旅行家集團 (TRV) 2005 Q3 法說會逐字稿

Good morning, ladies and gentlemen and welcome to the third-quarter earnings review for St. Paul Travelers.

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

At this time, I'd like to turn the call over to Ms. 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 third-quarter 2005 earnings.

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

All of these materials can be found on our website at www.StPaulTravelers.com under the Investor section.

I want to apologize for the delay in getting out the supplements and the webcast presentation this morning.

We had some issues with our vendor.

Today with us we have Jay Fishman, CEO;

Jay Benet, our CFO;

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.

They will refer to the webcast presentation as they go through their comments and then we will open it up for questions after their remarks.

I would also like to mention that we have a new addition to our Investor Relations team, Mike Connelly.

He will be working with us on the sell side as well as the institutional investors.

Before I turn it over to Jay, I would like to make the following message.

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, maybe 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, the post merger integration and other topics.

The Company cautions investors of any forward-looking statements involves 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-Q 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 use 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 supplements and other materials that are available in the Investor section on our website, StPaulTravelers.com.

With that, I'm going to turn it over to Jay.

Thank you, Maria.

Good morning, everyone and thank you for joining us this morning. 2005 continues as a year in which the profitability of our franchise is being clearly demonstrated.

For the first nine months of the year we have now posted operating return on equity of nearly 12% and operating income of 1.875 billion after approximately $1 billion after-tax of catastrophe losses from Hurricanes Katrina and Rita.

These storm losses negatively impacted operating return on equity for the nine-month period by approximately 6.5 points.

In that regard, this quarter reminded us of the major destruction that natural disasters can cause.

While the effects of Katrina and Rita significantly impacted our results for the quarter, we do underwrite wind exposure, we believe prudently, and we do expect events of this magnitude to occur from time to time.

The fact that we were able to absorb two serious weather events and still post a profit is testimony to our strong underlying profitability, disciplined underwriting and judicious risk management.

For the quarter, we recorded $50 million of operating income or $0.07 per basic and diluted share after absorbing the losses related to Katrina and Rita.

Jay Benet will provide you with an understanding of how we came to our estimates for these events in his commentary.

But in short, I believe that our approach is comprehensive and appropriately recognizes the level of damage inflicted by these storms based on the information we have to date.

With that, I'd like to spend a few minutes reviewing with you the results of our business on an operating basis before the impact of these storms.

For the quarter, excluding the catastrophe losses, operating income was $1.059 billion.

Operating return on equity was 19.3% and our GAAP combined ratio was 85.9.

We experienced strong underlying earnings in all of our segments driven by continued benign loss trends and strong net investment income.

We also experienced improving top-line performance.

In addition, the cash flow and capital generation ability of our franchise continues to demonstrate itself.

Turning specifically to premiums, excluding the impact of our runoff businesses, gross written premiums were up 2% over last year's third quarter.

Our Commercial segment was down just 1%.

Our Specialty segment was up 1% and our Personal segment was up approximately 6% over the prior year quarter.

Underlying these rates, we continue to experience exceptionally strong retention rates, renewal price changes that are generally consistent with the second quarter of 2005 and new business premiums that are, except for international specialty, nicely ahead of last year's third quarter.

With most market participants also reporting strong retentions, the attractive new business flow in the market is not substantial and we continue to exercise thoughtful underwriting judgment.

We're very interested in growing but only when the price supports the risk.

And as we look through the details of our premiums this quarter, we are pleased with the underlying dynamics.

I am sure many of you are interested in our view of what will happen in the market in the near term.

We can give you a sense of what actions we're taking and what we believe is likely to occur in the reinsurance marketplace.

We are, of course, examining certain aspects of our business.

First, Katrina has caused us to reevaluate what we consider to be coastal exposure.

Katrina's hurricane and tropical storm force winds extended 120 and 230 miles respectively from the eye of the storm and caused considerable damages far inland.

Second, given the storms of the last two years, we believe it is clear that we have entered into a period of increased storm frequency.

Consequently, we are reassessing the risk loads that we assign to catastrophe exposed property and, as necessary, adjusting our own risk and reward equations accordingly.

These are prudent steps and our work has already begun.

We will seek appropriate returns in a weather environment that has both more frequency and severity than the recent past.

Consequently, while we underwrite every account on its own merits, we expect rates to rise, capacity to become more limited and terms and conditions to tighten, particularly in catastrophe exposed areas.

As for reinsurance, we believe that prices will go up.

It is likely that property reinsurance rates will rise substantially but we also believe it is possible that reinsurance pricing in other lines will rise as well.

We believe that reinsurers are reevaluating their own risk and reward equations and that they will conclude that they need higher levels of profitability.

Therefore, we expect that they will bring a more aggressive attitude to the marketplace and if this occurs, we will reflect this in our own pricing models.

I am sure a number of you will ask if these storms will have an impact on our future plans for more dynamic capital management.

Our capital position remains very strong and we have demonstrated our ability to continue to generate capital internally.

We do want to make certain that our capital adequacy reflects our revolving thinking on how we evaluate our catastrophe exposure and we believe that market opportunities will emerge for which we want to remain well-positioned.

We will consider all of these factors related to the timing of capital management has we turn into 2006.

I would like to take a moment and comment on our outlook.

The combination of modestly rising interest rates continued benign loss trends and the growth opportunities I've spoken about should bode well for longer-term profitability.

