旅行家集團 (TRV) 2003 Q3 法說會逐字稿

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

This call is being recorded.

At this time I would like to turn the conference over to Ms. Laura Gagnon, VP of Finance and Investor Relations.

Please go ahead, Ms. Gagnon.

Thank you.

Good morning, everyone and thanks for joining us for The St. Paul Companies third quarter 2003 conference call.

With me on the call today are Jay Fishman, Chairman and CEO, Tom Bradley, Executive Vice President and CFO;

Mike Miller, President and CEO of Specialty Commercials, and Marita Zuraitis, President and CEO of Commercial Lines, as well as other members of the executive management team.

On the call we will address the quarter and year to date 2003 results, as well as review market conditions and our outlook for 2004.

Copies of the statistical supplement, press release, and power point slides relative to today's discussion are available on the Investor page of our website www.StPaul.com.

Definitions and reconciliations between GAAP and nonGAAP numbers that the company intends to discuss today are provided at the end of the presentation slides, as well as in the earnings release and statistical supplement as required by Reg G.

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 would 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.

The St. Paul Companies assumes no responsibility to update any forward-looking comment.

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 10-Q filed with the SEC and available through our website.

With that I'd like to turn the call over to Jay.

Thank you, Laura.

Good morning all and thanks for taking the time to be with us this morning.

We had a terrific quarter and posted record operating earnings both in terms of overall dollars at 233 million, as well as in terms of earnings per share at 96 cents per share operating, just a terrific quarter.

If you turn to slide five, and this is something new we are doing this quarter, providing you with a power point presentation so you can follow along as we go through some of the dynamics of the quarter.

You can see that operating earnings are up over 90% from the same quarter last year and that our annualized return on equity for the second quarter was in excess of 17%.

Book value per share increased 13% year over year and, importantly, year to date our operating earnings are up 28% from 2002, even after excluding the impact of the Western MacArthur settlement during 2002, and our annualized operating return on equity stands at 15.4%.

The significant improvement in profitability reflects continued successful execution of our strategies combined with an attractive market dynamic of improved pricing, albeit at a slower pace.

Our strategy to broaden our relationships with more of our distribution channel members, to become one of their key trading partners, as we describe it internally, began to show an accelerated net written premium growth in the last quarter and that growth continued strong into the third quarter.

Our ongoing premiums, shown on slide six, are up 25% and total premiums, including the impact of the run-off operations, up 7%.

That's the second consecutive quarter of positive overall net premium growth.

New business continued to accelerate and, as we discussed in the second quarter, this we think is really the measure of our continued success strategically.

In total we wrote $540 million of new business in the quarter and sequentially that compares to $418 million in the second quarter, and $372 million in the first quarter.

Of the $540 in our third quarter new business, $109 million was in small commercial, $140 million was in middle market, and just under $300 million was in our specialty business.

Now, if you recall what we spoke about at the end of the second quarter, for the six months we had done $90 million in small commercial new business and we had done $250 million in new business middle market.

That brings our year to date number in small commercial to $200 million of business, in a venture that initially we started up really seriously in January, and at this point we are running at nearly $400 million of new business in middle market.

We see that as clear indications of strategic success and feel very pleased with the agent response and the results that it's generating.

That kind of growth does bode well for the future.

Our acquisition of the renewal rights to the Kemper business, which we announced in May, is contributing to this growth and Marita's is going to talk about that a bit later.

I do want to make the point that we continue to be exceptionally disciplined in our underwriting and financial management and we are making absolutely certain that we grow only when we believe it is prudent as well as profitable to do so.

Growth without profits is not good and we are very focused on growth that can be achieved only at profitable levels.

Price increases continue but they are decelerating.

They remained in the high teens for specialty commercial and they are lower in commercial lines.

Across each of the businesses, though, price increases continue to exceed loss cost increases and margins continue to expand.

If you turn to slide seven, you can see that the combination of the earned effects of pricing, significant reduction in underwriting losses from the businesses we are exiting, and a continuing focus on underwriting discipline and expense management has resulted in continued improvement in the company's overall combined ratio now down to 94% in the third quarter from 105.7 in the comparable period last year.

Importantly the component segment’s combined ratio was 90.9, down from 92.1 in the third quarter of 2002.

The expense ratio continues to trend down reaching 27.7 in the third quarter, compared to 28.6 in the same period last year.

As I said earlier we are pleased with our performance so far this year and we are excited about the prospects for 2004.

Our ongoing business is very well-positioned for continued success and, as Tom will speak to later, we believe that our 2004 current year run-off losses will decline to less than $10 million per quarter in 2004.

Nuveen Investments, shown on slide eight, continues to generate a base of stable growing earnings for our shareholders, contributing 29 million or 12.5% of our third quarter operating earnings.

For eight years they have increased their assets under management net income.

The result of their strategy to offer a diversified set of products conservatively managed to high net worth individuals and this was accomplished in some of the most challenging environments that the asset management business has seen.

In the future we expect Nuveen to continue to be a substantial contributor to our shareholders returns, enhancing the continued improvement we expect in the returns generated by our insurance operations.

On slide nine you can see that in addition to the earnings generated by Nuveen it adds substantially to our book value in mark to market.

For the third quarter, marking Nuveen to market, after tax, added $4.01 per share of book value to $31.16, that's an increase from 14% of a year ago.

With that I'd like to turn it over to Marita for some comments on the commercial lines business.

Thanks, Jay.

Commercial lines generated strong net written premium growth, 37% in the third quarter.

That was due to a combination of both higher retention ratios, as well as increased new business volume.

Driven in part by the successful execution in renewing former Kemper business.

If you turn to slide 11, you can see that, during the third quarter, the company in total wrote approximately 165 million of business, formerly with Kemper.

We are very pleased with the agents reaction to this renewal writes acquisition and our success in writing what we believe to be very profitable business.

The benefit of purchasing a renewal rights offering, as many of you know, is that you only pay for the business you ultimately write.

