Globe Life Inc.
Q3 2009 Earnings Call Transcript

Published: 30 Oct 2009

[Operator:]

Good day, everyone, welcome to the Torchmark Corporation third quarter 2009 earnings release conference call. Please note this call is being recorded and is also being simultaneously webcast. At this time I will turn the call over to 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 may contain forward-looking statements that are provided for general guidance purposes only. Accordingly please refer to our 2008 10-K and any subsequent forms 10-Q on file with the SEC. Net operating income for the quarter was $122 million or $1.48 per share, a per share decrease of 2% from a year-ago. Net income was $101 million or $1.22 per share. Excluding FAS 115 our return on equity was 14.6% and our book value per share was $42.82, a 13% increase from a year ago. On a GAAP reported basis with fixed maturity, investment period of market value, book value was $39.92 per share. In our life insurance operations, premium revenue grew 2% to $414 million and life under writing margins increased 3% to $111 million. Life insurance net sales were $82 million up 9% from a year ago. At American Income life premiums were up 6% to $128 million and life underwriting margin was up 9% to $43 million. Net life sales increased 14% to $32 million. Producing agents at American Income grew to 3,929 up 36% from a year ago. Due to first three quarters of this year life sales at American Income have grown 16%. I believe it’s on a very good growth track and has good momentum and we expect to see similar sales growth to continue throughout 2010. In our Direct Response operation life premiums were up 5% to $133 million and life underwriting margin grew 12% to $33 million. Net life sales increased 10% to $33 million. Sales results in Direct Response were somewhat better than expected through nine months our Direct Response life sales are up 10% while achieving a $15 million reduction in our acquisition expenses. We currently expect to see comparable sales growth for 2010 while keeping our expense level close to the 2009 level. Life premiums at Liberty National declined 2% to $75 million and life underwriting margin was down 23% to $14 million. Net life sales for the Liberty National offices declined 12% to $11.4 million. And the producing agent count down to 2693. Net life sales for UA Branch Offices grew 84% to $2.7 million for the quarter. Significant changes were made during the third quarter to address the persistency and profitability of the business being written at Liberty National. These changes have improved the quality of the new business but we anticipate a continued decline in our sales and producing agent count during the fourth quarter. We expect this decline to reverse in the first quarter of 2010 and expect to achieve double-digit growth in life sales at Liberty National during 2010. On the health side, premium revenue excluding Part D declined 13% to $200 million and health underwriting margin was down 15% to $36 million. Health net sales declined 39% to $18 million. We believe the level of our health sales is close to bottoming out and currently expect 2010 health sales of around $70 million. With the announced dis-enrollments of over 600,000 Medicare advantage participants, we expect to see an improvement on our new Medicare supplement sales as well as Part D, although it is too early to predict how much improvement we'll see. Premium revenue from Medicare Part D was $48 million for the quarter, a 15% increase, while underwriting margin declined 11% to $6 million. Through nine months Part D sales have grown 29% to $16 million. The underwriting margin from our annuity business was $1.2 million for the quarter versus $300,000 a year ago. Administrative expenses were $37.4 million for the quarter down 2%. Year-to-date our administrative expenses are up less than 1%. For 2010 we anticipate administrative expenses to grow in the 1 to 2% range. I will now turn the call over to Gary Coleman our Chief Financial Officer for his comments.

[Gary Coleman:]

