旅行家集團 (TRV) 2005 Q2 法說會逐字稿

Welcome to the second-quarter earnings review for St. Paul Travelers.

We ask that you hold all questions until the completion of formal remarks, at which time you will be given instructions for the question-and-answer session.

At this time I would like to turn the call over to Miss Maria Olivo, Executive Vice President of St. Paul Travelers and head of Investor Relations.

Ms. Olivo, you may begin.

Thank you.

Good morning, everyone, and welcome to St. Paul Travelers' discussion of our second-quarter 2005 earnings.

Hopefully all of you have seen our press release, financial supplement, and webcast presentation released earlier this morning.

All these materials can be found on our website at www.stpaultravelers.com under the investor section.

Today with us we have Jay Fishman, our Chief Executive Officer;

Jay Benet, our Chief Financial Officer;

Brian MacLean, head of our Commercial and Specialty businesses; and Joe Lacher, head of our Personal business.

They will discuss the financial results of our business for the quarter and the current market environment.

We will be referring to the webcast presentation as they go through their comments.

We will then open it up for question and answer after their remarks.

We will promptly end the call by 10 AM in respect of several other insurers that have their calls scheduled at 10 AM.

Before I turn it over to Jay, who will start the discussion, I would like to mention the following.

Our presentation today may include certain forward-looking information as defined in the Private Securities Litigation Reform Act of 1995.

All statements other than statements of historical facts may be forward-looking statements.

Specifically we may make forward-looking statements about the Company's results of operations, financial condition and liquidity, the sufficiency of the Company's reserves, postmerger integration, and other topics.

The Company cautions investors that any forward-looking statements involve risks and uncertainties and are not guarantees of future performance.

Actual results may differ materially from our current expectations due to a variety of factors.

These factors are described in our earnings press release and in our most recent 10-K filed with the Securities and Exchange Commission.

We do not undertake any obligation to update forward-looking statements.

Also in our remarks or responses to questions we may mention St. Paul Travelers' operating income, which we used as a measure of profit, and other measures which may be non-GAAP financial measures.

Reconciliations are included in our earnings press release and financial supplement and other materials that are available in the investor section of our website.

With that, I will turn it over to Jay Fishman.

Thank you, Maria.

Good morning, everyone, and thank you for joining us for our second-quarter earnings call.

We're very pleased to report just an outstanding quarterly performance.

As our press release indicates and as you can see from the second page of our webcast, we posted operating income of $966 million or $1.38 per diluted share, operating return on equity of 18.6%, and a combined ratio of 87.6%.

Net income for the quarter, which included a $138 million gain from the partial sale of our Nuveen shares, was $1,069,000,000 or $1.52 per diluted share.

The quarter's results were driven by strong investment income, light weather, continued benign loss trends, the cumulative impact of our realized merger efficiencies, and net favorable prior-period reserve development of $50 million after-tax, primarily driven by our personal lines business.

For the first six months of this year, we posted operating income of $1,825,000,000 or $2.60 per diluted share, operating return on equity of 17.7%, and our combined ratio was 89.1%.

It is worth noting that the earnings for the first six months of this year have exceeded the individual earnings of either predecessor company for any prior year in its entirety.

Our revenue picture is showing momentum.

For the entire Company, excluding the runoff operations, premiums were flat quarter-over-quarter, despite last year's quarter benefiting from several renewal rights transactions.

This compares to a 3% decline quarter-over-quarter in the first quarter of this year.

Inside the revenue picture, the profile also continues to improve.

Retentions remain very strong.

In fact, for our commercial and domestic specialty operations, retentions are now at historically high levels.

We are doing an outstanding job of retaining our business, and the rate environment remains at a level where returns are still quite attractive.

In fact, in many of our businesses renewals price changes remain positive.

We believe that most of the companies in our industry will be reporting strong retentions this quarter, and as a result new business flow in the market remains somewhat limited.

Nevertheless, our new business generally continues to improve, and we write new business where the risk classification and pricing make sense, and we pass where they don't.

As we emphasized in our investor day conference this past May, we are growth oriented, but only when conditions reasonably allow.

Nonetheless, we are encouraged that new business in the second quarter is now approaching the levels we experienced in the second quarter of 2004.

Again, an encouraging picture.

Within personal, our homeowners and other business continues to show strong growth with very attractive combined ratios.

In auto, we continued to grow policies in force, but saw a quarter-over-quarter decline in auto gross written premiums for the first time in several years.

The decline, however, was only 1%.

As we roll out our new Quantum product we're optimistic about its potential favorable impact on production, and Joe Lacher will talk more about this in a few minutes.

Many of the initiatives that we spoke about at our investor day conference are well underway.

Our new business platform in Select became available for June 1 business, and it is encouraging to us that new business in Select for the quarter exceeded $100 million for the first time since the merger.

No predictions here, but encouraging early news.

A rollout of 30 district executives to support our regional executives is largely complete, and the agents are seeing a difference with our increased accessibility and responsiveness.

