旅行家集團 (TRV) 2002 Q4 法說會逐字稿

Good day and welcome to the St. Paul Companies quarter results conference call.

This call is being recorded.

At this time, I would like to turn the conference over to Miss Laura Gagnon, Vice President of Financial Investor Relations.

Please go ahead.

Good morning, everyone, and thank you for joining us for the St. Paul Companies fourth quarter 2002 conference call.

With me on the call today are Jay Fishman, Chairman and CEO, Tom Bradley, Executive Vice President and CFO, Timothy Yessman President of Claims, and other members of the executive management team.

On the call, we will address fourth quarter and full year 2002 results, as well as review supplemental data on our asbestos reserves.

Copies of the supplemental assessment presentation, the statistical supplemnt and the press release are available on the investor pages of our website.

This call is being recorded and will be made available on our website for one week.

Because this information is time sensitive, any broadcast of this call by any third party may not take place after that date.

I'd also like to remind you that any comments made regarding future expectations, trends and market conditions, including pricing and loss cost trends as well as other topics may be considered forward-looking under the Private Securities Litigation Reform Act of 1995.

These forward-looking statements may involve risks and uncertainties that could cause actual results to differ from our current expectations.

These factors are described under the forward-looking statements disclosure section in the company's most recent report on form 10-Q with the SEC and also available on our website.

With that, I would like it turn the call over to Jay.

Laura, thank you.

Good morning, everyone.

Thanks for opening up with a busy week by sharing some time with us.

I learned a couple of weeks ago that the expression "frozen tundra", is actually redundant.

The phrase "tundra" implies frozen, and as we sit here overlooking a frozen Mississippi river, I actually didn't think that the Mississippi could freeze, but as I walked out this morning and was greeted with a blast of minus 3 degree air, I will tell you this is a frozen tundra.

The reduncy works just fine, thank you.

We're assembled here, I've got basically the entire senior management team, so if there are any questions that come up during the call, there are people here with the expertise to answer them.

Also, we would like to give a bit of a warning for those of you who have the time to spend with us, I think it will be worth your time to stay with us.

We're going to go through our normal process of going through the results.

Bob Lamendola is going to speak with some specificity of what is going on in the Surety and Construction business.

And for those of you who have picked up off our website our asbestos analysis, I think we responded to the challenge of a new level of disclosure in the asbestos arena, and we have presented our data in a form that, for some of you, I think will look similar to the way the Travelers presented it.

That really is accidental.

I think we all look at our data in very much different ways but I think the presentation here will be easy to absorb and understand.

Lastly, I'm going to give some specifc insight and make some observations about our medical malpractice reserves and what is happening there and what our expectations are, so, with that, let me offer some general comments.

Tom will then take over to do some of the specific financials and then we'll go through the agenda as I just described.

This past year has presented a fair number of challenges for us, for the financial industries, in general, not limited to the investment climate or the economic climate, which of course were challenges.

For us specifically, completing our strategic repositioning as well as getting a significant asbestos loss behind us.

Always, we have been focused on doing our best to address issues as rapidly as we identify them and to put them behind us.

We closed the year in real solid shape.

We're a more focused company, we've significantly refined our insurance product mix, we've redefined our geographic appetite outside the United States and narrowed it significantly.

We strengthened our franchise in the small and middle market commercial insurance arena.

We grew and have improved the positioning of our core specialty businesses and we have increased our capital base at this point to exceed $9 billion.

We've repositioned from being an owner and operator of a sizable division reinsurance business to be become an investor in an exciting new platform with our formation of Platinum underwriters and our ownership, equity ownership of that entity.

We've made progress in administering the runoff of our health care, UK and Lloyd's business units that already runoff.

We addressed an extraordinary piece of litigation earlier in the year involving Western Asbestos, uncovered through an extensive review of our asbestos claims and that review will be the subject of the analysis we'll present later in the call.

I can report to you affirmatively that we are very comfortable with our current asbestos reserve position.

We exceeded our target of taking $125 million out of our expense-base run rate, that's in corporate expenses and in the insurance business, and we will continue to strive towards keeping execution and efficiency an operational necessity.

There is little more important than being a low-cost producer.

It provides us an opportunity to price product competitively in the marketplace and to invest in strategic endeavors that are important to the future of our business.

We remain absolutely focused on discipline underwriting results from operations, and we seek predictable and consistent operating income from our investments.

To that end, we significantly repositioned our investment portfolio this past year.

We have moved from equity and equity-linked securities into fixed income, and within the fixed income portfolio, we demonstrated superior credit quality performance over the year.

In fact, improved that credit quality dimension over the past 12 months and have moved to shorten the duration.

We'll talk more about that later.

At Nuveen Investments, actually can't say enough positive things about the job that Tim [INAUDIBLE]and John [INAUDIBLE] are doing, to stweard our assett managment business through a pretty tough securities market.

They've continued to demonstrate superior retail fixed income product service platform and Nuveen's diversification strategy leaves them in a good position to capture the benefits of a more balanced product line.

It's exciting that Nuveen's is currently managing an investment asset base of approximately $80 billion.

That's separate from the $23 billion in invested insurance assets and once again realized a more than 20% return on equity for the quarter and for the year.

Before just turning to the current quarter, one last comment on people and process.

This past year has been an awfully challenging but energizing one for all of us at St. Paul.

As we went through all the things we went through as I described a moment ago, we clearly challenged our people.

We have been very well served by the arrival of Timothy Yessman to head our cliams operation and Bill Hetman to head our investment business.

And Andy Ducett to oversee our administration functions.

With the rest of my senior partners stepping up to the challenge, we've worked hard to create a sense of urgency to compliment the higher energy level.

While some of us have been occupied this year with what we would now like to charaterize as legacy issues, a significant amount of energy has been directed toward establishing a newly-energized and stronger St. Paul, most importantly delivering to our distribution channels.

Turning to the earnings press release, the December quarter showed operating earnings of $194 million or 81 cents per share, generally in line with consensus estimates.

The results show continued positive momentum in commercial and specialty lines and international and Lloyd's, and reflects our emphasis on disciplined underwriting.

Pricing increase were strong across the board for our businesses, 27% for the year and 25% for the quarter and pricing remains solid.

The operational progress and results were impacted by both a change in the estimate of our expected recoveries from our Reinsurers on the Western asbestos MacArthur litigation settlement, and what we've judged to be a prudent reserve increase in our Surety and Construction segment.

Again, more later.

Our runoff businesses, health care, international and Lloyds and Reinsurance continue on track.

We're comfortable with our Lloyd's and Reinsurance reserves.

We continue to be watchful on the medical malpractice line and it's paid losses as we continue to work through the claims.

And we'll talk about that medical malpractice situation more specifically later.

The reported expense ratio was skewed by, what, believe it or not, are negative written premiums related to the Platinum transaction as we see the business.

Excluding that segment, the expense ratio was 29.8, and an awfully good 27.8 for ongoing segments.

We feel real good about where we are and we feel very encouraged about our prospects in 2003.

Let me turn it over to Tom to go through some more of the financials and we'll keep going.

Thank you, Jay.

We're very pleased to report operating earnings per share of 81 cents on $194 million of income, and net income of $1.02 on net income of $244 million.

First the components of the realized gain line this quarter.

We previously announced the closing of the Platinum transaction.

We recorded a $54 million after-tax on loss of Platinum.

This is comprised of a pretax gain of $29 million on the sale offset by a chargeoff of the $73 million deferred tax asset associated with the business of the old St. Paul Re U.K.

Obviously since we're no longer in the Reinsurance business in the UK, we can't support a gap deferred tax asset on the books.

It's important to realize however that we retained the tax attribute of these fees and NOLs and to the extent we can derive savings in the runoff of that book that will be basically tax free up to the first $73 million.

We continue to work that.

We recorded a significant realized gain out of our St. Paul international holdings operation of $131 million, all in tax benefits.

We derived this out of a combination our decision to exit much of the international business, along with a change in the UK tax laws as it relates to second tier holding companies.

This provided us the opportunity to unlock this $130 million tax benefit that was previously trapped within the UK holding company.

We have now had the opportunity to take that benefit on the U.S. tax return and record the associated benefit in our results here.

Finally, we've got after-tax, other after-tax investment losses of $21.5 million.

This includes $57.5 million of after-tax other than temporary impairments to the venture capital and fixed income portfolios, partially offset by realized capital gains on asset sales.

Moving to our components of our operating income, first a little bit of background.

We have added, you will note, a new reporting segment shown here in the press release and will be in our public disclosures.

That's called other.

It's made up of the runoff businesses, the size, reinsurance and health care which are seperatley disclosed.

It's the runoff components of Lloyds, of International and other Union America and other older runoff operations.

We now have the four operating segments for the ongoing businesses and the three operating segments for the exited businesses.

I believe it's fairly clear to see the different operating characteristics.

