Delphi Financial Group Q42008 Earnings Call Transcript

| About: Delphi Financial (DFG)

Delphi Financial Group (NYSE:DFG)

Q4 2008 Earnings Call

February 12, 2009 11:00 a.m. ET

Executives

Robert Rosenkranz - Chairman and Chief Executing Officer

Bernie Kilkelly - Vice President of Investor Relations

Donald Sherman - President and Chief Operating Officer

Bob Smith - Executive Vice President

Anita Savage - VP Finance

Mark Wilhelm - Safety National

Larry Daurelle - President and CEO, RSLIC

Analysts

Randy Binner - FBR Capital Markets

Beth Malone - (Wonder Leslie)

Joseph Demarino - Piper Jaffray

Eric Berg - Barclays Capital

Brian Roman - Robeco Investments

Jukka Lipponen - KBW

Mark Finkelstein - FPK

Operator

Ladies and Gentlemen, we thank you for standing by and welcome you to the Delphi Financial Group fourth quarter earnings call. (Operator instructions). I’d now like to turn the conference over to our host, Mr. Robert Rosenkranz. Please, go ahead, sir.

Robert Rosenkranz

Welcome to Delphi Financial’s fourth quarter 2008 earnings call. Our release was distributed last evening and posted on the company’s web site, along with fourth quarter financial supplement. This call is also being broadcast live on our web site at www.Delphifin.com.

Participating in the call this morning with me are Don Sherman, Delphi’s President and Chief Operating Officer, Bob Smith, Executive Vice President, Nita Savage, Vice President of Finance, Bernie Kilkelly Vice President of Investor Relations, as well as our colleagues at Reliance Standard Life, Safety National, and Matrix.

Bernie will now read a Safe Harbor statement.

Bernie Kilkelly

Thanks, Bob and good morning everyone. For those listening to a replay of this call that is being held on February 12, 2009, it contains time sensitive information that is current only as of this date. Statements made in this call relating to the future operations, performance goals, and expectations of the company, as opposed to historical facts, are forward-looking statements under the federal securities laws.

These statements are based on assumptions and estimates by the company that are subject to various uncertainties and contingencies. Discussions of these risk factors can be found in our fourth quarter earnings release yesterday, our third quarter Form 10-Q and our 2007 Form 10-K.

These factors could cause the companies actual results to differ materially from those expressed in any forward-looking statements made during this call and should be considered carefully. The company specifically disclaims any duty to update forward-looking statements made in this call.

In addition, certain non-GAAP financial measures will be discussed on this call. The comparable GAAP financial measures, along with reconciliations to such measures, are contained in our fourth quarter earnings release and financial supplement, accessible on the company’s web site.

Now, I’ll turn the call back to Bob.

Robert Rosenkranz

Delphi’s insurance businesses closed out an excellent year, with strong performance in the key insurance metrics. Our combined ratios were favorable. We achieved solid growth in premiums and production. The excellent performance of our insurance operations was offset by disappointing investment results, particularly on investments mark-to-market through the income statement.

On our third quarter conference call, back in October, we discussed our plans to reposition our investment portfolio, to reduce volatility in our investment income, while continuing to earn attractive returns.

I’m going to provide more details in a few moments, but in the storm 2009, our exposure to assets that are mark-to-market, through the income statement, was less than half of the level at the start of 2008. We’ve worked to redeploy cash into our traditional fixed income asset classes, but have proceeded cautiously, as the economy faltered rather sharply, since our third quarter call.

As a result, we continue to hold larger than usual percentage of our portfolio in short-term investments. On balance though, we believe our investment portfolio repositioning has set the stage for higher levels of investment income and improved earnings for Delphi in 2009.

In this mornings remarks we’re going to cover four main topics. First, I’m going to ask Don to review our fourth quarter results. Then, I’ll discuss fourth quarter investment performance, including our realized and unrealized losses in the quarter. Third, I’ll discuss our balance sheet and capital position, and finally, our outlook and earnings guidance for 2009.

After our remarks, we’ll be glad to answer questions. And now, I’d like to turn the conference over the Don Sherman.

Don Sherman

Thanks, Bob and good morning everyone. The excellent year for our insurance businesses was capped off by a strong performance in the fourth quarter. Our full year group employee benefits combined ratio improved to 92.2% from 92.4% in 2007. That same ratio for the fourth quarter was 93.2, compared to 92.3 in the fourth quarter of 2007. The slightly higher ratio in the last quarter of the year is primarily due to some adverse development in group term’s white claims, which we believe is within the normal variation for a block of business of our size.

We believe our 2008 combined ratio level is sustainable for the foreseeable future, as we continue to benefit from our disciplined pricing and underwriting at both Reliance Standard, and Safety National.

In the fourth quarter, Delphi achieved 7% growth in core group employee benefit premiums, driven by 9% growth in premiums at Reliance Standard. Core premiums also rose 7% for the full year 2008, with premiums at Reliance Standard growing 10% for the year. RSL passed the $1 billion milestone in premiums for the first time in 2008.

Production at RSL rose 13% in the fourth quarter, driven by a 22% increase in group life production. Sales growth was boosted by a continued increase in the number of new cases sold in our small case niche and good success in our integrated, or integrated employee benefit, or IEB program that is targeted at larger cases.

