美國家庭壽險 (AFL) 2016 Q3 法說會逐字稿

Welcome to the Aflac third-quarter conference call. (Operator Instructions) Please be advised today's conference is being recorded. I would like to turn the call over to Ms. Robin Wilkey, Senior Vice President of Aflac Investor and Rating Agency Relations. Ma'am, you may begin.

Thank you and good morning. Welcome to our third-quarter call. Joining me this morning from the US is Dan Amos, Chairman and CEO, Kriss Cloninger, President of Aflac Incorporated, Paul Heyman, President of Aflac, Fred Crawford, Executive Vice President and CFO of Aflac Incorporated, Teresa White, President of Aflac US, and Eric Kirsch, Executive Vice President and Global Chief Investment Officer.

Joining us from Tokyo is Hiroshi Yamauchi, President and CEO of Aflac Japan and Koji Ariyoshi, Executive Vice President, Director of Sales and Marketing.

Before we start, let me remind you that some of the statements in this teleconference are forward-looking within the meaning of the federal securities laws. Although we believe these statements are reasonable, we can give no assurance that it will prove to be accurate because they are prospective in nature. Actual results could differ materially from those we discussed today.

We encourage you to take a look at our quarterly release for some of the various perspectives that can materially impact our results.

Now I'm going to turn the program over to Dan who will begin this morning with some comments about the quarter as well as their operations in Japan and the US. Fred will follow with brief comments about our financial performance for the quarter and the outlook for the year. Dan?

Good morning and thank you for joining us today. Let me begin by saying that I am pleased with the Company's overall financial results for both the third quarter and the first nine months of the year. As you no doubt saw, from yesterday's press release the strong results gave us confidence to upwardly revise our operating EPS outlook for this year to the range of $6.40 to $6.60.

Fred will provide more color on earnings and our outlook during his comments.

I will lead off by providing an update of Aflac Japan, our largest earnings contributor. From a distribution perspective, our traditional agencies, which include individual agencies, independent corporate agencies, affiliated corporate agencies have historically been and remain today viable contributors to our success. Additionally, our alliance partners continue to advance our strong results.

I am particularly pleased that just this month, Japan Post, through its 20,000 plus postal outlets, began selling our new cancer insurance product, designed exclusively for cancer survivors. Our traditional agencies first began selling this product in March of this year.

While we anticipate the sale of our cancer insurance or cancer survivors, will be slightly additive to our overall sales results, more importantly, it underscores our reputation and commitment to being there for Japanese consumers when they need us most. These various distribution outlets further our goal of having a presence in all the places people want to make their insurance decisions.

From a product perspective, I am pleased with the progress we have made in limiting the sale of first sector savings profits which are interest-sensitive. First sector product sales decreased 54% in the quarter, putting us squarely on target to reduce first sector sales by at least 50% in the second half of the year compared to the second half of 2015.

We have been aggressively employing product from select channels, conservatively repricing our waves and endowment products for the reality of a prolonged low interest rate environment. We are extremely encouraged with the significant progress we made in limiting the sale of the first sector products.

Turning to the third sector sales results, you will recall that we upwardly revised our annual sales target for these products last month at the Tokyo analyst briefing, making this the second positive revision to our sales target this year. At the meeting, we announced a new third sector sales outlet to flat to up 5%. We are pleased that Aflac Japan generated a third sector sales increase of 2.5% for the quarter and 5% year to date.

These strong sales results in the face of difficult comparisons reflect stronger-than-expected productivity across the majority of the distribution channels. This is even more notable when you consider the sales through the bank channels have been moderated significantly by restrictions on the sale of first sector products.

I will remind you that the fourth quarter still presents difficult third sector comparisons, particularly following two years of extremely strong cancer [and] medical sales.

Our third-quarter sales results also benefited from the July introduction of a new third sector product called income support insurance, which accounted for JPY708 million or 3.3% of the third sector sales. This product provides fixed benefit amounts in the event that a policyholder is unable to work, due to significant illness or injury. Additionally, this product was developed to supplement the disability coverage within Japan Social Security system.

Our income support insurance product targets young to middle-aged consumers ranging in age from 20 through their 40s, a segment of the population in which we believe were underpenetrated and represented. By focusing our efforts on this demographic, we believe that we are building relationships to lay the groundwork for the sale of cancer medical insurance later in life.

While it is still early, we are happy with the reception of income support insurance as received. We believe this product has the potential to gradually develop into a new Aflac pillar product over the long term.

Turning to Aflac US, we are pleased with our earnings -- are exceeding our expectations for the first nine months. Profitability in the quarter was driven by improving benefit ratios that we continue to see over the last several years. We have simultaneously put resources back into the business and particularly we are investing in an end-to-end system for the group platform that will provide the capabilities of all of our group constituents, including brokers who typically sell group products.

While we are expanding our presence in the voluntary worksite insurance market, we are also being very disciplined in the pricing of the business, especially as it relates to the profitability within the smaller case group space that includes employers of 100 to 250 workers.

