大都會人壽保險 (MET) 2007 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

Welcome to the MetLife second-quarter earnings release teleconference.

(OPERATOR INSTRUCTIONS).

This conference is being recorded.

Before we get started, I would like to read the following statement on behalf of MetLife.

Except with respect to historical information, statements made in this conference call constitute forward-looking statements within the meaning of the federal securities laws, including statements relating to trends in the Company's operations and financial results, the markets for its products and the future development of its business.

MetLife's actual results may differ materially from those results anticipated in the forward-looking statements as a result of risks and uncertainties, including those described in MetLife Inc.'s filings with the SEC, including its S1 and S3 registration statement.

MetLife Inc.

specifically disclaims any obligation to update or revise any forward-looking statement whether as a result of new information, future developments or otherwise.

With that, I would like to turn the conference over to our host, Ms.

Tracey Dedrick.

Please go ahead.

Thank you, Colin.

Good morning, everyone.

Welcome to MetLife's second-quarter 2007 earnings call.

We are delighted to be here this morning to talk to you about our results for the quarter.

This morning we will be discussing certain financial measures not based on generally accepted accounting principles, so-called non-GAAP measures.

We have reconciled these non-GAAP measures to the most directly comparable GAAP measures in our earnings press release and in our quarterly financial supplement, both of which are available on our website at www.MetLife.com on our Investor Relations page.

A reconciliation of forward-looking financial information to the most directly comparable GAAP measure is not accessible because MetLife believes it is not possible to provide a reliable forecast of net investment related gains and losses which can fluctuate from period to period and may have significant impact on GAAP net income.

Joining me on the call this morning are Rob Henrikson, our Chairman and Chief Executive Officer; Steve Kandarian, our Chief Investment Officer, and Bill Wheeler, our Chief Financial Officer.

After our brief prepared comments, we will take your questions.

Here with us today to participate in the discussion are Bill Mullaney, President of Institutional; Lisa Weber, President of Individual; Bill Toppeta, President of International, and Bill Moore, President of Auto and Home.

And with that, I will turn the call over to Rob.

Thank you, Tracey.

Good morning, everyone, and thank you for joining our call.

We are pleased to report another record operating earnings quarter for MetLife, reflecting the strong fundamentals of our businesses.

Total operating earnings were $1.3 billion or $1.72 per share.

Our average return on equity for the first half of the year was a strong 15.3.

We had excellent topline growth of 8.5% from the prior year period, record assets of $553 billion, strong investment income and very good underwriting results in all of our businesses.

As a result of our strong earnings performance in the first half of 2007, we are increasing our guidance to 5.65 to 5.80 for the full year.

Due to the recent volatility in the Capital Markets, I feel it is important for me to remind you that MetLife is committed to maintaining a high-quality, well-managed investment portfolio.

I have asked Steve Kandarian, our Chief Investment Officer, to discuss our subprime portfolio after my opening remarks.

But first let's look at our line of business results for the quarter.

First, Institutional business.

Institutional's record operating earnings of $521 million represent a 15% increase over the second quarter of 2006, which up until now had been the best quarter ever for this line of business.

In addition to the exceptional investment performance which helped all of our businesses this quarter, Institutional's results were characterized once again by strong across the board underwriting results.

Later Bill Wheeler will take you through the details of the segment results, but I would like to make an observation on the quality of the results this quarter.

As I said before, the continued solid underwriting performance of all of these businesses is evidence of one of our most important strengths.

Our long-standing consistent adherence to the fundamental principles of sound risk selection and pricing discipline have helped us build a large well-priced block of enforce business.

This diverse and well-priced enforced block is the foundation for our solid earnings performance.

After a particularly challenging 2006, we are pleased to see our group insurance new business quote volumes and activity return to more normal levels.

In fact, sales of our Group Term Life product year-to-year are up over 40% compared to the first half of 2006.

In our non-medical health segment sales are up about 50% compared to the first half of 2006, driven primarily by solid sales of our dental and disability products.

In all of our group insurance segment, premiums and fees and other revenue are trending at or above the 2007 target levels we set with you at Investor Day last December.

As you know, by this time of year, group insurance quotes on business with January 1 effective dates have begun.

Although it is way too early to predict results, we're quite pleased with this quote activity so far and encouraged by the early wins in the upper end of the market for 2008.

In our Retirement & Savings business, general account policyholder balances grew by more than 12% over the year ago period.

Strong positive net flows mainly due to funding agreements and sales of our global GICs and drove the increase in general account balances.

Although these products generally have slightly lower net spreads than some other products in this segment, they are quite capital efficient.

We will continue to prudently participate in these markets to generate attractive returns.

So Institutional business delivered strong results this quarter.

Looking ahead, we will continue to focus on new business and renewals in the third quarter, and we are optimistic about what we're seeing so far.

Now turning to the Individual business.

Individual business had a record earnings quarter.

As a result of strong business growth, excellent investment performance and improved underwriting margins, Individual's operating earnings were $449 million, up 27% from the year ago period.

In our Individual Life businesses, operating earnings were up 16% from the prior year period, reflecting strong investment results and improved underwriting margins which you may recall were depressed a year ago due to the establishment of additional reserves on certain blocks of Travelers life policies.

