Lincoln National Corp (LNC) 2002 Q2 法說會逐字稿

Please stand by for the commencement of the teleconference of Lincoln National Corporation, August 1, 2002.

Ladies and gentlemen, thank you for standing by. Welcome to the Lincoln financing group's second quarter 2002 earnings call. All lines are now in a listen only mode. Later there will be an opportunity for questions and answers. Instructions will be given at that time. As a reminder, today's call is being recorded. I would now like to turn the conference call over to your host, Miss Priscilla Brown. Please go ahead.

Thank you, Holly. Good morning and welcome to Lincoln's second quarter earnings call. You heard the safe harbor cautions while you were in queue. Earlier this morning, we posted a press release and statistical supplement on our website as usual, we also filed equity market guidance on S.E.C. Form 8K. To the extent that you have additional questions on the equity market guidance given, you should be aware that we can review your application. However, once we reach the middle of the quarter, we will be unable to provide updated guidance. I'd like to turn the call over to John Boscia and Rich Vaughan. Their brief comments will be followed by a 30-minute Q and A period. John?

Thanks, Priscilla. And thanks to all of you for joining us this morning.

Let me start by stating very clearly that we are extremely disappointed with the stock market and the impact it had on our earnings for the second quarter. By far, the primary cause of the decline in operating earnings was the impact of the significant drop in the equity markets.

The Standard & Poor's 500 was down 13.7% in the second quarter, and this affected our earnings by $35.3 million versus the first quarter of 2002. Our market sensitivity guidance had been that a 1% move in the equity markets was to impact after tax earnings by roughly $6 million annually with some of the impact immediate and some experienced over the next few quarters. The guidance we gave was predicated on not having a significant move in the markets.

In various presentations and in a 10-K we indicated that the guidance could change if there was a significant shift in the market. The fact is we are witnessing and in many respects battling one of the most troubling equity markets we have ever seen. This past quarter was the most difficult of the recent slew of tough quarters. During the third quarter of 2001, equity markets were down 15%, but the significant drop occurred with the events of 9/11.

The second quarter of 2002 was different in that we saw a continually declining market with zero bright spots. In other words, no recoveries. Each month's performance was negative. The total decline was 13 .7% from the end of the first quarter 2002 and down 19.2% from the second quarter of 2001. Fortunately, quarters like these are rare. There have only been five quarters in the past 30 years within the S&P 500 was down over 13%. Unfortunately, we have seen two of those five quarters within the past 12 months.

The equity markets resulted in a charge for unlocking of the assumptions underlying the DAC and the PB&F assets. These assets are finite amounts that must be expensed over time. Accordingly, unlocking results in noncash charges in the current period can decrease the amount expensed in future periods. Given that the overall level of retirement stack assets to account value established at only 2.17%, we feel that considerable margin exists to absorb substantial further market deterioration, even at levels in excess of 50%.

We are not at all concerned about DAC recoverability on our business. I'd like to repeat that sentence. We are not at all concerned about DAC recoverability on our business. Though I am very disappointed with the impact the market had on earnings this quarter, as I look at the business in those segments we can control, I see positive fundamentals in all of our business segments. These strong fundamentals remain the key drivers of our business and will lead to earnings growth over the next few years.

The most important leading indicator of that future growth is positive net client cash flows. So I'd like to spend a minute on that topic. Total net flows not only were positive, but a record $1.1 billion for the second quarter. Net flows were positive in all of our domestic segments, both for the second quarter and for the trailing 12 months. This is the fourth consecutive quarter of positive flows for our retirement segment and the second consecutive quarter of positive net flows at Delaware. The life insurance segment continues to have very steady, positive flows, as well. Obviously flows are a function of business retained on the books and new deposits. With respect to redemptions within our retirement segment, we remain well below pricing and under 10%.

Mutual fund redemptions were 3.7% better than industry average for the first five months of this year according to LCL data. In our life insurance segment, we continue to report persistency in line with or better than pricing.

