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Reinsurance Group of America, Inc. (NYSE:RGA)

Q3 2010 Results Earnings Conference Call

October 26, 2010 9 AM ET

Executives

Jack Lay – Senior EVP and CFO

Greig Woodring – President and CEO

Analysts

Jimmy Bowler – JP Morgan

Andrew Kligerman – UBS

Steven Schwartz – Raymond James and Associates

Jeff Schuman – KBW Investment Bank

Nigel Dally – Morgan Stanley

John Nadel – Sterne Agee

Alec Ofsevit – Credit Suisse

Sean Dargan – Wells Fargo Securities

Eric Berg – Barclays Capital

Mark Finkelstein – Macquarie

Operator

Good day ladies and gentlemen and welcome to the Reinsurance Group of America’s third quarter conference call. Today’s call is being recorded, and at this time I would like to introduce the President and Chief Executive Officer Mr. Greig Woodring and Senior Executive Vice President and Chief Financial Officer Mr. Jack Lay. Please go ahead.

Jack Lay

Okay, thank you and good morning. Welcome to everyone to RGA’s third quarter 2010 conference call. Greig Woodring, the CEO, will briefly comment on the results we released late yesterday and then we’ll respond to questions from our participants. I’ll turn the call over to Greg following a quick reminder about forward-looking information and non-GAAP financial measures.

We will make certain statements and discuss certain subjects during the call that will contain forward-looking information including among other things, investment performance, statements relating to projections of revenue or earnings, and future financial performance and growth potential of RGA and its subsidiaries.

You are cautioned that actual results could differ materially from the expected results. A list of important factors that could cause actual results to differ materially from expected results is included in the earnings release issued yesterday.

In addition, during the course of the call, we’ll make comments about our results based upon operating income both on a pretax and after-tax basis. Under SEC regulations, operating income is considered a non-GAAP financial measure. We believe this measure better reflects the ongoing profitability and underlying trends of our business. Please refer to the tables in our press release for more information on this measure and reconciliations of operating income to net income for our various business segments.

With that, I’ll turn the call over to Greig.

Greig Woodring

Good morning, thank you for joining us. I will provide some brief comments on the third quarter results and then we’ll open the line for your questions. Strong third quarter operating income totaled $128 million or $1.72 per diluted share. Last year’s third quarter was also strong with $115 million of operating income or $1.56. Consolidated net income also totaled $128 million or $1.72 per share this quarter compared with the $118 million or $1.61 per share last year.

Consolidated net premiums including $81 million from the Group Reinsurance business totaled $1.6 billion during the quarter, an increase of 16% on an original currency basis and 17% on a U.S. dollar basis over third quarter 2009.

For the first nine months, net premiums increased to $4.9 billion or 18% on a reported basis, 14% on an original currency basis compared with last year. Net investment income totaled $288 million this period with an average yield on the portfolio of 5.66%. This yield was slightly higher than our second quarter 2010 yield of 5.51% due to a higher level of income on our small limited partnership portfolio which can be a little inconsistent on a quarterly basis.

Looking ahead to 2011, we expect continued downward pressure on our overall portfolio yield. For example, if free investment rates hover around 4% and remain there throughout 2011, we would expect to see an adverse effect of $0.20 to $0.25 per share next year compared with 2010.

Impairment losses including mortgage loan evaluation allowances reflected in income were less than $10 million for the quarter. Our net unrealized gain position rose to $833 million benefiting our book value per share, which is up 29% since year end to $68.30 including ALCI.

Third quarter interest expense was significantly higher than we’ve seen in third quarters past as we typically settle a previous year’s uncertain tax position related to FIN 48 and reserve any applicable interest accrual. Since we extended the prior tax year that would have typically been settled in the third quarter, we’ve not yet reversed any applicable interest accrual on any related uncertain tax positions. The effect was roughly $11 million of additional net interest expense which we would expect to roll off at a future period.

The active financing with exceptional legislation was not extended this quarter as well, so we added another $5 million to our tax position which had an adverse effect of $0.07 per share. As Congress passes an extender package this year, we will reverse the position which currently totals about $15 million year to date.

On a consolidated basis, foreign currency fluctuations added $0.02 per share this quarter compared to third quarter ’09.

Now turning to segment results, our U.S. traditional business including the Group Reinsurance business reported pretax operating income of $101 million compared to $85 million in the third quarter of 2009. Premiums were up 16% for the quarter including the Group Reinsurance business and 6% without it. The Group Business posted another better than expected earnings result. Mortality experience fell in line with expectations this quarter. The U.S. marketplace continues to be a little more competitive than a couple of years ago, but it still presents a generally favorable operating environment.

Our U.S. asset intensive business reported another strong quarter overall with $14 million of pretax operating income, down from an unusually strong $20 million in the third quarter of ’09. We expect to earn about $15 million per quarter from our asset intensive operations.

