The Hanover Insurance Group, Inc.
Q3 2009 Earnings Call Transcript

Published: 4 Nov 2009

[Operator:]

Hello, and welcome to The Hanover Insurance Group 2009 third quarter earnings conference call. All participants will be in listen-only mode for this event. (Operator Instructions). After today’s presentation there will be an opportunity to ask questions. (Operator Instructions). Please note this event is being recorded. I would now like to turn the call over to Bob Myron, Senior Vice President, Finance. Please go ahead, sir.

[Robert P. Myron:]

Thank you operator. Good morning and thank you for joining us for our third quarter conference call. Participating in today’s call are Fred Eppinger, our President and Chief Executive Officer, Marita Zuraitis, President of our Property & Casualty Companies and Gene Bullis, our Executive Vice President and CFO. Before I turn the call over to Fred for a discussion of our results, let me note that our earnings press release statistical supplement and a complete slide presentation for today’s call are available at, in the Investor’s section of our website at www.hanover.com. After the presentation we will answer questions in the Q&A session. Our prepared remarks and responses to your questions today, other than statements of historical fact, include forward-looking statements. These include statements regarding expectations of segment earnings, pricing, accident year results, premiums, expenses, development of loss and LAE reserves, returns on equity and other projections for 2009. There are certain factors that could cause actual results to differ materially from those anticipated by this press release, slide presentation and conference call. We caution you with respect to reliance on forward-looking statements and in this respect refer you to the forward-looking statement section in our press release, Slide 2 of the presentation deck, in our filings with the SEC. Today’s discussion will also reference certain non-GAAP financial measures, such as total segment income, segment results excluding the impact of catastrophes, ex-CAT loss ratios, book value excluding accumulated other comprehensive income and accident year loss ratios among others. A reconciliation of these non-GAAP financial measures to the closest GAAP measure on a historical basis can be found in the press release or the statistical supplement, which are posted on our website as I mentioned earlier. With those comments, I will turn the call over to Fred.

[Frederick H. Eppinger Jr.:]

Good morning everyone, and thank you for joining us. As usual I will take a few minutes to talk briefly about our results. I’ll review some of the initiatives we have underway and put our third quarter results in our competitive position to context. Marita and Gene will provide additional insight into our performance and trends in our business. With respect to our earnings in the quarter the fundamentals of our core business remain very strong. In addition, all our strategic initiatives have good traction, which makes us very positive about the current mix of our overall book of business. The growing partnership with winning agents in our expanding product offerings. Our business momentum and our financial strength position us very well to the continued disruption we see in the marketplace. We also feel very good about the strength of our investment portfolio, our capital and liquidity position and a resulting flexibility it gives us with respect to the capital actions that we are taking to drive shareholder value. With respect to the results for the quarter as noted on Slide 4, we generated net income of approximately $50 million or $0.97 per share for the quarter compared to a net loss of about $62 million or $1.21 per share in the third quarter of last year. We generated segment income of approximately 45 million or $0.89 per share compared to about $3 million or $0.07 per share quarter-over-quarter. Putting catastrophes aside our combined ratio was approximately two points higher than the prior year quarter, driven by higher than expected accident year losses and higher expenses. On a law side, earnings for the quarter were impacted by continuing weather related losses, the impact of the economy and the state of the insurance margin. In particular in Personal Lines, the largest driver of our performance shortfall was above historical average losses for non-CAT weather. While this trend has put pressure on our short-term earnings, it has made significant rate increases much more achievable particularly in many of our markets that are dominated by regional competitors. In Commercial Lines, we had higher than expected losses in some lines that were driven by increased loss incident, as well as more cautious approach towards setting our [last year lost things]. We think this is a prudent approach given where we are in the market cycle as well as in the state of the economy and its potential impact on industry lost revenue. We don’t expect this to have a long-term impact on our results, because the improving quality and mix of our business and the rate increases we are now achieving. On the expense side earnings were impacted by ongoing investments we are making in product, distribution and infrastructure principally in commercial lines as well as increased pension related expenses across our business. Our top line perspective we continue to be pleased with the growth trend and the progress we are making in our overall book of business. We are maintaining a disciplined underwriting approach both in terms of pricing and terms and conditions. Net written premium growth for personal and commercial lines combine with 5.7% for the quarter and 3.2% year-to-date. The growth we are achieving is the result of the positive actions we are taking and the momentum we have established in many areas of our business. In personal lines we continue to [thoughtfully] improve our product offering and at the same time improve our mix, writing an increasing amount of attractive account business. In fact as of September 30, 2009 over two thirds of our business is now in account. We continue to manage our core states for margin while growing in states targeted for growth. While overall, our net written premium in Personal Lines was flat for the quarter we grew 6.2% in the growth today. We have strengthened our field teams in these states over the past 18 months and we are working hard to develop and build on partnerships with the best winning agents in these states, in order to continue the positive momentum we have already established. In Personal Lines, our overall rates were 4.4% above the prior year and based on filed and approved rates, we expect this trend to pricing to increase in the fourth quarter and into 2010. We believe these increases will keep us ahead of loss cost deflation also take into account the on going trend of rising weather related losses. All with a view toward increase profitability in future period. In commercial lines we achieved 15% growth, driven by our more specialized businesses such as Niches, Professional Liability, Marine And AIX as well as our increased segmentation of our core commercial offerings. We also continue to expand our specialty offerings with a long-term view toward improving our overall mix in margin of our commercial lines business. Our outlook for all our strategic investment in specialty, each period is very bullish for the remainder of 2009 and 2010. Separately we continue to push ahead with our launch into the western part of the country, leading with middle-market niches and industry segment along with a full breadth of our specialty offerings all of which we feel aline well with business opportunities in the region. Obviously, a significant portion of the agents we consider winning agents resided in this part of the country as well as over 30% of the specialty niche businesses we target. Ultimately this expansion will improve our geographic diversification, leverage our product investments and build on our partnership strategy. We're ready, we have a significant transparency to attract this new business opportunities with our selected partner agents and expect to see some meaningful impact on our 2010 results. Though our westward expansion as well as generally across all our commercial lines platform we are bringing on highly talented individuals as well as tees of people that we feel strongly will help us continue to drive growth in our commercial lines business We have never been in an better position to acquire terrific talent in our business. While we're excited about the profitable growth and improvements in our mix of business, we expect from the investments we are making, we are also keenly aware of the pressure these investments placed on our expense ratio. However, they represent a critical component of our long-term strategy and enable us to capitalize in the opportunities we see in the marketplace. While expense ratio for the year will be at the high end of our previously issued guidance, we are pleased with the progress that is being made on all our strategic investments and confident that we are on track, over the next five quarters to meet our investment hurdles and achieve the ROE improvement discussed during our Investor Day. In terms of our core commercial lines pricing, we continue to have pricing increases on our small commercial and middle-market businesses in the low single digit. Moving on to our balance sheet and capital, we consider prudent management of our investment portfolio and our capital to be core tenants of our operating strategy. In particular capital management is an important level to increase shareholder returns. With capital market continuing to normalize and our capital position continuing to strengthen we made several important capital management decisions during the quarter. First, we successfully completed the process of restructuring a portion of our debt through driving a $125 million 20 year loan from the Federal Home Loan Bank of Boston at a cost of 5.5%. This served to lower our overall cost of capital and decreased our interest expense on a pro-tax basis by approximately $2 million per year. Second, we continue to buyback stock during the quarter, in October at prices below our book value, which is immediately accretive to book value and earnings per share. Third, we increased our existing share buyback authorization by a $100 million and expect to continue to opportunistically utilize the program. And lastly we increased our annual dividend by 67%, the $0.75 of the share and announced our intentions to move to a quarterly dividend in 2010. All of these items represent tangible steps to increase shareholder returns and the buybacks and increased dividend demonstrate confidence we have in our company’s overall financial condition and our ability to generate strong profitable growth going forward. As shown on slide four, our book value per share increased by 10% in the quarter and 30% for the year-to-date driven by increases in the value of our investment portfolio, as well as in our operating earnings. At $48.6 per share, our book value per share is now the highest it has been in any point in the company’s history. In summary, we produce solid results in a very difficult economic and marketing environment and while we anticipate from negative trends to persists through the end of the year and into 2010, we are very optimistic about our company’s ability to manage through it and create significant shareholder value. Although the insurance cycle has not fully turned, I’m pleased with our ability to achieve price increases in both personal and commercial lines. And I’m very pleased with the quality in the mix of our new business coming from our new product investment. Our ex-CAT combined ratio of 93.7% is very solid compared to many of our regional competitors, but it does not meet our expectation. However, given mix improvements, our pricing action increased expense leverage we are confident that we will see meaningful improvement in 2010. Without question in the past year has been characterized by more change and challenge than I have seen at any time in our business, but with disruption comes real opportunity. I’m very pleased with the way our company has performed over the course of the year and I’m more confident than ever, that we are positioned to capitalize in the opportunities that we look forward over the next several quarters. With that I will turn the call over to Marita to review our business.

