Hanover Insurance Group Inc (THG) 2010 Q1 法說會逐字稿

Good morning. Welcome to the Hanover Insurance Group first quarter 2010 earnings conference call. All participants will be in listen only mode. (Operator instructions). Please note this event is being recorded.

I would now like to turn the conference over to Bob Myron, Senior Vice President of Finance. Please go ahead.

Thank you, operator. Good morning and thank you for joining us for our first quarter conference call. Participating in today's call are Fred Eppinger, our President and Chief Executive Officer, Marita Zuraitis, President of Property and Casualty Companies and Steve Bensinger, our Executive Vice President and CFO.

Before I turn the call over to Fred for a discussion of our results, let me note that our earnings 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. Our prepared remarks and responses to your questions today other than statements of historical fact include forward-looking statements. These include statements regarding expectations of segment earnings, after-tax segment earnings per share, pricing, accent year results, premiums, expenses, development of loss and LAE reserves, returns on equity and other projections for 2010. There are certain factors that could cause actual results to differ materially from those 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 two 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, after tax earnings per share, 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 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, everyone and thanks for joining us. I will give you some context to our results for the quarter as well as discuss how I view our progress. The first quarter of 2010 was particularly challenging for our industry due to an elevated level of catastrophe. While we incurred catastrophe losses of $34 million during the quarter which was about $10 million or $11 million above our expectations, I am nonetheless very pleased with our results.

As shown on slide four, net income per share for the quarter was $0.87. Our operating EPS of $0.66 represents an increase over the prior year quarter and reflects strong underlying trends and as shown on slide five, our book value per share increased 3.8% in the quarter and 34% in the last 12 months driven by an operating result, gains in our investments portfolio and our share buyback activity. We have made good progress this quarter on all the leverage to improve our operating results that I discussed with you last quarter. First, we had good momentum in growing our specialty and commercial lines businesses and leveraging the investments we have made in these areas. Second we improved our geographic and business mix which should drive improved and more stable results in our future. Third we continued to get improved pricing in both personal and commercial lines and finally we continue to take thoughtful capital management actions. I will briefly review each of these areas.

First, on reaching what I would call better scale in commercial lines, in the first quarter we grew 33% driven by our renewal rights transaction with OneBeacon, as well as our growth with specialty line. While it's too early to give a forecast of how much the OneBeacon business will ultimately renew we feel very good about how the arrangement has gone so far. The transaction began through a reinsurance arrangement with OneBeacon for January 1, and subsequent renewals and we have been very pleased with the level of enthusiasm from the legacy OneBeacon agents to partner with Hanover and with how many of these high quality agents are converting most or all of their OneBeacon books to us. We have also hired many great people from the organization across multiple disciplines and we expect to leverage these hires over the course of 2010 and our future periods.

Generally in the first three months we are getting rate increases on the renewal rights transaction similar to those that we are experiencing in our legacy commercial lines business. The quality of the renewals and how they have progressed thus far allows us to maintain our underwriting and pricing discipline while achieving attractive retention rates. I also feel great about the transaction that we are getting in our specialty businesses.

We closed in -- I'm sorry -- we closed on our acquisition of Companion on March 31, and the integration of this Company and its book of business into our suite of products is off to a good start. Our partner agents have expressed strong interest in Companion health care's offerings and we believe we will be able to cross sell our core commercial lines products to Companion's client base. I believe we will be able to see some impact towards our partners towards the second half of the year. Separately we have started writing business placed by our other recent accusation benchmark effective April 1. Benchmark was an experienced team of underwriters that offers coverages for architects and engineers and represents a very attractive addition to our professional lines suite of products and our level of expertise in this area. Lastly we continue to have strong momentum at AIX evidenced by the recent announcement of our partnership with Barney and Barney in which we will underwrite two of their very attractive programs.

It is particularly notable that in the first quarter our net written premiums in commercial lines exceeded our net written premiums in personal lines. This is a testament to all of the thoughtful actions we have taken throughout the course of our journey to diversify our Company, improve our mix and expand the capabilities of our organization. As I had previously indicated, our expense ratio particularly in commercial lines is higher than our long-term target. As you know, we have expected that the commercial lines expense ratio would be high in the first half of this year, much of the increase in expenses this quarter reflects upfront investments in the renewal rights deal and our western expansion efforts. Additionally, we continue to ramp up our AIX and other specialty capabilities. For all of these initiatives including Companion, benchmark acquisitions, there are significant up-front costs as we integrate operations, build new products and make policy form and rate filing. We have put people and infrastructure in place ahead of the premium in order to provide the highest quality of service to our partners. The mechanics will work in favor prospectively as we earn in the growth we are achieving in net written premium in the later part of 2010 and into 2011, we expect the expense ratio to decrease. While net written premium and commercial lines increased 33% the first quarter our earned premium only increased 12. This percentage increase should be higher in future quarters.

