Hanover Insurance Group Inc (THG) 2006 Q3 法說會逐字稿

Good day, ladies and gentlemen. Welcome to the Hanover Insurance Group third quarter earnings conference call. My name is Henric, and I will be the audio coordinator for today. At this time, all participants are in a listen-only mode. We will be conducting a question-and-answer session toward the end of the conference. [OPERATOR INSTRUCTIONS] As a reminder, this conference is being recorded for replay purposes.

On the call today we have Sujata Mutalik, Vice President of Investor Relations; Fred Eppinger, President and Chief Executive Officer; Ed Parry, Executive Vice President and Chief Financial Officer; Marita Zuraitis, President of P&C Companies; and Mark McGivney, Senior Vice President of Finance. I would now like to turn the call over to Sujata Mutalik. Please proceed, ma'am.

Thank you, operator. Good morning and thank you for joining our third quarter conference call. Participating on today's call are Fred Eppinger, President & CEO; Ed Parry, our Executive Vice President and Chief Financial Officer; Marita Zuraitis, President of Property and Casualty Company; and Mark McGivney, Senior Vice President of Finance. Before I turn the call over to Fred for a discussion of our results, let me announce that our earnings press release and our 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.hanover.com. After the presentation, we will answer questions in a Q&A session.

Our prepared remarks and responses to your questions today, other than statements of historical fact, may include forward-looking statements. There are certain factors that could cause actual results to differ materially from those anticipated by the press release, slide presentation, and the conference call. We caution you with respect to relying on forward-looking statements and in this respect refer you to the forward-looking statement section in our press release and slide 2 of the presentation deck.

Today's discussion will also reference certain non-GAAP financial measures such as total segment income, segment results excluding the impact of catastrophes, [inaudible] and loss ratios excluding reinsurance reinstatement premiums, and accident year loss ratio, among other [inaudible]. A reconciliation of these non-GAAP financial measures to the closest GAAP measure on a historical basis can be found in the press release or the statistical supplement which are posted on our website, as I mentioned earlier. With those comments, I will turn the call over to Fred.

Good morning. And welcome to our third quarter earnings conference call. As announced in our press release, segment income after-tax was $28 million, an amount which, as you know, includes an after-tax charge of $34 million for additional Katrina reserves that we announced a few weeks ago. Pretax Property and Casualty segment income, excluding the impact of catastrophes, was a solid $117 million, including pretax benefit of $7 million for a litigation settlement relating to our Opus Investment Management business. I am very pleased with the results, which continue to track well with our expectations. Both our Personal Lines and Commercial Lines businesses continue to deliver strong results.

Our Commercial Line segment reported over 16% growth in the quarter, but on a comparable basis, which excludes the effect of reinstatement premium last year, Commercial Lines growth was 11% for the quarter, which is ahead of our guidance and consistent with our objective of delivering growth that is above industry averages. We continue to see strong contribution from the investments we have made in our inland marine and bond businesses, which grew significantly, and at the same time, our traditional drive lines also grew 5% country-wide.

As I look forward, I see continued momentum in Commercial Lines. Our operating model continues to mature and improve, the number of partner agents continues to grow, and our specialty businesses continue to provide growth and value to our agent partners. This gives me confidence that we will sustain profitable growth this year.

In Personal Lines, our reported written premium growth in the quarter was 8%. But on a comparable basis, which excludes the effect of reinstatement premium last year, our growth was a little over 3%. That growth was driven by new business growth in our Connections Auto [suite]. This represents a significant turnaround from where we were just a couple of quarters ago, and even more encouraging, when Massachusetts Personal Lines is excluded. In Mass, as you know, we have taken a very conservative position towards growth.

And this year because of our coastal action, the state mandated redistribution of high loss ratio ERPs, and our reduction -- reduced assignment from the involuntary pool, we are experiencing some one-time reductions in premiums. Growth outside of Massachusetts was 8%. Personalized investments in service, operating model and product enhancements are also starting to take hold. New business production across our entire network was up over 100%, now accounting for over $200 million in premium year-to-date.

As we look forward in Personal Lines, we can also see continued momentum. Connections Auto is now in the 17 states that we planned to be in for this year, and we also released a significant upgrade for our homeowners product in September. The enhancement to this product will make it easier for our agent partners to do business with us, and pave the way for our new homeowners product, Connections Home, that we expect to introduce during the end of the first quarter of next year.

While we have grown, we have done so responsibly. And as you know, we attacked our PML levels during the last 3 years, reducing them in all our areas of concentration. Over the last couple of quarters, given the latest RMS models and the unfolding reinsurance market, we have taken an even more aggressive position in some very select geographies of Cape Cod, Long Island, Florida and Rhode Island, where we transferred our property book to Narragansett Bay Insurance Company.

While this impacts our growth, it makes our financial position even stronger. Even with these actions and current market conditions, I believe we can continue to outgrow the market over the next year. In addition to our top line growth, I am also pleased with other aspects of our performance this quarter. Our accident year margins continue to be strong, and we continue to benefit from a stable reserve development, further demonstrating the strength of our balance sheet.

Turning to expenses, you will note the higher expense ratio than in the second quarter of this year, and Ed will review that in more detail. As I have said, I expect this year to be the high water mark for expenses, and that over the next 2 or 3 years we should see a 3 point improvement in our expense ratio. And as I discussed during last quarter's call, the uptick in the second half of this year was driven primarily by us accelerating a number of investments. We believe this makes sense because we felt margins would be excellent this year, and we anticipated the market becoming somewhat more difficult next.

