Lincoln National Corp (LNC) 2008 Q3 法說會逐字稿

Good morning, and thank you for joining the Lincoln Financial Group's third quarter 2008 earnings conference call. Today's call is being recorded. 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. (OPERATOR INSTRUCTIONS) I would like to turn the call over to Vice President of Investor Relations, Mr. Jim Sjoreen.

Good morning, and welcome to Lincoln Financial's third quarter earnings call. Before we begin, I have an important reminder. Any comments made during the call regarding future expectations, trends and market conditions including comments about capital, liquidity, expenses and income from operations are forward-looking statements under the Private Securities Litigation Reform Act of 1995. These forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from current expectations. The risks and uncertainties are described in the cautionary statement disclosures in our earnings release issued yesterday and our reports on forms 8-K, 10-Q and 10-K, filed with the SEC. We appreciate your participation today and invite you to visit Lincoln's web site, www.lincolnfinancial.com, where you can find our press release and statistical supplement, which include a full reconciliation of the non-GAAP measures used in the call, including income from operations and return on equity to the most comparable GAAP measures. A general account supplement is again available on the website as well. Presenting on today's call are Dennis Glass, President and Chief Executive Officer and Fred Crawford, Chief Financial Officer. After their prepared remarks we will move to the question-and-answer portion of the call. I would like to turn the call over to Dennis Glass.

Thanks, Jim, and good morning to all on the call. Overall, our results in the third quarter were good when viewed against the backdrop of equity markets, credit conditions and slowing economic growth. Our capital and liquidity positions remained strong through the end of the quarter augmented by our decision to reduce the dividend. The reduction, while not an easy decision to make, given the dividend history of the Company was a prudent one and aimed at strengthening our capital over time. The Company has a strong and diverse liquidity position. We've increased our cash holdings and our general accounts as a precautionary measure and while this has a minor impact on margins, we view this as a temporary move. The diversification and quality of our balance sheet mitigated the losses we reported in the quarter, primarily in the financial and mortgage backed asset classes. A lack of liquidity and widening credit out spreads drove the unrealized losses to higher levels. We have no significant single security in an un realized loss position, except for the credit linked notes, which we believe are manageable and we saw a $250 million reduction at par in the CLNs during the quarter.

It remains unclear at this point when the stimulus plans put in place by the government will restore sustained liquidity and confidence in the market. Until then, it is difficult to predict what the implications are for, other than temporary impairments or unrealized losses and prolonged economic weakness can create a difficult credit environment over time. We remain confident in our approach and discipline surrounding the management and valuation of our invested assets and will take appropriate actions to maintain the integrity of the balance sheet. Fred will go into detail on the DA hedge program, but I would note that our hedge program has been effective in large part and that based on the third quarter market levels, any projected actual claims paid on the guarantees would not begin until towards the end of the next decade.

Turning to the fundamentals, new business production was relatively strong in the insurance businesses, again taking into consideration the economic environment, while the asset management business was hard hit by declining asset values and negative consumer sentiment. Our reported earnings came in at the higher end of the guidance we shared in our prerelease and there were a number of notable items that surfaced as part of our annual review of models and assumptions. Assets under management in the aggregate decreased by 21% from the prior year quarter putting pressure on earnings but mitigated by the contribution of spread and mortality and morbidity margins to the bottom line. These latter nonequity sensitive normalized margins are approximately 70% of our total third quarter results. Expense levels remain relatively flat and we are of course looking at discretionary spending as a means to compensate for declining revenue growth. We are moving ahead on our IT related merger integration because this is critical to effectively managing expenses over the longer term. As part of our annual planning process, we are revisiting spending plans, which is prudent in today's environment.

Let me drop down to a few more headlines by area starting with retirement solutions and annuities. Total variable annuities deposits were down 14% from the prior year quarter and 13% sequentially. Sales did trend down somewhat as the third quarter progressed and are again trending down in October amid the disruption particularly in the wire firms along with the obvious volatility in the equity markets. While we do expect consumer sentiment to weigh heavily on purchasing decisions in the near term, we don't necessarily view the new emerging distribution channel landscape as a negative. Recent and/or pending combinations among certain wire and bank distribution partners may present opportunities given the strength of our relationship. Fixed and indexed annuity deposits and flows were mixed and we remain cautious, recognizing that these products are sensitive to the relative value proposition of other deposit oriented products. Defined contribution, in our defined contribution business, deposits are down 13% in what is typically the slowest quarter of the year. Deposits in the micro to small market were essentially flat year-over-year and sequentially, while deposits in the mid to large market were down 20% from 3Q '07, which quarter benefited from a small number of high dollar cases.

In mid September we launched our new Lincoln director product that will now offer more than 80 investment options and will be positioned as our primary product in the micro to small marketplace. The new director product includes fiduciary support, planned sponsors, accumulation strategies and tools for plan participants and will also offer our patented distribution option, Eye For Life Advantage. We have a strong management in place, and we are moving this business forward. Life insurance. As part of creating the insurance solution division, life insurance results now include executive benefits, that is the (inaudible) business previously reported on a stand alone basis. Life insurance sales of $190 million in the quarter were down 4% from the prior year quarter but were up 15% from the second quarter. We saw sequential improvements in universal life driven by prior initiatives to fine tune pricing and enhance our underwriting service. Sales of Money Guard, our universal life product with long-term care benefits were up 26%, and continue to benefit from a focused and expanded distribution effort. Looking ahead, the fourth quarter is historically the best life insurance sales quarter for the year. However our expectations for this year are muted given current conditions.

Group protection. The group protection business stood out in the quarter. Not only because of its solid results but because of the natural hedge it provides through products and earnings diversification. Net earned premium was up 10% over the prior year quarter, fueled by organic growth and favorable persistency. Sales increased 13% over the prior year quarter, as our distribution expansion and restructuring continued to yield results. Let me turn to Delaware. The investment management Delaware has not been immune to the turbulence affecting the capital markets and the asset management business in general. However, a deep product line up supported by high quality investment teams has helped to mitigate the market impacts. On a relative basis, excluding the fixed income asset sale in October of last year, our assets under management fell $25 billion in the last 12 months. This is approximately a 16% drop and puts us in similar and sometimes favorable light versus our competitors, some of whom have lost over 30% of asset base.

Retail sales of $2.7 billion were relatively in line with last year and the prior quarter. Institutional sales after adjusting for a CDO issuance in the third quarter of last year were also flat. A bright point, institutional client fundings in the quarter surpassed $700 million and includes mandates in our fixed income products and our large cap growth products. Let me turn to distribution. In our distribution companies we have been focused on getting in front of clients, and conducting business as usual. Given that the head of LSD has left, I'm spending time with our management team and wholesalers as I look to name new leadership in the organization. LSD possesses deep bench strengths and both internal and external interest in the leadership position has been strong again, given the quality of the organization, it's reputation and its people. 100% of our leadership team remains in place, and we have had no related wholesaler departures. We have 844 wholesalers, as of the end of the third quarter, which was up 5% from the approximately 800 at the end of the second quarter. I would expect to name a new head of LSD shortly.

