American International Group Inc (AIG) 2011 Q2 法說會逐字稿

Good day, everyone. Welcome to the American International Group Second Quarter financial results Conference Call. This call is being recorded.

Now I'd like to turn the conference over to Ms. Liz Werner, Head of Investor Relations. Please go ahead.

Thank you and good morning everyone.

Before we get started I'd like to remind you that today's presentation may contain forward-looking statements which are based on managements current expectations and are subject to uncertainty and changes in circumstances. Any forward-looking statements are not guarantees of future performance or events. Actual performance and events may differ possibly materially from such forward-looking statements. Factors that could cause this include factors described in our 10-Q, under Managements Discussion and Analysis, and in our 2010 10K and subsequent 10-Q's under Risk Factors. AIG is not under any obligation and expressly disclaims any obligation to update any forward-looking statements whether as a result of new information, future events or otherwise. Today's presentation may contain non-GAAP financial measures. The reconciliations of such measures to the most comparable GAAP figures are included in our financial supplement which is available on AIG's website www.AIG.com.

At this time I'd like to turn our call over to Bob Benmosche, our CEO. Bob?

Thanks, Liz, and good morning to everybody and we have a lot to cover so I want to be pretty brief and I'll turn it over to David.

The key for this quarter though, and I do want to comment and stress it, is that we completed the last hurdle for this company for the conditions of closing for our restructuring and so by issuing 100 million shares and raising that equity capital, it allowed the Treasury to terminate the Series G preferred and so therefore, in my mind, AIG's crisis is over. We no longer have any direct obligation that we have to be concerned about vis-a-vis the government. Whatever is owed to the government for what they gave us in the beginning is all covered by collateralized partnerships for the common shares that we issued to them back in January. So today, we are independent of government support which is very important for our employees and our clients as we go forward.

There's clarity. AIG is here. We're an investment grade company and if you look at our results for the quarter our top line is strong. Our retention of clients is strong. Our retention of people is strong. So all of the fundamentals of running this Company are moving in the right direction. You could see in Chartis for example, that the combined is now 97.7% for this quarter, working its way down and you know that's a huge book of business so it takes time to do that.

You also will see in Sun America the strong top line in terms of those products that they sell. That's a good story as they were back in all of the distribution systems. UGC has a good control over its mortgage business. In fact, they're now leading in market share in terms of that business and have a very strong performance in terms of losses relative to their competitors. That's going well and of course as you saw in ILFC, we've been able to deal with our legacy aircraft with the announcement of this acquisition of Air Turbine so that will give us more options and the late cycle of the life of those airplanes which we did not have before. So when you look overall, we're in good shape.

I also should mention that non-Shan looks like it will close and that will finally get done. That's another $2.1 billion, $2.2 billion we'll be able to bring in house and deal with paying down the SPV with the US Treasury so that's another good sign so overall, we're in great shape. We can look forward and focus on operating results which we have over the last 4 or 5 quarters in particular. You can see it in our performance and I'll have David now take you through the details of that so you can reconcile what we reported and some of the nuances in those numbers. David?

Thanks, Bob, and good morning, everybody.

Let's turn to Slide 7 for the earnings highlights. Second Quarter net income was $1.8 billion up from a loss of $2.7 billion a year ago. Importantly, our after-tax operating income attributable to AIG which is our principal non-GAAP measure was $1.3 billion versus $800 million a year ago. On a per share basis, after-tax operating income was $0.69 for the quarter versus $1.18 a year ago. Book value per share was $49.18 up 2% sequentially. Adjusted ROE was 6.3 for the quarter, 8.3 year-to-date.

Let's turn to Slide 8. Chartis reported pretax operating income of $789 million, down $166 million from a year ago due to an extraordinary level of natural catastrophe losses. Catastrophe losses in the Second Quarter this year were $539 million largely from US tornadoes and storms versus $300 million a year ago. Sun America posted $743 million in operating income in the Second Quarter down $115 million from a year ago. The Sun America results included $176 million decrease in the value of our main lane 2 investment due mainly to spread widening on the underlying non-agency RMBS securities.

We also increased our reserve for IBNR by $100.6 million as a result of enhancing our death claim practices. ISFC, operating income was $86 million for the quarter compared to $182 million a year ago. ILFC had $60 million of interest and other costs associated with their debt issuance and the subsequent tender offer for bonds and took an impairment charge of about $42 million on a handful of aircraft that were either going to sell or put into part out. As you might have read, again as Bob mentioned, we announced the acquisition of Air Turbine, the part out business which will provide new opportunities and options for us to manage the older aircraft in our fleet.

Turning to Unite Guarantee, our mortgage guarantee business reported $13 million of operating income versus income of $226 million a year ago. Last years income benefited from $232 million of favorable prior year development while this quarter included $25 million of unfavorable prior year loss development. To put this in context, United Guarantee has roughly $3 billion in net loss reserves. In addition, the Second Quarter included a $40 odd million favorable settlement with a former underwriting customer. Newly reported delinquent loans continued to decline yet overturned for previously declined or rescinded claims increased. Domestic first lien reserves per delinquency remains steady at about $29,000 per delinquency.

