Manulife Financial Corp (MFC) 2002 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the John Hancock investor relations third 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 you are using a speakerphone, please lift the handset before asking a question. If anyone should require assistance during the conference, please press star, then zero, on your touch-tone keypad.

As a reminder, this conference call is being recorded.

I would now like to introduce your host for today's conference, Ms. Jean Peters, Senior Vice President of Investor Relations. Ms. Peters, you may begin your conference.

Thank you, Stephanie. Good morning, everyone. Welcome to John Hancock's third quarter earnings conference call. As you know, our press release and financial supplement, released last evening after the market closed, are available on our Web site, www.jhancock.com.

We realized as we released our earnings on Halloween night that our two biggest risks were, one, the headline risks that everything would be interpreted in terms of spooky earnings and frightful accounting, or that everyone would have gone trick-or-treating and we wouldn't have gotten any calls at all. So we appreciate those of you who showed restraint in your headlines and didn't use the trick or treat analogy, and the many of you that stuck around and did call us and work through the numbers, either before or after you went trick-or-treating with your families.

This morning on the call, Tom Moloney, our Chief Financial Officer, will take you through the results of the quarter, and on hand for the question and answer period are members of senior management, including our Chairman and CEO, David D'Alessandro, head of retail, Mike Bell (ph), Chief Investment Officer John DeCiccio (ph), head of JH Funds, Maureen Ford (ph), and head of our Guaranteed Structured Financial products, Jean Livermore (ph).

Before we begin the discussion of the quarter, I'll make cautionary remarks regarding forward-looking statements. During the course of this call, we 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. Such 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, our 10-K and 10-Qs, and other filings with the SEC.

With that, I'm pleased to turn the call over to Tom Moloney.

Thank you, Jean, and let me add my welcome to you all to our third quarter conference call. Clearly, the third quarter was the latest in a series of difficult quarters for our industry, given the market volatility, the economy, and a mixed state of affairs, and new questions about DAC and guaranteed minimum death benefits.

The negative impact of all of this on Hancock's earnings was readily apparent in our third-quarter results, but there were many positive trends in the quarter as well, and we'll discuss both this morning.

Our results illustrate the fundamental strength of our products, brand, distribution, and investment strengths that make us a growing and profitable competitor in our core retail and institutional businesses.

We reported third quarter net operating earnings per share of 64 cents diluted, including a reduction of 9 cents per share related to the DAC adjustment in our variable businesses, particularly annuities. Excluding that write-down, net operating earnings per share would have been 73 cents, up from 72 cents in quarter 2, and 10.6% ahead of the 66 cents in the third quarter of last year.

The quarter's lower than usual effective tax rate of 25.6%, driven by the impact of the DAC's change on pretax earnings, as well as increases in tax preference investments. Our effective tax rate for the year will be around 28%, about where we estimate 2003 will also end up.

Spread-based earnings from protection, fixed annuities, and institutional products were strong, driven by growth in invested assets on solid sales, stable net investment spreads, and expense management.

Maritime Life, our Canadian subsidiary, recorded strong growth in pretax net income, driven by sustainable improvements in the group business margins, growth in retail from the Royal Sun and Alliance acquisition, constantly improving -- consistently improving margins in the Aetna block, and other reserve changes.

But understandably, it's been the DAC issue that has generated the most questions from the Street, so I want to talk in detail about the numbers and methodology behind our actions which we announced a week ago.

We test our variable annuity and life block for full DAC recoverability each quarter and we determined this was not a problem. At the same time, Hancock's longstanding DAC amortization practice has been to identify a reasonable long-term separate account growth rate based on historical market performance, and to assume that historical variances from the long-term rate revert over a medium term -- in our case, over five years, with caps and floors to assume reasonability.

Under our mean reversion process, once the cap is exceeded, the DAC asset is written down and further amortization accelerated to levels in line with the cap. We unlocked DAC in the third quarter because was the nearly 18% drop in the stock market pushed the reversion to the mean assumptions above our cap. We also changed our long-term growth assumptions to 8% from 9%, and reduced the cap to 15%. We revised those assumptions after looking at long-term market returns and research based on cap-end modeling. Both the long-term and medium reversion rates are gross of product fees, a more conservative approach than net of fees that will require market returns of about 150 to 200 basis points higher than stated returns.

We expect these quarterly changes to increase future DAC amortization by less than $1 million for variable annuity and variable life combined.

Although we retained our existing reversion to the mean exposure, with the new lower cap, we can quantify for you the amount of the additional charges that would have occurred if we had taken a fresh start. That charge would have been about $18 million after-tax, or some 6 cents per share. We consider that this would have been accounting change which would have permanently eliminated the reversion to the mean methodology, and that was not a good approach, in our view.

Let me further quantify the earnings sensitivity to actual market returns that fall short of our 13% reversion assumptions. If the market returns an annualized 8%, we estimate the quarterly amortization would accelerate by an additional $2.2 million for the two lines combined, or about $1.4 million after tax. We believe providing this detail of DAC makes clear that if equity markets decline, it will impact earnings. However, the dollars involved are relatively small for a company that generates about $800 million in after-tax net operating income.

