旅行家集團 (TRV) 2008 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 would like to turn the call over to to Miss Gabriella Nawi, Senior Vice President of Investor Relations.

Miss Nawi, you may now begin.

Thank you.

Good morning and welcome to the Travelers discussion of the second quarter 2008 results.

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

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

With me today is; Jay Fishman, Chairman and CEO, Jay Benet, Chief Financial Officer, Brian MacLean, President and Chief Operating Officer, 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, and the current market environment.

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

Before I turn it over to Jay, I would like to draw your attention to following on page one of the webcast.

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 SEC.

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

Also in our remarks or responses to questions, we may mention Travelers's operating income, which we use as a pressure of profit and other measures that may be non-GAAP financial measures.

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

With that, I will turn it over to Jay.

Thank you, Gabi, and welcome to the team.

It is good to have you here.

Good morning everyone and thank you for joining us today.

We are very pleased with our solid results this quarter, with operating earnings of $918 million or $1.50 per diluted share.

Operating return on equity of 14.3%, and a combined ratio of 89.3%.

Rather than focusing on the specific results we posted this quarter, which Jay, Brian, and Joe will review with you in detail, this morning I will take a few minutes to share our perspective on the current operating environment.

Reviewing our first six months, the underlying business has shaped up about as we had expected.

Our revenue strategies are paying off in each of our segments, and we see that in our retention rates, which remain very high.

As we outlined at investor day, our agents and brokers are embracing our products, and that is reflected in the significant increase in deal flow to us in business insurance, primarily from TravelersExpress, our new small commercial platform, and IndustryEdge, our new middle market products.

In personal insurance as well, our progress is evidenced by the success of Quantum Auto and Quantum Home.

Nevertheless, our close rates are actually down, as we have responded with discipline to the more competitive new business environment.

We have tremendous tenure among our underwriters, and we are pleased that they have applied their knowledge, learned during previous cycles, by exercising such discipline in this marketplace.

So far this year, rate and underlying loss trends are generally developing as we had expected they would, with some variances about which Brian will speak later.

Net investment income is down, as short rates declined much more than we had originally anticipated they would, and returns on non-fixed income investments, while positive, remain significantly lower than last year.

We continue to be extremely pleased with our asset portfolio.

We are gratified that Moody's upgraded our debt and insurance financial strength ratings during the second quarter, while so many other companies are being pressured to raise capital, Travelers remains very strong, with a superior balance sheet, and significant liquidity.

When we look out to the rest of the year, we are aware of the current economic environment, and the potential for an interesting combination of continued low interest rates, a lower growth economy, but higher inflation.

We are looking at a macroeconomic environment which has changed significantly over the last six months, and we are certainly taking that environment into account, in terms of how we go to market.

But let me be clear, we have not yet seen evidence of any real spike in inflation in our lost trend data.

Finally, we have been in discipline with regard to the left side of our balance sheet, as we have to the right side.

Bill Heyman and his folks have done a terrific job in thinking about risk, and in making sure that our risks and return equation is disciplined and thoughtful.

As a result, so far we have been able to avoid all of the missteps that plagued so many other financial service companies.

We manage our business with long-term returns and profitability in mind, and this philosophy has served us particularly well.

So tying it all together, we remain committed to our long-term financial objectives, and I believe the franchise is well positioned to achieve them.

History would suggest that our confidence is well placed.

Since January of 2005 we have achieved an average return on equity of 15.3%, after $1.9 billion in after tax catastrophe losses, including the largest US catastrophe on record, as well as an increasingly competitive in pricing environment in much of our business dating back to 2005.

Our underwriting results over time are a real indication of our underwriting experience, skill, and discipline.

So when we look forward to our goal of a mid teens over time, it is based on what the businesses have achieved, how we underwrite, and how we manage our capital.

With that let me turn it over to Jay.

Thank you Jay.

Let me begin by going through some of the highlights for the quarter, as shown on page three of the webcast.

As Jay mentioned, second quarter 2008 operating income was $918 million or $1.50 per diluted share, producing an operating return on equity of 14.3%.

Our weighted average diluted share count declined to 611 million shares, as we continue to generate capital in excess of our growth needs, and used $750 million of that excess capital to repurchase 15.3 million of our common shares in the current quarter.

And despite dividends and share repurchases of $4.1 billion in the last 12 months, adjusted book value per share grew by 12% in the past year, and 3% in the current quarter.

Later Brian and Joe will discuss the drivers behind the slight decrease in net written premiums.

So let me end my comments on this page by noting how pleased we are to have received a ratings upgrade from Moody's this quarter.

Page four of the webcast shows the components of operating return on equity, as we first displayed them in our May 2008 investor day conference.

Fixed income net investment income, less interest expense, remain the major driver of year-to-date operating ROE.

This passage of time component produced an 8.8% return in the current period, down slightly from the prior two years, due to lower short term interest rates.

A much smaller contributor to operating ROE, both historically and year-to-date, is non-fixed income investment income, which produced a positive return of 0.3%, down as expected, due to current market conditions.

Underwriting income continued to provide a strong return of 5.8% year-to-date, driven by,healthy underlying underwriting margins, along with net favorable prior year development, and despite the very high weather-related losses.

As the data on page five indicates, both cats and net favorable prior year reserve development played a meaningful role in our results.

Cat losses, which were concentrated in the business and personal insurance segments, resulted from the unusually large number of severe weather events, that occurred during the quarter, including tornadoes, hailstorms, and floods, in various regions of the United States.

Cat losses net of reinsurance, added 6.6 points to our GAAP combined ratio this quarter.

Net favorable prior year reserve development, resulting from better than expected loss experience in each of our business segments, reduced our second quarter GAAP combined ratio by 9.8 points.

As this slide indicates, our GAAP combined ratio, when adjusted for cats, net favorable prior year reserve development, and last year's timing impact of the change to the fixed value based agent compensation program, increased by 2 points.

This increase, which was less than the 2.4 increase in this year's first quarter, was generally consistent with our underlying expectations for pricing and loss cost trends and also included the impact of the small increase, in the number of large property losses that Brian will discuss later.

Page six provides further information about our net favorable prior year reserve development in the quarter.

Development was concentrated in our commercial businesses for accident years 2004 through 2007, and primarily related to liability lines, and was net of an $85 million increase in environmental reserves.

There are many factors that have contributed to our favorable reserve development in recent quarters, some we can control, and others we cannot.

Within our control, are processes that help to detect unfavorable trends that can lead to unfavorable development, such as having the analytical tools, management information, and culture, to maintain strict underwriting discipline at all times, while maintaining thoughtful and responsible reserving methodologies, that constantly look back to current underwriting and claims experience.