Our principal objective in investing heavily in these new capabilities is to drive fundamental margin improvement in our overall book of business through geographic and mix shift which is the second lever I mentioned previously. Our overall mix of business continues to improve. In core commercial lines we are growing our segmented and niche businesses much of the OneBeacon business we are renewing is also segmented or a niche. We are also diversifying our exposures in commercial lines after we entered seven new western states on January 1. So far most of the premium writings in the West are driven by OneBeacon renewals by our reception from our new partners have been excellent and I expect we will see broader flow in the second half of the year as all our products are proved in the new states. And lastly specialty continues to make up a growing portion of our overall commercial lines book driven by our acquisitions in new product investments.

I am also pleased with our personal lines mix improvement as we continue to grow the percentage of our business that is in full accounts and our book continues to shift to a more diversified geographic profiling. The improvement in our third profitability lever pricing is more notable and personalized. However, we continue to achieve modest rate increases in our core commercial renewals as well. Pricing continues to be challenging in larger accounts but in the small to middle market we have -- that we target we are able to get positive rate increases this quarter.

Finally, we continue to take a very proactive approach to capital management. As a result, we decreased our capital's overall -- excuse me -- our Company's overall cost of capital and increased book value per share through stock repurchases which should also drive our hourly and EPS higher in future periods. We also increased our annualized dividend rate by 33% in the quarter. Steve will provide more detail on these capital management actions in his remarks.

It is still a tough investment environment with new money yields at levels lower than a year ago as evidenced by our decreased book yields. However, we still believe our conservative investment philosophy is prudent and we don't have any intention of stretching for yield or taking more credit or duration risk. So as our first quarter results demonstrate, we made some important progress and are on track to improve our margins and return on equity through utilization of the leverage we have at our disposal and we will continue to make strides in future periods.

In conclusion, I would like to provide some perspective of what you can expect to see from us in the coming quarters as well as my views on the state of the market. Next quarter we will continue to drive commercial lines growth through our continued focus on the OneBeacon renewal and on our western expansion which should begin to generate more new business growth. We have a substantial number of new product filings in the pipeline related to the broadening of our capabilities associated with our recent acquisitions and we also have product and new state launches for our existing segments that when approved will generate growth in our specialty businesses. Earned premium growths should pick up in the second quarter helping us to leverage some of our up-front expenses and expense ratio in commercial lines should start to decline. I believe we should continue to see improved profitability in personal lines. Higher margins in the first quarter were a product of fundamental and persistent changes in the makeup of our business, a dramatic mix shift to account business, stronger agency partnerships and rate increases therefore are putting random weather events aside we should see these higher margins in the P&L continue for the coming quarters. From a pricing environment perspective the market is generally supportive of our rate increases in personal lines. We are seeing similar trends from competitors so we don't expect that achieving rate increases for the remainder of the year would put excessive pressure on our premium writings or retention levels.

In commercial lines, the market is very competitive and we are again seeing irrational pricing actions from some of our competitors in the core commercial business. We intend to maintain our pricing discipline and not follow the market down in that respect. Lastly, the state of the economy continues to generate headwinds but thus far this has had a limited impact on the margins of our business and does not change how I feel about our prospects going forward. With that, let me turn the call over to Marita.

Thanks, Fred, good morning everyone and thanks for listening to our call. I am pleased with our results in the first while the insurance environment this quarter was as difficult as it has been for the past several quarters in terms of economic and pricing conditions, our underlying trends have improved. I'd like to review the sources of that improvement and also touch on some areas of focus in our businesses starting with personal lines on slide seven.

Our first quarter produced $34 million of pretax segment income compared to $3 million in the prior year quarter, driven by lower catastrophe losses but most importantly driven by better underlying loss margins in both our auto and home owners lines. First a couple of observations on catastrophes, our cat losses in the quarter were lower on a relative basis than many of the others -- of the other competitors in the industry. Our aggressive catastrophe management over the past has resulted in a reduction of our coastal risks in the northeast as well as in other parts of the country. In addition, the tracks of the first quarter storm missed much of our northeast footprint. Most of this quarter's winter storm activity was in the Mid-Atlantic where we have a relatively modest personal lines market share. So despite the fact that we maintain a significant presence in the northeast, our losses were mitigated. We had our fair share of snow and freeze losses as we always have and expect to have in the first quarter but we were spared from the excessive water and wind damage that affected many other companies. We realized the importance of continuing diversification and aggressive catastrophe management and we continue to make this a priority.

Excluding the impact of catastrophes our personal lines combined ratio in the current quarter was 93% compared to 99.3 in the prior year quarter. As far as noncatastrophy weather is concerned, we believe this quarter was more or less a return to the long-term average. Excess snowstorms in the northeast were offset for us by a relatively quiet weather quarter in the Midwest. Our geographic mix usually results in elevated weather losses in the first quarter. Overall we are comfortable with our pricing which takes a much more conservative view of the weather. We estimate that at least two to three points of the improvement in our personal lines underlying loss ratio was driven by changes in mix of business and price increases that we put through last year. Frequency improves substantially especially in homeowners and auto physical damage coverages while severity maintained relatively stable levels. The increase in auto liability severity that we saw in the latter part of last year in which we talked about on our call in February has moderated.