We also this quarter have the realignment of the results of our aggregate, our previous aggregate excess treaties, we call them 1999 and 2000, we had corporate aggregate stoploss treaties.

Each year, and those treaties are capped out, but each year as the relative performance of all of our businesses in the '99 and 2000 accident year changes.

As that mix changes, we're required to reallocate premiums of losses amongst the segments and report those.

It adds to a bit of noise to what we're seeing in the quarter, but we try to give all the detail necessary so you can see the actual reported amounts and also the apples and apples comparisons by giving the [INAUDIBLE] reallocation.

Last year and this year to see the valid comparison.

Operating earnings were obviously driven by continued strong performance in most of our ongoing businesses.

Commercial lines, especially commercial and International Lloyds all delivered significant underwriting profits.

Average rate increases over the course of the quarter was 25% on top of 27% average for the entire year.

A big part of the success in the quarter and the year is the improvement in results from the successful execution of our repositioning strategy, particularly the exited businesses, 2002 net premium in the runoff segments are down 60% to $1.3 billion.

Excluding the impact of this aggregate reallocation, the fourth quarter health care premiums are down 84% and this new other component representing International Lloyd's and Union America are down 95%.

Driven by the exit of these businesses, a focus on profitability over market share, underwriting losses for the year, excluding both [INAUDIBLE] and Western MacArthur, improved by over $1.1 billion.

The two significant components otherwise in the operating earnings this quarter, Jay briefly mentioned, is the reserve action in the Surety Construction segment and the adjustment of our Western MacArthur loss.

In the Surety and Construction segment we increased loss reserves on the 2001 and prior years by $175 million.

This was driven by the impact of the current economic environment on the Surety market and the impact of 100% claim review on sectors of the Construction business that we began to exit in 2000.

Later in this call, Bob Lamendola will provide further insight into the segment and will discuss the reserves a little further.

Additionally, regarding Western MacArthur, the fourth quarter includes $115 million benefit from a reduction of our estimate in the net loss associated with the Western MacArthur settlement.

The second quarter, we announced a pretax loss of $585 million, which included an estimated net reinsurance recoverable of $250 million.

This estimate included a provision for uncollectible reinsurance.

In the fourth quarter, following a detailed analysis of the several thousand underlying claims in the settlement, the relevant reinsurance contracts and the recoverability of the related reinsurance, we adjusted our total recoverable, net recoverable up from the $250 million to the $370 million total recoverable, bringing the pretax net loss on the settlement to $472 million.

A quick run through some of the other specific segments, especially commercial, again, reported solid results with adjusted combined ratios of 82.3% in the quarter and 87.9% for the year, reflecting conrinued underwriting discipline and significant price increases.

Can I interrupt for a second?

When we use the phrase "adjusted year" what we mean is adjusted for the reclassification of the aggregate excess treaty.

In fact, on the very first page of the press release where we talk about adjusted net written premium and adjusted net earned, the only adjustments that we're making there is for the allocation of the ag excess.

We're trying to do here is to demonstrate what amounts to the real economic numbers that are not otherwise masked by some of these reallocations.

So when Tom speaks about adjusted, we're really reflecting here the true underlying economic dynamic that is occurring within the business exclusive of some accounting noise.

Absolutely, and all of those numbers are shown in the release.

As I was mentioning, especially commercial, indicated price increases of 29 points for the quarter and 27 for the full year.

Commercial lines again had a good quarter, the adjusted results excluding the Western MacArthur adjustment that I mentioned was 88.5 for the quarter and 90.8 for the full year.

In the exited -- I'm sorry, in the international business, we continue to report record earnings in addition to selling or putting into runoff the operations in eight countries.

The ongoing the international operations of the UK, Ireland and Canada, continued to report record levels of profitability and achieved over 40% average rate increases.

The remaining businesses and Lloyds that are ongoing are short tailed, highly-profitable businesses that are reporting underwriting profits in '02 and are expected to continue.

In the exited health care segment, 99% of nonrenewal notices have been sent and executed.

Of the 82 large hospitals offered reported endorsements this year, only 12 accepted and there is only four more left to offer during 2003.

With respect to the premium in this business for '03 would fall to about $25 or $30 million.

Finally in the Reinsurance segment, will change obviously dramatically going forward with the execution of the Platinum deal.

For this quarter, the full results of the operations for the month of October are included this in this business from October -- from November 1 forward they're part of Platinum.

You will also see a significant negative premium for the quarter, that represents the seated premium that we sent to Platinum to effect the book transfer of both the premium reserves and the loss reserves for '02 business to begin that operation.

Going forward, this segment will just have the results of the runoff of the losses and the associated expenses of the business that stayed on our books.

Our recording of our equity pickup on the earnings of Platinum will run through the investment income line.

Underwriting cash flow for the quarter was a negative $507 million.

This includes negative cash flow of $257 million for health care, outflows of $125 million for Reinsurance, and an outflow of $94 million for World Trade Center payments.

Excluding these items, the cash flow for the ongoing business was a negative $34 million.

Jay mentioned the success in achieving our expense goals.

This is driven primarily by reducing head counts by 1500 positions over the course of the year.

Over a thousand of those reductions in the exited businesses reduced another 350 positions in corporate staff areas and a little bit over a hundred in the claim area.

We supplemented that by adding over 300 positions in the ongoing businesses, so we funded the growth and support of those businesses through the excess takeouts that we were able to achieve during 2002.

Last operating item, fourth quarter catastrophe activity was again fairly light, totaled $11.5 million in pretax cap losses, versus $131 million in the same quarter last year.

For the full year, caps were $66.8 million pretax.

Switching to the balance sheet.

You'll note year-to-year Reinsurance recoverables were up about a billiondollars.

A good portion of this increase relates to the Platinum transaction I just mentioned where we seeded over $400 million in reserves and maintained a 100% core to share agreement on those reserves as they run off.

You bet that will continue in our recoverable until they runoff in Platinum.

The reminder is due to the $370 million recoverable on the Western MacArthur matter.

The year end shareholders equity of $5.7 billion increased 12.5% over the prior year.

This increased capital base, along with premium reductions in the exited businesses reduced the statutory premium to surplus ratio to 1.3-1 in '02, versus 1.6-1 in '01.

Total invested assets increased 4.2% to $22.4 billion in '02, while the mix of equities and venture capital investments reduced from 9.1% at the end of '01 to 4.2% at the end of '02.

The average rating of our fixed income portfolio remained at double-A plus while we shortened the duration of the fixed income portfolio from 4.1 years at the end of '01, to 3.4 years at the end of '02.

Finally in December, we completed the purchase of the renewal rights to the U.S. professional liability and DNO business of Worlds [INAUDIBLE] Alliance U.S.

This business trades under the name of Profin.

The profile of this business is very similar and complementary to our own, in that it targets small and midsize commercial and nonprofit businesses.

This is a pure renewal rights deal.

We're not assuming any premium or any prior reserves.

We completed this deal in December in time to impact the January renewals.

Of the $125 million available from this book, we expect to renew between a half and 2/3 preprice increase on to St. Paul paper over the course of the year.

As part of the deal, we also had the opportunity to hire a number of talented claim and underwriting people from the Profin team.

Thank you.

Just actually one other bit of understanding of the numbers, and only because I asked the question, so I figure maybe some of you will as well.

We spoke about a change in the estimated Reinsurance recoverable of $120 million, and yet we show that the benefit is only $115 million.

The difference of the $5 million is simply an estimate, an increase of the estimate of the expenses, legal and other that are associated with the Western MacArthur transactions.

So it's a positive 120 in Reinsurance and the negative 5 in the expense load.

I want to turn attention to the Construction and Surety segments.

Obviously a $175 million reserve increase and what is going on there.

We do have, as a matter of our philosophy a strategy of maintaining a strong balance sheet, and we just perceive that to mean anticipating problems as early as possible, dealing with them and moving behind us.

The only way to deal with an issue is indeed to get it behind you.

With respect to Surety, it's clearly a loss problem being driven by the overall economic environment.

I don't think that anyone would have anticipated in 1999 and 2000 the speed and the depth to which with the economic environment would deteriorate.

The Surety business has cyclical characteristics to it, and we believe what we're seeing now is simply the other side of the cycle.

It's not a long tail business, but I think it's fairly described as an intermediate tail business, and you write these bonds in periods of economic certainty, and you make a projection of what the environment will be when losses emerge and it's here that the depth of the change has been relatively dramatic.

What we've done is considerably bulk up the 2001 in prior years in the Surety arena to reflect the more challenged economic environment.

We actually did that already in our 2002 loss pick, so those who would ask the question about how does the 2002 year look, we feel pretty good about it, and we have in our plans and budget continued to assume a very difficult economic environment for '03 in the Surety arena.

Bob will speak more specifically to that.

In the Construction arena, Bob Lamendola took over the business, really in the late part of '99, early part of 2000, and it really effected a repositioning of the business that he inherited.