In the interest of transparency of disclosure, we do intend to provide supplemental data in our forthcoming 10-Q in the form of a table that will detail the potential amount of DAC costs or benefits that could result quarterly from any variance in market performance versus our current cap.

As we announced last week, we revised net operating income earnings per share guidance for 2002, primarily to adjust for the DAC write-down. We now expect full-year operating earnings per share of $2.75 to $2.86 per share, up 5% to 9% over last year's $2.62 per share. The revised range implies fourth quarter net operating earnings per share of 71 cents to 82 cents compared with 71 cents in the fourth quarter of last year.

Turning to 2003, we have estimated guidance - we have established guidance for 2003, net operating earnings per share growth of 7% to 11%, based on our expectations of 2% per quarter equity market growth and reasonable improvements in the overall economy. However, there are still a number of concerns that are on the horizon, including the equity markets, legislative issues, terrorism, and the level of consumer confidence that could impact both our earnings and sales guidance. We expect to drive this growth through continued solid sales growth in core retail and institutional operations, effective management of investment spreads, and ongoing expense management.

We expect to see solid growth in nontraditional life, on improved equity markets and mortality, and in long-term care as that business continues to benefit from top-line growth and lower unit cost.

In annuities, the same dynamics we saw in 2002 between fixed and variable should continue, with fixed benefiting from sales growth and stable spreads, and variable struggling due to lower account balances coming into the year, and higher amortization.

On the institutional side, we anticipate continued solid growth in the spread-based business, as spreads remain healthy and asset growth, due to sales of new products such as Signature Notes. We also expect a modest pickup in independent investment along with the market. I will provide 2003 sales guidance figures a little later.

Also baked into the 2003 guidance are several offsets, including anticipated higher employee pension costs of 10 cents to 15 cents per share driven by the impact of weak equity markets on plan assets and potential adjustments to plan assumptions, costs of about 4 cents per share from the implementation on a prospective basis of expensing employee stock options. Also, we plan to discontinue our common stock repurchase program for 2003. However, we will continue to review this decision during the year.

Recently, our ratings, and those of many of our peers, have come under pressure from the rating agencies, given their negative industry outlook. Hancock's financial strength rating has been downgraded by both S&P and Fitch to AA, and we are currently on credit watch at Moody's, which has us at AA too. In addition, we are currently rated A++ by A. M. Best.

In all the public and private commentary provided by the agencies on these matters, the issue of capital has never been cited. In fact, the agencies have publicly stated that our capital ratios are strong.

On the investment side, we have factored into our 2003 earnings per share guidance about 60 to 70 basis points of principal losses on bonds impairment and 15 to 20 basis points for interest losses. Those estimates are significantly above the levels we saw in 2002 and 2001 but still above our long-term averages of 30 to 35 basis points, as the recovery in the credit markets we had expected in 2002 begins to take hold in 2003.

For commercial mortgages, we expect principal losses of 30 to 35 basis points, and interest losses of 18 to 22 basis points, as the fallout from the economy takes its toll in the real estate marketplace.

Turning briefly to Q3 results, net income was 54 cents a share, up from 33 cents in Q2, and even with a year ago, when there were 5 cents -- 5% more weighted average shares outstanding. Gross impairment on bonds and mortgages were 110 million before tax, DAC, and participating policyholder offsets.

The largest impairment, with $33 million on Enron-preferred (ph) stock, and 22 million on U.S. air equipment trust certificates. Additionally, we took about $20 million in write-downs of CDO equity traunches. These losses were largely offset by gains from fixed income prepayments, sale of equities securities, and changes in fair value of hedged securities used to provide protection in a low interest rate environment to meet the fixed rate guarantees of certain company liabilities.

Under FAS 133, the $50 million net gain on the liability hedge, though unrealized, flows through realized gains and losses.

A quick look at the drivers of net operating income for the quarter show how strong brand name and delivery -- diversified business mix and distribution, as well as our extremely strong and disciplined asset liability management, can help keep our top line growing and cushion earnings volatility in these very choppy markets. Net operating income from GICs (ph), funding agreements, and group annuities was $103.5 million pretax in the quarter, up 22% from the third quarter of 2001.

Average invested assets rose 12% and net investment margins were 142 basis points versus 143 basis points last year. Spread-based earnings included a one-time underwriting gain of $52 million from processing (inaudible) of deferred annuities. 5.2 million -- I'm sorry. Net operating income from retail fixed annuities was 33.4 million pretax in the quarter, up 26% over last year's quarter, a 34% jump in average account balances and aggressive management of crediting rates more than offset a drop in net investment margins to 203 basis points from 230 basis points last year, which was unusually high due to the inclusion of some one-time partnership income.

With average renewal rates slightly over 4%, we still have room to cut further, if interest rates continue to fall, and we are redesigning products to lower guaranteed minimum rates of 2%.

In variable annuities, guaranteed minimum death benefits in the quarter were $3.9 million versus 1.4 million in the prior-year period. Net of fees, DAC, and taxes, the impact to net operating income was about 1.4 million, up from 600,000 in Q2 and 300,000 in the third quarter of 2001.

