Globe Life Inc.
Q3 2008 Earnings Call Transcript

Published: 23 Oct 2008

[Operator:]

Good day, everyone and welcome to the Torchmark Corporation third quarter 2008 earnings release conference call. Please note that this call is being recorded and is also being simultaneously webcast. At this time I would like to turn the call over to the Chairman and Chief Executive Officer, Mr. Mark McAndrew. Please go ahead, sir.

[Mark McAndrew:]

Thank you. Good morning, everyone. Joining me this morning is Gary Coleman our Chief Financial Officer, Larry Hutchison, our General Counsel, Rosemary Montgomery, our Chief Actuary and Mike Majors, Vice President of Investor Relations. Some of my comments or answers to your questions this morning may contain forward-looking statements that are provided for general guidance purposes only. Accordingly, please refer to our 2007 10-K which is on file with the SEC. Net operating income for the third quarter was $132 million or $1.51 per share, per share increase of 9% from a year ago quarter. Net income was $0.72 per share as a result of an $0.80 per share charge for impairments in our bond portfolio. Excluding FAS 115 our return on equity was 15.7% for the quarter and our book value per share was $37.99, up 8% from a year ago. On a GAAP reported basis with fixed maturities carried at market value, book value is $27.95 per share. At that book value our return on equity would be roughly 21%. In our life insurance operations premium revenue grew 3% to $406 million. And life underwriting margins increased 2% to $108 million. Life insurance net sales were $75 million for the quarter, up 13% from the third quarter of 2007. At American Income life premiums grew 8.5% to $121 million and life underwriting margins was up 12% to $40 million. Net life sales increased 15% to $28 million with first year collected life premiums also growing 15% to $21 million. The ageing accounted American Income was up 10% from a year ago to $2887 [ph]. I continue to be pleased with the results of American Income and expect double-digit growth in sales to continue in 2009. We have begun work on a new need based computer sales presentation which we hope to introduce the first half of next year similar to something we are doing at Liberty National. When implemented we believe this presentation will increase our average sales size, improve our persistency and have a positive impact on agent retention. We are also close to 50% complete with our centralization of the lead generation at American Income. In those areas where we have assumed this responsibility lead generation increased 33% during the quarter and sales increased over 25%. We expect to have this completed by the end of next year. In our direct response operation, life premiums were up 6% to $127 million and life underwriting margin grew 2% to $30 million. Life net sales increased 7% to $30 million. While we continue to see some declines in our response rates in our insert media, we have however seen some very encouraging test results in both our pricing and packaging in this media during the third quarter. We believe these changes will more than offset this decline in response rates although it is too early to project 2009 sales for the distribution system. We will do so on the next call. At Liberty National, life premiums declined 1% to $72 million and life underwriting margin declined 4% to $18 million. Net life sales grew 47% to $13 million and the agent count was 3476, up 69% from a year ago. I continue to be pleasantly surprised by the sales growth at Liberty National and expect it to continue. While collected premiums and margins decline slightly the sales have now reached a level to Liberty National can contribute meaningful growth in both premiums and underwriting margins for 2009. On the health side, premium revenue excluding Part D declined 9% to $231 million and health underwriting margin was down 7% to $42 million. The health net sales declined 49% to $29 million. The health sales results of United American continue to deteriorate in both branch office and independent agency channels. This market remains highly competitive and also appears to be negatively impacted by the economy. We are continuing our efforts to shift sales into life and supplemental health products which have higher margins and better persistency. I would also like to point out that a major portion of our health underwriting profits are generated at Liberty National and American Income. While these distribution systems account for only 23% of our health premiums, they contribute roughly 44% of our health underwriting profit after administrative expenses. Premium revenue from Medicare Part D was down 21% to $41.5 million. Although underwriting margin was flat at $6.4 million, primarily as a result of a renegotiated contract with our pharmacy benefit management. Administrative expenses were $38 million for the quarter, down 4% from a year ago. Year-to-date administrative expenses were up a half of 1% and are in line with our expectations. I will now turn the call over to Gary Coleman, our Chief Financial Officer for his comments on our investment operations.

[Gary Coleman:]

