旅行家集團 (TRV) 2009 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.

As a reminder, this call is being recorded today, July 30, 2009.

At this time, I would like to turn this call over to Ms.

Gabriella Nawi, Senior Vice President of Investor Relations.

Ms.

Nawi, you may begin.

Thank you.

Good morning and welcome to the Travelers discussion of our second quarter 2009 results.

Hopefully all of you have seen our press release, financial supplements 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.

Speaking today will be Jay Fishman, Chairman and CEO, Jay Benet, Chief Financial Officer, and Brian MacLean, President and Chief Operator Officer.

Other members of senior management are also in the room available for the question-and-answer period.

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 up for questions.

Before I turn it over to Jay, I would like to draw your attention to the 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 statements involve risks and uncertainties and it is not a guarantee of future performance.

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

These factors are described in our earning press release and in our most recent 10-Q and 10-K filed with the SEC.

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

Also in our remarks or responses to questions, we may mention Travelers' 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 recent earnings press release, financial supplement and other materials that are available in the investor section on our website, Travelers.com.

With that I'll turn it over to Jay.

Thank you, Gabby.

Good morning, everyone, and thank you for joining us today.

Pages three and four of our webcast summarize our second quarter highlights as further described in our press release.

All-in, bottomline performance was modestly better than we expected and we are particularly pleased with what we accomplished in written premiums.

Brian will have more to say about that a bit later.

We are reporting today somewhat later than usual, driven simply by the way the calendar worked and the fact that we built in a few extra days in our schedule due at a conversion to a new ledger system which we successfully completed in the first quarter.

Interestingly, this timing has allowed to us listen to a few other calls and to observe some of the market commentary.

There has been a fair amount of discussion about market trends.

Is this a hard market, a stealth hard market, a continuing soft market, a softly hardened market or is the industry on or off the wagon?

Any of you can pick your own sound bite.

However we view the conditions, our challenge is to execute in the only environment that exists and that's the environment that we face today.

What you've heard from us in the past and will hear again today, is a very consistent story that the Company is really well-positioned to execute across our franchise and to continue to pursue and achieve our financial goals.

We are executing where we see attractive opportunities and when we don't, we pass.

Having said that, understand that we are seeing many of those opportunities.

We've grown our premiums in both business and personal insurance at rates and profitability which our metrics indicate are at levels with which we continue to be comfortable.

You all know that we are a very quantitatively driven organizations and I believe that many respects Travelers has set the standard for understanding its business and operating on a quantitative rather than an anecdotal basis.

We are going to share some of that data with you this morning and I believe will you see the thoughtfulness in our approach.

Just to refresh everyone's memory, we've been successful driving rate upward generally since the second quarter of last year.

That success continued through this quarter as well.

In fact, we've been able to achieve positive rate change in each of our three business segments in the quarter.

Nonetheless, we are reluctant as we were last quarter to make declarations about what the future holds.

While we are really pleased that we've been able achieve these rate gains over this period, it has struck us as somewhat counter intuitive that one could with certainty forecast rate gains in a recessionary environment.

We refrain from making predictions and focus on executing in the environment we are in.

To some extent, we feel a bit like the great philosopher Yogi Berra, we understand once observed that it's really difficult to predict anything, particularly if it's in the future.

All-in the insurance market is much improved from where it was just a year ago.

It's been an exciting time, not only as a result of our strong competitive positioning, but also due to the business that's been in the marketplace as a result of the disruption specific to a few individual carriers.

We are staying focused, but tending to customers and brokers and agents and working hard to grow our business.

With that, let me turn to returns, the metric that we probably focus on most.

For the quarter, we produced an operating return on equity of 11.3%.

You might ask how we reconcile this return to our long-term goal of achieving a mid-teens return on equity over time.

Please turn to slide five and let me share with you an illustrative analysis that demonstrates the impact of current investment yields on our returns.

First, given the turmoil in the financial markets over the last year and a half, we've made a decision to accumulate cash at our Holding Company that exceeds our long-term target of one times dividends and interest or $1.1 billion.

We currently have a total of $3.3 billion of holding company cash, $2.2 billion in excess of our target.

Our long-term philosophy with respect to capital management has not changed and our current expectation is that we will redeploy the excess cash into our share buy-back program overtime.

That redeployment would serve to lift return on equity by approximately 100 basis points.

Next, you all know that short-term yields are virtually at zero right now, compared to a longer term historical yield of perhaps 2.5% after tax.

The impact of this shortfall has been to lower operating income by about $25 million per quarter, impacting operating return on equity by about 40 basis points.

This is driven by the fact that we maintain a short-term liquidity investment portfolio of approximately $4 billion to $5 billion to assure liquidity in the event of a catastrophic event and prevent us from having to liquidate assets in a period of economic turmoil.

Lastly, it's worth noting the impact of the reduction in yields on our $4 billion non fixed income investment portfolio.

For the quarter, it produced a negative 2.1% return.

A more normal annual yield, given the risk profiling of these assets, might be around 7% after tax over time.

This shortfall has the impact of reducing operating income by approximately $100 million per quarter, impacting operating return on equity by 150 basis points or so.

An important observation is that if we don't believe these assets will ultimately yield returns appropriate for the risk, we will ultimately lower our allocations to this asset class and increase our allocations to more certain, less volatile fixed income securities which even now yield around 3% to 3.25% after tax.

The total impact of these last two items is a reduction in returns of approximately 190 basis points.

Our premise is that we will at some point return to, by historical standards, a more normal investment environment.

This slide is not a projection or a restatement in any way of current results.

The best way to perceive it is as an illustration of why we believe that a target of mid-teens return on equity over time remains an achievable goal.