As for the balance of 2005, last quarter, we indicated an operating return on equity in a range of 15 to 16% for the full year assuming normal catastrophe and non-catastrophe weather and excluding any prior year development -- I'm sorry -- excluding any further prior year development.

On that same basis, today, we would have increased our guidance for the year by approximately 100 basis points.

However, the effects of Katrina and Rita, net of the third quarter positive prior year development, caused us to anticipate a return on equity for the full year 2005 approaching 13%.

Please note that as we do not yet have an estimate for Hurricane Wilma, this guidance does not take into account any catastrophe costs for the quarter and assumes no further prior period reserve development either positive or negative.

I would also remind you that we're in the midst of updating our asbestos and environmental study and we will share it with you when it is available.

We would note that the A&E environment, both generally and specific to us, has not changed significantly since our adjustment last year.

Therefore, assuming no adverse events in the fourth quarter, we believe that any adjustment to A&E reserves that might be required would be substantially less than that which we recorded last year.

Before turning it over to Jay as to the ongoing industrywide regulatory investigations, we have no updates to provide from those which we have shared with you over the last several quarters.

But finally, let me just take a moment to thank our claim people for their tireless energy in these difficult times.

These are people who face challenging human circumstances on a daily basis and do their best to be professional and meet our customers' needs and expectations and are doing a great job.

We have reached out and provided support to the people impacted directly by this tragedy with a $1 million contribution from the Company to the American Red Cross and an additional $375,000 from the Company's employees to various organizations providing Hurricane Katrina relief efforts.

Additionally, we established an employee disaster relief fund, which assisted over 150 of our own employees who were displaced from their own homes.

Our employees have been remarkably generous to that fund as well and for that, I am personally most appreciative.

With that, let me turn it over to Jay.

Thanks, Jay.

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

I do have a couple of points to mention though.

The 683.8 million share count used this quarter and our fully diluted EPS calculation is lower than the diluted share counts used in previous quarters due to the antidilutive effects of convertible securities.

This occurred as a result of the reduced level of income reported this quarter due to the cats.

In addition, our outstanding share count increased this quarter to 692.2 million mostly due to the planned issuance of 15.2 million shares in August for which we received proceeds of 442 million in settlement of forward purchase contracts related to equity linked notes dating back to 2002.

Page 4 shows the after-tax costs of Hurricanes Katrina and Rita by segment and including reinstatement premiums.

Our estimates of loss for these storms have not been based upon broad assumptions such as marketshare percentages applied to industry estimates.

Rather, we based these estimates on reported and projected claim data for these storms as well as claims and related factors from other recent storms such as demand surge experience.

Large claims are one of the most significant drivers of loss in any storm.

We have performed site visits and claim reviews for approximately 90% of all large claims that have been reported, which we define as any claim over $100,000 and established claim files and individual loss estimates for each of them.

For all other claims, we continue to establish claim files and loss estimates factoring into our loss estimates for large and small claims alike, policy limits, demand surge, time and cost of business interruption, additional living expenses for individuals and applicable coverage in accordance with long-standing interpretations of our contract language, among other things.

We then use several different projection techniques to arrive at appropriate levels of IBNR.

It should be noted that these estimates are subject to uncertainty given the recent timing and scope of these storms as well as the delays we experienced in accessing certain damaged areas and we will continue to closely monitor these estimates going forward.

Doreen Spadorcia, who heads up our claims operations will be available during the Q&A to answer any questions you may have with regard to our claim efforts.

Although it is way too early to comment specifically about Wilma, based upon industrywide loss estimates, knowledge of our exposure base and what little we have seen on the ground, we believe that our loss for Wilma will not come close to reaching our corporate cats rate of retention of 750 million.

Page 5 shows our reported operating income and GAAP combined ratios in total and for each of our business segments, including three items included within our third quarter operating income; cat losses, prior year reserve development and the impact of reestimations of first and second quarter current year loss ratios due to new information and insights.

We have provided this data to aid in your understanding of the current and prior year quarters.

We continue to see very healthy underlying margins in all of our business segments.

Our current quarter combined ratios for Commercial, Specialty and Personal, excluding the three items I just mentioned, were 91.1%, 90.4% and 86% respectively.

The strong rate environment of the past several years coupled with continued favorable frequency of non-cat related losses and no surprises in loss severity remain the major drivers of these favorable margins.

We were once again pleased with the results of our reserve evaluations this quarter, which we previously told you is an ongoing quarterly process, other than for A&E for which we complete an annual study in the fourth quarter.

We do note that in our Commercial segment this quarter there were redundancies in our middle and small business reserves that were mostly offset by strengthening of our assumed reinsurance reserves.

We always experience some levels of movement in our reserves, some positive and some negative, and for the current quarter, the net of all of these movements was favorable in the Commercial segment as well as for the other two segments and the Company as a whole.

What I would like to do now is to turn things over to Brian and later to Joe, who will give their views on our response to the storms and to provide further insights into our business operations.

Thanks, Jay.

I'm going to take a few minutes to discuss the segment earnings and production for Commercial and Specialty and I will start with comments, excluding Katrina and Rita, and then come back to the storms and how they may impact the market going forward.

But first, the Commercial segment had very strong underlying earnings, which were consistent with last quarter and another excellent combined ratio.

The key drivers behind the numbers are some very positive frequency and severity trends.

Frequency is very modest, actually negative in several lines of business and severity trend is minimal to normal across the book.

In Specialty, even including the storms, a reasonable quarter with 130 million in earnings but that amount would have almost doubled without the storms.