At Lincoln Financial Network, the delivery of high quality expert advice remains the top priority as individuals struggle with personal financial decisions. While we may see a slowdown in absolute sales in the near term, LSN continued to manage to break even levels or better for the quarter and year-to-date. Clearly this is an effective retail organization, particularly given the caliber of talent. With that let me turn it over to Fred to discuss the financial highlights in the period.

Thanks, Dennis. Our reported income from operations in the quarter of $316 million or $1.23 per diluted share includes a number of offsetting items that combine to reduce the quarter's earnings by about $21 million or $0.08 per share. Our reported earnings also included merger expenses of $13 million pretax. Notable items in the quarter included the results of our third quarter prospective DAC unlocking related model refinements together with retrospective unlocking, this primarily impacting the life results. Offsetting our DAC work were favorable tax adjustments, the result of filing our 2007 tax return. Net income of $148 million or $0.58 a share was impacted by realized losses and impairments on general account assets as well as the net results of variable annuity hedge program.

Turning to our business segments and starting with annuities, earnings in the quarter included negative retrospective unlocking related to the markets of roughly $12 million. This was more than offset by $21 million in favorable tax adjustments related to our separate accounts and other net positive items totaling roughly $4 million. Average variable annuity account values decreased roughly $3 billion or a little over 5% as compared to the second quarter. The markets impact on account values was somewhat offset by roughly $1.2 billion of variable annuity positive flows in the quarter. Expense assessment revenue was down a little less than 5% sequentially, supported somewhat by our practice of charging living benefit fees on a guarantee amount versus account values. Fixed margin contribution together with reported spreads of 189 basis points reflect a decrease in interest earned attributed to building more liquidity in the portfolios. In addition, we had a classification item which impacted interest credited, this having no ultimate bottom line impact. We estimate normalized spreads in the 200 to 210 basis point range going forward.

Our defined contribution earnings came in as expected recognizing the impact of fee income due to the equity markets, this offset by better than expected fixed margins. We recorded our third consecutive quarter of positive net flows helping to soften the impact from weak markets. Average variable account values were down by roughly $1.4 billion driven primarily by the market with overall expense assessment income down 8% sequentially. Fixed margin contribution was strong, the result of a large of make whole premium collected in the period. We would estimate normalized spreads to be roughly 220 basis points, more in line with our outlook going forward. In our life segment the results of unlocking, model refinements and other items negatively impacted the quarter's earnings by a net $30 million. Model refinements resulted in an adjustment to universal live reserves offset by the net positive impact of overall DAC unlocking. When looking at forward run rate earnings, the unlocking and model work in the quarter results in a ongoing $7 million negative quarterly impact to our life earnings. Fundamentals remain stable with average universal life in force up 4% over the prior year, adjusting for the DAC and model work, mortality margins and expense assessment income follows a steady increase in our book of business.

Fixed margins in the quarter benefited from roughly $23 million pretax of alternative investment income, this somewhat offset by weaker than expected prepayment income. Reported spreads came in at the high end of our expected range of 180 to 190 basis points. Our group protection business continued its record of strong quarterly performance. Loss ratios performed within our expected range both in life and disability lines with overall nonmedical ratios coming in at just over 71%. Solid revenue growth continued with net earned premium increasing 10% over the comparable 2007 quarter, fueled by organic growth and better than expected persistency. Delaware's reported earnings were weaker than expected but not surprising given the markets. C capital returns negatively impacted earnings by $3 million along with another $3 million of after tax expense items that are not expected to repeat in the fourth quarter. Third quarter market decline drove period ending assets under management down $6.5 billion sequentially, which together with the impact of negative flows served to reduce revenue in the quarter by roughly $14 million.

Expense initiatives launched earlier in the year continued to yield positive results in the quarter. Consolidated general and administrative expenses are down sequentially and we continue to focus on defending overall expense ratios despite weakness in revenues. We expect merger expenses to be in the range of $12 million pretax for the fourth quarter, tailing off more dramatically as we enter 2009. In the quarter we recorded gross losses and impairments on available for sale securities of $406 million. Of this amount roughly $43 million is attributed to securities where we may no longer have the intent to hold to recovery. Approximately 50% of the true credit impairments and realized losses were concentrated in financials, along with impairments on RNBS totaling approximately $80 million pretax. As we break down our $4.9 billion of unrealized loss position at the end of the quarter, we have very little in the way of concentration among the top 20 positions. Many of the larger positions are with financials benefiting from a combination of the TARP and consolidation. As Dennis mentioned, we were able to reduce exposure to credit linked notes in the quarter by $250 million as one of our holdings paid off at par.

We experienced elevated levels of breakage in our variable annuity hedge program due to the extreme conditions experienced in the quarter. Incorporating the equally volatile FAS 157 nonperformance risk adjustment, the hedge program contributed $58 million to the quarter's net income. Before the affects of DAC, tax, model refinements and 157 nonperformance factor, gross breakage in the quarter was a negative $336 million, or approximately $83 million net of DAC and tax. The ineffectiveness was concentrated in a handful of extreme trading days, such as the Monday after the Lehman bankruptcy announcement and the day the house failed to pass the original TARP legislation. The breakage in the quarter can be attributed to a combination of basis risk, currency movements and the impact of an extreme intra-day volatility. These same conditions have continued into the month of October. We remain focused on balancing GAAP net income volatility with the long-term performance of the hedge program recognizing any meaningful potential claims under the living benefits are several years into the future.

Turning to capital and liquidity, and as noted in our prerelease, we estimated our excess capital position at around $500 million as of the end of the third quarter. We did end up taking a stronger RBC into the fourth quarter than indicated in our prerelease. However, we expect the combination of continued general account impairments and the market decline in October to negatively impact our statutory capital position. Obviously, and as we learned yesterday, much is dependent on the market's performance for the rest of the year. We have suspended our repurchase activity and halved our dividend, the dividend action generating roughly $200 million a year in additional capital. We believe both moves were well received by the rating agencies. We are being proactive with the agencies keeping the communication lines open and regular. We were pleased to have received Standard and Poor's strong enterprise risk management rating this past quarter, which situates us well among peers. Our liquidity position remains strong and with diverse sources of contingent liquidity. As of the end of the quarter, we have not experienced any unusual activity in our product flows. We have only a modest amount of securities out on loan, roughly $400 million and have joined the Federal Home Loan Bank of Indianapolis, where we can borrow up to $1 billion at reasonable rates.

At the holding company we have around $120 million outstanding under our commercial paper program and over $1 billion in unused and multi-year committed bank lines. We are focused on building capital and liquidity through expense controls, exploring reinsurance strategies and recognizing a slowing of production tends to require less capital. October markets have impacted our insurance separate account values, down roughly $16 billion before the rebound in yesterday's performance. We ended the third quarter inside our variable annuity DAC unlocking corridor, requiring about a 5% market decline to pierce the inner corridors offsetting off analysis on potentially resetting the base amortization assumption. Even with yesterday's performance, we have in fact pierced the inner and potentially the outer corridor levels. If conditions do not materially improve, we may unlock our DAC amortization model for equity market performance. We would estimate any fourth quarter unlocking in the range of $250 million after tax as of yesterday's close. While not a cash or statutory capital issue, the unlocking would reduce our reported earnings in the quarter. I would caution that this is simply an estimate and could differ according to the markets and upon making a final decision regarding our best estimates. Now let me turn it back over to Dennis for some closing comments.