In addition to strong earnings results, Individual life sales showed good sequential growth.

On a LIMRA basis, life sales were up 8% compared to the first quarter of 2007.

As we mentioned previously, we've made significant investments in our independent channel service capabilities and have taken steps to improve our underwriting risk selection.

As a result of these actions, both our independent channel and our career agency have picked up appreciably, particularly in sales of our Universal and Term Life products.

Annuity operating earnings were a record $270 million for the quarter, up 31% from year ago levels, mainly driven by robust investment results and favorable market performance.

Our total annuity premiums and deposits reached a new high of $4.5 billion, up 6% year-over-year due primarily to the staged introduction of various annuity products and writers, including the 6% GMIB Plus writer in key states and channels.

Sales of variable annuities were up 17% in our agency channel and 5% in our independent channel year-over-year.

Our total annuity net flows were positive this quarter, primarily driven by strong variable annuity net flows of $1 billion.

Auto and Home's solid operating earnings of $108 million for the quarter were driven by increased revenues and reduced operating expenses.

Total sales in the quarter were up 17%, lead by our group channel where sales were up 22%.

Our top group accounts were up over 26% over the prior year.

Auto sales were up 24%, fueled by strong sales in the 43 states where we have introduced our METRIX Auto program.

In addition, Grand Protect, our package product, continues to attract customers in the higher end of the market, representing an increasing percentage of our sales.

Overall the retail focused businesses performed well this quarter with increased life sales, higher annuity premiums and strong Auto and Home sales.

Now turning to International business.

International's operating earnings this quarter were $117 million, up 83% compared to the second quarter of 2006.

Record premiums, fees and other revenues of $1 billion reflect an increase of 17% from the prior year period.

International's strong performance was driven primarily by business growth in Latin America and Asia Pacific.

Total sales in international led by Korea and Japan were up 14% from the prior year period.

In Korea sales were up 39% from the prior year period, primarily driven by strong sales of our new GMAB product.

In Japan our annuities sales were up 8% from the prior year period, notably while the bank channel in Japan was down 8%.

We recently introduced a new target GMWB type product in Japan and expect sales growth to continue with the launch of additional new products later this year.

Assets under management in our Japan joint venture, MSI MetLife, reached $20 billion, up 56% from a year ago.

Revenue growth in Latin America also contributed to International's strong quarter.

In addition, in Mexico we successfully renewed policy number one, the term life coverage for the federal government employees for a three-year period.

Overall International is performing well with strong earnings, revenues and sales in the first half of the year.

So, as you can see, our businesses are delivering good top and bottom line growth, strong investment income and a solid ROE.

Before Bill Wheeler takes you through the details of our record performance, I would like to turn the call over to Steve Kandarian to discuss our investment portfolio.

Steve?

Thanks, Rob.

As Rob mentioned, given the recent turmoil in the financial markets, we thought it would be helpful to take a few minutes to talk about the investment portfolio.

As of June 30, we owned approximately $2.3 billion of subprime residential mortgage-backed securities, which represents less than 1% of our total invested assets.

These holdings show up in asset-backed securities on page 39 of the quarterly financial supplement.

98% of these holdings are rated Aaa or Aa, and the remaining 2% are rated A or Bbb.

The $52 million of our holdings rated A or Bbb are all from 2004 or earlier vintages, which benefit from stronger underwriting and greater housing value appreciation.

As of June 30, our unrealized loss in the portfolio was approximately $29 million, most of which is attributable to higher interest rates.

We also own $83 million of collateralized debt obligations that are backed by subprime mortgages.

95% of these securities are rated Aa or Aaa, and the unrealized loss in the portfolio was $3.6 million at June 30.

In addition to subprime exposure, we hold $6.9 billion of Alt-a RMBS, which is in the residential mortgage-backed securities line on page 39 of the QFS.

All of these investments are rated Aaa, and 77% are Super Senior Aaa, which carry double the credit enhancement of the standard Aaa tranche.

The unrealized loss in these holdings was $39 million at June 30, which was again primarily due to higher interest rates.

We have no holdings of Alt--a RMBS backed by second liens.

Finally, we have no exposure to any of the subprime-related hedge funds that you have been hearing about in the news.

I realize you may have questions regarding our private equity portfolio, interest rate movements and general credit conditions which I will be happy to answer in Q&A.

And with that, I will turn the call over to Bill Wheeler.

Thanks, Steve, and good morning, everybody.

MetLife reported $1.3 billion of operating income for the second quarter or $1.72 per share.

As Rob mentioned, this is our best quarter ever and a 34.4% increase over the second quarter of 2006.

Our return on average equity is 16.8% for the second quarter and 15.3% for the first half of the year.

This morning I'm going to review our financial results, as well as our outlook for the remainder of the year.

Let me begin with topline revenues which we define as premiums, fees and other income.

Topline revenues were $8.6 billion this quarter, an increase of 8.5% over the second quarter of 2006.

We had strong growth in a number of our business segments.

In International record topline revenues of $1 billion were driven by stronger sales throughout Latin America and Asia Pacific and helped International grow revenues by 17% over the year ago period.