[Marita Zuraitis:]

Thanks, Fred. Good morning everyone and thanks for joining us today. Fred gave you a broad overview of our operations and I’ll review our business specific trends. Starting with the discussion of our overall P&C results on slide 7. Our third quarter produced $74 million of pretax segment income compared to $14 million in the prior year quarter. Segment earnings were up from last year primarily driven by lower catastrophe activity excluding CATs the combined ratio in the current quarter was 93.7% compared to 92% in the prior year quarter. This moderate margin compression is reflective of a number of factors, including increases in expenses, driven by an investments in our operating model and our product breadth and higher losses in some business lines driven by weather and economic conditions. Net written premiums were $689 million in the quarter, this represents a 5.7% increase over the third quarter of 2008. Our more specialized businesses such as niches, professional lines, marine and AIX as well as increased segmentation of our core commercial offerings, fuels our year-over-year premium growth. I’d like to discuss the drivers underlying these results in more detail starting with personal lines. Turning to slide eight, our Personal Lines segment reported pretax earnings of $27 million in the current quarter compared to $18 million in the prior year quarter. Earnings in the current quarter were impacted by lower CAT losses, higher underwriting expenses and higher ex-CAT accident year losses in our homeowners line, which was primarily weather related. At our second quarter earnings call we shared with you plans to accelerate some technology product in ease of doing business investments in our personal lines in the third and fourth quarters of 2009. We can now see these expenses running through our numbers in the current quarter. These initiatives gathered under the umbrella of Think Hanover campaign leverage and emphasize our total account product suite allowing us to support our growth initiative in our newer states and to more effectively preserve margin and market share in our core states. We expect these higher expenses to continue in the fourth quarter, but starting in 2010 our cash spending on these projects will decrease significantly. As we’ve discussed in the past expenses in the current quarter were also impacted by increased pension cost compared to the prior year, and finally the year-over-year expense comparison also was affected by a reduction of variable compensation expenses made in the third quarter of 2008, which was related to the first three quarters of 2008. The variable compensation reduction was a consequence of decreased profitability in 2008 due to heavy CAT losses in the third quarter. Fire ex-cat accident year losses in personal lines were driven by ongoing higher than usual weather related losses in our homeowners line, while weather had a more limited effect on profitability in this quarter compared to the first and second quarters of this year, the fact that the trend is continuing mix of an ongoing area of focus and a main driver of continuing rate increases in our homeowners line. Overall, the combination of increased rate to address these weather related losses along with our prudent risk appetite and underwriting practices makes us comfortable with the expected profitability of this business. Our business mix also continues to improve, driven by successful initiatives implemented last year to write more account business, to move away from higher risk drivers and to carefully manage our costal property exposures. Turning to slide nine, to discuss our personal lines growth for the quarter. Net written premiums decreased two tens of a point compared to the prior year quarter. Our growth strategies in personal lines as well as our top line results remain similar to prior year quarter trends. We are striving to preserve our market share and margins in Michigan, Massachusetts, New York and New Jersey, while increasing exposure in states targeted for growth. Written premiums decreased 2% in our big four states combined in the quarter. With respect to states targeted for growth however, net written premium increased 6% and PIF grew 5% with impressive momentum in states like Ohio, Illinois and Wisconsin. Overall, we continue to grow personal lines business that’s associated with the lower risk profile and higher retention. We attribute our retention improvement in personal lines to successful past mixed management actions in homeowners and in connections auto and our focus on riding more multi-car and multi-account business that’s consistent with our strategy. As I just mentioned the investments that we’re making in our Think Hanover, our intend to make writing account business more convenient and beneficial to our agents. As Fred mentioned 66% of the new business we write in personal lines is now coming from full accounts, which means we underwrite the customer’s home, auto and other lines. The portion of our account business has grown 4% since the end of 2008 and 9% since the end of 2007. As a result of this full account strategy, our PIF counts and homeowners business grew 5% in the quarter primarily coming from our newer growth state like Ohio and Wisconsin. In personal lines overall we continue to see sequential and year-over-year improvement in the growth of policy accounts, which comes from states targeted for growth. We expect to sustain this upward momentum going forward as we anticipate better retention of this business due to our improved profile. At the same time we remain disappoint in our approach to pricing, pushing enough rate to get ahead of loss cost inflation as well as pricing our homeowners line to address the higher weather. Our auto rates increased 4% in the quarter, while homeowners rates were up 5% and we have larger increases in both auto and home in the pipeline. As we look into the future we have visibility into growth. And profitability improvements in personal lines, which are supported by investments in products and ease of doing business enhancements, as well as our commitment to the independent agency channel, which we know is very important to our partners. Now moving onto commercial lines on slide 10. Pre-tax segment incomes for the quarter was $39 million compared to a $7 million loss in the third quarter of 2008. Catastrophes were $9 million in the current quarter compared to $59 million in the third quarter of last year. On an ex-CAT basis the current quarter combined ratio was a 94% or 2.5 points higher than the prior year quarter. Our commercial lines underwriting expenses were higher in the current quarter compared to the prior year quarter reflective of continued investments in products, distributions and infrastructure in new and existing lines of business and geographies, which are critical to our future success. In contrast with the cross-the-board