It also gives you an advantage in the marketplace over other companies competing for that business.

You have the account history, the underwriting file, the claim file, past risk control reports and developed information.

That helps you adequately assess the risks and therefore be able to establish appropriate pricing.

Given all these dynamics, our underwriters intentionally focused a great deal on the Kemper opportunities.

However our field force is under no pressure to hit any predetermined targets arising out of the transaction.

In addition to Kemper renewals we have established new relationships and new sources of business flow.

We don't view Kemper premium as a one time boost to revenue but as access to a long-term source of new business.

We do expect additional premium from the transaction in the fourth quarter of '03 and early into '04.

We believe that by then we will have added meaningfully to the premium base as well as the future profitability of the business.

As you can see on slide 12, the commercial lines business continues to perform very well; reporting a third quarter combined ratio of 87.2 and this compares to 88.5 a year ago.

We continue to see the positive impact of the earned effect of pricing.

Across our commercial lines business we take on new business only when we are convinced that the price is adequate.

We remain focused on underwriting profitability first.

Our year to date loss ratio has improved 1.3 points over 2002.

Similarly we continue our disciplined approach to expense management as well as productivity improvement as indicated by the 2.6 point expense ratio in the improvement in the quarter and the 1.9 expense ratio improvement on a year to date basis.

The net result of all of these effects is underwriting profit growth of 41% in the quarter and 57% on a year to date basis.

Now I will turn it over to Mike Miller for a discussion of our specialty commercial business.

Thanks Marita.

Specialty commercial information is on slide 13.

Specialty commercial continues to perform very well.

The overall growth rate and net written premium of 19.3% for the quarter is driven by a combination of strong pricing, improving renewal retentions and robust new business.

Overall price increases approached 20% for the quarter, notably in F PS, technology, oil and gas, umbrella, marine, and our construction segments.

On a year to date basis our pricing across the entire segment is at 22%.

Renewal retentions continue to improve in most segments and significant improvements were evidenced in F PS, public sector, and marine.

New business in total was the strongest of any quarter of the past few years and remains constant with our selection quality standards and profitable pricing levels in excess of loss cost.

Our premiums in the surety and construction segments were intentionally flat.

Clearly these indicators are evidence of our strong leadership position in these specialized underwriting operations and demonstrate the clear support of our agents and brokers.

We are quite pleased to record a solid 92.5% combined ratio for the quarter.

This includes the impact of a 115% combined ratio for surety and construction.

The surety and construction combined ratio was driven by construction.

As you know, the commercial construction industry continues to experience difficult times and history would suggest that losses run higher in times of economic stress.

In light of that we have cautiously increased our estimate of the current year loss pick and this quarter reflects a nine-month cumulative adjustment.

Nevertheless, we anticipate that price increases and disciplined underwriting actions will continue to drive the results to profitability.

In our surety operation, which has been dealing with the same difficult economic environment for contractors, our flat premiums are a result of our more stringent underwriting in these difficult economic times, a reduction of our exposure to the very largest contractors through co-surety arrangements and closure of unprofitable branches.

In our other segments in the specialty commercial total, our already profitable results will continue to improve, driven by earned effects of pricing well in excess of loss cost trends.

That's our overview on specialty commercial.

Thanks and before I turn it over to Tom I want to add a comment to Mike's review with the specialty business.

We are going to be updating our (technical difficulty) surety segment disclosures this quarter to provide some additional understanding on the dynamics of that business.

Now, in addition we offer some specific information related to a construction contractor that failed to make payments under certain of its debt obligations during the third quarter of 2003.

The contractor has developed a plan to restructure its operations and its financing and is negotiating revisions to its credit agreements.

In the third quarter of 2003, following our detailed review of this plan, we made collateralized advances to this contractor.

Based upon substantial work done by us and outside advisors, we believe that the contractor will be able to fully complete the projects contemplated by its plan.

As a consequence we expect our advances to be fully repaid by cash flow from the contractors operations, planned asset sales, reinsurance recoveries and, if necessary, recovery on the collateral.

Accordingly we do not expect to incur a significant loss with respect to this account.

As part of the plan, we may issue bonds for new projects but subject always to our underwriting criteria.

To offer fuller understanding we have taken the analysis one step further.

In the unlikely event that the contractor fails to complete all of its current projects, we estimate that our aggregate after-tax loss, net of estimated collateral, reinsurance recoveries and co-surety participation, would not exceed $80 million after tax.

Again, I reiterate that we believe that to be an unlikely event.

With that I am going to turn it over to Tom Bradley to go through some of the financial information.

Thanks, Jay.

Slide 15 shows our underwriting cash flow trends.

These numbers do not include investment receipts, just pure underwriting results.

Positive cash flow in our continuing business continues to improve.

Total ongoing, I'm sorry, total underwriting cash flow increased to $260 million in the quarter from a negative $160 in the second quarter.

Included within the $260 million was approximately $650 million of positive cash flow from the ongoing segment.

We continue to see a trend of increasing cash flow in the ongoing business and a decreasing negative cash flow in our run-off businesses and expect that trend to continue into 2004.

In addition, we are expecting to begin to receive loss payments from the 1999 and 2000 corporate aggregate stop loss reinsurance treaties, which we believe will enhance cash flow by as much as $500 million in 2004 compared to 2003.

We continue to believe that invested assets at the end of this year at cost, will be about even with the end of last year in spite of the $1 billion of negative cash flow, negative underwriting cash flow in the first quarter primarily associated with the $750 million Western MacArthur settlement.

The balance sheet on slide 16 shows that shareholders equity is up $500 million from December, as higher interest rates impacted our unrealized gain in the fixed income portfolio, offset and increased by earnings during the period.

In addition to this impact you will notice that we have adopted FAS 150 during the period.

This reclasses our trust preferred securities as debt.

However, this does not restate prior periods so you will note that mismatch when looking at the prior period.

Our capitalization, as shown on slide 17, continues to improve.