Also within our control are initiatives that can actually give rise to favorable reserve development, such as the claims initiatives we introduced in recent years, that reduced actual claim costs from claim costs assumed in reserving, that had been based upon historical settlement values.

These claim initiatives have included faster settlement of auto claims, and the use of managed care techniques for workers compensation claims, among others.

Factors that are not within our control include improvements in the legal and judicial environment, including tort reform.

All of these factors have continued to play a roll in the favorable development of our prior year reserves, and in many cases have translated into improved estimates of profitability for current year business.

Before turning the microphone over to Brian, I did want to provide an update to certain information we last provided to you over a year ago, at our May 2007 investor day conference.

Since that time, we have been actively managing our cat risk, by reducing hurricane exposure in coastal areas in the southeast, and changing our reinsurance coverage to reduce tail risk, and related capital charges, particularly as they relate to northeast wind.

Our focus has been on reducing exposure to highly severe, extremely low frequency events.

As can be seen on page seven, our estimated probable maximum loss for a single hurricane at the 1-in-100 level, net of reinsurance and after tax, has been reduced to $1.4 billion, or 5% of common equity.

And a single el hurricane at the 1-in-250 level, also net of reinsurance and after tax, has been reduced to 2.2 billion or 9% of common equity.

I should point out that these estimates would correlate to extremely large industry events, much larger than say a Katrina.

Our P&L estimates are based upon the assumption outlined on page 22, in the appendix to this webcast presentation, and factor in the July 1, 2008 cat reinsurance renewals, that are incorporated into the chart provided on pages 20 and 21 in the appendix.

The only significant change to our cat reinsurance program in this year's July 1 renewal, was the addition of another $250 million of northeast only coverage, which brought our northeast cat treaty up to $500 million, and when combined with our $500 million cat bond, brought our total northeast coverage up to $1 billion, all excess of 2.25 billion.

The cost of our national cat treaty was $77 million, for the coverage period July 1, 2008 through June 30, 2009 down from $100 million for the prior year period.

I should also point out that this information regarding P&L's is based upon output from analytic modeling related to probability and potential losses, which are inherently unpredictable, and that actual cat losses could be materially greater than indicated.

I urge you to read page 23 of the appendix to this webcast.

With that, let me turn things over to Brian.

Thanks, Jay.

I will begin by going over the production statistics for our commercial businesses.

As you can see, the results continue to be strong.

Current market dynamics are obviously impacting our results.

As our numbers indicate in the aggregate, we are managing these market dynamics quite well.

Looking at the details on slide eight, you can see that retentions remain at high levels across all of the domestic US commercial businesses.

These overall high retention levels reflect our ability to withstand marketplace pressures, and execute on our strategy to keep profitable business, and not sacrifice underwriting results.

In the international operations, retention was down, due to the intentional non-renewal of certain property business in Canada, and auto business in Ireland, and competitive market conditions impacting our Lloyd's business.

Our business in the UK continued to have strong retention numbers.

The renewal price change, which reflects both rate and exposure changes, remains generally consistent with recent quarters.

RPC in the select business, which represents about one quarter of the business insurance segment, was still positive and consistent with the last two quarters.

In the remaining domestic businesses, the change in RPC was down modestly, due to declining exposures, which reflect the broader economic environment.

Underlying rate changes were consistent with last quarter.

The improvement in the international renewal price change was due to increased exposures, primarily in Lloyd's.

Again our organization has done a great job on preserving our renewal book, at appropriate price levels.

The new business dollars are shown on slide nine.

In the aggregate they're essentially flat with second quarter last year, and last quarter.

In the domestic businesses, they were down slightly, and in the international operations, new business was up primarily due to Lloyd's.

But to get the real story, you have to get beneath the written dollars, and look at deal flow, quote ratio, and hit ratios.

Overall, the flow of new business commissions was up in most all our businesses, and in some businesses they were up dramatically.

For example, in commercial accounts, our core middle market franchise, and construction, which comprise about 25% of the premium in the segment, quotes year-to-date were up about 20% from 2007, and 50% from 2006.

Our new product offerings, platform enhancements, and strong positioning with agents and customers, have continued to drive this heavy flow of opportunities.

We continue to feel good about the quality of the opportunities we are seeing.

Accordingly, we are quoting on much of this business, and our quote ratio remains fairly consistent with historical trends.

Unfortunately, the pricing on new business continues to deteriorate.

Since we are being just as selective as we have always been, our hit ratio, or the percentage of our quotes where we are winning, has been declining through '07, and the first half of 2008.

We believe that is evidence of our underwriting discipline.

We think the real story here, is that we have built a franchise which is driving significantly more opportunities our way.

In this more challenging pricing environment, that has enabled us to maintain share, where we seek to do.

But more importantly, it leaves us extremely well positioned, for when the market conditions improve.

With respect to International, the increase in business over the prior year quarter is driven by Lloyd's.

As part of our strategy, we have hired two underwriting teams, Powering Utilities and Yachts that have generated over 50 million in new business in the quarter.

These are experienced teams that understand their market.

Turning to the Business Insurance segment financial results on slide 10, you can see that net written premiums declined 4% quarter-over-quarter.

The decline is due to the market pricing dynamics I just discussed, and in these market conditions it feels like the right answer, especially with retention levels remaining very strong.

On slide 11, business insurance operating income was down 18% from the same quarter last year.

The adjusted combined ratio on the page was 93.3 for the quarter, a 2 point deterioration from the second quarter last year.

This decline reflects some compression of our core margin, which is essentially in line with our expectations of the benign loss trends and moderate price declines, as well as a modest increase in the number of large property losses, which I will discuss in a few minutes.

Our expense ratio, after considering the timing impact of the agent compensation program, is up about 9/10 of a point.

6/10 of this is due-- is the result of a reduction in national account fee income, and the remainder is primarily from the decline in earned premium.

So for the domestic US business we feel great about how we are executing in some difficult market conditions.

Business volumes and margins are down, but modestly, and given the marketplace, we believe that is a very good result.

Turning to Financial Professional and International Insurance on slide 12, the segment continued to produce positive results with operating income of 34%, from the same quarter last year, driven favorable prior year development.

The adjusted combined ratio of 95.3 was also up 2 points in this segment, from the second quarter of '07, reflecting the same market conditions I just described in Business Insurance, as well as the increase in large property losses.

It is probably worth noting right here, that the increase in our loss and LAE ratio in this segment, is not the result of increased losses in our management liability business, which includes our D&O portfolio, or our Surety business, which includes our exposure to contractors in general, and the central artery project in Boston in particular.

