Good morning, ladies and gentlemen, welcome to the fourth quarter and full year earnings review for Travelers. We ask that you hold all questions until the completion of formal remarks, at which time you'll be given instructions for the question and answer session. As a reminder, this conference is being recorded on Tuesday, January 25, 2011. At this time, I would like to turn the call over to Ms. Gabriella Nawi, Senior Vice President of Investor Relations. Ms. Nawi, you may begin.
Thank you, Sharon. Good morning, welcome to Travelers' discussion of our fourth quarter and full year 2010 results. Hopefully, all of you have seen our press release, financial supplement, and webcast presentation released earlier this morning. All of these materials can be found on our website at www.travelers.com under the investor section. Speaking today will be Jay Fishman, Chairman and CEO, Jay Benet, Chief Financial Officer, and Brian MacLean, President and Chief Operating Officer. Other members of senior management are also in the room available for the question and answer period. They will discuss the financial results of our business and the current market environment. Then we will open it for questions.
Before I turn it over to Jay, I would like to draw your attention to the explanatory note on page one of the webcast. Our presentation today includes forward-looking statements. The company cautions investors that any forward-looking statement involves risks and uncertainties and is not a guarantee of future performance. Actual results may differ materially from those projected in the forward-looking statements due to a variety of factors. These factors are described in our earnings press release and in our most recent 10-Q and 10-K filed with the SEC. We do not undertake any obligation to update forward-looking statements. Also, in our remarks or responses to questions, we may mention some non-GAAP financial measures. Reconciliations are included in our recent earnings press release, financial supplement, and other materials that are available on our website. Thank you, I'd like to turn it over to Jay Fishman.
Thank you, Gabby. Good morning, everyone, thank you for joining us today. We're very pleased with the results that we're reporting today, not only for what they say about 2010, but also for how they continue to demonstrate the strength of the Travelers franchise and how well-positioned we are for the future. Our operating return on equity for the full year was 12.5%, and our growth in book value per share for the year was 11%, both including or excluding net unrealized gains on our investment portfolio. Since the beginning of 2005, our average annual operating return on equity is 14.1%, and our compound annual growth in book value per share is 12.9%, or 11.5% excluding the impact of FAS 115.
Since we began our share repurchase program in the middle of 2006, we have repurchased nearly 289 million shares for $14.5 billion at an average price per share of $50.15. The shares repurchased now total approximately 42% of the shares that were outstanding at the time we began the program. We have accomplished all this notwithstanding an operating environment that over these years can only be described as complex. Positively, loss cost trends during this period have been relatively benign and have certainly contributed to the significant favorable prior year reserve development we've experienced. Negatively, the difficult economic conditions over the last three years have contributed to declining exposures, deteriorating pricing, challenging credit markets, and historically low interest rates. The industry has also faced three significant CAT years in the period, that is 2005, 2008, and 2010, and two years, 2006 and 2007, that had low levels of CAT losses.
We believe that our consistent top-tier performance over these six challenging years demonstrates a fundamental competitive advantage that we have in assessing risk and reward on both the liability and asset sides of the balance sheet. Risk selection has been a key driver of our performance over this period, and with our investments in talent and infrastructure, will continue to drive our performance in the future. In terms of the current operating environment, Brian will take you through it in more detail. Given some of the trends we saw in the fourth quarter, we are somewhat more optimistic than we were a few months ago. In business insurance, exposure changes, one element of demand for our product, was positive for the first time in nine consecutive quarters.
With respect to pricing, as we've shared with you previously, renewal pricing in business insurance has been about flat for most of 2010, results that are obviously better than those that have been reported in the CIAB surveys. In the fourth quarter, renewal pricing in business insurance not only improved versus the third quarter, but also within the quarter as the months progressed. While these comments are not intended to forecast future pricing, these results suggest that our pricing strategy is beginning to have some traction, and we hope it continues. Given our strong retentions as well as the new business and account growth we've achieved over the last few years, we have significant positive leverage to an improving environment. The final thing I'd like to leave you with, and again, Brian will take you through the details, is our performance and position in personal insurance.
In our agency homeowners business, we grew policies in force by 3%, and despite the significant CAT activity during the year, we delivered a combined ratio of 95% for the full year. Let me spend just a moment on what that performance really indicates. The 95% combined ratio that we posted reflects 15 points of CAT losses for the year, as well as the impact of some favorable reserve development in the line. But even excluding the impact of favorable prior year reserve development in the line, we would still be well under a 100 combined ratio. We believe that this performance meaningfully demonstrates the success of our homeowners strategy. In our agency auto business, we grew policies in force by 2% and delivered improved profitability, posting a combined ratio of 97%.
Personal insurance now represents 35% of our net written premiums. We're pleased with what we have achieved and optimistic for what we believe we can continue to deliver. To conclude, we're confident in our ability to select and manage risk regardless of the operating environment. We're hopeful that we'll see an improving operating environment in Business Insurance. We're pleased with the solid performance in Financial, Professional, and International businesses. We're optimistic for our prospects in personal insurance. With that, let me turn it over to Jay.
