旅行家集團 (TRV) 2003 Q1 法說會逐字稿

Good day and welcome to the St. Paul Company quarterly results conference call.

This call is being recorded.

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

Please go ahead.

Good morning, everyone and thank you for joining us for the St. Paul Companies first quarter 2003 conference call.

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

On the call we'll address first quarter 2003 results as well as review market conditions.

Copies of the statistical supplement and the press release are available on the investor pages of our web site.

The supplement provides reconciliation between operating earnings and net income as well as other detailed financial information.

This call is being recorded and will be made available on our web site 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 would also like to remind you that any comments made regarding future expectations, trends and market conditions including pricing and lost 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 in the company's most recent report on form 10K with the S.E.C. and available through our web site.

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

Thank you, Laura.

Good morning everyone from St. Paul.

It is indeed a pleasure to be with you this morning.

This was a record quarter for the St. Paul both in terms of operating earnings and in terms of operating earnings per share.

We generated $206 million in operating earnings during the quarter.

More than any other quarter in the company's history.

Net income was $181 million.

Our operating earnings of 86 cents a share includes $9 million of losses or 4 cents a share resulting from the sale of our nearly 70-acre Baltimore campus.

If you add those two together, that's $215 million in operating earnings or 90 cents a share.

That's how we look at quarterly performance here.

The $215 million equates to an operating return on average equity of 17%.

Obviously we're seeing the results of our strategic repositioning hit the bottom line.

The combined ratio improvement in our ongoing segments from 99.3 to 90.5 year over year after adjusting for the described elimination of the Lloyd's reporting lag is a clear driver behind our improved profitability and in addition, [indiscernible] investments delivered a very strong quarter continuing to increase assets under management and holding their margins in the most difficult of securities markets.

In fact, it feels pretty good not to have to review a list of what fors in this release.

Upon review, you'll see there was no impact from cats, no credit issues of any consequence, no significant reserve increases, no new issues related to asbestos claims, this was indeed a solid consolidated business result.

Our goal continues to be to deliver consistency in book value growth and returns and our execution is very much our key.

Our strong performance this quarter speaks to how we have delivered in our strategic initiatives and how we're leveraging an obviously re-energized culture that embraces financial and underwriting discipline, expense consciousness and an attitude of acting as owners and having the sense of urgency to do it right.

We're beginning to evidence the earnings power of the company.

We have largely addressed the issues confronting us since the closing quarter of 2001 and as a result, we are able to focus more and more of our attention on the kinds of initiatives that will help us enhance our long-term ability to deliver more consistent long-term performance and hopefully continue to break records in terms of our profitability.

An example of that is our initiatives with our distribution channels and our small commercial insurance efforts about which I'll speak in a moment.

We know you're all interested in rate increases and indeed, we continue to get rate increases where rate is needed with average rates in the entire book still up in excess of 20%.

Rate increases are higher in specialty and in some cases, in some lines dramatically so.

In commercial, we continue to achieve mid teens rate gains obviously well ahead of lost costs.

The enthusiasm of our distribution partners for doing business with and growing their business with us more importantly is clearly evident and as a result, we're succeeding in increasing our penetration with key distributors in the U.S. with an intense focus of being a key trading partner with important distribution organizations.

This is an extremely important component of our longer term strategy.

Let me turn to the individual lines of business.

Specialty commercial with 1.3 billion dollars in net written premium continues to perform just exceptionally well.

Net written premium growth excluding the impact of eliminating the Lloyd's reporting lag was 16%.

The reported combined ratio improvement from 99.1 to 91.0 resulted in $118 million of pretax underwriting profits.

Adjusting for the impact of the extra quarter, the combined ratio is even better at 90.5 generating $108 million of pretax underwriting profits.

We have combined our surety and construction and international and Lloyd's businesses within the specialty commercial segment.

Mike Miller will now lead the overall specialties segment.

Bob Lamendola, the prior president of our construction and surety unit has decided to retire but has graciously agreed to stay through the remainder of 2003 to help transition our businesses to Mike's leadership.

Bob has shepherded this business through a very difficult economic environment and I want to thank him for the legacy of strong underwriting and disciplined management he's leaving behind.

Surety is a business that's generated significant profit for us during Bob's tenure.

Kent Arness will continue to lead the ongoing international and Lloyd's activities and Kent will report to Mike.

Kent has done a tremendous job in executing the streamlining of this business in complex environments around the world and improving its results and we look forward to his continued contributions.

Let me turn my attention to commercial lines.

Commercial segment of our business with $535 million of net written premium in the quarter also continued to perform very well.

Growth in net written premiums of just over 7% is primarily driven by solid rate gains and selected selectivity on new and renewal businesses.

Earned premium increases were just over 8%.

Retentions for this segment continue to increase.

The combined ratio of 90.3 was a 9.1 point improvement over last year driving pretax underwriting profits of $38 million in the quarter.

We know we've been asked a lot about how our small commercial rollout is doing.

It is indeed proceeding very well.

We initially had established a target of reaching $1 billion book of business in this line over the next several years.

And we are very encouraged by the new business traction that we are experiencing.

By the way, in most importantly, that traction is not the result of an aggressive pricing strategy.

We're not burning our way into gain market share.

But rather it is coming from leveraging our existing distribution platform which was very much the articulated strategy.

We expect to have our second service center operational by early in the second half of the year.

And we're very well-positioned to take advantage of the disruption occurring in this highly fragmented marketplace.

