The Phoenix Companies, Inc. (NYSE:PNX)
Q4 2009 Earnings Call Transcript
February 11, 2010 1:00 pm ET
Naomi Kleinman -- Head, IR
Jim Wehr -- President and CEO
Peter Hofmann -- Senior EVP and CFO
Chris Wilkos -- EVP and Chief Investment Officer
Bob Glasspiegel -- Langen McAlenney
Eric Berg -- Barclays Capital
Welcome to the Phoenix fourth quarter 2009 earnings conference call. All participants will be in a listen-only mode until the question-and-answer session. (Operator instructions). Today’s call is being recorded. If you have any objections, you may disconnect at this time.
I will now turn the call over to the Head of Phoenix Investor Relations, Naomi Kleinman. You may begin.
Good afternoon and thank you for joining us. I’m going to start with the required disclosures and then turn it over to Jim Wehr, our President and CEO for an overview of the quarter. Also with us today are Peter Hofmann, Chief Financial Officer, Phil Polkinghorn, Senior Executive Vice President for Life and Annuity, Chris Wilkos, Chief Investment Officer, Dave Pellerin, Chief Risk Officer and Mike Hanrahan, Chief Accounting Officer.
Our fourth quarter earnings release, our quarterly financial supplement and the fourth quarter earnings review presentation are available on our Web site at phoenixwm.com.
Slide #2 of the presentation contains the important disclosure. We may make forward-looking statements on this call that are subject to certain risks and uncertainties. These risks and uncertainties are discussed in detail in our fourth quarter earnings release and our latest SEC filing. Our actual results may differ materially from such forward-looking statements.
In addition to Generally Accepted Accounting Principles, we use non-GAAP financial measures to evaluate our financial results. Reconciliations of these non-GAAP financial measures to the applicable GAAP measures are included in our press release and the financial supplement.
Now I’ll turn the call over to Jim.
Thanks, Naomi and good afternoon to everyone. We appreciate your taking the time to join our fourth quarter and year-end call. Before Peter takes us through the numbers and Chris reviews the investment results, I want to give you my perspective on Phoenix as it stands today.
Clearly, on the surface, our fourth quarter operating loss of $34 million is disappointing. You might even think the quarter was a set back. And for that matter, maybe the full year. What I want to do today is get below the surface, strip away unusual items, legacy issues and economic impacts and give you a real, behind the numbers look at Phoenix. In my opinion, all signs point to a better year ahead for four key reasons.
First, we’ll see the effects of our aggressive expense reduction efforts kick in. Second, our capital will grow organically. Third, our investment performance continues to improve. And fourth, growth initiatives will gain more traction. But I’m getting ahead of myself. Let’s stay with 2009 for a few minutes.
Clearly, we are a company in transition. As you would expect, there is a lot of noise in our numbers as a result. But when you strip away the noise, there is both fundamental strength and progress. And neither is there by accident. They come from deliberate action and tough decisions along the way. As you may recall, I said last quarter that Phoenix turned the corner and that many key metrics were showing signs of solid improvement.
I went on to say our continuing focus on our four strategic pillars, a healthy balance sheet, policyholder security, expense management and a sustainable growth strategy was beginning to have the intended impact. And that was why we believe Phoenix was on its way to a better future in 2010 and beyond.
Given today’s report, probably asking yourself those claims are still valid and realistic. It’s a fair question. And it’s one my management team and I can answer with a definite yes. Let me tell you why.
Phoenix is a better company today than when this management team took up the strategy I laid out early last year. That’s because we focused on those four pillars, kept our eyes on the future, not the past and were willing to make a series of necessary and often tough decisions.
Did we achieve everything we need to? I’d say we achieved a lot, but not everything. Look at RBC. We set a stretch goal of 300% and we didn’t get there. But it’s important for you to have perspective.
When we laid out that goal, reinsurance played a big part in our plans. What we found in the reinsurance market as we pursued those plans however was increasing risk aversion, fewer players, more demands and more complexity.
