旅行家集團 (TRV) 2006 Q2 法說會逐字稿

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

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

At this time I'd like to turn the call over to Mr. Michael Connelly, Vice President of Investor Relations.

Mr. Connelly, you may begin.

Thank you.

Good morning and welcome to the St. Paul Travelers discussion of second-quarter results.

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.st.paultravelers.com under the investor section.

Today with us we have Jay Fishman, CEO;

Jay Benet, CFO;

Brian MacLean, Head of our Commercial and Specialty Businesses; it Joe Lacher, Head of our Personal Business and other members of senior management.

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

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

Before I turn it over to Jay, I would like to draw your attention to the following.

Our presentation today includes 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 our earnings guidance is forward-looking and we may make other forward-looking statements about the Company's results of operations, financial condition and liquidity, the sufficiency of the Company's reserves and other topics.

The Company cautions investors that any forward-looking statement involves risks and uncertainties and is not a guarantee 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 and 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' operator income which we use as a measure of profit and other measures that may be non-GAAP financial measures.

Reconciliations are included in our recent earnings press release, financial supplements and other materials that are available in the investor section on our website stpaultravelers.com.

With regard to the regulatory matters affecting our industry, the investigations described in previous quarters and in our most recent 10-Q and 10-K remain ongoing as are the Company's efforts to cooperate with the regulators.

Therefore, we will not report further on these matters at this time.

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

Thank you, Mike.

Good morning everyone and thank you for joining us today.

We're pleased to announce another quarter of strong financial results with operating income of $959 million or $1.34 per diluted share; operating return on equity of 16.6%; and a combined ratio of 89.8%.

As you can see from our press release and as Brian and Joe will share with you later, our topline performance was also very strong.

Also in the quarter on an after-tax basis we reported record net investment income of $673 million, net favorable prior year preserve development of $68 million and catastrophe losses of $44 million.

Lastly, we initiated our share buyback program repurchasing $250 million of stock during our quarter or 5.6 million shares.

We're also very pleased that during the quarter we were upgraded by Standard & Poor's to a financial strength rating of AA- reflecting our Company's earnings generation ability and capital strength.

We intend to keep our comments brief this morning and in that regard, let me quickly share with you our view of marketplace conditions.

Profit margins on our products remain very attractive as evidenced by our accident year combined ratio of approximately 90%.

Pricing in the Southeast particularly for property risks continues to increase significantly.

And while we all hear anecdotes about increasing commercial lines competitiveness, in fact we generally observe stable pricing outside of the Southeast market.

The personal lines auto market is becoming more competitive although Quantum is allowing us to take share.

Retentions remain historically high across the board and loss trends continue to be fairly benign.

And lastly with retentions high throughout the industry, quality new business flow remains somewhat limited.

Nonetheless, our topline performance this quarter was quite encouraging.

Gross written premiums were up 4%, 5% and 10% for commercial, specialty excluding cat risk which we sold late in 2005 and personal respectively; and 8%, 8% and 10% for net written premiums respectively.

Brian and Joe will give you more color behind these statistics.

But we are particularly pleased by our improving topline performance over the last few quarters.

Also in the quarter we completed our catastrophe reinsurance placement satisfactorily.

Our national program now has a retention level of $1 billion and the dollar amount of coverage is $558 million.

In addition to our national program, we also purchased a $500 million program for certain Northeast exposures and Jay Benet will provide you with more detail on this in a few moments.

The catastrophe reinsurance market remains very challenging with availability down and pricing significantly up.

But importantly for us, we are not overly reliant on catastrophe reinsurance to achieve an acceptable value equation for our property business.

Our gross line underwriting approach as well as our size and financial strength position us well even in this challenging market.

Turning to our guidance on page 3 of the webcast, we are increasing our 2006 full-year guidance to $4.90 to $5.10 a share from the previous range of $4.70 to $5.00 a share.

The increase primarily reflects the achievement of a strong second quarter.

The assumptions underlying our guidance include catastrophe losses of $250 million after tax or $385 million pretax for the remainder of 2006 and no additional prior year reserve development either favorable or unfavorable.

Average outstanding diluted shares are assumed to be 723 million for the full year before the impact of any share repurchase activity in the remainder of the year.

We're sure many of you are curious about matters pertaining to recent events at the Big Dig and Tom Kunkel who runs our Bond business is here to speak about that topic with you later on in our discussions.

In summary, we are very excited about the positive momentum we've achieved for the first half of 2006 and we begin the second half of the year in excellent financial and competitive position.

With that, let me turn it over to Jay.

Thank you, Jay.

Page 4 of the webcast summarizes our second-quarter 2006 financial performance.

While most of the information on this page is self-explanatory, I do want to point out a few things.

This is our second straight quarter of plus $950 million of operating income reflecting a continuation of the very healthy underwriting results that we've been experiencing.

Our consolidated GAAP combined ratio is 89.8% and record after-tax net investment income.

On the topline, quarterly earned premiums of $5.2 billion increased over the second quarter of last year as well as sequentially, that is when compared to the first quarter of the current year.

