Hanover Insurance Group Inc (THG) 2008 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Q1 2008 The Hanover Insurance Group earnings call. My name is [Colby] and I will be your coordinator for today. At this time, all participants are in listen-only mode. We will be facilitating a question-and-answer session towards the end of this conference. (OPERATOR INSTRUCTIONS) I would now like to turn over the presentation over to your host for today's call, Sujata Mutalik, Vice President of Investor Relations. Please proceed.

Thank you, Colby. Good morning and thank you for joining our first quarter conference call. Participating in today's call are Fred Eppinger, our President and Chief Executive Officer, Gene Bullis, our Executive Vice President and CFO, and Marita Zuraitis, President of Property & Casualty Company. Before I turn the call over to Fred for a discussion of our results, let me know 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 section of our website at www.Hanover.com. After the presentation, we will answer questions in the Q&A session. (inaudible) remarks and response 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 or the slide presentation in the conference call. We caution you with respect to reliance on these forward-looking statements, and in this respect, refer you to the forward-looking statements section in our press release and slide two of the presentation deck.

Today's discussion will also reference (inaudible) non-GAAP financial measure, such as total segment income, segment (inaudible) excluding the impact of catastrophes, excat loss ratios, and accident (inaudible) loss ratios, among others. Our reconciliation of these non-GAAP financial measures to the (inaudible) 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 thanks for joining our call. Today we will review the first quarter results and provide some insight into the trends in our business. Let me start by saying I'm very pleased with the strength of our performance and quality of our earnings for the first quarter of 2008. Segment earnings after tax were $57.3 million or $1.09 per share compared to $60.2 million or $1.16 per share from the prior-year quarter. Earnings were slightly lower in the current quarter because of significantly more weather-related losses this year than last year . Book value per share was up 2% in the quarter at $45.23 per share, up from $44.37 a share at the end of 2007.

Our fourth quarter trailing [PNC] leverage return equity was 13.7% at the end of the first quarter of 2008. These advances resulted from strong earnings of our Property and Casualty segment, which earned $98 million in the first quarter of 2008, compared to $100.9 million in the prior-year quarter. Catastrophe losses and more severe winter in the Midwest and the Northeast, where we have a significant presence, led to higher weather-related losses in the first quarter of '08. These losses were not outside our expectations for a typical first quarter, but were much higher than our experience in the prior-period quarter. Earnings in the current quarter would have been ahead of prior quarter by $2 million just adjusting for cats alone.

In addition noncat weather-related losses also were higher, particularly in Personal Lines, and are reflected in a higher current accident losses, which would otherwise have reflected an improving action year trend in the aggregate consistent with our ongoing expectations of maintaining or slightly improving accident year margins. Additionally, our business portfolio has continued to mature very favorably, particularly in Commercial Lines, and consequently we experience reserve releases related to prior action years across almost all our lines. At the same time, our balance sheet continues to remain very strong as we maintain our current reserve margin of actual indications of over 5% at the end of the first quarter. We continue to reserve our current action year prudently, giving careful thought to the pricing environment, introduction of new product enhancements, and penetration of new states.

Clearly, our earnings power has remained strong and our underwriting practices have remained disciplined, as we continue to write business that maintains our [accident year] margins while we generate favorable prior [action year] reserve development. This is indicative of the quality of the business we are writing.

Turning to growth, our overall net premium growth in the first quarter was about 3% or 2.7%. This is within the range of our expectation for the first quarter, given the tough comparison to the first quarter of '07. We continue to work at gaining shelf space with partner agents, and it is our expectation that we should achieve somewhat higher growth rates as we go through the year, resulting in mid-single digit growth through the year in aggregate. Personal Lines premium was flat compared to the fourth quarter of '07, but was down about 4% when compared to the first quarter of last year. While this is partly a function of high first quarter [base], we are also experiencing the impact of current economic and competitive factors in Michigan and Massachusetts.

As we have discussed previously, Michigan continues to present a challenging business environment, with a weak economy and a shrinking Personal Lines market. But I'm confident that we'll continue to manage this market very well. In Massachusetts, we are transitioning to a new competitive market system. Our first quarter results still reflect last year's mandated 12% rate decrease. Open market conditions took effect on April 1and at which time our average 8% filed rate decrease will come into play.

We remain very positive about the new era of managed competition, as we see a huge opportunity for us to offer our distinctive value proposition to Massachusetts agents, something we haven't done before or couldn't do before. However, '08 will be somewhat of a transition year. We will contribute to the top line pressure primarily due to filed rate decreases. But we will see [accounts] increasing as we gain share.