Something that makes our entry easier to accomplish.

We are on track for small commercial to make a meaningful bottom line impact in 2004.

All in all, we made very solid progress in our four underwriting businesses.

Let me give you a quick comment about our runoff businesses.

Again, we get asked a lot of questions about that and we've made some real progress here as well.

We have shared with you our key variables employed in managing our healthcare runoff in the fourth quarter conference call and I'm very pleased to report that medical malpractice book is performing positively.

The redundancy ratio about which we spoke continues to be in a comfortable zone and in fact, is showing improvement.

Case development has been ok and new claims what we call emergence, has been considerably lower than what we had originally anticipated.

This lower emergence is attributable, we believe to the low levels of reporting endorsements that were purchased last year compared to what we had anticipated would be and in fact, a real focused effort by our claim department last year that was undertaken to identify and report new claims very quickly.

If this trend continues and we did see it in each month of this quarter, it will be a very positive factor for our healthcare reserve development.

Now, I would like to turn to Tom Bradley, our CFO to review some of the financial details.

Thanks,Jay.

First, addressing some of the financial reporting revisions, we are now reporting all specialty segments in a single specialty segment in all exited segments are reflected in the other segment.

The new reporting is consistent with our new management structure that Jay just described.

We will continue to provide you information on surety and construction and international and Lloyd's subsegments as well as the runoff operations in healthcare and reinsurance for the remainder of 2003 with detailed commentary at that level included in the 10Q.

We believe this reporting structure is more consistent with how we define our specialty businesses and similar to what national peer companies report thus providing better comparability.

For this quarter, I would like to review three financial factors which influenced our results.

The sale of the Baltimore campus, the elimination of the reporting lag at Lloyd's and a reclassification of commission expense, also at Lloyd's.

As we indicated in our press release, the sale of the Baltimore campus resulted in a $9 million or 4 cent per share after tax operating loss in the quarter.

Because this was a wholly owned property used in operations, the realized loss on the sale was recognized above the line in operating earnings.

The pretax loss of $14 million is included in the other net in our property liability segment reporting.

The sale of this 70-acre campus generated a significant amount of cash and we will reduce our ongoing occupancy costs in the Baltimore area as we relocate to a more traditional facility.

Moving to Lloyd's, the elimination of the one quarter reporting lag at Lloyd's decreased total underwriting results by $27 million.

The $27 million figure is actually split between a $10 million positive impact and the ongoing operations and a $37 million negative impact in the runoff segment detail.

This elimination of the reporting lag at Lloyd's is kind of the end of a three-year process whereby reduced reporting lags in our reinsurance operation at London two years ago.

We took away the reporting lag at the international operation a year ago.

And successfully eliminated the reporting lag at Lloyd's with our reporting this year.

Now, all of those foreign operations are reported on a co-terminus and consistent basis.

The other Lloyds issue is the reallocation of commission expense.

We reclassified certain commission expenses in the Lloyd's business.

Prior to this year, some Lloyd's commission expenses were included net -- within the net premium line.

We had -- we estimated our commission expense but due to some of the limitations of the Lloyd's accounting and reporting and the fact that these were mixed capital syndicates, we did not actually have an exact commission expense number so in effect, the additional commissions were reflected net within the net written premium line.

All commissioned are now included in the expense line.

Prior periods have been restated to conform to this new classification which has the impact of grossing up both net written premiums and expenses.

This reclassification has no impact on bottom line underwriting results.

As a result of this reclass, the Lloyd's and international segment expense ratio for the quarter is about 7 points higher than we have seen in the past.

On an ongoing basis, Lloyds will continue to have a higher expense ratio than we've seen previously.

A 7 point increase on 20% of our ongoing premiums would therefore increase the company's expense ratio on a run rate basis by 1.4 points.

Looked at another way, if we exclude all of the Lloyd's business out of our ongoing business expense ratio, it would be 28.2 for the first quarter compared to 28 during a comparable period in 2002.

And very consistent with where we've been performing recently.

We will surely be posting supplemental information on our web site that will provide a historical quarter by quarter impact of the reclass.

Next, let me add some color to the runoff businesses which include healthcare, reinsurance and the other international runoff businesses.

Premiums have fallen off dramatically over the past year.

The first quarter current year underwriting losses for the business were about as expected at about $60 million.

We expect current year underwriting losses excluding prior period development to be in the high end of our previously disclosed $100 to $125 million range.

Reported underwriting losses in the recent period include net prior year reserve increases of approximately $40 million.

Reinsurance runoff continues to perform very well but we did fine tune reserve balances as a result of internal and independent actuarial reviews of Lloyd's syndicate primarily in the 2000 year of account.

Cash flow during the quarter was substantial prior to previously discussed payment for the Western MacArthur settlement of $750 million, 9/11 payment and runoff operations.

These payouts reduced our invested asset base slightly.

However this draw down in invested assets should reverse itself over the second half of the year.

Moving to our reinsurance programs, as of April 1st, we renewed our property reinsurance coverages.

The terms of this year's renewal actually improved over last year and the rate is slightly lower.

Our catastrophe reinsurance program was again renewed at $550 million of coverage in excess of a $100 million retention.

Our property per risk cover now provides $244 million of coverage in excess of the $6 million retention.

This is an increase over last year's program which was $119 in excess of 6.

The addition of another $125 million of coverage on this treaty eliminates the need to go out and buy expensive facultative reinsurance for those programs where we need the additional gross limits.

