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Protective Life Corporation (NYSE:PL)

Q2 2010 Earnings Conference Call

August 4, 2010 8:00 AM ET

Executives

Eva Robertson – VP, IR

John Johns – Chairman, President and CEO

Rich Bielen – CFO

Ed Berko – EVP and Chief Risk Officer

Carl Thigpen – EVP and Chief Investment Officer

Analysts

Steven Schwartz – Raymond James & Associates

Mark Finkelstein – Macquarie

John Nadel – Sterne Agee

Ed Cia – Bank of America

Tom Gallagher – Credit Suisse

Darin Arita – Deutsche Bank

Andrew Kligerman – UBS

Ian Gutterman – Adage Capital

Operator

Good day ladies and gentlemen and welcome to the second quarter 2010 Protective Life Corporation earnings conference call. My name is Mary and I will be your coordinator today. (Operator Instructions) As a reminder this conference is being recorded for replay purposes. I would now like to turn the presentation over to your host for today’s call Ms. Eva Robertson, Vice President of Investor Relations. Please proceed.

Eva Robertson

Thank you operator and good morning, welcome to Protective Life Corporation’s second quarter 2010 call. This morning’s call will be hosted by John Johns, Our Chairman, President and CEO along with Rich Bielen, our Vice Chairman and CFO. Late yesterday afternoon, we released our earnings press release along with our supplemental financial information and that can be found on our corporate website at www.protective.com.

Before we begin I want to make sure to remind you that in addition to our discussion today we are using a slide deck which can be accessed through the website on the webcast viewer. You may follow along with slide deck advancing the slides on your own.

Also the call today will include some forward-looking statements which express expectations of future events and results. Actual events and results may differ materially from our discussions today. Please refer to our press release and the risks and uncertainties as well as risk factors section of the company’s most recent report on 10-Q and subsequent report on Form 10-K for more information about factors that may affect future results.

The discussion may also contain non-GAAP financial information. Please see our supplemental financial information on the website for a reconciliation of GAAP financial measures. At this time I would like to turn the call over to John Johns.

John Johns

Thank you Eva and good morning everyone and welcome to Protective Life second quarter conference call in which we will discuss the results that we released last night.

I’ll start by saying that from my perspective we thought it was a pretty solid quarter. In general each of our operating segments was on planned for the year, if you exclude some mark-to-market accounting issues. We were a little behind in our corporate and other segment due primarily to the fact that we’re not quite on schedule in terms of investing excess liquidity for our business plan for the year but overall I think we were reasonably satisfied with the results as we reported.

Couple of things to point out. We did continue to enjoy trend of favorable mortality in the quarter. I think it’s worth noting that since 2005, and that’s when we began to securitize, redundant on reserves, we’ve been keeping one of the separate tally on our actual incurred mortality as compared to our expectations at the time of pricing our products and during that period on a cumulative basis, we’re running at about 85% actual to expected and interestingly that’s about where we are in this quarter. so over five year period, we’re about 85% and in this quarter we’re about 85%.

Our net realized losses for the quarter were about in line with our expectations, Rich will give you deeper discussion of that in just a minute but I think in general the trend in impairments and realized losses is tracking about what we expected them to be. We are very pleased that our book value again increased in the as reported, increased in the quarter. It’s up 24% this year and it’s up 89% over the second quarter of ‘09 and obviously what’s going on there is that the mark-to-market on our securities is going up in this environment.

We expect to see some continuing impairments out in the future but at the end our expectation is in line with our plan. Sales in the quarter were pretty good, we bought across the lower flag sales were essentially flat on a sequential basis but for our plan we saw a nice increase in universal life sales as compared to term sales and we do see in our new term UL products are seeing acceptance in the marketplace as we introduce them.

Annuity sales were very strong in the quarter, healthy growth across the board, also very pleased that our variable annuity sales were up actually, I would like to point out that with respect the products, the variable products that we are selling about 40% of our sales this year, products that did not have a roll up feature and then of those who do have a roll-up feature about two-thirds of the sales are of our most conservatively designed products.

So I’m very pleased with that as well. So I think that gives you a quick kind of summary. We – again we reported $0.62 in the quarter that compares to a $1.03 same quarter last year on an operating basis net income which would of course include the affects the realized gains and losses, $0.47 in the quarter that compares to $1.16 last year.

And with that I’m going to turn it over to Rich and Rich will walk you through the details of the quarter.

Rich Bielen

Thank you Johnny. Good morning everyone. We’ll start on slide three of the slide deck and just walk through the earnings per share as Johnny mentioned for the quarter, we report $0.62 of operating and year-to-date we’re at $1.39. On a net income basis for the second quarter, we’re at $0.47 and year-to-date we’re at a $1.27. On a dollar basis after-tax operating income was $54 million and $122 million for year-to-date and net income is $41 million with $111 million year-to-date.

As we always do if you turn to slide four, we try and highlight anything that we think is somewhat unusual in the quarter and we classify them under what we call non-core items and core items. There were three items that we would suggest are non-core. The first is the annuity fair value items related to the fair value on our variable annuity and our equity index annuity. That actually reduced earnings by $13.9 million or about $0.11 per share for the quarter. We also during the quarter were able to repurchase some notes related to our UL securitization. It will not have any impact on the capital. It will not have any impact in terms of the funding of those reserves, but occasionally we were able to buy those in the secondary market and we just continue to hold those notes for the remainder of the period of the time and we recognized the gain at $9.5 million during the quarter.