There were at that time approximately 4,000 accounts.

They were fairly widespread all the way from small up to large construction accounts, with much of it being first dollar ground up guaranteed cost business.

Bob correctly made a decision back then that the construction business requires significant loss control, it requires a real investment on behalf of the principle to mitigate and be engaged in losses, and frankly, it helps to have skin in the game.

So Bob made a decision to go out of the small end of the contractor business because the loss-control efforts were simply not adequate and the expenses involved in the business were too high, and to move increasingly away from guaranteed cost and to loss responsive and loss-sensitive programs.

In the course of doing that, the number of accounts has fallen from 4,000 down to about 1700.

So it's a meaningful change.

What we began to see was an experience in the loss rate that was higher, and as we dug into it, and Bob will explain the depth in which the work was done, we discovered that much of this loss trend was related to this block of business from which a strategic decision was made to move away from.

This loss adjustment brings that book of business in proper line with what we think the loss pattern will eventually emerge.

Let me turn it over to Bob to talk more specifically about.

Thanks, Jay.

Let me start with Surety.

Since the start of 2000, we have exited approximately 15% of our contractor Surety business.

With the downturn in the economy, we have continued to tighten our underwriting controls.

In January of this year, we closed 11 offices and consolidated businesses, a business in 9 others.

We also centralized credit authority for all but the very smallest accounts, and we will continue the underwriting review of all of our contractor accounts.

Also in 2002, we saw the first significant price increases in the Surety businesses in years.

We believe this will continue in 2003 as the industry continues to consolidate.

While we took steps to curtail our commercial Surety following 2000, we have gone even further in 2002.

We significantly reduced our commercial Surety exposure on the larger and more complex business by about half actually.

And finally for contract Surety in 2003, we successfully put in place a meaningful excess of loss reinsurance program, which gives us better coverage than 2002, but for about the same price.

Moving on to Construction.

As Jay mentioned, we really repositioned this business over the last two years.

Our strategy was and is to move away from the smaller ground up business and to focus on larger contractors.

Contractors with higher deductibles or loss sensitive and funded programs.

As Jay mentioned, these customers lend themselves to our loss control engineering and they have skin in the game.

Neither of these situations exist in the smaller accounts for us.

Since 2000, we have more than tripled our average account size, and that's even factoring out rates, which I will mention in a few moments.

Another positive effective of our strategy is that we have a more managable business.

We reduced the numbers of accounts as Jay mentioned from around 4,000 to less than 1800, again much more manageable.

In '02, we completed the most thorough claims review done in our business.

As Jay said, 100% of our general liability and worker's compensation claim files were reviewed and adjusted as necessary.

Based on that review, our actuaries believe they have a much more accurate view of our business reserves.

In 2002, our average price increase for construction was 30%.

That followed two years of double-digit price increases and we expect double-digit incomes in 2003 and '04 for this business.

Now, Tom, did you want to get into the discussion of reserves?

Yeah, just a couple of things to add.

As Jay and Bob mentioned, most of this increase is driven by trends in businesses that we've been exiting.

And this 100% claim review on particularly in the G.O. sectors of exiting businesses.

In addition to those specific case increases, the company increased IDR reserves to recognize these same trends to the unreported claims, which is about a third of the total $175 million increases.

These increases bring our 2000 active year reserves up almost 28% and the 2000 active year loss ratio up over 10 points to 95.4.

It increases the 2001 reserves by almost 17% and increases the accident year loss ratio in 2001 over 7 points to 76.

These are big increases, which we believe will put us on solid ground for this segment.

You may be wondering about 2002, I think Jay's mentioned we feel very good about the recent business.

A combination of the underwriting actions that Bob mentioned, along with particularly in the construction business, obtaining 30 points of written price increases over the year, which in '02 is 23%, 23 points of earned price effect.

Finally, I would like to talk a little bit about the accounting characteristics on the Surety business and reserves.

Recall last quarter and in our third quarter 10-Q, we talked about the impact of a higher frequency of the lower severity Surety losses emerging during '02.

As a result of that, we substantially increased our loss estimate for 2002 and Surety and a similar type of that moving in '03.

It's actually the, you know, the largest annual estimate we've had in some time, and we feel comfortable about that.

There is also a characteristic in Surety as we begin to discuss in the third quarter 10-Q, that certain of the larger losses have not occured and are not recorded or booked until a valid claim is asserted.

So, you know is some go-forward exposure to these claims that emerge, there is nothing that is or can be reserved at this point, but we fell very comfortable with the reserve on the routine part of the losses that emerge out of this.

Tim.

Great, just a couple of concluding remarks about '02 and '03.

First, one clarification.

The reallocation of the aggregate access treaty has zero impact on consolidated net income or consolidated operating income.

It's simply a reclassification of premiums and losses from one segment to another as those losses emerge, so the consolidated numbers are good as described.

As we look forward to '03, we believe that we will meet and indeed exceed our 15% operating return on equity target in 2003.

We expect robust rate gains to continue in our core business with the exception of Surety and Construction.

We'll get rate gains but we would anticipate there a breakeven from an underwriting profit standpoint.

We see invested assets being flat with investment income perhaps down slightly.

And lastly we expect the estimate that we have given on the runoff losses of 120 to $125 million very much still our best estimate.

What I would like to do now is to turn our attention to the asbestos summary that has been out on the web.

Timothy Yessman who has claims is here to go through it with you.

I think it's important.

We are aware of the fact that another company has a call at 10:00.

We're going to do our best, 10:00 eastern time.

We're going to do our best to move through this, but this is important, and for those of you who follow us, we would appreciate your continued attention.

With that, let me turn it over to Tim.

Thanks, Jay, very much.

If you've been working for the presentation that does appear on the list, so it's -- [INAUDIBLE] You have it in front of you, I would reference the pages as we go through it.

The hardest of this presentation is to, once again, present our conclusions regarding St. Paul's thorough review of its asbestos exposures and related reserves.

On page three of the presentation, as set forth in the agenda are the items we wish to cover.

Some important major conclusions regarding our review.

We have determined that our $326 million net asbestos reserve represents our best estimate of our ultimate liability.

Our company's asbestos exposure is consistent with its historical underwriting profile of small and regional companies.

Fortunately because of this underwriting profile, we have limited involvement with major defendants.

Wellington participants signatories to the Wellington agreement and our remaining net exposure is modest.

Likewise, we have limited involvement with major bankruptcies and we have a very small number of cases in litigation. 94% of U.S. direct case reserves pertain to mature, long-standing policyholders for which we have had claims for sometime.

We have also looked at recent tenders, policyholders that have submitted their first asbestos claim to us within the last three years and have concluded that they, too, involve smaller regional companies with an insignificant asbestos exposure to date.

To understand St. Paul's asbestos exposure, it's important as I set forth on page five of the presentation to view the company from a historical perspective.

Excluding Western MacArthur, which was settled in the beginning of '02, St. Paul has paid in its entire history $331 million in U.S. direct asbestos losses.

St. Paul limited its exposure, as I mentioned, is attributable to underwriting concentration in small and regional companies.

As I have been reminded by Marine Reserve of Commercial Lines, this company has never had a unit in underwriting devoted to national accounts.

One difficulty that I have always had in describing St. Paul's exposure is often difficult for me to explain what we don't have.

And a number of you have written very good reports pertaining to what is going on in asbestos, and I'm very grateful that I learn from them as well in terms of current developments.

And one analyst of Prudential was kind enough to permit me to reference her report written in October of '02.

And it's helpful because she referenced in there 33 major bankruptcies that have occurred in the conflict of asbestos and clearly embedded in that discussion wasa reference to what's referred to as the "Dirty Dozen", the top 12 major pending bankruptcies.

And that's important because from our standpoint of the 33 major bankruptcies referenced in her report of October of '02, we have only one unresolved account, an excess policyholder for us with a net exposure of $100,000.

Likewise, in her report she referenced 96 major national defendants, defendants that are in litigation across the company.

We have active claims on only six of them and four are high-level excess with a net potential exposure to us of only $10.5 million.

Of the six, we only have two active primary policyholders and they represent a product only exposure with remaining limits of $18.6 million.

Similarly, we have only insured nine of the 36 Wellington policy shareholders.

These are policyholders that along with insurers in 1985 entered into agreement covered in disputes between them [INAUDIBLE] by the agreements.

Of the nine, the two that are unresolved are excess policyholders with a net exposure to us of $3.1 million.

With this historical experience in context, we should talk about, as I do on page six and set forth what we reviewed.

We reviewed from a ground-up analysis all active policyholders with a loss reserve on all their claims in total of $100,000 or more.

We looked at all active policyholders that have paid losses greater than $100,000.

We have looked at all active policyholders with five years or more of primary coverage.

As I mentioned, we looked obviously into all Wellington agreement exposures.

All active policyholders with settlement agreements, all pending asbestos coverage litigations, also policyholders engaged in bankruptcy, either because of asbestos or for other reasons.

