Hanover Insurance Group Inc (THG) 2008 Q3 法說會逐字稿

Good day, ladies ladies and gentlemen and welcome to the third-quarter 2008 Hanover Insurance Group, Inc. earnings conference call. My name is Dan and I will be your coordinator for today. At this time, all participants are in listen-only mode. We will conduct a question-and-answer session towards the end of this conference. (OPERATOR INSTRUCTIONS) As a reminder this call being recorded for replay purposes.

I would now like to turn the call over to Mr. Bob Myron, Treasurer of the Company.

Thank you, Operator. Good morning and thank you for joining us for our third-quarter conference call. Participating in today's call is Fred Eppinger, our President and Chief Executive Officer, Gene Bullis, our Executive Vice President and CFO, and Marita Zuraitis, President of Property & Casualty Companies.

Before I turn the call over to to Fred for a discussion of our results, let me note that our earnings press release and a current report on Form 8K 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 web site at www.hanover.com. After the presentation, we will answer questions in the Q & A session.

Our prepared remarks and answers to your questions other than statements of historical facts include forward-looking statements. These include statements regarding expectations of earnings, pricing, accident year results, premiums, expenses and other projections for year end 2008 and beyond. There are certain factors that could cause actual results to differ materially from these anticipated by this press release, slide presentation and conference call. We caution you with respect to reliance on forward-looking statements, and in this respect refer you to the forward-looking statements section in our press release, slide 2 of the presentation deck, and our filings with the SEC.

Today's discussion will also reference certain non-GAAP financial measures such as total segment income, segment results excluding the impact of catastrophes, ex-cat loss ratios and accident year loss ratios, among others. A reconciliation of these non-GAAP financial measures to the closest GAAP measure on an historical basis can be found in the press release or the statistical supplement which are posted on our web site, as I mentioned earlier.

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

Good morning. Thanks, Bob. I would like to thank everyone for joining our call. And today with all that is going on in the insurance marketplace and the credit markets in general, I thought it would be helpful to focus my remarks this morning on our observations about the industry, our current position both financially and strategically, and to provide some brief comments on our performance. Obviously Marita and Gene will provide a lot more insight about our third-quarter results and our year-to-date trends.

In essence, there are three messages I would like to leave you with today. First, while the quarter was challenging for us given the significant level of catastrophes and turmoil in the financial markets, I like our current financial position and our ability to take advantage of the market turbulence now and in the future. Our capital and liquidity position gives us the ability to thoughtfully capitalize on business opportunities that are becoming more abundant. In addition, our investment portfolio is very conservative given our very limited exposure to equities and alternative investments which gives us confidence in our ability to successfully manage in today's economic conditions and still focus on profitable business growth. Our portfolio is also very transparent and easy to understand. Now we hope that the information we provided in the press release and in today's call will make it even more so.

Second, though the market has been competitive, we see real progress and impact from our strategic initiatives around our partner conversion in our specialty business world. This gives me confidence to our ability to grow profitably, even in the current economic environment, and deliver on our promises to our shareholders and our other stakeholders.

Third, the significant investments we have made across our company over the past five years around attracting and developing talent, uniquely position us vis-a-vis our regional competitors to capitalize on the tremendous disruption and dislocation in the market today. This is particularly critical given we believe we can see a better pricing environment over the next year, and some significant movement of business.

It is clear that our industry is undergoing significant change which creates opportunities for strong, nimble companies. From the beginning of our journey, we have focused on building a financial, underwriting and product and operating platform that can capitalize on the weakness of other companies in a down market. As we have said before, pricing cycle puts significant pressure on weaker companies, and just before the turn, you see these companies dramatically pull back, giving stronger companies with solid balance sheets and underwriting capabilities the opportunity to capture more business at a better margin. We believe the combination of the weak economy, Midwest storms, and turmoil in the financial markets will accelerate this trend.

We also believe that this will create real opportunities for us and for winning independent agents as they look for strong, stable markets to help them compete, but without becoming overly concentrated with a few large markets. Given the severity of some of the trends we see, many companies will have to shrink to preserve capital which could accelerate the hardening of the market pricing sooner than we might have expected just a few weeks ago.

We are well positioned to compete and win in this environment. Over the course of the last five years, we have been building a company that would be able to deliver on its promises, regardless of prevailing market conditions. While we could not have predicted how disruptive the situation would be, we knew all along there would be an increasing disruption in the marketplace, and that in order to achieve our goal of being the best regional P&C company in the markets we serve, we would need to build a company that could thrive on challenging times. We have been careful to establish a very solid financial foundation, to maintain a disciplined investment management approach, and to create an infrastructure that would help our agent partners succeed when others struggle. Our momentum around financial strength is counter to the trend in the market and is apparent to our agents.

In a time of numerous downgrades, we are one of the few financial companies receiving upgrades. In the previous two quarters, our financial rating has been upgraded by S&P and Moody's, and we are one of the very few P&C companies with a positive outlook from A.M. Best.