Turning to our other reporting unit. It is reported a loss of $984 million in the quarter versus $135 million a year ago. Due largely to the mark to model loss of $667 million on our Maiden Lane III investment and to a lesser extent our Capital Markets wind down portfolio. As you know, Maiden Lane III is a special purpose vehicle that holds multi-sector CDOs purchased in the Fall of 2008 in which we own a subordinated Traunch plus a 1/3% residual interest. As of June 30, the value of our share of Maiden Lane III was $6.4 billion, down 10% sequentially but importantly up 28% from our initial investment. We essentially gave back the $744 million gain in the First Quarter.

Prior to the Second Quarter we reported 8 consecutive quarters of gains. In the Second Quarter, credit spread widening and the corresponding impact on fair value model discount rate assumptions were the key drivers in the Maiden Lane III value. Cash flows within the underlying CDOs remain steady and we still anticipate receiving pay outs beginning in 2014. The Maiden Lane III cash flows to date have paid down $12 billion to the Federal Reserve Bank of New York or about 50% of their senior loan. Asset Management which is included in other head income of $92 million for the quarter down from $303 million a year ago due largely to the tightening of credit spreads in the asset book from a year ago.

Capital Markets had a loss of $160 million, roughly $160 million due to the unrealized mark-to-market loss on the super senior credit derivative portfolio versus a gain last quarter. The loss was driven by a decline in values of the multi-sector CDS book. The wind down again continues to progress very significantly. This book had 7 quarters of favorable marks before the Second Quarter and our view of intrinsic value hasn't changed. Remaining in the multi-sector book is about $6 billion of notional, for which we hold liabilities of roughly $3.2 billion, most of which we've already posted collateral against.

Independent views support our belief that the actual settlements under these contracts will be less than the GAAP liability and the collateral postings we have, thus giving rise to the potential intrinsic gains we believe are worth the GAAP P & L volatility that we are required to report. As previously disclosed, the Second Quarter marked the end of the active wind down of AIG FP, the remaining derivative portfolio of the Capital Markets are predominantly non-complex market derivatives entered into manage the risks of AIG, and its affiliates or our hedges on those positions.

At the end of the Second Quarter approximately $29 billion of notional remains in the CDS portfolio of which $22 billion does not require active trading management. The remaining $8 billion CDS which is being actively managed has over $1 billion of upside we believe against the modest contingent liquidity need going forward. Also during the Second Quarter, AIG FP agreed to terminate 2 super senior regulatory capital transactions with a combined net notion of over $24 billion that was notional as of March 31 and those have previously been subject to possible additional collateral postings and finally our remaining investment in AIA appreciated about $1.5 billion in the quarter.

Turning to Slide 9 which shows the after-tax income reconciliation. Reconciling items have declined meaningfully as most of the restructuring activities are behind us. Also, we adjust for taxes since we apply a pro forma tax rate to our operating earnings. The taxes are added back here to the GAAP net income to get to GAAP net income since we aren't paying much tax and we currently have a full valuation allowance.

Jumping to Slide 11, our capital structure. This reflects the January 2011 recapitalization and reduced leverage. Our leverage is currently in the low end of the range of our long term target and we still assume a 20%-25% debt to total capital as part of our apparitional goals.

Turning to Slide 13, Chartis. Overall, I would note that Chartis reorganization in the global commercial and consumer business is beginning to develop some positive momentum. Net premiums written excluding Fuji and the impact of foreign exchange increased about 2.4%. Prior year development was insignificant for the quarter after considering related loss sensitive premiums. The 4 business lines with the largest reserve strengthening at year-end 2010 saw little activity in the quarter. The combined ratio on an accident year basis excluding CATs was 97.7%. The expense ratio remained essentially flat. We are intensely focused on reducing general operating expenses in a thoughtful and deliberate way but we will continue to make strategic investments in projects that better position Chartis for the future.

Turning to Slide 14. Net premiums written benefited as I said a minute ago from our Fuji acquisition but otherwise were around 2.4% up for the quarter. Pricing is trending positively overall, in particular in the US market, we're experiencing low single digit increases on average lead by a commercial property and Workers Compensation lines. Customer retention as Bob mentioned is also strong.

Turning to Slide 15, Chartis Investments. Net investment income for Chartis was $1.14 billion in this quarter up 2.6% from a year ago. The primary driver of the increase is approved interest in dividends and the effects on consolidation of Fuji, Chartis continued to reduce its Multi bond position which was 28% of the Chartis investment, invested assets in the quarter down from 31% last quarter.