Unlike many of our regional competitors, we have aggressively invested in new database products, innovative operating models, and assembled a tremendous team to create a distinctive offering for winning independent agents, that could allow us to hold margins and grow throughout the cycles as top quartile property and casualty companies have done. Just in this quarter, we have launched Connections Auto in 5 additional states, with Georgia launching last week. And as I mentioned, we released a significant upgrade to our homeowners product.

In Commercial Lines, we rolled out a new rating engine for our package business in two-thirds of our states, that should enhance our underwriting throughput. And we are currently launching our Bond Direct system that automates small surety bonds and our automated Builders Risk system, along with a number of other small commercial enhancements.

Additionally, we continue to invest in our claims operating model, which is centered on developing an operating model that improves claims efficiency and delivers a scalable organization, and one that is aligned to meet the diversified growth needs of both our Personal and Commercial lines of business. And we are earning our cost of capital while we continue to invest in these capabilities in our strategic position. For example, our investments in claims are beginning to deliver results that will help us sustain margins.

And along with growth, we are maintaining the quality of our property, workers comp, auto and specialty business through the use of predictive models. Strategic investments of this kind are expensive, yet necessary to deliver sustainable value for the long term. I think you're starting to see these investments, many that we've already made, separate us from our competitors. This is helping us to establish a strong position with our agents and to leverage these relationships to increase our flow of business.

To summarize, I feel very good about our performance and believe we have turned the corner strategically in the P&C business. 2.5 years ago we started this journey to create a special Company that focused on delivering a package of products, technology and service responsiveness to meet the needs of the best agents in the business.

Obviously, we still have a lot of hard work to do in order to prove that we are a top quartile Company. However, our position is improving every day. The market conditions are remaining fairly competitive, yet so far we were able to grow without sacrificing margins. There is clearly less shopping of policies in personal lines, and you can see this reflected in lower new business production among competitors. In addition, some competitors are taking very aggressive positions in certain segments of our Commercial line.

As I've said before, I am committed to delivering profitable growth and I remain convinced that a top quartile Company can prove -- can grow through the cycles, they just grow less. With the investments we have made, we have positioned the Company well and given ourselves a chance to compete successfully and responsively through the cycle. I am confident we are on the right path, and I am more convinced than ever that the best of both strategies combine the people, products and technology, and service capabilities of the best nationals with the local presence and responsiveness of the the best regionals is working. And now we will be a very strong Company in this challenging market environment.

Before I turn the call over to Ed, I will briefly comment on the Life companies. First, included in net income for the quarter is a gain of $8 million from the sale of Financial Profiles, a financial planning software company we had acquired to complement our life and annuity business in the late '90s. This gain is recorded in discontinued operations. The sale generated $21 million in proceeds, which is held at the holding company.

While relatively small, we are pleased with this transaction and it represents yet another step in our commitment to free up life capital and focus our Company as a property and casualty company. Additionally, I want to report that we have successfully completed the transition of our Life and Annuity business to Goldman Sachs on schedule, and we are on track to outsource our remaining Life operations by the first quarter. This will result in a variable expense structure for the remaining Life businesses. The Life segment results have also performed as predicted and in fact, somewhat better than our guidance we had provided at the beginning of the year.

And finally, as you know, we declared our annual dividend a few weeks ago. We increased our dividend amount by $0.05 to $0.30 per share, reflecting the improved earnings power and capital strength of our Company. With that, I will now turn the call over to Ed for a review of the financials.

Thank you, Fred, and good morning again, everyone, and thank you for joining our call. As usual, I'll be using a slide presentation during my remarks, and I trust all of you have that available. It's up on our website. So if you do, please turn to slide 5 for the third quarter financial highlights. Net income for the third quarter was $33 million, or $0.65 per share, compared to a net loss of $562 million, or $10.51 per share for the third quarter of last year. Segment income after taxes was $28 million, $0.54 per share in the current quarter, as compared to a second loss of $109 million, or $2.04 per share in the third quarter of last year.

Results in the third quarter of last year included an after-tax loss of $140 million for catastrophe losses related to Hurricane Katrina, and an after-tax loss of $475 million on the sale of our variable life and annuity business. The current quarter's results include the previously announced after-tax loss of $34 million for Katrina, a $5 million after-tax gain for a litigation settlement related to our Opus Investment Management subsidiary, and an after-tax gain of $8 million from the sale of Financial Profiles that Fred just mentioned.

Now let's turn to slide 6 for a discussion of our pretax segment earnings. Pretax Property and Casualty segment income was $53 million in the current year quarter, compared to a loss of $128 million in the prior year quarter. Excluding the impact of cat losses and the benefit of the litigation settlement, P&C pretax segment income was $110 million in the current year quarter compared to $118 million in last year's third quarter. This $8 million decrease is the result of higher underwriting and loss adjustment expenses, partially offset by improved loss performance, and to a lesser extent growth in our specialty line.

Now, let's look at slide 7 for a review of Personal lines. The Personal line segment generated pretax earnings of $35 million in the current quarter versus $28 million a year ago. The net impact of catastrophes was $21 million in the current quarter, compared to $102 million a year ago. Excluding the impact of [cabs], pretax segment income was $56 million this quarter compared to $74 million a year ago, representing a decrease of $18 million driven primarily by increases in expenses, which I will discuss in a moment.

