Manulife Financial Corp (MFC) 2002 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the John Hancock Investor Relations 2nd quarter conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session, and instructions will follow at that time. If anyone should require assistance during the conference, please press start then 0 on your touchtone telephone. As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference, Miss Jean Peters, Senior Vice President of Investor Relations. Miss Peters, you may begin your conference.

Thank you, Denise, and good morning, everyone. Welcome to John Hancock's earnings conference call for the second quarter of 2002. As you are aware, our second quarter press release and financial supplement were released last evening after the market closed. They are currently available on our web site, www.jhancock.com.

This morning, Tom Moloney, John Hancock's CFO, will take you through the results of the quarter. Also on hand are members of senior management, who will be available for Q&A. They include, David D'Alessandro, John Hancock's Chairman and CEO; Mike Bell, Senior Executive Vice President for Retail; John DeCiccio, our Chief Investment Officer; Maureen Ford, President of John Hancock Funds; and [June Lipermoore], Head of GNSSP.

Before we begin the discussion for the quarter, I'll make the traditional cautionary remarks regarding forward-looking statements. During the course of this call, management may make statements that are forward-looking within the meaning of the Private Securities Litigation Reform Act. These statements may include projections, estimates and descriptions of future events. These statements are subject to a variety of risks and uncertainties, which may cause actual results to differ materially, and in this regard, we refer you to the cautionary statements contained in our press release and in our 10-K and 10-Q's and other filings with the SEC. With that, I'm pleased to turn the call over to Tom Moloney.

Thank you, Jean. Good morning and thanks for joining us on our second quarter earnings call for 2002. As you have seen, we've reported net operating income of 72 cents per share, up form 64 cents in the second quarter of 2001. We think the 12.5% increase underscores the fundamental vitality of John Hancock's retail insurance franchise and institutional spread-based businesses. Compared with the first quarter, net operating earnings per share was up 5.9%. Driving the growth year-over-year and sequentially were solid sales of core retail and institutional products and strong growth in invested assets, stable net investment margins, higher earnings at Maritime Life, our Canadian subsidiary, and aggressive expense and capital management. These drivers more than offset the negative impact of the two-plus years of declining equity values on asset management fees and the impact of the credit markets.

These results show the continued strength of Hancock's underlying operating earnings capacity, and we're confident our long-term growth and investment strategies will drive increasing values to shareholders.

Looking to the balance of 2002, however, we expect earnings to be under pressure from the market's impact on equity, assets under management levels, and continued credit defaults. Product sales remain a bright spot for both our retail and institutional businesses. Clouding the outlook is a likely drag in the economy from ongoing uncertainty in the financial markets, and in no small part due to the corporate governance and accounting scandals that went from the business page to front-page news almost overnight.

It's appropriate -- it appropriately has captured the focus of the Federal Government, the Securities and Exchange Commission, and other regulatory bodies, which are promligating new rules and regulations all of us have to learn to live and manage within.

With that as a back-drop, we have updated our previous published earnings guidance. We anticipate net operating income for 2002 of $2.83 to $2.91 per share, up 8 to 11% over $2.62 per share in 2001. That compares with our previously published guidance of 10 to 12% growth, which as you will remember, anticipated an up-tick in the economy and the equity markets in the last half of the year. This obviously does not appear to be in the cards at this time.

We have not only decreased the range but widened it because of all of the uncertainties within the environment we operate. Built into the revised net operating earnings guidance is the likelihood of future interest losses on our investment portfolio. We based our projections on the asset valuations of July 17, when the S&P 500 was down 6.5% from the end of June, and 21.8% from the start of the year.

In addition, it also assumes that the Standard and Poor stays in the range of plus or minus 2% for the balance of the year. And as we've mentioned before, net operating earnings per share will include a gain of 4 cents for the year from the elimination of goodwill amortization. On a net income basis, the $94.5 million in net realized investment losses in Q2 were clearly higher than we had anticipated. And many of them emerged in the waning days of the closing process for the quarter. As a point of interest, of the bond write downs, about $85 million were right at the end of the quarter close.

Like everyone else, we were surprised by the speed at which WorldCom fell into bankruptcy. Many of the large credit losses came in the troubled energy sector as fallout from the Enron debacle. The string of accounting frauds that ensued and cyclical losses triggered by last year's recession continuing well into the current year, took a painful toll on our bond portfolio.

Gross principle losses on fixed income securities, which include corporate bonds, commercial mortgages and agricultural mortgages, were $211 million in the quarter and real estate writedowns were about $16 million. They were offset by equity gains of $85 million in the quarter.