And finally, I'd point out that our average diluted share count of 720 million was up 1.4% over the second quarter of last year due to the August 2005 issuance of 15.2 million shares in connection with our equity link notes partially offset by second-quarter '06 share repurchases made in connection with our recently announced $2 billion stock buyback program.

During the second quarter we purchased 5.6 million shares at an average cost of $44.37 under this program.

As the data on page 5 indicates, second-quarter consolidated operating income was $7 million or 1% lower than the prior year quarter driven by catastrophe losses that were $36 million higher after-tax partially offset by an $18 million increase in net favorable reserve development which was $68 million in the current quarter.

This was our seventh straight quarter of consolidated net favorable reserve development ex A&E, and our fourth straight quarter in which each of our three segments recorded net favorable reserve development again ex A&E.

In commercial net favorable reserve development was $1 million after-tax.

Our recent experience had indicated a need to strengthen certain assumed reinsurance reserves but this strengthening was more than offset by favorable development caused by improved frequency and severity trends primarily in property, auto, and general liability coverages.

International business drove $29 million of after-tax favorable reserve development in specialty and better-than-expected auto loss experience primarily drove $38 million of after-tax favorable development in personal.

In addition to cats and reserve development, the quarter included an additional legal provision of $42 million pre and post tax related to investigations of various industrywide business practices by certain government agencies as previously described in our 10-K and 10-Qs.

Margins continued to be very strong in all of our segments.

Our consolidated GAAP combined ratio was 89.8%, 2.2 points higher than the prior year quarter and 1.6 points higher ex cats and prior year development.

The loss and loss adjustment expense component ex cats and prior year development decreased by 0.5 points due to the strong retention of our profitable in-force base, better-than-expected frequency of non-cat related losses and better-than-expected loss severity all consistent with recent trends.

However, our expense ratio increased by 2.1 points mostly due to the increase in legal accruals and an increase in advertising expenditures in line with previous announcements.

You should note that each of our segments reported similar increases in their expense ratios mostly for these same reasons.

Our 2005 catastrophe reinsurance program which expired on June 30, 2006 has been replaced by the 2006 program which runs through June of '07.

Needless to say, the program has been significantly restructured given the dramatic changes that have taken place in reinsurance availability, cost and coverage since Katrina, Wilma and Rita, as well as our evolving views of risk and the cost benefit of risk retention or transfer.

A side-by-side display of the old and new programs is shown on page 6..

Last year's program comprised a national all perils limit of $875 million, attaching after retention of $750 million.

This year's program is divided into two components, a national all perils limit of $558 million similar in coverage to last year's program but attaching at a $1 billion retention; and a $500 million Northeast only limit attaching a $2.25 billion.

The $558 million national all perils limit runs within two layers.

We retain up to $362 million for losses ranging from $1 billion to $1.5 billion and we retain up to $330 million for losses ranging from $1.5 billion to $2.25 billion.

Over $2.25 billion, we retain everything except for losses resulting from Northeast hurricane, earthquake and winter storm freeze, for which we have full coverage between $2.25 billion and $2.75 billion.

Each of the two components of the new program has one reinstatement.

Importantly, the Northeast only policy allows for losses from a single covered peril anywhere in the U.S. to be used to satisfy its $2.25 billion retention.

This is an important feature given the possibility of a single hurricane first striking the Southeast and then within a stated number of days striking the Northeast as well.

In this scenario, losses incurred in the Southeast while not covered by the Northeast only policy, can be combined with losses incurred in the Northeast to determine if the $2.25 billion retention has been exceeded.

On balance, the new program increased our 1-in-250 loss estimate by approximately 100 to $200 million after-tax and I would remind you that we continue to operate as a gross line underwriter and do not rely on cat reinsurance to run our businesses.

Finally, as expected, the cost of our cat reinsurance did increase.

While we paid $75 million last year for the $875 million all perils limit, this year we paid $118 million for the $558 million limit with its higher retention.

Before Brian and Joe provide more insight into second-quarter operating results and current market conditions, we thought it would be helpful to update you on two current topics.

Tom Kunkel, President and CEO of our Bond Business, will comment on the central artery project in Boston and then Brian will comment on D&O coverage related to recent stock option issues including backdating.

So let me turn it over to Tom.

Thanks, Jay.

This morning I'd like to spend a few moments discussing the incident in Boston's I-90 seaport access tunnel, one portion of the Boston central artery also known as the Big Dig.

On July 10, ceiling panels in this tunnel collapsed causing an accident and a fatality.

There have been numerous news articles that have been written over the past few weeks speculating on who if anyone is at fault.

One of the parties mentioned by the media has been Modern Continental, who, as many of you know is a construction contractor that St. Paul Travelers has provided surety bonds for in the past.

It is important to realize that we are only in the preliminary stages of our investigation.

Our information regarding the cause and responsibility for this accident is limited.

Despite public pronouncements by various Massachusetts state officials, there have been no determination of fault in this matter.

State and federal officials are investigating all possible causes of the incident including but not limited to design, installation, and unanticipated post construction stress to the anchor system.