Thank you, Fred. Before we go to Q&A, let me comment on capital. We have said in our remarks we entered the fourth quarter with somewhat stronger capital than indicated in our prerelease. We have a well diversified asset portfolio, no liquidity issues and well diversified profitable businesses. Again within these businesses, during the quarter, close to 70% of the earnings were driven by margins that are not related to equity markets. Capital raising activity, if any, will be related to unfolding events. Our objective remains to run businesses, protect our franchise and take actions that are in the best long-term interest of our clients and shareholders, and now let's turn it -- open it up for Q&A.

Thank you, sir. (OPERATOR INSTRUCTIONS) We will take our first question from Andrew Fagerlund with UBS. Please go ahead.

Good morning. The first question is around the hedging breakage of about $232 million. I think, Fred, you were saying basis risk, currency, extreme intra-day volatility, could you drill in deeper and give us a clearer sense of exactly why it costs so much and what the impact might be to excess capital or RBC as we look forward to the fourth quarter?

Sure. Andrew, thank you for the question. First of all, drilling deeper on the pretax and DAC breakage of 300, roughly $330 million, a little north of that, 50% of that breakage was related to basis risk, more specifically the underlying performance in the separate accounts versus the indices we use to hedge the liability. It's very important. We use fairly sophisticated mapping processes to track or correlate the best we can the indices to the potential performance estimates of the underlying separate accounts. And so we would expect to go through periods of times where basis risk will contribute to a particular quarter or take away. Indeed, it was a particularly severe period for basis risk. I think the underlying separate accounts underperformed the indices by some 400 basis points in the quarter. We wouldn't expect that kind of severity going forward. Most importantly, Andrew, in that particular piece of it, again, representing 50% of the breakage, we would expect over the long run for basis risk to even out over time, and in fact map our hedge process accordingly.

Another big component of the hedge breakage was really the -- in particular these few days where you had intra-day massive swings in not just the equity markets but also in other indices, interest rate swings with a flight to quality, more crisis like conditions. And it's very difficult for our hedge program -- in fact, the hedge program by in large is not designed to keep pace with those kinds of intra-day moves. And so that contributed about 30% or so of the breakage when looking at it. And then finally, there was some currency movement. We had a situation where the dollar I believe strengthened roughly 700 basis points against most of the currencies in a fairly sudden fashion as currency changes go. And our program had a little bit of difficulty catching up with that. That was not a large component of it. I would say 10 to 15% of the breakage in the quarter. It's also something we can address going forward with strategies.

Importantly when looking at these intra-day volatility, we have had to make some I think prudent decisions over the long run to somewhat expose ourselves to more -- to some of the volatility in our structure recognizing that the cost of purchasing hedges and the cost of benefit right now is not really rational given the pricing we are seeing. And so we end up being on the margin, and I would emphasize only on the margin, a bit short volatility which will bring about greater breakage during these extreme periods. But we would expect that GAAP to close over a longer period of time. We think it's also prudent and more consistent with a longer term view of the other aspect of the hedge program, which is delivering assets in time to pay claims over the long run.

That leads me to my follow-up. At the same type of basis risk issues, volatility in the quarter, the fourth quarter, can we expect a similar type charge in the fourth quarter? And more importantly, what kind of impact would it have on excess capital? Maybe it's easier to look back at the third quarter. What kind of impact did that have on excess capital in the third quarter and then we can extrapolate in the fourth.

Let me address that. And I will address what we are seeing in October, Andrew, I'm happy to talk about that. Because this is fairly realtime, we track it pretty closely. In terms of capital, you don't see the same risk based capital impacts that you see from the GAAP breakage. There's a different accounting that's involved in it. And so we see more of a muted impact, if you will, related to the performance of the hedge program. You have more of a cost of the program that will run through and weigh down your RBC over time. For Lincoln through the use of captive reinsurance, this results in increasing the premiums we pay to settle or account for, if you will, the added cost of the hedge program, not unlike the valuation premium that we use in our GAAP results and have incorporated into our operating earnings in the period. So you don't see quite as much an impact there on the capital side. Now what you do, and also by the way I should say, you don't have the mark to market swings because of that captive reinsurance and that's importance. That swing, by the way, can really add back to your RBC and at times as well as take it away. When it comes to October, we are seeing the same conditions in October that we saw in the third quarter. That breakage right now -- I should say actually as of the end of last week, was hovering between $400 million and $500 million pretax and DAC, importantly also offset by the same nonperformance risk factor that served to soften and in fact end up contributing net income to the bottom line. In other words, the same sort of irrational or crisis type marks that we are getting that are influencing liability, namely implied volatility being off the charts. Those same sort of economic inputs are impacting the nonperformance risk as well serving to largely offset it. So many of the themes that are running through our P&L this quarter, you will see run through as we go into October. Again, October is October. We see this thing move around quite a bit. And we have to watch for the rest of the quarter to see how it turns.

So as of now, excess capital is similar to that $500 million number that you outlined, despite even hearing rating agencies somewhat concerned about equity exposures on the excess capital is in that $500 million?

Yes. Let's talk about the separate question of where is your capital position as you stare at the month of October. So as Dennis mentioned in his comments and I mentioned, we carried a slightly stronger risk based capital into the month of October than we had in our prerelease. In our prerelease, we had said 385%. It's actually closer to 400% as we started to finalize more of the numbers off the quarter. This by the way, I should remind you, is an estimate that you make mid quarter. Ultimately print your blue books and that dictates your final RBC. But we have a pretty good read on it. So we carried a bit of a stronger RBC in the quarter and that's helped us. We would estimate -- we have done some sensitivity analysis around this, if you were to assume a 30% drop in the equity markets, and again with the rebound yesterday we came up quite a bit from that. I think we are running at around 19ish or so percent down through the end of close yesterday. If you assume the 30% down market, that would have roughly a 25 percentage point negative impact on our RBC. That's because we -- as a variable annuity writer, we still have to do all the calculations related to AG34 and 39, which is the reserving guidelines as well as C3 phase 2 work. When you have a severe market decline, it will weigh down on your RBC and that's about the sensitivity analysis I would give you.

We will move to our next question, sir. That will come from Jimmy Bhullar with JPMorgan.

Thank you. Good morning. I had another question on your hedge program. It's not on the numbers. It's more on like the severe breakage you've seen this quarter, whether you agree the markets rational or irrational. Has it made you either reevaluate or think about strategy for the VA business? This is a business you make roughly $120 million, $125 million on each quarter and you mentioned that basis points or basis risk over time would even out, but let's say the market remains volatile for a long time. Have you thought about either changing strategy in the market in terms of offering living benefit guarantees or maybe raising prices or looking at the product again and maybe pulling back a little bit from the market? Would you discuss that?