For the first half of the year, total realized losses for the year, after taxes, was about $147 million. We have not identified any specific potential fixed income losses going forward, but based on the current environment, as we have just outlined, we believe it is reasonable to expect additional losses in the second half of 2002.

We believe potential gross losses could be as much as $200 million. We believe we can use about $40 million in net gains to offset such losses. Nevertheless, Hancock's balance sheet and cash flow remains in superior shape, even after absorbing significant net realized losses over the past year, our book value per share is up 4% to $20.42.

And on a statutory basis, we estimate our consolidated net gain from operations will be about $600 to $650 million in 2002. As of six months, our net gain from operations is $294 million, including the class action settlement and the statutory DMVD reserve increases.

On the top line, our growth engine is firing on multiple cylinders. Hancock recorded strong sales and asset growth in life insurance, retail fixed annuities and individual long-term care policies, at $9 billion nontraditional life insurance account balances were 6% higher than in the year ago quarter, as the 28% increase in sales help offset the negative impact of sharply lowered equity values.

Fixed annuity account balances climbed 33% to $7.7 billion on 132% gain in sales, while individual long-term care reserve reached $1.9 billion, up 29% on a 10% rise in sales as a growth in the underlying businesses. Based on a strong first half of the year, we have updated retail sales guidance for the full year.

We expect core life insurance, which excludes corporate owned life insurance and bank owned life insurance, to increase 15 to 20% over 2001, that's up from previous guidance of 12 to 15%. Including corporate owned life insurance and bank owned life insurance, we expect total life sales to grow 3 to 10% from the previous range of 2 to 5%.

For total annuities, the growth range of 30 to 45%, up from 25 to 30%. And long-term care, the new target is 8 to 14%, up from the 6 to 12% range.

In upping the retail sales guidance, we assume there will be some stability in the capital markets and in consumer confidence. However, there are clearly concerns affecting the equity and credit market that it could impact our guidance. They range from the unknown effects of the corporate government and accounting scandals could have on the economy, as well as consumer confidences, to the impact that the frenzy around federal legislation could have on our products.

Turning to the institutional side, averaged invested assets for our spread-based products total $23.6 billion, up 12% over last year. And we are on target to hit annual sales of about $6 billion, which would be an increase of about 9% over 2001.

Meanwhile, net investment spreads remain healthy. Demonstrating the effectiveness of our asset liability matching techniques in tough market conditions. For Gix, Fund agreements and Group Annuities, the spread in the second quarter was 148 basis points, up from 145 last quarter. Although the most recent quarter included $5.4 million in earnings from a sale within one of our parterships. But even without the partnership income the spread was at the high end of our long term pricing range of 100 to 145 basis points.

The retail annuity spread was 199 basis points, compared with 200 last quarter and 197 in the year ago quarter. As declines in crediting rates, basically have kept pace with falling earnings rates. We continue to aggressively reduce costs during the second quarter as we reach to the markets on settled decline. At John Hancock's [inaudible] net operating income rose nearly 6% to 14.5 million, thanks to a 25% reduction in operating expenses.

Company-wide operating expenses fell 6% from last year's quarter, even as we grew premiums by 24% and product fees by 13.5%. And the year ago quarter did not include expenses associated with our acquisition of World Sun Alliance for about $2.1 million.

As you all know, two industry issues have generated a lot of attention among investors recently: The recoverability of deferred acquisition costs and guaranteed minimum death benefits. Given the markets recent decline and volatility, there has been much concern about whether variable annuity writers will be able to recover their capitalized acquisitions costs, commonly dubbed Dak [ph]. To put things into perspective for John Hancock, our current VA separate account assets are $5.7 billion, with a variable annuity dak balance of $372 million, a relatively small dak asset overall. And contrary to an analyst report issued recently, our variable annuity dak balances isn't skewed heavily to businesses written in 2000 and 2001.

Most of our sales during 2001 in fact were made under an exchange program that did not incur any additional deferred acquisition costs. It's also important to note that about 35% of our variable annuity assets are in fixed income accounts, money market funds, or other accounts that aren't correlated with the stock market. So account values tend to decline less than the market during a downturn.

For example, in the second quarter of 2002, the Standard & Poor's 500 index was down 13%, while our variable annuity accounts were down 8.3%. John Hancock financial services tests it's dak balances quarterly with a model that uses inputs, including market performance, lapse rates and expense levels. Under this methodology, which we have used consistently over the years, our dak was recoverable at the end of Q2.