Although they are not included in our GAAP revenue results, sales of annuities in Japan were $1.3 billion this quarter, up 8% over the year ago period on a Yen basis, another very strong quarter.

In Institutional topline growth of 7.2% over the year ago period was driven by solid results in Group Life and Non-Medical Health, which was lead by our Dental and Disability businesses.

Even though Retirement & Savings revenue growth was only 4%, I had said many times sales here can be lumpy, and the best way to evaluate growth in Retirement & Savings is to look at the balance sheet and not GAAP revenues.

In this quarter Retirement & Savings general account liabilities grew by $4.1 billion, which is a 19.2% annualized growth rate.

Also, in Individual business, annuities with an outstanding sales quarter and good equity market performance had revenue growth of 16%.

Turning to our operating margins, let's start with our underwriting results.

In general, underwriting performance was strong, and in Institutional again this quarter the results were exceptional and broad-based.

Group Life underwriting results were excellent.

Our mortality ratio of 89.2% was well below our target range of 91 to 95.

Group Life underwriting results also benefited from an $8 million after-tax reduction to policyholder benefit relating to an administrative data review.

In Non-Medical Health and Other, Group Disability's morbidity ratio of 90.8% was quite strong and reflects continued improvement in reported incidents.

Non-Medical Health and Other underwriting results also include two unusual items.

First, we established a claim reserve to account for a change in certain group long-term disability claim processing protocols.

The impact of this is an after-tax charge of $9 million.

Excluding this charge, the Group Disability morbidity ratio would have been 86.8%.

We also made an adjustment to our reserves on certain group long-term care policies, which resulted in a $10 million after-tax charge.

In Individual business, our mortality ratio was 90.9%, which is higher than normal due to two large claims which hit this quarter totaling approximately $38 million.

These claims were almost entirely offset by reinsurance and had a limited bottom-line impact.

Turning to Auto and Home, we had another excellent quarter with an 87.4% combined ratio, including catastrophes.

Included in this result is favorable prior accident year development of $23 million after-tax and a $10 million after-tax lower than planned catastrophe claim experience.

Moving to investment spreads.

Again this quarter we had high returns from corporate joint ventures of private equities, which resulted in record variable investment income of $140 million after DAC, tax and other offsets, or $0.18 per share higher than our pretax baseline plan of $295 million.

Retirement & Savings, Annuities and Corporate and Other were the main recipients of this income.

The second quarter is typically our strongest with respect to variable income, and we expect results to return to more normal levels for the remainder of the year.

Moving to expenses, our overall expense levels declined sequentially and included several onetime items.

Corporate and Other included an after-tax benefit of $20 million from the release of a legal reserve.

In Institutional accelerated DAC amortization required under SOP 05-1 resulted in a $12 million after-tax charge.

Also, in Institutional non-recoverable overpayments of certain dental claims resulted in an after-tax charge of $9 million.

In International the impact of the strong Korean stock market resulted in a $4 million after-tax decrease in DAC amortization.

And in Individual there was a $7 million after-tax expense accrual release.

Net of all these adjustments, expenses were approximately 30% of revenues.

This is a little higher than our target and reflects some incremental investments in our businesses this quarter.

Before moving to operating earnings, I just want to mention two other items of note.

In Corporate and Other we recorded a $25 million after-tax gain from a legal settlement relating to the General American acquisition.

Also, we had a $9 million tax benefit in international due to several non-recurring factors.

Turning to our bottom-line results, we earned approximately $1.3 billion in operating income or $1.72 per share, representing a 34.4% increase in operating EPS over the second quarter of last year.

Our preliminary statutory operating earnings are approximately $720 million this quarter and $1.6 billion for the first half of 2007.

Total statutory capital at June 30 is approximately $18 billion.

Given our -- because of our strong performance in the first half of the year, we expect to exceed our previous earnings guidance of 5.05 to 5.30 and are now expecting operating earnings per share of between 5.65 and 5.80 this year.

We also expect that our ROE for 2007 will be approximately 14%.

Finally, additional share repurchases could be made during the second half of 2007 depending on market conditions and other corporate considerations.

As of June 30, 2007, MetLife had approximately $440 million remaining on its existing share repurchase authorization.

Before I wrap up my remarks, I just want to mention that on May 24 the Company closed on a private transaction to fund AXXX reserves related to its Travelers ULSG block.

The transaction funded $2.3 billion as of June 30 and replaced a similar amount of short dated letters of credit previously used to collateralize these reserves.

This was a very attractive transaction for us because it is a 30-year commitment and also provides capacity to deal with peak reserve requirements.

We view this transaction as a permanent solution for funding AXXX reserves for the Travelers block at a very reasonable cost.

In summary, this was a strong second quarter and first half of 2007 for MetLife, and we are well positioned for the rest of the year.

With that, let me turn it over to the operator so we may take your questions.

(OPERATOR INSTRUCTIONS).

(inaudible), Citigroup.

It is actually Colin Devine.

I was wondering if you could give us some update on how the pension closeout market is evolving for you right now and whether with the rally in the bond market, that is pretty much something that is put off until next year and if that is why you I guess raised the possibility of -- I will use that in quotes -- "stock buybacks" on the second half?

Thanks.

I will start by giving a little color about what is happening in the closeout market.