We will be distributing the first version of our district controllable financial statements, which will provide franchise-wide income statement and production information for each of the district regions over the next 60 to 90 days.

This will help us measure how effective each district's overall performance is and how successful we are in penetrating that region's agency brokers.

We have staffed up our sales and marketing organization, and Kate Preston, our new EVP for field marketing, joins us full-time in the middle of September, but she is already meaningfully involved on a part-time basis getting our marketing efforts more systematic and focused.

The Company's capital position and financial flexibility are very strong.

The internal generation of earnings of $1.8 billion for the first six months of this year and the nearly $2 billion of after-tax proceeds from the sale of our investment in Nuveen is significantly improving our holding company liquidity and statutory capital position.

We also reduced our total debt by over $800 million from year-end 2004, including the elimination of the Nuveen debt, and recently completed the combination of our two insurance pools into one.

A.M.

Best has assigned a rating of A+ to that pool;

Moody's has assigned Aa3; and Standard & Poor's and Fitch have left their ratings unchanged at A+ and AA-, respectively.

During the quarter we were also pleased to announce a settlement with Kemper with respect to our central artery cosurety exposure.

The settlement resulted in no charge being required in the quarter.

As we indicated in our announcement with respect to that settlement, we believe that our reserve position for the contractor involved in the central artery project is sound.

Momentum feels quite good in the business, and as a result we are optimistic about the rest of this year.

Loss trends remain fairly benign.

Rate remains comfortable, and the energy in our organization is quite high.

As a result of the earnings so far this year and our outlook for the second half of the year, we're raising our financial targets for 2005.

We previously indicated that we were comfortable moving higher in the 13% to 15% operating return on equity range.

We're updating our operating return on equity range for 2005 to 15% to 16% and are comfortable toward the middle of that range.

It is important to note that this is assuming normal catastrophe and noncatastrophe weather for the rest of the year and no further prior-period reserve development, either positive or negative.

The cumulative prior-year reserve development for the first six months of this year was an after-tax benefit of $86 million.

Our assumption for catastrophe losses for the second half of the year is $75 million after-tax, predominantly in the third quarter.

We're also assuming that the very benign noncatastrophe weather that occurred in the first half of this year will return to more normal levels in the second half.

Our base measure for equity is average shareholders' equity for 2005 excluding FAS 115; and of course we're also taking into account the change in equity resulting from the conversion of our equity-linked notes.

With respect to future capital management plans, subject to being on target to achieve our ratings goals, and given our earnings generation ability, we will seriously consider active capital management actions if meaningful growth opportunities are not available to us.

Assuming we stay on track to achieve these goals, we will evaluate these alternatives as we turn to '06.

Before I turn to Jay Benet, let me now give you an update on the regulatory matters impacting our industry.

As we previously reported, in connection with the ongoing industry-wide investigations related to finite reinsurance, the Company had undertaken an internal review with respect to finite reinsurance products the Company both purchased and sold.

Last quarter, we reported that the Company's review with respect to products purchased had been completed.

We now also have completed our review with respect to finite products sold.

Based on this in-depth review and the information obtained by the Company in the course of that review, the Company has concluded that no adjustment to its previously issued financial statements is required.

We would like to note, however, that these as well as the other regulatory investigations described last quarter remain ongoing, as are the Company's efforts to cooperate with the authorities.

In that regard, we do not intend or pretend to speak for any regulator.

Any of the various regulatory authorities could ask that additional work be performed or reach conclusions different from those of the Company; and accordingly it would be premature to reach any conclusions as to the ultimate outcome of these matters.

This will be all that we really have to say with respect to these matters.

With that, let me turn it over to Jay who will cover the operating dynamics of our business this quarter.

Thank you, Jay.

Page 3 of the webcast contains financial highlights for the quarter, many of which Jay has already mentioned.

To briefly reiterate, net earned premiums of 5.1 billion were consistent with the prior-year quarter.

We achieved record operating income of 966 million.

Operating income per share came in at $1.38, and we recorded an extremely healthy ROE of 18.6%.

Our underlying earnings power remains quite strong and (technical difficulty) benefited from favorable weather, favorable prior-year reserve development in our Personal segment, and higher-than-expected investment performance in our private equity portfolio.

Turning to page 4, we continue to see very healthy margins in all of our business segments.

Our consolidated combined ratio was 87.6% for the quarter, or 88.9% excluding cats and favorable prior-year developments.

This is better than both the 95.1% we recorded in the second quarter of 2004 and the 91.0% we recorded in the first quarter of 2005, also excluding cats and prior-year development.

The strong rate environment of the past several years, coupled with continued favorable frequency of loss and no surprises in loss severity, have been the major drivers of these favorable margins.

Our expense ratio has also improved by 1.4 points to 28.2% in the current quarter, down from 29.6% in the prior-year quarter.

Page 5 shows gross written premiums by market for our three segments, including a comparison of second-quarter 2005 with second-quarter 2004.

Overall, premium volume of 5.9 billion, excluding the impact of the run-off businesses characterized as Commercial Other, was up slightly from the prior-year quarter, the first time this has been achieved in several quarters.