We looked at a significant portion of our policyholders that have reported their first asbestos claim to us in the last three years.

We looked at all active policyholders with a potential nonproduct exposure as well as having more than 50 pending asbestos claims.

In review and in quick summary, the analysis for each policyholder looked at the available insurance coverage, the underlying coverage available to the policyholder, the policyholder's potential liability, historical and projected claim activity, the jurisdiction or the jurisdictions that they're involved with, the claim severities they face and have faced, the historical and anticipated settlement values, our applicable covered defenses to their claims as well as their historical reinsurance recoveries.

All of these were reviewed to evaluate our asbestos exposure and their related reserves.

Before we begin a more detailed discussion of the categories of our policyholders, please turn to page seven for an overview of our reserves.

This line on page seven provides a high-level review of St. Paul asbestos reserves.

At the end of 2002, St. Paul's total reserves for asbestos, excluding Western MacArthur's and $8 million for worker's compensation is $326 million.

Importantly, 53% of the reserve is for incurred but not reported claims.

The ending case reserve is predominantly U.S. written policyholders and approximately $100 million.

You will note, too, please, excluding Western MacArthur, St. Paul has only paid in 2002 $48 million in asbestos-related losses.

And that it's up from $14 million more than '02, and the reason I reference 14 versus the 48 to the 36, was that there was $2 million in Reinsurance losses, I'm sorry, in worker's compensation losses that were paid in 2001.

Frankly the growth is not there.

On page eight, as I said earlier, we provide a snapshot of our asbestos pay and reserve summary by category.

As I have said, the total reserves at year end 2002 are $326 million, which is referenced at the bottom of the page.

Of that total, $100 million in reserves belongs to the 681 policyholders, which were active in 2002, active meaning that they have open asbestos claims.

And that basically that 681 policyholders were subject to evaluation.

We'll certainly provide more details of 681 in a couple of minutes, but this page is intended to provide a snapshot look of these accounts by category.

Note we have only four active Wellington policyholders.

For eight policyholders, our obligations are fully resolved under settlement agreements.

Three of these settlement agreements require guaranteed payments.

Five other required payments based upon the claim experience, and we have a reserve established of $9.2 million based on our assessment of that risk.

We have 669 other active policyholders in 2002.

Ten of them were closed during the year with modest payments of less than a $1 million in total for all of these policyholders.

We have 49 policyholders as listed in which the total loss payments from the entire time that we have had the policyholders and active account over the years is at or in excess of $100,000.

However, I should reference that only twelve of those have payments to date, historical to date, which are in excess of a $1 million.

For 610 policyholders, a substantial portion of our inventory cumulative loss payments for the entire time that we have them is less than $100,000.

On page nine, we provide some greater detail pertaining to settlement agreements and our exposure to Wellington.

First, let me discuss our Wellington accounts.

It is very important to note that St. Paul has never been a signatory to the Wellington agreements.

But a comparison of our accounts with the list of Wellington participants is the usual backdrop to compare and evaluate the St. Paul asbestos book.

Once again, the company only insured nine Wellington participants, four have exclusions and of course because of them, we have no claim activity.

Three are settled, two of which have remaining payments which are fully reserved, totalling $8.1 million.

We have only two unresolved policyholders involved with Wellington and our net liability on them is only $3.1 million.

Other than what I have referenced, we have no further exposure as it pertains to Wellington, we have no litigation or arbitration pending with these unresolved policyholders, we have no bankruptcy-related proceedings pending with them.

In the context of settlements, St. Paul also doesn't have a significant exposure arising from the settlement agreements.

As you can see, we have three settlement agreements that obligate us to make guaranteed payments.

Under these agreements, all of the company's coverage obligations are fully resolved and released.

And we have reserved the obligation on those agreements at $10.7 million.

We also have a category of settlements that require our payment based upon claim experience.

Five accounts fall into that category.

These settlement agreements cap our obligations completely, whether we make the payment depends upon the number and severity of claims that get filed against them in the future.

As you can see from the prior page, our cumulative loss paid is approximately $2.7 million of those policyholders.

We have established reserves of $9.2 million consistent with our anticipated projected new claim activity for them.

The important observation is that regardless of the future of these policyholders and their asbestos exposure, our payment obligations to them are capped at just $21 million.

On page 10, we provide an overview of over, of other active policyholders, non-Wellington, nonsettlement policyholders.

As you will note, 49 of them have cumulative loss payments at or greater than a hundred.

Please remember that only 12 of them are greater than a $1 million, 610 of them are below $100,000 in cumulative loss payments and, once again, we're showing that 10 of them were closed in 2002 making the total for the numbers 669.

St. Paul has of 541 -- I'm sorry, 541 of the 610 active policyholders have had no loss payments in 2002.

Of these 541 active policyholders, 513 of them have had no loss payments in the last three years. 358 of the 610 have had no loss or loss expense payments in 2002.

Of these 358 active policyholders, 325 have had no loss or loss expense payments in the last two years.

Of these three 58 active policyholders, 325 of them have had no loss or loss expense payments in the last three years.

We also, as I mentioned in the beginning of the presentation, looked at policyholders tendering their first asbestos claim in the last three years.

And there is a discussion about that in the context of policy, they're doing so in the analyst report that I referenced at the beginning of the presentation.

I should add that St. Paul has had 453 policyholders who have tendered their first asbestos claim to us in the last three years.

Of those, we have been able to close 37 of them, mostly without any payments at all.

The new accounts are small, and we have not paid more than $100,000 on any one of them.

Total cumulative payments have been small as well, with $1.8 million in 2002, and $2.6 million inception to date.

These payments are falling predominantly towards litigation costs due to our active management of the policyholder claims.

I should add 207 of the 287 open policyholders we have not made any payments in 2002.

Interestingly, 47 of our active policyholders, 47% of our entire active policyholder base were opened in the last three years.

And I did note with some interest this morning, the article in the Wall Street Journal pertaining to premises exposure and, frankly, I didn't find anything new in the article because the issue pertaining to premises exposure in the context of major petrochemical companies has been an issue that's been around since the late '80s and the early '90s.

And clearly in the context of small and regional companies, the nature and description they provided to the Wall Street Journal is similar in the context of the nature of what we're seeing in the last three years.

Small companies with small limits, small years in which we insured them and also, frankly, very few claimants being presented.

And I would add, too, that in the context of premises exposure, especially for small policy holders, it's a very different case than it is in the context of a major petrochemical company, that was aware of the asbestos, aware of the dangers of asbestos as well as product defendants being who are being held to strict liability standards and the context of the legalisms that pertain to a premises case for a small policyholder, the law that governs them is similar to the law that would govern a slip and fall in the context of negligece and what they were aware of in the nature of their duty.

In the context of the article it was informative but from my standpoint, nothing new in the context of asbestos.

In the context of covered litigation and bankruptcy.

I have had the privilege to talk to many of you in the context of these calls as well as, and other places regarding covered litigation and bankruptcies and to the best of my knowledge I believe we're the only company that discloses the total number of pending covered litigation matters as well as the number of bankruptcies, policyholders that we have in bankruptcy.

And frankly, I do think that it is extraordinarily important that insurers inform what is going on in the context of their litigations and in the context of their bankruptcies and also litigation bankruptcies also provide a highlight of what is the nature of their books, small versus large.

As you will note on the page we uncovered litigations in bankruptcies, we only have 13 pending covered litigation matters.

Five pertain exclusivly to high level excess policies, and I wish to tell you about that, to.

In the context of those five, and this is the only reference I will give in the context of litigations, we're being dragged in as an excess carrier when they're desputing with their primary and underlying umbrella carriers in the nature extent of their obligations.

Many jurisdictions require that all insurers be named in that litigation.

And in the context of providing an overview of the high-level excess policies we have in place here, if we were obligated to pay, which in certain circumstances we don't believe will happen here based upon our layer of coverage.

The worse-case scenario for us in all of these cases is less than $25 million.

We also referenced five policyholders that are in bankruptcy whether for asbestos or other related reasons.

None of them are involved with the major bankruptcy cases that are pending in Delaware or recently signed to Judge [OLLEN] or, in which Governor Cuomo has been asked to mediate.

I have been asked several times to comment about all that is going on before the Judge [OLLEN] and the difficulty I have in responding is that St. Paul doesn't have anything before Judge [OLLEN].

Threefore making difficult consult to apply on the current state of affairs there.

Once again, an indication that our profile from the underwriting standpoint didn't result in that type of exposure.

We have one policyholder characterized as a national defendant, and one often referred to as part of the dirty dozen, our maximum exposure on the policy holder is $100,000 of net.

The main policyholders are reflected under our overall strategy and as you can see one policyholder has settled and we're waiting court approval.

Another one we have prevailed at the trial level and the context of it, the important issue for us, and we anticipate that issue will be affirmed on appeal.