As you know, whenever the market performs differently than our pricing assumptions, we accelerate dak in the current period so to some event, we actually compensate for the lower market impact. However, we do use an expected reversion to the meaning over five years to recalculate the remaining amortization factors.

In this current environment, we have modeled assumptions of further additional declines of 10% in each of the two subsequent quarters to June 30. We then capped expected future returns in the mid teen level. Using these assumption, we could face a one-time write-off of dak by the fourth quarter of just $14 million after taxes, or about 5 cents a share.

The earnings per share guidance does not include a potential write-off. We must also expect to see higher ongoing amortization between 3 and 4 million dollars per quarter after taxes.

The second concern is about guaranteed minimum death, in income benefits. Again, this is a relatively small problem for Hancock. In Q2, our net guaranteed minimum death benefit payment, after rider fees, was only $1 million pre-tax. This is up modestly over a year ago quarter by 200,000, and over Q1 of this year by $900,000. Our total guaranteed minimum death benefit exposure, that is if everyone died in the same quarter, is about 520 million after tax.

Before we open the call to your questions, allow me to address one final issue. As you know, John Hancock has tried to always be at the forefront of providing full and forthcoming disclosures to make our earnings as transparent as possible. We understand the heightened security by regulators, auditors and investors at this time, we want to assure you the results reported in our press release, together with that will be filed in our 10-Q, do and will include all material information known and available as of the filing date.

Since we know this question is on the minds of everyone, let me anticipate by saying David and I will be signing the forthcoming document required by the SEC and more recently by the [inaudible] legislation, without qualifications. However, if between now and the time we file our 10-Q, there should be an additional material event in the credit market or in any aspects of are business, we would of course announce such event and it would be included as additional information in the 10-Q. Thank you, and now let's take questions.

Ladies and gentlemen, if you have a question at this time, please press the 1 key on your touch-tone telephone. If your question has been answered or if you wish to remove yourself from the queue, please press the pound key. Our first question comes from Vanessa Wilson of Deutsche Bank.

Thank you. Good morning. Tom, I just wanted to go back over your comment about the statuator net income. You said 600 to 650 million in 2002. Does that include all the bond write-offs that you've taken so far and that you expect to take this year, and how is that affecting your statutory income?

I didn't push the button all the way. On the gain from operations, that is before net realized gains and losses, so that would -- and the 293 number that I used for the quarter to date does not include that, but we would still see an increase in our statutory capital as we see it, as we projected it out, for the rest of the year. We'd see what we call management surplus increasing from last year at about 4.6, $4.7 billion, up to around 4.8 billion.

Okay, and then Tom, just on your sensitivity analysis, you gave us on the dak recoverability, I was confused on the 10% market assumption. When does that start and how does that work, for how many periods?

What we've assumed that it would start in -- we get hit down 10% in Q3 and another 10% in Q4.

So cumulatively 20?

That is correct.

And the dollar amount is 14 for the full year 2002?

Right, and then three to four on a quarterly basis thereafter.

Aren't you already reporting higher amortization currently? Is this an incremental 3 to 4?

That's correct.

Okay, thanks very much.

You're welcome.

Our next question comes from Joanne Smith of UBS Warburg.

Good morning. I have three questions. One is, I was wondering if John could actually give us a little bit more color on the composition of both the investment grade and the below investment grade bond portfolio [inaudible] security portfolio? Second is, I was wondering if you could talk a little bit about the high benefit ratio in the long-term care business? It looks like benefits spiked a little bit versus the last year, quarter, and that if you could just give us a little color there. And then also on the tax rate, the variable annuity business, it looks like it went down significantly. Can you just talk about the dividend received deduction, if that's having an impact or what else might be having an impact on the tax rate? Thank you.

Joanne, this is John DeCiccio responding. In terms of the bond portfolio, in total, at the end of the quarter, we had about $44 billion of bonds. And in terms of the split between an investment grade and below investment grade, about 8.8% of the total invested assets, or $4.9 billion of bonds are below investment grade. And the balance of the bonds, that would be roughly $38.8 billion would be investment grade bonds.

John, can you give us a little bit of information concerning the sector exposures in those portfolios, please?

Sure. In terms of our industry exposures, for example, we have in utilities and project finance, roughly the bond preferred stock distribution is about 19%, in that area. We -- in terms of oil and gas, we would be roughly 11%, in manufacturing we would have 17%, bank and finance, about 12%. And asset backs about 9%, government about 4%.

Is that the total portfolio, John, or is that just the investment grade?

