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The Chubb Corporation (NYSE:CB)

Q2 2008 Earnings Call

July 24, 2008 5:00 pm ET

Executives

John D. Finnegan – Chairman of the Board, President & Chief Executive Officer

John J. Degnan – Vice Chairman & Chief Operating Officer

Analysts

Jay Gelb - Lehman Brothers

Dan Johnson - Citadel Investment Group

Matthew Heimermann - J.P. Morgan

[Unidentified Analyst] - Credit Suisse

Paul Newsome - Sandler O’Neill & Partners L.P.

Alain Karaoglan - Banc of America Securities

Joshua Shanker - Citigroup

Operator

Welcome to The Chubb Corporation’s second quarter 2008 earnings conference call. (Operator Instructions)

Before we begin, Chubb has asked me to make the following statements. In order to help you understand Chubb, its industry and its results members of Chubb’s management team will include in today’s presentation forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. It is possible that actual results might differ from estimates and forecasts that Chubb’s management team might make today. Additional information regarding factors that could cause such differences appears in Chubb’s filings with the Securities & Exchange Commission.

Please also note that no portion of this conference call may be reproduced or rebroadcast in any form without the prior written consent of Chubb. Replays of this webcast will be available through August 22, 2008. Those listening after July 24, 2008 should please note that the information and forecasts provided in this recording will not necessarily be updated and it is possible that the information will no longer be current.

I would now like to turn the call over to Mr. Finnegan.

John D. Finnegan

As we said in our press release today, in an otherwise excellent second quarter, results were adversely impacted by unusually high catastrophe losses and by one large surety loss. As a result, operating income per share was down 13% but still came in at a healthy $1.40. Overall, we’re pleased with our combined ratios of 88.5 for the second quarter and 86.2 for the first six months. We had particularly outstanding second quarter performance in homeowners and commercial multiple peril. Our six month underwrite income was $849 million and PNC investment income after tax was $654 million. Based on first half operating income per share of $3.05 and our outlook for the second half, we’re affirming the values we provided six months ago of operating income per share for the full year in the range of $5.70 to $6.10. This comprehends the change in our CAT assumption from three points to four points for the year. I’ll talk more about guidance in my closing remarks.

And now, John Degnan, who as you know has a new role as Chief Operating Officer, will discuss our operating performance in more detail.

John J. Degnan

We continue to have excellent performance by all three SBUs as reflected in their combined ratios. The headlines for the quarter were on the positive side, a blowout performance by homeowners, and substantial favorable loss experience in several other lines. On the other hand, we also had a large surety loss of about $75 million and 5.4 points of catastrophe losses amounting to about $160 million. Most of the CATs were commercial property losses primarily caused by the storms in the Midwest. 5.4 points of CATs is unusually high for the second quarter. In fact, it was the highest second quarter CAT impact we’ve had in over a decade and we’re not alone. For the industry as a whole, CATs were more than $6 billion, the highest amount of second quarter CATs since 2001 and more than double last year’s second quarter number. According to ISO, insured U.S. CAT losses for the first six months of 2008 have already exceeded CAT losses for all of 2007.

Mike O’Reilly will provide more details on favorable development in a few minutes but for now let me note that it improved this quarter’s overall combined ratio by about eight percentage points. Chubb Personal Insurance net written premiums grew 4% and CPI produced a combined ratio of 81.9, which was 3.4 points better than last year due to lower CAT losses. Unlike CCI, CPI was not very much affected by CATs in the second quarter with only 4.5 points compared to 8.1 points in last year’s second quarter. CPI’s excellent results were driven by homeowners, which accounts for two-thirds of CPI’s written premiums. Homeowners grew 3% and had a combined ratio of 75.1, that’s 8.7 points better than last year. Personal auto also had an excellent combined ratio of 86.7 and premiums declined 2%. In other personal lines, premiums increased 15% and the combined ratio was 101.5.