Jimmy, it's Dennis. Let me just say that we continue to think it's a good business over the long-term. Let me put shape around that. We take a look at different pricing runs and so, for example, a pricing run that only has a 4.5% equity market appreciation, would still provide us returns on a rate of return basis, ROE basis in the 12 to 15% unlevered. Clearly we are in the tail and there is a lot of jumping around that's occurring. Again over the long-term, we think this can be a good and -- good business and a profitable business. The other thing we need to step back from from time to time and the hedging program has a dual purpose of hedging the potential or, excuse me, creating assets for potential lability payments as well as a secondary issue of trying to calm down the GAAP income results. Let me just give you a number -- our hedge asset target at the end of the Q3, which is roughly the present value of expected future claims on a GAAP basis, before the nonperformance risk -- we take that out of there -- that was about $1 billion. The hedge asset number, which would be the amount of money available to pay those future claims was also about $1 billion and that $1 billion had 70 to 80% of it backed like cash collateral. So just on a GAAP perspective of trying to present value future claims and do you have assets available to pay those claims at the end of the third quarter, those two numbers were about equal and again runs at lower assumed equity growth rates than the 9% that's typically used, produces pretty good in turn rates of return. Now, on this issue of the target versus the asset, as markets move around, those numbers might pull apart, they have in the third quarter, but we would expect over time to be able to keep those pretty close to each other.

Now I had another quick one on -- you lost a few people to Sun Life after John Bosher joined. Have you -- then obviously you've announced the main one, but have you seen any other like either distributor defections or any people in sales management that have left -- if you can comment on that.

Yes. Let me put it in three categories. The management team that reported to Terry is 100% intact. The sales management team has seen no departures. And the external wholesaling team has seen no departures. I will tell you that in a market like we are in, there is plenty of demand from competitors for the talented people that we have. And there may from time to time be some changes. But the simple answer to your question right now is, nothing has changed.

Thank you.

We will move to our next question that will come from Edward Spehar with Merrill Lynch.

Thank you. Good morning. I guess Fred going back to the RBC and the 30% equity drop that you suggested, first could you just repeat again where you said you think the RBC ended, the Q3, and could you give us the dollar amount that that 30% drop would hurt your capital by? And maybe just could you help us understand what the pieces -- how much of it is just the -- how much is sort of carve them, how much is anything else we may need to know about.

So assuming a 30 % drop in the market had about a 25 percentage point reduction in RBC and we entered the quarter at about 400% RBC, a little bit north of the 380 that we talked about, and I should note this is the RBC for our principal life insurance subsidiaries. This would be the -- more or less, the consolidated RBC of Lincoln Life of Indiana, New York and one other small entity, First Pacific. And the impact of the markets the way to think about it is we entered in to the fourth quarter with about total adjusted capital of in and around $5.25 billion, right in that range. And the impact when you stress the market and do the after tax impact of the market, on that capital, i.e. kicking up the reserves under AG34 and 39, you had about a $275 million to $300 million reduction or impact to that total adjusted capital, from which you then your RBC to it to come up with the impact. Again, I would reduce it by about 25 percentage points, if you assume a 30% drop in the market and as we've seen it's rebounded a little bit. That answer your question?

Yes. I guess a follow-up on -- in terms of the -- comments, Dennis, that you made about 4% equity market returns providing 12 to 15% unlevered returns on capital. I'm assuming, though, that does not factor in the 37 to 38% kind of implied volatility that's in five- and ten-year S&P put options right now. I guess the question is, given the fact that I think it's a pretty concentrated market in terms of providing that type of cover, how do we know -- how can we confidently say that those implied volatilities, which we all know are double realized value over time, how can we be comfortable that those are ever going to come down?

We can't be comfortable that they will come down -- but again, we are in a period of time that represents the worse capital markets in seven years. And if coming out of this, these volatility levers were as high as they are now, we would have to reprice the product.

What about if they were even -- a year -- earlier this year, I think they were in the high 20s. Two years ago, they were in the low 20s. If they were just even in the high 20s, does that require product repricing?

I'm going to turn that over to Mark, because he is more familiar with that kind of a granular question. Mark Konen.

If you just step back and can't look at one piece of the pie, admittedly an important piece, but as we look at -- we currently are looking at whether or not to reprice or when, et cetera, and you make a point that it depends on what day you look at it. So you don't want to reprice at the high point and then find yourself regretting that in the marketplace. But if they remained at those kinds of levels, you would look at that, but then in conjunction with that, you would look at the other, what I'll call the actuarial input, policyholder behavior, et cetera, which have continued in this even in this market to be much better than what we priced for. Things like actually take rates and absolute withdraw rates coming out of these living benefits et cetera. So that serves to mitigate it. Obviously, there are other levers you'd pull, investment restrictions, et cetera. So it's a complicated thing. We are looking at it. I can't definitively say if vols were at 25% we would definitely reprice. But if we came out of this and they were at that kind of level, we would have to take a hard look at it.

Okay. Thank you.

Next question will come from Nigel Dally with Morgan Stanley.

Thank you, good morning. On capital, can you provide some comments on whether you expect the Treasury capital purchase plan to be extended to the life insurance? And if it were, would you be eligible and willing to participate? Second on the investment portfolio, certain classifications, such as CDOs and credit backed notes have been trading at $0.43 on the dollar. I know you don't use a bright line test, but it seems hard to justify not taking an impairment on those securities, given the price, if you could comment on that as well. Thanks.

On the first question, I think you asked if we thought that Treasury would extend the TARP program to insurance companies. And that is up to Treasury. I know what I read in the papers, which is they are mulling it. Based on the current eligibility requirements, which would require some type of a federally regulated holding company, Lincoln would not be eligible. But again, from what I read in the papers, this seems to be an emerging issue. Let me come back to the credit linked notes as the second question. As I said, we had a $250 million repayment from $850 million, now down to $600 million in total. The credit linked notes, although a single note, we have been able to swap out of individual credits to protect the cushion inside the note. So the reason that we don't see a need to take a write-down in that is that is on a credit by credit basis as we anticipate problems, if we decide to swap out, we can and secondly, there remains quite a bit of cushion in the level below us.

And we'll move to our next question that will come from Steven Schwartz with Raymond James.

Good morning everybody. I'd like to follow up on a question of (inaudible). Is there some prohibition outstanding against them possibly poaching that may expire and then may lead to people leaving?

No.

No. Okay. And then, Fred, can you just explain to me following up on Ed's question, in the 30% decline in the equity markets, the market goes down 30 %, the reserve itself would obviously go up under actuarial guideline 35 and actuarial guideline 39, presumably the hedge would have some effectiveness, does that not get counted on a statutory basis?