On Slide 17. Turning to Sun America Financial Group. Sun America's operating income was $743 million in the quarter down $115 million from a year ago. As you can see, Sun Americas operating income has been relatively stable for the last 5 quarters. This quarters volatility relates to market volatility for RMBS and in particular and its effects on the value of Maiden Lane II which is included in the Sun America group. We also increased our reserve for IDNR by roughly $100.6 million as I mentioned earlier. Our business remains diverse, strong, good momentum in sales and deposits, customer retention and importantly, net flows.

Turning to Slide 18, premiums deposits and other consideration. Life insurance CPPE sales increased 29% sequentially, largely driven by retail sales. Western National, while continuing to maintain its pricing discipline again achieved sales of over $2 billion in the quarter due largely to certain bank partners negotiating lower Commissions and exchange for higher crediting rates for our customers. All in all, total net flows for retirement services of $726 million were positive for the second consecutive quarter.

Turning to Slide 19 for Sun America Investments. Net investment income was $2.46 billion down $167 million from a year ago. As I mentioned, Maiden Lane II negatively affected this quarter by $176 million versus a positive $120 million a year ago. Partnership income was strong again this quarter due to performance of our private equity and hedge fund investments which are reported on a 1-quarter and 1-month lag respectively. Excluding Maiden Lane II investment income increased by 5% on increased interest and dividend and partnership income. Most importantly, our base yields increased sequentially as we redeploy cash. More on that in a minute from Bill Dooley.

Turning to Sun America spreads on Page 20. Reported spreads declined despite the redeployment of cash. Declines and other enhancements which is mainly Maiden Lane II more than offset the growth in interest and dividends. Looking ahead as we continue to take capital gains to realize the economic value of our substantial capital loss carry forward deferred tax asset, reported spreads could be pressured. We're choosing economics over reported GAAP measure.

Now a few words on income taxes on Page 22 and 23. As more fully described in our Second Quarter 10-Q, we apply a frame work for evaluating the need for evaluation allowances. Among other factors, AIG must emerge from its recent cumulative loss position, demonstrate a level of sustainable profitability. AIG's US consolidated income tax group has reported taxable income over the first half of 2011 and is currently projecting taxable income for the full year of 2011.

In addition, the group expects to emerge from the cumulative loss in recent years in the second half of 2011. If these factors are met, the valuation allowance for the net operating loss, the non-life capital loss carry forward, and the foreign tax credits could be released during the Fourth Quarter.

Realization of the life capital loss carry forwards remains more challenging and that portion of the valuation allowance will be released as a carry forwards are realized. We still expect an effective tax rate of roughly 25% to 30% for the rest of the year on our operating income driven by our substantial investment in tax free Munis. Other discrete items in any given quarter will impact the rate as well. This quarter, among other things, we settled disputes previously reserved for and the effect was favorable on the quarter.

And finally a word on our outlook. Consistent with the next steps of our Company, and our increasing focus on long term operating results, we outlined a number of long term apparitional goals in our First Quarter 10-Q which we affirm again this quarter. We expect to continue to execute on the operating and Capital Management actions to achieve these goals.

At this time I'd like to turn it over to Bill for a few comments on the cash redeployment. Bill?

Thank you, David.

As we entered 2011, we had high investable cash balances in the insurance companies and over the course of the first half of the year, we invested those cash proceeds in various asset classes to give the various durations necessary for the insurance companies. So in the first half of the year, we invested just under $50 billion and the average yield across-the-board are those investments were roughly between 4.5% to 6%. So when we entered the third quarter, we were fully invested with all the cash that was available at the beginning of the year.

Okay, Operator? At this time we would like to turn the Conference Call over to Q & A. We would like to try and take one question and one follow-up from all the analysts and hopefully we will have time to do more and they can get into queue.

(Operator Instructions)

We'll hear first from Josh Shanker with Deutsche Bank.

Good morning, everyone.

My question and they are up front and not related but similar. I'm trying to understand, the $100 million reserve charge in Sun America for incurred but not reported debt. And two, it seems for two quarters in a row we've taken charges on a revision outlook on cash flows for life settlement contracts, given about 6,000 contracts it seems like a pretty significant charge over two quarters. I wanted to talk about whether that will moderate and what your outlook is there.

We'll have Jay just briefly give you an update on what the process changes were and then we'll have Peter talk about the life settlements. Jay?

Good morning, Josh. It's Jay Wintrob.

The increase of $100.6 million in the IBNR was in response to industry-wide regulatory inquiries which we were in receipt of regarding our life insurance claims settlement practices and compliance with the unchained property laws. Our practices in that area are currently and have been completely consistent with all the applicable legal requirements and all of the historical industry standards. Having said that, we use this as an opportunity to enhance our practices. We voluntarily initiated a review using for example, the Social Security Administrations death master file and as a result of that review, we chose to post the IBNR of $100.6 million, so that's the background on that.

Is it most certainly non-recurring in nature?