One of the things that we are seeing this year relative to last year is we are seeing a lot more activity in the market in terms of conversations that we are having with clients around the possibility of pension closeouts.

Our pipeline at this time last year did not have very many deals in it, and this year we have a much more robust pipeline.

In the first half of last year, we did $19 million worth of deals.

In the first half of '07, we did $84 million worth of deals.

So when we talked at investor day about $1 billion of closeouts, it was a combination of smaller and larger deals.

We expect that we will get those smaller deals this year.

And the larger deals I think are less predictable, and it's just going to be a question of how quickly the market moves toward doing some of those deals.

Bill, you may want to talk about some of the --

Just to jump in, do we really need a 10-year?

I think, Bill, you've talk before closer to the 5.5 range for this to work.

It is hard to tell.

I think, as we said before, these particular situations are going to be event driven, and they are going to be a function of where each customer is, a function of how well funded their pension plan is, how concerned that might be about equity markets given the mix of investments that they have around pension plan assets.

And interest rates are probably a driver as well too.

One quick follow-up for Steve as well.

And if you could give us the size of your securities lending portfolio at the end of the second quarter.

[$49 billion].

I might just add -- it is Bill Wheeler -- that in terms of buyback activity and why did we decide to kind of announce that we may enter the market again, given that we have other obviously -- we think we may have other uses for capitals over the next 18 months, two years.

We have today at the holding company at June 30 just under $3 billion of cash.

If we -- in sort of a status quo scenario, we expect that to be approximately $4 billion by year-end.

And yes, we do have some of that maybe earmarked for things like dealing with the converts in '08 and '09 and possibly some other activity, but we also frankly look at where the stock is today, and we think given where the price is that this is probably not a bad time to be entering the market and buying back some stock at what we consider to be a relatively cheap price.

So we want to make sure that we are ready to do that by putting everybody on notice that we may enter the market again.

Thank you.

I am glad we agree on the last point.

It is Steve again.

Actually it is $50.6 billion.

Jimmy Bhullar, JPMorgan.

I have a couple of questions for Steve and then one for Lisa.

On the unrealized gain or loss numbers that you gave on the subprime and Alt--a 29 million, I think 39 million, I think those were as of the end of the second quarter.

Most of the decline in the market has been since the end of the second quarter, so if you can give us an update on those numbers.

Secondly, you have had very strong variable investment income in the last several quarters, and I think part of that has been driven by corporate joint venture income.

What is the outlook for that if IPO activity slows?

And then one on the variable annuity business, sales were obviously very strong this quarter.

You mentioned the new GMIB.

I think there's also a bonus special in the independent channel.

If you can discuss your outlook for VA sales in the second half?

I will take the subprime loss, unrealized loss issue first.

I don't want to give an exact number.

It obviously moves day by day --

Yes, but just some idea on how that (multiple speakers)

I will give you directionally.

It has moved a little bit but not a lot.

Two things have happened.

One, spreads have widened out since the end of the quarter.

The flip side is the interest rates for treasuries have come down.

Those two impact the number.

And overall it's still a very small number.

It is less than or about 1% of our total unrealized losses.

And again, the vast majority of that number is interest rate related, not credit.

Credit is only about 2% of that number.

So 98% interest rate related overall for unrealized losses, and this is about 1%, the subprime piece of that number.

So the second thing I think you talked about was variable income and some outlook for the next couple of quarters.

We do report our private equity returns on a lag basis for about half the portfolio under the equity accounting method.

So when you see numbers for the second quarter of 2007, you are really looking at fourth-quarter '06 returns.

The other half of the portfolio is in the cost method, and that flows through more directly.

So we anticipate the third quarter still will be a reasonable quarter since it is lagging to the first quarter of '07 for about half the portfolio.

In terms of what happens beyond that, it is hard to say.

It depends upon these capital markets and whether the subordinated debt markets open back up again, the bank loan markets open back up again and overall whether private equity deals start getting done.

Our returns are driven by a number of factors.

One is buyouts getting refinanced where they are (inaudible) out money by refinancing the transaction they already did.

That market right right now is shut down but it could reopen in the fall.

It is also driven by IPOs, and right now that is soft as well for these kinds of transactions.

But again, that could open back up in the fall.

So it's really hard to look out more than a quarter or two in terms of these kinds of returns.

But I would say we have enjoyed some extremely strong returns over the last couple of years, and we have been basically cautioning people over that period of time that these are unusually high returns.

And historically, the returns are more in the 15% range long-term, so that means some of the years are below that and some are above that.

For the last couple of years, it has been well above that.

On the variable annuity side, our year-over-year comparison is to a record second quarter of 2006 where we achieved the number one position in (inaudible) and sales.

So that was our year-over-year results, which were really strong.

On our sequential growth, as I mentioned last quarter, we expected a significant lift from our 6% GMIB writer and did, in fact, see it.

So what we saw sequentially is that we are up 25% very strong across both our agency distribution channels as well as Independent.

And that is our sequential increased is attributable to -- about 60% of it is attributable to the 6% GMIB Plus writer which was in all channels.

Also, we continued to roll out our lifetime withdrawal guarantee into additional firms.