Similar to Commercial, Specialty is experiencing excellent underlying frequency trends and normal severity.

The result is an adjusted GAAP combined ratio of 90.4, almost identical to last quarter.

Excluding the weather, a great earnings picture.

But we are in the weather business and from that perspective, business was not good this quarter.

We have significant commercial marketshares in the Gulf states.

Although we write very little in the immediate coastal counties, these storms had significant damage further inland where most of our risk count is located.

So the storms were a big part of the story.

The bulk of the catastrophe loss in the Commercial segment was from large and midsize commercial risks with lesser, but still significant, impacts in the small commercial area.

In Specialty, the energy and marine businesses were responsible for over half of the gross catastrophe loss.

However, both of these businesses have their own reinsurance programs in addition to participating in the corporate cat program.

So not nearly as big an impact on the net.

The remainder of the cat loss in Specialty was primarily from our Lloyd's and public sector businesses.

Turning to pages 6 and 7, we're seeing consistent momentum in both gross and net premiums.

Core commercial results were essentially flat with last year, actually up slightly if you exclude the catastrophe reinstatement premiums from the net numbers and this compares to down 2%, 8%, 9% and 12% for the previous four quarters.

In Specialty, gross premiums were up 1% and net was up 2%.

The net was up 5% if cat reinstatement were excluded.

As we have been saying all year, we're looking for improving top line but given market conditions, that doesn't mean big growth numbers.

So we're very pleased with the modest growth in what had been a softening environment.

Looking at the production stats on page 8, it is a very similar story to the previous two quarters.

In Commercial accounts, retentions remain very strong at 80%.

Renewal pricing remains negative but only slightly and new business trends are improving.

Third-quarter new business was considerably higher from the comparable quarter last year.

Within these businesses, the property lines, both midsize and large risks, had been shrinking with larger than average rate decreases.

I will talk about the property market conditions in a minute but we think these trends will improve.

In select, the small commercial area results continued strong.

Retentions of 86% for the quarter was two points above last quarter, which was our previous historical high and renewal pricing is slightly positive.

In the new business area, we were up above $100 million and up almost 10% from the prior quarter -- from last year's third quarter.

All in all, we're very bullish about our small commercial opportunities.

We expect retention levels to remain strong, north of 80%, and new business levels to improve gradually.

In domestic specialty, the same trends continue.

Retention continues to improve and is now over 80%.

Renewal price change is slightly positive and new business is up considerably from third quarter of last year.

The Construction segment is driving much of the top-line improvement over previous quarters as this business has gone from some major reunderwriting in late '04 and earlier this year to a more stable position.

The other businesses in this segment continue to perform well.

In international specialty, it's the same story with slightly negative price change and solid retention.

New business opportunities here have been steady in Canada and Ireland but down in the U.K., which benefited from a renewal rights transaction in 2004 and where competition has stiffened.

So overall, a very solid production story but the bigger question is where do we go from here given the growing uncertainty around catastrophe exposed risk.

Certainly we expect market pricing to harden but how much for how long and for which risks are the big question.

Including Wilma, as an industry, we're probably well north of a cumulative $50 billion loss.

The models, which we all use, significantly underestimated the severity of these events but more importantly, it is clear we're in a period of increased event frequency.

So it is not the 2005 loss we're concerned with, it is the change in probable loss assumptions we all have to begin recognizing.

So what if Houston/Rita scenario is what is on our mind.

So where do we go?

As Jay said, we, at St. Paul Travelers and the industry, must re-evaluate the fundamental risk reward equation for coastal property.

Our average annual loss assumptions appear inadequate.

We have to reassess these and see where the market goes.

The solution will be part price.

It will be part terms and conditions and part selection.

So what is our posture?

Right now, we are not running away but we are re-examining.

As we adjust our view of right price and right terms, we're going to market with the view that there could be a real opportunity.

We are clearly a company with the capital and the capability to meet the market needs but the conditions have to be favorable.

I'm sure there will be considerable questions on this topic, so for now, I'll turn it over to Joe to cover the Personal lines story.

Thanks, Brian.

The Personal segment continued to deliver strong earnings, excluding catastrophes for the quarter, with a $292 million operating income and a 79.2% GAAP combined ratio.

That is nearly a five point improvement over the year-ago quarter.

These results were driven by strong net investment income, continued favorable prior year loss development and another period of benign loss trends.

Frequencies remained level or modestly declining and severity increases are moderate.

We are feeling terrific about the underlying strength of this business.

Clearly, catastrophes were the big issue for the quarter.

Brian and Jay had mentioned that Commercial and Specialty losses tend to be driven by larger claims.

Personal was just the opposite.

The losses here are driven by frequencies and average severities.

The losses in Mississippi, Alabama and Texas, while significant and wrenching from a human perspective, have generally been consistent with what we have seen in other significant storms.

Our losses for this quarter's events are disproportionately impacted by losses from New Orleans and the surrounding area where frequencies and average severities have been exceptionally high.

This is where we have seen the greatest deviation in results versus what the models had predicted.

Let's turn for a minute to the impact of the storms on a going forward basis.

Over the long term, we have had a very conservative risk underwriting profile.

We have got very limited coastal exposures and we extensively utilized loss mitigating terms and conditions.

We've already discussed the frailty of the models and the likelihood that we're experiencing a period of increased storm frequency.

This has caused us to a re-evaluate our risk reward views across cat exposed areas and we're in the process of reassessing our view of what is an appropriate definition of coastal exposures.