Although sales in the quarter were lower-than-expected, I would remind you that I said many times that fourth-quarter sales and particularly sales in the last three weeks of the year largely determine our annual sales results. Our efforts are focused on increasing the productivity of our career agents and brokers. I believe the measures that we have rolled out over a six-month period, beginning in the fourth quarter of 2014 are the wide approach, and as you will recall, one major element of the changes we made, including compensation to better align incentives of the career agents with Company sales results.

We are continuing to fine-tune our compensation package for our top sales management to closely align paying with performance. With this superior incentive program, we are seeing our top sales management being paid extremely well. And some of the poor performing sales managers have decided that they would rather concentrate on sales instead of management.

While we would have liked to have seen the measures' more immediate impact on our sales results, we know that it can take some time. However I want to point out that we are exceeding our profit target while implementing these changes. Most importantly, we continue to believe the changes that we have made to our sales infrastructure and compensation are in the best interest of the Company to produce long-term results.

We also remain encouraged with the broker business. Over the last few years, our sales through the broker channel have grown. Our fourth-quarter sales results have become more and more impactful as you saw in 2014 and 2015. This means it becomes more and more challenging to project full-year sales even though sales results for the first seven -- nine months, we know.

Although I am encouraged by a pipeline of business scheduled for the fourth quarter, we are still enhancing our forecasting of how much of the pipeline materializes into actual sales results. Therefore we believe Aflac US will require a particularly strong fourth quarter in order to meet the lower end of the 3% to 5% target increase for 2016.

I would remind you that our brand is a key differentiator for Aflac, both in Japan and in the United States. As a product innovator and trusted brand in both countries, we have experienced a tremendous amount of success, leveraging the strength of our brand to drive sales. In both countries, nine out of 10 consumers recognized the Aflac brand.

But our brand is more than the Aflac duck or the advertising initiatives. It's also about how we take excellent care of the policyholders. In Japan it's our powerful brand that has propelled Aflac to ensure one out of four households. In the United States, we processed, approved and paid nearly 1.3 million one day pay claims in the first nine months of 2016. And most importantly, 96% of the policyholders that use one day pay said they are likely to refer other people to Aflac.

We believe this will result in more new sales going forward.

Our products are well suited in both Japan and the United States markets and we are well positioned in the two largest insurance markets in the world.

Turning to capital deployment, let me just say that we continue to view growing the cash dividend and repurchasing shares is the most attractive means for deploying capital, particularly in the absence of any compelling alternatives. We are on target to repurchase about $1.4 billion of our shares with the majority already repurchased during the first nine months of the year.

The Board of Directors action to increase the dividend by 4.9% demonstrates our commitment to rewarding our shareholders. This marks the 34th consecutive year of increasing our cash dividend. We are proud of the achievement and our objective is to grow the cash dividend rate in line with the increase in operating earnings per diluted share before the impact of foreign currency translation.

We continue to manage the business for the long-term benefit of the shareholders, the policyholders, and all stakeholders. We believe we will continue to achieve more by building on these strategies and the foundations that have propelled our success.

By doing this, I believe we will continue to enhance shareholder value while delivering on our promise to the policyholders. And now let me turn the program over to Fred who will cover the financial results and outlook. Fred?

Thank you, Dan. Our third-quarter performance continues the strong financial results recorded in the first half of 2016 and execution on key initiatives designed to drive long-term growth and effective allocation of our capital. Our results were driven by strong overall margins in both Japan and the US. Operating EPS increased 16.7% or $0.26 per share, with little over half the growth driven by the strengthening of the yen and the remaining from share repurchase and pure earnings growth. Excluding the impact of the yen, operating earnings increased 7% as compared to the previous year's quarter.

Our Japan segment margins were solid. We concluded, as part of our annual actuarial review process, that it was appropriate to reduce the IBNR reserves for our cancer insurance block of business by approximately JPY4.6 billion or $0.07 a share. This amount is very similar to the adjustment we made in the third quarter last year and reflects continued strong cancer claims experience.

Expense ratios were generally in line with our guidance. In the US, benefit ratios continued their favorable transfer the year. Our expense ratio is favorable to our expectations for the quarter.

Consistent with previous years, we fully expect our expenses to tick up in the fourth quarter as we make progress on certain strategic initiatives and increase our promotional and IT spend. Overall, our US pretax profit margins are set to perform at or above the high end of our [2015] guidance range of 17% to 19% for the year.

In both Japan and the US, we will spend some time on our December outlook call discussing revenue trends. Benefit ratio drivers, and specific to expense ratios, where we intend to invest in the platform throughout 2017.

Turning to investments, results were both the quarter and year and were aligned -- year to date were aligned with our expectations as we continue to navigate the low yield environment and further diversify our portfolio. As we discussed during our analyst briefing in Japan, we continue to execute on a comprehensive plan that includes curtailing interest-sensitive premium flows through actions to reduce the sale of first sector savings products, developing alternative high-quality yen investments, including a measured reentry back into yen private placements. Finally, executing on our US dollar investment strategy where we can hedge market value effectively and optimize investment income consistent with risk, ALM, and capital objectives.