We are generating strong core earnings and profitable growth in all of our lines of business. We have built a strong balance sheet and capital position putting hundreds of millions of statutory capital on our P&C book since we began our journey in 2003. Our C&L mix of business is focused on attractive industries and lines of business. Our reserve position remains very strong, as we continue to retain quarterly reserves in excess of 5% over actuarial indication and our debt is only 20% of total capital.

With the upheaval in the financial markets, we have very carefully examined our investment strategy and investment portfolio, and we have great confidence in both. We have managed our investments with great prudence. As I have said before, I am willing to take expense risk as we build our franchise since that represents controllable investment in our future but we have to be very careful with our investment and underwriting risk.

Cash and investment grade bonds represent approximately 96% of our invested assets. Our impaired assets this quarter represent only 1% of our overall portfolio. We do not have subprime mortgage debt. We have a very small allocation to equities in commercial mortgages and alternative strategies, and have negligible derivative exposures. As a result, we do not have to make significant adjustments to our investment portfolio and drastically reduce investment return. This means we will not get caught up in fixing problems and reducing exposures and leverage. Our focus will be where it should be on building our business.

We are confident about our capital position liquidity. In fact, we expect our liquidity at the holding company to be enhanced by the anticipated closing of our sale of FAFLIC later this quarter and we will use a portion of those associated proceeds to close on the purchase of AIX Holdings. We are not in position of having to raise capital in order to continue to meet our current objectives, and the board's announcement last week of our fourth consecutive increase in our annual shareholder dividend is further evidence in our confidence we have in our capital levels and liquidity.

In fact, our strong capital position creates opportunities for us. We are well positioned to continue to make strategic acquisitions of small balance sheet books of business in what is quickly becoming a buyer's market. We will continue to seek out opportunities to broaden our product capabilities to the extent these opportunities are financially compelling.

We are making smart investments in our business. We have increased our local market presence with some of the most well-respected professionals in the industry, significantly upgrading our management team and adding specialty capabilities by buildings teams and through acquisition. Additionally, we have invested over $250 million in the past five years to enhance our products and to improve either doing business, providing our agent partners and their customers the service and capabilities they expect. As a result, we have an outstanding operational foundation and we are really seeing our partnership strategy take hold.

Today, our product portfolio and service capabilities represent a distinct competitive advantage, enabling our agent partners to meet a wide range of their customers' needs and we will continue to invest in or acquire new products to enhance our product offering. Given that most of our partners and potential partner agents have cherries on their shelves that will need to either make changes to their expenses and business mix, there will be business shifts that create openings for us to significantly enhance our position in their agencies and deepen our relationships. As always, the key for us is to remain intently focused on the execution of our key strategic priorities.

Before I turn the call over to Marita and Gene I I would like to comment just briefly on the quarter. Our results, like those of most of our peers, reflect the unusually high storm activity for the quarter. We expect that insured industry losses will well exceed $20 billion, as well as the turmoil in the financial market. With this in mind, I think it is important to note that the scope of our storm losses were consistent with our risk models, our market share, and our pricing models, and we feel very good about our catastrophe management initiatives we have undertaken the past few years. And that overall, since the credit crisis began some 15 months ago, our investment portfolio has performed well.

Our core business also continues to perform well with favorable underlying trends. We continue to achieve solid growth across all of our businesses in line with our plan and ahead of industry averages. We are maintaining our margins, and favorable reserve development remain strong, indicative of our disciplined underwriting practices. So in spite of the storm losses and developments in the financial markets, we are on track to regenerate solid results for the year.

Obviously our economy and industry are going through difficult times, which makes it critical that we remain intently focused on all the key financial levers of our business. The improvements we have made across our business are paying substantial dividends. We have built an organization that today is competing competing with the best companies in our business, one that can manage through difficult times, and can capitalize on market opportunities creating a real value for our shareholders.

With that I will turn it over to Gene and I look forward to taking your questions shortly.

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 Slide 5 which presents our consolidated results for the quarter. For the quarter, we reported a net loss of $62 million, or $1.21 per share, compared to income of $54 million, or $1.03 per share in the third quarter of 2007. Net loss in the third quarter of 2008 reflects realized losses on investments from our continuing operations of $53 million, as well as losses on investments of $16 million realized in discontinued operations. The total realized losses of $69 million reflect preannounced impairments associated withholdings in Lehman Brothers and Washington Mutual, up $37 million, as well as impairments on other fixed income securities in the financial and other sectors.

The net loss for the third quarter also includes an additional loss on the pending sale of FAFLIC, comprised of the aforementioned $16 million of loss on investment assets, as well as other adjustments of about $6 million, principally related to estimated tax effects of the transaction, for overall FAFLIC loss of $22 million in the third quarter of 2008.

As you remember, in the second quarter of 2008, we reported a loss related to the FAFLIC sale of $68 million. The third-quarter results and adjustments bring our total year-to-date FAFLIC loss, including the expected loss on sale, to $93 million. The FAFLIC closing process is on track, and it is still our expectation that we will complete this transaction in this fourth quarter.

