Lincoln National Corp (LNC) 2003 Q4 法說會逐字稿

Ladies and gentlemen, the conference is scheduled to begin momentarily. Certain statements that may be made in this conference regarding LNC's recently released earnings are forward-looking statements within the meaning of the Securities and Litigation Reform Act of 1995. Forward-looking statements are any statements that are not historical facts and include, without limitation, any statements that may predict, forecast, indicate, or imply future results, performance, achievements and may contain words like believe, anticipate, expect, estimate, project, will, shall, and other words or phrases with similar meaning.

Forward-looking statements involve risks and uncertainties that may cause actual results to differ materially from results contained in the forward-looking statements. You can find Lincoln's cautionary language regarding forward-looking statements at the beginning of the MD&A section of its periodic reports on Form 10K and 10Q filed with the Securities and Exchange Commission and in various portions of those reports describing risk factors.

Ladies and gentlemen, thank you for standing by. Welcome to the fourth quarter, 2003, earnings conference call for Lincoln Financial Group. At this time, all lines are in a listen-only mode. Later we will announce the opportunity for questions and instructions will be given at that time. If you should need any assistance during this call, press star then zero on your telephone key pad and someone will help you.

This call is being recorded and will be available for replay beginning today through Monday, February 16, 2004. The replay can be accessed by dialing 1(800)642-1687, and entering the access code of 4801467, or on www.lfg.com/webcast.

At this time I would like to turn the call over to the Vice President of Investor Relations and Strategic Communications of Lincoln Financial Group, Pricilla Brown. Please go ahead.

Thank you, Roderick. Good morning and welcome to Lincoln's fourth quarter earnings call. You heard the Safe Harbor cautions while you were in queue, so I won't repeat them. We appreciate your participation today and invite you to visit Lincoln's website, lfg.com, where we have posted slides as a reference to today's call and statistical supplement and other pertinent information can be found. An updated equity market guidance spread sheet will be posted both on the website and in the company's 10K which will be filed in about a month. A full reconciliation of income from operations to net income is provided in our press release and on the website.

Now I'd like to turn the call over to Jon Boscia, Lincoln's Chairman and CEO, and Rich Vaughan, Lincoln's Chief Financial Officer. Their comments will be followed by a question-and-answer period. Jon?

Thanks, Pricilla, and thanks to all of you for joining us this morning. 2003 was a pivotal year for Lincoln. Our relentless pursuit to build an organization that is the partner of choice for the accumulation, protection and enjoyment of wealth, led to a company-wide realignment that fine tuned how the company would manufacture, distribute and support its products and services in light of environmental changes. Diligent and focused execution on the part of thousands of employees helped to produce a quarter and a year of very strong and oftentimes record results.

Let me share with you some of the highlights. Sales in the fourth quarter continued to break through records that we reported to you in the third quarter. We posted record retail deposits of $4 billion in the fourth quarter, and $13.2 billion for the year, as Delaware's investment performance continued to attract both retail and institutional assets and Principal Security, our guaranteed minimum withdrawal benefit rider, gained a strong foot hold in key distribution channels.

As a result of strong sales and good persistency, total net flows across all domestic businesses reached a record level of just under $2.5 billion for the fourth quarter, and 84% increase over the prior year quarter and a 39% increase over the third quarter. For the year, record domestic net flows of $6.2 billion were up 34% over 2002 results. It's this kind of organic growth driven by product and distribution combined with good market performance which will deliver bottom-line growth over the long term. The last time we saw positive equity markets for the year was 1999 when Lincoln had negative net flows of $3.4 billion. What a difference from 2003 with our positive flows in all domestic businesses.

Let me turn to the business segments starting with retirement. In our Retirement Segment the fourth quarter was the highest quarter on record for total variable annuity deposits and exceeded the third quarter by over 24%. Total variable annuity deposits of $1.5 billion were up 51% and individual variable annuity sales of $1.1 billion increased almost 65% over the prior-year quarter. And the variable annuity lines where we introduced the Principal Security rider this year, about 40% of new accounts elected the rider.

What is particularly gratifying is that only 7% of those electing the rider are taking withdrawals at the maximum rate allowed with the guarantee. As we have said in the past, this level of utilization is very good because it is an indication that we are reaching the target group we aim for when designing this rider. That target group is the comfort buyer. These are individuals who are still in the accumulation stage of life rather than in the income stage of life. Net annuity flows increased 94% to $536 million from the third quarter and hit the $1 billion mark for the year.