With respect to our US dollar program and hedge costs, our reported third-quarter costs were elevated recognizing we currently isolate and report the full cost of forwards in the period we purchase. Consistent with the strategy we have outlined at our analyst briefing in Japan, we have successfully executed on covering approximately $3.3 billion of additional US dollar assets under the hedge program and have proactively extended the duration of our forwards to better manage 2017 costs and associated volatility. Both of these actions will serve to exaggerate our reported costs in the period under our current reporting.

Amortizing the costs over the life of the forwards, the non-GAAP reporting convention we plan to adopt in 2017, our hedge costs for the entire book of hedges were $54 million pretax or $0.09 a share this quarter. Assuming no material change in hedging strategy and our current reporting method, our pretax hedge cost guidance remains in the $280 million to $300 million range for 2016.

Moving to an amortized basis for reporting, tactically extending duration, continuing to refine the asset allocation and hedging strategy will serve to reduce the quarterly volatility as we incorporate hedge costs into our definition of operating earnings for 2017. We will cover this approach and forecast in more detail at our outlook call in December.

Turning to capital, we commented last quarter that hedging additional US dollar asset classes would further strengthen our SMR. We ended the quarter with an estimated SMR above 900%, up significantly from last quarter. RBC is also preliminary at this point, but we expect it to remain strong in the mid 800% range despite the strengthening of the yen impacting our ratio negatively throughout the year. This was a result of the Japan branch embedded in our US statutory results.

Overall credit conditions are stable. Impairments in the quarter were modest, and preliminary -- and primarily related to our Japan equity portfolios where depressed market values have triggered impairments in accordance with our internal accounting policies.

We continue to return capital to shareholders. Between dividends and repurchase, we are returned approximately $1.7 billion to our shareholders year to date. We continue to spend down excess capital held at the holding company, and expect to achieve our target of $1.4 billion of repurchase for the full year.

As Dan highlighted, our Board elected to increase the shareholder dividend at $0.43 per-share per quarter, a 4.9% increase in marketing our 34th consecutive year of dividend increases.

Bolstered by US segment earnings outperformance and solid results in Japan, we're comfortable increasing our 2016 earnings guidance to $6.40 per share to $6.60 per share on a currency neutral basis. We have provided in our press release an EPS range for the fourth quarter assuming a yen to dollar exchange rate of 100 to 110.

As mentioned last quarter, we are conducting our normal actuarial review of interest-sensitive blocks of business in Japan. There are two smaller legacy blocks of interest-sensitive third sector business that may require strengthening as these blocks have been susceptible to strengthening in the past.

In addition, from a corporate perspective, post-retirement benefit liabilities are sensitive to long-term rate assumptions and, while not finalized, we anticipate an adjustment in fourth quarter and suspect this will be a common theme among many large corporate entities.

Overall, we remain well positioned in terms of core margins in capital strength and look forward to our December outlook call where we will expand on our strategic plans and 2017 outlook. I'll now hand the call back to Robin to begin our Q&A session. Robin.

Thank you, Fred. Now ready to start taking your questions but first let me remind you that to be fair to everybody, please limit yourself to one initial question and only one follow-up that relates to your initial question. We are now ready to begin with the first question.

(Operator Instructions) Jimmy Bhullar, JPMorgan.

My question was just on your higher EPS guidance. If you could discuss whether it was more the benefits ratio coming in better that gave you the confidence to raise the range or was it just lower discretionary spending. And to what extent are these things that will affect next year? Like if it is spending, could that spending go over next year or likewise, if it's the benefits ratio, should that continue to be favorable through next year as well?

Sure. Jimmy, thank you for the questions. This is Fred. Really the revision to our guidance is largely bolstered by outperformance relative to our expectations on the earnings front in the US.

However, I would add that year to date both the US and Japan have been traveling at generally favorable [ins] of our ranges for both benefit ratios and expense ratios. And so I made a point to say also or point out the Japan solid results are contributing as well. But the true outperformance relative to our expectations was more pronounced in the US earnings side.

In terms of as we look forward, we will spend a good deal of time not surprisingly during our December outlook call talking about the trends as we look at next year. So I will spend more time there.

I would say in general you would expect us in the fourth quarter, for example, to see some expenses tick up. This is not uncommon. If you follow the Company over the last few years, you'll see that tick up has to do with the timing of promotional spend and the natural progression of initiatives as we go throughout the year.

As we go into the next year we will continue to be investing particularly in our US platform and we will speak more about that. I don't know that I would suggest that to be material but you would see a slightly elevated expense ratio is reinvested net platform. And then in terms of benefit ratios, we have been tracking it, particularly in the US, at a favorable level.

We would expect to some degree to see a continuation of that near term eventually normalizing back towards our range. But we have seen some persistency if you will, relative to the benefit ratio being favorably throughout the year. And based on what we're seeing right now, that should continue for a bit, but we will talk more about it during the outlook call.