Turning to slide eight to discuss our personal lines growth in the quarter. In the first quarter of 2010 net written premium increased 1% compared to the prior year quarter. Mostly driven by higher rates in both auto and home businesses. Our average rate increase in the first quarter in both auto and home was 5% compared to the prior year quarter and our retention is improving, which we attribute to the mix of business shift that we undertook two years ago. We are building a book of multicar total account business that tends to be less price sensitive and as a result we were able to balance the need for additional rate without reducing retention. Our homeowners net written premiums grew substantially in the quarter reflecting those rate increases. Policy counts increased moderately driven by growth in our newer states like Ohio, Wisconsin and Illinois and as we continued our account rounding efforts and thus continued to build the foundation of total account business which tends to drive higher retentions.

Overall, our premium production in core states decreased 1.5%. We have seen aggressive pricing behavior from some of our competitors in their race for new auto business in Massachusetts and New York. We continue to maintain pricing discipline and therefore have seen reduced new business in these and several other states. In our growth states, net written premium increased 7%, in line with our strategy of diversifying our northeast and Michigan exposures. As we look to the rest of the year, we have visibility into continuing profitability in personal lines. Our view is supported by investments in our products and ease of doing business enhancements, change in our business mix and our commitment to the independent agency channel which we know is very important to our partner agents.

Moving onto commercial lines on slide nine, our pretax segment income for the quarter was $23 million, compared to $48 million in the first quarter of 2009. Catastrophes lowered our pretax earnings by $19 million in the current quarter compared to $11 million in the first quarter of last year. We believe our losses this quarter were consistent with our concentration in the affected markets and reflect our growing presence in commercial lines in the central and Mid-Atlantic regions. On an ex-cat basis our combined ratio in the first quarter of 2010 was 96.5 compared to 89.8 in the prior year quarter, remember 2009 benefited from a higher level of favorable development. Our ex-cat accident year loss ratio which we believe is a better indicator of the quality of our commercial lines book was 49.1 or 1.7 points lower than in the first quarter of 2009.

More typical noncat weather this year contributed to the favorable year-over-year loss comparison, underlying trends in our core commercial lines were also positive, especially in bop and auto where frequency and large losses were substantially lower than in the first quarter of 2009. Partially offsetting this positive comparison in our core lines was an increase in losses in our marine business. This being a property line tends to be lumpy quarter over quarter and we don't see anything alarming in the trends as we go through our analysis. In general, we are pleased with our stable loss ratio trends in commercial lines, especially given our rapid expansion into new product capabilities and our acquisitions. Our consistent results are a validation of our thoughtful approach to growth in the soft market, our underwriting discipline and our prudent risk management.

As Fred has already discussed with you in some detail our elevated commercial lines expense ratio this quarter is a result of our up-front investment in the people and infrastructure needed to serve our agents and customers in our expanded territories and in our new product capabilities. We expect the ratio to come down as we bring this business into our portfolio.

I'll now move onto review of our commercial lines growth on slide 10. In line with our specialization focus, our growth in commercial lines reflects the impact of the OneBeacon renewal rights transaction growth in our AIX businesses as well as growth in professional liability and other specialty businesses. Approximately 24% of our overall 33% commercial lines growth this quarter is attributable to the renewal rights agreement with OneBeacon. This was in line with our expectations. However, going forward it may be more difficult to maintain this pace of renewal retention as competition around this book may intensify. A large portion of the OneBeacon business is in segments and niches consistent with our small and middle market strategic focus. Typically this segmented business is similar to that covered on a standard commercial policy but there's enough differentiation in servicing, loss control or policy language to set them apart from regular flow business. This differentiation in product delivery with appropriate modifications in coverage historically drives higher margins and helps with retention of the business. Over 70% of the premium we have renewed so far falls within these targeted segments and niches. In the middle market space we are adding new segments like cultural institutions and additional professional services to our portfolio. In small commercial we have added several affinity programs.

We are pleased that we are getting the expected traction with our new western footprint with 30% of the renewals written from OneBeacon renewal rights transaction in the first quarter coming from these new western states. This validates our western expansion investment as well as diversifies our portfolio. Outside of the renewal rights transaction growth in our core commercial lines was somewhat dampened by increasing competitiveness in the middle market space. While our rate changes and small and middle market accounts were positive in the current quarter, our conservative underwriting approach put additional pressure on our new business volumes. We are being selective and conservative with respect to new business at this point in the cycle. However, we are fortunate to be able to access high quality business from the renewal rights arrangement to supplement our continued growth. Our specialty lines also continue to gain momentum. AIX is making significant strides with our key partner agents while maintaining profit margins. Our Hanover professionals unit has been bolstered with added capabilities of architects and engineers and miscellaneous professional liability products. We are seeing a lot of interest in our new specialty capabilities from our partners, not only in the products we offer today, but also in those under development. Overall catastrophes aside, commercial lines produced results in the quarter in line with our expectations as well as our long-term strategy. Going forward, we expect to continue to improve the quality of our business mix while growing at double-digit rates as we leverage the breadth of the business opportunities that we have created over the last couple of years. And with that, I will turn the call over to Steve.