We had to ask ourselves at what cost both current and future do we stick with this goal at this time. We answered by doing one small straightforward transaction that was a follow on to a deal from 2008. On its own, it did not get us anywhere close to our goal in 2009, but we are still exploring reinsurance opportunities in 2010.
RBC was hit by the additional charge we took on a legacy reinsurance business that dates back to the 1990s. Our discontinued group accident and health exposure. That was an example of something we didn’t need coming especially at a time when we didn’t need it.
And this recurrence of activity was especially frustrating because we have managed our remaining exposure down to a small number of contracts and prior to 2009 had not added to reserves since 2000.
The overall result was that we missed our stretch goal ending the year at 225%. I’m not going to tell you that 225% is okay. But given the improvements in many of our other metrics and the changes we’ve made in our business, net-net the drop in RBC is not as bad as it appears on the surface.
Yes, estimated RBC was 275% at March 31st of last year, but since then, our unrealized losses have dropped from 1.6 billion to 150 million at the end of January and there is much less demand on capital from our new business. We also see signs the tide is turning.
Looking ahead, we anticipate solid organic growth and statutory capital from cash generated by the in-force block of business. This will occur as a result of the expense reductions we’ve already implemented, lower sales training and more stable markets. And it should translate to about 40 percentage points of RBC improvement by year-end 2010. And as I just mentioned, we continue to look at reinsurance as a way to further strengthen our capital.
When I talk about Phoenix being a better company, I’m speaking to both the intangibles, such as the talent we’ve retained to make us successful in 2010 as well as the concrete facts, such as the soundness of our key fundamentals demonstrated by mortality, persistency, expenses and investment income.
Unfortunately, progress is rarely a straight line in any endeavor and nowhere, especially in today’s environment is that truer than with a turnaround like Phoenix. It’s not been easy and not without its frustrations.
But our willingness to make tough decisions from laying off more than a third of our work force to taking substantial charges to put the company on the right foot going forward is what’s making us a better company for shareholders, policyholders and their advisors, business partners and employees. And as a result of many of those decisions, our key business drivers are moving in a positive direction. But as everyone can see, progress does come with a price.
Let me turn back to the four strategic pillars and give you my perspective on where we stand on each. We said job one was a healthy balance sheet. Even with the drop in RBC, you will see from Peter’s and Chris’s presentations that Phoenix is sufficiently capitalized and we’re maintaining enhanced liquidity at the life company. Further, we have an adequate level of cash and securities in the holding company without taking a dividend from the life company in 2009.
Our debt position and liability profile continue to be both conservative and stable. For example, debt-to-capital is low at 24.7% and Phoenix has no debt maturing until 2032. And we have no material exposure to guaranteed investment contracts or institutional funding agreements, no securities lending activities and no credit default swaps.
I said a moment ago that a lot of tough decisions come with a price. Some sort of trade off. This was certainly true as we managed our balance sheet. Throughout the year we took steps to derisk our investment portfolio. But we didn’t want to take it too far and wanted to sell into strength. So we sold below investment grade holdings in a structured and carefully timed manner and only when it would not harm absolute capital levels. In other words, only when it produced a gain or a very small loss.
Now, our second pillar, policy holder security. When you come right down to it, all of our actions are focused on supporting this pillar. For instance, the enhanced liquidity on our portfolio adds an extra cushion against a very liquid market environment. This is another example of trade-offs.
While we gave up some investment income by holding more cash and short-term assets, which in a more normal environment we wouldn’t have done, having enhanced liquidity was the right decision for the uncertain world we are operating in. But as we’ll hear from Chris later on, we’re now redeploying some of that liquidity back into the market in response to recent improvements.
As I said last quarter, we continue to reach out to policy holders and to help them make decisions that best reflect their financial objectives. That includes providing them the information and analysis necessary to evaluate various courses of action. We were also working with our advisors to make sure they understand our efforts with their clients and the direction of Phoenix.
