旅行家集團 (TRV) 2010 Q3 法說會逐字稿

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

We ask that you hold all questions until the completion of 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, Thursday, October 23, 2010.

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

Gabriella Nawi, Senior Vice President of Investor Relations.

Ms.

Nawi, you may now begin.

Thank you, Frank.

Good morning and welcome to Travelers' discussion of our third-quarter 2010 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 in 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 Operating 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 and then we will open it for questions.

Before I turn it to Jay I would like to draw your attention to the explanatory note on page one of the webcast.

Our presentation today includes forward-looking statements.

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 those projected in the forward-looking statements 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 some non-GAAP financial measures.

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

With that out of the way, here is Jay Fishman.

Thank you, Gabi.

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

We are very pleased with our third-quarter results having posted net income of $2.11 per share, an increase of 28% over last year, and operating income of $1.81 per share, a 12% increase over last year's amount.

Operating return on equity was a strong 14.3% and we experienced very solid underwriting results across each of our business segments.

Our consolidated GAAP combined ratio was 90.6%.

In an insurance pricing environment that remains largely flat in commercial businesses we were pleased to produce an increase of 2% net written premiums for the quarter.

Investment returns remained reduced from historical patterns as remarkably low interest rates, particularly short rates, continue to impact net investment income.

Lastly, we have grown our book value from year-end 2009 by 13% to $59.11.

All-in a very strong quarter.

This morning we are going to do things a bit differently than we have in previous quarters.

All of the data that we have historically provided is still included in our webcast.

However, we are only going to hit the highlights and you can review the details on your own and, obviously, Gabby is available later to take any questions you may have.

Instead, we are going to take the opportunity to share a few additional insights into our business that we think you will find interesting.

First, we have spoken at length in previous presentations about our programs designed to grow our business organically.

This morning we are going to share with you summary analytics of our business insurance account growth and we suspect that a number of you will be surprised at the growth we have achieved.

Second, a number of you have asked about the impact reduced interest rates on our net investment income.

Jay Benet shared an analysis of the impact of reinvestment rates at an investor conference in September and we have updated it for current conditions.

We have analyzed the maturities in our fixed income portfolio for the next three years and we will share with you the projected impact on net investment income if reinvestment rates remain at current levels.

The municipal bond environment remains a topic of some interest.

We have updated an analysis of our municipal bond portfolio that we did for the second-quarter webcast based on current ratings and market conditions.

As we have said before, it is an actively managed portfolio where we are constantly evaluating risk and return of individual securities.

There are never any guarantees, tease but we couldn't be more pleased with the positioning of the portfolio.

Finally, before I turn it over to Jay Benet I want to comment on a topic that we are thinking about regularly.

As we have discussed before, we believe the most thoughtful way to run a property casualty business for the long term is to produce superior returns on equity.

As many of you understand, we can't promise consistent growth in either revenues or earnings and do so maintaining a thoughtful risk profile.

Consequently, a number of years ago, consistent with our aspiration for superior returns on equity and given what we viewed as typical underwriting and investment environments, we determined that we would target a mid-teens return on equity over time and do so by achieving top-tier profitability and returning excess capital to shareholders.

Two very important words in that previous sentence are 'over time.'

Since January 2005, the first full year after the merger of St.

Paul and Travelers, our average annual operating return on equity is 14.1%.

We have recorded more than $20 billion in operating income and have returned nearly $17 billion in total to shareholders, $13 billion in share repurchases, and nearly $4 billion in dividends.

Given the current general economic and investment environments, a few people have asked whether we intend to change our goal now.

We are certainly not economists nor do we know what the future holds.

However, the underlying assumption we are making is that the economy will eventually return to a more typical investment environment, particularly with respect to the fixed income world.

Consequently, we are not changing our goal now.

Having said that, we have been very clear in the recent past that the current environment simply doesn't permit achievement of a consistent mid-teens return right now if one assumes no favorable reserve development and normal catastrophes and weather costs.

If in fact the market ultimately presents long-term, meaningfully reduced investment returns, not only for us but also for the market at large, which for us are not offset by improved underwriting conditions, we will obviously rethink what that means for our aspirations and what investors can expect of us.

So for now our target remains intact and we continue to execute in the marketplace consistent with that goal.

We seek rates selectively and thoughtfully where rate is needed, especially in those cases where account loss experience has been inconsistent with our underwriting expectations, but we are always managing rate and retention with a clear view of maximizing long-term value.

To arbitrarily and aggressively seek rate and be a victim of adverse selection and watch our retention drop precipitously would not be a smart or thoughtful reaction to the current environment.

As Brian will explain in greater detail, our field people take their lead from us and right now their direction is unambiguous.

We feel great about how they are executing and we believe that we will continue to be amongst the best-performing property and casualty companies around.

With that let me turn it over to Jay.

Thanks, Jay.

I would like to start with a few overall comments about the quarter relating to pages four through 10 of the webcast.

Operating results, ex-cats, and favorable reserve development, and including net investment income, are generally in line with our expectations as they have been all year.

Our third-quarter results benefited from a relatively low level of cats, $117 million pretax, which was lower than prior-year cat losses of $158 million pretax as well as what we would, quote-unquote, normally plan for in the third quarter.

I would remind you, though, that year-to-date cat losses have been quite high, over $1 billion, on a pretax basis as compared to $441 million pretax in the first nine months of last year, which would approximate a more normal year-to-date amount.

We had another quarter of net favorable prior-year reserve development in each of our segments concentrated this quarter in DI and FPII.

The quarter's reserve development included an asbestos reserve increase of $140 million pretax.

Included in this asbestos reserve increase, and therefore in the current quarter's operating income, is a $70 million pretax benefit related to the recent favorable ruling we received against Munich Re and certain members of ECRA.

The total awarded to us by the court in this ruling was $417 million broken down as follows -- $251 million owed to us under the terms of the reinsurance agreement and interest of $166 million.

Based upon this ruling, we reduced our uncollectible reinsurance reserve by $70 million thereby reflecting in our financial statements a full $251 million owed to us under the terms of the reinsurance agreement.