The surety bond that St. Paul Travelers provided to Modern Continental with respect to this part of the project has a maximum contractual limit of $64 million.

And we have a 50% cosurety, A rated by A.M.

Best, on this bond.

Thus, St. Paul Travelers effective contractual exposure on this bond is capped at $32 million.

It's important to note that a number of prerequisites must occur, none of which have, before St. Paul Travelers would be obligated to pay any money under the bond.

To date we have not, nor has Modern Continental, received a claim associated with this matter.

It is also important to note that Modern Continental has coverage available to it through insurance policies.

It is a named insured on an owner-controlled insurance policy also known as an OCIP, with substantial limits covering general liability and completed operations purchased by the Turnpike Authority.

Modern Continental also carries its own liability insurance separate and apart from the OCIP program.

St. Paul Travelers does not participate in either program.

Our only insurance relationship with Modern Continental is that of surety and consequently we do not have any exposure to tort claims.

Considering all of the above, we are comfortable with the reserve position as it stands at the end of the second quarter.

Lastly, I should also point out that St. Paul Travelers does not provide the general liability or the errors and omissions coverage for the major design companies that have been identified.

Brian?

Okay, thanks, Tom.

Let me take a couple of minutes and cover the other topic de jour that is the D&O related backdating of options issues and then I'll go into the core business results.

D&O and backdating, clearly a developing situation that we are watching closely.

We do underwrite public company D&O.

We are basically an excess writer, in fact, a relatively high layer excess writer.

Our maximum net lines range from 5 to $11 million depending on the inception date and the gross amount that we write.

Those would be per account net lines and to date, the issue has been primarily derivative in nature.

So it is not class action and therefore the exposure has been primarily to defense costs with a few small settlements.

Potential losses for us should be mitigated by several issues.

First and foremost, our high excess position; secondly, our limits management; third, the claims made nature of the policy and the fact that defense would be within the limits; and lastly, the variety of coverage restrictions and defenses that we've had.

Clearly over last couple of days, you have all gotten a pretty good education on the topic from other calls and from reading various articles.

So I'm not going to rehash all of that.

But instead I want to take a couple of minutes and go through fairly specifically what our situation is today and why we are comfortable with it.

To date we have gotten 19 claims, some of which are actually in suit, others are just notice of circumstances, so that would be a situation where a company, given the claims made nature of the policy, has sent us a claim notice saying that there are some circumstance which may or may not trigger a suit.

We are only primary on one of these 19 claims and on that, for the account, we have a $10 million net limit.

For the other 18 where we are excess, our average attachment point is just shy of $40 million.

And a very important point there is that in our experience the ultimate value of a typical derivative action is well under $10 million.

So again, well short of our average attachment points on the claims that we have.

So we see the problem as it emerges as being primarily for the primary insurers and those lower layer excess players.

Our limits on the 18 excess claims average $10 million gross and $7.5 million net and again, that would be attaching at close to that $40 million level.

So in summary, we believe that based on the facts today, this is not going to be a big issue for us.

We believe that some of the 18 claims that we have actually will in ultimate value won't have any value.

And very few of these claims even have the potential to get to our level.

So overall, we believe the exposure is well within our current reserve levels.

So let me now go to the overall business results and when we get to Q&A, I'm sure you will have questions for either Tom and I on those topics.

Turning to page 7 in the webcast.

Both the commercial and specialty businesses had very strong second-quarter performance.

Starting with the commercial segment on page 7, operating income was $517 million for the quarter, and over $1 billion at $1,052 million for the six months.

That is down 2% for the quarter and up 8% year-to-date.

The accident year combined ratio was 90.6 for the quarter, up about 0.5 point from prior year.

The improvement in the loss ratio was driven by a continuation of the relatively stable loss trends we saw in the second half of 2005.

Claims frequency continues to be modest and severities well within normal levels.

The expense ratio is up primarily due to the corporate expenses Jay already mentioned.

Net investment income was higher due to both strong cash flows and higher investment yields.

Turning to the topline, net written premium in the core commercial which excludes runoff business, grew 9%.

All of our businesses are showing growth but some of the increase in net written was due to changes in the reinsurance program in national accounts and accordingly, gross written premiums were up about 5%.

Adjusting for the movement of business noted in footnote 2 on page 7, net written premium in commercial accounts was up 9% for the quarter while select improved 2%.

Growth in these businesses are driven by what is essentially a tale of two markets.

First, on the catastrophe exposed property risks, particularly in the Southeast U.S., there has been significant price increases and a tightening of terms and conditions.

Retention rates remain relatively high although below the countrywide noncoastal retention levels.

And new business writings are minimal.

The specific figures vary dramatically state by state and business by business with the largest price change in large accounts and select seeing significant price improvement but clearly lower than in the middle market.

So in the aggregate for this coastal market, we have shrinking risk counts, tighter terms and much higher prices all resulting in a growth of net written premiums.

Now in the other market, that is the casualty lines and noncoastal property exposures.