Thank you, Marita. Good morning, everybody and thank you for joining our call. This is my first conference call with the Hanover and I'm very pleased to be here. Today I'll be reviewing the Company's financial results, referencing the slide presentation and starting with slide 12. I would like to provide some color on reserve development and touch on a couple of nonsegment earnings items on our income statement before I move on to discussing our balance sheet.

Our pretax P&C segment earnings of approximately $58 million this quarter included $24 million of favorable loss reserve development. This compares to favorable loss development in the first quarter of 2009 of $32 million, which included adverse development from 2008 year-end, noncap weather events. Accordingly in line with our expectations, we are experiencing lower favorable loss development than we have seen in the recent past. We expect this trend to continue as we take favorable development from prior years into consideration when making current accident year selections. Also included in the current quarter result was approximately $10 million of favorable LAE development related to a decrease in the cost factors utilized for establishing unallocated loss adjustment expense reserves. We had not updated these factors for several years accordingly we did not have an expectation that will have an adjustment of this magnitude in future periods. In the first quarter of 2010 -- the first quarter of 2010 also benefited from realized investment gains of almost $11 million resulting from some portfolio repositioning.

Turning to slide 13, I'd like to briefly touch on our investment portfolio and yields. At the end of March, we held $5.1 billion in cash and invested assets. Cash and fixed maturities represent 99% of our total invested assets. Roughly 93% of our fixed income securities are investment grade. The average duration of the portfolio is 4.1 years. The composition of our portfolio remains largely the same as in the prior year period as well as in the sequential quarter. So I will not cover all of the investment slides.

Net investment income in the first quarter was $61 million compared to $65 million in the prior year quarter. This decrease is due in large part to the utilization of fixed maturities to fund stock repurchases of $274 million in 2009 and 2010, repurchases of corporate debt of $180 million and a $100 million pension plan contribution. While this lower level of investment assets produced lower net investment income, these capital management actions also reduced our interest in pension expenses. The decline in net investment income this quarter also reflected lower new money yields. The earned yield on our fixed income portfolio this quarter was slightly lower, 5.48% compared to 5.81% in the prior year quarter. New money yields were 4.19% in the first quarter of 2010, compared to 4.65% in the first quarter of 2009. As we look to the remainder of the year, we expect our NII to remain stable despite the lower yield environment. Strong growth in our insurance operations should drive a moderate increase in invested assets. We are also looking to selectively invest in areas currently undervalued by the market while not significantly adding duration and credit risk to our portfolio.

Let's turn to slide 17 for a discussion of our capital management actions. During the quarter, we successfully executed a $200 million, 10 year senior debt offering with a 7.5% coupon. As a result we estimate the new run rate for the pretaxed interest expense will be about $11.5 million per quarter. At March 31, 2010, our consolidated corporate debt stands at $632 million. This equates to a debt to total capital ratio of 21.5% which is well within rating agency thresholds. In the first quarter of 2010 we bought back 610,000 shares for a total value of $25 million through open market repurchases. We also implemented a $101 million accelerated stock repurchase transaction under which we have repurchased 2.3 million shares, thus over the last 12 months we repurchased 6.5 million shares or about 13% of our shares outstanding at the end of last March.

We did not repurchase any additional stock after the ASR transaction on March 30, so as of today we still have about $65 million of capacity under the $400 million stock repurchase authorization. As Fred said, this quarter we moved to a quarterly dividend payment schedule and paid our first quarterly dividend of $0.25 per share which represents an increase over the prior year of 33% on an annualized basis. We expect to generate additional capital -- additional capital in 2010 and as always will be thoughtful about its optimum utilization.

Turning to slide 18, our balance sheet remains very strong. Our GAAP equity decreased $57 million during the quarter reflecting the open market repurchases and ASR for a total of $126 million as well as dividends of $12 million. On a per share basis, however, book value increased 3.8% in the quarter to $51.59. At the end of the first quarter our statutory surplus was $1.75 billion and at 1.6 to 1 our premiums to surplus ratio remains more than acceptable for our current ratings and mix of business. Holding company cash and investment securities were $348 million at March 31. Additionally, on January 4, of this year The Hanover insurance Company made a $100 million contribution to the Company's qualified pension plan and as a result the plan was fully funded as of that date. The liquidity for this funding occurred within the Hanover insurance company. It did not affect holding Company liquidity or shareholders equity. The decision was driven by asset liability matching considerations. Finally, a couple of thoughts on our outlook.

Because pretax catastrophe losses in the first quarter were about $10 million to $11 million higher than our expectations, we are reducing our guidance range for the full year 2010 by $0.15. Thus, our new guidance range for after-tax operating earnings is $3.70 to $4.05 per share. The other assumptions for our guidance remain intact. With that, let me turn the call back over to Bob.

Thanks, Steve, operator, could you please now open the line for questions.

We will now begin the question-and-answer session. (Operator Instructions) The first question comes from Michael Phillips of Stifel Nicolaus. Please go ahead.

Thank you and good morning.

Good morning, Mike.