Now let's turn to life. Life sales for the quarter and full year set new records driven primarily by strong sales in fixed universal life and, in particular our money guard product. Retail first year premiums were $243 million, an increase of 17% over the third quarter and up 9% over the prior-year quarter. The universal life market became increasingly competitive during 2003, even though companies were transitioning to the new reserve requirements under AXXX.

We did see some pressure on our sales of traditional UL with secondary guarantees, but we were able to maintain quarter-over-quarter sales increases throughout the year. At the same time, we saw strong growth in our other universal life and term products. Our balanced product portfolio delivered total first year premium of almost $800 million for the year, a 15% increase over 2002, and net flows reached a record $1.38 billion for the year.

Turning to Investment Management, the fourth quarter and full year were absolutely terrific for Delaware in terms of both sales and net flows. Quarterly sales reached a record $3.6 billion, and the full year sales of $11.4 billion just missed setting a new record. Net flows are an integral part of Delaware's business success as they reached a record $3.7 billion for the year with more than 40% of the total coming in the fourth quarter. Delaware's focus on people, process and investment performance are really starting to pay off.

You probably saw Delaware featured on the cover of yesterday's Barron's as Delawares family of funds joined the winners circle with an outstanding one-, five- and ten-year results. According to the Barron's Lipper fund family survey, Delaware finished in the middle of the ten-year rankings, on the cusp of the top cartel for five-year results and number four out of 75 fund families in the one-year rankings. Focus on performance is paying off.

I will now turn it over to Rich so he can spend a few minutes on the financial results for the quarter. Rich?

Thanks, John. Yesterday Lincoln reported fourth quarter net income of $194.3 million, and income from operations of $178.7 million, or 99 cents per diluted share. Overall, the results are fairly straightforward when you take into account the equity markets and a few items that I'll highlight in a moment.

Let me begin with a few comments on the progress of our announced realignment and the accounting change reported in the quarter. With respect to the realignment, fourth quarter results were in line with the estimates we provided last quarter with the exception of timing on some of the restructuring charges. Certain expenses we initially estimated would be incurred in the fourth quarter are now projected to occur in the first quarter of 2004.

We have included slides on our website that summarize the actual realignment results for the quarter and for the year and provide our current estimates for 2004 and 2005. The only meaningful change in the revised estimates is a $10 million increase in expected pretax savings in 2004, and an $18 million increase in 2005.

Let me spend a minute on the accounting rule changes. In the second and third quarters we provided disclosures in our 10Q about the upcoming changes to the accounting rules for imbedded derivatives in modified co-insurance and co-insurance funds withheld reinsurance contracts under the FAS B's derivative implementation group issue B36. Boy, that's a mouthful. We also commented on variable interest entities under FAS interpretation number 46.

I won't recap the details, but we did implement DIG B36 and it did have an impact on earnings and shareholders equity. The numbers were included in the exhibits provided with our press release and are also presented in a document that is posted on our website. As we have said before, the implementation of DIG B36 does not have an economic impact on the underlying business, and to the extent there's an income statement impact, it will reverse over time. With respect to FIN 46, we were able obtain the necessary changes in the rules so that the CDOs that we manage didn't need to be consolidated.

Now let me provide some information on the items I referenced earlier that should be considered as you prepare your first quarter estimates. First item is the impact of the equity markets. Once again, the estimates calculated by the market sensitivity spread sheet were fairly accurate, not only in the aggregate but by segment as well. Backing out the equity markets impact on DAC and GMDB reserves from the fourth quarter earnings gets you back in line with our pricing assumptions for market growth rates. The actual amount for DAC and GMDB reserves is $13.7 million, slightly less than what the spread sheet indicates.

Another item is partnership income, which exceeded our return expectations in the fourth quarter. We look at expected returns on our partnership assets of about $260 million as an average annual return of 5% after tax. In the fourth quarter, actual exceeded expected by about $2.2 million after tax. $1.6 million of the favorable variance grown expected came through the retirement segment and $600,000 came through life. With these numbers you can estimate partnership income at a level you're comfortable with.

Looking at expenses, we had a sizeable true up of the incentive compensation accruals due in large part to increasing the match in the 401 K. plan. In the retirement segment, fourth quarter expenses were higher by $2 million after tax. $2.6 million in life, $1.8 million in Investment Management, $4.4 million in distribution. Those add up to $10.8 million for the enterprise as a whole.