Additionally, as you know, we have taken exposure management actions in Florida and Louisiana. The impact of these actions are reflected in our growth, but should continue to help our long-term margins. Offsetting these trends, we are seeing the validation of our strategy in our growth states, where we are [enjoying] positive growth momentum even in today's more competitive environment. We remain optimistic about our ability to generate solid growth in these states to balance out our position in Michigan and Massachusetts in the short-term, as well as overcome the impact of exposure management actions. Marita will speak to these in more detail in a couple of minutes. Our optimism in Personal Lines is based on our gaining traction on our full value proposition. Unlike the prior years, our Personal Lines product set is now more complete and has reached a level of distinctiveness. Our improved Connections Auto Product is in place and ready to to be sold across our entire footprint now, including Massachusetts.

Our Connections own product is well-positioned and is now available in our big 16 states. Additionally, we have expanded our toy capability, such as boats and [automobiles], and our commitment to service has really taken hold.

Additionally, we are taking rate action in most states. We believe the market will support this, and we are certainly seeing a similar pattern among our competitors. All in all, we expect marginal Personal Lines growth for the year. And we should still deliver on our overall growth guidance of mid-single digit growth in the aggregate by leveraging our more robust Commercial Lines business segment.

In Commercial Lines, we grew at 13% for the quarter . We made some strategic changes, as you know, to our reinsurance program that Gene will provide more detail on. But our Commercial Lines written premium growth on a direct basis was 5% for the quarter driven by our Specialty business, which grew at 20% in the first quarter. We closed on our acquisitions of professional direct in the third quarter of '07 and we closed on [our] land holdings in March of this year. We should continue to see positive growth momentum through the year from these acquisitions, as well as from our traditional growth specialties, which was at 9% for the quarter and is expected to accelerate throughout the year.

Also contributing to our positive outlook for Commercial Lines growth is the position of our small commercial platform. We made significant upgrades to our small commercial model and platform during '07, with many enhancements including more sophisticated pricing and an ease of doing business. The performance in our small commercial business started to gain real traction at the end of '07, and we expect to gain further momentum in our small account as the adoption of our enhanced model continues to increase with our existing and new partners. Of course, we would be affected by market conditions as we were in '07, particularly in middle market commercial segment where pricing competitiveness still makes it a difficult market. ut with the work we did in '07, including the acquisitions we made and the opportunities that we will continue to evaluate in '08, we have given ourselves many options for profitable growth and positioned ourselves well for success with our partner agents.

As I consider our progress, I remain convinced that our disciplined approach to identifying winning agent partners and our broad product approach is working. And we are building momentum and market share with our winning agents. At all times, we endeavor to carefully manage our growth at an agent level to ensure continued attractive margins, and this will never change.

To summarize, I am pleased with the results in the first quarter of '08, and I believe we remain on track to deliver on our commitment that we made to you on investor day. We remain confident on our ability to grow profitability in Commercial Lines. While meeting our Personal Lines growth objective has become more challenging, we are still making solid progress in our growth states, and we will continue to manage Michigan and Massachusetts carefully.

Additionally, we will continue to demonstrate underwriting discipline and you will see this in our ability to maintain or slightly improve our accident year performance. The favorable development in prior years reserve continues in the first quarter. And though we believe that our prior accident years are prudent reserves, there may be additional favorable reserve development through the year but likely at lower levels than we saw last year.

Finally, I remain convinced that we will lower our expense in L.AE ratio by a point this year outside of our [mixed change]. Clearly, this is a competitive market and a difficult economy. But our company's in a very strong position, and we have the talent and competitive position to be very successful. With that, I will now turn the call over to Gene for the financial review of

Thank you, Fred. Good morning, everyone, and thank you for joining our call. As usual, a slide presentation accompanies my remarks, and I trust all of you have this available. Please turn to slide five, which presents our consolidated results for the quarter.

For the quarters, we reported net income of $59 million or $1.12 per share, down from $64 million or $1.22 per share in the first quarter of 2007. Net income for the first quarter of 2008 benefited by $5 million or $0.09 per share from adjustments to after-tax net gain on previously sold businesses. Net income for the first quarter of 2008 also included pre-tax net realized investment losses of $5 million or $0.09 a share, compared to a gain of $2 million or $0.04 a share in the same period of 2007. This quarter, we recognized impairments of $7.5 million on certain fixed maturity securities, partially offset by pre-tax net investment gains of $2.5 million primarily from sales of fixed [materials]. The increase in impairments in the current quarter was attributable to credit market conditions not directly associated with financial institution losses.