Turning to Canada, it was another good quarter which yielded pretax operating income of $28 million, up from $22 million a year ago. This increase reflects better than expected claims experience in the current quarter, while last year’s experience was more or less in line with expectations. Premiums were up significantly this quarter, increasing to $206 million from $153 million last year. The increase was primarily due to a longevity risk transaction which contributed about $55 million of total premium including a one-time advance premium of $43 million where which we established a reserve. Foreign currency fluctuations added another $10 million to premiums for the quarter.

Regarding our international operations, Asia Pacific posted pretax operating income of $27 million compared to $28 million in the prior year period. Both periods reflected better than expected claims experience. Original currency net premiums were up 6% for the quarter and translated premiums were up 13%, totaling $274 million including roughly $18 million from favorable foreign currency fluctuations. Our operations in Australia, Japan, and Taiwan primarily contributed to the premium growth this quarter. Europe and South Africa reported pretax operating income of $16 million for the current quarter, up nicely from $7 million a year ago when the U.K. and South Africa experienced higher claim levels. This quarter, the U.K. posted strong top and bottom line results. Original currency net premiums rose 20% for the quarter. On a U.S. dollar basis, premiums were up 14% to $233 million. Foreign currency fluctuation adversely affected premiums by $12 million in the quarter.

In summary, we are pleased with another solid quarter which produced an annualized operating return on equity of 13% in spite of the challenging interest rate environment. We remain encouraged by our international and domestic operations which both again performed well and we’re excited about our growth opportunities across all markets.

Our group reinsurance continues to perform well. Our investment portfolio and capital position continue to improve.

The quarter was particularly strong from an operating standpoint when considering non-cash tax related expenses, reduced earnings per share by roughly $0.18 when compared to the prior year’s third quarter. Those tax related expenses were associated with the active financing exception in FIN 48 issues I mentioned earlier.

While we do expect to drag on investment income in the near to medium term associated with historically low new money yields, our business model does not rely heavily on investment income rather our results are primarily driven by our ability to effectively price mortality and morbidity risks; risks upon which we built solid track record of success. We continue to review block opportunities; however the timing and whether or not, we will be successful is difficult to predict.

Earlier this month, we announced an organizational restructuring which we believe will result and improve strategic alignment with our client’s needs across the globe. We will continue to review financial results and allocate capital on the same geographic basis that serves at the basis for our external segment reporting. And therefore, we do not anticipate making changes to our reporting at this time. If in the future, if change in segment reporting is necessary, we will provide prior period restated figures.

Finally, we’re looking forward to seeing investors at RGA’s first ever investor day conference to be held February 17, 2011 in New York City.

With that, let me say, we appreciate your support and interest in RGA and we’ll now take any questions you may have.

Question-and-Answer Session

Operator

(Operator Instructions) We’ll take our first question from Jimmy Bowler from JP Morgan.

Jimmy Bowler – JP Morgan

Hi, good morning. I had a couple of questions. The first one is just on trends in the U.S. market. You mentioned that competition had picked up a little bit. But maybe if you could talk about outlook for topline growth. It seems like session rates are continuing to drift lower in the U.S. And then, the second was just elaborate on your comments on low interest rates. Just wanted to see if rates do remain around where they are right now. Would you at some point begin to raise prices to reflect that or would you have to take a hit on your margins especially on new business?

Greig Woodring

Jim, the session rates in the U.S. do continue to drift downward. This is particularly true in some segments of the US market and what we have found is that our flow of new business is gradually drifting a little bit downward. We continue to – over the last couple years, of course, increase our market share just a bit. That has made up for a lot of it. We do expect that though the amount of business in the marketplace will continue to drift down for conventional mortality risk business. Not in any major way, there’s not a lot of new products coming out; so the old products and the old relationships continue to provide the bulk of the flow and that’s something that is favorable when you have a large market share to see, not much turnover in the existing arrangements that are out there.

With regards to your second question, yes, obviously, over time, if interest rates stay down, we will reflect that. You would be surprised at how little impact a slight change in interest rates has on through mortality risk pricing though. And remember, we’re pricing over a longer term, so what is the average interest rate yield we’re going to see over say the next 10 years is the more important question to ask, not what are the current rates of two-year treasuries or 10-year treasuries. So obviously, it will have an effect at some point in time then, when appropriate, we will raise rates.

Jimmy Bowler – JP Morgan

And then, just one more on your premium growth in Europe, you’ve had 20% growth roughly the last couple of quarters ex-currency. Just on what’s driving that?

Greig Woodring

We are first of all, seeing good growth through Continental Europe where we have not had a strong base in the past since we’re growing from a low base and the percentage growth rates are quite high. We’ve also had pretty good results in terms of growth in the UK; some of that coming from longevity business but a lot coming from mortality business as well. So it’s really coming across the board in the established markets of the UK and in the developing, for us, new markets I should say of Continental Europe.

Operator

Then, we’ll take our next question from Andrew Kligerman from UBS.

Andrew Kligerman – UBS

I have few questions. First Greig, you mentioned you’re taking some market share in the U.S. despite the lower sessions. So you had a good U.S. number up to 6% in the quarter net premium. Looking forward, do you think you could sustain, made upper a single digit premium growth in the United States?

