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The Phoenix Companies, Inc (NYSE:PNX)

Q3 2010 Earnings Call

November 2, 2010 11:00 a.m. ET

Executives

Naomi Kleinman – Head, IR

Jim Wehr – President and CEO

Peter Hofmann – Senior EVP and CFO

Chris Wilkos – EVP and Chief Investment Officer

Phil Polkinghorn – Senior Executive Vice President for Business Development

Mike Hanrahan, – Chief Accounting Officer.

Analysts

Bob Glasspiegel – Langen McAlenney

Steven Schwartz – Raymond James & Associates

Andrew Kligerman - UBS

Eric Berg – Barclays Capital

Operator

Good morning, and welcome to the Phoenix third quarter 2010 earnings conference call. Thank you for standing by. All participants will be in a listen-only mode until the question-and-answer session. (Operator Instructions)

I will now turn the call over to the Head of Phoenix Investor Relations, Naomi Kleinman. You may begin, thank you.

Naomi Kleinman

Good afternoon, and thank you for joining us. I am going to start with the required disclosures and then turn it over to Jim Wehr, our President and CEO, for an overview of the quarter.

With us today are Peter Hofmann, Chief Financial Officer; Chris Wilkos, Chief Investment Officer; Phil Polkinghorn, Senior Executive Vice President for Business Development; and Mike Hanrahan, Chief Accounting Officer.

Our third quarter earnings release, our quarterly financial supplement and the third quarter earnings review presentation are available on our website at PhoenixWM.com. Slide two of the presentation contains the important disclosures.

We may make forward-looking statements on this call that are subject to certain risks and uncertainties. These risks and uncertainties are discussed in detail in our third quarter earnings release and our latest SEC filings. Our actual results may differ materially from such forward-looking statements. In addition to Generally Accepted Accounting Principles, we use non-GAAP financial measures to evaluate our financial results. Reconciliations of these non-GAAP financial measures to the applicable GAAP measures are included in our press release and financial supplement.

Now, I’ll turn the call over to Jim.

Jim Wehr

Thanks, Naomi. And thanks to everyone for joining our third quarter call. As we’ve done on previous calls, I’ll provide an overview of the business. Peter Hofmann, will review our financial results in detail, and Chris Wilkos will bring you up to date on our investment portfolio.

Let me start with my perspective on this quarter’s results and what they say about Phoenix. First, there is fundamental profitability in our business. Second, we have a strong balance sheet that continues to improve. And third, we are making measured progress in our efforts to generate profitable growth.

These facts about our business are the direct results of our focus on four strategic goals; balance sheet strength, policyholder security, expense management, and profitable growth. In short, we have good straightforward results to report to you today, with a type of progress we anticipated.

Let’s start with fundamental profitability.

I stated that we’re profitable even though we reported a GAAP net loss and an operating loss, and that’s because our core operations did, in fact, make money. The DAC charges that swung operating earnings into negative territory was a result of our comprehensive annual review.

As part of this annual review, we made a number of assumption changes based on market conditions and our experience; two are of particular note. The first relates to the impact of the low interest rate on margins and we are certainly not unique in this respect. The second relates to the increase lapses and lower renewal premiums we are experiencing in portions of our Universal Life book of business, specifically the Phoenix Accumulator Universal Life or PAUL product.

I mentioned this emerging trend on our call last quarter and we have been monitoring and managing this block carefully. As it has seasoned, we have more experience that helped us refine our assumptions. As a result of our annual assessment, we adjusted our assumptions about these policies.

Excluding the unlocking and a tax benefit, our operating income was about $18 million or $0.15 per share. So what is the source of our core profitability? The answer is our business fundamentals, which are sound and improving. Mortality was favorable this quarter. We have excellent experience in the open block, particularly Universal Life and Closed Lock experience was in line with our expectations.

Year to date, mortality is also in line with expectations. In short, we have solid business that produced additional profit this quarter.

Persistency is another fundamental, and one you’ve heard me talk about a lot since it is a key measure of our policyholder securities strategic pillar. Overall, we’ve achieved a good trend line in life insurance, and significant improvement from 2009 levels.

While annuity persistency has been inconsistent, it is generally moving in the right direction, and also much improved. Expense management is another strategic priority, and ongoing discipline. The benefits we expected from our actions in 2009 have driven expenses down sequentially all year. As with the third quarter, year-to-date core operating expenses are down 15% from last year. So there’s been progress across the enterprise that is producing stronger fundamentals.