Coding activity was very strong in the fourth quarter. At this point, we do not see a material impact on quoting activity, from the challenging economy. Payrolls on our in force business, in January, increased modestly, which we attribute to our focus on companies with less than 500 employees. The competitive environment remains intense, but we continue to have success with our emphasis on voluntary products and with the IEB program, where absence managed services from Matrix give us a differentiated approach.

Premium at RSL’s turnkey disability division, CDS, increased 15% to 13.6 million, up from 11.8 million in last year’s fourth quarter. For the full year, premiums at that division were flat with 2007, at about $50 million. CDS continues to focus on growing, adding new turnkey partners, which tends to have a long sales cycle. We continue to be optimistic about the long-term growth opportunity at CDS and we’re pleased to see the good results in the fourth quarter.

In our asset accumulation’s segment at RSL, funds under management increased over 1.3 billion at the end of December, up from 1.1 billion a year ago. Sales of fixed annuities continued to be strong in the fourth quarter, as bank CD rates were viewed as less attractive. Annuity sales for the quarter more than doubled to 49 million, from 23 million a year ago. For the year, sales also more than doubled to 245 million, from 107 million in 2007.

We remained disciplined in setting crediting rates to hit our target spreads of 150 to 250 basis points. While current investment results impacted the profits for this segment, we expect improved profits in 2009, as we benefit from our investment portfolio repositioning, as Bob will discuss in a moment.

Turning to Safety National, we had a very strong quarter in Safety’s core product, Excess Worker’s Compensation for Self Insured Employers. Premiums were flat with last year’s fourth quarter, after having been down 6% for the first nine months of the year. Production rose sharply in the quarter to 6.4 million from 2.3 million in last year’s fourth quarter.

These positive trends continued in the important January renewal season, which is not reflected in our fourth quarter results, but in which Safety typically renews 25% to 30% of its book business. In January, Safety had record renewals of its customer base, continued strong growth in production, and a modest increase in payrolls. Safety’s book of business continues to be focused on industries that we believe are less exposed to economic conditions, with two-thirds of our customer base in municipalities, health care, and educational institutions.

More importantly, the market for excess Worker’s Compensation, remains firm after 8 years of favorable conditions. We did have an average 4% decline in rates, but those rates remain at very attractive levels and we’ve also been able to balance any decline in rates with improvements in contract terms, so that on a risk adjustment basis, we believe our book remains very favorable.

We achieved a 1% average increase in self-insured retentions, the important level at which risk shifts from our clients to us. The average attachment point is now over $500,000, compared with an average of $300,000 at the start of the hard market in 2001. So, we continue to feel very good about the business we have written, and are continuing to write. We see no signs that the market will soften significantly anytime soon, since there continued to be substantial barriers to profitable entry into this market segment.

Now, I’m going to turn the call back to Bob, to talk about the investment results.

Robert Rosenkranz

Well, thanks Don. In the fourth quarter, investment income continued to be impacted by losses from our alternative assets, where returns are mark-to-market through the income statement. These investments were down around 11% for the quarter, reflecting the poorest results in a decade for any strategies exposed to equities or credit. This shortfall load profits in our employee benefits segment and resulted in a loss in the quarter for (ph) accumulations segment.

As we discussed in our last conference call in October, we focused in the fourth quarter on repositioning our investment portfolio, with the goal of reducing volatility in investment income, while continuing to take advantage of opportunities to earn attractive returns. A major part of this effort was a reduction of our exposure to assets that are mark-to-market through the income statement.

At the end of 2008, assets with this exposure were 270 million, down from 426 million at September 30, and less than half the level we had at the beginning of 2008. There remaining portfolio consists primarily of credit opportunity strategies, which we believe are economically extremely attractive, and market neutral strategies, which we expect to be less volatile and less correlated with general market conditions.

The second major part of our repositioning is to redeploy our cash into more traditional fixed income asset classes. We were able to put some money to work during the fourth quarter in municipals, senior charges, and mortgage backed securities. But, we proceeded with caution, as the faltering economy increased the risks in pretty much all classes of fixed income securities.

Our short-term investments were 400 million at December 31, a modest decline from the 444 million at September 30, but at 9% of total invested assets, this continues to be an unusually high level.

Looking ahead, we believe our portfolio repositioning will reduce volatility, while helping us earn attractive returns, more in line with the historic performance of our fixed income assets, which have averaged after tax equivalence in the 5.5% to 6% range over the past several years.

Looking now to our realized investment losses in the fourth quarter, we had after tax realized investment losses of 18.5 million, 17 million of which were from other than temporary impairments, primarily on bonds in our fixed income portfolio, spread across a number of sectors, including mortgage backed and corporate loans.

We continue to apply a consistent, methodical process for evaluating other than temporary impairments, which is discussed in our 2007 Form 10-K and in our third quarter Form 10-Q. This process includes projecting ultimate losses in principle, short-falls in expected cash flows, the financial condition and prospects of the issuer, and our ability and intent to hold the investment until recovery.

