Reinsurance Group of America's CEO Discusses Q3 2011 Results - Earnings Call Transcript

| About: Reinsurance Group (RGA)

Reinsurance Group of America, Incorporated (NYSE:RGA)

Q3 2011 Earnings Conference Call

October 25, 2011 9:00 AM EST

Executives

Jack Lay – Senior EVP and CFO

Greig Woodring – President and CEO

Analysts

Steven Schwartz – Raymond James and Associates

Jeffrey Schuman – KBW

Jimmy Bowler – JP Morgan

Ryan Krueger – Dowling & Partners

Thomas Gallagher – Credit Suisse

John Nadel – Sterne Agee

Andrew Kligerman – UBS Securities

Operator

Good day, and welcome to the Reinsurance Group of America’s Third Quarter 2011 Results Conference Call.

As a reminder, today’s call is being recorded.

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, Mr. Lay.

Jack Lay

Okay, thank you. Good morning, and welcome to RGA’s third quarter 2011 conference call. Greig Woodring, our CEO, is with us today. I’ll turn the call over to Greg after a quick reminder about forward-looking information and non-GAAP financial measures. Following Greg’s prepared remarks, we’ll open the line for your questions.

To help you better understand RGA’s business, we will make certain statements and discuss certain subjects during this 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.

Keep in mind that actual results could differ materially from the expected results. A list of important factors that could cause actual results to differ from expected result is included in the earnings release we issued yesterday.

In addition, during the course of the call, we will make comments on pretax and after-tax operating income, which is considered a non-GAAP financial measure under SEC regulations. We believe this measure better reflects the ongoing profitability and underlying trends of our business. Please refer to the tables in our press release and quarterly financial supplement for more information on this measure and reconciliations of operating income to net income for the various business segments. These documents and additional financial information may be found on our Investor Relations website at rgare.com.

With that, I’ll turn it over to Greig for his comments.

Greig Woodring

Thank you, Jack, and good morning to everyone. Overall, claims experience was slightly higher than we expected this quarter, but well within a standard deviation. And weak equity markets and low interest environment also adversely affected our Asset Intensive business. Like most quarters, underwriting results were mixed by segment. Good results in Asia Pacific and Canada were offset by weak claims experience in our US and Europe and South Africa segments.

Operating income was a $152 million or $2.04 up from last year’s $128 million or $1.72 per share. Current quarter results included tax benefit associated with the impact of previously enacted tax rate reductions and deferred tax liabilities in Canada, amounting to $33 million or $0.44 per share. Statutory tax rates both at the federal and provincial had been lowered and the adjustment rates, and it relates to applying the lower tax rates to the related deferred tax liability on the balance sheet. Since we’ve built up a sizable deferred tax liability in Canada over time, the adjustments reflect the lower enacted rates was reasonably significant.

Foreign currency fluctuations helped operating income by $4.5 million or about $0.06 per share. Annualized operating ROE was 14% for the quarter and 13% over the last 12 months. Consolidated net income totaled a $147 million or $1.98, up from a $128 million or $1.72 per share last year. Reported premiums were $1.8 billion, up 8% quarter-over-quarter. The third quarter of 2010 included a one-time annuity premium. Ignoring that, the premiums increased about 7% in original currencies.

Investment income was off 7% this quarter, totaling $268 million with the yield of 5.29%, which is down 37 basis points from last year’s third quarter. Contributing to this decline in investment income was a net $38 million decrease in the fair value of option contracts supporting equity-indexed annuities. Excluding those contracts, investment income was up 6% quarter-over-quarter, despite the decline in yield.

Our net unrealized gain position grew to $1.1 billion, an increase of 46% since the second quarter, adding $4.81 to book value per share, which is now 77.29. Excluding AOIC, book value per share is $59.48. Its current interest rate environment continues to put downward pressure on our overall portfolio yield as we invest new money at lower rates. Our third quarter yield was 5.29% compared to 5.66% last year as we said, and 5.35% in the second quarter of this year. And while this trend adversely affects our investment income, we do not feel that it will force us to write-down deferred acquisition costs or to bolster reserves or capital even if low interest rates persist for five years or longer.

RGA’s results continue to be primarily driven by our ability to price mortality and morbidity risks. While we closely manage market risk such as interest rates and equity markets, they are secondary to mortality risk for our overall performance and long-term outlook.