Thanks, Mark. I want to spend a few minutes discussing our investment portfolio and liquidity and capital. First, there are several positive developments in the third quarter, net unrealized losses in the fixed maturity portfolio are $396 million, a decline of $1.8 billion from the peak of the $2.2 billion at March 31st, 2009, and the lowest level since year-end 2007. In addition, we improved the overall quality of the bond portfolio by reducing below investment grade bonds by 23% to $946 million, and we bolster the capital to insurance companies by contributing a $125 million of cash from a parent company to the subs. The first two items the reduction of the unrealized losses and the reduction of below investment grade bonds are interrelated. In previous quarters we chose not to sell below investment grade bonds because we generally buy and hold and any under valuations were such that we felt that we would receive a better risk adjusted return by holding them. Due to the significant improvement in valuations in the third quarter, we determined that for certain below investment grade bonds we would get a better risk adjusted return by selling them. Thus late in the quarter we sold $315 million of below investment grade bonds. To offset the tax losses from these sales, we sold $443 million of investment grade in NAIC Class 2 bonds. Because the sales occurred so late in September, very little of the proceeds were reinvested as of September 30th. On the balance sheet, these proceeds are included in cash, short-term investments, and receivables from the sale of securities. We are currently in the process of investing these funds in investment grade securities. I will include the impact of this portfolio repositioning in my comments on the investment portfolio liquidity and capital. First, the investment portfolio on our website are three schedules that provide some information regarding our portfolio as of September 30, 2009. They're included under supplemental financial information in the financial reports and other financial information sections of the Investor Relations page. As indicated on these schedules, invested assets are $10.1 billion including $9.4 billion of fixed maturities at amortized costs combined equities, mortgage loans and real estate are $33 million less than 1% of invested assets. As the $9.4 million of fixed maturities $8.5 billion are investment grade with an average rating of A minus. The low investment grade bonds are $946 million, and once all of the sales proceeds from the portfolio repositioning are invested will be 9% of fixed maturities. This compares to the $1.2 billion of below investment grade bonds and 13.1% of fixed maturities at June 30, 2009. In addition, the ratio of below investment grade assets to equity excluding FAS 115, is 27% compared to 36% at June 30. Overall the total portfolio is rated triple B plus the same as a year ago. During the quarter we charged realized capital losses for other than temporary impairments on five bonds. The total charge was $51 million pre-tax or $31 million after tax. Including the net gains on asset sales net realized capital losses for the quarter were $25 million dollars after tax. Year-to-date realized capital losses of $78 million after tax, for further information regarding impairments see the schedule on our website entitled summary of net realized investment losses. Now I would like to discuss the asset types within our fixed maturity portfolio. 75% of the portfolio is in corporate bonds and another 15% is in redeemable preferred stocks. All of the $1.4 billion are redeemable preferreds have a stated maturity debt and other characteristics that make them look like debt securities. And to date all scheduled interest payments have been received. None of these securities are perpetual preferreds. The remaining 10% of the portfolio consists primarily of municipals and government related securities. Our CDO exposure is down to $61 million and two securities were the underlying collateral is primary bank and insurance company trust preferreds. Now to conclude the discussion with investments, I’ll cover the investment yield. At June 30, 2009, we had $625 million of cash in short-term investments in the insurance companies. We had accumulated the cash in the second quarter because of the uncertainty regarding the commercial paper and long-term debt markets. With the $300 million of debt issuance in June and stabilization of CP market, we invested this excess cash in the third quarter along with our operating cash flow. In the third quarter we invested $957 million in investment grade fixed maturities, primarily in the municipal and industrial sectors. We invested at an average annual affective yield of 6.4%, an average rating of A, at an average life of 13 to 19 years. This compares to the 7.3% yield, A minus rating and 21 year average life of the bonds acquired in the first six months of 2009. The lower third quarter yield was due to us relax in the tenure of our investments in order to have a larger supply of bonds to invest in. Although we invested the excess cash from June 30, we ended the third quarter with excess cash due primarily to the portfolio repositioning. At September 30th we had approximately $1.1 billion in cash, short-term investments and receivables from sale of securities. $940 million in the insurance companies and the remaining $150 million in the parent company. We are in the process of investing the extra cash to insurance companies but will probably not have it all invested by year-end because of the already limited supply of bonds currently available, and the usual slow-down in the approaching holiday season. Since September 30th, we have invested $282 million at an average yield of around 6%, average life of 14 to 22 years, and an average rating of A. For the entire portfolio, the third quarter yield was 6.97%, the same as it has been for the last eight quarters. However, the portfolio repositioning in late September has reduced the portfolio yield, because the $758 million of bonds sold, had an average yield of 7.23%. As a result, the overall yield on the portfolio is now about 6.88%. And once the excess cash is invested, we expect the portfolio yield to be around 6.85%. Now, regarding risk based capital, as previously indicated we intend to maintain our RBC ratio at around 300% level that we've held in the past. This ratio is lower than some peer companies but it is sufficient for our companies, in light of our consistent statutory earnings, the relatively lower risk of our policy liabilities and our ratings. Entering 2009, our consolidated RBC ratio was 329%, by June 30th the ratio had fallen to 245% due to bond impairments and down grades and disproportionate share of dividends to the parent company during the first half of the year. In the third quarter we took step to improve the RBC ratio. We increased the capital insurance companies, by having a parent company contribute to $125 million of cash, and that committed to contribute another $50 million in the fourth quarter. We reduced required capital by approximately $27 million by selling below investment grade bonds as a part of the portfolio repositioning. Additional benefit of the repositioning is that our class 3 through 6 bonds are well below the regulatory limitation both in total and by individual class. With these enhancements and assuming no impairments or down grades in the fourth quarter, we estimate that the year end RBC to be around 313%, which means that we would have approximately $55 million of capital over that is required for 300% ratio. We performed a stress test assuming the following in the fourth quarter. Impairments of $30 million after tax, and assumed down grades on our bonds that are O-negative watch and outlook that result in down grades equal to the quarterly average during the first six months of the year. Even though down grades in the third quarter had an immaterial impact on the required capital. Under this severe scenario, RBC would be approximately 290% and we would need to put in additional $50 million into the insurance companies to reach the 300% level. We don't expect to have this level of realized losses and downgrades in the fourth quarter, but if we did, we have more than sufficient liquidity at the holding company to maintain the 300% ratio. At September 30th, the parent company had $150 million of cash. Free cash flow for the fourth quarter will add another $50 million. But as mentioned the parent will use $50 million to purchase surplus notes from the insurance companies in the fourth quarter. As a result, we expect parent company cash to remain at $150 million at year-end. In addition, we estimate that free cash flow for 2010 will add another $210 million to $230 million to parent company cash. In addition to the cash of the parent company, we have other sources of liquidity, such as debt issuance and credit facilities and inter-company financing that could provide another $1.2 billion of cash. So based on the results of our stress testing, the cash held at the parent company, and other liquidity sources, we believe the parent company has more than sufficient liquidity to offset the impact of further realized losses and down grades on the statutory capital of our insurance companies. Those are my comments. I'll now turn the call back to Mark.

[Mark McAndrew:]

Thank you, Gary. As a result of bond sales in the third quarter, which Gary mentioned we are revising our guidance for 2009 to a range of $5.90 to $5.95 per share. For 2010, we currently anticipate operating earnings per share to be between $6.05 and $6.25, assuming we do not reinstate any share repurchase. Those are my comments for this morning. I will now open it up for questions. David?