I'm sure the result will be an expansion of that definition.

However, we do feel good about the fact that our existing pricing assumptions have previously incorporated some impact from model frailties.

They will likely need to be further adjusted.

We anticipate some significant marketplace disruption as competitors more realistically reflect catastrophe exposure in their risk appetite.

We believe that overall we are well-positioned to compete and take advantage of opportunities in the resulting marketplace.

When we look specifically at the homeowners and other lines, the results there, we're very pleased with them.

Profitability here is very strong.

Year-to-date, including catastrophes, the GAAP combined ratio is 97.9% and excluding cats, it is 71.7%.

When you turn to Page 10 and take a look at production, the impact of a softening marketplace and increased competition is clearly visible broadly across the marketplace.

Against this backdrop, we have got very strong retentions that continue to remain stable.

Renewal price changes at 8% continue in excess of observed loss trends.

Policies in force grew for the quarter 6%.

Comparison versus the year-ago quarter is down to the impact of the RSA renewal rights transaction.

Excluding the impact of RSA, the new business is up over 14% year-over-year.

Overall, we have got very, very strong results in the homeowners line.

Auto results also delivered another quarter of strong profitability with a GAAP combined ratio of 84.8%, including 1.2 points from the impact of catastrophes.

Retention is also strong and stable.

Renewal price change has dropped to 1% reflecting the increase in market competitiveness.

Policies in force grew by 2% consistent with the second quarter.

Excluding the impact of the RSA transaction, new business increased 10% from the year ago-quarter.

Again, consistent with prior discussions, we continue to see more significant challenges in the regulatory and competitive environments in the Northeast.

As a result, we are experiencing lower new business levels.

Strong growth across the rest of the country continues to offset this impact.

Earlier, we've talked to you about the rollout of our Quantum Auto Program and Quantum Homeowners Program, our fourth generation of tiered pricing.

We wanted to share some numbers with you so we could give you a feel for its early success.

Turning to Page 11, you can see those.

Through September, we had Quantum Auto active in 11 states.

Here, we are comparing weekly production the 12 weeks before Quantum rollout to the period following its introduction.

We are seeing very significant lift from this program, growth rates generally jumping 15 to 20 points after introduction.

The program allows us to target a broader cross-section of risk leveraging very sophisticated multivariate analyses.

What you really find when you peel under these numbers is that we're seeing an increase in the number of agents quoting with us, an increase in the number of quotes per agent, an increase in close rates and an underwriting profile of business written generally and completely in line with our expectations.

The program is clearly powerful and is further positioning us as a top tier competitor in the marketplace.

We have rolled out an additional two states this past week end bringing the total to 13.

We will have 20 active by year-end and we will complete the auto rollout in the first half of 2006.

We have got a similar program in property, a Phase I program, active today in 16 states and we will rollout a more powerful Phase II product, Quantum Home, in the first half of 2006 and completed over 2006.

Again, as you can see from these results, a very powerful product and we are very pleased with the results in the marketplace.

With that, I'll pass it back to Jay.

Thanks, Joe.

Page 12 once again demonstrates the steady growth that we have been experiencing in average invested assets.

Growth in the quarter was fueled by approximately 1.4 billion of positive cash flow from operations, additional proceeds of 532 million related to the completion of the Nuveen sale, which brought the total proceeds from Nuveen to just under 2.4 billion and the 442 million received from the planned issuance of common stock related to our 2002 equity linked notes, as I previously discussed.

Average invested assets now stand at 67.6 billion.

NII of 625 million after-tax, shown on page 13, continued its upward trend in the quarter.

Once again, we experienced steady growth in fixed income NII fueled in part by the investment of the Nuveen proceeds and also experienced strong performance in our non-fixed income portfolio mostly due to private equities.

As a result of this growth in net investment income, the after-tax yield increased by 10 basis points in the quarter to 3.7%.

Our capital and liquidity position, shown on page 14, remained strong and consistent with the objectives we established earlier in the year.

Debt to total capital is a healthy 20.8%.

Book value per share, excluding the impact of FAS 115, now stands at $31.46, only a $0.82 per share decrease from the second quarter, despite the hurricane losses and the issuance of shares related to the equity link notes and surplus increased from 16.1 billion at the beginning of the quarter to over 17.7 billion at the end of the quarter.

With that, we would be happy to take any questions you might have.

(OPERATOR INSTRUCTIONS).

Tom Cholnoky, Goldman Sachs.

I wanted to just pursue the whole cost of reinsurance issue and what is going on there in terms of A, your plans for reinsurance purchases in 2006 for your cat programs and then secondly, to follow up on your comment regarding higher prices for reinsurance.

You deal in a lot of highly regulated lines, which don't give you a tremendous amount of flexibility to change rates very quickly relative to what your reinsurance costs are going to be, especially in areas like homeowners and certainly in the personal lines area.

And I guess my question is how much of an ability are you going to really have to pass on these higher costs to your consumers as well as trying to increase the rates that you are getting on the business that you're retaining net?

Well, Tom, first on the comment about reinsurance.

Our property catastrophe treaty comes up for renewal July 1 and we utilized one full limit associated with Katrina but we still have one full limit remaining outstanding.

So we don't really face the issue with respect to renewal until July 1.

But conversations that are going on in the marketplace and discussions certainly would suggest at the moment that the reinsurance marketplace right now, as we sit here right now, is -- chaotic may be too strong a word, but not very much so.