Regarding the new accounting guidance and deferred acquisition cost which will take effect early next year, we expect to reduce capital by about 6% to 9% excluding AOIC. Further we project operating income to be adversely affected by 6% to 10% in 2012. This is a noneconomic accounting change that simply changes the timing of expense recognition for certain acquisition costs. The impact to income reflects our relatively higher organic growth in recent years and the long amortization periods for our mortality business.

Turning to segment results, our US Traditional business reported pre-tax operating income of $83 compared to a $101 million last year. Mortality experience was adverse by less than a 0.5% this quarter, while prior year quarter was in line with expectations. Premiums were up 4% this year and totaled $971 million.

Our Asset Intensive business in the US results were hampered by poor performance in the equity markets during the quarter and reported pre-tax operating income of $1 million, down from $14 million a year-ago. Despite the poor results this quarter, this business has done well on a year-to-date basis.

Our Financial Reinsurance business continued to grow this quarter as it has all year, reflecting strong fee income. This business added about $6 million to pre-tax operating income up from $4 million a year-ago.

Turning to Canada, pre-tax operating income $36 million, up 28% over last year’s result of $28 million. Both results were very good and reflects favorable mortality experience in each period.

Premiums totaled a $186 million this quarter, a decrease of 10% from last year’s $206 million, which included a one-time bump of $43 million from the new longevity transaction. Premiums were up 14% excluding that transaction. Favorable foreign currency movements added up about 5% to the current quarter growth.

Turning to our international operations, first in Asia Pacific, pre-tax operating income increased 15 percent to $31 million compared with $27 million last year. The results in Japan, Hong Kong and Southeast Asia lead the segment. Premiums rose 20% to $328 million with significant help from weaker US dollar. In local currencies, premiums were up 7%. Year-to-date premiums are up about 5%.

Next, our Europe & South Africa segment reported pre-tax operating income of $14 million for the current quarter, down from $16 million last year, reflecting adverse claim results in several European markets. Results in the UK operations, the segment's largest, were however in line with expectations this quarter. Premiums were up 23% to $286 million, compared with $233 million last year. Ignoring the lift from currency fluctuations, premiums rose 19%, a strong result. Year-to-date premiums are up 21% excluding currency well ahead of our expectations.

In summary, ignoring this Canadian tax benefit, our third quarter results came in below our expectations with some mixed underwriting results and market driven adverse results in our Asset Intensive business. Nonetheless, we’re pleased once again with the relatively strong operating ROE, along with the life insurance industry we had faced challenges associated with stock market volatility and low interest rates. However, in our initial life reinsurance, our results should continue to be more stable due to our lower asset leverage and our diminished reliance on investment performance to generate profits. We have persevered through weak macro environments in the past and are confident that we will successfully navigate through the current conditions.

We repurchased about 838 shares of common stock during the quarter for $43.1 million. RGA remains focused on delivering consistent returns for our shareholders along with strong capitalization and market positions across the globe. We appreciate your support and your interest in RGA.

And now, we’ll take any questions you may have.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). And we’ll take our first question from Steven Schwartz with Raymond James and Associates.

Steven Schwartz – Raymond James and Associates

Hi, good morning, everybody. A few – I want to stick to this and then I’ll get back in the queue for later. But I want to stick with corporate and other right now. A couple of issues with regards to tax rate. Generally speaking that has been – excluding the Canadian thing obviously that has been lower in the third quarter. I think that’s a seasonal thing surrounding FIN 48 if I remember correctly – and maybe I’ve got this backwards – and then interest expense in corporate and other as well has been historically low, I think that has to do with some tax audits. Maybe we can talk about why didn’t happen in the quarter.

Jack Lay

Yes Steven, this is Jack. You were right. If you went back historically, normally we would clear a tax year in the third quarter and I’m not talking about last year I’m talking about the years prior to that.

Steven Schwartz – Raymond James and Associates

Right. Last year was the first quarter I think if I remember correctly.

Jack Lay

Yes, well, a couple of things happened last year. But if you want prior to last year we would typically clear in the third quarter. Last year, we did – we actually cleared a return in the fourth quarter, so you had some FIN 48 impact in the fourth quarter. I think when you referenced the first quarter we had a tax reserve adjustment that did have some impact on the overall interest expense that we had built up there. So I think that maybe creating a little bit of an anomaly that you’re seeing there. But –

Steven Schwartz – Raymond James and Associates

Okay.