[Operator:]

Thanks. (Operator instructions) Our first question comes from the line of Bob Glasspiegel with Langen McAlenney.

[Bob Glasspiegel:]

Good afternoon, everyone. You guys are good poker players, you never sound excited or nervous, but the body language I assume is that you feel lot better about your capital position 6/30, given the financial markets in the third quarter. Is that a fair assessment?

[Mark McAndrew:]

I think that's a fair assessment and versus where we were six months ago when our unrealized losses come down $1.8 billion, we have to feel pretty good about that.

[Bob Glasspiegel:]

Okay. You throw the share repurchase as you're ignoring it which sort of means that you think it's at least theoretical possibility in 2010. What are the benchmarks that we should be looking for that would make you feel comfortable to resume your share repurchase program? To put it another way, if you execute your plan and impairments are downgrade and are in line with what you're thinking, what is the soonest you could consider buying back stock?

[Mark McAndrew:]

Well, we're not in a position to make any commitment there, yet, Bob. It is something that we'll continue to monitor each quarter and discuss at our Board meetings, but it is a little premature to try to set a date. Obviously things that will impact it will be what future impairments and downgrades are, although, we believe the worst of that is over, and other potential uses for the cash. So, I just can't predict right now when that might occur.

[Bob Glasspiegel:]

Okay. Direct Response coming in above where you thought it was, is that anything related to the economy not being as bad as you feared, or something from an execution point of view?

[Mark McAndrew:]

Well, it's a little bit of both. Actually we started to see some of our response rates increase which I think has a little something to do with the economy. That was the only segment that we felt like the economy had some impact on. But overall a number of the tests that we performed earlier in the year, we were able to roll out with, and the results have been good, and I'm very optimistic about where we're headed next year.

[Bob Glasspiegel:]

Thank you very much.

[Operator:]

We go next to the line of Jeff Schuman with KBW.

[Jeff Schuman:]

Thank you. Good afternoon. Mark, you touched a little bit on some of the things at Liberty, but I guess I didn’t quite come away with an understanding of what's happening there in terms of why you're still challenged and what sort of compensation and other changes you made there. So could you kind of give us a little –?

[Mark McAndrew:]

Sure. Well, as I mentioned last quarter, we saw some significant deterioration in the persistency of the new business being written over Liberty National over the last year. And they're very closely tied into when we went to electronic application and laptop sales presentation. Part of the problem there was, as we went to the electronic application, we no longer required the agent to collect the initial premium on these sales. We didn't have adequate controls in place to really guarantee the quality of the business we were writing. So we have made some changes, and we've tied management's compensation more closely to the overall persistency of the business being written. We've delayed paying agents until after that first premium payment clears the bank, and so that we know we have a good bank account, there is money in the account. So we've made some changes. We anticipated when we made though, that some of the agents and some of the managers who had quality issues that were below our standard, that we would see some turnover there and we have. Again, it was planned on, and we'll continue to see a little bit of that in the fourth quarter, but we think we've made the changes necessary to improve the profitability of the business, and we believe by the first quarter of next year we will be in a position to start seeing some good growth there again.

[Jeff Schuman:]

Okay. That's helpful. And next for Gary. Gary, you give us a lot of information around things sort of impacting portfolio yield. I guess the answer to my question maybe embedded in what you already given us but maybe you can help me out. If you want to think specifically about the kind of the cost of the portfolio repositioning, either in terms of yield or dollars, can you isolate what the cost of that expected to be essentially?

[Gary Coleman:]

Our portfolio yield has been or last several quarters 6/97, and now just snapshot of the portfolio as it is, it is down around 688. So it costs us 10, 11 basis points.

[Jeff Schuman:]

Okay. Thank you. And then lastly, Gary, as Mark said , it is hard to know when you get back to share repurchase mode, but when you kind of clear the credit crisis a little further and kind of get back in that mode. Are you likely to kind of get back to the fairly straightforward way that you kind of managed capital and cash flow historically? Historically, you pretty much pulled the regular dividend, serviced the holding company and bought back stock and it was pretty straightforward. Are you likely at some point to kind of get back to that kind of technique, or are you likely to need to kind of manage holding company a little differently going forward based on what we've experienced in this cycle?

[Gary Coleman:]

Well, Jeff, we want to make efficient use of our excess cash. Although, it is something that we're more open now to looking at potential acquisitions, and as a credit markets continue to improve and open up, that's a possible use for that excess cash, too. So, it's really impossible to say right at this point just how we'll use our excess cash next year, but we will try to use it as efficiently as possible.

[Jeff Schuman:]

I guess part of my question was about the holding company, historically, you didn't carry a lot of cash at the holding company. As we get beyond this crisis, can you get back to that mode, or out of prudence will you carry a different level that going forward?

[Gary Coleman:]

Jeff, one difference for the – I think we can get back to that, maybe we leave a little more cushion there, although, we came into the year at 329% RBC. We'll be a little more careful from that standpoint. I think one difference you may see is that the cash may not come up to the holding company as quickly. We may – in the past we never managed RBC ratios at particular quarters and that's become more of an issue. You may see more of a spreading of the cash out over the year as opposed to bringing it out in the first half than second half.

[Gary Coleman:]

Jeff, short-term, as far as 2010, I will have to say we will be a little more prudent as far as holding some cushion at the holding company level.

[Jeff Schuman:]

Great. Okay. Thanks a lot guys.

[Operator:]

We'll go next to Ed Spehar with Banc of America.