We rolled it out into two firms where we are seeing a significant take.

In fact, one of those firms has a 90% election rate just right out of the gate.

And then finally, the 6% GMIB bonus was just in the independent channel, and I would just remind you that last year we also had -- in the second quarter, we also had a special.

So the uptick does not come out of the special, and that was just on the independent side and was actually funded by expense takeouts.

(multiple speakers)

And then you asked the question about what do I expect to see in the third quarter?

What I would say is, and I also mentioned in Q1, that we are making progress on our annuity product rollout.

We are waiting still for approval in two major states, New York and Oregon, on our LWG product, and we will see more sales from our annual step-ups and our GWB product that we just introduced in July, as well as payout rate enhancements on our GMIB Plus.

I would say that you can expect to see pretty much more of the same on the annuity side for Q3.

Okay.

And can I just ask like a quick follow-up on the pension closeout business.

You've talked a lot about this the last several quarters, and so far this year you have done $84 million in volume.

I think the second quarter was only $1 million.

As a base of your revenues, the $13 billion, it is not even 1%.

But my understanding is this is a big long-term opportunity, but this is not something that is going to make you raise earnings estimates in the near-term.

But I think there has been a lot of talk about this in the market.

But if you can just clarify it, what sort of an opportunity do you see from pension closeouts in terms of an earnings impact over the near-term?

Let me answer that for you.

I would acknowledge we have been asked a lot about it.

We have not been talking much about it other than when we get asked.

And I would just echo both Bills' comments that remember -- as a matter-of-fact, I made the analogy in the closeout business similar to acquisitions.

We are opened 7 by 24.

We see large deals because of who we are.

A lot of people are asking us for advice and discussion around this very topic, and for us to project what kind of sales we might see in the short-term, I think would at best be misleading.

So when we write that business, assuming that it comes down the pike, the best thing I can say is you can be assured that it will meet our pricing targets and exceed 15% ROE targets.

Yes, that is helpful.

And the only reason I was asking is because I think expectations out there are too high for this, and so far no one even knows what the pricing terms are going to be and what returns are going to be, especially on large cases.

But thank you.

Yes.

And keep in mind, on large types of business, as I said before, it is not -- there is much opportunity in terms of the structure of these deals and the amount of capital provided by the buyer and the balance between the capital strains.

They can buy the buyer and the seller that cause each deal to look different.

But we will maintain those pricing disciplines.

Ed Spehar, Merrill Lynch.

I had a couple of questions related to some comments in the prepared remarks.

I guess the first is, in terms of the fund flows that you mentioned in Retirement & Savings in the GIC and the funding agreement area, you mentioned that spreads were narrower but they were very capital efficient.

I was wondering if you could give us some sense about the marginal returns on capital for the business that you're doing today in Retirement & Savings?

And then on the Life side, I was wondering if you could give us a sense for any earnings impact from the AXXX securitization, and clarification on the comments you made about I think changes in underwriting or better risk selection or something driving better Life sales.

I am wondering if you could clarify that for us.

It is Bill Mullaney.

Let me answer your question with regard to the sales we have had, the asset sales which are around global GICs primarily in funding agreements.

The spreads that we have been seeing on those transactions are north of 100 basis points, probably around between 100 and 120 basis points.

And the return on equity that we're getting on those transactions are in excess of 15%.

And with regard to AXXX, the earnings impact is -- I guess direct earnings impact is de minimus.

But why do we think this is a good deal, and sort of a little bit of a ground breaker is, as you probably know as you follow this, there has been a lot of issue about how do you deal with AXXX redundant reserves?

And the way the industry -- the way the industry has dealt with it a couple of ways, but you know these reserves are going to last on the books a lot of them for 30 years.

And there is not sort of a solution which lasts 30 years for the most part until now.

And if you know how these reserves work over time, they grow.

And they peak out at about 15 years.

And so even though we have to deal with -- so we sort of have a short-term fix to what is sort of a long-term reserve problem or issue, and the rating agencies have obviously recognized this.

And they reflect -- and they have sort of said we want to see longer credit commitment facilities; otherwise we're not going to give you credit for this.

And if that actually happened, if they did not give us credit for it, these shorter solutions, that would have a big impact on capital and then obviously earnings.

So we think we are sort of out of head here a little bit in terms of how we have dealt with this issue, and this was a very big deal and sort of in terms of a 30-year commitment and capacity to fund peak reserves.

So effectively the incremental cost here is very modest, and so it is a good deal.

With respect to underwriting, look we are prudently picking our spots.

We continue to refresh our underwriting to make sure that we are competitive, and we continue to do that.

Our growth in Life sales sequentially is a story not only about our underwriting and refreshing that, but it is also really about the service infrastructure.

Specifically what I talked about on the last call is that we were making technology investments and investments in our service platform, and we are really seeing all three strategies come together and kick in on all cylinders this quarter.

So it is about underwriting, it is about service and it is about relationships.

Just to give you one example on the service side, one of the things that is happening with respect to what we have done from a technology standpoint, is one of our competitors actually just came out and announced that they are not accepting any informals for the next two months because of their paper log backup.

And we have all of ours imaged and work flowed, and we have it such that we can turn around status in less than three days.

So quite an improvement there.