Core commercial gross written premiums of 2.4 billion were lower by 2%, compared to being down 7% in the first quarter of this year; and Specialty was up 1%, compared to being down 3% in 1Q '05.

Personal continued its growth trend and was up 4% in the quarter.

Similarly, core commercial net written premiums for the second quarter, as shown on page 6, were lower by 2%, an improvement from the first quarter of 2005 when they were down 8%.

Specialty was up 6% compared to being down 12% in the first quarter; and personal was up 4%, similar to its 5% first-quarter growth.

As a reminder, we're disclosing both gross and net written premiums due to changes in our casualty ceded reinsurance programs that have made specialty ceded and net written premiums not comparable period to period.

It should also be noted that Discover Re has been moved to the Commercial segment for all periods presented and, for the first time, we do not show pro forma premium comparisons for the quarter since St. Paul is now included in the prior-quarter GAAP results.

With that, I will turn it over to Brian.

Thanks, Jay.

I am going to take a few minutes to talk about the Commercial and Specialty segment results and the marketplace as we see it today.

Starting with the Commercial segment businesses, with profits of 530 million and a combined ratio of 89.5, the earnings picture is excellent.

For the six months, this segment has now earned just shy of $1 billion.

Consistent with the overall results, earnings were helped by a mild weather quarter and strong net investment income; but the underlying trends were also positive.

So even though prices are declining, the decline in the aggregate is fairly modest; and loss trends from both the frequency and severity perspective are favorable.

So in fact, if you look at margins so far this year, even excluding the positive weather trend, the margins are clearly holding their own.

From a top-line perspective, we continue to feel good about our direction.

Excluding the run-off ops, premiums were down slightly, about 2%, but, as Jay mentioned, significantly improved from where we have been in recent quarters.

In the current market conditions we are pleased with this progress and believe our organization is executing appropriately.

Focusing on some of the production stats on page 7, we can see that in our core guaranteed (ph) cost markets, Commercial Accounts and Select, retentions are strong and new business is rising.

In both of these markets, our current product profitability margins are very strong, so our overwhelming priority is to retain our book.

In Commercial, retention was over 80% with only a modest decline in price.

We would obviously prefer to have prices rising; but given current conditions and loss trends we're very comfortable at these levels.

New business dollars have now risen in three consecutive quarters.

It is at the highest level since the merger.

Although new business pricing is currently very competitive, we're confident the quality of what we are writing is very strong.

We're particularly encouraged by deal flow, and by that I mean the number of opportunities that are coming into our field organization each month.

Our flow of middle market accounts has risen for the last five months, and we believe it is clear evidence that the agency plant has gotten over any concern they may have had with us over the merger.

Speaking to some of the businesses within Commercial Accounts, the core field book, which is the largest part of this business, continues to build momentum.

Retentions are now around 80%, with the renewal price change around -2%.

This is where we have been for the last 11 months or roughly since last August.

The challenge has been new business, where we believe pricing is declining faster.

As you all know, it is harder to measure change in new business pricing; but the normal gap that exists between renewal and new pricing is certainly widening, and we're watching that very closely.

In our dedicated first-party businesses, we have had a good deal of success.

In the Inland Marine and Agra businesses, we have seen modest but consistent growth over the last four quarters and feel great about our position in these markets.

In the large property risks, which is a significant area for us, we have had fantastic retentions, 90% for the quarter; and although prices have softened, terms and conditions are holding, and we're confident that our margins in this line remain strong.

Shifting to Select, or the small commercial area, the results here have been even stronger.

Retentions of 84% for the quarter is at historically high levels, and renewal prices are still rising, although the rate of increase is moderating.

The price change is consistent with our expectations, but with the retentions even stronger than our original forecast.

We have now run at 85% the last two months, and we will try our best to sustain these levels.

But we're confident we can keep this number north of 80%.

The Select new business continues to move up each month, and is now above 100 million for the order.

Like Commercial Accounts, new business pricing is more competitive.

But with our new product and agent interface rollout in June, we believe we will see more quality flow in Select, particularly in the small account marketplace.

This should help drive some modest new business growth in the third and fourth quarter.

So overall in Select we're pleased with our top-line growth. but more importantly we're pleased that fundamentally it is being driven by strong retentions, and in this market that is a great dynamic.

Turning to the Specialty segment, earnings rose to 221 million with a combined ratio of 90.9.

We continue to see a very solid month over month trend; and again favorable weather and improved net investment income are part of the picture, as well as the improved performance of our surety business, which we have discussed in prior quarters.

From a top-line perspective, the Specialty business had a solid quarter, with gross written premiums up 1% and net written up 6%.

Looking at the drivers on page 8, in Domestic Specialty retentions continue to rise.

The increase is due to the improvement in retention in the construction business, which was up to 74% retention in the quarter.

That had been running around 65% for the previous four quarters.

As we have discussed previously, we have been aligning our underwriting profiles in the construction business and have now worked through a full renewal cycle in that area.

