美國家庭壽險 (AFL) 2009 Q3 法說會逐字稿

Welcome to the Aflac second quarter earnings conference call. Your lines have been placed on a listen-only until the question and answer session.Please be advised today's call is being recorded.

I would now like to turn the call over to Mr. Ken Janke, Senior Vice President of Investor Relations.

Thank you, Lori. Good morning. Don't worry, everybody, it is our third quarter conference call. Joining me this morning is Dan Amos, Chairman and CEO, Kriss Cloninger, President and CFO of AFLAC incorporated, Paul Amos, President of AFLAC and COO of our US Operations , Jerry Jeffery, Senior Vice President and Chief Investment Officer, and joining us from Japan is Tohru Tonoike, President and COO of our Japanese business.

Before we begin this morning, let me point out the Safe Harbor language. I'd like to remind you that some statements in this teleconference are forward looking within the meaning of federal securities laws. While we believe these statements are reasonable, we can give you no assurance they will proved to be accurate because they are prospective in nature. Actual results could differ materially form those we discuss tody. I would encourage to you look at the most recent press release for the some of the various risk factors that could impact our future results. With that, I'll turn the program over to Dan who as usual will begin with some comments on the quarter and the outlook for the year and then I'll follow up with just a few financial highlights. Then we'll be happy to take your questions.

Thanks, Ken. Good morning, everyone. I hope you've had a chance to look at our third quarter press release. Before I discuss our insurance operations in Japan and the United States, let me comment on our current financial results and balance sheet. We're very pleased with the third quarter from an operating earnings perspective. Operating earnings were $1.25 per diluted share, up 22% over the third quarter 2008. Excluding the impact of the yen, operating earnings rose for the 13.7% quarter and 13.9% for the nine months. Based on year-to-date financial results, we're confident we will achieve our annual objective of a 13% to 15% growth before the effect of foreign currency. Net earnings in the third quarter were again influenced by realized investment losses.

However, our realized losses were significantly lower than a year ago and also below second quarter levels. The vast majority of the realized losses in the quarter resulted from impairments of perpetual securities. As we communicated on our second quarter conference call, we anticipated impairments on certain perpetual securities in the third quarter because they were below investment grade and were expected to be below book value for a specific period of time. You may recall that in July we projected $265 million of equity impairment charges on the perpetuals in the third quarter. The actual after-tax impairment charge related to the perpetual securities in the third quarter were $212 million. The amount was lower than expected. Improved market values, which were partially offset by the stronger yen at the end of September, compared to the end of June.

We did not book corresponding impairment charges to the perpetual securities on our statutory financial statement as we continue to believe that we would receive the interest in principal payments that are contractually due. Assuming the yen dollar exchange rate and pricing of the perpetuals remain unchanged from the end of the third quarter, no additional downgrades to below investment grade, we expect to incur a GAAP charge of $100 million in the fourth quarter under the equity impairment method.

However, I want to again remind to you two important points. First as we discussed before, these charges will not impact GAAP shareholder equity because all the perpetual securities are categorized as available for sale and are carried at fair (inaudible) value on the balance sheet. Second and most importantly, we would not be required to record comparable impairment charges on a statutory accounting basis if our credit analysis continues to demonstrate the securities are money good.

Our risk-based capital ratio remained high at the end of September, based on the estimated statutory financials, our RBC was 405% at the end of the quarter, which is above our internal target of 375%. The decline in the ratios since the end of 2008 has resulted from increased in the required capital component of the RBC formula. The required capital increase has been primarily driven by the downgrade of credit ratings and securities we owned, particularly perpetual securities.

Despite certain credit rating downgrades, we remain pleased with the overall quality of our investment portfolio. At the end of September, 92.9% of the holdings were investment grade. Among our holdings of perpetual securities, 81.3% were investment grade. Through the first nine months of the year, all the perpetual securities we owned were current on interest payments. Throughout our entire portfolio, we have only one company who deferred the coupons this year. That was a fixed maturities security.

It is possible that we will see coupon deferrals in the future, especially to the extent that certain coupon payments are based on capital or profitability tests on 2009 financial results. However, I would remind you that among our perpetual holdings, approximately 72% are upper tier two which are all deferrable coupon provisions. I would also point out that the deferral of the coupon does not automatically result in an impairment charge. Instead a coupon deferral would trigger a thorough analysis of the credit to it first make sure that the security we still want to own and second to determine if the impairment charge is warranted.