Also due to some legacy lines we have in our acquisition block and otherwise we did get impacted by the health legislation which restricts some of the desired stability of compensation. On a pre-tax equivalent basis that reduced earnings by about $1.7 million, about a penny a share as a result of a higher tax rate.

So as we look the non-core items were negative roughly $6 million for the quarter and then in terms of our core business, we saw mortality across all of our business and we’ll go through each segment being more favorable than we planned for by about $6.1 million or about $0.05. And that includes mortality not just in our life marketing area but our acquisitions area and even some negative mortality we’re seeing in our annuity area based on some life contingent contracts we have.

Turning to slide five, walking through for everyone our net realized investment gains and losses for the quarter. We did have some impairments in the quarter of $16.8 million. I did see in the note there is people wanted some of the breakdown there, of that $16.8 million, $12.1 million was related to our Alt-A bonds, $600,000 was related to some Sub-prime bonds, there was about $1.2 million related to our corporate portfolio and then other prime RMBS there was an impairment of $2.9 million.

So the bulk of it was related to the securitized portfolio, we continue to monitor that pretty carefully and take any impairments necessary. Walking through the rest of the items there, the Modco which in the past is sometimes close in volatility this quarter was relatively modest. It contributed $1.4 million. Our own trading activity in the securities portfolio during the quarter resulted in the net realized gain of $5.7 million or $0.04 a share. We do continue to have some interest rate related to revenues to protect us against some higher rate environment with the drop in rates in the second quarter; we saw that mark-to-market being negative $6.4 million or a negative $0.05.

And then there is just a miscellaneous number of items that totaled $3.8 million or $0.03. So for the quarter, our net realized investment loss was approximately $19.9 million or $0.15 a share. I will comment on year-to-date on impairments. We are currently running between the first and the second quarter at approximately $29 million which is less than what we originally planned for during the year. So we think the losses continue to trend down as time goes on and we’re pretty comfortable of where the portfolio is.

Turning to slide six, our book value per share under the second quarter was $36.02, that’s up from $28.96 at year end and up 9.3% from the $32.96 at the end of the first quarter. Without ASCI, at the end of the quarter we were $33.95 versus $32.72 at the end of the year. Going down in the reconciliation of accumulated other comprehensive income; I’ll just point out a couple of things. As you can see our gross unrealized losses continue to improve. They were a little over a $1 billion at year end ‘09. they’re now down at $633 million and the gross unrealized gains have improved pretty dramatically from $640 million to $1.124 million resulting in a net unrealized position on those securities portfolio today of $491 million versus the unrealized loss at year end of 403 and then at the end of the first quarter, that unrealized gain was approximately $61 million.

Other point in terms of equity, we estimate that our RBC as of the end of the second quarter is 431%, so that’s very consistent. It’s up from year end, down a little bit from the first quarter but a very healthy ratio as we move forward.

Moving to slide seven, we continue to just put this into the package because we know in the past we’ve gotten a lot of questions on our RMBS portfolio. We did see some continued migration early in the second quarter but that appears to have slowed over the last 60 days or so. So here is a breakdown in the prime portfolio which is currently at approximately $3 billion. Your pay (ph) on the mark-to-market is about $400 million and our mark-to-market the Sub-prime is down at $37 million and you can see the amortized cost numbers below.

And if you turn to slide eight, as a reminder of everybody, at this point 99% of all of these portfolios are either super senior or seniors. So we believe the recovery rates if there are any losses on these securities will be extremely high and as we reminded everybody, the average life of this portfolio is relatively short and so when we show you below is based on the amortization in the second quarter, the annual life amortization is 30% on the Prime, 21% on the Alt-A and the Sub-prime is a little slower at about 12%. But as you can also see based on current prepayment expectations the average wise is around three years or less of these portfolios.

Turning to slide nine, just to reminder since it was in the news especially during the second quarter, although things have calmed down somewhat, sovereign exposure, we don’t have any sovereign exposure to any of the Greece, Portugal, Italy, Ireland or Spain. We don’t have any bank exposure except the Spain and there we are $23.5 million and its one of the US domestic subsidiaries of this one of the Spanish banks and this was current as of the under July. So we don’t have any exposure in terms about area,

Moving to slide 10, the commercial mortgage loan portfolio. The total portfolio is currently $4.9 billion with an average loan size of $2.6 million. Our weighted average life amortization is 21 years, loan to value is estimated at 53% with the coupon is 6.3%. When we look at this, the actual delinquent loans and foreclosed properties that we currently have on the books is $29.9 million. Its fixed terms of 1%. As you recall FAS 167 requires us to consolidate in what are our previous securitizations and under those we had restructured a couple of loans, where we amended the terms.

Interest was being collected, principal was being collected and those loans are currently performing but that’s totaled in those securitization $35.7 million, so we’ve broken that out separately. Moving on, also there is a lot of questions that we’ve seen over the last week or so from competitors about liquidity and interest rate management. Let me make a couple of comments there. Our cash and short term investments do continue to be elevated. We had been making good progress on investing that cash through the beginning of May and then with the crisis in Europe, what we saw was basically the corporate bond calendar just dried up and we did not see a lot of new insurance.