We are in a period of unprecedented investment return dislocation and while we have been smart and thoughtful about avoiding virtually all of the problem areas of investment, the impact of lower yields is having a significant impact on our return on equity.

Before I turn it over to Jay, I'd like to make a general comment about returns that are being reported by a number of companies in our industry.

As all good companies do, we compare ourselves to the best competitors in the industry and analyze revenues, margins, returns and profitability.

What is apparent from this analysis is that not all companies classify income or losses from alternative investments in the same way, particularly as it relates to operating income.

Before you come to conclusions about relative returns and profitability, we encourage you to make sure that you look at results on a comparable basis.

And with that, let me turn it over to Jay.

Thanks, Jay.

I know this sounds a bit repetitious, but I have to say, and frankly I'm happy to say, that our investment portfolio, our reserves, our capital and our liquidity remain in very good shape.

Turning to page six, operating company capital once again remained at or above all target levels.

Our debt to total capital ratio was at its 20% target, the midpoint of our 15% to 25% AA range, and that's after successfully placing $500 million of ten-year, 5.9% senior notes during the quarter.

Holding company liquidity increased to over $3.3 billion, or approximately three times our target level, and that's even after $750 million of second quarter share repurchases.

And we've got negligible amounts of debt maturing.

Book value per share of $47.29, including $865 million of net unrealized investment gains after tax, increased 5% during the quarter while book value per share of $45.76 ex FAS 115 increased 4% and we closed the quarter with approximately $26 billion of common equity.

Our $73.4 billion investment portfolio continues to be of very high quality and well diversified across industries, investments types and individual issuers.

The portfolio's pretax net unrealized gain increased from $803 million at the end of the first quarter to almost $1.3 billion at the end of the second quarter.

Fixed income investments comprised 95% of the total investment portfolio, below investment grade investment comprised only 2.5% of fixed maturities and the duration was 4.0.

I do want to point out one thing that did impact the portfolio this quarter; the downgrading of a bond insurer that caused a movement of certain of our bonds from the AAA category mostly to the AA category which was just enough to move the overall quality rating of our fixed income portfolio from AA plus to AA.

I should also point out that this change was not the result of weakening credit quality in the underlying bonds.

I'd also like to mention that during the quarter, we adopted two new accounting standards; FAS 115-2, recognition and presentation of other than temporary impairments and FAS 157-4, determining fair value when the volume and level of activity for the asset or liability have significantly decreased and identifying transactions that are not orderly.

Despite the length of these titles, neither impacted us in any significant way.

During the second quarter, we produced a net realized investment gain of $8 million after tax, including after tax impairments of only $19 million.

For those of you wondering, second quarter after tax impairments would have been a little more than $30 million higher under the old standards.

FAS 115-2 also resulted in a $71 million increase made directly to retained earnings as of April 1, 2009, and offset by a corresponding decrease made directly to accumulated other changes in equity from non-owner sources, bypassing the income statement.

The information that appears on page seven is based on the schedule that appears in our Form 10-Q, showing unrealized losses on investments for which estimated fair value is less than 80% of amortized cost.

This amount has decreased from the first quarter.

It now stands at only $374 million, a tiny fraction of both total investments and shareholders equity.

We continue to closely monitor these investments as these are the most likely source of future impairments.

I do want to point out, however, that FAS 115-2 has changed the nature of the data in the table.

For example, much of the amounts that appear in the greater than six months but less than 12 months column is the noncredit loss component for these investments, amounts that are more likely to have been written off already under the old standards.

These amounts may or may not be written off in future periods, depending upon estimates of future cash flows related to these investments.

And as a result, amounts are more likely to age in this schedule than they were under the old standards.

As shown on page eight, operating income of $732 million declined 20% from the prior year quarter.

This was primarily due to $170 million after tax reduction in net favorable prior year reserve development, a $77 million after tax reduction in net investment income, margin compression that we had anticipated in our plan based upon recent pricing and losses cost trends, and higher than expected non-catastrophe related weather.

All of which were partially offset by a $101 million reduction in cat losses.

Notwithstanding the favorable cat loss comparison though, our current quarter cat losses were higher than we would have expected.

Excluding cats and net favorable prior year reserve development, our GAAP combined ratio was 94.4% and as Brian will speak to in more detail, we remain pleased with the underlying profitability of our business.

Second quarter net investment income of $547 million after tax as shown on page nine, while down from the prior year quarter, was up from fourth quarter 2008 and first quarter 2009.

Tying back to what Jay said earlier in his commentary about ROE, the overall yield of the portfolio continues to be negatively impacted by the very low short-term yield environment and negative non fixed income returns.

The long-term fixed income portfolio's after tax yield was 3.6%, consistent with the prior year quarter while the short term portfolio yielded only 30 basis points, down from 170 basis points.

The non fixed income portfolio recovered somewhat, yielding a small negative of 2.1% -- a negative 2.1% which is much better than the negative 14.9% and negative 11.1% in the two most recent quarters.

And consistent with our practice, we updated as best we could our non fixed income returns through June 30, despite the usual time lag in which investment managers report results.

Page ten of the webcast shows the three major contributors to operating return on equity.

Fixed income NII less interest on corporate debt, what we refer to as the passage of time component, contributed 8.1 points year-to-date, down slightly from prior years due to lower short-term interest rates.

Non fixed income NII, a much smaller contributor to operating ROE, but one that varies from period to period, contributed a negative one point and underwriting income contributed 4.8 points.

Cumulatively from January 2005, we produced an average annual ROE of approximately 14.2% which is consistent with our stated long-term goal of mid-teens ROE.

One final note, we did successfully renew our cat reinsurance program on July 1 and have included a schedule in the appendix to this webcast.

