旅行家集團 (TRV) 2007 Q2 法說會逐字稿

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

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

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

All of these materials may be found on our website, www.travelers.com, under the investors section.

Today with us we have Jay Fishman, CEO; Jay Bennett, CFO; Brian MacLean, COO; Joe Lacher, head of our personal and select businesses, as well as other members of senior management.

They will discuss the financial results of our business in the current market's environment.

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

Before I turn it over to Jay I would like to turn 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 statements involve 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 Traveler's operating income which we use as a measure of profit and other measures that may be non-GAAP financial measures.

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

With that let me turn it over to Jay Fishman.

Thank you, Mike.

Good morning, everyone, and thanks for joining us today.

The second quarter was another very strong quarter for us and the results very much speak for themselves.

The 29% growth in our operating income per share is a reflection of our operational success and our continuing focus on capital management.

In that regard we have already purchased almost $2.5 billion of our company's stock since the beginning of our buyback program in May 2006.

Our combined ratio was 87.8% and operating return on equity was a strong 18.6%.

All of our business segments performed very well and net investment income of $758 million after-tax was at a record level.

Adjusting for the recent sales of our Mendota and Afianzadora subsidiaries, our top line grew at a conservative 2% which feels about right given the marketplace.

Brian and Joe are going to cover the details, so let me just fill in with some market color and commentary.

First, let me address the renewal book.

Retentions were strong in all three of our segments; renewal price change remained positive in personal lines and select, was modestly negative in middle market and was about flat in our specialty and international businesses.

These are very good dynamics and continue to support the very attractive margins that we have been experiencing in these businesses.

With respect to new business, commercial lines has recently become more competitive, consequently we were judicious during the quarter about the business we wrote and, as we discussed with you at our investor day, our analytics are important in that regard.

Nonetheless, there were opportunities and we took them and we continue to be disciplined.

While the competitive dynamics in personal lines have also increased they have done so to a lesser extent and new business margins remain broadly attractive.

Across all of our businesses we believe that our product breadth, ease of access and infrastructure support make us the premier agent oriented carrier and these advantages will continue to serve us well.

In summary, retentions and renewal price change remained fairly stable and, as I've shared with you before, these are the leading indicators that we watch.

While the new business market continues to be competitive when we consider the relative stability of the renewal business and that fact we are generating a combined ratio in the high 80s we feel good about the business.

With that let me turn it over to Brian.

I'm sorry, I'm turning it over to Jay, beg pardon.

On page 3 of the webcast you can see that our net earned premiums were $5.3 billion in the quarter, a 3% increase from the prior year quarter, and that we also recorded $87 million of net realized investment gains after-tax, mostly resulting from the bundled sale of a substantial portion of our venture capital portfolio.

In addition, our weighted average diluted share count has now dropped to $676 million in the current quarter from $720 million a year ago, mostly due to our repurchase of over 48 million common shares during the last 14 months or 7% of outstanding common shares at the inception of our current share repurchase program.

We are now approximately halfway through this $5 billion program.

The diluted share count also decreased by 16 million shares effective April 18, 2007 due to the redemption of our $893 million of contingently convertible notes.

While page 4 highlights certain items that have created sizable variances in prior period-to-period comparisons, these items did not vary much in the current periods.

Cat losses at $26 million after-tax in Q2 2007, which were all in our personal insurance business, resulted from heavy rains in the northeastern United States in April.

No other weather activity, including the three storms that caused flooding in the UK during the second quarter, produced losses that were high enough for us to categorize as catastrophes.

Nonetheless, these UK storms did cost our FP&II business approximately $20 million after-tax.

There are certain topics I'd like to cover related to the net favorable prior year reserve development of $83 million after-tax that we experienced in the current quarter, and the first is ACandS.

As we previously disclosed, we recently settled all ACandS asbestos-related coverage claims subject to U.S.

Bankruptcy Court approval of $365 million after reinsurance and indicated that we did not expect this settlement would have an impact on our earnings.

We've now completed our quarterly review procedures related to all asbestos exposures factoring in the ACandS settlement and have concluded that no adjustment to our asbestos reserves is warranted at this time.

The second topic is environmental for which we reported a $120 million after-tax charge to strengthen reserves this quarter.

This charge was mostly due to an analysis of recent changes in patterns of litigation costs related to defending and/or prosecuting our obligations for these types of claims.

Notwithstanding environmental this was our sixth quarter in a row of net favorable prior year reserve development and, importantly, each of our business segments recorded net favorable prior year reserve development for the quarter.

There's one additional item I'd like to mention with regard to second-quarter operating income and that is that the current quarter included after-tax benefits of $58 million related to the effective settlement of IRS exams for all years through December 31, 2004 while the prior year quarter included $23 million after-tax related to the settlement of certain state tax matters.

Before Brian and Joe provide more insight into the second-quarter operating results and current market conditions, I'd like to provide you with a summary of our current cat reinsurance program which, except for the cat bond, is in place through June 30, 2008.

The cat bond has a three-year term beginning May 8, 2007.

Referring to pages 5 and 6 of the webcast, the national all perils component of the program was renewed with the same two layer structure as the expiring cover attaching it a $1 billion retention level and extending up to $2.25 billion.

The place limits for 2007 is slightly higher at 575 million as compared to 558 million for the expiring cover.