Retentions in the other businesses in this segment are all solid, with most running well above 80%.

Renewal pricing has remained positive and actually a little better than our expectations.

So a very solid picture in renewals.

New business has increased each of the last three quarters and is now back above 200 million a quarter.

Given market conditions, where new business pricing is very competitive in some products, we're very comfortable with these levels.

As the same time, we have been able to experience strong growth in selected industries, such as Oil and Gas and Ocean Marine, and will continue to look for these opportunities.

In the international it's the same basic story, with solid retentions, level renewal pricing, modest new business, but very strong profit margins.

Within the international book, the core UK and Lloyd's businesses are performing well.

Renewal pricing is slightly positive everywhere except Ireland, where the marketplace is anticipating loss trends to moderate due to recent reforms.

So all in all we believe an excellent quarter.

Earnings levels have exceeded all of our expectations.

Profits were driven by solid fundamentals and continuing strong margins. as well as help from mother nature and strong net investment income.

On the top line, we have been able to keep our book at solid pricing levels and find enough new opportunities to begin to see some net growth in certain markets.

We believe this is the absolute right strategy in this market; and quite frankly we're thrilled with the results.

Now let me turn it over to Joe, and he will cover the Peronal line story.

Thanks, Brian.

As with the other businesses, the Personal segment reported a terrific quarter.

Profitability was very strong, with earnings of 266 million and a combined ratio of 81.6%.

Earnings were helped by underlying improvement in loss ratios, increased volume, and favorable prior-year reserve development, and mild weather; partially offset by our continued investment in pricing sophistication, ease of doing business, and claim effectiveness capabilities.

Loss trends remained modest and profit margins have continued to expand.

From a production perspective, we continue to see the impact of the softening market and increased competition.

In homeowners and other lines, both profitability and growth remain robust.

Written premiums were up 12%.

Policies in force grew 8%.

Retentions remain strong and stable, and renewal prices remain ahead of observed loss trends.

Our growth continues to come across diverse geographies, with no disproportionate growth in catastrophe-prone areas.

We continue to leverage our strengths in this line to drive more profitable growth.

As you review all of our production statistics, please recall that the Royal & SunAlliance renewal rates transaction impacted growth in new business throughout 2004.

In homeowners and other, the declines in new business year-over-year are nearly all attributable to the impact of RSA.

Organic new business is generally consistent with prior-year quarters.

Turning to auto, we continue to grow policies in force, which stepped (ph) up 2%, but saw a decline in auto written premiums for the first time in several years of 1%.

The potential disconnect between these two statistics is driven by lower new business and more challenging competitive and regulatory environments in the Northeast, which typically generates higher average premiums for policies, and strong growth across much of the rest of the country.

Our profitability is solid across all of these states, and we're pleased with the results of our efforts to diversify our geographic footprint and the resulting growth outside of the Northeast.

Overall, retentions remain consistently strong.

Renewal pricing increased, but increased more modestly than prior-year quarters.

The moderating growth in auto is really driven by new business.

Even after adjusting for the impact of the RSA deal, organic new businesses declined from the year-ago quarter, reflecting the overall marketplace conditions and competitiveness.

As we have discussed before, however, we're not content to passively ride up and down with the marketplace and environmental tide.

Our focused investments are continuing.

As Jay mentioned earlier, we have launched the latest version of our tiered pricing programs this quarter; we're calling them Quantum.

For auto, this program is our fourth-generation tiered pricing program.

It is obviously early to declare victory, but initial results are very positive.

We're pleased with the increased flow of new business, the increased hit rate, the underlying underwriting profitability of the business, and all of the early metrics that we are watching.

We have rolled out six additional auto states this past weekend.

We will have over 20 in the market by the end of the year.

We have rolled out an early-stage Quantum homeowner product in three states during the second quarter, and anticipate another 10 by year-end with similarly strong early results.

We're excited about the opportunity that these programs present and how they are being received in the marketplace, and we look forward to their impact on the top and bottom line going forward.

With that, I will pass it back to Jay.

Thank you, Joe.

Page 10 demonstrates the steady growth that we have been experiencing in average invested assets.

Growth in the quarter was fuelled by approximately 740 million in positive cash from operations and the proceeds received thus far from our Nuveen divestiture, which have totaled approximately 1.9 billion.

Average invested assets are now just shy of $66 billion.

Page 11 shows the current composition of our investment portfolio by asset class.

At 93%, the portfolio has an even higher percentage of fixed-income and short-term securities than our target of approximately 90%.

Below investment-grade bonds comprise only 3.2% of the bond portfolio.

The rating on the bond portfolio remains a solid AA+, and the duration is down to 3.9.

Net investment income of 598 million after-tax, shown on page 12, has also continued its upward movement due to steady growth in fixed-income NII and continued strong performance in our non-fixed-income portfolio.

Within the other investments category, private equity returns were once again the largest contributor to the favorable quarter; and overall the portfolio's after-tax yield remained at 3.6%.

A major story for the quarter was the steps we took to dramatically augment our financial flexibility and capital strength, as summarized on page 13.