Next, let me address the balance sheet. As I said earlier, we have a strong balance sheet that continues to improve. Statutory capital has grown every quarter this year and increased 29% from $574 million at yearend to 738 million at the end of this quarter.

RBC now stands at an estimated 297%, up from 223% at the end of last year. The annual

DAC review, I covered earlier, reflects our best estimate of where we are today and our assumptions on how our business will perform. This exercise has given us confidence that the DAC asset on our balance sheet is sound.

Of course, the health of the balance sheet depends largely on how well we manage our investments, and we have good results to report, once again, this quarter. The value of the portfolio improved further as unrealized gains grew in the third quarter of $461 million. This represents an almost $800 million swing from yearend when we had 325 million in net unrealized losses. And the level of below-investment grade bonds in the portfolio dropped modestly to 9%. Other balance sheet metrics remain strong, specifically debt to capital remains relatively low at 24.8%.

My final point about the quarter is that it contained tangible evidence that our growth initiatives are gaining traction and our prospects are improving. Annuity product development and sales are the first area where we are seeing our middle-market strategy take hold. We continue to build a good trend line in annuity deposits, which are increasing at a measured pace at just under 40 million for the quarter, they were 44% higher than in the second quarter, and more than tripled at $12 million from a year ago.

The sales growth so far has been concentrated independent marketing organizations, and this is a market segment we have focused on intentionally over the last year. We recently announced an alliance with the AltiSure Group. With them, we’ve developed an innovative annuity product to be marketed exclusively through their IMO network. We’re excited about both this new relationship and the new product.

Our distribution company, Saybrus Partners, continues to build momentum in third-party insurance sales in addition to the distribution support they provide for Phoenix’s products. Saybrus added a third client this past quarter, and is on track to break even by first quarter 2011.

In summary, we continue to focus on things we can control. By doing so, we strengthen the company and provide installation from things we can’t control. We’re putting the building blocks in place to execute in our growth strategy as we head into 2011. This quarter demonstrates the fundamental profitability in our business, the strength of our balance sheet, and that our growth initiatives are gaining traction and our prospects are improving.

We appreciate you joining this quarter’s call, and look forward to keeping you updated on the company. I’m going to turn it over now to Peter and Chris, and we’ll take your questions after their presentations, Peter?

Peter Hofmann

Thanks, Jim. The financial themes this quarter, which build on what Jim said, are shown on Slide 4 of the presentation. We had a net loss of 25 million due to the unlocking charge, but core earnings were solid at 17.9 million or $0.15 per share. We continue to generate statutory capital as reflected in surplus growth this quarter.

Expenses were lower reflecting the actions taken last year. The investment portfolio continues to appreciate and credit impairments moderate it further. We had an adverse impact in the quarter from two factors, which drove the unlocking charge. One is the effect of higher lapses and lower renewal premiums related to the policy areas, Universal Life block; the second is the effect of low interest rates, primarily on our annuity business.

Slide 5 highlights the trends and GAAP operating income and book value. We have spiked out discrete items that affect operating income in comparisons, there are two this quarter; the unlocking charge of 36.3 million and an $11.3 million tax benefit.

As we indicated in prior calls, our operating earnings comparisons, we have a zero effective tax rate this year. Deviations from this tax rate have largely been due to the GAAP intra-period tax allocation rules.

Backing out these two items results in adjusted earnings of $0.15 per share. Book value per share improved by $0.45 to $11.72. The increase was driven by higher investment evaluations.

Slide 6 shows income statement detail, excluding the closed block. Revenues remained flat compared with last quarter and are modestly down from a year ago. As already mentioned, mortality experience was very good this quarter. This, along with the reserve reduction due to the unlocking, account for the significantly lower benefits versus last quarter and a year ago.

Expenses were 60.4 million, meaningful below the prior year and last quarter. The regulatory closed block contribution of 14.4 million is in line with the past two quarters and consistent with guide path of the block. We had realized investment losses of 18 million, credit impairments were 11.9 million, and showed both year-over-year and sequential improvement.

Our variable annuity-hedging program performed well, generating a modest $1.2 million economic loss in the quarter. In addition, there was a $5.9 million loss from the non-performance risk factor that represents the change in the GAAP liability due to Phoenix’s credit. This reflects spread widening for a double D credits.