[Ed Spehar:]

Thank you, good afternoon. I wanted to follow up on free cash flow for 2010, Gary, I think you said 210 to 230, which is a lower number than what I would think is a normal free cash flow numbers. So can you explain that a little bit more? Does part of that reflect holding more of a cushion at the holding company or what's going on there?

[Gary Coleman:]

Well, part of it is, again from this year's earnings and the impairments that we had this year are holding down the earnings for this year. And that's – and also the new business, increased new business, where Liberty is going to hold their earnings down a little bit. But we will hold a little extra cash. We're just not sure how much. That's why I'm giving you a range. And it's really kind of early to give a range because I haven't even seen our third quarter numbers. So, I try to be conservative with that. We'll have a better idea of free cash flow when we get into the fourth quarter. But the single biggest factor Ed, was the impairments we had during the year.

[Ed Spehar:]

Can I follow up on that? Because there seems to be some – it seems unusual to hear about statutory dividend capability capacity being limited by impairment s because I think statutory dividends are a function of prior-year operating gain or 10% of surplus and it's either greater-than or less-than when you look at the state. So why – and there is some confusion about this net earnings limitation which I'm not sure, I mean there is different opinions on this sort of related to Nebraska regulation. I'm wondering if you could give us a little bit more on that.

[Gary Coleman:]

Well, Nebraska standpoint, it was different than say, Delaware, Nebraska requires – you take your operating earnings less any loss, if you have losses you have to reduce the losses on it, and that's different. In Delaware it is operating earnings and in Nebraska it is operating earnings and if you had realized losses you have to deduct that.

[Ed Spehar:]

Okay. And then I guess the – maybe I'll follow up with you on that because I want to talk a little bit more about the specifics, because it seems like – it is unclear to me that that's the approach that makes sense given that you're a life company. I know there is some controversy about this Nebraska wording. But I wanted to ask you about the guidance for 2010, and I'm sorry if I missed this. But the wider range, little bit wider range, is it because we're early on here or is it specifically related to sort of uncertainty about how quickly you reinvest cash or share buyback I don't think is included in that number. But can you give us a little bit about maybe in terms of why the range is wide?

[Gary Coleman:]

Well, that is typically what we've done in the last couple of years, anyway, Ed, we started out the year with a little wider range and then we narrow it as the year goes along. Although, there is still some uncertainty there, and I would have to say there is some conservatism built in there, as far as particularly on both the investment income side as well as underwriting margin side. But Gary, you can on the investment side, we've assumed that we're basically investing funds at 6% for the entire year.

[Ed Spehar:]

Yes, that's correct.

[Mark McAndrew:]

But it's kind of a normal – this is typical of what we've done in the last couple of years, Ed.

[Ed Spehar:]

Okay. Thank you.

[Operator:]

We'll go next to Mark Finkelstein with FPK Research.

[Mark Finkelstein:]

Hi, couple of quick sessions here. I guess, firstly, why the rationale of issuing a surplus note rather than just doing what you're doing with 125 and just putting another 50 in the stack company?

[Gary Coleman:]

Well, I think it gives us a little more flexibility. Also it helps us from the tax standpoint. It generates – we need non-insurance company income, and so, the sales from that standpoint it's – and it gives a little flexibility in terms of, that money could be paid back at certain points in time.

[Mark Finkelstein:]

Okay. And I guess just thinking about 2010 and even beyond 2010 into 2011, I mean obviously the primary health block is in essentially in run-off. The in force is down to 129. How much do you estimate the earnings impact from that business essentially from here going to zero in terms of whether it is operating earnings or EPS, or what have you?

[Gary Coleman:]

Mark, I guess that is another way you can look that is the in force on the hospital/surgical block is down to 129 million and Rosemary, our profit margin on that business…

[Rosemary Montgomery:]

The underwriting margin on that business is probably around, I would say around 6%, 7%, and based on, assuming that there is no further persistence deterioration, we would expect that to hold.

[Mark Finkelstein:]

And that is pretax.

[Rosemary Montgomery:]

Yes

[Mark Finkelstein:]

So, you can kind of see the potential impact there that’s in run-off mode.

[Gary Coleman:]

Again, that's 16% of our total health enforced premium. One of the things on the Medicare supplement side, that’s still, we saw 457 million Medicare premiums on the books which is 55% of our total and it declined by just over 1% in the quarter. And I think with the Medicare advantage disenrollments and the potential for there is going to be two new standardized Medicare supplements plans coming up next year. I'm cautiously optimistic that we can start seeing some growth in the Medicare supplement side.

[Mark Finkelstein:]

Okay. I guess, just one final question on the run-off of the primary health block. I mean, is it 6% to 7% goes to zero and no additional overhead expenses go to the other businesses, therefore the margin on the other businesses get hit because of a lower premium margin or can it literally go to zero and literally no changes in the margins Med sup and the other health businesses?

[Rosemary Montgomery:]

Are you asking if they're independent? Because I think I would say the answer is yes. But if that block entirely runs off then I would expect the Medicare supplement profits that we're still seeing would hold.

[Mark Finkelstein:]

Right. Okay. And then just one final question on capital. I understand you're going to kind of hold to a more normalized RBC throughout the year. But is that number going to call it 300% or are you going to target at little above that as a stack company?

[Gary Coleman:]

I think the proprietary it maybe – we have a little bit of a cushion there. It is going close – we're not going to go up to 400%, closer to 300%, but we'll try to maintain a cushion.

[Mark Finkelstein:]

At the stack company.