I was going to ask if it's safe to assume that the $67 million from OneBeacon could be annualized but it sounds like from Marita's comments she said something about expect increased competition there. That might not be the case safe to do that?

I think the point is if you look at traditional renewal rights deals they tend to come at 50%. Clearly we are running better than that right now and I feel very good about what is happening with our agent partnerships and how well they are working with us. What we are just cautious about, obviously, is that obviously the pricing, we are going to watch pricing and we are going to still get the pricing we need to get to make sure that the margin is good and we are obviously always watching competition as it kind of tries to compete for that business as well. So we are cautiously optimistic about it continuing but wouldn't be surprised if it didn't but we are managing this as we said when we did the deal through margin, we are getting our rate increases just like we are getting rate increases through the rest of our book and we are trying to keep the business that is attractive to us as we look forward but again, I would tell you, Mike, we are optimistic about what's happening.

What's of deeper importance, I think, is the fact that I feel wonderful about the partnerships we have built with these agents already. I mean, we have gone out and met every single one of them, we have had great conversations. I think they are our kind of guys and so when you look at the 500 total and 300 new, this is a terrific step forward for us, particularly in the new geographies. It is going to help us for the long haul and we are going to be in a good place with them. I don't know, Marita, if you want to add any color to that.

Yes, the only thing I would add is obviously we are really pleased about the way it's going. This is business that we know in classes that we know well with agents that we know well. So we are pleased with the way it's going. The only thing I would add is because of the way we did this with closing and announcing virtually at the same time, we got a nice jump on this. So as natural competitiveness starts to occur, we could see that trail off a little bit, but we are very pleased with the way it's going and bullish that, we have done a good thing here.

Great. Thanks. If I could turn to personal oil for a second. I kind of had the impression that some of the stuff you've talked before in terms of reunderwriting that to get it more account focused had largely been done and so that with kind of the new stuff you did last year like the Think Hanover initiatives and things like that would maybe see a better turn in TIP than we saw for personal autio than we did, so I wonder if you could talk about that. It's still negative in fact more negative than last quarter so I was surprised by that.

Yes, one thing I would say is you have to keep in mind that Massachusetts and potentially New York may have lagged that a little bit as managed competition came to Massachusetts. But you're right, the majority of our heavy lifting, our shift of mix, our focus on multicar, multiaccount business, our ability to push rate is also -- is certainly paying off in the profitability but you've got to remember that there's a couple of states there that are lagging a little bit in that turn. We are pleased with the profitability of that line and where it's going.

Yes, and again I think it's a good observation. I think on the Think Hanover and the Hanover household a lot of the stuff has been rolling out in the first quarter. It is starting to work in our growth states. I do feel that we will hold our own there as we go forward, particularly in the growth states and I would just tell you that because of the way the weather unfolded last year and the noncat weather, we have been really aggressive even with our full accounts on pricing in our core states and I think we are seeing the result of that a little bit in the northeast. But again, I'm comfortable with that. I think we -- if you look at our partner agent retention it's better than our general agent retention and the mix of business is skewing more and more towards accounts but it's a great observation. We are very -- we are working hard and as I said in the last call, I think what we have done on Hanover household is very powerful. I think we are going to start getting more into what I call near affluent business I think we are going to continue to have a better and improved mix in our growth space. I feel that we are not giving up on personal lines. I just think it was important for us to make sure we manage profitability right now and we will continue to get the mix better going forward.

Thanks. Last one for me now, speaking of lagging states, in Massachusetts does the fact that the new direct guys coming in are now writing a triple-digit loss ratios does that help you or is it customer base is too different?

Great observation. Whatever we had left over that was single auto with noncore partners I could tell you--.

It found a home.

It found a home. Right. They are being very aggressive. And now, what's encouraging, it happens everywhere, if you watch New Jersey, three years ago, four years ago when I went to competition, there's a 10% of the market that truly is what I call this self-served market that goes fast. It's the guys that have just one car, not a lot of substance as far as other assets and what we have seen is that's gone quickly to the players. Now what you've also seen to your point is these guys are registering triple-digit kind of results and so you've seen Progressive take pretty significant rate increases and we expect to see it settle in. We don't have a big auto when we book. You have seen the hit more aggressively in our competitors that are very skewed to auto. There's a couple as you know guys that are Massachusetts only players that are very, very heavy auto and they have lost quite a bit of share so we did, we lost, if you look at it, we lost some auto that we had particularly with outside of kind of our best agent partners but I do think that will settle because I do see rate increases coming and we kind of expected it and I feel good about it where we are.

Thanks, Fred, appreciate it.

Thank you.

The next question comes from Cliff Gallant of KBW. Please go ahead.

Good morning, Cliff.

Good morning. Couple questions on investment income and how we should think about that over the next year, year and a half and two parts, one is as the OneBeacon book grows and accrues to you, how much investment income benefit will that get us next year? And then secondly, with the -- I'd like to ask Steve Bensinger how he views the risk profile of the investment portfolio would he consider trying to improve the yield or increase the yields with a higher risk appetite?