And then if I could ask one more, just on your hedge cost, it was pretty high this quarter. To what extent did the increase -- you're just increasing duration and if you could just give us some color on how far you are going out on new purchases and what the basis point cost is for that just that you are putting on?

Yes, there's really two principal drivers of the hedge cost being up, given how we reported. And that was really the tactical moves made in the quarter and it was a combination of extending duration as you mentioned. I would say over the past year for example, we have pushed that duration of our hedge portfolio out from roughly four or five months to upwards now of 10 months and that means by definition, we are buying out into the one year, 18 month timeframe. In some cases, on the forward curve.

This is in part not only to manage for volatility which we think is important for consistency and stability of our reported earnings and costs, but it is also because we have actually seen a flattening of the forward curve where it's more economic for us to go a little longer and lock some of that in. So we have been quite tactical on that front.

The other piece that is contributing, of course, is just simply covering more assets. And then, particularly covering assets that we've been building in the US dollar portfolio. Things like bank loans, commercial real estates, and equities, we are covering those assets -- are important not only from a pure hedging perspective but also you get the favorable capital treatment or really protect the favorable capital treatment that you need for SMR.

So those have been the two areas of contribution. I would say about 35% or so of the costs related to duration expansion in the quarter and about 40% of the cost increase are the costs you are seeing related to covering additional assets just to give you some round numbers.

Again, we will be moving to an amortized basis which is a more logical way of looking at the cost going forward. I tried to give you some color for what the quarter looked like if you were to amortized cost today, we really believe in the tactical moves we are making. And during the outlook call, we will give you a full rendering of how the year would look and how the comparable years would look as we incorporate it into our forecast for 2017.

Thank you.

John Nadel, Credit Suisse.

Two questions. One, Fred, just real quick, what is the size of the notional amount of the hedged asset program as of the end of the third quarter? I know it was $14.3 billion or $14.4 billion last quarter. It sounds like it's probably in the $17.5 billion, but if you have the number that would be great.

Yes it's -- and Eric, you can jump in, but I think we're traveling close to $16 billion and this would be particular to the forwards, that we are covering. So John realized that we used two instruments to hedge. The vast majority of what we use are forwards and that's where the cost comes in.

We also do some collaring on a small portion of the assets, which tends to be a much, much lower cost type approach to hedging. The vast majority of our hedging is done using forwards and that notional is traveling around $16 billion, up from around $12.7 billion in the second quarter to give you an idea.

And I think -- I'm going to anticipate where you may be going with this question from an understanding forward costs, and that is if you were to take our $16 billion in notional and just hold that constant. We are seeing costs traveling between 170 to 180 basis points. Actually more recently, it's gotten a bit favorable coming off of DoJ and Fed announcements. That's what we have moved to accelerate locking in some of the costs. But we think it's more wise to be thinking in that 180 basis point range and that gives you a sense of where we are traveling from an amortization perspective.

Okay, that's helpful. And would you anticipate that a Fed hike, I guess in December, would -- all else equal, would increase that cost?

It's always hard to say and the reason for it, John, is while on in theory, a Fed moving rate is up and a DoJ staying put or continuing to move rates down widens out your hedge costs, realize that things are priced into the market.

So to what degree a Fed rate hike is already priced into the market is a bit speculation. I don't know, Eric, if you have any --

I would just add to Fred's comments today if you looked at one year hedge costs they are about 168. But we are anticipating upward pressure for exactly the reason you said. If you look at the forward curve one year from now, one year hedge costs are about 200 basis points. So to Fred's point, the market is anticipating the Fed hike.

Yes, understood.

One year from now we would expect hedge costs probably to be higher by 20, 25, 30 BPs, anticipating some Fed activity. But even by the Federal Reserve's own public announcement, even if they raise rates, they have been very clear, slowed, and gradual, nothing sharp because the US economy won't support that.

And then that -- last follow-up on this one is just -- if you look out a year from now, approximately how much growth would you expect to see an actual US dollar investment program that would require the hedge?

Yes, I think we will provide some backup to that, John, on the outlook call. I don't want to steal some of the analysis from that, so I would suggest you will go into more detail.

I will point this out however. It's not simply a matter growth in the US dollar program which I would anticipate to be gradual. It's also the mix of where we are investing. And what you have seen us do through bank loans, for example, middle-market lending and then more recently exploring transitional real estate lending -- which is just a form of bridge loans on commercial real estate -- these are all characterized as being floating-rate US dollar investments.

That's particularly advantageous for us because, one, you will tend to hedge that using short dated forwards where it's relatively less expensive forwards. But also from a duration matching perspective, you end up -- bent to the same pressure that is supplied to hedge costs tend to result in increased LIBOR rates and returns or yields on the floating-rate securities.

But one of the things that we are working on is not just the notion of asset allocation and where the US dollar program goes, but also refining our asset allocation in that portfolio to be more effective as I mentioned in my comments. More efficient and effective in hedging and in the process of further managing volatility.

That makes sense. Thank you.

Michael Kovacs, Goldman Sachs.