The amount of national and Northeast-only limits remain unchanged, as did our $1 billion retention and the various attachments points were essentially unchanged.

The cost of the program increased only modestly.

And with that, let me turn the microphone over to Brian.

Thanks, Jay.

As Gabby said, I will speak to the results of all our business segments.

John Albano, Alan Schnitzer, Doreen Spadorcia and Greg Toczydlowski are here with us and will be available to answer questions.

Before I go into the individual business unit results, I will provide some broader commentary and I'll start with the rate picture on page 11.

We are pleased that we were able to achieve positive rate change in each business segment.

Personal insurance rates have continued on a positive trend for quite some time.

In business insurance, the rate environment has been improving for the last year and turned positive for the first time in over four years.

Similarly for financial, professional and international insurance, rate turned positive at year end 2008, following two years of negative trends.

The relevance of this trend to our future profitability is obvious.

Otherwise, in terms of the larger picture, claim frequency trends are favorable; in fact negative in some of our businesses.

And severity is at overall normal levels resulting in improved loss trend.

Given these trends, we feel good about our product margin.

Although we continue to experience some margin compression on a written basis, it is at lower levels and in some businesses margins are stable to slightly improving.

Despite current economic conditions, our premium trends year-over-year have been stable.

Even as individuals and businesses have become more price sensitive, our retention levels remain very strong.

New business is robust and overall achieving our targeted rate of return.

So all-in, we feel great about our position and our results this quarter.

Turning specifically to the business insurance segment and slide 12, operating earnings were down from last year primarily driven by the drop in investment income and anticipated margin compression.

Compared to the prior year, cat activity was down and favorable prior year development continued, but not at the same magnitude as last year.

Adjusting for these impacts, the combined ratio was a solid 95.5.

Net written premiums have remained essentially flat for both the quarter and the year-to-date period.

And as I said, given the overall environment, we are extremely pleased with this result.

We are continuing to see the impact of economic contraction in the obvious industries like construction and trucking, but most of our commercial businesses are seeing growth.

Turning to the production statistics on slide 13, retention remains strong and renewal premium change is improving and has turned positive in select accounts.

But as I already mentioned, the story here is really the rate picture.

The next page takes the renewal premium change data and splits it into its two primary components, pure rate and exposure change.

You can see that across all of business insurance rate is improving, while exposure is declining but at a fairly modest rate so overall premium change trends are moving in the right direction.

New business results shown on the next page have improved significantly this quarter and are up 13% quarter-over-quarter with strong contributions from each business group.

In select accounts, we've been talking about our platform roll-out and that continues to drive new business.

In the individually underwritten businesses, we've continued to see a strong flow of new opportunities and are pleased that we are winning our share.

We've been speaking to you for quite some time about our competitive advantages, our breath of product, industry leading metrics, point of sale capabilities and leadership position with independent agents.

We believe these advantages matter and are driving the increased opportunities.

In fact, what we bring to the market has never been more valuable.

We have tremendous optimism about our opportunities and have strong controls and metrics to ensure we are executing appropriately.

With that said, we spend a lot of time analyzing the quality of the new business we put on the books and are comfortable because of our analytical capabilities.

The illustration on slide 16 is a simple depiction of a product lifecycle which quite frankly, could be any insurance product or products from any number of industries.

The profitability of a book of new business almost always improves over time as we better understand the book and take appropriate underwriting, risk mitigation and pricing actions.

I doubt this is a new revelation to any of you.

So the question here is not just the profitability today of the business we are putting on the books, but do we have the ability to actively manage the business?

Do we have the tools to understand the business and track and measure the impact of the actions we are taking?

We believe our metrics and tools, which allow us to analyze the pricing and quality of our new business and renewal business, are as good as anyone in the industry.

And we believe we have some of the best point-of-sale talent to take this information and make the right decisions in the marketplace.

We measure our expected returns on new and renewal business.

We measure our pricing at subsequent renewals.

We examine the performance of our renewal book by loss ratio band.

And we do all of this by line, by business, by office.

The result is that overall the new business that we are writing is generating positive ROEs and more importantly, we believe this price is consistent with generating our target ROEs over time.

So we feel great that we've been able to grow share and we are confident that we know what we are doing.

If market conditions change, our approach will change accordingly, but right now we are confident about our ability to compete in these market conditions.

Moving to financial, professional and international insurance segment on slide 17, operating earnings were down from last year due to less favorable prior year reserve development.

Current year margins, shown in the adjusted GAAP combined ratio, were very strong with the improvement coming primarily from less large loss activity in international.

Net written premiums for the segment after adjusting for the impact of changes in foreign exchange rates were down slightly resulting from fewer construction surety opportunities.

We feel very good about the topline story in these businesses and so let me turn to slide 18 to go over some production statistics.

Here you can see the reduction in surety premium which is a direct result of decreased construction spending.

We remain the clear market leader in this product and have made a conscious decision to maintain our high quality credit profile.

In these more challenging economic times, this is led to less business, but has allowed us to maintain our excellent profit margins.

As I said in discussing our growth in business insurance new business, we know what we are doing.

We know when to grow and when not to, and the same applies here.

We continue to feel good about our position in this market and the opportunity for us as the broader economy improves.

On the management liability side, the key dynamic is the rate improvement inside the renewal premium change.

Renewal premium changes plus 1%, but the rate change is plus 4%.

Rate on the management liability components of financial institutions is up over 10% and public company liability rates are up 4% which compares to down double digits a year ago.

We feel great about these rate improvements, but want to emphasize that given the return levels on these products in the general marketplace, some strengthening was needed.