The overall market conditions are consistent with what we've been saying for most of the last year; that is very strong retention levels, relatively stable pricing and a relatively modest flow of quality new business.

So overall away from the Southeast cat exposed market, we're seeing very stable condition which are resulting in real growth exclusive of rate in the 2% to 4% range.

Shifting now to our national accounts business which again for us is almost exclusively a casualty business, the net written results were up significantly over last year but they're impacted by changes to our reinsurance programs for discover re.

Excluding discover re, net written premiums were up 6.8% in national accounts most of which was due to the timing of retro premium adjustments.

This is the same accounting issue we talked to you about last quarter but in this quarter's results, it is increasing our net written premium numbers.

More important than the reinsurance or accounting issues, we continue to see a reduction in fee income from the national business.

Fee income is down due to lower volumes in the residual market pools that we service and from a decrease in new business primarily in the portion of our business where we provide claims service on a fee basis to companies that choose to self-insure.

Reviewing the specific production statistics on page 8, commercial accounts retention is at 82% while renewal price increased to 4% reflecting the pricing from cat prone property exposures.

New business is slightly down from last year's second-quarter figure in what remains a very competitive new business market.

This quarter was, however, our highest new business quarter in the last year.

In select, customer retention was at 84% while pricing has remained very constant.

As I said, select is experiencing similar dynamics as commercial accounts but price changes are not as dramatic so the countrywide all lines price change is a little lower but still positive at 2%.

New business is up 11% over last year as we are seeing the impact of the platform changes we started to roll out during 2005.

Moving to the specialty segment on page 9, operating income is up 30% over last year.

The improvement was driven by higher investment income and favorable development on prior year reserves of $29 million as compared with unfavorable development of $11 million last year.

Excluding the impact of the prior year development, the loss ratio improved modestly period to period as we continued to experience solid margins in these businesses.

Turning to net written premiums, they are up 7% and excluding the impact of the cat risk business we sold last November, net written was up 8% from a year ago.

In the domestic businesses, the increase in financial and professional services is due to the growth in financial institutions and professional liability.

In construction, although retentions were fine, premium was down as this continues to be a fairly competitive market for new business.

Bond growth was driven by strong performance in executive liability and contract surety as well as lower ceded premiums.

The growth in our onshore oil and gas business is driving the growth in other domestic specialty.

Within international and Lloyd's, the growth came primarily in Lloyd's and Canada.

In Canada, a good mix of price retention and new business were also complemented by reduced reinsurance costs.

In Lloyd's, where much of our business is property, marine and energy, the market dynamics for cat exposed risks was similar to those in the U.S. commercial business.

That is, price is up strongly, but offset by reduced exposures due to the management of our cat position.

As was the case in the commercial segment, the overall increase in net written is somewhat impacted by reinsurance transactions.

Absent these transactions or more simply on a gross written basis, specialty premiums excluding cat risk were up about 5%.

Looking at the production statistics on page 10, domestic retentions were strong and up from last year and pricing remains positive, up 5%.

New business is down due to the sale of cat risk.

In the international business, UK and Ireland continue to be very competitive.

Pricing has improved modestly and retention, although flat with last year, is down from recent quarters.

In summary, we feel great with the performance of our book across both the specialty and commercial businesses.

Margins are solid.

Retentions are terrific.

The property market along the Southeast Coast is responding to the results of the last two year's storm seasons and away from the coast, pricing has stabilized.

So continued good performance in those businesses.

Now I will turn it over to Joe Lacher for the PL story.

Thanks, Brian.

As with our other businesses, the personal segment delivered strong earnings this quarter with operating income of $203 million and a combined ratio of 90.1%.

As you look at page 11, operating income was down $63 million versus prior year.

This variance was principally driven by $14 million of less favorable prior year development and $36 million more catastrophe losses.

The combined ratio benefited from 3.6 points of favorable prior year development and was hurt by 4.1 points from catastrophes.

Additionally, the loss ratio was impacted by increase in ULAE costs and reserves in the quarter and expense ratio was impacted by items that Jay Benet had discussed earlier.

Overall, net written premiums for the quarter grew 10% over prior year with growth coming in all lines across diverse geographies.

We're pleased with the earnings and growth from this segment.

I'll provide some additional color on the lines within personal turning first to homeowners where our GAAP combined ratio was 83.3% for the quarter.

As you can see on page 12, homeowners production continued its strong and consistent performance.

Our retention remains stable at 87%; renewal price change is down from the prior year quarter to 5% and it is generally in line with observed loss trends.

Our policies in-force growth increased to 8%.

New business was up about 26% versus the prior year quarter and continues to be generated again across diverse geographies.

Marketplace and homeowners continues to be a complex one.

In Atlantic wind exposed areas, there is increasing activity.

Most carriers are executing some combination of rate activity, changes in terms and conditions or exposure reductions with new actions emerging regularly.

Capacity is at a premium.

Our efforts to ensure our risk reward equations are appropriately balanced continue and are being executed very locally.

In non-wind exposed geographies, the marketplace is more stable.

While profit margins in these regions appear to be strong, we continue to see disciplined market behavior.