But first let me comment on loss in premium trends. We continue to see favorable reserve development. In the current quarter, prior year reserves developed favorably by $14 million, an amount roughly equal to last year's third quarter development. This quarter's development is primarily related to the 2004 and 2005 accident year. Additionally, current accident year results remain solid, in line with the prior year at just over 50%. Written premium growth for the quarter was 3%. However, as Fred said, written premium growth excluding Massachusetts was just over 8%.

Now let's talk about expenses. Several factors contributed to the higher expenses in the quarter. First, expenses associated with variable compensation were about $8 million higher in the current year quarter. One half of this increase is due to an unfavorable comparison, because in the third quarter of last year, we reduced our year-to-date accrual to reflect the effects of Hurricane Katrina.

The other half of the increase is due to a current year adjustment to reflect this year's expected earnings. Second, last year's third quarter expenses benefited from an unusually large premium tax refund of about $3 million which did not recur this year. Aside from these items, expenses were higher this quarter for the same reasons we discussed previously, and are driven by increased spending in claims, primarily related to the development of our new operating model there, the impact of new accounting for stock-based compensation, higher technology costs, and to a lesser extent, an increase in the proportion of overhead expenses absorbed by this segment.

Now let's look at Commercial lines results, which are on slide 8. Commercial lines segment generated pretax segment income of $8 million in the current quarter, compared to a loss of $101 million in the prior year quarter. The impact of tax was $43 million in the current quarter, and $144 million a year ago. Excluding the impact of these catastrophes, pretax segment income was $51 million in the current year quarter, up from $43 million in the prior year quarter.

This $8 million increase was driven by favorable development of prior year reserves and increased earnings in specialty lines, partially offset by higher expenses. Let me comment on each one of these items. Prior year loss and loss adjustment expense reserves developed favorably by $26 million this quarter, compared to $11 million in the prior year quarter. This $15 million increase was driven primarily by worker's compensation, Commercial Auto, and commercial multi-peril, and primarily relates to the 2004 and 2005 accident years.

Additionally, growth and improved current accident year performance in our specialty lines accounted for about $9 million in earnings improvement quarter-over-quarter. Slightly more than half of this improvement was driven by growth in inland marine bonds, which as you know, typically carry lower loss ratios than our traditional business, and now accounts for 17% of our Commercial lines book, up from 11% last year.

The other half of this improvement was due to more favorable current accident year performance, again, primarily driven by specialty lines. Partially offsetting these items was an increase in expenses of about $16 million quarter-over-quarter. The factors contributing to higher expenses in Commercial lines are similar to those discussed in personal lines, and include the increased variable compensation expense, increased technology spending, a continued shift in product mix to specialty lines that typically carry a higher expense ratio, the impact of new accounting for stock-based compensation, and to a lesser extent, an increase in the proportion of overhead expenses absorbed by this segment.

Now, let me comment just very briefly on production, which is on slide 9. On a reported basis, the Company's overall net written premium increased by 11%, 8% in Personal lines, 17%in Commercial lines. However, these reported premium amounts benefit from the inclusion of the Katrina-related reinsurance reinstatement premium which decreased net written premium in the third quarter of last year.

If we exclude the effect of this reinstatement premium, net written premium was up 6% over last year, to $603 million. On this adjusted basis, Commercial lines net written premium increased by 11% over last year, and Personal lines increased by 3%. Once again, outside of Massachusetts, Personal lines growth was over 8%. New business net written premium increased significantly in both Commercial lines and Personal lines, with a 49% increase in Commercial lines to $80 million, and a 91% increase in Personal lines to $77 million. Marita will discuss production in more detail in her remarks in a moment.

Now let's turn briefly to the Life Companies. Life Companies continuing operations reported a segment loss of $1 million. This represents a slightly better result than our guidance, due to higher than expected net investment income. In discontinued operations, we reported an after-tax loss of $3 million in the current quarter related to the expenses associated with transitioning these businesses. These results are in line with our guidance and expectations.

Before I turn the call over to Marita, I would like to provide some updated guidance. In Commercial lines, we expect full-year growth to come in at the upper end of our guidance of mid to high single-digit growth. In Personal lines, we expect full-year growth of about 5% on an as-reported basis or 3% to 4%, excluding the effect of the reinstatement premium. Total earned premium growth is on track for low to mid single-digits, driven by Commercial lines. Our expectation for Property and Casualty earnings is consistent with our ROE target of about 12%. Our accident year margins are holding as expected.

We continue to believe that our net investment income for the fourth quarter will be consistent with 2005. Our effective tax rate remains consistent with our guidance for the year of about 32%. And we expect our OUE and LAE ratios in the fourth quarter to remain relatively consistent with the levels in the third quarter. Finally, we now expect Life segment results from continuing operations to generate a pretax loss in the range of $6 million to $8 million for the full year. And with those comments, I will now turn the call over to Marita.

Thanks Ed. Good morning, and again, thanks for joining our call. Let me start by saying I remain pleased with our performance. We continue to gain momentum in both our business segments. Our loss performance remains strong, and our overall returns are consistent with our objectives. Ed discussed our financials in detail, so I will focus on our profitable production. As we've said from the start, we will grow, first by investing in our capabilities. We have made meaningful investments in our products, our underwriting insight, and teams of experienced field leadership. And this is enabling us to achieve those objectives.