What we have done, Steven, is that on that basis, we have structured a captive reinsurance treaty, where we reinsure the hedge program off. That allows us to get reinsurance treatment as it pertains to claims payment. Now, there's an arms length structure here, where you pay the premium and in fact you pay the entire rider charges over to the reinsurance vehicle, it in change then, is a position to pay claims when and if they come due. And as you know, it's far out in to the future. What you have to do is a couple of things. First of all, those premium payments need to reflect the costs that are being taken on by the captive reinsurer, so as hedging costs go up or they need to retain more moneys, as a result of hedge ineffectiveness, or any other costs that are affecting the reinsurer, we need to kick those premiums up and that kicking of the premiums up would weigh down on your (inaudible) and your RBC over time, but more in line with the notion of a net valuation premium and -- that we talked about earlier on a GAAP basis. The other thing I would note that's very important is you have an appointed actuary who each year has to sign off on the reserves and any reserve relief received on a reinsurance basis. So if there are questions as to asset quality or your ability to recover, then you would normally under cash flow testing, need to kick up your reserves to account for that also. So it's very important as a company that we make sure enough premium is going up over there and it's properly reflecting all the cost of the reinsure. The only other thing I would say is the rating agencies, which often play a role in this as you know, they have their own capital models and they tend to look through these structures and really try to understand them for what they mean when comparing company to company. And of course, we've spent quite a bit of time talking about these structures with the agencies and they feed them into their models accordingly. So you can assume all of this is being pulled together when we think about excess capital position.

Moving to our next question, that will come from Jeff Schuman with KBW.

Good morning. Fred, I have a couple of questions related to the hedging numbers. First of all, I need help in reconciling between the 231.5 of hedge program effectiveness on page six in the supplement and the number that you cited which was 336 on a pretax preDAC basis. And then secondly, I'm wondering if this translation this quarter of 336 pretax preDAC to 83 after tax, after DAC, is in rough terms kind of normal and the sort of mapping that we might do, might anticipate in the future?

The answer to your question in terms of the statistical supplement is we have a line item called hedge program effectiveness, and that has $231.5 million as the breakage. But what I have done is added the unlocking of $79 million -- close to $80 million above into that number. The other thing I've done is I pulled out the net valuation premium, where you can think about that as the portion of the fees that are attributed to if you will the hedge. So what I was doing was really grossing up the breakage for the -- sort of what I call pure breakage, that is purely how we look at the target liability and purely how the hedge assets had performed. And that's how we get to the 336 that I quoted on my script. Then later on in conversations, I talked about October and I talked about that we track this obviously 24/7 and that we're seeing gross breakage between $400 million $500 million as of last week -- very important -- as of last week, because it changes daily. And that is -- basically that's equivalent to the 336 that I mentioned in my script comments or my prepared remarks.

That's helpful. Actually, the second part of the question was I think in the third quarter the 336 pretax preDAC maps to 83 after tax, after DAC, so I'm wondering if we could anticipate the same sort of offset if in fact the fourth quarter number ends up being 400 to 500, could we ratio that down in the same way?

The technicians around me would caution to be careful, but directionally you wouldn't be far off by taking that relationship.

Lastly, the -- what is the cumulative after tax, after DAC, impact of the FAS 157 adjustment? In other words, if and when your credit worthiness is completely restored, what would sort of maybe reverse out of book value?

Right now, to give you an idea of that, Dennis mentioned a target liability of about $1 billion, this would be without the nonperformance risk. When you incorporate the nonperformance risk, I believe that comes down into the $550 million range, which you could assume that being effectively the cumulative impact of NPR when looking at that balance sheet item.

So the delta, 1 billion minus 550, 450 would be the impact.

Excuse me, I'm sorry, say that again.

So the delta, the impact would be 450, 1 billion minus the 550?

Right. That's the way I look at it is how has that balance sheet liability progressed? And so it's up around $1 billion at the end of the third quarter, but when you account for the -- when you account for the NPR, then that brings it on down by better than $400 million down to that mid 500. As we go forward in to the October month, you see sort of a similar pattern, that is you've got this large gross unlocking I talked about. You also have an equally large, potentially larger nonperformance risk offset for similar reasons.

Just to be clear, in principal, I assume it works way in the both directions. In other words, if your credit measures improve, then it goes the other way in a similar fashion, is that correct?

That's right. And something you want to be careful about is in all this conversation, you could walk away with just the blanket assumption they are always going to move in kind. And that's not necessarily how it would work. I think when we see extreme conditions like this, they tend to heavily correlate. It's very important, so we are seeing out of the box tail, as Dennis called it, conditions in the assumptions, so you see a higher correlation between a liability jumping substantially in a single day or in a month and a similar reaction in the nonperformance risk. But if you were to revert back to more normal historical times, you would find these measures don't always coordinate with each other, since of course the nonperformance risk is related more to our specific credit condition and market conditions overall could be changing differently.

Very helpful. Thanks lot.

Moving to our next question, that will come from John Nadel with Stern Agee.

Hi, good morning. Couple of quick ones. Dennis, if the TARP was actually offered to life insurers, including Lincoln, but the caveat was that you needed to change your holding company to a bank holding company, is there any reason you would be reluctant to do that?

I would have to understand what the business activity restrictions are. From what little I know about it, I doubt seriously that it would prevent us from doing any of the things that we are doing. So based on what I know, the answer is we would do that.

Okay. Fred, real quick one on risk based capital, so you're starting the fourth quarter at roughly 400%. Could you remind us for your current ratings what your -- what the targets are with respect to the rating agencies, sort of understanding the caveat being obviously that they are changing the rules it seems every day.

I'm glad you ended your question with that comment. Saves me time in my answer. The historical view and I would also say this, that we have in fact as it turns out, met with the ratings agency as part of the annual review just in the last month and dialogue was very constructive and we remain in close contact with them in what conditions are taking place and how we are positioned. But conventional wisdom is that you ought to be hovering around 350% RBC or better, and that's normally where we want to target. In fact historically, we've tried to keep ourselves within a zone of 350 to 400%. Some of this development is just reflecting on the make-up of your business. So that's an RBC that I believe situates Lincoln well for AA rating standards. So that's what I would normally like to do. Again, you need to remain in close contact with the agencies after giving affect for the events of the market, their views of the world and what is appropriate or inappropriate RBC and how they are dialing in their own particular models -- they all have their own models -- is something you have to stay close to. But that's how I would size it, John.

Final one quick for you, is just I know you had some plans and expectations for securitization before the end of this year, any changes in those plans or expectations, given the state of the markets?

The first of all all of my quoting of RBC is without any credit given to a reserve securitization. That remains something we hold in the bag, if you will, relative to managing RBC over time. That, by the way, is what I mean when I talk about among other things potential reinsurance solutions available to the company. Now conventional securitization is clearly out of scope right now with the markets the way they are and irrational conditions that we are facing to issue various securities out there. What we are doing, however, is looking for whether or not -- or exploring whether or not there are other forms of funding such a vehicle. And I'm not prepared at this point in time to give specifics around that, but I can tell you both Lincoln, as well as I know a few of our peers, are exploring those options and seeing whether they could make sense. It requires you also working, of course, with the various regulatory bodies that you run this securitization through and so we have to work in partnership with them. So I'm not going to rule out the notion of getting a securitization done. What I would tell you is it would be done in a less conventional structure given the marketplace.

Okay. So the original expectations for something order of magnitude similar to last year's level of capital, sort of relief, if you would, is still on the table but in a nonstandard sort of structure potential?