Importantly, the benefit of the $166 million interest award was not reflected in either the current quarter's asbestos charge or in the current quarter's operating income since GAAP requires this interest to be treated as a contingent gain generally until all appeals have been exhausted and/or the dollar amount is received.

All of our capital leverage and liquidity measures remained at or better than target levels.

We had holding company liquidity of $2.8 billion at the end of the quarter, which was more than twice the target level, due to the timing of share repurchase activity and the timing of dividends from our operating companies for our holding company.

During the third quarter we repurchased $600 million of our common shares, a higher amount than we would normally repurchase in the third quarter due to the strength of our balance sheet and the light wind season we have experienced thus far, and paid $169 million in common stock dividends bringing the total cash we returned to our shareholders in the past nine months to almost $4 billion.

Third-quarter operating ROE was 14.3% and book value per share once again increased, up 6% in the quarter and up 15% from a year ago.

Page four makes reference to our very high quality investment portfolio which includes a $4.6 billion pretax net unrealized gain at the end of the third quarter, up significantly from the $2.8 billion pretax net unrealized gain we reported at the beginning of the year.

A little over 60% of the net unrealized gain relates to the muni bond portfolio.

Page five provides an update of certain data we previously provided to you related to our muni bond portfolio.

There have not been any significant changes in the portfolio recently, notwithstanding our active management of the portfolio based upon a risk/reward view for each individual holding due to its very high quality.

The portfolio currently includes bonds that have gross unrealized gains of $2.8 billion pretax and bonds that have gross unrealized losses of only $8 million.

That is right; only $8 million of losses, not billions.

I would also like to make some specific comments related to page nine of the webcast.

During a presentation I made at a recent conference, I referred to today's low interest rate environment and provided an illustration based upon our portfolio's scheduled bond maturities in 2011, 2012, and 2013 of the impact on net investment income in those years if the current interest rate environment persists through this period of time and all of the variables, such as average assets, mix, credit quality, and duration, remained constant.

The illustration I provided at the conference was based upon reinvesting at 10-year rates that were approximately 100 basis points lower than the combined yield on the maturing bonds, rounding the interest rate differential to the nearest 50 basis points.

Since then interest rates have fallen even further and we have updated the illustration to reflect a 150 basis point interest rate decline.

We have also added another line to the illustration which shows the differential between 2010 NII and these subsequent years.

Again, all other variables being held constant.

That includes the partial year impact of reinvesting 2010 maturities at lower interest rates.

The full-year impact of this activity will not be felt until 2011 and subsequent years since the 2010 maturities will have taken place throughout 2010 rather than on the first day of the year.

As you model these years, I would also remind you that NII will also be impacted by the reduction in average invested assets that results from our share repurchase program.

With that let me give the mic over to Brian.

Thanks, Jay.

(technical difficulty) webcast slides are just typical disclosures on the business segment.

Results are on pages 11 through 22 and we will, of course, take questions on any topic.

Instead of going through the slides I will give a few perspectives on our businesses and the marketplace.

In Business Insurance we continue to be very pleased with the positioning of our franchise.

Both our account retention and flow of new business opportunities remain near historically high levels, which we believe will enable us to grow premiums if and when the economy improves.

Core underwriting margins continue to contract modestly in the quarter consistent with both prior quarters and our expectations.

In short, the loss cost trend slightly outpaced earned rate changes.

We continue to see the negative impact the economy is having on our insureds exposures.

Audit premiums, which are retroactive premium adjustment charge to reflect changes in insureds' payrolls, vehicles, property values, or business receipts, have improved but are still negative.

The exposure change on renewals, which is a perspective look, has also improved throughout the year and is now approaching zero.

On a combined basis these impacts are reducing premiums approximately 2% through the third quarter.

So in other words, our data suggests that the economy is bottoming out but we don't see any evidence of current economic expansion.

Given these trends our underwriting strategy remains consistent -- retain our quality business, optimize the profitability on this retained book by getting rate where it is warranted, and write new business for long-term profitable growth.

Directionally this strategy may be the same as many of our competitors but by aligning it with our competitive advantages, namely our talent, technology, actionable management information, and breadth of distribution, we believe we are very well positioned.

Over the last seven quarters we have seen significant account growth and as a result we believe that we are growing market share.

On slide 16 you can see that since year-end 2008 we have grown accounts in Business Insurance by an 8.5% compound annual growth rate.

On the next slide we have taken this data and broken it out for two of our major businesses.

In our small commercial business, or select accounts, you can see that it is growing by a 10.6% CAGR.

This increase has been driven by our Select Express product, that is our no-touch insurance solution for small business customers.

Through the combination of our sophisticated rating capabilities and cost efficient front-line delivery we are able to provide our agents and customers with an industry-leading product and platform.

Within Select, in the plus end or the larger end of this market, we have allowed our accounts to decrease due to extremely competitive market conditions.

On the slide you can also see that we have grown commercial accounts by 4.4% compound annual growth rate.

The increase in the number of accounts in this business is driven primarily by the continued introduction of new products and the specialization and expertise that these products and our front-line underwriting and claims staff bring to the marketplace.

This growth in commercial accounts is representative of what we are seeing across our middle-market businesses.

So we are encouraged by this increase in the number of accounts and, again, if and when the economy improves the resulting impact on exposures should create a compelling written premium trend.

Given both this top-line dynamic and the current core underwriting profitability of this book of business, we remain very pleased with Business Insurance's current performance and its position in the marketplace moving forward.

In a Financial, Professional, & International segment I will make just a few overall comments.

First, writings in our international businesses are down compared to prior-year quarter as we are addressing risk and pricing in light of catastrophe and others severe weather losses over the past year.

Secondly, although we remain very pleased with the market position and quality of our construction surety business, the impact of the economy on construction spending has resulted in fewer new business opportunities and our writings in this quarter reflect this.

Lastly, we continued to monitor the analysis on impacts of the financial marketplace disruptions on our management liability business and our conclusions remain the same.

That is our losses are developing within or slightly favorable to our expectations.

Turning to Personal Insurance we are extremely pleased with both the underwriting and production results in the quarter.

In both agency auto and property policies in force continued to grow and core underwriting margins expanded as earned rate increases outpaced loss cost trends.