Accumulatively, for the year, the program is down by 1.2 million before any adjustments for Phoenix’s credit.

Turning to the fundamentals, on Slide 7 shows mortality cost ratios for the open and closed blocks. You can see the positive open block experience this quarter reflected in the low ratio of 53.4%. Experience in the closed block was typical and within expectations. As a reminder, because of the policyholder dividend obligation, closed block mortality experience has not directly affected GAAP earnings.

Slide 8 shows annualized aggregate surrender rates based on contract value surrender. Annualized life surrenders were at 8%, about level with last quarter. Annuity surrenders were 11.8% compared with 13.4% last quarter. Note that these ratios do not include lapses in which policies expire with no value.

One of our critical initiatives continues to be controlling expenses. Slide 9 shows consolidate statutory expenses and GAAP expenses adjusted for non-core items. The reductions we have taken over the last seven quarters are clearly visible, driven primarily by lower employee-related cost.

Year-to-date statutory expenses are down 23% and before deferrals, GAAP expenses are down 15%.

Let me spend a moment on the unlocking charge. As we mentioned, this quarter we conducted our annual comprehensive review of actuarial assumptions, use to support DAC as well as certain reserves. The overall net impact was a charge of 36.3 million.

Slide 10 shows a breakout of these adjustments by income statement line. While a number of assumptions were changed, the charge was primarily driven by higher assumed lapses and lower renewal premiums in the PAUL UL block. In addition, the impact of the low interest rate environment was reflected, particularly in annuities.

The UL unlocking accounted for roughly 25 million of the total charge. To put that in context, on Slide 11 I’ve shown the accumulative referrals and amortization related to UL since yearend 2004. This represents the period of most significant growth in UL sales.

As you can see, we deferred over 1 billion of commissions and expenses during this period, but we also amortized over 650 million. Of the 646 million balance at September 30, approximately 400 million relates to the PAUL block. As you can see from the pace of annual amortization, this asset is expected to amortize rapidly into earnings over the next two to three years. Tax adjusted, 400 million of that translates into about $2.25 of book value per share.

The key variables affecting the pace of amortization are lapse rates, premium persistency, and mortality. As already mentioned, the unlocking was driven by the first two of these; lapses and premiums. Let me emphasize that the unlocking was not related to mortality. Mortality on this block to date has been in line with expectations.

On the statutory side, there’s of course no DAC associated with the Universal Life business, and it has been an important contributor to the capital generation that you can see on Slide 12. We have year-to-date statutory net income of 45.7 million, and a statutory net gain from operations of 46.1 million.

Statutory surplus for Phoenix Life has increased by 29% versus year-end 2009. The increase was driven by core earnings, gains in the alternative asset portfolio, and increase admitted to deferred tax assets.

The increase in the estimated RBC ratio from year-end 2009 was due to improved surplus and the reduced balance sheet risk, driven by a reduction in the percentage of below-investment grade bonds and lower variable annuity capital charges.

With that, I’ll turn it over to Chris, for a discussion of the investment portfolio.

Chris Wilkos

Thanks, Peter. Jim talked about the strength of our balance sheet and the investment portfolio has certainly contributed to that strength. In the third quarter, the Phoenix portfolio produced solid results in key areas, including a sharp appreciation in portfolio values, reduced bond impairments, and stronger credit quality. Before we talk about the balance sheet, let’s start with net investment income on Slide 13.

Sequential net investment income decreased by 22 ½ million, primarily as a result of lower venture capital and partnership returns; 17 million of this decline occurred in a closed block, whose investments results do not directly impact top rating earnings.

As you recall, our second quarter venture capital and partnership returns were particularly strong, and we had expected a reduction in these returns for Q3, specifically the one quarter lag in partnership accounting reflects the weak equity market returns of the second quarter in our current results.

Given the strong stock market of the third quarter, we expect improvement in alternative returns for the fourth quarter. Income from long-term debt security, decreased as the effect of the low interest rate environment continues to depress shields on new fixed income investments. We also have a slightly smaller asset base.

On Slide 14, credit impairments declined for a third consecutive quarter, falling to 11.9 million in Q3. Impairments were spread among several different sectors. We only had minor impairments in our corporate bond segment, which comprises the largest percentage of our overall portfolio. Notably; our private placement bond holdings suffered no impairments, reflecting the quality and covalence, inherent in those investments.