Yes. In fact, we've actually got an lot done on that project in terms of the work you need to do on the block, the structure of the captive reinsurance vehicle and in our particular case down in South Carolina, so we've done a lot of the base work to be sort of ready, set, go. But we need a few things to happen, rating agency reviews that are required around the structure and now we've got to really change the game, if you will, in looking at potential funding solutions given market conditions and we are working actively on that. But I would size it around what we've talked about historically.

Okay. So safe to assume then, just to close the loop on that, that you mentioned in response to Ed earlier, that the impact of the market 30 % drop, $275 million to $300 million after tax impact on your total adjusted capital, this is a potential opportunity to fill that hole?

That's right.

Thank you.

Something I should also note. I think you all understand this, but obviously we have been isolating the equity markets. The one that we keep our eyes on and the one you're most familiar with is of course the continuation of realized losses in the general account. So we commented on our unrealized position, and we commented on the fact that we would expect as it is in this quarter, things to be elevated going forward. So we want to watch that very carefully. That's likely to be the more major driver of thinking through capital conditions as we go forward.

And we'll move to our next question that will come from Suneet Kamath with Sanford Bernstein.

Good morning. Just had a few questions. I guess the first is a follow-up to Nigel's question and some the comments that Fred made about being in touch with the ratings agencies on a constant basis. Looking at your general account supplement, just rough numbers, you have something like $4.5 billion of securities that in the aggregate are below 80 percent of amortized costs, and I understand how the manage the duration of assets and liabilities and all that, but in your discussions with rating agencies, are you hearing anything in terms of them changing their views about how they either test for cash flow matching or view unrealized losses based on any sort of a discount to amortized costs. Just any directional thoughts that you could provide on that. And sort of related, if there was a situation where Lincoln Financial was downgraded from a AA to say a A plus, which of your businesses do you think would be the most impacted by such a ratings move? Thanks .

In terms of the agency approach to the general account, this is the way I would describe it, is their approach to the general account is substantially similar, frankly, to our dialog with the auditors. And that is they understand our OTTI process. They want to challenge, as our auditors would, where we are not taking impairments, particularly on those securities that have been under water for a long duration or are deeply discounted to market. And so we have to perform and supply all of the appropriate analysis to defend taking impairment if that's the decision. That of course is going to be driven off of the fundamentals and views of the likelihood of that security paying off. It also, of course, is heavily influenced by our intent to hold that security until recovery. So the rating agency dialogue is similar.

There is one difference with the rating agencies that, at least in Lincoln's case, we done proactively. And that is we stressed the unrealized loss positions on a security by security basis using oftentimes historical, deep sort of assumptions, that is assumptions of heightened default rates and we throw those stress conditions in front of the rating agencies as part of talking about forward-looking capital and the kinds of steps management will take in the face of either stressed or not so stressed conditions in the general account. So we push the dialogue further with the rating agencies, and the reason for that is we want everything out on the table and everything open and transparent with them, so they understand how bad it can get, under what conditions, what our point of view is and, most importantly, what sorts of steps would management take in the face of that. Otherwise, there has been no, what I would call, bright linish type dialogue. They are simply reviewing that and spending time with management as you would imagine they would.

In terms of the ratings reduction issue, one comment I would make about Lincoln that's very important is that we are largely a retail -- almost exclusively a retail based insurance company. Whether it be our individual businesses or whether it be participants that are part of group businesses or a defined contribution, we have very little in the way of what I would call more heavily rating sensitive -- rating sensitive issues relative to our liabilities. And as a result, we are not quite as severely hit or impacted with rating issues. You will typically find (inaudible) are more sensitive to ratings and so forth. Now what I would say, is we have for a long time talked about targeting and maintaining AA rated standards, remaining in the AA rated category as being important to run our business, and we would not pull off of that comment. That's our goal, that's what we want to design certainly over the long run and short run our ratios to look like and our dialog to look like. We think that's very important in dealing with the financial intermediaries that we sell through. And so I don't want to discount the importance of ratings, but I would remind you that Lincoln is not in the large (inaudible) businesses and funding agreement businesses and large institutional businesses that could be much more sensitive to ratings issues.

If I could just briefly follow up on the auditor issue since you brought it up, is it fair to say that the discussions with the auditors in the fourth quarter, given a sign-off on your financials, will be much deeper than sort of your discussions with them on a non year end, quarter end?

I think generically speaking, your dialogue with the auditors at year end across the entirety of your financial statements tends to be deeper and more significant than it is during the quarter. Now having said that, the OTTI and impairment issue is so front and center at companies and at the audit firms that, frankly, quarter-by-quarter, it's an intense and involved dialogue, period, for our company and honest talking with peers for all companies now. So I don't expect that tone to materially change. It's going the be the same OTTI dialogue and documentation effort that you would expect a company to go through.

Thank you very much.

This is the scheduled end time for our conference today, however, we will stay on the line with you at this time in an attempt to answer all of your questions. Our next question will come from Eric Berg with Barclays Capital.

Thank you very much. Fred, we've had today a very, very involved and technical and good conversation about the hedge program, discussion of actuarial guidelines and (inaudible) GAAP all that and valuation premiums. But in the end, I'm still not clear on the question did the hedge program work as intended? It's a simple question I just want to ask that simple question did it working as intended.

Yes and it's a very good question. The answer is, for the most part, yes. Is only reason I use "for the most part" is that when you go through these extreme conditions, you will uncover things you want to true up. So for example, can we dial in our mapping process a little bit more finely to attack more of that basis risk. I mentioned that we had currency separation in the quarter. It wasn't particularly big, in fact, it was in and around $50 million pretax and DAC of that breakage to be more pointed. There are things we can do to dial in the currency issues better to capture more of that risk going forward and we have that underway.. So when you go through these kinds of extreme periods, it will in fact expose some areas that you can dial in and do differently.

But when I say "for the most part it works" it's not only a comment relative to its effectiveness, which was better than 80% effective over the course of the quarter, which is good. But also that, when you're going through these periods of irrational markets and when you have the dual track of protecting GAAP net income as well as positioning this to be reinsurance in the future, you will proactively pull off putting hedges on an irrational period, which brings onto yourself a level of breakage that you consciously know about. In fact, we knew this was going to happen and there would be times like this. It actually underlines the rationale on pulling the breakage out of our operating earnings, because we wanted to be able to as a management team make good long-term economic decisions that don't have implications for our core operating earnings. What you don't want in operating earnings is the fact that this (inaudible). There is real cost related to hedging and you want that to run through your numbers. So the answer is, for the most part, this hedge program performed as we designed it and intended it to do. It will uncover some weaknesses and we are dialing in changes accordingly.

My other question related to one that I think (inaudible) asked with respect the to other than temporary impairment. And that is, my question is, do you think that by their very nature, what the order is called level three assets are assets that are valued using level 3 inputs, will necessarily all else the same be more likely to be impaired than level two or one. Is that just for sure or not necessarily?

I'm going to ask Doug Miller to give his perspective on it,.

Remind us of Doug's title.

Chief Accounting Officer of the company.

Thank you.

Eric, this is Doug. That's an interesting question. I think the difference between level two and three, I guess one could reach to that conclusion, but not necessarily will you end up with more impairments in three or two, depends on whether or not the model that you use during your level three and the inputs that you put into the model. I would believe that different companies could come to different conclusions on those type of impairments. So I wouldn't want to put a broad brush across that.