Let's now turn to Slide 6 for a discussion of our segment earnings. Our P&C operations generated $14 million of pretax income, down from $88 million in the prior year quarter, primarily due to higher catastrophe and related storm losses in the current quarter, which were $98 million and $25 million in the third quarters of 2008 and 2007, respectively. Ex-cat P&C pretax earnings were $112 million compared to $113 million in the prior year quarter.

Now let's turn Slide 7 for a review of Personal Lines. The Personal Lines segment reported pretax earnings of $18 million in the current quarter compared to $49 million in the prior year quarter. Catastrophe and related storm losses were $40 million in the third quarter of 2008 compared to $5 million in the third quarter of 2007. Excluding catastrophes, segment income was $58 million in the current quarter compared to $54 million in the prior quarter. Favorable prior year reserve development was $16 million in the current quarter compared to $10 million in last year's quarter, and was favorable in all lines with improvements primarily coming from Personal Auto.

Underwriting expenses were lower in the quarter driven in part by lower variable compensation. These positive impacts were partially offset by higher ex-catastrophe accident year losses in the quarter in our auto line, due primarily to an unusually low level of incurred losses in this line in the third quarter of 2007.

Now let's look at Commercial Lines results on Slide 8. Commercial Lines pretax segment loss was $7 million in the quarter compared to income of $39 million in the third quarter of 2007. Catastrophes and related storm losses were $59 million in the third quarter, $39 million higher than the $20 million incurred in the third quarter 2007. On an ex-cat basis, Commercial Line segment income was $52 million, or $7 million lower when compared to the prior year quarter due to lower accident year margins. The deterioration was observed primarily in our commercial multiple peril lines and relates to a higher incident of large property losses in the quarter compared to the prior year quarter. Maria will discuss large loss impacts in our book of business in more detail.

On a year-to-date basis, the CMP line shows improvement in trends in both large property losses as well as in the ex-catastrophe accident year loss ratio compared to the same period in the prior year. The ex-cat accident year loss ratio in our CMP line was 49.3% through nine months of 2008 compared to 50.6% in the same period of 2007.

Our Commercial Lines underwriting expenses compare favorably to the prior year quarter. As in Personal Lines, lower underwriting and loss adjustment expenses reflect a reduction in variable compensation. The favorable development of prior year reserves was $19 million in the third quarter of 2008 compared to $22 million in the prior year quarter. Losses developed favorably in all lines with slightly less development coming out of our specialty lines this quarter compared to the prior year quarter.

Finally net investment income was up $4 million. This is primarily due to the transfer of employee benefit-related assets and liabilities from FAFLIC to Hanover Insurance which was effective January 1.

Turning to slide 9. It provides a snapshot for our underwriting trends for the third quarter and year to date, and I will use this slide to share with you our full year 2008 outlook. You can see that our third quarter 2008 results were marked by catastrophe losses of 15.8 points. Through nine months this year, catastrophes impacted our losses by $156 million, or 8.4 points of combined ratio, compared to $46 million or 2.6 points during the same period last year. Therefore, our full-year 2008 earnings will reflect substantially high catastrophe losses, and accordingly, we expect to see a contraction of 2008 segment earnings when compared to 2007 results.

The table on page 9 also shows a quarter over quarter deterioration of our ex-cat accident year loss ratio which is due to a higher incidence of large losses this quarter. On a year-to-date basis, however, our ex-cat accident year loss loss ratio, as well as our ex-cat accident year combined ratio, compare favorably to the same period last year. Because of our current visibility for the fourth quarter, we expect to maintain or slightly improve our ex-cat accident year margins for the full year of 2008 compared to the full year 2007.

With respect to expenses, our OUE and LAE ratio improved by nearly two points in the quarter over quarter basis and by 0.6 of a point year to date. This was primarily due to some favorable prior year development in LAE this quarter compared to LAE Katrina reserve additions in the third quarter of last year. Also, this quarter included adjustments to variable compensation which will not recur in the fourth quarter.

Finally we have some seasonality in our expenses which usually causes the fourth quarter to trend upward. Therefore, despite a slight improvement in expenses through nine months, we continue to believe that our full-year LAE and OUE ratio combined will come in flat to our full-year 2007 ratio, as we discussed in last quarter's call.

Now let's turn to production, which is on Slide 10. Overall, net written premium was $652 million for the current quarter, up 4.8% from the third quarter of last year. This overall growth is in line with our expectation and is supported by growth in Commercial Lines at 11% primarily from our specialty businesses, including our recent acquisitions, and an uptick in our Personal Lines growth to 1.2%, rising primarily from rate increases in PIF growth in our newer states. Given the first three quarters of 2008, we continue to expect to meet our full-year outlook for overall mid single digit net written premium growth. Marita will discuss our production and underwriting results in more detail in her remarks.

Turning to a review of our investment portfolio, beginning on Page 12, the quality of our portfolios remain solid. The Company holds $6 billion in cash and invested assets at September 30, 2008, which includes $1.1 billion of FAFLIC assets that will move to the buyer upon closing of the sale. Cash and fixed maturities represent 96% of our investment portfolio with a carrying value of $5.8 billion. 95% of our fixed income portfolio was rated investment grade. We continue to have no direct exposure to investments in subprime mortgages or subprime mortgage-backed securities.