The other thing that we have done from a service standpoint, particularly on the Independent side where we've seen a very significant turnaround this quarter, is we created a service environment that works hand in glove in alignment with very specific focus firms where we have a lot of business so that we create really a small firm feeling there.

Tamara Kravec, Banc of America Securities.

If we could just circle back to guidance.

I know you have raised it and you have consistently been beating in the first half of the year.

But if we kind of back into the numbers, I guess I'm still struggling with on an operating basis it is almost like guiding down for the second half of the year.

So are you just comfortable with a conservative status?

Is it more the pension closeout, the LBOs and different issues that you think are just volatile.

If you could just talk a little bit about that.

No, we're not really -- we're not trying to signal anything special here.

We are not telling you that there's a big bomb coming or something.

What we're trying to say is, look, we have obviously had a great run.

We have talked a little bit about why it has been a great run the last two quarters in terms of our financial performance.

Clearly we're beating sort of our original plan expectations.

We have obviously reflected the decline in the recent stock market activity, which will have a little effect on our separate account balances.

We also think we probably will spend a little more money in the second half of the year.

I don't know how much more yet, a little more money in terms of investing in our businesses to make sure we have a successful 2008.

So that is really what that is about I think.

It is not really about that we're really worried about the next couple of quarters.

We feel pretty good about them, frankly.

So that is sort of the message we're trying to send.

Okay.

And can you just remind me what your outlook for spreads is built inherently into this revised guidance?

Well, I think our current scenario is in terms of sort of the interest rate environment is that we expect the 10-year to end 2007 at a yield of 475.

So it is, of course, a little higher than that right now.

We are obviously not expecting any sort of action by the Fed, so there are some hints that may actually occur.

And so we are -- that's a little -- and then obviously we are expecting, we always expect for a total return for the stock market of 5% a year.

That is what is always built into our guidance.

Over the second half of the year, we would assume 2.5% return.

So that sort of gives you some of the macro fundamentals.

Thank you.

Very helpful.

And my last question is on Traditional Life.

Earnings there were I guess on a core basis were down fairly significantly on a sequential basis.

Is there anything going on there that is the reason for that decline?

It is Tim Schmidt.

I think Bill mentioned earlier in his comments that our mortality experience overall was in line with what we expect, although it does bounce around product line to product line.

So basically what you are seeing in Trad Life is we had a little worse mortality experience there, offset by some better experience in VUL.

Okay.

And your expenses in that segment seem to be jumping around a little bit from quarter for quarter.

Is there a good run-rate to use going forward?

There is some variability.

Second quarter tends to be a little higher than first quarter.

I don't think there is any general guidance around run-rate going forward.

Tom Gallagher, Credit Suisse.

Tom, you okay?

I am alright I think.

I guess one first for Steve on the gross unrealized investment loss number.

It went up to $4.6 billion this quarter.

I guess you were sort of talking about it earlier but a more specific question.

Given the substantial recent widening of spreads and understanding net interest rates have also come down a bit, what would that gross mark look like today?

Have you looked at that?

Yes, the interest rates have come down and spreads have widened out.

They pretty much have balanced each other out.

There is not a significant change to that number if you marked it to today.

Got it.

Okay.

I guess another somewhat related question.

Can you just comment about how you are feeling overall about the portfolio?

I guess when you look at what has happened in the bond markets today, there is certainly some gloom and doom type scenarios that people are considering like '01, '02.

How are you feeling overall about where you see things trending from a credit loss standpoint?

How do you feel about the overall quality of the portfolio here?

We feel very good about it.

But obviously it is going to be driven by the economy largely.

The problems we are seeing right now in subprime (technical difficulty)--

Steve, I'm sorry.

I cannot hear you.

(technical difficulty)--

Okay.

And there has been a resetting of the pricing on the subprime area in mortgage-backed securities in general.

That is flowing through the other credit segments like CMBS, even in some cases corporate spreads.

I don't think right now we're at a point where we're saying these spreads are getting so wide that it is going to hurt the economy.

I think we're at the point where we're saying those historically tight spreads were probably unrealistic, and we still have a strong consumer out there stimulating the economy.

We still have strong corporate profits, but obviously if those things change, then the impact that will have on credit will be negative.

And we have been saying for really two years now that we thought that it made sense given spreads to be more conservative in credit.

We have done two things.

Since 2003, for example, we have decreased the percentage of securities we hold in credit from 46% to 41% of our total invested assets.

So we are lighter credit than we used to be.

The second thing is that we have moved away from Bbb bonds where a lot of credit problems typically happen in those cycles, and we have moved up market to A and above.

So I think we're well-positioned if the credit cycle goes in the wrong direction.

Got it.

Thank you.

And one last question from me.

Individual Life Insurance business now the last few quarters you have been talking about seeing some irrational pricing in the market, and now that you saw a sales increase at least on a LIMRA definition basis, I'm just curious if you're still seeing irrational pricing or has that improved?

I think it has improved somewhat.

You know, it is still out there.

It is not as much.

That is what I would say.

Joan Zief, Goldman Sachs.

I just have a few questions.

The first one is, on your individual distribution strategy, you have very broad distribution.