We also saw a reduction in the impairments from our non-agency mortgage-backed security holding, which includes prime [inaudible] and subprime. Our impairment experience reflects both declining overall market default rates and our ongoing efforts to manage our credit exposure. Lower impairments year-to-date have helped us strengthen our balance sheet and on a statutory basis, improve our surplus and RBC levels.

Please, also recall that since we have virtually no commercial mortgage home loans, we have no impairments in that asset class.

Slide 15, illustrates the continued improvement in the market value of the Phoenix fixed income portfolio, with the sharp drop in treasury rates during the third quarter, the portfolio’s value has appreciated to an unrealized gain position of 461 million, an improvement of over 780 million since yearend. All segments, corporate bonds, mortgage backed security, and asset back securities, saw improvement in market values.

Spreads tightening from their highs in the fall of 2008, to more normal levels have also contributed to portfolio depreciation. This improvement, along with reduced credit impairments, reflects the strength and resiliency of the investment portfolio.

The improvement portfolio evaluations has been a significant factor in strengthening our balance sheet and enhancing surplus. As shown on Slide 16, we have significantly improved the credit quality of portfolio over the last year. Reducing the below-investment rate ratio from a peak of 11.4% of bonds to 9% at the end of the third quarter. We have been able to achieve this reduction in our high-yield position over the last several quarters, with virtually no losses on sales and dispositions.

Our investment policy specifies a high-yield bond range of 6 to 10% of total bonds. Operating within this range, we will continue to look for opportunities to reduce low-investment grade holdings, but will carefully balance that against the need for the yield these assets produce.

As a reminder, we continue to produce a quarterly investment portfolio supplement, which is available on our website, and provides much more granularity on our investment portfolio. With that, I’ll turn the call back over to Jim.

Jim Wehr

Thanks, Chris. Lori, let’s open things up for questions.

Operator

Thank you, Sir. At this time we are ready to being the question-and-answer session. (Operator Instructions) Our first question comes from Bob Glasspiegel with Langen McAlenney. You may ask your question, sir.

Bob Glasspiegel – Langen McAlenney

Good morning, everyone. Two questions on the unlocking charge if I may. You sited increased lapses in UL and surrender rates in DUL, but it looks like on the chart, you’re lapse rates have improved, your persistency is improved in your life product. Is it that the improvement was less than you were looking for or am I looking at the wrong set of number?

And the second question regards interest rates, lower investment spreads and annuities. Did you sort of assume that the current low rate environment continues for ever or are there potential further hits if rates stay low down the road?

Jim Wehr

Bob, I’m going to ask Peter to take a swing at both of those.

Bob Glasspiegel – Langen McAlenney

Thank you.

Peter Hoffmann

Yeah, Bob. Let me start with the lapse question. The distinction that I tried to make, but obviously didn’t come through, was the surrender ratios represent policies that are surrendered for value to us. Lapses in the UL block basically represents policies that expire because there’s not sufficient fund values, not sufficient renewal premiums collected to keep them in force.

And our surrender ratios do not include the lapses on the UL block, or any block where there’s a lapsation without value. And it’s really the lapses that are driving the unlocking because in essence the policies are not on the books to glamorize the assets.

Bob Glasspiegel – Langen McAlenney

Is it because of underlying asset value declines, or people not putting money in?

Peter Hoffmann

It’s really not putting money in.

Bob Glasspiegel – Langen McAlenney

Okay.

Peter Hoffmann

Not paying for renewal premiums, which is related directly to the renewal premium assumption. So they are related if you think about it.

Bob Glasspiegel – Langen McAlenney

Okay. I think you may have to follow up on that off line. What about interest rates?

Peter Hoffmann

On the interest rate side, this is large in the annuity block, there are two pieces to that. The total was about 12 million or so, roughly half of that or so is related to some older fixed annuities that are close to their maturity, so there really isn’t enough – there aren’t enough earnings left in those to support that and we essentially wrote off the remaining DAC associated with that particular block.

The other piece of it represents the investment, the very short-term investments that are in the guaranteed interest account of the variable annuity business where we have to keep the assets quite short and there’s a statutory minimum credit rate generally of 3% that we need to credit. So there’s, you know, there’s been some fairly meaningful spread compression on that block of business. That’s roughly a $500 million balance that you can see in the supplement on the annuity page.