Chubb Commercial Insurance also continued to produce strong results. Although the second quarter combined ratio of 93.7 was not as good as last year’s 85.4, this year’s quarter included 9.2 points of catastrophe losses compared with 3.3 points last year. This year’s CAT losses occurred mostly in property and marine and resulted primarily from the Midwest storms. Excluding CATs, CCI’s combined ratio in the second quarter was 84.5 in 2008 versus 82.1 in 2007, which is outstanding considering the rate environment. We’ve continued to experience very favorable loss trends, which have partially offset the cumulative effect of declining rates over the past few years. Within CCI, multiple peril produced a combined ratio of 79.5, more than seven points better than last year. Workers comp came in at 77.8 and casualty at 91.9. On the other hand, property and marine came it at 120.4, which reflects 30.5 points of CATs.

In a very competitive market environment, CCI’s premiums were up 1% in the first half and down 1% in the second quarter. The ratio of new to lost business in the U.S. was 1.1 to 1 in the second quarter and we retained 85% of U.S. accounts up for renewal with an average renewal rate decrease of about 6%. We continue to exercise underwriting discipline and walk away from business that’s under priced.

Chubb Specialty Insurance delivered a second quarter combined ratio of 89.3 compared to 75.6 in the second quarter of 2007. Professional liability had a combined ratio of 84 compared to 80.5 in last year’s second quarter reflecting significant favorable development related to accident years 2005 and prior. Professional liability premiums declined 4%. In the U.S., second quarter renewal retention was 88%, the ratio of new to lost business was 1.2 to 1, and average renewal rates were down about 3%. For surety, net written premiums were down 10% and the combined ratio was 128.4.

As I mentioned earlier, we had one large loss. It involved the contractor on a large public infrastructure job and arose out of the inability of the contractor to complete the project within its estimated costs. Our payments will be made under both performance and payment bonds. As we frequently pointed out in the past, the surety business is naturally subject to occasional large losses but it has been highly profitable for Chubb. Over the last five years, for example, our surety combined ratio was average below 50. Even with the second quarter loss, surety’s combined ratio for the first six months came in at 81.4.

I’d like to make a few short comments on what we’re currently seeing in the marketplace. The commercial market remains soft, despite high levels of CAT losses and pressure on insurers’ profitability. Although rates are certainly not in freefall, with our price decreases hovering around 5% for the past three quarters there is some pressure on our margins. We combat this by careful exposure analysis, specialization and a disciplined approach to pricing. With respect to terms and conditions, we’re seeing an uptick in requests to broaden coverage particularly on large accounts for example by the use of broker manuscripts in place of carrier forms whereby increases in catastrophe sub limits. Generally the large the account the more competitive the pricing and the greater the pressure to broaden terms. As you know, we’re more of a middle market player with a small percentage of risk management business but, as with our price to pricing where the broadened terms and conditions are not supported by adequate premium, our underwriters are walking away from accounts.

Although the industries overall combined ratio will likely slip into triple digits this year, there is still excess capacity in the commercial market that will keep pressure on rates. Although given profitability pressures, we do not anticipate a free fall. In the specialty market, professional liability pricing trends are mixed but on balance slightly improved. For customers affected by the credit crisis including financial institutions and home builders, rates are definitely hardening. For financial institutions public B&O, albeit a small part of our book average renewal rates for the first six months increased by mid-teen percentages. For other customer segments rates continued to decline. Overall professional liability renewal rates declined about 3% which is the smallest quarterly decline we’ve experienced since 2006.

Because the credit crisis is very much in the news, including its effect on insurers, I thought I’d say a few words about our current view of credit crisis claim exposure as it relates to our D&O, E&O and fiduciary lines. We still haven’t seen anything surprising in the number or size of claims. Both the level of new claim activity as well as the number of claims we have in the aggregate remain relatively modest compared to what some might have expected given our market share in those lines and the pervasiveness of the credit crisis. As I’ve indicated in previous calls we continue to see the most claims activity in the D&O arena where we believe the greatest potential for exposure from credit crisis claims resides. So I’d like to provide a little color around our assessment of that area.

In that regard it bears repeating that our D&O underwriting strategies have left us in a much better position than we were during the corporate abuse events in 2002 and before. Of the CHUBB policies potentially implicated by the credit crisis claims to date more than one-third are [SOD A] only, more than 80% of them are excess, and almost 90% have limits of $15 million or less. The underwriting strategies I’ve described in the past have helped us to avoid some of the highest profile cases and to lower the potential severity where we do have claims.