Let's turn to slide six for a discussion of our segment earnings. Segment income after tax was $57 million for the quarter, down from $60 million in the first quarter of last year. Our Property and Casualty segment generated $98 million of pre-tax income, down from $101 million in the prior-year quarter primarily due to higher catastrophe and weather-related losses. Our life companies posted a $2.5 million loss from continuing operations, versus a loss of $1 million in the prior-year quarter. The segment loss in the current quarter was $1 million higher than expected primarily due to unfavorable mortality experience in our run-off traditional life business.

Now, let's turn to slide seven for a review of our [P&C] results, starting with a discussion of Personal Lines. The Personal Lines segment generated pre-tax earnings of $28 million in the current quarter, compared to $48 million in the prior-year quarter. Catastrophe losses were $11 million for the first quarter of 2008, compared to $7 million in the first quarter of 2007.

Excluding catastrophes, segment income was $39 million in the quarter, down from $55 million in the prior-year quarter. Ex-catastrophe earnings in the Personal Line segment were lower in the current quarter for several reasons. The principal factor was lower favorable development of prior-year reserves in the current quarter, compared to the prior-period quarter. Prior-year loss and LAE reserve adjustments were $12 million favorable in the first quarter of 2008, compared to $22 million in the first quarter of 2007. This reduction in favorable prior-year loss in LAE development was driven primarily by Personal Auto and is consistent with expected 2008 loss trends.

Additionally, ex-catastrophe accident year losses in our homeowners line were higher in the current quarter compared to our prior-year quarter. This is principally due to higher noncatastrophe weather-related losses resulting from a more severe winter in the Midwest than the Northeast. Approximately offsetting this increase in homeowners accident year losses is a small improvement in the Personal Auto accident year loss ratio.

Finally, loss adjustment expenses were about $2 million higher in the current quarter due to higher technology expense related to our new claim system, which is not expected to recur. Expense in this first quarter also reflect higher independent adjustor expenses that were needed to process the higher number of weather-related claims.

Now let's look at Commercial Lines results on slide eight. Commercial lines pre-tax segment income was $68 million in the quarter, compared to $49 million in the first quarter of 2007. Catastrophes were $8 million in the first quarter of 2008, which was consistent with $7 million in the first quarter of 2007. The increase in Commercial Lines earnings is primarily due to the favorable development of prior-year reserves, as well as improved accident year margins. The favorable development of prior-year reserves was $45 million in the first quarter of 2008, compared to $31 million in the prior-year quarter. Reserves developed favorably across all lines with improvement coming principally from our commercial multiple [parallel] lines. At the same time, the ex-catastrophe accident year loss ratio improved across most lines and was 49.2% in the current quarter, compared to 50.1% in the prior-period quarter.

Finally, net investment income was up $3 million. This is primarily due to the transfer of employee benefit-related assets and liabilities from (inaudible), our wrote-off life insurance subsidiary to Hanover Insurance, and to positive operating cash flows from the business.

Turning to slide nine, our accident year loss ratio in the first quarter of 2008 was 56.5%, which is up seven-tenths of a point to the prior-period quarter. This increase is entirely due to the higher incidence of noncat weather-related losses in Personal Lines, without which we would have improved our accident year margins. Despite these losses impacting our first quarter accident year trends, we continue to believe that we will maintain or slightly improve our accident year margins for the year.

Our expense in LAE ratio improved by seven-tenths of a point primarily due to favorable prior-year development [in] LAE. Excluding development, the ratio would have remained flat for the quarter, compared to last period's first quarter. We have some seasonality in expenses which causes the first quarter to carry a heavier expense load. Our expense management initiatives are working, and we continue to believe that we should see more significant improvements to our expense and LAE ratio starting in the third and fourth quarters, enabling us to meet our target for a point reduction overall subject to mix change.

Now let's turn to production which is on Slide 10. Overall, net written premium was $629 million for the current quarter, up 2.7% from the first quarter of last year. Written premium this quarter includes a benefit from changes we made to our reinsurance program. Effective January 1, 2008, we renewed our property catastrophe and casualty reinsurance program with some changes to the reinsurance structure. Changes to the reinsurance structure both at the top and the bottom, together with more favorable reinsurance rates, enabled us to realize meaningful cost savings.

In the first quarter, these reinsurance cost savings increased net written premium by $25.3 million, and net earned premium by $13.7 million .$10.7 million of the increase to net written premium in the first quarter will be nonrecurring. Our new structure optimizes our use of reinsurance. With more robust earnings power, we now have the capacity to retain more business in the lower layers that are typically placed at higher rates, and redeploy some of the savings to buy additional coverage at the top, improving our risk profile while retaining more of our profitable business.