In our international business, retention was down versus the prior year quarter as a result of a planned reduction in cat exposure within the Lloyds book of business.

Renewal premiums were positive with underlying rate improvement at 5%.

New business in the second quarter last year included $50 million from our entry into new businesses in Lloyds.

Excluding this impact and the changes in foreign exchange rates, new business was up double digits from last year.

Before I go to personal insurance, let me take a minute to update you on the impacts of the financial marketplace disruption on our management liability business.

We continue to monitor the analysis that we have shared with you during the last 18 months and our conclusions remain the same.

To give you some context into what we are seeing in the current economic environment and how we are managing it, we put some data together on slide 19.

Year-to-date, there have been 64 bank failures, compared to 25 in all of 2008.

We have management liability exposure to 26 of these institutions on a total of 32 policies.

Each policy on average has about a $4 million aggregate limit.

Our total net limits exposed to these 64 banks,failed banks, is approximately $100 million and obviously we accept actual losses to be a fraction of that amount.

Importantly, we had taken action through our active ongoing risk mitigation and review program on 70% of these accounts before the bank failure and these actions will significantly mitigate our ultimate exposure.

So again, we go over this material not to give you a complete picture of the financial crisis impact, but to illustrate through this the use of this vignette, how we are confident in our ability to manage the emerging challenges.

Our loss estimate and current earnings guidance incorporate this analysis.

In aggregate for financial, professional and international insurance, we feel great about this quarter's results.

Margins are solid.

We are growing where we want to and we are in a great position as conditions improve.

Moving to personal insurance, we made one change to the exhibits.

All of the written premium and production results shown depict our agency book of business which is defined as business sold through agents, brokers and other intermediaries or said another way, excludes our recently announced direct to consumer initiative.

Turning to slide 20 in personal insurance, excluding the impact of mother nature, both auto and property business continue to demonstrate sound fundamentals and substantial earnings power.

Weather did impact operating earning which were down from the same quarter last year.

You can see that the large cat experience was favorable, but non cat weather related losses in homeowners were significantly higher.

Looking at slide 21, agency autos combined ratio of 96% was a slight improvement from second quarter 2008 due to a slight improvement in both frequency and earnings rate.

Agency properties combined ratio of 99% was three points higher than second quarter 2008 driven by the non cat weather I mentioned.

Turning to slide 22, we continue to be pleased with our agency auto production results, especially in light of current market conditions.

Renewal premium change has increased to 5% this quarter; which has contributed to a slight drop in retention and marginal PIF reduction versus second quarter 2008.

Agency property production results remain strong across all the metrics.

We remain pleased with the continuing growth of the QuantumHome product and its ability to increase new business volumes despite challenging market conditions.

Across all our business segments, we are continuing to monitor loss trends, profitability and marketplace conditions as well as the changing economic climate.

We remain very pleased with new business growth and its underlying performance.

We have been and will continue to take rate where loss indications and market dynamics allow us.

We are continuing to consciously expand product offerings and better align our field point-of-sale capabilities.

In summary, while we cannot predict where the economy and the market will go in the second half of the year, we are pleased with this quarter's results and look forward to building on that success.

Before I turn it back over to Jay Benet, I want to take this opportunity to introduce Greg Toczydlowski and Doreen Spadorcia.

Greg has been a key leader in the personal insurance organization for 16 years and over that time has had experience in every area of the business.

He led the development and implementation of our Quantum product, and built and managed the product group for a number of years.

In the last year, his responsibilities were broadened to run the entire agency business on a day-to-day basis and this latest announcement further expands his roll.

Doreen Spadorcia has had experience running profit centers, staff and support areas and quite honestly is the best manager of talent that I have ever worked with.

She's currently runs our 13,000-person claim organization and the results there have been phenomenal.

This is a great opportunity to leverage Doreen's leadership talents by having her work with Greg to manage the strategic direction of the business.

We are confident they will be a great team and help to continue the impressive success of our personal insurance business.

With that, let me turn it back to Jay Benet.

Thanks, Brian.

Page 23 sets forth our guidance for 2009 which we are increasing based upon second quarter performance.

We are now projecting fully diluted operating income per share in the range of $4.80 to $5.05, compared to our previously announced range of $4.55 to $4.95.

Our guidance now assumes full-year cat losses of $410 million after tax or $0.73 per diluted share, based upon actual cats for the first half and an unchanged expectation for the second half of the year.

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

No significant changes in private equity and hedge fund valuations for the remainder of the year, as we are assuming unchanged capital market conditions, lower real estate partnership evaluations due to a continuing downward trends in commercial real estate values, additional share repurchases of $2.25 billion, bringing the sum total for the year to $3.0 billion, and no significant change in average investment assets ex FAS 115, and a weighted average diluted share count of approximately 565 million shares.

With that, we would like to open it up for questions.

(Operator Instructions).

Your first question comes from the line of Jay Gelb with Barclays Capital.

Please proceed.

Thanks very much.

Jay, can you give us some insight into what level of success you're having from attracting business away from the stressed competitors and maybe tie that into the new business growth in business insurance that we saw in the most recent quarter?

Sure.

First, the slide that we presented at the investor day conference showed, my recollection, is six competitors.

And we were showing accounts taken versus accounts lost and net, and all of them were positive.

I don't have that slide actually in front of me, but they were meaningfully positive.

If we did that slide again for the quarter, it's actually -- they are all positive and they are actually, I believe, all somewhat more positive than they were from the slide that we presented at investor day.

We continue to have success in the marketplace, not only from those competitors that perhaps are struggling, but from the real solid competitors as well.

We are just having real success in the marketplace day in, day out.

Now, I don't know how to quantify that in the context of written premium in the growth.