Skipping over to slide 14, we provide a breakdown of our corporate holdings, which represents 48% of our overall fixed income portfolio. Industrials constitute about 27% of the overall fixed income, and about 13% or $677 million is invested in financial sector holdings. The unrealized losses related to the portfolio of financial issuers were $102 million as of September 30, reflective of deteriorated market valuation during the quarter.

We believe these unrealized losses after adjustments for impairments in the quarter are temporary based on several premises. First, our portfolio financials is made up of high-quality debt securities, primarily banking. 92% of the overall portfolio is rated investment grade. It is well diversified with 74 distinct issuers, thus the average position is about 0.2% of the total fixed income holdings.

Second, recent government actions aimed at supporting the banking system should help the market values as financials recover. We expect the preferred equity infusions and the guarantees to bank borrowings via the government programs will lead to stabilization of banks, capital and lending, thus improving their financial strength and ultimately the market values of their debt.

Third, with our substantial liquidity position and latter duration structure in our fixed income portfolio, we have the reality and intent to hold these securities until recovery or maturity which will allow us to realize their anticipated long long-term economic value.

On the next two slides, we provided amortized cost and fare value for our largest corporate holdings. This is building that would otherwise be available in our quarterly statutory filings but we have provided it here in the interest of improved transparency.

Slide 17 describes our RMBS holdings. They constitute about $1.1 billion of our invested assets, with less than 15% held in nonagency prime securities. The market value of our RMBS portfolio is principally unchanged from last quarter and has only declined $10 million since December of 2007.

Commercial mortgage-backed securities constitute $462 million of our invested assets. This portfolio is well seasoned with approximately 92% from pre-2005 vintages, and is also well diversified by geography and industry type. As of September 30, 2008, we held $785 million in municipal bonds with an overall rating of AA minus. Financial guarantor Insurance enhanced municipals represents $344 million or 44% of this portfolio. The overall credit rating of our insured municipal bond portfolio giving no effect to the insurance enhancement is A minus.

Our direct commercial mortgage portfolio was only $43 million, it's high quality, and 64% of the mortgages mature by year end 2010. Equity securities represent $54 million of fair value, including $37 million of redeemable preferreds with an amortized cost of $47 million.

On slide 20, we display gross unrealized loss changes from the second and third quarter. The majority of unrealized losses, $192 million, relate to our fixed income corporate holdings due to the widening of spreads and credit market liquidity contraction. Again, we believe that the loss of market value is temporary. We will be able to hold these securities in question until recovery and ultimately realize their anticipated economic value. It is worthwhile noting that of the $263 million of gross unrealized losses as of September 2008, about $50 million relates to securities held by FAFLIC that are expected to be transferred to the buyer at the time of closing.

Moving on to Slide 21, we have some key metrics that outline the strength of our balance sheet. You see a contraction in the book value through September 30, which is impacted by losses in our discontinued FAFLIC business of approximately $93 million, or $1.83 per share year to date. The decrease in book value also reflects higher unrealized losses in our investment portfolio.

Despite investment impairments and the impact of the FAFLIC sale, per share book value excluding AOCI remains above $44. Excluding AOCI and the impact of exiting FAFLIC, book value increased 6.2% in the last 12 months. Our debt-to-total capital including AOCI is up slightly resulting from a lower book value base. Still, at 20%, our debt level is very conservative.

Holding company cash and investment securities were $260 million at September 30, and will increase by about $220 million as a result of the expected FAFLIC sale transaction. We expect to pay about $100 million for the acquisition of AIX which should also take place sometime during the fourth quarter. We have also declared an accrued and ordinary dividend of $166 million from our Hanover Insurance subsidiary to THG Holding as of September 30, which will be paid in the fourth quarter. This is the first dividend from our P&C subsidiary in several years and it maximizes our capital and liquidity flexibility. Even after this dividend, we expect to have a RBC in excess of 300 and a BCAR of well in excess of 200 in our P&C insurance company at year end. Upon completion of these transactions and the payment of our annual shareholder dividend, the holding company liquidity is expected to be at approximately $450 million.

As you know, we are on positive outlook from AM Best with respect to our financial strength rating, and we intend to present as strong a case as possible for an upgrade this rating season. We believe we have sufficient capital at the insurance subsidiary and the holding company to achieve this objective.

We have a $100 million stock repurchase program in state. To date we have repurchased 1.4 million shares for about $60 million which is unchanged from the second quarter. We will likely maintain this cautious approach to share repurchases for the intermediate term. As always, our goal is to use our capital as effectively as possible to strengthen our organization and ensure we are positioned to win in the long term.

With that, I will turn the call over to Marita.

Thanks, Gene. Good morning, everybody, and thanks for joining the call. As both Fred and Gene have discussed, catastrophe losses and the turmoil in financial markets have provided significant challenges in the quarter. However, we remain very pleased with the underlying trends and the momentum of our business. Specifically, catastrophes contributed 16 points to the third-quarter results bringing our combined ratio to 108%. Our ex-cat combined ratio was 92.6. This represents an increase of 1 point from prior year driven primarily by a higher incident of large losses in the quarter in our commercial multi peril line, and to a lesser degree our personal auto line. However, large losses can be lumpy in our business in any gien quarter.