Greig Woodring

Yes. When I said we’ve been taking market share, that’s over the last couple of years. Whether we’re actually, currently taking market share, I don’t know. We’ll see when we get results from the market out next year exactly how the year all settle down because the U.S. is a pretty big market and a big space, it’s not always clear exactly. We can guess exactly how we’re doing but we really can’t tell with some precision until we get the roll-up of results.

Andrew Kligerman – UBS

So, do you think that the growth can be upper single digit going forward or is it going to be a little tough?

Greig Woodring

I think it will be say over 5% but I don’t think we’re going to be at 9%.

Andrew Kligerman – UBS

Got it. And then, following up on Jimmy’s pricing questions, I think I recall last quarter, you mentioned that the ’97 to ’03 block of business, the pricing was a bit more competitive and hence the results are not coming through as well as say some of the later years. And now, let me couple out with some comments you just made on this call where it appears that pricing is getting a little more competitive. Greig, maybe you can give a little color on just where pricing is relative to a few years it go and relative to that ’97 to ’03 vintage or vintages.

Greig Woodring

Well, certainly. Pricing is a little more competitive as I said. There is not a lot of new pricing going on. Most of the business is continuing to come in at old rates. There’s not a lot of new product introduction into the market in other words. But even where there is new product, we have one nice share of several of the frees [ph] that have come out with what we consider good margins, appropriate margins. This is a lot, a lot better environment than it was around the turn of the decade.

Andrew Kligerman – UBS

Perfect. And then, lastly, you mentioned M&A that you continue to review blocks but the timing and success are hard to predict. But are you real active right now, Greig? Are you seeing a lot or is it kind of quiet in terms of what you’re looking at?

Greig Woodring

It’s reasonably active, Andrew. There are a couple of very large opportunities. So you have to sort of juggle mentally how likely they are to happen with the size and so forth. But I’d say it’s a pretty good environment right now and our sense is that it’s going to get better and we’re out on a limb saying that a little bit because we’ve been saying that there’s a lot of opportunities for a while and there have been. But, we have achieved pretty good growth rate over this time and while some of the opportunities that we have closed tend to be on the small side, we keep expecting this sooner or later. We’re going to see something a little bit more meaningful happen.

Operator

We’ll take a question from Steven Schwartz from Raymond James and Associates.

Steven Schwartz – Raymond James and Associates

Hey, good morning guys. I got a couple but I’ll just ask some few and get back in line. On the subject of U.S. business, if I take a look at the assumed business for the quarter, the assumed business went up into the, call at the $45 billion [ph] range in the third quarter or fourth quarter and you kind of let us tell that was going to happen that people are looking for capital and you saw your normal flow business hang up. It came down again into $30 million range for this quarter. Is there something there? Were there one-year treaties that ran off or something like that as the industry has gotten better capitalized again?

Greig Woodring

Steve, we did see some treaties that had changed and so forth. But I’d caution you to – that there's a lot of reporting noise in the quarterly numbers especially as it reflects new business which tends to come in lumpy. You might get two or three months’ worth of business from any company at a time, and so there’s a little bit of lumpiness to that. So I wouldn’t read too much into that but it’s true that our pipeline of expected annual flow of business is down a bit right now compared to what it was, say, at the first quarter.

Steven Schwartz – Raymond James & Associates

Okay. And then if I can follow up on that before, perhaps a second – Greig, you mentioned that there wasn’t a whole lot of new product. There is this UL term hybrid out there that seems to be gaining a lot of traction. Does that maybe affect your business going forward?

Greig Woodring

Well, it certainly the design is intended to eliminate the need for triple X financing. But frankly, in the reinsurance world, reinsurers have not done a lot of triple X financing in recent years; anyway, they’ve done a little bit of it, at least we haven’t. And we get a small amount, just incidentally, but we don’t really pick up large treaties with on a co-insurance basis with a lot of triple X heavy lifting there. And so that doesn’t change our business too much. And if everybody switched over to it, I don’t know that would change RGA’s operations very much at all.

Steven Schwartz – Raymond James & Associates

Okay, great. And then Jack, can we go over the interest expense thing again? I am not getting it. Generally speaking, there was a reversal that happened in the third quarter. By the way, I thought part of that happened in the first quarter of this year so that the effect would have been less in the third quarter but it still would have been there. But is this – whatever, I don’t what year you were trying to settle, but was this settled, and you didn’t get anything back, was it not settled in that year, maybe settled next year and maybe two years to get settled next year? What’s going on there?

Jack Lay

Yes, Steven. It’s the latter point that you just mentioned. Historically like clockwork, we’ve settled a year every year, and typically that’s in the third quarter. It didn’t happen this year because the year that would have settled has been extended. So presuming that it settles in the way that I guess we would expect it to, and the way that historically they have settled, then we’ll have certain tax positions that will ameliorate, and as a result, we would reverse some interest expense associated with those tax positions.

Steven Schwartz – Raymond James & Associates

Okay. So there’s a potential double-whammy coming sometime down the pipe?