Conventional debt to capital is 22.7%, down from 24.3 at the end of the year, primarily from growing retained earnings.

Total capital increased to $9.8 billion from $9.3 billion at year end.

Switching gears I'd like to talk about run-off so we can move to slide 19.

Run-off losses in the third quarter of $65 million included approximately $40 million of adverse prior year reserve development, substantially all of which related to our Union America subsidiary in London.

Current year losses in the run-off business were approximately $25 million, within the range of our prior guidance.

Reinsurance premiums have tailed off to $40 million in the quarter and healthcare premiums were actually only $1 million for the period.

We continue to estimate current year run-off losses in the 25 to $30 million range for the fourth quarter of 2003.

As a result of looking at our plan for 2004, we are estimating our current year run-off underwriting losses, as reported in the "Other" segment, to average less than $10 million per quarter in 2004, as Jay has mentioned.

We anticipate very little premium and no loss reserve adjustments in that segment.

What we have is basically the period expenses associated with managing those run-off businesses throughout the year.

On the next three slides, I'd like to give you some new detailed information on our healthcare reserves to give you a more robust sense of our assumptions and the trends that we are seeing.

Much of this information has been contained in the 10-Q but we think these graphical representations help understand where we are with these reserves.

Slide 20 shows the cumulative dollar amount of new claims for 2003.

New claims, year to date, are 7% better than predicted at the beginning of the year and we continue to believe that our original assumptions are valid as evidenced by the trend in the graph here.

On slide 21 you can clearly see the trend in case development on open claims.

Increases in reserves on existing cases have been worse than we originally expected, but so far this year, the impact of these increases has been offset by increases in the actual redundancy ratio.

As of the end of the quarter, we believe it is reasonable to expect the case development will drop to zero in the near future.

Slide 22 shows the historical redundancy ratios which we've shown you before.

As of the end of the quarter, the redundancy ratio required to have our reserves ultimately be adequate is 45%.

While we have had several months where the actual has been at or above that level, we are not comfortable that we can consistently perform above 45%.

As a consequence, if there is significant case development in the fourth quarter or beyond, such that it requires an increase in the redundancy ratio above 45 percent, it is likely that a reserve increase of some amount will be required.

Nevertheless, our range of reasonable reserve increases remains from zero to $250 million.

Before I turn it back to Jay, I'd like to address some questions raised by a number of analysts during the quarter regarding our reserves on our casualty reinsurance book of business as written by St. Paul Re during the late 90s.

First point is I would like to warn you that our schedule P is a poor analytical tool for the company in general and for the reinsurance business in particular, for a number of reasons.

First of all, finite reinsurance, which we call nontraditional reinsurance contracts, are included in the traditional casualty excess of loss data, reinsurance excess of loss data in part 1-O of schedule P. This business, obviously, has very different characteristics than a traditional casualty reinsurance business.

The business we wrote in our London reinsurance operation is not included in schedule P, and that made up about one-third of our business through most of this period.

Additionally stop loss reinsurance contracts distort the seeded loss, seeded premiums and carried ID&R, making it difficult to reconcile estimated ultimates with the carry balances.

The St. Paul was a significant purchaser of these contracts covering our reinsurance business in the late 90s.

Slide 23 shows what we have actually booked for casualty reinsurance losses by year for North American Casualty.

It includes our London reinsurance operation, but it excludes the finite business and the stop loss contracts that I mentioned.

Remember, this finite business tends to run around a break even which is why it tends to overstate the good years and understate the bad years.

But as you can see, compared to the industry numbers, we were conservative in putting these reserves up initially and they've remained carried at these levels.

Slide 24 also depicts the reinsurance mix of business during this period.

It is relevant to note that the make up of our book is not weighed toward medical malpractice, professional liability, E&O, or D&O, the more troublesome areas mentioned recently.

Our reinsurance operation were not permitted to right medical malpractice, for the obvious reasons of competing with the primary business, and interestingly nearly half of our business is auto liability.

Jay?

Tom, thanks.

Over the past two years this company has made tremendous strides in repositioning its business, dramatically improving its execution, and changing the culture, the way we think about ourselves and the way we come to work every day.

We are an energized, aggressive organization that rewards performance.

We are an organization that people want to be associated with and do business with.

The trajectory of the earnings are clear.

We are making steady progress to position the company to deliver higher profitable growth in 2004.

On a trailing twelve-month basis, earnings went from $2.90 at the end of the second quarter to $3.34 at the end of the third, an increase of almost 15%.

We are very optimistic as we look forward to '04.

We are not through everything but we've dealt with, quantified, or ring-fenced (ph) as many of the legacy issues as we can.

We continue to believe that we can generate mid-teens ROEs on an operating level and to the extent that we continue to benefit from improving underlying profitability, we will take the opportunity to reinvest in our business, in people, in training, in systems, in development, so that we can provide for the longer term future growth of this company.

And with that we are happy to turn it over to questions and try and be helpful in any way we can.

Thank you, Mr. Fishman.

The question and answer session will be conducted electronically.

If you would like to ask a question, please do so by pressing the star key followed by the digit one on your touchtone telephone.

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

Once again, please press star, followed by the digit one to ask your question, and we'll pause for a moment to give everyone an opportunity to signal.

We'll take our first question from Tom Cholnoky with Goldman Sachs.

I have one question going back.

Unfortunately, by the way none of us hear at Goldman could access your slides.

I don't know what happened.

Maybe our fire walls are two big or whatever.

Laura is actually checking as to why.

We became aware of that.

I hope other people have been able to access it, otherwise we'll obviously send them out later.

I think the data particularly in the medical malpractice, which is new, I think will help give you a robust understanding of it.

But that's not why I dialed in.

Maybe Marita or Mike, can we go back and just talk a little bit about pricing and how you define pricing?

Is this a concept of rate plus exposure and, if it is, can you break that down?

And then also talk about that relative to loss cost trends.

Yeah, Tom, when we give pricing we actually do it ex-exposure, it's pure rate.