technology and basic infrastructure investments in the beginning of our journey six years ago, we are now making more targeted and discreet investments in specific areas of business, which we believe have the best growth and profitability potentials. This investment strategy has been very effective. Over the last two years we have actively invested in several of our specialty Commercial Lines products and platforms, which are now driving significant growth. Our total specialty growth even excluding AIX was 15% in the current quarter. We are also seeing growth from our investments in selected industry segments in commercial middle markets. Lastly, we expect the cost we occurred ahead of premiums in our westward expansion initiative will be beneficial to our top and bottom line in future periods. Clearly these investments have put additional pressure on our expense ratio. However we consider these investments to be critically important to position us well for profitable growth in the future. We are willing to take this expense risk in order to take advantage of the market opportunities that are in front of us. They not only make sense on the standalone basis, but they also allow us to grow our share with partners, with partner agents across multiple lines of business as we become more meaningful to each of them. As in personal lines higher pension costs and a reduction of variable compensation expenses in the third quarter of 2008, negatively impacted the year-over-year expense comparison. Our ex-CAT accident year losses were lower overall in the current quarter when compared to the prior year quarter. This is due to better results in CMP large losses when compared to unusually high incidents of large losses in this line in the prior year quarter. Partially offsetting the lower CMP large losses in the third quarter this year was a moderate severity increase in some of the other commercial businesses. Our bond portfolio which is principally contract in commercial surety historically has had very limited level of losses. Given the state of the economy and a level of activity we are now seeing we have adopted a more conservative approach to establishing loss picks reflective of a higher incident of losses, which is quite typical in this recessionary economic environment. This more cautious approach to loss picks also drive us to increase current accident year loss expectations for our workers compensation line and commercial auto lines, which were driven by a combination of negative auto premiums as well as higher severity assumptions. Now turning to gross on slide 11. Our 15% net written premium increase in commercial lines for the quarter reflected the impact of our AIX acquisition as well as growth in our niche, professional liability, marine and segment in middle market products. We are positioning our current commercial lines growth strategy to minimize the impact of the recession. And at the same time we continue to emphasize specialization in deeper industry segmentation, which allows us to get an edge in pricing thus maintaining and improving margins. So far we've been relatively successful in this regard and I'd like to discuss our thought process related to each of our commercial lines businesses starting with our core lines. In our flow, small and middle market businesses we tried to explicitly avoid recession sensitive industry classes like contractors and building owners, which are prone to retail and office vacancies. We have minimized those classes in our new business writings to a negligible level. We also continue to tighten underwriting on flow businesses and to hold for a long pricing. We reduced our new business flow, which reduced our new business flow which decreased 8% in the third quarter of 2009 compared to the prior year quarter. At the same time our retention rate on renewal business is holding relatively well. Rate increases flatted a bit on a sequential quarter basis however, our rates were still up 2.5% to small commercials and 1% in middle market in the quarter. We did experience exposure decreases in the quarter clearly driven by the economy. To mitigate this we continue to segment our middle market businesses by the packaging of coverage's and terms for specific segments. We believe this will allow us to continue to grow our segment in middle market business and more importantly will help us preserve margins. Our segmented new business grew 6% including such segments in hospitality and assisted living. Our middle market niches continue to grow at a significant pace despite the slowdown in the economy and the difficult market conditions. Recently we've concentrated our product development efforts in more recessionary resistant business classes like education, human and professional services. Some of our best people and most experience underwriters have been tasked to service these products. As a result all of our nature offerings combined produce net written premium growth of 35% on a year-to-date basis. The marine line grew 20% during the quarter and stands at 8% year-to-date. Our marine book is a highly diversified and profitable book of business and we're very pleased with the growth. We're also extremely pleased with this substantial traction that AIX as achieved in the first half of the year validating the synergies gained by combining our businesses. Hanover's retail distribution and our A rating contributed to AIX's top line in the quarter. Our Hanover professional unit, which grew 49% in the quarter continuous to give us high quality business from a limited number of committed agents with lawyers professional, liability and capability. We have recently added an employment practices liability insurance program to the Hanover professional portfolio to address the unique risks of small and mid size businesses and organizations and allows us to be more distinctive to our agent local markets. This program offers protection for employers wrongful acts including coverage for discrimination, constructive discharge, termination, fewer to hire negligent supervision and temporary workers. With respect to our outlook on the market the overall state of the economy and the pricing climate in the insurance industry makes us cautious about near-term pricing. However we're confident that with partner, agents support and continued product innovations and industry segmentation we'll be able to continue to grow profitably across our commercial lines businesses. So in conclusion while continuing weather a slow recovery in pricing and the recession put some pressure on third quarter results. We remain satisfied with our strong fundamentals and above industry average top line growth. We expect the improvements that we're making in our mix and product offering to be fully reflected in our bottom line results in future periods as we continue to implement our strategy. And with that I'll turn the call over to Gene.