That is the total portfolio including both investment grade and below investment grade.

And can you just talk a little bit about how the composition of the below investment grade portfolio might have changed? I know that at one point you had some pretty significant energy and airline exposure. You had very little in the telecom and tech area. Can you just give us an update on that?

Okay, in terms of the below investment grade bond exposure, we have roughly the same percentage of below investment grade as we had at the end of the first quarter in utilities, roughly 25% of the below investment grade bonds in utilities. And in transportation, roughly the same percentage, about 14% in transportation below investment grade. And manufacturing, about the same, 29% below investment grade in manufacturing.

Thank you very much, John.

Yes.

Our next question comes from Colin Devine of Solomon Smith Barney.

Operator, before we go to Collin, we had a couple follow-ons from Joanne -- of her original question. Colin, excuse us, let us just finish answering Joanne's question.

Joanne, this is Barbara Luddy and I can address your question on the long term care benefit ratio. We saw some improved lapse in the current quarter versus last quarter. And when that happens we have to set up additional active life reserves for the larger imports population. And that's what's driving the benefit ratio. The claims part of it actually showed an improvement versus last quarter. We track an actual to expected claims, and that got better from last quarter. But the higher in force population necessitating higher reserves, popped up the benefit ratio a little bit.

Joanne, Tom Moloney. In reference to your question on the tax rates. For variable annuities, essentially the change really comes about because of the pre-tax income dropping so precipitously, compared to the permanent tax adjustments that remained relatively consistent.

Colin, thank you for your patience. Operator, if you could let Colin ask his question.

Mr. Devine your line is open. Thank you.

I have two questions. First is for John. I understood from David that you were in the middle of a study comparing the performance of your noninvestment grade, I guess basically the private placements there, versus how your public bonds have done through the cycle. And I was wondering if you might be able to give us an update on that. And then secondly, for Michael Bell, it would seem from the life -- very strong life sales you got -- that things with Signature in particular are turning around much faster than perhaps certainly I had expected. Perhaps you could just elaborate a bit more on where you're really having success and then in terms of specific agents, a bit more on products, you know, what's really hot, and, you know, what do you attribute all this to?

Colin, it's John DeCiccio getting back to you. On the -- looking at the investment grade and below investment grade bond performance, look back over the last two and a half years, and we looked at what percentage of the losses that we've had in the bond portfolio came from investment grade bonds that were investment grade at the beginning of the year in which they defaulted by calendar rear. In 2000, the percentage was 42%. In 2001, it was 36%. And probably most surprising of all, year to date, so far, in 2002, it's 33%. Now, given the fact that we've only had six months for those bonds to deteriorate, you can get some feel for how fast the freefall can occur. So while everyone tends to focus on the below investment grade area, there have been significant downfalls from the investment grade portfolios. In particular, if you look back at where the bonds were at the time of the acquisition of the bonds, that 33% number that I quoted for the losses from investment grade as of their rating at the beginning of the year, jumps to 58% for the first six months for 2002. So a lot of these losses are coming from bonds that were investment grade when they were purchased.

Thank you.

Hi Colin, it's Mike. I think that you're correct. We've had some pretty good success in instilling some of the discipline we talked about before, in the Signature career system. Plus, we continue to hire the experienced agents that we've mentioned, as well as picking up a couple of agencies in the southeast, which we, I think, also mentioned before. The overall productivity and the experienced agents, up about 8%, for the overall system, about 7%. A lot of that is coming from the universal product line which we did talk about before. And we've also had a pretty good quarter in pushing forward in UL as well. So, I think at least what we're seeing right now is consistent with the stuff we talked about previously. And we're going to continue to do exactly the same things as we move forward.

Great. Thank you.

Our next question comes from Michelle DeArdano of JP Morgan.

Good morning. I had a few questions. First, I appreciate that you don't have any -- you are not highlighting any specific losses in your $200 million expectation for gross principal losses. But could you give us a little bit more color on how you came up with this estimate and what are some of maybe the asset classes that you might expect some deterioration in, just so that we can get some comfort that this is a conservative estimate. And secondly, I was hoping maybe you could talk about the capital position, how much excess capital you have available to buy back stock in any debt capacity. And then third, on the SignatureNote products that you're going to be rolling out in August, are they going to be subject to the same regulatory restrictions of the 25 or 30% of earnings that it can't go above with the GNSSP segment?