And within the two layers we have reinsured 118 million of losses ranging from $1 billion to $1.5 billion and $457 million for losses ranging from $1.5 billion to $2.25 billion.

Over the $2.25 billion we retained everything except for losses resulting from certain events in the Northeast.

The Northeast's only protection has two components this year.

The first is a 67% or $500 million piece of the 750 million excess of $2.25 billion, reinsurance coverage from Longpoint Re, our new cat bond facility for hurricane related covered losses.

This cat bond is tied to an index that is based on industry losses as recorded by the property claims service division of ISO.

The second component is an indemnity reinsurance layer of $250 million excess of $2.25 billion that covers our actual losses as opposed to index losses resulting from Northeast hurricane as well as Northeast earthquake and winter storm freeze.

The Northeast Cat Treaty, which is an indemnity cover, allows for losses from a single covered peril anywhere in the U.S.

to be used to satisfy the $2.25 billion retention.

And recoveries from the cat bond program, if any, are first applied to reduce losses subject to the Northeast Cat Treaty.

Both of these Northeast only coverages were purchased with a single limit without a reinstatement effort a covered event.

The total cost of our cat reinsurance program declined from the amount paid in 2006.

The 575 million in national all perils limit cost $100 million this year as compared to $118 million for the $558 million of coverage last year.

And we also paid $12 million less this year as compared to last year for the combined cat bond and Northeast Cat Treaty while increasing the Northeast only limit from $500 million to $750 million.

With that now let me turn the mic over to Brian.

Thanks, Jay.

I'll speak to the commercial results and then turn it over to Joe who will take you through the personal insurance results.

Turning to business insurance on page 7, operating income remained strong and was up significantly.

The primary drivers of our profitability were healthy underwriting margins, improved investment income and the favorable resolution of certain tax matters relating to our runoff businesses.

The combined ratio improved in the quarter and was 88.1 or 90.2% adjusting for favorable prior year loss development.

We continue to see stable frequency and severity trends resulting in relatively modest lost cost inflation.

We had no cat losses this quarter in the segment and other weather losses were relatively light.

As I mentioned last quarter, the slight increase in our expense ratio represents ongoing investments to improve our marketing and branding efforts and to enhance our platform capabilities with our agent.

We're beginning to see the successful results of these efforts in our premium growth, as you can see on page 8.

Business insurance net premiums grew 2% with business insurance core up 3%.

The growth was pretty consistent at 3 to 6% across most of our businesses with national accounts and national programs in our specialized distributions being the exception.

As you can see from the business statistics on page 9, in general retentions remain strong and pricing is modestly down from last quarter.

New business volumes are up from last year's second quarter, but reflecting the more competitive marketplace, our new business in commercial accounts did moderate from first-quarter levels.

For select retention of 83% was consistent with last year but improved from more recent quarters.

Pricing, while still in the positive range, was down slightly from recent quarters.

New business, on the other hand, is up 20% from a year ago due in part to the initial rollout of travelers express, our enhanced quote to issue platform for small business.

This is a quantum like product which has both broadened our product reach and made it easier to access.

The appeal of this combination has led to wide acceptance by our agents, as you can see on page 10.

In the upper right of the page you can see that the percentage of our applicable business issued by the automated process is up dramatically.

Accordingly we've seen a significant increase in both the number of agents quoting and the number of quotes per agent.

The result is flow is up significantly and it's helping lift our new business results.

As I mentioned last quarter, we've rolled out Traveler's Express for our MasterPac product in 10 states with another 10 coming online in July.

We expect to roll out all 50 states and to begin a pilot of Travelers Express for worker's comp within the year.

Back on page 9 commercial accounts continued to have nice written premium growth of 6%, retention was strong at 85% and there was a slight decline in renewal pricing.

Both select and commercial accounts new business has benefited from recent product initiatives and selling more products such as auto and comp to our existing customers.

I know there's been some noise in the marketplace around carriers taking business in the middle market from E&S carriers.

As we said at our investor day, when we write a piece of new business we're pretty sure we know who the previous carrier was and we're very confident that our new business opportunities in this area are not coming from E&S carriers.

As I mentioned earlier, national accounts net written premium is down; this is due in part to lower premiums from residual market pools.

As the industry experiences more favorable worker's comp results, many accounts are moving back to the voluntary market hence reducing our assessment from the markets of last resort.

In addition, our core national accounts product is priced in conjunction with underlying loss performance to premiums here are down.

Our fee income is also down in this market as the result of less losses and residual market policy service in this current environment.

Overall this was a great quarter in business insurance; margins remained strong and we're growing our top line in a disciplined manner, an increasingly competitive market, through various marketing, product and platform initiatives.

Moving to the financial, professional and international segment on page 11, operating income of $152 million is up $3 million over the second quarter of 2006.

This was after we recorded $20 million of after-tax weather losses related to the UK floods.

As Jay Benet mentioned these were not classified as cat losses and accordingly both years had cat free quarters.

Both quarters also benefited from modest favorable prior year reserve development.

Net of these impacts, the primary drivers of our profitability were healthy profit margins which are evidenced by improved loss ratios in nearly all business lines, increase net investment income and modest benefits from rate of exchange.

The loss ratio of 54.7 includes about 3.5 points of UK flood losses.