Thanks, Mark. I want to spend a few minutes discussing our investment portfolio, liquidity and capital and share repurchases. First, the investment portfolio. On our Web site are three schedules that provide summary information regarding our portfolio as of September 30th 2008. They are included under supplemental financial information in the financial reports and other financial information section of our Investor Relations page. As indicated on these schedules invested assets are $10.1 billion with fixed maturities included amortized costs. Of this amount $9.6 billion are in fixed maturities. Combined, equities, mortgage loans and real estates are $42 million, less than 1% of invested assets. We have no counterparty risk as we hold no credit to default swaps for other derivatives. In addition, we do not operate a securities lending program. Of the $9.6 billion of fixed maturities $8.9 billion are investment grade with an average rating of A minus. Below investment grade bonds are $698 million with an average rating of BB minus and are 7.3% of fixed maturities compared to 7.8% a year ago. Overall, the total portfolio is rated BBB plus compared to A minus, a year ago. Net unrealized losses in the fixed maturity portfolio are $1.4 billion, up from the $670 million at the end of the second quarter. By sector, the largest losses are in the financials which comprise 42% of the portfolio at amortized cost, but 64% of the total net unrealized losses. Almost 85% of the total increase in unrealized losses during the quarter was related to bonds for which there were no downgrades in their ratings. Accordingly, we feel that most of the unrealized losses reflect the current liquid market that is contributed to a significant spread widening on bonds that are likely to be money good. Obviously, this is not a market to be a seller of bonds and due to the strong and stable positive cash flow generated by our insurance products we not only have the intent to hold our bonds to maturity, but more important, we have the ability to do so. Now, I would like to discuss the asset types and sectors within the fixed maturity portfolio. At asset type 78% of the portfolio is in corporate bonds and another 15% is in redeemable preferred stocks. There is no direct exposure to subprime or Alt-A. We have only $41 million in RMBS and CMBS securities, all rated AAA. A CDO exposure is a $131million in which the underlying collateral is bank and insurance company trust preferred. The average rating of these securities is A minus with none rated less than BBB. Regarding sectors as I mentioned, the financial sector comprises $4 billion or 42% of the portfolio. Within financials, the Life held property casualty insurance sector is $1.8 billion and banks are $1.6 billion. Financial guarantors and mortgage insurers total $180 million less than 2% of the portfolio. Next financial is the – the next largest sector is utilities which account for $1 billion or 11% of the portfolio. The remaining $4.6 billion of fixed maturities is a spread among 242 issuers in nine sectors. Now to conclude the discussion on investments I will cover the portfolio yield. In the third quarter we invested $263 million in investment grade fixed maturities, primarily in the industrial and utility sectors. We have invested an average annual effective yield of 7%, an average rating of A minus and an average life depending on future calls of between 26 years and 28 years. This compares to the 6.84% yield A rating and 22 year to 30 year average life of bonds acquired in the third quarter of last year. This is the fourth consecutive quarter that the new money yield was 7% or higher and also exceeded the portfolio yield. The average yield on the portfolio in the third quarter was 6.97% versus the same as has been for the last four sequential quarters. Now regarding liquidity and capital, our insurance companies primarily sell basic protection life and supplemental health insurance policies which generate strong and stable cash flows. In the third quarter only $3 million or 0.5% of premium revenue came from asset accumulation products where revenue is subject to changes in equity markets. Regulatory capital remain sufficient to support our current operations and ratings. As noted in previous calls our RBC ratio is just under 300% at December 31st 2007. It had dropped below our 300% plus target due to several unusual one-time items. In 2008 we have increased statutory capital primarily through intercompany transactions involving reinsurance and monetization of agent receivables. Even with the $70 million other than temporary impairment write-down in the third quarter, we expect RBC at 12/31/08 to be in the range of 305% to 315%. Finally, regarding capital management, Torchmark has no plans to raise equity capital or reduce dividends to shareholders. Cash flow at the insurance companies and free cash flow to the holding company remains strong. Free cash flow will be approximately $350 million in 2008 and although we haven't done our projections we expect 2009 free cash flow to also be in excess of $300 million. We have already used our 2008 free cash to purchase Torchmark shares. In the third quarter we spent $116 million to buy 2 million shares, and for the nine months we have spent $351 million in acquiring 5.9 million shares. Although we have already used our available cash for this year, we still have the ability to repurchase shares in the fourth quarter with funds raised through the issuance of commercial paper. In fact, to-date in the fourth quarter, we have spent $64 million to buy 1.4 million shares. Although we have explored making a strategic acquisition, the probability of such a transaction in the near-term is unlikely. At our current share price we would be reluctant to issue equity and in the current market it would be difficult to issue a sizable debt offering in order to finance acquisition. Thus, given the current conditions, share repurchases and to some extent reduction of short-term debt will be the best use of our available cash. Those are my comments. I will now turn it back to Mark.

[Mark McAndrew:]

Thank you, Gary. We are lowering our guidance for operating earnings per share for 2008 to a range of $5.85 to $5.89 due to the unforeseen changes in the credit and equity markets. After tax variances from our previous guidance include lower underwriting income on our variable annuity business between $1.1 million and $2.4 million in the fourth quarter. Lower investment income of $1.2 million due to loss interest on Lehman Brothers, Washington Mutual and Fannie Mae bonds. Increased cost of commercial paper in the fourth quarter of $1.2 million and roughly $1.6 million of parent company expense related to an acquisition in which we have withdrawn from negotiations. In summary, we believe Torchmark is in good shape. Our core life businesses are growing sales at a double-digit pace during tough economic conditions and we continue to generate strong predictable cash flows and earnings. Those are my comments this morning. I will now open it up for questions.

[Operator:]

(Operator instructions) And we will take our first question from Jeff Schuman at KBW.

[Jeff Schuman:]

Good morning. Wanted to come back to the issue of share repurchase. Obviously you do have very strong and steady cash flows which is a nice buffer and certainly the stock is very cheap. Is there any thought at this point, Gary, to maybe conserving capital for a while? I mean certainly I think in terms of trying to impress investors, all the conversations we have with investors at this point are in terms of measuring downside risk not so much in terms of who can kind of juice ROE or EPS the most next year so. Can you give us few more thoughts there please?