Jack Lay

Yes, you could look at it that way because likely, we’ll end up with – back on a cycle of one year settling per year, so that the implication there is that two years will settle at some point.

Steven Schwartz – Raymond James & Associates

Okay. And what year was it that was not settled this time around?

Jack Lay

It will be 2006.

Operator

The next question comes from Jeff Schuman from KBW Investment Bank.

Jeff Schuman – KBW Investment Bank

Good morning. I was hoping we could talk a little bit more about your gains with relation to flat fed interest rate. The $0.20 to $0.25 was a bit more than I expected, I guess. Given in part what you said Greig about the fact that the pure mortality business isn’t terribly sensitive to investment income, can you – any decompose sort of the sources of the $0.20 to $0.25? In other words, to what extent does that represent sort of compression on existing business versus marginally about profitable new business versus maybe sort of less investment income on surplus or excess cash. Can you source that out for us a little bit?

Jack Lay

Yes, Jeff. This is Jack. I think you all look at it as every year we have a considerable amount of free cash flow, and that’s either from operations or that’s from portions of the investment portfolio turning over. We try to project that in a way to try to determine what’s the impact of higher or lower, and in this case, lower new money rates that – yes, it’s hard to predict but we just kind of took a crack at if new money rates stay essentially where they are right now when we turn over the investment portfolio in a way that we typically do. In other words have the typical pro rata amount of that portfolio turnover. So we’re reinvesting in terms of new money rates and project what kind of operating cash flows (inaudible) that would be invested in new money rates, what would be the impact overall on operating income, and as a result, operating EPS.

It’s imprecise but that’s our best estimate in terms of how bad exercise plays out and what the impact would be in 2011.

Greig Woodring

And we wanted to do that analysis and share it because it’s such a hot topic. The other one, of course, is what happens to U.S. dollar and that can swing just about as much. Your guess is as good as ours to where it’s going but the trends are for a weaker dollar at the current moment clearly.

Jeff Schuman – KBW Investment Bank

So I guess it sounds like you’re not really fully-immunized on your existing business but you will take some margin compression on the existing business and then potentially layer in new business at somewhat compressed margin. Is that kind of the way to think about it, Jack?

Jack Lay

Yes, I mean considering our business is very long term and the duration on our investment portfolio doesn’t match that, and nor should it just because it throws up positive cash flow every year.

Jeff Schuman – KBW Investment Bank

Okay. And then in Canada, the credit business continues to kind of wind down, I guess it looks like, should reach (inaudible) if that continues to wind down, or does that flatten out or reverse at some point at. How should we think about that?

Greig Woodring

The creditor business that we’re doing in Canada?

Jeff Schuman – KBW Investment Bank

Yes.

Greig Woodring

Yes, that’s been a source of growth for the last couple of years on our premium book in Canada. This year it’s actually flat, if not down a percent or two. And so you could say we’ve kind of topped out on that business, but it’s not going to reverse, it’s a business that we would like to see at least stay at this level.

Jeff Schuman – KBW Investment Bank

Okay. Yes, I guess the trend look more dramatic in there. I mean I think the third quarter comparing it with a year ago was $18 million versus $39 million. The recent sequential trend has been 76, 34, 17. So it kind of looks like it’s dropping out pretty fast.

Greig Woodring

Yes. I think we’re down a percent or so for the year-to-date though in the premiums.

Jeff Schuman – KBW Investment Bank

Okay. And that’s sort of how we should think about it as being relatively stable from here?

Jack Lay

Yes. That’s what we’d hope.

Jeff Schuman – KBW Investment Bank

Okay. And then, lastly, you might have addressed this but I think (inaudible). The longevity business in Canada, was that something related to a DD-type [ph] pension plan or what’s the source of that and is there more of that stuff out there?

Jack Lay

There is more of that out there. It was a transaction with another insurance company, a client company, where we swapped payments. We swapped actual for expected payments.

Jeff Schuman – KBW Investment Bank

But the underlying business is what group pension-type business or what is the –?

Jack Lay

Yes.

Operator

And we’ll take our next question from Nigel Dally from Morgan Stanley.

Nigel Dally – Morgan Stanley

First I guess a follow-up on interest rates. Do you have an estimate of the total amount of cash flow you expect to have for investment in 2011? And then second, wanted to focus on capital management, number of components. First, what’s your estimate of capital ratio in the quarter, the excess liquidity (inaudible), and the total excess capital? Second with acquisitions, can you discuss where the trans-market rate remains property of interest? And third, if acquisition opportunity as time present themselves or the buyback is the most likely alternative as we look for 2011. If so, how much do you see as being free for buyback? I’m assuming you wouldn’t want to use all your excess capital.

Jack Lay

Nigel, this is Jack. Let me take that first one. I don’t have the analysis in front of me here in terms of free cash flow but if you look at – cash flow generates from operations, it’s typically between $0.5 billion and $1 billion annually. So we’ve got that as well as the typical roll off of the portfolio which – not just going up top of my head, that’ at least $2 billion there. So, it’s not insignificant in terms of the amount of free cash flow that we would have to invest throughout the year next year.

