美國再保險集團 (RGA) 2011 Q3 法說會逐字稿

Good day and welcome to the Reinsurance Group of America third quarter 2011 results conference call.

As a reminder, today's call is being recorded.

At this time I would like to introduce the President and Chief Executive Officer, Mr.

Greig Woodring, and Senior Executive Vice President and Chief Financial Officer, Mr.

Jack Lay.

Please go ahead Mr.

Lay.

Thank you, good morning, and welcome to RGA's third quarter 2011 conference call.

Greig Woodring our CEO is with us today.

I will turn the call over to Greig after a quick reminder about forward-looking information and non-GAAP financial measures.

Following Greig's prepared remarks we will open the line for your questions.

To help you better understand RGA's business, we will make certain statements and discuss certain subjects during this call that will contain forward-looking information, including among other things investment performance, statements related to projection of revenue or earnings, and future financial performance and growth potential of RGA and its subsidiaries.

Keep in mind that actual results could differ materially from the expected results.

A list of important factors that could cause actual results to differ from expected results is included in the earnings release we issued yesterday.

In addition, during the course of the call, we will make comments on pretax and after tax operating income, which is a considered a non-GAAP financial measure under SEC regulations.

We believe this measure better reflects the ongoing profitability and underlying trends of our business.

Please refer to the tables in our press release and quarterly financial supplement for more information on this measure, and reconciliations of operating income to net income for the various business segments.

These documents and additional financial information may be found on our Investor Relation's website at www.rgare.com.

With that I will turn this over to Greig for his comments.

Thank you Jack, and good morning to everyone.

Overall claims experience was slightly higher than we expected this quarter, but well within a standard deviation, and weak equity markets and low interest environment also adversely affected our asset intensive business.

Like most quarters underwriting results were mixed by segment, with good results in Asia Pacific and Canada were offset by weak claims experience in our US and Europe and South Africa segments.

Operating income was $152 million or $2.04, up from last year's $128 million or $1.72 per share.

Current quarter results include a tax benefit associated with the impact of previously enacted tax rate reductions on deferred tax liabilities in Canada, amounting to $33 million, or $0.44 per share.

Statutory tax rates both at the federal and provincial level have been lowered, and the adjustment relates to applying the lower rates to the related deferred tax liability on the balance sheet.

Since we built up a sizable deferred tax liability in Canada over time, the adjustment to reflect the lower enacted rates was reasonably significant.

Foreign currency fluctuations helped operating income by $4.5 million, or about $0.06 per share.

Annualized operating ROE was 14% for the quarter, and 13% over the last 12 months.

Consolidated net income totaled $147 million, or $1.98, up from $128 million, or $1.72 per share last year.

Reported premiums were $1.8 billion, up 8% quarter-over-quarter.

The third quarter of 2010 included a one-time annuity premium.

Ignoring that, premiums increased about 7% in original currencies.

Investment income was off 7% this quarter totaling $268 million, with a yield of 5.29%, with which is down 37 basis points from last year's third quarter.

Contributing to this decline in investment income was a net $38 million decrease in the fair value of option contracts supporting equity index annuities.

Excluding those contracts investment income was up 6% quarter-over-quarter, despite the decline in yield.

Our net unrealized gain position grew to $1.1 billion, an increase of 46% since the second quarter, adding $4.81 to book value per share, which is now $77.29.

Excluding AOCI book value per share is $59.48.

The current interest rate environment continues to put downward pressure on our overall portfolio yield, as we invest new money at lower rates.

Our third quarter yield was 5.29 compared to 5.66 last year as we said, and 5.35% in the second quarter of this year.

While this trend adversely affects our investment income, we don't feel that it will force us to drive down deferred acquisition costs, or to bolster reserves or capital even if low interest rates persist for five years or longer.

RGA's results continue to be primarily driven by our ability to price mortality and morbidity risks.

While we closely manage market risks such as interest rates and equity markets, they are secondary to mortality risk for our overall performance and long-term outlook.

Regarding the new accounting guidance on deferred acquisition costs which will take effect early next year, we expected to reduce capital by about 6% to 9% excluding AOCI, further we project operating income to be adversely affected by 6% to 10% in 2012.

This is a non-economic accounting change, this simply changes the timing of expense recognition for certain acquisition costs.

The impact to income reflects our relatively high organic growth in recent years, and the long amortization periods for our mortality business.

Turning to segment results, our US traditional business reported pretax operating income of $83 million, compared to $101 million last year.

Mortality experience was adverse by less than 0.5% this quarter, while prior year quarter was in line with expectations.