Thanks, Jay. I'd like to start with a few overall comments about fourth quarter and full-year results, as shown on pages four through seven of the webcast. Fourth quarter operating income of $864 million was lower than our very strong fourth quarter of 2009, in which we earned $1.155 billion. There are a few easily understood reasons for this. Favorable to prior year development was higher by $100 million after tax in last year's quarter. CAT losses were lower by $45 million after tax in last year's quarter. Fourth quarter 2009 included the benefit of a favorable re-estimation of current year loss ratios for the first three quarters of 2009, amounting to $52 million after tax.
The current year quarter included costs of $39 million after tax, which reduced fourth quarter fully diluted operating income per share by $0.09, related to our purchase and retirement of a large portion of our hybrid debt. Operating results excluding the impact of these items and including net investment income remained in line with our original expectations, taking into account normal quarterly fluctuations in non-CAT weather and large loss activity, as well as the timing of expenditures. We had another quarter of net favorable prior year reserve development in each of our segments, concentrated once again in BI and FP&II. Although somewhat higher than in the prior year quarter, CAT losses in the current quarter were lower than what we would normally plan for. Finally, fourth quarter operating ROE was 14.5%.
Turning to the full year, the very large CAT activity during the first half of the year resulted in significantly higher catastrophe losses as compared to full year 2009. The significant increase in full year CAT losses, coupled with slightly lower net favorable prior year reserve development and the cost of purchasing and retiring our hybrids accounted for almost all of the reduction in full year operating income as compared to 2009. Book value per share, while down 1% in the quarter due to the recent rise in interest rates, was up 11% from a year ago. All of our capital leverage and liquidity measures compared favorably to our target levels. Some additional items are also worth noting.
Given the historically low interest rate environment in the early part of the fourth quarter, we issued $500 million of 10-year 3.9% senior notes and $750 million of 30-year 5.35% senior notes, using $885 million of the proceeds to purchase and retire the more expensive hybrid securities we had outstanding. We ended the year with holding company liquidity of $3.6 billion, more than three times our target, due to strong earnings and the timing of dividends from our operating companies to our holding company. Our earnings strength, coupled with the strength of our balance sheet, allowed us to significantly increase share repurchase activity in the fourth quarter.
We repurchased $1.6 billion of our common shares during the quarter, bringing total share repurchases for the year to $5 billion and leading our board to authorize another $5 billion of future share repurchases in addition to the $1.5 billion remaining under the prior authorization. Overall, for the full year 2010, the total cash we returned to our shareholders through share repurchase and dividends amounted to $5.7 billion. Our strong holding company liquidity and operating company surplus enables us to plan for 2011 dividends and share repurchases that we expect will be well in excess of projected 2011 operating income. A simple way for you to estimate our 2011 share repurchases would be to start with your estimate of our after-tax operating income and add to it our additional capacity for share repurchases, which we currently estimate to be approximately $1.5 billion.
This, I should stress, is in addition to our normal dividends. Remember, we're not saying that our share repurchases will only be $1.5 billion. Rather, we expect share repurchases will be the total of the $1.5 billion plus estimated operating income. Total dollars to be returned to shareholders will therefore be this amount plus our dividends. Hopefully, this is clear. I remind you that any time we provide information concerning future share repurchases, we're assuming no significant changes in the operating and investment environments, relatively normal CATs, and no prior year reserve development, among other assumptions. I'd also like to make a few comments relating to page eight of the webcast.
During the third quarter earnings call, I referred to the historically low interest rate environment and provided an illustration based upon our investment portfolio's scheduled bond maturities in 2011, 2012, and 2013 of the impact on net investment income in those years if the then current interest rate environment persisted through 2013 and all other variables, such as average assets, mix, credit quality, and duration, remained constant. Since then, interest rates have risen by approximately 75 basis points. I've updated the illustration for you. As can be seen on page eight, the projected reduction in net investment income, as calculated in the updated illustration, is even less than in the prior illustration, which was not large to begin with. Please note, I don't plan to update this information going forward. With that, I'll turn things over to Brian.
Thanks, Jay. Consistent with last quarter, I will not be going through all the webcast slides, but we'll take any questions you may have on the disclosures on pages 11 through 22. Instead, I will share some perspectives on our business and the marketplace. In short, I'll make three basic points. In Business Insurance, we're beginning to see early signs of improving market conditions. In Personal Insurance, we're bullish on our business. In Financial, Professional & International, we're pleased with our underlying results given what is still a dynamic and challenging environment. With that as a backdrop, let me give a little more detail. In Business Insurance, we continue to be pleased with our overall production results this quarter. Account retention remains strong. We've seen exposure trend positive, and we continue to see strong new business flow.
On the pricing side, you can see on slide 10 that the fourth quarter saw us post the first positive renewal premium change since the first quarter of 2007. The result of all of this is an increase in gross and net written premium year-over-year. The favorable trends in exposure that we have previously observed have continued to the point where renewal exposure turned positive during the quarter. On slide 11, we have graphed our exposure change by quarter from 2006 to the present. Exposures began to drop in late 2008 as the economic downturn began. The decline accelerated into early 2009 and began to moderate throughout 2010. Based on the positive change in exposure in the fourth quarter of 2010, it appears that the impact of the decline in economic activity on our Business Insurance clients has bottomed out. We're seeing some firming.