Our in the money guaranteed minimum death benefit exposure was $845 million after taxes at the end of the quarter, and that's up from 520 million last quarter. Statutory GMDB reserves were 106 million, up from 59 million in Q2. In long-term care, pretax net operating income of 33.5 million was up 10% from the prior year quarter.

In this line, lower unit costs, higher premium margins, and an increase in invested assets were only partially offset by a lower earned portfolio rate and lower policy lapses.

In Canada, Maritime Life's pretax net income was 37.5 million, up 27.6 million from a year ago. Driving the gain were favorable experiences in life, investment products, and group health, the acquisition in October of 2001 of Royal and Sun Alliance Life of Canada, and a one-time pickup of $8 million from reserve changes from investment products.

Turning to sales, core retail life sales, which exclude corporate-owned life insurance and bank-owned life insurance, reached 58.9 million in the quarter, up 33% from the year-ago period.

We continue to leverage the strong Hancock brand, innovative products, and diversified distribution channels to steadily increase sales of single life products, both variable and universal, and reduce our exposure to survivorship products, which as you know have been hurt by changes in estate rules and possibly additional legislative action.

Survivorship Life, which accounted for as much as a third of total sales a few years ago, represents less than 15% in the third quarter, as single life products have more than compensated for the drop.

Over the past year, Hancock has made good on its promises to cost-effectively expand market share by zeroing in on distributors with the capacity and the desire to materially boost their Hancock business. It is these distributors who get the most wholesaling and servicing support.

Today, we are providing update retail sales forecasts for 2002 and establishing guidance for 2003. Core life sales, which includes -- which exclude corporate-owned life insurance and bank-owned life insurance, are expected to end the year up 17% to 22%, driven by continued success with our new single life variable and universal products. The previous forecast was for growth of 15% to 20%.

For 2003, we expect core life sales to be up 12% to 17% as we leverage the deeper distribution relationships developed in 2002 to win greater market share.

The forecast for Total Life, including corporate-owned life insurance and bank-owned life insurance, remains 3% to 10% growth due to the lumpy nature of COLI (ph) sales. For next year, we estimate Total Life sales will be flat to up 5%, again due to uncertainty around the corporate-owned life insurance business marketplace.

Total annuity sales growth is expected to be 55% to 65%, up from the previous estimate of 30 to 45%, thanks to the very strong fixed sales in the first half of the year. The group -- the growth was primarily driven by Essex, our third-party marketing subsidiary, and proprietary deals. We expect annuity growth to moderate substantially to 10% to 15% in 2003, given the large increase in fixed sales in 2002 and variable annuity sales remaining under pressure.

Long-term care sales are expected to increase 17% to 23%, up from previous guidance of 8% to 14% for 2002 on the strength of our new individual products.

In 2003, long-term care is forecast to increase 15% to 20%, building on the momentum from 2002. The guaranteed and stable value products sales growth is planned to be about 12% to 15% from growth in signature notes, annuities, and several new structured products. We anticipate that GICs (ph) and funding agreement sales will be about flat with 2002.

To wrap up, even though 2002 turned out to be a much more difficult year than any of us expected, Hancock executed the strategy we promised, leveraging diversified products and distribution, innovative products, effectively managing the growth and profitability of our institutional spread business, and deploying a superior investment operation to maintain spreads. As we head towards 2003, we are fully committed to increasing shareholder value with all the tools available to us.

Now let's open the call to questions.

Operator, let's go to the question and answer period, please.

Ladies and gentlemen, if you have a question at this time, please press the 1 key on your touch-tone keypad. If your question has been answered, or you wish to remove yourself from the queue, please press the pound sign. Once again, ladies and gentlemen, if you have a question, please press the 1 key on your touch-tone keypad.

One moment for our first question.

Our first question comes from Michelle Giordano from JP Morgan. You may proceed.

Good morning. I have a few questions. First, Tom, can you address what would happen -- what would be the impact if you did get downgraded by Moody's? What would be the impact on funding costs and sales?

Secondly, why such a big range in earnings guidance for the fourth quarter? I know typically you've had a bump-up in earnings from third to fourth quarter, but it seems like this is an unusually large range. Is there any scenario where you can get 82 cents in the fourth quarter? And then the third question is, if you could address, you know, just the capital situation, what you currently have available in terms of excess capital.

Okay. In the -- let me go kind of in the -- regarding the wide range on the earnings. I think there really is -- just because of the uneasiness around the whole marketplace, there are certainly some things that could happen that could move you up, but I think that, you know, the range is there to give people some movement and some room to do their estimating in. And I think it's also probably indicative of what you see in the First Call estimates. There's some pretty wide variations there.

As far as capital goes, we have $150 million of excess capital and we measure that, remember, Michelle, with that over 325 -- anything over 325% RBC, so it's a fairly high level.

Debt capacity is the same as we've talked about because we've done nothing. It's 250 million to 300 million. You know, preferred shares, you know, some type of hybrid instrument, you could probably do 5 to 750, and as we've talked about before, there's about $1 billion in the closed block securitization.