Unlike stock option backdating cases where our losses arose predominantly from derivative actions, the credit crisis exposures are being driven by the more traditional pattern of securities class actions which generally as you know are longer tail, have high damage potential, and are expensive to litigate. Bear in mind however that in securities class action cases, the most frequently invoked theory in recovery requires that the plaintiffs plead and prove scienter on the part of the directors or officers. That means generally having the necessary mental state to commit fraud.

The securities class actions arriving out of the credit crisis are likely to be the first significant cluster of claims evaluated under the stricter standards for pleading scienter that were established by the Supreme Court in the Tellabs case that was decided in June of 2007. As you may recall the Court held that an evaluating securities fraud claims at the very outset usually in the context of an early motion to dismiss. Courts must consider the defendant’s plausible explanations of non-culpability and that to be able to proceed with the securities fraud class action claim against directors and officers of the company, plaintiffs have to plead specific facts supporting an inference of fraudulent intent that is cogent and at least as compelling as any opposing inference of non-fraudulent intent.

Along those lines we’re very encouraged by a couple of strong trial court decisions this quarter granting motions to dismiss securities fraud class action complaints arising out of the credit crisis. In both of those decisions courts dismissed lawsuits based on the plaintiff’s failure to meet the Tellabs scienter pleading requirement as well as their failure to plead specifically which statements by the defendants were allegedly false and misleading and why. In both cases one key to the scienter issue was the court’s conclusion that internal review, discussion and debate over the impact of rapidly changing market conditions is normal business activity, not an indication of an intent to defraud. If courts consistently apply the pleading standard embodied in the Tellabs case, then many of the credit crisis security cases should be more susceptible to early dismissal and have a correlatively lower settlement value.

Notwithstanding the higher pleading standard for scienter though it would be shortsighted not to acknowledge that the credit crisis is clearly a major event and that the full scope of claims that arise from it is not yet known. Based on the number of companies involved and the market capitalization losses, there will surely be a significant amount of litigation in this area. Whether those actions will be dismissed at a higher rate as the elevated pleading requirements suggest they should be, or whether they’re ultimately settled or resolved at some prejudgment or trial will largely be a function of the facts in the individual cases and the consistency of the courts. Accordingly the ultimate cost to insurers is far from certain. In the meantime we are following our customary approach of establishing prudent IBNR loss reserves for immature accident years in these long tail lines of business taking into account all recent developments.

With that I’ll turn it over to Mike O’Reilly.

Michael O’Reilly

In addition to substantial underwriting income in the second quarter, property and casualty investment income after tax increased by 4%. You will notice that our net income was modestly lower than our operating income as we had realized net investment losses after income tax of $49 million or $0.13 per share. The realized losses were primarily a function of the stock market decline on the basis of which we wrote down several publicly traded equity securities that we deemed to be other than temporarily impaired. Property and casualty invested assets increased to $37.7 billion as of June 30, 2008 from $37.6 billion at year-end 2007.

Our fixed income portfolio remains heavily weighted in tax exempt bonds and has an average duration of approximately 4.5 years. The unrealized depreciation in the fixed income portfolio at the end of the second quarter was $55 million. Book value per share under GAAP at June 30, 2008 was $39.19 compared to $38.56 at year-end 2007 and $35.13 on June 30, 2007. Adjusted book value per share which we calculated with available for sale fixed maturities at amortized cost was $39.20 compared to $37.87 at 2007 year-end and $35.61 on June 30 of last year.

John mentioned the combined ratio impact of favorable loss development in the second quarter. We estimate that favorable development on prior year reserves by strategic business units was as follows: CPI about $25 million, CCI about $85 million, CSI about $110 million, and reinsurance assumed had about $15 million bringing the total favorable development for CHUBB to about $235 million for the quarter. For comparison, in the second quarter of 2007 we had about $185 million of favorable development for the company overall including about $25 million in CPI, $45 million in CCI, $100 million in CSI, and $15 million in reinsurance assumed.

During the second quarter our loss reserves increased by $241 million. Reserves in the insurance business increased by $296 million during the quarter about half of which is related to catastrophe losses and the surety loss. The impact of currency fluctuation on loss reserves during the second quarter was not significant. Reserves in our reinsurance assumed business which is now in runoff declined by $55 million. The expense ratio for the second quarter was [29.8 %] nearly identical with last year’s [29.6 %].

