auto.

And have you set the reserves differently there in light of the ruling?

I-- we look at it each day and I don't think we've made a significant change, given the ruling.

The claim department has built some preliminary estimates and they're not material at this time, but we continue to review that and look at how this will affect-- will affect that.

Yes, we do-- we do our reserves on a state-by-state basis so as things change at all in the various markets we take that into account. The other thing I'd point out about reserves and it's pretty obvious as people look at the overall reserve position and thought about-- looked at development is that overall we think we're in a very secure position on the reserves. So if we need to tweak things a little bit for one state, it shouldn't really have any material effect overall.

OK. And then the second question, you really focused this call on growth in personal lines in '06 more than I've heard before. Can you give us, maybe, a feel as to how much you think you can grow in '06 and why agents are going to do business with you?

Yes. I mean, one of the things that's pretty clear, Jeff, is that there's a distinction and you've seen it really grow and I-- between the haves and have-nots on the product front. And I would say that the hard market covered up some weakness of the folks with less sophisticated product.

And so when I look at why people are going to do business with us there are a ton of mid-size agents in our-- in our markets that are looking for an alternative to the 2 or 3 national players that really focus on auto only that both bring home and auto, but also a sophisticated product so they can grow. And so we've had tremendous response. There's 11 states that we have focused on for growth outside of our core-- our big one and you look at those states and our early conversations with agents, partner agents that we currently have and new agents that we're appointing, and there's a real need for a market that has a sophisticated product to help them consolidate what they've got now with small, unsophisticated regional players.

I would also say one other thing. A lot of people made a lot of improvement by gutting their homeowners product. They didn't really do the hard work of mix management, pricing, using multivariate. What they did is they took out coverages. And so what you've got now is a lot of agents saying, “God, I need a player, if for nothing else than E&O exposure, to have a homeowners product that I can partner with my auto product to kind of grow my business,” and do things like umbrella, which is a big part of their profit potential is to write a whole account, get the umbrella, as well.

So we believe very strongly that we are going to have a great reception to the new product, our account-rounding focus that we very much have and I feel very, very good about it.

As far as the amount of growth, I'd like to give more guidance as we get-- clearer guidance as we get toward the end of the year, because I want to see how these early states develop and, particularly the big states. If you can think about it, our first 3 states, I would say, was a-- was a kind of soft launch because we were testing the products. We were testing the way we did our agency management and so we didn't appoint a lot of new agents. We didn't aggressively sell it. We just partnered with a few agents and let it roll out and, as Marita said, it was very successful.

This next round is really bigger states. It's the New Yorks of the world, it's Indiana, where we're focused, and we're almost re-launching the Illinois, the Tennessee, the Maine with our new focused approach. So we're going to have a lot more knowledge about exactly how much growth as we come into the end of the year.

But I-- but I'm confident. Again, I can only tell you that, like in Tennessee, which was a very small state for us and something we've been in and out, first meeting we went to to discuss it we had 70 agents show up and the buzz we have right now and the requests for appointments and the people we're talking to is pretty intense. And it doesn't surprise me because, again, I see real opportunity for those that haven't invested in a product like this to kind of be really vulnerable to people like us that have an account focus and a multivariate product.

And the thought there is the agents can sell more because it's better priced into little niches where they can beat the competition?

Yes, it's a much broader-- Again, what we're doing for multivariate, if you think about where we were and one of the reasons why we had a run-off and we had to change our mix of business, most companies like us had very few tiers. When we got here it was 3. I took it up more, but it still only really was an effective product for a small portion of the business, maybe 30% or 40% of the business was it really targeted to price effectively.

This multivariate product can price effectively 80% of the market. Now a lot of these agents are letting go a lot of that business because they don't have a market for that or they give it to Progressive at less commission. And Progressive, obviously, doesn't have a homeowners product. So they're very vulnerable to the Allstates of the world that have a total account solution and a multivariate product. And so, again, it both broadens our underwriting appetite, but allows our agents to compete.

I had a meeting with 60 agents the other day in New York and they were talking about -- they all have regional companies. And they said, “God, we've met with that regional company and they're making a lot of money and we're doing OK, but we're shrinking with them.” And we said, “Well, how come you can only write a portion of their business?” And essentially it's because they had limited tiers. And so to me, the reason they were coming to this meeting and signing up to be a better partner with us was because this gives them the opportunity to place business with a different type of company that they think they can grow with.

So I'm actually-- again, I'm encouraged by this. It's hard work, but I think it makes a lot of sense and it's the right time.

That's a great explanation. Thank you.

In addition to the segmentation and the total account sale, the ease of doing business and speed that we brought to the market place with the new model and the new system that comes with the product is also-- is also a big benefit to the CSRs and the agencies who are placing this business.

Colin Devine, Smith Barney.