Furthermore, we have seen a strong recovery in the market values of perpetual holding. In fact, they are priced at approximately 83% of par value at the end of September, that's up from 71% at the end of March. Overall, we remain pleased in general and in our capital position specifically. Importantly, we believe our business will continue to build capital through strong statutory earnings growth.

Now let me turn to our insurance operations starting with AFLAC Japan. AFLAC Japan had a strong third quarter. Our persistency rate remained high and although it was slightly lower than a year ago it's been stable throughout 2009. In addition, our financial results met or exceeded our expectations for the third quarter. We were especially pleased with the third quarter sales results, which exceeded our expectations. Total annualized premium sales in the yen were up 6.5% for the quarter. For the first nine months, total new sales were up 3.7%. Based on these results, we have confidence that we will achieve our goal of flat to 5% increase for the year.

Sales in the third quarter were led by significant increase in the medical category, which was up 13.8% for the third quarter 2008. As you'll recall, we launched a revised medical product in late August. This was the first major revision of our popular EVER product since it was initially launched in 2002. The most notable change in this revision is the enhanced surgical benefit. In addition, the revised ever premium rates are gender specific. Rates for the most female buyers are lower than the original version of ever and most ages issued. Male purchasers generally pay less at the younger ages and more at the older ages. Overall, the profitability of the new plan is similar to our original EVER product.

During its first five weeks on the market, we sold 104,000 of the revised EVER products. We are very pleased with the initial response to the newest EVER product and were excited about the prospects for future medical sales growth. In addition, we experienced strong sales in our ordinary life category which were up 45%. This strong growth primarily resulted from the child endowment product we introduced during the spring. During the quarter we sold 21,400 child endowment products, an average premium of 154,400 yen. Which is significantly higher than the premium than our core medical or cancer products. We believe we could continue to attract customers to our new life products like child endowment. We also believe we could effectively cross-sell life products to customers with other AFLAC products. In fact, for every ten child endowment plans that were purchased, we sold two additional policies of other products to the same customers.

We were also excited with the improvement in the bank channel sales. In the third quarter, bank channel sales rose 55.2% over the second quarter to a record 2.2 billion yen, compared with a year ago bank channel sales were up 66.1%. At the end of September, a total number of 351 banks represent AFLAC Japan. Of that amount, 282 have been selling AFLAC Japan's core products like cancer and medical to the customers since the full deregulation of sales through banks in December of 2007. We hold a very strong position in the bank channel and have significantly more banks selling for us than any other operating in Japan.

We've also been expanding our distribution beyond the bank channel. In that regard, recruiting remains strong at AFLAC Japan. In the third quarter, newly recruited agencies were 21.1% higher than a year ago. And for the first nine months, we experienced 16.5% increase in recruited agencies. We believe our recruiting has not only benefited from the weak economy, but also from the strength of our brand and improved recruiting techniques. For the remainder of the year, we expect to see continued strong sales growth, and we believe we will extend the sales momentum into 2010 as well. We remain convinced that Japan remains a large and attractive market for our products. Despite the weak economy -- economic conditions and a competitive marketplace, we believe our strength and adaptability have positioned AFLAC to capitalize on the opportunity on the Japanese market.

Turning to our US operation, as the case of most industries, the most difficult economic conditions have continued to pose challenges to sales growth. During the third quarter, total annualized premium sales were down 7.2%, which was not a surprise. For the nine months, sales were 6.4% below a year ago. As you know, our persistency rate has been impacted by the extended recession. That was especially true in the first quarter. Fortunately, persistency rate of the US business has improved as the years progressed. Although the rate is not where we'd like it to be, our persistency rate in the third quarter was better than our financial modeling assumption.

Like the first quarter of the year, the basic activities of the US operation that normally led to sales growth remains strong. Recruitment of new agents has benefited all year long from the weak labor market as salaried positions have become more difficult to find. In the third quarter, recruitment of new agents was up 9.4% to more than 7,000 new sales associates. For the first nine months of the year, recruitment of new agents was 16.4% higher than a year ago.

The average number of weekly-producing sales associates in the third quarter was a little change from last year, however, the average number of weekly producers rose 8.1% in the quarter. New payroll accounts growth was also strong, rising 15% over the third quarter 2008. Payroll accounts opened by new agents was up 24% in the third quarter and 20.7% for the nine months. We believe strong increases in recruiting and new weekly producers coupled with significant payroll accounts growth will provide a solid foundation for future sales as the US economy continues to recover.