Premiums were up 4% this year, and totaled $971 million.

Our asset intensive business in the US results were hampered by poor performance in the equity markets during the quarter, and we reported pre-tax operating income of $1 million, down from $14 million a year ago.

Despite the poor results this quarter, this business has done well on a year-to-date basis.

Our financial Reinsurance business continued to grow this quarter, as it has all year, reflecting strong fee income, this business added about $6 million to pretax operating income, up from $4 million a year ago.

Turning to Canada, pretax operating income $36 million, up 28% over last year's result of $28 million, both results were very good, and reflect favorable mortality experience in each period.

Premiums totaled $186 million this quarter, a decrease of 10% from last year's $206 million, which included a one-time bump of $43 million from a new longevity transaction.

Premiums were up 14% excluding that transaction.

Favorable foreign currency movements added about 5% to the current quarter growth.

Turning to our International operations, first in Asia Pacific, pretax operating income increased 15% to $31 million, compared with $27 million last year.

Good results in Japan, Hong Kong, and southeast Asia lead the segment.

Premiums rose to 20% to $328 million, with significant help from weaker US dollar.

In local currencies, premiums were up 7%, year-to-date premiums are up about 5%.

Next our Europe and South Africa segment reported pretax operating income of $14 million for the current quarter, down from $16 million last year, reflecting adverse claim results in several European markets, Results in the UK operations, the segment's largest, were held in line with expectations this quarter.

Premiums were up 23%, to $286 million, compared with $233 million last year.

Ignoring the lift from currency fluctuations, premiums rose 19%, a strong result.

Year-to-date premiums are up 21% excluding currency, well ahead of our expectations.

In summary, ignoring the Canadian tax benefit, the third quarter results came in below our expectations, with some mixed underwriting results and market driven adverse results in our asset intensive business.

Nonetheless, we are pleased once again with the relatively strong operating ROI, along with the life insurance industry, we continue to face challenges associated with stock market volatility and low interest rates.

However in our initial life reinsurance, our results should continue to be more stable, due to lower asset leverage and our diminished reliance on investment performance to generate profits.

We have persevered through weak macro environments in the past, and are confident that we will successfully navigate through the current conditions.

We repurchased about 838,000 shares of common stock during the quarter for $43.1 million.

RGA remains focused on delivering consistent returns for our shareholders, along with strong capitalization and market positions across the globe.

We appreciate your support and interest in RGA, and now we will take any questions you may have.

Thank you.

(Operator Instructions).

And we will take our first question from Steven Schwartz with Raymond James and Associates.

Hey, good morning everybody.

A few, I want to stick to this, and I will get back to the queue for later.

I want to stick with corporate and other right now, a couple of issues with regards to tax rate, generally speaking that has been, excluding the Canadian thing obviously, that has been lower in the third quarter, I think that is a seasonal thing surrounding FIN 48, if I remember correctly, or maybe I have got this backwards, and then interest expense in corporate and other as well has been historically low, I think that has to do with some tax audits.

Maybe we can talk about why that didn't happen in the quarter?

Yes, Steven, this is Jack.

You are right.

If you went back historically, normally we would clear a tax year in the third quarter.

I am not talking about last year, I am talking about the years prior to that.

Right.

Last year it was a first quarter thing, if I remember correctly.

Yes, well, a couple of things happened last year.

Prior to last year we would typically clear in the third quarter.

Last year, we didn't, we actually cleared a return in the fourth quarter.

So you had some FIN 48 impact in the fourth quarter.

I think when you referenced the first quarter, we had a tax reserve adjustment that did have some impact on the overall interest expense that we had built up there, so I think that may be creating a little bit of an anomaly that you are seeing there.

Okay.

In the third quarter of this year, we did not reflect any adjustment vis-a-vis FIN 48.

There is a reasonable likelihood that we will have an adjustment in the fourth quarter, it is not assured, it just depends on where we are with the IRS in terms of clearing returns.

But to-date this year we haven't cleared any, so we had not the benefit of releasing any interest expense.

Okay.

Alright.

I will get back into the queue.

And from KBW, we will go next to Jeffrey Schuman.

Thanks, good morning.

I have a couple items and then get back in as well.

First of all on asset intense, I guess historically the correlation between those results and the market has not been that clear.

Certainly last year I think the second quarter was a down equity market quarter, but the unit earned pretty well.

Can you give us a little more perspective on why earnings were so sensitive to the market this quarter?

And then the other question is just wondering your thought process to pull the trigger on share repurchase, I think on the second quarter call you were still formulating your capital plans and I wanted to know why you have made the decision to start buying back here?