A couple questions. First, on personal lines, I appreciate there's been a targeted reduction in Massachusetts and that's driven a significant portion of the decline in written premium, but there's also been some disappointment, I think, in the past few quarters in Michigan. I was wondering, first, if we could expand on what's going on at Citizens?

Secondly, with respect to the net written premium for commercial, Marita mentioned, the speciality line was up but if you take that out I think total NWP for commercial lines was only up 1.2% year-over-year and that actually compares to being up 4.9% in the first quarter. So perhaps you could just expand a little bit more on that?

And then lastly, if we could address the life company, it's tying up close to $1.2 billion of capital. It's targeted return is, I guess, 0. What is your strategy to sort of unlock that or what is it worth? If it's not worth its stat book value then what do you think it's worth and how do you start to better put that capital to use?

I'd be glad to start, Fred, with-- with Michigan. I'm not sure I would portray it as a disappointment, considering the increase in margin that we've seen in that state. We-- as we talked about last quarter and again this quarter, we have decreased our PIF in Michigan. A lot of that had to do with the introduction of credit and better segmentation. A lot of it had to do with re-underwriting some of the business there.

And we continue to see decreases in PIF, but as we mentioned, new business is increasing with the new products and new capability that we've put in the state. So I think we've done the right thing, being bottom line as opposed to top line focused in that state and I'm really encouraged with the new business growth there.

So that's what I would say about Michigan.

Yes and let me just add, Colin, because again I just want to make sure people understand. I'm actually-- I pretty much expected exactly what happened and I would do it again. Margins are up everywhere, mix is better.

And let me try to explain, because, obviously, we weren't articulate enough about saying what we did. We didn't just do price increases. The company was probably 2 or 3 years behind on price increases, but they were also behind on segmentation of their book.

What we really did, on top of pricing, is introduce credit and a multi-tiered product right away. And the reason we did that is we had a significant portion of our book, 15%-20% of the book -- because we were late to credit, one of the last big companies to put in credit -- we had a significant portion of our book that was underpriced significantly, 15%-20%, because, obviously, without credit we got dumped-- a whole segment of business got dumped on us because we weren't sophisticated enough to know.

So when you put in that segmentation and the pricing, you obviously are going to drive out some segment of that business purposely. Now would I have loved for them to stay, getting 20%-plus increases? Sure. But that's an unlikely event, given the fact that we were late to the game and, frankly, because we don't have a product that fit that type of risk.

So, again, I feel-- it was purposely set to get to the margins and the profile of the book so that when you introduce a multivariate product like we are now you have a profitable base to grow from. You don't want to be growing from a weak base or a vulnerable base. So in my view, it's basically been focused on getting profit everywhere.

Now you're absolutely right on the Mass. and the-- Massachusetts and the program business is about half of all the business that is going away, but the other half is that segment that we purposely, in my view, repriced. And, again, would I have loved to keep more of it? If I could keep it at those kind of price increases, yes. If not, I'm glad to have it go and now we're positioned to grow.

Do you want to go with commercial?

Yes, your second question was specialty. What I would say to that is, obviously, working hard to increase profitability includes many components and a lot of that has to do with underwriting improvement and mix shift. And Fred mentioned BOP remediation, a hard look at our workers comp business and some movement there.

In addition, building specialty capabilities in businesses that have higher margins, in the marine, bond, umbrella, and shifting some of that mix by design. Even with all that movement, we did see $14 million of new business in the quarter from our core first-tier middle-market. So a lot of this is profit improvement plans and things designed to do exactly what the quarter gave us as far as margin improvement and we're very encouraged by our specialty growth. And if that's the best place to gain margin in commercial lines, then that's where we'll put our resources.

The other thing I would-- the other thing I would say and, again, we have been very clear, I think, on this point that it's about partner agents and so what we've-- what we've done is focus on the partner agents and slowly roll out with partner agents and that's why the growth with them, which I think is even more meaningful than the overall growth, because it shows where we're going is that 15%, which is a great mix between specialty and core. That's where our best underwriters have been focused and as we get more and more agents aligned like that and in those 3-year plans, we continue to see progress and feel comfortable that we can see this kind of steady growth through the cycle.

So I feel pretty good about that.

But, Fred, just to come back on the-- if we look at workers comp, commercial auto and C&P, net written premium was up year-over-year for those 3 lines combined 1.2%.

Right. In comp-- right, I agree.

So perhaps you can comment on that and your satisfaction with it or shall we expect to see that start to trend upwards faster? It certainly was my impression that's where the focus was going to be on growing the company, not just on the marine and stuff?

No, I agree and it will-- it will start to grow. And, again, one of the things that I mentioned and I'll say again, the BOP business we have worked hard to get the mix right. And so we've essentially gotten out of a lot of small, small agents we have just a little bit of business out with. We got out of a number of classes. We've shrunk the percentage in those classes and in workers comp we've been pretty aggressive at re-underwriting the mix and the book.