The fourth quarter included an adjustment to deferred taxes in Investment Management of about $8.5 million, arising from a change in the tax laws in the U.K. We were able to recognize the deferred taxes on the stock options previously expensed for UK-based personnel. This is a cumulative adjustment. The segment also had other favorable items that netted to about $1.5 million, which along with the deferred taxes, increased income in the quarter. Looking at the U.K., our expectation for 2004 earnings is around $38 million, a slight decrease from 2003 and in line with persistency expectations.

Turning to distribution, the combined distribution loss for Lincoln Financial Advisors and Lincoln Financial Distributors was $15.1 million for the quarter. This loss was higher than expected, due in large part to the incentive plans accruals I mentioned earlier. Looking ahead, we are projecting a distribution loss of around $40 million for the year, and would expect to see approximately $12 million of the loss in the first quarter based on prior year cycles and recent sales trends which add a high degree of variability to distribution results.

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

The fourth quarter capped off a year in which we saw the equity markets and our industry emerge from what could easily be described as one of the most difficult financial periods since the great depression. The Capital Markets, accounting scandals, fiduciary improprieties and the realities of terrorism combined to redefine the business and regulatory environments we now operate within. And it also changed buyer behavior, drawing into sharp focus the need for financial integrity and security in the products people purchase and the company's they invest in.

Lincoln responded by adhering to its principles of transparent accounting, responsible product developments and comprehensive risk management. The quarter's results provide continuing evidence of this commitment to our clients and shareholders and set the stage for what we expect to be an exciting year for the industry and for Lincoln.

Before turning the call back to Pricilla, I would like to note the continued improvement in Lincoln's return on equity. While we are not at the returns experienced prior to the three-year bare market, I am pleased with our steady progress.

This concludes our prepared remarks.

Thanks, John. We would like to now open the call for your questions. Please keep in mind that, like last quarter, we are asking that people ask one question and then one follow up, and then give others an opportunity to ask questions. We want to be sure to get in as many of your questions as possible on this call which will allow us also to provide additional detail on things we talked about on the call later in our one on one. Roderick, we'll take questions.

At this time, if you would like to ask a question, please press star then the number one on you telephone key pad. To withdraw your question, press the pound key. Please hold for your first question. Your first question comes from Jeff Hopson of A.G. Edwards.

Hi, good morning. In regard to life insurance, you've done extremely well with the sales. I'm curious about your sales outlook there; noting some tougher comparisons. I'm curious if you think that if variable life sales pick up in the industry, if that would be a challenge for you given that your universal life you picked up market share during the period when universal life was up for the industry?

Excellent question, Jeff. Jon, how about if you talk about sales a little bit and our positioning on a product basis?

I guess I'd define it as cautiously optimistic. On the universal life side, and as you know we do a lot of universal life business both in our money guard and our loss protection product. On the universal life side, I've seen a lot of competitiveness in the marketplace. I see a lot of companies pricing their products at [inaudible] rates that we would not price our products at. We are concerned with profitability. So that will be an issue as we look at 2004.

On the variable universal life side, we haven't seen the numbers reflect a move to variable universal life at this point in terms of actual sales; although when we do talk to our producers and we are starting to look at some of the case activities that comes into underwriting, we see an increase in volumes and our producers think that we will do relatively more VUL sales this year than we did in '03.

As far as our positioning with our variable universal life product, I think our current product is a little stale in the marketplace but we've got some aggressive plans for new product rollouts with our variable universal life product scheduled for the second quarter this year.

Okay. So in terms of your target for sales, not that you have a formal target, but is 10% a reasonable target for life sales? And, John, could you comment further on your thoughts that the industry is poised for an exciting 2004?

As far as growth in sales, I would say high single-digit, low double-digit. I think where the industry is right for increase in sales is particularly in the variable, with the variable product as I mentioned earlier. I think that's where a lot of the growth will come from, particularly from the wirehouse channel.

Okay. Very good. Thank you.

Your next question comes from Steven Schwartz of Raymond James & Associates.

Good morning, everybody. Can you hear me?

Yes, Steven.

Rich, could you talk about, in Investment Management, two things, in Investment Management it looked like you had other revenues and then insurance expenses both were up a lot but seemed to offset each other. Could you touch on that? As well, can you talk about in the life operations, benefits were very low, partially it seemed offset by policy holder dividends. Can you talk about what's going on there?

On the investment side, I think on the revenue piece one of the things that was kicking in there is we had seed capital investments and we had very good quarter from seed capital investments. One of the things that offsets that is we also have liabilities for deferred comp plans that when the markets are doing well they go up and therefore increase the benefit line or the cost line. So I think both of those are driven in effect by the market. They have an offsetting impact on each other, but do gross up those numbers.