In the second quarter, the margin of improvement widened. And we attribute this consistency to needs-based selling and extensive conservation efforts. Enterprise-wide deposits were also very strong as we had record domestic deposits of $3.2 billion in the second quarter as well as record domestic deposits for the first half of the year. I'll briefly comment on deposits and flows in each of our businesses before turning it over to Rich to continue the discussion relative to operating results in the quarter.

The retirement segment had positive net flows of $223 million in the second quarter. New annuity deposits have increased nearly 30% versus last year's second quarter and have remarkably matched the first quarter of 2002. We believe that Lincoln Retirement continued continued to increase market share. Choice Plus variable annuity sales for this quarter increased an impressive 42% over the prior year quarter, and we expect them to continue to gain momentum.

Fixed annuity deposits were nearly $430 million, up 31% from the second quarter 2001, but down 15% from the first quarter of 2002 as we used financial discipline and did not chase lower return business. In addition, fixed annuity net flows improved $121 million over the first quarter of 2002. To put all of these numbers into perspective, we must also consider that the trend in the annuity industry continues to be very aggressive pricing, including the use of high bonuses, high commissions, and living benefits. And also that for several years now the majority of the industry variable annuity deposits have been exchanges often into those aggressive products. On the other hand, Lincoln continues to stabilize and grow flows in this environment without using tricks, without promoting unwise benefits and without supporting inappropriate sales behavior.

We are the only top 10 provider that does not offer guaranteed living benefits. We have been successful by growing new incremental deposits and have implemented more stringent standards and controls on internal transfers. In fact, we have reduced our level of internal transfers on our core annuity products, Legacy and Choice Plus by over 50% since the second quarter of last year. In the life insurance segment, the balance of our product portfolio continues to help litigate the impact of the down equity market on sales. Total first year premiums for the quarter were up more than 30% over last year.

Retail life sales were up almost 16% from last year's second quarter, driven by strong sales in universal life, which was up 41%. Whole life was up more than 25%, and term was up 12% over the second quarter 2001. Lincoln Life also had a strong quarter in the COLI market. COLI sales, which are done on an opportunistic basis, more than doubled as compared to the year ago quarter. Life insurance in force increased $245 billion, up 10% from one year ago, reflecting strong sales as measured by face amount sold and favorable persistency. Delaware Investments assets under management were higher at June 30th than they were a year ago.

This is a statement not many investment firms can make and is attributable to investment performance, positive cash flows, the diversification of asset management styles and to the varied distribution channels it serves. Delaware's outperformance contributed to positive net flows of $622 million in the second quarter. Their institution institutional businesses and retail business had positive net flows up $455 million and $167 million respectively. The breadth of their investment capabilities can be seen on both the institutional and retail sides.

We won 22 new substitutional mandates in 11 different asset classes, and 23 of our retail mutual funds have been labeled Lippert leaders for consistent return, as well as 16 named Lippert leaders for capital preservation. Seven of our funds are in both categories. I've just spoken about the positive impact of asset flows at Delaware. Importantly, we're also beginning to see EBITDA margin improvement of over 1.6% for June 2002 year to date compared to the prior year to date period.

Before I turn it over to Rich, let me summarize by saying while this was a paradoxical quarter, we are focusing on the controllable, the things we can do to enhance shareholder value, things like innovative product development, broadening distribution, strong relative investment performance. All of these lead to positive cash flows in the short-term and quality long-term earnings growth. I'll now turn it over to Rich so he can spend a few minutes on the major changes in earnings.

Thanks, John.

Lincoln reported income from operations of $127.2 million, or $67 cents per diluted share. As John stated, the primary cause of the decline in operating earnings was the impact of the significant drop in the equity markets which affected our earnings by $35.3 million as compared to the first quarter. Immediate impacts of the market drop on DAC and PBIF unlocking and GMDB reserve increases in the second quarter was $32.7, or $17 cents per share.

Income from operations before the immediate impact of the equity markets on DAC, PBIF and GMDB reserves was $159.9 million, or $84 cents per share in the second quarter. Lincoln's retirement segment is most affected by equity market changes, and in the second quarter operating earnings were reduced 23.6 million by the equity market drop as cared to the first quarter of 2002. This was $4.8 million more than the application of the market guidance given because of the severity of the drop and its impact on DAC, PBIF, and most importantly, GMDB reserves.