In the rating agency front and particularly -- I guess it's, you know, Moody's with the credit watch and everything else, I think bottom line is, the issue would be if it's a one notch downgrade, there's probably not a lot of impact overall on the company and everything else. And I think that if you went to a single A rating, that would probably create some issues with the GICs (ph) because of the legal requirements from the Department of Labor for them, and what it would do on the funding agreement side, it would actually increase the -- it would increase clearly our cost of funding overall.

Great. Thank you.

And I think the likelihood is that, you know, would probably be a single notch downgrade, if anything. But, you know, I don't --I don't do the ratings.

Okay. And when do you think we'd have some resolution on the rating?

I have -- I couldn't tell you. That's a call that Moody's makes, not me.

Okay. Thank you.

Our next question comes from Eric Berg (ph) from Lehman Brothers. You may proceed.

Hi, and good morning to everyone. Tom, I have a question regarding accounting policy at John Hancock, and it is -- if you agree with me that the accounting should reflect not necessarily what you're required to do, but the underlying economics of the business, why don't you establish a GAAP reserve for the guaranteed minimum death benefits? I realize that the guidance hasn't been formalized, but we know that there is exposure there, as evidenced by the statutory reserve. Wouldn't it be the conservative and right thing to do to establish a reserve on your GAAP financials?

Eric (ph), we've spent a lot of time on looking at that very question overall. And, you know, there's a lot of things one would like to do. But, you know, given the fact that you have to follow what GAAP says, and our interpretation in working with our own audit firms and everything else, there is -- you know, that's the call we've made. I think that the statutory number, the hundred million, is way, way too conservative a number and all.

And also, you have to think about the fact is that, you know, as I indicated, the real impact of the guaranteed minimum death benefit on us has been really a very, very small, and we charge for it and everything else. So it's really not a big number. So I think the reserving would be relatively small.

So it's an issue we continue to look at. We're actually -- have a group that's looking at the new Financial Accounting Standards Board, and as you know from reading that document, it's complex.

Right.

And the fact is that, you know, one of the first things you have to do is go through a complicated process of determining whether your products are insurance products or whether they're investment products, and then there's a whole stream of rules that you have to run down. We have a new system in place that we're using to go through all of that modeling.

Okay. One other quick follow-up. In -- with respect to the DAC, I think you said -- I hope I understood you correctly -- in the beginning of your comments that, as a result of your unlocking the DAC amortization in the future will be modestly higher than it would have been, had you not made the unlocking. I'm a little bit confused, if I have that -- if I have your statement right, because I would think that having written down DAC, and therefore having less DAC on the balance sheet to write off in the future, but with the same number of years over which to write off the DAC, your DAC charges prospectively would be lower than they would have been absent this change, not higher.

I hope that hasn't been too confusing.

No, I understand the -- I understand the question, and I've spent more time than I care to in the world of DAC these days, and I'm going to ask Barbara Luddy (ph), who is designated the DAC person of the company, to respond to that.

Okay. Thank you.

Hi, Eric. It's Barbara Luddy (ph).

Good morning, Barbara.

Good morning. I think you're absolutely correct that over the remaining lifetime of the business, it has to work the way you've described. Because we've taken a charge to earnings, we have to amortize less in the future. The amount that's assigned to any particular time period can depend on a few different things, though. I think you understand the dynamics. There's a K factor, which is a ...

Right.

-- percentage of profit margins that you amortize. With the DAC unlocking change, the K factors goes up, the margins go down.

Right.

So the amortization in any given period is the relationship between those two dynamics. We believe that near-term, there's going to be a very slight acceleration of amortization. Longer-term, it should decline.

That pretty much solves the puzzle, or the riddle. Thanks very much.

Our next question comes from Joanne Smith (ph) from UBS Warburg. You may proceed.

Good morning. I have a couple of questions. Tom, if you could just take us through - there seems to be a lot of moving parts here, in terms of the guidance for '03. You know, on the one hand, you're expecting strong sales growth, you're expecting relatively stable spreads. You know, we're not obviously, you know, looking for any significant changes in mortality or morbidity experience.

On the other hand, we're also looking for higher pension expenses, for option expensing, increased amortization of DAC, you know, and all of these other things, and I'm just wondering, you know, if you could kind of take us through a little bit --in a little bit more detail how we get to the 5 to 9% growth. I mean, just the impact of the pension is giving me problems in my model, so if you could -- if you could take us through that.

And then the other question is, when you analyzed your DAC and decided whether to take a fresh start approach or not, I was wondering if you could take us through some of the assumptions, because I'm wondering if the assumptions are for continued sales growth in that business and how that impacts your view to the -- to the asset going forward, or if you actually took the scenario as if you were putting the business in, like, a runoff mode. So if you could take us through that as well.

That's a mouthful.

I'm sorry, I'm sorry.

Let me start with trying to -- trying to get you into, I guess, a comfort zone on the 2003 guidance of 7% to 11%. I think, you know, clearly you have to start off with that we are assuming some year-to-year mortality improvement given the first quarter call was totally consumed, I think, with mortality issues and everything else. So clearly that's one of the big items that I think you really have to think about.