In lateDecember, we were named along with 28 other insurance companies involving -- other insurance companies alleging claims that we should have disclosed information pertape to this harmful effects of asbestos to the general public.

I don't believe that case is meritorious.

We have only recently been served and have not filed a response as floating.

And that basically is an overview of our coverage litigations and bankruptcies in total.

One thing that is very important as often discussed in the asbestos context and a major focus of our analysis regarding the St. Paul asbestos book was the review of potential nonproduct policyholders.

And we reviewed detailed policy information on every potential nonproducts policyholder with 50 or more plaintiffs or claimants.

It's important to note that I reviewed all accounts and met this criteria regardless of whether the issue was raised by the policyholder or not.

I did identify one significant one as part of that review, and I defined significant as someone having a broad exposure of $25 million or more that.

Policy holder is now behind us and fully resolved.

That account stotd out among all the other accounts and as I just said, has been fully resolved.

The remaining policyholders were small, our regional defendants were contemplated by our reserve positions.

On page 14 of the presentation I provided an overview of St. Paul RE international and pools and Scott Anderson of our corporate actuarial is here if there are questions pertaining to it.

And, frankly, in conclusion, once again, our existing asbestos reserves represents our best estimate of ultimate liability, 47% are case reserves, 53% are incurred but not reported reserves, our asbestos exposure is consistent on smaller regional companies.

We we have limited involvement with major defendants and willing participants and we believe our remaining moderate exposure, we have limited exposure as I explained to bankruptcy and asbestos coverage litigation. 94% of our case reserves pertain to mature, long standing asbestos claims that where have been with us for a long time, and the policy of the claims to us in the last three years, are small and regional defends and have to -- [ Indiscernible ] In significant asbestos exposure as evidenced by our activity.

I thank you very much for your attention.

Thanks.

I know this can be mind numbing and it's a tremendous amount of data and no one expects any of you to have internalized and respond back to questions.

So what I'm going to suggest here with Laura is that we actually set up perhaps even a call specifically on this with Tim and allow you all to digest the information to ask questions and probe as you like.

This is really an attempt simply to get the information out there and it forms very much the evidence of our conclusion that our asbestos reserves are fine actually, absolutely fine, and we invite whatever inspection or inquiry that you would like into the topic.

It's as open a book as we know how to do.

You actually now have in front of you essentially a summary of all the data with which we wrestle every single month.

Before we go to questions, I want to spend a few minutes on medical malpractice.

This is important, and I'm asked about it frequently.

Medical malpractice is an interesting runoff block of business.

I described in the third quarter that we were in the fourth inning and it was simply too early to tell and I would tell you now that, and I may be wrong by an inning or so, but it sort of feels like the bottom of the 8th, and we're getting very close now to being able to ascertain whether our reserve position will prove to be adequate or not.

And it is to some extent becoming almost a arathmitic eercise, not subject to the traditional kind of actuary reviews that one's accustomed to, because we're in a runoff mode.

We have expanded the metrics in the decision that we included in our fourth quarter 10-Q and in fact anticipate expanding the disclosure and providing the additional information in our 10-K and our annual report, but there are essentially three significant metrics that become critical in the evaluation of medical malpractice.

The first is, and it's obvious to everyone, the number of new claims that come in.

The second is the extent to which case reserves, and a case reserve is an individual reserve set up for an individual claim.

The extent to which case reserves continue to be reassessed and grow, or do they stop.

And the last one is what we have come to call the redundancy ratio, which is curious when we talked about the second metric.

The redundancy ratio is simply the relationship, the inverse of the relationship of the amount that is paid on an individual case divided by the case reserve.

And, in fact, this company has always historically had a positive redundancy ratio, meaning that it has paid out less to settle a case than it has up in reserves.

And one of the things we anticipated happening when we moved to a runoff environment was an increase in that redundancy ratio as a result of a more aggressive style of claim resolution.

Now, let me back up for a moment and cover each of the three of those and share with you pretty crisply where we are.

First, we carry in our model a fairly robust budget for incoming new claims and at the moment, we see no issue with respect to the pattern or trend that is there.

Secondly, with respect to the development of individual case reserves, when Tim came in, Tim did a couple of things.

First, he changed the focus in the claim department to resolution as opposed to account maintenance.

Essentially there was a real emphasis that was brought to resolving claims, paying them, settling them and getting them behind us.

The way the claim handlers do that is they go through the facts and circumstances of the claims themselves and establish reserves that would be adequate to allow them to settle it.

And the emphasis here was on reviewing the most difficult, the old, the aged cases first, the ones that historically proved to be the most problematic to resolve, and then working our way forward to the more current claims.

In and the in the course of going through that review, what we saw was a fairly substantial increase in individual case reserves.

In fact, at the moment, peaking in the third quarter, and, in fact, the incurred level declined in the fourth quarter fairly significantly.

Now, what we anticipate in the incurs is an important factor, and we'll come back to that in a moment because I want to get to the redundancy ratio.

Probably 2 1/2, maybe 3 years ago, the redundancy ratio in our medical malpractice business was hovering around 20%, meaning that to close cases, we were spending 80 cents for every dollar of case reserve established and as we moved this book to a runoff block of business, that redundancy raesh year -- ratio has improved and improved substantially.

Let me share with you the numbers.

For all of 2001, the redundancy ratio was 28.9.

For all of 2002, the redundancy ratio was 32.4.

For the fourth quarter of 2002, it was 33.5 and for the month of December, it was 38.3.

Now, the interplay of the development in case reserves in the redundancy ratio is critical.

If we get no further adverse development in the individual case reserves, and that is unlikely in my opinion, that we will get no development at all, we would need a 36% redundancy ratio for the book to work out exactly on point.

And, obviously, for the year we're at 32.4, for the forth quarter, 32.5, for December, 38.3, and with no redundancy, with no increase incurred, we need 36.

If the incurred developed negatively by a $100 million from here, and we perceive that to be a substantial number, that would be a significant increase given patterns.

Then the redundancy ratio has to grow to 39% for the book to work out exactly at zero.

So there are a number of moving dynamics here and we're at the point where I feel pretty comfortable saying that we can tolerate at the current level of redundancy, essentially no further adverse development in case reserves.

We actually need to move the ratio up to 36, again, December was 38.3 for this to do work out.

One of the things all the time is if we miss, if we're wrong, how wrong might we be.

We spent time thinking about, that but I don't want to give anyone the impression that we're there for assuming or declaring that we will miss.

Quite the contrary.

The indicators here all continue to move in the right direction.

The question is: will they move in the right direction quickly enough.

But if you ask us how much might we miss, a five point miss on the redundancy ratio to us we think would be a big number.

That would mean going from 36 down to 31, when, in fact, for the year, we were at 32 in the fourth quarter at 33.

So that strikes us as being fairly out on the curve, and a 5 point miss from here on out in the redundancy ratio would convert to a required reserve adjustment of $150 million.

Now, on the other side would be the incurred development.

And as I have said before, if, in fact, we saw $100 million of additional incurred develop given the patterns we have seen over the last several months, that would be a substantial miss to us.

That would be a significant increase.

If we put those two levels together, that is that if we were to see a 31% ultimate redundancy ratio and a $100 million development of incurred, obviously, that would require a $250 million pretax reserve adjustment.

But it would be, as we sat and thought about it, it would be difficult for us to perceive that they would both move against us simultaneously.

They tend to move in lockstep together.

But once again, in the context of sort of being in that 8th inning, and watching the emerging data we thought it was prudent to share it with you.

To let you know that there is certainly no assurance that there won't be a reserve need, that we're watching the data carefully, and as it emerges and causes us, if it ever does, change our management best estimate, we will record it at that time.

But at this point in time, I think we have now shared with you in probably as crystal a way as I know possible, to share with you the data and the way that we look at the medical malpractice business.

The one thing that is interesting, we talked about the savings resulting from runoff.

Clearly watching that redundancy ratio run up in the way that it did is clearly indicitive of the fact that we are delivering those runoff savings.

The question at the end is: will they end up being enough to offset any potential additional development that might occur in the case reserves.

So, I know this has been a long call.

We have had a lot to share with you and we are, of course, opened for questions and further inquire and I am actually making an appearance tomorrow at the Salomon Smith Barney Investor conference and actually have some additional information on a few operational dynamics of our business to share with you then.

But, , with that, we're happy to open it up to questions and try our best to respond to the issues that you have.

Thank you, if you have a question today, please press the star key followed by the digit 1 on your touch tone phone.

Also, if you're using a speaker phone please make sure your mute function is turned off so your signal will reach our question.

Again, that is star 1if you do have a question.

We'll go first to Tom. [ Indiscernible ] Of Goldman Sachs.

Hi, this is Matt for Tom.

I just wanted to know if you could give us an indication of what you were seeing on the rate increase side for January 1.

I know you gave an aggregate number for 4-Q and the year, but any insights there and what lines you're seeing with the most opportunity?