On the life benefit side, I think I'll let Todd dig into that one. I think he's got all the detail that we need there. Todd, would you take that please?

Yeah, this is Todd Stephenson, Steven. You're right, the benefits line and the life stat supplement decrease by about $35 million over the third quarter. Two or three things are driving that, one, accounting for the front-end loads requires the capitalization and amortization and any historical back unlocking to be reflected in that particular income statement line. And in the third quarter of this last year, with our perspective unlocking we had about $15 million of increase in benefit cost due to unlocking.

The second major item in there would be, as you indicated the movement or offset between the participating policy holder dividends. What is done is that throughout the course of the year the various income statement items that accrue eventually to the participating policy-holders liabilities are set up in the benefits line and then ultimate payments occur in the dividend to policy holder line.

So that impact explains the majority of the balance of the change in both of those line items. Importantly, we would point out that our underlying mortality on our life business, which is typically what you'd expect to see in the benefits line, there is no real variance there in the fourth quarter. We are seeing mortality experience about as we expected.

Your next question comes from David Lewis, SunTrust Robinson Humphrey.

Good morning. A couple of things for Rich. The expense true ups of $10.8 million would imply 4 cents negative impact, mortality appears to be on track, obviously you take out the tax side benefit. So what is the fourth quarter run rate? And would you anticipate any of the tax true ups to continue to run into 2004 or is that a one-time issue?

The numbers that we took you through get you to an underlying number in effect of about 89 cents for the quarter. And then on the tax piece, that's a one time deal in effect, we have a change in the tax law. It allowed us to in effect recognize the cumulative benefit would be the same thing as having a tax rate change. When you do the accumulative catch up on our deferred taxes at once and there should be no significant ongoing impact. The good news is that, unless the laws change again, we will be able to continue to reduce the option expense for the U.K.-based personnel for taxes which in the past we couldn't. But it won't be very significant because this was a cumulative catch up.

And the 89 cents excludes the tax benefit?

Yes, it does.

Okay. Thanks very much.

All righty.

Your next question comes from Colin Devine of Smith Barney.

Good morning, gentlemen. I was wondering if you can you give us a bit of an update on your hedging program for the living benefit program? How has that evolved over the last quarter? We've seen some other companies bring out, I guess, some modifications on the design you rolled out. Perhaps you can talk also about your appetite to continue to right this product at the volumes you're doing?

I will take the appetite question and ask Todd to answer the hedge question, Colin. As far as appetite, the way that our product is being utilized out there we continue to have a nice appetite for it. As you know with this type of a product what the concern is is that people actually buy it for an income substitution and even though it's there to provide security at sometime in the future, they turn that switch on immediately. You could have problems with your actual result versus what you expected.

We indicated that only about 7% of the people are utilizing it. That's well within our pricing assumptions and parameters. So as long as we continue to reach that target market, which we have confidence we will do, we continue to find that attractive. Todd, if you would catch everybody up on hedging?

Certainly. As Jon indicated, we remain quite pleased with not only the level of sales with Principal Security, but the composition or quality of those sales. In other words, the rate of election and then the rate of actual utilization at the 7% level. I think that's important to underscore, the fact that when we introduced Principal Security in June, it was important that we had a hedging program in place at that same time. And our hedging program appropriately allowed us to offset what was the change in liability that would be occurring with the Principal Security withdrawal benefit with a delta hedging program.

We remain very satisfied that the delta hedging program is effective given the type of benefit design we have and a lot of the nonhedgeable risk that we feel very comfortable about that drive our product and we feel long-term will provide us an advantage with our product design. As we continue to implement the hedging program, we of course continue to review and evaluate its appropriateness not only for our existing withdrawal benefit exposure, which I might add with the sales we've had through the end of the year we are just under 2%, we only have 2%, in other words, of our total variable account values that have a withdrawal benefit feature. So given that scale and size we are very comfortable with the relative performance of our delta hedge program.

As we move forward in time, we just as we've done since day one, continue to evaluate and assess all of the hedging tools and opportunities, particularly as we would think about and be engaged in the research and development for potential additional living benefits or enhancements coming down the pike. So we would view, A, our current hedge program as very satisfactory, and while at the same time continuing to assess and review how we need and how we may want to expand that in the future.

Your next question comes from Eric Berg, Lehman Brothers.

Good morning. This is actually Pavo Bleinshik. One question, related to your retirement business. The sales were very strong so we were wondering, why didn't you see any meaningful increase in either operating revenues or operating earnings? Thank you. Sequentially.