[Gary Coleman:]

Jeff, we are not just buying the stock to be aggressive. The stock is trading – has been trading below book value that makes it a more compelling buy than even it has been in the past. We are not going to jeopardize our capital. We have spent $64 million in the fourth quarter. I wouldn't expect us to spend more than $30 million in the remainder of the quarter. If we went over that, I think we would start getting outside of the boundaries of our ratings. I think it would be wise to stop at that point. The additional commercial paper that we have used – the additional borrowing we are also not looking at leaving that out in a long period of time as 2009 gets underway and pre-cash – or cash starts coming up to the parent company. I think as I mentioned in my comments you will see as reducing our short-term debt. But it's just really more a matter of the price at the moment.

[Mark McAndrew:]

We also, Jeff, took a very hard look at our downside risk before we made the decision to go out. We just think our downside risk is minimal.

[Jeff Schuman:]

Maybe just to complete the picture, in terms of capital management, I know, Gary, you mentioned that you were able to kind of do some transactions and manage the RBC ratio a little bit. Do you have additional flexibility to kind of manage RBC little bit structurally or not?

[Gary Coleman:]

Yes, I think we do.

[Jeff Schuman:]

Any sense of how much that's worth?

[Gary Coleman:]

Not offhand. It would – I think we've been fairly conservative with our regulatory capital and there is still some room there. I can't put a number on it at the moment.

[Jeff Schuman:]

Okay. Thank you very much.

[Operator:]

We will take our next question from Jimmy Bhullar at JP Morgan.

[Jimmy Bhullar:]

Hi, thank you. I just have a question on your outlook for the ageing count especially at United American. It's been declining the last several quarters. When do you think it will bottom out and what are some of the things you are doing to try to improve that? And then with that if you could address your outlook for health insurance sales as well.

[Mark McAndrew:]

Okay. Jimmy, I wish I could be certain of where and when that will bottom out. The ageing count continues to decline. We are trying to move more of that production to Liberty National products which we're seeing some success with. But I really – I can't say with any certainty where and when it will bottom out. We are introducing a new under age 65 health insurance products started here in the last 30 days which we think will help that, but I wish I give you more guidance. It just comes down to, again, it's a very competitive and volatile market, and it's something at long-term, it's not a market that I really see as being a market that we want to be in long-term. So we are definitely spending most of our focus on the life and other supplemental health products that are more profitable and more persistent.

[Jimmy Bhullar:]

And then just on the life business, have you seen any impact recently of the economy weakening on your sales, obviously, the numbers in the third quarter were pretty good.

[Mark McAndrew:]

I haven't seen any – again, I think in the markets that we're in and the products we are selling true protection products, very simple products. We haven't seen any significant impact in our persistency of the business, and we are not seeing obviously, Liberty National sales were up 47%. American Income sales were strong. The only place we have seen anything, Jimmy, is in the insert media, in the direct response where these are more newspaper inserts and the coupon packs. We deal with a little lower income marketplace there. We have seen some decline in some response rates there although it's pretty well stabilized now. That's the only place we have seen anything. And again, as I mentioned earlier, actually, some of the product and pricing test that we have done in the third quarter we have seen very encouraging results as far as improving the profitability and improving the number of sales we are getting there. So I think that will offset that decline and we are – we sure like to see gas prices go down. I don't think any of our markets are affected by changes in the equity markets, but I do believe that lower gas prices can do nothing but help our markets.

[Jimmy Bhullar:]

Okay. Thanks.

[Operator:]

We will go next to Bob Glasspiegel with Langen McAlenney.

[Bob Glasspiegel:]

Good morning. I must stay short of Jeff's theme. Your stock is down 45% in the last quarter and Mark and Gary, your story sounds like not much has changed and you are doing your thing and taking advantage of it, and clearly, you think the markets got it wrong. The whole markets got it wrong with respect to credit because you seem awfully relaxed about your exposure to that issue. Have you done any stress test or sensitivity analysis to test whether in fact the market is right on this, how bad things could get and you are still fine in the cash and – ?

[Mark McAndrew:]

I will let Gary answer more fully. Yes, we have, Bob. It comes down to – we had a bad third quarter if you look at the write downs we had to take. But in looking we could sustain those same level of losses throughout every quarter, fourth quarter this year and every quarter next year and be fine. We would not have to raise equity. The unrealized losses that we see in our portfolio, again, we have the ability and the intent to hold those bonds. It doesn't affect our statutory earnings. We don't believe it's going to have any effect on us being able to dividend money up to the parent. Yes, we have looked at it quite a bit here in the last three months. Gary, you want to comment?

[Gary Coleman:]

Just add to that, as Mark mentioned if we sustain $70 million of losses in the fourth quarter and each quarter next year, we can do that and still keep our capital at the insurance companies above the 300% level. What that would mean is our free cash flow would go toward staying in the companies if we had those extreme losses, we wouldn't have the share repurchases. But – our earnings growth wouldn't be as high. We would still have earnings growth. The key thing here is that our – the types of products we write are not subject to equity market swings. I mean, there is – very consistent and we look for our profits to be consistent going forward. So –

[Bob Glasspiegel:]

I appreciate that. It's just that the credit markets have the bonds marked right we're going to have more Wachovia's in the next quarter. I am sure you are expecting some more if we go into recession. I mean if the BBB plus portfolio is going to start, have it some stress from cash flow and statutory perspective.