The reinsurers our still trying in their own way to figure out the cost of the risk unit related to property catastrophe pricing and exposure and there really isn't much going on at the moment, other than general discussions.

It has certainly been our impression from conversations that we have had with reinsurers that their expectations are up.

And as I reflected in my commentary, we just don't believe that they are thinking about the world in quite as a discriminating way as other folks do, which is to say that property rates have to go up a lot and casualty rates continue to stay flat or decline.

They are thinking about their business more as most business people do, which is how do I bring in more revenue to offset in their business what is increasing frequency and severity.

So our own personal expectation is that reinsurance rates will rise.

They will rise more in property but they will rise I think across the board.

As it relates to our other reinsurance, we do have a property per risk treaty.

The discussions with respect to that are encouraging but again there is really not very much going on in the reinsurance market in terms of commitments now and I suspect what is going to happen is not dissimilar to what happened September 11, which is the January 1 business that gets done will actually tend to be deeply compressed into December, both on reinsurance renewals that do have January 1 dates as well as primary policies.

Everyone is going to sit back until the costs become increasingly clear and I suspect it will be a busy last few weeks of December.

I am going to ask Joe to comment about pricing flexibility in the personal lines business but I would make an observation that there is substantial flexibility in the commercial lines arenas that obviously varies by state.

Some are using files, some file and use.

Others have substantial variability in their pricing structures even as they are submitted right now.

So there is substantial capacity on the commercial lines side to begin to implement changes quickly.

But with that, let me have Joe comment about personal lines.

You are clearly right that it is a regulatory or a highly regulated environment and we've got to run through individual filings at a state level.

Reinsurance costs are an easy item to go through and talk about when we're dealing with rate filings because they are a clear cost to the business and we can display them and show a state what they are.

So we don't generally get a lot of push back on that as we work through those filings.

What you have is a timing issue.

As we make those filings and individual states get approval and then renew policies into it, it will take a year to a year and a half to get that fully baked into the pricing but it really becomes a timing lag on it.

The relative order of magnitude, what you have got to remember on it, you can get a sense of what our total catastrophe reinsurance program costs based on what you see from a reinsurance premium perspective.

Personal lines absorbs only a piece of that.

That really only comes out to be a couple of percent relative to our premium base.

So even if it went up significantly, it might be a point over all that we would be looking at.

So we think we can manage that over time.

I would make one other point, Tom, which is we are not waiting for July 1 to reevaluate our risk reward equations.

We are making our judgments right now in a world of imperfect information and in a world of inability to get quotes.

We are simply making the assumption that the underlying costs of the property that we write, that we expose ourselves to, the average annual loss reflected by both frequency and severity, is up and that it is up in some cases substantially and so we are beginning to take price actions as we speak.

Thank you.

I may come back with a follow up.

Ron Frank, Citigroup.

A few things if I could, hopefully quick ones.

One, could you comment -- if you have already, I apologize -- on your retention, vis-à-vis the Florida cat fund in particular on Wilma.

Two, the commercial expense ratio, even if I adjust it down for the reinstatement premium, was around 30 and that would seem to be well up from the first half and I was wondering if you could comment there.

And finally, was there any significant effect of the catastrophes on third-quarter growth?

In other words, sometimes we see companies halt new business writings in affected areas just so they don't get more exposed over the balance of the season.

Was there a significant amount of that activity for you in the third quarter?

I will let Joe take the Florida cat fund and Brian can comment on the change in the third quarter in volumes and Jay as it relates to the expense ratio.

The Florida hurricane cat fund, our retention is about $30 million and our profile is consistent with what it has been in the past.

It is just adjusted according to the state per time looking into this year.

And then your private reinsurance, what Jay Benet referred to, that would attach above the cat fund?

Right.

The cat fund will impact the residential properties in our Personal segment and then for the entire corporation, the corporate cat treaty attaches at 750.

Okay.

Why don't I -- let me touch on the commercial availability in the third quarter.

Clearly we haven't done anything with curtailing writings and honestly, haven't seen a lot in the marketplace with any of that activity.

It is spotty but very, very little.

So I think it is pretty much still an open market with new business on definitely coastal exposures being probably the exception to that where there is some challenges.

So we haven't curtailed any of our writings at this point.

Ron, I'm having a little trouble understanding the question on expense ratio.

At least the data that I'm looking at would suggest an expense ratio ex cats for the quarter of 29.2.

Jay, I am looking at commercial in particular, and I'm looking at a reported expense ratio of 31, and it seems to me that the reinstatement premiums inflated that by about a point, which would still leave it well above where you were in the first half, if I'm not mistaken.

In the first half we, on commercial, were running 29.1 in the first quarter.

It was down a bit at 27.8 in the second quarter.

There are some timing elements of when we accrue things and whatever, but I think as it relates to the entire period looking at it on a year-to-date basis, it's 29.3.

So I wouldn't get overly --.

And in commercial, the expense ratio ex cats is 30.2.

Right.

That's what I was looking at.

Okay, so really nothing in the way of tech spend or new programs, what have you; it was just some --.

It's my recollection, Ron, there is some variable costs also that are impacting it.

Nothing major that is swinging the quarter.

Fair enough.

Thanks.

Alain Karaoglan, Deutsche Bank.

Good morning, and I have several questions.

The first one, Jay, relates to your reinsurance program which helps you this quarter, and clearly you're doing a lot of work and I'm glad to hear that you're making adjustments right now as opposed to waiting for the market, to see what the market will do.