On the rate side of renewal premium change, while the rate change was slightly negative for the quarter, we've seen a subtle shift in the pricing environment within the quarter as the market seems more receptive to rate increases. We are hopeful that this pricing trend will continue. Our underwriting margins for the quarter and full year, after our typical normalizing adjustments, were consistent with our expectations and continued to show modest compression due to loss cost trends slightly outpacing earned rate change. The solid results that we continue to see in this segment demonstrate the value of our underwriting strategy that we have articulated a number of times. That is retain our quality business, optimize the profitability on this retained book by getting rate where appropriate, and write new business wherever we see an acceptable balance of risk and reward.
As we begin to see a turn in the broader economy, we believe sustained, focused execution of our strategy will allow us to deliver on our commitment to continued growth and profitability. For Personal Insurance, I want to follow on Jay's comments to emphasize how positive we feel about this business. Having a robust Personal Insurance franchise with a strong agency channel is a competitive advantage and sets us apart from many of our key competitors. Both our Personal Auto and homeowners and other products have delivered outstanding growth in margins in an especially challenging economy. In fact, in 2010, Personal Insurance delivered record earned premium and policies in force. In our Agency Auto Business, we achieved meaningful growth in a stagnant market while simultaneously improving on our already strong underwriting margins.
New business growth was up significantly over prior year, which coupled with solid retention led to a 2% increase in policies in force from a year ago. Margins increased both for the quarter and the full year, resulting from continued discipline with our pricing and underwriting strategies. Our strong margins in this business position us well for continued success in a highly competitive market. Similarly, we feel great about our agency homeowners and other results. Although new business is down slightly from the fourth quarter last year, retention and renewal premium change were both up, leading to substantial growth in top line and policies in force. Adjusting for catastrophes and prior year development, we saw full year underwriting returns improve from 2009 as earned rate actions exceeded loss cost.
Given the uncertain economy and, in particular, the weak housing market, we are very pleased with our results and believe we are well positioned in this market. Turning to the Financial, Professional & International Insurance segment, net written premiums were down in the quarter, driven by several factors. First, the continued sluggishness in the economy, and particularly the impact on public and private construction spending, has significantly affected the volume of surety business in the marketplace. Second, primarily as a result of a challenging rate environment, we've scaled back the property exposure in our Lloyd's business. Third, in Ireland, we ended an exclusive relationship with a distribution partner in the fourth quarter. International growth remains a key investment area for us. We continue to look for opportunities in our existing footprint as well as in emerging markets.
In that regard, we're very excited about the joint venture in Brazil that we announced in November. Alan Schnitzer will speak to that transaction in a few moments. Excluding prior year development, margins in our international business for the quarter remained relatively flat year-over-year. In bond and financial products, we continue to see a challenging growth environment. As I said, in the surety business, the economy is resulting in a lack of business opportunity, but our margins remain strong. In management and liability, not unlike our business insurance strategy, we remain focused on executing a disciplined underwriting approach of retaining the quality business, getting rate where it's needed, writing new business wherever we see an acceptable balance of risk and reward, and positioning for growth when it makes sense. In summary, we feel great about the execution across all our business segments and how we are positioned going forward.
By maintaining our underwriting discipline and commitment to invest in and maximize the long-term value of our portfolio, we've continued to deliver solid results while at the same time expand our ability to deliver future growth. With that, let me turn it over to Alan.
Thanks, Brian. As you may have seen in November, we announced that we had entered into a joint venture agreement under which we will invest approximately $370 million, or 43% of the common stock of J. Malucelli, the market leader in the surety business in Brazil. We have an option to increase our interest to 49.9% within 18 months. Investment in newly issued shares will significantly increase J. Malucelli's capital level, positioning the joint venture for substantial growth. We currently expect the transaction will close in the first half of this year. We've been carefully considering our emerging market strategy for some time, and we're very pleased with this investment as a first step.
We view it as a significant opportunity for us to leverage our leading U.S. surety franchise to enter one of the fastest-growing insurance markets in the world, to do so with the benefit of a local market leader. In addition to the surety opportunity, we believe that the combination of our broad insurance expertise with J. Malucelli's established distribution network and customer base gives us an exceptional platform for expanding into the growing P&C market in Brazil. We've known the leadership of J. Malucelli for a number of years, we have the highest regard for them. The opportunity to be in business with them was a key consideration for us. They've built a great franchise by knowing their customers and through disciplined, analytic-driven underwriting, much the same way we built our business. Importantly, we share a common ambition for profitable growth.
With that, I'll turn it back to Jay Fishman.
Thanks, Alan. Before we open it up for questions, I just want to take a minute to echo the comments that Alan made a moment ago. We're very pleased and proud to be partnering with the Malucelli family in the Brazilian venture. We couldn't pick a better partner to have, we firmly believe that our business philosophies are remarkably compatible. I'd just like to personally send my best regards to them and let them know how excited we are about our future together. I just want to take a moment to thank all the Travelers employees who participated in the due diligence. It was hard work, it was all very well done. With that, let me turn it back to Gabby.
Thank you. We're going to open up for questions. Before we do that, if I can ask callers to please limit yourself to one question and one follow-up so that we can get to everybody. Thank you. Sharon, we're ready to start Q&A session, please.
Thank you. Ladies and gentlemen, if you'd like to register a question, please press the one followed by the four on your telephone. You will hear a three-tone prompt to acknowledge your request. If your question has been answered and you'd like to withdraw your registration, please press the one followed by the three. If you're using a speakerphone, please lift your handset before entering your request. One moment please for our first question. Our first question comes from the line of Jay Gelb with Barclays Capital. Please proceed with your question.