Adjusting for the flood and removing prior year impact the loss ratio improved from 53.7 to 52.8 and the combined was better by 4/10 of a point.

On the premium side, net written premiums were down 2% after the impact of the sale of our Mexican surety operation and the timing of certain reinsurance transactions.

These are the same transactions -- reinsurance transactions that positively affected our first-quarter result.

So I think a more meaningful perspective on our premium change in the quarter would be to look at gross written excluding the impact of Mexican surety sale and on this basis premiums were up 3%.

This increase was driven by strong results in construction surety somewhat offset by a modest decline in financial products due to price reductions and increased competition for new business.

International and Lloyd's gross written premiums increased 4% driven by strong business volumes in Canada and the UK.

Turning to page 12, you can see at the bottom the surety gross written premium numbers, which grew 9% from last year's second quarter.

This growth was driven by increased construction surety business volume resulting from strong economic conditions in the public works sector of the construction industry.

In financial products, retention of 85% was strong and up 2 points relative to the prior year quarter; pricing at minus 1% was down from recent quarters and new business declined $12 million reflecting increasingly competitive market conditions for professional and management liability products.

International and Lloyd's retention of 83% remained strong but was down from recent quarters while up 5 points when compared to the second quarter of 2006.

This was the quarter when we made significant reductions in our U.S.

cat exposed property at Lloyds.

Price change was zero, the net of mid single-digit negative rate changes offset by some exposure increases.

New business was roughly flat with the prior year as increases in Canada and Lloyds were offset by decreases elsewhere.

So overall we're very pleased with the commercial insurance results, margins remained strong, investments in our business are continuing to have a positive impact on production.

And so now I'll turn it over to Joe Lacher to review personal insurance.

Joe?

Thanks, Brian.

I'll refer to pages 13 and 14 for these comments.

Looking at our personal insurance segment, the overall commentary is very similar to the things that Brian just discussed.

Profitability levels remained very strong, operating income was up 36% to $276 million with an 86% combined ratio.

Catastrophe activity was moderate at $26 million after-tax and somewhat below the prior year quarter.

We also experienced favorable prior year reserve development of $32 million after-tax which was slightly below that seen in the year ago quarter.

Our results benefit from strong retention and modest growth despite a somewhat more competitive marketplace.

Overall our new business production is consistent with recent quarters and down from the prior year quarter.

Consistent with our targeted business growth strategy we continue to focus on increased agent appointments.

Year-to-date we have appointed nearly 800 new retail agent locations.

And the over 1800 retail agents appointed in 2006 currently represent over 10% of our year-to-date new business production.

Expanding our distribution reach is a key element of our growth strategy and we'll continue to appoint agents aggressively in strategic areas.

Turning specifically to homeowners, production results remained strong.

We've maintained a robust retention rate at 86%.

Our renewal price change was slightly higher than what we've seen in the last four quarters at 10%.

We continue to experience positive growth generated across diverse geographies with our overall policy in force growth at 6% over prior year quarter.

In recent periods we've experienced modest loss trends in the low to mid single-digit range.

Our homeowners business gives us a competitive advantage versus most of our peers.

The size and strength of our homeowner's portfolio gives us the scale to make investments and to bring innovations to the market that many of our competitors simply can't match.

This business has historically high retention rates and when sold in conjunction with our auto product creates an even greater customer loyalty especially in a softer market.

Our Quantum Home rollout continued this quarter with implementation in 10 additional states.

This brings our total to 17.

We are on track to roll out the majority of targeted states during the remainder of 2007 and early 2008.

This product offers unsurpassed product segmentation and will enable Travelers to continue to outperform the industry with profitable growth.

Production results in Quantum Home remain solid and in line with our expectations and we continue to closely monitor these results and are pleased with the current status.

Turning now to auto, our combined ratio was 92% for the quarter, an improvement from the prior year's 96% driven largely by year-over-year improvement in loss experience.

We continue to see moderate auto loss trends.

Adjusting for the anticipated mix impact resulting from Quantum, frequency was essentially flat, severity was up slightly.

These results compare favorably to industry trends.

We attribute this in large part to the success of our widespread claim initiatives.

In combination with our 3% renewal price change and contrary to most competitors' experience we have again improved profit margins in this business.

Turning to our production results, excluding the impact of Mendota, policy in force growth was 4% versus second quarter 2006 and net written premiums grew 1%.

Retention again remained strong and stable while average prices increased, as I mentioned, 3%.

Several things are worth noting in these results.

First, premium growth is somewhat below policy growth numbers.

Just as a reminder, this is very consistent with our results over the past several years.

It's heavily driven by mix differentials.

Our in force book has a heavy northeast concentration and our growth has been heavier outside of this region.

The difference in average premiums by geography drives much of the difference in growth rates between policies and premiums.

Second, really an overall comment, we are very pleased with these growth numbers.

While they're below the exceptionally strong numbers posted last year during the initial rollout of Quantum, they remain strong to most competitors.

Given that an increase in the competitive activity in the personal lines marketplace has been broadly acknowledged, we're very pleased to have simultaneously posted this 4% unit growth and a 3% renewal price change and executed the loss trend dampening claim initiatives that have allowed us to expand our profit margins.

We remain pleased with the results of our Quantum Auto product; it now represents about 28% of our total annualized written premium and is producing loss results in line with our expectations.