It's pure rate?

Yes.

So what we try and do, our concept of rate change is the expiring premium, the expiring premium and the impact on it, same terms and conditions and exposure.

And then we calculate exposure in a different element of our own internal reconciliation of what is happening to premium but it's pure rate.

As close as one can get.

Some of these are obviously estimates, but it's as close to pure rate as one can get.

I you could just compare that to what loss costs trends are, I know it differs by line of business but in general.

We've been carrying an estimate of loss cost trends across our entire book of from 7 to 9%.

That's a big blended number.

Obviously in some lines it's a lot lower and in some lines, emerging trends it's more.

When you look across the entire book, I can't think of a single business where rate is not exceeding loss trends at the moment.

Okay.

Terrific.

I may come back.

Thank you.

Once again to ask your question please press star followed by the digit one and we will pause.

We will move on to Michael Lewis, with UBS.

Good morning, again, just following up on the pricing trends.

If Marita can go into a little more detail exactly what the pricing trends look like in the small and medium-size commercial marketplaces and how St. Paul’s pricing compares to competition.

Again, going away from the business that you've written and the renewal rates you acquired, what's happening with your pursuit of business in general and how do you find the competitive market condition?

First of all I will let Marita speak specifically about the pricing in the lines of business.

I have no idea what other competitors are charging.

We analyze risk by risk, we make our own evaluations and determinations, if we win an account we feel good about it and the truth is if we lose an account we feel almost as good about it.

We do our own analysis and our own economics and whatever is happening in the competitive environment you all probably have as good or better view about it than we do.

Why don't you comment about what you see happening in the small and middle market?

Sure.

I think the key for us, and Jay made this clear, is that in both the small commercial marketplace, as well as middle market, we've had no problem being able to get the price required to capture the loss trend and to retain the business.

We are seeing some deceleration on the property side, but still are seeing increases on the casualty side, and are having no problem getting the loss trend, like we said, and getting the price we need to return these kind of profitability levels.

We are making it very clear to the underwriters that when they can get their price to right the account, when they can't get their price to walk away.

But it's going very well for us and we are not having an issue getting the prices that we need.

Mike, I think an observation, there's no seat change going on, it's not as though the pricing was heading up and then all of a sudden it hit a wall and it had stopped heading up.

First of all these things happen account by account, so any trend that we are talking about it's really homogeneous.

There are thousand and thousands and thousands of transactions that make up a rate change.

So there's no seat change.

Clearly what we are seeing are rate increases but at a slower pace.

Now on any individual transaction you can always find a competitor who may decide that they want that account for some reason who are willing to underbid you at a substantial price.

That's why retentions never get to 100%.

There are always specific circumstances where a competitor makes the decision for whatever reason they want that account.

God bless, they can have it.

I point out that the casualty lines continue to experience rate increases that are significant compared to property.

Property is at a slower pace.

And I think as you look to '04 property probably flattens out.

We are booked it’s actually 70% casualty, 30% property across the whole book.

Much of what Mike writes is casualty exposed business.

So we would anticipate, as you look to '04, still robust increases in pricing on the casualty lines, and I would say probably a flattening by the time we get into '04 on the property lines.

I don't know if that's helpful but that's what we see.

Thanks very much.

We will move on to Charles Gates with CSFB.

Good morning.

I was able to access the slides and the slides were tremendous.

Somebody did a good job.

Two questions.

Question number one, one of you said with regard to $540 million of new business during the quarter the $109 million was small accounts.

How do you define a small account for purposes of this?

I will let Marita give you the real specific definition, but our small business includes two segments that we talk about.

We talk about, and I think these are trademark or service mark names, we talk about our Main Street business, which is the true BOP business, the business owners package, true Main Street type accounts.

And then we have a somewhat proprietary position in, what I would call the large end of small or the small end of middle market, whichever you like that we refer to as Advantage Year.

And there's no one else we think that has their advantage of product that's done on the same technology platform as their small commercial.

And that truly, over time, has proven to be a real competitive advantage here.

But maybe you can fill in some more of the dynamics of small versus an advantage account?

That's perfect Jay.

I think having both of those products on the same technology platform has clearly been an advantage.

Our definition is not a premium definition but an exposure definition.

If we can get our arms around the underwriting, it's slot rated and it is more the complexities of the account as opposed to the premium that it generates.

But it's small, easy to handle, easier to underwrite, easier to mechanize, easier to get the data feed and it clearly is an exposure based definition not a premium based definition.

Given that, the majority of the accounts are under $50,000 in premiums.

We do have others more than that.

I'm sorry?

Can you break the two segments up.

Small commercial would typically be your middle market accounts are typically going to be in the $10,000 range, some of those getting up to the 20, 25,000 in premium.

Advantage typically is between 25 and $50,000 in premiums.

But again it really is based on the complexities of the account and not the premium that it generates.

Although Marita is right, she is giving you a limit on the small, what we call the Main Street book, but the average premium in the Main Street book would be under $10,000.

Absolutely.

It would run up to 25 or perhaps even 40 but the average is under 10.

My second and last question, the book, which is in the $10,000 range and less, that would be basically the new effort, Jay, that you are making as opposed to what was in existence before, sir?

That is correct.

What’s very excited about our growth in the quarter is that it is predominantly being driven by our Main Street book.

We also segment our book in classes of business and we call it, for underwriting purposes A, B and C business, so the lease hazardous, that business is being written in the second quarter and this is the propensity of the growth.

It is right in our sweet spot and we are very happy with writing that business, as well as our service center capabilities in servicing it.

Having the majority of that business going into a service center platform also improves our long-term retention on that business as well.

Thank you.

Marita actually made a very good point there that we hadn't really focused on before.

We do actually, and this is class rated business, we do actually track what we believe to be the underwriting, the quality characteristics what we identify it as A, B, C, and such and I seem to remember that we were booking 85% of the premium in A, B. and C. We ought to check that number to see, that's just a recollection, and that's terrific.