On a year-to-date basis, our large loss activity in CMP and auto is down. In fact, our full-year ex-cat accident year combined ratio has improved from last year, which is notable considering the adverse weather patterns we and the industry have experienced in 2008. We have a disciplined underwriting culture and we have maintained a solid book of business in this challenging environment while delivering on our expectations of above average growth.

Let me provide with you some perspective on the $98 million of catastrophe losses occurred in the quarter. As you know, this quarter was marked by several sizable catastrophe vents, with hurricanes Ike and Gustav being the largest. Catastrophe activity was obviously a major event for the industry with, as we believe, over $20 billion of industry losses in the quarter. Gustav's damage was concentrated in Louisiana where we have made good progress in managing our catastrophe exposure in both personal and commercial lines. This resulted in overall losses from Gustav being lower than our respective market share reflecting the impact of exposure management efforts.

Ike was an unusually far-reaching and long-lasting storm, affecting Central and Midwestern regions and even impacting Michigan. Total loss estimates vary, with expectations approaching $15 billion to $20 billion. Even at the lower end of that range, our Ike experience would be consistent with our market share in those affected states.

As we do after each large event, we have reviewed and analyzed all claims coming from catastrophe-affected states, and we were satisfied with the results. Our risk selection was in line with our appetite, and our underwriting guidelines were followed. Catastrophes are a part of our business. Over the past five years, we have invested a great deal of time to more effectively manage our catastrophe exposures in order to reduce earnings volatility and preserve capital. Our exposure management actions are on track. We continue to strengthen underwriting guidelines through the proactive use of model data and we closely monitor increased exposures in our new growth states like Illinois, Wisconsin and Ohio. The catastrophe events of the third quarter demonstrate that we are on track and our efforts have been successful.

While we work very hard to manage our exposures at appropriate levels, we are committed to meet the needs of our agents and customers when they suffer losses. Our claims teams continue to be highly responsive on these major events, and our efforts were recognized by our agents and their customers.

Now let me discuss our segment results. For the quarter, our personal line segment recorded net written premium growth of 1.2%, and an ex-cat combined ratio of 92.9%, representing over a point of improvement from prior year. This improvement was driven by higher favorable development and lower expenses. Our ex-cat accident year loss ratio was higher by approximately two points in the current quarter, driven by personal auto line and somewhat offset by an improvement in the homeowners line. Our personal auto results were affected by a difficult comparison to an abnormally low third quarter in 2007. In fact, our accident year loss ratio of 63.7 in the quarter equals the full-year 2007 accident year loss ratio.

As I mentioned earlier, third-quarter losses in our auto line were also impacted by an unusually high incident of large losses. As always, we are monitoring our large losses closely, and although we have clearly experienced abnormal weather losses this year, we do not see any other issues or unusual trends.

We continued to take pricing action in most of our states in the quarter. The pricing remains stable at about 1.7%. This figure does include an 8% rate decrease in Massachusetts personal auto, coinciding with the introduction of managed competition in that state. Excluding Massachusetts, pricing would have been about 2.6% in the quarter.

Now turning to growth. Personal Lines growth of 1.2% during the quarter is in line with our expectations. And our business mix continues to improve. We are shifting our mix to a more desirable, high-quality, multicar, multiline business. This is more consistent with our strategy to write account-focused business, and these accounts are typically less price sensitive and have higher retentions.

As I have done on recent calls, I will focus on four geographic segments: Michigan, Massachusetts, Louisiana and Florida together, and the rest of our footprint. Results continue to be in line with expectation in each of these groups.

In Michigan, where the economy is under the greatest pressure, we continue to focus on maintaining profit margins. Net written premium was up 1% in the quarter, an improvement over declining premium in the first half of the year. The improvement was driven primarily by rate increases and a stabilization of policies in force. Net written premium growth in our homeowners line was helped by the launch of our new homeowners product effective September 1. This product provides for more pricing points in our target segments, while emphasizing our account focus and providing numerous packaging capabilities. Agency feedback has been very positive and we have seen an uptick in better quality business in both the homeowners and auto since implementation.

As I mentioned our goal in Michigan is to maintain margins in this challenging economic environment, while maximizing our opportunities for growth. We have a long history and strong community ties in the state, and our partner agent base is extremely strong, helping us to achieve this goal.

Turning next to Massachusetts. As anticipated, net written premium growth moderated to more normal levels of about 2% growth in the quarter. As we anticipated, this is down from 10% in the second quarter as the initial new business rush from the Massachusetts auto reform slowed. The growth we have achieved in Massachusetts came despite the 8% files rate decrease in auto which I mentioned earlier. We are very pleased with the results in Massachusetts auto as our product is being very well received by our partner agents that is allowing us to grow our business and also maintain our profitability.