It should be noted that both of these property treaties previously had excluded all terrorism in their coverage.

This year, we have been able to add back coverage for domestic terrorism events which, as you know, under the new federal tree of terrorism coverage are not covered.

So, domestic terrorism is back in our main property and catastrophe covers.

We've also bought a separate terrorism carve out cover of $200 million, that's 200, covering all terrorism events, domestic and foreign and going up to an amount of $400 million which fits right below our trea deductible of approximately $400 million.

Now, let me take a moment to address a separate 8K filing we made this morning.

First of all, this has no impact on reported results for the first quarter.

This filing updates a previous disclosure relating to our commercial surety business with an approximate -- I'm sorry.

Bonds in our commercial surety business with an approximate combined limit of $120 million we issued on behalf of the company now in bankruptcy.

The total limits of these bonds securing worker's compensation obligations had an aggregate limit of $80 million and bond securing retiree health benefits had aggregate limits of $40 million.

In that prior disclosure, we indicated that the company continued to perform its obligations and had not asserted any claims.

In the last few days, we have begun to receive claims related to the worker's compensation bonds and expect in the near term to receive notice relating to the retiree health benefits.

We felt that the prior disclosure needed to be updated at this time now that claims have been asserted.

We are undertaking the regular process of evaluating the claims and determining any valid losses to be paid.

Workers compensation bond objections are inherently complex but we work quickly to obtain employment and injury data and complete the required actuary analysis.

The $120 million in combined bond face value represents the maximum possible claim exposure.

The ultimate losses may well be lower and is stated before applicable reassurance and before taxes.

Thus as we move quickly to determine the likely losses, we would box the possible impact at a maximum of 25 cents per share after tax.

But based on some very preliminary information that we have and we'll continue to analyze, could be substantially less.

Regardless, we do not view the series of bond claims as derailing overall operations from delivering on our mid teens full year return on equity objective.

The other item that we discussed in our year-end 10K disclosure regarding surety bonds related to a series of gas supply bonds totaling $192 million to one principal.

That principal has continued to perform on it's bonded obligation and recently completed a successful refinancing.

We view this as a very positive development.

A final comment on our capital leverage position.

Our shareholder equity balance stood at $5.9 billion at the end of March compared to $5.1 billion at the end of March a year ago.

At this time, we're comfortable with our equity and overall capital position which is approaching $10 billion.

We know that Moody's has returned us to a stable outlook and premiums to surplus remain at a very competitive level of 1.3 to 1.

Our debt-to-capital ratio is 28.2% including debt that will convert to equity in 2005.

Excluding that debt, which is issued as part of the capital raise last summer, our total debt to capital is 23.5 down almost 100 basis points since the end of 2000.

It is our intention to continue to deliver through the remainder of the year, with a target to drive that ratio down under 20% by the end of the year.

I'll now turn it back to Jay.

Thanks, Tom.

This next quarter sets us off for a very strong start for the rest of the year.

We have increasing confidence about both of our strategies as well as our execution.

We are maintaining our discipline to achieve the rate gains we view as necessary and we do continue to achieve rate increases across all lines exclusive of better discipline on terms and conditions in many of the lines in which we write.

And we expect the industry rate environment to continue strong into 2004.

The fact that we generated record dollars of operating earnings and operating EPS as we looked at 90 cents a share is proof positive we can indeed deliver.

Thanks for your time and we welcome your questions.

Thank you, sir.

Today's question and answer session will be conducted electronically.

If you would like to signal for a question, you may do so by pressing the star key followed by the digit 1 on your touchtone phone.

If you are using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment.

Once again, for any telephone questions, we do ask that you please press star 1 at this time.

We'll pause a moment to assemble our roster.

We'll go first to Michael Lewis of UBS Warburg.

Good morning.

I have some clarifications here.

Two things.

Number one, can you give me a little more clarification on what's going on in the runoff business now that you're talking about maybe developing at the upper end of the prior range and maybe I'm a little bit confused but the $60 million you reported in the first quarter versus the 99.

Was the 99 based on the fact that you would have two quarters in Lloyd's operation in one and that was the $39 million was from the prior quarter and also, Jay, just some clarification on talking about a mid teens ROE.

Are we basing that on ex-FAS 115 or with FAS 115 because it is quite a difference in the numbers.

First on the runoff amount. $60 million is the runoff loss associated with the current accident year which is what we have been given some prior --

This is actually very important.

Tom knows this business so well that he can actually sort of push by the issue.

There were a number of lines of business that we were exiting from but for a variety of reasons, we had obligations to continue to write certain amounts of premium in those lines.

For example, some amount of continuing medical malpractice on the tail business had to be written and the estimate of the runoff losses of $100 to $125 million, we had provided were at the underwriting losses based upon that business which we had to write.

So, obviously we were reserving for it at some pretty conservative levels.

I thought that would be helpful to sort it out.

Exactly.

And that guidance was related to those premiums which would continue to earn throughout 2003 and generate some level of loss in related expenses and our estimate for the full year is that that number is 125.

It is obviously front end loaded this as this stuff runs off and the current year loss of -- 60 is consistent with that 125 full year range.

The other 39 million dollars is the prior loss reserve adjustment that I referred to coming out of the Lloyd's operation.

We think, Michael, the way to look at it is we're going to come in from an underwriting loss perspective at the upper end of the range and that's simply a function of a little more business being written in those lines than we had anticipated.