Also as we have said from the very beginning, we will grow profitably, and that mandate hasn't changed. We are growing in all segments of our business as we had planned. Remember, our objective is growth, not by winning business one policy at a time, but rather by building partnerships with agents and winning a significant portion of their shelf space. We are currently in the process of working with our partner agents to update and develop 3-year business plans that establish both growth and profitability targets. These business plans will help deepen our relationship with our agents by offering them the right resources and support, and gaining commitments to shift share to us.

Now, moving to production, in Personal lines we reported 3% growth in the quarter, excluding the 2005 reinstatement premium, up substantially from a 6% decline for the same period last year. In Commercial lines we showed 11% growth for the quarter, compared to 6% growth in 2005. Let me give you some insight into our growth numbers and why we feel good about our growth. Let's look at Commercial lines growth of 11%.

First, we are growing in the places and in the lines we expected to. We reported robust growth in our inland marine and bond business, which grew 69% over the prior year on a year-to-date basis. In addition, our more traditional drive lines are also growing at a rate of 4% year-to-date. As I said, our growth rates reflect an intended change in premium mix, with significant growth in traditional high-margin inland marine and bond businesses. At the same time, we are also improving our market share in the standard lines.

Let me touch on our growth in inland marine and bond. As you know, we have invested heavily in both businesses over the past couple of years. And these investments are starting to pay off. Through September, we have over $113 million in premiums, a 69% increase over the same period last year, of which $88 million is new business. These are specialty businesses, where the success and the quality of the book is extremely dependent on the quality of the underwriting team.

I believe that we have assembled some of the best talent in the industry. These lines represent 17% of our Commercial lines book, providing us with better breadth and diversification of our earnings base. The growth in our traditional lines is also in line with our strategy, as we are growing in our sweet spot. C&P and Commercial Auto growth is being driven by first tier middle market segments, which is our sweet spot, defined as accounts with premium in the range of of 25 to 200,000. In this segment year-to-date, C&P growth was 13% and Commercial Auto grew by 10%. Although the market is tight, pricing is hanging in.

I am also pleased with our margins. Through 9 months, our rate increases, including exposure growth, were about 1.5%. Further, our accident year results in these lines also continue to remain solid, with a 48% loss ratio, excluding catastrophes and development. We monitor the quality of our business very closely, using various metrics, including class mix, line of business mix, policy size mix, and transactional quality, and I remain satisfied with the quality of our new business.

Finally, as expected, we are growing with our partner agents at a rate that is over twice the growth rate of our overall franchise. Once again, I remain satisfied with our Commercial lines production. It's coming from the right places, in the right lines, and in the right market segments. Our strategy to create a total account solution operating model in Commercial lines, tailored to our target market, which offers a broad risk appetite, problem solvers at the point of sale, together with a higher level of service and responsiveness is resonating in the market.

Now, turning to Personal lines, we recorded 3% growth in the quarter, excluding reinstatement premium, which is in line with the growth we have seen year-to-date. As expected, this growth is driven by Personal Auto and is supported by new business from our Connections Auto rollout states. With the addition of 5 more Midwest states, we now have Connections Auto, our [multi-variant] product, in about 17 states as planned.

Additionally, we are seeing growth momentum despite continuing to reduce our catastrophe concentration in coastal areas. As part of our ongoing catastrophe management program, we review our portfolio periodically, utilizing the dynamic portfolio optimization techniques and other analytics to drive risk/reward evaluations at a policy level. This has identified and driven individual decisions that enable us to leverage our capacity to grow more effectively. As you might have seen, we have taken some action to reduce homeowners policies on the Cape and in Rhode Island. This will affect roughly $10 million in premium. While this will put some pressure on top line in some of our states, we still expect to be able to achieve our growth objective.

Let me pause here and comment on our position in Massachusetts. We continue to shrink in this marketplace. Over of a last 3 years, we had a focussed strategy to improve our profit position in Massachusetts. Our plan included focusing on partner agents, reducing Coastal exposures, and improving our claim and technical capabilities. This led to a reduction in our premium, while significantly improving our profitability, a trade-off we're willing to make every day.

In 2006, our underwriting results continue to be excellent, but our premium is shrinking due to a continued aggressive management of our agents, less premium from mass car due to a reduction in the size of the pool, and a state mandated redistribution of higher loss ratio ERPs among the primary carriers in the state on a more equitable basis. While these factors have reduced our premium, they have improved our profitability. We now have built a very strong and profitable business in Massachusetts, and we expect to focus on cautiously growing our voluntary position in 2007. However our growth in the states, as both Fred and Ed mentioned, outside of Massachusetts is over 8% for the quarter. And as planned, we are growing faster outside of our big 4 states of Michigan, Massachusetts, New York and New Jersey.

I remain satisfied with the growth in our Personal line segment, our Auto Connections book is performing appropriately. Connections has provided the competitive leverage we expected it to provide. It is enabling us to diversify our footprint and exposure base outside of the big 4 states. Of course, given the sophistication of this new product, we expect to make ongoing adjustments. But our analysis around new business is thorough, and we can identify and respond to issues quickly. We carefully monitor new business distribution, flow, and hit ratios by agent and risk tier. About two-thirds of our new business production continues to be generated by the superior risk tiers, which is consistent with our current mix. Our overall hit ratio is where we would like it to be, within the 25% to 30% range overall, with a somewhat higher risk -- higher ratio, hit ratio in our more attractive risk tiers.