[Gary Coleman:]

Yes.

[Mark Finkelstein:]

All right. Thank you.

[Operator:]

We'll go next to Steven Schwartz with Raymond James & Associates.

[Steven Schwartz:]

Hi, good afternoon. Mark, if we could, can we revisit the discussion with Jeff on L & L, so I understand what is going on here? The problem was you move to laptops agents no longer collected the initial premium. How are you getting initial, well, presumably you got it by hand the first time around, but how do you get it after this change, how were you suppose at the beginning of wire transfer?

[Mark McAndrew:]

Well, I mean, for a number of years the primary payment mode has been automatic withdrawal from people's bank accounts on a monthly basis. So when we were dealing with paper applications, the customer wrote a check for the first month's premium, so we knew we had the first premium payment as well as from the check we knew we had good bank account information. Now, when we went to electronic application, we were drafting out of the people's bank account the first premium payment and a lot of it was just incorrect bank account numbers. We would have to go back and forth. But one, now we're making sure, a big change which is making sure that that first premium payment clears the bank before we advance commissions or pay bonuses and that had immediate impact.

[Steven Schwartz:]

Is the issue, I mean, you said wrong numbers, but is part of the issue some type of buyer's remorse, and would hand in half (inaudible) and now people pay him and then the transfer would just never be made because the purchaser had remorse.

[Mark McAndrew:]

Well, I am sure there was some of that. It's impossible to quantify why the initial payments weren't clearing. We just know we saw a significant deterioration coincide to the time with moved to electronic application.

[Steven Schwartz:]

You said that you've tied – you're not going to pay until the check clears I guess or until wire transfer is made and you tied the management to bonuses and pay to persistency. Any steps to make sure that that first payment comes in?

[Mark McAndrew:]

Yes, there is too. We again now with electronic application, because it is electronic funds transfer. We're processing that within 24 hours from the time the application is transmitted to us. So we only had to delay payment for a few days. But, no, we're now making sure that if the initial payment does not clear the bank, the agent is not paid for.

[Steven Schwartz:]

Very good. If I could, you mentioned Medicare disenrollment, Was that a, I couldn't quite hear the number, was that 600,000?

[Mark McAndrew:]

It's just over 600,000, I think somewhere 630,000, or somewhere in that range.

[Steven Schwartz:]

And then maybe, Rosemary or somebody can comment on how the Part D bidding went for you guys this time around.

[Rosemary Montgomery:]

The Part D bidding was fine. Our plans were approved. Our bids were accepted. We're going to generally be selling the same type of plans next year that we've had in 2009. The premium is going up a little bit by I would say approximately $3 a month. We also made some changes in our co-pays, but it's basically business as usual there, plus same profit margin that we have anticipated going into next year as we had for this year as we had for this year.

[Steven Schwartz:]

Okay. In enrollment you guess it would be about the same or do you pick up some LIS maybe?

[Rosemary Montgomery:]

Well, we’ve really picked up a real small region, Delaware, DC and...

[Steven Schwartz:]

Okay.

[Rosemary Montgomery:]

So, that will probably be about the same.

[Mark McAndrew:]

Although…

[Rosemary Montgomery:]

That’s the region we had.

[Mark McAndrew:]

On the individual side, I would expect to see some improvement there, just because of the 630,000 Medicare Advantage disenrollees, some of those people have the Part D coverage with Medicare Advantage plan. So, again we know where those disenrollees are occurring, and we've already developed mail links and print ads to target those areas and so hopefully we'll pick up some of that business also.

[Steven Schwartz:]

Okay, good point. All right, thank you guys.

[Operator:]

We'll go next to Randy Binner with FBR.

[Randy Binner:]

Thanks. Just a question on investment yields. I think in a conversation here you were talking about targeting 6% new money yields in 2010 with kind of the money that needs to be reinvested. Did I hear that right?

[Gary Coleman:]

Yes, Randy, you did. The reason we used the 6% is that's what we're – we've invested in so far this quarter. We actually think the rates may be higher than that. At least maybe toward the end of the year, but we settled on six because that is what we're investing in now.

[Mark McAndrew:]

It’s not so much that we're targeting 6%, Randy, it's just that we've used in our projection. We hope to beat the 6%.

[Randy Binner:]

And what's the mix of assets that's generating that kind of yield on a current basis?

[Gary Coleman:]

When you say mix of assets, you mean as far as –

[Randy Binner:]

You know, as far as credit, investment grade corporate, high-yield corporate. Are you doing any other structured stuff?

[Gary Coleman:]

No, no structured stuff. It is going to be in corporates. Investment grade corporates and we'll confine it to that. What may change is that, Randy there are fall to liabilities that are very long-term. We like to invest long because to match those [ph] liabilities. What we've seen though is, right now there is limited supply of bonds available. For some reason we're – we're not seeing long bonds at the yields we would like. So, for – right now we're investing a little bit shorter, and if we don't get the 6.5% of the long-term basis that we're looking for then we'll probably should shorten up a little bit, but we expect that it will get back to, again, the investment grade, corporates and generally 20 year maturities. Right now it’s a little bit less than that, thus we expect to get back to that at some point.

[Randy Binner:]

Great. And just one more if I could. As far as thinking about how the model the overall investment yields for the company, as there's a newer piece coming in, what would you expect that to kind of have downward progression into second or third quarter of 2010, or would it be flatter? Or it just kind of some timing of when you think that the overall yield might trough would be helpful for getting to the guidance number on 2010?