As John stated, we are very comfortable that our DAC asset is fully recoverable. There is no method prescribed under GAAP for guaranteed minimum death benefit reserving. Some companies recognize the cost of GMDBs on a pay as you go basis. We use a more conservative method that recognizes that there is an amount at risk that will result in future payments and that over time the market growth will reduce the payment stream. Our approach is expected to cover future payment activities.

Lincoln has followed a practice we believe is appropriate but does create some earnings volatility. The AICPA long duration task force has issued an exposure draft that hopefully will provide more definitive guidance for the industry to follow. We would anticipate that final guidance would require the industry to reserve for this exposure in some manner similar to our own practice and approach, although it will likely not be effective until 2004. In the U K the FTSE under performed the assumptions underlying the value of future profits in DAC by 14% during the second quarter. And that along with lower fees had a negative impact on earnings of $8.9 million. This was consistent with the guidance we had given you.

In Delaware, the drop in the equity markets lowered earnings by $1.4 million from the first quarter. While we have said that the impact of each one percent equity market movement would be insignificant to the life segments earnings, the severity of this quarter's decline lowered that segment's earnings by $1.4 million.

The equity markets impact our earnings in two ways. First is the immediate impact of the unlocking of the DAC and B PBIF assets and the im pact on GMDB reserves, which is driven by the ending market level.

Second is the ongoing impact of the lower account values, which lowers the fees we collect. Of the $35.3 million impact from the drop in the markets as compared to the first quarter, $29.6 million affects only this quarter and not the run rate. In the past we've given you annual earnings impact of a 1% change in the equity markets. However, a single number simply particularly stated cannot cover the extremes of the markets, nor does it address your focus on each individual quarter since some of the factors are immediate and others are ongoing. Therefore, we have provided updated guidance on how the movements in the equity markets affects earnings in an 8 K, which you should have access to now. The new guidance will reflect a range of equity market assumptions all based on variances from June 30th market levels. We've provided detailed descriptions of how to apply it based on various scenarios that can develop.

We think this level of detail may be one of the most comprehensive to be released within our industry, and it will be an important aid to your models of our company's results.

Now let's talk about other items which affected the segments earnings during the quarter. Looking, I don't understand the equity market impact, the second quarter performed pretty much in line with expectations. Relative to the first quarter, Lincoln Retirement had improved investment spreads but reduced been fit from the received deduction.

We continue to have performance of partnership investments relative to expectations. Mortality returned to more normal levels and in force grew to $245 billion. In the quarter Lincoln's realized capital losses were driven by losses on WorldCom, which accounted for over 50% of the net losses for the quarter. Our loss was mitigated due to our strength in our fixed income investment management area. It was a good decision to reduce our position early in the quarter so that we did not feel the full impact from the decline in WorldCom. Our exposure to the Telecom industry is approximately $1.5 billion, or 4% of our portfolio. And 86% of our sposh is investment grade.

As you are aware, Lincoln was sold primarily through an indemnity of Lincoln life. Because we are not relieved of our legal liabilities to the Ceding companies, the liabilities and obligations associated with the right insured contracts remain on the consolidated balance sheet of LNC with a corresponding reinsurance from Swiss Re. During the second quarter of 2002, Lincoln determined that disability reserves transferred to Swiss Re should be adjusted. LNC recorded an increase in reserves of $14.4 million after tax in the current period. A corresponding increase in the reinsurance recoverable from Swiss Re has resulted in a $14.4 million after tax increase in the amount of deferred gain recorded in connection with the acquisition of LNC's reinsurance operation by Swiss Re.

With that I'll turn it back over to John.

Over the last year, we have said that mid-year would be the point that we would make a decision on the use of proceeds from the sale of reinsurance. We have not found anything that is attractive from a strategic and a shareholder value perspective to date and at this point don't see anything on the horizon. We have not been sitting on our hands, though.

Through June 30th, we have used approximately $484 million of the proceeds for Sherry purchases and debt reduction and approximately $987 million of the proceed remain available at June 30th. In June we dividended $650 million of the proceeds from Lincoln life up to (INAUDIBLE) National Corporation. We intend to be active in repurchasing our stock at these very attractive prices as early as tomorrow. We have $323 million retaining make on our current board authorization for Sherry purchases.