Nigel Dally – Morgan Stanley

Okay. And then on the capital management?

Jack Lay

I’m sorry. Was the question on what is the projected RBC ratio or –?

Nigel Dally – Morgan Stanley

Yes, the overall (inaudible) capital ratio and your total estimate of excess capital (inaudible) and buybacks?

Jack Lay

The RBC ratio, that gets to be a little difficult in terms of, it applies solely to the U.S. operating subs. So when we take a look at excess capital, which we estimate to be $500 million to $600 million currently, that just simply presumes that we’ll maintain an RBC ratio $330 million to $340 million, if that’s helpful.

Greig Woodring

In terms of Trans-America, we really can’t say whether we’re involved or not, but that’s a process that our understanding is still in the middle, not towards the end.

In terms of buybacks for next year, we at this point continue to remain very positive about the opportunities we have to deploy capital, but we will at some point think about how best to manage our capital if some of those don’t materialize. We would, as you say, not use a buyback strategy for all of our excess capital but save some gunpowder. I’m not sure we’ve made a determination of what that would be at this point, Nigel.

Nigel Dally – Morgan Stanley

I guess that determination will probably be made more towards the end of the year, perhaps in your Investor Day next year?

Greig Woodring

Yes, end of the year, early next year, and again we will be gauging the relative attractiveness of doing that versus the growth opportunities we have. We’re still showing this year a double digit growth rate overall in our books, so that’s pretty good growth.

Nigel Dally – Morgan Stanley

That’s great. Thanks a lot!

Operator

And our next question comes from John Nadel from Sterne Agee.

John Nadel – Sterne Agee

Hi, good morning everyone. A question on the income statements, I guess in each of the segments. If I just calculate the benefits and claims or the benefits line as a ratio divided by premiums or net premiums, that’s how I would typically think about measuring mortality and on that level, the benefit ratio was up quarter over quarter in just about every segment. Now, the offset really seem to come through sort of lower dack in insurance expenses as a percentage of premium. So I guess my question is – this looked like a very atypical quarter because there seemed to be a lot of noise between those two lines. Can you give us a sense for what drove that? Should we really be looking at measuring mortality results more on a combination of those two line items? How should we think about modeling that? Because if I were just looking at those ratios without looking at the earnings or your commentary, I would have thought mortality was poor.

Jack Lay

Okay John, this is Jack. I’ve cautioned investors in the past that you really have to look at both of those lines, that is the policy acquisition cost line as well as the claims and change in reserve line, just because there’s a certain amount of interplay there. You can come up with kind of a little bit funny answer if you look at one and not the other. There’re other issues every quarter that affect that and maybe an example would be like the longevity deal that we put on in Canada where we will – because a lot of the premium is prepaid so to speak and not yet earned, we will reserve that, and as a result you end up with some implication on that loss rate that may give you somewhat of an erroneous conclusion simply because we’re trying to make sure that we don’t reflect that profit until we’ve actually earned it. So, that’s just one example, but there’s always examples like that in any of the lines so that’s why you really should look at kind of a total ratio to get a better feel.

John Nadel – Sterne Agee

Okay. I guess that’s helpful. I’ll follow up with you guys to think about that more in detail, sort of geography by geography, but that makes sense. If I look of it sort of on a combined basis, it clearly shows the trend was in the right direction quarter over quarter. Thinking about corporate results, despite the higher level of interest expense this quarter, your corporate pretax earnings was among the highest I can sort of remember. Should we be thinking about this as a reasonable run rate? Has there been some sort of change in capital allocated that drove that and how should we think about that?

Jack Lay

Yes, John, that’s always a difficult question to answer. Part of it is capital allocation, which can have some impact because if you can think of corporate as kind of a repository of all the capital and investment income and then it’s allocated based upon the economic capital needs of the various segments. So, it’s always hard to say what’s the actual run rate that you should presume in there, but I would offer that the current quarter run rate is not atypical in terms of what we expect going forward.

John Nadel – Sterne Agee

Okay. Is it fair to think about when quantify that sort of your view of excess capital as $500 million to $600 million, is that residing in corporate or is that still in some ways allocated amongst the other divisions?

Jack Lay

John, it’s both, but it’s predominantly accessible in corporate or at the holding company.

John Nadel – Sterne Agee

Okay. And in the last one, not necessarily – let me address it this way: the 13% ROE this quarter, you’re sitting on roughly $500 million to $600 million of excess capital, your quantification of it. So, if you guys were a little bit more right-sized on a capital level, it sure looks like the ROE is more like 14% to 15%. Understanding there’s some interest rate or new money yield pressure here. But I guess my question is, maybe to be a little bit more specific, how much longer do you sit on that kind of capital waiting for an opportunity to either get to the finish line or not? I just look upon your stock and I think about it relative to some others that I cover. Maybe not the VA companies or the larger multi-lines, but you think about it relative to some of the more underwriting driven earning streams and everybody’s buying back stocks, and buying back stock it would appear to be, over the long term, very attractive levels and you’re still sitting, you’re not. I guess I just ask for a little bit more specificity on your timing.