You are talking about a quality business being written in those categories.

Thank you.

And Ron Frank with Smith Barney will have our next question.

I guess it falls to me to dwell on negatives today but, Tom, I wanted to go through some of the issues you talked about vis-a-vis the runoff and other items.

First of all if we can start with the med mal?

I want to be sure I understand what you said.

Going back to the three slides, it looks like new claims are about in line, maybe a little better, is that fair to say?

They've been better pretty steady throughout the year and year to date, 7% better than we would have expected as of the end of the year.

And looking at the chart on 21, the prior year case development is a little worse than you expected or.

Yeah, we expected it to drop down.

We were hoping it would drop to zero faster.

The trend is obviously there but it's not to zero yet.

It's heading in the right direct but not as fast as you would have thought?

That's right.

And then the redundancy ratio has gone up and that's the rate at which case reserves are developing redundantly as I understand it?

Let me help here on one point.

First I think the redundancy ratio can largely be thought of as the result of the other dynamics.

You look at new claims and you make a projection of what they are going to be.

You look at case development and you make a projection.

And then you look at your actual redundancy month to month, you put that together and arithmetically you end up with a required redundancy.

And the required redundancy for the remainer of the book is now at about 45% and that's largely been the impact of the development during the year being worse than we had anticipated it would be.

What I am seeing on slide 21.

22.

Well, 21, correct, right.

We had hoped that would go to zero faster.

So your conclusion is that that, as and when that required redundancy ratio were to rise significantly above 45, and that would most likely be a function of the reserve development, slide 21 continuing to be stubborn, shall we say, in going to zero.

Right.

What might trigger an increase in reserves.

That's correct.

We could sustain actual redundancy ratios above 45.

We have had some months that are, but to sustain that we think wouldn't be the appropriate thing.

I think you are focusing on the right issue, Ron.

We believe that new claims will ultimately end up either at or below what we originally anticipated.

And as some point, we haven't yet, at some point we will take those projected savings and crank them into the model as well.

So we are not worried about new claims.

I don't want to beat it to death, but as of now, what you are telling us is if that redundant ratio holds at 45 you have to increase reserves or if it rises above you have to.

If it rises above.

Okay.

And so far it looks like over the last several months it's sort of been hovering around there.

That's right.

The analogy -- never mind about my analogy.

Next point.

On the reinsurance Tom, you mentioned how you've set your picks versus the industry.

I think the issues that are being raised generally and what gave rise to all the questions you got, people are wondering how well reserved the industry is.

So as opposed to that comparison, can you tell me where your reserves are versus your own indicated ranges or those of outsiders, if available?

We are booked at our indications and we've talked before about the fact that as of the end of '01, prior to committing to doing the Platinum transaction and deciding to retain the '01 and prior business, we did bring in a third party reserve actuary, Middleman and Robinson.

At your indication means middle of your indicated range?

It means our selected estimate which is within the range.

We feel comfortable with our reinsurance reserves.

We are not counting an indicated deficiency on the book and hope it gets better over time.

Our carried reserves are equal to actuarial best estimates.

Finally, Jay, did I hear you correctly that in evaluating the potential for loss on that contractor that's the subject of the Q disclosure that you retained outside advisors?

We did.

We used Forensic Accountants and we used construction experts to come in and help us evaluate the status of the projects, the amount of work that was left to complete, and the amount of funds that were remaining on the contract, yes, we did.

Lastly I promise, the medical mal, this is not a binary outcome, in other words, if the ratio going goes to 45.5, you don't necessarily take all of the 250.

That's exactly right and, in fact, I think that you could look to the amount of development, I am not predicting anything, but I think you can look at the amount of monthly or quarterly development and begin to get a sense of a feel of what the next several months could look like if it doesn't go to zero.

Okay.

Thanks.

Sorry to take so much time.

Next you will hear from Jay Cohen with Merrill Lynch.

A couple questions.

We heard from some other companies, they've seen an increase in asbestos claims recently and others have said they've seen an increase in casualty reinsurance claims.

And I'm wondering in those two areas where you have an exposure what are you seeing?

Are you seeing any noticeable changes in the claims patterns?

On the casualty reinsurance, we’ve talked about that in general on this slide on 23, from a pattern standpoint, it's not a lot different because we think we reserved it strongly to begin with.

So in terms of seeing actual movement and development, that's not been a big factor.

On asbestos, we've seen a little tick up in what we would call higher frequency, lower severity type claims.

Nothing in the severity arena but a little bit in frequency.

I know that someone else was speculating as to whether the perception that legislation might emerge, perhaps it precipitated it.

What we are seeing would not a trend define.

It's a little tick up but nothing dramatic.

Next question.

Just to maybe simplify or try to come to a possible conclusion about Ron's questions.

In your original guesstimate of worse case scenario of $250 million, I would assume after you've had three quarters now this year to look at it, I would have thought you would narrow that range.

But would you say the chances of a loss hitting that level are still uncertain, less than they were at the beginning of the year, can you maybe qualify the 250 a bit more than you did earlier in the year?

I don't know that we are ready to handicap it to be honest with you.

I expressed even 18 months ago that this was a complicated matter with a lot of moving parts.

And everyone was pushing us to try and come to conclusions earlier and I kept saying, look, we are in the fourth inning, was my recollection.

I think we are probably in the seventh inning or something like that now and it's going to become in the near term increasingly apparent where this is going to end up.

To be candid with you if ask you three different people inside the company who work with this every single day you likely would get three different answers about what the ultimate outcome would be.

It's difficult for us to conclude.

We think that the analysis that supports that reasonable downside case of 250 still stands, and that's where we are, Jay.

I wish we could be more helpful.

And to the point it isn't binary, it's a range of zero to 250 and it is going to depend on these statistics as we watch them month to month and settle the claims.

On the good side the book has been managed so we believe that the more difficult, the oldest, the worse cases were dealt with earliest.