Turning to capital management. During the second quarter of 2008 we repurchased 5.5 million shares at an aggregate cost of $281 million. Under the current authorization, as of June 30 there were 9.3 million shares remaining for repurchase. Pending on market conditions our intention is to complete the repurchase of all these shares by the end of this year.

And now I’ll turn it back to John Finnegan.

John D. Finnegan

Let me make a few concluding remarks about the results. We’re pleased with the underlying performance of the business as CHUBB continues to operate very successfully in a challenging market environment. That performance is manifest in substantial underwriting profit and attractive renewal retention levels. On the asset side investment income continued to increase while we have continued to return significant cash to shareholders through the stock buy-back program. In addition we’ve been able to avoid the mistakes that have led others to take massive asset write-downs as related to the mortgage and credit crisis.

Based on our results from the first half and our outlook for the rest of the year, we are reaffirming our original guidance for operating earnings per share in the range of $5.70 to $6.10 for the full year. The updated components of this guidance are as follows. We expect net written premiums to be flat to modestly low for the year. Based on our actual catastrophe losses of 3.6 points in the first half, we are increasing our CAT assumption for the full year from 3 points to 4 points. The expected higher level of cap losses in the second half reflect the fact that we’re now entering the heart of the hurricane season. For those who would like to make a higher or lower cap assumption, the impact of each percentage point of catastrophe losses on operating income per share for the full year is approximately $0.20.

For our 2008 combined ratio, we expect a range of 86 to 88. This is based on a combined ratio range of 85 to 87 for CPI, 90 to 92 for CCI, and 82 to 84 for CSI. We expect 2008 property and casualty investment income to go 3% to 5%. Finally, our operating income per share guidance is based on an assumption of $368 million average diluted shares outstanding for the full year.

To sum up our results, each of our SBUs had a substantial underwriting profit. Total underwriting income for the first six months was $849 million. P&C investment income after tax for the first half was a very strong $654 million. Adjusted book value per share increased 10% from a year ago. And we’re on target to complete our share repurchase program by the end of the year. We believe our results continue to distinguish CHUBB from the pack by demonstrating that we can produce superior bottom line results in a challenging market environment.

And with that I’ll open the line to your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Jay Gelb - Lehman Brothers.

Jay Gelb - Lehman Brothers

On the surety loss, can you give us a sense of what year that was initially written and whether you put out those type of limits on any single risk at this point?

John J. Degnan

Well remember Jay, think of surety not as an insurance policy but we have treaded aggregations which we monitor carefully in surety and all of the other areas of the company where we have credit risks and we write against the credit worthiness of the account. So it would not be unusual for us in connection with a particular account to have a credit line out in that amount through a surety bond or a series of bonds. I don’t know precisely the year in which it was written. The loss is a 2008 calendar year event but I’m not sure the date on which the bond was actually executed.

Jay Gelb - Lehman Brothers

Does a magnitude of that size of exposure trouble you at all in a slowing economy?

John J. Degnan

No. We’ve taken a look obviously at the overall surety book in connection with this loss. It’s a diversified book. It’s spread among commercial contractors, very small exposure to residential contractors, commercial accounts that don’t do construction accounts at all. Given the diversified nature of the book and the aggregate risks that we have attaching to any one loss, we’re not concerned. It’s been a very profitable book for the last five years. The last major loss we had was the Enron surety loss several years ago. It’s a book which occasionally is going to produce for us given the way in which we write this business a large loss in a single quarter and our time came due in this quarter. But it doesn’t concern us about the overall structure of the book nor does it reduce in any way our commitment to the surety line of business.

Jay Gelb - Lehman Brothers

On a separate issue, the pace of the buy-back slowed second quarter versus first quarter. Our sense was the buy-back could be finished a little faster than the end of the year at the current authorization. Can you tell us why the buy-back slowed or maybe what you’re thinking about in terms of velocity of completing the authorization?