Okay, thank you.

We will move to our next question from Bob Glasspiegel with Langen McAlenney.

Good afternoon. It appears you have been thoughtful at funding out most of your debt longer term but there is I guess $1 billion or so, if I'm reading the SEC documents correctly, of debt coming in the next couple years. What should we think in terms of interest costs going forward, assuming no external increased financings?

I think the most immediate maturity we have coming up is I believe in April for about $500 million. Clearly if we were to just flat dead, refinance that at consistent or at an equal structure like that, while you may have favorable treasuries relative to historically, you've got a fairly substantial GAAPing out of spreads.

Where does the market tell you that your debt would be today. I know it's ridiculous and you probably won't do it and hope it will come back.

I think it was about five or six -- the federal security credit default swap. We are about 600 or 700 over. That was Randy. That's consistent with the rest of the insurance. All the peer group is up in and around that territory. So what you want to be be doing is really as a company right now is starting the process of building alternatives relative to any maturities that are coming down the road. And so keeping yourself with a lot of dry powder in your commercial paper program for example, we've got $120 million under CP and it's $1 billion commercial paper program.

What grade is that?

Excuse me?

What grade is that?

The commercial paper?

Yes for new stuff.

It changes daily. But I would say we have been quoted depending on the duration, in and around 50 to 75 basis points over LIBOR in some cases, sometimes down. A little inside of that I'm being told, but not attractive but available. Also things like the Federal Home Loan Bank we joined. That is now down at the life company. But through some mechanics, you can use to it move some money around on a temporary basis. That tends to be actually very favorably priced and not nearly as sensitive to the sharp movements that are going on. So I think you typically end up pricing there more at like a LIBOR plus 10 to 15, maybe 20 over LIBOR, right in that area. So what you want to do these days is have yourself multiple accesses to avenues to grab money such that you can wait out a storm and issue into the longer term markets when ready to do it and when more competitive.

Pension fund assumptions, I can't remember what you have left --

I'm sorry, could you repeat that again Bob?

Pension fund assumptions perspective, I can't remember what you have left that might be sensitive to that.

From pension funding perspective, as we entered in to the third quarter and through the third quarter, I think we remain pretty well in a funded position, I don't expect too many surprises there. What I would say is we do have more of a underfunded position in the U.K., which is a different sort of regime as you know. There's third-party trustees, there's different sorts of assumptions that are applied. And so I would expect over time there to be some level of funding. This is not a particularly big exposure of the company on a -- relative to our company. I do anticipate over time there to be some diversion of capital to suring up pension under the current market performance, but we entered into this storm in a very well funded position on the pensions overall.

The return assumptions aren't going to be tested severely.

We haven't revisited those. So I wouldn't comment on them now. I know Lincoln, historically, has always been in and around a normal range of long-term assumptions, haven't been aggressive on that front but we would have to revisit those assumptions and I couldn't really give you an ironclad answer right now.

Thank you.

Moving to our next question that will come from Tom Gallagher with credit Suisse.

A follow up on the captive reinsurance for the variable annuities. Fred, the 275 to 300 million stress test scenario, I presume the rating agencies actually unwind the captive rebenefit and look for sort of what the gross hit would be before you get that benefit. Is that the way they're looking at it? And if so, when you do that same stress test, would your capital be in excess at AA levels.

The stress test I'm doing is a market drop, not necessarily sort of a hedge effectiveness concept, if you will, recognizing that the reason that you have the hedges on is to absorb in part those market drops and offset it. The stress I'm doing is just really to the actuary guidelines surrounding the liability on variable annuities period with a market drop, and so that's at roughly 25 percentage points. When it comes to the reinsurance vehicle and looking through it, I believe the rating agencies, particularly to their own capital models, look through and treat that likely very similar to stat accounting these days, where you would effectively keep all of your rider fees, you would pay out hedge costs, you would have a mark to market on hedge instruments versus the liability, which are on two different accounting bases. And then they give you credit for hedge effectiveness, you get a credit if you will from a C3 phase 2 perspective for having an effective hedge program in place. I believe that ends up covering you, if you will, in upwards of 70% of claims, that's how the factor comes in. When you do a look through, if you will, that's more or less the look through treatment that I would expect the rating agency to go through. And so you could assume that when they are thinking about our ratings and thinking about our capital structure, that's the type of work they are trying to do.

So just to follow up on that, so I guess the 275 to 300 million number seems small in proportion to both the way carvem gets marked and C3 phase 2 should play out.

It's tax effective, too, keep in mind.

Even tax affecting it, it seems somewhat small. That's just my judgement. I want to get a better sense from you with conversations you're understanding of the various rating agency models, do you think that's kind of the impact that they think your capital is likely to absorb in a down 30 market. The comments that I've heard from some of them would suggest the impact's going to be substantially larger for that. Not Lincoln specifically but more an industry question.

It would be a bit of speculation on my part to dive back into their model, some which they publish openly, some of which are more internal and are changing quite often. In fact as you know, most of them have been trying to adopt their version of VA carvem and their version of C3 phase 2, so it's a little speculative for me to say. But I would assume that they are taking into account the market drops and trying to stress their models and incorporating that and thinking about -- thinking about our rating. Again it's a little speculative on my part to kind of try to judge what the rating agencies might be doing. But we track those models relatively closely, we try to track them and I would expect similar impact of the market being down to what I talked about with the NAIC models.

So with market down 30, you're still working assumption is you all have adequate capital levels to maintain the AA.

We have what we believe to be capital levels that are consistent with AA rated carriers. The only thing we have to caution is with the changing landscape in the agencies, something else that's worth mentioning just in terms of Lincoln, when you look at AG34 and 39, VA carvem on the reserving side and C3 phase 2 as being solved, there are some very company specific issues to be aware of. For example one of the bigger ones your mix of variable business. And something to keep in mind about Lincoln is when you're staring at our $55, $56 billion of variable accounts, recognize that only $26 billion of that, if you will, roughly half, is -- has a guarantees attached to it. We benefit now only from that age of our business and the fact that much does not carry guarantees, but also we benefit from the defined contribution business which is quite, quite old, quite stable and without guarantees. My understanding of VA carvem and C3 phase 2 is that those mix of business issues will tend to -- for Lincoln dampen some the impact as compared to a player that may be solely in VA with guarantees as driving their life business.

Understood, thank you.

Moving to our next question, that will come from Darin Arita with Deutsche Bank.

Thank you. Just wanted to go back to the number, Dennis and Fred, you brought up in terms of the $1 billion -- $1 billion hedge target, is that the amount of claims you'd expect to see on a present value basis? Is that what I understood?

That's correct.

What are the assumptions behind that? In particular, the benefit utilization rates and market appreciation assumptions.

There are a number of assumptions benefit -- in that calculation. In fact, those assumptions tend to mirror the same assumptions that you use when you're pricing out the product. So it has policy holder behavior aspects to it and how that would influence the potential for paying claims or not, has of course capital market inputs involved in it. It has persistency related inputs involved in that calculation. Very, very importantly, it has product design assumptions involved in it. So in other words, what sorts of things have you done on the product side, such as investment restrictions or therefor that impact the likelihood of paying claims. So it ends up being how all of those things incorporated into then present valuing the likelihood of potential claims out into the future.