[Gary Coleman:]

I look at this way. First of all, I think we do have – versus our peers, we have a high BBB exposure. But as I mentioned I think that's offset to large extent we have no equity, mortgage or real estate exposure. In addition, we have – we've done a great deal – We do a great deal of credit research not only when we buy but follow-up on our BBB bonds. We're comfortable with those bonds. The other thing I mentioned is if you look at our BBB bonds they are 48% of the portfolio. The unrealized losses for BBBs are 49% of the total unrealized losses. In other words, the unrealized losses are spread throughout the portfolios at all ratings and it's – I mean I would be more concerned if 49% were BBBs and we had 89% of the total unrealized losses of BBBs. I think I will be more concerned. But I think the fact that see the spread indicate that it is just reflective of illiquid market throughout and we think it's going to improve. I hate to think that is more concerning to us is that out of our $70 million loss that we booked this quarter, $50 million was in Lehman Brothers, and a week before it went in bankruptcy, Lehman was rated A. It was a surprise to everybody. Those are the ones that you can't predict. It concerns us there maybe some of those out there.

[Bob Glasspiegel:]

One last question, your debt to capital ratio year-over-year is up from 22 to 28. And mostly it's the AOCI [ph] hitting the denominator more than debt levels going up. Fourth quarter we are off to another sort of crappy start. Is there a debt to capital ratio that starts to become a material issue or not?

[Gary Coleman:]

Well, if you exclude the ALCI [ph], it's – we are 22.6% which is in line with where we have been. And I know the rating agencies are looking at that. But they generally look at it excluding unrealized losses. So still even at 28% using that basis, I think we are probably okay.

[Bob Glasspiegel:]

There is no bank covenant issues – ?.

[Gary Coleman:]

No, definitely no bank covenant issues at all.

[Bob Glasspiegel:]

Thank you, Gary.

[Gary Coleman:]

Sure.

[Operator:]

We will go next to Randy Binner with FBR Capital Markets.

[Randy Binner:]

Hi, thanks, everyone. I noticed from the press release that AIG was not included in the impairment this quarter. From Gary I was just hoping to get some color on that. How that decision was arrived at, maybe where those are and how you are looking at that exposure in particular, I think it's about $105 million.

[Gary Coleman:]

Yes, it is $105 million. Randy, the $57 million of the $105 is bonds of the operating subsidiaries, and, of course, everybody is looking for those to be sold and assume that the bonds will go along with them. The other roughly $48 million is – $27 million is senior secured debt at the holding company and then another $22 million is junior subordinated debt at the holding company. Obviously, we have exposure there. The exposure is if they go into bankruptcy. We're not going to sell the bonds. And so at this point we do not write them down because at this point we don't have anything to indicate that they will go into bankruptcy and we are set to monitor that situation as we go forward.

[Randy Binner:]

Okay. Great. And then moving to commercial paper. Could you give color on how well you are able to roll that now? You quantified the higher expense for us which is very helpful, but maybe some color on how that market is moving and then how your ratings I believe are A1P2 might coincide with the CPFF, commercial paper funding facility that the Federal Reserve has organized, and if that would be something that you would consider accessing?

[Gary Coleman:]

Yes, we would. You're right about the A1P2. But we also have an F1 from Fitch. And as a result of having those two higher ratings, we are eligible to be in the CPFF program and in fact, we have registered and we should be able to start accessing that market late next week. The situation regarding commercial paper prior to September 15th it was pretty easy. We just determined how much we needed, we got it immediately, we got pretty much whatever maturities we wanted to. It didn't go up more than 30 days. Since that time, we have been able to place the commercial paper that we needed. In fact, we have issued more than has matured. But we are seeing maturities more in the 10 – we are seeing it for a while just one day paper. But we – now, it's more in the 10, 11 day maturities and as I mentioned the price has gone up. We were – our interest rate there was less than 3% prior and now it's closer to 6%. So we have been able to place the paper. We are paying quite a bit more. Now what the CPFF will do for us when we get involved with that. We will be eligible to sell up to $300 million of commercial paper. It will be 90-day paper. As you probably know the rate that we paid on that is an overnight rate index plus a spread and today that rate is about 3%. So as we are able to payoff the CP that's out right now and then borrow into the CPFF, we will see our rate transition from the 6% level for the first half of the quarter to more of a 3% rate towards the end of the quarter.

[Randy Binner:]

And that's 3% all in index plus spread and then – is that correct?

[Gary Coleman:]

That's correct. That's today. That rate will change. But where it stands today it's about 3%.

[Randy Binner:]

I mean so I guess the CPFF I think last forever. So is it – how do you view it as a transition to more normal credit markets? Are you committed to continuing to use short-term debt on the balance sheet or would you want to transition out and rely more on kind of the natural cash flow of the organization?

[Gary Coleman:]

Historically, our short-term debt has averaged around $200 million. Going over $300 million has been an unusual event for us. And really, we use it – the timing of our cash flow is coming up from the insurance companies, varies, and so we use it just for short-term needs. I don't think that's going to vary going forward. I think the last under the CPFF the last paper can be issued in April, late April, and so really – and that's 90 days. So what – between now and the end of June next year, we will be using that program, if nothing else, one, to reduce our costs that we are paying down to commercial paper and then secondly, we also – we would rather not draw on our bank line. We haven't done that. And this program will help us lower the cost without having to draw on that bank loan. But overall, I think we're not going to ramp up all the full $300 million under this program and borrow the full amount we can under our short-term line. I think in the long run you will see that commercial paper going back to about $200 million average.