To conclude, we are achieving the premium growth we expected in both segments of our business. As Fred mentioned, our best of both value proposition that combine smart underwriting, sophisticated products and the capabilities of the nationals, with the responsiveness and personal approach of the regionals, of knowing our agents and our competition better, and having an adult at the point of sale who can make decisions starting to take hold.

Of course, the market remains competitive, and it will take hard work to achieve the growth targets we've set for ourselves, while being responsible and sustaining margins. But I believe we have positioned ourselves to remain competitive, even if the market becomes more difficult. I remain pleased with the progress, and I am optimistic that we will continue to deliver on our commitment. And with that, I will turn the call back to Sujata.

Operator, we're now ready for questions.

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

A question on your loss reserves, and then your accent on your picks. I mean, your reserve releases continue to accelerate, yet it seems to me that your accent on your picks continue to remain conservative. They're down a bit. But I was wondering, as you look forward, how do you see that playing out? Do you think your accident picks will start coming down to reflect the strong loss -- the favorable loss development you have been seeing? Or do you think you will continue to fuel reserve releases going forward? I just wanted to kind of get your thoughts on how does that dynamic work out?

Yes, Dan, I think -- your observations are right on. I think over time, particularly given how we see the market going forward, I don't think we'll -- over time, that is over the next year or 2, continue to see these same levels of development. We always endeavor to be conservative on our reserves, and we make our picks on the current accident year. But I think the trends are such that we won't see this level of favorable development going forward.

Okay. But presumably, the accident years, I think -- you are pretty conservative relative to reserve development that you're seeing currently, I think. Is that a fair statement?

Well, certainly the last couple of accident years, the development is bearing out the fact that our initial picks were conservative.

Great. Okay. That is helpful. And then can you just refresh us on when you are meeting with the rating agencies again for your annual review? And just what are your thoughts going into that meeting for the potential for a ratings upgrade?

The meetings are a little staggered. I think as you know, they have always been that way. We start the conversation with Best in the mid December to mid January time frame. The other agencies come later. More in the early spring. And although we start the conversation with Best around that time, it seems that we really never get it firmed up and completed until we get sort of past the first quarter. Right around the same time that we are having initial conversations with the other agencies.

As you know, we speak with them all on a quarterly basis. We talked to them when we had our Katrina announcement here several weeks ago. We talked to them again about results for the year on how we are doing against plan. We continue to feel very good that we have delivered on the things that we told them we would deliver on.

Okay, great. Thanks, guys.

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

If no one is there, I guess I'll keep asking questions. Just one other thing on the other specialty segments. You have shown some very strong growth there. Where do you see that ending up as a percentage of the total book of business, given the amount of staffing that you put on that? How do you see that progressing in the intermediate term over the next few years?

This is Marita. I think that is going to depend on the growth in the other segments that counters that, and what the market gives us next year. It is about 17% now. I can very comfortably see it in the 20% range. But that is really going to depend on, again, what the market looks like going forward. We have very experienced people in both the inland marine and bond segment. And we have the products necessary to round out books of a lot of our agents out there. But that is really how I would think about it.

Yes, Dan, this is Fred. And I would also say that we think about specialty a little bit broader than bond and marine, obviously. We have been developing niche positions in things that also complement our business. And our goal has always been that if 25% of our premium can be in these kind of specialty niche type of positions that give us something unique along with the flow business, it is a really nice model for us.

So like our Moving and Storage program, I think, is quite distinctive. We've done some things on churches that are quite distinctive. So again, I would say that in that 20% to 25% range is a nice mix for us, and in the $100,000, $200,000 kind of commercialized business we're in.

Okay, great. And then where does the staffing in that marine group now stand as you continue to add people there?

We have probably about 70 people, between those 2 businesses. And again, some of the best people in the industry, I'm convinced of it.

Okay, great. Thanks. That was helpful.

Ron Bobman, Capital Returns.

I will fill the void. I was wondering if you could talk a little bit about the Katrina development. What's -- at more of a street level description as far as claims reopened. And also could you give us an update as to what the gross Katrina number is now? The number of claims you have gotten and how much has been paid? And maybe some IB&R figures versus case? Thanks.

Yes, I think the gross number is -- what is it -- slightly -- slightly over $600 million. The pays are very high. We've closed upwards of 99% of Personal lines claims and the Commercial lines, it is in the high 80s. So I think we have done a very good job settling the claims.

What we have seen here in the last number of months and it is the reason for the adjustment that we made several weeks ago, is a reopening on a number of claims, of both Commercial and Personal lines. We also saw a reasonable amount of litigation that was filed right around the July time frame, in both Personal lines and Commercial lines. At the end of the day, we don't think that will affect our indemnity costs all that much. But it certainly required us to make a provision for LAE costs.

On a case-by-case basis, particularly around Commercial lines, there have been some claims that have been reopened around the issues of flood versus water. We are in a couple of unique cases we think will -- we needed to bring reserves up. Although, I don't think that that's going to be a pervasive issue for us. So it was really all of those -- essentially those 3 or 4 factors that I just mentioned that gave rise to the increase that we made.