Michelle, this is John DeCiccio. In terms of how we came up with the 200 million, we really did not focus on any individual issues or even in particular sectors, trying to ascribe, we looked at the total amount of losses that we've taken so far. And given the $208 million of bond losses in the second quarter, and [inaudible] said that about 85 of that was really late breaking results and one as near as a week ago in terms of 46 million of losses coming from that bond. We looked at the fact that we had a better than average beginning of the year first quarter number, and then a higher than expected second quarter year number, and it might even be looked at as some third quarter events working in there, and looked forward in terms of what we thought for the balance of the year. And basically said that the 200 million would be reasonable to expect, given the run rate and given the fact that a composition of a lot of the losses in the second quarter report are things that have really materialized very recently.

Michelle, this is Thomas Moloney. In reference to your question on the capital position data, et cetera, based on looking and holding on RBC level of about 325%, at the end of June, we'd say we had about $200 million of excess capital, and the debt capacity remaining is around 250 to 300. And we believe we have like preferred stock capacity, or some high bread of 5 to 750, and if we really wanted to do something, vis-a-vis an acquisition or something, we really do have also the close block securitization concept, which is about a billion dollars overall. So I think, you know, we still have a lot of flexibility, and with the continued growth in the statutory earnings and capital, as we look forward to the end of the year, I think we'll be even adding more capacity as we go along. On the SignatureNotes question, which will actually -- I think our first issuance will be after we file the 10-Q on the 14th. So that -- but right now, the internal decision is for it to be included in our own internal limits of 20 to 25%. You know, that's something that we will continue to watch and look at and study, and so it's still open for debate, but right now, it is included.

Thank you.

You're welcome.

Our next question comes from Ken Bekerberg of Lazar Management.

Yes, good morning everyone. Two questions, if I could. The first just going back to credit for a moment. I wondered if we should be concerned at all about nontraditional structured airline obligations? We've heard some rumblings in the market about that particular asset class. And then secondly, I guess for Thomas Moloney, with regard to stat capital, I notice that it dropped relative to 1Q, and wondered is that an issue of GMDB reserving or is it something else? Thanks very much.

Ken, this is John DeCiccio responding. In terms of your reference to nontraditional structured airline securities, I think you may be referring to equipment trust certificates or so-called double enhanced equipment trust certificates, double ETCs. In terms of the enhanced equipment trust certificates, or the double ETCs, these are still generally rated A or higher, even with all the difficulties in the airline industry. And certainly we would look at them as a very strong part of the portfolio, since they're loan-to-value ratios typically are 40% or lower. So those we feel are extremely solid and secure. In terms of the the equipment trust certificates themselves, they generally have a 75% loan-to-value type structure, and again we've seen cases where companies that have gone into Chapter 11 and tried to reorganize and even liquidate some of their planes, we've seen structures where the equity owners of these securities come to the ETC owners and offer to be paid out at par. We've actually seen that in Midway Airlines this -- this past year. So we feel very good about those so-called nontraditional structured airline paper.

Ken, this is Thomas Moloney. In reference to the drop between Q1 and Q2. Remember there's $100 million worth of dividend payments that were in Q2, there was only 11 in Q1. The - just to put your mind at ease on the guaranteed minimum death benefit, that was $16 million and of course that goes through net gain from operations. So that was only $16 million increase. And the rest of it is really -- the capital gains -- capital losses, both realized and unrealized.

Thanks Tom, that was helpful.

Your welcome.

Our next question comes from Sneet Kmath of Sanford Bernstein.

Hi, I have three questions, actually. First in terms of the buybacks. Can you give us what your expectations are, what you've built into your earnings guidance in terms of share repurchases for the balance of the year? That's number one. Number two, the 5.4 million of recoveries that you referred to in your spread-based business, can you just explain again what that is, what was caused by it -- what it was caused by? And then the last question is, have you given any thought to taking options expense through your income statement?

Let me take the first question and then John -- I'm going to ask John to do it and then David will speak to the last question. As far as the buyback program, right now -- at the end of the first quarter -- second quarter excuse me, we have $580 million left in our total program. And as we've said before, we are an opportunistic buyer. We believe the pricing clearly on the stock is very depressed. And so we will be doing whatever is appropriate as we go forward.

Hi, this is David D'Alessandro. We of course are looking at, as everybody is, expensing options. Right now, our study is looking at a number of things, for example, should it be done on a pass basis or a prospective basis? It appears that some companies have announced programs on a prospective basis. They're using a black shoals methodology or some other method, and we're anxious to see what our insurance brothern are going to do. Because while our stock options are available to everybody today, and you can do the calculations, we think that as we see the rest of the industry go, we will also come along with it. But there has to be some consistency in the methodologies, if we do it, so that all of us are not trying to pick through the fine type. My own view is, it appears that while I've not talked to any of the other insurance companies, clearly America is headed in some direction here to at least make the stock options a lot more transparent in some form or other. But I think we need a little time to wait on the industry, as well as decide on methodology, so it's consistent.