Michael O’Reilly

Jay, we weren’t trying to do the thing 25% a quarter. As you suggested the second quarter slowed from the first quarter. We probably did a little bit more in the first quarter mainly because there was lots of opportunity to repurchase chunks of shares, but the slowdown in the second quarter was not anything that’s planned. Certainly if you look at the 28 million share reauthorization which we’re currently operating under, we’re more than halfway done at the end of June. So there’s a potential we might be finished by the end of the year but that’s not something that we’re really trying to time.

The only thing we are making sure is that we do plan on completing it by the end of the year. And then at that point when we’re done with it, we’re going to take another look, we’ll obviously have a budget for what we expect to do next year. We’re going to continue to balance off the desire on the part of shareholders to have excess capital returned and the requirement from the rating agencies to make sure that we’re adequately capitalized. And given our outlook, given what our balance sheet looks like and our expectations going forward, we think we can satisfy both of those constituencies.

Operator

Your next question comes from Dan Johnson - Citadel Investment Group.

Dan Johnson - Citadel Investment Group

On the overall trying to look through catastrophes, trying to look through reserve releases, maybe you can check me with my math, but it looked like on a year-over-year basis that ex cap, ex reserve release combined ratio was up about 600 basis points, sort of 91 versus an 85?

John D. Finnegan

I think that’s right and that includes a little over 2 points though from the surety loss but right.

Dan Johnson - Citadel Investment Group

That’s almost 2.5 so you’re sort of rounded. It comes to around of 400 basis points up and I haven’t had a chance to get into the segments but it looks like maybe it’s coming from CCI but I haven’t had a chance really to look. Can you talk a little bit about where the uplift in the combined ratio is coming from?

John D. Finnegan

If you’re talking accident here, it’s about 4 points excluding surety and it’s a little bit higher in CCI than CPI. Of course CPI was okay. But I think that’s consistent. If you remember from the beginning of the year, our guidance called for a 4 point deterioration in our combined ratio this year and we’ve reaffirmed guidance and the guidance said that we’re calling 4 for our calendar year based on ex cap basis of course but the guidance we’re calling for at the end of the year is the same initially. So we planned for a 4 point deterioration which is basically reflects the margin erosion in the business due to continued rate declines in the area of mid single digits in both CCI and CSI.

Dan Johnson - Citadel Investment Group

On the second item, as you mentioned you’ve held your guidance stable so far year to date, the reserve redundancies have added about $0.80 along those lines. How does that compare to the reserve releases that were in your guidance?

John D. Finnegan

We didn’t have any reserve releases. We’ve talked about that on a few occasions in January and April so let me address the issue more broadly. As we said at the beginning of the year we don’t have any specific provisions for favorable development and our overall earnings guidance. This remains true in our affirmed guidance. The amount of favorable development in future quarters obviously depends on loss experience in such quarters.

In terms of individual lines however, what I said in January and April is still true. To achieve our guidance target in CSI would require some significant favorable development and professional liability. Such would not be required in our commercial, personal or reinsurance assumed lines. When you move the overall corporate level, it gets more complicated at $5.70 to $6.10 per share operating income guidance. This encompasses a range of pretax operating income of nearly $200 million and there are many ways that earnings in this range can be achieved, whether it’s by higher or lower than expected contributions from our individual business units and our different mixes of accident in year and prior year performance. So what I can say is there’s no specific reserve release comprehended in our overall corporate guidance either initially or at this point in time.

Dan Johnson - Citadel Investment Group

The surety business is a little bit cat like at times. What over a longer time period do you write the surety business to from a combined ratio point of view?

Michael O’Reilly

You really have to look a little bit at what John Degnan talked about in his prepared comments on the combined ratio over the last five years has been about 50. This tends to be a business where we’ve had many quarters that we haven’t had any losses at all and so the combined ratio tends to be around 30, which is really the expense. The nature of the business is you’re going to get these pops because unlike other classes of business that tend to be more longer, you think about them in a longer sense. There’s no IBNR reserves here so basically when you have a loss you put it up, but we really like this business going forward.

Our results relative to the industry are significantly better, we’ve got some opportunities outside the US because of our global distribution, and this is a good business. It’s certainly one of our go classes. By its nature it’s a relatively small piece of our business. You’ve only got about $350 million in premium on an annualized basis out of $12 billion so we think we’ve got plenty of room to grow it and we’ve got a good balance sheet and financial position where you can take an occasional hit. The fact that for six months the thing is still running at a combined ratio in the low 80s so overall we’re pretty pleased.