As I hope you noted, we completed the acquisition of Continental American Insurance company or CAIC on the first of October. You'll recall that CAIC is a specialty insurer that focuses on selling the same time of voluntary products at the work site that AFLAC offers but on a group basis rather that's on an individually underwritten basis. Although the fact from financial impact of this purchase is small, we believe it has potential to greatly benefit in the US marketplace in the long term. Specifically, CAIC will help us meet the product needs of the field force when they pursue larger payroll accounts. It also helps the broker community know that we are committed to growing the broker distribution channel in access in the large employer market. We believe that CAIC is a very good fit for AFLAC for both business and cultural perspectives.

We are continuing to work on an integrated CAIC marketing and administration into the US business, and the process is moving along very well. We will be formally introducing CAIC products and training to our sales force in a couple of months in our annual December kickoff meeting. But our sales force is already excited about welcoming CAIC into the AFLAC family. As we think about fourth quarter sales, we will continue to be challenged by the weak economic environment. In addition, the loss of Wal-Mart, re-enrollment will also dampen fourth quarter sales. Although that will be somewhat offset by the sales through CAIC. It's still a bit too early to project sales outlook for CAIC group business for next year, however, as I mentioned, on the second quarter call, our 2010 sales objective will reflect the combined outlook for AFLAC and CAIC.

Our earnings outlook for AFLAC incorporated has not changed for this year and remains unchanged for 2010 as well. Our objective is a 13% to 15% increase in operating earnings per diluted share in 2009 excluding the impact of the yen. For 2010, our objective is 9% to 12% increase in operating earnings per diluted share before the impact of the yen/dollar change rate. I want to remind you that my number one priority is to maintain strong capital position. Overall, I believe AFLAC remains well positioned in the two best insurance markets in the world. As our commercials indicate, when people get sick or hurt in this work, they need cash to cover the uncovered expenses that arise. This is true in good times and bad. And whether you're talking about the US or Japan.

Although we've certainly faced challenging times along with the rest of the world, our operations continue to perform well and our balance sheet remains solidly positioned. I have every confidence in our business model and the fundamental need for our products and the future for AFLAC. Ken?

Thank you, Dan. Let me just briefly take you through some of the third quarter numbers beginning with AFLAC Japan and we'll then get to your questions. Starting with the top line in yen terms. revenues rose 2.6% for the quarter. Investment income was down 2% reflecting the impact of the stronger yen on AFLAC Japan's dollar denominated investment income. Excluding the effect of the stronger yen, investment income was up 2.9%. The annualized persistency rate excluding annuities was 94% for the first nine months of the year, down from 94.6% for the comparable period of 2008, but up slightly over the first six months of 2009.

In terms of operating ratios for the quarter, the benefit ratios continued to improve as we'd expected. It was 59.9% in the quarter compared with 62.2% a year ago, excluding the impact from the stronger yen and investment income, the benefit ratio was 59.4%. The expense ratio for the quarter was 20.1%, up from 19.5% a year ago. The increase in the the expense ratio reflected in part higher advertising expense and increased DAQ amortization. Reflecting the improvement in the benefit ratio the pretax margin expanded from 18.3% to 20% in the quarter. And with the improvement in the margin, pre tax earnings increased 11.8% for the quarter in yen terms. Again, unwinding the impact the strong yen on AFLAC Japan's dollar investment income pretax earnings were actually up 16.7% on a currency neutral basis.

For the quarter, we invested cash flow in Japan in yen securities at an average yield of 2.77% including dollars. The blended rate was 2.89% for the quarter. The lower new money yields compared with prior quarters reflect spread compression around the world. The portfolio yield was 3.8% at the end of September, down 5 basis points from the end of June and 16 basis points lower than a year ago.

Turning to AFLAC US, total revenues rose 2.2% for the quarter. The annualized persistency rate for the nine months was 71.3%, which is down from 73.5% a year ago but up very nicely from the first half of this year. Looking at the operating ratios from the US segment, the benefit ratios was 51.9% compared with 52.7% a year ago. The improvement in the benefit ratio reflected favorable claims experience on some lines of business as well as the (inaudible) higher lapses compared with a year ago. The operating expense ratio was little changed from a year ago at 30.6% compared with 30.4%. The pretax profit margin improved as a result of lower benefit ratio to 17.5% up from 16.9% a year ago. As a result, pretax earnings rose 5.7% for the quarter. For US investments, new money yield for the quarter was 7.36% versus 7.48%. The yield on the portfolio at the end of September was 7.2%, down two basis points from the second quarter and 15 basis points above a year ago.