Bob Glasspiegel – Langen McAlenney

If lower rates stay where they are – if rates stay low where they are, is there – are there more DAC charges coming, or is it just low spreads that we just have to deal with?

Peter Hofmann

On the fixed annuity block, like I said, we’ve essentially written on the DAC, so that one is pretty much done. No the bearable annuity side, you know, short-term rates go – and I don’t know how much lower they can actually go from here, but if they – if they remain sustained, there’s, you know, there’s some exposure there. I would say that we’ve built in pretty low rate assumptions at this point. And a lot of our Life business is much longer term in nature and has adjustable costs so whether that’s crediting rates, or dividend scale on a disclosed block, that allows us both time because the portfolio rolls over more gradually and we can invest longer. And at the same time, we can adjust price. So less exposure there, I would say.

Bob Glasspiegel – Langen McAlenney

Thank you.

Operator

Thank you. Our next question comes from Steven Schwartz with Raymond James.

Steven Schwartz – Raymond James & Associates

Hey, good morning everybody.

Jim Wehr

Good morning.

Steven Schwartz – Raymond James & Associates

I have a few. I was just wondering, you mentioned a couple of times the favorably mortality in the open block. It came in, I think you said it was 53 1/2%. My notes would suggest that that’s actually not that – it’s slightly favorable. So I’m probably off here. What do you consider a more normal number for the mortality benefit ratio?

Jim Wehr

Again, I’m going to turn to Peter to talk about mortality and maybe Phil might chime in as well.

Steven Schwartz – Raymond James & Associates

Okay.

Jim Wehr

Peter?

Peter Hofmann

Hi, Steve. The mortality ratio has probably become a little less useful as an exact predictor of mortality. And the reason for that is that we have seen declines in the level of COI fees, so the ratio in and of itself is not quite as reliable and you can’t interpolate last accurate as you could maybe a couple of quarters ago. So we’re actually looking at whether there’s a better metric to share.

Our estimate of the favorable mortality in the quarter is around 7 million or so pre-tax across the business.

Steven Schwartz – Raymond James & Associates

Okay.

Peter Hofmann

And again, you can’t get there directly from adjusting the ratio because of the CLI trend.

Steven Schwartz – Raymond James & Associates

Okay. Peter, you said that’s pre-tax pre-DAC?

Peter Hofmann

Yes. No, after DAC.

Steven Schwartz – Raymond James & Associates

After DAC. Pre-tax, after DAC. Okay, great. I appreciate that. And then I wasn’t sure if I was interpreting a statement that you made correctly. You were talking about the DAC amount that is filled there from the PAUL product, and expected it to come off. I think you said in about three years or so. Does that mean if we were to normalize the adjustments that you made this quarter, does that mean we’ll see the DAC amortization amount move higher all else equal, or just all else equal, just kind of be at the same rate?

Peter Hofmann

My point was, all else equal, amortization would be slightly less because there’s less of an asset to amortize. But my point was that if you look at the chart, at the level of amortization, remember this is 25 million or so on the base of a billion dollars originally deferred.

Steven Schwartz – Raymond James & Associates

Okay.

Peter Hofmann

If you look at the pace of amortization on that slide on the right, you can see that at that pace you get through 400 million of that pretty quickly. It’s indicative of the cash flows that are coming off of that UL block amortized, that balance.

What we wanted to do really is give you a – sort of put it in context and size the block from a GAAP perspective and give you some sense of what’s involved.

Jim Wehr

So just to be clear, so as it goes through that rapid amortization and the balance is diminished, the potential for future DAC adjustments is also diminished.

Steven Schwartz – Raymond James & Associates

Okay. So that was the point of it. Okay, great. And then one more if I may. In the second quarter, I have in my notes that you had a benefit on I guess in your benefits line due to – well actually – I’m sorry, it was a cost due to the negative markets on your unhedged GMDBs and some other embedded derivatives. Did you have a gain in this quarter from the market moving up?

Peter Hofmann

Yes. And it’s not – it’s the guarantee limb death benefit and guarantee minimum income benefit, which we don’t hedge. Yes there was a gain.

Steven Schwartz – Raymond James & Associates

Right. Okay. Peter, do you know how much that is so I can stick that in my model?