Jack Lay

John, this is Jack. That’s certainly a fair point and it’s obviously one that we deliberate upon here, that we have a continual discussion of. We recognize we don’t have a particularly efficient capital level now, but at the same time we’re weighing opportunities that are out there and we’re certainly looking at that. Your question is, at what point do we as a team throw up our hands and say, “You know, we’re better off returning some of this capital or in some way right-sizing the capital base.” We don’t have a day on that. I think we kind of answered previously that likely by the first quarter, we’ll have a better feel for opportunities to deploy that capital and it would be an ongoing deliberation. We recognize certainly and we recognize that it’s not the most efficient capital base now, but you always have to weigh that against ratings implications as well as opportunities in the market place and that’s what we do continually.

John Nadel – Sterne Agee

Yes, understood. It just seems to me you could pretty easily right now deploy that capital whether it’s into a deal or into buybacks or something else, I guess. You could pretty easily offset the new money yield drag to the extent that that would have continued through ’11.

Jack Lay

Yes, understood, absolutely. We certainly –

Operator

Our next question comes from Alec Ofsevit from Credit Suisse.

Alec Ofsevit – Credit Suisse

Hi, good morning. Just one question following up on the low interest rate issue, are you seeing any changes to lapse rates on your underlying policies due to lower rates because customers view the value of policies price 5 or 10 years ago much more highly?

Greig Woodring

No, Alec. We do a detailed lapse study once a year. We did it, concluded it in the summertime. I certainly didn’t hear anything like that. And in fact, a lot of our business comes from the mutual companies who are paying a pretty good interest rate on their dividend scale these days.

Alec Ofsevit – Credit Suisse

So, in your initial pricing, is there a lapse assumption that you have kind of across the board?

Greig Woodring

Yes, we have a set of lapse assumptions that would vary by a company, by a type of product, and by agent, by all sorts of different things so there’s a lot of lapse assumptions. Generally, we’ve been achieving what we need to achieve on the lapse side. It’s not been an issue or even a concern.

Operator

Our next question comes from Sean Dargan with Wells Fargo Securities.

Sean Dargan – Wells Fargo Securities

Good morning. I have a couple of questions about the upcoming Congressional elections and the possible impact on your business with a possible change of majority in at least one House. Just wondering what that means in terms of the active financing exception and also the estate tax.

Jack Lay

I’ll take the AFE question, and it’s an easy one to answer. We don’t really know. It’s very difficult to predict the extent to which Congress will find a reason to extend the AFE. We’re hopeful that it will happen in the fourth quarter but kind of changing dynamics in Congress, it’s kind of hard to determine what implication that has on something like an AFE extension.

Greig Woodring

There is the possibility that before the new Congress is installed in the lame duck session that matters are attended to that have been neglected all year and hopefully that we’re on that list. In terms of estate tax, when I talk to companies around the industry of the direct side, I don’t find too many that are really gearing up to do anything major on the state tax at this point. But certainly, it’s something that needs to be addressed one way or the other and if it’s addressed through inaction that is if it just reverts back to the 55% tax and higher deductible, at some point, the estate tax will generate large insurance sales which of course would be generally beneficial to us. But I don’t expect that to ramp up real quickly after the beginning of the year. I expect people to wait and see exactly what’s really going to happen and some of these estate planning efforts take many months to put together anyway. So, I would expect that it will be almost a year from now before you really can gauge what’s happened on life insurance sales from estate tax and certainly on reinsurance sales.

Operator

And we have a follow-up question from Steven Schwartz from Raymond James and Associates.

Steven Schwartz – Raymond James and Associates

Just a couple like I said. Jack, the spread fixed annuity, it looks like you came down a lot in the quarter. I expected it to come down but it came out a lot sequentially. I was wondering if you can comment on that.

Jack Lay

Yes, I guess, there are some impact of amortization there that would influence that spread. But we see that a little bit on the fixed annuities every quarter that there are some change up and down that sort of thing. But we would not expect the overall profitability of that business. We don’t see it changing dramatically.

Steven Schwartz – Raymond James and Associates

Okay. And then, if I may just as a follow-up on the corporate which I think John asked. Really, I thought looking at historical numbers, the outliner there that pushed that number up despite the interest expense was the interest income and I just want to make sure that that’s there’s nothing weird going on there, that’s just the capital allocation and that’s real earnings.

Jack Lay

Yes, it is. It is real earnings.

Operator

Our next question is from Eric Berg from Barclays Capital.

Eric Berg – Barclays Capital

Thanks very much. Good morning to everyone. I wanted to return first to the issue of excess capital. I believe you said that the operating cash flow of the business runs between a half billion and a billion and that turns into or maybe I misunderstood the discussion of excess cash flow, pardon me, yes, excess capital of the same amount. Is that coincidence that the operating cash flow and which are now calling your excess capital are both in the area of $500 million? Could you just clarify what the $500 million that you referenced earlier was and whether in fact that the excess cash flow is also $500 million – excess capital is also $500 million?