Again, our results overall were very strong for the quarter and our position inside the independent agency marketplace is virtually unparalleled.

We anticipate capitalizing on all of these strengths to continue to profitably grow this business.

Again, I'll pass this back over to Jay.

Thanks, Joe.

Page 15 indicates that while average invested assets continue to grow rate of growth has flattened in recent quarters.

This decrease in the rate of growth has occurred despite the continuation of strong operating cash flows due to share repurchase activity.

Operating cash flow was $1.1 billion in the current quarter while share repurchase has exceeded $600 million.

It should be noted that our share repurchases were somewhat below what we had intended to do this quarter as we were required to be out of the market while the ACandS settlement was being finalized.

We expect to add to our planned repurchase activity during the third quarter.

The quality of our investment portfolio remains very high and unchanged from the period shown and below investment-grade securities were 2.6% of the fixed maturity portfolio with duration at 4.1.

After-tax NII, as shown on page 16, was extremely strong at $758 million for the quarter, up 13% from last year's second quarter.

The fixed-income portfolio continues to benefit from the increased investment asset base and higher reinvestment rates while the non-fixed income portion of the portfolio experienced very strong performance in all of its major components -- private equity, hedge funds, and real estate related investments.

Our after-tax yield was 4.2% for the quarter.

Page 17 provides an update of the information we provided to you in our first-quarter webcast concerning exposure to sub prime/Alt-A mortgages which for Travelers remains negligible.

We have only $102 million of asset-backed securities collateralized by sub prime mortgages with an average credit rating of AAA, 95% of which are from vintage years 2003 and prior which was before the "residential real estate bubble".

We also have only $103 million of CMO securities backed by Alt-A collateral and no CDOs backed by sub prime mortgages.

So in total these investments represent only 0.3% of our total fixed income portfolio.

It's also worth noting that no securities in our entire residential real estate mortgage portfolio have been downgraded or placed on credit watch during 2007 and that we have made inquiries of the hedge funds in which we invest, and based upon these inquiries have concluded that we currently have negligible exposure to sub prime Alt-A mortgages in the hedge fund portion of our investment portfolio as well.

As page 18 indicates, we ended the quarter with $25.5 billion of common equity ex FAS 115, up 4% since the beginning of year, and book value per share ex FAS 115 of $38.76, up 7% since the beginning of the year, each after the impact of $1.35 billion of share repurchases and $366 million of common dividends.

Book value per share ex FAS 115 was up 15% from a year ago.

Our debt to total capital ratio of 20.8% was in line with our target of 20%.

Our stat surplus was just under $22 billion and our holding company liquidity stood at $2.3 billion exceeding our $1.1 billion target of one year's worth of interest and dividends due to the timing of our debt refinancing activities, dividends from the operating companies to the holding company and share repurchases.

We expect to be at or near our target level for holding company liquidity by year end.

Our balance sheet continues to be extremely strong and, given current market conditions and barring unforeseen events, we expect to continue to generate more than enough capital to support our business.

We continue to grow book value while returning excess capital to our shareholders.

Page 19 summarizes our updated guidance for 2007 which, as you can see, we are increasing.

We now expect fully diluted EPS for 2007 to be in the range of $5.80 to $6.05 versus the guidance we provided last quarter of $5.60 to $5.85.

This revised EPS range assumes the following -- full year cat losses of $530 million pretax or $355 million after-tax; no additional prior year reserve development either favorable or unfavorable; the estimated $100 million after-tax full year timing benefit that resulted from accounting for the change to the new fixed value based agent compensation program, most of which I'll remind you was recognized in the first half of the year due to the mechanics of the DAC calculation; invested asset growth in a low single-digits which factors in approximately $2.5 billion of share repurchases for the year along with dividends and weighted average diluted shares of approximately 675 million for the year after share repurchases and employee equity awards.

And with that we can begin the Q&A session.

(OPERATOR INSTRUCTIONS).

Jay Gelb, Lehman Brothers.

First, I was wondering, Jay, if you could talk to us about what your view of pricing trends will be going forward in terms of the industry's potential excess capacity and what that could mean in terms of the competitive environment, particularly on the commercial line side?

Thanks.

Sure.

The market has continued, as I think as it has over that last several quarters, to be an interesting one in that the renewal market, which again represents 85% round numbers of our business, continues to display a considerable amount of stability.

Retentions remain high; renewal price change runs from a couple of points negative to a couple of points positive.

Brian actually can share the data on rate, pure rate in that regard.

There's not a meaningful difference in when a question comes around.

We'll have him share that; we get asked that from time to time.

And so the renewal market has I think maintained a stability that has surprised, I think, most industry observers for how long it has been acting this way, and lots of speculation about why that is.

The new market has had a sort of increasing amount of attention.

I think part of it is driven by the fact that that there isn't all that much new business in the marketplace.

With retentions high, the actual number of accounts that end up in the marketplace is less than it would otherwise be, so the accounts that are there get latched on pretty hard.

I think that the competition that exists for those new accounts is more heated than it was six months ago, but I don't see anything in that competition that is inappropriate or silly.

I think every company brings its own dynamics to that analysis.

Its implication with respect to loss trend, its investment profile, all of those things.

So we are anticipating for at least the next six months that the new business market will continue to be increasingly competitive.