[Randy Binner:]

Just real quick, can you remind us what the bank line is?

[Gary Coleman:]

Pardon?

[Randy Binner:]

What's the capacity of the bank line?

[Gary Coleman:]

Our bank line is – we have $600 million line, we have $200 million dedicated to letter of credit. So the least $400 million for either borrowing or back up for commercial paper.

[Randy Binner:]

Great. Thank you very much.

[Operator:]

We will go next to Tom Gallagher, Credit Suisse.

[Tom Gallagher:]

Good morning. Wanted to just come back to the question of free cash flow and how you are thinking about the environment. So if the plan is to have $300 million of free cash flow, I assume that contemplates very little credit losses for ' 09. I just wanted to get clarification of that.

[Gary Coleman:]

Yes, I'm saying $300 million plus with no credit losses.

[Tom Gallagher:]

Okay. So essentially, what we can think about is $300 million after tax credit losses on a static counting basis being the thing that would start wipe out your free cash flow for the year. So on a free tax basis what the $450 million which would be what 4% to 5% of your entire investment portfolio. Is that the right way to think about the stress test here?

[Gary Coleman:]

Yes.

[Tom Gallagher:]

Okay. The other question is have you had any discussions with the rating agencies just in terms of continuing your buy back and whether or not that could put some pressure on your ratings?

[Gary Coleman:]

We've had just some preliminary discussions, but nothing in detail. We have – I think they have a good feel for our risk profile. The way we look at that free cash – that is free cash. If we need to put some back into the insurance companies to maintain our capital not only from a regulatory standpoint but also from the rating agencies, we can do that. We have the flexibility to do so. So – to answer your question, we haven't had in-depth discussions. We will probably do that later. But we don't have anything that will restrict us.

[Tom Gallagher:]

And can you talk a little bit about how important ratings are to your franchise? The reason I ask that is you've got some other life insurers who have pretty good capital positions even further truing up their – or strengthening their capital positions over sort of prospective fear of any negative rating actions. Can you talk a little bit about how the balancing act? How important is your rating and how you sort of view that with your planning process here?

[Mark McAndrew:]

Gary, I will address it on the marketing side. In the markets that we're in and – again, we're not really marketing any investment type products. We're really selling small face amount life insurance primarily in middle and lower middle income markets. The only rating we've been advertise is A best rating which is A plus. If that rating were to drop a notch to A, I don't think it would have any impact at all on our life sales. We don't want to see it drop, but I don't see any impact on the marketing side of any ratings change.

[Gary Coleman:]

I would add – I mentioned that our commercial paper ratings are A1P2 and F1. We would definitely like to keep two of those at the one level. So that's a consideration.

[Tom Gallagher:]

Okay. And then last question more on the business side. So is it fair to say with the very weak health insurance sales and barring something unusual as we think about '09 we will see premium revenue on the health side decline double-digits? Only because you are seeing much larger decline in sales which should be a leading indicator of where premium revenue goes next year. Would that be a fair conclusion at this point?

[Mark McAndrew:]

It's – again, we will give more guidance on the next call. It's really difficult to say. It's possible. Again, I don't think you will see underwriting margins decline because the premiums that we're losing are the least profitable premiums we got out there. And it's just difficult to predict at this point. But it's possible that we could see double-digit declines in health premiums, but I don't think we will see that in health margins. But again, we will give more guidance on that on the next call.

[Tom Gallagher:]

Okay. Thanks.

[Operator:]

We will go next to John Nadel, Sterne, Agee.

[John Nadel:]

Hi, good morning, everybody. Mark, maybe just a quick philosophical question for you. If the businesses is less impacted or not impacted at an A rating versus an A plus or versus – let's say a low AA, I guess I wonder why not manage the – from especially from a capital management perspective to the A rating?

[Mark McAndrew:]

Well, as far as – we pay more attention to the S&P and Moody's ratings as far as our credit concerned and Gary, you can address that. Those are more important to us –

[John Nadel:]

For the holding company, right?

[Mark McAndrew:]

Right.

[John Nadel:]

And then I guess A.M. Best obviously on the insurance side? Okay.

[Mark McAndrew:]

Yes. We do take pride in A plus, but if there was a compelling reason that we decided to manage to an A rating, but we are basically already dividending out the statutory earnings each year from the subsidiary companies and that's really we're able to maintain an A plus rating by doing so.

[John Nadel:]

Okay. A follow-up question maybe on the investment portfolio and thinking about a little bit of sensitivity around the risk-based capital ratio. Mindful that a fair amount of the portfolio at the insurance subsidiaries is in BBB category, if – in the sensitivities that you discussed a little bit earlier in the Q&A, have you taken a look at the sensitivity to your risk-based capital levels? Should you see downgrades from the BBB to a BB or below rating category and what that means from a risk-based capital perspective? How much of that can you sustain?

[Gary Coleman:]

To answer your question, no, we haven't looked at that. Well, I say that, our projections take in, in fact that we at times do have downgrades. We haven't, we didn't go in and stress test that we would have a big multiple of more downgrades. We didn't do that, but we haven't seen that so far and if we do we will revise the test. I'm not sure how much impact that will have. We will take a look at it.