Overall we are pleased with the lines results and are positioning and anticipate an ability to continue to grow the business profitably.

Turning to auto, profitability was solid with a GAAP combined ratio in the quarter of 95.5%.

There is a little bit of noise in these numbers.

It is up from the year ago quarter principally due to a reduction in the amount of favorable prior year reserve development, some increase in ULAE costs and reserves and the expense ratio impacts Jay had described earlier.

When you back out the noise, our accident year loss ratio broader was slightly better this quarter than last year.

Production results remained strong with retention stable at 84% and renewal price change at 1%.

Both new business and policies in-force saw significant increases in the quarter reflecting the continued impact of our Quantum auto product rollout.

PIF growth versus the prior year quarter was up 10%.

Quantum is currently active in 33 states and the District of Columbia.

This represents the bulk of the impact of the program's rollout.

We have a number of states where we may introduce the program in the future but due to operational or regulatory constraints, we have delayed their implementation.

In past calls and our recent investor day, we discussed this program in great detail.

We continue to monitor and tune the program actively and remained pleased with the results.

As we look broadly across the auto marketplace, we are seeing signs of increased competition for business.

Profitability is very strong for the industry and we continue to see low single digit loss cost trends that are somewhat outpacing renewal price changes.

As Jay mentioned earlier, there is significant increasing competitive pressure across the auto marketplace.

We are seeing everything from rate activity to commission changes to increased advertising.

We are pleased with our results and we do anticipate continued profitable growth but are also anticipating an environment where more and more competitors are driving to increase their auto growth.

I'd like to make one more comment relative to auto, really just as a heads up for you as you prepare to review our numbers in the third and fourth quarters.

During the second quarter, we made a decision to move the bulk of our new business to six-month policy terms from twelve-month policy terms.

As we've discussed before, the increased pricing segmentation in our product structure requires us to tune and adjust it more regularly.

The shorter policy term allows the book to more quickly respond and incorporate these adjustments.

The change favoring six-month policy terms will have a timing impact on our reported written premiums in the third and fourth quarters.

Obviously the written premium on a six-month policy is about half of a twelve-month policy; on a full year basis, they generate the same written premium.

The change will impact somewhere in the neighbor neighborhood of 30% to 40% of our new business and will cause new business written premium and total written premium to be somewhat reduced in the third and fourth quarter.

By the first quarter of 2007, new business written in the third quarter of 2006 will be renewing and the timing impact will have passed.

As you would expect there is no impact to policies in-force, earned premium or operating income resulting from the change.

Again this is just an advance notice and it doesn't have any material impact on this quarter's numbers.

With that, I will pass it back to Jay.

Thank you, Joe.

As you can see from page 13, for the first time average invested assets crossed the $70 billion level growing $800 million in the quarter to $70.5 billion.

Growth was driven by very strong operating cash flows which are almost $900 million for the quarter up over 25% from the second quarter of last year and the receipt of $786 million of proceeds from our recent senior debt issuance which is expected to be used to retire debt and trust preferreds maturing or becoming callable in the fourth quarter of this year.

Average invested assets are up almost $5 billion from a year ago.

The quality of our investment portfolio remains very high but the low investment-grade portion continued to decrease from its already low level and the duration extended slightly to $4.2.

After-tax NII as shown on page 14 reached a record level of $673 million in the quarter up 13% driven by very strong growth in fixed income results.

The fixed income portfolio benefited from the increased invested asset base as well as higher rates.

On average, the rates on asset purchases in the quarter averaged approximately 60 basis points higher than the rates on asset sales and maturities adding further momentum to NII going forward.

The performance of the non fixed income portion of the portfolio was comparable to the very strong second quarter of the prior year and the very strong first quarter of this year.

Private equities, hedge funds and real estate investments all contributed to this strong showing.

The after-tax yield on the total portfolio was 3.8% or 20 basis points higher than a year ago consistent with this year's first quarter.

Lastly as page 15 indicates, we ended the quarter with over $23 billion of common equity and book value per share ex FAS 115 of $33.83, both up 7% since the beginning of the year, after $250 million of share buybacks and dividend of $343 million.

Although our debt to total capital ratio increased by 90 basis points to 21.9% since the beginning of the year, excluding the brief funded debt of approximately $800 million, it decreased by 110 basis points to 19.9%.

Either way it was well within our target range.

Stat surplus which now exceeds $19 billion also increased by 7% since the beginning of the year and holding company liquid assets were over $2.7 billion or $1.9 million ex the prefunded debt.

Given current conditions and barring very extreme cat events, we expect to continue to generate more than enough capital to support our business growth.

And consistent with what we had said on the first quarter, we remain committed to both growing book value and returning excess capital to our shareholders.

Having concluded our prepared remarks, we'd now be happy to answer any questions you might have.

(OPERATOR INSTRUCTIONS) Alain Karaoglan with Deutsche Bank.

Good morning.

A question on the topline growth.

Obviously it is good news when companies are growing but why shouldn't we be concerned with the topline growth given that we are in a softening environment?

Could you maybe elaborate on that?