And that, in fact, virtually half of it -- half of that upper end of that range has already been recognized in the first quarter.

Uh-huh.

I'm sorry.

The ROE calculation is F 115.

Yes.

The ROE calculation is the FAS 115 adjustment.

We'll go next to Ron frank of Smith Barney.

Morning.

I have two questions.

One, the reserve development, the prior year reserve development at Lloyds of $37 million, the 125 forecast is excluding reserve development and that, of course is, the big excluding.

So, I was wondering, Tom, if you could -- or Jay, if you could give us some more color on where that $37 million came from.

It was my impression that that book of business was relatively short tailed and that the risk of development there vis-à-vis med malor reinsurance was relatively low and I'm kind of surprised to see that be the source of the negative surprise and also, could you tell us whether it is correct to assume that the $18 million gap underwriting profit for reinsurance basically goes to zero.

Or was that tag ends a function of the sale or a transfer of the book.

I'll let you answer the second.

I'll handle the first.

Are you a little confused about it.

There were a number of Lloyds syndicates from which we exited.

And the $39 million provision here is from one of those long tail casualty line segments, syndicates that we exited.

Two important points, I think - or three.

This was a mixed capital syndicate.

It was not one that we had complete control over and in mixed capital syndicates at Lloyds, there are rules one has to follow.

We actually have to go out and the syndicate has to go out and get an independent actuary to do an assessment and in fact, that was done.

The independent actuary makes a report to the capital providers and from a governance perspective, we felt it was entirely appropriate to simply record the recommended amount.

I would tell you that $39 million, I wouldn't call it a rounding error but in the context of the size of the business that we conduct in Lloyds and have conducted in Lloyds, it is a very modest change.

I just don't think that you get a recommendation anymore for any reserve adjustments of any size and ignore it.

I think you go ahead and you go ahead and you book it.

We have exited all of the long tail lines at Lloyds and we remain in four areas.

Aviation insurance, we even got out of the aviation reinsurance business because we felt the underwriting controls were -- the underwriting information which is not as robust as we would have liked it to have been, we're in marine, we’re in property, and I would say that our property folks there are some of the best I've ever met.

I was there all last week with Mike and Kent.

Lastly, we have an A&H personal line syndicate there that's a very profitable operation.

But that's it.

We're not in any long tail lines of business at all at Lloyds.

Do I infer correctly then that there are no other syndicates you've exited where you are still awaiting similar actuary opinion?

Let me clarify.

Thank you.

Let me clarify, Ron.

It wasn't just one syndicate that the adverse development came from.

It was a review of all of the syndicates that you're in -- including those in which we're still have ongoing businesses and the -- But there was no adverse development from the ongoing.

In fact, they're performing extremely well but the lost development came from four long-term syndicates.

They were mainly North American casualty based operations and the reason why we exited is we about didn't feel that it was a good way to write the business and I think if anything, what's happened in the past 12 months has been a validation of that.

So, when you talk, Jay, about the getting the independent opinion, was that for all four of them or one of them?

It was for all four.

It was for all four.

Yes.

So, my question again is and I think I'm hearing the answer yes.

Can we assume that there are no other syndicates that you've exited where we are still waiting for this actuary opinion?

Yes, that's correct.

Ok.

Let me just -- one caveat.

This is an annual event at Lloyds.

This is for the year 2000.

And so next year, similar time, we're gong to have a report for the year 2001.

Or actually doesn't quite work that specifically but we'll have another report next year but I think that the size of this one and the fact that these things are beginning to age.

The [INAUDIBLE] size of this one is beginning to age, gives us a fair amount of confidence that this is a continuing shrinking issue, not a growing one.

Ok.

And on the reinsurance --

Ron, your second question, I had mentioned that we were very happy with the reinsurance runoff.

We said a number of times we felt that it has been conservatively reserved for some time.

I don't know.

That's going to bounce up and down a little bit over the course of the year but I think when you look at the three components of the runoff segment together, looking at that 125 as being the total is probably the right way to look at it.

It's interesting.

We had a presentation here in our management meeting yesterday from Mark Whitmore who actually runs the -- what is now St. Paul Re -- the reinsurance segment.

We went through spending a couple of hours with them and went through a whole series of examples and behaviors and I think what -- well, I think -- what is happening and what will continue to evidence itself is a business-like and professional approach to resolution of reinsurance claims.

If the claim is meritorious and is covered and is appropriately documented, we'll pay it and we'll pay it promptly.

If it is not covered, if it is subject to dispute, if there are serious issues or questions on it, we'll dispute it and we will pursue all of the remedies that are available to us and the big difference in that is that one is not in that regard impacted by marketing considerations.

It is not unusual in the reinsurance business in an active environment for the underwriters to come over and say look, see it his way.

Pay the claim.

Otherwise, we're going to lose the business relationship from them.

And in fact, we're freed from that.

The reserving policies in the business historically were set based upon that kind of pattern of behavior.

And that's what gives us a relatively high degree of confidence that as this book continues to work out that, in fact, we'll see savings from it.

What's one of the things that's been interesting to me is that there have been a number of constituencies who seem to think that because a business goes into runoff, that somehow the risk of the reserves being adequate is increased.

That's just 100% dead wrong.

There is nothing about putting a business into runoff that increases its exposure if one -- versus if one continues to be in the business.

It is, in fact, 180 degrees the opposite because you are now freed up from the issues of having to deal with claims in a marketing environment.