[John Nadel:]

Okay. I think I understand that the capital charges, I guess they become increasingly difficult the lower the rating category.

[Gary Coleman:]

They do. It's just – again, we just haven't seen – matter of fact we had less downgrades this quarter than we had the prior which is well, we certainly hadn't that many downgrades in the lower investment grade portfolio.

[John Nadel:]

Okay. And then finally, Mark, I wouldn't necessarily expect you to name the company you were looking at. But – can you give us a sense for, to the extent that there was – and it sounds like there is a lot of at least discussion of various opportunities out there. Maybe some significantly bigger in size and maybe more out of your comfort zone, but could you give us a sense for where you most interested, what sort of deal characteristics would be important in terms of metrics especially around accretion? Would you be willing to suffer some dilution or no?

[Mark McAndrew:]

We were willing to. When we started looking at this particular company, the – it was not in the current environment. Our stock was up around $63 a share and the credit markets we felt comfortable we could raise the cash at a reasonable price. But it all went away. So in this environment we don't – we basically put that on the back burner. Because – are we willing to issue equity at our current price? No, I'm not willing to issue equity to make an acquisition at the current stock price and also the credit markets are such, as Gary mentioned, we couldn't raise the capital anyway. So unless it was the size of an acquisition that we could basically make with our free cash in the next 12 months, anything larger than that at this point we couldn't do if we wanted to. The valuations that you are seeing are very attractive, but we just – we wouldn't be willing to take that credit risk.

[John Nadel:]

Yes. Understood. Thanks very much for the openness.

[Operator:]

And we will go next to Maria Panamar [ph] at New York Life.

[Maria Panamar:]

Hi. I have several questions. The first one is if you could address liquidity at the holding company and how you intend to refinance the August '09 debt maturity?

[Gary Coleman:]

We have a $100 million coming due. And at this point our preference would be to refinance that. If it is happening today, it would be difficult to do that. We would have to use our free cash flow to retire that debt. But that's – in August when that comes about and when we get to that point, hopefully, the debt markets will be open again and we can refinance it. If not, we may have to allocate a hundred million of our free cash flow to retire.

[Maria Panamar:]

With regards to your bank line, are there any restrictions there whether – could you talk about any restrictions as it relates to either ratings or leverage or net worth?

[Gary Coleman:]

There are regarding net worth and leverage, but we are not anywhere near approaching those. We are well within our covenants.

[Maria Panamar:]

Could you talk about what those covenants might be?

[Gary Coleman:]

I don't recall at the moment. But I know that there – again, I can't recall the exact ones but we're well within it.

[Maria Panamar:]

And just a liquidity of the holding company, how much cash you might have there?

[Gary Coleman:]

As far as cash, we have very low cash at the holding company at the moment. As I mentioned we've – the free cash flow for this year, we've used for share repurchases today. We don't have assets at the holding company. All our assets are down in the insurance companies, but we do – as far as liquidity at the holding company, we do have the bank line I mentioned earlier and the ability to issue commercial paper under that bank line and that's what we are using for liquidity at the moment.

[Maria Panamar:]

Okay. And then just finally, you have some preferred stocks in your portfolio. What industry would those – are those also financials, redeemable preferred stock?

[Gary Coleman:]

Yes, the bulk of those are financials. I don't have that right here in front of me. But I know they are mostly in banks and insurance companies.

[Maria Panamar:]

Thank you.

[Operator:]

We will go next to Steven Schwartz, Raymond James.

[Steven Schwartz:]

Hey, good morning, everybody. So no intention of recreating 1990 and going back after American General?

[Mark McAndrew:]

If you can tell me how I can raise that much money – yes, if you can guarantee me loans that I can issue equity at $60 a share, we would be happy to go look at it.

[Steven Schwartz:]

Okay, I will remember that if the stock goes back up. A couple of questions here. Gary, first, you were moving along pretty fast. You stated a number I think it was the percentage of the increase in the unrealized loss that was due to downgrades. Could you give that number again?

[Gary Coleman:]

Okay, I must have been going fast. We said that 85% of the increase in the unrealized losses from the second quarter were in bonds where there was no change in rating. There was no downgrade.

[Steven Schwartz:]

Being 15%. Okay. Following up under this question of AIG it sounded your impairment policy was – if the underlying company entered bankruptcy or not. I don't know if this is accurate or not but S&L has you having about 41 million or so of National City, maybe if that is accurate, maybe you can discuss that and what your thoughts are there vis-à-vis impairment?

[Gary Coleman:]

Yes, we do have 47 million. There again as far as our analysis is that that we don't think they are not going into bankruptcy, that there is not an impairment at this time. There is a possibility that that will happen, but we are again – as we mentioned, we are not going to be selling these type assets. It's going to be whether they do go into bankruptcy.

[Steven Schwartz:]

Okay. And then I don't remember. Is Rosemary there by any chance?

[Rosemary Montgomery:]

I am here.

[Steven Schwartz:]

Hi, Rosemary. Could you in the second quarter – if I remember correctly, you had a little bit of a mortality issue. Maybe you can address how things turned out in the third quarter. I heard there was no mention and then I think your bidding is done for Part D. Maybe you can touch on an outlook for Part D in '09?