In our property line of business weather losses were both less than third-quarter expectations and a welcome relief from the pattern we saw in the first half of the year.

While the continental US was not meaningfully impacted by any of the storms generated during the peak of the hurricane season, the number of near misses this quarter highlights the importance of underwriting controls and risk management policies in this business.

Agency property production results for the quarter continued to be strong in spite of the difficult housing market with quarter-over-quarter PIP growth remaining at historically high levels.

In agency auto, our new business continued to improve and we had our best quarter-over-quarter policies in-force increase since the end of 2008.

Given the continued expansion in core underwriting margins and strong top-line trends, we remain pleased with both our current and going-forward positions in these businesses.

So across all of our businesses we feel great about our execution in the marketplace.

One of the primary reasons we believe our organization has executed so well in these times of uncertainty is that we have kept our message to the field clear, unambiguous, and consistent.

And that is that in these market conditions, just like pretty much any other, the role of our underwriters is to maximize the long-term value of the portfolio, to balance the desire to keep our quality business while at the same time optimizing the returns on that portfolio.

Fundamentally, they do that by making sure they understand the account's risk characteristics and can estimate the potential losses from these exposures.

They then seek to select risks in the marketplace where the premium level is appropriate for this view of the losses.

We believe our field understands their role, has the best tools in the business to execute, and as long as they can keep doing this we will keep competing in the marketplace successfully.

With that let me turn it back over to Jay.

Thanks, Brian.

Page 23 summarizes our updated guidance for full-year 2010 fully diluted operating income per share, which we have increased from the previous range of $5.20 to $5.45 to a range of $5.75 to $5.95.

In round numbers this should translate into an operating ROE of just under 12%.

We are now assuming cat losses of $765 million after-tax or $1.58 per diluted share, which incorporates our actual cat losses for the first nine months of the year and our original estimate for the fourth quarter; no further estimates of prior-year reserve development, either favorable or unfavorable; a low single-digit decrease in average invested assets, ex unrealized gains and losses, resulting from a reduction of holding company liquidity due to the share repurchases; full-year share repurchases of $4.5 billion to $5 billion; and a weighted average diluted share count after share repurchases and employee equity awards of approximately 485 million shares.

Jay would like to say some additional comments before we go to Q&A.

Thanks, Jay.

Just before we open it up, we have had a pretty good run here for some time and the folks around this table, I think, actually get an undue amount of credit for that performance.

We have very publicly acknowledged all the folks in the investment department who have done a remarkable job in unprecedented conditions of keeping this company moving ahead.

But the fact is I want -- and our own folks listen to these calls.

I just want to spend 15 seconds letting 30,000 people know that we recognize that business is done in the field a trade at a time, and we couldn't be more appreciative of the underwriting discipline and the thoughtfulness and your attention.

And I don't care whether they are commercial lines underwriters or personal lines underwriters or they are in claim or technology or ops or risk control, this is a complicated business.

We have got 30,000 folks who understand it and keep the organization moving ahead and I just wanted to take a minute to say thanks.

With that, operator, we are ready to open it up for questions.

(Operator Instructions) Keith Walsh, Citi.

Good morning, everybody.

I guess first for Brian on auto; I guess lots of talk in the industry about positive rate trends so why the decision here to loosen terms and conditions with the 12-month product?

And also, if you can comment on the direct initiative where we stand and I have got a follow-up.

Thanks.

Keith, this is Greg Toczydlowski from Personal Insurance.

On the annual policy, first of all I will take that one, there is a number of dynamics that we look at in the annual policy; some of them being agency selling behavior, retention, and pricing.

When we look at all those dynamics together we thought it was the appropriate time to drive that inside the business, and I think the margins and the growth are showing that.

That is clearly not the only feature that we have been throwing out there into the marketplace that has a positive impact, but when we look at all of them we feel good about having that in the product.

Let me make just an observation on that, that agency costs matter very much in the equation too.

Instead of dealing with obviously two renewals a year, you deal with one; not an insignificant difference.

On the direct initiative, we don't actually have a lot to say.

We continue on course with the plan that we set.

We said we were going to be investing and losing money and in fact we are.

On the positive side we are beginning to learn a fair amount about the customers that respond, what they find attractive in the value equation.

I will let you know, we are doing about 5,000 policies a month in our direct initiative now and so we are on our way to learning.

But make no mistake, we view it as a very long-term investment.

Okay.

And then, Jay, just to follow up on pricing.

I acknowledge your comment that you said the ROE has been very strong the last several years, but the charts show clear price deterioration.

Why the continued focus on growing in certain business lines here when clearly the accident year ROE is probably sub-10% at this point?

Thanks.

I think the second half of your question or the statement is actually just in error.

We look at a lot of data.

In fact, I am not sure anyone analyzes data any better or more robustly than we.

And I will tell you that even assuming current reinvestment rates now, current reinvestment rates now, the portfolio, meaning the combination of renewal and new, on our business insurance business is not in single digits.

It's actually better than that.

Now the dynamic is we are focused -- I thought my comments really were fairly specific about this -- we are focused on retention and I would say taking new business selectively.

No one should come to the conclusion that we are focused on growth.

There isn't anything in the comments or in the data that would give anyone, that should point anyone to the conclusion that we are focusing on growth as the words you use.

It is a very selective approach.

It is not only based on price but it's risk selection.

We spend most of the time on these calls speaking about rate.

Our folks in the field spend most of their time focused on risk selection.

So it's, as I said, a complex business where you are balancing elements.

I just couldn't be more pleased with how we are managing through this largely unprecedented environment.

Okay.

Thanks for clarifying.

Jay Cohen, Bank of America Merrill Lynch.

Thank you.

Two questions.

I will just ask them both and let you guys address them.

The first is, Brian, I think you had mentioned that your core combined ratio in Business Insurance has gotten worse and but it looks like it has gotten better.

And I am wondering what is driving that, that ex-development and ex-catastrophes.

And then secondly, maybe for Jay Fishman, when you think about your ROE are you making any adjustments for your own cost of equity capital given the changes in interest rates?

Presumably that has come down as well.