Okay. Well, let me take the last question first, if I may, Cliff. In terms of the quality and the risk nature of our portfolio, frankly, I think it's just right for the current environment. It's very conservative, I think it has the right balance of mix right now in terms of small -- relatively small components of high yield and equity but principally focused on conservative fixed maturities. I think the duration is about right given where we are and the laddering of the book is right so I would say overall I don't think you should should expect to see much.

The environment right now is sort of back to where you're really not getting paid very well for the risk that you're taking if you go further out on the yield curve or if you go into higher risk issuances so I really don't think that's prudent for us at this point in time and it's served the Company very well to be as conservative as it has so I think we will maintain that. As I said in my remarks in response to your first question, it's hard to give specific components of what's going to add what to new asset creation, new invested asset creation. It's a mix of many, many factors but right now based on everything we see, we think that the gradual buildup of the investment portfolio in response to our growth should offset what we see right now as declining yields and new money and as we said, we think the first quarter is a relatively good indicator for the rest of the year right now.

Thank you very much.

Thanks.

The next question comes from Sam Hoffman of Lincoln Square Capital. Go ahead.

Good morning, Fred. Just had a couple of questions. On the pension, I just wanted to clarify when you say that it's fully funded, does that mean that there's no risk to the Company either if interest rates go down, equity markets go down and that there shouldn't be any expense going forward in the other expense line.

No, you can never say there's no risk in defined benefit pension plans because it depends on exogenous factors that are outside of our control. Based upon all of the factors that we were able to consider in January at that point in time and I say it's still probably the case right now that that $100 million contribution created a fully funded situation. If there's dramatic changes in market conditions again where you see losses in value and securities in the future, if that were to happen on a significant basis, that could certainly change those assumptions.

Should we assume that under a normal market scenario there's no longer any (inaudible) or expense for that item going forward?

No. You should not assume that. I think the first quarter -- in the first quarter we had a little over $3 million of total pension expense and that should be the ongoing quarterly run rate based on the current assumptions.

Okay. Second question is on the debt capital risk based on your comment on the call, should we assume that you're going to be maintaining roughly the same amount of debt going forward or was that meant for refinancing the existing debt at some point?

I think what I said was that our current debt-to-capital ratio of 21.5% is well within rating agency tolerances and guidelines. That doesn't mean that it couldn't fluctuate higher or lower depending on the circumstances and the activities that we need to fund.

If you think about what we did, if you go back the full 12 months, we took advantage of the disruption in the marketplace and once I got -- we got the upgrade, we refinanced a bunch of our older debt and were able to go to the federal home bank board and get attractive capital that we put in the insurance company at about 5 1/2 % or so, but we only put up about 125 because of I wanted to make sure that some of that debt was at the holding company and I think about this as getting our debt level at about the place we wanted it to be this second tranche of debt so I feel very good about this 20% plus, where we are and I like the mix of what it is but if you'll think about it from 12 months ago we obviously took about a $30 million gain from the refinancing. I like our mix now and obviously in the same time, we released and bought back a lot of shares so that our cost of capital is a little bit more like the best companies now. I just thought we were a little bit out of whack and now I think we are back in whack. To Steve's point, depending on how we grow and how you think about potential future transactions, we will keep in mind kind of rating agency guidelines but we are at the low end within our rating structure so we have plenty of room, if you will if we had to or thought it was needed but I'm very comfortable with the current structure. It's very typical in some of the better companies to be about this level.

Can you comment, can you give the holding Company cash at the end of the quarter and comment on your priorities for the use of it?

Yes, it's about $348 million and obviously we have gone to a quarterly dividend now and we have -- so we will obviously have a commitment to that. We have our debt and our debt payment that we typically do out of the holding Company as well and -- but I think your broader question is do I feel that we are still adequately capitalized or have excess capital. I would tell you, in a normal world I think we still have excess capital and by the end of the year we are going to have more excess capital even with our current growth rate and so the -- as always, the first priority for the Company is to have profitable growth that beats cost of capital and if there is opportunities to continue to do that, we will do it, if not, we will think about other ways to make sure we use the capital appropriately and as we decided in the last couple of years we have given some back and I think I always think about that and we will think about that going forward because I do think we are at a point where we still have some room here as we look at the future.

Now, I will tell you that the market is playing out just like we expected it, people are talking about the market being a little softer. I never expected it to turn quick. I think the -- a lot of the financial disruption was a side show to the underlying structure in the industry and I think as market turns in the next 12 to 18 months, weaker players are going to have problems. You're going to have significant underwriting. I think you're going to have significant opportunities and I think we have positioned ourself to capitalize on that, so some of this capital I'd like to make sure we had enough powder dry so we are having a lot of capabilities we have now built and so as the market turns and when it turns and when people stub their toe, we will be ready. So some of this as we get closer to the turn is to make sure that we have excess capital to capitalize on and get opportunities that present itself but as always Sam we try to be thoughtful about the balance between the business opportunities in front of us and then given share holders the money back if we feel we don't have an appropriate use.