I know it's a pretty dynamic equation, but could you share some of the numbers there in terms of utilization rates and market appreciation?

We have historically talked about utilization rates. We talked about basically the take rate, that is how many of these things we sell, are they actually taking the guarantee. And then of that how many of them are taking any level of income and how many individuals are taking the maximum income they can take. And those are the parameters we look at. And I believe all of those parameters are -- first of all, the take rates are much higher. That is, as we gone over the last several quarters, more and more of the product was sold with a guarantee. But the underlying utilization of the guarantees, those dynamics have not changed materially really over the last several quarters. That's in fact the kind of policyholder behavior that we are paying very close attention to when we go through these markets, when we say we haven't seen as of the end of the third quarter an very unusual activity. Something also worth noting on the topic of assumptions is, of course, we try to input where we can provisions for adverse deviation, if you will, or cushions involved in some of the issues. And what we are finding and continue to find is that, while some of the capital market inputs are outside of our long-term expectations as you might well understand, the policyholder behavior assumptions that are embedded in the calculation we tend to be better -- doing better than those assumptions which helps to offset or soften some of the capital markets inputs.

Okay. That's helpful. Can we turn to the death benefits? Can you help me understand what happened in the income statement for annuities? There are a couple of pieces that were moving around.

Couple of comments I would make on it. First of all, understand that when there is more in the moneyness, if you will, of the difference between the death benefit guarantee, minimum death benefit, due to account values being down, you will naturally suffer more mortality expense and you'll see some of that running through and that will result in things like some associated negative DAC unlocking with it as well, depending on if it's outstripping what your long-term assumptions would be for it. So you see a bit of that sort of weighing down on results. The other thing you see is that we have -- you will see a jump in the operating earnings component of the realized gain and loss and that jump is really the effect of the hedge assets, if you will, offset by an equally large jump in the benefit line item, which is the benefit ratio unlocking associated with the death benefit. So those offset each other effectively when looking at the bottom line P&L. I don't know if that's the noise, if you will, or moving parts that you're looking at.

Right. Were they offset more or less one-for-one there this quarter?

You've got pre and post DAC issues, and I don't know that I'd go as far as call it one-for-one but highly correlated.

And if we think about the fourth quarter -- the markets ended at these levels, should we expect this sort of movement as well?

If markets remain low in their in moneyness remains where it's at, you'll see this elevated level of death claims for a period of time. That would make sense to me. These are not items that move the total P&L for our variable annuity or annuity business, particularly in a particularly large way but is would weigh down on it. It's one of the other headwinds you face in the down market conditions.

We have time for one additional question. We will take that from Richard Wagner with Citadel Investments.

Thank you very much. It's Dan Johnson. Let's talk a bit about the DAC going back up on the balance sheet. I understand the accounting concepts on the realized and unrealized gains. Is there a limit to the amount of DAC that can be put back up on the balance sheet? And what sort of tests do we use to test that limit?

I'm not quite sure the direction of your question. What I want to say is that our DAC build-up, if you will, is governed by our DAC policies, and that is paying particularly close attention to what we DAC and what we don't DAC and we tend to be -- we believe we are conservative in tracking other volume related type expenses beyond commissions and so forth. I'm not sure if you're talking about this -- if what you're talking about is retrospective and prospective unlocking and that DAC being unlocked positively and negatively?

I'm going in for the fact that, for most life companies, when they generate let's just say unrealized losses to keep it simple, that a meaningful part of the unrealized loss gets moved from one asset to another asset, meaning an investment, to another asset called DAC, and is there a limit to -- and I want to say that that's been couple hundred million dollars in the quarter was added up on the DAC balance. I don't have that page in front of me.

You know what I recommend? Before we get mired in to this level of detail, what I would recommend is that maybe we take this offline and we can kind of, with the statement in front of us, walk you through that question. It's a valid question. I'm not suggesting it's not, but I think it's better handled offline, if we could.

Okay. Great. Then I'll just jump to the other one, and that's in terms of the DAC breakage and the nonperformance. I understand why there is obviously netted together on an accounting point of view, and you've been good enough to break them out for us. But just going forward. we shouldn't count on those being linked together, that the credit markets could become little more normal and your credit default swap numbers could look something more like history, which would reverse the benefits. But that doesn't necessarily mean that environment would create a positive hedge breakage. I just want to make sure I'm understanding. I think of that hedge breakage as sort of money lost. Yes, that's probably the way I would put it. Would you agree or disagree with that?

I would agree with the first part of your comment being that, over time when markets finally normalize, you may have a different movement in the nonperformance risk than you would in the liability. And what I commented on earlier, and this tends to be almost a truism in capital markets, is that when in a 4 and 5 standard deviations away from the from the mean type tail event, you'll see a lot of things more heavily correlate. And we're finding the extreme jumps in the liability to be offset or more than offset by the extreme jumps in this particular assumption as a result. What I wouldn't agree with is this idea that the breakage is going to outright result in a loss, because remember I made a conscious decision to balance the issue of mark to market related issues on the GAAP net income and the long-term viability of these assets to pay off claims. So I'm going to absorb a level of breakage consciously, realizing that as time goes forward and volatility and other capital markets assumptions come down, that liability will fall faster than the asset falls and thus closing the GAAP over time.

Understood. And finally, with the realized gains -- or losses in I guess in the quarter on a GAAP basis, what was the similar realized gains on a stat basis?

The way to think about it is your -- the portion of -- you have $406 million, I think it is, of realized losses and impairments. Of that, I said $43 million of it is really items that we move to the intentless list and that amount you tend not to take a statutory hit on. The other securities that you take to the stat accounting, you will take the impairment to it and the only difference in the two is that there could be tax differences in the way it's done.

So if we look at it on a -- ignoring the tax, I'm confused, is that most of it went to the stat line as well or just a little bit went to the stat line?

Most of it went to the stat line. We also had I think true up for a certain class of securities that have been deemed impaired for stat, and we've taken that out, so you may see a little bit of separation between GAAP and stat on that.

Understood. Thanks for holding the call open for so long.

It's okay. And you should also know all of my comments about third quarter RBC of course is incorporating this notion of forecasting the dropdown, if you will, of the realized losses and impairments through the stat line.

Great, thanks again.

Yes.

Ladies and gentlemen, unfortunately, we have no time to take any further questions. I would like to turn the conference back over to Mr. Jim Sjoreen for any additional or closing remarks.

Thank you for joining us on the call this morning and for the patience as we worked through some very good questions. As always, we will take questions on our investor relations line at 1-800-237-2920 or via email at www.investorrelations@lfg.com. Also as a reminder, we will be hosting our annual conference for investors and bankers on Wednesday November 19th in Philadelphia, and it will also be available via webcast. Please contact investor relations for information. Again, thank you for your participation today and have a good day.

Once again, ladies and gentlemen, that does conclude today's conference. We'd like to thank you for your participation. Have a wonderful day