[Rosemary Montgomery:]

Sure. Yes, for the second quarter, we had mortality issues that we talked about in three of our lines, Liberty National direct response and I believe United investors and of the first two, the claims did come back down as we had predicted. So we didn't see any mortality issues remain there. United investors did still have higher claims in the third quarter than what we had anticipated. However, we had gone back and done a little bit more analysis of that and that's just a line that has high average size policies, but low volume in terms of claims. So it can fluctuate. And we went back and looked at the higher average size claims, ones over $250,000 and that's really where the fluctuation was. It wasn't a fluctuation in terms of number of claims to any great extent.

[Mark McAndrew:]

If I could, Rosemary, just add in looking back at the prior two years, 2006, 2007, claims over $250,000 at United investors, we average one a month. In the second and third quarter this year we average 3 months. But those were on average roughly $400,000 claim. And that is the fluctuation. The claims under $250,000 that very stable, and so we continue – I continue to believe that it's just a blip, but – sorry, Rosemary, go ahead.

[Rosemary Montgomery:]

That's fine. In regard to Part D, we really aren't anticipating any much difference in terms of what we're going to do in 2009. Our products are going to be pretty similar. We didn't change the rate a whole lot. We have lowered our benefit structure. We lowered our co-pays because of expected improvement in the discounts that we're getting off of the drug costs. We are expecting still that our underwriting margin will continue to be 11% next year. As far as the outlook for the fourth quarter of this year, I had originally anticipated that due to the discounts that we were going to get off of the drugs that we would also show a 15% underwriting margin for the fourth quarter. However, our actual to expected for this year is running a little bit over 1. And now I don't think that we are really going to see that 15% continue into the fourth quarter and it will probably go back down to the level it was in the first six months of this year.

[Steven Schwartz:]

Great. Thanks a lot.

[Operator:]

We will go next to Lynn David [ph] at KBW Asset Management.

[Lynn David:]

Hi. Thanks, guys. Did you mention at the beginning of the call that you did some intercompany transactions that helped RBC? Can you give us how much they helped RBC and if you can explain a little more about what kind of transactions they were, little more detail?

[Gary Coleman:]

As I mentioned it involved reinsurance and monetization of agents receivables, agents balances are not admitted for regulatory capital purposes and we were able to sell those intercompany to one of our companies that's where we can admit them. That was – I think that's probably $20 million plus that we were able to increase capital. The reinsurance was I think a little over $50 million of additional capital that we were able to do there. Again, those are – as I mentioned earlier, there is – there maybe some more capacity there. We are trying to be conservative when doing that.

[Lynn David:]

On the reinsurance, is that done through a third party or done through sub?

[Gary Coleman:]

This is all intercompany.

[Lynn David:]

So you got some subsidiaries that are over capitalized still. Is that what you are saying?

[Gary Coleman:]

We have a Bermuda company. It's a Torchmark company. When we do the reinsurance, we are transferring – we are reinsuring policies that have deficiency reserves in the United American, Liberty National, we are reinsuring those with our Bermuda company, and Bermuda company is not required to set up a deficiency reserves. A lot of people do that with outside reinsurance. We just certainly do it inside. The cost to us doing that is we have to have letters of credit to support the amount of the insurance, but that's a very low cost. And so, this doing that reinsurance is a low cost way of increasing the statutory surplus of Liberty National, United American globe.

[Lynn David:]

Got you. Thanks very much.

[Operator:]

We will go next to John Lanford [ph], Royal Capital [ph].

[John Lanford:]

Hi, thanks for taking my question. Just another question on the investment book. If you look at the roughly $600 million increase in mark-to-market charges that occurred in the third quarter and roll that forward, obviously given the volatility we have had thus far this month, any estimate of what the charge would be today?

[Gary Coleman:]

Well, we have done an estimate. We think that we were $1.4 billion of net earned losses at the end of September, we think that would be $1.9 billion now.

[John Lanford:]

Okay. So roughly another $500 million, right? And can you talk a little bit about how that actually would – is that offset at all by some back write ups or how that would actually manifest itself in your book value?

[Gary Coleman:]

There is just a small amount of a back offset. Because we have very little business that's asset accumulation type business where you have that situation. So really it's immaterial as to how much of that part of it is.

[John Lanford:]

Okay. Thanks very much.

[Operator:]

We will go next to Jeff Schuman at KBW.

[Jeff Schuman:]

Thanks, again. Just wanted to clean up a few numbers. When you were talking about the changed guidance I think you mentioned its impact, the variable annuities of 1.1 million – to 2.4 million. I wasn't sure. Is that a delta that we should apply towards your normal run rate? Is that what we should do?

[Mark McAndrew:]

Well, obviously that depends on what the stock market does between now and year end, but that's kind of the range that we see the potential in the fourth quarter. Obviously if the Dow goes back to 11,000, we won't have those losses, but Rosemary, you want to comment?

[Rosemary Montgomery:]

Yes, I would like to add one additional thing. That was definitely related to two things really. We had been seeing higher than expected lapses in that line. So that takes that into account, but also the bulk of it really is based on the fund balances. It does depend on what would happen to that in the fourth quarter.