Turning to some other items for the quarter, excluding FAS 115, the ratio of debt to total capital was 19.9% at the end of September compared with 17.5% a year ago. Noninsurance interest expense in the quarter was $24 million, compared with $6 million a year ago. The higher interest expense reflected the debt issuance of $850 million of senior notes earlier in the year as well as the impact of the stronger yen on our dollar denominated debt. Parent company and other expenses were $21 million in the third quarter compared with $9 million a year ago. The higher parent company expenses in the quarter resulted from a reduction in the discount rate on unfunded pensions, preacquisition costs associated with the purchase of Continental American and lower investment income at the corporate level. The operating margins improved for the quarter, the pretax margin rose from 17.5% to 18.4%, and the after-tax margin increased from 11.5% to 12.1%.

On an operating basis, the tax rate was little changed at 34.3% chaired with 34.5% in 2008. And as Dan mentioned, operating earnings per diluted share rose 22.5% to $1.25, which exceeded our guidance. The stronger yen increased operating earnings by $0.09 per share for the quarter and $0.23 for the first nine months. As you heard, operating earnings per share increased 13.7% for the quarter excluding the impact of currency and 13.9% for the nine months.

Finally, let me comment on the earnings outlook for the balance of the year. As Dan reiterated, our objective for 2009 is a 13% to 15% increase ex-currency on a per diluted share basis. If the yen averages 90 to 95 yen to the dollar in the fourth quarter, we would expect to report operating earnings of $1.08 to $1.16 per diluted share. For the annual number that would equate to $4.75 to $4.83 reflecting that currency scenario. This morning the first call estimate consensus was $4.77 for the full year.

We're ready to take your questions so Lori you can begin the polling process. We do want to make sure everyone has a chance so please try to limit your questions to one and we can get back to you if you have a follow up.

Thank you, sir. (Operator Instructions) Your first question is from Colin Devine.

Good morning, folks. If Ken or if Kriss is there I'd like to talk about the investment impairment policy. I must say it's a struggle. I can't recall any other insurer that we've covered that has this sort of two processes. One for GAAP and one for stat. With Lloyds now in the paper this morning talking about a recapitalization and convergence of the press, what might that mean for AFLAC? It would seem to me that hey are going to be converted at discounts and par and I don't know how that's not going to hit statutory capital. The other thing that I'd like to know if we even just took the losses this quarter so your impairment of Lloyds and ran that through stat, it seems to me that your RBC ratio would be down to 350%, basically. Is that when you have to step in and raise capital?

I'm going to let Jerry talk about some of the impairment policy. You know this is Kriss. Regarding raising capital, the 350% is a little bit below our target RBC number, but it's still well in excess of the level at which would you face any regulatory intervention, so to speak. The point at which you have to start producing plans to adjust capitalization is well below 350%. As you probably know, I mean, we've said it time after time, we strive to maintain higher than average risk-based capital ratios for various reasons, one of which is our exposure to the yen/dollar exchange rate. The yen dollar exchange rate happens to be very strong at the moment. So that's, we think, fairly fully reflected in our RBC model.

Regarding other impairments, Colin, we're just following the accounting rules basically. The accountants changed the rules on us in the third quarter 2008 regarding the treatment of the hybrid securities. They required them to be all treated as equities, essentially for the purpose of addressing impairment policy. So the equity impairment model requires that if a security is underwater by a certain percent by a specified amount of time, you're required to impair it, regardless of your evaluation of the credit worthiness of the security. And the credit worthiness of the security is what we use on a statutory basis. That's consistent, again, with statutory accounting rules.

So we've got two sets of rules. We always followed the credit worthiness model on our perpetual portfolio up until third quarter 2008. At that time, as I said, the accountants changed the rules on us. So that's why we've had this equity model impairments. I'll let Jerry specifically address Lloyds, but --

Yeah, Kriss. Just two comments. I'm not in any way suggesting AFLAC faces a solvency issue. The point is, even if we just took this quarter's impairment and recognized that on a stat basis, just the $200-odd million, you're at a $350 million RBC ratio. And the other point, okay, and I appreciate what you're talking about to the accounting practice. To the best of my knowledge, this is the only company that we certainly look at that isn't essentially booking on a stat basis or the books on the GAAP. I remember when this happened the first time, Bill Wheeler, who like you is no slouch as a CFO, he never even heard that it was possible. And we're now over $1.1 billion in impairments in the last five quarters. All of a sudden, this-- if you were following through on a stat basis, it does seem to me the RBC ratio's in trouble and it's going to be the rating agencies that enforce the hand on capital raising, not the regulators.