We did not really chase the market at that point, cash is accumulated again here during the second quarter. But one thing I want to emphasize, there has been a lot of questions about spread management. All of our segmented portfolios are very well matched on an asset liability basis. We at this point do not see any spread concerns with respect to either the annuity or the UL business, where there has been a lot of questions. This liquidity that’s been building up on our balance sheet, we hold in our corporate and another portfolio which effectively represents the capital and surplus of the company.

So from an AOM perspective, we’re very well matched and we don’t see any real issues surrounding spread management for the foreseeable future. The real increase in terms of earnings is when we can get the capital and surplus and invest it at a higher rate than just having it in short term investments. Also that we look at this and there has been a lot of questions about timing in how we invest, our intention is to have this liquidity invest – completely invested by the end of the third quarter and we’re estimating based on the way we looked at the second quarter in going forward that the liquidity is approximately a $5 million drag to earnings in corporate in other.

Moving on to the divisions, life marketing, we report $35.8 million of earnings here in the second quarter versus $40.7 million in the first quarter. Our favorable GAAP mortality of $9.7 million here in the second quarter versus $14.5 million in the first quarter. As Johnny mentioned, when we look at our actual to expected mortality and primarily the favorable mortality is coming out of the term business, in the second quarter that actual to expected was about 85% and that’s where it has been on this most recent business.

When we started the year and set out our plans for everyone, when we estimated the $3 million a quarter and we had simplified it by putting it into a dollar basis, if we had translated that into actual to expected, it would be approximately 95% and in future quarters what we intent to do is talk about the actual to the expected so that people can have a better ratio and I think that’s more consistent with maybe somehow – some of our competitors talk about the business in the mortality.

In the second quarter, our UL represented 56% of total sales, so while we’ve made considerable progress on our shift to more UL versus term. Our expenses were also slightly better than planned. If you move to slide 12 you can see the total sales for the quarter were $43 million and I will point you to a couple of things. They are on the term side. We saw our term sales decline from $21 million in the first quarter to $18 million in the second but you see the momentum in the universal life line going from 21 to 24 and that the shift that we have been talking about. It is occurring and that momentum continues on at this point.

Moving out to the annuity segment, the fair value items negatively impacted the quarter $13.9 million. On slide 13 I would really point you the blue bar which showed the earnings without the fair value that was $14.5 million. We continue to see spreads outperform planned year. We had record VA sales which I will point you to on the next chart. We also continue to have positive segment fund flows. And one thing I mentioned in my opening comment one of the things holding down earnings here is that we do have some life contingent single-premium immediate annuities and as we estimated the mortality there we at had a negative variance in this line of business of $1.5 million. So the secular trends that are helping us on the life side we have got a mortality actually hurting us in this line of business.

Turning to slide 14 sales for the quarter on annuities are $738 million, up 21% over the second quarter of last year and up 30% over the previous quarter. Variable sales were the record $413 million and we continue the balance between fixed and variable. What I would like to do, also the account balance increased 2.7% sequentially and is up over 20% since the second quarter of 2009.

Turning to the next slide, GMWB fair value component, I would like to spend a minute on what we will be doing going forward on hedging. During the second quarter we were starting the process of hedging into early May as we saw the account balance move up and as we came off the first quarter conference call with the Greek crisis we saw the volatility spike, interest rates dropped. So in the second quarter what we saw in the GMWB is we saw a $14.6 million negative fair value changes and what we have done in very high level terms is just break down the sources of that.

As you can see almost half of the change related to the drop in interest rates are46%. The equity component which we think is where the majority of the real economic risk is was only 16%, new business as these sales keep coming on the books as 10% then you have a lot of other things including volatility that totaled about 28%.

If you then turn to slide 16, we have now been in the process here in July of actually adding a hedge to the program. We are very sensitive around the risk management. We spent a lot of time over the last year to make sure that we would have a program in place and although we all know that there will be some variances to this and there was some volatility that may not be fully able to be hedged what we wanted to do is give you some parameters around which we will be hedging this part of business.

The first goal is to maintain EPS volatility on an annual basis of less than 5%. We also intend on maintaining any statutory capital volatility to less than 5%. For the moment in this market we are going to hedge the equity and interest rate exposure. The volatility component we will hedge over time. The volatility is currently still somewhat elevated and we do not think economically it makes sense to try and hedge that right now.

The parameters around which we are trying to manage this volatility are under two what I will call scenarios. One is an equity market decline for current levels of 40% and also an interest rate decline from current levels of 100 basis points and those will be our guideposts. And as we implement our program and we are approximately 60% of the way through implementing it we believe that we can maintain this level of parameters with those kinds of declines in both the equity and the fixed income market. In fact based on our current plans we need to be able to tolerate some more volatility ____ 450 focus.

Turning now to slide 17, acquisitions, for the quarter we are reporting 30.2 million. It continues to just be a stable earnings pattern here. We do not see a lot of volatility underneath. Earnings are actually somewhat ahead of plan. The runoff continues to track at the 6 to 7% when we look through the underlying business and just to remind everybody, we are in the process of an insourcing initiative. We are going to bring of the chase business back on to our books and service it here in Birmingham and that project is on track to be completed by the end of the year.