Thanks, good morning. I'll give you the two questions up front if that's okay. The first is on the municipal exposure. The impact of the marks was somewhat better than we were modeling. Perhaps you can talk a little bit about that in terms of how you're marking the municipals and how you're thinking about that investment class broadly, given what's been going on in the past couple of months. The other question has to do with the share buyback. Our sense is Travelers could buy back around $4 billion in stock in 2011. If we look back at what was originally offered for guidance in 2010, the original starting point was $3.5 billion-$4 billion. Ultimately, it ended up at $5 billion. I'm just trying to get a sense of what might give upside to your initial view on buyback activity. Thanks.
Jay, Bill Heyman . The first question, in terms of how we mark them, they're marked independently. We obviously don't pick our own prices. To the second, if you look at the fourth quarter change in mark-to-market, about 80% tracked the mark-to-market of Treasuries. What remained wasn't very large. We attribute that to the high credit quality of the portfolio. As was always true in the high-yield market, it has now become true in the municipal market that the biggest single determinant of prices is the flow of cash in and out of municipal bond funds. Those flows exhibited a lot of volatility in the fourth quarter. What is interesting to me is when municipal bond funds sell holdings in bulk to raise cash, they circulate bid wanted lists, which we see through the dealers. We comb them for opportunities.
We rarely find bonds that are on our list of bonds approved for purchase. When we find one, we rarely find it at a price we're inclined to pay. That means to me that we've set the bar pretty high, which in times like these is good. In terms of the news that has dominated the press in the last quarter, and really going back further than the last quarter, I guess I would say some of it's news and some of it isn't news. That state and local finances were stressed has been known to every serious institutional participant in the market and has informed our investment decisions for five or six years, not just recently. It may be news to the general public. That has had good consequences.
It has led state and local officials to confront these problems in the last three or four months in a way that hasn't been evident before. Perversely almost, we're encouraged by what we read.
As we were chatting about this before, Jay, in respect of your question relative to the index, I think the three principal differences are the mix of securities that we hold relative to the mix that are contained in the index. Two, our duration is shorter than the duration of the index. The third piece, and probably the least significant of the three, but nonetheless meaningful, is that the credit quality of our portfolio is at a different level than the credit quality of the overall index. Those who have been using the index to make estimations of change in market values are going to get inaccurate results.
Yeah. As to the question on the share repurchases, just going back to last year, and when we originally provided some guidance as to what we thought the share repurchases were going to be, it was based upon what we thought our earnings would look like, as well as the starting capital and cash positions that we had at the beginning of that year. To the extent we increased the amount of buybacks, it was a refinement of both of those parameters. We saw earnings that included favorable prior year development last year. We hadn't considered that, of course, in our earnings guidance. To the extent we have favorable development that adds to our earnings, we adjust our buybacks accordingly. We'll continue to do that going into the future.
As it relates to the capital position at the beginning of this year and the cash position at the beginning of this year being 2011 now, we factor in where our operating company capital is, what the holding company cash is. I point you to the item that I mentioned earlier. We do have $3.6 billion at the holding company that allows us to look at share repurchases in excess of what we think our current year operating income is going to be. All those things are factored into the estimates that we provided, Jay, and I hope that fully answers your question.
It is. Thank you.
Our next question comes from the line of Keith Walsh with Citi. Please proceed with your question.
Hey, good morning, gentlemen. First question, just within the release, you mentioned that the loss ratio modest potential modest increase in 2011. If you could give us a little more color around that, and then I've got a follow-up.
Yeah. Keith, this is Brian MacLean. It is really just the simple arithmetic of on the loss trend side, we are expecting what we have been seeing, which is frequency running at near flat levels, which is good.
That doesn't mean zero. That means not changing from current levels.
Right.
Yeah.
Right. Frequency change. Right. Severity trends running somewhat consistent with inflation, and that is low single digit loss ratio impacts. Across the commercial business, very modest earned rates. The net of that would be a slight margin compression. The personal insurance dynamic, a little different. Greg, why don't you just kind of run through the same things for auto and home?
Yeah. For automobile, we are certainly seeing a contained environment from frequency, a little offsetting pressures on severity, but you see our RPC is offsetting those loss trends. On the property side, just due to the volatility of that line when we normalize some of the peaks of the weather, we are seeing frequency relatively flat in the low single digits and severity upward in the higher single digits. You see our two consecutive quarters of RPC of 9%, so we feel good about both products inside the personal lines portfolio.
Again, just to make sure we say it in English, in the personal insurance business, we would anticipate expanding margins.
Correct. Yeah.
In the Business Insurance line, we expect modestly contracting margins.
Right.
Okay. That's really helpful. The second question, just going back to munis. If you could just mention, talk to if we saw a rating agency downgrade on a bond, would that trigger a loss? Thinking about there's a lot of talk about states declaring bankruptcy. What would the implications be there? Finally, spread opportunities must be actually quite attractive for new money right now. How are you thinking about that? Thanks.