Todd, do you want to take that one?

Sure. Starting first with operating revenue, importantly we did see in the driver of earnings, a significant increase in revenue that related to expense assessments having increased from about $115 million for the third quarter up to $125 million, or just under for the fourth quarter, reflecting obviously both the increase and net account values, as well as the continued improvements in the equity markets.

I would point out that there were a couple of positive revenue items in the third quarter that were not recurring or not to the degree, most importantly a much higher level of make holds and prepayments impacting our net investment income line in the third quarter, that decreased significantly as we expected in the fourth.

We also had, in the third quarter in the other revenue line about $6.5 million related to the MODCO reinsurance agreement with our fixed annuity reinsurer. So a settlement on that transaction ran through revenue line. as well as through operating income for the quarter as did the make holds and prepays. So when we drop down and look at those unusual items as they impact the third quarter and then look at and compare the expected levels of assessments driven from the equity market performance, we see and are very satisfied that, as expected what was driving underlying earnings growth was the increase in average variable account values.

The investment items I mentioned before, as well as the MODCO were a significant driver of quarter-over-quarter change and then, as Rich had indicated in his comments relative to incentive compensation, there was an additional expense load in the fourth quarter for retirement and other business segments.

Your next question comes from Andrew Kligerman of UBS Securities.

Hello?

Yes, Andrew.

Yes, hi, good morning. Sorry, I had gotten dropped out so excuse me if anything is repetitive, but two questions. The first one is with regard to LFA and LFD and the operating performance. I believe Rich said that there would be a loss of around $40 million versus the $66 million last year. So could you talk about how you plan to chop that much off of the loss? And then I'll have a follow up.

There's a number of moving parts obviously in the distribution line. What we see and what we report from within the corporate other section obviously is a net number, net income kind of number, income from operations. The underlying expenses and operating revenues of those businesses are much, much greater than what you see going through those lines, so there's a lot of leverage in the revenues and expense side.

We are actually expecting to see benefits coming from both as we tackle in effect getting more effective in the wholesaling side of our operation. We are also investing more in wholesaling. So you've got two things pushing the Lincoln financial distributors piece, much more effective wholesalers, but also added wholesalers, one being a positive and the other being a negative.

On the LFA side, we are realigning a lot of the operations and part of the project fitness numbers that we put out, the realignment numbers have a big impact on Lincoln financial advisors as to how their offices are structured and how they are creating consistency between operating offices so that we can leverage the expertise that we have across the enterprise. We are expecting to see substantial improvements in the operating results in effect in those operations, both those operations in effect in 2004. Does that help you?

Yes. Thank you. The follow up would be on the GMWB product. Can you specify what the fee or the withdrawal benefit is and how you feel about Hartford, what does that tell us about Hartford bumping theirs up to 50 basis points from 35?

Yeah, Andrew, we are at 45 basis points on the guaranteed side which we feel very comfortable with because of the nature of the client contract that we are selling there. I really am not in a position to comment on anything that Hartford may be doing with their product pricing.

Your next question comes from Ed Spehar of Merrill Lynch.

Good morning. A couple questions. Rich, I was wondering if you could go through the unusual DAC GMDB adjustments? Maybe if you could just give them to us by segment? And then in terms of the withdrawal benefit, could you talk about what the financial statement impact would be if there is a big move in the equity market at the end of the quarter, or if we have a big increase in volatility? What would that mean in terms of how we would see this benefit accounted for, how it comes through the financial statements? Thanks.

On the GMWB, if we have changes in the equity markets during the business day, and we don't have a sudden drop in effect overnight so that we end up with an inability to either be buying or selling at the appropriate times, we could see some breakage. You could see some reserve increases that we wouldn't have an offsetting income statement item to handle.

Right now most of the deposits that have come in on the GMWB are well out of the money, i.e. they have no net amount at risk, we have no reserve on those, we are currently carrying zero reserve of the GMWB. And if the markets then go down from a point in time where we start going to a reserve is when the hedge actually kicks in on the GMWB program.

We do have a sizeable portion of our GMDB reserves in the hedging program. So if markets start going down, we will in effect put more hedge in place to cover those. But at this point we've got, I think it's about $15 billion of our variable annuity business with GMDB reserves covered under the hedging program and then obviously the GMWB business is completely covered as well. So while it's not 100% in place on all of our GMDB, it is starting to pick up a fairly sizeable piece of the entire exposure. So unless we have a sudden drop in the markets that we can't cover, we shouldn't have much of an income statement impact from the GMWB.