And I tried to explain that to people and perhaps on one of these calls, no names but we can use an example or two to demonstrate why that is so important.

And it is.

There is nothing about being - not writing to do business that increases the risk of reserve inadequacy.

It is, in fact, exactly the opposite.

Last one, I promise.

A quick one.

That's the 18 is or is not part of the 125 negative expected for the year?

It is part.

It is part.

That's not a prior year's thing?

Development thing?

There may be a part of it that is.

The development number was net.

It is part of the 99 total loss but the 125 related to the 60 is still the guiding factor.

Right.

Ok.

Ok, thanks.

We'll now take a question from Chris Wymans of Williams Capital.

Yes.

The question has to do with your small business commercial strategy.

Could you just get into a little bit what is the cause of the disruption.

I assume it is certain players leaving the field.

But also why is this market so fragmented?

I know that State Farm controls -- has the largest player in this market.

Yet it only controls maybe 4% of it.

Go ahead, Chris, sorry.

So, where does the growth come from?

In other words, if it is so fragmented, doesn't it get kind of costly to acquire this business?

First, you've got some bad misperceptions about the way the business is done.

It is at least a $50 billion marketplace.

I've been through a lot of market research.

It is at least 50 and as much as $75 billion.

When you look at the large players, by my estimate Travelers is doing about $2 billion a year of it.

I think Safeco is doing a billion and perhaps Hartford is doing -- I haven't seen their numbers yet but let's say $1.4 billion.

Those are really the large players so there is a very substantial amount of premiums that continues to be housed in -- and I'm talking about stock companies now as opposed to State Farm, much less visibility there about the kind of business it is.

But the business continues to be very, very highly fragmented.

And it is in the process of consolidating but not dramatically so.

And maybe that changes over the next few years but that's really where it is today.

The secrets -- obviously they're not such big secrets because I share them with everybody all the time about success in the marketplace.

Or having a technology platform that allows agents to quote rate and issue the business extremely cheaply.

If you're an agent and you have a $10,000 premium in small commercial, that's actually a pretty big account.

You've got a grand total of $1500 to work with as a commission to take care of that account.

A few phone calls, a few certificates of insurability, a missed endorsement, a change of address, and time spent quoting it amongst eight carriers can eat that $1500 up in a heart beat.

What agents are looking for are ways to execute it crisply and cleanly and with as little touching as possible.

And that is a key factor for success at the agent level and it is a key factor for success at the market level.

Until the real advent of the Internet at the agent level, there were many large carriers who were thinking about getting out of this business because the expense load of it was so high, that they just couldn't make a buck doing it.

It was the -- it was not the Internet at the company level but the use of the Internet at the independent agent office that really was the breakthrough.

So, having that technology platform to do it is a critical factor for success.

We have that now.

It is rolled out.

It is as good or better than anybody else's out there.

Go out and ask any agent.

You'll get the information from them.

So, that's the front end.

So, it is not expensive to move it.

As long as one has a technology platform that's more compelling than the technology platform of the market from which the account is currently with.

That's the secret here.

You're looking -- we never kidded ourselves.

We didn't think we were going to take share from the Travelers or the Hartford.

We never believed that.

We've always told that to everybody.

Their business is simply too good and it is simply too stable.

It is not in an agent's interest to move that book.

Our goal is to continue to take share from the fragmented marketplace and the other competitors who simply don't have that level of technology support.

The back end component of small commercial is a service center.

The same issue.

The agent can't afford to service these accounts.

That gets to things like certificates of insurance, change of address, endorsements, change of vehicles and actually, the renewal process.

The renewal process can be very expensive.

And so having a service center that can do that and presumably one gets paid for doing that, so it becomes a profit center for the market in which they're doing business, offers the ability of the agent to get out of the servicing business and thereby, increases profitability.

Those are the very two clear elements for success.

Now, you have to have feet on the street.

You have to have a real sales force.

A year and a half ago, we had none.

Today we have over 75 people in our small commercial organization completely dedicated and focused on building this business and we've taken them from the best of the competitors.

These aren't people that we've moved from other jobs internally who weren't cutting it.

We went out and we hired folks from the best of the competitors.

Our commitment to this business is serious and it is real and it really has under it two strategic elements.

First is on its own, it is a good market.

This is where real new business gets created.

Chuck Clark at Travelers used to say to me all the time and I used to laugh, he would look at me and he would say "you know, realize there is no new business.

Your new business is somebody else's nonrenewal."

When you think about that, you can get a headache in our business.

But in fact, in small commercial, there really is new business.

There is new business creation to demographic and immigration trends and patterns support it.

That's where new business creation really occurs.

So, it is a critical market to be in.

Lastly, the only way to be a go-to partner for your agents, the only way to do it is to be a broad base supplier of products and services so that whatever business walks into their door, you're able to respond.

It doesn't mean you'll quote everything or you'll write everything but you want to become important to that agent and if you're not going to be a provider of product in a competitive, meaningful way for an enormous portion of the premium that exists in the U.S. insurance economy, then you're missing the boat.

Those are the elements that drove us into it.

That's why it is so important for our success.

Just one follow-up to that.

It seems to me that the Safecos, Travelers and Hartfords of this world have gone after this business in a focused way for a long time.

They're entrenched.

And they have also had the opportunity to go after the business that they're not serving yet.

So, the question is what's the comparison of the quality of the business you're going to get that you're not going to take away from these guys?

Chris, you can look at large agents.

One of the things also that's happened in this industry is that the agencies themselves have consolidated to increasingly larger entities.