We believe there is no substitute for seasoned judgment, so we don’t use a formulaic or bright line approach for OTTI. Our process and its application are reviewed by our outside auditors and the impairments we took in the fourth quarter reflect our best evaluation of our portfolio in light of current market conditions. But the credit cycle continues to unfold and with a $5 billion portfolio, we would expect to have some additional OTTI write-downs going forward.

As we’ve discussed in our previous conference calls, Delphi’s managed accounts with an outside investment manager DB Zwirn which is in runoff mode. Our investments primarily involve participation in high-yield fixed maturity securities, such as corporate loans, as well as some ownership interest in limited partnerships, limited liability companies, and equities, which are a part of our mark-to-market assets.

At the end of the fourth quarter, our (inaudible) ran around 185 million, down from over 300 million at the beginning of 2008. We received about $100 million of scheduled payments of principle and interest during the year.

During the fourth quarter, we had after-tax OTTI write-downs from the Zwirn portfolio of 7.2 million. We continue to expect our investment with Zwirn to run off over the next several years.

I want to now turn to our balance sheet and capital position. Book value per share, excluding mark-to-market adjustments, was $24.77 at the end of December, compared with 24.34 at the end of 2007. But like most financial institutions with large bond portfolios, the unrealized mark-to-market adjustment to our book value was substantial in 2008, reflecting a dramatic widening of credit spreads. Our book value per share, including this adjustment, was $18.41 at the end of December, compared with $23.57 at the end of 2007. So, a year-over-year change of around -22%.

It’s important to note that while we found the account and convention of characterizing virtually all of our bond holdings as available for sale, and therefore, marked-to-market through the balance sheet, in practice, we hold the majority of our fixed-income securities to maturity. We’re able to hold our bonds to maturity because the bulk of our insurance liabilities are very long-term and very stable, such as our Excess Worker’s Compensation and Long-term Disability reserves.

In our asset accumulation business, our liabilities are almost all individual fixed annuities, with no variable annuities and a minimal amount of institutional business.

Delphi’s insurance companies ended the year with RBC Capital ratios very nearly equal to those at the beginning of the period. Statutory capital at our insurance companies was up about 120 million year-over-year, which included the contribution of some holding company assets and proceeds from borrowings on our credit line.

At the end of 2008, we had about $30 million in financial assets at the holding company and 143 million in unused borrowing capacity. It’s notable that even in a very disappointing year, income from operations covered our interest expense, some 86 times.

For our final topic, I want to discuss our outlook and earnings guidance for 2009. We believe the strong underwriting results of our insurance businesses that we’ve achieved this year are sustainable for the foreseeable future.

Regarding our outlook for top line growth, we’re encouraged by strong production in RSL and Safety National in the fourth quarter and by Safety National’s excellent January renewal period. At the same time, however, we’re being conservative in our budgeting, in part due to the potential impact of the recession on payrolls and small business job creation.

For investment income, we believe our investment portfolio repositioning will reduce volatility, while still earning attractive returns. So for 2009, we expect operating earnings and operating ROE to be significantly improved over the levels we had in 2008. We currently expect operating earnings per share in 2009 to be in a range of $3.20 to $3.50.

This guidance incorporates what we believe are reasonable assumptions for top line growth and underwriting results, given the current negative outlook for the economy in the financial markets. Investment income is projected based on the current portfolio run rates and does not incorporate redeployment of some $400 million in cash balances, on which we are currently earning negligible returns.

So in closing, Delphi’s insurance businesses achieved excellent underwriting profits in 2008, which we believe are sustainable for the foreseeable future. We’re optimistic that our continued strength in our businesses and the investment portfolio repositioning we’ve accomplished will enable us to achieve significantly improved operating earnings in 2009. And at this point, I’d be happy to take any questions. Operator.

Question-and-Answer Session

Operator

Certainly. (Operator instructions). We’ll take our first question from the line of Randy Binner, with FBR Capital Markets. Please go ahead.

Randy Binner - Friedman, Billings, Ramsey & Company

Hi. Thank you. Just on the guidance, I guess a little more color about how the yield would ramp back up and maybe just more explanation of how we would see those funds come back on line. It just seems like, in my model, it would be—you know, you’d have to really start ramping up that portfolio to get to that yield. So, just maybe color on when you’re—if you’re feeling more comfortable now with the market and how you look to ramp that back up.

Robert Rosenkranz

No, on the contrary. The guidance that we gave, simply projects a run rate on the existing assets currently held in portfolio. It does not assume any kind of ramp up in yield from the investment of cash balances.

Randy Binner - Friedman, Billings, Ramsey & Company

Okay, so it’s the portfolio as currently positioned?

Robert Rosenkranz

Yes, exactly.

Randy Binner - Friedman, Billings, Ramsey & Company

Okay, and just one other quick one on the investments and I’ll get back in the queue. With the negative results in the fourth quarter, on the alternative investments, where—how much of those losses, if you will, were from issues that are being exited, versus items that remain in the current holdings with the alternative investments?

Robert Rosenkranz

I don’t have that completely top of mind. We’ll get back to you on that.

Randy Binner - Friedman, Billings, Ramsey & Company

Okay, that’s great. I’ll get back in the queue. Thank you.