Financial, professional and International net written premium of 985 million in the quarter, were flat with the prior year, Bond and Financial products premium quarter-over-quarter declined, but was more than offset by net written premiums from our International operations.

Our International operations which benefited from the new business growth from the two new units at Lloyd's, also reflected the favorable impact of exchange rates.

Now I want to take a minute to talk about the property large loss dynamic that I mentioned is running through both commercial segments.

This increase in loss activity is being driven by primarily, by a modest increase in the number of large property losses, in excess of 5 million net of reinsurance.

We obviously anticipate some losses of this size, but in the first half of 2008, the actual number of losses was above our normal expectations.

So to really quantify this for you, we are talking about seven losses in Business Insurance, and five in Financial, Professional and International.

More importantly, we manage our limits tightly, with a maximum net retention of 15 million in Business Insurance and the UK, and 5 million in our Canadian and Lloyd's operations.

So in the aggregate it is not a large financial exposure, but it is impacting our combined ratio comparisons of 2008.

The bigger issue is, do we see this as a trend?

If so, is it from our underwriting?

I can tell you for all large losses we scrutinize them very closely.

We have examined all our large property losses, we challenged ourselves and looked at all of the data.

The events run from gamut from the fire at Universal Studios to a large sugar plant explosion, to a fire at a hotel under construction in Boston.

So we have not seen anything we could yet call a trend, other than the obvious, that many commercial losses are fire related.

So our assessment is that this is not a result of our underwriting or pricing decisions, but is an aberration.

We are aware that industry-wide losses are also up.

So we know that the issue is not unique to our results.

But in summary, although it is certainly worth noting for the quarter and year-to-date results, we don't see this as a trend, but we are watching it very closely.

Stepping back to the larger picture, overall our results in this quarter considering the softer insurance marketplace, and the general economic conditions, were very solid.

We experienced strong levels of retention, modest price declines on our retained book, a significant flow of new submissions, and our core margins are performing as expected.

With that, let me turn it over to Joe Lacher for the Personal Insurance results.

Thank you Brian.

Personal Insurance results start on page 13.

Not surprisingly, weather is a significant part of the segments results for the quarter.

Even against that backdrop, Personal Insurance produced strong results with a combined ratio of 97.3% and $122 million in operating earnings.

We had strong production results with increased new business and retention renewal pricing ,and year-over-year policy enforced growth, consistent with recent quarters.

When comparing the quarter's profitability to the second quarter of 2007, earnings were down primarily driven by significant adverse cat and non-cat weather related losses, somewhat less favorable prior year reserve development, and lower net investment income.

Excluding these items, and the impact of the timing of the 2007 agent compensation program change, the underlying combined ratio was in line with prior year quarter.

Looking specifically at our property results on page 14, and in the statistical supplement, you can see the impact of adverse weather on the quarter.

Not news to any of you that the industry experienced for the second quarter, is projected to be one of the worst second quarters in a long time.

While our property results were impacted by nearly 19 points for catastrophes, we still recorded an underwriting profit with a 96.5% combined ratio.

At the same time we continue to grow our business.

Policies in force increased 3%, retention remains stable at 86%, with a renewal price change of plus 6%.

We remain pleased with the continuing growth of the Quantum Home product, and its ability to increase new business volumes, despite competitive market conditions.

Quantum Home policies now represent a little over 10% of our policies in force.

Shifting to auto, our combined ratio for the quarter was 97.9%.

Catastrophes negatively impacted that combined by 1.5 points in the quarter.

We are pleased with our production results in the current market conditions.

New business volume was up over 12% versus the prior year quarter, and is at the highest levels we have experienced since the first half of 2006, and the roll out of Quantum Auto.

Policies in force grew 3% over the prior year quarter.

At the same time our renewal price change was plus 2%, with retentions consistent with prior quarters.

We continue to make investments in our business, infrastructure and distribution capabilities to fuel our long-term profitable growth.

These investments continue to impact our results.

Our on going agency appointment strategy is one example.

As an anecdotal illustration, one of our regions reported in their last internal operating review that over 20% of their new business volume this year, came from agents appointed within the last 18 months.

They continue to deploy a systemic segmented distribution expansion and management process, that is yielding growth opportunities without the need to be imprudently competitive on pricing.

Turning to page 15, I would like to touch on loss inflation in the auto line.

Excluding the anticipated impacts from the broader risk profile of Quantum, we saw loss inflation in the quarter to be essentially flat.

Frequency trends were down just slightly.

We experienced total severity trends up just slightly.

Similar to recent quarters, we saw physical damage related severity in the low single digits, and body injury severity slightly decreasing.

We believe this is a big deal.

These numbers are not loose impressions, rather they are based on our actual experience.

As we've previously discussed, our bodily injury results appear out of pattern, and better, than what a number of our competitors have reported.

We believe this a direct result of our claim initiatives, which leverage the strength and breadth of our multi-line claim organization.

This continues to be a leverageable competitive advantage for us.

While the marketplace remains competitive, we are seeing increasing signs of firming, particularly in the auto line.

We are continuing to monitor these, and monitor loss trends, profitability and marketplace conditions, as well as the changing economic climate, as we adjust our tactics going forward.

We remain pleased with the businesses underlying performance, and look forward to building on that success.

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

Thanks, Joe.

Net investment income for the quarter is shown on page 16, with $624 million after tax, or $134 million lower than the prior year quarter.

Fixed income related NII which was down only $7 million from the prior year quarter, was impacted by the lower short term interest rates.

The major variance between the two periods occurred due to non-fixed income returns which remain positive, but well below the prior year period level as we had expected.

This low level of non-fixed income related NII resulted from lower real estate and private equity partnership gains, due to low transaction volume, given current market conditions.

Overall our after tax yield was 3.4% for the quarter.

Turning to page 17, our investment portfolio and our balance sheet continue to be in terrific shape, as we continue to avoid the issues that others have had to deal with.

We ended the quarter with almost $26 billion of common equity, ex-FAS 115, and book value per share ex-FAS 115 of $43.45, up 3% in the current quarter, and up 12% since a year ago, all this after $3.4 billion of share repurchases and $730 million of common stock dividends during the past 12 months.

Our capital remains at or above all of our target levels, and we continue to generate significant amounts of excess capital and liquidity.

Our debt to total capital was 19.7% at the end of the quarter, compared to our 20% target, and holding company liquidity was 2.2 billion or twice our target of one year's worth of interest and dividends.

Page 18 provides updated information concerning our guidance for full-year 2008.

We continue to expect fully diluted operating income per share of $5.55 to $5.85, which translates into an operating return on equity of approximately 13% to 14%.

Our guidance incorporates our results for the first half of the year, and assumes a continuation of lower short term interest rates, and the more challenging environment we experienced in the first half, for non-fixed income investment returns.