Thanks.

Jeff, this is Jack.

In terms of asset intensive, I think if you look back, I don't recall exactly the results of second quarter of last year, but if you look back particularly if you go back 2.5 years or so, when the market was really in upheaval, you saw some fairly negative operating results on that unit.

So there was some degree of correlation, it is not perfect by any stretch.

You did see some of the same, at least directional movements in our operating earnings that you saw this year.

I am referring back to the third and fourth quarters of 2008, in that time period.

Regarding the buy back, we have had an existing authorization outstanding for years, that when our stock traded off fairly dramatically in the August time period, we thought, well let's take advantage of that authorization.

We didn't go beyond that, so we ended up buying back roughly $43 million of stock at right around $50 or share or so.

We would not have anticipated that even six months ago.

We didn't anticipate the trade-off in the stocks, and so had not really planned to take advantage opportunistically of any sort of downward pressure on the stock, but we did in the quarter, and we used up the remaining authorization that had been outstanding.

Where do you go from here?

Will you seek a new authorization, or where will you go from here?

It is not particularly clear.

We do deliberate in terms of an additional authorization, but I can't sit here and tell you that we are going to buy back stock if it trades at X rate, we just haven't made that deliberation, if we think it is an opportunistic time, we will go back to our Board and have that discussion.

Okay.

Thanks a lot, Jack.

We will go next to Jimmy Bhullar with JPMorgan.

Hi thanks.

I have a question first on the reasons if you could just give us some insight into the reasons for the significant earnings hit, because of the new DAC rules, I think you mentioned the high growth.

It doesn't seem like, even based on what you wrote has been in the past few years, that the EPS seems a little bit too large, maybe there is something else.

The other question that I had, was just on the Asia business, your margins you mentioned were low in Australia, I was wondering if that was disability claims, or was that related to life insurance claims?

And then just on your plans related to capital management, you mentioned you had evaluated buybacks some time later on, but what do you see in terms of the deal environment out there, and whether there are opportunities so far, potentially to acquire blocks of business?

Jimmy, this is Jack.

I will take the comment on DAC.

We have been going through a modeling process for some time now, and commiserating with our auditors to make sure that we have not missed anything.

The result was pretty much as we expected.

So maybe our investors, I guess it is always hard to tell what the expectation is, unless you really dig into the DAC and what we have been capitalizing.

But if you think in terms of we have been building out an international operation, and there has been some expense involved there, some of which was variable and we have been DACing, and the type of costs that will be difficult to DAC if they are not related to successful efforts going forward.

So I goes my point is, we pretty much ended up where we expected to be, in terms of we expected that sort of hit to capital and ongoing earnings, primarily because of the relatively higher growth rates, particularly in the international segment over the last six, eight, ten years.

Okay.

In terms of Australia, Jimmy, the experience was less than expected this quarter.

Mostly, or maybe completely, variance due to the individual lump sum claims, not particularly the disability claims.

We had one disability account that is tracking pretty much along the way we have expected it to, and now we are off of that risk, and it should be winding down over the future, although that will happen slowly.

But Australia was slightly below what we expected for the year, or for the quarter.

In terms of the deal environment, it seems to be heating up a bit.

There seems to be a little bit more discussion right now, I don't know whether that is going to produce substantial transactions, or whether that is just discussion at this stage, but we are very active right now.

And the US margins being a little weaker, was that life claims or disability claims, because I think second quarter your disability claims in the US were elevated as well?

Yes.

On the group business it was close to expected, just a little bit worse, after a good year last year.

Okay.

In the US regular mortality business, mortality was off a bit as well, but actually we were affected more by lapse rates which I think I had mentioned in the past, lapse rates and accounting adjustments due to reporting in this quarter, than we were by strictly speaking mortality.

Mortality was off $3 million or $4 million out of $600 million-plus.

Okay.

Thanks.

Our next question comes from Ryan Krueger with Dowling & Partners.

Thanks, good morning.

Legal & General put out a press release this morning saying that they entered into a $390 million/Pound longevity transaction with RGA, I was wondering if you guys could comment on that?

No, I actually haven't even seen that press release.

We work on a number of transactions with companies in the UK, it is a very active longevity market, and have done a number of those transactions over time.

Typically what we do is a longevity swap, where we exchange actual and expected flows, as opposed to taking on assets and asset risk.

So it is a continuation of something we have been working on for a number of years, and a significant part of our UK operation is longevity business these days.

Do you consider that type of size to be a material transaction, or is this just in the course of normal business?