Operator

Thank you. We’ll take our next question in from the line of Beth Malone with Wonder, Leslie (ph). Go ahead

Beth Malone - Wonder Leslie

Thank you. Could you just talk about what you think the rating—how you’re interacting with the rating agencies over these results and the outlook and whether if they decided to downgrade, would that have a material impact on your business in the divisions?

Robert Rosenkranz

Well, I’m going to ask Bob Smith to give some color on that, but I think we believe that our RBC ratios, which have essentially been unchanged during the year are consistent with our ratings and really we don't see any rationalization for downgrade. We are of course on negative outlook as is most life insurance industry, but Bob, can you give some color?

Bob Smith

Yes, we previewed as you might expect the results for the quarter and the year with the four rating agencies that follow us, two of whom have us on negative outlook, S&P and A.M. Best, as Bob mentioned they've got the whole life insurance industry on outlook.

So I mean you can never say never dealing with rating agencies of course, but my sense is that it wasn't too much blow back from them and it might be sort of in the range of expectations. I think when their comments about negative outlook were made public with some anticipation of results that you've seen in the quarter, so again you can never say never with dealing with that constituency, but I think we had healthy discussions with them and hopefully things remain as is and ratings stable, so.

Beth Malone - KeyBanc

That is fine, thank you. And then on the excess Workers' Comp business, I know Don said that you felt that the pricing and the environment seemed to be relatively stable. But with the economy weakening, would there be a movement among some of your customers to go away from self-insuring because of financial issues? Is that a possibility you could lose some customers because they might not meet the financial criteria to be self-insured?

Donald Sherman

Beth, we have not seen that as a development as yet. We look at that book very closely in terms of both new customers and customers who are unable to renew and look at the reasons for the loss and my colleagues at Safety might be able to help me. I think if I remember right we only saw one account on the list on the 1-1 (ph) list we did not renew that exited self-insurance. Am I recalling that right, Mark? Do we have our colleagues at safety on the line?

Mark Welhelm

Yes, Don and Beth, this is Mark Welhelm at Safety National. Don, your recollection is correct. Recall also, Beth, that two-thirds of the self-insured business we write are governmental entity hospitals, schools that really don't have that sort of financial concern from the regulars are respects self-insuring.

The remainder of our business, we saw in January that apples to apples compared to January a year ago, payrolls were actually up on average 2% which really indicates the predominance of those recession-proof classes. We haven't seen an exodus from self-insurance.

They realize that it's really the most economical way to handle their claims and unless a state is expressing some sort of concern, they're going to stick with it. We haven't seen any difficulty with our insureds maintaining their collateral levels with the state, so in response to you, we haven’t seen that movement away from self-insurance.

Beth Malone - KeyBanc

Okay. Thank you.

Robert Rosenkranz

And I might just emphasize, Beth that at Reliance Standard Life, the accounts that we had this January that we also had a year ago, those payrolls are up about 3% year-over-year. So our book of business as a company is just I would say quite impressively insulated, I wouldn't say it's completely insulated, but it certainly has very, very favorable defensive characteristics compared to the economy as a whole.

Beth Malone - KeyBanc

Okay, thanks.

Operator

Thank you. We'll take our next question from the line of Joseph Demarino with Piper Jaffray.

Joseph Demarino - Piper Jaffray

Thank you. On the excess Workers' Comp business, what would you say is the biggest driver of that growth in production?

Donald Sherman

Mark, do you want to comment on the production numbers for the quarter?

Mark Welhelm

Yes, I'll take it. We we're very pleased with our results and I would point to a couple of things that play a role. We've had a very focused and disciplined underwriting and marketing approach that has really shown some qualities in the latter half of the year that are appealing to the buyers.

There seems to have been a flight to comfort and stability as opposed to some of our competitors that are as we mentioned in previous calls the repackaged competition, but at the same time the competition we had was very responsible.

We saw our hit ratio climb throughout the year and especially high hit ratio in the fourth quarter. So I think it's just a combination of execution on our part and a reputation of stability at the company, the senior management here has been together for 25 plus years and the underwriters and reps that our clients are dealing with have been working with them for more than a decade as well. So there's a little bit of hunkering down there I think that played a role in it.

Robert Rosenkranz

Maybe I can say something that Mark could not graciously say which is that we have made a change in the senior management at Safety responsible for marketing and business development and I think that that change frankly has been a very positive factor in producing the results that we're seeing.

Joseph Demarino - Piper Jaffray

Okay. Thank you. And do you anticipate or have you noticed an increase in companies to move into the self-insurance market as the economy slows maybe as they would like to look at that as an alternative to their current program?

Donald Sherman

Joseph, this is Don Sherman. As I think Mark commented in response to one of the questions, we think the competition and the competitive environment has been pretty stable. By and large we've seen pretty rational behavior out there from a pricing point of view.

We don't see any major new entrants. We think there are attributes about this product that make it more difficult than others for new entrants to gain quick profitable market share.

Joseph Demarino - Piper Jaffray

I was referring to customers.

Unidentified Company Representative

Customers going in.

Unidentified Company Representative

Customers going in.

Robert Rosenkranz

Yes.

Donald Sherman

Oh, I beg your pardon.