Wanted to focus a little bit on the US sales slowdown this quarter and relative to your longer term expectations and wondering if we could dig in a little bit more to what was really driving that this quarter. It seemed like a slowdown across some of the accident and core cancer products, but any additional color you can provide would be helpful.

This is Teresa. So thank you for the question, Michael. The weak sales this quarter really, I think, attributed to the changes we've made that are settling in. The market that is succeeding has three fundamentals.

One is heightened broker collaboration. The second as, as Dan talked about, productivity per producer -- increased and improved productivity per producer and then the third thing is an increasing conversion rate that were approved to producers.

So what we are really focused on is making sure that we manage the full performance of all of the markets from that perspective. We are seeing some positives. We are seeing positive growth in new account [AT]; we're seeing positive growth in producer productivity, but we don't have all markets clicking on all cylinders.

And so that is really the focus from a US perspective.

And I will make one other comment. The new contract we put in 18 months ago or so -- what you saw is -- if you will remember, we had an enormous fourth quarter that year and a lot of people stayed around, continued to produce, but now that half of the organization is doing great and is making more money, the other half is making less money.

These ones that are making less money were making more money under the old contract. So they are having to perform to get paid which is the way we want it. But a lot of them are reevaluating, how hard do I want to work for that money? And if they want to work hard, they would make a lot more.

And some of them are saying, you know, I have done well, I am going to take my money, and I'm going to move more towards just sales and not have to worry with sales management. And how much more complicated it's gotten.

[Everwell], one day pay, all these other aspects have changed them from just being a sales manager to the managing -- or changed them from just managing sales to being a real sales manager which includes looking at profitability, making sure we are disciplined in our approach to offering group products at certain prices.

And -- so we are going through a little change with that that we hope wouldn't happen but I am certainly not surprised. And so that's the other aspect.

Great. And then I guess now that it's been 18 months as you mentioned since the initial rollout, do you feel like most of that is through the system or should you expect a continued drag from the transition through the next couple quarters?

I think that it is hard to call -- I can't tell you how much the market has changed. And I've been around here a long time. And it's always been more of the same for the first 25 years I was doing it. Now it's not.

It is -- our great sales organization which I am so happy with. And -- but in addition to that, it's the brokers, it's the change from -- we never had the skew of business to the fourth quarter but because of the way they have rolled the accounts, the way it's working now, it wears me out. It's like a football game where you've got to pull it out in the fourth quarter.

But the numbers are becoming larger and larger and we're trying to shift it more to the third quarter and it worked. They still want to turn it in in the fourth quarter.

And we had more control over the associates because they listened more. But when you deal with this broad-based broker, you just take it with -- so, but we've got this big pipeline. So I think things are moving in the right direction, but I still believe next year, the fourth quarter is still going to be big because of the way it happens.

Yes. And I will say, from a pipeline perspective, when you look at reenrollment, you look at new business in the pipeline, the pipeline looks good. So we feel good about the pipeline. But to Dan's point, you've got to pull it out in the fourth quarter which is very, very different from what we have been accustomed to in the past.

Great. That's helpful. And one last follow-up on that. As we think about the promotional expenses, I know Fred and others mentioned that those tend to be higher in the fourth quarter, should we expect them to be above prior year's levels as a result of trying to pick up some of the potential sales growth in the US?

Not particularly. Actually, our overall budget year over year is relatively stable from an overall promotional and marketing spend. There may be modest differences quarter over quarter from a timing perspective in particular timing of ad spend and so forth, but the notion of it being bunched around enrollment season and in the fourth quarter is not unusual. And there is not really a large step up delta, if you will, to the promotional spend.

I want to make one final comment and that is I don't like the sales quite where they are. I like them better, but I like what is happening in our operations.

I like the idea that we are doing the one day pay. I like what is happening with Ever Well, I like how the brokers are coming on. I like what I'm seeing in writing large accounts but we are being disciplined and not just writing every account. Some that couldn't be profitable were passing by.

I like what Teresa is doing in merging the brokers and the associates together. But with that are growing pains. But all in all, I am pleased with what's taken place from that regard. I just want stronger sales.

Thanks.

Seth Weiss, Bank of America.

Fred, I wanted to follow up on your comments that in the US you expect the beneficial underwriting trends to persist in the near term, but normalize back in the long-term. Could you just comment on what gives you the visibility in both the near term and long term?

Yes, the -- what we're seeing right now is -- first of all, realize, of course, benefit ratios will fluctuate each quarter and so there will be quarters where we are in our range in quarters where we move within the range are a little favorable.

But what we're seeing year to date, even somewhat last year -- in the latter stages of last year is a consistently favorable benefit ratio. And what we see going on there we believe relates to -- somewhat to mix of business.

And two particular types of business that are driving this, we believe, are one, group business where group business naturally is priced to and expected to travel at a lower benefit ratio than you would find, say, on individual products and the way it's priced. And that's just a function of how it's priced and structured as a product. And as group business grows and becomes more of our in force and plays more of an influence on our benefit ratios, you'll see a little bit of that.