On the issue of the $5.4 million extra income for the GSFP segment. One of our BA asset partnerships sold an asset and took a gain on that asset. And because, under a BA asset we're treating it with the equity method of accounting, that comes through as an income item. And so we wanted to highlight that as a one-time item that would not be a recurring event.

Great. Thank you.

Our next question comes from Liz Warner of Goldman Sachs. Good morning. I just had a couple of quick questions.

I was wondering if you could just remind us what your pricing assumptions are for credit losses? I seem to have in my older notes that you have assumed that your credit losses run at your -- or run at the historical rate of around 33 to 35 basis points, and that gets you to a 15% RWE. And I just wondered if you are still pricing for that type of credit loss experience or not? And then secondly, if you might have a couple quick numbers on GMDB, I was wondering what the payments were before the rider fees and I was wondering what the GMDB statutory reserve was this quarter and a year ago?

Liz, this is John DeCiccio getting back to you on the question of what we're pricing for losses. For a triple B average portfolio, which is the level of our own portfolio, we would expect about a 33 to 35 basis point long-term level of loss over the life of the security. That is what we continue to price for, and it has been our long-term experience. Obviously losses this year are higher, but then again, spreads that were investing new money at are also higher than our targeted spreads as well. So we're also taking advantage of those opportunities in these uncertain times.

Can you just tell me what spreads are now versus -- why you got the 148 now versus what your target is?

I'm sorry, could you repeat the question, please?

What your targeted spread is? You said spreads were higher than your target.

Spreads that we've achieved on acquisitions are in excess of what we would need for spreads to meet a 15% ROE.

Right, and what was the spread necessary for the 15% ROE?

That would vary by credit quality and duration of the bond, our whole matrix, and we would not share our pricing matrix over this conference call.

Okay. Thank you.

Our next question comes from Eric Berg of Lehman Brothers.

Thanks and good morning. Three questions. First of all in the protection area, although sales have been very, very strong, and I want to acknowledge that, especially in the Signator area There hasn't been much earnings growth in the protection area through the six months, basically earnings have been flat on a pre tax, you know, dollar basis. And I'm hoping maybe Michael or someone else, can sort of point me to the items in the individual businesses within protection, or in specific line items, to help us understand why the earnings have not been growing in the face of strong six-month sales growth. My second question is, in the corporate and other area, it looks like in the June quarter versus the March quarter, there was a large increase in the negative amount, in the loss, a large increase in June versus March. I'm hoping someone can explain to me sort of what that increase was all about. And third, finally, in the guarantee and structured financial products area, it would seem that we're basically -- we have a business that is heavily dominated right now by the funding agreement business, with the GIC business shrinking and periodic contribution from annuities. I guess what I'd like to know is, is that okay to have a business as seemingly dependent as it is on the funding agreement business? Thank you.

Hi Eric, It's Mike. Let me [inaudible[ your question a little bit, hopefully give you a reasonably complete answer. If you look at the 2Q over Q2, we took a dak [ INDISCERNIBLE ] of 3.9 million in the second quarter of '01, for increasing some administrative fees in some variable life business, and that caused us to recalibrate the dak amortization schedule and recognize higher future fees, and that resulted in a one-time 3.9 million dak [inaudible] in that quarter. And we did touch on that in the press release. We also had more favorable mortality in 2001. And we talked about that, in that 2001,you know, we're seeing favorable mortality experience. In second quarter of 2001, we're seeing normal mortailities -- second quarter of 2002, seeing normal mortality, not giving us the same high gains as we got in 2001. That's about a three to four million dollar difference. And then third point within the -- in the quarter over quarter, the poor separate account performance depresses some of our fee income and steps up dak amortization. Now, if you look first half over first half, mortality becomes even a bigger issue. Because as we talked about in the last quarter, to everybodies delight for an extended period of time, we had much higher [inaudible] claims about 14 million or so. So our mortality was even worse in the first quarter. And if you kind of [inaudible] for those overly positive things last year and some overly negative mortality in the first quarter of this year, you actually get growth that looks a little bit more like mid-teens profitability, when we compare apples and apples.

That was great, if we can go on, please.