Our record earnings and strong operating cash flows, plus the proceeds we received thus far from the Nuveen divestiture, will allow us to add significantly to our already high levels of stat (ph) surplus.

We have reduced holding company debt by over 500 million since year end, and over 800 million when you include Nuveen's debt.

We have eliminated 2.4 billion of goodwill and intangibles from our balance sheet, and we have increased tangible book value per share by 24% from $20.52 at year-end to $25.35.

We have also been able to retain high levels of liquid assets at our holding companies and have successfully combined our credit facilities into a single $1 billion five-year facility, taking advantage of current market conditions.

We successfully re-marketed the debt component of our $443 million equity-linked notes during the second quarter and in the third quarter will receive 443 million of new cash in exchange for the issuance of common stock, in connection with the equity component of these securities.

As a reminder, this stock issuance will increase our capital base, thereby impacting ROE calculations.

But it will have no impact on diluted share counts or earnings per share.

With these actions and the combination of our major insurance pools into one as of July 1, effective January 1 of this year, we achieved rating upgrades to a unified A+ from A.M.

Best and Aa3 from Moody's for the combined pool.

We're extremely pleased with these achievements.

Results of these actions appear on page 14.

Our debt-to-capital ratio now stands at 21.3%, in line with our long-term target of 20%.

Book value per share has risen to $32.90; or if you exclude the impact of our 962 million after-tax unrealized investment gains, to $31.48.

And as I mentioned, tangible book value per share has increased 24%.

Finally, we are providing a brief update of the Nuveen divestiture as shown on page 15.

On Tuesday of this week, Nuveen received approval from the shareholders of its funds for the change in control.

As a result, we will receive $402 million today from the settlement of our forward contract with Nuveen.

The other forward contracts, for which cash was already received in the second quarter, are scheduled to be closed out shortly.

Based on these transactions, we expect to record a below the line after-tax gain, that is, as part of discontinued operations, of approximately $70 million in the third quarter; and our remaining ownership of Nuveen will be less than 5%.

With that, we end formal presentation.

One comment of clarification.

This is Jay Fishman.

One of my associates here indicated my comment about that we will be distributing the first version of our district controllable financial statements -- obviously that is not to the public; it is to our field force.

So those are documents that will stay internal to our organization.

But it's a critical element of our management of the field force.

With that, we will now open it up for questions and we would like to be as helpful as we can.

(OPERATOR INSTRUCTIONS) Ronald Frank with Smith Barney.

If it makes you feel better, those of who know you probably figured we were not getting those statements.

I have got a couple of questions.

In the Specialty area, I didn't catch gross numbers by line; but I am assuming the big growth we saw in some lines like bond and elsewhere on the net line, that also relates to retention, basically.

Yes, fundamentally.

I have a question on something you didn't discuss.

I'm sorry; just to make sure we understand your question, Ron, when you talk about retention, you are talking about retaining business, not retention of exposure?

No, I am talking about your change in renewal -- I'm sorry, in reinsurance and ceded business.

No, that is what I thought you were asking.

The answer to that is no, not for bond.

Because there was significant growth in bond in particular, so I was wondering if you could add some color on that then.

We're looking at each other here, seeing who is going to answer.

Sorry.

The growth in the bond, and if you're concluding FCS (ph) business into that --

Yes.

We have had some decent opportunities there.

Part of that, Ron, is the movement of some of the Gulf business into the FCS line.

So that is a piece of that equation also.

So it probably isn't as robust as it looks there, but we are experiencing growth there.

We feel very good about the business that we have been retaining, similar to the other markets, and have had some opportunities in the new area.

Pricing selectively there has been -- there's obviously a variety of products there, but it is up-and-down, but we have seen some opportunities there.

A question regarding run-off books --

Let me just ask one -- let me answer in partial because I am sitting here with the page run on bond.

Just to correct the record.

The gross quarter-over-quarter does not have much of a change in it, second quarter '05 versus second quarter '04.

The net does.

So in fact the reinsurance is providing an impact on it.

I apologize for that.

Okay, okay.

That being said, I guess you're seeing some good opportunities, effectively, maybe offset by some loss; and the reinsurance is affecting it as well?

Yes.

Moving to the run-off books, we don't seem to have heard the last in the industry of the infamous '97 to '01 accident years, in terms of their development for a lot of companies, including one that is going to have a conference call right after yours.

In that context, I was wondering if you could refresh us on your review process for the reinsurance run-off book in particular, how often you review that, what the process is, and your comfort level with those reserves in the context of what we continue to see and hear in the industry at-large.

This is Jay.

In terms of the reserves, as you know, we review reserves each quarter.

It's a constant update process.

The run-off reserves are part of the overall segment relating to commercial.

When we look at the overall commercial reserves, we are very pleased with the reserve positions that we have at this point in time.

So we do follow everything that is taking place in the industry, but there is nothing at this point that would cause us to change what we have.

Okay, thanks very much.

Jay Cohen with Merrill Lynch.

A couple of questions.