There are many agency operations where the St. Paul is the number one provider of product to that agency.

Many of them, big important significant names.

Where we traded on our ability to sell specialty lines and excess umbrella and quality middle market business.

We have -- I mean there are names and maybe I can get their permission and we can share it with you at some point but the market penetration of this company in many of these agencies are substantial and all we're doing is leveraging that relationship to begin to generate our fair share of the business.

It is not my intention that we will take business from the Travelers.

So, the way I look at it, instead of being a $50 billion market, it is a $48 billion market if I take Travelers out.

There's still plenty of room.

You can take out the Hartford and maybe is a $46.5 billion market.

It is so fragmented and poorly served, that it is not hard.

The amount of new business that we've done in the first three months I would tell you even surprises Marita.

It doesn't surprise me.

I was always the ultimate optimist here but the amount of new business we've done in the first three months gives us a lot of confidence that we're building a real business here.

Ok.

I still don't get why is it so fragmented?

Does that signal something about the rest of the market that's out there?

I just think it's one of those markets that hasn't been worked over yet.

We want to be one of those competitors that's there to work it over.

Thanks a lot.

Ok.

Our next question comes from Miles Henderson of Victory Capital Management.

Yeah.

Good morning.

I was hoping you could help me out here.

I was looking at the -- we can go back to the original [indiscernible] report and add the 4 cents to it for the loss of the sale on the real estate.

My question has to do with the inclusion for the -- I guess you would call it the fourth quarter of Lloyds and I -- tell me if this is correct.

It appears that that 8 cents from that fourth quarter of Lloyds is included in that number, that 8 cent loss.

Am I missing something?

Should that be taken out?

And the other question would be the $39 million adverse development at Lloyds that was in the business you exited.

That was -- that exited line is also part of the Lloyds quarter that was in the -- was included in the fourth quarter.

Yeah, I think in the simple lest form, we reported 86.

It included the loss of 4 cents from the campus.

You have to understand, this isn't an investment property we sold.

I understand.

This was an enormous office park that at one point had 2400 employees..

I'm not confused about that.

We added back the 4.

We get 90.

If we hadn't accelerated the Lloyds quarter, it would have been 97 cents.

Isn't that the number we provide in the back? 94? 94 cents, sorry.

Plus the -- I'm sorry, let's go back and do this right.

We see 90.

Then if we hadn't accelerated -- the acceleration of the Lloyds quarter reduced the earnings by 8 cents.

So, if one wanted to say gee, X the acceleration, you had a 98 cent quarter, how does that -- what do you think about that?

I wouldn't argue at great length with you.

I just didn't want -- I'll leave that to you to make those adjustments and comparisons here but it is pretty clear if we had not accelerated the Lloyds numbers, we would have shown 98 cents in the quarter.

My only other remaining question would be that $39 million adverse development at Lloyds -- that was part of the more recent quarter that was accelerated.

That's right.

In that 8 cent negative.

It is in that 8 cent negative.

Right.

All right.

Thanks.

Pleasure.

Our next question comes from Steven Labbe of Langen McAlenney

Actually Bob Glasspiegel.

I got two forms of the same question.

It looks like -- you did 98 cents, decent but better than the street.

This quarter as I look at the numbers, with the burden of worse runoff than I had been bottling, I think you had been thinking and you're reaffirming sort of '03 operating guidance of what you can accomplish.

Even with again higher runoff and a surety loss which I guess may not have been in your plan.

So it sounds like in a couple of ways, you're saying the underlying operations are really coming in much better than you thought they would be.

Where is the greatest source of upside surprise to generate the really good results?

First, let me go through a couple of pieces that you mentioned.

I lost my train of thought there.

It has been a long morning already.

The business, essentially, is really -- I'm sorry.

This is where I wanted to go, the 120 versus the 60.

Our guidance of 100 to 125 million was based upon the amount of business that we were estimating would be written in the year.

In 2003 and the reserving practices that we would take against it.

And first, the only reason we're at the higher end of that range now is because it appears that the amount of business that we're going to write this year in these lines turned out to be at the higher end of that range.

Nothing's changed.

It is not as though there's reserve development or anything else.

It is simply a rate volume equation.

The volume is going to be up a little bit.

So the underwriting losses are in fact going to be higher.

Put aside the $39 million.

One never budgets for reserve development.

You never anticipate it.

The fact is if you budget for it, you should be booking it now.

So, we had no reason to think that the $39 million was going to come out.

We didn't budget it.

It was never part of the $125.

The $125 was purely and simply based upon the volume that we underwrote.

But again, I would just point out to you that 60 of the 99 is -- 60 part of 125 is a way to think of it.

We have already taken the losses of 60 million of the 125, so as we look out over the next three quarters, what we're anticipating on those three quarters is basically another $65 million of runoff losses and to answer your question, we're not anticipating any adverse reserve development.

One never does.

You always do the work.

You book the number that's given to you.

You assume that it reflects all the issues and you go forward.

So, just as you think about the rest of the year, I think in terms of sort of modeling out, if you will, the runoff losses, the losses occurring in those businesses that we're running off.

You've got $65 million to be spread over the three quarters and I again wouldn't anticipate any other or future reserve development there.

There isn't anything particularly unusual in the first quarter.

There isn't.

There isn't anything I could say that we looked at gee, we had an unusual gain.

Or we had an unusual this or that.

This is really as described.

The 98 cents had to be above what your expectations were.