Now turning to Florida and Louisiana. Our exposure management actions are in full swing. The nonrenewal of our Florida homeowners business is progressing as planned and should be completed by year end. As I mentioned earlier, our concentration management actions in Louisiana are also on track. Our expectation is for a 16% reduction in premium by year end in those two states combined, which will suppress our Personal Lines growth rate for the year by about 1.5%.

Outside these four states, we've gained momentum as expected during the quarter, with a growth rate of 5%, showing improvement each quarter this year. Our success is based on our partner agents strategy and we have a growing pipeline of opportunities to continue this success. In summary, I continue to be pleased with our Personal Lines results and I'im confident we will maintain our net written premium compared to last year's levels while delivering solid margins in the segment.

Now turning to Commercial Lines. Our Commercial Lines results this quarter, like those in Personal Lines, were significantly impacted by catastrophe losses. On a ex-cat basis, our combined ratio was 92%, or 5 points higher than the prior year quarter. As I discussed earlier, this was driven by results in our CMP lined, and specifically large losses in the quarter. A few large losses can produce swings in our quarterly underwriting results. Our large loss experience was favorable in the first two quarters of this year, so even with this third-quarter activity, year to date large losses in CMP have actually declined. Additionally, our ex-cat ratio has improved for the full year in both the CMP line and Commercial Lines overall. Obviously, we are monitoring the book of business closely as we constantly review underwriting and watch for any symptomatic trends.

Now a couple points on growth. Net written premium growth was 11% in the quarter. It came primarily from our specialty business with growth of approximately 30%. Our recent acquisitions of Verlan and PDI, now referred to as Hanover Specialty Property and Hanover Professional, respectively, made meaningful contributions to our overall growth. We are pleased with the substantial traction that these businesses received in the third quarter. We saw an uptick in new business production from Hanover Professionals, with approximately two-thirds of the new business coming from Hanover Partners. This validates the synergies between this recent acquisition and the Hanover. Hanover Specialty Property new business also increased significantly. Based on a very positive response to the new capabilities from our partner agents, we expect continued momentum.

Our other specialty lines grew almost 20%, driven by a very successful quarter in our school program, one of our key niches, which has a significant amount of 71 business. This type of impact from our niche business is an important part of our strategy, and we have several opportunities to be delivered in a short term, including capabilities in the nonprofit social services segment. Additionally, we saw continued growth in our bond business, where the availability of high-quality business opportunities remains solid. We continue to approach this business with strong underwriting discipline and a conservative appetite.

Our traditional lines also showed an improvement in growth in the third quarter driven by new business levels, improved retention, and less renewal pricing declines. Additionally, growth from our partner agents continued to outpace overall growth, demonstrating the success of our agency focus strategy. Also, we continued to show momentum in the small market segment where our small commercial platform has been very well received. This new platform, coupled with our commitment to exceptional service, gives us confidence in continued partner agent growth in this important segment.

Perhaps most importantly, and as I have stated, we have seen a reduction in price declines in our traditional commercial Lines in the quarter. Certainly I do not pretend to know exactly what the pricing a environment will bring going forward, but we are encouraged to have been a lessening of the soft market in the quarter, and our optimistic that we may start to see an opportunity for price strengthening going forward. As we look to close out the year with a strong quarter, we will maintain our commitment to underwriting discipline, putting margins and prudent risk management before growth, and gaining market share in a manner that's consistent with our strategy.

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

Thank you, Marita. That concludes our prepared remarks. Operator, could you now please open the call to questions.

(OPERATOR INSTRUCTIONS ) Your first question comes from the line of Michael Phillips, Stifel Nicolaus. Please proceed.

Thank you. Good morning, everybody. A couple of questions. First, a high-level on Personal Lines. With the new leadership at the top there, in there about two months, what have you heard from Gary in terms of what he sees as his top priorities going forward in Personal Lines? I will start off with that.

The key in Personal Lines for us, as you know, from the beginning, is we are -- Personal Lines and Small Commercial is what we call ballast for or overall strategy with partner agents. We are a little bit different than most. We don't try to attack it one risk at a time. What we are trying to do, as they consolidate their shelf space to fewer players, is to have more of our partner agents give us a significant share of their personal line. It's really that that's dormant. What I mean by that is account-based business they have had for quite a while. We clearly have been -- that has really been the focus of our strategy and so much of our investment portfolio.

Before Marita talks about the specifics, I just want to talk a little bit about why we went out and got Gary. My view is that the opportunity in Personal Lines is greater than we anticipated probably five years ago. Given what I am seeing is that portion of an agent's business is becoming a more important part of their profit pool. It is more stable. It is more consistent. And as they go through the pressures of the economic downturn and turns in the -- maybe even consolidation of the number of customers they have, that is becoming more important, even to the winning and more significant agents in the country. And when Gary -- it became clear to me that there was some turmoil at his prior place, it was important for us to get somebody who had been a CEO for quite a while in that business and could handle a significant business. So we are thrilled to have him onboard. So with that, Marita, is there any specifics you want to share with them about our strategy?