And finally, given the soft market, given that interest rates it sounds like your yields are going to continue to be low and you're taking a conservative investment posture, what -- can you update us on the time frame that you think you could achieve your corporate ROE objectives?

Again, it's a great question. I still am very focused. As I said last quarter, I've got this kind of this six quarter view. We are going to move forward and improve every single quarter. These yields as you mentioned that affects perhaps your thought process but it also affects your cost of apt, obviously if it's permanent and as many people worried about inflation as lower yield so my view is that we are improving, if you look at what we have done both on a capital side and on our mix of business and how I -- if you look at our percentage with partners, the kind of quality of business we are bringing on, I am very focused on improving every quarter and and I believe we can get to our targets in that kind of six quarter time frame. Again if we see opportunities that present themselves to us that I make the case to you our shareholders I'm going to do it. If I think there are additional opportunities that are presented to ourselves that we want to invest in. But right now I feel very good about it and if you think about our plan, this plan is more improvement quarter to quarter than typically in the 6.5 years I've been here but it was set up purposefully this way because of these opportunities we saw that we took advantage of in the fourth and the first and second quarter and I think we are in a good spot to kind of continue to improve performance through the year. And we got to do that, we have got to demonstrate that.

Thank you.

The next question comes from Larry Greenberg from Langen McAlenney. Please go ahead.

Good morning, Larry.

Good morning, Fred. With the OneBeacon and even going back over the last couple of years, there's been so much noise in the expense ratio line. I'm just wondering, as you look at the Company now positioned with more commercial than personal lines business, if you could just look out and try to normalize the expense structure, what type of expense ratio do you think the Company is ultimately moving toward?

Great question. Obviously I talk about this a lot and it's all odd this year, right, because we are going to improve probably our expense issue to almost every line and it could go up because the mix is going to be so skewed towards commercial versus personal but if you kind of normalize it for mix of business or what I've said is that I believe we are about a a point and a half heavy, I mean, if you look at what we have done and again you got to normalize it for mix of business because as we grow our bond business or our marine business, obviously they all have different expenses but if you look at the total thing I have purposefully invested a point and a half, that was by the way 2, 2.5, 2 at the beginning of our journey because we were so commodity driven as a business but it's a point and a half or so I would say and this year I believe that we will make progress somewhat in the individual lines of business but we are very top heavy in the first couple of quarters in particular on expenses and again, people say well, Fred, you know, can't you get less?

But remember, personal lines is going to be an account oriented, near fluent total account rider and in the same thing in commercial, it's going to be a lot of niche, a lot of segmented business and so we actually look at this line by line by line and I got additional expenses from geographies because they are not scale. I have additional expense in these emerging businesses and we have additional expense because of leaders, I would call field leadership because of our strategy and our conversion of partner agents. Those are the big categories. And within that if you look at it, there is still a little bit of infrastructure cost. I mean, one of the great, I tell you in the last 12 months we have filed 1500 policies so we have launched 1500 policies if you look at all the states and all the products. Well, that costs a lots of money so there is a startup that we have gone through building these businesses, there's also been infrastructure cost in our professional lines and things but it's about a point and a half and your point is right, it's a little noisy. It was clearly noisy in the first this year with so many new things going on but we have a lot of leverage to go and on the expense ratio and I feel we can get it and I believe if you look at our competitors by the way, what you've seen is a lot of the regional companies have as high a loss ratio as we have but they are not investing. It's getting there because they are shrinking they have got an infrastructure they have got to make.

We don't have that issue, we have an explicit investment, we know exactly where it is, we know exactly what we are getting. I would also tell you the other thing that I would say is underlying all this, the variablization of our expenses is 100% better than it's ever been in our technology area and some of the data entry so the operating models are much better in all our businesses and so much more of this excess expense today is this up-front cost, this startup cost and this lack of scale that we have in a number of geographies and a number of businesses, so it's a great question because we think about it obviously as one of the important levers as we go forward. And again, I would rather have that as a lever because it's easier to control than some of the other levers, right? That we can manage but it's a good question. I appreciate it.

Thank you.

There are no more questions at this time. However, we now see a follow-up from Michael Phillips of Stifel Nicolaus. Please go ahead.

Thanks. One more follow-up, if we have a second here.

Sure. Sure.

I guess I'm kind of -- one of your little stress -- part of your strategy has me always confused and if you can talk about it, when you do the Verlan thing and you get into a specialty business like Verlan and then when you do PDI you get into that and then later I guess when you first talk about PDI, you say this is for a certain niche it's the lawyers and then benchmark comes along and it's a certain niche for architects and engineers. I had thought that when you did PDI, the idea was to expand that somehow within that current framework and not find somebody else like the benchmark did so clearly I was wrong and I guess I'm missing something there.

Great question and I confuse a lot of people, including my wife. But the PDI thing, let me -- what we did is PDI is the platform for our professional lines. What benchmark is essentially is a group of talented underwriters. That's all it is. We didn't buy it for its infrastructure. We didn't buy it -- so what we have done is we have built PDI and the LPL business, used that infrastructure and then we are going to tag on architects, engineers, accountants where you'll see us do that. You'll see us do miscellaneous and sometimes that takes the form of just hiring a team of four people.