Anything we have now would be anecdotal.

The system closes at the end of the month and that's when it accumulates.

We don't -- I don't have any insights into January yet.

Okay.

We'll go next to Dan Johnson, UBS Global Asset Management.

Thank you, question on the asbestos presentation.

Tim, could you talk a little bit about the folks that have tendered claims in the last three years -- I guess I've got one observation and then a question.

Would it be normal to expect much in the way of payments for really any of these claims during the last three years.

I know travelers looked at this the sale way just given the, , the nature of the court system, , and other aspects of insurance, , would you really expect to have paid out much anyway?

And and then second, the really question is what sort of claims are being made, from those newer policy claims.

Thank you very much.

You're welcome.

Tendering claims for the first time in the last three years.

In many ways there is a great deal of discussion pertained to peripheral defendants that have been dragged into the litigation, that has pending against the big ones, as well as the fact that some of the big ones are in bankruptcy, so they're not available in the context of the lawsuits and so the attorneys have been pursuing and going after other small companies and small regional companies.

Small companies being isolate in the state, regional being more than that.

Yes, in the context of payment of asbestos claims, as you noted we closed 143 of them.

One thing that is important to note is that the absolute asbestos exclusion plays a role with the policy holders and bars coverage for asbestos-related claims on the policyholders big or small, but, a good portion of the large claims were being closed for the purpose.

Secondly, you would anticipate payments because asbestos claims are being litigated against policyholders.

The average duration of a claim because -- against the policyholder can become one to 1 1/2 years and the reason I say that is because quite a bit of asbestos litigation gets settled, depending on u -- depending upon the nature of the jurisdiction.

We would anticipates payments but also a substantial portion of our money in the politics of our prior pay, even our prior pay on policies that are closed, gone to seriously defend the cases.

And again, unlike Wellington signatory, major product manufacturers.

The case against the small regional companies is difficult, because their am pertained to the asbestos was limited or nonexistent making it more difficult from a client-attorney standpoint.

I hope that is responsive to your question.

So the actual pay here is -- is that including the defense expenses?

Yes.

So, really given the dollar amount shown, that is probably predominantly defense expenses.

some of it is defense expenses, some of it is indemnity.

It's a settlement on the case where you're not quite sure what it is.

You simply settle the claim.

Right.

That's exactly right.

And the sort of claims being brought about here.

Well, frankly, you know, the "Wall Street Journal" referenced it, you're dealing with policyholders that may have distributed a product, one which they had asbestos wrapped around their pipes and visitors to their facility were exposed to asbestos.

In terms of their nexus to the population, it's rather small because, frankly, the nature of their product sales were small, and frankly their clients were relatively small.

You're dealing with very much a limited geographical exposure.

And finally, then, if you take a look at what you have seen others publish, and I am presuming you haven't had time to look at what ACE is doing this morning, and you compare some of the bottom-up studies with a more helped-down analysis, -- analysis, some of the stuff put out by the ram studies, , do you see any trends in the bottoms-up studies that seem to differ with the observations of the top-down studies?

Clearly, clearly in the context of all these studies, and the discussions pertaining to them, the asbestos exposure, okay, continues, unfortunately, to persist with those that have had a major nexus to asbestos, as a major product manufacturer or one that was a major product manufacturer and also coupled their manufacturing processes with the installation of the asbestos.

In the "Wall Street Journal" article today, it referenced major petrochemical companies that asbestos for thermal and electrical installation across their plants across the country and labor young one workers were exposed to asbestos in the context of construction or reconstruction of those facilities.

In addition, insurers, and you're certainly seeing, I haven't seen anything from Asia, obviously, but clearly I anticipate you're going to see their obligation to Wellington par participants and they're continuing to fund expass policies.

Clearly also you seeing policyholders with a long-standing paying history, seeing increase pays on existing accounts.

And frankly, the major focus of asbestos continues to be, as evidenced by all the studies, is that the concentration are on policyholders for a long period of time, pay greater than a million in exposure, have exposure to Wellington, or have a major defendants in asbestos litigation.

Have paid their product limit and are dealing with the nonproducts exposure.

And for insurers that have ensured them, they're dealing with the question of the nonproducts exposure, and why the nonproducts exposure is a thorny one and a great deal of focus of those insurers that have ensured the major companies, either Wellington or a major defendant referenced in the annual report is that the product coverage is exhausting.

That they have made substantial premium payments for asbestos and now, their claim is being turned or suggested to be a nonproducts claim.

And why that is important is under policies issued to such major companies, nonproducts claims, a general liability policy issued in 1985 and prior does not contain applicable aggregate for nonproducts or premises-related exposure.

But clearly, the focus of the asbestos exposure continues to be, unfortunately, the long-standing policyholders that have had a long history with asbestos litigation, and it continues to persist against them.

Clearly the bankruptcies that pertain to them arise out of the fact that they have exhausted their coverage, perhaps exhausted their assets and are now trying to resolve within the context of asbestos.

Fortunately for us, and once again, it's because, and it's very important.

It's because our historical underwriting concentration was not with them.

It was with these smaller original companies.

It's just circumstance of our underwriting that doesn't present the exposure.

I'm very fortunate for that.

Clearly the other companies with a national accounts presence are having to deal with long-standing national account that have had a long-standing asbestos problem.

It's the major guys continuing to be the issue for the nonproduct side of the equation.

It's quantifiable, , because there are, , limit on the policies.

It's the -- the nonproduct side of these long-standing clients that continues to be the wild card?

Correct, and I would also add to that that in addition what is occurring is that excess policies issued to those policyholders to have long-standing asbestos exposure are being reached at a rate or, frankly, are being reached when they were not previously anticipated to be reached and that is putting pressure on the insurers of those major asbestos defendants because it was not anticipated that those attachment points would be reached.

Great, thank you very much.

And the combination of thi=ose two makes it a very big issue.

Great, thanks.

We'll go next to. [ Indiscernible ]

Yeah, Jay, on your own reinsurance where do you sit in terms of Jan 1 renewals and do you have anything else that renews going out further this year.

Yeah, the only renewals we have had in January 1 was our Surety business, which was spoken about on the contracted is.

Yeah.

It renewed for better times -- terms at the same price.

Our property renewal comes up in April and our casualty renewal comes up in July, so that's still ahead of us.

Yeah, what are you budgeting for those contracts?

Well, that's a very good question.

There are two elements that we're thinking about.

First, we hear the same thing that you hear, and I suspect it's sort of advertising from the reinsurers, rates are clearly going to be up, particularly in casualty lines.

So we're anticipating that.

The other piece from our assistant point is that we actually bought down last year or own terrorism cover, we extended our pro risk program to cover terrorism and bought 200 million X of 100 million terrorism coverage, cover for terrorism, and we're wrestling through the issue now of what the economics of that transaction are and whether it would give sense given the federal terrorism legislation to renew that or not.

I think I can tell you where with some certainty that we expect Reinsurance pricing generally to be up significantly.

This is just from reading.

I'm repeating what you guys tell me.

You're telling me you anticipate rating being up 25, 30%, that sounds right and we have this terrorism treaty that serves to offset some of that cost.

Yeah.

How about cat cover?

Well, again our property comes up in April, so we're not out there yet and I just don't know.

We haven't, we just don't know.

Thanks.

Pleasure.

Once again, if you have a question, please press star 1 on your telephone.

The next question from Sandler O'Neill.

Good morning.

Just a question on the construction lines, , do you expect that the, , number of large claims peaked in late '02 or do you expect them to peak in '03.

This construction insurance?

Yes.

chilly, our large claims were down in '02.

The -- the reserve adjustments were for, , a larger number of small accounts, , that are now inactive, that we're no longer wide writing, so, I don't anticipate there will be a big change in large claims, if that's your question.

There's always, and it might be because of the way the segment reporting, there is, I think, some risk to large losses in the Surety business.

The Surety business, , has basically two kinds of lines.

There is a high-frequency, low severity for which we book our IBNR, in which we anticipate it, and then there are the high-serearity, low nexty kind kinds of event, single-name transactions, some of them are very public at this point.

Where our policy is essentially we will record a reserve when a claim is filed and it's determined to be bonafide, so I think it's possible.

I'm not anticipating any, I'm not sitting on, you know, we're not sitting on any particular large losses but just in full response to your question, you know, given the economic environment, there is always the possibility that a name or two in the Surety book could pop during the year.

And it's just adding to that and moving away from the insurance part, we did have, , some frequency of severity in '02, and we base that on economic factors, , and I don't think it will be worse in '03.

Okay, great.

Thank you.

We'll go next to Michael -- excuse me, Robert.

Good morning.

Jay, I see you serve reluctantly into the earnings guidance business for '03, which is up -- not done, but you got there short of cryptically to their --

No, no, I deny that, actually.

Honest with you.

Okay.

There are some elements of our business that I think are so difficult to anticipate from the outside.