Robert Rosenkranz

Yes, I mean I think in theory, well, more than in theory, I mean somebody who switches to self-insurance is going to get some immediate cash flow benefits because obviously when you're buying first dollar coverage, you're paying your loses in effect upfront.

Whereas if you're self-insuring, you're paying them as they develop, so that there is a cash flow advantage to that switch. And in theory you would think that in an economy where people are trying hard to maximize cash flow that would create greater demand for excess Workers' Comp, but I emphasize that it's theoretical. I mean I can't really say honestly that we've seen anything statistically meaningful along those lines.

Donald Sherman

We do some correlation analyses on premium and premium growth with economic activity and it hasn't shown it to be particularly sensitive either correlated with the economy or correlated against the economies. So we don't think that's going to become a major driver. Be nice if it did, but we don't think that's the case.

Joseph Demarino - Piper Jaffray

Okay. Thank you. That's helpful. And one last question, the lower net investment income, that's primarily a result of the mark-to-markets, correct? Or is it also the higher cash allocation?

Robert Rosenkranz

Well, the principal difference in our forecast this year, I mean the 320 to 350 range versus the range we indicated at the end of third quarter, the primary driver there really is the fact that we have substantially higher cash balances at the end of 2008 than we expected to have and the reason for that is we have been pretty cautious.

I mean as the economy really fell off very, very badly and pretty suddenly in the fourth quarter, it obviously increased the risk of virtually any class of securities other than governments, I mean whether you were dealing with municipalities or dealing with corporate credits or real estate related credits, the economic conditions deteriorated encouraged us to be more cautious in the way in which we were deploying cash. So that's the principal, in effect, driver of our changed earnings estimate.

Donald Sherman

If you look at it from the fourth quarter basis, the disappointing results on the mark-to-market assets are a bigger driver in the fourth quarter of the shortfall of net investment income.

Joseph Demarino - Piper Jaffray

As opposed to the cash?

Donald Sherman

Yes, the cash was the important part in looking at the change and where we did our guidance level, but for the fourth quarter it was the disappointing results in the mark-to-market assets, yes.

Robert Rosenkranz

And to be honest, we now feel like mark-to-market assets are at a level where the variations coming from that particular source are not apt to be terribly material in our results.

I mean it's a small enough portion of the total and it's skewed heavily enough toward very low volatility strategies that are truly and rigorously market neutral that we feel like we pretty much solved the problems of quarterly earnings volatility that were clearly a major issue for us in 2008.

Joseph Demarino - Piper Jaffray

Okay, got it. Thank you.

Operator

Thank you. Our next question is from the line of Eric Berg with Barclays Capital.

Eric Berg - Barclays Capital

Thanks very much. Bob, good morning to you and to your team. I still am struggling to understand here how we get from $0.35 in the December quarter to an average of say $0.85 per quarter projected for 2009. Here's my thinking, your underwriting income, and I'm not sure how much it's going to grow by, I mean you're going to have some premium growth and stable maybe some modest deterioration in underwriting margins, but the big delta it seems to me has got to be on the net investment income side as you have said. Now you're cash position in say the March quarter I'm thinking is going to be roughly similar to what it was on average in the December quarter so again how do we get from $0.35 to $0.80? Will it all be in the absence of these mark-to-market losses? I'm just kind of struggling here with that.

Robert Rosenkranz

Oh, that’s certainly a major component I mean if you've— the fourth quarter numbers include a write down right through the income statement for the worst quarter in history.

Eric Berg - Barclays Capital

And what was the dollar impact of that relative to plan?

Donald Sherman

Eric, the mark-to-market portfolio in total was approximately $45 million negative for the quarter.

Eric Berg - Barclays Capital

And you would have expected?

Donald Sherman

On a pre-tax basis.

Eric Berg - Barclays Capital

And you would have expected? I mean you look for what, 3% per quarter annualized rate of return? Or pardon me, 12% annualized rate of return?

Donald Sherman

Well, certainly historically we had been looking at 2.5 to 3% per quarter, call it 10 to 12 annualized. In the guidance we've been giving we are using lower rates, the bottom end of the range includes a zero return on the remaining portfolio for those types of assets.

So the big element in getting from the $0.35 for the fourth quarter of '08 to a number that would be in the range of our current guidance is simply the elimination of the $45 million loss that we incurred in the fourth quarter.

Robert Rosenkranz

And just to emphasize what I said to Randy, the range that we're giving, the 320 to 350 range, is achievable if we got zero rate of return from alternatives and it assumes that cash balances are not reinvested.

All we're doing is taking a snapshot of the existing current set of holdings and projecting the income from them. So it's pretty straightforward.

Eric Berg - Barclays Capital

Yes, no, now I've got it and that cleared it up. My second and final question relates to production. While you did enjoy better production in St. Louis this quarter than in the year ago quarter, the total production of the corporation has been flat now for three years looks like, I don't have the '05 numbers in front of me, but '08 was flat with '07 and '07 was flat with '06. When do you think it is possible to start showing sales growth out of this company?

Donald Sherman

I think if you look at the numbers in the financial supplement, you accurately have described what the numbers show, but in the details of those numbers, included in the early years in the financial supplement are the production numbers from the ERC renewal rights. So I think that's a bit of a challenging comparison for that particular and very episodic reason.