They were above the street expectations.

We have our own budgets and we have our own performance standards and we're going at it this year.

So, I don't know how to answer that.

There isn't anything in this first quarter that occurred that was particularly inconsistent with the basic performance levels of the business.

I mean you've got the new surety plus the higher runoff losses this quarter so, and your reiterating sort of '03 operating.

Our budget -- I would never like to talk about budget in this, but our budget for runoff losses in this first quarter was $60 million.

We were spot on and we had the additional $39 million but they were spot on our budget from a runoff plan perspective.

Again, there isn't -- the basic core stuff of our business, pricing, expenses, retention, new business, they're all doing real well.

The surety thing, you know, we'll deal with.

The outside box on it is -- literally the outside box is 25 cents a share.

But we do, and Tom mentioned this.

We do have some very anecdotal evidence and the anecdotal evidence comes from the claim organization that's currently managing the worker's compensation claims on behalf of the bankrupt company.

We got a report -- not a report.

It was a phone call.

We got a phone call indicating the reserves that they were carrying against the penal sum of the bonds, and it's less.

We haven't seen a piece of paper, so I'm not prepared to step up to their planned assessments.

I'm not prepared to step up to their analysis.

We're obviously going to have to do our own and we will.

But at least this phone call that we got that described the reserves would give one a level of encouragement that it be could be significantly less.

Ok.

Thank you very much.

Pleasure.

Our next question comes from Steve Shapiro of FF Investments.

My questions has been answered.

Thank you.

Thank you.

Next to Bill Wilt of Morgan Stanley.

Good morning.

Was hoping to get your help in -- I wanted to go to the commercial line segment and the 7% premium growth there.

Just to get your help in reconciling the 7% growth rate.

I think you had also mentioned that retentions increase and premium increases were in the high or mid to high teens.

I was hoping to get your help in bringing those together.

It is actually just arithmetic.

I'll answer but then I really want to turn it over to Marita to give you a feel for what's happening in the business.

If you use a number -- and I'm not going to tell you what the retentions are but I'm just going to share with you an example of how the arithmetic works.

Let's assume for a moment that retention were 80%.

And you were getting rate of 15 just to pick a mid teen number.

On the 80% of the business that you retained, you're getting 15% rate gains.

So, you're down -- the 80% retention means if you think of the book as a portfolio, you're down 20%.

Even under the best of markets, it is awfully unusual to see retention that gets above 80%.

Business moves for lots of reasons.

A lot of the times you make the decision that the account relationship isn't working and you choose to nonrenew.

That happens frequently.

There are any number of accounts that we make the decision that we don't want to be with.

Sometimes they leave for a better price someplace else or better terms or whatever it is.

But it is unusual to see retention on dollars.

Not on pit counts, on dollars, not on policy count, to be above 80.

Then if you have 15% new business, new business is a percentage of expiring income, so you've got an 80 retention, you've got 15% rate.

What did I say? 20% new business.

You obviously if you do the arithmetic will find that your rate gains, your actual growth, your growth in premium will be below 10%.

So, it is really just a matter of looking at those dynamics.

What is the retention.

What is the new business percentage of expiring and what is the rate gain.

In our situation, basically, we've got a rate gain let's call it in the mid teens and we've got a retention and new business combination that is less than 100.

If it were at 100, you would be realizing your rate gains.

The sum of our retention and new business is less than 100 and that's what's doing it and I think very strategically.

These are things you measure.

Don't you drive to but you act in the marketplace given what's out there.

But that's -- let me turn it over to you to fill in.

Absolutely.

I would say that middle market is acting exactly the way we anticipated and planned for it to act.

We've been focusing on the bottom line, not the top line and that's clearly has come through with very profitable numbers.

When Jay was talking about retention, another issue is there is a certain amount of consolidation in the business, there's a certain amount of business that goes out of business.

We're seeing retention behave exactly where we want it to be behave.

Pricing is still solid.

And new business is strong.

One of the things you get in combining middle market with small commercial is that we've said that it will take some time to get the system built and deployed.

It is built.

It is one of the best systems out there.

It is deployed through the agency plant.

We're in the middle, like with any start-up, of doing rate and form filings on a new product .

As Jay said, we never had a meaningful small commercial product in the marketplace.

Now we have that.

To add it to our set of other products and to partner that with very strong middle market franchise and a strong specialty offering so we're offering our agents another product.

So, putting these businesses together we're happy with the growth that we're seeing and we're going to see more growth in '04 when we begin to see small commercial hit the bottom line as well but I would say it is performing exactly the way we expected it to perform and we're getting from the field what we've asked from the field.

I think another point that's important is that it is difficult and I'll explain why to compare one company to another.

There are many company that do some technology business but don't identify it as a specialty and include it in their middle market business.

There are companies that write DNO that don't identify it as a specialty but carry it in their middle market business.

You've got a DNO business where rate gains continue positively off the charts.

Capacity is tight.

Premium growth is up dramatically so there are some people who provide broad based middle market reporting where the numbers will look more robust than ours but that's because what really have been the high growth, high premium rate areas, we've treated as a separate unit and specialty.

So, be a little careful in comparing one business middle market to another.

The devil is in the details on that.

Quick second question if I may and thanks very much for those remarks.

On small commercial I guess two-fold.

Jay, had you mentioned you're a premium target early on in the call for a small commercial I think looking out over the course of the next year.

That was part one.

I said years.

Over the next few years.