Commercial Lines net written premium increased about 13% for the quarter, compared to the same quarter last year, while Personal Lines decreased by 4%. Personal Lines production was somewhat lower than we expected while commercial lines growth was on target. Marita will discuss production in more detail in her remarks.

Now let's turn to the investment section. As you can see on Slide 12, our general account invested assets had a carrying value of $6.1 billion at the end of the first quarter of 2008. Fixed income securities, cash [and] cash equivalents constituted 96% of our portfolio. Equities were less than 1% of our portfolio. 95% of our fixed income portfolio carries an investment grade rating, and the average quality rating of our portfolio is A-plus.

Turning to Slide 13, you can see the sector breakdown of our fixed income portfolio. Here again, we have a conservative risk profile with 49% of our fixed income portfolio in corporates. MBS and CMBS were 28% of our portfolio, and our municipal bond portfolio constitutes 15% of total investments.

On Slide 14, you can see the breakout of our residential mortgage-backed securities, which represents a total of $1.1 billion, with less than 14% of this portfolio in nonagency securities. Our nonagency securities carry a AAA rating. None of our mortgage-backed securities have subprime exposure.

On Slide 15, you can see the breakout of our commercial mortgage-backed securities, which represent $468 million of our portfolio. 81% of our CMBS portfolio is rated AAA quality. Approximately 95% of our CMBS holdings were from pre-2005 vintages, with 5% from 2006 vintage and none from 2005. The entire CMBS portfolio has a weighted average loan-to-value ratio of 67%.

Slide 16 breaks out our municipal bond portfolio. We have $825 million of municipal holdings, of which $366 million carry an insurance enhancement by financial guarantors. However, the average underlying ratings quality of these securities, even without regard to the insurance enhancement, is A-minus.

Turning to Slide 17, we have provided some additional information on our unrealized losses for the year. Gross unrealized losses on below investment grade fixed maturities and equity securities, a useful indicator of potential (inaudible) impairments, was only $17 million on March 31, 2008.

Finally, on Slide 18, we have some key metrics that outline the strength of our balance sheet. Our book value per share was $45.23, up 2% for the quarter and up 10.5% compared to March 31, 2007 book value. Our operating leverage of 1.4 to 1 and our financial leverage of 18.1% continue to reflect our exceptionally strong capital position.

Finally, our holding company cash reflects our buyback activity, offset by a $17 million dividend received from (inaudible). Through April, we have repurchased a total of $38 million of value of shares, of which $33 million or 765,000 share repurchases were completed in the first quarter. With $282 million in cash [and] investment at the holding company, we have ample liquidity.

Finally, let me recap our outlook for this year, which remains substantially unchanged. We expect to achieve that written premium in the mid-single digits in Commercial Lines, and we expect our growth in Personal Lines to be relatively flat, [with] overall net written premium growth of mid-single digits. We also expect to achieve low to mid-single digit growth in operating earnings per share, excluding the impact of catastrophes.

Fred has already reiterated most of our outlook assumptions. In addition to the operating metrics, our effective tax rate is expected to be in the range of 33% to 34% for the stand alone PC segment, and we also expect the continuing operations of the life company to operate at a loss of $4 to $5 million, up from the $3 to $4 million guidance we had provided earlier. We are continuing to explore alternatives for unlocking the capital supporting our life business, and will provide updates when we have something definitive to communicate.

In summary, even with difficult market conditions, we believe our business platform will be capable of delivering above industry average results. With that, I will turn it over to Marita for a review of our Property and Casualty business.

Thanks, Gene. Good morning, everyone, and thanks for joining the call. Like Fred, I am very pleased with our company's performance through the first quarter of 2008 . Our Commercial Lines segment delivered very strong results for the quarter, and our Personal Lines earnings were also very solid. Our overall combined ratio was 95% for the quarter. Written premium growth was also within the range of our expectations for the quarter, and, as we knew, we would suffer from a tough comparison to the prior-year quarter particularly in Personal Lines. Net written premiums grew 2.7% for the first quarter. Commercial Lines growth of 13% was offset by a 4% decline in Personal Lines. And as Gene pointed out, our growth numbers include the benefit from changes to our reinsurance program.

I'll provide some insight into the results of each of the segments starting with Personal Lines. Personal Lines segment income of $28 million in the quarter includes $11 million in catastrophe losses and an additional $9 million in noncat weather-related losses. As a result, the combined ratio in this segment was a 101.2 in the quarter. Our ex-cat accident year loss ratio was about two points higher than the prior-year quarter driven by our homeowners's line. This is due to higher noncat weather-related losses which we can see clearly in the data. Our accident year loss ratio has improved by nearly a point in Personal Auto which was less impacted by weather. These results reflect our commitment to disciplined underwriting even under more competitive conditions.