The other dynamic, though, is really more guaranteed issue business where the actual building reserves tend to be slower and more moderate in the early years. And so as you start to sell more of that guaranteed issue business as a proportion of other business, you will see just a slower ramp-up in reserves and a generally, more favorable near-term benefit ratio.

So that's what I mean when I say we would expect to see as those types of businesses age, that they will age back into our expected long-term range of benefit ratio.

But for a period here, it looks as if we are traveling at a -- again, a persistently low benefit ratio relevant to our expectations. And again, it's all on the margin. We are traveling at maybe 50 or so basis points better than our guidance in general. But we will provide more of an update on this and some trends as we get to the outlook call.

Great, thank you. And one quick follow-up just on the hedge costs. You commented or reiterated that $280 million to $300 million range for the full year -- I believe you are already at the low end of that range. So could we assume that you have effectively done most of your purchases for the year on the US dollar-denominated program?

That's right. Unless we take a different tactical approach, for example, deciding to aggressively lock in more long-term hedges, then we would expect to stick with that guidance. And what that really means is you can see we have covered effectively all of our needs. We are right now about 98% covered, if you will, on our hedge activity in 2016.

And furthermore, we have gone into 2017 and we have covered or locked in, if you will, about 40% of our costs in 2017.

And that's what we want to try to do. We're going to try rolling, if you will, as we go forward so that we can create a level of consistency in our hedge costs.

Great, thank you.

Humphrey Lee, Dowling Partners.

Good morning and thank you for taking my questions. Just another follow-up on these hedging costs. Given a lot of the Japanese insurance companies are talking about expanding their foreign investment program backed by a hedging program behind it -- so from a hedging insurance perspective, given the higher demand, do you see any potential impact on the hedging costs from a capacity perspective from your counterparties?

From my conversations with the team, I will ask Eric to weigh in though -- the forward market -- particularly the forward market involving two of the largest and most stable currencies on the planet, dollar and yen, is such a deep and strong market that you tend not to see the ebb and flow of purchasing and selling having a tremendous impact on it.

There will be times where supply and demand do play in fact into the forward cost. That's natural. And by the way, by locking in a little bit longer, we have the ability to step out on the margin where necessary, and step back in tactically and that's part of what we tried to do on the margin.

So there's no doubt, there is some possible influence. But I'm not sure, given the depth of this market, that it would be significant. But Eric, maybe you have some comments.

I would just add Fred is absolutely right. There is not an issue of the availability of forwards. There's plenty of capacity and the markets from counterparties. However, it does drive in to the price of the forwards. We tend mostly talk about the difference between central bank policies between the Fed [and] Japan. That is the largest driver and (inaudible) the largest driver. But there is also something called the basis.

The basis is basically a reflection of supply and demand for dollars but to your point, a lot of the Japanese insurers and other investors outside of Japan are buying a lot of dollar assets and, therefore, in the currency markets. And that will drive up the price of the forwards, but it will not reduce the supply. There is more than ample supply. The most liquid market in the world.

Said to that point, even if longer term, the interest rate environment to become more normalized. But if there is [a slide], there is the demand from the Japanese insurance companies that could create an upward pressure on the basis.

That's like it's investors from around the world. Not just Japanese insurance companies.

Okay. And then just to follow up on the US dollar investment. So to the point that they are definitely a greater demand from foreign buyers of US assets -- so for your tactical shift in terms of your asset allocation to bank loans and middle market lending, have those asset classes been tapped and by the other foreign buyers as well, and if so, can you talk about the competitive landscape in terms of sourcing of these assets?

Sure. Happy to. It's a very, very large market and it is attractive to insurance companies like ourselves. However, there is a trend of the shift of capital available to the long -- middle-market nonmarket, even transitional real estate. And what I mean by that is there's hundreds if not thousands of lenders across the United States lending to thousands of small middle-market companies and in the real estate market.

Historically, banks have been the capital providers to those loan markets -- to the lenders as well as re-syndicating some of those loans. Because of Dodd-Frank, the banks have removed themselves from that market. It's no longer capital-friendly for them. For an insurance company like us, we like to focus on credit risk and underwriting where we can negotiate very tight [confidence] of a high predictability of securement of loans and our money. So it's an attractive asset class. So yes, it's true.

There is a trend of insurance companies and other investors substituting for the banks. So in a way, it's a zero-sum game. I couldn't give you exact specifics, but insurance companies are coming in were banks are leaving, and providing that capital to the market.

Now naturally, it's supply and demand, so there may be more demand than there has been in the past and that might tighten spreads a bit. But you are getting paid for taking the credit risk and those types of particular loans. Companies -- you're also getting senior secured status. Very tight negotiations to your favorite to protect yourself in case there's any credit challenges with the Company.

Okay, thank you for the color.

Ryan Krueger, KBW.

Fred, first, I wanted to follow up on your comments about the fourth-quarter actuarial and post-retirement benefit review. Are those -- are anticipated impacts from those included in your fourth-quarter EPS guidance or would that be viewed as separate impacts?