Jack Lay

Yes, Eric. Look at that as nothing but a coincidence. I mean, there are two pretty different issues. I think our earlier question related to with the impact on changing investment rates and I was trying to articulate just how much cash flow, don’t think of it as free cash flow of the holding company but just cash generated by our operations that we typically invest. So, they’re really two different things.

Eric Berg – Barclays Capital

Okay. Second, I was hoping we can build an earlier response regarding these longevity swaps. I understand that the underlying, I guess in response to Jeff’s question that the underlying liability is to find a benefit plan that the customer here is one of your ceding insurance companies and that you are swapping cash flows. But can you just explain a little bit more, what is the notional amount? What are the cash flows being swapped here? And you meant in actual to expected longevity. Could you just explain it a little bit more detail how this arrangement works? Thank you.

Greig Woodring

Think of it as the opposite of YRT [ph], a regular mortality business where we are collecting a premium for the expected death benefit and paying actual claims. This is the other way around. We are paying actual benefits for people who live and receiving expected payments the other way. So it’s almost like the inverse of YRT. And part of this is a risk management tool because we have so much mortality in our books. We have a pretty good situation to write some longevity risk which is – got basis risk in it but it’s still somewhat negatively correlated to our mortality business.

And under extreme scenarios of changes in that shocks either mortality or longevity will do really well in one and poorly in the other. But in most scenarios, we will expect to make money on both sides. And so, we have a limited appetite for longevity and most of what we had done so far has been in the UK. We were happy to pick up a nice transaction in Canada from a good client, a solid company and we will expect to look for a little bit more of this. But we do have a limited appetite on the longevity side.

Eric Berg – Barclays Capital

Last question relates to the earnings in Asia. I certainly paid attention when Jack was saying that results to vary from quarter to quarter and should not be focused on (inaudible) year-to-date results. But still, is there anything that I need to understand as to why, I believe it is the case that excluding the impact of currency earnings in Asia were down even though yes, they were down?

Greig Woodring

I think Eric, that only has to do with the fact that last year’s third quarter was extremely good.

Eric Berg – Barclays Capital

Was it?

Greig Woodring

Yes. It certainly wasn’t a disappointment region wide. As always, had some ups and downs. Australia didn’t have a particularly good quarter but New Zealand did for example. Most of the other countries had good results but if you look – if you aggregate it enough, you get to the region wide. We’re very happy with Asia results this quarter.

Eric Berg – Barclays Capital

And what’s the mortality experience? Is the idea here that it was unusually good than last year or just – or both this year and last year were good and this year was just not as favorably as last year?

Jack Lay

That’s it, yes. Yes, that’s it. Last year was extremely good.

Eric Berg – Barclays Capital

Thanks very much. I’m all set.

Operator

And we’ll take our question from Mark Finkelstein from Macquarie.

Mark Finkelstein – Macquarie

Hi, good morning. Question about U.S. mortality, I think it was in the first quarter. You talked about certain vintages of U.S. business that had slightly lower margin having a more prominent impact on earnings currently that was affecting the benefit ratio. And I guess my question is when does this start to subside? Is it at 2011 event or is it later?

Greig Woodring

Yes, Mark. We expected to start subsiding in 2011 but having said that, what that means is that it will be a marginally less impactful in 2011 and will wane in future years. Remember the lifetime on this business is 30 years, so this will continue to blend into the overall stream of results for a long time but the business is higher return before that era and higher return after that era. And it’s one of those waves that goes through our lifetime and we will see that affecting us for some time. But it will begin to wane by our reckoning next year. I don’t expect the basis.

Mark Finkelstein – Macquarie

Okay. Just going back to Nigel’s question actually, I think you sized the capital margin at $500 million to $600 million. I don’t know if you actually said how much of that you’d be willing to use on a block or an acquisition.

Jack Lay

Mark, this is Jack. The reality is we’d be willing to use all of it on an acquisition. I mean, if we see an attractive opportunity, we would use that and then, some if it was needed because the presumption is if the pricing is attractive, we can find other means including accessing the capital markets to take advantage of the opportunity.

Mark Finkelstein – Macquarie

Okay. And then, just finally, on the UK kind of pretty strong ex-currency growth; it had been a trend for the last couple of quarters. I guess, what drove the growth this particular quarter?

Greig Woodring

I think just overall business. I say a lot of it was longevity. We’ve done some longevity transactions in the U.K. over the last couple two or three years that had begun to wade into the premium accounts, but we’re getting growth on the mortality side too.

Operator

(Operator Instructions) We have another follow up question from Steven Schwartz from Raymond James and Associates.

Steven Schwartz – Raymond James and Associates

I’m sorry guys, but if I may, Asia, the outlook there as we know, not a whole lot going on, kind of a pause. We’re seeing premiums be flat. Greig you talked in the past at least that you thought new business was coming as new products were developed. I was wondering if your thoughts have changed there.