Right. Most certainly, this is now part of our claims practices going forward. We will continue to use this and other information as it develops. And again, the inquiry was industry wide, not specific towards American General or Sun America Financial Group.

But the answer to the question is I believe that the process change that Jay talked about and is more about a process change. You know there's a question about what practices are but we looked at our practices and said --we think we should do it a different way--.

On the basis of what we've changed our practice to be, the team believes that they got this worked out in this IBNR, and this puts the problem behind us. And on a go forward basis, it will be part of the normal operating procedure so you would see it as part of our numbers. So I think this closes it out.

From what we can see right now, let me turn it over to Peter.

On the life settlement impairment charge, I'd like to just put it in the context of the overall life settlements portfolio which totals a carrying value of $4 billion. We have instituted increased scrutiny of the longevity assumptions with updated medical information on individual life. This is a book which has fairly large insured values per life.

And as a result of those updated actuarial assumptions, which were validated by third party scrutiny in this quarter as well, we have added the impairment charge. We would not anticipate future charges anything of that scale, but on the other hand as I said, it's fairly lumpy in terms of individual lives but when we take an impairment it's an asymmetrical charge when any single contract is impaired but you don't take positive news when it comes in, so there's an asymmetrical aspect of it. When we take an impairment, we basically look at current yields on similar contracts to mark down the position.

In the queue, you described it as enhanced process change. You had $60 million of charges in Q1 and $180 here. Is the process change fully in effect so that we don't expect this to recur as sort of a change in the outlook or just be mark-to-markets from here on out?

It's not mark-to-market.

It's actually cost accounting so you basically are looking for impairments of individual lives and so if you've got evidence that your assumption there is too aggressive then you mark that to market but you don't mark up. The opposite where you have information that suggests that you have it valued too low. So the enhanced process is just increased scrutiny on this book with additional third party scrutiny to validate our own assumptions.

That's what's changed and I would not expect charges of this magnitude going forward but on the other hand I would not expect it to be zero either. There will be some volatility and it's asymmetrical because the positive news comes in the form of a higher expected yield over the approximately 10 year duration of these contracts.

But we also have taken a -- completed a very deep strategic review of what we're doing here. We're going to think about how we modify it, but this is not an area that we're going to be emphasizing going forward, we're just thinking about how to deal with it.

So over time, we're studying this as an asset class and we don't think it's something we're going to be growing.

Okay, thank you for the color.

We'll hear next from Donna Halverstadt from Goldman Sachs.

Good morning.

I have a question about a business, that's a small slice of your business mix pie but I'm just not clear how you think about it and I wanted to understand philosophically or strategically how you're viewing United Guarantee. Whether it's core or non-core or just merely a placeholder until some future point in time when we know if there's going to be a more robust future demand function for private MI.

And as a follow-up to that, the pace of flex in the MI industry is picking up rapidly and I was curious whether or not you'd be interested participating in any restructuring of the current industry makeup.

We see UGC has really done a dramatic turnaround of that business. I feel they have employed an excellent technology now behind their claims process and so they've got themselves very much under control for the legacy book. They've done a wonderful job of reinventing how they underwrite mortgages so they have a model now that works very effectively on new business. And the experience that we've been seeing over the last started in 2009, so you look at 2009, 2010 and 2011 so far that experience is exceptional relative to our history as well as the industry. So we are pricing for the right risks and we're getting the risk that makes sense for us as a company and we're not competitive in those risks which we obviously are concerned about.

Having said that, our market share has grown dramatically, and with that performance. So we don't see any need to help anyone else out. And so for now, the business we operate that as well as ILFC is do no harm to the core franchises of the Company. But unlike ILFC, we feel that UGC does provide us a tremendous insight into a major aspect of our investment, which is residential mortgages and so on.

We also believe that as the government begins to pull back in some way out of the mortgage guarantee business, there may be a better market for us and here this may grow. And so for now it's running very well and it's enhancing whatever we do here not only from a small amount of earnings but also by the intelligence that provides us what's going out in the economy, so for now we see it as a keeper.

Great. That's helpful, thank you.

Our next question comes from Jay Cohen of Bank of America, Merill Lynch.

Yes, I've got one question and Ed Spehar will have a question as well on the life side.

My question on the property casualty side. I'm wondering if you could talk about some of the claims trends you're seeing. Obviously, with the review last year there was some negative surprises in claims trends in various businesses. As you've entered now 2011, I'm wondering if you can update us on the claims trends particularly in places like excess casualty and excess comp?

Hi, Jay. It's Rob Schimek speaking.

I think you can see from our quarterly review of our carried reserves that we did not experience any significant deviation from our expectation during the quarter with respect to claims trends. That's one of the things we focus on each quarter. We have an expectation based off of our carried reserves of what should happen during the quarter and we compare that to what actually did happen during the quarter. I think -- we generally speaking right now, it's a class of business by class of business distinction here, but generally speaking, we are seeing rate change in line with lost cost trends in particular, for example, with respect to Workers Compensation where you're seeing rate increases.