Grow into a billion dollars.

Very good.

Thanks.

And are you using a reinsurance partner specifically or separately for a small commercial?

No.

The limits are so low and the exposure is so low that the only thing you have on that is potential catastrophe exposure and there's no individual reinsurance treaty or facultative use in small commercial.

Very good.

Thanks.

Pleasure.

We'll now take a question from Mike Deion of Sandler O'Neil.

My question also concerns the commercial lines unit, with some of your expenses and deployment on the small commercial already out and with the overall combines down in the low 90s given your targeting growth in '04, is it possible to get that combined ratio down into the mid to high 80s level?

I don't know is the answer.

I would rather focus on one part of your question which was the expenses behind it or the expenses in small commercial are behind it.

I think that is in some respect true but my own experience is that business ventures, new business strategic ventures fail because of a lack of investment.

And this is important to our long-term success.

Extremely important.

So, from my perspective and many of you who have been in business with me for a while know my view about expenses as I've given Marita and her group carte blanche from an expense standpoint to grow and develop and build this business.

This is going to be a success.

If the expense ratio should pick up a little because we're making expenditures in people and systems and training and technology and development that make for successful businesses, you bet we're going to continue to do that.

I think the bigger issue in terms of the drive of the combined ratio down from here but be careful where you spend it by the way as I said that.

Don't spend it in one place -

It's mostly rate.

It is rate is what's going to carry that business to more levels to more improved levels of combined performance than expenses will.

One of the things we've been pleased about is the expense discipline within middle market is helping to fund for some of the things that we're doing in small claims.

Absolutely right.

There is another point, too, and this is by way of example but understand that it is more than just one example.

When you weren't in this business for real, when you were only playing at it, you would sign up an account and you would sort of pretend that it was small commercial.

When in fact it wasn't.

And a really good example of that would be fast food chains.

We have more than our share of fast food chains in this organization when I got here.

Everything from the typical burger organizations that you all know and love so well to bagel, one of the national bagel chains.

We had a substantial amount of that.

That is not small commercial business.

And in fact, historically, those group accounts are never priced appropriately.

They just aren't.

And when you looked at the profitability of those accounts here when I got here, they were terrible.

But they filled the premium void and so they continue to stay on the books.

Marita and I had an agreement from the beginning.

If it didn't meet the profit threshold, or if it didn't meet the class, very important.

If it didn't meet the class definition of business that really meets a small commercial underwriting technological box, let's get rid of it!

And we have.

And we're at the tail end of that process and I think that one of the reasons why the retentions are perhaps lower than many of you would have expected but yet the profits are higher is because we've chosen to nonrenew accounts that were not profitable and could not have been converted into the kinds of class business that fits small commercial.

She and I have been in sync exactly on this and everything that we've done, every nonrenewal has been done thoughtfully and intelligently and some of these fast food chains get priced like restaurants but they're really locations for mayhem that happen to serve food.

And the insurance exposures that are attendant in those have nothing to do with hamburgers and so you got to realize that and you got to move on.

That's helpful.

Thank you.

Pleasure.

Our next question comes from Ira Zuckerman of Nutmeg Securities.

Getting on to the investment side.

First of all, can you give us an after tax number or tax write on investment income?

We have an effective rate of close to 30 for the entire operation.

That includes the current mix of investment income to underwriting income.

For the quarter?

That's for the quarter and I don't expect it to change much.

And given the negative cash flow in the quarter with the big payments, has there been any significant shift in the investment portfolio?

In terms of distribution?

No.

We reported the last couple of quarters that we've shortened the duration a bit in anticipation of interest rates but otherwise, no.

Nothing major in terms of the mix on the overall portfolio.

Thank you.

That is star 1 for any questions.

We'll go next to Jay Cohen of Merrill Lynch.

Just a couple of questions.

The first is do you have the carrying value of Nuveen at the end of the quarter?

Yes.

Give me a minute to the get to the page.

I'll ask the other question while you're looking for that one.

That is if you hadn't eliminated the one quarter lag, which hurt the earnings by the 8 cents, wouldn't that 8 cents have come in later in the year anyway?

Oh, sure.

It would have come in.

That negative impact would have been reflected in the second quarter.

Absolutely.

Just wanted to clarify that.

No question.

Jay, the carrying value of Nuveen at the end of the quarter is about 565 million dollars.

$565 million.

Jay, just a point in full disclosure, most of the eight, 60 of the eight -- I'm sorry.

Let me do this differently because I'm going to confuse apples and oranges.

Much of the eight was in fact anticipated and budgeted.

That portion of $39 million, the Lloyds development was not anticipated by us.

Obviously one never anticipates reserve development.

Either good or bad.

It happens when it happens.

Right.

Ok.

It would have been reported in the second quarter.

Your question is correct.

Following up on this last point, the carrying value.

As I do the math and the way I think about it is I kind of take Nuveen out of your book value and out of your market cap and it looks like the insurance operations trading like a shade above book value.

Is that the right way to think about it?

You're looking at it the same which we look at it, Jay.

That's how we think about it.

So, yes.

Ok.

Thanks a lot.

That's the opportunity, I guess.

Thank you.

Ok.

Miss Gagnon, it appears we have no further questions at this time.

I would like to turn the call back over for any additional or closing remarks.

Thank you all very much.

I will be in my office for the remainder of the day if you have any follow-up questions.

That number is 651-310-7696.

Thanks.

That does conclude today's conference.

You may disconnect at this time.