Also, when you stop and look at the revenue growth that has taken place over the last couple of years, both on the institutional business side as well as on the -- on the retail side, those items are starting to take traction in these -- in these earnings projections. There's improved separate account performance that is showing up. Clearly long-term care, as I mentioned, there's improvement in the unit cost, and also in the growth of that business, throwing off additional margins on the investment side.

And also, you know, when you talk about the long-term growth, there's also growing assets on the fixed annuities side. You're getting full-year effects of those that you sold later in the year there, as well as part way through the year. That's true of our institutional business.

The federal long-term care case is starting up in 2002, which there was nothing in the current year, and probably somewhat of a small drag from expenses. And with, you know -- overall, with kind of the continuing expense management that we've talked about, we've continued to manage that very, very closely across the -- across the whole organization.

So it's not -- you know, there's not any one kind of place in the -- in the whole organization. There's a whole series of positives. And then you do have the three kind of negatives that we outlined for you: The pension costs, the stock options, as well as the -- stopping the program on the stock buyback program.

Tom, if I could just -- if I could just follow up for a second here before we move onto the next question. If I'm thinking about looking at the spread-based businesses and I'm looking at the type of credit losses that you're expecting, as well as at least where annuities are concerned on the retail side, you've got a fixed annuity portfolio that's growing quite rapidly, but it's a relatively small portfolio, so as you put new money on to work, to support that portfolio, it's coming on at lower new money rates and that -- and because of the size of the portfolio, it should be having a much larger impact on the total portfolio yield.

So if I'm looking at spreads and I'm looking at, you know, the -- what's going on in the investment portfolio and I'm looking at what's going on in the credit loss side, I'm concerned that we're going to see a pretty meaningful decline in spreads in '03. And can you just make me feel better about that?

Well, I don't know if I can make you feel better about it but at least let me give you my answer and then we can go from there. And I -- you know, if you want, we can probe into the investment side by having John speak a little more about it.

But remember, on -- even though the -- you're bringing on assets at a lower rate, as they come into the portfolio, sure, there will be some diminution in those -- in those overall earned rates. But as I indicated, we're still over 4% on our current crediting rates on the portfolio. And so we will continue to plan on, as long as the rate -- interest rates are going down on new money, we'll continue to lower those crediting rates, and plus the actions that were taken this year in lowering those rates -- and they have been aggressive -- you'll get a full-year impact into the current year. So you got to take not only what's happening this year, but also what has -- what's -- "this year" being -- when I was speaking, I was talking 2003 versus what has happened in 2002.

And a lot of the credit losses that -- you know, the write-downs that have been taken that we talked about, those were in non-accrual state anyway for most, or a good portion of 2002. So they weren't really contributing to the 2002 earnings rate. So there's a bunch of dynamics that are working through. We've spent a good many hours -- David has a very thorough planning process. Most people have other names for it, but a very thorough planning process in which we go through and break down all of those numbers, dig behind them, and it actually starts with John DeCiccio's area (ph) with the generation of investment income, and it goes right through all the business units. So we're feeling pretty comfortable with what we have here as the -- as the overall guidance.

Okay.

Oh. What was the other -- the DAC question. I think Barbara may have forgotten it by now.

Joanne (ph), I think you were asking do we assume new sales or a closed book of business, and whenever you would do DAC on logging for your book of business, it's only on the business that is currently in force, so the annuity business, which is largely single-premium business, there -- you know, there wouldn't be an expectation of much additional revenue coming into the business on the life side, where it's generally annual premium business, you get renewal premiums from the business that's on the books but you would not make assumptions about new sales just as new sales are brought into the company. They're valued using your now current assumptions.

Our next question comes from Bob Glasspiegel (ph) from Langen McGowney (ph). You may proceed.

Good morning. If I could look at page 30 of your stats supplement, the middle column, it looks, digging behind the numbers, as if there's been some conscious effort, on my superficial analysis, to upgrade the quality for the first quarter and sometime the BAAs as a percentage of total fixed went down and the junk (ph) went down, but more than sort of the write-downs in the quarter, is that a valid superficial assessment, or is there something else behind the numbers explaining the higher concentration of A and better in the total?

Bob, this is John DeCiccio (ph). In terms of the structure of the portfolio, during the third quarter, as you're probably well aware, the bond market was very spotty in terms of the opportunities available to us, and we really have taken this opportunity to put some money into very high-quality CMBS senior traunches and basically parked the money there. We don't want to hold it in cash, obviously. But we get decent spreads, and we get reasonable income on that basis, and we've used that as a parking opportunity.

.Also, it will be an opportunity going forward for some portfolio management to improve spreads going forward. So we've reflected the market. We're not going to push on a string. And we're basically very happy with this quality investment.

So there's no sort of negative spread implication beyond -- I mean, I know it's embedded in whatever your guidance. But I guess it could help spreads on the to the extent that you unpark (ph) the money, but this isn't a long-term, you know, position that you're taking here?