I haven't done it frankly so I don't know how to comment on that.

Thanks.

I have two separate issues.

The first is how long do you think it will take you to complete the pace of the increased share buy-back program?

And then finally if you could comment on the potential for Chinese drywall losses in construction claims that would be helpful too.

Why don't we have John Albano speak to the drywall and then I will come back for the share buy-back.

Jay, as far as the drywall is concerned, most of the affected buildings were built or repaired in the 2006, 2007 timeframe.

Imports of the drywall actually began a little bit before that, but most of what we are seeing in terms of repairs and new building construction is in those two years.

We are talking about a couple of years of exposure.

Our exposure to the Chinese drywall situation would appear to be minimal.

We are not a big writer of residential contractors.

We are not a big writer of importers of foreign building materials.

We've looked at the claim activity.

We've looked at our limit of liability for each one of those and we view it as deminimis.

And I just make an observation, and obviously we've done everything one can do to analyze what is an early emerging situation.

This is still, from a claims and activity perspective, quite early and who knows where it will go.

But what we've attempted to do is to understand where the exposure potentially could be, analyze our commitment to those exposed lines and feel pretty good about it.

We will watch it carefully and we'll report on it periodically as quarters emerge.

Jay, as far as the pace of the buy-back program, I think in prior years we've said that we usually will hold back a little bit in the third quarter, given that it's cat season.

But in this particular year given the amount of cash we've built up at the holding company, our desire is to go into the market more aggressively than that.

For purposes of the thinking ahead, we are just planning on doing it pretty steadily between now and the end of the year.

Consistent with the pace you had in the second quarter?

In terms of the dollar amounts that we are putting forth in the guidance, it would be at a higher amount than what we did in the second quarter.

Thanks for the answers.

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

Please proceed.

My first question is whimsical.

I'm wondering where the little dog is.

I've been waiting for it on TV.

You don't watch enough TV.

We're spending plenty of money on it.

I'm surprised you haven't seen it.

All right, all right.

I will keep watching.

Following up on Jay's question, one of your very large competitors, who I won't name, spoke earlier this morning, and said they are seeing great submission flow and winning great business in the small commercial arena.

I'm wondering if there's room for two very large competitors to be doing that and who is losing the business?

Our data speaks for itself.

The written premium in select is as presented here.

I don't know anything about anybody else's numbers.

I know a lot about our own.

And if you go to page 15, we did $154 million in Select, up from $133 million last year, premised largely on the roll out of TravelersExpress and the success that it's having in the marketplace.

I don't know about anybody else's numbers, but there's plenty of room for us to be successful.

And the final question, I realize there's a lot of people, where are deductibles going for small commercial business?

Is that a common discussion that you're having?

Is that actually unusual?

What are your agents experiencing in that regard?

There is -- this is John Albano.

There is very little movement in terms of deductibles on smaller accounts.

Smaller accounts tend to have lower deductibles obviously than larger accounts and based on their financial condition, not looking to move that up.

More broadly, we are seeing in larger accounts a little bit of movement in terms of deductibles on some larger accounts.

But it's not a significant shift.

Okay.

Thanks for the answers.

Pleasure.

Your next question comes from the line of Matt Heimermann with JPMorgan Chase.

Please proceed.

Good morning, everybody.

Two questions if I may.

Just with respect to some of the slight moves down to retention -- let me rephrase that.

How important has that retention drop been to actually being able to generate the positive rate changes across all the segments?

This is Brian.

I think you have to look at it a little bit specifically business by business.

In personal insurance, I think specifically on the auto side, we were ahead a little bit of the market curve on getting some rate increases filed there.

And there is probably also some economic drivers there with consumers being a little more price sensitive.

We feel real good about that trade-off and felt we needed to get the price movement.

And so there it's pretty correlated.

In the small commercial world, there is probably also a little bit of economic impact there with some business failures, again not a dramatic number but maybe that's moving our retention a point.

We don't think there it's been as connected to the pricing, but is to some degree.

In the middle markets, the numbers have bounced around a bit, but at 85% levels we continue to feel great about our retention.

Again just in the context of looking over time, the Select retention of 80% is the same as it was in the second quarter of '08.

The retention in commercial of 85% is the same as it was in the second quarter of '08.

And in other business insurance, we are from 82% to 81%.

Hard to see anything in those numbers that would indicate any substantial change or shift.

Obviously we've always said retention is an important -- maybe the most important leading indicator.

We'll obviously keep on watching it.

But this is -- at the moment nothing more than another quarter that I would characterize as being in sequence.

And based on that, it sounds like you're still pretty comfortable that that trend can continue through the end of the year?

Again, I'm trying to resist the notion of forecasting because the market -- when I say the market, I'm really responding more broadly to the issue of the economic environment in which all companies compete -- we are all competing in the same marketplace.

And given the recession and given the lower payrolls, lower projected sales, lower amounts of transportation, just lower amounts of economic activity which translates into premiums, it's just an awfully difficult time to look into the next two quarters and predict anything other than just being out there and banging away.

I'm just going to refrain from it.

I don't see anything in the second quarter where any alarm bells or genuine concerns are there.

Okay.

Then with respect to the PIF decline in personal lines on the auto, which I believe was auto driven, is there any particular type of customer that's driving that retention change?

As Brian -- good morning, Matt this is Greg Toczydlowski.

As Brian indicated, we are just seeing the economy generate a price sensitive consumer across a pretty broad group of a profile.

We are not seeing any shift in profile of our last business.

Right now, our focus is very much on the pricing discipline.

Looking at where our combined ratios are for the quarter, we feel good about the combination of the two metrics.

Okay.

Thank you.

And then, Jay, one quick follow up.