We also recognize that our early-on plan for the year didn't envision quite the level of competition that we saw even in the first six months in the new business market, and so some of those economics will come home to roost in the second half of the year.

That is very much incorporated in our guidance already.

But I don't know that I see things changing dramatically.

We are just as confused about the anecdotal reports of the marketplace, I think, as everyone else.

And in that regard, we've tried to understand them, we have tried to actually reach out to a couple of these firms that do it, and we have not gotten any calls that.

We've tried to understand it because you want to know the answer too, and we don't get it.

We've just not gotten answers back.

The new market is not nearly as frenzied as the anecdotal dynamics would suggest, and our numbers and I think all of the other companies' numbers, at least as I have seen coming out this quarter, support and show that.

So yes, I think that the market is a relatively stable new business market at awfully good margins.

Again, we are producing combined ratios that begin with 8, that is pretty substantial, and a new business market that is certainly heating up.

I don't know how else to better characterize it.

The thing that I would add to that -- this is Brian MacLean -- is that obviously that answer differs a little bit as you look across the spectrum of commercial markets.

So the larger account markets we definitely see as having heated up a lot more than on the other extreme, the smaller accounts, and probably expect that to continue.

So as you hear other companies talk that play almost more exclusively in those arenas, they would be at the higher end.

At the small end, it is probably going to be -- the select business we look at more like a personal lines almost dynamic from a pricing perspective.

And then one other, just to add some specifics to what Jay was saying, he said our pricing -- our view of the marketplace has played out a little bit more negatively than we had hoped.

We're talking a point or two from a pricing perspective there.

Now, a point or two isn't insignificant when you layer it across a book as big as ours, but we're not talking about dramatic movement from what we had expected in our plan.

And I'd also by the way, even though you asked to focus principally on commercial lines, the word on personal is actually worth it.

The personal lines market, the one in which we compete; I think that is often forgotten.

We compete virtually exclusively in the independent agency marketplace, so those that are out there banging away with enormous amounts of advertising expenditures and beating each other up are really not the ones that we compete with day in, day out.

We compete with them when a customer decides to leave the distribution channel, but that is a very different decision from moving along markets.

Our personal lines business continues to be doing very well, rate largely -- and you have to adjust for mix -- but rate largely is positive.

You see it in the RPC.

It is actually up 3 points.

In fact, if anything if you look at the data -- I think it was on page 19 -- on page 14, sorry -- you can actually see that if anything, renewal price change has actually picked up over the last several quarters.

Now again, there are some mix issues involved in that, but we watch with just a -- it's nice to be on the outside to some extent of the frenzy of the more direct writers against whom we just don't compete.

And our market continues on the personal lines side to be very pleasant.

It's just a nice place to operate and do business.

Great, thank you.

And my next question is on the excess capital position for Travelers.

You've got the $2.5 billion remaining in the share buyback, when do you expect to complete that by?

I think if you look at how much we've been purchasing in the last several quarters you get a feel for what the run rate is.

We're talking about doing $2.5 billion for the entire year, so it'll probably get us through around the middle of next year.

Thanks for the answers.

Brian Meredith, UBS.

A couple of quick questions here.

First, can you talk about terms and conditions and what's happening there in the commercial lines marketplace?

I'm hearing increasingly that you are seeing some loosening in terms of conditions particularly for companies renewing business, just trying to keep business in order to keep rates up.

Largely speaking I would say that it really has not been a factor.

There are two lines of business in particular where there has been some loosening of terms and conditions.

One is in the excess casualty business, excess umbrella, and our business in that book has actually shrunk meaningfully as we've chosen not to respond to the broadening of terms and conditions in that marketplace but that is one that's happened.

It's also happened to some extent in the national property business, although there recognize that it had tightened as a result of the increasing catastrophe environment broadly across all of the national property business, even those that were not catastrophe exposed, because capital was just becoming a bit more precious.

So there is some change in the national property arena, nothing in any way troubling.

And in the rest of our businesses broadly, the rest of our guaranteed cost business we'd say for the moment no change.

Great.

And Jay, I wonder if you could also talk about -- or Brian -- the stable frequency we're seeing in the commercial lines business.

And what do you think it's potentially due to?

Would you expect the frequency trends to kind of reverse themselves or go back to more normal levels here going forward?

Is it due to the tight terms and conditions we saw after '01?

Can you kind of talk about that a little bit?

Yes, I think it's a lot of factors.

Part of it is the terms and conditions that have gone through the industry, part of it is general safety in our whole society, part of it is maybe risk selection.

We've seen -- our frequency trends are still very good.

We're seeing -- still actually seeing some negative trends in some of our businesses.

It's flattening out a bit and we expect it to continue to do that.

Again, a normal environment's frequency would often tick up a bit.

But we feel pretty good about where it's been, but it has flattened out some from where we were 12 to 18 months ago.

Great.

And if I can ask one last question.

On the commercial lines book, if I think about what your loss picks are generally speaking on your new business versus what your loss pick would be on a renewal book of business -- and I understand it's a lot of generality, but on average what would the difference typically be?

I'm trying to translate it, but basically 10 points is a way we think about it.

As we've talked about in the past, we look at our pricing deviations and we think we're -- a normal range is something from maybe low single-digits to double-digits and we're probably at the higher end of that range now, around 10 points or so.