Greig Woodring

Yes, that pertains to Korea and especially in Japan to a little bit lesser to extent. I think we’re seeing good signs in both those markets that growth is turning around as we expected, especially in Japan. Korea, we are seeing smaller transactions than we had done before. I think it’s the smaller individual agreements begin to come online, so it does look like it’s starting to turn around, but the outlook there is a little less certain and Japan looks like it’s going to come on very nicely for us over the next five or six years.

Steven Schwartz – Raymond James and Associates

Had we broken the Japanese code?

Greig Woodring

No.

Steven Schwartz – Raymond James and Associates

Not yet, okay.

Greig Woodring

We would still see that as a very attractive market for us.

Steven Schwartz – Raymond James and Associates

Okay, thank you.

Operator

And a follow-up question from Jeff Schuman from KBW Investment Bank.

Jeff Schuman – KBW Investment Bank

Hi. I was hoping to come back one more time to the longevity business. You noted that longevity risk is a natural hedge to the mortality risk. I’m curious as to the motivations for client companies to do that because I would think it would serve as a useful natural hedge to them as well. Is there a particular reason why companies would look to lay this off? Is it just a matter of their own, kind of unique capital situation, or kind of what would sort of motivate it from their end given that it would appear to be a natural hedge for them as well?

Greig Woodring

Yes, Jeff. It is to a certain extent, but there’s so much more longevity risk than there is mortality risk in some of these markets, especially the U.K. these days. The companies quickly get overloaded with the longevity risk and that’s the reason they lay it off. It really is the situation that if a lot of the longevity risk were actually written by insurance companies as opposed to just being held by individuals, say in the U.S., the number is – I’ve seen anywhere from $3.5 trillion to $5 trillion of premiums that could be laid off if that was all in the hands of insurance companies. What’s really the case is that it’s only a few markets where insurance companies are heavily involved in taking this longevity risk, and one is the U.K. where they’re quickly overloaded with longevity business.

Jeff Schuman – KBW Investment Bank

Okay. And then apparently in Canada as well?

Greig Woodring

Well, at least in one particular case. It’s growing around the world though. Like I said, unfortunately in some senses, we have a limited appetite. We really don’t want to become a longevity company, we like the mortality business, and so we will have to make sure that we approach this in the correct way.

Jeff Schuman – KBW Investment Bank

This is probably must be the stupid question, but does being a mortality risk expert translate directly to longevity risk or is it not quite that simple?

Greig Woodring

It’s not quite that simple but certainly we have a lot of insights from our expertise on the mortality side. We actually even do a fair amount of underwritten annuities in the U.K. market where we use our underwriting expertise.

Jeff Schuman – KBW Investment Bank

Okay. And then one other area I was curious about. We’ve seen a couple transactions lately basically consolidating runoff life insurance operations, United Investors, and then more recently Liberty Life. Do you have interest or ability to kind of partner up with people who might be in a position to kind of administer blocks like this and for you to kind of lay this financial capacity? Is that something that you have kind of worked on or be interested in or not?

Greig Woodring

Yes, we did not work on either one of those particular cases but we have worked on others and that’s a scenario we would be very happy to participate in.

Jeff Schuman – KBW Investment Bank

And do you think these recent transactions represent an extending pipeline or how should we think about that?

Greig Woodring

Yes, we think that they are the apparent part of a first wave of this consolidation.

Jeff Schuman – KBW Investment Bank

Okay, great. Thanks a lot, Greig.

Operator

And we have a follow-up question from John Nadel from Sterne Agee.

John Nadel – Sterne Agee

Thanks. I’ve got a question for you. If we think about your year-to-date actual mortality results versus expected or versus priced for, however you want to think about that, given 1Q is relatively poor on mortality but obviously the second and third quarters have been okay, about how far have year-to-date results on mortality deviated from expected?

Greig Woodring

John, that’s always a little bit hard to exactly pinpoint, but we certainly have not filled up the hole of the first quarter completely. We’re not too far off of expected, and certainly the last two quarters have been very good, either expected or maybe even a little bit better. (Inaudible) the third quarter, but we have not gotten back to where we would like to be for the year.

John Nadel – Sterne Agee

Yes, I know. It didn’t seem like that. Let me ask it slightly differently. I’m interested in sort of the sensitivity. If you had a one sort of standard deviation, shortfall, or God forbid, better than expected mortality over a full year, how much of an impact is that on EPS? I don’t know whether you can say it in actual per share earnings hit or percentage change, can you help us with that?

Greig Woodring

Yes, I can, but maybe not off the top of my head because I don’t remember what the most recent standard deviation number is, but it’s certainly something we can calculate and do calculate. It’s over $10 million pretax, so it’s over $0.10 a share. It’s probably quite a bit more than that, actually. I would think it’s many cents per share.

John Nadel – Sterne Agee

Okay. I’ll follow up with you offline then. Thank you.

Operator

(Operator Instructions) Gentlemen, it appears we have no further questions at this time.

Greig Woodring

Okay. Well, thank you to everyone for joining us for this conference call. (Inaudible) any other questions develop, feel free to give us a call here in St. Louis. And with that, we will end the third quarter call. Thanks again.

Operator

Once again, ladies and gentlemen, that concludes today’s conference. We appreciate your participation today.

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