But it is line of business by line of business specific. I think the overall point is that actual results are trending in line with our expectations.

The other is important to stress that they've enhanced their processes. What you're seeing us do is enhancing a lot of process because we really want to tighten this place up and really improve the quality of our performance. And about $10 billion of our reserves this quarter were looked at by third party actuates so we're going through a quarter-by-quarter and they validated that our reserves are if anything just slightly above what they saw as essential estimates so I think it's $10 billion. But as we go through it, we're seeing everything coming in line that the reserves continue to be what we said very strong.

This is Ed. I have a question for David.

Can you give us any thought on how much of this life capital loss carry forward is $23 billion of gross attributes? How much you think you might be able to realize?

Yes, sure.

As we said earlier, the - we've got about $7.5 billion of DTA, net DTA related to the life capital loss carry forward. And as we look at the life portfolio, it has about Oh, I think about $8 billion or so of gross gains. And so that -- if you tax back the gains that sort of gives you a sense of how to think about the real opportunity right now because that's the inventory of gains that we have and then the question is how do we go about achieving that. In part, we are realizing capital gains in the life companies themselves actually selling the securities.

And then there are other strategies involved where we have other opportunities to realize at least for tax purposes the gains and we are in the process of evaluating it. My sense is, Ed, as we've said maybe up to 25% of that number of the $7.5 billion we would expect to get, because the expire dates run between 2013 and 2014, and so time is very different than on the NOLs which run out until 2028. So the fourth quarter evaluation as I was commenting on will be around the NOLs which we expect to realize fully, the foreign tax credits we expect to realize fully, and the non-life capital loss carry forward we expect to realize fully.

So David, it's helpful. So if you expect it to maybe up to 25% of the $7.5 billion that would suggest about $3 billion of gains harvested in the portfolio, right?

Well, no, think of it differently.

If there's about $2.5 billion, let's just -- again $2 billion - $2.5 billion of DTA. And the DTA is effectively, that's 35% of the actual gains -- you need gains of if we were to realize all $8 billion worth of gains, take--

I've got it. I had the math backwards. I guess the question though if you had $6 billion of gains, wouldn't that be probably given out maybe around $700 million of annual investment income?

There's a tradeoff and that's I say we're balancing economics here against the GAAP reported number and a GAAP reported spread. And we're sensitive to that but that's why there are other ways to realize those gains other than just straight out harvesting.

Ed, I think what we're doing right now is we're assembling a, I guess world class team in my mind because there may be some that are good but nobody better, that have put their minds around how we begin to deal with this. And how we can do things in a way such that we trigger a taxable gain on what it is we have here. So sometimes you don't actually have to sell it, that you get caught with a taxable gain. So there's all kinds of theories and strategies we're putting together and we're going to do everything we can to maximize this number.

However, we are also mindful that we don't want to do it to the extent that we would harm Jay's business so we're being mindful of the NII there and that's a challenge. We have a team to do it and that's why David is going to be conservative come the fourth quarter of what he thinks will be realized.

Thanks, we vote for economics if you care.

By the way, John's number was pretty good.

What was it?

154.

Liz said I have to wait. My boss says I have to wait.

Ed thanks for the endorsement of the economics versus GAAP. Appreciate that.

Mike Nannizzi of Goldman Sachs has our next question.

Thanks. Just a couple questions here.

Trying to reconcile the development -- we've got a 98% ex-CAT combined ratio at Chartis, 97.7% ex-CAT in the prior development. The development shows as being 0% and 91% adverse and a 91% in return premiums and then in the Q, it looks like about $100 million additional adverse development from the first quarter, so that's Page 125 of the Q. Just trying to reconcile if I could and one follow-up, thanks.

Hi, Mike. It's Rob Schimek so let me just provide clarity here.

Sure.

So first of all, I think you generally said this correct, so prior year development for the second quarter is adverse but we write loss sensitive business. And on the loss sensitive business, we have accrued premiums, and so the net of those two items in the second quarter are largely offset. The way that it works in the combined ratio itself though is that the prior year development affects the numerator, but the accrued premium or the loss sensitive premium affects the denominator. So it's not an exact 0% gain in the combined ratio itself.

And then I think we talked about in the First Quarter, one of the significant drivers on our development in Q1 was the fact that we had a settlement of a historical issue associated with one particular line of business and it's disclosed reasonably clearly in the 10-Q. But it was that item that really drove prior year developmental all in the First Quarter of 2011.

Okay, but so in the Second Quarter it looks like you had just on that adverse versus the loss sensitive. So is that the same business so you had adverse and then in addition, you had additional premiums related to that adverse development because it was business you had written on a loss sensitive basis? Or are they two separate items?