In the long frame over a cycle we generally have seen sort of between 5 and 10 points of differential.

There are actually sometimes interestingly enough we're at zero, that happens too.

But in normal markets that's what we see.

So that's the price difference.

And then I guess you would also see your loss pick on the business actually would be (multiple speakers)?

No, I think we're giving you loss ratio points.

Oh, you are.

Okay, good.

That's kind of incorporated into -- it's a price difference but it kind of incorporates the thought process of comparable loss experience, part of that is driven by we're looking at accounts -- obviously we know our renewal book better than we know a new book, etc.

But I wouldn't add a loss deterioration on top of that.

Understood.

Thank you.

Larry Greenberg, Langen McAlenney.

Good morning.

Two questions.

First, just on your comments on asbestos, did you effectively complete what we commonly refer to as your ground up review that's usually done in the second half of the year?

And then secondly, you mentioned the flow or the lack of flow of business that goes from the E&S market to the standard market, but are you seeing -- we've heard that there are some large E&S markets that are actually getting a lot more aggressive trying to write standard business.

And I'm just curious if you're seeing any of that, particularly at the large account level?

Just doing asbestos first -- Larry, this is Jay.

No, we did not complete our annual roundup claim review study.

That is something that is underway and last year we completed that in the third quarter and given the environment this year and where we are we'd probably expect to complete that again this year in the third quarter.

However, having said that, we also had indicated in our SEC filings, and I think we might have mentioned it on the call, that we've supplemented those procedures that we've used in the past given the changing asbestos environment where it's more of a frequency play as opposed to a severity play with additional techniques that we're able to use on the data on a quarterly basis so that our quarterly procedures are more informative, more robust.

And that's what I was referring to when I said that we've completed the quarterly procedures and reached the conclusions we have.

On me E&S side, Larry, we're really not seeing a lot of it.

In the large account world we're a primary carrier.

We don't play in some of those markets.

But Jay, unless you've got a different perspective I really don't think we're --.

No, I'm just debating how to answer.

Our appetite for guaranteed cost on the casualty side in particular of the business really kind of runs out of the upper end of the mid market.

Of our entire national accounts book, 90% of it is loss responsive, 85% is worker's comp.

So we're just not a large account casualty writer in any meaningful way, so we don't see it.

That profile is very well understood amongst brokers and agents.

And that would all apply across the maybe midsize accounts as well?

Certainly haven't seen anything in the midsize business that would suggest a change in the flow.

If you actually take a look on the business dynamics page you'll see that the amount of new business in the second quarter was down not significantly from the amount of new business in the first.

Again, we talked about being able to have the analytics to see what was coming at us and I think what was available in the market in the second quarter just didn't hold up to inspection the same way it did in the first.

So I don't think that -- certainly from our perspective we certainly haven't been taking on what would be considered business coming out of the E&S market in any way.

Great, thank you.

William Wilt, Morgan Stanley.

Good morning.

A point of I guess clarification on the -- I'm looking at slide 17 in the handout which is (inaudible) hopeful.

This is the mortgage-backed securities.

Can you quantify outside of the derivatives, I guess the CMOs, CDOs, quantify the size of the Company's holdings in mortgage backed securities broadly or more traditional MBS?

And then split that between commercial, residential, government-sponsored entity versus sub primary originated?

Yes, we can.

It's -- : Yes, we can.

We've got a total residential mortgage portfolio of $7.3 billion, $4.9 billion of it is U.S.

government or GSE guaranteed -- GSE sponsored.

And we're dealing with $2.4 billion in the aggregate of nonguaranteed CMO's and ABS'.

And the 102 and the 103 that we've given you is that portion of the 2.4 that is either sub prime or Alt-A collateralized, all the rest of it is not in the sub prime or Alt-A market at all.

That's helpful, thanks.

I assume the rating on that is in the AA.

The average of the 2.4 is AAA.

If you look actually, the average of the 2.4 is AAA, the average of the $102 million on page 17 is AAA, the average of the 103 is AAA.

So it's -- and again, I think that the ratings in all of these securities are likely to change over the next few months as agencies take a somewhat different look at them, but you couldn't start from a better position than the AAA ratings we've got.

Because also the 102 is 95% from vintage years '03 and prior which, as Jay mentioned, was really we think very much before the bubble and the CMO securities we believe was actually 65% 2003 and prior if I recall correctly.

I know it isn't on the slide but I believe that was the number.

Thank you for that, it was very helpful.

I've got two others, I'll only pick one.

I guess the personal lines, personal auto and home.

Could you just do a high-level wrap-up of your commission strategy a new and renewal business, where it is today versus and maybe how it's evolved over the last six months or a year?

Thanks.

From a base commission perspective it hasn't meaningfully changed over the last couple of years.

We have base commission plans that we apply to agents; we do sometimes vary them at an agency level for different reasons but they are generally consistent.

They run about 15% on auto and about 20% on home.

We obviously have had the impact of changing and shifting away from contingent commission into the value base commission program that we've discussed before.

That program has been rolled out in what I would describe as very successfully.

Our agents understand it, have responded well to it and embraced it and I would say that things are moving on positively.

It's got overall economic expenses consistent with what we would have seen before --

What would you generally describe as the range of the value based component of the commission?