But what are you doing with respect to earthquake exposure and the availability of reinsurance or pricing going forward?

Are you also looking at these exposures and taking pricing of that into account if a year from now, the cost of reinsurance for catastrophe may be significantly higher?

I'll make a couple of observations.

We made the active decision wind first, rocks later.

But the answer is absolutely, earthquake is on our list, and I do think that the experience of Katrina in particular and the related evacuations, even Katrina and Rita.

I was actually having a conversation with representative David Dreyer from California, and I made an observation that in the event of an earthquake there is no notice.

The event happens and you're in it.

So the notion of evacuation is just all the more challenge.

So we are giving a lot of thought to earthquake.

We did announce that our cat risk business is being sold.

Timing remains on track, and a not insignificant amount of our earthquake risk in California will be at least on a runoff kind of basis.

We will retain the risk historically, but on our runoff basis it will be conveyed out.

So fairly quickly, that will go down.

Obviously, we still have New Madrid fault and other exposures, but the answer is yes, we are taking that on and we are thinking about what it means.

Notwithstanding the fact that the models were disappointing in their accuracy, they are nonetheless the starting point that we all use because it is the best information that we have got.

And without them, if we simply ignore them in their entirety, we start with nothing.

So we are all at the moment, I would characterize it as kind of jury-rigging the numbers and the output of the models to reassess what our exposure is and therefore what our reinsurance profile should be and, in fact, over the longer-term what our gross exposure profile should be.

The second question, Jay, relates to the pricing of your business.

What are you assuming in terms of frequency of severity in the pricing of your business?

Are you assuming that the very positive frequency that was mentioned on the call is going to continue and you have that in that pricing, or you are assuming a reversion to a sort of mean or higher frequency?

Well as you saw what we did in this quarter, we reflected a reestimation of the current year loss ratios through the nine months and we did highlight out the impact of the first six months on the earnings for this quarter.

Specifically, it would appear that those trends continue for the rest of this year and we have not looked out beyond that.

We have not yet done our budgeting or our evaluation for next year.

But indeed you are focusing on what turns out to be a very critical budgeting assumption, which is does one assume that loss trends, do they continue to improve?

Do they stay neutral or do they deteriorate modestly?

And there is a little bit of crystal ball work in that kind of an analysis.

It just is interesting that the assumption that we made for this year, at least through the nine months, turns out to have been incorrect and incorrect in that the actual loss experience is turning out to be much better than we had originally anticipated.

The next question is on personal auto, on Quantum Auto.

In the states you have introduced it, there is significant increase in growth rate and growth in a softening auto market or more competitive market is always concerning in this sector.

When you look at your pricing relative to competitors, do you find them much below the competitors for the business you are or is it just because you're offering this product and giving it to your distribution that you didn't have before that you're getting the extra sales?

I think there is perhaps a little bit of both but the overwhelming majority of it is driven on the product breadth.

The increasing sophistication of the pricing segmentation allows us to get more granular with the pricing and be more competitive on a much broader cross-section of risks without having to fundamentally use the brute force method that less sophisticated competitors have to use where they just flat out had a sale.

This is driven by being smarter in terms of how we execute inside of the marketplace and bringing it to the marketplace in a fashion that is very easy to deal with and easy to do business with, which is why we think we are seeing agents generate more quote activity with us both at a number of agents level and the volume per agent.

We have widened our sweet spot.

If you go back a few years, the customers that fit into our underwriting profile were a narrower slice than Quantum allows.

So as we have widened that sweet spot out and the multivariate pricing model gives us a high degree of confidence in the pricing at a wider range, what we have actually done is effectively opened up our product to a wider range of customers.

And so the growth is less about price accommodations to bring in new customers.

It is getting a right price out to customers who before we didn't have any right price for.

There was no price.

So this is unit growth of the best type.

What gives us a higher degree of confidence around it on top of that is the investment we're making inside of our claim organization, which are substantially improving their ability to manage what ultimately would be a little bit of a higher frequency, because as we expand that sweet spot and go to customers who are a little less of a risk profile than the most highly preferred will see a few more claims.

That expanded claim capability will help us mitigate the severity, which we really think becomes a wonderful one-two punch that together provides a great advantage.

The last question that I have is on capital.

If I do some back of the envelope premium to surplus ratio analyzing your premium in the third quarter, it suggests (indiscernible) to surplus ratio that is below 1.2 to 1.

It suggests very strong capital positions.

Do you have cash at the holding company, how much do you have and what are you thinking from a capital positions or this new environment of price increase is going to provide you with so many opportunities to utilize that capital?

Well, first, we obviously do have cash at the holding company.

A company with our rating should have a balance of cash at the holding company that is appropriate and we do.

We don't specifically indicate what that level is but it is substantial.

Jay shared with you that our statutory surplus is now at $17.7 billion and obviously you know what are premium numbers are so it's not hard to calculate the ratio premiums to surplus.

And I back to my comment at the last quarter, we were getting increasingly confident about our ability to more aggressively manage capital looking into 2006 and feel pretty good about it.

I think the only two things that cause us to pause a bit in that regard are making sure that we believe that we have a capital position that is adequately positioned against our catastrophe exposure.

I think that it would be foolish for any company to simply make the assumption that what was acceptable 60 days ago is the same number acceptable today.

I'm not speaking about rating agencies or anything else;

I'm speaking about the fiduciary responsibility of managing a business of this complexity and making sure that the capital is adequate.