That is a fairly large one.

We have had a number of transactions on the longevity front that tend to be quite chunky though.

Okay.

I just wanted to follow up on the DAC accounting impact.

I was also pretty surprised by 6% to 10% magnitude.

I guess the way I was looking at it is your DAC capitalization and amortization kind of tends to run at a fairly similar amount, so I would have expected both to be reduced by around the same 10% to 15% that you reduced DAC, and not produced that big of an impact, so am I looking at that wrong, or how should I think about that?

This is Jack.

It is a little difficult to look at it that way.

Because a lot depends on the relative extent to which you are growing parts of the operation, there may be a little more expense intensive than others.

So if you take a step back look at very macro sort of ratios like that, you don't always get the right answer.

Okay.

Thank you.

Okay.

From Credit Suisse, we will go next to Thomas Gallagher.

Hi.

First is also on the DAC, and then just one on the comment on interest rates, and how it won't be a balance sheet impact for five years or more.

Just on the new DAC roles, I totally appreciate your comment that it is noneconomic non cash, but how do you all evaluate the economics of your business?

The only financials that we can see is GAAP, and I recognize that you have other sets of financials, but we don't have access to most of those in terms of statutory, so anyway, can you help us think about how you would really evaluate your business and the economics, if GAAP is not the right way to do it, or maybe it is a modified GAAP?

That is my first question.

We do look at GAAP and that is where we tend to focus.

We also internally have been creating embedded value statements for some time, as we get those more stable, perhaps we will share some of those in the future.

Statutory is not something we manage to very much at all.

And so in terms of the way you evaluate capital, you are using GAAP as your sort of evaluation of capital adequacy, as it relates to financial statements?

Yes.

So then, I guess, that the impact of book value, I guess it is just hard to get my head around how this is a noneconomic event, if this is a 6% to 9% adjustment to what you are using as book value from a capital adequacy standpoint?

Well, Tom, your point is well taken.

Noneconomic can mean a lot of different things.

I think if you look purely cash flows, it is noneconomic.

On the other hand, if your economic definition includes various ways to measure results including US GAAP, then it is hard to say it is completely noneconomic.

Noneconomic really relates to just discounting cash flows in which case this doesn't have any influence at all.

At the end of a period of time we will be in the same place as we would have been otherwise, is I guess the way to put it.

Yes.

That was my follow-up too.

Understanding that this is a change in timing and not ultimate outcome, what would the crossover be, if the initial implementation reduces book value by 6% to 9%, and earnings by 6% to 10%, is there a crossover period where we can think about earnings actually increasing over prior estimates?

Is it five years out in the future?

Can you help us think about the timing a little bit?

Yes, there is, but it is very influenced by growth rates going forward.

I will say this, we are in a very long-term business.

If you presume no dramatic changes in growth rates, it takes a period of years before you hit a crossover point, at least eight to ten years.

Got it.

Yes.

And that is just due to the long-term nature in most of your contracts.

That is right.

And last question, if I could I can on interest rates.

Can you comment a little bit about if interest rates remain where they are at today, why there wouldn't be any impact to DAC nor reserves?

Is that really, because I am thinking that you have a lot of recurring cash flows here, and long duration guarantee products, is that more, and so in some ways on the recurring premium that you are getting in the door today, unless you have an ability to reprice or reset some assumptions within the product itself, I would imagine there is going to some level of margin pressure.

Is it that you have enough cushion today?

Or is it really just at the end of the day, mortality margin is the vast bulk of your ultimate margin, and interest rate margins are just not that relevant?

Tom, it is really both of those two latter points.

The margin really relates primarily to mortality reserves that we set up, which aren't really influenced to any meaningful degree just by interest rates going forward.

If you think of our book of business, primarily a big lump of mortality business, under FAS 60 guidelines, it would take a pretty dramatic sort of influences in terms of investment yields, before we would have a capital or reserve/DAC sort of consideration, in terms of writing down DAC, for instance.

Okay.

Got it.

Thanks.

We will go next to John Nadel with Sterne Agee.

Hey, good morning everybody.

I have got a couple of questions.

Greig, on the US mortality, or on US traditional business, I guess, you mentioned mortality was only a $4 million shortfall in the quarter, but that lapse rates and timing of reporting, I guess had an impact.

Can you help us understand what that means, the lapse rate issue and the timing of reporting?

I mean, can you help us understand what that is, quantify it maybe?

Yes, John, and they weren't real big effects either, I think the lapse effect was another $5 million or $6 million in quarter say, I am doing that from memory, don't hold me to that, but it is about that order of magnitude.