Eric, this is Thomas Moloney. In reference to the comment about the operating earnings on corporate and other, I think some of the items that I'll cover here, we've covered I think Earl and I talked to you out in when we had our February meetings. So let me walk through them. And I will do it from pre-tax, but I think it's after tax probably makes much more sense to look at this business and where it went from. The delta was about 6 million instead of the 20 that you were looking at. But the major drivers on a pre-tax basis is that, as you know, we use the corporate account to fund the business growth in our other businesses, and so with the growth that's taking place in our fixed annuity businesses, as well as guaranteed and stable value products and several others, what we do is move assets out of this and fund the other growth, so earnings would be depressed from that perspective. Also funding the stock buyback program comes out of this account. Also as we mentioned in the press release too, that this quarter, partnership income was down somewhat from the prior quarter. And then of course the other item that affects the pre-tax earnings negatively, but actually has a positive after-tax effect, that's the FAS 113 accounting for leases and the way it works through. And on an after tax basis of course for low income housing tax credits and other tax advantaged investments, helped to really create the -- probably the more realistic look at what's going on with that account, being off about -- being down about $6 million. And I'm going to ask Jean Livermore to speak to your last question.

Thanks very much.

Hi Eric. On your question on the mix of business in GSFP, it is true that funding agreements are now the biggest product overall. But you have to remember that we manage funding agreements and [inaudible] together. And we basically try and go for the lower cost of funds. And recently, for the last couple of years, we've found the lower cost of funds in the funding agreement market. Also, they tend to be longer duration products, so that they'll stick around longer and stay in our books longer than the [INAUDIBLE], which tend to turn over more frequently. And as for the annuities, it is true that the sales of the annuities tend to be lumpy. Because we do Jumbo's occassionally. But we've had very good growth in the annuity product. If you look year over year, it's up 12%, which I think is very good. And here again that's a very long duration product, so that will stay on our books for a long time.

Thanks very much That was all very helpful.

Our next question comes from Caitlin Long of Credit Suisse First Boston.

Good morning. A couple questions for John on the investment portfolio. Can you give us a breakdown of the 9% of your investment that are in asset backed securities, what type of securities they are?

Caitlin, John DeCiccio. On the asset backed security portfolio, we have about 36% in CDO's, and those would be focussed in the high quality A, AAA, and double A areas. We have about 30% in so-called double ETC's that I mentioned earlier, the enhanced equipment trust certificates. We have about 5% in auto receivables, 8% home equity, and then smaller in manufactured housing and credit cards, about 5% credit cards.

And how much of the ABO portfolio is below investment grade?

We have 91% in the senior trenches and 9% in the subordinate trenches. And some of the subordinate trenches would be investment grade, I don't have the exact breakout here.

Okay. That's helpful. And then I know that your Enron-related position was written down in the quarter. Can you just give us some color. I got some from Jean last night. But I want to understand the process that you've gone through for really double-checking the valuation that you have on those securities and what's in there, what's left, and how confident you are that there won't be an additional hit there.

Sure. In terms of Enron, we wrote down -- it was approximately $22 million writedown in the quarter. And what it's based on, I think we've indicated to you, all we're holding are what were private transactions with Enron, these are not public bonds. However, a number of them were subordinate positions within private transactions. And we basically -- our analysts feel that they will fall back to being unsecured obligations of Enron. So we look for those valuations to where the unsecured obligations are currently trading. And we saw a deterioration in the unsecured values and trading values, and we reflected that in the valuations here. We do the very best we can with valuations at each each quarter, and these valuations are reviewed with our auditors. And we feel comfortable that we have reflected all the information that we currently have. Of course, going forward, I can't tell you what information may develop in the future, but that -- we're comfortable with where we are.

Okay, and then last question, Tom. On the -- in corporate and other segment, you mentioned the higher employee benefit expenses, can you just give us some more color on what that was and how much it was in the quarter and what we should think about modeling that for -- in going forward?

Caitlin, It was only up slightly over Q1 versus Q2. I think it was less than actually a million dollars. And after taxes, it was nothing. I think that was in reference into the -- in the press release to the prior year quarter.

Okay.

Okay

Okay.

Thank you.

Thank you.

Once again, ladies and gentlemen, if you have a question at this time, please press the 1 key on your touch-tone telephone. If you are using a speaker phone, please lift the hand set before asking your question. Our next question comes from Peter Marco of Tudor Investment Corp.

I'm actually all set, thank you.

One moment for our next question. Our next question comes from Joanne Smith of UBS Warburg.