Jack Lay

We – in the third quarter of this year, we did not reflect any adjustment vis-à-vis FIN 48. There is a reasonable likelihood that we will have an adjustment in the fourth quarter. It’s not a shortage, it just depends on where we are with the IRS in terms of clearing returns. But to date this year, we haven’t cleared any, so we haven’t had the benefit of releasing any interest expense.

Steven Schwartz – Raymond James and Associates

Okay, all right. I will get back in the queue.

Operator

And from KBW, we’ll go next to Jeffrey Schuman.

Jeffrey Schuman – KBW

Thanks. Good morning. I’ll just hit a couple of items and get back in as well. First of all, on Asset Intensive, I guess historically the correlation between those results in the market hasn’t been that clear. So certainly last year, I think second quarter was a down equity market quarter, but the unit earned pretty well. So can you give us a little more perspective on why earnings were so sensitive to the market in the quarter?

And then, the other question is, just wondering your thought process to pull the trigger in share repurchase. I think on the second quarter call you were still kind of formulating your capital plans and I was just wondering sort of how you made a decision to start buying back here. Thanks.

Jack Lay

Jeff, this is Jack. In terms of Asset Intensive, I think if you look back, and I don’t recall exactly the results second quarter of last year. But if you look back – particularly if you go back 2.5 years or so when the market was really in an upheaval, you saw some fairly negative operating results on that unit. So there was some degree of correlation, it’s not perfect by any stretch. But you did see some of the same at least directional sort of movements in our operating earnings that you saw this year. I’m referring back to the third and fourth quarters of ’08, in that time period.

Regarding the buyback, we had an existing authorization outstanding for years that when our stock traded off fairly dramatically than the August time period, we thought, “Well, let’s take advantage of that authorization.” We didn’t go beyond that, so we ended up buying back roughly $43 million worth of stock, get roughly – right around $15 a share or so. We would not have anticipated that even six months ago. We didn’t anticipate the trade-off in the stock, so – and really planned to take advantage opportunistically of many sort of downward pressure on the stock, but we did in the quarter and we used up the remaining authorization that had been outstanding.

Jeffrey Schuman – KBW

Thank you. So where do you go from here? Do you seek any authorization or where will you go from here?

Jack Lay

It’s not particularly clear. We do deliberate in terms of an additional authorization. But I can’t figure and tell you that we are going to buyback stock if it trades at X rate. We just haven’t made that deliberation. We will – if we think it’s an opportunistic time, we’ll go back to our Board and have that discussion.

Jeffrey Schuman – KBW

Okay. Thanks a lot, Jack.

Operator

And we’ll go next to Jimmy Bowler with JP Morgan.

Jimmy Bowler – JP Morgan

Hi, thanks. I had a question first on just the reasons – if you could just give us some insight into the reasons for the significant earnings hit, because of the new DAC rules, I think you mentioned the high growth. But it doesn’t seems like even based on you’re your growth has seen – has been in the past few years that the EPS hedge just seems a little bit too large, but maybe there is VOBA there is something else.

And the other question that I had was just on the Asia business. Your margins you mentioned were low in Australia. I was wondering if that was disability claims or was that related to life insurance claims.

And then just on your plans related to – like just on capital management, you mentioned you would evaluate buybacks sometime, but later on – but what do you see in terms of the deal environment out there and whether there are opportunities to acquire – potentially acquire blocks of business?

Jack Lay

Yes, Jimmy, let me – this is Jack, let me take the comment on DAC. We go and we have been going through a modeling process for sometime now and commiserating with our auditors to make sure that we haven’t missed anything. The result was pretty much as we expected. So maybe our investors – I got to tell you it’s hard to tell what the expectation is unless you really dig into the DAC and what we have been capitalizing.

But if you think in terms of – we have been building out an international operation and there has been some expense involved there, some of which was variable and we have been DAC-ing and the type of costs that will be difficult to DAC if they’re not related to success efforts going forward. So – and I guess my point is we pretty much ended up where we expected to be in terms of – we expect that sort of a hit to capital and ongoing earnings, primarily because of the relatively higher growth rates, particularly in the international segment over the last six years, eight years, 10 years.

Jimmy Bowler – JP Morgan

Okay.