When you are referring to the renewal price change, you were including exposure change.

I am wondering if you take, say, the Commercial Accounts, which is down 2%, what would more of a pure rate change be in that business?

Let me just look at the number.

But you're absolutely right, first of all, that when we talk about renewal price change we're talking about rate and exposure.

And exposure can come from a variety of different reasons, one simply just more exposure on the accounts.

The other is sometimes getting the values right on accounts.

So although as exposure it really is probably (ph) price.

I would say that the rate change is a slightly higher negative than what we are seeing, but not dramatically higher.

So instead of a -2 overall we are probably seeing maybe a -3 or so in rate, and some modest exposure gains running through there.

That can vary business to business, obviously.

But in the aggregate, that is where kind of our middle book is.

Great.

Next question is the new business.

You had mentioned you are seeing I guess a widening of the price between what it takes to get new business and the expiring premium (indiscernible) decline.

Yet your new business is actually accelerating.

I guess it's accelerating from a depressed level, so I am wondering if you could put the new business generation -- and I guess in the Commercial business and in Select -- in context from a more historical standpoint.

Maybe as a percentage of premiums.

How do you view that current new business, given the fact that there is a widening in the price?

I think that is a great question.

That is the stuff we agonize over all the time.

All things being equal, I think you have hit it exactly.

If we were a steady-state company, you would look and you would say, given what is going on in the new business pricing, those numbers should be dropping as opposed to rising.

You're absolutely right.

Our numbers last year were clearly below what any company in our position would consider to be the norm.

So in middle market, for example, real rough numbers, we are now mid to high teens as a percentage of base in new business.

That is up from last year where we were single digits.

If you go back in time, let's say to the middle '90s, it would not be unusual to see 28 to 22 or even 23%.

So I think that the new business level as a percentage of the base that we are seeing now is in fact largely appropriate, given the market conditions for new business pricing.

We encourage folks to look.

Flow is up.

That is one thing.

We actually had a senior management meeting just a couple of days ago, and almost universally the reports were that the flow of opportunity -- meaning the deal flow that was coming into our organizations -- was up.

We will take some pricing risk on new business; we generally don't take classification risk.

But I think it is a reflection of the fact that pricing for new business is more competitive, and we look to the underwriters to be appropriately disciplined.

The numbers would suggest that they are.

I think part of it is that in '04 we clearly worked through a merger, and we worked through it with our distribution force.

I think we are in much better stead there now.

We are seeing more deals, we're seeing more flow, and we're working internally -- and this is Jay's comments around regional and district executives -- figuring out how we can bring and leverage appropriately the power of this franchise and the breadth that we have.

That is part of the opportunities that we're seeing through there.

So we think that is what is driving our new business growth, and not fundamentally chasing stuff in a declining market.

That is a helpful answer.

Just one last quick question.

The equity-linked units, I assume when they convert into common equity, that there won't be a change in the book value per share that you report.

Book value per share will be impacted by the additional Common Stock that we issue.

SO there will be cash coming in and stock being issued.

So I would imagine it would have an impact on book value per share.

But a relatively small one.

Great, thanks.

Alain Karaoglan with Deutsche Bank.

I have a few questions.

First, I want to thank you for the thorough overview that you gave at the beginning.

In terms of the expense ratio, it is down significantly from last year.

Is that a level that we should expect, barring business mix and impact on acquisition costs going forward?

Do we still think there is more room to take expenses?

Jay, you had mentioned that you're making investments in some of the business, and Joe mentioned that you're doing some in the personal lines.

I would say to the first part of your question, I think you were asking, is this a level that is sustainable?

I think the answer to that is, yes, it is a level that is sustainable.

In terms of whether it dramatically improves from here, I think it is predominantly a question of premium production more than it is in terms of further reductions in expenses, where we have made really sound progress on getting to our targets.

I would not expect the expense ratio to be benefited in the future from substantially increased merger efficiencies.

I think the investments that we're making will largely offset the impact of any other dollars that we're able to generate through.

The other question that I just want a clarification is with respect to the Nuveen impact on book value.

You mentioned that shareholders' equity will be increased by $443 million in the third quarter.

Does that include the $70 million in expected third-quarter gain?

Actually, the 443 million relates to not Nuveen but the equity-linked notes that we have outstanding.

That is really just the completion of the transactions that were contemplated when the equity-linked notes themselves were issued.

There's debt outstanding for a while; the debt got remarketed; actually our interest rate on the debt went down when we did the remarketing.

The next piece of that and the finalization of it really is to settle the equity component of it, which is as I mentioned getting 443 million of new cash.

Of course you get the investment earnings on that.

Then you're issuing Common Stock in exchange for it.

The Nuveen piece is the settlement of the transactions that we laid out in the second -- I'm sorry, whenever we did this last -- the first quarter, indicating that we did have some forward contracts, and when we got cash, when we didn't get cash.

That is just moving on its natural course.

That is what the other amount relates to.

So just thinking about the book value, should we think about 443 plus 70 of increase in book value?