With respect to ratings, as you probably know, in the last year or so at probably not the best moment, municipal ratings were pushed upward so that a given rating implied the same probability of default based on history as it does on the corporate side. Yes, we watch the ratings carefully for downgrades, but we attach less importance to them than outsiders might think. Yes, we like the aggregate credit rating of our portfolio, but it would be very easy to construct a portfolio with the exact same aggregate credit rating, with which we were very uncomfortable. We're not slaves to the ratings. When ratings change on either the municipal or the corporate side, the first take we do, certainly the first take I do, is, does this mean that the probability of the instrument being money good is significantly lowered?
If not, we generally stick with it.
This is Jay Fishman. Let me cover briefly the issue of the potential change in bankruptcy. Those who don't know, there's been some chatter in a New York Times article last week reporting on some consideration about amendments to the Federal Bankruptcy Code that would allow states access to it. Right now, the states don't have such access. It's obviously an extremely complicated issue, both legally as well as politically. As we parse through it a bit, there are, in addition, serious issues of constitutional law, it's not at all clear really what people are actually discussing and therefore what the implications might be. It's been interesting to us over these last few days to listen to a few states actually reject the notion that even if such an access were provided to them, that they would seek it.
It reminds me a little bit like taking a horse to water, but not necessarily getting them to drink. We'll watch carefully as to what happens. Let me just make a couple of points which I think really are relevant. First, there seems to be this bias amongst even sophisticated people to view municipal securities are all the same, as if somehow we own some pro rata share of an aggregate monolith marketplace, and that's just not the case. Everyone understands that in the taxable fixed income world, the issuer and the specific terms and conditions of the instrument matter, that's equally as true in the municipal arena. In fact, something that's not often understood is that a significant portion of our municipal portfolio is actually secured by a pledge of specific revenue streams.
By the way, in the context of municipalities that do have access to the Bankruptcy Code, the view is that those pledge of specific revenue streams would survive a bankruptcy filing, and in fact, those securities would continue to be paid in the ordinary course. Of course, that's an assumption that that same condition would hold true at the state level if the states were allowed such access. We'll watch this carefully, and it'll always, as Bill spoke earlier, affect our view of risk and reward. When we think that there's some change that we ought to be making in the portfolio, we'll make it. Let me close with a little bit of data that perhaps you'll find interesting, which is, to Bill's point earlier, this is not new news to us.
It's an issue and a concern that we have been watching for a very long time. If one takes the 10 states that at least our analysis suggests are the most challenged, whether that's through pension or medical liability, medical payments, or debt obligations, we own an aggregate in all of those 10 states, and this is excluding pre-refunded bonds. We own an aggregate of $1 billion of state-issued general obligation bonds in those entire 10 states. That represents 3.1% of our municipal portfolio. In terms of maturity, about 23% of that billion dollars matures in the next three years, and about 46% matures in the next five years.
Even if one looks at those states that have been spoken about in the press or those that people view as being challenged, our position with respect to those states is actually modest relative to the entire portfolio, and it remains an area where we watch and look carefully.
Our next question comes from the line of Greg Peters with Morgan Stanley. Please proceed with your question.
Thank you. Good morning. Wanted to just explore within the presentation that it looks to me like you guys are now getting rate across most of your business lines, just raw pricing. I wanted to sort of tie that to your assumption with regards to the margin outlook for this year. What is the disconnect there? It seems to me that if rate is going up, which I think is different than expectations, why would margins be going down from a loss perspective?
Greg, this is Brian again. Just to work backwards a little bit, but to say it. Personal line, simplistically, we are clearly getting price, and we believe margins are expanding a little bit. The question I assume is on the commercial, the business insurance side.
We can do that
I think you can see the numbers that first of all, the rate that we're getting on a written basis is pretty modest at this point. Think of less than a point. Actually, the renewal rate for the quarter on page 12 is still a fractionally negative number. We're looking at modest improvement. There's also an earn dynamic here. Where if you look at what's going to earn through the income statement as the year plays out, it takes a few quarters. Even if that starts to ramp up, it's going to take a few quarters to have that have an impact on the P&L. When we look at some modest rate and pick whatever number you want, but two, three, whatever loss ratio points of pressure from the loss side, it nets to a modest negative.
Okay, there's nothing in your book that you're seeing in particular that has changed.
We tried to pick the right words, we think subtly, in the fourth quarter, we saw some lift in as we went through the months of the quarter, some lift in the commercial pricing environment. Also we talk a lot about we're a disciplined company. We talk about the numbers. We also do talk to our people, talk to brokers, talk to agents, talk to customers. So we have a mood, and that mood seems to be marginally more positive or less negative, however you want to say it, in recent months, and we're encouraged by that.
Greg, as I explained in my comments, written renewal rate in Business Insurance for the year was about flat. That written rate is going to convert to earned as we turn into 2011. We still anticipate, as we always do, a loss trend that has some lift to it. If you've got flat earned rate and some loss trend, you've got slightly compressing margins. Our hope is, as I said earlier, that what we saw in the fourth quarter continues. It's not a prediction, if we saw in the fourth quarter and that line continues, one can anticipate getting to positive rate on a written basis sometime in 2011. Obviously, that will get earned in the following months as well. It's predominantly what's happened over the last 12 months defining what will be recorded over the next 12 months.
Excellent. Thank you. Just to shift gears and last question is, at the holding company level, the liquidity jumped considerably sequential. Did you all do a special dividend through the quarter? How much, and how can we, from the outside sort of think about that going forward? Because you've been great in terms of the capital management visibility into this year, the one thing we can't see is what you're taking out of the subs and the willingness to do that.