Colin, let me add this one thing to emphasize what Kriss has said. There is no basis to impair those perpetual securities on a stat basis because they're being evaluated for their credit worthiness and the ability to return interest and principal to us. The equity impairment method that was handed to us last October does not speak to that at all on a GAAP basis. It is purely a function of price decline and the length of time over which that security is under water. That's not what happens on a stat basis. You can say this is what RBC would be if you took the $212 million and through stat. There is no basis and no reason to take it to stat.

Well depending on where Lloyds is going on the through cap, I guess we may see it, Ken.

Let me comment on Lloyds, Colin You've obviously followed the situation. I think as with many of these perpetual securities, there is a tremendous amount of confusion. So let me start by outlining what our tier one exposure is to Lloyds. It totals $7 million. Let me talk a little about what the recapitalization speculation is and some of the comments Lloyds has made. It's nothing official, but based on everything that we've heard and in our conversations with Lloyds and others, they plan a capitalization that may negatively impact tier one holders, and if this recapitalization were not fully subscribed, there is a possibility it could impact upper tier two holders as well.

However, I'm sure you read the statement this morning and so you must know that in that statement, they said they are confident that this hope that this offering will, in fact, be fully subscribed. So there is, yes, the possibility to cram down on the tier one exposures. We acknowledge that that's a risk. We still haven't seen the details of this. If when the details emerge we find that the tier ones are in fact in jeopardy of having coupons canceled, then we'll re-evaluate the $7 million holding that we have. And absolutely it will be up for stat impairment at that point. That answer your question?

We're getting there. Thanks.

Good. Let me make one or two other comments just as a follow up to that -- follow-up to that. First of all, Colin, we think one of the difficulties or, I'll say, even fallacy with the GAAP equity impairment model is that once you write something down, you're not allowed to write it back up. If we wrote everything down to market at the end of March, we would have foregone the opportunity to reflect the $2 billion increase in market value on those available for sale security. They'd have had to been carried to the March 31st value forever. I think that's absolutely ridiculous. Our unrealized gains has declined substantially since March -- the end of March and we would have foregone the opportunity to write that up.

Second thing is relative to RBC, I'm sure other people have questions about this. We came in at an estimated $405 million at the end of this quarter, but that doesn't count over $500 million of cash at the holding company. Some of which we could have contributed to the Life company if we want to the window dress RBC ratios. We didn't choose to do that. RBC only matters at the end of the year when it's counted officially for statutory. We're going take a look at all that. At the end of September, we chose to maintain our flexibility in terms of how we deploy those resources available to us. I guess I'll just wait. I'm getting on a soap box but we've got several things we're able to do and we're evaluating relative to where we want to be in terms of RBC at year end. I'll just stop right there and take further questions.

Thanks, Kriss.

Okay.

Next question, please.

Yes, sir. Your next question is from Andrew Kligerman.

Good coverage there on the capital. Other issue is the benefits ratio in Japan, year-over-year it improved 170 basis points, in line with your 150 to 200 basis points year-over-year improvement, but historically, I think you were guiding towards 50 to 100 basis points a year. What are we looking to see next year and maybe even longer term, what kind of improvements are we to expect in the Japanese benefits ratio?

I think it will continue to improve. I'm not--this quarter and really for some time now, we've continued to see a decline in the number of days in the hospital for cancer treatments. That's one of the principal driving forces behind the client and the benefit ratio. How long can it last? Well, they still in Japan have much longer hospitalizations than you see worldwide for cancer treatment. So there's still some room for additional improvement. As in the past, we've got some contribution due to mix of business, but I'd have to say that above expectation improvement and benefit ratio's been driven by the decline in the hospital days, Andrew, and I don't know how to forecast how much longer it's going to go on. It certainly has gone on for sometime. Japanese government's still putting pressure on the providers to reduce the healthcare costs in Japan to help control budget expectations and the population's aging and the like.

Kriss, I don't know if you know off the top of your head, but what's the average hospital stay currently? What do you think you might be able to guide to next year in terms of the improvement--not as much as you saw this year?

I think the average stays are around four weeks. I think it's around 27, 28 days. Don't absolutely hold me he to that. But I think for cancer hospitalization, that's in the ballpark. It used to be 60, Andrew.

Right.

So it's come way down, but it's got room to go further. I think relative to next year's guidance, it'll probably be in line to what we guided to for 2009.

Got it. Thanks.

Your next question is from Nigel Dally. Your line is open.