I have been directly involved in a number of these visits and calls and I can tell you we are receiving positive reactions regarding our efforts and the Phoenix name still carries a level of brand equity. I would like to think our efforts are helping that. Based on what we continue to see, our surrender levels remain quite manageable.
Expense management is our third pillar. We set back in May that our expense-related goals were to align our expense structure with business volume and our evolving model, to reduce annualized controllable expenses by approximately $65 million, reduce our work force, streamline our operations and adjust our compensation programs.
How did we do? We exceeded our original $65 million goal and eliminated $110 million in annualized expenses. We did that fully realizing a notable portion of those reductions would be offset due to severance costs and increased pension costs and consequently, wouldn’t show any meaningful benefit until 2010.
But had we not taken those actions, it is almost certain we would have shown an increase in reported operating expenses in 2009 because we could no longer defer significant distribution costs the way we had in prior years. And that would simply be unacceptable.
Our fourth pillar is building a platform for sustainable growth. So more tough decisions. When we lost our largest distributors early in 2009, an obvious response would have been to substantially eliminate our wholesaling operation, but then we would have had nothing to work with to restart growth. Instead, we reduced it, but retained enough to retool and reposition one of our key capabilities.
Now we have a new distribution company, Saybrus Partners and it has its first consulting agreement with the well regarded financial services firm Edward Jones. At the same time, we forged new distribution relationships for our own products, including about 20 with independent marketing organizations. We are expanding our core life and annuity product line to address the needs of the middle market customers served by these newer distributors.
This year, we’ll continue expanding those distribution channels while also looking for additional partners for Alternative Retirement Solutions products. And of course, we continue to pursue additional clients for Saybrus.
Clearly, we have a ways to go as we reposition, rebuild some of the elements of our business, but we are taking the right steps forward. The fact is 2009 was a difficult year for us, but we didn’t flinch, we confronted the challenges head on, made tough decisions and took action. Consequently, we are a better company. We made progress against our game plan for the benefit of Phoenix, its shareholders and other constituents.
Let me turn it over now to Peter and Chris. As always, after their presentations, we’ll take questions. Peter.
Thanks, Jim. Please turn to Slide #3, which shows a summary of our fourth quarter results. Excluding unusable items, which I’ll review in just a moment. We had operating income of 22.2 million or $0.19 per share.
As Jim said, trends in the core business were stable or improving. Higher alternative asset returns boosted our net investment income. Surrenders remained elevated, but very manageable. Expense reductions began to have some impact, although more on a statutory than a GAAP basis and overall mortality was in line with expectations.
The net loss of 106.4 million or $0.91 per share reflects lower realized losses, costs related to actions taken in the fourth quarter and charges related to a legacy business. Realized losses were 6.8 million. The level of credit impairments and the performance of our hedge program, which runs through this line reflects a stable market environment and good risk management.
We recorded a GAAP loss of 22.7 million associated with the announced sale of PFG, Philadelphia Financial Group, which has now been moved into discontinued operations. The sale is expected to close in the second quarter and benefits statutory capital and help focus the company on its core strategy.
The real adverse unexpected development this quarter came in the form of a 46.7 million charge in terms of reserve strengthening in our discontinued group accident and health reinsurance business. The exposure in this book of business has been managed down significantly since it was placed into run-off in 1999 and we certainly did not expect the emergence of this level of loss.
However, we believe that our reserves, which now stand at 61 million, adequately cover the expected future losses from the block. We think that these actions taken in 2009 make the company well-positioned for a return to profitability in 2010.
Slide #4 highlights the trend in operating earnings and book value. For the fourth quarter, we’re spiking out about $0.48 of unusual items, excluding which operating income was $0.19 per share.