I was just wondering, as you look to where the opportunities lie in the marketplace going forward, are you going to increase your investment in any one particular distribution channel versus another and try and accelerate the growth there?

That is my first question.

My second question is you have a lot of money sitting at the holding company, but only a $441 million authorization.

Do you think we should expect some revision in that authorization anytime soon?

And then my last question really just has to do with how much money do you guys really have?

You've got the $4 billion hopefully at the end of this year in cash.

You generate free cash flow on an annual basis.

What is some of the off-balance sheet values that you calculate in your balance sheet?

Do you have an opportunity to securitize any of the closed block if you really needed money as well?

So I was just curious as to how you see what the real financial resources of the firm as.

Okay, I will start.

We love our broad distribution.

It gives us some -- it really gives us brass and it gives us stability.

So I would not say that there is -- when I think about the independent side as compared to the agency distribution side, sometimes one does better than the other.

I would not say that we are investing in one or intend to invest in one any more than the next.

Okay.

With regard to authorizations first.

Our MO is basically that we go and ask the board for $1 billion -- authorizations of a $1 billion chunk at a time.

That is sort of what we have done ever since we have been public, frankly.

And then I doubt we're going to stop doing that.

I think that works, and the board meets quite regularly, and so it is always easy to keep up.

I don't really -- so sort of what we see in other authorizations too.

Well, when the old one gets rundown, we will get a new one.

I mean we will not wait.

But there -- I kind of hesitate to kind of hint at a buyback number because this is really going to have to be opportunistic in terms of what we're going to do.

I feel like if I put out a number, I'm committing to it.

So I don't really want to do that.

But obviously we have a lot of resources, and the $440 million current authorization is actually no limit whatsoever.

So it's just sort of a technicality.

With regard to how much cash we have really, we have a lot.

So just to pick out a few things.

We have just -- I always hesitate to throw out a number.

I know some people like to kind of say a number of what their excess capital number is.

That sort of implies that we are going to draw it all down tomorrow.

In fact, some of the excess capital opportunities are going to take time to really take advantage of.

And when I say time, it could be years.

So just to give you a sense of it, our real estate equity portfolio, even though we have taken some substantial gains, there is a lot still there, still unrealized gains based on the appraisal values we do every quarter.

That is in the billions.

Could we securitize the closed block?

Absolutely.

What size is that?

That is 1 billion sort of number.

Are there other assets we own that we could redeploy?

Yes, that is 1 billion sort of number.

But you cannot do these all at once.

You have got to tie -- you obviously got to do them in relation to running your Company and other things we want to do.

So we do track these things.

We look at them.

We're committed to managing capital efficiently and having a nice ROE and hopefully having a very nice stockprice.

So you can be rest assured that we are going to work on them.

And we will let you know when we need to make an appropriate announcement.

Suneet Kamath, Sanford Bernstein.

Two quick questions.

First, on the $50.6 billion securities lending portfolio, can you sort of tell us what the returns are on that today versus maybe some sort of historical average like you did with the private equity portfolio?

Just some high-level guideline.

And then on the Group Life, I just want to understand this strong underwriting concept.

Because my understanding is that this business is repriced annually, and I'm looking at the quarter to quarter swing.

So first quarter versus second quarter on a normalized basis I think it was $114 million of earnings in the first quarter, 141 in the second quarter, so that is a sizable increase.

I'm just wondering if this business would normally have that kind of a range of underwriting.

Because you did not sort of pull anything out as extraordinary, so I'm assuming it is within a normal range.

Is it just the fact that that range is pretty wide?

First, as to sec lending, the environment for sec lending is less favorable than typically we see because part of our program is driven by the shape of the yield curve, and an inverted yield curve at the short end is not positive for us.

So it has been tracking somewhat below plan but not a lot below plan.

If the yield curve became more normally shaped, the earnings from that program certainly would be expected to go up.

But we really don't give out specific numbers about what kind of earnings we experience in each segment of variable income.

With regard to the Group Life business, a couple of points I will make.

First of all, the second quarter is typically one of our better quarters from an underwriting perspective.

There is some seasonality in our results, and if you look back and track over the last several years on a quarterly basis, you would see some movement in the overall mortality rate.

Our mortality performance for the first half of the year has been good.

We expect it to come up a little bit in the second half of the year, but certainly well within the range that we talked about at investor day and probably more toward the low end of the range.

In terms of pricing, while these are written as annual contracts, a lot of our Group Life businesses actually has multi-year guarantees.

And so it is not uncommon for us, particularly at the upper end of the market, to have guarantees that go out five years.

And so you don't get as much repricing in the Group Life business as you might think.

And so that is one of the reasons why we have been able to grow that business off the base because the rates really don't change as much as you might think.

Eric Berg, Lehman Brothers.

Steve, actually I have a couple of questions for you as well.

First, with respect to the lag issue that you raised and the timing of sort of when business conditions get reflected in your financial results, since it seems that you are suggesting that there is a two quarter lag, I think you said the current -- the quarter that was reported last night, the June quarter's results reflect December quarter's activity.

Should I infer from that if I am understanding how this accounting works correctly that the inactivity that we're seeing now in the bond market and the impact of that on private equity would be reflected in next year's first quarter?

(multiple speakers).