If you look at the core production excluding that and it happens to be in that three-year snapshot, '06 was a particularly good year. You go back to '05 and you look at the production, our lines of business excluding excess Workers' Comp, we've grown 10% a year over that time period.

And then the excess Workers' Comp business, we've really been able to maintain our premium position off of a very strong increase in persistency and with the production now coming back at Safety, we think that augers well for us to continue to have a reasonable revenue growth and—

Robert Rosenkranz

And just a footnote to what Don said, we've added in this period $50 million of turnkey premium which did not show up in the production statistics, but do show up as incremental premium. So I think that will help give you the picture of how insurance revenues have been growing nicely through all of the mechanisms that we've just discussed.

Eric Berg - Barclays Capital

That was a very helpful reminder. Thank you for reminding me of that.

Operator

Thank you. And we'll go to our next question then and that comes from the line of Brian Roman with Robeco Investment Management.

Brian Roman - Robeco Investment Management

Good morning. A couple of questions, most of them I think are redundant at this point, but maybe a little more clarification. First of all what was the guidance number you gave for the year?

Donald Sherman

It's 320 to 350, Brian.

Brian Roman - Robeco Investment Management

And that was down a little bit?

Donald Sherman

It was down from 340 to 380 and as Bob said primarily as a result of us now forecasting in the guidance not reinvesting the 400 and some million of cash that we're currently sitting on.

Brian Roman - Robeco Investment Management

Okay. You do 335 in this environment would be a big win in anybody's book. What is the expected yield on the investment portfolio at this point that you're kind of putting in this mix?

Donald Sherman

Well, the main driver is the fixed maturity pocket, Brian, and that's between 5.5 and 6 pre-tax equivalent yield.

Brian Roman - Robeco Investment Management

What are you investing in? That's a pretty good number.

Donald Sherman

Well, a lot of that is Legacy assets, so—

Brian Roman - Robeco Investment Management

Okay.

Donald Sherman

They've been around for a while, so—

Brian Roman - Robeco Investment Management

Okay. The 350 million on the balance sheet, I think that's the number, it’s somewhere here, 350 million on the balance sheet of AOCI, Bob you gave a little Bobby English thinking (ph) you think some of that ends up falling through the income statement? Could you elaborate on that a little bit.

Donald Sherman

Well, I think was Bob was alluding to is we did have some other temporary impairments in 2008 and who knows what the future will bring, but it's likely there'll be some more.

Brian Roman - Robeco Investment Management

Well, actually that begs the question because I know you're not going to give me the book value at the end of January unless you want to use this public forum to do it. Do you think there's been some recovery in that number in the January period?

Donald Sherman

Yes, I mean I know what the performance pre-tax on the portfolio is and it was up, the marks if you will were up 1% for the month. So I'm not sure what the number is off the top of my head when you factor that down through, back and after tax, but yes, I mean we saw in January kind of reversion away from flight to quality and so—

Brian Roman - Robeco Investment Management

Are you saying the total value of the portfolio went up 1%, so it's $45 million or the stuff that's been marked down got marked up 1%?

Donald Sherman

No, the whole portfolio.

Brian Roman - Robeco Investment Management

So that's what, investment portfolio is about $4.5 billion?

Donald Sherman

Book value is almost 5.

Brian Roman - Robeco Investment Management

5 (inaudible) so that'll be $50 million recovery in the quarter?

Donald Sherman

Correct.

Brian Roman - Robeco Investment Management

Is that right? That's not bad.

Donald Sherman

A month.

Brian Roman - Robeco Investment Management

Yes, yes.

Donald Sherman

A month does not a quarter make.

Brian Roman - Robeco Investment Management

I understand that, hey, what if we had—

Robert Rosenkranz

Today's snapshot can— I mean I guess I mean that's why these snapshots are so volatile and—

Brian Roman - Robeco Investment Management

Well, we have four of them a year, so over the year's you've been public, probably a pretty good book.

Robert Rosenkranz

Exactly, (inaudible) excited about, but clearly it's been a decent month for bonds.

Brian Roman - Robeco Investment Management

Okay, your ratings at this point, you said your RBCs about the same as where you left it last year, when was the last communication you had with S&P or A.M. Best where has you on negative watch at this point?

Donald Sherman

Well, as we said earlier in response to a question, Brian, we previewed the quarter and the year with all the rating agencies.

Brian Roman - Robeco Investment Management

Yes.

Donald Sherman

But we've been in touch with them the last week.

Brian Roman - Robeco Investment Management

Yes, and they still come out tomorrow and say they're going to make a change.

Donald Sherman

Well, you never say never. We think those discussions were healthy and consistent with expectations, but you never know.

Brian Roman - Robeco Investment Management

Right.

Donald Sherman

So the rating agencies generally have the life insurance industry on negative outlook.

Brian Roman - Robeco Investment Management

Well, I just wonder if you did not have the alternatives portfolio, would you still be on negative outlook, but if you hadn't had it in the first place, but that's now water over the dam. The rest of the alternatives portfolio, another question here, you expect still work your way out of it. I mean it was like 400 some odd million, how much of that would you want to keep and how much is held up with delays on redemptions?