You said it exactly, Mike. So we have adverse development on business that was written years ago and the premium accrual is on that same business. Recall or just remember the way this actually works -- we do our analysis across the entire portfolio maybe in excess of a thousand different cohorts of data that we're analyzing. So the adverse development is the sum of all of those but all of the accrued premiums on the loss sensitive business, 100% of it relates to business that's also being included in and it is the driver of the net adverse development that we experience for the quarter.

So the answer to your question is absolutely positively these are directly and specifically interrelated or they are an exact match between adverse development and the premium accrual and the loss sensitive business. I'm just saying to you, there's thousands of different ways that we slice this data and so there are other pieces of increases in prior year development and other places where there's decreases in prior year development. But the primary driver of why you have adverse development is related to those -- net adverse development is related to those premiums we also accrued on loss sensitive business.

I'll follow-up after on that one just had another math question but if I could, just wanted to understand what happens, again Chartis, US, it's consumer lines and it sounded like from the Q, you discontinued a couple programs, otherwise saw some growth there. Commercial lines you had a big E&O policy sounded like higher rates in comp, commercial decline in specialty comp. Just trying to understand what got you to the plus 4.6%? Is it a combination of those items or is it underlying that got you there?

And then the expense ratio was about a 200 basis point decline sequential just trying to understand how to think about those as well. Thank you very much.

Well I think the first thing, is that as we have looked at all of our lines of business, all of our individual relationships through the scrutiny of whether they meet our risk adjusted profitability targets, certain programs just didn't make the cut and the particular consumer example you cite was one that whatever way you look at it, it just didn't make sense going forward so we terminated that program.

In terms of the overall trend, we saw an increase in ratable exposure which helped the general positive trend. Hopefully, the economy continues its recovery and that trend doesn't reverse itself but we're not holding our breath. In terms of other favorable rate trends, property is probably the most promising, especially -- property cat and especially outside of the US, but in the US, we're also seeing a slight hardening.

And then the expense ratio?

Well I'm sorry, one other thing that I would mention for you there, Mike, is that in the second quarter of last year, we did our first CAT bond and so the prior year premium associated with commercial property is reduced by the amount of premium that we seeded on that CAT bond which was approximately $100 million. So we are higher in the 2011 quarter simply because we did not seed premium again on a new CAT bond so just wanted to add that.

Very fair, thank you.

Real quick on the expense ratio if that's okay? About 200 basis point decline, just trying to understand you clearly making some changes. Cutting some specialty comp lines, I imagine there's still outstanding claims on those. Just trying to get a handle on how the expense ratio goes down?

Is that where we think it's going to be or is that just kind of a dip here in the Second Quarter?

Well let me start with an overall comment on the expense ratio and then I'll hand it over to Rob.

The expense ratio is not something we target. It's an outcome of things that we do target which is improvement in our costs, regardless of whether they appear in the expense ratio or the loss ratio. And I think that we're very conscience of the importance of reducing our fixed costs and then focusing on unit costs associated with claims management. And so, as we do that, that has an effect on the expense ratio.

And secondly as our business mix shifts from high severity low frequency to higher frequency low severity businesses, then the expense element goes up but the amount of capital intensity goes down. So as we factor in capital costs, that again is another important shift. So as we shift towards these lower risk consumer lines then we expect the expense ratio to go down and the acquisition cost obviously higher as well in those lines. So it's an outcome of our strategic shift towards lower risk businesses with better repeatable earnings characteristics but we're very focused on expenses; however they're categorized. So as far as the specific shift maybe Rob why don't you explain that shift.

I'll just give you a couple more things to keep in mind, especially here in 2011 and I think certainly for the first part of 2012, we embarked on a number of very important strategic fundamental investments in our platform including for example, work we're doing on Sovreign T2 in Europe. And we're also undergoing a very significant finance transformation effort inside of the Chartis finance organization to put us all into one single common financial platform around the world. Each of those items among others we think are very important to the long term sort of viability of our platform and those will cause our expenses to go up as we go across the next year or so. However, you will see us also continuing to demonstrate progress on the items that we've been targeting as an overall reduction of GOE.

One thing you will see from us is as we now have a full year of Fuji consolidated into our operations, Fuji carries a higher expense ratio and you should expect that will also have an impact on us as we move forward in the rest of the year. We do a lot of work on a quarterly basis to make sure that we've got a appropriate evaluation of bad debt, whether it's on premiums or whether it's just on any receivables we have in the books. So one of the things that benefit us in the current quarter was a reduction in bad debt expense also, and that will be lumpy on a quarter to quarter basis really just based off of the facts and circumstances of that analysis.

Very helpful, Rob and Peter. Thank you very much.

We'll hear next from JP Morgan's Jimmy Bhular.

Hi, good morning. I had a question on capital flexibility.

Obviously you had to raise equity earlier this year to replace a Series G preferred and maybe have to hold that as a cushion, but you sold Nan Shan. What do you believe your current excess capital position is on the balance sheet? Also how much Free Cash Flow you expect to generate this year of given the high cat losses? And then any comments on potential uses of this capital.