There was some reporting noise, which there is always reporting cleanup or uncertainty that happens in a quarter, it goes both ways.

This quarter it was the wrong way.

The lapses have been up in our book for about the last 18 months, and we have seen an increase in lapses in the industry that are reflected in our book, and that has effected us.

There is some VOBA on some of the old Allianz business too, and when one of those particular policies that has some VOBA attached to it lapses there is a write-off of that, so lapses can affect us by both decreasing premiums, decreasing profits, and potentially some write-off of VOBA from time to time.

This quarter was a quarter where the effects of that combined with administration exceeded the morality effect.

Okay.

So and the lapse rate issue is, I imagine it is something that is probably more economically sensitive, and we might expect that to continue?

Well, we don't know.

It seemed to jump up for a while there.

It could be that, it could also be some financed business that is just no longer needed, it is hard to say this early in the game, but it is clear that lapse rates have moved up from our last study to the one before that.

Okay.

And then on the DAC accounting item, just to come back, because there is a lot of noise in your GAAP statements around DAC, particularly from the movements of the embedded derivative items in the asset intensive segment, can you give us a sense, if you stripped out asset intensive, what level of capitalized costs and what level of DAC amortization should we be basing our adjustments off of?

John, this is Jack.

That is a hard one to answer.

When you say basing your adjustments.

In terms of writing off existing DAC is one thing.

Where should we be focused.

I guess this is more of a modeling type question, but where should we be focused on the lower DAC amortization going forward, but the higher level of non-deferrable expenses.

I assume from your commentary that we should be focusing that on the non-US segments, but if you could just help us, that would be great?

Yes.

I am not sure I can break it down.

I am not sure we are prepared to break it down in terms of the operating segments.

I will say that the more dramatic effect will be on the international segments for the reasons that I mentioned earlier.

We were relatively speaking capitalizing more costs in the DAC balance, than we would for instance in the broader mortality block in the US, because the expense load was lower in the US.

I would facultative business will have a higher effect, but I wouldn't expect that the asset intensive business would be unduly bad.

I was going to mention that, you should essentially the DAC adjustments that we are talking about are not related to the asset intensive, business, I wouldn't.

No, I assume that to be the case, that is why I am trying to strip that out.

That line item tends to move so much quarter to quarter based on the volatility of the markets.

That is right.

That is right.

And then two more quick ones.

Last quarter you guys said that to the extent that M&A or deal activity by this year end came in lower than your expectations or didn't really materialize, that you would revisit capital management buyback in early 2012, is that something you still stick by?

Yes.

Yes.

John, we continually look at capital efficiency.

The comment was, if we go several quarters, which would take us into 2012, and just haven't had the opportunity to meaningfully redundant capital, then there is a much higher likelihood you will see some action in early 2012 on that front.

Just as a follow-up, for instance, this Legal & General deal that was announced this morning, is this more of a financial reinsurance transaction, no balance sheet, no real capital to put up, or is this something that we ought to think about as using up capital?

No.

That would be a real deal, but it won't use up much capital.

Okay.

Finally on interest rates.

Your commentary on rates definitely indicates that sustained low rates is not really a meaningful concern, certainly not a concern regarding the balance sheet.

Is there something that you would say, Greig, is unique about RGA in this regard, or is this commentary about no real DAC impact, no real reserve impact, even looking out over a period of five years, is that something that we should be extrapolating to the other life insurers as well as to the primary companies, or is there a particular product line that you guys don't participate in, that you would expect to see some pressure?

Can you give us some help there.

The reason I think that we are probably in better shape, is this big block of mortality business, where we collect one year's premium at a time.

The contribution of interest on that business is a lot less than a typical level premium, either term or whole life policy, especially a whole life DAC policy.

We don't build up the assets, and we don't have the asset leverage that other companies have, and so that is I think the main difference we see.

Okay.

Alright.

Thanks, very much.

And from UBS Securities, we will go next to Andrew Kligerman.

Hey, good morning.

Last quarter excess capital was roughly at $0.5 billion.

I assume that is about the same.

There were no major movements there?

Yes, Andrew, this is Jack.

That is right.

It is roughly $0.5 billion.

Okay.

And Greig you mentioned that M&A was heating up, make maybe you can elaborate a bit more.

What type of M&A is heating up, what are you interested in, are you looking to buy a small reinsurer, do you want to assume a block of reinsurance from another reinsurer, or is it just blocks of traditional mortality from primary insurers, what particularly is heating up and what are you interested in?

For the most part, Andrew, it is blocks of business from direct life insurance companies.