In some respects, you can see it if you take a look at the statutory surplus levels that we describe in the supplement. That won't give you a reconciliation, but it'll at least give you a feel for what the subs are carrying. To your specific question of in the fourth quarter what did we do? We did take out dividends out of the operating companies. Given the size of the dividends, we did require regulatory approval, which we got with no issues whatsoever. We have good relationships with the states. We're very forthcoming in terms of what our levels are, what our plans are, and we took out about $2 billion in the fourth quarter, brought it up to the holding company, and ended up, as I said, with operating company capital that for all our operating companies, we're at or above our target levels.
Okay, did you take about $3 billion out as in 2010 then in total?
It was actually more than that.
More than that. Okay, excellent. Thanks, guys. Great quarter.
Our next question comes from the line of Cliff Gallant with KBW. Please proceed with your question.
Good morning. I was interested in the Brazilian joint venture, just wondering if this is a sign that perhaps you're more interested in international expansion generally. What is your appetite for international acquisitions?
Cliff, we have talked before with you all about having an interest in what I would characterize as a fairly limited number of developing markets. We've talked about having an interest in developing a joint venture in India. We actually were in the preliminary stages at one point and had identified a partner there, ultimately concluded that the partner's business interests and their business philosophies were not compatible with our own, and we broke that off. We still have a desire to enter into a business relationship in India. 1.3 billion people with an economy growing at 9%-10%, more for the next generation of leadership of this company than the one that's here now. You've just got to believe that that will eventually turn into a very robust insurance market and one that remains nascent, tiny by any standard, and very much up for grabs.
We want to be there. The Malucelli situation was really very opportunistic, and it really came about because of an outreach from the folks in Brazil, and I'll have Alan speak about this, the Malucelli group reaching out to our surety business, obviously the leading by market share surety business in the U.S., to talk about learning about doing business together, and out of that grew this opportunity.
Yeah, that's right. We've been thinking about the emerging market opportunities for some time and evaluating what might be best for our first step. As we were spending time in Brazil, the Malucellis reached out to us. Just given the really high compatibility of operating philosophies and ambitions, both short-term and long-term, it just seemed like a great opportunity for us to make a first investment in the emerging markets. We'll continue to look in other emerging markets and evaluate those opportunities over time as well.
It's not a global ambition. Our view is that our goal is to create shareholder value by producing mid-teens return on equity over time. Whether we do that with more in the emerging markets or a little less in the emerging markets, we always keep in mind what our target is. We don't have any ambition to be a global company. We will look for our spots in the international arena very carefully, where capital can be deployed at a reasonable level of risk, but the projected returns are commensurate with the risk that one takes on. Again, tying it right back to where I started my comments this morning, a thoughtful evaluation of risk and reward. It's not about size.
As Brian mentioned before, we like our existing footprint, and we'll continue to look for opportunities to leverage our extensive U.S. product set in those geographies as well.
Thank you very much.
Our next question comes from the line of Matthew Heimermann with JP Morgan. Please proceed with your question.
Hi. Good morning, everybody. Two questions. First, when you think about your outlook or your hope for pricing and loss costs in 2011, can you just maybe give us a handicap of whether or not you think the risks are more to the upside or the downside in terms of how you might be surprised on rate and loss cost? The second question would be on workers' comp. Was wondering if you could just give us an update on some of the trends you're seeing, both in the loss sensitive side of the business as well as the guaranteed cost side.
With respect to the first question, Matthew, I think the only way I can respond is to look back historically, which is that over the last several years, loss trend has been less than we had assumed it would be. That's happened in large measure because frequency was less than we had assumed it would be, but also because inflation has been, from a severity perspective, has been quite benign. That's been the trend over the last four or five years. I'm not an economist, and I'm not going to attempt to make any predictions or forecasts.
Relative to pricing, we've been pretty transparent about what our pricing strategy has been, which is that we've been attempting to get rate where we need it, that's especially true in circumstances where an account's loss experience has been inconsistent, which that which we anticipated or projected when we underwrote the account. There's nothing new about our pricing strategy. It was just interesting to us that in the fourth quarter, it was more the market. I hate to use that phrase because it always sounds like our pricing strategy is not active. It's a very active one. We were able to affect that pricing strategy with greater success than we had previously. I think that's the answer on that.
The one thing that is interesting is if the exposure projections are what they are, if you look at what's happened to exposure over the last 12 months, it's not too hard to project a line of increasing exposures into 2011. That, given the account growth that we've had over the last several years, would be a nice factor. That's the best way to sort of assess it, I think.
Matt, this is Brian on the comp side. I'd start by saying our data would say we've been pretty good in this business. Our combined ratio for a good number of years has run a fairly significant favorable delta to the industry, we think that's due to a real disciplined selection process. That's by industry, that's by state. Secondly, we believe we've got a real claim advantage in how we manage those claims, both the lost time and the medical dimension to that. We feel great about our comp book. With that said, there are clearly pockets of heat coming through comp line, there are certain states and certain environments that have become more challenging, we're watching those closely.
The favorable side there would be that it's probably the line that's got a little bit of pricing energy to it, we hope that that will continue. I'll throw it to Bill Cunningham. I don't think we're seeing anything fundamentally different on the guaranteed cost versus the loss sensitive book.