Robert Rosenkranz

No, the number is 270 million.

Brian Roman - Robeco Investment Management

Okay.

Robert Rosenkranz

And that includes roughly a quarter of that or maybe a little bit more than a quarter is assets that are in the (inaudible) liquidating portfolio.

Brian Roman - Robeco Investment Management

Okay. Alright. Thank you.

Operator

Thank you. And our next question then comes from the line of Jukka Lipponen and with KBW. Please go ahead.

Jukka Lipponen - KBW

Good morning. Have you completed your annual reserve study and if so what was the outcome and any reserve releases or increases or any of that?

Donald Sherman

Jukka, as you can imagine doing this, we've gone through those reserves with actuaries and auditors as well, so we feel like the numbers we have are solid numbers from an actuarial and a reserving point of view. When we look at the reserving at Safety National, we're always on a moving average kind of basis there so there's no bright line that says release or adverse development of X amount. But we feel like the trend that Safety National has been improving over the last few years and has continued to do that, so we feel good about where we are from a Safety National point of view, both on a reserve position and a trend for reserves. And at Reliance we had good development patterns and we feel like we're very strongly reserved there and that's part of the reason why we're reasonably optimistic about maintaining these combined ratios that we think are as good as anybody in the industry.

Jukka Lipponen - KBW

And any changes to discount rates for the DI or the excess business?

Donald Sherman

Not yet. We have not yet decided and won't for another couple of weeks on discount rates either for disability or excess Workers' Comp, but we're working on that now. They might be lower than they were last year.

Jukka Lipponen - KBW

And, Bob, with respect to CDOs, what is your current position and what kind of things do you have in that portfolio?

Bob Smith

We have about $120 million of CDOs in the portfolio, all of which are basically COOs, I mean there's really nothing else in there. They've done okay. Hasn't been the best performers for sure, but with the underlyings, in effect being senior secure bank loans, we feel pretty good about the underlying.

We feel pretty good about the structures etc., but all asset classes as you know in 2008, especially in the fourth quarter that hint any degree of credit associated with them did not do well. Agencies, MBS agencies, treasuries, etc, you can see this in the Barkley's Ag numbers which are high quality investment grade performed reasonably well. Everything else did not.

Jukka Lipponen - KBW

Do I have it correct that that position was roughly double at the end of the third quarter?

Bob Smith

No, I don't think so.

Jukka Lipponen - KBW

Okay. And lastly and I'm sorry if I missed this in your prepared remarks, but in the annuity business, the benefit or interest credit line seemed to move up and was there anything unusual in there or what was driving that?

Donald Sherman

I'm sorry, Jukka, the benefit line in the annuity business.

Jukka Lipponen - KBW

Correct.

Donald Sherman

The benefit line we think is roughly in proportion to the increase in assets under management. There wasn't anything particularly promotionally oriented out of what we did in the new production, so we think that that book has the reasonable profit margin expectation built into it.

Jukka Lipponen - KBW

Okay. Thank you.

Operator

Thank you. Our next question is from the line of Mark Finkelstein with FPK. Please go ahead.

Mark Finkelstein - FPK

Hi. Good morning. I have a few questions. I guess just going back to capital a little bit and thinking about RSL, it is still growing, I guess statutory impairments you would expect to continue to be elevated, downgrades are going to have an impact on required capital. I guess do you anticipate having to put more capital into RSL in 2009 and if so, where do you see that capital coming from?

Donald Sherman

Our current plan for 2009, Mark, would have RSL being able to continue to develop its growth off of internally generated capital. We do have resources available at the holding company if some combination of faster growth and/or more impairments created a question at RSL from a capital point of view. We feel like we have financial flexibility to support the business if it's required but we think the business is actually on good footing to continue to develop the capital for it's own support.

Mark Finkelstein - FPK

Okay. And actually just what is the quick breakout of the alternative portfolio between RSL, Safety and I guess if any is still in the holding company?

Donald Sherman

I don't have those numbers at our fingertips, but we can get back to you with that.

Mark Finkelstein - FPK

Okay. Great. And then I guess you historically have been able to operate RSL at an A minus rating. I'm just curious what would be the impact on Safety if it were downgraded? I thought that one was a little bit more important to be at an A rating. Can you just give your thoughts on that?

Donald Sherman

Well, we think there is a marginal benefit, a benefit at the customer on the margin to have the stronger rating, so we believe it's worthwhile for us to continue to support the businesses in a way that would give us the prospect to maintain the rating. And I think from Safety's point of view, we do view that business as modestly sensitive to the rating, so it's important to us.

Mark Finkelstein - FPK

Okay. Great. And then I guess, Larry, can you just talk about persistency at RSL kind of following fourth quarter, I mean in terms of renewals going into 2009? Have you seen any changes in persistency trends?

Larry Daurelle

Hi, Mark. No, we have not seen any changes in persistency quarter over quarter for the last couple of years. Everything's in line both in the persistency line.