As a percentage of our initial gross, we have increased our reserves at this point by some 13% or 14%, which, near as we can tell, is very much in keeping with companies that were similarly situated to us, with the market share that we had and the exposure we had in the region. So I don't see that our experience around our reserves, at this stage of the game, is at all unique. We feel good about where we are going forward.

Our approach was a little unique. A lot of folks, if you watch the numbers, put low numbers out and then increased them pretty significantly at the end of last year. Because our initial estimate was pretty close, we didn't have any significant difference in our point of view at the beginning of the year. And as I've said, these very specific issues we're seeing now, we thought it was appropriate now to be more refined about our estimates. But we feel very good about it.

Just to discuss a little bit further, the reopens on the Personal line, is that basically sort of repair costs, demand surge, et cetera?

What is unique about this situation, is there is a larger percentage of people that are just now getting contractors. And so what you see, is it is not huge numbers, but the estimates are a little bit higher now that they are getting their repairs. And so what we wanted to do was make sure we did a better set of predictions as far as how we were going to see that unfold over time.

And again, it is just a unique -- this storm is unique in that so much of the repair is being done, here, we're talking a year later, which causes a little bit of inflation in materials. And when you look at a year later, there are little things that are different from the original estimate. But again, we feel good about the way we thought about it and predicted it.

Would you give me the split for the 600 or 620 of gross between Personal and Commercial and approximately the number of claims?

We don't -- do you have that handy, Sujata? I'm not sure I have that level of detail handy. We can certainly give you a call.

I will call back.

-- get that to you.

Thanks. And nice job, continued good progress.

[Patrick Meegan], [Hutgins and Wiley].

Looks like a light day on the question volume, so I thought I would ask you a couple questions. And the main one is, just what is the base level from which our expense ratio should go down the 300 or so points?

Again, what we said is you can see where our expenses are through the 9 months, right? For Personal and Commercial. And the guidance that we've just given is that we expect to see the fourth quarter expense ratios, LAE and OUE, in an amount equal to the third quarter. I think if you do the math, it gets you to a mid 34 for OUE, and just under 11 for LAE.

Okay. Got it. So the high water mark is basically for the full year, as opposed to for Q3 -- ?

Not the last 2 quarters, right, Patrick? It's the average for the year.

Got it. Excellent. And now that you mentioned the transfer of AFLIAC to Goldman Sachs is complete, does that mean that that is the end of the kind of string of small discontinued losses we have taken below the line?

We haven't talked about -- we haven't talked to the Street obviously, about what we see for next year, but we are close enough to it, I guess now, to comment on it. For continuing operations, from a continuing operations standpoint, that is for the retained business, that we didn't sell, we expect going forward to break even in that segment. So we don't expect to see those losses.

Okay. And then, but the AFLIAC losses -- ?

I think we will have some level of discontinued ops loss in the early part of next year. Having more to do with contingent liabilities and activity around that, and some trailing operational things, but I don't expect it to be significant.

Okay. Excellent. And then, just a comment. Certainly, hats off to you guys on the conservative reserving. We have seen a pretty consistent string here of reserve release that's indicated that the earnings quality you guys have generated over the past couple of years has been very high, Katrina notwithstanding.

Yes, it's really -- I mean, I think 3 years ago we took a look at our practices. We knew that we needed to invest in the business. And we knew that as we were investing, we were going to need some help on the P&L to power our way through that. It certainly came out just as we'd expected.

I wanted to comment as we look forward, because I think a little bit different from other people. We are planning a portfolio here. We to try to invest in a number of places in a number of ways, one of which is on quality of mix of business, which I think will help get -- we built this thing for this kind of market. That's the way I think about it.

We didn't build this thing for a market that grows at 10% rates, and the wind hits your back. I feel very good about being in the position we are in right now, where our losses are in a very good position versus the opposite, which is just going after expense reduction and have losses high. So we have some, I think, pretty good position going into this market.

Okay, Well, thank you very much for the additional comments and answers to the questions.

Larry Greenberg, Langen McAlenney.

I was just wondering if Marita could talk a little bit more specifically about pricing that you are seeing in Commercial lines, with may be a focus on what you are seeing on your new business growth versus expiring premium on those accounts?

I think it is an excellent question. It's a very flat environment for us right now. Again, if you remember this segment that we are in, our sweet spot that we talk about that first tier middle market, this is a relatively boring segment.

It didn't see the price increases in the harder market. It is certainly not seeing price decreases in this market. It is somewhat of an underserved market for us, and we've attacked it heavily. That, combined with the growth in our specialty lines, which do tend to be individually account underwritten, even in tough times.

I think that has allowed us to keep a relatively flattish pricing environment overall. We do look at not only the price of our new business compared to the price of our renewal book segment by segment and compare that to make sure it doesn't get out of whack. And I'm comfortable with that. We also look at something that we call an efficiency ratio, which is the loss ratio in that first accident year of new business versus the loss ratio of our retained business, and we're also comfortable with that.

So I think we get the fact that new business is newer, and we keep track of both pricing and profitability on that book. And we're comfortable with where we are. Overall, like I said, the environment for us has been relatively flattish.

One of the things you are seeing and obviously, you've heard comments from others, what you see in this kind of market is obviously a much more fluid pricing around larger accounts. You're seeing, people are aggressive in comp, which we kind of anticipated. Large comp, in particular, is where you get swing when people can't generate growth, they go into large comp. Particularly people that aren't very skilled.