Your portfolio ex the bond wraps, is that double AA as well?

Yes, either way, it's a AA portfolio.

Okay.

Perfect.

Thank you.

Your next question comes from the line of Jay Cohen with Banc of America Merrill Lynch.

Please proceed.

Thanks.

Good morning.

A couple of questions.

Jay, slide 5 was an interesting one where you adjust for the ROE for these I think reasonable factors.

One adjustment you didn't make was the combined ratio.

The presumption would be that the combined ratio you guys are producing now is a normalized level.

And I'm wondering if you can reflect on that a bit and then I'll have one more question.

We thought much about it because obviously it's an important element.

You've got a couple of things kicking around in there.

You've got favorable reserve development and it's certainly appropriate to ask the question to the extent to which that's sustainable.

You've got excess cats in the quarter, relative to what we would consider to be a normal cat exposure -- normal cat loss for the second quarter.

Ultimately what we did was we ran the same analysis.

If you go to the slide that shows the combined ratio ex-ex -- my recollection, let me get to it, but I think it was 94.4 is my recollection.

That's right.

And even if one were to round that up for what might be considered a normal cat exposure, you get to -- and these are approximates, Jay.

I'm not being terribly precise here.

But even if you call it a 95, and then if you look out and make the assumption that given what's happening with rate and given what's happening with loss trends, that you can envision the circumstance where on an earned basis looking out there that margin compression potentially could stop, you'll get to that same mid-teens level.

It will be a little bit lower obviously, 95 versus 94.4 is six-tenths of a point in the other direction.

But it's just arithmetic.

If you run a 95 combined and assume a more normalized investment return environment, I think it will point you generally in the same direction.

You could ask questions like what happens if rates get much better.

It will be better.

Will that have an impact on investment returns because the market changes?

I don't know.

If rate gets really turned down, is it different?

It was funny.

I was asked a question before, if rates -- and this goes back probably about six or nine months.

If rates never change and if investment yields never change, how do you get to mid-teens return on equity.

And the obvious answer is we can't.

There has been a cyclicality to the business and a cyclicality to investment returns.

And that's frankly why we talk about returns over time.

There's a presumption that there's a mean line -- a normal line within all of those cyclicalities.

And around that line, we think a well run business still has the ability to produce that mid-teens number.

That's great.

A second one, more specific.

When you discussed some of the bank failures, there was a comment that the Company quote, took action ahead of time on some of these accounts.

And I'm wondering what that means.

What action did you take to reduce your risk?

Jay, it's Alan Schnitzer.

It's the typical underwriting action you take any time you look at underwriting an account.

It's limit, it's A side versus B side, it's the whole nine yards in term of underwriting.

But obviously, you feel that it was effective enough to reduce your risk from what otherwise it would have been?

Sure.

It changed the risk profile of those accounts.

Okay.

Let me stop there.

Thanks a lot.

Pleasure.

Next question comes from the line of Mike Nannizzi with Oppenheimer.

Please proceed.

Thanks.

Just a question on guidance.

When you look at the change from before to now, how much of that change is due to second quarter cat reserve development and share repurchase activity versus how much of that change is due to a change in expectations for the latter part of the year?

Thanks.

This is Jay Benet.

A lot of it is -- as we said, the guidance change is based on the performance as things developed.

Lots of the change in the guidance was driven by the second quarter.

The guidance previously didn't include any estimates of favorable development so that's fully factored in.

The excess cat is going the other way -- is factored in as the weather that Brian was talking about before.

I think if you add up all those numbers and look at the impact of the increase in the share buy-backs, you probably end up with something close to about -- somewhere between $0.25 and $0.30.

Got it.

Thank you.

Your next question comes from the line of Brian Meredith with UBS.

Please proceed.

Good morning.

A couple quick questions for you.

First, your big competitor reported this morning has some asbestos increases in reserves.

I was wondering if you can give us a status on what you are seeing with respect to asbestos claim activity?

Asbestos?

Yes.

We haven't talked about it in a long time.

It was a little hard to hear what you said.

We review our asbestos reserves on a quarterly basis and we did not make any changes to our asbestos reserves this particular quarter.

I can't comment on what somebody else was saying, but at least at this point in time, nothing has really changed in our view.

Okay.

Great.

Second question, Jay, just back in the whole ROE discussion quickly.

What would you say that the long-term fixed income returns that you would expect in your business is when you are evaluating where rate levels need to be?

Obviously you have to expect fixed income returns to start trending upward here, right, to get your mid-teens ROEs?

Two different points.

There's the illustration that we put forward here is making two adjustments.

It's making an adjustment to short term yields which obviously generates into a portfolio quickly.

You've got very short duration, short yields change so is your investment income.

The alternative arena actually has a relatively quick responsive rate also, tied to valuations -- equity valuations and such.

Our real fixed income portfolio, we are running a duration of about four.

And so the change even to the extent that new money rates change, given the share buy-back, given the way we are deploying capital, you are not going to see the fixed income investment yield change very much.

It's going to continue to just crank out what it is it cranks out.

Then obviously as the duration moves, it will change slowly.

We are talking now about a ten-year treasury.

I looked yesterday.

I didn't look this morning.

Ten-year treasury at 3.6; this is an investment environment in that fixed arena that will allow us to get to the mid-teens on the presumption that short rates eventually return back from in effect zero and the alternative investment portfolio begins to return consistent with its real risk profile.

I feel confident about the first.

If we are going to have short rates at zero, we are going to have other problems that we are going to be dealing with in a couple of years that are going to be quite different from the ones we are dealing with now.