Now turning to slide 18, stable value, stable value spreads were flat in the quarter at 126 basis points. We earned $11 million versus 11 million in the first quarter. Earnings here are slightly ahead of plan. The ending balance is consistent with our expectations and we actually had early in the second quarter sales of $257 million. As a result now of the cash buildup that we have seen recently since the Greek crisis, we made the decision that for the third quarter we will not be selling any business until we get all the cash deployed so we would expect this balance to drop to approximately $3 billion.

If for some reason we fall behind on the cash plan, we see another $200 million of runoff in the fourth quarter this year which would drop into $2.8 million at yearend 2010. So we will really decide opportunistically whether to sell contracts to keep the balance upward is really dependent on the availability of good investments in terms of doing that.

Turning to slide 19, asset protection, we report $6.6 million of earnings for the quarter. That is about $600,000 ahead of plan. Our service contract sales have improved 16% over the second quarter of 2009 and just to remind everybody when they look at the first quarter, $13.1 million, in the first quarter we had settled our lender’s indemnity litigation and had a reserve relief of 7.8 million.

Turning to slide 18, just to look at the sales, you can see that the sales are up pretty consistently across the board. They are $88 million here in the second quarter of 2010 versus $76 million a year ago and that is consistent with the improving economy and the improvement in unit sales for the division.

I think with respect to corporate and other, I really hit all the items but one point I will make is that in the trading portfolio what you saw in the quarter was we showed you that we had a loss of 5.1 million. That portfolio is now down to approximately $181 million so it continues to decline but that $5 million was actually offset based upon some other extraordinary income items including about $1 million of participating income, some prepayment fees otherwise that came in so as we look at corporate and other overall we were still hurt by about $5-million liquidity drag. And with that I will now turn it back over to Johnny for the outlook.

John Johns

Yeah. Thanks. First, let me write a few comments about our outlook for the rest of the year and beyond. Our focus is just staying on plan. We will continue to block and tackle and execute plans that we established earlier in the year. That would include though continuing to emphasize growth in our universal life product line which would transition away from traditional term chassis and put more emphasis on our true universal sales.

We did see some nice growth opportunities in the annuity segment. Our growth there will be balanced and thoughtful and certainly will be oriented to our risk management strategies based upon again we see some opportunities that are attractive there. In asset protection as Rich indicated we do see an encouraging sales trend there. We are seeing some gradual improvement in US auto sales. Longer term, we do have some exciting opportunities we think in our new small joint venture opportunities in China and in Europe. We continue to work on that.

I guess the thing that probably most are (ph) pursuing right now is we are seeing acquisition opportunities again back in the market. We have been very busy over the last couple of months looking at several different opportunities and we are hopeful at some point we will be entering the acquisitions phase with the transaction. Rich also indicated our capital position remained strong with an RBC ratio about 430% so we have capital available to invest in acquisitions.

This whole issue around liquidity is a difficult one. We would like to get all that cash invested and remove the earnings drag that Rich referred to but we are not going to do that if it means doing anything that we are not comfortable with in terms of sticking to our investment guidelines and our concentration guidelines there so we will just have to play that out over the rest of the year. In general the longer-term view is that we plan to grow our business, change the business model a bit.

We are emphasizing innovation, differentiation and underwriting profits in every line of business. We are very focused on capital deployment. We recognize that (inaudible) is not where it should be and needs to be and that is uppermost in our mind as we look at everything we do and as we think about strategic planning early in the next year, improving returns on capital will be right at the top of the list of our priorities.

So I think it would be fair to say we are encouraged by what occurred in the second quarter and we are pretty optimistic as we look to the balance of the year that we are going to be stay on plan execute the plans that we laid out at our investors conference earlier in the year. With that I think I will then turn it over to you for your questions. We will be pleased to hear them and respond.

Question-And-Answer Session

Operator

(Operator instructions) Your first question comes from the line of Steven Schwartz – Raymond James & Associates.

Steven Schwartz – Raymond James & Associates

Hey, good morning, everybody.

John Johns

Good morning, Steven.

Steven Schwartz – Raymond James & Associates

Just a couple of I imagine are not going to be that tough. The one question that popped to me last doing numbers I tracked, and I imagine the others did as well, kind of your normalized benefit ratio you gave us on the life marketing side, you gave us favorable mortality and the unfavorable mortality back that out to come to some type of normalized benefit ratio, I think losses less than mortality divided by the quantity of premiums and investment income to give us some type of normalized number and something popped out at me last me last night. That number was around 76% in 2008 that would indicate the normalized number.

It was about that in 2009 and all of a sudden in the first quarter and second quarter we are looking at numbers, I am looking at numbers like 81.5, 82.5 and I am just trying to figure out what is going on. That would be my first question. Then Rich you keep on telling you had excess liquidity. I’m wondering if you could just give us a number of what you think that is.

Rich Bielen

Okay. Steve, I will handle the second question and I will turn over the first one to Steve afterwards, Steve Walker, but with respect to excess liquidity we think that normal liquidity should be in the range of about of 1% of assets so I would call that $300 to $400 million. We are currently sitting at the end of the second quarter approximately $1 billion so the plan would be to get that $500 million deployed and that reinflates (ph) into the current market rates; roughly that is $5 million drag a quarter.

Steven Schwartz – Raymond James & Associates

Okay. Thank you, Rich.

John Johns

I just wanted to make sure I am clear on how you are calculating your benefit ratio before I respond to your question.