Greig Woodring

In terms of Australia, Jimmy, the experience was less than expected this quarter. Mostly or maybe completely a variance due to the individual lump sum claims not particularly the disability claims. We had one disability account that’s pretty – tracking pretty much along the way we expected it to and we are now off of that risk, and it should be winding down over the future, although that will happen slowly. But Australia was slightly below what we expected for the year – for the quarter.

In terms of the deal environment, it seems to be heating up a bit. There seems to be a little bit more discussion right now, but don’t know whether that’s going to produce substantial transactions or whether that’s just discussion at this stage. But we’re very active right now.

Jimmy Bowler – JP Morgan

And the US margins being a little weaker, was that life claims or disability claims? Because I think second quarter, your disability claims in the US elevated as well.

Jack Lay

Yes, the – on the group – the group business was close to expected just a little bit worse after a good year last year. In the US regular mortality business, mortality was off a bit as well, but actually we were affected more by lapse rates which I think I had mentioned in the past, lapse rates and accounting adjustments due to reporting in this quarter than we were by strictly speaking mortality. Mortality was off $3 million, $4 million out of 600 plus.

Jimmy Bowler – JP Morgan

Okay, thanks.

Operator

And our next question comes from Ryan Krueger with Dowling & Partners.

Ryan Krueger – Dowling & Partners

Thanks, good morning. Legal & General put out a press release this morning saying that they had entered into a 390-million pound longevity transaction with RGA. I was wondering if you guys could comment on that.

Greig Woodring

No. I actually haven’t even seen that press release. We work on a number of transactions with companies in the UK, it’s a very active longevity market, and have done a number of those transaction over time. Typically, what we do is a longevity swap, where we exchange actual and expected flows as opposed to taking on assets and asset risk. So it’s a continuation of something we’ve been working on for a number of years and have us – a significant part of our UK operation is longevity business these days.

Ryan Krueger – Dowling & Partners

You consider that type of size to be a material transaction or is this kind of just in the course of normal business?

Greig Woodring

That’s a fairly large one. We’ve had – we’ve had a number of transactions on the longevity front that tend to be quite chunky though.

Ryan Krueger – Dowling & Partners

Okay. And then I just wanted to follow-up on the DAC accounting impact. I was also pretty surprised with the 6% to 10%. And, I guess, the way I was looking at it, your DAC capitalization and amortization kind of tends to run at a fairly similar amount, so I would have expected both to be reduced by around the same 10% to 15% that you reduced DAC and not produce that big of an impact. So am I looking at that wrong or how should I think about that?

Jack Lay

Well, this is Jack. It’s a little difficult to look at it that way, because a lot depends on the relative extent to which you’re growing parts of the operation that maybe a little more expense intensive than others. So if you take a step back and just look at very macro sort of ratios like that, you don’t always get the right answer.

Ryan Krueger – Dowling & Partners

Okay, thank you.

Operator

And from Credit Suisse, we’ll go next to Thomas Gallagher.

Thomas Gallagher – Credit Suisse

Hi. I guess the first is also on the DAC and then just one on your comment on interest rates and how it won’t be a balance sheet impact for five years and more. Just on the new DAC rules, and I totally appreciate your comment that it’s noneconomic, noncash, but how do you all evaluate the economics of your business? The only financials that we can see is GAAP and I recognize that you have other sets of financials, but we don’t have access to most of those in terms of statutory. So anyway, can you help us think about how you would really evaluate your business and the economics if GAAP isn’t the right way to do it or maybe it’s modified GAAP? That’s my first question.

Jack Lay

We do look at GAAP and that’s where we tend to focus. We also internally have been creating embedded value statements for sometime. As we get those more stable, perhaps we’ll share some of those in the future. Statutory is not something we manage to very – very much at all.

Thomas Gallagher – Credit Suisse

And so in terms of the way you evaluate capital, you’re using GAAP as your sort of evaluation of capital adequacy as it relates to the financial statements?

Jack Lay

Yes.

Thomas Gallagher – Credit Suisse

So then, I guess then the impact of book value – I guess it’s just hard to get my head around how this is a noneconomic event if this is a 6% to 9% adjustment to what you’re using as book value from a capital adequacy standpoint.