Let me just ask, I interrupt, because you used the phrase pockets of heat.
Yeah.
That has a certain energy to it. You want to expound on it just a little bit?
Sure. As we looked at our workers' compensation approach, we're looking at it state by state, industry by industry. As we look at some states, given some jurisdictional issues, we see more pressure on loss, as a result of it, we see more need for a raise. We're not going to get into our individual state strategy for competitive reasons. In those states where things have been heating up on the loss side, we have been getting more rates. Again, on an overall basis, we look at the line and we make very thoughtful overall decisions because at the end of the day, it all boils down to individual risk decisions.
Going into guaranteed cost versus loss responsive, I guess the one comment I would make is the larger loss responsive buyers in terms of economic impact, that business gets impacted both based on payroll as well as losses. As loss experience in general for the line, frequency was dropping on some of those larger risks. We met that large loss responsive business. We put our fees under management. That's where that pressure came from as exposure was down even more on the larger loss responsive business. If you look at that trend now, that's actually starting to bottom out as well. We're starting to see the large loss responsive business start to flatten out on the exposure side as well.
Okay. That color is helpful. Thank you.
Our next question comes from the line of Mike Manici with Goldman Sachs. Please proceed with your question.
Thanks. Just one first question on the direct-to-consumer business in personal lines. About three points, it looked like three expense ratio points there. It's a bit more than last year. Can you just kind of talk about how that build-out strategy works? Is it kind of a stairstep function as you allocate resources, or was that advertising that you kind of paid up front in the fourth quarter? I just have one follow-up. Thanks.
Yeah. Those questions are actually more specific than even, not that I'm willing to respond, but we're capable of responding to. This is a long-term program, and it will take years for us to develop a direct-to-consumer business that meets our own profitability and return thresholds. We are still in the early stages of the learnings that we have to go through. Those learnings extend all the way from how to drive a customer somewhere, whether to a call center or to a website, and then how to get them through the process, convert to a quote, and then convert to a sale. These remain the early days, and the loss that we're experiencing in that business is about what we expected it would be, because that's how we're planning it. Our mindset is to incur that loss which is necessary to maximize the learnings from the experience.
It's really driven more by what do we have to learn than we have to of what do we need to spend. The encouraging thing, and there are some encouraging things. The encouraging thing that we've discovered about the direct-to-consumer business is that we're increasingly pleased with the customer that's responding to the Travelers' solicitation, whether that's through direct mail or digital media, or through a broad-based media. We understood generally, at least we thought we did, what kind of customer responded to the existing direct-to-consumer businesses. We weren't sure what our brand name and our value proposition brought to the market, and therefore, who the customers were who would respond, and who the customers were from a socioeconomic perspective that would ultimately respond to the proposal. We're encouraged by that.
What we're seeing are young versions, at least we think, what we're seeing are young versions of our future independent agent customer. That just fits hand in glove. We're at the early stages of it, and we will lose that which is necessary to keep the learnings moving in the right direction and maximize the long-term business opportunity.
Great. Thanks, Jay. That makes a lot of sense. Just one question, Bill, if I could. Back to munis just for a second. I realize most of the movement in pricing in the fourth quarter was rate related, driven by treasuries. Where would that be today, if we were to think about where a sort of mark would be today, given some of the volatility, at least so far this quarter? If you think about that book and these potentially just temporary rate or technically driven price changes, how does that impact your thought process around buybacks, if at all? I appreciate that. Thank you very much.
Well, in terms of where the portfolio is this month, it would be hard for me to make a guess. My guess is very little change because most of the appreciation or depreciation is correlated to treasuries. On the 24th of the month, I wouldn't hazard an estimate of the month-to-date progress.
Yeah, as far as the buybacks, it really doesn't factor into our discussion about buybacks at all. As I said before, we don't take great pleasure in seeing the unrealized gains in the portfolio at any particular level and say, "Gee, this is great. Let's go buy back more of our shares and want to change it.
Right.
It doesn't really enter into it.
Okay.
Specifically, the mark-to-market in the bond portfolio, whether municipal or taxable, is not a capital item. The mark-to-market positive does not add to capital, and the mark-to-market negative does not delete from it. We're driven very much by earnings and cash flow and the ability to realize excess capital from the balance sheet. That's what drives us.
Great. Thank you very much.
Our next question comes from a line of the name Quiz with Credit Suisse. Please proceed with your question.
Hi. Good morning. The first question is for Bill Heyman. What percentage of your municipal bond portfolio do you actually manage to get quotes from the market? Or is it just based really based on interest rates because it's an illiquid market?
It's based on more than interest rates. In terms of what percentage we get dealer quotes, I wouldn't say the portfolio is 90-something% in, I guess, what is called Level Two pricing, whatever that implies, which is sometimes dealer quotes. For what it's worth, we have a lot of confidence in the liquidity of this portfolio. We rarely see these bonds put up for much of what we own, put up for sale. When we do at an attractive price, we snap it up. We think similarly, if we had to realize liquidity from it, even on a large scale, it would not be very difficult.
Okay. Second question is on the personal lines. You managed to improve the profitability in 2010 versus 2009. Where do you see profitability going in 2011, both on the homeowners and on the auto side?