Well, it's not a long-term position depending on how the market performs. I mean, if the market -- if the bond market just doesn't come back in issuance for a few more quarters, we're not going to be moving out of those positions, but that's in our projections as well.

And does that affect -- I assume that does affect your marketing plans, then, as well. You're probably less aggressive to the extent that you're parking new money in higher-quality stuff.

Our pricing does reflect the -- what we expect to get in the way of investment acquisitions. You're right there.

The other point I wanted to make, maybe it's not as clear to everybody, but we make quite a lot of discussion about the fact that we do take credit risk, but we avoid interest rate risk, and I think the reason that a lot of our spreads have been holding up very well in this environment is because we're not suffering the penalties of prepayments the way that you would be if you had done a lot of mortgage-backed securities that were not call protected the way our commercial mortgage-backed are, and the way that most of our portfolio is call protected. So I think that's something that people need to take into account.

Thank you, John (ph). That's helpful.

Our next question comes from Vanessa Wilson (ph) from Deutsche Bank. You may proceed.

Thank you. Good morning. Tom, could you give us a sense -- you gave us a sense of where your capital position is today. What is your ability to generate fresh capital in the balance of 2002, and looking out to 2003? And then I had another question regarding competition in the guaranteed investment contract funding agreement area. You're taking a cautious look ...

Vanessa, we're having trouble hearing you. Could you speak louder?

Okay. Did you hear any of the first question?

Hello?

Just repeat it briefly, please.

Okay. The first question was asking what type of capital -- what levels of capital you can generate in '02 and '03. And the second question relates to competition in the GIC (ph) and funding agreement business and your cautious outlook there.

Okay. Let me handle the capital question, and then Jean (ph) will take on the - Jean Livermore (ph) will take on the funding agreement question and all.

As far as the capital generation, Vanessa (ph) , the -- our outlook for this year is to generate about $640 million worth of statutory earnings. That's down a little from our normal 700 million or so, and that's primarily -- you know, as we've talked in the past, the growth in our fixed businesses, both fixed annuities and also the GICs (ph) and funding agreements and the -- and now the signature notes, because they require higher capital requirements. Also, in the universal life area and all, because Mike's been doing a great job there. And those are actually run through your statutory earnings.

And on the 2003 number, right now what we're looking for is somewhere in the $700 million range for additional -- you know, back into the more normal run rate of the company's statutory earnings and all. And with the slowdown also next year, or anticipated slowdown next year in the capital issues around the bond and mortgage portfolio, net-net, that also will help to grow surplus as well.

And Tom, with the realized capital losses that you expect next year, how would that affect that number?

I'm not sure of the question, Vanessa. You mean the 65 basis points that we've got in there?

Yes.

Vanessa, John DeCiccio (ph). In terms of the gross losses, the 65 basis points on the bond portfolio, it would be a little bit over 300 million of gross losses. That's, of course, before DAC and the pass-throughs to the closed block and taxes and all of that sort of thing. And any gains that we might take.

And we still have expected by the end of the year, we probably have about 100 million of unrealized equity gains that we will have.

Thank you.

Our next question comes from Caitlin Long (ph) from Credit Suisse First Boston. You may proceed.

I think we have one other question left from Vanessa.

Okay. So this is Jean Livermore (ph), and Vanessa (ph), you asked about the competitive environment in the GIC (ph) and funding agreement market. In the GIC (ph) market, we've actually seen our quotes down about 28% so far this year. So basically we have a smaller market with the same number of competitors, and so it has been very competitive. We haven't been chasing the market, so we've actually been losing a lot of the quotes by wider margins than normal.

So if you compare our GIC (ph) sales year over year, we are down. But again, we're not going to chase that market.

In the funding agreement market, what you saw is very strong first half of the year -- if you look at industry data, they wrote -- or the industry wrote between $20 billion and $21 billion of funding agreements in the first half of the year. And then if you look at just the third quarter alone, it's less than $4 billion. So you've seen a real slowdown, and I think that is reflecting sort of the market uncertainty that we have.

And with the rating downgrades and the concerns about the insurance industry, both domestically and internationally, you've seen insurance company spreads widen more than the marketplace, and so there has been much less issuance in that marketplace. And again, we like that market generally because of the low cost of funds, and if we're not going to get the low cost of funds, we're going to be -- we're going to hold back a little in that market.

Let's go to Caitlin Long (ph) now, please.

You may proceed.

Thanks. Actually, a great segue from Vanessa's question about the capital losses impacting your ability to form capital next year. You talked about the capital gains. Are we expecting to see some of those in the fourth quarter? And what's the guidance for credit losses in the fourth quarter generally? And then also, what about the reports in the Boston newspaper that your building is for sale? I presume you have a nice gain on that?

Caitlin, this is John DeCiccio (ph). In terms of fourth quarter guidance, I think we've said before we expected about $100 million of bond gross losses. We would also be expecting some mortgage losses, so we'll be close to about 110 million of losses in the fourth quarter, is our expectation.