As far as the adjustments on a segment basis, obviously every one of the businesses has a little bit of some of these and some have no contribution to others. If I look at in effect the guidance that we talked about, from the life side, we come to an underlying run rate of about $74 million, retirement side, about $84 million, and Lincoln U.K. about $9.5 million, Investment Management, somewhere around $11 million, and about $12 million, as I indicated, for the distribution loss, and then obviously we've got other corporate financing, et cetera, built into those numbers as well. Pretty much at levels similar to what you saw in the fourth quarter. So total corporate other line is about $18 million, and in total you are looking about $161 million, which equates to about 89 cents a share. Is that helpful?

On the WB answer, it's still a little confusing to me, I guess, why, we have two leading companies here in the variable annuity business and one feels, a little bit different products, but one feels that it's appropriate to hedge market risk volatility and interest rates and another, yourselves, feel it's appropriate to hedge market risk. Could you maybe try to help us understand what is it that's so different about your feature that would make it inappropriate to try to hedge those other risks?

Todd, we've talked a lot about this internally. You want to take that one?

Yeah, I think it would be inaccurate to say anything that would be inappropriate to hedge those other Greeks [ph] with our product. As we indicated earlier, as we introduced our Principal Security benefit we felt that given its expected initial size in terms of sales and in force that a delta hedging program was more than appropriate and significant enough in order to hedge most of all of the volatility in the liability that would be created under typical or what most expected equity market scenarios.

As I indicated earlier, we are constantly looking at all of the available tools and processes that would or could afford a more complete or a hedging result that would take us up slightly in the percentile of a hedge effectiveness. But based upon our existing product, existing exposure we feel very comfortable with our delta hedging program.

As we would get more significant, as far as the exposure to GMWB and other risk, we will be continuing to evaluate the hedging program that we have in place as to whether or not its adequate. But as Todd indicated earlier, the GMWB currently is 2% of our entire variable annuity portfolio and that's a relatively small piece so we feel comfortable I think with the risk that we currently have on the books.

The type of reserving and the relative magnitude of each type of guarantee and benefit covered by the hedge program has to be considered when you look at whether or not we are doing what you think we need to do. And as Todd has indicated, we will take this further when the exposures get more significant and/or if we add different benefit features that we believe can be tackled effectively from a risk management perspective with the hedge as the primary risk management vehicle.

Thanks, Rich, I would just underscore what you said there. As we change benefits or features inside of the product and if we were to decide to go after other segments of the marketplace, then other hedging strategies certainly bear much closer analysis.

Your next question comes from Michelle Giordano with J.P. Morgan.

Good morning. My first question is on capital. I was hoping that you could talk about what you estimate your year end RBC ratio and excess capital to be as of the end of 2003? And if you can give a little bit more color on the fact that you expect your share repurchases to be active in 2004. And specifically what would this mean also for dividend increases?

My second question is on your spread outlook for fixed annuities and universal life and if you could share with us what your interest rates scenario would be under those spread out looks. Thank you.

Todd, could you go ahead and take the spread outlook piece and then hand it back to me and I will take the capital piece.

Sure thing. Focusing first on our annuity business. If you start with an assumption that there are no change in new money rates over the balance of 2004 from what we started the year, we would expect to see at the first half of the year, basically a continuation of the, what I'll call net adjusted spread in the fourth quarter. And by net adjusted spread, taking out the impact of make holds and prepays. If you start with the 3 basis points I believe in the fourth quarter relative to make holds and prepays our spread was 204 basis points.

We would see, at least through the first half of the year as we continue the path of aggressive crediting rate actions on our portfolio products, we would see us being sustained at about that 2% level. As we look forward to the last half of 2004 we would see us moving down somewhat but still within that range that we've talked about previously, that overall our fixed annuity product spreads and these will change over time as product mix changes but we had indicated earlier a range of 190 to 210 basis points. So we would see the fourth quarter very much being in that range.

And on the life insurance side, obviously the same path has been taken in terms of maintaining our spreads via aggressive crediting rate action. We would see some continued drop, very, very marginally in our net investment yield. We expect to be able to manage most of that with crediting rates. However, again, as we, particularly as we move closer towards the end of the year, if you look at our spreads, for example, on our FAS 97 lines having moved up a little bit in fourth quarter from 153 basis points to 161, we would expect basically through 2004, in most all interest rate scenarios, to stay within that range.