There will be earnings related to (multiple speakers), that's right.

Just from these impacts.

When you gave your guidance on ROE, did you take into account this increased equity?

Yes, actually one of the reasons for mentioning it was to make sure that you understood.

Again this is not -- don't think of this on a per-share basis.

I wanted to make sure that everyone understood that there was going to be an additional $443 million of equity that was going to be coming in, as a result of these equity-linked notes.

We do take that into account when we look to our targets for the remainder of the year.

Okay, thank you very much.

Jay Gelb with Lehman Brothers.

Jay, could you update us on the (indiscernible) expense savings going forward?

We had established initially a target of 350 million run rate by the end of this year and $450 million by the end of next.

We are certainly well on our way towards meeting all of those targets.

Frankly I believe that they will be met sooner than we had originally indicated.

In fact, the analysis does suggest that we actually have achieved the $350 million run rate as of this quarter, and are well on our way -- again from a run rate perspective -- to realizing the additional 100 million.

So I would not change those estimates, but I do think they are coming online somewhat earlier than we had expected.

Great.

Then could you also update us on what you think the prospects for TRIA extension or renewable are, and if that doesn't comes to pass, what path you will take?

I think that, first, I was encouraged the last few weeks with the dialogue, and I think Treasury Secretary Snow's comments in front of Congress were very encouraging.

So all of us I think believe that ultimately -- believe that there will be some form of TRIA that comes out of the Congress.

From our own perspective, it had been our opinion that the best answer with respect to TRIA was really limiting the recovery to nuclear, biological, chemical, and radiological events.

We feel that the industry does have the ability to underwrite through events that are not of those nature.

We have come to call that conventional terrorism.

I am not sure that is a particularly kind comment, but as opposed to weapons of mass destruction terrorism.

Weapons of mass destruction we don't know how to price.

We don't know how to evaluate.

We don't know how to rate.

We don't know how to risk.

So our view is that the best answer is that the private markets embrace the more conventional terrorism and that government be the ultimate reinsurer of events of weapons of mass destruction.

In fact, I think the dialogue has been pushing increasingly in that direction, so we are encouraged.

We are a Company that actually took terrorism exposure quite seriously, and whether TRIA were to pass or not pass would actually not have very much of an impact on our underwriting profile.

We have limited our terrorism exposure.

The only cities where it has been something of an underwriting issue has been New York and in Washington.

Without TRIA we obviously would become exposed to nuclear, biological, chemical, or radiological events.

And if the world thinks that somehow this industry could withstand the dropping of an atomic weapon on a major metropolitan city and somehow we all come through it solvent, I think those are unreasonable expectations.

So we have shared with our Board that is those kinds of event of that magnitude that really are franchise threatening.

So that is why we speak to that as an important part of TRIA.

But beyond that, it is really business as usual for us, whether it passes or not.

Last question.

Can you give us a sense of where you feel most comfortable with your premium to surplus ratio selling out over time?

That might give us a little bit better indication of how aggressive you could be on share buybacks.

I think that rather than answering it in terms of premiums to surplus, I think the more relevant answer is actually ratings.

Our target has been to be at least an A+ from A.M. Best; we're now at that level.

It is to be in the AA category from Fitch, Moody's, and Standard & Poor's; and we are in that category with two of them.

We're not yet in that category with Standard & Poor's.

They still have us rated as A+.

I think those are the appropriate ratings levels for a company of this size and profitability.

So it would really be the maintenance of those ratings, and then looking to the earnings generation ability of this Company.

If in fact this Company can indeed produce internal earnings of more than $3 billion a year -- and I am just using that obviously based upon a return on equity number -- then the question becomes, are there growth opportunities to support $3 billion of incremental capital, less the dividends you pay on a regular annual basis?

And if there are not, we would not propose to sit and husband that capital, but we would propose to turn around and give it back to you all, so that you could make better investments with it.

So that is how we think about it.

I am hopeful that again as we turn towards '06 that that opportunity will be more -- it will be more timely to have that discussion.

Great, thanks for the answers.

Brian Meredith with Banc of America Securities.

Two questions.

First, on the Personal lines side, I noticed that the askmere (ph) loss ratio ex-cats appeared to have stabilized sequentially.

Is that indicative of maybe we're seeing that pricing is now all of a sudden running in line with the loss costs?

Or is there still a pretty good spread between those?

Is there a particular line you're thinking of?

Auto insurance I guess would be the one that jumps to mind.

I think it is a safe statement.

With RPC's running around 2%, that is really where we think we are.

I think, Brian, it is helpful if you look at the lines within Personal lines, you would say that auto margins in fact have stabilized out.

Homeowners, which is a variable, tremendously, based upon weather and somewhat more unpredictable, but assuming a normal weather pattern, rate on homeowners continues to exceed loss trend.

I am sorry, RPC continues to exceed loss trend.

Great.

The next question is, the initiatives that you outlined for growth at your investor day.

I am wondering how far along are you in rolling those out to the agency force.

Some of them are well on their way.

Certainly the organizational changes we spoke about are just about finished.