The quality of our business remains solid as we continue to see favorable development of reserves in prior accident years, and our underwriting initiatives aimed at improving mix of business, particularly in Personal Auto have also enabled us to sustain margins. Personal Lines growth was down 4% in the quarter on a direct written premium basis. This outcome is not unexpected as we knew we suffered from a tough comparison this quarter, particularly in Personal Auto. However, written premium is stable compared to the fourth quarter of 2007, with growth in Personal Auto offset by homeowners which was impacted by our cat management initiatives. Our new business and renewal retention rates are stable on a sequential quarter comparison.

Let me discuss the key factors affecting growth this quarter and what it means for our outlook. We have four states that need to be discussed separately. And these are, as you can imagine, Michigan, Massachusetts, Florida and Louisiana. The trends in the remainder of our states are more homogenous and can be addressed as a group.

So, let me start with Michigan. As you have heard us say before, Michigan remains a challenging state with its weak economy and competitive pressures. Given these pressures, our focus has been on maintaining our profit margins. As a result of all of these factors, our Personal Lines policy counts have come down about 1% a quarter throughout last year, and this trend continued in the first quarter of 2008. Net written premium in Michigan was down 3% in the quarter driven by Personal Auto.

Our homeowners premium grew as we were able to take inflation adjustments to rate and overcome the lower policy counts. We continue to pursue several actions to stabilize and improve our Michigan position. We have already taken some rate action on our auto book early this year, and we have more planned for the subsequent quarters. We believe the market will support this. We have also stepped up our agency management actions, working closely with our partner agents to aggressively retain business while finding opportunities to consolidate shelf space and to grow new business at profitable margins .

Again, our focus remains on the bottom line and on maintaining margins while maximizing our opportunities for growth. We have long-standing and strong agency partnerships in Michigan, and we know the marketplace very well. We believe, barring any further deterioration of the economy, we can maintain and, over time, improve our performance going forward.

Turning next to Massachusetts, net written premium was down about 10% in the quarter. This was primarily the result of the mandated 12% rate decrease in Massachusetts Personal Auto that took affect on April 1, 2007. And as Fred pointed out, managed competition came into effect starting April 1, 2008 and at that time, our average 8% filed rate decrease will come into play.

Putting aside these rate decreases, we are very optimistic about our potential opportunity in Massachusetts and our ability to use our [multi-variant] product and our full franchise value to drive profitable growth. Our initial feedback is very positive as agents are responding enthusiastically to our value proposition. We expect that we will compete effectively in the new environment and, over time, will grow our market share.

Our Personal Auto policy counts were up 4 percentage points, compared to the prior- year quarter. As we continue to gain traction, the outlook for the state will improve. Of course, 2008 is a transition year for us, and while we expect to grow in Massachusetts over the long haul, we do not expect Massachusetts to contribute to growth during 2008 due to the current rate environment.

Finally, turning to Florida and Louisiana, here we have taken catastrophe management actions that have significantly improved our risk profile. As we previously discussed, we have now started non-renewing Florida homeowners business effective December of 2007. This represents a total of about 12,000 policies, and about $11.5 million in written premiums for the year. We continue to reduce homeowners concentrations in Louisiana. These types of strategic decisions have enabled us to reduce our PMLs each year over the last three years, improve our risk profile and obtain more favorable rates from our reinsurers, which is one of factors contributing to the reinsurance savings this year. The impact of these intentional actions represent a 15% decrease in Personal Lines growth for the quarter these two states. Balancing the desire for growth while optimizing risk in maintaining margins are the trade-off decisions we make every day.

Putting aside these four states with their unique considerations, the trends in our remaining states remain positive despite the challenging market. We are gaining traction in these other states, and this will be evident once we get past this tough first quarter comparison.

Let me spend a minute explaining this tough comparison. As you may recall, we began taking significant corrective actions last year to improve the profitability of our Connections Auto book. These actions, which were aimed at improving pricing and mix of business, had the impact of reducing our growth in less profitable auto segments beginning in the second quarter of 2007. The timing of these actions has created a difficult year-over-year comparison to the first quarter of 2007, when our growth in Connections Auto had not yet been materially impacted by these actions.

Again, our personal auto premium in the first quarter of 2008 is up compared to the fourth quarter numbers. Looking forward, the remaining quarters of 2008 should see a much less unfavorable comparison to prior-period quarters.