Those items included 18 million in unlocking charges related to our fourth quarter actuarial assumption review, 19.2 million related to a reinsurance transaction with Swiss Re in the fourth quarter, 7.8 million in non-deferred distribution expenses, which we have been reporting to you regularly, and 11.4 million in tax expenses.
As we’ve indicated in prior calls, we expect to have significant noise in our GAAP tax line for some time, but will have an effective tax rate of 0%. So if you note total tax expenses for the year were 115.7 million and that number is equal to the valuation allowance that we established in the first quarter of the year. So backing that out, the guidance of a 0% effective tax rate held true and for the foreseeable future that is what we would guide to going forward.
A more detailed earnings summary is shown on Slide #5. This is the view that shows our income statement detail excluding the closed block. Revenues in the open block improve versus the third quarter reflecting the improvement of net investment income. GAAP operating expenses were about even with the prior year’s quarter. However, note the decrease over the course of the year. In the prior year comparison, our expense reductions have been offset by higher pension expense and lower deferrals.
The DAC amortization and benefit lines reflect the unlocking adjustments recorded in the quarter. And as you can see, the regulatory closed block contribution remains stable and consistent with the glide path of the block.
As we do each fourth quarter, we conducted a comprehensive review of our DAC and related SOP reserve and B assumptions. We adjusted a number of assumptions and while some have favorable effects, the overall net income impact was a charge of 18 million.
Slide #6 breaks the adjustments out by income statement line item. The unlocking adjustments related to surrender rates, expenses, mortality rates, premium persistency and investment margins. Again, this was a comprehensive review and we feel very good about where the assumptions stand today.
The fourth quarter reinsurance transaction strengthened statutory capital, but also, as I indicated, generated a one-time GAAP loss from the write-off of DAC associated with the block.
Slide #7 covers some of the details of discontinued reinsurance charge in the quarter. As I said before, we are obviously disappointed about the emergence of losses in this business, following what overall was a successful resolution of some of the largest exposures, namely Unicover, Zentar [ph] and the London markets spiral business.
Since this business was placed into run-off in 1999, we’ve reduced exposures by more than 500 million, secured recoveries of 350 million, all through more than 150 settlements in the course of which we reduced the total number of outstanding contract by 90%. The incremental charges arose this quarter from reported loss developments, developments in arbitrations, commutations and settlements in a small number of remaining contracts.
Of the total loss this quarter 30.7 million relates to an adverse development on about 15 contracts, a number of which were commuted in the fourth quarter. An additional 16 million represents a one-time true up for reserving errors. We believe our year-end reserves are appropriate and our focus for 2010 will be on seeking resolution on the relatively small number of remaining active contracts.
Turning now to mortality results, please refer to Slide #8. Overall experience, including both closed block and open block results, was in line with expectations. As you know, mortality experience in the individual blocks fluctuates from quarter-to-quarter, especially in the large case UL block. We again saw this in the fourth quarter.
With two relatively weak quarters in the year, UL mortality in 2009 was below long-term expectations. And for 2009, if you recall, we expected mortality margins closer to 45%, the actual results came in at 37%. On the other hand, results in the UL were quite favorable. As I mentioned in the last several quarters, we expect mortality markets to begin decreasing as lower new business volumes are being written.
We continue to closely watch persistency and slide #9 shows annualized aggregate surrender rates based on the contract values surrendered. Here is where experience can differ significantly by block of business.
Life surrenders remain somewhat elevated, however, annuity surrenders are at their lowest level in many quarters. Let me reiterate that from a general liquidity perspective, these numbers do not represent cash out the door, because in many cases there are loans outstanding against the policies and for more recently written business, charges are due upon surrender.
In addition, the measure that we show here includes separate account surrenders. As you heard from Jim, one of our critical initiatives in 2009 was to reduce expenses.
Slide #10 shows consolidated statutory expenses adjusted for non-core items. We completed our planned staff reductions in the early part of the third quarter and are beginning to see the impact of these actions and of lower business volumes on a statutory basis.