Yes, I just wanted to ask about the -- how you're -- how you're looking at making new investments in your investment portfolio. I was wondering if you were a little bit more active these days in the secondary market, given that the new issue market is extremely difficult? And if you are active in the new issue market, can you tell us what you're seeing out there in terms of spread, how far out on the risk curve you're having to go in order to get the required yield, and if you have increased the difference between your asset durations and your liability durations at all to compensate for the steep, you know, spread?

Joanne, this is John DeCiccio. Let me take your last question first. Because I can tell you we are certainly not increasing the difference between the asset durations and the liability durations. We continue to avoid interest rate risk and managed credit risk. In terms of your first question, we are active both obviously in the secondary and in the primary market. But as you indicate, the primary market has been spotty at best. There are opportunities in both areas, created by the uncertainties that we see. And we see some attractive opportunities. And basically we are quite active in finding investments in the very -- in some of the niche places that we do directly ourselves. So we do take a very pro-active stance in finding them. We are finding attractive spreads, as I indicated earlier, in those that meet and exceed our guidelines in terms of ROE's. Now, in terms of the quality level here, we really are doing very little in the way of new below investment grade bonds. We've kept this -- mostly all of our new acquisitions are investment grade bonds. We really are managing very carefully the exposures to below investment grade bonds. We're taking account of the fact that we've seen many downgrade here's. And we have also managed to keep our bond portfolio, level in terms of below investment grades as a percentage of assets at 9.1%, exactly where it was at the end of the first quarter.

John, just as a follow-up, in terms of the investment grade portfolio, are you finding that you're having to buy more triple B's or are you still investing heavily in AA's? Can you give us some color as to how portfolio composition in the investment grade area might have changed?

We really -- I would say we have not had any significant change in that composition. We have, over the past few years, had an increase in our triple B exposure. And that we did that as we moved out of the position we had at the end of '97, where we had an unusual amount of A and higher rated bonds because we didn't like spread levels, but those spread levels widened back, we moved back to our more normal position relative to having a triple B portfolio. And our goal is always to maintain a -- roughly a triple B average quality.

Great. Thank you very much.

Our last question comes from Tom Gallagher of Dresna.

Hi. A question for Tom. I still noticed expense -- general operating expenses were down about 31 million versus Q1. Can you just comment on whether this is a run rate going forward, where you stand now with regard to your annual goal for extensives, and whether there's any more room for cuts this year?

Hi Tom. In reference to your -- to the expense question and all, we're actually planning, as we indicated, I think David talked to it in Q1, about increasing the expense program from $20 million up to an additional overall $20 million. And we're running on that track and everything else. Q1 was particularly low in expenses and there was also some other things going on within that expense line, with reassurance and all. But I can tell you right now we are right on track overall for achieving our targets.

And, Tom, were any expense cuts accelerated in 2Q, or can we assume it's going to -- you're going to gradually move them down for the balance of the year?

I think that you'll find that they're pretty much spread out through the balance of the year, because we took most of our actions very early in Q2.

Okay. Thanks. And then just one question on your fixed annuity business. Can you just comment on where you've been trending from a crediting rate standpoint, especially through the bank channel. And whether or not you're -- now that rates, at least from what I've been hearing from agents, have started to come down pretty dramatically, whether or not you're going to start seeing some slippage and deceleration of sales momentum of fixed annuities? Thanks.

Hi Tom, this is Michelle VanLeer. On a new money crediting basis, over the second quarter, we started the quarter with a base rate in our one-year product of 4.6%, and we took that down about 40 basis points over the quarter, ending at 4.2 and we've taken the rate down another 30 basis points since the quarter has ended. And I think as the press release indicated, we did have sales slow down somewhat from first quarter to second quarter, but we're being very careful to manage our spreads both new and in force, to maintain them, and we expect that the 199, 200 basis point spread we have overall to stay level through the rest of the year.

Okay, and are you getting any indications from what you've been seeing, at least on a quarterly trend rate as your [inaudible] rate, that that's having an impact on sales or is it fairly smooth throughout the quarter?

Tom, actually I think you'll see it is coming down slightly, and we intend it to, because we want to be very disciplined about the base rates and continuing to take them down. I think the market is helping that the variable sales are not very popular right now, but we do expect some deceleration as we continue to aggressively move crediting rates down.

Thanks a lot.

Please continue with any closing remarks.

Thank you, operator. And thank you everyone. We look forward to talking to you throughout the coming quarter. Thank you.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may now disconnect. Thank you and have a great day.