In terms of the capital gains situation, we plan to take about 20 million of capital gains in the fourth quarter, we said before, at the last conference call, but the hundred million I quoted is where we'll be after we take those gains.

Caitlin, this is David D'Alessandro. Let me answer your question about our building. The "Boston Globe" was actually incorrect, despite what has been written since then. We are simply studying the issue. As you know, many public insurance companies do not own their home office real estate, and it's, of course, leaking the moment you ask for an estimate anyplace, you immediately get a number of rumors.

But we are clearly seriously looking not just at our tower, but we're looking at all of our home office properties, of which there are quite a few. We expect to complete that analysis sometime in the coming 4 to 6 weeks, and make a recommendation. But we still haven't decided, even at that, as to whether or not it makes sense to bundle all the properties or look at selling them individually should we go forward, and that's also because we're concerned about, if we were to go forward, the issue of whether or not they are not only more valuable as a group versus individually, as well as worrying about missing the market.

I would -- I would love to give you what you're probably looking for for your capital models, and that's what the book value and the capital gain, but I'd rather not prejudice the valuation at this stage since, since that article appeared, I've gotten no less than 25 phone calls from serious real estate people around the world. So I'd rather not tip them at this point as to what we're looking at, but we'll be -- when we -- should we go forward, we'll be glad to fill in that information.

Okay. Great. And then John (ph), just to follow up on your Enron exposure, what's the balance of that at this point?

Okay. The balance of the Enron exposure is $110 million. We did receive a $10 million pay-down from Enron-related entities during the third quarter, and the way that was split out is about 50 million of that 110 would be a senior unsecured claim against Enron, and about 60 million of that is based on basically a call on assets that the -- that Enron had, direct call on assets.

Of the 60, 20 is basically performing, and we are receiving principal and interest on that investment, and 40 million looks like it will be restructured, and we are following those activities right now.

Okay. Thank you.

Our next question comes from Peter Monaco (ph) from Tudor Investments. You may proceed.

Good morning. Thanks for your time. A couple questions, Tom. What is the scope, at this point, for further operating expense reductions out of the approximately 1.35 billion run rate that I think it is? Secondly, can you talk more specifically, please, about what precisely you would need to see on the economic and market landscape in order to reinitiate the share repurchase program?

And related to that, when and if you do reinstate the share repurchase program, can we assume that you will be as aggressive as you can possibly be under the prevailing then circumstances, particularly as and if, at that point, you have a cash hoard related to either the sale of the tower, a closed block (ph) transaction, or both? Thanks a lot.

Thank you, Peter, for your questions.

On the -- on the operating expense reductions, we have not put a final stake in the ground but, you know, what I can tell you is that we continue to be very, very aggressive across the company overall from an expense reduction. So I'd say that somewhere between 20 million and 30 million is not an unreasonable kind of number, although I think with what's going on with the growth in the company and everything else, it will be hard to be able to say that there will be net reductions, as we've seen in the past, of expenses. We continue to be very aggressive on that front, and I see no reason to let up on it.

On the share program, on the share repurchase question that you had -- and, you know, when would we relook at it, what would be the economic environment -- I think as we look through and see what may be happening later in 2003, my real focus will really be on how well the equity markets are behaving. Also, on the credit losses, from an overall perspective. Are we doing better than what we had been anticipating? You know, all of this is predicated on the assumptions that we've laid out in our -- in our plan in the press release and what I've just talked about. So it will be measuring against that overall results.

And, you know, as far as hypothetical results, we'll have -- actually deal with those when they become actual events, because there's a lot of work to be done between now and doing any one of those events. So we'll deal with them, we'll talk with everyone, and we'll let you know on that point.

And if we were to go back in to the marketplace on a stock buyback program, as I've indicated to everyone in the past, we will continue to be very opportunistic in the deployment of that capital in the stock buyback program.

Thanks a lot.

Our next question comes from Junek Mats (ph) from Sanford Bernstein. You may proceed.

Hi. Just a question on the fixed maturity portfolio. I think in the second quarter, about 42-odd percent were in privates, and I'm wondering if you have the comparable number for the third quarter ..

We can't hear you. Can you pick up your handset, please?

Yeah. Can you hear me now?

Yes.

Okay. It was a question about the fixed maturity portfolio and what percentage of that portfolio was in private placements. I think the number was 42% last quarter. And then, just more generally on that same topic, I mean, with account values or asset values fluctuating so much, how do you get comfortable with the carrying value of the private placements? What sort of accounting assumptions are you using?

This is John DeCiccio (ph) speaking. The portfolio is still roughly about 42% in private placements. In terms of the valuations of those private placements, we basically do that every quarter. We get all of the public and 144(a) bonds, where there are broker quotes available. That helps us to look at what the spreads are in the marketplace for various qualities and various industries, and various maturities. And with those broker quotes, we are able then to use that information in developing spreads in the private placement area, and we use those spreads informed by the current broker quotes to help us mark-to-market the private placement securities.

Thank you.

Our next question comes from Steven Schwartz (ph) from Raymond James. You may proceed.