And on the personal auto side, at a combined ratio of 95.5%, that is probably as high as it can get to produce an adequate return on equity.

Could you tell us what you expect going forward and what were the changes to the ULAE that occurred and does that change going forward?

This is Brian.

Why don't I take the first question and then I will flip it to Joe Lacher for the second piece.

We actually feel very good about our core commercial numbers and the growth that we are seeing and I guess I'd say look at the details on page 8 and where we are getting it.

And I know there are a lot of anecdotes and a lot of stories about how soft things are getting and a lot of those come from people who work in this organization that we talk to all the time.

But when we really look at our data in our core businesses we are running solid 80 plus% retentions.

We're getting net-net positive price increase and again that is obviously being driven somewhat by the Southeast coastal dynamic.

But away from that, our core casualty businesses and the rest of our property markets prices are not declining on our retained book.

They are basically pretty flat.

And we are writing a decent amount but not an excessive amount of new business.

If in our numbers we were having significantly lower retentions, and prices dropping and we were growing because we were putting a lot of new business on the books it would be alarming.

But we feel very good about where the market is today.

We don't know where it's going to be in 30 days.

But we feel good about where it is and where our growth is coming from.

This is Jay Fishman.

A comment I'd add to Brian's is that you used the phrase given that we're in a softening environment, we at least through the second quarter we just don't see that.

We don't see that we are in a softening environment.

We have been experiencing a very stable environment at particularly attractive margins.

So the fact that we're able to grow in that environment strikes us as being a really good thing.

Alain, this is Joe Lacher, coming back to your question on personal auto.

We tend to agree with you that the combined ratios in the 95, 96 range are about as high as you'd want to get to earn an adequate ROE.

We don't believe this is the run rate going forward.

And again, there's a couple of things running through it this quarter.

The first to your question on ULAE, we've talked before about our continued investment in claim initiatives that are driving and having a positive impact we believe on ultimate loss payout.

What we've got in this quarter is some increase in those levels that's a run rate basis but we also have between 1.5 points and 2 points of increase related to increasing ULAE reserves.

We should have been pushing those numbers up a little bit in prior period.

It didn't move as quick as we wanted to on those.

And we also are seeing that at the increased spend level that we've got right now, losses that are on the books will have ULAE associated with them at somewhat higher levels, so we made that adjustment and really think of that as a onetime item running through those pieces.

There are some onetime expense ratio items that Jay Benet talked about before that are running through and we've also seen a little bit of pressure on the expense ratio related to underwriting reports.

With our dramatic increase in new business activity, we order more underwriting reports on new business than we do on renewal business.

So that is running through these numbers somewhere between 0.5 point and 1 point of pressure related to that and we don't anticipate that that is going to be there on a run rate basis once the growth rate stabilizes inside of the business.

So those things add together to make us feel more comfortable about the run rate combined ratio going forward.

Thank you very much, nice results.

(OPERATOR INSTRUCTIONS) David Small with Bear Stearns.

Good morning.

Just a few questions.

The first one is on the homeowner side looking at the PIF growth there, given your commentary that the non-cat regions are fairly stable, how much of the growth that you're getting here which is pretty significant is coming from regions you'd describe as cat prone?

Our growth is biased away from cat prone regions.

When we look through it across states we're contracting in a state like Florida.

You take a state like Texas, you really can't look at it on a statewide basis and understand what is going on.

You have to separate it coastal and noncoastal to understand it.

And we'd see more growth away from hurricane exposed areas.

We have the bulk of the growth in units that's coming there is in noncoastal exposed areas.

There are some coastal exposed areas where we have some modest growth but they tend to be warmer, sorry cooler water environments [less away] from the areas that you would intuitively think would be the most hurricane exposed.

Okay.

And then just to go back to Alain's question.

You mentioned retention or pricing on retained business is flat.

Could you just give us some commentary on pricing on the new business that you are winning on the commercial side?

I would say the delta of new to renewal pricing is in traditional levels.

There is always a new business discount in the marketplace ranging somewhere in the single digits or so -- you know, 5% to 10%.

And we watch that very closely.

We watch our pricing deviations in each of our businesses and I would say they are running at traditional levels.

So we are very comfortable with that.

So it is fair to say that new business pricing is down about 5% to 10% year-over-year?

No, what I'm saying is new business pricing relative to renewal pricing is always for almost [ever and ever] there is a discount in the market where to write something new, you are writing it at 5 to 10 points off of what your retained book is running at.

Or it would be if it was retained business.

A better way to describe it that we assume that a new account will price at 5% to 10% lower than it would if it were a retained account.

And obviously our current year loss picks are structured to accommodate that.

That is not a surprise to us.

We obviously build it into our current year loss pick so that the new business component reflects a higher loss ratio than the renewal component.

But to get to the way you said it, it is harder obviously to measure precisely than it is the renewal book.

And by that I mean the year-over-year change.

But our mood is that new business pricing is essentially where it was about a year ago.

And that obviously changes market-to-market and state-by-state.

But not dramatically different from what we've seen.