[Eugene M. Bullis:]

Thank you, Marita, and good morning everyone. As you just heard our third quarter operating income was $45 million after tax already $0.09 a share. Both weather in the difficult economy played a role in our results for the quarter. Based on our year-to-date results in a more cautious outlook for the remainder of the year, we are adjusting our full year 2009 pretax segment earnings outlook to a range of $280 million to $290 million. Pretax segment earnings excluding interest on corporate debt and realize investment gains on losses. This revised outlook is based on an assumption of a modestly higher ex-catastrophe current excellent year loss ratio when compared to the full year 2008. Reflective of higher weather in the first three quarters of current year as well as a stronger than expected negative impact of the economy on our accident year fix. All other assumptions remain unchanged. Combined personal lines and commercial lines we expect to achieve mid single digit net written premium growth with some full year catastrophes of 4.2% of net written premium. We continue to expect lower prior year development as compared to actual amount of 2008. We expect our full year total expense ratio to be in the higher end of our current guidance of 1 to 1.5 point increase driven by higher hedging costs and other investments in our business. And we expect an effective tax rate of 33%. I like to touch on a couple of other items not covered yet on this call, on our income statement for the third quarter before I move on to discussing our balance sheet. Net income this quarter was higher than operating income by about $4 million driven by a federal income tax benefit of non-segment income. This benefit was related to a release of a deferred tax valuation allowance associated with realize investment losses recorded earlier in 2009. In the third quarter of 2009, operating results reported in our other P&C segments were $7.5 million and included the effect of favorable reserve development of $10.5 million from our runoff voluntary pools business. The reserve development relates to pools that are in runoff would excess in casualty reinsured association of ECRA being the largest and before years the association as a third party actuarial firm perform and actuarial study in pool reserves. The $6.4 million favorable adjustment of our ECRA reserve was based on the results of this periodic study, which was completed in the third quarter. Additionally, during the quarter we lower our estimates on a large pool claim by $3.1 million. This higher favorable development in our other P&C insurance segment was partially offset by higher pension expenses and lower net investment income in the segment due to a lower level of holding company investment assets. Now I would like to move on to discussion of our balance sheet starting with a quick overview of the company's investment portfolio. And I am now on slide 13, at the end of September we held $5.3 billion in cash and invested assets including assets in our discontinued accident and health business. Cash and fixed maturities with the carrying value of $5.2 billion represent 97% of our portfolio, nearly a roughly 93% of our fixed income securities and our investment grade. Composition of our portfolio remains largely unchanged from the prior quarter. The average duration of the portfolio was 4.1 years. Debt investment income from continuing operations in the third quarter was $62.1 million compared to $65.5 million in the prior year quarter. This decrease is primarily due to our utilization of fixed maturities to fund the 2009 repurchase of our corporate debt at the end of the second quarter of 2009. While this lower level of investment assets produced lower debt investment income it also lowered our pretax interest expense by $3.7 million in the third quarter of 2009. The decrease in that investment income this quarter also reflects lower net new money yields. The year end yield on our fixed income portfolio has remain relatively flat at 556 through the nine months of 2009 compared to 560 for the same period of last year. New money yield were 492 in the third quarter of 2009 and 466 for the nine months. I would like to draw your attention to our CMBS information on slide 15. In the third quarter we added $63 of CMBS to our portfolio to targeted act of purchases. The market value of our CMBS portfolio at the end of September was $338 million, which still represents only 7% of our overall fixed income holdings. Approximately 20% of our CMBS is fully to fees and approximately 77% of the company's CMBS holding are pre-2005 vintages with 8% now coming from 2007 and 7% from 2006 and 8% from 2005. Although we've added some assets risks from more recent vintages we feel very good about the selections as they are very well protected predominantly first cash flow AAA paper. We had very strong CMBS expertise, which we have fairly demonstrated through this market cycle. Notably as of the end of September our CMBS portfolio was in a net unrealized gain position. Moving on to a discussion of our unrealized positions for the quarter on slide 16. The total market value of our investment portfolio excluding cash increased to $5 billion at the end of the third quarter. This quarter we saw a significant improvement in our net unrealized position, which move from a $72 million pretax loss at the end of the second quarter of 2009 to a $118 million pretax gain at September 30. Improving credit spreads combined with relatively stable treasury rates help boost market values within the portfolio. Turing to page 17, for a discussion of our recent capital management actions. Our strong capital position and normalization of capital markets allowed us to undertake several notable capital actions in the third quarter. At the end of the quarter we successfully completed the process of restructuring the portion of our debt, through drawing a $125 million 20 years loan from the Federal Home Loan Bank of Boston at a cost of 5.5%. This served to lower our overall cost of capital decreased our interest expense on an after tax basis by approximately $2 million a year. As of September 30, 2009 we are carrying $434 million of debt, which is made up of $122 million of senior debt, $166 million of subordinated debentures, $125 million of federal home loan bank loans and $21 million of miscellaneous debt inherited from recently acquired subsidiaries. Our debt total capital ratio was now at 15% giving no equity credit of the subordinated securities and including the full federal home loan bank as debt in the financial leverage calculations. During the third quarter of 2009, we repurchased approximately 725,000 common shares for $29 million. At the end of the quarter we had a $104 million of capacity due remaining under our recently expanded $200 million stock repurchase program. During October, we have also repurchased approximately 239,000 common shares for $10.2 million through a 10b5-1 program leaving $94 million remaining under our current share repurchase authorization. Finally, we recently declared an annual dividend of $0.75 of share, which represents an increase of $0.30 or 67% from a dividend paid last year. As Fred mentioned, capital management is an important part of our overall operating strategy and we will use this lever overtime along with our earnings growth to achieve our targeted returns. On slide 18, we've displayed changes in our book value, which improved by 10% in the third quarter of 2009 and 30% on a year-to-date basis. The improvement was primarily driven by increases in the fair value of our investment portfolio of $159 million after tax for the quarter or $3.18 of share as well as earnings. On slide 19, we have some key metrics that will highlight the strength of our balance sheet. Our GAAP equity grew 8.4% in the quarter to $2.4 billion. The growth was higher on a per share basis reflecting the $29 million of share repurchases. Our insurance company statutory capital stood at $1.7 billion at September 30, and 1.5 to 1 our premium to surplus ratio remain more than acceptable for our current ratings and mix of business. On the liability side of the balance sheet our loss and LAE reserves remain strong. We believe our loss picks are appropriately conservative given the economy and we also continued to have a margin of about 5% between carried reserve and our actuarial indications. Holding company cash and investment securities were $311 million at September 30. In summary, our goal is to use our capital as effectively as possible to strengthen our organization, take advantage of growth opportunities and ensure that we are position to win in the long-term. With this I will turn the call back to Bob.