John D. Finnegan

You probably want to run it in the 80s over time, too. Given the volatility of the business. You’d probably want to run it in the low 80s and it certainly has done that over time.

Operator

Your next question comes from Matthew Heimermann - J.P. Morgan.

Matthew Heimermann - J.P. Morgan

Was there any impact on premiums from the surety loss in the quarter or any type of reinsurance pass-through?

Michael O’Reilly

No.

Matthew Heimermann - J.P. Morgan

So that was just solely production. Is there anything that’s driving that production in particular or is it just lumpy business and chalk it up to that?

John D. Finnegan

It’s a lumpy business. The first quarter was up substantially because we had a lot of pipeline projects. We saw a decline in premiums in the second quarter which I think pretty much signaled the last time around. We didn’t see the business being as robust for the balance of the year as it was in the first quarter. But it’s nothing other than market conditions, changing our appetite in some regards, walking away from a few accounts, looking for more collateral. We’ve had a little less new business in the second quarter than we’ve had in the past but that’s just all a function of good underwriting.

Matthew Heimermann - J.P. Morgan

You guys have your own commissioned scheme that you apply to all your brokers. I’m curious given some of the broker consolidation we’ve seen, does the size of a broker drive their compensation under the program?

John D. Finnegan

Well, they’d like it to but we don’t disclose specific amounts of commission either standard in the case of most of the multinational brokers or the combination of standard and supplemental guarantee commissions with respect to the others. By and large our commission philosophy is based upon both meeting market competition, the quality of the business that’s produced to the extent we’re allowed to do that through supplemental guarantee, it’s all over the lot. In some lines of business it would be bigger for some of the multinational brokers; in others, it wouldn’t. But beyond that general characterization, we don’t disclose the specifics obviously because of the negotiations we have with all the parties involved.

Matthew Heimermann - J.P. Morgan

I just wanted to make sure that we didn’t necessarily in a market where rates might be working against us have to worry about being extorted in other places.

John D. Finnegan

No, I would say we’re not going to be extorted.

Matthew Heimermann - J.P. Morgan

Can you just remind us what you’re seeing in trends outside of financial and maybe subprime related professional lines?

John D. Finnegan

In losses, do you mean?

Matthew Heimermann - J.P. Morgan

Yes, just kind of reported losses, frequencies or severities and whether there’s any noticeable change?

John D. Finnegan

Basically in professional liability we’re seeing some of the entities that track this on a global basis, Stanford and [inaudible] are reporting an uptick in activity during 2008. In our own book the overall specialty new arise counts have only increased about 2% year to date and in fact they were down 10% in the second quarter over last year’s second quarter. And those claims you’ve heard me refer to, Matt, before as severe claims that involve accounting restatements or M&A. We’re up a bit year-to-date over last year but nothing surprising to us given what’s going on out there.

Matthew Heimermann - J.P. Morgan

If anything it sounds like a bit of stability relative to what the first quarter brought.

John D. Finnegan

Yes, I’d say that.

Operator

Your next question comes from [Unidentified Analyst ] - Credit Suisse.

[Unidentified Analyst] - Credit Suisse

Just to follow up on Matt’s question, the number of claims out of subprime seem to have fallen in the second quarter this year versus the second quarter last year, is that the case?

John D. Finnegan

That’s not what I said. I was addressing the overall professional liability new arise claim features and they increased 2% year-to-date and they were down 10% in the second quarter over last year’s second quarter. We don’t break out separately the number of claims related to credit crisis. That’s an entire professional liability trend.

[Unidentified Analyst] - Credit Suisse

What is the number of claims now versus the 99 to 2002 timeframe, and why do you think that the number of claims now is lower than back then?

John D. Finnegan

I’m not sure that I’ve ever broken out the number of claims from 99 to 2002. You’re generally talking about the cluster of cases that we call corporate abuse cases. First of all, we haven’t seen the end of all the claims we’re going to receive that possibly relate to credit crisis as the crisis itself spreads. Secondly, to the extent that they do turn out to be lower, I think that will reflect the changed underwriting strategy and appetite that we have in this area of business relative to what we had in the 2002 and prior years. Remember back then we had acquired executive risk in 1999. Three years following that we had an increase in aggregate exposures because we had both the CHUBB policies and the ER policies. It’s not an apples-to-apples comparison between the two clusters of losses given the change in our underwriting strategy.