[Gary Coleman:]

Well, we're at – I think we'll end the year; our portfolio yield will be around 685. If we invest at six next year, we have quite a bit of money to invest, that could get down to around 670 by the end of the year. So the average would be there to beginning and the ending. The difference is, though, if we invest at 6.5 to 50 basis points more, you don't see that much of a decline in the yield. So it's going to – again, at 6% we would go from around 685 to 670, invest at 6.5% and then maybe 685 to 680 or a little above.

[Randy Binner:]

Okay. And so one more –

[Gary Coleman:]

Those last numbers I gave you, 670, that’s what the portfolio yield would be at the end of the year, so for the year it would be the average of 685 and the 670.

[Randy Binner:]

Right. Got it. Just one more question. So there is a range obviously on 2010, and earlier, Mark, you said there is combination of underwriting and investment yield conservatism. But wouldn't it be mostly be investment yield conservatism between the 6 and 6.5 or better?

[Mark McAndrew:]

That’s a big part of it, yes.

[Randy Binner:]

All right. Fair enough. Thank you very much.

[Mark McAndrew:]

Yes.

[Operator:]

We'll go next to Eric Berg with Barclays Capital.

[Eric Berg:]

Thanks very much. Good morning to everybody in Texas. So you announced to the world that essentially nobody is going to get paid any longer until the check clears and that's very clear and it makes complete sense to me, but is it possible that, that alone is leading to this very significant drop in first year agents at Liberty? And then I have a follow-up? Or other factors that we need to be sensitive to?

[Mark McAndrew:]

No, that’s basically the change is in the compensation that we made really because of the current decline there. But, again, we expect that to be basically a run out here in the fourth quarter and turn around in the first quarter.

[Eric Berg:]

Question, agent count, it looks like there has been a big drop as well in the agent count at the UA Branch really continuing. Can you remind us why that is happening and what’s being done to address that, if you want to – is in fact that is a problem. I shouldn't presuppose it is a problem. But what’s behind that one and what’s being done to correct it if in fact that's your goal?

[Mark McAndrew:]

Well, the cause of it is still – it's very difficult to move agents who have traditionally written health insurance into writing life insurance. And as we continue to convert more of those offices, we've continued to see a decline. Now, that, for example, I'll just say at the end of the second quarter, we had converted 44 of 78 UA offices to the Liberty National products and basically transitioned them to write more life and supplemental health. During the quarter we moved to 11 more offices over, and as we continue, we're now down to – there's only 18 UA offices that have not been converted. So we'll continue to see some drop-off there as those offices are converted to Liberty National. It’s difficult to teach agents a new market play. So, the trick is, we've got to hire more new agents and train them how to write life insurance in the supplemental work side products. And we're continuing to push that and try to incentivize the recruitment of new agents. So that should be completed here in the next couple of quarters.

[Eric Berg:]

Last question, Mark, is purposely meant to be broad and I'll preface by saying that I understand that your answer to my question is going to be necessarily – will have to be heavily caveated, but realizing that there is so many changes taking place in healthcare, I would like to know, what do you think two to three years from now, whatever, look into the distance and make your best guess, what’s the complexion of your health business is going to be. Is it going to be Medicare supplement business, is it going to be limited benefit business? Where is this business from the 30,000-foot level, where is this business headed? Where will it settle down three years from now in terms of its complexion?

[Mark McAndrew:]

Okay. My feelings about where health insurance is headed is you're going to see a few large players basically take over the individual health insurance marketplace. I think as far as agents are concerned, I think you're going to see standardized plans with minimum benefits with significantly higher minimum loss ratios than what we see today. Those higher minimum loss ratios are going to make it very difficult for an agent to make a living selling individual health insurance, at least the broad benefit major medical type products. I think you are going to see it become more of a commodity. But on the bright note, I think a lot of those agents that are in that marketplace are going to be looking for a different marketplace to get into. I think right now, I think you will see a significant number of those agents move back into a Medicare supplement marketplace, with – because I think the Medicare Advantage plans, I think the 600,000 disenrollees this year is just the first of several years worth of disenrollees and with the new supplement Medicare plans coming out mid part of next year, I think there will be renewed interest in the Medicare supplement world. But as far as agents are concern, I don't see a long-term future in the major medical business. And I think a number of agencies who have been in that marketplace are seeing the same thing.

[Eric Berg:]

I guess just one clarification and then I'd like to do requeue if necessary, so that others can ask a question. Why was the high loss ratio, or higher loss ratios that you would see mandated loss ratios, can you clarify why would not make for an agent to make money, his commissions is a function of selling the policy, not how profitable it is at the company level?

[Mark McAndrew:]

Well, but it’s driven by, for example, Eric, if we've got a 60% minimum loss ratio, that allows us 40% of the premium for profit and commission, acquisition expense. If they raise that to 90% minimum loss ratio, that only allows 10 points for profit administration, and compensation. Well, and it may not go to 90 but I would be surprised if it doesn't go to at least 80. You take that from 60 to 80, that basically squeezes out any compensation that's available, because the company still needs to make a profit and pay for their administrative costs.

[Eric Berg:]

I got it now. Thanks very much.

[Operator:]

We'll go next to Mike Grondahl with Northland Securities.

[Mike Grondahl:]

Yes, Mark, can you talk little bit about your sales outlook for American Income in Direct Response as you're kind of looking at '10 and kind of the strategies you're going to employ there?