First on the combined ratio and I will throw it to Jay Benet for some of the specifics, but obviously every quarter there is stuff running through the combined.

We still see when we net out everything that we think is unusual a slight deterioration in what we would call the core combined ratio.

But, Jay, why don't you go through some of the changes.

Jay, in a period it's a period comparison.

We try to look at, as Brian said, what are the key core underlying trends of price and loss costs, but there are also things that will impact it -- small weather, non-cat weather in one quarter versus another, or year-to-date one year versus another.

We have talked in the past about large loss activity.

Last year we made a re-estimation of the full-year loss pick for business insurance in the fourth quarter.

We also did that in the third quarter but when you do that it impacts prior quarters of the current year.

So I think when you see the full-year results you will see more of what Brian is talking about.

If there are impacts associated with large loss activity and small weather, we will try to point that out as well.

That makes sense, thanks.

In terms the return on equity, it's actually an awfully simple story.

The return on equities that we publish in our press release and in our financials is straightforward GAAP return on equity, which is the earnings that we reported for the period divided by average equity for the period.

And Jay and Doug can take you through all of that.

We obviously understand that if our entire $70 billion investment portfolio were repriced today at today's reinvestment rates that we would end up with a different return.

We understand that.

Internally the analytics that we have we actually do look at it that way.

We actually do evaluate products and businesses and lines based upon investing cash flows at today's available rates.

It's those analytics that form the basis of our pricing strategy and our volume strategy and they are proprietary.

They are important, they are the subject of substantial discussion here, and it's that return that gives us our approach to whether we are aggressively growing, not aggressively growing, or willing to shrink.

Brian spoke today about letting the large end of Select shrink because the pricing was such and the risk selection is such that the returns simply aren't adequate to support the business so we are letting that shrink somewhat.

And certainly we understand, and one of the reasons that Jay presented the schedule that he did about investment income, is that if these investment markets continue, if they are what they are, and the underwriting environment never changes and there is no more favorable development, yes, we are not going to be able to achieve the mid-teens return on equity.

And we certainly understand that.

It's actually not all that difficult to model out the business and see what you think it is.

We certainly do it all the time and it can be achieved.

So it's all pretty simple.

The numbers that you get in the press release are GAAP, things that we are all accustomed to getting, and internally we have robust analytics that let us evaluate current underlying profitability based upon today's reinvestment rate.

And that is what establishes our underwriting energy or enthusiasm.

I appreciate that.

I guess my question really surrounded the hurdle rate, what you need.

In other words, if you are comparing your ROE versus your own cost of equity capital, if that cost of capital has come down shouldn't the hurdle rate come down as well naturally?

That actually gets to the comments that I made and it's just absolutely spot on.

There has, at least in my career, never been a period where the gap between the cost of debt and the cost of equity has been any wider than it is today.

I find it actually remarkable that there are high-quality equities where the dividend yield is actually higher than the debt yield on the 10-year debt, high-quality companies.

So it tells you that the marketplace is at the moment somewhat upside down.

And the real question that you are asking and I think it's an extraordinarily relevant one is, is that going to continue?

Can you possibly be in an environment where the two-year Treasury is at 2.4% and the cost of equity is at 10% or will there not be arbitrage activities that will take place that in one fashion or another will lower that gap, reduce that gap, into a more normal historical range?

We are extremely attentive to it.

One can speculate that one way the cost of equity will go down is a rising equity market.

Some folks have asked me, why do you think the market generally is rising now.

One of the answers to it is that it's reflecting a declining cost of equity.

It's somewhat counterintuitive to think of it that way, but frankly it's entirely possible.

So I don't know what the cost of equity will be in a few years.

My guess is that you have got a financial company three years from now in today's environment and you look back three years from now and the company has achieved a 10% cumulative return on equity you will feel great.

You won't feel good, you will feel great.

And if you look broadly at the financial services arena, and we do and I do, and you look at the returns that institutions are producing, particularly in the banking arena where the rules and regulations and leverage dynamics are changing so much, I think that the dynamic of what returns are going to be over the next few years is a fascinating question and what it is that investors are going to see.

But my comment was, for now, our goal is our goal.

We will do the best we can.

We are not going to act arbitrarily and go out to the marketplace and say -- the worst thing in the world to do is to go out to the marketplace and say we want five points of rate on every account.

You will get five points rate on accounts that need 10 and you will lose accounts that don't need any.

The easiest way to get adverse selection is to take away the underwriters' authority to evaluate risk and return on the individual trade.

So no mystery here.

We acknowledge the environment is not possible right now, not that you can't achieve mid-teens returns, but the two words 'over time' are just critical to us and that is how we think about it.

This as a long-term business and we manage it over time.

Great.

Thanks, Jay.

Brian Meredith, UBS.

Good morning.

Two questions here.

First one, I was hoping, Jay, if you could talk about the general administrative expenses in the business insurance unit; big, big drop this quarter.

Anything unusual going on there and then I have one follow-up?

I am going to sound like I am repeating myself a little bit from Jay Cohen's question, but as it relates to the expenses -- and, again, in any quarter you can have some things go up and some things go down.

I think last year we had some assessments that came through in the third quarter.

This year we had some credits that came through in the third quarter.

I think overall we have been very thoughtful in trying to manage our expenses and keep the expense ratio in line.

Those are the kinds of things that have created the period-to-period variability, but there is nothing in particular from an operational standpoint that is driving it.

We do have differences in timing of things like advertising costs and travel that go through, so I can't think of anything in particular that I would point to that says this is a fundamental change.

Is there like an underlying kind of rate that we can think about?

Are expenses kind of flat; are they down a little bit?

Just trying to kind of think about it going forward.

I don't want to necessarily drop expenses by 10% a quarter here going forward.

I would say relatively flat, particularly if you look at it on an expense ratio basis.

Okay, terrific.

Then the second question for Brian.

Loss cost inflation in the commercial lines area; we have heard a little bit this quarter about some tick up in some loss costs inflation from some other companies.

I am wondering what you are seeing.

So splitting it into two pieces, frequency for us has been very flat.

Granted, that is compared to last year and the year before where we were having some significant declines in frequency in some of our businesses.