They may be mortality based, they may be other types of business, but the level of discussion seems to be on the uptick a bit.

Got it.

And what other types aside from mortality would you have an interest in, what other lines?

We would be interested in various different annuity blocks and other business like that.

It is very difficult to price in this environment though, so it is very difficult to close transactions.

We have seen a lot of interest in Europe on different things that would help free up solvency to capital, so we are starting to see discussions happening that we thought might happen in that regard.

And then when you said annuities, variable annuities, would that be included?

No.

We are not looking at any variable annuity blocks right now.

Got it.

Last quarter I think you had a negative $8 million to $10 million variance on the long-term disability, and you mentioned earlier that the claims were in line with expectations, maybe a little color on the expectations?

Or are you kind of, has your expectation for long-term disability kind of gone up, in terms of losses relative to where you would have thought a year or two ago, so that would be the in-line with expectations, and what is your sense on that line going forward.

Has it stabilized?

That business, this is on the group side in particular.

Group, Yes.

To some extent in Australia, but in fact, that business is historical quite volatile, it does go up and down, and a few large claims can swing it.

The results this quarter were okay, I don't mean to say that everything is back to completely great for that business, but it was extremely good last year, and it is more normalized to even a little bit high through parts of this year.

This quarter was more in line with averages.

So I don't think we have changed our assessment, but we do recognize that this business does show characteristics of that volatility.

Are you getting a sense that the primary companies have repriced a lot of it so far?

Don't know that actually, Andrew.

I think that these tend to be one year at a time contracts.

We look at the groups when we price the groups we look at the experience, and set our own price on what we think is the appropriate risk we are taking.

Got it.

Thanks a lot.

(Operator Instructions).

We will take a follow up from Steven Schwartz.

Hey, okay, I have got some more now.

First I want a couple of follow-ups if I may.

On lapses, Greig, is this triple X business, is that maybe what is driving this, that it is coming off?

Yes, to some extent it is on the term business, but it is across the board though.

Okay.

And then, Jack, just as a follow-up, the question with regarding to interest rates and the lack of sensitivity is basically reflecting the fact that your business is primarily written on a wire key basis?

Yes.

That has a lot to do with it.

That is right.

So then if I can go on to some of my own now.

Canada, results in Canada looked weird to me, particularly with regards to how you explained it.

I did notice, well my first question is, did the in force in Canada in Canadian dollars go down from the second quarter?

It looks like it to me, it adjusted.

Steven, this is Jack.

It may have.

I am just going from memory here.

Okay.

That would surprise me a bit if it did, Steven.

That is something we focus a lot on volume in force.

Okay.

Maybe I will revisit with John.

Following up on in Canada, two things, you cited good mortality, but if you take a look at the loss ratios that you put out between critical illness and traditional mortality, the traditional mortality, that ratio looked actually high relative to the past eight quarters, to me towards the higher end of that.

So I sort of wonder where we see the good mortality coming out?

And then how I see the good results is you had a very, very large uptick in net investment income from the second quarter, from the mid-40s, if I remember correctly, $40 million to $52 million, or something like that, maybe you can explain that in the context of your mortality statements?

Well, Steven, in Canada we have premiums that last for a long time.

Lapse rates that are extremely low.

Okay.

And you do build up substantial amounts of assets in Canada.

Okay.

That is one part of our operation that builds up assets.

You would expect over time the loss ratios, if you are just calculating claims to premiums, or claims and reserve increases to premiums, to drift higher and higher and higher as investment income becomes more of the funding of the claims that you pay and the profits that you bring to the bottom line, so I would expect that Canada is harder to look at a loss ratio and develop meaning out of it than the US is by quite a bit.

I would expect a drift upwards.

What I can tell you is that we understand what pricing mortality was, and we understand what we expect mortality to be given where it has drifted over time, and this quarter we were a couple million dollars better than expected on that mortality side.

I understand where you are going with that.

This is not necessarily a YRT type of business.

I mean I am looking at a 15, somewhere around a 15% increase in investment income between the third quarter and the second quarter?

Yes, Steven, that is right.

It did go up to $52 million, a lot of that relates to the amount of capital associated with the business, that is how we allocate the investment income.

Okay, so there was more capital allocated in the quarter?

That is right.

That makes sense to me.

And then if I may, the collateral finance, I guess the repurchase for a lack of a better term, was that scheduled, was that something voluntarily that you saw that an opportunity to do, is that a use of capital, how do we think about that, and maybe what you do going forward?