[Mark McAndrew:]

Well, again, at American Income, we feel like we've made the changes over the last two or three years necessary to really put us in a position for growth, and we have seen double-digit growth now for at least six quarters in a row. I feel very good about the track it's on. I don't see any major changes necessary there to continue the type of growth that we've been seeing. One, we're starting to look at trying to move – continue to move beyond just the labor union marketplace, and still writing middle income working class Americans, and we've got some people in our Direct Response operation trying to assist there to try to continue to grow that company even outside the union marketplace. But it’s on a very good track right now, and I expect to continue to see strong double-digit growth for the foreseeable feature at American Income. The Direct Response, I am pleased with where we are at and we've had a number of tests that we have done this year on product pricing and packaging that have been very successful. Going into next year, we already feel pretty good about at least high single-digit if not low double-digit growth, and that’s assuming that none of the additional test we do during the course of the year really come through and deliver better results. So we are ending the year, feeling pretty good about where it's that. But it’s still a constant challenge in Direct Response. We have to constantly find better ways to do things to continue that growth. But I feel very good where we are going into the year.

[Mike Grondahl:]

Okay. Great. Thank you.

[Operator:]

(Operator instructions) We’ll go next to John Nadel with Sterne Agee.

[John Nadel:]

Hey, good afternoon, everybody. So, just a couple of quick questions to go through risk based capital just a little bit more, and the free cash flow commentary just to make sure I have got this straight. So, year-end ‘08 the 329 RBC was roughly $1.3 billion of total adjusted capital and about $390 million of required capital. Gary, I think you mentioned a fall into around 245% or 250%, as of June, can you give us the comparable what the numerator and denominator sort of in a range was, with the vast majority of that drop driven by the denominator rising?

[Gary Coleman:]

While we were at 12/31/08, it was a $1.281 billion of capital and $1.389 [ph] of required capital, and where we were at June, we saw a decline in capital due to impairments and we also believed the biggest impact was the increase in the RBC, and it was up about a little over $50 million.

[John Nadel:]

Okay. So the denominator was up about $50 million, the numerator would make up about the rest?

[Gary Coleman:]

Right.

[John Nadel:]

Okay. And then Joe, as you sit here and look forward under your scenario on the December year-end ‘09, getting back to that sort of – I think you mentioned 313% was your internal estimate based on some of these movements and expectations, what’s the composition then, like if we level – if we take that forward from June to December, I guess, I would have to imagine that the vast majority of the improvement there is actually coming from the increase in the numerator with the injections down?

[Gary Coleman:]

Well, that’s the greater part, but we have also reduced the denominator, as I mentioned with the sales – and of course – we are going to have investments in the fourth quarter, we factored that in. But, we are reducing the required capital – or the risk based capital, but the bigger impact is $175 million of cash that we put in.

[John Nadel:]

That's going in on the numerator. Okay. Okay. And then how about retention of earnings, is that playing a major role here, are you still dividending under your normal scheme up to the holding company?

[Gary Coleman:]

Yes, it’s a normal – we haven’t changed anything there.

[Mark McAndrew:]

Although, next year, Gary, as we talked about, as you mentioned, we will probably spread the dividends out more evenly during the year, just to maintain that RBC during the course of the year.

[Gary Coleman:]

That’s for next year. I thought you were talking about what we had done this year.

[John Nadel:]

Yes. I know. I appreciate the commentary about next year. Yes, it’s helpful. Okay. And then I want to do come back to, Ed, I think, was pushing back on you a little bit on the $210 million to $230 million free cash flow to the parent in 2010. Yes, I mean, that’s definitely below your normal historical level. I understand earnings, maybe a little bit more conservative, maybe they are pressured a bit by net investment income, but I mean, is that – is that 210 to 230, is that purely driven by the level of statutory earnings in calendar year 2010 or is some of that carryover from 2009?

[Gary Coleman:]

No, actually the dividends that we’ll take from the insurance companies in 2010 will be based on 2009 earnings.

[John Nadel:]

Yes.

[Gary Coleman:]

Okay. So that’s – we are also going to see a little bit of increase in our interest expense because we issued a $300 million debt in June.

[John Nadel:]

Got it.

[Gary Coleman:]

But, really I cautioned you on the free cash number. Again, I don't have our third quarter statutory, and it’s really…

[John Nadel:]

It’s just been early estimate.

[Gary Coleman:]

An early estimate. I think it will be at least that much. And really my point in giving that number is that we feel like we’ll have $150 million of cash at year-end, and then year-end ’09, and then we think call it 230 – free cash next year or that will give us another $380 million of cash.

[John Nadel:]

Okay.

[Gary Coleman:]

In addition to that, John, within the companies, assuming no impairments we are going to generate about an extra $100 million of earnings over what we take out in dividends.

[John Nadel:]

That is down in the new life companies, is that right?

[Gary Coleman:]

It has been in the life companies. And so…

[John Nadel:]

To get what the…

[Gary Coleman:]

There is an extra 100 million – that’s going to be generated within the company that, you know, goes to capital, and if there are impairments, it can come out of that first before we ever even have to take any of the $380 million.

[John Nadel:]

Got it. Back down. Okay.

[Gary Coleman:]

So I think we are – I think we are in a very good position, and I think we’ve got a lot of good things going for us here.

[John Nadel:]

Okay. And the other question is more on the business. Looking at the life insurance results, they are just watching a trend of commissions and acquisition expenses, you know, obviously realizing a couple of cases sales have been doing pretty well, but are commission levels in sort of absolute terms or maybe as a percentage of premium, percentage of new sales, are commission levels higher than they were maybe a year or two ago to the agent?