We will be discussing alternatives for the remaining proceeds with our Board of Directors next week. Alternative uses for the Lincoln Re proceeds will take into account capital markets affect on earnings, capitalization, the movement of monies from variable accounts to guaranteed products and the preservation of our ratings. In June AM Best upgraded Lincoln Life from A to A plus superior. Our operating fundamentals have improved significantly in recent years. Implicit in A. M. Best's upgrade was management's continued attention to the quality of our balance sheet.

Our fundamentals have also contributed to avoiding the stridewide ratings action taken by Standard & Poor's these past few days. Lincoln remains focused on maintaining and improving upon our already strong financial strength ratings.

With respect to Lincoln's dispute with Swiss Re regarding the sale of Lincoln Re, I must tell you that we are precluded from commenting on the matter except to inform you that the litigation is continuing over the issue of whether the matter will be addressed through further litigation or accounting arbitration. In accordance with the new S.E.C. order that applies to the largest 945 U.S. publicly-traded companies, those with annual revenues of over $1.2 billion, Rich and I will be signing our sworn statement on the financial reports already filed this year and the current 10-Q. What we can control inside of Lincoln we are controlling well and we are continuing along a path of improvement in all of the areas that will ultimately drive future earnings growth.

We are not happy with the market's impact on the actual numbers delivered this quarter, but we remain confident that the fundamentals of our business remain strong, and we are competitively well-positioned for long-term growth. In a strong market even weak companies will appear to do well. However, it is during these down markets that only strong companies show the strong underlying fund amount as that Lincoln has produced.

We'd now be happy to take your questions.

At this time I would like to inform everyone in order to ask a question please press star, then the number 1 on your telephone keypad. We'll pause for just a moment to compile the Q and A roster. Your first question comes from Edward Speher, Merrill Lynch.

Good morning. A couple questions on DAC. I'm looking at the 8-K now, and there's a scenario in here where you talk about a 5% decline in the market in the third quarter and a 5% decline in the fourth quarter. And you show a column that has current effects in each of those quarters, which I'm interpreting to be the one-time impact. I guess the first question is is that correct.

And secondly, you know, nationwide, I had put out a number where they said if the market stayed where it was July 26th, which I believe is about 15% below where we were at the end of June, that there would be expected to be a certain charge. And if I look at your disclosure here, although it's not directly comparable, it looks to me like, you know, that type of scenario in your case would maybe be another $70 million type of number after tax. And so, I was wondering if you could help us out a little bit there. I understand that everybody is giving out different numb bers, and it would be nice if we could kind of make a comparison company to company on a comparable basis. So, any help you could give there would be appreciated.

This is Rich. The way you should look at the one-time impacts, if you take a look at the guidance in the 8-K, if you move down in the retirement section to the line that says GMDB and DAC and then look in the current effects in the third quarter, those two for the retirement segment would be the one-time sort of impacts from the market move in that quarter. The other items would be the run rate kind of impacts. Now, if I move down to life insurance, since that is strictly a DAC unlocking, that entire amount would be the one-time amount. In the U.K. section, you'd pick up the DAC and PBF as the one-time amount. So, you'd take a look at DAC and GBMV's, and life insurance is all DAC. So, those are all the one-time impacts.

Another way to kind of track this, if you went back to the scenario 1 that has a steer market move and you go to the market effects reported in the second quarter, you take the GMDB and DAC out of retirement, the life insurance impact of $1.4 and the DAC PBIF for the Lincoln U.K. and those add up to $32.7, which is the number that we've quantified as the one-time impact to the market in computing the $84 cents per share. You should be able to take these guidance numbers that we've given in here and apply it to basically any reasonable kinds of market outcome. And and so, we don't intend to kind of take everybody through each potential one, but we'll certainly let you take a look at what we've given you here, try to apply it to a given percentage, and if you want to give that back to us we'll certainly kind of do a check over the next two weeks. But once again, as Priscilla indicated, we do want to put a deadline on that because otherwise as we get later and later in the quarter, it becomes too much like giving outdated earnings guidance.