So that is one and we're doing that right now.

And secondly is there has been lots of companies that have turned out to the marketplace and raised capital to anticipate growth opportunities.

We have all the capital we need and to the extent that those growth opportunities emerge, we are just exceptionally well-positioned to be there and to ride that wave and so the only comment I would make is that this is just going to be more of a quarter-to-quarter re-evaluation.

As we get more information about our risk profile, as the growth opportunities emerge, we will be able to reassess on a fairly constant basis where we stand and whether we're ready to commit that capital to more aggressive capital management.

Thank you very much.

Brian Meredith, Banc of America Securities.

A couple of questions please.

First one, Jay, I believe you guys play in some of the offshore energy market and I'm wondering how much of your loss was from the offshore energy business and what is your appetite for that business going forward?

I'm trying to think of specifically the offshore component.

As I said, in our Specialty segment, about half of our gross -- more than half of our gross loss was energy marine.

Less than that on a net basis.

And they do have their own reinsurance policy that actually has fairly low retentions on a per occurrence basis.

The bulk of that loss would have been offshore.

The reinsurance program I assume -- more of the question is the appetite going forward.

I assume that reinsurance program is going to be decidedly more expensive here going forward.

I mean clearly that's the market that everyone is examining.

I think it is probably one of the segments.

Offshore energy exposure was one of the segments that, from an industry perspective, was in the aggregate, one of the most underpriced.

If you just look at the amount of premium that comes into that business and the amount of loss that they have experienced in the last to wind seasons, the losses are multiples of the premiums.

So everybody is looking at that and our appetite will be a function of what we think pricing is going to be going forward and obviously the cost of the available reinsurance.

I would observe that having that oil and gas specialty unit is I think a terrific positioning for us with oil at 60 odd dollars a barrel or 70 odd dollars a barrel and with constant discussion about demand and supply and the ability to meet the demand, the fact is that we think oil and gas underwriting expertise is going to be in increasingly high demand and having the capital to commit to that over time is going to turn out to be one of the areas I'm sure we're going to be able to grow in because the kind of business that we do fits in the kind of energy environment that we are beginning to confront.

So I don't worry about -- I don't worry about margin squeeze in that business.

Quite the contrary.

Next one and I don't know if I missed it but Jay, any comments on TRIA and its renewal and looking at the bill in its current form and what consequences it may have for your assessment of your exposures?

I think that -- first, on a general statement, I think that TRIA socially has some real value.

This is was not a nuclear event.

This was not a radiological event and the federal government has already committed in excess of $60 billion to the relief efforts that two serious wind storms provided.

So I've always been an advocate that says in a nuclear event, in events of great consequence, all one has to do is look at the films of Hiroshima and Nagasaki in World War II and just think about New York City for a moment and understand that, notwithstanding whatever one's position is, that the federal government is going to play a meaningful and substantial active role in any rebuilding effort that takes place following an event of that nature.

It is either going to be done in a systematic thoughtful way before the event occurs or it is going to be done in a chaotic and odd way after the event occurs.

In fact, the insurance industry will play a substantial role in that because we are the intermediary.

We're the ones who will get the dollars to the impacted individuals and the rebuilding effort begins.

So I think there is a meaningful social roll there and I think it is appropriate.

For our Company, frankly, we have not been positioned our Company such that TRIA is a particularly important element.

If TRIA were not renewed, there isn't anything about our underwriting profile that would, in any serious way, change.

We have underwritten to our exposures that exist today and it is a $35 billion retention.

The current retention under TRIA is a size of an event that is a September 11 event, another one.

Now obviously TRIA would provide protection in the event of nuclear or biological radiological chemical events that would substantially exceed that.

From a Company perspective, that would actually be our position, that the long-term solution here is in the government providing reinsurance.

And by the way, as an industry participant, we would be happy to pay for it, but to have reinsurance for those kinds of events.

And I do think that that is the right long-term answer.

So as a participant in the industry, we support it.

If it didn't happen, it wouldn't be dramatic for us.

We certainly have an underwriting profile that is sound and will stand the test of time.

But I do think it is the right answer and I believe actually that there will be a renewal of TRIA in some form or fashion.

Last question, there are several reinsurers that have had some fairly substantial losses, outsize losses here from the hurricanes.

I am wondering if you all are reevaluating who you use on your reinsurance programs.

That's a constant process that we go through in evaluating the creditworthiness of reinsurers.

And based upon what losses we had this quarter and where our treaties are placed, we were pleased with the grouping of reinsurers that we have been doing business with.

But again, that is an ongoing evaluation that we will continue to make.

Jay Gelb, Lehman Brothers.

First, you mentioned the Florida hurricane cat fund retention is $30 million.

Could you tell us what the actual limit of coverage is?

And then second, I'm trying to get a better sense of what the fully diluted share count could be in the fourth quarter and under what type of dollar level of profits do the converts become antidilutive.

And then third, if you could also comment on the reserve review to see if that takes into account anything from other legacy liabilities like medical malpractice and assumed reinsurance.

Thanks.

We are going to give Joe a minute on Florida hurricane cat fund answer.

On the share count, if you go back to what the diluted share counts were in the second quarter and it adjusts for the issuance -- well I guess you don't have to adjust for the issuance of the equity linked notes because that was in the diluted already.

It is pretty much going to be what we saw in the second quarter.

As far as levels of income, I think you need a fairly low level of income for it to not be dilutive.

So I would just use the indications that we have given you from the second quarter and the third quarter now as how to model that.