And you also are seeing it sounded like the contractors, large contractors in liability lines, those kind of lines are getting more crowded now as people are going into those to try to grow. We don't really have a lot of exposure to any of that. So we are just a little bit odd. And it's why we built the Company the way we built it, to kind of avoid some of those swing -- what I call swing markets.

The other thing I would tell you, in Personal line, if you have seen a lot of the other guys that are seeing shrinkage and frankly, price swings, a lot of folks have basically appointed a ton of new agents and have a little bit of volume with a lot of agents. And they are also being very aggressive with aggregators. That is the most commodity-oriented segment of our business. We don't have much of either of those. We don't believe in it. So we have much more of our volume with partner agents and future partner agents.

And we only go to aggregators that actually have an underwriting component [inaudible]. So what you are seeing right now in my view is the folks that are in more the commodity -- what I call commodity segments, are going to get hit first. The question is, how far does that go? But we feel relatively good about being in the smaller segments, the more boring segments, and the kind of business that is more around retention and partner agents. Which, again, makes us feel more comfortable with how we think about our [inaudible] share shift with those agents.

Thanks. Are you willing to share any color on the efficiency ratio? Or how first year business performs relative to your renewal book?

There is really not a significant difference. We look for those differences, but now our new business is performing very similar to our retained book. So we would look for variances there. Where you would find a variance with a new product, you would immediately make changes so that that variance didn't continue. But we don't have a significant difference between our new business and our existing book.

Great. Thank you.

Cliff Gallant, KBW.

Just a couple of questions. 1, on some of the new business numbers, like the 67%, could you give some -- do you have any statistics around where that might be coming from, in terms of new agents or new states? Or is it -- and how long does it take a new agent appointment before they are really productive for you?

If you are referring to the 69% increase that we saw in inland marine and bonds, inland marine in particular, because it is a growing segment for us and we are building the expertise there. In inland marine, we started our efforts, obviously, with books of business that the underwriters that we attracted were familiar with. Inland marine is a segment, I think, where the business follows the underwriter more typically than almost any other business segment.

So again, you start small with agents that you know, that have inland marine expertise. You build the book. And then over time, you -- the whole reason for doing this would be able to write inland marine business across our existing plant. And we are in the process of extending those capabilities to our partner agents who also have this inland marine business. So where we are is, pretty much across the board in inland marine, depending on the segment that you are talking about as far as how business is spread, but the idea would be able to cross-sell these businesses and write the inland marine and bond that those agents have.

Is that similar, Company-wide? I think I saw in the press release it was 67% of new business -- net written premiums in the quarter?

I'm sorry, Cliff. Could you say that again?

Overall, Cliff, that's right.

Overall, right. Is that similar, then? I mean, when I look at that number of -- when I look at that new business premium growth, I was just concerned about the quality of that book. And I thought as an indicator of that, we could look at -- where is that coming from? Is it simply new agents? Or is it penetration of existing agents?

It's all of the above. And I think you have to remember when you talk about percentages, that this was a relatively small book for us to begin with. We didn't have a lot of inland marine business as a Company. We didn't cross-sell and round out accounts as much as we probably could have. And now that we have the expertise, we can do that.

Again, the general -- let's talk about whole new business growth, because I think it is a good question. The vast majority of our new business growth in Commercial is with our partner agents. So if you look at it, the growth rate in those partner agents, those 270 or so that we believe that are across the threshold as a partnership, are really in the 20s in total growth, and a lot of our new business growth. And if you look at it, it is coming not one at a time, as Marita said, it is now we are getting movement of books of business and positions with them. And that is why we have the lack of difference between our new business results and our existing results. Because we're not just doing it in new business one at a time.

In Personal lines, it is a little bit more of a mix, because we have a number of our agents that are relatively new in Personal lines outside in these new states that we are growing in. I would still say to you that it is the 40 or so core agents in each one of those states, that are making up much of the business, which we have created these 3-year plans with, and a commitment to get to be 1 or 2 on their shelf space. And so they work with us a lot more aggressively on how to get what I would call, a ballast, by moving legacy books to us to get started.

So again, unlike -- we don't go and find the biggest aggregators in every state and try to win this new business against Progressive and Travelers. It is not our schtick. Our whole thing is we pick those 40 or 50 agents where we think that we have a real opportunity, and then we try to prove to them that the product is effective. And then move books of business.

As far as your question, we have a maturity in a lot of these agents. It differs by age, but we talk about get through the first year to prove yourself, and really show how we can get our position larger. Then we go for the big ask, to go to the next stage of our relationship that occurs over the next 12 months. So in a lot of these cases, it is a couple year exercise. But the conversation starts at the beginning. This is election. Again, what is different about us than any company that I know, we put an enormous amount of effort in agent screening and selection.

And it is an interview process, if you will, that says who can be a partner. And we actually did that of all of our existing agents, too. I mean, it wasn't just new ones. We have actually gone through that process that Marita talked about, that 3-year planning process, that says who can be a winning agent. And one of the things we look for, besides just gross of the agent, is we look at who else is on their shelf space.

Where we are getting tremendous success today, is people that have a lot of their shelf space with legacy products in Personal lines. The old ISO 3 tier products. Where they are seeing [PIP] shrinkage and don't have a product that allows them to grow. And on the Commercial side we are seeing a lot of our success with people who that really have not been effectively competing in that 25 to $75,000 risk because they are big companies have the black box, and they haven't got a company that they can partner with to go after that business, and have an underwriter locally. So again, I would say to you that it takes time. There's no question, we'll have more partners at this time next year than we have this year. But we really watch like a hawk how that business comes in, and that margin. And so I actually feel very good about the results of our growth today. And I guess, Marita is there -- ?