Yes. I think what it all boils down to is, the reason why Gary joined us, when, as Fred said, we went after him, and it was because he thought the strategy was right. He believed in what we were doing. And the account-based strategy with partner agents and growing the majority of our business with franchise partners he believed was the right way to maximize profitability and growth in this market. So he is really looking forward to continuing to advance that strategy and believes that what we are doing in the marketplace is right.

Okay. Thanks. A dotted line follow-up to that is, can you give us some details on what you see as the priorities for Jim Hyatt and his new role there?

That's a great question. One of the things that is happening, as you know, our mix of business is becoming more balanced around three stools. When we started, we were probably a personal lines business, six, seven years ago, that did small commercial and accommodation. We now have a three-stool approach. We have the personal lines. We have commercial core which has both small and very effective what we "smiddle -- low end to middle market. And have a speciality business that is growing significantly in breadth and capabilities, particularly in niche areas.

If you think about, not the top two or three, but the top BI 100, if you will, across the country, those agents that are of significant size and scope, we are becoming one of the most interesting markets for them, because they are seeing consolidation in their markets and turmoil. And as we have grown our portfolio, while it is still very small face value, the breadth we have, like in some of of the legal liability area and the niches, those folks have significant portions of that business. And so it was important for us to have somebody that looked cross region, if you will, because most of these cross different regions. And frankly, in some cases, are organized around different niches or lines of business. And it was important for us to have a senior executive that could match up with the CEOs of these institutions and really coordinate our efforts.

Both the actions still occur, location by location, underwriter by underwriter, but that coordination we think has real umph for it. Again, I would suggest that we have become very interesting to them because they are facing consolidation of their shelf space with fewer better players, and are looking for a little bit of diversity in the markets they deal with, and we are building a better capability that is more relevant for them. So in my view, that's an important role for us, and it was the right time for us to do it now that we have these other capabilities that are more appropriate for that customer segment.

And I think building off that success was important. Over the last couple of years, one of the largest growth pockets we have seen and success with the Assurex partners across the US, and building off of that success, Jim has really hit the ground running, tapped into a lot of the things that have already been successful for us, and is really getting some traction and momentum sharing best practices and driving some of those more complicated relationships across the footprint.

That is perfect. Thanks a lot. Last one for now for me, still on Personal Lines. It sounds like Marita's comments on Michigan were a little bit more positive than in the past, and that's good to hear, but in personal auto, the PIF declines were still a little bit surprising. It doesn't sound like that has much of a Michigan drag as in the past. What else is going that is brig the PITH down to numbers?

There is still some Michigan drag. You have to remember that we filed rate increases in Michigan, as I mentioned, that is helping there. And Michigan is still a very tough environment. We are helped by playing insider baseball, if you will, in that state, knowing the agents, knowing the environment, and our opportunities we feel are still strong. Focusing on margin is the key for us. It is a lot of work and a lot of attention to do that, but we are bullish on the fact that we continue to do that. But make no mistake, Michigan is a tough environment. Across the board, we are seeing a premium increase. PIF is beginning to stabilize, but this is a quarter-by-quarter.

I will also say the PIF decline is pretty severe both in Florida, Louisiana and Michigan. And, again, we believe that, and as you know, the legal limits in some of those states, you've got to be thoughtful and deliberate, but we got out of homeowners essentially, and that is working its way through. If you looks at our PIF reductions it is really concentrated in those three states. I feel pretty good about all those decisions.

And also on Michigan, let me just -- one of the things that has happened in Michigan that makes it a little bit easier is the weather in Michigan has been significantly impacting our regional counterparts. So the combination of a tough economy and the weather that Michigan has experienced in the second and third quarter has created a lot of aggressive behavior in our regional value to catch up with rates. So I would see that the stabilization of Michigan will continue. People are catching up with us on rate in a pretty fast order because of their problems financially.

But the PIF decline, as I said, is very concentrated in those three states. There is probably a little bit in a couple of other start-up states as we reconfigure the product a little bit by region but it is really driven by that.

Okay. That's perfect. Thanks a lot, guys.

(OPERATOR INSTRUCTIONS) The next question comes are Rohan Pai of Bank of America Securities.

Good morning, Fred.

Good morning, Fred. Fred, first question. You've highlighted in the past Hanover's value proposition to agents, its strong financial position and product breadth relative to mutual and regional companies. At this point, are you seeing any signs of capital stress among the mutual companies due to the equity markets?

That is a great question. And it is one that is not as visible to the market, because they're not big companies and it doesn't get written about it. But to me, Rohan, it is unbelievably apparent. I think you know, if anybody follows the mutuals, what you know is they tend to carry a little more surplus because of their scale and size. What most mutuals do is they run their insurance traditionally with bonds and fixed income, but they'll take what they consider quote/unquote excess, and invest it in equity. So almost every mutual was a greater percentage of equity than a typical stock company.

What you have seen is a dramatic decrease, obviously, in those portfolios. So what is excess, quote/unquote, has gone down dramatically. We actually create a data base for our benefit competitively of the top 100 mutuals in the country, and look at their investment portfolio. If you look at that, the vast majority of them have taken surplus hits on their equity side.