Our guidance now assumes full-year cat losses of $785 million pre-tax, or $510 million after tax or $0.84 per share after tax, which has been adjusted for actual cat losses in the first half of the year.

No further prior year reserve development, either favorable or unfavorable.

No significant change in average invested assets ex-FAS 115, and after approximately $2.7 billion of share repurchases for the full year, and a revised weighted average diluted share count of approximately 610 million shares, after share repurchases and employee equity awards.

Before we take questions, I would like to turn it back to Brian, who has a clarification.

One quick correction.

When I was talking about the business insurance new business flow, what I should have said was that submissions from agents of deals was up 20% from 2007, and 50% from 2006 in our middle market construction, and construction businesses.

I incorrectly used the word quotes there.

Our quote activity is obviously up, but not that dramatically.

So with that.

So with that why don't we open it up for questions.

(OPERATOR INSTRUCTIONS).

Your first question will come from the line of Jay Gelb, with Lehman Brothers.

Please proceed.

Thank you.

Good morning.

I was hoping you can touch on a couple of points.

First on the auto frequency trend can you outline to what extent you think that is driven by higher gas prices, and consumers driving less, and the sustainability there.

Also with the combined ratio in auto in the high 90s, do you feel you need to be taking more rate?

The second issue I wanted to touch on is, I don't know if you can quantify the full impact of the non-cat weather, and the large property losses in the quarter?

And finally, Jay, if you can touch on your appetite for M&A at this point.

That's getting in five for the price of one Jay, well done.

Joe, do you want to start with auto frequency?

On the auto frequency piece, Jay, we have seen all of the reports on fewer miles driven per vehicle, and lots of speculation on gas prices.

We are going to-- my answer is going to be equal speculation.

At this point it is unencumbered by fact.

It looks like it to us.

There's no real way to tell.

That seems to be the most logical conclusion.

We are not not making the assumption that it is sustainable, and will continue to drop over the long term, given where we are right now, that's not the basic assumption we're looking at going forward.

We are constantly watching it, and we will see what happens, but we are not assuming a sustainability, as we think about how we are going to navigate the business.

Relative to the pricing dynamic, we shoot for a mid teens ROE.

I am not going to comment on specific pricing strategies, of how we are going to work through it.

We are obviously in the upper end of the tolerable combined ratio, and we are obviously seeing the marketplace conditions that we talked about.

We will factor all of that into our pricing thought process.

The one observation I would make Jay, is if we were updating the grid that we shared with you previously at investor day, for targeted product returns, the combined ratio in auto that we generated in the quarter, and I think for the six months, let's check that, but I believe it is true.

It is true.

The returns that we had in ex for the auto business, it would still be in that box that meets our targeted threshold returns.

So it-- at these levels, even given this interest rate environment, because we are factoring that into our analysis, there's-- the auto business continues to produce our targeted return in that 13% to 18% range that we have disclosed previously.

At a 97.9 I pointed it out, we have 1.5 impact on catastrophes, running through that number, you don't typically see that running through auto numbers.

You can track our cats on auto for a while.

That's somewhat atypical.

We are okay with where it is.

And the response to the merger and acquisition question is the same as it would have been if we were asking three months ago.

There's nothing that has particularly changed.

We think we have the tools and the requisite skills to grow our business organically.

That's clearly our focus, any transaction that we would even consider, we would do so only in the mindset that it will-- that we would be convinced conclusively to shareholder value.

That kind of analysis would always incorporate the risk associated with any transaction.

And I've articulated before, balance sheet risk, and capital risk, and people risk, and systems risk, and it is high.

We have done enough of them to know how high those risks are.

The answer with respect to the M&A environment is no different than it would have been in the first quarter.

On the property large loss thing, Jay we are not disclosing the discrete number, but I give gave you a lot of information there.

If you want to do the arithmetic for the first six months and say well if it is about a dozen losses and I gave you the limits, and they weren't all limit losses but you can, you can come up with a number.

I think the conclusion there is, it is causing a little blip in the first two quarters, the bigger issue as I mentioned in my comments is what does it mean for going forward, and we are looking at that just like everybody else in the industry.

So.

I would make an observation, Brian did actually articulate three of the losses.

Two of the other ones were aircraft actually.

So it is-- it is all over the lot.

It is just not specific.

Yes.

There's clearly-- it looks like a bunch of random events, but at some point you wonder.

All right.

Thanks for then answers.

Let me correct that response.

I'm sorry, Let me for the record.

The airline events that I was just making reference to, actually fall below the threshold that Brian identified as large property losses.

I misspoke.

I apologize.

Your next question will come from the line of William Wilt, from Morgan Stanley.

Hi.

Good morning.

Thank you.

The first a general question, Jay I heard your remarks at the outset on inflation.

I think the recap was that it is on the radar screen, but not yet showing up in the loss cost trends that you are analyzing, at least not in an outsized way.

I guess one, confirming that's the right characterization, and two, what types of inflation are highest on your radar screen?

That's question one.

Thanks.

And your characterization is actually right on.

It is, I think all of us are aware of the inflation risk predominantly from what we have been reading, in the financial press, watching oil now albeit at $126 a barrel, down from $140, and the sort of attention that has been played to it.

What I think that people would anecdotally think is, that perhaps we have seen it in construction materials already.

We have certainly read about increases in prices of cement, and increases in prices in building materials generally.

Interestingly enough it hasn't yet evidenced itself in any substantive serious way in our loss trend data.

Not with standing the anecdotal observations, but given the fact that we incorporate an estimate of inflation, as we price our product and reserve our product, it would be foolish of us not to have it higher on the radar screen, than perhaps it might have been six months ago.

We have, the industry has benefited have from a long standing period of benign inflation, and I think that has to some extent offset some of the pricing pressure that has been around for a couple of years.

If in fact that changes, if the inflation dynamic changes, it is obviously something that we need to begin to think about in the context of our pricing strategies.

That's-- I think why we have identified it as an item of concern, and it belongs on the radar screen for any responsible management team.

This is Brian.

When you look at the hierarchy of concerns, the other one that would be high on the list is medical inflation, which would run through obviously our workers' comp, and many of our liability claims.

So, we watch medical inflation very closely.

Thank you for that.

The same characterization holds true there, it is on the radar screen but no apparent change from the recent--?

Right.

We are always seeing minor ups and downs, but nothing systemic.

Want to comment though because it is obviously information that's available on the workers' compensation--.

Correct.

For example comp was a line where we actually, net had a little bit of unfavorable development in the quarter.

That was due to seeing both pharmaceutical costs, and long-term care costs inflate higher than what we thought.