So the declines have leveled off but we are still pretty pleased with where they are leveling off at.

The core loss inflation or severity component of it is pretty benign.

It's not a zero; it's a plus number but it's a mid to low single digits plus number.

So overall loss inflation continues to be in a pretty good place for us.

Okay, thank you.

Cliff Gallant, KBW.

Good morning.

Two questions; the first pretty simple.

There was recent news about Chinese drywall in a settlement that looked like State Farm was reaching.

I was wondering if you had any comment on or an update on your view of Chinese drywall.

And then second, I was wondering if you would care to speculate on a larger basis what you think the industry accident year combined ratios or I should say the industry accident year ROEs look like in comparison to what you are reporting.

We have enough trouble keeping track of our own.

We are one to pass on trying to estimate what the industry is.

Good morning.

This is Doreen Spadorcia and I will take your Chinese drywall question.

Bottom line, we haven't seen anything that would cause us to change our view that we talked about previously; I think we showed you a slide in the first quarter.

We just don't think it creates a significant exposure to us.

Basically, what has changed since the first quarter is we have probably got a few more insureds that have made claims against us and then on the positive side we actually had a ruling in the District Court in Virginia finding that our homeowners policy does not provide coverage for Chinese drywall.

The State Farm settlement there have been some multi-district issues.

There are two cases pending that have a lot of class action plaintiffs as well as a number of defendants and some companies that have had large homeowner populations have chosen to participate with some of those settlements where you have seen some of the Chinese drywall manufacturers and some distributors putting in some dollars.

But for us we have not participated in those given where our exposure is and the positive ruling that we received.

Okay, thank you.

Matthew Heimermann, JPMorgan.

Good morning, everybody.

Two questions.

First, could you give us a little bit more color on the BI account growth slide you showed?

I guess I would be curious, one, whether or not there is a dramatic difference in account size for the growth -- for the new accounts versus maybe the existing book if you go back to year-end 2008?

And also, just given what we have seen in premium could you maybe just discuss how the exposure trends at those new accounts maybe contrast with exposure change on the existing book?

And then I will have a follow-up.

For starters, on the mix dynamic within the account growth, we tried to break out the small commercial from the middle market.

Obviously in small commercial we are absolutely growing it from a mix perspective in the smaller [ex] so that is driving some of the dynamic of the total.

But within that the express component of small commercial, which would have a fairly consistent account size, is growing dramatically so we feel good about that.

Importantly, just so that people know the terms, Select Express is the technology platform that we introduced now, I don't know, maybe three years ago that has really dramatically changed the way the smallest end of our small commercial business is processed.

I discussed this before but the predecessor platform was 20% underwritten in the technology, 80% was referred out to underwriters for review.

This is a very slow approach to the smallest end of the business.

80% now is done in the technology and only 20% comes out for human intervention, so it is dramatically different.

That forms the basis of the flow, the significant increase in quote activity that we have seen from agents.

We are just being quoted a whole lot more with this platform because it's easier and more efficient, and as a result that business is growing significantly.

It is the smallest end of the small commercial business.

And I think, Matt, and you can correct me if I am wrong, the gist of your question is are we getting the growth just because we are shifting mix or do we think we are actually growing like type of accounts.

And the answer is there is a piece of it that is mix, but the bulk of it is we are growing like type of accounts.

And in the middle businesses the average account size of what we are bringing in here was fairly consistent with our renewal book of business.

The difference between the account growth is basically the exposure, the audit premium and the renewal exposure change year over -- not increasing year-over-year.

And help me a little bit with the second half of what you were asking?

You got to it with the last comment so that is helpful.

The other question I had was -- I needed to follow up on Brian -- actually may I will ask a different one.

On the direct side, I guess are you at a -- you used the word, I think you used the word experiment, Jay, but it looks like the premium volume is starting to decelerate sequentially, kind of low to mid $20 million on a quarterly basis.

Would expect that to grow I would assume.

But I guess are you proactively kind of trying to restrain the growth in that channel till you ensure, you kind of understand the dynamics, or are you now at a point where growth will be what it will be?

You kind of have a more clear view of the appetite and some of the variables that you want to pay attention to.

I will give you my perspective and I will ask Greg to chime in as well.

It's sure closer to the former than the latter.

We are actually -- I wouldn't say constraining; that is not quite the word.

But what we are doing is we really only doing that amount of business that we need to do to continue to advance the learnings.

And the learnings are how do we get a customer to respond to an ad, how do we get that customer, either through our call center or our technology platform, to actually end up with a quote, how do we convert that quote to a sale, and then most importantly who are we bringing in and what is the loss experience?

What we have said, the pricing track we are using for direct is the same pricing track we use at our agency [plant].

It is our presumption that the loss experience between those two groups will be different.

That the act of where one purchases is an identifying characteristic, a projecting characteristic of loss experience.

So we are just trying to do enough to keep the learnings moving ahead.

We are not remotely at the level now where it's go invest in advertising dramatically and whatever we can do, we can do.

But add please.

I would just echo Jay's comments.

We spend a lot of time watching the economics and the operational expectations of the business, and they are both right within the targets of where we want to be.

As Jay said, the function of the top line is how we advertise, how we entertain ourselves out in the digital space.

Clearly that is the amount of investment that we put in this.

I think it's a fair assumption that if you look at the last three quarter's run rate that is a fair assumption of what we could expect for this business to continue running at 12 months going forward.

And as Jay said, we are really trying to really maximize our learnings with minimizing the investments inside this business.

As we get more of those learnings we will continue to grow the business, so very cautious in how we are doing it.

Wouldn't characterize it, by the way, as an experiment.

The implication of that is is that -- we are committed to making this work.

It will take years, it will take years, for us to the get to the point where it gets to break even or, frankly, becomes profitable, but we are committed to getting there.

What we are doing is to Greg's exact point is balancing the cost of investment with the value of the learnings that come out of it.

Okay, that is fair.

That was my poor word choice.

I guess based on your last comment then it isn't fair to kind of think about quantum as a parallel in terms of -- because I think there was about a 24-month period of kind of rolling that out and to the point where you were kind of fully comfortable just letting it run.

So it sounds like would be much longer.