Yes, I call that opportunistic in that collateral financial, those notes outstanding or structured notes, that we saw an opportunity to take them in, buy them back in one of our operating companies, that so we can still use them in terms of collateralization, but essentially we have removed them from the balance sheet, and saw an opportunity to buy those back at roughly $0.65 or $0.66 on the dollar.

So the longer terms economics were very attractive, and we bought those back in.

Now I think to your latter point, would we expect to continue to do that?

We have almost reached our limit in terms of the amount we would be comfortable buying back without going through a full tender, so unless we dramatically change course, I wouldn't expect to see us buy back any meaningful and additional amounts.

The accounting would suggest that would have no effect on capital?

That is right.

Alright.

Thanks, guys.

Okay.

A follow-up from Jeffrey Schuman.

Thank you.

I want to come back first to the interest rate issue, in your scenario, you talked about 50 basis points of weak compression over five years, and I think that was probably a comforting result relative to what some people had feared, but I was wondering if you could talk a little bit about what drives that.

Is that driven more by compression in the legacy business, or is that more of a reflection of layering in lower new business returns?

I guess it is both, this is Jack.

If I understand your question, certainly we have an investment portfolio that is rolling off a duration of over seven or eight, somewhere in there.

The modeling reflects those funds being reinvested.

There is new money coming in associated with new business production, so we would contemplate, of course we would price for that, but would contemplate lower new money rate on those funds coming in.

So have I answered your question or--?

Part of what I am getting at is, what new business returns look like today?

I mean we have established that YRT is not among the most investment income sensitive businesses, but I mean, are you repricing it, and if you don't reprice, what kind of returns are you getting on a lot of your new business today?

Well, as we price new business, we certainly take, we certainly reflect our expectation of investment yields, and we kind of anchor them at current new money rates.

Though we would certainly consider the investment income environment, the investment yield environment as we price any new business, we would.

So that is factored in, okay.

The other thing I wanted to come back to again was the asset intensive.

To what extent were lower earnings this quarter driven by variable annuities versus equity index?

I guess I am used to thinking of equity index business often being pretty tightly hedged, and not seeing at least for the companies, not seeing a lot of pressure come through in a quarter like this, was it more the VA or more the equity index?

It was more the VA, but probably in terms of the shortfall versus expectation, I think two-thirds of it related to VA, and one-third related to EIAs or equity indexed annuities.

Okay.

To the extent that the VAs, just trying to understand the kind of the basic factors here.

Is a big piece of it just fee leverage, or is it DAC and locking, or some reserve adjustments, or what kind of hit?

Yes, DAC unlocking certainly moved both the performance on the EIAs, as well as the VAs.

Okay.

So that was a material factor.

Thanks, Jack.

We will take a follow-up question from Thomas Gallagher.

Just a follow-up on the YRT question.

Can you give a sense for how much of your business can be repriced annually on the life insurance side, versus something where you have locked in pricing for a longer period of time, just a rough split of that would be helpful?

Tom, almost none of our business can be repriced, the group business can, but that is a small piece of business at this stage.

The mortality business for the most part is locked in.

Our comment related to pricing on new business, not repricing existing business.

So in terms of the recurring premium that comes in, that can't be repriced, got it.

Okay.

So you are just looking at the margin potentially having a lot of room to go down over the next decade or so, if interest rates remain low, as opposed to being able to do anything on the pricing side?

On the existing block, yes.

Clearly if interest rates go down, we make less money, but the fact that we get a new premium each year, and that is sufficient to pay claims, means that the investment component of our profit is quite a bit less than other businesses in that YRT business.

Thank you.

And we will go to Ryan Krueger with Dowling & Partners.

Thanks, I had a follow-up on the interest rate commentary.

I just wanted to clarify one thing, in the lease you talked about a 15 to 20 bip decline in 2012, and 50 bip decline in 2016, I interpreted that to be the decline in your portfolio yield.

Am I incorrect, or does that relate to the ROE or to the portfolio field?

That relates to ROE.

Okay.

I guess I wanted to follow-up with that, because it seems a little inconsistent with some previous statements you have made, where I think you said last year that low rates might cost a $0.20 to $0.25 per share impact on EPS, which I think is around 3% or so of EPS, 15 to 20 bips of ROE would only translate into more like 1% of EPS.

I am just trying to reconcile those two comments?

Your point is accurate in that a lot relates to how the portfolio is running off.

We had a little more dramatic impact I would say over the last couple of years, and it is starting to moderate somewhat as you reach, as the new money rate goes down, but you reach at some point some degree of equilibrium.

Last year when we made that comment, we were couching that in terms of interest rates stay where they are, we would see our portfolio yield come down in effect by that amount.