Peter Hofmann

I don’t have that piece isolated. Naomi can get that for you. Overall when we look across the business, our estimate of the favorably impact of the market is around 5 million.

Steven Schwartz – Raymond James & Associates

Okay. So this would be part of that 5 million?

Peter Hofmann

That would be, but only a piece of it.

Steven Schwartz – Raymond James & Associates

Okay. All right, yeah, I’ll talk to Naomi later. Thank you guys.

Operator

Thank you. Our next question comes from Andrew Kligerman with UBS.

Andrew Kligerman - UBS

Hey, good morning.

Jim Wehr

Good morning, Andrew.

Andrew Kligerman - UBS

I have a question on Saybrus; how much did the third-party product sales – how much did the – what kind of traction did you get? If you could give us some numbers by product, maybe who might be a big – whose products you might be selling big as well?

Jim Wehr

Let me kind of break that into the components. The largest at this point, Andrew, is clearly Edward Jones. That was the first partner we announced just about a year ago. I think it was on our last year’s November earnings call. So that is off to the strongest start simply because it has the – has been in place the longest time. We’re seeing new volumes in their system in line with expectations. They actually ramped up the volumes – the volumes have ramped up quite nicely in the third quarter, but there is a bit of a lag between the new business applications and the realization of revenue, which comes after they go through the underwriting process and get funded.

So we’re seeing the – we’re seeing the application volume, but the revenue is lagging a bit there. But the application volume is in line with expectations and ramping up nicely.

Wells Fargo, which is the second in line, is really just getting started and we’ll have to go through that same ramp up application translating into revenue. But in spite of those two moving along at what we characterize at a measured pace, we are still forecasting breakeven for Saybrus in the first quarter of next year.

Andrew Kligerman - UBS

And Jim, maybe just some revenue numbers that you tallied up to date that you could give us?

Jim Wehr

You know, Andrew, we have intentionally been vague beyond the break even commitment or expectation we have shared. I think as we get more experience in that business and start to feel more comfortable with the run rate, we’ll be in a better position to provide that kind of granularity. We know you guys are interested in sizing this bread box if you will, but the size and shape and the components are changing as you would expect with the various startups.

So as we – as we feel more comfortable with what we’re seeing, we’ll provide that information.

Andrew Kligerman - UBS

Okay. That’s fair. How about on the RBC rates? You’ve got a 7-point sequential move, you’re at 297. Any plans to sharply increase that, any initiatives that you might have or any way to really ramp that up to 350 or 400?

Jim Wehr

We have considered alternatives along those lines, Andrew, over the last year plus. As you can see, we really haven’t implemented anything. And I would say while 350 is clearly better than 297, the incremental value to us of that 50 points of RBC improvement is not as compelling as it was a year or so ago. So we will continue to evaluate those types of things, but I think that’s probably the best answer I can give you.

Andrew Kligerman - UBS

Okay. Thanks a lot.

Jim Wehr

Yep.

Operator

Thank you. (Operator Instructions) Our next question comes from Eric Berg with Barclays Capital

Eric Berg – Barclays Capital

Thanks very much. So Peter, returning to the DAC unlocking, I have a question regarding taxes and one regarding DAC unlocking.

Just to be – just so that I can sharpen my understanding, are you essentially say that 2/3s of this was Life related, 1/3 annuity?

And then with respect to the Life, the great majority of it related to this distinction that you’re making to lapses rather than – change lapse assumptions rather than surrender assumptions, is my rough math correct, or would you like to correct it?

Peter Hofmann

Your rough math is correct, Eric. I would add in, it’s not just lapses, but the renewal premium assumptions that as I indicated, are interconnected to some degree with lapses, but are a separate assumption.

Eric Berg – Barclays Capital

Sure. And the I just wanted to clarify, with respect to the tax issue, you had an operating loss in the quarter and you explained to us repeated that because of your tax situation you would have a – effectively you would have a zero effective GAAP – zero GAAP-effective tax rate, yet you recorded a tax benefit in the quarter. Help me understand, is the presence of that benefit because you had a loss and the idea that you would have a zero tax would apply only in the context of earnings? Is that the point that this zero effective tax rate applies only in the context of earnings and not on the context of the loss? Thank you.

Peter Hofmann

I’ll try to take that, Eric. And you’ll, I think feel sorry you asked the question. But it’s not – that’s not the case.