On the alternative investment returns, to the extent that capital will redeploy, again if a ten-year treasury is 3.6, if these assets aren't going to get back to an appropriate risk adjusted level over some reasonable period of time, no one is expecting it in the next quarter.

If they don't get back there, we will eventually cut the allocations to that asset class and redeploy it somewhere else where the risk adjusted returns are more appropriate.

The analysis here was really at the barbell ends of our investment portfolio -- the very short end and the alternative investment end.

The stuff in the middle is doing just fine.

Got you.

The presumption there also is -- as you mentioned earlier, is the favorable reserve development has to continue here as well.

Again, I think I answered Jay's question early about that.

To the extent that one were to simply assume that there would not be any more reserve development and cats would become normal, whatever that means, but normal given our exposure.

If you want to sit down and do the arithmetic at a 95 combined which is about where you get to at current margins, you'll actually see that the analysis holds true even in that case.

It doesn't -- it's still an achievable goal.

How do we feel about it?

To the extent that rate continues to move up, we feel more bullish about it.

To the extent that loss trend continues to remain benign, we feel more bullish about it.

You're right.

There's any number of variables in this.

The extremes at the moment in the context of the environment that we operate in, and I'm speaking now broadly about insurance and investments' the extremes are at basically zero yields for short term investments and at alternative investments, effectively also being zero at the moment.

Those are the two extremes.

The underwriting environment that we are in is just fine.

It's just fine.

Again, it's fine in the current quarter and it's fine in the context of looking at at least where rates seem to be heading.

I am going to resist from making the predictions.

But if you look back to the second quarter of last year, rates have been moving in the right direction and loss trend has been relatively benign.

That's a pretty good scenario.

I have no idea if it will continue.

But those are all the factors that go into how you think about returns in our business.

Great.

And then just quickly.

Any push back from agents with respect to the direct distribution?

Does it at all contribute to the drop in PIF in the quarter in personal auto?

This is Greg Toczydlowski again.

We've been working very closely with our agency plan, and communicating with them and just educating around all our direct-to-consumer initiatives, including the advertising around that and the partnership has been very strong.

And quite frankly, as they've seen the campaign out there, we've received many positive remarks around it.

We are going to continue with that partnership, but we don't believe it's had any impact on our production.

I agree with what Greg said, but that's not to say that we haven't taken a call or two or three from agents who are bothered -- troubled by what they perceive to be a different strategic direction.

But they are clearly significantly in the minority and again, I will reinforce what Greg has said.

There's certainly no indication that anything as it relates to our business in any substantive way in volumes is attributable to that.

Thank you for the answers.

Pleasure.

Your next question comes from the line of Larry Greenberg with Langen.

Please proceed.

Thank you and good morning.

Jay, I won't ask you to predict what rates are going to do going forward.

But if I were to assume that your business insurance rate trend were to continue, would you be at a point by the end of this year where you weren't losing any margin on written premiums?

We actually have spent a lot of time talking about that exact question and we are going to answer it.

We are going to talk about written and then we are going to talk about earned because the two things are different, but I will let John tackle that question.

You want to do it instead?

I think John was just hesitating to say what we -- I think given -- this is Brian.

Larry, how are you doing?

I think what's important in this is don't perceive this to be a forecast.

We are not forecasting rate.

You actually asked the question the right way which is if rate trends continue, which is not to say that we are telling you that rate trends are going to continue.

If rate trends continue, we would believe that by the end of this year on a written basis, our business insurance segment broadly would be experiencing improving margins.

Great.

Thanks.

Second question.

It will take awhile for that to show up in earnings.

Obviously it takes awhile.

(multiple speakers)

I get that.

On the investment side, has Bill gotten any more optimistic on the capital markets environment?

Hi, Larry.

This is Bill.

Hey, Bill.

Obviously the psychology is much better, although we don't pay a lot of attention to psychology when we invest.

If we did, we would have invested very differently going into this crisis.

On balance, it can't hurt that the psychology is better because it will make it marginally easier to refinance the large amount of commercial real estate mortgage debt and private sector debt, largely high yield buy out related, that has to be refinanced in the next 24 months.

But we still think there will be a considerable shortfall in the amount of debt that has to be refinanced and the capacity of the market to refinance it.

We are determined that as little of that unrefinancable debt as possible be in our portfolio.

At the margin, believe it or not, we are probably still reducing risk on a day-to-day basis.

We find there's very little penalty for doing it.

In fact in the case of securities, we don't hold any, but we hold some that were severely marked down.

The recovery in prices has been amazing.

Yet in many cases, the same obstacles to ultimate payment remain and that's what we focus on.

We focus on getting paid because in a fixed income security which holds 95% of the portfolio, your upside is to collect the cash flow you bargained for.

And do we feel better?

I think we feel better with everybody else.

But we are looking at things as hard nosed as we ever have.

Great.

Thanks.

I think in the past, not too long ago, you had indicated that partnership, private equity type of asset classes might be some of the more interesting ones.

Have you or are you inclined to put any new money to work in those asset classes?

We've given the message to everyone that we are open for business, but there is surprisingly little quality fund raising activity in private equity.

Now there is a lot of noise has been made about the secondary market.

If secondary assets were trading in volume at appropriate discounts, we certainly have the capital for it but we think there's been a lot more smoke than fire there.

It's been a very quiet year.

But not lack the willingness on our part.

Not lack of willingness on our part.

Frankly, we've been surprised by the low capital goals in our funds -- the negative cash flow -- that is the excess of capital calls and management fees over distributions is running at a much lower rate than we had anticipated.

Great.

Thank you very much.

Your next question come from the line of Paul Newsome with Sandler O'Neill.

Please proceed.

Good morning and thank you for the call.

Wanted to shift to the investments just a bit.