Jack Lay

Tom, you’re point is well taken. Noneconomic can mean a lot of different things. I think if you look purely a cash flow of this noneconomic – now on the other hand if your economic definition includes various ways to measure result including US GAAP, then it’s hard to say it’s completely noneconomic. Noneconomic really relates to just discounting cash flows, in which case, this doesn’t have any influence at all.

Greig Woodring

At the end of a period of time, we’ll be in the same place we would have been otherwise, is I guess the way to put it.

Thomas Gallagher – Credit Suisse

Yes, and that was my follow-up too. Just when understanding that this is a change in timing and not ultimate outcome, what would the crossover be if the initial implementation reduces book value by 6 to 9 and earnings by 6% to 10%? Is there a crossover period where we can think about earnings actually increasing over prior estimates, is it five years out in the future, or can you help us think about the timing a little bit?

Greig Woodring

Yes. There is, but it’s very influenced by growth rates going forward. So I will say this, we’re in a very long-term business. So if you just presume no dramatic changes in growth rates, it takes a period of years before we hit a crossover point – at least eight to 10 years.

Thomas Gallagher – Credit Suisse

Got it, okay. Yes, just – and that’s just due to the long-term nature in most of your contracts?

Greig Woodring

That’s right.

Thomas Gallagher – Credit Suisse

Okay. And then just last question if I could on the interest rates. Can you comment a little bit about if the interest rates remain where they are at today, why there wouldn’t be any impact to DAC nor reserves? Is that really because I’m thinking that you’ve a lot of recurring cash flows year and long duration guarantee products? Is that – is that more? And so in some ways on the recurring premium that you’re getting in the door today, unless you have an ability to reprice or reset some assumptions within the product itself, I would imagine there is going to be some level of margin pressure. Is it that you have enough cushion today or is it really just at the end of the day mortality margin is the vast bulk of your ultimate margin, and interest margins are just not that relevant?

Greig Woodring

Yes. Tom, it’s really both of those two latter points. The margin really relates primarily to mortality reserves that we setup, which aren’t really influenced to any meaningful degree just by interest rates going forward. So if you think of our book of business primarily a big lump of mortality business under FAD 60 guidelines, it would take a pretty dramatic sort of influences in terms of investment yields before we would have a capital or reserve/DAC sort of consideration in terms of lighting down DAC for instance.

Thomas Gallagher – Credit Suisse

Okay. I got it. Thanks.

Operator

And we’ll go next to John Nadel with Sterne Agee.

John Nadel – Sterne Agee

Hi, good morning, everybody. I’ve got a couple of questions. Greig, on the US mortality or in the US Traditional business I guess, you mentioned mortality was only a $4 million shortfall in the quarter, but that lapse rates and timing of reporting I guess had an impact. Can you help us understand what that means, the lapse rate issue and the timing of report? I mean, how – can you help us understand what that is, quantify it maybe?

Greig Woodring

Yes. And John, they weren’t real big affects either. I think the lapse affect was another $5 million or $6 million in the quarter say. I’m doing that from memory, so don’t hold me for that, but it’s about that order of magnitude. And there was some reporting noise, which there is always reporting cleanup or uncertainty that happens in a quarter, it goes both ways. So this quarter was the wrong way.

The lapses have been up in our book for about the last 18 months and we’ve seen sort of an increase in lapses in the industry that are reflected in our book, and that’s affected us. There is some VOBA on some of the old Allianz business too. And when one of those particular policies that has some VOBA attached to it lapses; there is a write-off of that. So lapses kind of affect us by both decreasing premiums, decreasing profits, and potentially some write-off of VOBA from time-to-time. And this quarter was a quarter where the affects of that combined with administration exceeded the mortality effect.

John Nadel – Sterne Agee

Okay. So then – in the lapse – the lapse rate issue is, I imagine it’s something that’s probably more economically sensitive and we might expect that to continue.

Greig Woodring

Well, we don’t know. It’s steamed to jump up for a while there. It could be that, it could also be some financed business that is just no longer needed. It’s hard to say this early in the game. But it’s clear that lapse rates have moved up from our last study to the one before that.

John Nadel – Sterne Agee

Okay. And then on the DAC accounting item just to comeback, maybe – because there is a lot of noise in your GAAP statements around DAC particularly from the movements of the embedded value – I’m sorry the embedded derivative items in the Asset Intensive segment. Can you give us a sense, if you stripped out Asset Intensive, what level of capitalized costs and what level of DAC amortization should we be basing our adjustments off of?