Yes, it's -- here is how to think about it. In terms of our fourth-quarter estimates, the postretirement benefit adjustment -- we have allocated or set aside in our forecast, in our estimate, an amount of money that is preliminary and we don't have the final. Because it ends up being the result of a final posting of the pension interest expense or basis points from a composite.

And so what the pension world waits for is the production of that composite but we fully anticipate it to be down. It's hard to envision them being the recovery in it and as a result, we have a greater level of confidence there will be something. And so we have set aside some money for that.

In the case of our review of these blocks of -- legacy blocks of business I mentioned, that is not in the numbers because we really are too early in the process to know what might be the practical ranges or if there would be a reserve strengthening at all on those products. And so, we do not have anything in the numbers for that.

Okay, thanks. And then another follow-up on US sales. Is the comment that it would be more challenging to meet the 3% to 5% full-year target? Should we view that as more reflective of somewhat lower sales in the first few quarters of the year, relative to what you would've expected or does it have more to do with your actual outlook for the fourth quarter and broker production?

I think the broker production as far as the pipeline looks pretty good. So, within the range. I had hoped that we would be a lot further along after the third quarter. And so I would view it more so as my disappointment of where we are as of the end of the third quarter.

However, I will say this. As Dan said, we -- there is plenty of opportunity for us to really bring in new business. We also are looking at the profile of the business that we're trying to bring in and we are turning down some of the cases. And so when we talk about it's going to be a little bit more difficult, it is really going to require a great fourth quarter for us. Now we said that the last couple of years and our sales teams delivered.

So that is really just kind of how I'm looking at it at this point. Do you have anything else, Dan?

No, that's right.

Okay, thanks a lot, appreciate it.

Yaron Kinar, Deutsche Bank.

I also have a question on US sales. So, in talking about your forecast, and in the environment you're seeing right now, you talk a lot about the distribution force and the dynamics that you are seeing there. Could you also talk a little bit about what you are seeing in terms of the competitive landscape from a manufacturing perspective?

From a competitive -- and did I have manufacturing perspective? Okay. So from a competitor perspective, we are seeing a lot more competitors in the voluntary space, some of the employer paid benefits are now becoming voluntary benefits, so again, additional voluntary benefits in the space.

At this point, we are also seeing competitive bids specifically on the broker business. Some of the bids, as I've said earlier, we really are passing on because of the profile of the business and we want a really stable product profile. And some we are choosing to partner to get. Like the long-term care type products. So we're trying to go to best-of-breed to get those.

So really from a competitive set, we are seeing a lot more competitors in the market but we feel -- we still feel good about what we're doing in the market as well.

I want to say one other thing about this. This is not unusual in that I can go back 20 years ago and remember when our competitors got in the market and they were going to give unlimited cobalt and chemotherapy benefits.

We kept telling ourselves we couldn't meet that. They ended up having 50% rate increases. Two or three times in a row to offset that.

The good news is we have got all these statistics with what we've been doing in the cancer insurance business and in this area for so many years -- we kind of know how to price it. And some didn't want to make low balls. It generally bites them later on.

And yes, it gives us a little problem short-term with sales. Go back 20 years ago, we were losing sales to some of the competitors. A couple those companies aren't even in business anymore and the few that were had to change the way they approach things.

So this is not that unusual that we are having people lowball on products. We have seen it in Japan even. But the fact is we know what we're doing and we are pricing it right and we're giving the customer good value. And in return, we are making a good profit.

I appreciate the color. And then another question. Regarding the revised guidance, if I back out of the numbers correctly, I think I got to roughly flat constant currency earnings in the fourth quarter and the midpoint of that guidance range. And if I heard Fred's comments earlier, I think those numbers don't include the potential adjustments to reserves or on the pension front at this point -- retirement front, sorry, at this point. So what other drivers are there right now that are serving as a head wind relative to last year or is it just that last year was a very strong quarter?

No, I would say in general it's really a couple of things. One is what I mentioned -- we believe there will be a bit of an acceleration in expenses in the fourth quarter. That's what we are forecasting.

Sometimes that plays out, sometimes the timing of that doesn't play out. But at the moment, that's our forecast. And then again recall that I did, in fact, include some level of expense related to what we believe is an inevitable postretirement benefit adjustment related to interest rates.

Now again, that's not finalized and you need to understand the final before you can book anything. But we know enough to know that there is probably range bound amount in there.

So that's a little bit of what is traveling through the number. And obviously we will continue to do our best to meet or exceed the forecast as best we can.

But I thought that fourth quarter usually sees an acceleration of expenses. So wouldn't that have held true last year as well?

Yes, it's all relative. It's a matter of how big acceleration was last year and how big this year. So I would say those are really the issues.

Got it. Thank you very much.

Tom Gallagher, Evercore ISI.

Another question on the hedging program. So Fred, if you factor in the cost of hedges currently, and then you consider the impact on your first sector business like [Ways], are those products still going to be profitable when you factor in the cost of rolling these hedges here? And is that the way you're thinking about it at a discreet product level in terms of profits or are you thinking about the hedge in a different way? Is that sort of a corporate expense? It's discreet and not being factored in at the product level?