Okay.

All right, thanks.

No, no.

This is going to be much longer.

Yes, this is going to be much longer than that, yes.

Jay Gelb, Barclays Capital.

I want to ask a broader picture question on the situation with the bank dislocation with regard to mortgage servicing.

Could you talk about how or what the implications might be from the insurance side on that from a directors and officers and errors and omissions perspective, as well as what the implications could be for Travelers investment portfolio?

Thanks.

Jay, it's Alan Schnitzer; let me take the first piece of that related to the insurance business.

It's early days and when I say early days I mean in the context that we are still learning about the facts and circumstances and so it's hard to really come up with a definitive insurance exposure perspective in that environment.

But having said that, we have taken a look at our exposure to the top 15 mortgages servicers and our exposure is really very, very limited there.

That is in some respects a fallout of the credit crisis underwriting we have been doing going back to the first and second quarter of 2007.

So all of the big names that you and we have been reading about in the news we have very, very limited exposure there.

We don't view it as an exposure really to the community banks and we think that is because they just haven't been foreclosing in the kinds of volumes that would have involved the processes that are really in question here.

And we haven't seen any indication that that is the case.

So, at least early days from an insurance perspective, we are not viewing it as an outsized issue for us.

On the investment side, just first a couple of facts.

First, our entire portfolio of subprime and Alt-A ABSes are actually $300 million, and $200 million of that was 2004 and prior, and we have added $100 million selectively since the crisis began, so not a significant investment there, still all very highly rated.

On the residential CMO side, we have $2.3 billion of that, again, virtually all 2004 and prior.

We turned away from the market as both the mortgage market and the real estate market really heated up.

$862 million of it is agency and $1.4 billion is non-agency.

The facts and circumstances of this, of what actually is happening and the implications, are as confusing as I have ever seen it and it is not at all clear what the long-term issue really is.

If we are talking about episodic relatively short-term delays in foreclosure activity, our assessment is no problem with respect to the investments.

And we have already seen some of that episodic short-term delay.

At the other extreme is the notion of a long-term industry wide broad-based foreclosure moratorium.

We don't know how to assess that.

I don't know how to assess something that actually has never happened before.

And frankly, I think of all of the issues that will occur the impact on asset-backed securities may actually be the smallest in that kind of an environment.

So I don't know how to size up that kind of long-term broad-based moratorium.

Again, the episodic short-term stuff, we could be wrong on this, but our assessment is no underlying problem.

With respect to the flip side of the issue which is the ability to put mortgages back to the originating institutions, of course, the GSEs have always had that.

There is nothing particularly new on that front.

And again, we could be wrong on this, but our assessment has been that it is hard for us to figure out a scenario where mortgages get put back to their originating institution and the bondholders lose.

The originating institutions seems to me could be in a position to lose, but we have some difficulty figuring out the scenario where the bondholder loses.

But early days on this would even be an understatement.

It is right at the beginning.

Bill?

I wouldn't add much.

You obviously read the story about PIMCO and The Federal Reserve Bank of New York sending a letter to Bank of America with a list of 158 pools where they would like to see mortgages put back.

We looked at that list, by the way, and found we own three of them.

We think -- I think there are three crosscurrents.

One, the validity of foreclosures which have taken place.

Two, the ability on a perspective basis to foreclose.

Of course, they are beginning to get more particular in terms of what they demand and that is probably good.

And three, the whole put back phenomenon.

And they would cut differently across the portfolio.

My guess is the probability of any of the three having a significant impact to us or anyone else might be more remote than the newspapers are suggesting and whatever happens is going to happen over time.

To the extent that there is a put back phenomenon we would benefit.

It's easier for GSEs to put back mortgages than non-agency pools because all the GSEs have to do is prove they weren't conforming.

So we would be beneficiaries but we are not counting on much.

Thanks.

That was very comprehensive.

Just to circle back to the property casualty exposure.

Is there a stand-alone mortgage servicing E&O type of coverage that would be meant to respond to that or is that all lumped into the broader bank D&O and E&O programs if there is availability for that these days?

When we think about our exposure it's way heavily weighted toward the D&O and E&O side and, again, underweight on the larger institutions.

There is coverage that I think is available in the market; we just don't write a lot of it.

All right.

Thank you.

Vinay Misquith, Credit Suisse.

Hi, good morning.

On the personal auto side could you provide some color on your PIF growth in the agency channel?

Some have opined that the direct way is the way to go and you seem to be growing in that channel pretty well.

I will take that.

This is Greg Toczydlowski again.

We have been focused very much on a couple of areas.

One that we talked about earlier is some of the features in the automobile and, two, is some of our geographic expansion.

We have seen an under penetration in the Midwest and the West and we have been appointing agents out there are over the past few years.

Based on those two really it has been driving some of the sequential PIF growth that we have inside the book of business.

Okay, that is great.

The second question is on pricing in the Business Insurance.

It appears that you are happier to take maybe pricing down just a tad just to keep your business and to grow a little.

Just wanted your perspective on the risk to that strategy.

We are at all-time historical lows in terms of frequencies.

Do you think that this is the right time to maybe to grow your business?

Well, I will let Brian step in but I want to start off with the premise that tactical and strategic imperative number one, two, and three is retention.

And, again, somehow the conversation always seems to kind of kind of drive to growth, but we start out with a focus that the book of business that we have is the book of business that we understand, that is priced appropriately, that is of the highest return.

And so we approach our retention book in a very, very thoughtful kind of way.

The growth dynamic that you are seeing here in the charts, the account growth, I have got to go back and talk to the fact that one is being driven by Select Express, which is a technology platform that lowers costs, lowers agent's costs, lowers our costs significantly.

And so it has been a platform-based dynamic of growth; not price-based, a platform-based dynamic of growth.

Bill Cunningham, in his middle market business, it has really been about new product development and rollout.

We have provided lots of information about that previously, not a price-driven strategy.

Again, the data -- it's so clear that it supports this.

You are looking at retention that is at historical highs and renewal pricing that is more or less at flat, a little below or flat.

And so our focus is not -- and it does seem to get confused to some folks -- is not to cut price to aggressively grow our book.