[Jeff Schuman:]

I wasn't quite sure what the numbers meant. Is that a delta versus a run rate or it's an estimation that you would actually lose –

[Mark McAndrew:]

We were anticipating underwriting margins of about $750,000 in the fourth quarter. Yes, it would translate – not all of that would be a loss, but we are now expecting to take a loss in that line of business in the fourth quarter.

[Jeff Schuman:]

Okay. And that view is as of 930 or as of more recently given the subsequent market decline?

[Rosemary Montgomery:]

It's actually as of 930 with some estimate as to what we think could happen as of year-end.

[Jeff Schuman:]

Okay. And then – I'm not sure I transcribed very well. Did you specify an amount for the impact of the lower investment income on the securities?

[Mark McAndrew:]

Yes, it was $1.2 million after tax.

[Jeff Schuman:]

Okay. Thanks a lot.

[Operator:]

We will take our next question from John Hall of Wachovia.

[John Hall:]

Thanks very much. I'm just going to go back to the topic of acquisition and capital, a little bit now. I wanted to be clear about your walking away from the deal was a function of financing as opposed to pricing or anything else?

[Mark McAndrew:]

Yes.

[John Hall:]

Secondly, as you look at that M&A environment, how would you categorize sort of the pricing environment? Are public multiples at a lower point than what private multiples are? Are they roughly in sync?

[Gary Coleman:]

The multiples that you are willing to pay – again, acquisitions, the size you are talking about with AIG, most anyone is going to have to raise some equity to make that type of acquisition and if – when you look at the price you would have to issue equity at, it obviously lowers the price you are willing to pay in an acquisition. So yes, the multiples that you are seeing for potential acquisitions are coming down, have come down.

[John Hall:]

Great. I was just wondering, you had mentioned possible use of cash as buying in debt. I was just wondering what the decision process would lead you in that direction to do that?.

[Gary Coleman:]

No, I was referring to there was a question there we have $100 million of maturity of our debt in August of 2009. It would be our intention to refinance that but it would be difficult to do that in today's market and if conditions persist I hope they don't, but if they do, still in August of '09 it's still this difficult, then we can instead of – if the refinancing was too costly or difficult to get, then we could use a portion of our free cash flow to pay the maturity.

[John Hall:]

Great. Thank you very much.

[Operator:]

And our final question comes from Richard Weiner [ph] at Citadel Investment Group.

[Dan Johnson:]

Great. Thank you very much. Actually, this is Dan Johnson. On – going back to just a quick question on impairment policy. On Page 13 of the supplement I think is where you got your $1.4 billion to the broken out by asset category. I think if I understand right, generally on the corporate and again on the preferreds, the intent is not to impair until effectively you think the company – the company issuing the bond will be going bankrupt or unless you intend to sell the security. I just wanted to frame that right before going and asking my question.

[Gary Coleman:]

Well, that's – it's maybe a little more involved than that, but I think what we have to look at is we've got these losses. If we were going to sell all our bonds, we would realize those losses. So we would either realize them by selling them or we have to do an impairment if we were going to sell them. Our position is we buy and hold to maturity. So as long as – when maturity comes they pay off the bonds, then if the market value is half the par value for that, it really doesn't make any difference. So when we are – when we are looking at this, we are trying to see what the net realizable value is going to be of the bonds and there is – indicates Lehman obviously going into bankruptcy there we are not going to recover the full value. We are going to recover something, but not the full value. But when looking at other bonds that maybe – again, their market price maybe 50% of their book, well, that's more of a sign of the market. If we were going to sell today, we would get $0.50 on the dollar, but we are not going to sell and as long as their fundamentals look good and we don't see – it looks like they will go into bankruptcy, we are not going to do other than temporary – in our minds it's not are their temporary impaired and we're not going to write it down.

[Dan Johnson:]

Regardless of the age at which those are I guess that in your mind at an unrealistically depressed price?

[Gary Coleman:]

Right.

[Dan Johnson:]

So let's go under the CDO. You fair valued the CDO down about 80%. Two questions. One, can you remind us of the underlying collateral of that CDO and given that that's not a single entity that you can determine whether or not they are going to go to bankrupt – become bankrupt. What is the test to decide whether or not that $100 million of unrealized loss would become considered other than temporary?

[Gary Coleman:]

Well, the underlying collateral on those securities are, as I mentioned earlier, trust preferred issued by banks and insurance companies, primarily – I think there is a small amount of other. We have a pretty high tranche in our stress testing, it would be substantial defaults before if we get to the point where it would affect our tranche. So but when you put that out to different brokers, what would they pay for those at particular time or what would people pay for them, again, the market is affecting it. But when you are talking about whether we are going to recover our value at this point we think their money good.

[Dan Johnson:]

The A minus rating on that CDO was that the original rating or is that I guess current rating?

[Gary Coleman:]

No, that's a current rating.

[Dan Johnson:]

Has that been marked down over the last year in terms of rating downgrade?

[Gary Coleman:]

No, I don't believe it has. Again, there is – we have got – there is three or four and as I mentioned the lowest is BBB, but overall they are A minus.

[Dan Johnson:]

Thank you very much.

[Operator:]

And there are no more questions at this time. I would like to turn the call back over to management for any additional or closing remarks.

[Mark McAndrew:]

Well, those are our comments for today. Thanks for joining us and we will talk to you next quarter. Have a great day.

[Operator:]

That does conclude today's conference. Thank you for your participation and you may now disconnect.