No, it's not discreet. In the sense of when we look at our -- putting new money to work if you will premium and what new money assumptions that -- just call it the new money curve, we need to achieve to achieve certain profitability levels, we not only factor in what I would call the gross yields we would expect on investing our money, but when it comes to the US dollar program, we also are projecting a head cost environment into the net yields that we expect to support the product.

So when we are pricing a product like Ways, we are looking not only at the interest rate environment and mix of investment and associated credit spread if you will, but we also in our case have to be factoring in heads costs. So it's a very real part of how we think about the product.

So as a result, all of the repricing that we are doing is really having to take into account the low interest rate environment, our asset allocation, hedge cost, and then most notably in Japan is also a recognition that the standard rate with the discount rate assumption used for reserving practices is going to come down materially in Japan at the end of March of next year.

All of those things have been factored into pricing out our savings or interests sensitive related first sector products, namely Ways and child endowment in making sure that we can adhere to a decent profitability.

Okay, so we shouldn't be thinking about worrying about DAC or reserve adequacy for your first sector business in a broader sense when you consider what's going on with these hedge costs?

Right. We do that actuarial work. I pointed to a couple of legacy blocks of business as it relates to being particularly closer to the edge and we have to watch and carefully watch that and these tend to be blocks of business that you are familiar with. Dementia, super care, these are products that we have been watching for a number of years.

But we do the testing work on all of our products both third sector and first sector in the fourth quarter. Not surprisingly, we will see the reserve margins squeeze on first sector savings products as it relates to the current environment including hedge costs. But we have solid margins in those areas.

And so at the moment, we don't see that as a risk. It's more these acute -- what we're calling legacy smaller box that are actually third sector business, to be technically correct.

Okay, and then just a follow-up for Eric. Can you comment on what is the breakeven of where hedge costs would have to go to the point where you would say this has been a negative decision from an economic standpoint in terms of building up this US dollar portfolio.

Clearly running at 180 basis points, I know it was high. Is that still -- is that a net positive? Like when you factor that in and look at the yield and the risk related to building up this program?

Absolutely. The approximate number is 2% meaning our earnings are about 3.6% if you look at the stock hedge cost, call it [160], [180]. We've got a 2% margin built-in. We would just like to follow-up a little bit on Fred's comments before to put this in context, but your focus appropriately so is on the large increase this quarter.

When we went into this program, we presume the long-term average of has costs is somewhere between 2.75 and 3. So we were very clear when we got into the program, heads costs were historically low and that was about 60 bps back in 2012. They kept traveling down to 20.

So what we're seeing now is more of a normalization. We could never know exactly when or where the exact macro dynamics that would make hedge costs go up. But we always knew they would go up so even though they are at 168 to 180 basis points today, it's about 50%, 60% of the way towards the long-term average.

But then if you think about that long-term average, it would take quite a huge amount of growth in the United States for the Federal Reserve to raise interest rates substantially to get to those numbers. It could happen someday, but we've got a 2% margin to be precise on your question before we would be saying, gee, this is a breakeven trade.

Got it. So really this would have to cost you 350 to 400 basis points before it became breakeven?

That's right. And finally I will just again reiterate what Fred said earlier. That assumes we are passive and we do nothing. But again we continue to look at asset allocation and changing the mix of the assets to set our match off against those has costs like the floating-rate assets.

We also look at the current composition of the portfolio. We may decide to lighten up on certain asset classes. And then of course there is the -- how do we look at the hedge strategy itself which we continue to look at and, as Fred has mentioned, continued to lengthen duration.

So if we just were passive, that's the answer. But we would expect to continue to manage that with a fine tooth comb to preserve as much of that margin, whether it's to higher income for a better heads cost management. So that will be dynamic over time certainly.

And Eric, when you compare the cost, is that to JGB yields? Is that the benchmark?

That is the ultimate benchmark. So that's another great point, Tom. Three or four years ago, 20 or 30 year JGBs were 2% when I got here. They traveled at 10 basis points a few months ago. Now they are at about 40 or 50.

So it's all in relativity and once again, the dollar program has limits and we're actually pretty close to those limits. We have some capacity and, as Fred said, we will talk more in the December outlook call about future purchases. But in context of a large global portfolio, we like the diversification. Because if all we were buying were yet assets and we've got quite a large amount every year of maturing private placements, old assets at 2% and 3%, our reinvestment net investment income would go down pretty rapidly as well. So it's a diversifier and it's a balancing act, but that's why we have limits on each part of our program.

Okay, thanks.

Thank you very much. We are at the top of our right now, so before we and today, I want to take the opportunity to remind everybody as Fred had mentioned earlier, that we're going to have our 2017 outlook call that will be held later this year on December 2, so we want to make sure you mark your calendars for that event on December 2 and for further details on the call, please feel free to call our investor and rating agency relations department and we look forward to speaking to all of you and thank you for joining us today.

And that concludes today's conference. Thank you for your participation. You may now disconnect.