It's to use our competitive advantages where they exist, like Express, like the new product development in middle market, that allows us to -- the geography that Greg spoke about where there are ways to grow your business without being pricing competitive to do it.

And then the other dynamic within pricing.

You use the right words.

I mean if you look at any of our Business Insurance statistics that are in the package the negative price we are talking about is somewhere around a negative one.

And we have talked about this a lot in the past and Jay touched on it, it's the spread across the portfolio that really matters there.

If we were getting minus one on each and every account that is one strategy.

We have got accounts in here where we are getting plus 10s and we have got accounts that are certainly getting minus 10s.

It's blending to something pretty close to neutral.

We feel good about the profitability of our book and we wake up every morning wanting to retain most of those accounts.

So I think to characterize our strategy as taking down prices to grow in our minds is not consistent with how we think about it.

I want to take the opportunity to clarify something because I am quite certain Gabi will get 10 calls before the end of the day on this, and it gets back to the analytics that I was speaking about before that evaluates returns on an investment return basis today.

Let me be a little more specific.

So we are talking about allocated capital.

Each of our products, each of our businesses, based upon the duration and the volatility our actuaries assign an amount of capital to.

The embedded return that we calculate for the portfolio assumes that the premium dollars come in at new investment rates, but that the capital, because the capital sits and just continues to roll, has a much longer duration.

So the capital that supports it is somewhat more reflective of the historical capital embedded in the portfolio.

So premiums come in entirely at new money rates.

Again, this is analytics that we use; the capital, based upon allocated capital to that product, reflecting more of the historical duration kind of -- because again it sits and supports the business.

As one piece of business rolls off a new piece of business comes on, the capital has a different duration than the new premium base.

And if you look at the business insurance segment in the aggregate, as we did just yesterday in making sure that we could answer this question, the policy view, the return that we see in the business that we are writing today, is very low double digits.

That is where it falls.

I don't want to get more specific than that because obviously it's reflecting of our pricing strategy.

But it wouldn't take much to move it into high single digits, but it's very low double digits.

Okay, that is great.

Thank you.

Greg Locraft, Morgan Stanley.

Good morning.

Wanted to follow up on the holding company liquidity and get an update.

I can't get the math to reconcile.

I am looking at the end of the second quarter.

I added net investment -- I am sorry, net income, took out share repo and dividends, and it looks like liquidity was almost a couple hundred million higher.

Could you help reconcile the math there?

Was there a dividend in the quarter perhaps?

Well, let's see.

At the beginning of the quarter for holding company liquidity we had about $2.4 billion.

The way, the mechanics of this thing are taking dividends out of the operating companies and bringing them up to the holding company.

I mean there are other things that impact it, like stock options and equity awards; that is a relatively small number.

Taxes come into play.

There is going on the other way interest on the corporate debt, shareholder dividends, stock repurchases themselves.

Any pension plan funding we do so those are the components of it.

I am not sure you can really have full visibility for all those components.

But what ends up happening is that the $2.4 billion grows to $2.8 billion.

The two major drivers of that are the size of the dividends coming up from the operating companies versus the amount of share repurchases that go out.

Okay.

But there was no special dividend, like -- if I recall, in the first quarter did you take a special dividend up and there was nothing in the quarter?

No, we had a dividend in the quarter.

Let me clarify what is going on with the dividends.

I think in our 10-K at the beginning of the year, of course, we had indicated that we could take dividends up without special authorization of something around $3.5 billion is my recollection.

Somebody is going to look that up for me.

But we also said during the first or second quarter, I am not sure which one, was that based on the capital positions of the operating companies, which had gotten very robust, we were actually going to go to our regulators and say that we wanted to take capital out of the operating companies at a higher level than that would have indicated and get their authority to do that, which we did.

We did that in the first quarter.

When you do that it also changes the dynamics going forward of what constitutes a normal dividend versus what constitutes a special dividend.

So in each of the quarters we have gone to our regulators and said we would like to take X out and in each of the quarters we have been given permission to do that.

But it's all in conjunction with a strategy, as Jay has talked about, of always right-sizing the capital to place.

And you have heard me say before that we manage to a certain level of capital in the operating companies to support the AA ratings and that is all we are doing.

So our regulators understand that, the rating agencies understand it, and it's just what is flowing through right now.

Okay.

So I guess, just to be clear then, so when we take your end of period holding company liquidity and we -- all we get is kind of what net income is and then we know what you are buying back and we know what your dividending to shareholders.

What you are saying is there is an amount that you guys are going to the regulators intraquarter and requesting to take up from the subsidiaries?

And that doesn't necessarily correlate one to one with net income?

That is correct.

That is correct.

We take monies out of the operating companies each quarter because we are making money in the operating companies each quarter.

If you look, you take a big picture view of what we have been saying for the year, our guidance is for share repurchases of $4.5 billion to $5 billion.

You look at what our year-to-date net income is and that certainly doesn't equate to a picture for the year of $4.5 billion to $5 billion.

So those two numbers alone are showing that we are taking capital out of the place.

Okay.

So I guess to push one more level on that then is so therefore the payout can sustainably be ahead of net income for the foreseeable future?

You get to a point where you have taken out the excess capital.

So you eventually get to a steady state where the payout is going to be based upon what is your net income, what are your capital needs in the company, and what are your various targets for holding company liquidity and debt and everything else.

So eventually you do get to a steady state.

Greg, we had talked previously and you all know that we are going to stop the practice of giving guidance when we get to next year, but one of the things I think that we probably do have to provide some continuing visibility on is our projected share repurchases.

Because to exactly your point, you really can't independently make an assessment of what our capital position is and what is available.

So my guess is that when we get to the fourth quarter and we have got our plans and budgets all squared away for next year, notwithstanding that we are really not going to speak to EPS, but we will give you a robust understanding of what our capital management plans are.

Okay, great.

That is helpful, thanks.

The other one on capital management is just the dividend policy.

Could you just remind us how you set that?

Because the dollars allocated to dividends obviously have been flat for a while the share count has gone down.

So just how do you think about that going forward or how have you thought about it historically?

Whatever you are comfortable on.

We take a look at what the dividend yields are for comparable companies in the property casualty space.