I'll ask Greg to comment, I think we've already answered the question, which is we actually expect widening margins, meaning lower combined ratios in both the auto as well as the homeowners business, driven by earned rate gains that will exceed loss trend. Is there anything specific you want to add to that?
The only thing I'd add is that's obviously based on the loss trends that we're watching today that has so much to do with miles driven, and as those things change, we'll change our pricing philosophy also. Those are the assumptions we're working with right now.
Weather will be weather.
Yep.
Yes.
Okay, that's great. Thank you.
Our next question comes from the line of Paul Newsome with Sandler O'Neill & Partners. Please proceed with your question.
Good morning. Thank you for the call. Do you think you're gaining share in personal lines, to focus on that a little bit, or is it exposure gains? If you are gaining share, and it does look like that to me, could you maybe think about or talk about where it's coming from in that business?
Yep, absolutely. This is Greg Toczydlowski. We do believe we're gaining market share when you look at our unit growth and our top-line growth. When we look at the source of that business, we look at that at the very local level. There's over 1,000 competitors in this marketplace, so we have regional players. Predominantly, when we look at the agency business or even in the direct channel, the thrust of our new business is coming from non-independent agency type carriers. Again, we watch that very locally, and we'll continue to do that, but we feel good about our market share expansion in that product line.
Non-agency, independent, that's basically career agency systems, right?
It could be captive, it could be career, it could be direct. When we look at our new business flow and we ask who the prior carrier is, and that is an underwriting question that we ask, a significant percentage are moving from non-independent agency channels, direct captives, career such, into the independent agent channel.
Okay. Thank you. I may be just missing something. Completely separately, I was looking at sort of the other investment category. This may be a Jay Benet question. It looked like the book yield fell significantly, but the gross investment losses were up significantly. Am I sort of missing something? Is there some reason why the book yield would go a different direction than that?
Maybe I'll take that offline with you. We're not sure we understand the question here. Maybe we can get to the next question. I'll give you a call after the call.
Sure.
Great. Thanks.
Our next question comes from the line of Larry Greenberg with Langen McAlenney. Please proceed with your question.
Good morning. I guess my simple question is, what's your level of confidence that what you saw in the fourth quarter in business insurance really marked kind of an inflection in the operating environment?
No declarations here, Larry. Sorry. One quarter does not a trend make. It's interesting, it's encouraging, it's consistent with the strategy that we've brought to the market. Our share of the business, while significant, is not sufficiently large to be a price leader. We do what we do, and competitors react, and they'll react independently, and we'll see where we go. I don't know.
Fair enough. Thanks.
Okay. Operator, this will be the last question, please.
Our next question comes from the line of Jay Cohen with Bank of America Merrill Lynch. Please proceed with your question.
Thank you very much. Two questions. The first is, when you look at the claims frequency and you describe the environment as still fairly accommodating, are you seeing any early signs of a change there? That obviously has been a pretty important factor in the profitability.
The short answer is nothing.
I'm looking at Brian because two really separate questions. We experienced a number of years where frequency was declining in many lines of business, and over a period of time here, that has leveled out. I certainly would not say to you that frequency is continuing to decline.
It may, but it's not what we're seeing at the moment. What we are broadly seeing, and it's very much a function of individual line of product, is flattening of frequency. I don't know, other than in the little area that Bill Cunningham was speaking about in workers' comp, if there's anything, and even that was small. I'm just trying to be very thoughtful about the response.
Right. To your point, a couple of years ago, comp frequency was falling dramatically.
Falling down.
That clearly has mitigated.
Yeah.
For the last year, it's been very stable.
Great. The other question was on exposure, and I'm wondering
What are the key things driving it? I'm assuming it's mostly just payroll and revenues at your insureds going up.
The biggest driver is business receipts, and the second driver is payroll. Most of our liability products are rated off of business receipts, and as those have rebounded, or actually, the right words would be as those were falling less throughout 2010, the exposure change was less negative, and it's back up to a slight positive. Then payroll is a piece of it.
It's important to remember, Jay, though, that these are estimates that our insureds are making about the next 12 months.
Yes.
At policy renewal, they make estimates of payroll and sales and square footage and trucks on the road. The first thing that we're seeing here, interestingly, is a change in the sense of optimism about the insureds themselves. They see a projected change in exposure. Of course, we come back in at the end of the policy period, we do an audit, and we make a determination of what the actual exposures were, and we bill accordingly. We have had negative audit premiums for the last several years, which really speaks to how rapidly and how deep the decline in the economy was because it actually exceeded the expectations that the insureds have. Now, sort of first derivative, interesting to see that insureds are beginning to have a different view of what their business prospects are.
Now we'll see ultimately what the real numbers end up being as the months go on and we're able to go back and begin to do audits. If we get back to historical patterns, most importantly, if we get back to historical patterns, we would expect to end up with positive audit premium billings because customers tend to understate their exposures. At least historically, that's been a true pattern. Now we'll see how insightful our customers really are.
Well, if their estimates are as good as mine, that's money in the bank, I got to tell you.
It's okay with us.
Thanks a lot. Appreciate it.
Pleasure.
Ms. Nawi, I will now turn the call back to you.
All right. Thank you very much for joining us today. Of course, as always, Andy Hersom and I are available in investor relations for any follow-up questions. Thank you, and have a great day.