[Robert P. Myron:]

Thank you Gene. Operator that concludes our prepared remarks could you please open the line to questions.

[Operator:]

Thank you. (Operator Instructions). Our first question comes from Jay Gelb of Barclays Capital.

[Jay Gelb:]

Thanks good morning.

[Frederick H. Eppinger Jr.:]

Good morning Jay.

[Jay Gelb:]

In terms of the guidance outlook for 2009 being taken down just a bit. What are the implication with that, are there for that for 2010 especially looking in terms of the expense ratio as well as capital management, the stock ratings [and intangible value]?

[Frederick H. Eppinger Jr.:]

Yeah, I actually feel like for 2010 the conversation we had that in yesterday still [over]. So I mean obviously the company has three levers, Jay that are pretty clear for our improvement of our returns. We have the capital lever, expense lever and the mix and margin lever. And there is no question that the economy and kind of the uncertainty around this kind of non-CAT weather has made us feel little bit more conservative in the fourth quarter, but if you look at the rate we are achieving and frankly what's already been approved we feel very, very good about the increasing margin in personal lines, as some uncertainty around how the weather enforced, but we have assumed that is significant above the average weather continues. And so I feel like while there is some short-term issues there, I feel like the vast majority of that we have transparency to overcome. So I’ll look at our action here as and I say we will see improvement next year. And I feel good about the mix in commercial and that we are achieving obviously the economy in the written premium like our places that comp little bit of pressure on that, but we are achieving rate increase and our mix is improving a lot. So I feel pretty good about 2010 and how that will unfold. On a capital size obviously as I said one other things that I’m watching is the particular opportunity that presented itself to us both organically and inorganic, we are seeing some interesting opportunities present itself to us in the market place partly because of our upgrade, partly because of this west coast expansion, we obviously have started doing some capital of action that give capital back as I could have transparency the excess if you will. We will continue to move in that direction if its appropriate if there is opportunities to increase shareholder value I will do it, but we are obviously not shy of how moving in the direction of giving capital back to shareholders if we feel that its excess and I think we have signaled, we’ve shown what we’re doing and as these opportunities either come above or don't, we'll react appropriately and that’s why I feel confident then ad, on the run rate by the end of next year. I think I have some transparency the significant improvement in our return. The final level is this expense thing and as I look at the IRR of every single thing we invested I’m really not disappointed in anything that too I wish that pricing and commercial is a little bit robust faster sure. The IRR so and almost everything I can get my hands on as far as early results, I feel very, very good about, so I see a real leverage of expense opportunity next year. It probably going to unfold in the first quarter, but as this stuff comes in as I watched the West Coast expansion you will see our improvement on expense ratio. So if take together all those three levels I’m still focused on and relatively confident that by the end of the next year we’ll do as we said at the Investor Day, is there a little drag in the fourth quarter maybe in the first quarter sure, but again if you look at rate increases I mean we are still a significantly a personal lines company. And if you think about where we are in our state, that we are in some big states where it is dominated by regional company. We outperform them by multiple points and what this weather gives us is an opportunity to take continue take our price increases as we do but, thus we do but up them a little bit. And just think about our competitors having to take 12% or 14% rate because they were behind that creates massive disruption for them. So now only what we get away 5%, 6%, 7%, 8% rate increases that were sort of earn our way through. My view is we have a chance actually drop because the disruption of what they are having to do to catch up creates some real opportunity for us and so I actually think that helps us in kind of throughout next year. So I don’t get about all of them and so I say yes we’ll be conserved by the fourth quarter hike as we give new guidance we will probably do it at the next quarter call for next year. We will try to talk about how that sequences through the year, but I feel still that the what we said in the Investor Day is very durable as we end the year unfolds.

[Jay Gelb:]

So what is that translate into a return on equity for 2000 timeframe?

[Frederick H. Eppinger Jr.:]

But we haven't guided that free to average for the year, but what I said is that I would like to see us get to that or target by a run rate by six quarters, which is actual the fourth quarter next year and I believe we can get there. But we will as I say we haven’t given all the guidance on the average numbers on all laps of the year, which we will say next earnings call.