On a positive note, the mixed improvements that these actions were aimed at, such as an increased proportion of multi-car policies and more whole account business that are consistent with our strategy, have taken hold and we are starting to improve retention, indicators and margins. Once we get past this first quarter hurdle, we see positive momentum in these states, which gives us confidence that our strategy's working effectively. We are focused on our partner agent strategy and on winning new business through the consolidation of shelf pace rather than one policy at a time. We can see traction on these fronts giving us confidence that we can grow profitably through the cycle.

In summary, given our outlook in Michigan, the transition phase we are in in Massachusetts, coupled with the catastrophe management actions flowing through, it would be more prudent to anticipate relatively flat growth in Personal Lines this year while we remain confident in our strategy based on our growth state trajectory. Importantly, earnings in Personal Lines should remain solid as we expect to maintain our ex-catastrophe accident year margins. Our loss trends remain stable, and we plan to maintain and improve our accident year margins by taking rate actions that are consistent with expected loss trends. We believe the market will support this, and we are currently earning in about 2% of rate increases in the first quarter.

Turning next to Commercial Lines, we had another strong quarter with segment earnings of $68 million. Reserves related to prior accident years continue to develop favorably across all lines reflective of our disciplined underwriting, and our current ex-cat accident year losses improved a point to 49.2%. Our combined ratio was 85.3% for the quarter.

Net written premium growth was 13% in the quarter. This includes a 4-point benefit due to the consolidation and cancellation of our umbrella treaty that will not reoccur in subsequent quarters of 2008. Aside from this, the strategic changes of our reinsurance program will continue to benefit growth in subsequent quarters. Direct written premium growth in Commercial Lines was 5% in the quarter. This growth came primarily from our specialty business, which grew a robust pace of 20%. As expected, PDI and Verlan provided a good lift in the quarter. Our other specialties also grew by 9% on a direct basis.

In a more competitive market with price pressures, Specialty Lines continue to provide us with better breadth and diversification of our earnings base. With over $300 million in annual written premium, Specialty Lines now represent a mature book of business supported by strong agency distribution, and constitute about a third of our Commercial Lines book. Our traditional business also continued to show positive momentum in the quarter, with growth and exposures and in written premium. Pricing remains competitive particularly in the middle and larger market segments. However, we continue to compete effectively in the small market and get pricing.

Additionally, the completion of our small commercial operating model provides yet another stimulus to growth in our traditional business. During the past year, we have done a tremendous amount of work enhancing the product and the operational effectiveness supporting our small commercial platform that allows for easy quoting, issuance and renewal of policies through our agency portal. The agents can now see all the components of their small business accounts, including commercial auto and workers' compensation. And we believe we are now well-positioned to write more of this [ballast] flow business that has very attractive economics, as more of our partner agents adopt this enhanced model.

To sum up the growth story in Commercial Lines, our first quarter growth gives us confidence that we will meet the mid-single digit growth objective we laid out on investor day. I also feel good about making our overall commitment of mid-single digit growth, knowing that there are enough positive catalysts to prudent growth in Commercial Lines that.can be used to balance the challenges we may face in Personal Lines. Even more importantly, while we expect to make our growth goals in Commercial Lines, we expect to do so by maintaining or improving our accident year margins as we did in the first quarter.

I think we have demonstrated our commitment to underwriting discipline, putting margins and prudent risk management before growth and gaining market share and in a manner that is true to our strategy. And with that, I'll turn the call back

Thanks, Marita. Operator, with that, we will open up for questions.

(OPERATOR INSTRUCTIONS). Your first question comes from the line of Jay Gelb with Lehman Brothers. Please proceed.

Thanks and good morning.

Good morning, Jay.

How are you?

Great.

I was hoping you could update us with your conversations on the rating agencies. And I know you don't have a -- an update today on the potential [settlement] life business, but maybe you can walk us through how you see that playing out?

Sure. Great, Jay. On the rating agencies, obviously we are right in the middle of those conversations. We got Moody's upgrades last quarter. We have had terrific conversations with S & P that just concluded. And we are in the middle of kind of the quarterly best march we go with them as well. I am very optimistic about the last two pieces of this occurring sometime over the next 12 months. You know, I can't decide when they are going to do things. But I would tell you the conversations we have had have been very positive. We are meeting all their expectations and I actually feel very, very good. We've said the way the calendar works and when people make the best decisions, my guess is an S & P decision will come before a best decision but I feel very, very good about those conversations. Gene, do you have anything to add on that?

No, I think that is exactly where we are and we're expected to see-- We are out there with a positive outlook from S & P and they have to do something with respect to that sometime in the next two months.