[Gary Coleman:]

Well, at American income they’re the same basically as they have been for 10 years.

[John Nadel:]

Okay.

[Gary Coleman:]

In the direct response side, we are not commissions – acquisitions and expenses, as I mentioned, in 2009 will be significantly less than what they ran last year. Liberty National, they are up, but they are up because the persistency of the business deteriorated. So we are deferring that over a shorter period of time over less premiums.

[John Nadel:]

Okay.

[Gary Coleman:]

It's not that we have raised commissions; it is because the persistency of the business deteriorated. We have to amortize quicker.

[John Nadel:]

Okay. And then just one quick follow-up on that on the issue with respect to the – I appreciated your openness and your commentary about your controls over that – the – over those sales. Have you been able to recapture any of those commissions?

[Gary Coleman:]

I don't have a number of some. But that 's – the agents who are writing the poor-quality business are really the agents that we’ve seen turn over.

[John Nadel:]

Yes. Okay. And so just get rid of them, and, you know, it’s a cost, but it is a cost and we are done.

[Gary Coleman:]

Yes.

[John Nadel:]

Okay. Understood.

[Operator:]

We’ll go next to Colin Devine with Citi.

[Colin Devine:]

Hopefully, two final ones for you. First, you have talked a lot about book keeping more cash in the insurance operations, a little more cash liquidity at the holding company. What does that mean for your long-term ROE expectations? Are those going to be a little lower in the future than perhaps we have seen in the past? And then the second question, when do you think we are going to start to see the, sales growth you've had in the last, six or seven quarters, and life starts to flow through to moving the a lot of the (inaudible) little faster?

[Mark McAndrew:]

You want to address the ROE, Gary?

[Gary Coleman:]

Yes, Colin, first of all, we've already seen a little bit of decline in ROE this year from holding cash. Again, the great bulk of that cash is down at the insurance companies and we are – we are now going to get that invested. Remember, I said, we were holding cash to the end of June and we got that invested in third quarter and also we did portfolio repositioning and we ended up with $700 million extra cash. But we are going to get that invested, and so we still have the cash as a holding company, and, you know, if we hold that, that will – that will have an impact on the ROE, but, you know, one thing to remember out of that 14.6 ROE that we were reporting, almost nine points of that come from insurance and operations. So we are going to have that, and I think that the ROE will stabilize, and I don’t think you are going to see much of a climb from where we are now.

[Colin Devine:]

Sort of stabilizing more in a 14, 15 range, and stay there at 15 to 16, you enjoyed in the past?

[Gary Coleman:]

Well, I think it can be between where we are now and 15. But, again, it has dropped down to 14.6 because we haven’t got that money invested. We will get that invested and we will see the impact of that. On the life premiums, we’ve been running roughly 2% growth in life (inaudible) with the sales projections we made for last year, for next year, we expect the life premiums to grow somewhere around 4% to 5% next year, so we’ll start to see improvement in our life premiums next year with a continued growth of sales.

[Colin Devine:]

What does that mean, then, for your thoughts about just sort of long-term nominal (inaudible) growth rate for Deutsche Mark?

[Gary Coleman:]

Well, that’s where – we got to continue to obviously grow sales. If we are continuing to grow sales double-digit, the growth on life premiums will continue to accelerate. Now, it would take us to get it to say 10% growth – that would take us a couple of more years, obviously, to accelerate it from 4 to 5 up into that kind of range. But, as long as we can continue to grow sales double-digits, each year, that percentage grows in premiums should improve by a couple of percentage points.

[Colin Devine:]

Okay. So we should expect perhaps a little lower ROE, which reflects reality today, but perhaps somewhat faster or stronger organic growth? Is that a fair take-away for the outlook?

[Gary Coleman:]

Yes. That's our hope.

[Colin Devine:]

Thank you.

[Operator:]

We’ll go next to Ed Spehar with Banc of America.

[Ed Spehar:]

Thanks, just one quick follow-up to John’s question. Gary, when you said that these numbers, assuming you are going to keep – I think you said $110 million of statutory earnings down at the life company. Does that mean that when we are talking about this free cash flow number that it’s – that it’s not just, the – it’s not the full dividend you would historically take up. It’s, not 100% of prior year’s earnings, it’s two-thirds or something?

[Gary Coleman:]

No, Ed, what I meant by that is our earnings next year, within the insurance companies, will be greater than what we are dividending out. Remember, what we are dividending out is coming from 2009 earnings. The earnings will be…

[Ed Spehar:]

Right, I got it. Okay, I got it.

[Gary Coleman:]

And that in itself will be greater, we think around a $100 million. So therefore, capital will go up just for that reason alone.

[Ed Spehar:]

Right. And then – in terms of operating earnings, are statutory operating earnings, don’t they sort of run about 100 million a quarter?

[Gary Coleman:]

Yes, that’s – we are projecting it will be in or around $360 million for next year.

[Ed Spehar:]

Just on an operating basis.

[Gary Coleman:]

Right, on operating basis.

[Ed Spehar:]

Okay. Thank you.

[Operator:]

It appears there are no further questions at this time. I would like to turn the conference back over to you for any additional closing remarks.

[Mark McAndrew:]

I would just like to thank everyone for joining us this morning and we hope to be with you again next quarter.

[Operator:]

That does conclude today's conference. Thank you for your participation.