They're so cryptic that rather than allowing you all to make gross mistakes in different directions, there are a few areas where we're going to provide you some directional input.

You guys are pretty good in modeling so you can take it from here now.

Actually I thought you said you hoped to, or expect to exceed, meet or exceed your 15% ROE objective in '03

That was a question asked me back when we raised the equity offering.

Right.

We did our equity transaction.

Listen, you can do some arithmetic here.

It's not terribly difficult.

If you take the fourth quarter and do fairly normalizing assumptions, don't assume any rate, just take the fourth quarter as is and so, if rate gets better, that adds something.

If cats get worse, it takes something away, but I think you can use the fourth quarter arithmateicmatically as an indication of our ability to meet that threshold.

Yes, but I just wanted to make sure I understand the 15% ROE, , on, if you take average, what I project average book value for '03 to be, works out to be somewhere, just sort of $4.00, and I wanted to know whether that sort of thought process reflects any noise in nonrecurring, in runoff activities from the guidance that you gave, or is that just sort of a potential shock factor that could impact you forgetting your ROE objective.

I think there is probably a FAS 115 adjustment in there that needs to be wrestled with a bit.

Yesterday you're talking --

Yeah, I think you have to look at the book value excluding the unrealized.

Again, our book value, because that can move as much as it does.

But I wouldn't get overly, I wuoldn't get overly technical.

I'm not really giving guidance.

I'm not giving guidance.

I'm simply saying that given the dynamics of this business, it's, and again, I look at book value ex that.

That our ability to achieve a 15% return on equity is consistent with -- it's where we were, where we were when we raised the equity or perhaps somewhat stronger.

But you're saying that even with runoff noise, with the -- entering the 9th inning, hopefully not extra innings in Surety and Construction, you feel comfortable with the 15% ROE next year.

I do, but it clearly doesn't anticipate, when I say fell comfortable, you're pushing me in a direction again.

First of all, I'm assuming in that statement of 15% does not assume an adjustment in medical malpractice.

It simply, as I say, the way that I -- the way, Bob, was I took the fourth quarter, I normalized it, I fussed a bit with some of the underlying dynamics apparent to you as they are to me, and -- and I get there.

When you normalize it, are we talking the 88, the 94?

I'm just doing -- the only adjustment I made is adjust for the Surety reserve action of 175 and the reinsurance transaction of 115.

That's the only things I'm doing.

Okay, well, that gets you down to roughly 90 combined rate or lower run rate.

Is that fair?

In the quarter that's correct.

I don't want to do math on the phone with you, Bob. [ Laughter ]

I am trying to understand what you say, Jay, there is much noise in the numbers.

Let me share with you.

I know there is a lot presented here.

There is less than there seems.

Let me tell you how I would tend to look at it.

I need to be careful.

I'm not advocating or ignoring anything I'm about to describe, but I believe the approach we took in Surety was prudent and anticipats the issue and deals with the issue in a definitive way.

From my perspective, I look at the earnings potential and size up a plan and a model for next year.

That doesn't mean I'm not accountable for it, but I excluded it.

I also realize the Western MacArthur reinsurance adjust is a one-time event and so I exclude that.

And I come back to a level of earnings, simply making those two kinds of adjustments.

And the rest of it, the rest of what you perceive to be very noisy is, in fact, the normal comings and goings of being in the insurance business, so I don't adjust for essentially anything else.

I make those two adjustments, I sort of take a look at what I believe to be the core earnings strength of the company, and I feel pretty good about it.

Now, that doesn't mean that the wind won't blow or the earth won't shake.

We're in there, we write catastrophe-exposed business and that could change it.

It doesn't mean I'm declaring victory on medical malpractice.

I'm not.

Quite the contrary, I'm not, but I simply took the fourth quarter and did what I just described and looked at the run rate.

You guys are pretty good.

You can figure out an increase in run rate on premium.

I mean you have pretty good insights into what is happening there.

I would tell you that lost cost is probably running 7 to 9%.

That's sort of what looks to us like lost cost is going to run as we go into '03 versus '02.

And then I think -- I have given you some information on investment income where I said sort of down, but down slightly, in fact, what I would location look from a cash flow standpoint is the Western MacArthur painted last year, even given the runoff business is ex-Western MacArthur, our cash flow is positive.

We expect operating cash flow next year, ex-Western MAC to be positive.

MacArthur, our cash flow is positive.

We expect operating cash flow next year, ex-Western MAC to be positive.

There are a lot of good things here, and the number of, of sort of -- sort of hurdles to jump over, I think, for us to get there is getting -- is getting smaller and smaller.

Someone said to me once you don't know that you have turned the corner until you look back and realize you can't see the other direction.

And you know, it starts to feel here like we're reaching that point.

That we, , that we have gotten in line.

Thanks.

I'm trying to understand what you were trying to say on the call.

I think I'm there now.

I'm not a forecaster but I looked at -- I simply looked at what I saw was average equity.

I took the fourth quarter run rate, a made adjustment for rate loss trend and divided it, and I said gee, we said before that we didn't think raising equity would stop us from earning 15%, and we still feel that's okay.

I appreciate it.

Thank you.

Just a reminder, to ask a question, please press star 1 on your telephone and make sure your mute button is turned off.

We'll go next to Eric Holmes of. [ Indiscernible ]

Good morning, with the terrorism insurance bill in effect now, how disruptive is the reunderwriting and offering separate terrorism policies, , effecting your business and are a lot of clients taking it.

Kevin Nish runs our national property group, the most impacted by this.

Kevin actually had the offer letters out to all of his insured by the end of November, which I think, if I recall correctly, the legislations was passed in the third week and I think what Kevin did in marshaling resources to put the offers out was astounding, so we had essentially the national property business, which is where it's most risk exposed out promptly, and the truth is I don't know what the response is.

Do you have insight to that perhaps?

Jay?

Yeah.

Can you hear me?

I can.

I'm sorry.

Yeah, I'm on the phone.

First I would say I don't think that it has been that disruptive.

You're right that Kevin did get on this .

We're seeing, , today the majority of the customers are purchasing, , that cover.

By a majority, , it goes up and down by month, summer the majority on the larger customers.

We don't see that on the middle market customers to the same extent that we do on the large property customers and what I would say is we're seeing ebbs and flows in the marketplace as we learn what the other carriers are doing as far as rates but it hasn't been disruptive.

Indeed, one of our decisions is whether to renew our cover to be the extent to which customers talk off their terrorism option.

Okay.

Thank you and your asbestos disclosure has been very helpful and comforting -- cold fronting.

Thanks.

Appreciate it.

We'll go next to Jonathan Adams.

Brown Browhters Harriman

Can you elaborate what is driving the change in the redundancy ratio between mid '02 and the end of the year.

Yeah, and I will ask Tim to edify as we go.

It's a touch complex because of how the two factors in Iraq.

First, when you're in the business of writing a particular product line, claim people tend to be customer friendly, and what I mean by that is that you recognize that you're in the business, you want to continue to renew existing customers, so you tend to be accommodating, even where the company might have the unilateral right to do something different.

For example, the two best examples that I have used in the past is in many states, aurguably even most states, the company, the medical malpractice insurer, has the unilateral right to settle the case withot regard whether the insurer agrees or not.

That is not our policy here.

Our policy here was to defend and defend and defend when the customer wanted to be defended.

Tim actually has some wonderful data that shows what happens when you change that.

It was from a particular region where the number of cases that went to jury was actually the same in a particular quarter, but the jury verdicts went from, I'm going to do this from memory, went from $40 million to $4 million, I remember, from the same number of jury verdicts, which essentially demonstrates that you learn to try the right cases and settle the right cases, and it's that type of behavior, it's representing the company's interest more distinctly than one can when you're in the business.

The other example other example is our unilateral right to council.

The comp[any often deferred to the insured.

As a consequence, you get less than crisp representation in fairly complex matters, so now we represent our position and represent it aggressively, and that clearly is leading to an increase in that redundancy rate.

Now, the second issue is by encouraging resolution, claim handlers very quickly understand that the way you do that is to get the case reserves up.

And they have done that.

They have clearly done that and done it with enthusiasm.

Now, of course, when they're setting the claims, they're setting them based upon historical trends and historical patterns and not typically taking into account the change in claim settlement behavior that we're trying to encourage.

So who what we expected would happen was the reserves would go up and that the claim behavior would become more resolution aggressive and as a consequence, the redundancy ratio would begin to increase.

That is exactly what is happening.

Now, the one thing I can't sort out is the extent to which claim handlers are in effect over reserving for some reason, you know, this is the data the numbers move around.

It's difficult for me to tell you this wouldn't happen, although I couldn't figure out why it would, that a claim handler would overestimate the reserve and then obviously settle it out, and the redundancy ratio looks better but, in fact it's artificial.

I think over the next number of months, relatively short months, 3-6, we're going to know exactly where we are.