Mark Finkelstein - FPK

Okay. And then I guess just finally, Bob Smith, I guess what are you buying in terms of new investments right now and I guess I think on the last call you talked about kind of some of the best opportunities, still remaining cautious and you reiterated those comments on this call, but I mean just thinking about some of the changes in the fair values that you've disclosed between third quarter and fourth quarter in the supplement which were very helpful. I guess what are you buying? Are you doing anything in the mortgage-backed area? What traunches are you buying? Anything that you can add on that would be helpful.

Bob Smith

Alright, Mark, I think it's part of the point of the commentary about having so much cash and being very cautious is that we're not buying anything right now. We did a little bit in the fourth quarter, high-grade munies, a little bit in very high grade, high, part of the capital structure and some MBS, but I mean our view is with the economy deteriorating, credit spreads continuing to be pretty wide, and asset classes underperforming, we're just being very cautious.

We'd rather have the capital markets clarify themselves more than we see right now before we start putting money to work, so we're really effectively not doing anything.

Mark Finkelstein - FPK

Okay. Thank you.

Operator

Thank you. And we'll take a follow-up question from the line of Randy Binner with FBR Capital Markets.

Randy Binner - FBR Capital Markets

Great. Thanks again. a lot of the other analysts helped clear up some of my other questions on the guidance. Just one final quick question on the hedge funds, it sounds like you feel that you solved the problem there and it's a smaller portion of the investment, lower volatility, but it did, when we think about forecasting, it did track fairly well to most hedge fund indexes, so I just want to be clear that we shouldn't really be looking for that kind of correlation as the index is going forward when we think about how the final result will come in.

Robert Rosenkranz

Yes, I mean I wouldn't say that there was— yes, I can't really help you very much on that. I mean part of what's in that (inaudible) alternatives is really a runoff of certain assets in this (inaudible) liquidation portfolio that just happened to be in a form where the accountants asked you to mark-to-market to your income statement. Most of the equity exposures that were embedded in the alternatives have been eliminated. I mean we had those exposures because we felt it was a meaningfully uncorrelated with the bond market which was obviously the bulk of our portfolio, but we've pretty much taken equity exposure out of the strategy now.

And the focus really is on credit opportunities where we think the opportunities are just incredibly alluring and yearend marks may have been just extraordinarily depressed. I mean I know that there are individual securities in our portfolio that I'd love to buy at yearend marks and there's just no way to buy them anywhere near where the pricing surfaces (ph 01:04:21) have been marked, so that's sort of part of that strategy.

And the other part is pretty rigorously market neutral approaches that did pretty well in 2008 and that don't show any meaningful correlation with either the stock market or the bond market. But again, I want to emphasize that the total level right now is such that we wouldn't really expect this to show to be a meaningful driver of results going forward.

Randy Binner - FBR Capital Markets

Okay, great. That is very helpful. And just one final question also somewhat on guidance, it seems like the benefit ratio assumption for Reliance is going to be roughly flat with that in '08 and so I just wanted to confirm that that is the case and maybe to get color from Larry potentially on if you've seen any incidence or severity increases due to the soft economy in the disability book there?

Larry Daurelle

Randy, we have not seen any changes in incidence and severity to the book. And pretty much looking at where we have been for the last couple of quarters.

Randy Binner - FBR Capital Markets

Okay, great and am I reading that correctly that for the overall guidance you'd be looking at roughly a flat benefit ratio to '08?

Larry Daurelle

Roughly, yes, you can assume that.

Randy Binner - FBR Capital Markets

Okay, excellent. Thank you very much.

Robert Rosenkranz

And just a little color on this, I mean the reason people think that there might be a correlation with benefit ratios in a soft economy is the thought that gray area claims are going to be pushed by people who feel like they might lose their jobs and if they have a choice between pursuing a gray area disability claim or getting unemployment insurance, they're better off with a gray area disability claim. So that's the mechanism by which it's thought that a soft economy will produce higher benefit ratios.

And there's not a huge amount of statistical evidence to support that one way or the other, but it's a logical expectation. But again, that sort of brings me back to the payrolls of our employers are actually up about 3% in our sales' case, about 2% in safety's case year-over-year so these are employers who are not firing people, in fact they're adding payroll, so I think the mechanism by which a weak economy can lead to deteriorating benefit ratios is something that we're at least so far pretty well insulated from.

Okay, Operator, I think we're at the top of the hour, if we have time for one more question?

Operator

Thank you. That final question then comes from the line of Eric Berg with Barclays Capital. Please go ahead, sir.

Eric Berg - Barclays Capital

One quick follow-up and that is will you remain at that $270 million with this focus on credit and market neutral strategies or will the rundown of these foreign book of business take that $270 million figure lower?

Robert Rosenkranz

It's apt to drift lower, but with performance it could get higher if we get some unusually attractive opportunities. We're pretty comfortable with where it is now to be candid, although I think it's probably more likely to drift lower with the runoff (inaudible) than it is to drift higher with accumulated earnings.

Eric Berg - Barclays Capital

Thank you.

Operator

Thank you. Gentlemen, I will turn the call back to you for your closing comments.

Robert Rosenkranz

Closing, I just want to thank all of you for participating.

Operator

Thank you. And ladies and gentlemen, that does then conclude our conference for today. We thank you for your participation and for using AT&T Executive Teleconference service. You may now disconnect.

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