And then as it relates to the reserves, the reserves are looked at in their totality each quarter.

As I mentioned, A&E is and everything else is being looked at real-time.

So what we disclosed before is these are the things that popped out of the reserve analysis.

And then on the Florida coverage under the cat fund.

It's 110 million.

110 million of coverage.

Is there participation with that?

Yes.

I believe it is 90/10.

90/10 up to 110 or 110 --?

We can recover about $110 million and we are on the hook for 10% of the losses in excess of 30 million.

All right.

Thanks very much.

Charles Gates, Credit Suisse First Boston.

I have two questions.

I guess the first question is that George Joseph, the individual at Mehona General (ph), has opined that he thinks that some insuring (ph) programs are basically taking a stance of take all comers.

Would you comment on that as it's specific to St. Paul Travelers and in answering, would you comment to what extent perhaps you see the industry's definition of a preferred risk having changed?

I guess the only other question I have is the numbers that you have shared in the past for expense savings as a result of the merger after-tax have been 202 million I believe for '05 and 260 for '06.

Could you comment on that as well?

I can.

I'm having some difficulty connecting with those numbers.

What we did say and maybe you're giving the after taxes.

Yes, sir.

Yes, sir.

That's fine.

We said originally that we would achieve a $350 million run rate by the end of this year and a $450 million run rate by the end of next year.

We have already achieved the $350 million run rate currently and are actually on the cusp of achieving the $450 million run rate.

We are actually quite close to it and suspect that we will be at that level sometime in the early part of 2006.

Nice going.

Relative to the first part of your question and I didn't hear his exact comments so I can't exactly clarify what he meant by them but in general, tiered pricing lets us deal with a much broader cross-section of the marketplace so it comes closer perhaps to thinking about (indiscernible) take all comers basis but not exactly.

When you offer one or two or three prices for risk, it was very rudimentary and because each individual company would have its own different underwriting profile and pricing structure, you'd find dislocations and significant differences in prices.

As we take into account more variables and the interaction of those variables with each other we can get more granular pricing to the point where it becomes almost a smooth pricing curve.

There will still be risks where for certain reasons we won't be able to get a price that we're comfortable with either because of certain state regulations or other items.

So I don't think we'll get to a take all comers component.

I do think there is still a segment of the marketplace that is a nonstandard segment that performs differently and you can't fully reach with some of these tiered pricing programs.

You have to have a different set of operational criteria in and around it.

But I do think for the standard and preferred market segments you really can get to the overwhelming majority of risks.

As a result, I don't think it's going to become as important to identify preferred risks.

I think it is going to become more important to identify risks that you can correctly price.

And that difference lets us compete more broadly and it really gives us a distinct advantage over less sophisticated and smaller carriers who don't have the breadth of information or the resources to build the programs to drive that level of sophistication.

I would actually take the argument even a tiny bit further, Charlie.

It seems to us that you're either in an increasingly segmented arena or over time, you are increasingly selected against because what the segmentation really is supposed to do is to match the right price for the right risk.

And therefore, those companies that don't use that will tend to over time to get more of the right customer but the wrong price and it will rarely work in a positive way.

It will tend to work in a negative way.

So we see over time, and I am not declaring this to be in the immediate future, but that the world in personal auto is going to sort itself out between those that do have the technology and continue to invest and develop it and those that don't and over time they fall by the wayside.

J.F.

Trembly (ph), HSBC.

I'd like to cycle back to your comment regarding the management of your coastal exposures.

Can you provide additional color as to how you define your coastal exposures, which states and how precise you get in your definitions?

Do they go by ZIP codes?

Here, I am trying to get at the portion of your total premium volume that might be subject to disclose (indiscernible).

I think that's going to be a very difficult effort for you to undertake because we're just not at the stage yet where we are even thinking about it in quite that context.

Shortly after the storm, I was visiting in Hattiesburg, Mississippi.

Hattiesburg is I think about 80 miles inland from the shore and there was not a house that I passed the day I spent in Hattiesburg that wasn't damaged in one way or another.

Some much more, some far less.

But the frequency there was really quite remarkable 70 miles inland.

And I think you have got to take a look at coastal exposure that runs not only along the Gulf Coast but the Southeast and the Middle Atlantic and ultimately up into New England.

And so I really can't yet give you that sense.

It is just too early for us to say it's X miles inland or Y miles inland and just don't have the ability to do it.

I mean with that said, we clearly look at ZIP codes.

We look at first county in, we look at second county in.

I think like everybody we're -- and this has been going on for actually a couple of years.

Orlando isn't sitting on the Coast but it has some coastal like exposures.

So we are looking at areas like that all up-and-down the East Coast.

But it would be very hard to give you percentages.

And we significantly differentiate our pricing based on those zip codes and construction characteristics in there.

This isn't news to us that we should differentiate those pricing components.

It just means we need to push up the amount of that differentiation.

And in a sense -- and I'm sorry folks but this is the last question that we're going to be able to take.

We want to respect the next company's time.

If you look at what has happened in Florida over the last 15 years, essentially the definition of coastal has changed and gotten greater with each passing year and that portion that is considered less hurricane exposed has simply shrunk.

We used to talk about the triangle within Florida as being non-coastal and now we're almost down to basically one metropolitan city and even there we see what damage can happen in Orlando.

So I think that is part of the process we have got to go through.

Operator, thank you very much.

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

This concludes Q&A portion of today's call.

You may now disconnect.