Because one of the things that we always ask ourselves, is is the inventory homogenous?

Is it changing?

And in fact if it is changing, we think it's changing for the better.

So we are encouraged and we are optimistic about that.

That could actually help account for some of the development that we saw during the year being worse than we had expected.

If that turns out to be true then we are going to see lesser development down the road.

There are too many moving parts to be definitive.

Fair points.

Last quick one, was there any favorable prior year development in some of your other businesses or was the accident year pretty close to the calendar year in those businesses.

Pretty much a straight book.

There was no favorable development in the quarter.

Thanks for the answers.

Our next question we'll here from Jay Gelb with Prudential Equity Group.

Thank you.

I just want a couple of clarifications.

First on the commercial lines, looking at the renewal rate acquisition deals you've done.

Can you give us a little bit more flavor in terms of what we should be building into the models from a premium standpoint, say fourth quarter and 2004?

Let us talk about that internally before we respond.

I want to give some thought.

From a Kemper perspective, year to date we've written approximately $200 million in business associated with the transaction.

We are pleased with the quality of the business as we stated before.

We will see some addition of business in the fourth quarter, a little more going into the early part of '04.

But, as we said, our field force is under no obligation to write the business.

We haven't established targets, but that's what we've done so far on the Kemper transaction.

Is most of that business front loaded?

For example did you cancel and rewrite everything to start with the date of the transaction since most of it comes up front.

There was a substantial amount of cancel and rewrite in it, so that’s correct.

That's why Marita is saying, by the time we get to the end of 2003 most of the written premium impact will have been reflected on our books.

There will be some into the first quarter.

Okay.

That's helpful.

Thank you.

And on the surety and construction standpoint, you raised the loss but can you give us a feeling of what the underlying business was running at from a combined ratio standpoint, excluding the pick, for the nine months and the third quarter?

We just don't provide that level of granular detail on the underlying loss picks themselves.

Let us take that under advisement and we will see what we want to do about that.

We generally just don't go into that level of granular detail on individual business lines.

The increase in the pick was some, it was not overwhelming.

And it was really done to reflect, there was an interesting article in the Wall Street Journal just I think early part of last week, which talked about the fact that the commercial construction segment continues to be very much in the doldrums and that the industry as a whole has been largely supported by the residential segment.

We, of course, really are not involved in residential contractors.

We are a commercial contractor insurer and as a consequence it's been an experience that in difficult economic times losses tend to run.

So what we are doing here is a preemptive move, if you like, to reflect the possibility that '03 losses, as they ultimately develop, will emerge worse than we would have thought 6 months ago.

It is a current year adjustment.

It is not a change in prior year reserves.

Maybe if I can approach that another way.

Based on taking the pick action this quarter, do you think we've seen kind of the worst of the results in surety and construction from an underwriting result standpoint, that things should improve from here going forward?

I guess I have to think about that a little.

What you will see is obviously we had a cumulative effect in the combined ratio in this quarter because this was a nine-month true up so it will be benefited in the fourth quarter as a result of that.

That will be a modest improvement.

We are going to continue to be conservative in the surety line.

The only thing I can think of and there's no subtle hint here, there's no warning, surety losses are to some extent unpredictable and you just never know.

But given what we know now I would say it certainly isn't likely to go up.

If anything I would say it's, the answer to your question would be cautiously yes.

Okay.

And finally on the new disclosure in the Q. Is that related to a contractor in the big dig in Boston?

We are not going to make any further disclosure on the specifics of the insured.

We think that we have quantified a significant exposure for you.

I think what's important, Laura, and I will stick up for her for a moment, she gets lots of calls and lots of questions.

And we do try and tell people, when we have something to say, we'll say it and those aren't gratuitous words.

They are meant quite seriously.

We are proud of the transparency of our disclosure.

We don't think that there's anybody else in the industry that provides the kind of forward-looking data and the forward-looking exposure analysis that we do.

And it's not that we are ducking the question.

The honest answer is, when we have something to say, we will say it and we have said it, so that's where it is.

I hope it helps you.

It does.

And Bob Glasspiegel with Langen McAlenney, will have our next question.

Good morning.

It seems like I am more optimistic about cash flow than you are.

I mean, based on the third quarter trend it looks like it would take only $180 million of insurance underwriting and investment income cash flow to beat where you started the year at cost.

You had over $500 million this quarter.

Was there something funny in the third quarter run rate that we shouldn't extract into Q4?

No, I was just referring back to the original assumption we made and just trying to indicate that I think it's pretty solid that we will get there.

That was just conservative elements in your forecast as opposed to a specific forecast that I was - I was overreacting to.

Yeah, a year ago we weren't sure but we were trying to give you some guidance and now we are pretty come comfortable with that.

You said Q3 run rate if it is a good legitimate one assuming that the underwriting holds at the current rate, into '04 we should have 500 million for the year.

I think it could be up to 500.

There's some timing on the way these payments come in, but that's kind of a bonus from having done (indiscernible)in '99, 2000, we are finally starting to get paid on them.

So north of $2 billion of cash flow, if you extract the third quarter run rate, wouldn't be a mistake.

Whatever your calculator is, Bob.

That's your number.

Okay.

If I could work the surety question just a little bit harder.

I think your numbers and what your 10-Q is going to disclose seems to be pretty encouraging.

There were some bigger estimates for what the potential exposure might have been floating around.

Where have the outside people been wrong versus where you are coming from and coming to much higher numbers?

I think that the surety business is a pretty complicated matter and some people try to go to websites and pick up a little factoid here and a factoid there and make a conclusion from inconsequential, incomplete and often inaccurate public data.

What it took us to do this is to roll up our sleeves and go through each and every single one of the individual projects on which we have a bonded position.

And that means determining its percentage of completion, the bills outstanding, the underlying cash flows related to it, cost to complete, the amount of considerations still coming from the third party.

This was hard work.

This was a lot of people working for a long period of time on a series of complex matters.