[Jay Gelb:]

Is that consistent with the Investor Dat that's possible?

[Frederick H. Eppinger Jr.:]

Yeah, absolutely because when I talked about is this 12% over getting to the 12% in a six quarter period because of two, the big thing right as I got a about a point and half of excess expense that we are kind of putting into model here to take advantage. And I have a lot of excess capital, right, and I still have excess capital even after the actions I’ve taken because I’m looking for is there going to be opportunities unfold for us and in both cases those are going to get better through the year, right. On the capital, I’m going to make a decision as soon as we come with transparent debt with excess right if we can use this to increase shareholder value will give it back and on the expense side that will go down, right, because in essence these investments are coming through for us. And again if they are not I will retch it back, what were and what we're spending. So with a 12% kind of fixed quarter run rate that's what we talked about business.

[Jay Gelb:]

Right, finally kind you quantify the excess capital at this point?

[Frederick H. Eppinger Jr.:]

Yeah, still again, we have done a little bit, slight if you look at, as we look out next year, within that 300 to 400 range still. I mean, we've done a lot of interest in good things, but we are also earning in the money so I would say is still in that range as we looked for the full year next year.

[Jay Gelb:]

That’s very helpful. Thank you.

[Frederick H. Eppinger Jr.:]

Thank you.

[Operator:]

Our next question comes from Dan Farrell of FPK. (Fox-Pitt Kelton)

[Dan Farrell:]

Good morning.

[Frederick H. Eppinger Jr.:]

Good morning, Dan.

[Dan Farrell:]

Fred, can you just comment on what you’re seeing currently in the environment for MNA activity?

[Frederick H. Eppinger Jr.:]

Yeah, I mean it’s fascinating again I would tell people, this is that quietest storm I’ve ever seen, but it’s a storm. What do I mean by that, clearly the spreads and investment rate to come back, but it kind of it was shy of release that’s a visible, but underneath all of this what we see is continuing term now particularly for this small companies. I mean and again what we’re seeing in particular the geographies we compete in, a lot these regional companies are getting killed. I mean there is a lot of 115s, 120s out there and they’re under a lot of strap. And so we see both kind of organic opportunities because of that as they have the shrink and hunger down, but I would also say that for some of these small capitalized specialty companies there are more and more meaningful conversation about should they get out because as the capital they have to carry and the third deal with the economy, I mean it’s the first time in the 50 years we should talk about the capital thing that’s coming back and all that but the reality is this is the first time in 50 years that the cycle has coincided with an economic downturn. Those two things put tremendous pressure on folks that are heavy into some of the specialty areas that are most effective by the economic so our view is you are going to see it how, is there a still some higher than should be expectations develop pricing for some of these sure, but what we see is lots of meaningful conversation going on out there with some of these smaller specialty companies and frankly in some of the other companies that are sub scale and some line thinking about capital preservation and protection, so I would see that we are getting into that stage of the market that if you are going to see renewal rights you will start to see them in the next 12 to 18 months as people kind of rejigged their portfolio. And again I don’t think its our business everything happens lower than people expect, but it going to happen, you can the see the strains out there, you can see some of the opportunities that are presenting. Our philosophy they don’t need them, I don’t need any transaction to do what we are trying to do, but we are consistently having conversations because I feel there are some wonderful teams out there that are contemplating their future and I felt there is some real opportunity. The other interesting thing that’s happening and it’s the thing, tale of two cities that I’m sure you guys see even better than I do as you talk to the companies, that all this additional capacity or new capacity if you will coming from Bermuda and overseas to the big brokers for large accounts has created a blood bath in some of these segments at the high end. And that’s going to put continued earning pressure on some of these guys. Luckily those folks don’t have the distribution or retail distribution in the operating model if you get the small phase value stop, but that puts pressure on the people we complete with that live up there, that live in the wholesale market and all the program equivalent companies that completing against AIX that almost all go through wholesalers in large account. Rich helped us because we are well protected by that and there overall economic will be challenged by that, so I remained bullish or and what you are going to see I don't think its going to easy I don't think we are going to have the big transaction per se, but I think we are going to see the continued consolidation of smaller companies and the share shift in the retail with small companies.

[Dan Farrell:]

That's helpful thank you.

[Frederick H. Eppinger Jr.:]

Thank you.

[Operator:]

Our next question is from Cliff Gallant of Keefe, Bruyette & Woods.

[Cliff Gallant:]

Good morning.

[Frederick H. Eppinger Jr.:]

Good morning, Cliff.

[Cliff Gallant:]

Just wanted to talk a little bit more about the expense lever you talked about?

[Frederick H. Eppinger Jr.:]

Sure..

[Cliff Gallant:]

And sort of expense ratio to go down it really mainly to leverage existing platforms and I was wondering if anything you could do more proactively. Are you considering any reductions in any?

[Frederick H. Eppinger Jr.:]

No. I think Cliff its both.. I talked about you know you heard me talk about it's in the lot but it's the third, third for us almost. It is if you look at Marita, have mentioned one of our big capital investments and discretionary expenditure this year, which was Think Hanover we believe that there is a wide open opportunity as some of our personal lines compares went direct and some of the other guys will come advertising by pulling over agents to got a fewer agents with account offering and toward. We put a significant amount of effort in this over the last 15 months and spending on a broad run rate and IP product investments in personal line. The way it works about half of that is expense and half of that is capitalized. Well, you will see it this year take our discretionary investment and technology will go down. So that is very proactive and if you remember two years ago we put a lot of work in variablizing our IP costs. So we can take our IP costs down very quickly and it's very, variable mostly the partners outside partners. So we have that ability to do it so we proactively can move there. Second a big part of our expense this year was our pension were scratched up because that the way the timing of the market the capital markets collapse in the fourth quarter first quarter that some of that comes back for us as well. So you will see that is a more quicker expense leverage well. So yes, it is growth but there is the discretionary expense stuff that you will see us managed. The other think I would tell you is that we don’t because it gets in the wash. Our full quarter efficiency is going up every quarter, we have paid, we had this journey. So we worked hard on variablizing a lot of different costs that data entry and stuff, so some of that is very proactive and again that's why I will get some of it next year. I'm not as we give guidance next year will be a little bit clear about it, but it's not hard to imagine us getting more leverage on expense rates Now, the one warning I'd give you is that I will also be very open about where do we opportunities because what I'm seeing is lot's of action. Now a lot of decision yet on transaction things, but we will always be very transparent and if I see something that creates some significant IRR strategic share return, we always will jump on it. But this West Coast expansion or upgrade and the disruption we're seeing with some of the major players we compete with as created with our transparency and our comfort level and my ability to see an IRR very clearly, and get commitments before we started. And if we didn't see this disruption what I've waited probably six, four months because of the ramped down of personal lines absolutely. But I saw the opportunity and I doubled down a little bit to involve at the same time. So we believe the expense leverage is absolutely there we will take some proactive actions to get out it, but I will also be very transparent particularly as over the next two quarters, if I see anything else where I feel that is a real opportunity to take a lot of risk opportunity to capitalize on it, which we believe is an expense risk versus the loss. But again both have been completely open for that.