Good morning, everybody. I want to ask a few questions here. John, I was wondering if you can kind of run down where you are these days on airline exposure vis-a-vis ETCs (ph), which seem to be the most risky class. And then, how much exposure is remaining on the CDO. And then I got a couple of others.

Hi, Steven (ph). In terms of the ETC (ph) exposure, we have a total ETC (ph) exposure of $558 million, in our portfolio for the airlines. We also have about 684 million of double ETCs (ph), which as you know, are much higher in the -- in the whole capital structure, and they're very - have been very secure.

In terms of the CDO holdings, currently we have about $1.3 billion of the investment-grade CDO holdings. We have about $87 million of what are below investment-grade traunches. And we have 50 million of equity, which is the riskiest portion. But of that 50 million of equity, 25 million are backed by investment-grade securities, rather than below investment-grade. The other 25 are backed by below investment-grade.

Okay. Thanks, John. I appreciate that. Just a couple of other quick questions here. Variable annuity sales in financial institutions took off in the quarter. I was wondering what was going on there.

Hi, Steven (ph). It's Mike Bell (ph). The third quarter variable annuity sales were driven by sales of a product we have with a guaranteed fixed rate bucket, and as the rates continued to come down through the quarter and through September, we decided we couldn't support that guarantee anymore and we pulled it. Now, we had to give notice when we did so there was a little bit of a rush there but that product is out of the market.

Okay. And then just quickly, if somebody can talk on LTC (ph) -- this is a little bit off point, but I was wondering about claims patterns. I've talked to a couple of people in the retail LTC business who are pointing to extensions of claims, maybe claims that are going a little bit longer than anybody thought, and what that -- what that might do to your claim reserve. I was wondering if you saw that.

Hi, Steven (ph). This is Michelle van Lear (ph). We're not seeing that in our claim experience at this point, both in terms of severity, duration, extensions that you'd be talking about. And, you know, frequently or incidence. Things are running within, you know, our same actual to expected that we've kind of been reporting quarter over quarter.

Okay. Thanks. Let's let somebody else take a chance.

Steve, this is David D'Alessandro. Let me just add a comment. When you look at the extension of claims in that business, it's important to also look at the underlying product that was sold to begin with, because the product sold years ago, seven, eight, 10 years ago, as well as even recently, have some different features in terms of not only the product itself, but how long claims are supposed to go.

And there were some very, very, very aggressive underwriting and some very, very aggressive pricing in the marketplace as it continues today, as we saw in annuities some years ago, so I would not be surprised if some people are saying that they're seeing claims hang around a little longer than they expected. And I think a lot of that has to do with their basic product design to begin with.

Okay. Thanks.

Our next question comes from Ronald Macintosh (ph) from Fox Pitt Kelton. You may proceed.

Thank you. Three quick questions. One for Tom. It looks like your DAC amortization was 8 million higher, even after the unlocking. Do we look at that as saying that you actually put some of the un-locking through operating earnings, i.e., you did your unlocking at July 1st instead of September 30th. And if so, does that 8 million come back in the fourth quarter, given the markets are up 10%? That's the first question.

The second question, I think you have mortgage loan defaults going up this year -- as I recall, I think you cried wolf on that issue a year ago. I'm asking now whether you see a part of the country or part of your portfolio that looks a little softer than it did perhaps a year ago.

And then lastly, for David, is industry consolidation dead?

Ron, let me take the first one. Then John will follow on with your question. On the DAC amortization, I think kind of the summary answer that you gave is the right one, that we actually did do the adjustment for the quarter, you got acceleration, and then we did the DAC write-down, so you must be looking inside our books here. John?

Ron, this is John DeCiccio (ph). This is the boy who cried wolf. In terms of the mortgage portfolio, we do an internal analysis and we look at the fundamentals, obviously, in all these markets, and we then calculate where we see softening, and basically where we're seeing the softening is in the retail sector of our portfolio. We're looking at that very closely, and that would be the area we would expect losses.

Now, having said that, I have to tell you our 30 ,60, and 90-day decline delinquency at this point are cinch, but nonetheless, we have to think that the fundamentals have weakened and we would anticipate during 2003, something will be coming at us.

Thank you.

Hi, Ron (ph). It's David D'Alessandro. I know we'll all be spending quality time next month when we are in our investor conferences, and I'm sure I'll get some questions on this subject, but I'll give you my short answer right now on industry consolidation.

I certainly don't think it's dead. I believe what's happening is -- certainly the Europeans won't be around for some time, and there may be a couple of companies in this -- in this country that are at least gasping for breath at the moment. But I believe what's now going to happen is we're going to start seeing something I suggested to you a few years ago should happen, and that is, when people are -- get past some of these crises and the markets come back a little bit, I think there will be serious questions about the ability of many companies to grow, not only double digit, but also to be able to price to market, and we may see some of that domestic consolidation that we hadn't seen in the past.

Now, there are some barriers to getting that done, but I do think we're going to see much more of that when people get breathing room.

Thank you.

It appears there are no further questions, ma'am, if you would like to continue.

Thank you, operator. I'd like to conclude the call.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program. You may now disconnect. Everyone have a nice day.