What has happened of course, is that interest rates have come down further since then, and quite dramatically even.

It is more than the $0.20 impact this year.

Okay.

I wanted to clarify then.

So you are saying that the EPS impact would be more than $0.20 to $0.25?

I am saying it has been in the last year.

There is a point at which, and what we are saying when we do this going forward, is that if interest rates stay low for a long time, what it should do, but we are not saying they go down to zero either, if the interest rates go down to zero, the effect would be less.

Okay.

Thanks.

We will take a follow-up from John Nadel.

Thanks for the follow-up.

Just a couple of quick items.

With the Canadian tax rate change here, what should we be thinking about in terms of your consolidated tax rate going forward?

John, this is Jack.

The effective rate going forward is only modestly affected, because we are talking about solely interest rate changes, I am sorry, tax rate changes in Canada.

So it probably carves, I haven't tried to look at it this way.

Well maybeif we can think about it in terms of what did the Canadian tax rate go from to?

It dropped about 4 points, 4 percentage points.

Okay.

That is helpful.

So your portfolio yield in 3Q was 5.29%, where is new money yields in the third quarter?

Yes.

Considerably lower than that.

I guess I am trying to understand how far below that though?

Because we all focus on the ten year, you are probably investing further out on the curve, and my suspicion is you are buying just about anything but Treasuries right now.

Can you give us a sense for where your new money yield was during the quarter?

Yes I would say on average it is around 4.25%?

Okay.

We have to the extent that nothing changing forever, we have 100 basis points of downside to your portfolio yield?

That is right.

Okay.

Where are the offsets to that?

I mean, at what point do you say to yourself, we need to alter our expense load, we need to do some things differently to combat that, obviously I would expect your to reflect that in your pricing of new business, but your new business is a percentage of your in force is obviously small.

What do we do with the operations?

That is a good point.

Obviously pricing is affected, but we also look at expense efficiencies, and we do that now, and there will be even more pressure if we are in a prolonged low investment yield environment, because just to make the economics of the business work, you have to look long and hard at the efficiency of the operation, that is what we would do.

Is there a particular business that you emphasize in a 4.25% new money rate environment, or a particular business that you completely deemphasize in that type of an environment?

It happens by default a lot of times.

Like I said, annuities loss of business is very hard to price right now because we reflect current interest rates.

And YRT business on the other hand, looks pretty good.

Okay.

The last one for you is just a sizable net unrealized gain on the investment portfolio, I don't expect you to necessarily be working to monetize any of those gains, but also a very sizable foreign exchange gain, I wonder if there are any strategies you envision deploying to monetize some of that?

John, on the FX front, we don't look at it as much trying to monetize a gain, as we do look at it just to ensure from an enterprise risk management standpoint, we are comfortable with the currency exposures for the businesses that we are operating.

We continually look at that, just to be sure are that we don't in our internal view get over-exposed to any particular currency, and suffer a detriment down the road because of movement in that currency.

But I think the philosophy is a little different than trying to as you suggest, trying to monetize any existing gain on a particular currency.

Okay.

And the last one is just a request for additional disclosure.

Your segment disclosure income statement shows us policy acquisition costs and other expenses all on one line.

Given all of the moving parts with the DAC accounting change, really would appreciate to the extent you could separate out capitalization from amortization?

Okay, John, let us consider that.

We have another follow-up from Steven Schwartz.

Last time, I promise.

Two questions here, just following up on Ryan's question.

The investment yield gradually drops 50 basis points over the five-year period, but the 15 to 20 basis points in 2012, and the 50 basis points by the end of 2016 refers to return on equity?

That is right.

Okay.

Good.

Glad I got that.

Going back to YRT.

Just so I have got this straight, the point isn't that you can change your pricing, the point is that the pricing is such that it goes up every year to reflect the increased mortality charge on a book of business?

Well that is correct, Steve, but I think the bigger point in terms of interest is that we don't hold the money for that long, it is only one year at a time.

We are not expecting a lot of investment income off of the funds we get.

Right.

That is because you are simply pricing for mortality each and every year?

Correct.

Got you.

I just wanted to sure that my understanding was correct about what was going on.

This is Jack.

I think we are at the end of our allotted time.

So we may need to end the call at this point.

And there are no further questions in the queue at this time Mr.

Lay.

That works well.

Okay.

Thanks to everyone for joining us this morning.

Any other questions feel free to give us a call, and with that, we will end our conference call.

Thank you ladies and gentlemen, that ends your presentation, we thank you for your participation.