Steven Schwartz – Raymond James & Associates

Yeah, I could be doing this wrong or maybe it does not make sense but basically what I look at is losses, benefit, expense divided by the sum of premium and investment income and to get to a normalized number I back out what you suggest favorable or unfavorable mortality is.

John Johns

It seems that if you look at our 10-Q and 10-K you will seen an exhibit in there that talks about the effects of reinsurance on our income statement and another component that is missing from your formula there is within our operating expenses we have allowances that we receive from reinsures, from business that we have previously reinsured. So if you do not include that component in this calculation that is getting skewed numbers particularly when you look at it quarter to quarter because you have business that historically prior to above (ph) was 90% coinsured and that has big influence on that ratio and also since we have been retaining more of the business, our books, so you are going to see over time is that (inaudible), that bigger percentage of our total more losses coming through the benefit line but obviously we are going to have more premiums as well. So I think part of the SKU that sets ‘08 (ph) is really coming from the growth of that blocks where we retain 90% or more of the business.

Operator

Your next question comes from the line of Mark Finkelstein of Macquarie.

Mark Finkelstein – Macquarie

Good morning. I have a few, I guess, detailed questions. I guess, first one is on life’s marketing earnings, one your competitors, actually, is having an issue where they assumed a longer duration of the ten-year level premium term policies that were written call it 2,000x (ph), so that’s in higher lapsation and the FAS 60 accounting, didn’t account for that and, therefore, they are taking deck write-offs. Is that in, anyway, an issue that’s affecting your amortization or could essentially assume that all this policies would lapse at the expiration of level premium turn day?

John Johns

Mark, this is Johnny and Steven, Rich trying (ph) me in but, we’re familiar with issue and what we’re saying in terms of false (ph) level lapses is not inconsistent with our pricing for the products that are now reaching that point in time. Also, remember, too, we were 90% con-ensured on business is now reaching that point so we’re not observing that phenomenon right now and I booked a business when the business hits – - it should be reaching that post-level premium point.

Mark Finkelstein – Macquarie

I guess just a question on this near (ph) hedging, how should we think about the earnings impact or is it completely immaterial at this stage of implementing a hedge program, if you’ve currently, kind of, really not been hedging it. And secondly, are we going to hedge new business or we’re going to try to put in place any hedge program that covers the existing account balance?

John Johns

Mark, I will respond to the first part of that. I’ll let Ed Berko, who is, as you know, our Chief Risk Officer, try and do the second part of your question relating to how we’re going to handle your business.

The truth is we were hedge for the moment, it really not – - it’s going to be expense associated with (inaudible) using future smart kit (ph) that will not be the case overtime. As we build more robust program, we’ll start to spend money. We have a hedge budget for that, but for the moment, the cost of hedging is not that material for earnings expectations for the time being. And as you want a comment on how we’ll handle hedge and future business.

Ed Berko

Hi, Mark, it’s Ed. With hedging, the current block, as Richard mentioned, we started to break into the hedge in sort of late July, we’re about 60% done. We shouldn’t be fully hedged by the end of this week or early next week and we’re going to increase the hedge program as we continue to increase the block in sales.

John Johns

And, Mark, just to clarify the final point there is, one thing that we have that’s probably unique relative to some of the competitors, is this block is relatively new and so in implementing this, our benefit days and account values are relatively similar so our execution here at these levels, what was hedged, is almost as if it’s a fresh block. We don’t have any legacy losses that, related to business, written a few years ago.

Operator

Your next question comes from the line of John Nadel, Sterne Agee.

John Nadel – Sterne Agee

Just one question for you guys. One is around that $5 million estimated drag. I assume that’s a quarterly drag and is that pre or post tax?

John Johns

Yes, it’s pre.

Ed Berko

It’s pretax.

John Nadel – Sterne Agee

So then if I look at the bigger picture at the quarter, it seems you guys are pegging the core number, is around the reported number of $0.62 after you guys adjust for some of the noise. And maybe we’ll get another $0.04 or $0.05 once the liquidity, excess liquidity, has invested. So we’re getting towards the highest 60s. What gets you to the mid-70s which I think was originally sort of the expectation for the back half of the year and that’s probably pushed out as a result of holding on the liquidity a bit longer than you expected but as we look out to next year, how do we get to that mid-70s range?

John Johns

John, a couple of things that there are, I think, 62 was consistent with consensus. I think, we think, (ph) the quarter of our core basis was probably a little better than that. We’d probably call it between 62 and 65 based on its mortality that we’re seeing. That’s why we want to spend a couple of minutes on where actuals are expected on versus original expectation. We also see, we get some seasonality in our business so the fourth quarter tends to be better than the first quarter. So if you kind of start rolling the numbers, if you (inaudible) to 65, the excess liquidity gives us close to just 70 and then we see on the line growth of the business without an acquisition being somewhere between 8% to 10% on an annual basis. What really moves the ROE (ph) is that we can get the excess the capital deployment and acquisition but just on natural run rate at this kind of organic level, can get us 8% to 10% growth going forward.

John Nadel – Sterne Agee

And then just to go back to the deployment of capital, or extension of deployment of capital, and the 430 or so percent RBC (ph), I assume there’s little or relatively little cash of the holding company, so all of your excess capital’s sitting in the insurance entities, right?

John Johns

That’s correct.

John Nadel – Sterne Agee

And are you still thinking about a $500 million, thereabout, as deployable capital and what would that do in terms of, where would that take the risk based capital ratio down to?