Moving on to the capital piece of your question, we are currently estimating our risk-based capital for year end in the 315 to 320% range. With that in mind, and where we are from a capital planning perspective, we expect to be able to do at least $100 million worth of share repurchases during the year. We would expect to those heavily weighted towards the first half of the year at this point in time. Obviously, as we go through that process if anything would change we would obviously have the flexibility to either turn it off or expand it. So that's currently where we are targeting things.

From a dividend perspective, we manage our dividend over a long period of time and as you've seen we've had gradual increases in dividends for, I think it's about the last 15 or 16 years. It's a long history of dividend increases. I wouldn't anticipate any significant change in our dividend patterns going forward. We address the dividend with the Board in our November board meeting each year and that would be the next time I would anticipate any action on the dividend.

Your next question comes from John Hall with Prudential Equity Group.

Great. Thanks very much. Rich, this is for you on DIG B36. I was wondering if anyone was going to go with it. Does that make you change your thoughts about engaging in any more MODCO reinsurance transactions? Is there anything practical that you have to change about your business because of it?

The only thing that would probably change going forward, we've done a number of distribution arrangements where we have MODCO arrangements in place, that we haven't done in the past would be that I'd want to segregate the portfolio so that we could make sure that the portfolio could be mark to market to offset the imbedded derivative change which then gives you in effect a bottom line neutral impact.

Where we are getting some noise going through in effect the bottom line is where we effectively have portfolios where the program is small enough right now that it's not a separate portfolio, therefore, we can't mark a portion of the portfolio to market. That would be what we change going forward. But it is just noise in the income statement. It is very disappointing that we have to report it that way. It's sort of like the FAS 115 stuff in that we hope no one pays any attention to it, but it's going to be on the income statement and it's hard for people to ignore what's in the income statement.

Great. If you were to segregate those asset portfolios more finally, would that at all impact the cost of reinsurance? Does that raise the cost of doing the deal?

Not effectively for an operation our size, we run probably 50 or more separate portfolios already and setting up another one is not very costly from our operations side on the Investment Management side of the business.

Your next question comes from van Vanessa Wilson with Deutsche Banc.

Good morning. Rich, on your slide for project fitness, the second slide which gives the actual for '03 and the estimate for '04, I just want to understand how this effects earnings? If we are looking at '04, for example, an after-tax impact on the top half of $3 million, and then below that, $22 million of that is in restructuring charge, does that mean that operating earnings are higher by $25 million?

That's the current projection is that the impact on operating earnings is going to be about $25 million positive, and that's about $11 million more than what we previously estimated. And then on the bottom line, some of those costs in effect move to restructuring cost so that the bottom line improvement at this point is we expect to see about $3 million in net income, that's after restructuring charges, improvement, and that's about $6 million higher, or better than our previous estimate.

Okay, let me -- I'm getting confused now.

I understand.

Let's do it, the 2004 column has an after-tax impact of a positive $3 million on a net income basis.

Yep.

And then $22 million is restructuring, so on an operating earning basis we have a positive $25 million hitting earnings.

Correct.

Okay. Then you pushed forward $11 million.

The 11 -- okay, go ahead.

And that's a plus? I thought that was additional expenses pushed forward?

It was, but we also had reduced expenses that offset it so you didn't see much change there.

Okay. Okay. I got it. Thank you, Rich.

Okay.

Bye.

Your next question comes from Tom Gallagher, Credit Suisse First Boston.

Good morning. One follow up on the buy-back. Can you comment on what's changed between your investor day and now in terms of, I guess, a more definitive stance on buy back? If I recall back, you had commented that you were going to wait until the rating agencies turned a bit more positive on the sector before resuming buy-back. Is it that your capital position is improved between then and now to the point where you could free up an additional $100 million?

The primary thing that's happened since investor day, which was in early November is we had another really strong quarter of earnings. The markets, both credit and equity have continued to do very well which were also criteria in my analysis. And then the one piece that hasn't happened yet is the rating agencies haven't gotten in effect more favorable from an outlook perspective, but we also are feeling from them in their body language that they are heading in that direction.

So we have, we believe a solid capital plan, we've got solid capital position and our risk management activities, I think have been enough to reduce profile from a risk perspective to the point where we feel comfortable starting with $100 million of share repurchases and starting that program sooner rather than later.

Okay. And will the capital being used incorporate any of that which was used as an extra cushion against the variable annuity guarantees which I remember being a little over $300 million, or is that still going to remain there?

I'm not sure I understand the question.

If I remember correctly, you had talked about having an extra $300 million-plus of statutory capital backing your variable annuity block. Does that still remain or will you start lowering the, sort of over funding if you will, of your variable annuity business?

