Dear Fellow Shareholders,
We ended 2009 with significant financial flexibility, having improved our capital position, further strengthened our loss reserve position, and completed the sale of our non-specialty Commercial Lines business, freeing up capital for continued growth of our more profitable Specialty Lines businesses. The agreement reached in February 2010 to sell our Personal Lines business, which we expect to close in the second quarter of 2010, will free up additional capital, further enhancing our financial flexibility.
Capital
Total capital (equity and debt) increased in 2009, while capital requirements
decreased, resulting in a healthy amount of undeployed capital at year-end. Specifically,
shareholders’ equity increased by $274 million, net of $80 million in shareholder
dividends, and debt decreased by $112 million. As a result, financial leverage
(measured by the ratio of debt to total capitalization) decreased by nine points
to 30 percent. In the meantime, net written premiums decreased by 3% and net
reserves declined by approximately $50 million, resulting in a decrease in our
capital requirements over the course of the year. Pro forma for the sale of our
Commercial and Personal Lines businesses, capital requirements in 2010 will decline
further.
Reserves
We recorded $83 million of net favorable development on prior accident year
loss reserves in 2009 (4.3 points on the combined ratio), reflecting favorable
trends in our loss experience and conservatism in our original estimate of the
reserves. In addition, we strengthened our loss reserve position, moving our
recorded loss reserves from a point 67% into our range of loss reserve estimates
at year-end 2008 to a point 78% into the range at year-end 2009.
Investments
The asset allocation of our investment portfolio remains conservative, with 87%
of invested assets in fixed income and the balance in equities. The fixed income
portfolio is high quality and short duration; and our exposure to equities, measured
as equity investments as a percentage of shareholders’ equity, is as low as it
has been in at least the past five years.
Outlook
With a persisting soft market; a low interest rate environment, but steep yield
curve, reflecting the potential for inflationary pressures in the medium to
long term; and uncertainty regarding the strength of the nascent economic recovery,
we continue to emphasize underwriting discipline and a strong / conservative
balance sheet. We believe this will serve us well in the current climate and
position us well when conditions improve. In the meantime, we enjoy significant
financial flexibility. As always, we will manage the capital in our business
with the goal of maximizing total value creation for shareholders over time.
Respectfully Submitted,
Paul H. McDonough
Senior Vice President and Chief Financial Officer