The implementation of the systems behind them.

We are beginning the process of sales and marketing training.

We're doing both sales training at the operating level and sales management training at the more senior level.

We have a companywide technology review going on that is being led by Bill Bloom.

This is very short interval stuff.

We're talking about feedback and results in the next 60 days where the goal is to evaluate in each of our business the technology that touches the customer and the agents and compares it to the competitive arena.

From that we make decisions about where investment dollars will go to maintain our competitive profile in that regard.

I would say we're not yet as organized on new product development as I would like to be.

But you can only do a few things at a time.

But that is going to come on next.

I am just pleased.

I think that the organization has embraced the notion that proper marketing, proper attention, proper flexibility, proper focus at the point-of-sale can indeed make a great deal of difference.

It is not just about price.

Okay, so therefore these initiatives -- probably not going to see the real impact of them until at least the second half of this year or maybe fourth quarter?

I actually even would think longer than that, Brian.

When I announced these I said you will not see short-term results from any of these initiatives.

I am certainly not anticipating that we will see anything dramatic in the results.

I was actually on the phone, but this is just an example, I was on the phone yesterday with one of our bond folks in the Milwaukee office.

We have a program going on to attempt to aggressively cross-sell our bond business with our middle market.

This fellow, John, out in Milwaukee in the past month had actually introduced the bond business to 15 new middle-market accounts, accounts where we had middle-market business but we didn't have any bond business with them.

And it was -- I was listening intently to his description of how they did it and the way they went at it.

Obviously, 15 accounts doesn't even show up in the financial statements, but if we can get 20,000 field people out there thinking the same way and acting the same way, over time that will make a big difference.

Great, thank you.

Larry Greenberg with Langen McAlenney.

Thank you and good morning.

You have now had three pretty solid quarters of other investment income, private equity, whatever.

Is there any idea to give us what you might consider a normalized rate for that line?

Yes, Larry, if we could figure out ahead of time what this was going to do, we wouldn't be working here at an insurance company.

All joking aside, it is an area as you see that has some quarters that have nice surprises on the upside.

There are quarters where it is less robust.

The way I look at it personally is I generally take a run rate calculation, basically just an average of the last four or six quarters, and that is what we kind of look at as somewhat normal.

It is a part of the portfolio that we have brought down in the last year.

As I mentioned, fixed income used to be 90% of the portfolio.

It is up to 93.

So the absolute level of dollars relative to the total portfolio for the other investments is lower now that it had been, but whatever you think the equity markets are going to do is probably the best guess as to what that should be on a quarter-by-quarter basis.

Fair enough, thanks.

Can you elaborate a little bit on the Northeastern auto market and why that might be more competitive than other areas?

I think you have got a couple of things going on there.

One, New Jersey has flipped itself upside down and changed the competitive dynamic inside of that state.

We had a pretty big market share there and size operation that we had tuned over the last ten years to take advantage of the old structure, which the operating model we had there caused us to intentionally try to move a little bit slower to manage that environment.

As the environment has moved and become much more competitive and looking a lot like you'd find in other states, carriers who have not had that inforce book of business have been able to come in and move a little quicker.

We're retooling all of our products and systems capabilities and will roll them out in the first part of September, which will put New Jersey, for us anyway, very consistent with where we are in the rest of the country.

But in that short-term time period, it has made it a little bit more challenging to move around.

Another example is Massachusetts.

It's a difficult regulatory environment, one where we have a sizable book of business that performs reasonably well, but we are intentionally not trying to grow it as we ripple through the environment in Massachusetts and trying to see what's going to happen there from a regulatory reform perspective.

So that is an intentional case of what we're dealing with.

So you get things like that moving through the region.

Great.

Then just one absolutely minutia question.

In the interest and other line, investment income was actually down this quarter.

Is there an easy explanation for that?

I'm sorry, could you repeat the question?

In the interest and other, I think net investment income was a -12 million.

Yes.

We have, as part of the Nuveen transaction, we have the forwards to account for, and the impact of the way the accounting works for the forwards just comes through on that particular line.

That will disappear when the forwards are settled.

Great, thank you.

Cliff Gallant with Keefe, Bruyette & Woods.

Good morning.

I just want -- a quick question on the operating cash flow.

It was a -775 other within that, which seemed to have led the operating cash flow for this quarter to be a little weaker than previous quarters.

I was just wondering what is within other operating?

Well, one of the major reasons that it is different this quarter is we're proud to announce we're paying taxes.

We talked about the NOLs that we had in prior quarters and the full utilization of the NOLs associated with the Nuveen transaction.

What you're seeing there as the major driver is just the tax time.

And I think on the second page of the statement of cash flows, you'll actually see -- I think it's about $350 million we paid.

Okay, thank you very much.

Thank you all.

We very much appreciate your time and attention this morning.

We are again cognizant of other companies' calls, and so we are going to sign off.

Thank you once again.

Ladies and gentlemen, we thank you for your participation in today's conference.

This concludes your presentation and you may now disconnect.

Good day.