So I think that what people miss is that it is a sophisticated business with pretty complex analysis behind it and I think people often try and meet that incomplete inaccurate public data and draw a conclusion from it.

God bless.

I've always said when we have something to say we will say it.

Was it recoveries from reinsurers (indiscernible) people were missing or was it less costly to finish the projects where you had more hard assets to get.

I think it's if you step back broadly from the issue, what we had was a contractor who hit a particular cash flow difficulty.

The projects themselves had integrity.

The work was well done.

There was not rework that needed to be done.

The contractor wasn't going out of business.

They weren't putting down their tools and walked away.

So the question is, how much cash was needed, this is the analysis that had to be done, how much cash in the form of the advances was needed to get the contractor over the cash flow hurdle?

And then, if we had done that, this was the analysis we had to do, did we have a high degree of confidence that that solved the issue and would allow the contractor to complete the projects?

The answer to that was a firm yes, once we got over the cash flow hurdle, we believe that the contractor has all ability now to complete the projects in accordance with the contract terms.

It also happens to be that the advances are highly collateralized and make us feel, with real assets, and make us feel very good about the ultimate collectability of them.

So I think it's in the trenches.

It's in the operations of being in the insurance business.

It's analyzing and adjudicating a claim led by a group of professionals who actually know what they are doing.

So that's the long and short of it.

Just to conclude, the fact that you are waiting until the 10-Q to disclose it suggests that this is a recent resolution of the matter with the contractor?

We say that we don't anticipate a loss.

Right.

I mean, this is, we said when we have something to say we will say it.

If we had thought that there would have been a significant loss that needed to be recognized in the quarter, just like we did with any number of other instances where we were confronted with that, we would have issued the necessary documents including, if appropriate, an 8-K.

The 10-K is driven more by in the posted quarter, you view the Q, and you look at all your risks and uncertainties and we've been pretty up front in the past about when we see things on the horizon that might have some uncertainty around them we put them in there.

That's what triggers it being a Q as opposed to an 8-K in the middle of some period.

Thank you.

I think that's generally reassuring.

If you can look back at the history of this company over the last two years we have not been in any way shy about putting the investing public on notice, including, from day one, on issues that we thought were substantive and potentially meaningfully impactful to the earnings and doing so on a current basis.

This because we think we have no loss we think that it's appropriate that the disclosure be here.

Thank you very much.

Next question we will hear from Chris Winans from Lehman Brothers.

Thank you.

A couple of questions.

First, can you characterize the source of your new business especially on the box business?

In other words, your bigger competitors, more competitors, regionals, that kind of thing?

I think we are doing a good job in taking business that agents choose to drive our way.

We have obviously been benefited by the Kemper renewal rights.

I don't really have any comments to make on where the business came from, with the exception of the benefit, and we can disclose it, of the impact of the Kemper business.

In terms of the rates and the underwriting environment, do you see any signs in the rest of the book, any parts of it, of any further tightening or stability or loosening in terms of terms and conditions?

No.

In a nutshell, again.

There's been no seat change.

There's been no dramatic turn.

It is not that on an individual account you won't find something but, no, I would say generally the answer is no.

To go after the surety question again.

I'm a little bit puzzled by your, in the big dig there is a company called Modern Continental that you are clearly the surety on along with a couple of other co-suretys.

And we've been able to have discussions with some of your co-suretys on that particular company and their particular problems.

All of this information is in the public record.

This is a Public Works project, so it's not hard to get the documentation.

There's also been plenty of press on Modern Continental's problems and lawsuits and what have you.

So my question is, what is the hesitation to specifically talk about this specific company since this is obviously a one company issue?

We have a policy of really not discussing individual insureds.

They are our customers and we have certain obligations to them, beyond, other than that which is necessary to meet our obligations to the investing public to and make appropriate disclosure.

And we think we have made full and appropriate disclosure to that matter and we really have nothing else to say.

Just that when so much information is public record it just seems unnecessary to take that approach on a sort of blanket way.

At any rate, and finally on that surety estimate, the worse case scenario that you say you are disclosing in the Q. If I can just get one detail, what is the assumption on that $80 million worst case regarding reinsurance?

Is that a net of reinsurance estimate?

Yes.

What would be the gross estimate?

We've not disclosed it.

Why is that?

Because we think that there is no reason to think that it wouldn't be collectible.

We've disclosed.

What we disclosed is the exposure that we currently believe to be, what I would describe, again, as an unlikely worst case which is that the contractor puts down their tools and walks away from all the contracts.

They are obviously still in business.

They are still completing the projects.

They are still working.

So we don't anticipate a loss.

What we've tried to do as a as it (indiscernible) disclosure is to provide a worst case analysis of the loss if circumstances were to somehow change and we think we've done that, Chris.

Thank you.

Okay.

Thank you.

Next I will move on to Mike Dion with Sandler O'Neill.

A question regarding workers comp.

That’s been a line that's hampered a number of commercial underwriters over the last several quarters.

If you can comment on any trends you are seeing in the smaller or mid market lines as it relates to workers comp particularly as medical costs continue to rise?

What I would say on the Workers' Comp. line is that we have historically been a conservative writer of Workers' Comp.

We have strong underwriting discipline in the line.

Our percentage of Workers' Comp. to the total book that we write has not changed at all over several years of tracking it.

We continue to track it.

We know the states where it's more difficult to do comp, and we track those even more significantly and closer.

We are comfortable with the comp that we write and we are going to continue this same underwriting stance that we've taken.

I think just two observations just in the context of this, this is a company that, deep in its culture, actually has a bit of an aversion to Workers' Compensation.

It's been interesting here.

And I think companies do develop underwriting cultures that way.

We do have a bit of one and candidly, we are actually trying to break that down a little bit because it's an important element.

But our exposure in the comp arena has been undersized for a company of our size.

And secondly, you are right about the trends in medical, the medical component within Workers' Comp. but I remind you that, at least as of the last data I saw from the Workers' Compensation Board, it's still almost two-thirds of Workers' Compensation losses are indemnity dollars and one-third medical.