[Cliff Gallant:]

All right, thank you.

[Frederick H. Eppinger Jr.:]

Thank you.

[Operator:]

Our next question comes from Michael Phillips of Stifel Nicolaus.

[Michael Phillips:]

Thanks, good morning.

[Frederick H. Eppinger Jr.:]

Good morning, Michael.

[Michael Phillips:]

Covering upon Freds, we are still largely a personal line company, couple of questions on that segment. Fred you mentioned in you opening comments 6.2% increase in your growth states, I think Marita said that the core four were down two, what was the number for the non-core for? Is that we mean by the growth states? Is that everything else.

[Marita Zuraitis:]

Yeah.

[Frederick H. Eppinger Jr.:]

Yes.

[Michael Phillips:]

Okay.

[Frederick H. Eppinger Jr.:]

That's basically everything.

[Michael Phillips:]

Okay, I'm trying to get the dollar amount of this discretionary IP spending in personal lines then impact it's in the third quarter.

[Frederick H. Eppinger Jr.:]

Well, in total the discretionary if you look at what we've done over the last five or six years, that the run rate of the company I believe a normal run rate for us. It's always going to be in the $45 million discretionary debt run rate at the levels. This year and again I can't give you the exact number of expense versus amortization that number got into the low 60 right, so because we accelerated a budget development until its real month to take it back down to that a normal run rate. Now again some of that capitalized, some of that is expense, it typically runs 50

[Marita Zuraitis:]

And specifically in personal lines because we packaged the product enhancements with the ease of doing business enhancements in this Think Hanover campaign that the buss and the attraction and the impacts that we're getting is much more substantial than if we had stretched it out. So clearly the acceleration of these IP investments and product investments in the third and fourth quarter build well for the attraction that we'll get in personal lines in 2010 which is why we talked about our cash spent in that area being less than 2010 because it really was an acceleration and packaging of all those things together, so we could have market impact with the Think Hanover offering.

[Michael Phillips:]

Okay can I speak one more.

[Frederick H. Eppinger Jr.:]

Sure.

[Michael Phillips:]

In the personal lines you said 45% auto and home rate increases if I am going to get even better, I can see the confidence in current actual year improving next year, there and in the specialty side I can also see it there, what confident are you there you can do that maintain or improve the current margins on the core commercial lines?

[Frederick H. Eppinger Jr.:]

That's a great question.

[Marita Zuraitis:]

In the core commercial as we mentioned in the script that's exactly why new business at a lower level in the third quarter that had been prior, you see price holding 2.5 in small and one in middle market is not significant but it certainly better than the averages that we're seeing out there in the industry. We're very careful about what we have taken, we're very careful on how we price it. I would say we're holding our own but I completely agree with you, I think it's an excellent question and we have intent focus on that segment. And that's a segment that the growth will be what the growth is. We underwrite it prudently and we price that appropriately and if its fixed and its fixed and doesn't we're okay with that because we're seeing growth in high.

[Frederick H. Eppinger Jr.:]

One of the things that to remember about as the non-segment at middle market we have. We have most of our business is quite small, right, with the vast majority. And so, well 2.5 in some of the lines are complete inflation its pretty dam close. And what we're doing is reunderwriting, so we actually feel pretty good, but it is the challenge. That should be is the heart of what we need to focused on for our momentum. If that making sure that all our middle market is segmented in achieving the right rate and our mix continues to improve. But again one of the benefits we have is most of our business is small. We got out of most all of our large account and frankly like model line comp, we don’t have it. So, for the most part, part issue is kind of the small middle, but what Marita likes to call it [shmiddle], which is the low of middle market the unsegmented portion of that and making sure that our underwriters are absolutely displenishing rate now. Again we have gotten rates most of our competitors will talk about middle market not being positive. We have been positive in middle market now for fourth quarter, and we have been positive obviously since April on most of our business. So, I feel good but it is the right depression is the place we need to zero in and make sure that we're managing our business properly.

[Michael Phillips:]

Okay, guys, thanks a lot I appreciate it.

[Frederick H. Eppinger Jr.:]

Thank you.

[Marita Zuraitis:]

Thank you.

[Operator:]

Thank you. Our next question comes from Sam Hoffman of Lincoln Square Capital.

[Samuel Hoffman:]

All right, yes, good morning.

[Frederick H. Eppinger Jr.:]

Good morning, Sam.

[Samuel Hoffman:]

Good morning. I just had two questions. On other commercial lines your loss ratio which it's been in the 35 to 40% range pretty consistently since 2006 and even into the beginning of this year is now kind of in the mid 40s. And, I think the last quarter you had described kind of an increase in severity of the cost and of the increase in the loss effect and now it's I think more it's kind of the permanent increase at least for the time being. And so I guess my question is can you give a bit more color as to what specifically is causing it, is it just the business surety business or there other class of the business that you are being more conservative on? And then also are there other lines that are giving you concern where you potentially might need to increase your pick in the future?