In the fourth quarter, we also announced that we would freeze our defined benefit pension plans and we reduced the size of our board by 27%. We have been reporting non-deferred distribution expenses as unusual items over the past three quarters. The establishment of Saybrus Partners has a couple of implications.
First, with the decision to retain our distribution organization and launch Saybrus, we view this cost as an investment in that initiative. By moving the distribution staff to Saybrus, we are reducing statutory expenses in the insurance companies.
Second, as new sales of Phoenix products begin to grow, the insurance entities are paying a variable distribution cost to Saybrus rather than carrying the full expense. So the statutory expense picture should continue to improve.
On a GAAP basis, expenses will decline more slowly than on a statutory basis. A significant portion of the reductions that we took were in new business areas that retired sales volumes would have been deferred.
So in terms of deferrals, we only deferred 400,000 of expense this quarter compared with a 1.9 in the third quarter, 5 million in the second quarter and 12.2 million in the first quarter. On a GAAP basis as well, we do expect continuing benefits to emerge in 2010.
Slide #11 updates some schedules that we first showed you in the second quarter of 2009. It relates to our deferred tax assets and the DTA for capital related accounts that is shown here decreased from September 30th while the DTA related to ordinary accounts increased. These changes are related to results in the quarter as well as true-ups from the resolution of our 2004 and 2005 Federal Income Tax Audits. As you can see, we continue to carry a full valuation allowance against DTA.
As a reminder, GAAP tax valuation allowances have no bearing on whether deferred assets will ultimately be available to reduce taxes. We believe that our tax attributes still have substantial value and as you can see, substantial time remains for us to ultimately recognize these benefits.
Let’s move to realized losses on slide #12. Chris will cover the impairments and transaction losses in a moment. I’ll just comment briefly on our variable annuity hedging program.
Overall, we are pleased with the performance of the hedging program which had a $700,000 economic gain in the quarter. The gain was offset by the change in the GAAP liability due to the FAS 157 nonperformance risk factor. For the full year, our loss on an economic basis was a modest 2.7 million.
Finally, a summary of our balance sheet metrics on Slide #13. Leverage remains modest at 24.7%. We’ve continued to repurchase our debt in the open market. Through the fourth quarter, we effectively retired 46.1 million par amount of our $300 million senior debt issue.
Holding company liquidity was at 63.9 million and cash and securities as of December 31st. Statutory surplus of 574 million for Phoenix Life is down modestly from September 30th. RBC is estimated at 225% at year-end 2009. The decline from year-end 2008 was primarily due to ratings migration in the company’s bond portfolio, annuity reserves, net of derivative losses and credit impairments. The charge for discontinued reinsurance also depressed surplus and RBC.
Consolidated pretax gain from operations improved from a loss of 69.8 million in the first quarter to a gain of 42.9 million in the fourth quarter. Let me end with a critical point that Jim already stated earlier.
The emerging statutory trends indicate that Phoenix life is clearly moving into a period of significant organic capital generation. You need only look at the quarterly statutory results in 2009 to see the improving trends. This is the direct result of the expense reductions we have already implemented, lower new business strain and the more stable market environment.
To reiterate, without any incremental reinsurance transactions, we project our in-force business to generate over 40 percentage points of RBC by year-end 2010. That estimate does not include any benefit from the sale of PFG nor from any reinsurance transaction that we continue to evaluate.
With that, I’ll turn it over to Chris for a discussion of the investment portfolio.
Thanks, Peter. My job in managing the investment portfolio is really all about the company’s first pillar, a healthy balance sheet. And the story this quarter is a good one. As investment markets continue to improve in the fourth quarter, the Phoenix portfolio benefited in several key areas, including higher net investment income, a continued appreciation in portfolio values, stronger credit quality and a high level of liquidity.
Let’s start with net investment income on Slide #14. Net investment income increased by 6 million from the third quarter to the fourth quarter, the third sequential quarterly increase. The increase was attributable to the continued rebound in the performance of alternative investment assets.