It actually get, if you will break the comp disclosure down by year, which I don't think we do publicly, the more recent accident years, I think it is 2005, 2006, 2007 were still developing favorably, and it will be 2004 and priors that were net negative.

But that was an example of seeing some relatively minor, but worth noting inflation.

Jay spoke about it earlier.

What you are hearing is actually an example of the feedback loop that exists between claim department, loss analysis, right back into underwriting.

It is incorporating what we are seeing on the front line, on the claims side, back into our underwriting analysis, hope keeps us a step ahead of the game.

Thank you for that discussion, I'll squeeze in another quick one, if I may.

Jay you have talked quite a bit before about the evolution of the pricing cycle, and suggested that folks should keep an eye on retention ratios and as the new business penalty.

I guess looking for an update to that discussion.

Retention ratios hanging in there.

Has the new business penalty shrunk, is that part of the reason perhaps that retention ratios are remaining stable?

Well, no.

I don't think so, is the short answer.

First, I would characterize the retention ratios as actually, I wouldn't use the words hanging in there.

Almost in a sense they're different.

This is a different cycle than anything, certainly that I think anybody sitting around this table has ever experienced before, this long into a pricing deterioration, albeit a modest one where retentions have stayed at the levels they are, and they continue to look just very, very solid.

If anything in the second quarter.

This is more anecdotal than factual, because it's hard to track it, quite at currently.

Our sense was.

that the market for new business became somewhat more heated.

And the little bit of data I can offer that is interesting, Brian ran through the point so quickly I think it gets lost.

The number of, the actual deal flow submission that we are seeing, is up in many of our businesses, and they're up dramatically.

You want to talk about competitive advantages, you can't-- if you never get a deal on the house you can never bid on it.

So Brian talked about a 50% increase in deal flow submission, in the sum of middle market construction over the last, was it three years?

Two years?

Three years--

Really that's quite amazing.

The quote ratio, the number of times that we quote has largely stayed flat, kind of mas or menos on that, but the hit ratio is actually down.

The number of times that we are succeeding is actually down, and you would take that, we take that as kind of a leading indicator on the nature of the competitive market for new business.

So based upon that data, we would conclude that the second quarter was somewhat more heated for new business, not less.

I do understand that you will then say, how do you figure retentions are staying as high as they are?

That's the same question that sort of been out there for a while.

This is an interesting market.

There's a new business market that has a certain aggressiveness to it, and a retention market that has a surprising amount of stability to it.

Beyond that I--

I mean the other point I would make, and maybe in a little bit of giving us some credit here.

I don't think there are a lot of competitors that talk about deal flow numbers, so it is not something you can see easily, but given-- I doubt that many of them would be talking about a lot more deal flow right now.

So I think part of it, honestly does speak to our position in the marketplace, and both our ability to retain our accounts and our ability to attract significantly more deal flow in an economic environment, where I don't think there's a lot more deal flow out there in the aggregate, speaks somewhat to our franchise, and what we have been doing.

Thanks for the answers.

Your next question will come from the line of Josh Shanker with Citi.

Hello, good morning.

Good morning.

My first question regards the environmental reserve addition.

What are you seeing in environmental, that led you to this modest reserve addition overall?

This is Jay Benet.

There's not a lot going on.

What we saw in the data that we had is, that as it relates to pending policy holders.

It is not driven by new stuff coming in.

We did see some upward development in defense costs, and some of the settlement values, so we just reflected that in this quarter.

And just refresh us, how is that-- has there been any trend there, or is this a one off, in terms of where we've seen the previous quarter?

I wouldn't say there has been any trend.

I mean each year, each quarter we go through and evaluate what's taking place.

Some times it takes longer, for information to develop for us to act on it.

And we do, as you said, recognize the fairly modest increase to the reserves.

It is just indicative of us always staying on top of what's taking place in our reserves, and making sure our balance sheet is as current as can be.

And second, you mentioned that 2004 through 2007 years, particularly in liability, have been showing some favorable developments.

Particularly that 2007 year, what kind of data are you getting?

Is that certainly the minority of the impact, or are you seeing that 2007 is really turning into a year you might see some profits turning out over time?

That's a great question.

When we talk about where the reserve development is taking place, obviously it gets highlighted in particular years, but it also goes back to something that is inherent in the reserving process, that being that when you start analyzing 2004, 2004 provides you information as to not just 2004, but the starting point then for 2005, 2006 and 2007.

Each one of the analyses, rolls into the next.

So when we talk about adjusting 2007, it is not an adjustment based on, gee, the current long tale information that is coming in at a rate that is lower than we expected.

That's not the primary driver.

The more current of the year is driven by more than the rollover effect of what's taking place from the prior years.

Okay.

Finally, and I am being as nonspecific as possible, and really intend to be.

But in the events that you were to make an acquisition, what sort of financial message in terms of pay back, or in terms understanding what has to be in terms of being accretive to Travelers.

What do you have to see early on, and what do you have to see over a three to five year period to justify it, in your mind?

I am not sure I really, Josh, know how to answer that question, other than to say, which is the is the same thing I have been saying, we would have to be convinced that a transaction would add to shareholder value.

And I think the way you analyze that, is based upon the specific circumstances at the time.

Every transaction I have ever been involved in, has always stood on its own analytically.

Everyone added something different from another.

The way you approach thinking about what it did for your franchise, there's the transaction that simply adds volume, that you bring in geographically you would kind of analyze one way, but a transaction that helps you get through a strategic initiative that might be important, you might have a longer view of.

I don't know really how to answer it, other than to say that, that anything we ever looked at, will have to pass a high threshold test of creating shareholder value.

Okay.

I will leave it at that.

Appreciate your candor.

Your next question will come from the line of Matthew Heimermann, with JPMorgan Securities.

Hello, good morning everyone.

Good morning.

I guess my question is just the economy, and its potential impact on exposure.

Some of the brokers, have opined that at-- particularly at the smaller end of the market, that's becoming an issue in their eyes.

It doesn't look, based on the premium trends that necessarily is indicative of what might be happening, broadly speaking.

So I was wondering if you would just give some insights there?

First let take make sure we are talking about the same thing.

When we talk about exposure, we think about it as units of insurance.

So if you are writing an account, and they have one truck and they are growing their business, and they add a second truck and they need more insurance, that to us is a change in exposure.

So if that is the concept.

Okay.

Jay, I guess it would be more broadly than that, since exposure could be for work comp, payrolls, auto.

It can be that plus just maybe discretionary decisions about how much coverage.

Of course.

A lot of our products are rated on receipts, et.

cetera.

Right.

We are an industry that likes economic growth.

The more economic growth there is, the more stuff there is to insure.