John Johns

The $500 million and the way we back into that number, is if you assumed that the requirement for us on stable life business was 350% RBC? With an RBC ratio of 431 that translates into a differential between the two of $500 million.

John Nadel – Sterne Agee

Okay, so this is not a levering-off on top of that. So this is just the capital.

Rich Bielen

Having one other thing to consider, we don’t talk about very much. But we still have secure cashable (ph) term reserves that are building. There’s no real excess chance for us to go lease that capital now because we’ve incurred expense and we have excess liquidity and we have excess capital. But there’s a bit more there to have the right opportunity down the road.

Operator

Your next question comes from the line of Ed Cia, Bank of America.

Ed Cia – Bank of America

I have a few questions. I guess, first, on the VA hedging program, could you tell us what would happen to annuity earnings if you hedge the entire block including volatility, just roughly?

Rich Bielen

Ed, when we looked at hedging the entire block including volatility and paying for that, if our estimates are riding our pricing, our current pricing can cover all of the requirements to maintain our current level of earnings. The fees we collect from the policy holders, given the mix of our business, we believe can cover the expenses hedging this program on a normalized basis.

Ed Cia – Bank of America

I guess, Rich, the question would be, how would there not be an earnings in path for – - if we look at your run rate earnings that you’ve give us, how could there – - the thing to me, there would have to be some sort of earnings impact on the in force (ph) book if you went out and paid money to hedge all the volatility related to that book.

Rich Bielen

The offset to this is actually sitting in the GMWB liability that we have on the book. So even though we’ve been collecting premiums prior to hedging, we’re also been building a liability on the other side offsetting that. That’s why when I broke down the basis in the second quarter, about 10% of the GMWB liability related to the, basically, the growth of the business.

Ed Cia – Bank of America

How do we think about, sort of, the risk of the earnings risk in this business still going forward if right now it doesn’t seem like the plan is to hedge volatility so is this – - how much of that unusual item in the quarter related to the VA mark which you consider to be economic. Is it the 16% you suggested or is it some higher percentage?

Rich Bielen

We think that real economic risk is the equity component which is the 16%. The interest rate is the discounting of those claims and the volatility is buried in that other number, but it really is a very small number in terms of what that impact is because long term vol went up a little bit but it didn’t have that material at one time

John Johns

It’s probably two, three stance of vol in the charge, let (ph) a fair value charge that we took and we’re positioned now. I mean using the future’s approach for the moment, we’re protecting our downside by giving up some upside earnings, it just caused back and up interest environment or enough equity market. So it’s really not a current earnings issue, swing-by options. In the future, we’ll pay something for the option and we’ll capitalize some of that and start to expense it as the option decays but we don’t think that it’s going to be immaterial. I’m thinking, since (inaudible) kind of swing, maybe would be the range of cost if we were fully-hedged using a different program that require amortization and the cost of the gratuities that we’ve purchased. I mean that kind of order of magnitude in terms of (inaudible).

Ed Cia – Bank of America

Are you saying it would be in the neighborhood of $0.10 a share annually if you had to fully hedge all tallies (ph), is that what you’re saying?

John Johns

Everything. Maybe these options (ph) instead of futures since you’re protecting your downside like giving up some of your upside appreciation as the stock market goes way up. So it’s not an earnings call so that currently there would be some opportunity cost if the stock market were to go way up.

Ed Cia – Bank of America

Just one last – - I don’t know if this is an easy answer, I just suspect it’s not, but just going back to the idea that the overall earnings growth rate is 8% to 10% annually without an acquisition, it’s difficult from the outside looking in to understand that if we have a third of the earnings that are running off at a mid single-digit percentage. I mean it does imply a very high rated growth I think relative to the industry for the other 2/3 of the company. So can you just help us a little bit with that?

Rich Bielen

I think that we can take this off as long as we go back to what we presented at the investor conference in March. Now based on where we currently are and that we worked through a lot of, what I’d call, the legacy issues around securitization in life marketing. We think life marketing increased (ph) low double digits going forward at our current sales haste. We thing annuities, overall, with our current increase in balance grows also with double digits. We think asset protection grows at double digits. We also know we’ll be building capital in surplus. And in acquisitions, this year we’re going to be held down a little bit because of this conversion that we’re doing and are hoping that next year, we’ll offset that with some expenses and really hold earnings there in 2011 about flat in acquisition?

John Johns

Yes. It’s very possible that next year, we won’t see run off in the earnings because the benefit from this insourcing project will just about incur (ph) normal policy lapsation effect.

Operator

Your next question comes from the line of Tom Gallagher, Credit Suisse.

Tom Gallagher – Credit Suisse

First, just a quick follow up, Johnny, on that last point you made. So the insourcing deal which phase do you expect that to give you back maybe the normal 5% to 6% run off that you would expect to see in the acquisition segment. Is that the right way to think about it?

John Johns

Yes. You’re close. I mean, I can’t tell you it’s exactly that but it would certainly mitigate that if we give cost saves (ph) that we expect.

Tom Gallagher – Credit Suisse

Do you expect that to use up any capital or is that really a sort of a back-office utilization initiative going on?

John Johns

It’s back office. We’re basically paying for it as we go. I think we’ve built in to our forecast for the year that will take us – - expense in the fourth quarter that’s built in to our –

Rich Bielen

$7 million or so of expense.