At an individual agency level that could range anywhere from zero to 6 or 7%.

And again, those are the edges of it.

It probably runs forth in total a little less than 2%.

Thanks for that.

So the value based component would be replacing the fixed 15 with something less fixed and something averaging --?

What it does is as you look at it from an income statement perspective is you'll really seen no change other than the timing impact of what we're seeing for the accounting treatment.

What you'll see at an agent level is comparable economic opportunities, but it will no longer be contingent, it will be all fixed and set at the beginning of a time period.

That's actually the point.

It's an entirely fixed commission.

It's set at the time the policy is issued.

And there's an old base commission in many cases tied to our filings.

And then depending upon the agent's individual performance we add to that a commission that's a value based, but that is fixed and it's fixed up front and not subject to anything, not contingent on any performance of the agent or of us.

And I guess to make sure we're answering your question, are you trying to figure out how it would flow through the financial statement to figure out how to model it?

Or are you looking for economic or market activity?

Are we getting your --?

No, you got it.

I was looking at just the overall economics and that's helpful.

And the last bit was just the references to 15 and 20 on personal and -- or excuse me, on auto and home respectively refers to both new and renewal?

Generally, but it varies by geography.

There are some places where we differentiate them on new and renewal.

It's not as simple as -- that would be the simple answer I'd give you.

It's admittedly inaccurate when you drive to local geographies.

Sure, understood.

Thanks very much.

Joshua Shanker, Citi.

Following up on Bill's question, I'm interested to know what you're seeing among your competitors in ways of compensating brokers particularly on the personal side, whether that's changing at all and how they are responding to some of the changes that you've made in that area?

First we can only tell you what we read in the newspapers and in the public reports, because that's the only information that we have.

It looks to us that Chubb's compensation program for independent agents is structured very similarly to ours, at least as they've described it in their press releases.

And we noted that Hartford reached a resolution earlier this week with respect to the issue and their description of their plan was sketchy at best, but they described it as a supplemental plan and it would be interesting to see what they come up with.

We haven't seen anything beyond what was discussed.

A number of the other companies, against which we compete at the independent agent levels, continue on old-fashioned contingency or profit-sharing programs.

We really -- beyond those folks who've entered into settlements we really haven't seen any meaningful changes other than the normal ordinary course changes that we'd see in any other year.

Okay.

And then to -- is there any way you can put any color -- I realize this is a very general question, but it's a customer who you would desire who is anmonoline customer who comes into an agency looking for auto insurance versus looking for auto and home, how much more likely are you to be able to find a happy marriage between you and that customer given those two scenarios?

Meaning if they just one monoline auto?

Right.

How much more competitive is the environment for you in the monoline auto area than it is in the auto and home area?

I'm not sure how to even go about answering the question.

A lot of times what will happen with customers is they'll buy one of the products and they'll wait and deal with the other one at an expiration date.

So we can track how often we deal with one product, we can track whether they were account rounded at the initial sale or whether they became account rounded later.

But finding out what is a long-term monoline auto and tracking it back to success rates and hit rates, we're not going to get it as precise as you're looking for.

I'd have to think about it.

We certainly offer a discount in most states to those customers who purchase both.

So from an -- and that's an expense and cost driven dynamic, it's not a margin-driven dynamic, it's expense.

So we'll certainly have a more competitive price.

But if you're really asking what success rate do you have following the quote?

We'd be happy to look at it and see if we can get any data.

I don't think we know anything off the top of our heads here.

I appreciate the answer.

I'll come back to you guys.

Thank you.

Matthew Heimermann, JPMorgan Securities.

Good morning.

I guess just one competitive question and it really more relates to you've seen some consolidation amongst some of the more regional providers and you obviously have differences in commission programs between some of the larger national providers and some of the regional providers.

So I guess my question is geared at, you talked a little bit about the dynamics and how, as your broadening distribution agents are receiving national carriers with changing commission structures vis-a-vis some of the regional carriers who seem to be completely against those types of programs.

I'm not sure where I exactly thought your question was going.

In terms of receptivity, there's a statistic that we've shared with you earlier that I think will give you a sense of agent reaction in substance to the compensation plans.

We offered our commercial agents the option of switching over to the new plan from the old plan.

We were not required to do that, we decided to give them an option.

Of the ones who were offered the program 70% of the number of agents representing 80% of the premium dollars that we have opted for the new program and that's about as telling to me as anything.

There's lots of anecdotes about who likes what, but when given the choice, when given the choice, sophisticated commercial lines agents opted overwhelmingly to take the new program.

So we certainly don't feel that we are at any, any disadvantage with respect to this program.

Most of them, and this sounds a bit anecdotal, I would say most of them who've communicated with us have communicated to tell us that they think it's actually from their standpoint a better plan.

So I'm not sure exactly what you're driving at, but we certainly don't feel at a competitive disadvantage because of the compensation structure.

I guess I wasn't so much speaking to what the adoption of your agents had been.

I guess it's a poorly worded question on my part.

But more so, I guess as you look at your business flows, new business, etc., there is kind of a divide between you and some larger players and the regional market.

So when you look at where new business is coming from in the market, where you think about on the margin if you're losing business, are there any distinguishing factors between big and small that you can make, that may speak to differences in the way that people are thinking about compensation or am I just going too far afield here?