Income from alternatives jumped to a positive 11.2 million in the quarter, up from 4.4 million in the third quarter and sharply higher than the losses experienced earlier in the year. Alternative investment returns have rebounded alongside improvements in the equity and debt markets, encouragingly for the Phoenix portfolio because of the one quarter lag in partnership accounting.
Improvements in alternative returns have not yet fully materialized through our income statement. Due to this lag effect, we expect continued improvement in the first quarter of 2010.
As Jim described, this improved trend in net investment income illustrates the soundness of our investment portfolio and its ability to weather the chaotic markets of the last 18 months.
Slide #15 shows fourth quarter credit impairments by sector compared to results for the last three quarters and full years '08 and '09. Impairments on two positions that totaled about 10 million drove the fourth quarter increase. We do not view this increase as a precursor to higher impairments going forward, but more a reflection of the timing of impairments. Results for the quarter were within our expectations.
The full-year results of 108 million represents a sharp decrease from 2008 results and represents only about 1% of total assets, a significant accomplishment in the credit market environment of 2009, where default rates for all fixed income securities soared and high yield default rates reached double-digits.
In spite of market concerns about commercial real estate, our CMBS portfolio has held up very well and we have suffered minimal impairments in this category of bonds.
Slide #16 illustrates the continued substantial improvement in unrealized losses in the Phoenix fixed income portfolio. With tightening credit spreads in all sectors, the unrealized loss in the portfolio have declined sequentially by almost 80 million to 325 million or about 3% of total portfolio book value.
With treasury rates back down again in January, we have calculated that the January month and unrealized loss has dropped to about 150 million. During 2009, we experienced a decrease of over 80% in unrealized portfolio losses compared to the year-end 2008 total. The improvement in portfolio evaluations has been a contributing factor in strengthening our balance sheet and stabilizing surplus
The trend in lower unrealized losses has also substantially increased the liquidity in the portfolio as the majority of securities can now be traded at prices that are at or exceed their accounting values, reducing our need to hold more highly liquid assets.
On Slide #17, the portfolio’s percentage of below investment grade bonds declined from 11.4% at the end of Q3 to 10.8% at year-end. Improvement in the ratio is attributable to sales of high yield assets, the NAIT re-rating of non-agency mortgage-backed securities and a dramatic slow down in the number of down grades to below investment grade.
Our third quarter estimate at the NAIT ratings modification would have a 12 percentage point beneficial impact on our RBC ratio proved to be correct. The re-rating increased the overall quality of our non-agency RBS holdings and was an affirmation from the market of the overall soundness of the portfolio.
During 2009, downgrades to below investment grade were significant in all bond market sectors, especially in structured bonds. Beginning in the fourth quarter of 2009, we have seen a decrease in below investment grade downgrades. That coupled with the significant appreciation in low investment grade markets in '09 has meant that we can sell many positions at levels close to book value.
As Jim noted, we have used this strength in the below investment grade market to sell smart rather than simply selling into fire sale conditions that prevailed in the first half of 2009. We continued to de-risk the portfolio through high-yield sales, maturities and pay-downs during the first quarter. We expect to be able to bring the high yield percentage down under our limit of 10% in the next few quarters if credit market fundamentals remain strong.
Since the majority of our below investment grade holdings are structured bonds and private placement bonds, we expect the severity of any perspective losses on these securities to be much less than for an equivalent portfolio of corporate bonds.
Slide #18 provides an update on liquidity in our portfolio at quarter-end. Our liquidity position is unchanged from year-end '08, but decreased from about 12% of the fixed income portfolio during mid '09. The improvement in bond valuations has allowed Phoenix to decrease highly liquid assets.
More importantly, we have shifted the composition of our liquidity pool from very low yielding treasury bills and notes to higher yielding agency mortgage-backed securities.