John Johns

Close fourth quarter IM (ph) is the termination pay before making known the – –

Rich Bielen

Yes. (Inaudible) group is doing it now. We have to make a termination payment under our contract then we’ll get out of it. So that’s about $7 million but the benefit of it next year will start to come back quickly.

Tom Gallagher – Credit Suisse

Okay. And then just a question on RBC. I noticed that credit losses looked pretty low, yet RBC went down a little bit just sequentially. Can you comment on what’s going on there? What drove that?

John Johns

Yes, Tom, it’s really the impact on Golden Gate III securitization and the accounting there. We infused down equity into that new subsidiary and weigh such for accounting works that is effectively non-admitted. And so when we went through our numbers, we actually – we knew were going to see a little bit con in our RBC, in fact, we actually did better than we thought. We thought we’re going to end the quarter at about 425 or so, it turned out to be a little better than we thought as part of our plan.

Rich Bielen

Again just to elaborate on that a bit, the way our securitization works is it cost should capital of – the capital we have to put down in our sub, as Rich said, is not immediate but over time as you cover the build up and we’re done at reserve. Reserve can more than get back – the benefit back up over time.

Tom Gallagher – Credit Suisse

So, Rich, is the right way to think about that so I presume that’s AXXX or XXX. But is it – I presume the securitization has sort of blunted the statutory strain to some extent. But is there – should we think about this thing? There’s still a little bit of a drag in the early years and then you get that back in the later years? Or how should we be thinking about that?

John Johns

The securitizations we have now, Don, is taking care of term business from ‘07 and prior. So really our ‘05 through ‘07 vintage, that’s all done. It’s funded beyond the key, either through this new facility we did or our old facility. We do have the term business starting in ‘08 that is still on the books. That is blunting our statutory growth and majority referenced before that that is building on the books. At the end of the year we think that, from the term side alone, that’s roughly $250 million, we know that will continue to grow. We currently don’t have any intention of securitizing it, unless we know where the capital is going to, at least as reserves.

Rich Bielen

We are planning all are in. Just some self-funding that, which we think we can comfortably do and maintain very robust RBC ratios.

John Johns

It is sort of contingent capital, if you will. It’s there. We were to get a big acquisition or something and our place to put it.

Tom Gallagher – Credit Suisse

Got it. And then last question. Rich, can you comment at all about sort of what you’re seeing now and outlooks for prepayment income and how you expect that to affect investment income overall and redeployment?

Rich Bielen

our forecast don’t have any prepayment income in the – we are assuming. We did see some in the second quarter and it offset the trading loss. But we’re not expecting any going forward, and that would be pleasant surprise for us if we see that come true.

Rich Bielen

Thank you.

Operator

Thank you. And our next question comes from the line of Darin Arita, Deutsche Bank.

Darin Arita – Deutsche Bank

Hi. Good morning. Just going back to the comments on the life marketing low double-digit growth rate. Is that – the one year growth rate for 2011 for the tick up on the Golden Gate restructuring? Or is that really your expected long-term growth rate?

Rich Bielen

That earnings is really our – when we, Darin, talked back in March we don’t see anything different at this point. We look through the earnings forecast in terms of – we have the sources of earnings for light marketing and what we saw for the next couple of years was double-digit earnings growth off of the plan of 2010, which had now factored in all of the securitization and activity that we have gone through. So we have that all in our plan when we met in March.

John Johns

One thing though, I guess, is a bit of that is also investment income on the bill off of reserves. So to the extent we were to have a big acquisition and we securitized some of those reserves and that would dampen the growth rate there but it would be picked up in more than all set by growth in the acquisition plan.

Darin Arita – Deutsche Bank

Okay, got it. That makes sense. And turning to the variable- annuity line, you talked about the clause on hedging. But I was just wondering about the cost on the side of hedging and around risk management and systems, where are we there in investing? And how much more needs to be invested?

John Johns

We’re pretty much fully stacked up now. And still pretty well built out the same and we are investing some money in technology but it’s not going to be material to our results.

Darin Arita – Deutsche Bank

Okay. And all of these are being done in-house now? Or are we still using third party around us? Because I imagined that the cost are quite significant to run a hedge program.

John Johns

I think most companies now are using some services in one of those large actuarial consulting firms that help us run some of the metrics around the product. I think that’s pretty standard now along many riders. But in terms of the real hedging work itself, Ed has a staff of people that he has brought on board and we’re doing that, and again it’s in the numbers you’re seeing. We’re seeing it facts out.

Operator

Thank you. Your next question comes from the line of Andrew Kligerman, UBS.

Andrew Kligerman – UBS

Hi. Good morning. Two questions. First, on the acquisition. Johnny, you indicated some optimism but the team has been somewhat optimistic since Investor Day back in March. So, I guess, I’m just kind of wondering what you’re seeing out there that gives you continued optimism and why we may not have seen a transaction of the past few months. And I have a follow-up.

John Johns

Good question, Andrew. I think back in the early part of the year, our optimism was really built around a view that we should start to see some transactions because the conditions in the industry were conducive that that is to say we see a lot of underperforming companies in books of business. We see a lot of small subsidiaries of large companies were not at good strategic fit. So we thought the stage was set. The difference between then and now is we’re actually working on transactions like that. We’re seeing things. So whether or not we’ll get one, we’ll never know. There’s always an option process and the little better typically wins. But we’re done from being hopeful to actually busy in terms of same things, so that’s the status.