That's helpful, Rich. If I could follow up, one question, you talk about the impact of 5% decline in each of these quarters. And if I sum up those components that you have...those components that you've just laid out, it's in the neighborhoods of like $18 million or something in a quarter. Is it too simplistic to take that $18 million and say that's $18 million for 5%? You know, if I want to assume down $15, multiply it by 3? I know there's a front end issue here versus, you know, over the course of two quarters, but is that gonna get you, do you think, in the ballpark?

Well, if you fake a look at what we've given you on page 9 of the impacts, as well as... and take those numbers in effect, which is the 5% pieces, and pick the given percentages, and also look at what's on page 10, which is in effect detailed guidance on how you apply these, and the fact that we're giving you factors here that have to be applied on a cumulative basis, I think if you read through the detailed example that we give right under the table on page 10, you will see how to apply it relative to how much is impacted in the first quarter, and then using that basically becomes your base, you move forward. So, I think you want to model this out. And I will not say there's any simplistic way of doing...that's why we've given the great level of detail that we've put in here.

Okay. Thanks a lot.

Ed, one other thing. I think you'd asked whether there was any likelihood of a future significant charge. From what I understand from nationwide, they are along the lines of either a charge for impairment or a major unlocking. If that is the case, we are on a regular unlocking basis. And you can take in effect these regular unlockings, the DAC and GBMD reserve increases and model them out pretty significantly. We've got a huge cushion between where we are today and where the markets would have to drop to before we would have an impairment of our DAC asset.

Thank you for the detail.

Okay.

Our next question comes from the line of Colin Devine, Salomon Smith Barney.

Good morning. A couple questions. One related to the (INAUDIBLE), and second maybe to talk about something a little more meant in terms of where sales are going. Rich, can you just...again, it's going to be easiest for everybody when we can compare companies across each other. Nationwide was talking looking three years forward, they got a 15% earning. Maybe you can relate it a little bit how you're looking at your DAC, and why you do or do not have a collar? I think all America had a 12% collar. Also, on the GMDB, perhaps you could relate your statutory GMDB reserve and quantify that relative to what you've got up on a GAAP basis and the distinction between the two. And then perhaps John or whoever could talk a little bit about where you're getting the annuity sales, where you're starting to gain traction, some of the new products, how they're doing, and perhaps a similar kind of update on the life insurance numbers.

Okay. First, I think you talked about the dollars.

Yes.

We do use in effect what we call caps and floors in effect in our reversion to the main assumptions on future marshal returns. I believe where we are today as far as reversion to the mean on an average, weighted average basis, is about 13%, a little over 13% future market assumptions underlying the reversion to the main. I believe our caps are on average earning about $14.5. So, we've got in effect some additional cushion before woe come up against our caps on average. Some of the max rates in the models, and what we do here in our reversion of the mean is go from this point to in effect the end point of the DAC amortization, whether that's three years out on a block or five years out on a block or 12 or 15 years out on block. We're reverting to the mean over the remaining life of the DAC amortization, as opposed to a shorter or much longer period that we believe some others may use.

Just to come back on something there, if we took the 15% market decline in the second quarter, would that push your 13% return assumption up towards the top of your collar of 14 and a half and then lead to the sort of one-time charge we're looking at from Nationwide, which I think is in the $200 million range?

You mean if we repeat another quarter like this?

Looking at we're sitting in the third quarter today...presume your 13% number was as of the ends of the second quarter.

It was as of the second quarter. It would push it up, but it doesn't move up very quickly. We're currently down I think from an S&P perspective through ends of July about 7.1% on the Sapp. Obviously there's been a ton of volatility in the month of July. The market was down almost 20% then had a 14% rally for a net from point to point of about an 8% decline.

That would put it up, what, maybe another half percent.

Yes, well within the point margin.

Okay.

On the GMDB, the stat reserve is in the $48 million range. The GAAP reserve is about $26 million. Basically in a ratio of about 2 to 1 at this point. And I believe that is also fairly consistent with where they were at the end of the first quarter as far as a ratio. But both of them basically doubled in this quarter.