In the third and fourth quarter, we redeployed a large portion of our cash and short-term treasury position into agency mortgage-backed securities, a move that resulted in a yield pick up of about 450 basis points on over 300 million that was reallocated. We are comfortable reducing the extra cushion of liquidity that Jim described needing during the first half of 2009.
Slide #19 summarizes our non-agency residential mortgage holdings by borrower type, credit quality, vintage and collateral type, the factors that drive the ultimate performance of our NDS. Our story remains largely the same.
The Phoenix RMBS portfolio is high quality, seasoned and has a substantially higher amount of fixed rate mortgages compared to the market overall. We believe these factors drive relative performance and a percentage of delinquent loans in our MBS holdings is about half of the market delinquency rates for each of the categories in this table.
Slide #20 shows a snapshot of our CMBS portfolio. There has also been little change during the last several quarters. We recently reviewed Moody’s loss estimates for the overall CMBS market and calculated that our overall portfolio has over five times the amount of credit support required to withstand the Moody’s loss projections.
Recent equity analyst reports have also calculated that Phoenix’s CMBS portfolio is likely to suffer minimal losses. This speaks to the careful construction of this piece of the portfolio and our unwillingness to invest as underwriting standards weaken. It is also important to note we have almost no exposure to commercial mortgage whole loans and only a small exposure to own real estate.
With that, I’ll turn it back over to Jim.
Thanks, Chris. Before we take questions, I want to wrap up with my view of 2009 and look ahead to 2010. As I said, 2009 was a tough year. The economic environment, the short-term costs of the trade-offs we made, short-term consequences from not taking action we thought unwise and even some bad luck. But there’s a lot of strength below the surface of those challenges.
As we head into 2010, I am confident we are in a much better position than we were a year ago. The $110 million in expense reductions we implemented are kicking in. Our investment portfolio is much healthier with unrealized losses down 90%. The business is now in a position to generate substantial organic capital that alone can improve RBC by about 40 percentage points.
And our growth initiatives are gaining traction, especially with Saybrus Partners and new relationships with middle market distributors. We expect a year of positive momentum for Phoenix and look forward to reporting our progress back to you.
With that, we’ll take your questions.
(Operator instructions). And first we have Bob Glasspiegel with Langen McAlenney
Bob Glasspiegel -- Langen McAlenney
Good morning. Jim, how are your benchmark in Saybrus is and there really initial signs you can give for how it’s doing?
Bob, clearly, Saybrus is a start-up as we’ve characterized it. The first critical benchmark was getting a client and getting a meaningful client and we did that. As we head into the beginning of the year our writing business for that client, our expectation as you would expect with a start-up is that, that business will ramp up over the course of the year and our expectation is also that we’re looking to add clients during the course of the year.
So, in terms of benchmarking beyond that, our view is that, as with many start-ups, 2010 will be a year where they are not breaking even, but that we anticipate breaking even as we move into 2011. And it’s very early in the game, Bob, so to do a benchmark or comment beyond that would be tough. It would be tough to do.
Bob Glasspiegel -- Langen McAlenney
Okay. My follow up is your projection for 40 bps of RBC improvement, does that have any allowance for impairments and downgrades and if so how much?
It’s Peter, Bob. It does, we’re banking in about 2.5 times the long-term default rates. Our typical projection in a normalized year is to use long-term default rates. We’re doing about 250% of that.
Bob Glasspiegel -- Langen McAlenney
No downgrades or --
Downgrades, we are not explicitly modeling downgrades, we think and Chris can chime in here. We think that the pace of downgrades has slowed.
Bob, we would assume that we would make high yield sales that could offset any downgrades at least in the 40 basis point scenario. As I noted, we’ve seen the pace of downgrades, especially in some of the sectors that we have slowed dramatically, so, we’re comfortable that we can offset any further downgrades either with sales or maturities or paydowns in low investment grade holdings that we currently have.
And that was our experience in the fourth quarter.