[Unidentified Analyst] - Credit Suisse

I believe you mentioned that it takes a while for these things to get settled or to be litigated. What is the basis on which you reserve for these claims?

John D. Finnegan

As always we reserve to ultimate when we have sufficient facts available to enable a claim examiner to make a recommendation of, this is on a claims basis, for what that case is ultimately worth. As you know, in this line of business we set aside a substantial amount of the original premium in IBNR against the possibility of late developing losses. So it’s a class of business where we acknowledge that the ability to get on a case-by-case basis the claims right early is very difficult, more so than in an auto or homeowners loss. So we set aside a significant amount of IBNR against the ultimate reserves that develop more slowly on a case basis. And we believe that we, as I said earlier, in these immature accident years where there’s going to be development later, we reserve conservatively at the outset.

Operator

Your next question comes from Paul Newsome - Sandler O’Neill & Partners L.P.

Paul Newsome - Sandler O’Neill & Partners L.P.

I was wondering if you could go into detail about how severity trends have impacted in commercial insurance as well as personal lines; some of the basics of what you see in terms of severity trends. People are asking about whether or not we’re going to see inflation [inaudible].

Michael O’Reilly

Generally in the commercial book we’re seeing about what the market’s seeing by way of an inflationary trend of about +/-5 points. In personal auto for example we’re a very small player. We have relatively low frequency in the quarter and only modest uptick in severity. I’m not sure how many lines of business you want me to go through exactly. We’re monitoring closely the general inflationary trends but frankly in a lot of our book the lower frequency is offsetting the impact on the losses that the inflationary trends would have and we’re keeping that balance as much as we can.

Paul Newsome - Sandler O’Neill & Partners L.P.

Is the frequency trend particularly in auto impact or are you also seeing that as well in commercial? Others have seen some pretty substantial auto frequencies.

John D. Finnegan

We’re not a good indicator for the auto business. We have a very small auto business. We had a good quarter. John, what would you say about it?

John J. Degnan

We’re around an 80s combined ratio where we’re not seeing anything that significant and whatever we see is just not a good benchmark for the big players in automobiles. In commercial I’ll say that when you look at the deterioration in accident year, it can all be ascribed to the rate decline year-over-year. That’s where you’re seeing the impacts. We’ve had rate declines of 3%, 4%, 5% over the last few years and obviously it’s apt to take a little toll on margin compression but the numbers wouldn’t indicate it’s anything more severe than that.

Michael O’Reilly

To flesh out that point I made earlier about the relationship between frequency and severity due to inflation on it, on an overall book the new arising claims in the second quarter of 08 across all lines of business decreased 9% from last year’s second quarter and they’re down 2% year-to-date. So I think it validates the point that we’re keeping them in check.

Operator

Your next question comes from Alain Karaoglan - Banc of America Securities.

Alain Karaoglan - Banc of America Securities

On the corporate and other expense, could you remind us other than interest expense is there anything else that affects that category? It seems to have picked up from the second quarter of last year.

Michael O’Reilly

Yes, there are a couple of other things in there but the main one is interest expense. Keep in mind that we issued some new debt earlier this year to early refund some debts maturing later on this summer and in addition we got the share buy-back in there so the overall amount of money available for investment which would offset any of the expenses is really down.

Alain Karaoglan - Banc of America Securities

Are there any other items that have affected the expenses going up in this quarter?

Michael O’Reilly

No, not really. There are some real estate expenses in there but that was pretty modest. So there’s really nothing in there other than normal fluctuation and like I said the interest expense was up.

Alain Karaoglan - Banc of America Securities

In terms of the surety business, in this environment given the credit issues and you mentioned you have a big appetite for it, are you not concerned that you should be a little bit more careful given the credit environment? We’ve had and it’s a high severity, low frequency business. What is your view on the construction business and why are you so comfortable to be willing to grow that business today?