This isn't going to take much longer to resolve itself out.

Is there anything in the progression, whether it's number of claims that you may have settled in December for example, or the nature of those claims that would make you think that the ratio that was achieved in December is abnormal or nonreflective of what is happening in the entire book?

This is Timothy Yessman.

No, frankly '02 was a tough year in the context of claim resolution and putting some tough problems behind us in the context of claims.

That, you know, when we review them by raking in the medical malpractice we found, we identified as troublesome and we were eager to put it behind us.

The that fact that we have seen the increase in the redundancy rate in '02 has been very comforting to me, given how much of the liability, you know, I believe we put behind the company in '02.

But, Jonathan, one point.

The numbers do bounce around on a month-to-month basis a little.

We have seen them turn down in given month, and we have seen them turn up, although frankly the 38-3 in December was the highest for the full calendar year.

There is nothing in particular about December that would have precipitated an unusually high result, but it's a little difficult to look at any one-month higher or lower and come to any dramatic conclusion.

That's why I gave you the quarterly progression as well as the year to date so you could get a sense of where we are.

It's clear that the redundancy rate has to continue to get better for this to work out.

We're not at the level that it needs to be.

It has to continue to get better, and it has to continue to get better and the incurres have to drop down pretty dramatically, so there is some work to be done here still for this to all work itself out.

Thank you.

Our next question comes from Bill Wills, Morgan Stanley.

Good morning.

One backward looking question and one forward-looking question.

The backward-looking, just wondering if you could say -- have all the major lines of business been reviewed from a reserving perspective, been reviewed with now with data, say either as of 9/30 or year end 2002?

Yeah, I'm looking at Scott Anderson who is our head actuary sitting here.

He's nodding yes.

Okay.

I know -- do you, as of 9/30.

The level of exam that goes on, and I -- look, I have been in the business only 10 years, so it's not really all that long, but whether it's a function of what has happened in the corporate arena generally, where the impact of Sarbanes-Oxley or the notion of having the CEO and CFO, I will tell you the level of scrutiny going on here from an internal as well as an external prospective is just different from anything I have been accustomed to.

We sort of kid around here, we talk about, you know, we audit every day all day, and so there is no hiding.

Now, Bob described an exam where he did a 100% review of general liability in worker's comp claims.

That's exceptional.

We haven't done that level of in-depth review on every line of business.

That was resippitated by overall data indicating there was a problem and we needed to understand it.

First not only to record the right adjustment but more importantly to make sure we were pricing and underwriting our business properly.

The best thing you can do out of a difficult situation is to make sure that you're pricing your product and underwriting it correctly.

And, so, we -- every single line has been looked at with great scrutiny, and that's where we are.

Okay, much appreciate it.

The forward-looking question, which I'm guessing you all would appreciate the chance to talk about.

Could you just give us some color -- you referred in the press release the St. Paul Main Street because it's an automated, sounds like an automated underwriting or insurance platform.

Just if you could, color expectations for growth in 2003.

Is it going to add new growth?

Is it just rewriting of existing policies on a new platform?

It's clearly not that.

It's -- although there will not be a significant contributor to earnings from Main Street in '03.

We do anticipate in '04 a different answer to that question.

The -- the small -- you know it's interesting.

Let me take a minute because I think it does define our strategy and our focus.

We see ourselves as being at one side of the insurance spectrum.

The customer being at the other, and the broker and agent being square in the middle.

And the best thing we can do to build a robust, healthy, dynamic growing insurance business is to where we can bring the skill and expertise to provide as many product solutions for that agent and broker as his customers demand of him.

And that's important because some of you tend to get a little hung up in definitions of specialty or general commercial, and you get awfully narrow.

If you sat with a group of agents, agents see themselves as being in business and they hustle all day and bring in accounts.

What they're looking to do is find suppliers and product who make it happen easily and consistently with an underwriting strategy.

Our clear focus is to be a great specialty underwriting company, to be a great general underwriting company, to essentially meet as many of those product needs as we're capable of needing.

In the one area where this was not competitive at all was in the small commercial arena.

The two competitors in my judgment anyway who, defined excellence and net marketplace are the Travelers and the Hartford.

And after doing a lot of study and a lot of thought and a lot of understanding about what makes the dynamics in that business tick, and you're right, it is a very slick front-end underwriting system that executes quickly, crisply and in a defined box.

And if you have a $10,000 account, your total commission is $15000 .

If you missed a -- $1500.

An agent can spend $1500 and make no money.

So having a front-end platform gets the transaction done crisply and quickly.

It's critical.

And having the service center where the agent can offload the servicing obligations but they don't have the size and scale to do that business effect elf.

Those are the critical element reallies to that success.

We have spent a year in bringing what we had here up to speed.

We're excited about it.

The marketplace is enormous.

I'm asked frequently how are you going to grow a business there, you know, a bet between Travelers and the Hartford, maybe there is $3 to $3 million effectively in the commercial.

Best estimates are that marketplace is at least a $50 billion mark.

Let's assume that half of it is in business and doesn't fit, an underwriting box with this type of remote sort of hands-off underwriting.

You still have $25 billion.

That is still a marketplace where there's plenty of opportunity for this competitor who can execute well and think broadly about the business to compete.

It's not turning away from specialty, thinking of the agent squarely in the middle of the process and doing our best to deliver as many products as that broker needs. '03 will have volume, not much in the way of profits, and '04 we expect profits to come ramping on.

That's great.

Thank you very much.

Pleasure.

We'll take a follow-up question from Don Johnson, UBS Global.

Thanks.

Since most of the stuff obviously dates back, asbestos I'm talking here, dates back at least two decades or so, could you roughly break out whether you want to do it in dollars or policyholders, the split from USF&G, or even the general sense would be helpful.

In general, the nature of our asbestos book is USF &G exposure.

So, say 2/3, 3/4 at least?

Yes.

Okay.

Thank a lot.

You're welcome.

We'll talk a follow up with a question from Ira Zuckerman, Netmeg

Yes, you mentioned you cut your duration fairly significantly.

Can you give us the idea of thing behind that, and what the impact going forward will be?

Yeah, I'm going to actually let Bill Heyman answer the details of that.

What really drove it was a concern on our part that inevitably interest rates are going to rise, and when they do, the impact of the mark-to-market of the fixed income portfolio for the surplus could be problem problematic, so we began to take actions that we thought were prudent to mitigate the risk going forward.

This is Bill Heyman.

The reduction in duration and, I don't think intended to reduce it much further, does not represent an opinion on when interest rates will rise, but desire at what we thought was manageable in terms of foregoing NII, topreserve us am, reserve gap-Bobbing value, when they do, to support underwriting performance existence and attractive rates.

Okay, I assume also by going short, when interest rates do rise, you will have an opportunity to reinvest the short into longer duration?

That's the intent.

Okay, thank you.

That's what I thought.

Thanks.

Operate operate second follow-up from. [ Indiscernible ]

From cash flow from ongoing operations, I thought you said was a negative $30 million or so.

Is that a correct number?

Negative 34, correct.

In the third quarter, it was positive.

Was there anything that is one sort of seasonality in the cash flow generation?

No, I mean other than that, it's really subject to a lot of timely issues.

The third quarter for our ongoing cash flow is a positive $400 million, which is actually pretty huge.

If I, you know, take the -- in fact, it was over 4 -- 400.

If you take the two quarters and average them out, at 200 a piece, it's probably a little more reasonable.

So I can't find any particular, , reason why it would swing that much, other than timing of payments and payments and receipts.

So that the forth quarter was, I think, the third quarter was an abnormal high, and I think the third quarter is -- fourth quarter is less than I would expect.

$200 million a quarter is a fair characterization of where you are right now.

Yeah, that is certainly our current run rate.

Again, --

I'm not projecting.

Yeah, although again we obviously have a cash flow, fairly detailed cash flow model for next year, and it is -- it is in the aggregate, Mod lest -- modestly negative, and negative because of the impact, well, one could say it's modestly negative because of the runoff business or because of Western MacArthur, you can take your pick, but we anticipate it being modestly negative '04.

Returns recoverable?

Say it again?

You increased your, you know, reinsurance recoverable for Western Mac this quarter.

Was that a cash flow projection for Western Mac?

Of course, for the whole year, I am not sure.

I think the models included originally, a section -- it's actually a very good point.

It will change.

The models assumed the reinsurance recoverable that we booked recently, perhaps this adds $100 million to it, and that's obviously on a pretax basis.

We have to run that through the model again.

It won't have an enormous impact on it, Bob.

Okay, thank you.

At this time time, there are no further questions.

I'll turn the conference back over to you for additional closing comments.

Thank you all for spending all this time with us today.

If you have any additional questions, I will be in my office and I will be accessible all day long.

That number is 651-310-7696.

Thanks again.

Thanks, all.

This does conclude today's conference.

Thank you for your participation, you may disconnect at this