Andrew Kligerman – UBS

That’s great. And then Rich mentioned loss on hedging to protect interest rates against higher interest rates and it cost you $6.4 million. I’m wondering if you do any hedging around interest rate forms to protect your portfolio against the low interest rate environment. Could you give a little color on that? And then second, if rates do remain low with the 10-year treasury, where it is today, it’s around three, what would you expect the impact on earnings over the next two to three years would be?

John Johns

Rich, why don’t you answer the second question first.

Rich Bielen

Yes, Andrew, one of the reasons I want to make the point during the comment is we are very well matched in our blocks of business. And so when we look, we reviewed in our acquisitions business, we run the duration of those assets up in the eight, nine year range, so they’re very long. There’s not a lot of reimbursement there and we have ran off of that block. In our businesses, we’re running our universal life business currently, but then as a duration of north of 10. So we do have some reserve growth to deal with but we don’t have a lot of reimbursement with over the next couple of years on that block. And we actually already had mentally factored in declining yields in terms of future yield projections on that block at this point. We also looked and we still have, somewhere probably on our own block, somewhere between 50 to 100 basis points of room in terms of credited rate strategy. So we think overall, we can manage it within a package where we won’t see a lot of impact.

John Johns

Certainly over the timeframe that you suggest and in consistent operation that Rich has mentioned. And as we think about how we do our debt calculations, our expectation within those calculations is actually, on that migration down on interest rates, we’re not assuming an urge to some higher mean, some higher level. We’re actually planning for kind of a downward slope. I think we’re in pretty good shape for that timeframe. We discussed with respect to interest rates. Ed, you want to address the macro-hedge issue?

Ed Berko

Sure. Andrew, just to answer your question, what we did is we put on a hedge to protect against the 100 basis point interest rate drop. So in Q2…

John Johns

On the VA.

Ed Berko

On the VA, right, for the FAST 157.

Andrew Kligerman – UBS

Okay, that’s the deal.

Ed Berko

So what happened in Q2 was interest rate, they were low. We didn’t think they can go much lower but they actually dropped 80 basis points. And as Rich mentioned, that was about 46% in the increase in MWB (ph). We hedged that, and as both Johnny and Rich had mentioned, we have not used any options in the hedging strategy. We designed an option-based hedging strategy and about the time we’re ready to start executing and legging into it, the Greece crisis were outdated and involved spying for both equity markets and fixed income. So it’s starting to trend down and as ball floating comes lower to more historic levels, we’re going to start adjusting the hedge to being options-based.

Andrew Kligerman – UBS

That makes perfect sense.

Ed Berko

Okay.

Operator

Thank you. Your next question comes from the line of Ian Gutterman from Adage Capital.

John Johns

Hello, Ian.

Ian Gutterman – Adage Capital

Hi, Johnny. How are you? I just have a follow-up on the excess liquidity. Rich, you mentioned that the delay in investing is, sounds like a lack of acceptable investment opportunities. Can you just clarify what do you mean by that? What are you looking for? And what are the chances at the end of Q3 your still unhappy with the alternatives or are we still sitting on the 500 million?

John Johns

We’re going to throw your question to Carl Thigpen, our Chief Investment Officer.

Carl Thigpen

Good morning. When the Greek crisis hit and all the uncertainties with the euro, the corporate issue at the market, which is primarily what we play in, is the high-grade corporate issue into market. Because as you know, the structured market is pretty much shutdown with no prime RNBS issuance and with the agency spreads being so tight, we’re primarily buying high-grade corporate. And so in the second quarter as that market dried up, we continued to have sales and maturities until the cash build up during that time. The market has opened back up now, as earning seasons currently on the way and we are starting to see another good flow of high-grade corporate. So we do expect to put money to work pretty rapidly.

Ian Gutterman – Adage Capital

Okay. Great.

John Johns

And our goal is to be fully invested here, certainly by the end of this quarter.

Ian Gutterman – Adage Capital

Okay. Great. And just one more on the VA side. You mentioned it was about 2/3 your products that have roll-ups or in the most conservative option. Can you just describe what that option is?

Carl Thigpen

The roll-up feature there is a 5% roll-up.

Ian Gutterman – Adage Capital

Okay. And what else is on that product as far as particularly looking down? Or is there anything else?

Carl Thigpen

In the base product it would have a debt benefit or return of premium debt benefit. And then for an extra fee, you can get a ratchet debt benefit. Those are basic kind of fits.

Ian Gutterman – Adage Capital

And as occasional restrictions on that?

Carl Thigpen

Yes, not more than 65% in equity, 35% in fixed income.

Ian Gutterman – Adage Capital

Great. That’s all I have, thank you.

John Johns

Okay, thanks. I think we’ve reached the end of the hour and many of you are leaving the call to go to another call. So why don’t we just wrap it up there, as always, if you have detailed questions or some other issues, we’re happy to address those offline.

Once again, we thought it was a pretty solid quarter. We are pleased with it, and we’re going to go to work and try to do the same for the rest of the year. And thank you all for participating in our call.

Operator

Thank you for your participation in today’s call. This concludes the presentation and you may now disconnect. Have a great day.

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Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

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Source: Protective Life Corporation Q2 2010 Earnings Call Transcript
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