John D. Finnegan

It’s clear that the difficult credit and economic environment is certainly going to affect a level of our ongoing surety business and we’re not going to underwrite outside the context of that. And it is also true the surety growth is more correlated to the growth or contraction of the business industry than most lines of business in CHUBB, so as the economy’s worsened we’ve taken on fewer new customers in the quarter, we’ve lost a few more than we normally do, we’ve trimmed our lines on some customers, and we’ve increased our collateral, but given the nature of our book we do believe that our surety customers are weathering the storm better and above the norm and have less exposure to loss than others in the industry.

That’s the quality of the underwriting that we believe is reflected. I think when Mike was talking about the growth opportunities for surety he pointed out specifically outside the US possibilities in Latin America and other places around the world where we have an increasing presence in surety. We’re going to grow the book but we’re going to do what we always do at CHUBB. We’re going to grow it if we can do it profitably and we’re not going to do it if we can’t do it profitably.

Michael O’Reilly

Let me point out one other thing in surety which I think is really important. About five years or so ago we really instituted a capital market pricing mentality in surety because after all this is a financial guarantee business, it’s not really like our normal P&C business so that’s really where I think a lot of the underwriting discipline comes into it. We need to get paid enough to reflect the underlying credit of the person that we’re writing the bond for. So this is a very disciplined underwriting process that we go through. Each account is individually underwritten and as John said it’s well diversified across several different classes but it is something that on an economic basis is fully impacted by the economy. It’s really the growth of the business is impacted by the economy and we’re mindful of the fact that we’re in a recession or in a recession-like environment anyway.

John D. Finnegan

There’s an implication, I don’t know whether you intended it or not, in your question that the loss was somehow related to the credit crisis or the poor economy and in fact this loss is not related to the credit crisis. Without getting into the details of the claim, this is a loss that probably would have happened outside the context of what’s going on in the broader economy. I don’t want to leave you with a misimpression.

Alain Karaoglan - Banc of America Securities

On unrealized losses or change in the unrealized, Mike, did you mention it was a depreciation of $55 million so would the net change from the first quarter be around $600 million, and I assume most of that is primarily due to interest rates increasing?

Michael O’Reilly

Yes, that’s correct.

Operator

Your next question comes from Joshua Shanker - Citigroup.

Joshua Shanker - Citigroup

My question concerns your appetite for reinsurance. What are you seeing or what have you seen from your potential suppliers of reinsurance, their positioning? Does it reflect the broad market or is it different and would you be a greater buyer next year?

John D. Finnegan

We tend to be a gross underwriter so we really like our book and where we use reinsurance would certainly be in the CAT categories whether it’s our overall catastrophic treaty, whether it’s in our property per risk treaty both inside and outside the US, that’s really a function of trying to dampen down volatility and really deciding how much risk we are able to bear on any particular large event. When you look at the rest of our business we think very carefully about what the economic value is of the reinsurance that we’re buying so if pricing in reinsurance tends to come down and particularly if high quality insurers bring prices down we would tend to want to buy some more and vice versa.

So at the current time we really don’t use much reinsurance other than our CAT area but certainly if pricing continues to come down might see us buy a little bit more. In fact we did buy a little bit more limit on our CAT treaty this year partially reflecting price and partially reflecting some of the mechanics of how our first CAT bond that we issued last year reset. But overall we’re very mindful of the price and that’s one of the serious things that we analyze when we’re deciding how much reinsurance to buy.

Joshua Shanker - Citigroup

You said if it keeps coming down. Is your scouting report that you’ve seen the reinsurance trends of those providing it to mimic the general market?

John D. Finnegan

Certainly the property reinsurance has held up quite well in CAT areas although it’s lower than it was last year and it’s reflected in what we actually purchased. The cost of our CAT treaty this year was for relatively similar coverage was down about 7% from where it was in the prior year. And we are seeing reinsurance offered to us on some long tail lines that would be cheaper than they would have been any time in the last couple of years. But I certainly wouldn’t have implied that it’s in freefall. It’s certainly something that on an economic basis we probably prefer to keep our book intact the way it is.

Operator

There are no further questions at this time.

John D. Finnegan

Thanks for joining us and have a good evening.

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Source: The Chubb Corporation Q2 2008 Earnings Call Transcript
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