Rich, if I could modify that a bit, on a pretax basis our statutory reserve is $89 million, up from $46 million at the end of March.

Okay. Sorry about that. But the relationship has held true.

Okay. And the $89 is what I would see on your statutory blanks when they're filed?

Yes.

Thank you.

With regard to where the sales are coming from from both a channel and from a product perspective, I'm going to ask Lori Stenzaru to talk about the annuity blocks of business, and I'll ask John Gada to follow up from Lori in talking about the life insurance side.

On the annuity side, Colin, we're seeing increases in sales in almost every distribution firm that we do business with. As I've indicated in the past, both of the major whole selling forces that we have, whether they be choice plus or our American legacy IPCs are still relatively new. Both of them are growing. And as they grow, we get increases in the number of wholesalers, plus we're starting to seal productivity increases. And you couple that with the underlying great performance from some of the American funds and del wear sub accounts, we are very well-positioned in the market place today.

And John, do you want to comment on Life?

On the Life side, we see the most significant increase in our universal life sales. On a year to date basis we're up 45% through June. What we're seeing is life from the variable products to the UL.

We also had seen, as we mentioned earlier, significant increase in COLI sales, although we see the COLI business as an opportunistic strategy in terms of product, we thought this year was a good year to be aggressive in the market place. And we've had a lot of success with that. Term also is up 23% through June. And the causes I think are twof old. One, we've updated our portfolio. We've got a more competitive product.

And the second reason I just classify as the post 9/11 impact. I think that's had a huge effect on our sales. If you look at it from a distribution channel perspective, our MGA channel is up significantly and our wire house channel is up significantly.

Thank you.

Our next question comes from the line of Andrew Kligerman of Bear Sterns.

I have a few questions, but first I want to make sure I understand that 13% number that Rich just mentioned to Colin. Does that imply 13% compound annual market appreciation a year over the next, say, three to five years would be required, and once you real realize that you'd have to do a major unlocking? Is that that what you're implying there?

What it is saying is that's the rate that is implied. It needs to be attained in effect for reversion to the mean to in effect get a 9% market-year-old gross on the business from in effect when we went onto the reversion to the mean. So, we started off at 9. Since we've gone onto the reversion to the mean methodology, which was in the beginning of the year 2000, we've had negative markets, which has then pushed up in effect what the future markets have to do to in effect fully amortize in effect the DAC that's on the books. That is a net number. It's net of M & E charges, as well. The weighted average remaining life of our dpak DAC is about 8.6 years in there.

Okay. So, you would need that 13% on a compound annual basis over the next eight years? Is that what you're saying?

John, do you want to address that piece of it?

Yes. What that means is you would need that assumption in order to escape any additional unlocking, either positive or negative. If the growth rate is greater than that, you would have positive unlocking occur during certain time periods. If it's lower than that, you would have a continuation of minor negative unlocking occur.

Okay. So, you're more minor and major unlocking on a quarterly basis is above and beyond that 13%? Is that what you gauge it off of, not the 9%? You're gauging your quarterly unlockings off of the 13?

Well, your quarterly unlocking would be relative to actual market performance compared to the 13% necessary in the mean reversion formula.

Okay. I think I have a handle on that. It sounds to me that it is all right. This is my first major question on the issue. It seems to me, or appears that, you know, some of your peers, probably Hartford, probably Nationwide, I would need to talk to them about that, but they tend to have a smoother DAC amortization process and do not unlock until they hit major data points.

In contrast, it appears that Lincoln National unlocks on a quarterly basis, and if you hit these major gaps, you know, as we were just discussing the 13% not being able to be achieved, then you will take an even larger unlocking. The question to you is why do it owe a quarterly basis? It swings your earnings around in a way that investors finds it confusing and hard to follow. Why not go to an approach where it's a little smoother, and then, like Hartford and like Nationwide, if the time comes, take a big hit to earnings.

John, do you want to address that one? Yeah. Well, I guess our approach has never been to account for deferred acquisition cost and the am orderization process in a way that would put us at risk for having to take those type of big baths on an infrequent but ultimate basis.