Could you describe, maybe at least qualitatively, how within each segment class as opposed to the allocation, you think -- are you meeting or exceeding industry averages, particularly on the hedge funds?

Relatedly, if could you give us maybe an example of how you may be more conservative in your accounting for the hedge funds?

I think you mentioned something along those lines in your prepared remarks.

Let me speak to the second point and then I am going to turn it over to Bill.

We are not more conservative.

Our alternative investment income or loss is classified within operating income.

And so when you look at operating income for us, it includes for example the $20 million loss from alternative investments that we recorded in the quarter.

I don't know what anybody else does from a conservative or aggressive perspective, but many people classify the alternative investment gains -- income or loss below the operating income line.

Operating income comparability from one company to another -- it's easy to do.

Virtually everybody gives you the disclosure, but the nature of the classification is quite different from one company to another and is worth looking at.

With respect to our performance, obviously we do compare it to published benchmarks we can find.

We try to be pretty granular by type of hedge fund.

Over the last couple of years, we've actually done very well relative to those benchmarks.

But as a rule, what we benchmark here is not performance but risk.

We try to keep the amount of risk in the portfolio pretty constant from year to year.

And we grade ourselves at the end of the year by how much return, of the return that was possible given that amount of risk, we were able to capture.

We do look at the return benchmarks.

We are often surprised by how well we do, but our primary focus is risk.

Thank you.

Your next question comes from the line of Vinay Misquith, Credit Suisse.

Please proceed.

Good morning.

Two questions, first on the ROE.

The slide mentioned a higher amount of cash at the holding company.

When do you propose to invest the extra $2 billion in cash?

Because it seems that the $1 billion that you plan to use for share repurchase that will you generate in your net income over the next two quarters.

Our guidance is already speaking to approximately $3 billion of -- it's speaks very specific.

It says we are approximately $3 billion of share repurchases for the full year.

You obviously know what we've done for the first six months so you have some sense of what we are anticipating to do for the last six months.

To the extent that market conditions and circumstances allow, we obviously have the capacity to do more.

If market conditions and circumstances for whatever reason become problematic, we will always adjust our program relative to what's going on in the market.

But we generally have been a company that has projected out share repurchases in a way where --that our tilt if you will, is to probably do more than less, assuming that the market continues to support the activity.

The other thing that I would add is that the holding company cash is the amalgamation of lots of activities that take place.

One of them is getting monies from the operating companies through operating company dividends up to the holding company.

And that's not done on a basis that says, here's what the operating company earned in the quarter, let's bring that up.

There's a whole different timing track for that.

What at we do in projecting out what kinds of share buy-back activities we should have is we project.

Here's today's holding company cash.

Here are the dividends that are going to come out of the operating companies.

Here are the payments that we're going to be making at the holding company for interest and dividends and things of that sort.

And these are the amounts of cash that we will have at the end of the third quarter, at the ends of the fourth quarter With that more comprehensive analysis, we then come up with, okay, what is the amount of buy back that we should have and what will that leave us at those points in time with regard to holding company cash.

Fair enough.

Could I just ask a follow up on that?

When do you think this penalty that you have, because you have access cash at the holding company, when do you think that that will go away because you will -- keep purchasing extra stock?

By putting in the guidance, saying that we were going to do $3 billion of repurchases for the year.

That would bring the holding company cash balance down considerably from where it is.

We still -- as Jay and Bill have talked about, live in this world where we have a recession going on.

There's economic uncertainty out there.

Doing the $3 billion will not bring us down to the target at the end of the year.

We are still being a bit cautious.

But it will bring us considerably lower than where we are today.

Sure.

And is the $3 billion for the next 12 months or is it for six months?

The guidance is annual guidance.

You should think about it as we've done $750 million through the second quarter and the $3 billion is for the year.

That would leave $2.250 billion for the rest of the year.

That's great.

One separate question if I may.

I think you mentioned the frequency and severity of loss cost trends were very manageable.

I was just hoping you could expand on that.

Should we see a stabilization or a continuation of very low frequency and severity trends?

Do you think that your current profitability would remain the same over the next 12 months, despite pricing being flattish?

I think, again -- this is Brian.

I think again you have to think about it a little bit across the spectrum of businesses because there's a lot of businesses here.

Frequency trends in our personal auto business for example, have been running very favorably.

We are constantly, like everybody else, trying to figure out the causes there.

Some of it is economic driven, as in people driving fewer miles, et cetera, et cetera.

Overall, the frequency trends we've been seeing across personal businesses and much of our business insurance have been trends that we have been seeing for quite awhile.

We don't think they are just short-term anomalies.

If I get a little of your question, I think it's similar to the one that Brian Meredith asked a little while ago which is if these trends continue as they are continuing, how do we feel.

Again if you have frequency levels running in some businesses actually negative and overall I would say, better than historical and severity -- again this is a broad aggregate across the Company, severity running pretty typical, that's a positive place to be from a loss trend.

Then if you get some positive rate with that, margins will improve.

Obviously as long as rate change, even though it was heading in the right direction, as long rate change was still negative that was implying compressing margins, albeit at a slower rate.

Once that rate change passes above zero, you are now talking about at least the possibility of expanding margins, depending upon what happens to loss trends and of course, the ability to sustain those positive rate gains.

And it was, and again, just commentary about the quarter, this is the first time in a long, long time where the rate change in all three business segments was positive.

You look out and would say to the extent that continues, that's a bullish indicator.

Fair enough.

Thank you.

Thank you.

I don't think we have any more questions.

With that, we will close our conference call and thank you all for joining us today.

Thank you for your participation in today's conference.

This concludes the presentation.

You may now disconnect and have a good day.