We look at payout ratios.

We recognize that we are in a business where the wind blows and the earth shakes so we take that into account in the past.

What we have been fortunate enough to be able to do over the last couple of years is look at, well, we have a very solid earnings stream.

We have paid out roughly $700 million, if you look at the dollar amounts, in each one of the years.

You are absolutely right; our share count has gone down as a result of the repurchases.

So we have been increasing the dividend to bring the dollar pay out roughly back up to the same level, which has basically kept the payout ratio and the yields very competitive.

Okay.

Totally shifting gears from capital management, can you comment at all on the workers' comp pricing environment?

We are hearing stuff out of Florida and others.

What are you seeing at the margin there?

Sure, this is Brian.

If you look at our numbers you will see that we have been growing our workers' comp business and actually we have been growing it for about 10 years.

We have been growing it fairly gradually.

In the aggregate, for our book, we feel very good and while the economy has clearly impacted the exposures -- payroll changes in some places have been dramatic -- we have been adding accounts and seeing some moderate growth in the line.

The bottom line is comp, maybe more than any other product we do, is a state-by-state, industry-by-industry, account size by account size kind of dynamic.

So we look at a very granular level and really believe it's the classic risk selection gain and feel good about it.

One thing I would comment on, and maybe I will throw it to Bill Cunningham, is the AM Best data on comp got a good bit of play.

That is just a slice of the industry and you need to understand what it is that is looking at.

Right, the AM Best study that Brian is referencing was a composite of the state fund business and the mono line workers' comp market business.

As you look at that, many of those state funds are markets of last resort.

Obviously, as we talk about selection and the things that we have in place, selection is not possible when it's the market of last resort and the pricing is not always appropriate.

So as we look at the profile of our book and our results are much different than that.

Yes.

So, Greg, we would agree that there are certain states and certain industries where we would be very concerned with comp and be pulling back, but in the aggregate we feel good about our book.

Okay.

Are rates at the margin -- is pricing going up or down for that line?

Again, it's a state-by-state, and for competitive reasons are going to get into state specific, so I would tell you on an overall basis our workers' comp pricing has been fairly consistent with the approach we have been taking over the last few quarters.

We have not seen a dramatic change.

No shift, okay, okay.

Last one for me on direct --

What is it Greg?

Just on direct auto, just because there is a lot of money that is being spent in that direction.

Just so I understand your pricing that business the same to both agents as you are to the direct customer so there is no benefit for going direct to the Travelers at this point to the customer?

Relative -- yes, relative to the agent.

They get the same price whether they go to the agent or they come direct.

It's the only pricing track we have.

We don't have one with any -- we have no experience in the direct channel so we don't have any ability to create a pricing track yet based on experience.

Okay, okay.

I will follow up with that more off-line.

Thanks, guys.

We have time for one more questioner.

John Hall, Wells Fargo Securities.

Great, thanks very much.

I will have only two questions; I will give them straight up.

The first one has to do with whether you are utilizing any enhanced commission structure as you go after any new business, whether that is part of your program on the commercial line side.

And the second one has to do with the comment that Brian made.

You talked about the economy, or if and when the economy improving, it having a very positive effect on exposure and potentially premium trends.

I was wondering if that notion is factoring into your retention strategy and how so.

First, on the commission side nothing unusual.

We pay base commissions and we pay supplemental --

We don't have any -- I am asking -- we don't have any specials on with respect to growing or anything else?

What we are doing now is not a change from what we (multiple speakers).

Change from what we have been doing.

Our fundamental programs there over the last several years have remained very constant, both in structure and in amount.

We will obviously, through predominantly our fixed value based commission, differentiate one producer, one agency versus another.

Those that grow more will have a higher fixed value based supplement than others.

But there is nothing, no special on with respect to growing this month or anything like that.

Right.

Okay.

So you are not utilizing any of the platform savings that you talked about in that direction?

In small commercial, I don't think we changed the commission structure with Express, did we, when we put it out?

We did for a little, maybe years ago but not currently.

Yes, no is the answer.

No, no.

Okay, great.

And the second question was --?

On the economy and retention.

You know, it has been an interesting phenomenon that we speak about a lot and we have talked about it for literally years that the renewal market has had a remarkable stability to it that actually is consistent with those of us who were in the business in the '90s experience then.

There is a robust competitive environment for new business, but yet the renewal book seems to be -- and this is universal, by the way.

It's not just us.

You can look at any carrier, any quality carrier, you speak to agents, you speak to brokers, they will all comment -- all; the ones we speak to -- will observe that the renewal market has a remarkable stability.

Customers are just happy; most customers are happy just staying where they are.

In effect, as long as the premium doesn't go up they are happy with the broker, they are happy with the carrier (technical difficulty) experience good.

And the business just is there.

Yes.

And on the exposure change, if your comment is getting at is there anything -- let me answer it directly.

There is nothing explicitly in how we are evaluating business or pricing business that contemplates a growth in exposure and therefore a different profitability dynamic on the account going forward.

Obviously, we think about in these -- we are hopeful in these conditions that if you have got accounts and you feel comfortable with them today, as the economy expands they are going to get bigger and that will be a better thing.

But we are not building it into the economics of how we are viewing the trade.

And the notion in today's environment, I am sure like most of your employers, the ability, willingness of your employers to take on added costs that aren't justified with underlying activity is a substantive issue for every business.

And it's a substantive issue for our customers.

It's not particularly easy nor well received to go to a customer that is getting through a challenging economic environment and suggest that we just raise the price for insurance.

So our retention strategy is molded by the environment we are in, by the economic environment that we are in and a realization that there are real live customers on the other side of the transaction.

You have got to be responsive to the overall economic environment and manage the business for the long term, and that really defines the approach.

Great.

That answers the question.

Thank you.

Ms.

Nawi, I will now turn the call back to you.

Great.

Well, thank you all for listening.

If you have any follow-up questions, please contact myself or Andy Hersom in the Investor Relations department.

Thank you very much and have a good day.

Ladies and gentlemen, that does conclude the conference call for today.

We thank you for your participation and ask that you please disconnect your lines.

Have a great day, everybody.