Absolutely. I think that's been business planning that we kick off this time of the year allows us to sit down and very specifically talk about the product mix, where the growth is going to come from, the anticipated margin that we expect from the business, real business plans, with these partner agents. And our growth, as Fred said, with the partner agents is double of what it is with the rest of the franchise, starting with these pretty aggressive business conversations during the business planning process.

And again, one of the things I think that is different than most companies, yes, we want to do all these things to provide new, new with our agents. And that's why I love the specialty business. Because it allows our agents to get new, new to them. So a lot of our growth is not new to the agents. And that maturity of that business gives us insight into the profitability. That is a significantly different strategy than just going against 6 other carriers for all new, new. I mean, in a market like this, what you want is transparency to the profit pool that an agent has, and get access to that business. And what that requires is, you've got to have something to bring to the table, which is why we've invested in these specialty business to allow those agents to get some new, new. But a big portion of what we are getting, our business that we have transparency to the earnings of it, because it has been on the shelf space of one of these agents. So again, it is a little bit different than just put the products out there, and let them sell themselves on an auction.

But it sounds like then that the, is it 1,000 or so agents that you appointed this year are not necessarily driving this year's growth.

No, and remember, that is Personal lines. Okay. So what is different about Commercial and Personal, we pretty much had the agency plant we needed in Personal -- Commercial. I think we got rid of about 100 and we gained about 100. In Personal lines, these 17 states we launched Connections in, there are many of these states, Arkansas, Tennessee, Ohio, Wisconsin, that are states that we had 30 or 40 agents.

And what we want is 120 agents in those states. And that we are going through a process by which we are making them partners. And you are absolutely right to say, the amount of premium from those guys is not that great in Personal lines right now. And we are just starting. I mean, 5 of these states we launched this quarter. Right? So a lot of these are just starting the march.

Now, the places where we have had more experience, like a New York, where we launched Connections. Or in Illinois, what you are starting to see is those initial appointments are starting to be the majority of the business. The partners, if you will. So again, it is a process in Personal lines to really assimilate and pick. Now, one of the things I would tell you, in Personal lines you usually get 125 to 560, which is the opposite of Commercial.

What I mean by that is in Personal lines, you screen them the best you can, you really understand them. But you end up getting rid of some that you don't think you can be partners with. Whereas in Commercial, you really build it up small groups of them at a time. Because you kind of know who has commercial business and what their trading patterns are. So again, I feel very good about this approach. But it is a very, in my view, very scientific approach that we have taken toward this.

Thank you. That is very helpful. Actually I did have 2 quick follow-ups. Separate questions, really. Ed, I was wondering if we could get the employee count today versus what it might have been a year ago, or maybe at year-end. And then my second question was, in terms of January 1 renewals and how you are feeling about what your reinsurance needs might be? Do you have any sense of how you will approach the market?

Let's talk -- [inaudible] just briefly on the reinsurance point. We can get to the head counts. And obviously, by the way, you all know if you follow the Company, in the last 3 years, we've gone from 6,000 to roughly, 4, 100 employees because of the Life transaction and a lot of other things we did around overhead to shift the investments to our P&C business. But let's talk about the reinsurance. And then I'm going to have Marita, because she just got back from London, and we did a trip to London and to Bermuda.

We have taken very aggressive actions, and targeted actions in a scientific way, that have made the new RMS models a non-issue for us. Non-issue. We have been able to reduce our PMLs to the point where we don't see any of that having an impact to the rating agencies or to the reinsurers. And to the opposite, I think our portfolio today is better than it was in any of the last couple years. Which really puts us in a great position to start these conversations and negotiations with the reinsurers. Obviously, the trend last year was a certain increase in January, a greater increase in July, but this light year has helped us some. So, with that, I would love Marita, you can give people an insight on what you learned and where you think we are.

I think Fred is right. You are well aware that our treaty comes up 1-1. I am sure you noticed a lot of the 7-1 renewal increases that have occurred. But I'm sure you have also noticed the profitable results that many of the reinsurers are now posting, plus a relatively quiet cat season.

As Fred mentioned, we have met and are currently meeting with all our reinsurers. And we are getting credit for the PML reductions and the cat management process that Fred talked about. I think there's a range of possible outcomes for our January renewal. But we're confident that we'll see reasonable 1-1 renewal pricing, and get credit for all of the good work that we have done. Our meetings went extremely well, and we're positive about what that 1-1 renewal will look like for us.

Thank you.

Cliff, on the head count, for the total Company, where we are today, it is probably somewhere around 4,300 or 4,400, which is roughly equivalent to where it was a year ago. The interesting thing is, the Life head count is down several hundred. And the P&C head count is up several hundred. And it is up in the areas that we have invested in that we talked about for the last 3 or 4 quarters.

Thank you very much.

Sir, at this time, you have no additional questions. I would like to turn the call back to Sujata Mutalik for closing remarks.

Thank you, operator. And thank you, everyone, for joining our call. Once again, if you have any additional questions, we are here for you. Talk to you soon. Bye-bye.

Ladies and gentlemen, this concludes the presentation. You may now disconnect. Have a good day.