A very stable market really since last year's wind season.

Okay. (multiple speakers).

On the personal auto book it looks like premium per policy is down a little bit and I think at the analyst day you mentioned you were also moving down market a little bit to a little bit riskier driver.

So I guess intuitively I would have thought you would have to see premium per policy moving up a little bit.

Could you just help us understand that dynamic?

Sure.

The biggest chunk of it has to do with geographic diversification.

We've got a book that's -- the bulk of it is premium in the Northeast where average premiums per policy and per vehicle tend to be higher than across the rest of the country.

And we intended to also help you understand at the analyst day some of the geographic spread that we are seeing and that drives the gap.

Okay, thank you very much.

I would actually add one comment to what Joe's answer was to your question about coastal homeowners.

In terms of Atlantic or Gulf exposed areas, we do not have an active growth strategy in homeowners in any of those areas.

That is not to say that there might not be some growth in a given state in a given quarter.

But your question was really what percentage of the growth comes from non coastal exposed as a strategic orientation most of it, almost all of it.

We do not have a growth strategy in Atlantic or Gulf Coastal exposed homeowners.

Okay, thanks.

(OPERATOR INSTRUCTIONS) Jay Cohen with Merrill Lynch.

A couple of questions.

First in the homeowners business, the renewal price change was kind of level at 5%.

And I guess I would have expected to see that number move up simply because of what is happening in coastal areas.

That's the first question.

And then secondly maybe a bigger picture question, what's been most surprising I guess with your numbers, with other companies' numbers, has been the very moderate claims inflation we've seen.

And I'm wondering if you can as you guys think about that issue, what are some of the factors that are driving it and do you expect this to be a sustainable issue going forward?

Are we just in a new environment where the claims inflation is fairly moderate?

I'll obviously have Joe answer the first question and I'll take a shot on the second one although we speculate about this too.

There are some things we know.

We know that cars are built safer than they were.

We know that seat belt usage is up from where it was.

We know that children are almost universally in seat belts now in cars and 15 years ago that was not the case.

We know that there is much stricter enforcement of DWI laws across the country, all of those kinds of things we think have had an impact in the automobile business in terms of its claim frequency.

I'm sure there are other things.

We're not a company that is yet declaring that the price of fuel is translating into fewer miles driven and therefore is having a continuing impact on frequency but obviously we will continue to watch that.

I think that and again this is very speculative on our part, but this was a trend that we particularly began to see after September of 2001.

And our general view is that how business is and individuals think about their insurance coverage today and the value of it is a bit different than it was 10 years ago.

We are seeing fewer smaller claims.

I would say that we see fewer questionable claims than we did before, that people just seem to be understanding that the value of the insurance policy is in its long-term ability to respond to emergency situations not to everyday repair and maintenance kind of events.

Now again, very speculative on our part but those are the kinds of trends we see.

Workers' comp obviously tends to be inversely related to economic activity and so that has been a winner generally over the last several years.

Again to the extent that our concludings are right, and we're not sure they are, these things do seem sustainable to us.

And this is not been a pattern that has developed in six months, it has actually been a multiyear pattern that has been developed and does indeed seem to be sustainable and real.

Jay, relative to your homeowners pricing question, we would anticipate that our RPC will tick up a little bit in subsequent quarters.

You get a couple of things going on in that process.

There is a greater lag time in the personal segment than there is in the other segments in terms of how we can move on pricing between what you have to do from a rate filing perspective and moving that through insurance departments and then when the effective dates start to hit individual policies.

The second component, and we've given you a fair amount of information in the past on our homeowners business and its relative rate adequacy and our relative comfort in terms of the returns that were generating in that business, has us feeling good about where it is in a lot of spots so our press on that has been perhaps a little less than some other players have had.

So we would anticipate that you will see some of that ripple through from a coastal perspective in subsequent quarters.

I would also remind you that changing terms and conditions doesn't show up in rate.

So higher windstorm deductibles, higher deductibles overall which are a meaningful part of the action here to mitigate coastal exposure just isn't going to show up in a quantitative way.

Thanks for your thoughts.

(multiple speakers) a significant part of the strategy.

Thanks.

Larry Greenberg with Langen McAlenney.

Thank you.

Good morning.

Hey, Joe, can you just refresh my memory on Quantum?

For policies on renewal that come up in states where it's offered, do those get transferred to the new forms?

Right now the program is on a new business basis only so they do not.

There are a couple of states that have small PIF volume where we are affecting a transfer but not to any material degree from a risk count perspective.

Is it just because it just shakes things up too much?

Is there a plan that ultimately everything will be transferred?

At some point we would anticipate that they would move.

When you move state by state, there are different reasons.

Some from a regulatory perspective don't allow that or facilitate that move.

And it would be a challenge.

In some cases the pricing structures are different that there might be some level of disruption around it.

And really a chunk of it is we wanted to roll the program out, understand how it works, tune it, and get comfortable with its structure and effectiveness and how we were working it before we took a significant portion of the book and subjected it to that rating mechanism.

Great.

Thanks.