It is going to be a two quarter lag?

Yes, half of our portfolio approximately is the equity method where there is that two quarter lag, and half is the cost method where it flows through directly when a transaction occurs.

So on the equity method, we get both realizations when they sell a transaction and return funds to the limited partners like us.

We also get mark-to-market from them.

So if they go and remark their portfolio at year-end, which is the time they will probably most focus on doing that, that flows through to us in the second quarter of the following year.

So that does impact typically the second quarter more than other quarters.

And when pricing is going up, obviously it becomes a positive to our second quarter.

If pricing is going down, it would be a negative.

So that is how the accounting works, and I would say yes that there's going to be a lag effect.

It is not 100% lag for two quarters, but there's some lag effect from that accounting treatment.

Let me just mentioned -- you did not ask this question -- let me just mention related to this in terms of what it means for us on a bottom-line basis.

If you see these markets really slow down or even close up for a period of time, it is because spreads have really widened to the point where private equity sponsors don't feel they can make the kinds of profits they need to make for their investors.

Now obviously that is a negative for us in one sense.

But I just would mention that our total outstandings for private equity funds is $2.4 billion, which again is less than 1% of our total invested assets.

And obviously we have a lot more than that in credit and other kinds of spread securities.

So while the LBO piece may be going down, the spreads we're realizing on the big piece of the portfolio will be going up at the same time.

So there is a lot of balancing that goes on in these numbers, and I would not get too focused on one piece, the 1% piece of the portfolio.

My second and final question relates to the accounting for the ABS that you discussed in great detail in your prepared remarks and relatedly the CDOs, both categories backed by subprime mortgages.

My question is this.

Everyone is saying that they have -- all the big insurers are saying Aaa, Aa, and we are hearing this over and over.

But I'm wondering as losses are incurred at the lower tranche levels, let's say that sort of definitionally erodes some of the protection.

And to the extent that that would be to downgrade Aaa's becoming Aa's and maybe that is not the case.

Maybe that is not a fair presumption that just because some of these -- just because some people take losses who have the lower tranches, that your securities will be downgraded.

But does it necessarily have to happen like that.

And if it does, if a Aaa became a Aa or a Aa became Aa-, does that have accounting implications for you necessarily?

Do you have to mark down the securities based on a ratings change?

Let me -- there is kind of several parts to that question.

I will try to handle all of them as I can here.

We do own almost exclusively the higher rated tranches, Aaa, in some cases Super Aaa and some Aa.

It is true that if the lower tranches get hit, then there is less below you in terms of subordination before it gets up to you, and the rating agencies could go back in and rerate some things, which in some cases they already have.

None of our securities were rerated for the quarter that we're talking about today, the second quarter of 2007.

One bond it was I think $350,000, very small, was rerated down one notch since then in July.

But let me just mention what we have been doing for awhile now.

We actually made a presentation in June of 2005 to our board about the real estate market in general, and this was a piece of that analysis.

And we were concerned back then about a real estate bubble in parts of the marketplace, including subprime.

And we started changing the way we were buying those securities really back in '04 but in a more major way in '05.

And one thing we started doing is buying what is called seasoned paper, and we started buying more and more of that.

What occurs is in the first five years of these structures, all the payments from these mortgages go to the Aaa-rated tranche, which we hold again -- most of what we hold is Aaa rated.

So what is going on there is the subordination is actually getting better in those kinds of securities because what is below you is not getting paid back, and what you have as principal is coming down.

So we're getting more and more security behind us and below us as we buy those kind of seasoned securities.

In addition, at time in '05 and '06, you really were not being paid to take risk in this marketplace or a lot of other marketplaces.

The flip side of that, which the positive is, is to buy extra protection in enhancements was very, very cheap, sometimes one basis point, two basis points, almost nothing.

We bought a lot of protection.

So we feel extremely good about our portfolio.

I can't say there will be no losses ever ever, but I feel extremely positive about the quality of our portfolio.

The unrealized losses are very small, and I do not anticipate any major problems in our portfolio.

Last quick one and then I will genuinely be done.

By buying extra protection, do you mean buying higher rating still or buying credit to full swap?

I'm sorry, can you repeat that please?

Sure.

You mentioned at the tail-end of your comments just now that buying extra protection was cheap.

Do you mean that you would buy higher rated bonds than you otherwise would have or you purchased credit default swaps?

It was not credit default swaps.

There are enhancements you can buy in the marketplace for these securities, and we were buying those enhancements.

Ladies and gentlemen, that will conclude our question and answer session.

Speakers, please go ahead with any closing remarks.

I would just like to thank everyone for the call.

I understand there has been some difficulty in hearing some of the speakers.

We would be happy to clarify anything that you could not understand.

You know how to reach us in IR, and we will be happy to take your questions for the rest of the day or next couple of weeks.

Thank you very much.

Ladies and gentlemen, this conference will be available for replay today after 11:30 AM and ending August 8, 2007 at midnight.

You may access the AT&T Teleconference Replay System at any time by dialing 320-365-3844 with the access code of 872258.

That does conclude our teleconference call for this morning.

Thank you very much for your participation, as well as for using the AT&T Executive Teleconference Service.

You may now disconnect.