Bob Glasspiegel -- Langen McAlenney
Thank you, Jim.
And our next question comes from Eric Berg with Barclays Capital.
Eric Berg -- Barclays Capital
Thanks very much. Good afternoon to everyone. Two questions. Peter, how can we tell from the available disclosure that this deterioration in mortality margin is not a result of a growing anti-selection? The big elephant in the room here is that we’re going to have, your healthy lodge leaving you. How do we know that’s not happening?
The fundamental reason is that it’s a very short period and I think to make an assessment on long-term trends based on a short period is pretty difficult. I don’t know if you have any --
I guess more to the point, the results as Peter said in the quarter, can be more volatile than they would be over the long-term. When we perform our mortality studies over longer periods, we’re still within, our actual to expected results and this quarter, in particular, was one claim away from being a better than average quarter. So I don’t know how much you want to read into, one more person died than perhaps should have to make it a good quarter versus an adverse quarter.
Eric Berg -- Barclays Capital
Okay. The second question, with respect to the surrender rates, Peter, you mentioned something that I heard, but didn’t quite understand and that has to do with the fact that the measure of surrender rates includes the separate account activity. What is the point there? Why is it important that we know that?
The problem was that to the degree that surrenders create a concern around general account liquidity, separate accounts surrender and they obviously come out of separate accounts, so it really doesn’t have an impact on the general account liquidity picture.
Eric Berg -- Barclays Capital
And we have another question from Bob Glasspiegel with Langen McAlenney
Bob Glasspiegel -- Langen McAlenney
Peter, you probably expected this one coming. On your run-off reinsurance, you said the exposures are down. Can you give us some quantification just on the number of exposures and the risks as you see it quantifiably?
Hi, Bob, I did not expect that one, but Dave Pellerin happens to be here, who is very much in the middle of this business, I’ll let him address it.
Hi, Bob, this is Dave.
Bob Glasspiegel -- Langen McAlenney
How are you doing?
Doing okay. In terms of this run-off book of businesses, as you heard and know, it went to run-off in 1999. About that time we had an excess of 2,000 contracts in the book of business and as Peter indicated, we’ve reduced that significantly, roughly, 90% over the past ten plus years. Even in the past six months, when we took a charge in the second quarter, that time, we had roughly 300 open contracts on this book of business and since then in the fourth quarter, we’ve cut some successful commutations behind us such that we’ve taken about 100 of those off the books. We’re down to 200.
Roughly speaking, and it’s really a subset of that that we’re most concerned about where we’re seeing the adverse reported loss development again here in the fourth quarter. So, roughly 15 contracts, in particular, that are of most concern. As we noted in the second quarter, part of what appears to be happening, there are longstanding disputes elsewhere in the market that have apparently been resolved and we’re seeing these troublesome contracts loss development that in some respects relates to that to the resolution process elsewhere.
Bob Glasspiegel -- Langen McAlenney
Given these are, what, eight year to ten year old disputes, one would think that the toughest, stickiest contracts are the ones still open, where there might be more volatility. Is that a sort of incorrect view or --
I wouldn’t agree with that entirely. Certainly from Phoenix’s perspective, we had lots of sticky exposure that was on our plate early on, and indeed, it took us a good four years to five years into put a dent into those exposures. We were and have been aware that there were outlier exposures in terms of disputes elsewhere and while those, as I indicated are causing us to assess and strengthen reserves here again in the fourth quarter, I would not characterize those as particularly sticky. It’s more outliers that just tended to be on the backburner while some of the larger, more notorious exposures were dealt with.
Bob Glasspiegel -- Langen McAlenney
Okay. I would like to now turn the meeting back over to Mr. Wehr.
Well, thank you. I’m hopeful that our presentation was so thorough that we anticipated most of the questions. Like to thank everybody for their time and attention this afternoon and enjoy the rest of your day. Thank you.
And that concludes today’s call. Please disconnect your lines at this time.
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