In this particular case there was an MGU that had six very talented underwriters that came together that we chose to do it and get a little bit of business to leverage the infrastructure we invested in. But it's not like we had to reinvent the wheel on our IT or our infrastructure or rating engines, et cetera. Now, obviously, you have to extend those rating engines every time you go to a CPA or you get a little bit of difference but you're absolutely right we didn't necessarily have to buy a company quote/unquote to get into architects and engineers so every time we make a choice.

Now, for instance, I didn't talk about when we got into the private company VNO that we bought a company but we bought a team. We brought in in that case six people and we tagged that onto some other infrastructure we bought. Now, it could have just as easily bought a group of six that called themselves something, so because as you know, most of the acquisitions we are talking about are teeny from a premium point of view. These aren't big, but they are fill-ins to our strategy around some of these areas of expertise but you're absolutely right. As you look out, I talked about how I want to expand transportation. We have already limos and we have moving and storage and we have some expertise. If I thought that we could get a Company that brought great claims expertise and infrastructure that supplemented that, I would buy the Company. But I don't have to. We could -- there's a couple of categories especially that we are after right now and we are interviewing individuals et cetera so I could either extend it with just hiring a team or we could buy somebody but it's an individual economic assessment and it's not like we have to buy companies to do it. We have got most of our framework in place. You'll see the same thing in E&S. We have been building out our capabilities in some of these lines to round out our excess and surplus capability.

If we thought that it was more efficient to do a team or an opportunity presented ourselves to us that came with good premium with our kind of agents which is always the trick, we might think about it. But I don't -- we don't need to do that. We can go out and get expertise to leverage with our partner agents because if you think about it the core of our strategy is the -- is really our partner agents and providing with them the kind of specialties that they have that are connected, that we can extend from our capabilities today. But so some could be fill-in, some could be just teams but it's a great question because it is -- I look at it as you know, I have talked to 50 various companies probably in the last six quarters because there are so many people out there for sale. We often don't believe we need to do it or it doesn't make any sense but we are always looking for an opportunity to look at adjacent specialties that our partners are asking for us to have the capabilities to provide and we can either go at it organically or inorganically and that's why we are excited about where we are. We have good momentum, people clearly think about us in this way now so not only do companies come to us but agents come to us with ideas so I feel very, very good about that but I apologize for the confusion because it isn't -- it isn't one or the other. It's trying to do it in the most efficient way in front of us, but as I've always said, I don't need to do a lot of acquisitions and I don't need to do big ones. We believe we are in a place now that we can continue to gain share with the shelf space the best agents in this country because of the breadth of capabilities that we have built.

And I mean that's helpful. Certainly confusing just on my part, but as you expand Rolandon into the specialty industrial these guys that used to be property only does that mean you're hiring casualty underwriters?

Let's go there. So what's great about Hanover industrial is that that was coatings, right, but within their business they ran cosmetics, they did a little bit else but they had limited capacity. We have spent the last 18 to 24 months building that capacity and that expertise that extends from coatings so that we can do all kinds of plastics, et cetera. It's still at its heart small HPR industrial risk that we are good at and it's property, stuff that blows up. Now, the casualty side of that, we actually broker out. We don't do it ourselves. And we have built a value proposition to our agents where we have bundled them both but we actually are brokering out the liability portion for the most part so we have built a brokerage capability within it and we are now providing the full solution for those small accounts, so all of the sudden we have a broader portfolio and a more complete portfolio but it was based on the expertise that we acquired and then we have extended that through a few hires. Rita I don't know if there's any--?

The only thing I would add to sum it up when you think about Verlan, PDI, now engineers and architects it's all very consistent with our total account strategy to give our partner agents one stop shopping to write their best middle market accounts and it works quite well for the partner agents to be able to have one place to go for those kind of capabilities and very consistent from what we have been saying from the very beginning.

In that particular case, I want to -- sometimes we don't like high severity lines, we like small face value, more consistency because I want people to see that we are building an earnings power that's very consistent. So we often outsource quote/unquote if you will and in that particular case we don't want to take on that kind of severity that the casualty line tied to those lines present. There are much better people than us that specialize in that business and I would rather access them but what we do is we assemble. We assemble a small account in an efficient way and deliver it to these top thousand agents in this country and it gives them the ability to maximize their earnings and retention while we don't take on volatility we are not comfortable with.

So again, it's what we have been talking about all along is really starting to come together for us. You're starting to see us as a pretty nice alternatives to some of these national companies so we were at our partners club this week and a lot of the agents are talking about it with a national company with a regional approach the broad capabilities but know them well and think of them as a partner and so it's starting to come together, starting to come together.

Thanks to all of you. I appreciate the time.

Thank you.

Thanks. This concludes our question-and-answer session. I would like to turn the conference back over to Bob Myron for any closing remarks.

Thanks very much to everyone for participating. We will talk to you in a quarter's time.

The Hanover insurance group first quarter 2010's conference call has now concluded. Thank you for attending today's presentation. You may now disconnect.