Getting back to the capital issue, it seems that aside from impairments, the impact of yen strengthening is also an area that many investors are concerned about. If the exchange rate headed down to say around 80, it would seem that you would have a potential problem. So Kriss, I'm interested, what can be done to reduce or eliminate that sensitivity of the capital ratios to the yen? And is that something that you're presently looking into? Thanks.

Okay. Well, one way to handle that's to bill more yen capital. I said in the past, we've got a bias toward building yen capital. We left some 40 billion yen there this year than we otherwise could have repatriated because we suspended a share repurchase, we didn't need that cash in dollars so we left that in Japan. I think we'll have a bias toward retaining yen denominated capital in AFLAC Japan in the future. And depending on-- we've got one additional -- well, not one additional-- we've got several issues of Samurai notes outstanding at the present time, but one due in 2010 is about 40 billion. One of our options is to look into refinancing that in yen and taking the sum of 15 billion yen or so we presently hold at corporate and contributing that as capital to AFLAC Japan if we feel like that's appropriate or necessary.

So we've got some options there. 80 yen to the dollar might, cost us another 30 or 40 basis points in RBC, but again, that's one of the reasons we maintain above average RBC ratios. I think we've got the flexibility to deal with 80 yen to the dollar. Once we talk about 50 yen to the dollar, if that ever came true, we'd have probably some more thinking to do, but I think 80's certainly something we could stand.

Thanks, Kriss.

Your next question, sir's from Randy Binner. Your loan's open.

Quick on on [Takafuji]. There was downgrades there in the fourth quarter and I was hoping perhaps Jerry could shed light on how those downgrades may affect the risk-based capital ratio?

I don't think I'm the right one to comment but what I can say about Takafuji in the event that you don't know is that our exposure has been significantly reduced in the fourth quarter. We, as I'm sure you know, owned 50 billion yen or we had a 50 billion yen exposure to Takafuji in our yen portfolio this month. We exercised a put option which was promptly accepted by Takafuji on 20 billion of the 50 billion exposure. So that cash will be redeployed into NAIC one alternatives, and with the lower exposure from 50 to 30 billion Takafuji, I would expect the impact to RBC to be minimal.

Okay. Great. So you're swapping NAIC levels basically with two pieces of the 50 billion? Okay, great. Then I guess your comments on Lloyds, it sounds like the Lloyds plan may specifically affect tier one holders and maybe or hopefully not affect upper tier two holders but ING is obviously going through restructuring situation as well. What kind of read through from the Lloyds and ING situation should we have for all the other tier one and upper tier two holdings you have with other European banks?

The ING is entirely different. They have a lot of different subsidiaries and they are not consolidated in any where near the way that Lloyds is with (inaudible) and Bank of Scotland. So I don't read a lot into it other than to say that the EEU is a very activist organization and its being very pragmatic. Looks at banks the same way we do which is case by case. And you should as well. So I think that is the take away from this. Unfortunately it's not a take away which you make any sweeping predictions about how they're going to treat bank capital overall. What you can say definitely is that they are looking at this on a very much of a spoke basis.

Okay. And just a follow up on one of our earlier comments. Is there an official running total of the total GAAP OTTI that has not been pushed over to stat?

It would be the perpetuals. I think in every quarter since the third quarter of last year that we had 191 million of OTTI on a GAAP basis related to perpetuals. We've disclosed that. I don't know the number off hand of this year, I believe, it was in the area of 340 or so million. But we've got that in our releases where we could go and piece that together.

347.

Fair enough. We'll look back for it. Thank you.

The next question, sir,from Darin Arita. Your line is open.

Thank you. Hoping from Kriss to get a little more color on the RBC ratio change in the quarter going down to 405 from 459. The movement was a little more than I would have thought, but was wondering if you could separate the components for us in terms of the effect from the yen, the effect from new credits downgraded and also further migration of existing credits?

Well, the required capital or the required risk-based capital went up about 20% in the quarter. And our total adjusted capital went up about 5.6% in the quarter. I'd say there was very little yen effect in the quarter. I think the quarter end exchange rates were close between June 30 and September. So most of it related to ratings migration and also there's a size concentration factor in the mechanics of the RBC formula where you have to take your top ten holdings that are not rated NAIC category one and Takafuji migrated into that category at the end of the third quarter. Of course, 20 billion of it came out in the fourth when we exercised that put option. But at September 30 it was there and caused that size concentration factor to increase fairly significantly.

So most of the decline in RBC ratio related to the increase in required capital due to the ratings changes. We did build capital. I was pleased with the 5.6% increase during the quarter. So we're watching the outlook for additional ratings changes, obviously, and we're going to have to consider that as we plan for the year end RBC position.