I don't think so.

We've talked before, that Quantum in personal lines was a critically important program to allow us to compete with the more sophisticated product differentiators.

And until we had Quantum one could argue that we were perhaps at a bit of a competitive disadvantage and Quantum I think narrowed that gap -- not only that, I think it eliminated that gap in its entirety.

So when we used to think about, again in the agent's office, who are the most challenging competitors and you can look at the statistics of who has what market share and you'll see what names.

But it was really only one company that we felt that our product was not up to snuff with and all of the effort in Quantum was to deliver a product to the agent -- this is so important; we are considered an agent friendly company -- to deliver a product to the agent that they would want to sell and represent and certainly Quantum has done that.

And that's I think the only thing that we can think about in terms of identifying specific companies against whom we're competing or a product in some way has had an impact.

All right, thanks.

Charlie Gates, Credit Suisse.

Good morning.

I only have two questions.

My first question -- why do you think the pricing data that you show on page 9 of your presentation is so different from that shared by the Council of Insurance Agents and Brokers?

It is a good question.

First, I take a good deal comfort -- we compare our public data with the public data that comes out from other large well performing companies.

At first it looks to us like our data looks very much similar to theirs.

Two, our data is real.

It's not a survey and I think any time you go out and you survey data you're going to get a less analytical response.

You're going to remember accounts that you remember and an agent, for example, probably doesn't even know of the hundreds of small business accounts that get renewed by the customer service reps on a daily basis, that basically they get renewed flat.

It's just those are not the kinds of accounts that a principal of an agency would even know about or be aware of.

As it relates to MarketScout, we have wrestled with their data.

I've looked at it and I try hard to understand it.

I don't.

We have called them interested to get together to meet and understand it more than 10 times and they've not returned our phone calls.

So we are more than anxious to get involved, we're more than happy to learn and understand how other people accumulate data.

We know how we do and we stand by it.

The survey data, I understand how sketchy it can be.

The MarketScout data is just a mystery.

I guess my follow-up question is similar.

Quoting the fellow who runs Liberty Mutual, "Commercial insurers are exhibiting completely irrational behavior." That's what he said 48 hours ago.

Charlie, I'm just curious, did you check his growth rates?

I'm just curious, if you take a look at the guy who made the comments take a look at the growth rates in the business.

Surprising to me, we grew 2% and again, I think that there are different markets.

And we are not a large account casualty writer, never have been.

I think our numbers really speak for themselves in the context of a more challenging environment.

We agree that it's more challenging, I agree.

But, go ahead, I'm sorry I interrupted.

The only other question -- is the environmental charge, is that in part lead based paint?

No, the environmental charge has nothing to do with lead based paint.

When would you typically review your environmental reserves?

That's the last question.

The environmental reserves, like the asbestos reserves, go through various quarterly procedures and there's no set time frame in which we don't review them.

So we're always analyzing them and updating them.

Thank you.

David Small, Bear Stearns.

Good morning.

Just a quick question on personal auto.

With renewal pricing up 3% and written premium per policy down 2% it looks like the price differential between renewal business and new business is pretty wide.

Could you just talk a little bit about that?

And as we move along, and Quantum has been out for a while, would you expect that gap to narrow?

First, I think you're looking at the data wrong, so I'm going to disagree with your conclusion a little bit.

The net written premiums, you've got to look at them first, they're down in total because of the sale of the Mendota business.

So if you pull that out premiums are up 1%.

Policy in force is up 4%, again excluding the impact of Mendota.

And the difference between those two numbers is very consistent with the delta we've seen in policy in force growth and premium growth over much of the last couple years and it's largely driven by geographic mix.

We have a large percentage of our book that's in New York, Mass and New Jersey and other Northeastern states.

Those states have been experiencing very modest growth rates and we've seen much bigger growth rates in states that run across the Midwest, the South and the West.

And the average premium in Missouri is meaningfully below the average premium in New York.

So when those unit counts grow in those spots it actually causes the premium growth overall to be at a slightly lower rate.

It is largely mix driven, it's not a function of a broad pricing differential.

This is actually an interesting question and Joe knows more about this than I do, but just want him to comment because I think there is a bit of a misunderstanding in the market about this.

In commercial lines there clearly is pricing flexibility of a broader nature which renew in renewal.

In personal lines, because of the more regulated structure and also because of Quantum, which does a very specific job of identifying characteristics to people to risk, the magnitude of the difference in personal lines between new pricing and renewal pricing, the pricing should be thought of much differently than you think of it in commercial.

The interesting question in personal is you get the same loss experience.

But in terms of pure pricing I think it is a more narrow band.

Am I --?

Within an individual program, unless there's a filed differential for new and renewal business, they are going to move along the same rating program.

Now you can have different programs active at different times or you can make some of them dormant which can result in differences around that, but there's not the same judgment that you'd have when we had the conversation on new verses renewal pricing that we were having earlier in commercial.

Okay, that's actually helpful.

Thank you.

That was our final question.

At this time I'd like to turn the call back over to Jay Fishman for closing remarks.

Thank you all.

We appreciate your time and attention and Michael and Dave are available to take any calls or questions that you have.

So thanks very much.

Thank you for your participation in today's conference.

This concludes the presentation.

You may now disconnect.

Good day.