We are also positive outlook,as we know it best. And the guidance they have given is kind of 18 to 24 months. So, when they gave it to us. So again, I think this year is a big year for us in both cases. Nothing in the conversations that make me anything but optimistic about it. As I said, I was very happy with the Moody's move, which preceded the other two. One the Life Company, again, we are in the process there. I don't see any reason why this can't be achieved. It is, as we said, it's not anything like the first deal we did. This is a more straightforward book of business. And as you know, we kept it solely because we wanted to retain the tax atributes that were in it. I think it was the right decision but now it's the right decision to move forward to [monetize] it, and I think we will do that. Now, the way we are thinking about it, Jay, is very straightforward. What I liked about the situation for us is that obviously we have had some amount of dead capital tied to that life business because we have held it to really get those tax attributes.

So we could -- you could see ourselves this year as we come to conclusion on that transaction being able to free up capital, if we give back to our share holders, or to take and put it in a much more productive 12% return type of business. So, I see that's going to be a tremendous boost to people's transparency of our company. I think it was the right decision to keep it because the NPV was good on the tax attributes. But I would tell you that you can just do the math, right? The [R o E bump] from taking dead capital and either applying it to our business of a 12% return, or giving it back to shareholders should be a very positive action and the right action that we should be able to achieve this year. Again, Gene, is there anything else that-- (overlapping)

Yes, it's a process that we don't want to get out ahead of ourselves in terms of specific disclosures. But we set out to achieve an outcome that we set at investor day and I think we are on track to do that.

Okay. Then my last question is, given the significant transaction we saw last week, I was wondering if that makes you relook at inbound or outbound M&A within property casualty?

No. I mean, again, I think I've been pretty clear on this the last four years. I believe very strongly that we are going to see a consolidation of the industry. I think that there are 500 little companies that represent about 45% of the $450 billion market that are sub scale. There are about 18 to 20 that are big and what you are going to see is the big guys potentially buy each other, and you are going to see the consolidation of these small opportunities. And what we are seeing is lots of opportunities to talk to a number of companies that I've done the last couple of years, and pricing expectations are more in line now. And people are more thoughtful about what they have and they don't have. So, I continue to see opportunities for us. I don't need them, per se, but we will continue to look at them. And if we think it helps our value proposition and we can make significant shareholder value accretion, we'll do it.

The other thing I would say is that we had built this company to take advantage of disruptions. So, one of the best days of my life was when St. Paul's and Travels merged and we were table to acquire a lot of talent and this safe co-opportunity presents an enormous opportunity for us. Both the disruption at the agency level and small commercial across our network where they just lost a market, and in a talent that is going to be uneasy about the consolidation challenges that that company now has present real shareholder value accretion opportunity for us if we continue down the path to accelerate some of our partnerships because of the deal.

So, we have always been very active. It's been part of what I do. I talk to everybody always because I do think that this is the part of the cycle where these opportunities represent and I think what we are going to try to do is what we have done in the last four years, to try to do the right thing to create shareholder value and capitalize in the opportunities presented.

I'm pretty -- again, I have said all along I talked about how casually I thought it was going to happen. This one is not, to me, a surprise at all. I do think there will be something among the big guys, given the pressure that they face and I think there will be a lot of small guys that will also feel the pressure some sub scale. So, we are still optimistic about the opportunity it presents to us.

Great. Thanks for the answers.

Your next question comes from the line of Rohan Pie with Banc of America Securities. Please proceed.

Good morning.

Good morning.

Good morning. I guess the first question had to do with the personal auto. Just looking at the calendar year, combined ratios have been rising sequentially in each of the last four quarters. It was 102 in the first quarter. Based on general's comment that maybe reserve release is combined going forward what kind of combine ratio are you willing to tolerate in personal auto on a calendar year basis.

I think what we are talk asking 95, 96. I feel we can hit that where accident years will improve this year . I think people know I think this weather thing was a little bit, it's what we don't really have big cats. We are a kitty cat kind of company and the first quarter tends to be most volatile for us given drive time storms and freezes like we had this year. But I'm actually quite bullish on our personal lines. If you look at where we are with our core accident years acts of weather they continue to improve and I think they are going to be very table.

Now, we are very conservative . if you look at what we do. Because if you recall the last two years we totally revamped our personal lines home and auto in every state. Connection is now $500 million business. And so we were very conservative about our accident years, because we were going turning over an entire book of both home and auto as we watched those new products and going into new states.