So there's a tendency to over exaggerate the impact of medical trends on Workers' Compensation losses.

Great.

Thank you.

Bill Wilt with Morgan Stanley will have the next question.

I will be quick considering the time.

Looking ahead to growth.

I wonder if you can speak to the infrastructure investments that you think might be necessary to support the growth.

I guess I am thinking of claims, administration, technology and so forth with an eye toward your thoughts about the company's expense ratio in conjunction with the growth?

Yeah, I would say it a little differently.

There's an interesting notion if you are in the manufacturing environment and you hit a spell where profits are particularly strong, companies make decisions to make investments.

They build new plants.

They higher new people.

They make investment in a long-term structure.

What we are talking about here would be the same kind of thing.

Where, if in fact, the opportunity presented itself for us to continue to hire field people, to continue to put people on the Street, to make investments in better and more sophisticated modeling techniques for our, particularly our automated underwriting environment, but we would only do so within our ability to continue to produce the kinds of mid-teens returns that we are talking about.

I think you take the opportunity when times allow you make those kinds of investments and then obviously when times don't you scale them back.

So I wouldn't get overly concerned about its impact on its expense ratio because I would actually view it more as a by-product of underlying profitability rather than as a necessity to meet existing demand.

That's helpful.

Thanks.

Tom, I think last time we spoke if I remember correctly The St. Paul, the holding company was going to pull or request an extraordinary dividend from Fire and Marine, is that right, did it happen and if so how much was it?

Year to date we've taken $125 million dividend above the statutory minimum from the Fire and Marine.

Is there more expected or is that likely it?

We haven't decided what else we would do for the fourth quarter.

For now that's where we are as of now.

That's helpful, thanks.

If you could hit me one last time with the definition of the redundancy ratio, that would be helpful.

Sure.

The redundancy ratio is actually a fancy name on what's pretty simple.

If you have a case reserved for an account that's up for $100 you settle the account for $60 you have a redundancy ratio of 40%.

It's the case savings divided by the carried case reserve.

You would ask the question, and I did, because this is different, why does that happen?

And obviously from the graph you see that it happens each and every single month.

The answer is that we believe that you encourage claims adjusters, you know, claims don't age well.

They are not wine, they are more like beer.

And the ability to deal with claims promptly and move them, is not only the decision that you make at the management level but it gets down right to the controls that exist at the claim adjuster’s level.

So if you allow the adjusters to set their own case reserves at levels and if they know they can settle the case, and then encourage them to do a good job in settling it, you get the combination benefit of they get taken care of sooner and they get taken care of by definition at lower dollars.

And what's interesting the real proof in the pudding here is the extent to which the claimed inventory overall has declined in this environment.

Not just now but I am talking about the entire claim book inventory is down and down significantly from when we started two years ago.

And it really is an indication of the ability to attend to claims more promptly and so we allow the claims adjusters to have the responsibility and the authority to handle them and then we watch the ultimate performance.

As this process has gone on the redundancy ratio has actually grown from the low 20s when we started it to now the early 40s.

To go back to your last question just for the benefit of everybody else on the call, I just want to do say that from an extraordinary dividend as defined isn't that extraordinary.

It's defined that the state allows you basically automatically to take a certain level of dividend and take (ph) above that and you go to the state and get approval and they look at you and decide, yeah, that's no problem.

It's defined as an extraordinary dividend.

I didn't want to give the impression that it was any kind of urgent matter that we had to go to the state and get that.

That's helpful.

I think if I ask any more questions on the redundancy ratio my actuarial credentials might get revoked.

Thanks for the help.

And Steven Gavious with Dryfus has the next question.

Thank you.

My issues have been addressed.

We will take time for one last question.

I know that there is another call, I think that began 10 minutes ago.

We'll take one last question.

Yes.

We will take one last question and that will be from Brian Meredith with Banc of America Securities.

Hi, good morning it's actually Tamara Cravack.

Brian is on the Excell call.

A couple quick questions.

On your aggregate stop loss reinsurance program.

How much of that is actually remaining as of now and, in other words, how much more adverse development can you have there?

Second question is, will you conduct a year end reserve review similar to what you did last year, and is that going to include reinsurances as well as asbestos?

And would you have a review by a third party as well?

And then I have one more follow up.

The first question on the aggregate stop loss is those were actually just in place for the '99 and 2000 accident years and they were fully utilized.

So there's no more recovery that would be expected from those treaties.

Okay.

And we didn't do an independent reserve review last year.

I'm not sure what you're referring to.

I mentioned that in the reinsurance business we did one at the end of '01 prior to executing on the Platinum transaction.

So would you then do one this year, do you think?

No, we close our books each quarter.

We go through a robust closing process internally.

It's reviewed by our independent auditors, but we won't be going outside to bring in any outsiders to do anything particularly special.

The level of work that's done here on a regular quarterly basis is exceptional.

That includes your asbestos book, right?

Yes.

Lastly what is your appetite for additional renewal writes deals just following the Kemper acquisition and what is your operational capability to undertake another renewal writes deal if something comes up?

Two good questions.

We have plenty of appetite as long they are properly priced and sometimes they are and sometimes they are not and when they are not we get full very quickly.

We do look, we look at anything that makes any sense and there are a number of books that have floated around.

On the question of our ability to execute, I think what this team did in pulling the Kemper thing together, the issue of cancel and rewrite was a big deal.

We basically renewed nine months worth of business basically in about three to four months.

And I think the execution that was done here was phenomenal.

I have no problem, no lack of confidence whatsoever to put this group into another significant renewal writes transaction.

We can do it.

Great.

Thanks.

Pleasure.

All right, Laura, back to you.

Thank you, everyone.

I will be in my office for the remainder of the day if you have follow up questions or if we were unable to get to your question.

My number is 651-310-7696.

Thank you all.

We will speak to you next quarter.

That will conclude today's conference call.

Thank you for your participation.