So we are all for building new plants, and hiring more people, and adding to payrolls, and when payrolls shrink and plants get closed and shuttered, our economic engine turns the other way.

In its simplest form, if we're-- and I can tell you what we have seen so far, is that exposure while positive I think in the quarter, was nonetheless lower than what it has been, if that is an early indicator of some slowdown, then that is what it is.

I don't know for sure.

It is just too early to tell.

But I would say again exposure in the aggregate was positive in the quarter.

It didn't shrink, but it is down from where it was, and we will watch that very carefully.

It is, and again I am not sure that we can do much about it.

We will write more workers' comp business when payrolls go up.

To your point, we'll write more property insurance.

As companies expand, we do better.

As companies contract, we do a little worse.

Okay.

That's helpful.

The other question I had was just as you, there has been a lot of M&A, this isn't your appetite, but there has been a lot of M&A that's happened, particularly smaller, regional companies.

Does that help or hurt your strategy?

And I guess what I am really going at is, I viewed one of your advantages being kind of your pockets, and your resources, and your technology, which creates an advantage.

As some of these companies perhaps become part of bigger organizations, do you worry about that eroding, or given that some of these businesses are net new, they still don't have the economies to scale you have?

I would say first, that given the stability of this organization, given its feel for stability, we hope that we are beneficiaries any time there's any dislocation in the marketplace.

And any time there is a transaction where one company is combining with another, in the agents office there's always dislocation, always.

And given our stability, and the clarity of our underwriting profile, that in the near term, we end up as a beneficiary of those things.

So that is more of an aspirational statement, but a belief, more than I can show you analytically and prove to you.

In the long term there isn't anything that has happened in last year, two years, that cause us to feel at any competitive disadvantage, or that the advantages of the company have in any way been compromised or marginalized.

I just don't believe that.

The transactions have been largely related to relatively small companies, with either relatively small geographic footprints, or fairly narrow underwriting profiles.

I just don't think it makes much of a difference.

I said before, I didn't think that the two Liberty Mutual transactions would particularly change the competitive marketplace, much at all.

I still believe that.

I still think we are just very well positioned in a competitive arena.

We are unusual if that we are a very big company, but with a focus on small and middle market commercial business.

Most-- I mean that's-- and it is really a function of the history of the organization, how it came together.

It has come together with a bunch of individual companies, that all have that end of the market to focus.

We love it, and we think we have-- one of the real advantages is the ability to bring expertise, platforms, the TravelersExpress has been nothing short of a home run, it really has been remarkable.

It takes real assets to be able to do it, it takes real wherewithal, if you are a little company, with a little footprint you haven't got much of that to create a TravelersExpress.

The real scale opportunities that come to us, are because we are as big and solid as we are, and yet we market to an end of the market that most competitors don't have that scale.

So it is just an interesting place to be.

Okay.

Thank you.

Your next question will come from the line of Alain Karaoglan, from Banc of America.

Good morning.

Thank you guys for keeping the balance sheet conservative.

I have a couple of questions, Jay.

If I look at the current accident year combined ratio, up around 92.5 and add 2.5 points of normalized catastrophes, you would be around 95 take or give, give or take a few, which would suggest the return on equity, based on your slides, for up around 12%.

When would it be time to focus more intently on the expense ratio, given that the pricing environment is continuing to be challenging, the opportunities, you are doing the best to get new business but top line isn't likely to grow significantly?

Yeah, I think we focus on expenses all of time.

It is always time to focus on expenses.

It is never a time not to.

But we don't focus candidly on the expense ratio, as many I think, analysts tend to look at.

And the reason is, that when you look at the success of this organization, much of it has happened because of investments which drove an increase in the expense ratio, and ultimately provided a more than offsetting benefit, significantly more than offsetting benefit, at the loss ratio.

I would use all of the claim work Joe has talked about so effectively over the last couple of years.

That takes real people, and real systems, and real spending to have happened.

And so I would tell you that what we do everyday, is we think about the long-term returns that are available to us in the business.

And we make the investments that we are going to make, that we are convinced will add to that value equation, and allow us to continue to hit the mid teens ROE over time.

That's the way we think about the business.

If an investment won't get us, won't help us meet that goal, we are not going to make it regardless of the environment we are in, and if it does make it, we are going to try like heck to make that investment, regardless of the environment.

There are going be times where-- and we are not yet there.

That's an important point, we are not yet at the point, where it would be appropriate to start chipping away at the investment strategy of the organization.

It has been very successful.

It has a great governance and diligence process around it, and we will continue it.

If in fact the market continues to deteriorate, and two years from now we are having this conversation, the bar gets raised, and we look at it differently.

But it is not, I would tell you that when you look at Travelers, it is not at all like the old days, in a sense, it is not about cell phones anymore.

It is not about plants in the office.

We are unbelievably expense conscious, expense focused organization.

By that I mean, no one wastes any money here.

No one wastes any money.

Ultimately what you are really talking about, is the level of investment that we make to build our business for the future, and that gets rigorous analysis all of the time.

Okay.

A follow up to that.

On the personal auto business, maybe for Joe, the combined ratio is 98.6, and if you go to 97.9, if you take away the cat.

Where reserve releases 2.2 similar to what you have had in the personal lines, because that's would suggests a combined ratio closer to 98.5.

Any way to quantify what is the investment you are making?

Why are you still comfortable that you are okay, and we shouldn't worry more about it going forward?

The reserve releases, and we don't disclose those by line were, were generally consistent, but lower in the quarter than they had been for auto.

But they have also been somewhat consistently running for some period of time, inside of that line.

When we look at the combined ratios, and we look at the mid teens ROE and the range we put on them before.

We see the line running inside of that range.

Admittedly at the less profitable end of that range, but inside of the range.

It is not hard in our business when you have the analytics to sit down and know exactly what combined ratio will translate to what return.

It is not anecdotal.

Joe has a chart, and the chart that he has shows here is the combined ratio, the achievable return in that product.

We know it.

We are watching it very, very carefully.

And there will come a time when you turn around and go, if we run the business for the long term, and we are going to make those hurdles, something has to change as we think about pricing strategy.

So it is, it is I think Joe said it right.

I don't know that we are at the low end of the range of acceptable margin.

The lower end.

We are certainly at the lower end of it.

But still well within that range that lets us meet those thresholds.

If it changes, we will change our pricing strategy.

We will rethink it.

What we experienced in the quarter was flat loss trends, and a 2% positive RPC which isn't total gloom and doom.

And I promise that's the last question, Jay.

In terms of the question on M&A transaction, you mentioned that you will judge them all, in terms of creating shareholder value.

I assume that relates to your mid teens return on equity on average, over time, that any transaction you would like it to achieve this, that's how you would measure creating shareholder value, from a financial point of view.