In conjunction with that, those mutuals have also had very tough storm seasons. Most of them are focused Midwest companies. We've had two quarters of very difficult weather. And when you add those to the fact that the reinsurance cost that those guys are going to have to incur -- because remember those guys buy down more than regular companies that you're used to, so they buy way down -- the reinsurers now are taking their concentration into consideration. Because what we are learning in Iowa and Ohio is that if you are too concentrated in one state, you have an above-average risk for reinsurers. As as you see reinsurer rates go up, and you will, because they're capital issues, it will hurt the mutuals more than people who are spread.

So what I see is this, quote/unquote, excess capital that people said was being built up by the mutuals has had a distinct turn in the last three quarters. And so we see some stress. I think what you are going to see is commissioners start talking about financial strength more than they're been talking about.

So, again, it doesn't make the press because they are small companies, but, as you remember our strategy, $135 billion of the market is in our kind of business with what we call subscale companies. And we believe in the next year all of this is going to hit them a lot harder than people understand. And, again, I think it happens slow with mutuals, It tends to be organic. What they tend to do, because, again, surplus notes are not accessible to them any more. Finite Re is not accessible to them anymore. And so there is challenges about ratings because if they lose their ratings, they have a real problem. So what you will see them do is shrink their business to support their surplus. That is what mutuals tend to do. They slowly shrink when they have a problem like this to ensure that their surplus ratio is appropriate. We think that translates into more pricing stability.

Now, none of this stuff happens overnight, but it is the right question to ask for us. That is a very significant trend that we watch carefully and creates, in our view, potential opportunity over the next 12 to 15 months.

Thanks for the detail. The second one is, assuming we head into a dislocated P&C marketplace in 2009, how will you view your specialty commercial business? Is it a segment that is going to expand into new niche classes? Or will it still be the hook for agents to write your standard business which is -- ?

That is another good question. What we've tried to do is, as you know, in general, the specialty businesses we try to get in through the cycle tend to have higher margins than some of these core lines. So we just didn't get into specialty businesses randomly. It was small face value stuff with high expense connection to it that is sticky.

What you are going to see is a lot of those businesses should expand, continue to expand, because they tend to be businesses that are more of an oligopoly because fewer people are in there. So they are places that require typically a little bit more surplus for those that are in them, so you will see price, in my view, both solidify and increase, maybe at a even a greater rate. But the reason we are in those businesses is to get the overall franchise. So, we will grow those businesses, and I like the diversity of the income that come with it, but, what we always do is ask for -- we don't give that capacity to agents without having the conversation that says we want a partnership across other lines. So it will continue to always be about the partnership. But it does present an opportunity for us.

And I would go a step further. The disruption in the marketplace is allowing us -- as you know, we've hired 2,500 to 2,800 people in the last 36 to 48 months, the amount of people that are terrific, that will be available in some of those interesting specialty lines, is going up quite a bit. And so our view, in a thoughtful way, we are continuing to do that. We continue to interview. And it allows us -- like in this human services that Marita talked about, we think that's a tremendous opportunity for us. The amount of quality people we brought in to do that is tremendous. Again, I could see specialty continuing to grow faster than the rest of our business for quite some time, as we thoughtfully expand the niches and penetration.

The other point I would make is when you look at our -- schools is a great example, if you look at our mix. We are pretty thoughtful about rollouts. We have been in the school business for three -- we have been incubating that. We have a great team. We built the capability. But we are not even in all of our states yet. We are just barely, probably in 50% of the states effectively at the end of last quarter. That will be a lot greater in January. But some of this growth just is from simply rolling out these niches to the additional states. So we are both bullish on tho specialty growth as well as on its continued ability to leverage the core. I mean is that fair, Marita?

I think that is right. That is the whole beauty of the specialty businesses. It has got a double whammy. It has the first by itself. There are high margin good specialty businesses but then they also serve as hooks to build stronger, deeper agency relationships. So you get both benefits from them. I think you are absolutely right.

Thanks. And then finally for Marita, what is the commercial strategy in Louisiana again? I know you have been reducing your exposure for the last two or three years, but it somehow seems that even if you have a large event once every five or eight years, it will be hard to make money in commercial Lines in the state.

Yes. We agree. We have taken an overall approach to the state and quite frankly have significantly reduced our commercial exposures to offset the fact that we can't, by regulation, get the personal lines exposures as low as we might ultimately want to get them. So balancing that and looking at that as a combined property writing in the state is how we've approached this from the very beginning. We have been very conservative with commercial business in the state, and the majority of our new business writing is really coming from the casualty lines as we take a very conservative approach to cat management in the state. You are absolutely right. And we manage those concentrations down quarter by quarter.

Great, thanks, Fred. Thanks, Marita, for the answers.

(OPERATOR INSTRUCTIONS) We have no further questions in queue. I would now like to turn the call back over to Mr. Bob Myron for closing remarks.

Well, thanks to everyone for participating on our conference call. And we look forward to speaking to you again next quarter.

Thanks very much, everybody.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day.