And then just secondly, is it possible to get a breakdown for the commercial segment between the reserve strengthening that took place in assumed reinsurance and what the other reserve releases were?

This is Jay Benet.

We manage the reserves and report the reserves by the segments.

And what we tend to do is if there is some movement that we think is appropriate to comment on, we will comment.

But we don't really get into all the specifics given the way these things are measured.

I mean we do things by market, by product and whenever and it just gets too complicated.

So what we really look at is how is the segment performing in this particular case, the segment, commercial had favorable reserve development.

There's lots of little ups and downs and movements but we thought it important to just mention this one.

Fair enough.

And then are you not allowed to take a tax effect on the legal charge?

I noticed it was 42 both pre- and after-tax.

I would say that we just didn't tax affect it.

And obviously from the numbers that is a true statement and ultimately we will determine what the actual impact is.

Thank you.

Jay Gelb of Lehman Brothers.

Thank you.

First on the reinsurance program, could you give me the number again, the 1 in 250 exceedance probability for loss estimates in catastrophes?

Well, back in investor day for hurricanes, the 1 in 250 after-tax, after reinsurance number that we talked about was $3.3 billion.

At this point in time, we are in the process of running the new models, updating our database for the all the changes in underwriting that have taken place.

So the only real insight we can offer you at this stage is all things being equal to what we talked about before, how does the new reinsurance program potentially change that recognizing that the reinsurance program itself, because it has a Northeast component of risk, it is going to change a lot in terms where the peaks are and how the model works.

But we thought it important to give you some information and that is information is it's probably going to change it by 100 to $200 million at that level after-tax.

Higher?

Yes.

Okay.

And then what is the total cost of reinsurance '06 versus '05?

I believe you gave $75 million a year ago and then $118 million for '06.

Is that all-inclusive or just consistent with what you bought last year?

That is consistent with what we bought last year.

That is the national all perils cover.

And for competitive reasons, we don't feel it appropriate to just break out all of the cost of all of the reinsurance that we buy.

Okay.

And separately, could you give us an update on the legacy liability environment, particularly asbestos and environmental?

And then your plans if any for a reserve review in the back half of the year?

They're really isn't anything to report at this point in time when you're talking about A&E.

As we always do, we have a rather lengthy process that we go through to evaluate any changes; changes if any in A&E and when we're done with that study, we will be reporting it later in the year.

Will that be a fourth-quarter event?

Normally we do it in the fourth quarter, yes.

Okay.

And then just more broadly from the legal environment or what you are seeing from newly rising claims.

Is it getting better, worse, the same?

I think what we can comment on is the macroenvironment and obviously you read the same newspapers that we do.

From a macro perspective, meaning an overall industry wide perspective, certainly the asbestos environment is no worse than it was a year ago.

On a micro basis as it relates to us, we really have nothing to say until we get further along in our study.

That's helpful.

Thanks very much.

I would clarify that when I say normally we get it done in the fourth quarter, the obligation we have is when we are done we will report it to you.

And if we are done sooner, we will report it sooner.

Okay, thank you.

Ron Frank with Citigroup.

Yes, two things.

One is following up on Larry's question.

Qualitatively even without breaking it out it's my impression that the reserve strengthening for assumed reinsurance that was done late last year was relatively significant.

And I was wondering if even directionally if you could give us a feel for whether this was as significant a strengthening as was done toward the end of last year for assumed reinsurance?

And the second question is if you could give us a little detail on what the principal changes were to the non cat reinsurance programs since that seemed to be a significant driver of what took the mid single digit gross premium growth up to upper singles on the commercial and specialty side?

As far as trying to somehow size for you the assumed reinsurance, as I said before, we look at the reserve increases or decreases, first on a segment basis and then decide if there's something meaningful to talk about.

So we're really not going to add something to it.

If it were a very tiny number we wouldn't have said anything.

So there is some size to it but it's nothing of the magnitude that really has an impact on the segment therefore we didn't say anything about it.

And on the reinsurance front in the commercial segment, that was pretty much exclusively discover re and really that's a situation where over the course of the last year we've revamped a little bit of how we operate that Company and how we behave in that segment.

The big difference being that previously much of that business was written and fully reinsured off.

We've gone through and kind of looked at the book and decided which businesses we wanted to write and we retained much, much more of that and stuff that we didn't want to write and 100% reinsure, we don't write anymore.

So it is really a change in the business model at discover re which is pretty much pretty dramatically changed their gross and net numbers.

And was there anything significant on the specialty side?

Nothing significant that had a major impact on our results.

I mean there were some changes in bond and what we did, some stuff internationally, but nothing as focused as that.

Not a great deal.

Okay, thanks.

You're supposed to be on a beach with an umbrella drink in your hand.

What are you doing here?

We just want to wish you good luck in your next phase.

Thanks a lot, Jay.

And give me about 48 hours and I will be obliging you.

At this time, there are no further questions in the queue.

Thank you.

So with that we will close our conference call and we will speak to you all again next quarter.

Thank you.

Thank you for your participation in today's conference.

This concludes the call and you may now disconnect.