So our conserve tis im, we were out first last year with some of these accident years increases and that is why we think this opportunity continue to decrease it. So our goal, by the way, is 12% weed through the ciggal. We don't mess around. That is what we focus oi'm very clear we are going to do that. I have no qualms about us doing that on the pand Cbusiness and as we get rid of the life business and get these upgrades our capital will be better managed and more appropriate and that will be very easy to do for the overall business. So I feel very good about where we're going and again, I think we have some transparency to the proving accident years that I feel are going to be fine. What you have seen in some of our competitors, because of the appointment of many agents and the commodization of auto is that you will see greater return from them than from us because what we are doing is focusing on fewer agents an account-based business with partner agents so we won't have the voluntary that you see from doing a lot of business say with ago gators and on the internet where you are essentially having all the impacts of kind of the new business curse when you compare auto to auto. Our game is more of an account-based play. So again, you can back into 12% returns based on our capital and therefore we think that's what we need to do and that's what Wii we will do over

You know with the frequency and severity trends and this line being roletively benign and our ability to drive some rates in personal auto and the market's acceptance of that rate is really giving us hope looking forward as to the long-term profitability of that line.

But is those are two separate subjects. Our reserve releases when you turn over as much book as you do we are very thoughtful and conservative that in total we create shareholder value. Can he think about it that way because we did enter new states with new products . it is not two separate

Thanks for the detailed answer. Marita, what kind of rate increase were you referring to? What prices are you putting through and what are you seeing in the marketplace for personal auto?

Yeah we mentioned specifically what we did in Michigan. And obviously it differs by state and location. But the answer to that question will be as much as the market will possibly bear. And the hope is that we can continue to push that bar high and higher. I can tell you that all of our rate activity at this point is on the positive side of the house not the negative side of the house. But those numbers obviously differ dramatically by individual states. What the rate need is, what our indications are, what the market will bear . but we are clearly seeing a trend toward positive numbers and the market's ability to bear

We track in every one of our states, every one of the major competitors. Say the top ten. And we have a map and what you ever seen as a turn going into the first quarter, last year it was kind of split. And near the tail end it became more 50/50. Now you are seeing most people are taking rate. And so the opportunity here is dramatic. Now we are pretty aggressive about taking rate every year in almost every market, Massachusetts being the exception. But what we see, is people starting to take rate and we believe that you will see that to be very common practice by the second half of the year. Everybody is seeing the same results. And so we are relatively bullish on seeing rates the second half of the year.

I guess on a different note, in Michigan there seems to be a bill for.

Taking out credit?

Exactly. Yeah .

Yeah. It's on the House side. The republican side is the Senate. But we do not believe that that has any legs at all, because the, on the house side, it just barely passed. And what we are hearing is it's not going to be taken up by the Senate. The other thing introduced the more important thing for afford built in Michigan is there has been a bill filed in the Senate about the pip coverage. It is the only state in the Union that has mandatory pip coverage and what we are looking for is a different type of optional environment that would save Monday if I consumers. And frankly, avoid the potential cost shift and go risk that could occur in the pip area in Michigan. So we are pretty bullish that something will happen like that, much more likely than the credit thing. I can't imagine the credit thing has much legs, given what I have seen in the political environment in Michigan.

Okay, that's good news. And this finally, Massachusetts you seem pretty bullish on growing policy count despite the price decreases. What is the combined ratio there in the last state for personal auto?

We do very well in Massachusetts and he believe we can maintain what we have in Massachusetts going forward. It's one of the few states where you are actually still seeing frequency declines. If you recall we were late to the game in Massachusetts both for fraud. And the other thing is we didn't have an assigned risk plan so people didn't take responsibility. One of the big reforms that you now see phasing in of a resigned risk plan. You are going to see underlying costs in Massachusetts actually con to be a little bit better. They probably will flatten out this year. But what we will see is main taping our margins. The one place we have spent a little bit is we did, I think I talked about it the last call. We spent a little bit more on expenses than others because we put in a full multi-variable product where others held back.

One of the optimistic feelings we have is that this is the time when these other folks have not a lot of segment tation for us to really improve our position in the agency shelf space because we have so much better segment tation than particularly the market leaders here and the ability to increase margin is real for us. Because now it's based on your own experience, not just the overallstate's experience. So we believe that we can continue to improve margin. We are very solid and we are happy with our haling yins ask I don't see a deterioration of those margins except we did spend probably $2 or $3 million more kind of this a one-time expense play around the new product and services that put a little pressure on our expense margin this year.

Knowing the state as well as we do clearly gives us a market advantage . there is no doubt about

Great. Thank you Marita for the answers and for the results .

(OPERATOR INSTRUCTIONS)

All right known. I thank you all for joining the call and we look forward to talking to you again.