So you're right that the net/net increase is not as impressive as it will be and you will start seeing growth in those lines of business more consistent with what we're doing with our target agents. So I feel that that's where the progress will be.

Yes, Colin, I think the numbers are the-- If I remember right, comp's down period over period by about 10% and that's obviously pushing the overall numbers down to a lower amount. If you take out comp we're probably up around 4% or 5%, I think.

I'm not even sure that much, Ed. I'm looking at commercial auto and C&P, if you just want to look at those 2, they aren't that much.

But maybe we can, then, turn our attention, Fred, if you could outline your strategy for the life company? And it ties up this $1.1 of capital. It's making no return. What can be done to unlock that or is Allmerica basically stuck with that in run-off and you're going to have this capital trapped for an extended or protracted period of time?

Colin, I don't think there's a whole lot new to say on this. Our strategy remains what we've articulated it to be.

Ed, with all due respect, I was really-- the question's for Fred.

OK. But it's the same answer, whether you get it from--

That's fine.

--Colin, whether you get it from-- whether you get it from Ed or you get it from Fred. So if I could just complete my thought, then I'm sure Fred will have-- we'll give Fred ample time to comment.

But for the benefit of everybody else on the phone that may not be as familiar with this as you are, Colin, it really starts with managing this business to put ourselves in a position to extract capital. And then the question becomes, how do we monetize the capital around those life entities?

And I think it's fair to say that in the short 2 years or so since our difficulties we've already done or we have done, I think, a very good job of extracting capital. And, as you can see this quarter, we continue, I think, to do a good job of building the capital base.

And our strategy is to look at all the alternatives that are available to us in retaining it, through taking dividends or disposing of part or all of the business. And, as I said, I think we talked about this a lot last quarter, about how we've been very diligent and very careful to understand the broad M&A market with respect to what might be available for the disposition of this business so that-- so that we're informed about that particular alternative and such that if that makes more sense to-- did make more sense to sell rather than hold, based on value for our shareholders, we're in a position to act on that.

And we continue to think that way and we continue to behave that way.

So, again, Colin, I-- we've had this conversation many, many times and it obviously has been a focus for the last 2 years since I've been here. It is obviously difficult to get access to the capital, which has been demonstrated, I think, over the last 2 years as we have improved the capital base and worked with the regulators. We've shown some progress to get it-- dividends because of our improvement in the management of the business and I think we have improved our management of the business because it, obviously, didn't have the same kind of outlook it has today.

Part of the increased value, by the way, of the statutory surplus is the increased value of the P&C franchise, because some of that surplus growth comes from the earnings growth and the tax benefits of the earnings growth of the P&C, so a lot of the reason we've increased the value of the life surplus is because of the increased performance of the P&C company.

The question of how to unleash that capital is, obviously, something we spend a heck of a lot of time on, both from our work with the regulators and discussions with the regulators, but also in the strategic alternatives. Then-- and, as I said, we spend a lot of time doing it. We continually look for the alternatives and try to figure out the best way to free up that capital.

But it's, obviously, a difficult situation and difficult strategic issue facing the company. Right? We all know that, given the situation and the fact that the regulators have to approve any access to that capital and, obviously, it's not an ongoing business so those that would be interested in that asset would have to be interested in it from a financial point of view, strictly, because it doesn't have any strategic value because it is not an ongoing business. And so with that comes the understanding of all the liabilities that come with that business.

So it's obviously a difficult strategic question and it's one that we work very hard at and we're dedicated to creating value for our shareholders with it, but I-- again, it's the same options that we've laid out in a lot of detail over the last 2 or 3 quarters and we continue to pursue it as aggressively as we possibly can.

In terms of, if you are able to get a dividend out of it, which I think Ed indicated he's certainly fairly confident that you will this year, is your expectation that you'll continue to retain that at the holding company? Or could we see your capital redeployment program expand beyond the reinstatement of the dividend value and the share repurchase.

Yes, obviously, there's-- in my view we always constantly say and think about how to use capital that we get access to and if it makes sense to deploy it to the shareholders we'll do that-- just that. We-- obviously on the P&C side we're coming from a position with a B company to need to retain that capital to get back to the A rating so that we can be a top quartile player on the P&C side.

My conversations with the rating agencies would say that we have, obviously, achieved a significant amount of progress over there and have given them comfort that our capital levels are approaching what the good companies, the good A companies are. So, therefore, if we get access to excess capital, we're going to access what's the best way to use that capital, whether there's opportunities to grow our core business or to use it to give back to shareholders.

Operator, I think that with that we're out of time, so we will close this quarter call and I just want to let people know that, as always, we-- IR will be here and I will be here answering questions. Thank you.

Thank you and that does conclude today's conference call. We thank you for your participation and have a nice day.