I don't recall saying we had $300 million backing our variable annuity block. I do remember at one point, and it's a year and a half ago, I think, that we had $300 million of excess capital. And obviously since that time went through a lot from a both credit and capital markets perspective. And that's in effect where we stopped the share buy-back and went into in effect a batten down the hatches mode going through some very tough credit markets, et cetera.

Since then things have improved considerably and we've also reduced the amount of capital that is standing behind the GMDB reserve because that reserve has come so far back out of the market and that amount of risk has gone down substantially. The current reserve that we are carrying for the GMDB at the end of the year is about $46 million, which includes about $6 million that is specific to claims that are in process. So there's about $40 million reserve and about $6 million that is in process of payment.

Your next question comes from Joan Zief of Goldman Sachs.

Thank you. Good morning. I wanted to ask a little bit more about the variable annuity business. Going forward, would you say that the leverage to earnings from a positive market is becoming less or is it increasing? I also wanted to ask you what your 1035 exchanges were as a percentage of your sales? And what do you expect your after-tax annuity margins to be? Do you think that the after-tax annuity margins are going to stabilize and be stable at these levels because of whatever added costs or do you think we will start to see some significant operating leverage in the variable annuity, in the annuity area?

Let me address the first one, then turn it over to Todd on the questions on the annuity side. We are getting just a little bit less leverage, the equity markets, from the business and the reduction is primarily driven by the fact that our earnings volatility was substantially affected by our GMDB reserving, and that reserve has obviously come down substantially plus we will be changing the method of doing the GMDB reserve under the new guidance starting in the first quarter and the SOP 0301 application, there will be a different application in effect to those kind of benefit reserves.

So to that extent, I don't expect to see the volatility, both positive or negative, that we've seen in the past in the equity markets from that specific reserving activity. The volatility that we get from DAC is sill present in our business and that piece I would see continuing. But, yes, some less volatility based on what we are doing today from a reserving perspective. Todd?

Yes, the remaining two questions, Joan, I believe one was related to level of 1035 activity. If you look at our two primary individual variable annuity products, Choice Plus and Legacy, the percent of our business coming from external 1035 exchanges is about 40% if you add another 2 or 3% related to a nominal amount of internal exchanges. So about 40% in total of our flow business is 1035 exchange.

Second question related to annuity margins, obviously, as you know, our retirement or annuity business is heavily influenced because of the size of the variable annuity assets and the impact it has through its fee income structure, the impact driven from the equity markets. So, obviously, very dependent upon the level of sustained equity market increases and then, additionally, as you indicated, we would expect to continue to gain momentum on the operations side vis-a-vis expense efficiency and all in be able to continue to improve our overall annuity margins.

Todd, this is sort of a follow up to a previous question that was asked, and that was how much capital we have behind our GMDB reserve on a statutory basis. Do you have any feel for that, is that number available?

Yes. We have, and again this is our own internal required surplus formula. At the end of December we were carrying about $183 million of required surplus relative to our remaining GMDB exposure. So it has come down significantly as you would expect having peaked somewhere in the mid-$300 million range.

Thank you.

Roderick, I think we have time for one more.

We have a follow-up question from Colin Devine.

Jon, I was wondering if you might be able to expand on the slide you used at Smith Barneys conference where you looked forward and attributed 55% of your earnings growth over the next three years to net flows. Could you just perhaps give us a bit more color on how you got to that figure?

Yeah, the genesis of that slide was a discussion that we had had with our Board of Directors in presenting our three-year financial plan to them. So we were looking at our projected 2006 earnings compared with 2003 forecasted earnings. And we took all of the differences and put them in appropriate buckets. And I think there is a large belief, and one of the questions earlier kind of reinforces that, that the dominant driver of earnings is the market.

And what we did in our projection was to assume the type of market conditions that we use for our product pricing which is basically a 7% net equity market growth. And when you look at it on that basis, about 55% of the difference between our '03 and our projected '06 earnings was attributable to net cash flows. And it really shows the importance of net cash flows and I believe there is a slide up on our website that shows the swing that we had had in our net cash flows and the importance that we've been placing on those.

At this time there are no further questions. I would like to turn the call back to Pricilla Brown for closing remarks.

Thank you, Roderick. Thank you, all, for so many great questions. I'm pleased that we got most of the material items in the quarter discussed on the call. Please do give us a call afterwards if there are any questions that we have not answered for you. As always we are available on the IR line, that's (800)237-2920. Thank you and have a good day.

This now concludes today's conference call. You may now disconnect.