Can you put a number in terms of either RBC ratio points or the change in required capital from the 20 billion on Takafuji?

It might be ten points just guessing. Off the top of my head, something on that order or magnitude.

Thank you, Kriss.

The next question, sir's from Tom Gallagher. Your line is open.

Two questions. First is if the RBC risk charge, Kriss, just follow up on the point you just made is really what's driving reduction in RBC, why wouldn't you consider a risk reduction program by disposing or at least shrinking a considerable amount of your below investment grade holdings? If I just use rough numbers and I say you're getting at least a 10% risk charge for these assets and also some concentration hits as well, why wouldn't you consider selling those if the sale was not meaningfully greater than 10% relative to where you currently carry it?

Second question is just on the yen impact on RBC. Can you tell us economically speaking, why is it that there's that much sensitivity? Is it because of the reversal of currency bonds or something else driving that?

Okay. On the latter question we've, for a number of years, have said that we wanted to have most of our equity denominated in dollars because we've got primarily dollar shareholders, and we think our shareholders have accepted the notion that earnings are sensitive to yen and we report, including the effect of yen and excluding the effect of yen. But once the earnings have flowed into equity, we thought that stability of the dollar capital was fairly important. We knew that we had some exposure when yen strengthens and we've accepted that.

I think depending on where the yen sorts out, if it stays in the 90 end of the dollar range, as I said, we've had a bias towards building yen equity for sometime now, and we've taken steps to build yen equity, and I think we'll continue on that position. It's very expensive to--people have asked, well why don't you hedge the P&L and do futures contracts and this and that? We've looked at the costs of doing that. The costs of doing that is very, very high. So that's part of an answer to that. Now, the previous question related to RBC, I'm trying to --

The gist of the question, Kriss, was --

Okay, I got it.

Okay.

It's a simple matter of economics versus financial reporting. We look at the credit worthiness of our investments, and as I said, at the end of March, if we had sold them all at the end of March time, and taken a $5 billion realized loss, we'd all be fired by now because the instruments have come back in market value, I wouldn't be talking to you if we'd done that at the end of March.

Kriss, I agree with that comment. That was a very different time. The securities have rallied massively since then. Now, to me the tradeoff now, relative to not only the current hit you have on the blown investment grade securities but also where they're going, these securities will continue to be downgraded. Just, there's clearly momentum behind it. So my only point is now to me there's a much harder decision to make looking at what my charge to capital would be relative to the costs-- to the hit I would take by is selling them. Is that something you're contemplating? Are you going to stick with your current course?

I'll say that it becomes a matter of judgment. And I appreciate your point, Tom. Believe me that's all part of management. That's part of what we're charged with doing, and we're certainly paying a lot of attention to it. I mean, investments has occupied my time, 95% of my time, over the last nine months, and it never did before. I'm going let Jerry speak to the specific --

Yes, Tom, let me speak to your comment about the momentum is behind the back of the downgrade bow here. I don't know where the momentum is. I don't think anybody does. I think what we can do is we can say that ratings have historically been lagging indicators not leading indicators.And that has clearly been the case here. We've had an unprecedented rally in credit over the last six months. Something that we had never seen. And the downgrades have continued to occur.

So who's right? The rating agencies or the markets? I don't think any of us knows. So all we can do is rely on fundamental credit research. I would point out to you that as of today none of our perpetual securities have failed to meet their financial obligation to us. So it's not clear to me that there's any benefit to go on a wholesale selling spree. Don't forget, I think the world in March was saying gee, prices are going low and lower. And valuations are going to zero. That prognostication is clearly wrong too. So trying to forecast is not something that we find very profitable. Credit fundamentals are what drives our costs.

Another aspect of this, Tom,if we did sell securities, they're high yielding securities that are not presently in default. If we sell them, take the hit, we've got less money to invest at much lower yields. So that's the alternative. Putting the money out today is much harder than it has been historically. It's a much lower yield environment. That's another operating point we have to consider.

Fair point. Thank you.

Sir, your next question is from Ed Spehar. Your line is open.

Thank you. Good morning. I was wondering, Kriss, on -- I know you haven't disclosed this nine-month statutory operating gain, but given the build in total adjust to capital, it would seem like your statutory operating earnings were perhaps not that much different than the quarterly run rate we've seen in the first half. Is it your sense that that's the case?

Yes, that's accurate.

I mean, that would suggest that your statutory earnings for the first nine months of this year would be more along the lines of what the annual earnings were last year on an operating basis.