In today, our approach has been to conservatively value our DAC asset and the impacts of all factors, including equity market appreciation or depreciation on a quarterly basis. FAS 97 and GAAP is pretty it in terms of expecting, if not requiring you to do exactly that in each reporting period. We have applied that mean reversion to the mean formula that Rich described since mid 2000. That has been applied on a quarterly basis, resulting in the levels of periodic quarterly unlockings, both positive and negative.

I think it's important to also look at the result of how we apply our DAC principles and results in that if you look back at a point in time, John and Rich both referenced the relationship of our DAC asset to our account values at 2.17%. We're basically at the same level of DAC asset ratio, if you will, that we were at the beginning of 1997.

So, that is indicative of a process that as the equity markets have moved, as account values have changed, we have recognized the impact of equity market swings into our DAC process and ultimately into our results. Again, you know, I think the important point to be underscored here is that by doing that process we are much, much farther removed from any possibility of a major DAC recoverability issue. If you look at our aggregate block of business, we have a K factor, which is the significant driver of the amount of amortization in any period given the gross profits for the period for our annuity business in the range in the aggregate of 50 to 55%.

Had we not recognized the impacts of equity markets all along, we would be carrying potentially a much higher K factor, which means that if we had all future -- DAC will ultimately be amortized at some point, whether it's in current periods or future periods. We feel our process appropriately is consistent with GAAP expectations, and then also allows us to maintain a very modest and very conservative relationship of DAC ratio to account value.

Okay. That's fine. I understand that you're trying to be conservative there, but it has an awfully punitive impact on your stock and makes it difficult for investors to get a sense of the normality of your earnings. So, I would suggest, you know, trying to do something closer to what your competitors do. They seem to think they're conservative, as well, and don't get penalize odd a quarterly basis for what is mostly a non-cash item here.

In any event, let me move on. I have two quick questions. One, with regard to the Swiss Re issue, I think the amount in dispute is $770 million. I know you can't talk to that issue. But with regard to your potential stock repurchase, do you feel that any of that capital needs to be set aside or is encumbered by the potential dispute? And then I have a quick detail question.

On page 14 of your statistical supplements, your retirement savings income, you have an other revenue and feline. You earned $10 million in the fourth quarter of '01, $5.8 million in the fourth quarter of the first quarter of '02, and then it turned into a negative 3 item. Can you explain why the swing in that item? And those are my last two questions.

Andrew, while they're looking at the numbers to reference in the stat supplement, on the Swiss Re, the way that you phrased your question is essentially asking us to handicap what we think are...our ultimate cost, if anything, may be. What we are considering as we look at potential share repurchase is all of the factors that are going to come into play on our capitalization levels inside of the company. I would guess that probably would biggest impact on our capitalization levels is something that is somewhat unknown. And that is if the equity markets continue to be volatile and we have people that are transferring from variable sub accounts into a guaranteed sub account, they're going from something that requires almost no capital in surplus to something that last a much higher capital in surplus requirement.

So, there are a lot of factors that we're considering as a part of that, including Swiss Re and other contributions. But I can't say how much is attributable to each piece.

Okay, John. Maybe let me take one last swing. At the beginning of 1 Q in discussion with management it appeared that before these equity markets declined, there was about $8 or $9 hundred million of capital that you probably could have deployed for Sherry purchasing barring an acquisition. How much of that do you feel safe....and you've already used almost $200 million in the second quarter for that repurchase. How much of the remaining, saying, six to seven hundred million would you feel comfortable using for repurchase going forward? Would you use your whole authorization of 300-plus?

What I'd say on that, Andrew, is some of the numbers that we just discussed earlier we just dividended up $650 million towards the end of the quarter from the life company to the parent company. We have $300 million of authorization. That's $300 plus million of authorization remaining. We're moving money into the holding company in advance of a board meeting next week.

I had made a mistake, some of you may recall a couple of years ago when I announced our intent to recommend a particular Sherry purchase authorization level -- share repurchase authorization level. And I said that to the street and it appeared in print before we had our board meeting. Our board didn't like being put in that type of a position, understandably. So, what we're doing now is saying that we've moved a lot of money to the holding company, and we have a board meeting next week.