I think that's right, Alain.

You've got it exactly right.

If ultimately we can achieve mid teens, and we end up taking on a transaction, and we end up going down to single digits, we haven't achieved much, have we?

And I do think you have to look at these things in the long term, and that gets again to what were the capital demands of whatever you buy, and it is a complex issue, but I think you have expressed it exactly right.

Thank you very much.

Your next question will come from the line Vinay Misquith, from Credit Suisse.

Hello.

Good morning.

On the workers' compensation business, we saw some small adverse development in the 2004 and prior years.

Does that change your mind about your decision to increase your workers' compensation business in small accounts?

No.

We have talked about this a little bit in the past, but we are a company that from a guaranteed cost perspective, is relatively underweighted in workers' comp, but from an overall corporate expertise, and capabilities, and I am speaking to our larger account comp servicing carrier capabilities.

We are a very experienced and knowledgeable comp company with, we are pretty confident, if not the best, one of the absolute best claim engines in controlling comp losses.

So we think we know the line very well.

We have historically had a very cautious, some might say overly cautious view of guaranteed cost comp.

We have been over the last couple of years, very selectively moving forward, and trying to look at areas both by accounts size.

So we have done more on the small account than not, and also by geography.

This is not close the a one size fits all, but one where we are taking a very selective look at comp, and we continue to think there's opportunities.

We went through a bunch of this at investor day.

We talked about some of our claim capabilities there.

So I think that's worth referring back to.

But we still feel good about the line, and the 2004 and prior stuff hasn't really changed our view.

All right.

And the second question is on personal auto.

Joe mentioned that your BI claims are increasing less, or maybe they are decreasing versus the prior years.

Could you help us understand what specifically you were doing versus the other personal auto insurers that keeps your BI claims lower?

Sure.

This is Joe.

I did say that our BI severity was decreasing, not increasing which would at least when we heard other folks talking about it the last can couple of quarters, that's inconsistent.

I will point you back to what we did in our recent investor day presentation, because you can get a fair amount of slides and description, longer than I can give you the tale end of this call, on those.

But we are taking advantage of the full breadth of our claim capabilities, the managed care capabilities that we have in our workers' comp claim, to use nurses, to triage medical claims from a BI perspective.

That we are using our medical bill repricing capabilities from worker's comp in the breadth of our network, to run medical bills through from an auto perspective.

Those are capabilities that other players wouldn't have without the volume of medical losses that we have running through the entire organization.

One things that it is no secret, but it is not necessarily visible from our financials, we are a very, very large, very successful, fee for service, workers compensation claim handler for large national accounts.

We don't write the guaranteed cost the first dollar insurance, that you typically think of.

But we handle substantial amounts of claims for large companies, being paid a fee, for managing those claims on their behalf.

There is a significant developed over, literally decades, workers' comp claim handling engine, that exists in this organization with real first rate medical claim expertise, handling a medical losses that occur in on the job site.

That expertise is stretchable.

It can be stretched from that workers comp platform, over into the auto body injury work, and if you don't have that workers' comp engine behind you don't have the ability to do that.

That's a perfect example of where the size of the organization benefits, really, at the point of claim.

There's a real difference, competitive difference.

That's great.

Thank you.

Your next will come from the line of Ian Gutterman, with Adage Capital.

Hello, Jay.

I want to go back to the M&A topic and rather than dance around I thought I would try to ask a little more directly.

Knowing your ability to comment may be limited.

There has been a lot of very public media reports about RBS, and who's interested in that property.

I guess what is surprising to me, and the part I hope you can talk about, is I can understand why you would want to take a look at any big property on the market.

But when we see all of these media reports that everyone else is dropping out, and you are one of the final three left, it implies you are relatively serious about it.

I guess what is confusing-- what I hope you can address, is from your past comments about M&A, you said international is not a priority, and I can't recall any time in the past you talking about being interested in getting into direct distribution.

So, it just seems that I'm not-- I can understand you wanting to look at deals that fit strategically.

I guess I don't understand why more international and direct distribution, whether it be RBS or some other company fits strategically with Travelers.

It is a very thoughtful question.

Let me go back to 2005, when it was reported on page A1 of the Wall Street Journal, that we were in deep talks with Zurich Financial Services, and sources close to the talks were reporting that a transaction was imminent.

The only thing I can comment is, we are not responsible for media reports.

We are responsible for what we say.

Ultimately the reason we came out with our commentary in the Zurich transaction, was that it was being viewed by everyone as though we had said something, and being viewed as fact.

In fact, it was proving to be not in interest of our shareholders, not to say something.

I felt responsible to do so.

I don't feel that sense of responsibility now.

I think it is very counterproductive to building shareholder value to comment every time someone suggests that we are looking at something.

We are going to look at some things, we are not going to look at others.

You know as I have said before, I think thoughtful managements always stay in tune to what's happening in the marketplace, and try and stay knowledgeable about things.

But I think you have to look back on my earlier comment which is, we-- notwithstanding the history of the company, and the fact that it was built by acquisition, we are in a very different place now.

We are in a very, very different strategic competitive place.

The only time we would ever look at something, seriously, would be if we were absolutely convinced that it would add to shareholder value.

So if you're questioning that something wouldn't create shareholder value, you can make the assumption that we ask ourselves the same question.

I would like to leave it at that.

I don't think I have anything more to say about any specific company, or any rumor.

That's fair.

To be honest I don't want you to have to refute everyone out there either.

That's a very good answer, and I guess I think you guys are doing a great job instituting the strategy you are on.

I would hate to see you change to do something dramatically different.

It sounds like we are on the same page.

Thank you.

Thank you Ian.

Your next question will come from the line of Jay Cohen, from Merrill Lynch.

Thank you.

Jay, your stock has been hovering around or even slightly below your book value per share.

I guess theoretically, what the market is saying, is either one, they don't believe our book value per share, which frankly given the reserves that you seem to give and the cleanliness of your asset portfolio doesn't seem to be a big concern, or the second issue is, your ROE is relatively quickly going down to your cost of equity capital, I don't know, 9%, 10%.

I guess I am going focus on that.

What kind of environment would you have to see for your ROEs to go from where they are now, down to that level, and what do you think chances of that environment to merging in the next two years?

There's a slide in Jay Benet's presentation that answers the question.

If you take a look on page four, so far for this year we have earned a 9.1% return on equity from our investment portfolio, in an environment of short rates.

We circled the short rates on the backslide, because they're actually half of what they were a year ago.

1.7 short rates, versus I think 3.8, a year ago.

That is talking about a 200 basis point drop in short rates in that period of time.