Eric Berg – Barclays Capital

Okay, okay. This might be better offline. So why don’t you give me the shorthand version.

Peter Hofmann

I’ll give you the short answer. The benefit as related to what we refer to as GAAP intra-period accounting rules, which by even our – by all standards, I think would be considered complex [inaudible] intuitive.

What they require us to do is regardless of whether we have an expense or benefit, to allocate that expense and benefit among different income statement categories. So continuing operations, discontinued operations and other comprehensive income, so the OCI.

In the case we’re in, where there’s a full valuation allowance recorded against our ordinary DTA, we would typically expect a zero percent tax rate under the rules, under the Intra-period accounting rules.

However, there is an exception to those rules. If there is a loss from continuing operations and positive income from discontinued operations and OCI, this exception applies. And what the exception basically requires us to do is to run the utilization of a tax benefit through continuing operations even if the income that utilized that benefit is in OCI or discontinued operations.

So it’s a geography issue and it’s a classification among discontinued operations, OCI, which is off the sort of traditional net income statement all together, and continuing operations. And how exactly the allocation ends up is pretty unpredictable and not always intuitive.

Eric Berg – Barclays Capital

Now, just one final last one. Is the tax benefit therefore that you – when you talk about the discrete items including a tax benefit and the DAC-related event leading to what’s called your normalized earnings or your adjusted earnings, is the tax adjustment that you’re making there essentially taking you down to a zero GAAP effective tax rate, or is that yet another matter, is that a tax benefit that you’re calling a discrete item yet another matter still?

Peter Hofmann

No, that’s exactly what we’re doing. We’re saying that because we have a valuation allowance against fairly significant net operating loss carried forward, we, you know, any income tax expense theoretically can be absorbed by those net operating losses; because there’s a valuation allowance that would immediately offset the utilization of the NOL so there’s a zero net impact on income versus of course, if we have loss, we put up an additional DTA or net operating loss and also put an additional valuation allowance with other [inaudible] effective impact.

That’s sort of how we expect things to occur other than for this exception that I just mentioned.

Eric Berg – Barclays Capital

Okay. That was a very helpful start, it really was, and I’ll circle back with Naomi to go over it in a little bit more detail. Thank you very much.

Peter Hofmann

All right.

Operator

Thank you. Our next question comes from Bob Glasspiegel with Langen McAlenney.

Bob Glasspiegel – Langen McAlenney

Good job on that. The annuity sales – she showed persistence to get through that. The annuity sales, maybe give us a little bit more color about the types of products that seem to be getting traction. And is this a line that we can build from in the future for Glide Pep?

Jim Wehr

Bob, I’m going to ask Phil to give us some color on the annuity sales.

Phil Polkinghorn

The majority of those are fixed-index annuities and while they have slightly different benefits, they have similar chassis, ten-year surrender period, ten-year market value adjustment. But different interesting-earning methods. And we’ve been at this a while, growing sales [inaudible] organization channel and they’ve continued to grow. Jim mentioned the new relationship with the [inaudible] group. It’s off to a very good start and is contributing to our overall sales already. So you know, without forecasting sales, I would expect to see that trend continue.

Bob Glasspiegel – Langen McAlenney

A little bit more, I’m curious what are the rates and the caps and stuff?

Phil Polkinghorn

Sure. The products all contain a one-year point-to-point with a cap and the most recent cap was, you know, around 5%. It’s going down in early November to the mid 4s. But each product also have a number of other crediting methods that we can give you some information on each of them. But they’re priced roughly equivalently and they also all have a guaranteed interest account that is down in the twos. And interestingly enough, a non-trivial portion of the money is allocated to that guaranteed interest account.

Bob Glasspiegel – Langen McAlenney

Okay. That sounds interesting . Thanks.

Jim Wehr

Bob, should we have somebody from Saybrus give you a call?

Bob Glasspiegel – Langen McAlenney

Try to sell me some product? I’d like to look at it, in all seriousness. Thanks.

Jim Wehr

We’ll do that, Bob.

Operator

Thank you. At this time I’m showing no further questions. I would now like to turn the call over to Ms. Kleinman.

Jim Wehr

Well, I’m going to wrap things up and just, once again, thank everyone for their time, attention and interest today. I look forward to talking to you in the future. Take care.

Operator

Thank you. That does conclude today’s conference call. Thank you all for joining. You may disconnect at this time.

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