Okay. Fair enough, John.

Andrew, related to the other revenue and fees, I don't have an answer as to what's caused the variability. Richard, do you have any idea with what you have available to you?

Yes. Essentially, Andrew, the change in that relatively small revenue line item from period to period and particularly from the first quarter to the second quarter relates to experience re funds on reinsurance agreements we have, primarily an Modco agreement on our fixed annuity block. And a lot of it ends up being just geography on the income statement in that the experience refund would impact revenue. But it's there to cover...it has some offsets elsewhere; I E, interest credited, and some expenses.

So, technically it should really net out to a zero once I get to the bottom line?

Technically it's much closer to zero as a bottom line impact, yes.

Thanks very much.

Our next question comes from the line of Mario Mendonca, CIBC World Markets.

And Holly, we'll make this the last question.

Okay.

Good morning. The last few years when the markets were actually doing particularly well, excluding these last two, that is, if companies that applied floors or the bottom of the cap that was significantly below zero or maybe not even significantly low, but slightly below zero some of the issues that we're experiencing now might not be so important. Could you talk about what your floor is and whether that really would have mitigated some of the issues we're speaking about now?

John, do you want to take that one?

Yeah. Currently our floor on a prospective bases is about 1% net account value appreciation. One of the dynamics, and again, Rich referred to it as going to a forward liking reversion to the mean process in mid 2000. Prior to that our preexisting or prior DAC valuation systems and models had effectively, had effectively or inherently recognized and created in essence the similar type of reversion to the mean phenomenon. What we chose to do at inception date of our new version to the mean was go forward with the typical 9% equity market appreciation.

In reality we had recognized some of the accelerated amortization in prior periods relative to a longer term reversion to the mean form LA. So, we're a bit handicapped, if you will, based upon the 9% assumption that we made from 2000 forward relative to what that remaining market appreciation needed to be over a longer term to still meet the 9% threshold.

But again, whether you pick 9%, 5% or even 2 as your required appreciation from that point forward, you're still dealing with the same finite amount of DAC asset to be amortized over roughly eight, eight and a half years on average. Obviously the higher the hurdle rate prospectively the 9% we assumed the more volatility you would have in unlocking relative to a lower hurdle rate from June 2000 forward.

But the floor essentially is 1% net of...did you say certain net of fees?

Net of M & E and asset management fees, which average about 2%.

So, you actually need about 3%, then.

Correct.

And with respect to the GMDB reserves, forgive me if you've already described this at some point or on another call, about but could you describe the methodology used in establishing those?

It's based upon an economic model approach where at any point in time, and at June 30th, for example, we have a difference of about $3.3 billion between the amount of account value and potentially the death benefit that would be paid at...should everyone die within that customer base. What we do is assume a normal or expected mortality against that population of contracts that are in the money and calculate an economic reserve.

In our case that on a GAAP basis is around $27 million dollars. And the basis of calculation there is to look at the net amount of risk at any point in time, recognizing the formula, the expected market appreciation targets we just talked about, and with that you have a decreasing net amount at risk or exposure over, in this case, about a 20 to 24-month period. The net reserve, then, that we carry is the result of computing the expected mortality or payments against the amount of death benefit we assume we'll have at risk during that period.

So, the key assumptions and perhaps areas of risk would be market performance, mortality assumption, lapsation, would those be the key ones?

Those would be the key ones.

Thanks very much.

I'd like everyone on the call for allowing us to go beyond the 30 minutes we said we would take here. But it seemed important to let the discussion continue. I'm sure there are calls in the queue. We look forward to speaking with those of you who still have questions after the call and after you've had a chance to pull down the document on the website and at the S.E.C..

So, thanks again for your time today. And we look forward to helping you get through the numbers.

Ladies and gentlemen, this conference will be made available for replay beginning at 1:00 p.m. today, August 1st, 2002, until August 9th, 2002. During that time, to access the playback service, please dial 1-800-642-1687. International participants may dial 706-645-9291. The access code is 4924312. That does conclude your conference for today. Thank you for your participation.