We had a 9.1% return on equity, just from the investment portfolio, which means if you wanted the answer to the question is, a 100% combined ratio would have produced a 9.1% return on equity in this quarter.

You see the numbers.

How far are we away from 100% combined ratio.

If rates continue to go down, 3%, 4%, 5%, we will eventually get there, but we are a long way from 100% now.

Great.

Thank you.

That's why four is there, to show that there's a sustainable level of return on equity in our business, just embedded in the left side of the balance sheet.

And it is pretty powerful.

I think that, I think that people tend to forget that.

That's why we present it that way.

That's helpful.

Thank you.

My pleasure.

Your next question will come from the line of Brian Meredith, from UBS.

Hello.

Thank you.

Jay, Brian, you commented pricing continues to be pretty competitive here.

One, I was hoping you could get more granular, and say what lines of business right now are you worried about, or actively pulling away from, versus what lines of business you think are attractive?

And then could you make some comments on what is happening with terms and conditions?

Let me take a quick shot, Brian.

This is Brian.

Consistent with what we have said in the past, what a lot of folks say, from account size perspective, maybe most importantly, the larger the account the more pressure, not to say that there isn't pricing pressure everywhere, but clearly smaller accounts a lot less than larger accounts.

You can see that a little bit with the fact that small commercial we are still seeing total price change, a little positive, and underneath that total rate change would be slightly negative, but very consistent.

From a line of business perspective, I would say, large property stuff is under pressure, and something that we are looking at, although the large loss dynamic that I talked about, especially being industry-wide is beginning to have a lot of folks rethink that.

So that might be one that we see some signs of actually the softening mitigating a little bit.

Nothing dramatic other than that within the lines.

It is much more of an account.

The only other thing I was thinking about is, and this gets to some extent to size.

If you had to pick one, we are not very large in it, but the excess casualty business, the umbrella business is one that has been subject to not an insignificant amount of price deterioration.

I would just want to, and even in that business, I would you know because you used the words pull ago way from.

I would say we are not pulling away from that market, but it is one where more accounts than not, we see some pressure there.

It really comes back if you look at the retention rates, we're not in effect pulling back from anything in our business.

It would show up in the retention as if we were, in any serious way.

And I think that the relevant question is, in the new business environment, what's going on?

You can look at the new business numbers and sort of get a pretty good feel for it, I think of what it is, and how we are reacting to it.

Are terms and conditions loosening at all?

You know, not, not dramatically.

I mean there's always some movement as markets move, but on our book, I would say not dramatically.

And I would probably put the same comment in.

The bigger the account the much more pressure there's going be on that.

Just to think of it though, as we describe it, there's only a few businesses that we are in, where terms are conditions play, small commercial for example.

You really wouldn't talk about as the question is being asked.

If you think about question changes in terms and conditions, you would think of that in national property, you would think of it in some of those lines.

The individual negotiated if you like accounts, but again the smaller you get, the less it becomes even a substantive discussion

Basic product.

Is that fair?.

Great.

One last question then for Joe.

On the PD severity you said was up modestly, what would you attribute that to, and would you expect it, the impact of raw material prices rising here may continue to put pressure on that severity, here going forward?

I think it is just generally what is in there already.

It is the normal inflation end costs, whether it is parts, or labor rates, or the like, as our sense is, and you get a level of model symbol drift that is running through.

Specific to damage severity, just because the newer cars tend to have a higher value, and there's a different repair cost there.

So it is that and we would expect that trend would generally continue.

Macroeconomic level there hasn't been any meaningful wage push inflation yet.

It doesn't mean there won't be, but you can actually look at Bureau of Labor statistics data, and there's no significant wage push.

One of the things we will keep watching, as a leading indicator.

Great.

Thank you.

Your last question will come from the line of Josh Smith from TIAA-CREF.

Hello.

Thanks for taking the question.

It is on the investment portfolio.

No one would argue that you don't have the one of the cleanest ones out there.

I am curious how you feel about the turmoil surrounding the GSEs, and how that may impact your securitized leader at the more senior levels.

And secondarily, with the two monolines being put on watch for downgrade by Moody's, I notice that your AAAs dropped significantly, sequentially in the quarter, I imagine that was because of downgrades on the monolines on your muni books.

So if you can talk about how (inaudible) deal into AA how that would impact your credit quality?

First Josh we gave an analysis, last quarter where we took the entire municipal bond portfolio, and it is on the web.

You can see it.

Where we actually gave the ratings underlying the securities ex the wrap.

There's an analysis there.

That hasn't changed in any significant way.

The portfolio would change from a rating perspective modestly.

I just noticed that 10% triple went from AAA to AA.

I thought it might have been due to the monolines losing ratings.

Can I address it Jay?

Yes, please Bill.

We are just getting the page.

Let's go back and take the questions if order if we could.

In a way we look at the GSEs not unlike municipals, as the mortgage-backed securities can be viewed as mortgage backed which are insured, the residual is insured by the GSE.

In terms of straight obligation of the GSEs our total for both is a mere 19 million, in which can be characterized as nothing more than a placeholder.

We look at them as financial institutions which have always been much more leveraged than the big money center banks, and have treated them accordingly.

With respect to our mortgage-backs, we look at them on the strength of the underlying mortgages, and try not to attribute too much value to the implicit guarantee of the US Government, if there is one, or guarantee by the GSE of the pools.

The underlying mortgage is underlying our mortgage backs, are in terms of age and seasoning, we think pretty secure.

So we feel pretty good about them.

Skipping to the municipals, I think one has to remember that the principal concern with the monolines, is less with their insuring municipal bonds, which have very low default rates to begin with, than with their insuring of structured products, and with respect to those products when the insurance falls away, there's much greater concern.

With respect to municipal bonds, again, I think one has to remember that the rating scales are very different.

A AA, in fact maybe maybe even a less than a AA municipal, defaults with the same frequency as a AAA corporate.

And you have probably read the newspaper of congressional testimony by municipal treasurers, asking or demanding that the rating scales be adjusted.

So we have always felt very secure about the credit of the municipal portfolio, even in the absence of insurance.

We have never owned a security where we felt we needed the insurance.

Our view has been that the insurance is very valuable if a country treasurer absconds with some money.

But in a period of financial stress, the insurers are likely to have as much stress, as the insureds.

That's what we are seeing.

So I hope that's responsive.

Okay.

Thank you.

That's better than we can do, Bill.

Thank you.

I think that closes us up.

Gabi, or Mike?

Yes, that does close us up.

Thank you very much, and any further questions to either myself or Mike Connelly in investor relations.

Thank you for your participation in today's conference.

This concludes the presentation.

You may now disconnect.

Have a wonderful day.