I'm going to turn it over to David but I want to stress that raising the hundred million -- selling the hundred million shares was a condition of closing to demonstrate we could. Remember for to be allowed to be where we are today, completely independent of government support that we had to prove we could get unsecured debt all the way through derisking FP and our credit ratings and also raising equity capital. So the G was put in as a stop gap until we demonstrated that. So that's really about bringing us to that level at this point in time. And we've also told you that we want to over solve some liquidity during this period of time so that the rating agencies can absorb where we are and see how we operate throughout 2011.

So that's what we did and again keep in mind that we had to demonstrate our strength, having given up $30 billion of committed government support plus the implied support above that. So that as all the condition on closing and maintain strong investment grade rating on a standalone basis. Having said that David can talk about what we'll do with the proceeds.

Jimmy, good morning, the Nan Shan proceeds will be used to repay -- or pay down the AIA SPV balance. So there's about $11.5 billion of obligation the SPV has to the US Treasury. The Nan Shan proceeds nearly $2.2 billion will be used to reduce that balance. So again which is a great outcome for all the stakeholders, so that's where those proceeds are going to go.

I would point you to our 10-Q disclosure Page 142. We talk about the capital liquidity availability at the Holding Company the nearly $13.1 billion. As we discussed earlier it's not so much about excess capital today as much as it is about the generation of distributable available capital as we continue to execute on our business. And again we reaffirm our aspirational goals which we set forth in the First Quarter Q that the $25 billion - $30 billion of capital management activities over the course of the next several years we believe are still very achievable at particular light of the continued progress that we're making.

So again, we'll continue to try to optimize the capital structure of the company. We're building sufficient liquidity at the Holding Company. Again the final determination of whether or not we are designated a SIFI will ultimately be determined some time later this year, we expect And so again, all those will play into when and how much and to what degree we commence our Capital Management. But at this time, it's about building the pool of available capital.

And by the way we have done a lot of sensitivity testing around SIFI. And we're very confident that SIFI will now cause us to go up but we are well above where SIFI is at so we don't see it getting in the way of our flexibility and thoughts at this stage of the game from what we've studied.

Any comments on free cash flow that you expect to generate this year?

Well we have as we laid out as part of our earlier equity markets discussions, capital dividend capacity at our operating companies and those expectations have not changed. And so we will continue to expect to receive dividends from our operating companies to bolster the $13.1 billion we have.

And lastly, on AIA, you have restrictions on selling debt. I think you can sell some of that in October -- beginning in October. But how do you view that asset and obviously it gives you exposure to the international Markets to the extent you continue to own it. Do you think you can hold on to it or is it more going to be opportunistic?

I think we're going to study it and when we get to October, we'll know what the Markets are, we will know where we are. As we talk about the SPV that it's collateralizing, as David just, said we're 11.3.

We've got about $2.6 billion of cash that's sitting there in support of contingencies for Met Life, consider the sale of the Met Life stock and the deal with Alico. And so we need to take that out, we're down to about $6.5 billion and that's collateralized for example, by ILFC as well as AIA and so there's a huge amount of money. We're going to be taking a look at strategically where we are, what we need to do, what makes the most sense come October, and then the team will do that which we believe will give us the best shareholder value for the company going forward. It's all about how to create shareholder value as we get into the fourth quarter as quickly as we possibly can.

Thank you.

Andrew Kligerman of UBS has our next question.

Hi, good morning.

Going back to the Sun America question for Jay, so $8.4 billion in cash and short-term investments is deployed during the quarter. You go from a base yield of 5% up to 5.36% but you also harvested I think I read $3.4 billion of gains. So now we're at 5.36%. If nothing were done going forward in terms of harvesting that $8 billion of gains that you have left, where does the base yield go? And then the other part of it is if you're willing to discuss how much of that gain you want to harvest what kind of impact would it have negatively?

This is Bill Dooley.

Let me just make a comment with the base yield increases on future cash flows. A lot has to determine on obviously where the market goes in that period of time, so that's a harder question to answer. But when we're taking the gains on the Sun America portfolio, we're doing it in a deliberate way so we can kind of close the gap between the give up and what we're getting.

The other thing we don't want to do is to create another large cash balance at the life company level, so I'm looking for offsetting assets that are basically the same type of assets even though there's going to be a yield difference because they are moving in the marketplace. So everything is being done in a very deliberate way.

So you want to minimize the impact?

We're trying to minimize the impact but at the same time pick up the gains.

Got it. So then with the $8.4 billion that you deployed shouldn't that yield of 5.36% go up next quarter barring any taking gains on the other stuff?

Well as the sales take place, the gains are coming in and -- but I'm redeploying those funds at lower yield levels just because in the movement in the marketplace. But economically, as David was saying for the consolidated entity we're much better off by taking those gains and having a smaller yield on the underlying assets in the Insurance Company.