Right. We've said the run rate's close to $2 billion.

You are almost at $2 billion through the nine months it would seem--probably at $1.8 million through the nine months.

Yes. Yes. Ken just made the comment, part of that's a yen. That's correct-- $2 billion's what's in my mind based on last year and the we've seeing some strengthening. That's probably the $300 million at 15% yen strengthening or so.

And then the other question was on the GAAP statement, the parent company expense was very high this quarter versus other quarters. I think there were some unusual items in there. How much of that--what looks to be like $18 million higher number than it would have been running would be considered a 3Q event versus something we should be looking going forward?

About $7 million of it was related to the change of the discount rate when we booked the full amount.

There was a couple million dollars of investment income lower than a year ago and I think the preacquisition expenses of CAIC were one million. You won't see that going forward.

The biggest item that's going to continue is the increased interest expense obviously.

Okay, but the discount rate was just a 3Q event not going forward.

Right. That's over and done with. Okay.

Sir, the next question -- I'm sorry. The next question's from Mark Hughes.

Thank you very much. Could you quick give us your evaluation of the Japanese economy right now? Then any thoughts on the flow of new products in the pipeline and the potential effect on new sales in coming quarters.

This is Dan. Toru, you want to answer that?

Yes. This (inaudible) economy is somewhat in line with what we have been seeing in the last couple months. It seems to be improving not very fast but slowly improving. Since we had just had new government in place and their policies, including their common policies, are not very clear, yet. So I think we have a good idea about certainty in the future. The second question is, we are looking at various opportunities, but at this point, there is nothing we can tell you about new products which are scheduled to be lowest in the near future.

I'll make a couple of comments first of all regarding the economy. I used this analogy that if you think of a sports injury, the US versus Japan is the US is shocked over being injured, meaning the economy, and therefore they're tentative and reluctant to push hard and recover. On the other hand, Japan's economy has been bad so long, you reach a point with a sports injury where you say look, if I don't go ahead and just push myself, I'm never going beat this. So they tend to push on. I feel like Japan's economy has been so bad so long even though it hit probably the worst stage in the last 12 months that we've seen in the last ten years, they still were not as shell shocked as, say, the US economy. So I feel like our introduction of a new distribution system with the banking system has played a big role in helping us offset some of the issues that are out there today.

As far as new products, what I will say is this new medical product that we've introduced, I'm expecting big things from. As I mentioned in the speech, we've written 104,000 policies. I think that's going continue, and I think you'll see strong sales from medical products in the fourth quarter, and first quarter for sure. So it may even carry us through next year. So new products are not an issue right now. I think making sure we take care of this new EVER product is the issue and that will be the driving force for AFLAC Japan.

Any effect on persistency of the new medical product?

No, not really. Persistency in Japan's been very, very stable. We don't expect any changes due to that product.

Thank you.

Lori, we have time for one more quick question then we'll have to conclude the call.

Thank you, sir. Your final question will be from Eric Berg. Your line is open.

Thanks very much. Jerry, certainly understand and appreciate that your portfolio is very different from those of other north American based life insurers with the (inaudible) long duration and heavy component of private. Still, credit spreads across all rating categories have improved. Especially in the below investment grade. My question is one building on one that I asked Ken last night. I just like your own impression. Why don't you think your unrealized losses have shrunk percentage wise nearly to the degree that some of the large admittedly incomparable portfolios have at your big US life companies? Why don't you think you've seen the same reduction percentage-wise that they have?

Hi, Eric. Look, it's -- there's no way to answer your question by comparing us to other insurance companies obviously because just the composition of the portfolios is so different, but I would agree with you, in fact, one of the things that I've been looking at at the 9/30 valuation, I'm convinced that these valuations are extremely conservative. You could argue overly conservative. But it's the discipline we use and the process we use, so I have gone back to the pricing services not to challenge the prices which I think in some cases are too low, but just to point out to them some data points for them to look at in subsequent quarters when they evaluate some of our securities.

So, I think some of our large holdings some of our large investment grade holdings have not revalued to the level they ought to be. Look it's better that we're too conservative than too aggressive in our pricing. I also would say going forward, pricing is a totally imprecise process and it will never be perfect, but we are looking at a couple different alternatives right now to improve pricing anyway, because we do want to get as much precision as we can. But again, given the nature of our portfolio, it is impossible to be as precise as an equity mutual fund.

Thank you.

Thank you all for joining thus morning. If you do have any follow-up, please feel free to give Robin or myself a call at your convenience. We're here all day. Thanks again.