[Frederick H. Eppinger Jr.:]

Sure, it's a good question. I mean the other obviously makes might good money for us. So let me just now the other has changed the nature of what and other has changed dramatically since the day to described. We didn't own AIX, B4 obviously also and there is a lot of the other specialty lines and bonds is obviously in there to. So what we have done again, when you look at what we looked it's particularly around the severity business, it's not a big amount. But we did take the actions here off because of where we are in the cycle. We still doing great and making money its line, but I just deal that given where we are in the cycle and given the activity we're seeing in contractors and general in the industry that it was appropriate for us to do it. It obviously at the same time we are thinking about pricing had going forward and I feel pretty about what pricing we're achieving in those lines. On AIX, we did have some severity but it was on programs if you recall what I said before the last call and I feel very good about this. When we bought AIX there was no program because their rating was not programs that we would have written. And so we have discontinued all those programs, but there was some severity that came out of those programs as we ran them off. So that we feel good that that has gone, so I don't think that was a permanent thing, it was just, it was one of those things where they as a low related company build a little bit stuff that was a little that we wanted to drive off. So that's really again you are actually right we did it up we are being conservative, I feel like the earnings business has been and will be fine, but we didn't take it up.

[Samuel Hoffman:]

And are there other lines that you might acquire an increase in the loss going forward?

[Frederick H. Eppinger Jr.:]

Yeah, obviously this year our numbers Marita talked about in our script was a return premium in comp there is a impact now what's interesting about us as we don't have much comp total and we don't have a lot of model line comp and we don't have a large comps. So the the smaller comp is performing very well for us, but we did have a movement in that line, which is almost directly attributable to the increase in return premium again it's a peanut in total. But it is the other place that we look. The auto well over time that has come down a little bit it's still very attractive to us our commercial auto and we actually stabilize, so that the question for us is nice the huge fear about our commercial result. I would say our commercial results is really two issues one is earning in the additional expense we have in commercial, which changes our combined ratio dramatically and then the other issue is just making sure as we go forward in our flow businesses as was asked earlier that we are achieving that kind of rate and pricing in mix that we're comfortable with so that we don't have a slow decrease in margin. But again I don't see that happening yet, and so I feel very good about what's coming in and as Marita both the growth there because we have the plenty of growth in stuff where we believe we have adequate margins, there is no real need to push it. So net I feel kind of we're in pretty good shape.

[Samuel Hoffman:]

And then when the does the AIX business that is not the quality of that's you are looking at?

[Frederick H. Eppinger Jr.:]

Pretty much go on. I would say with this quarter because again the nice thing about them that they have a conflict where they can, the way those programs work you could just stop. Right, it is no remnant it just goes a way. So we would have closed on December of last year I guess, so it might be a little bit in the first quarter but a vast majority of that that's all behind us. So I feel very, very good by the way about. I would say the AIX does upgrading increase then coming on board using a retail distribution, the quality and what I call age of that business. Most of that business were picking up AIG with AIX is stuff that with the people we were getting it from for years if not getting so it is tough and stable transparent and good margins. So I'm pretty excited about it.

[Samuel Hoffman:]

Okay. My other question is for 2008 and 2009 you have experienced pretty consistent higher and non-CAT and CAT losses and commercial lines then you would expected and because of that you probably can be getting some good price increases going forward. So my question is what in your statistical analysis makes you believe that this is actually get business mainly in the states that you located and the pricing that you are going to getting. Is this in fact get business get business has it been under price given the higher CATs that are expected currently in the marketplace given the companies that really been competing aggressively moving their business to the Midwest from places like Florida and California and so forth.

[Frederick H. Eppinger Jr.:]

Yeah its a great question. So again when we look at it, we can’t remember the entire industry destroys economic value, right. So on average if now just homeowners. The entire industry doesn’t earn across the capital through this cycle. So homeowner is not a unique think about our industry. So when you look at some of those analyses if I say homeowners is under price. We all performing our core states against regional companies and a lot of case is 5 to 10 drop point. So there is no question that homeowners has underperformed through the cycle and there is also any question that the Midwest, part of the Midwest has chronically had some problems probably in the last three, four, five years it’s been graduated as people have gone to those market. So both of those things are true. Now if you look at our business, through the cycles been great. So yes for seven quarters we’ve had above average non-CAT weather and I wish I was fair enough to know who was permanent or not. Well I am smart enough to know as to assume it is. And take rate that essentially makes get this across the capital assuming that is permanent. Now our data would tell, that this is a relatively cyclical thing. And over the last couple of decades the last two-years have been the worst two-years as far as non-CAT weather and it is, it is spiky, it is somewhat cyclical. But that’s just better for us if it goes back to normal. So we have assumed a higher, but I the question you asked is the right one, we believe very, very strongly this account focused nearer fluent focus that we have that our full account and our homeowners on a standalone basis in the account are well earned cost capital through the cycle. We believe that, we believe we can achieve excess returns in that business and in the account through the cycle. Now again, I would tell you that you are absolutely right about this non-CAT weather its been, there is 26 state in the last two-years that have had their single worse storm ever. And its all occurred in the last couple of years, which is our remarkable thing, right. So again I do think that its important for us to stand top at rate, its important to make sure that we are not do any model line home. And if you seen us get out of Florida home, you see us get out of Road Island home, you seen decrease our exposures in this Southeast dramatically where we thought there was chronic problems with pricing. But I think where we are, we are very confident that we have set it up to get our target insurance through the cycle, okay?

[Samuel Hoffman:]

Thank you.

[Frederick H. Eppinger Jr.:]

Thank you.

[Operator:]

This does conclude our question and answer session. Gentlemen do you have any closing remarks today.

[Frederick H. Eppinger Jr.:]

We don’t, rather than just thank everyone for their participation on the call. And we look forward to speaking with you again in quarters time. Thanks very much.

[Operator:]

Thank you for joining us today. This time the conference has ended, you may now disconnect your lines.