Andrew, it's David. Just to make sure we've got our facts right. I think we've taken about $350 million of gains thus far this year in that zip code, not $3.5 billion.

I'm sorry that was what you sold $3.5 billion to get that amount of gains, right?

Just want to make sure you understand--

Yes, no, I do.

Thank you.

If I could just add to what Bill and David said a couple things, Andrew. One is some of the cash was redeployed rather late in the quarter so I don't think we've seen the full impact of that yet in the base rate.

All subject as Bill mentions to reinvesting new cash flow in this quarter, but again, that's one point. And the other thing is that in terms of being deliberate, we are still in a negative IMR position in our life Company so 100% of these gains are going also to increase our statutory capital at this point as opposed to increasing our IMR reserve. So that's the kind of thing we're taking into account as we do this in a deliberate way.

Got it so that's good, Jason. There is some yield - there is some interest income pick up as we go in to the third quarter. Nothing you could kind of give us a sense to model for?

I'm not comfortable with that only because there's still a third quarter to go but we know that all of the activity in the second quarter is not reflected in the base yield.

And then just while I've got you the discipline around Western National in terms of there was a big pick up in deposits. Maybe just give a little clarity on what was so disciplined there?

Well we continue to target approximately 12% to 12.5% after-tax internal rate of returns and we're getting our pricing. We're closely coordinated with our asset group on the Investment Management side and Bill we're back reinstated in all of the distribution that we were in prior to the fourth quarter of 2008. And I believe we have going now the most we've ever had, I think 12 separate rate for compensation tradeoff programs across all of our different banks; large medium and small. And that's been a big driver of the activity where banks are trading off commission compensation in order to offer the customers moderately higher creditor rates and that's a win-win for everybody.

So we feel good about what's happening at Western and in our fixed annuity business. The absolute level of interest rates historically has had an impact on that, higher is somewhat better. On the other hand we see our customers more and more interested guaranteed returns for some meaningful part of their portfolio. So the pricing is solid and the sales activity has remained solid and I think Western and everyone there is doing an excellent job with it.

Great. Thanks a lot.

And one thing -- Andrew, the one thing to keep in mind and for everybody to keep in mind is Western has a product chassis that is unique to the industry. So think about it as today I think they price maybe 230 different combinations and permiantations of different capabilities so that here is how much money we have and how do you want to slice and dice it. And as Jay just said several very large banks have decided to finally see what happens when you cut Commissions and go ahead and see if you can get the volume to do better and we're seeing huge volumes in these institutions that are very large. So this is a competitive advantage because of the way and the uniqueness of that front end. And you add to it a very strong low cost operation that comes out of Amiarillo, Texas for now which is a very high quality group.

You put that together and it gives them the opportunity to get this kind of price with this kind of volume. So it really is unique and it's very hard for competitors to get to this overnight because you got to build that model and then get people comfortable in using that model. So it really is an incredible capability.

Great. Thanks, Bob.

We'll move on to Tom Gallagher with Credit Suisse.

Good morning.

First, Bob I just had a follow-up on the comment about the Treasury SPV in terms of the $6.5 billion that would be left and potential assets or sources to repay that. You'd cited AIA and ILFC. Any thoughts on Main Lane 3 - Main Lane 3 stake,$ 6.5 billion? Should e assume that's not on the table because it's I guess fully in control of the Fed or is there a chance that you can monetize that say within the next couple of years?

That's my first question.

You guys got some extra money because we can talk.

I don't know how anybody is going to buy our interest. It's totally under the control of the Fed. All I can say is the cash flows -- remember in the 2 years or so has gone from $24 billion to $12 billion. It's doing about $350 million a month in cash flows so the cash flows are strong regardless of the pricing that's going on here.

We're all trying to figure out the pricing better to reflect the real value here. But there's no question Main Lane 3 has a tremendous amount of value down the road and so if we would think you would do the numbers some time in 2014. It depends on how strong they say that our $6.5 billion - $ 7 billion that is sitting in there will start to flow in here and so you just have to take that out of the equation.

It's just something coming down the road it's just mainly we hope to take the volatility out of Jays earnings that didn't succeed, but that's another one that has a lot of economic value over time. So the only properties and remember those are collateralized so in order to free up the collateral you'll have to pay it down. And those are 2 major properties that are there supporting and I think Main Lane 3 is there but that's just an extra safety valve down the road.

But the cash coming in Treasury wants first priority on that cash because that's the deal. So as we monetize these assets we don't get to leave them with main lane 3 and SPV taking at 5% they want their cash and that's what we're negotiating when the time comes as to how we exit from that SPV.

That's all the time we have for questions. I'll turn the call back to our speakers for any closing or additional remarks.

I'd like to thank everyone for joining us this morning and let you know that we are available to follow-up with you on all questions, so please feel free to give us a call and we will get back to you if you're still in Q. Thank you.

Thank you all very much.

That does conclude our conference. Thank you all for your participation.