Jack Lay

John, this is Jack. That’s a hard one to answer when you say basing your adjustments.

John Nadel – Sterne Agee

Well, in terms of writing off existing DAC is one thing. Where should we be focused? I guess this is more of a modeling type question. But where should we be focused on the lower DAC amortization going forward, but the higher level of non-deferrable expenses? I assume from your commentary that we should be focusing on that on the non-US segments. But if you could just help us on that, that would be great.

Jack Lay

Yes, I’m not sure I can break it down. I’m not sure we’re prepared to break it down in terms of the operating segments. I will say that the more dramatic effect will be on the international segments for the reasons that earlier, just that we were relatively speaking, capitalizing more cost in the DAC balance than we would for instance in the broader mortality block in the US, because the expense was lower in the US.

Greig Woodring

I would say facultative business will have a higher effect and I would also – but I wouldn’t expect that the Asset Intensive business would be unduly bad.

Jack Lay

Yes, I was going to mention that. You should – essentially the DAC adjustments we’re talking about are not related to the Asset Intensive business. I wouldn’t.

John Nadel – Sterne Agee

Yes. No, I assumed that to be the case, that’s why I was trying to strip that out, because that line item tends to move so much quarter-to-quarter based on the volatility of the markets.

Jack Lay

Yes, that’s right. That’s right.

John Nadel – Sterne Agee

Okay. And then just two more quick ones. Last quarter, you guys said that to the extent that M&A or deal activity by this year-end came in lower than your expectations they didn’t really materialize, but you would revisit capital management buybacks in early 2012. Is that something you still stick by?

Greig Woodring

Yes. I mean, John, we continually look at capital efficiency. But the comment was, if we go several quarters and which would take us into 2012 and just haven’t seen the opportunity to meaningfully deploy redundant capital, well then it’s a much higher likelihood you’ll see some action early in 2012 on that front.

John Nadel – Sterne Agee

Well, just as a follow-up, for instance, this legal and general deal that was announced this morning, is this more of a financial reinsurance transaction, no balance sheet real capital to put up or is this something that we ought to think about is using up capital?

Greig Woodring

No. That will be a real deal, but it won’t use up much capital.

John Nadel – Sterne Agee

Okay. And then finally just on the interest rates. Your commentary on rates definitely indicates that sustained low rates is really not a meaningful concern and is certainly not a concern regarding the balance sheet. Is there something that you would say, Greig, is unique about RGA in this regard, or is this commentary about no real DAC impact, no real reserve impact even looking out over a period of five years, is that something we should be extrapolating to the other life insurers as well to the primary companies, or is there a particular product line that you guys don’t participate in that you would expect to see some pressure? Can you give us some help there?

Greig Woodring

The reason I think that we’re probably in better shape first of all is this big block of mortality business where we collect one year’s premium at a time. The contribution of interest on that business is a lot less than a typical level premium, either term or whole life policy, especially a whole life term policy. So we don’t build up the assets and don’t have the asset leverage that other companies have. And so that’s I think the main difference we see.

John Nadel – Sterne Agee

Okay, all right. Thanks very much.

Operator

And from UBS Securities, we’ll go next to Andrew Kligerman.

Andrew Kligerman – UBS Securities

Hi, good morning. I just first, last quarter, excess capital was at roughly $0.5 billion. I assume that’s about the same. There were no major movements there.

Jack Lay

Yes. Andrew, this is Jack. That’s right. It’s roughly $0.5 billion.

Andrew Kligerman – UBS Securities

Okay. And then, Greig, you mentioned that M&A was heating up. Maybe you could elaborate a bit more on what type of M&A is heating up, what are you interested in, are you looking to buy a small reinsured, do you want to assume a block of reinsurance from another reinsurer, or is it just blocks of traditional mortality from primary reinsurers. What particularly is heating up and what are you interested in?

Greig Woodring

Yes. For the most part, Andrew, it’s blocks of business from direct life insurance companies; they maybe mortality based, they maybe other types of business. But the – a level of discussion seems to be on the uptick a bit.

Andrew Kligerman – UBS Securities

Got it. And what other types aside from mortality would you have an interest in? What other lines?

Greig Woodring

Well, we would – we would be interested in various different annuity blocks and other business like that is very difficult to price in this environment, also it’s very difficult to close transactions. We’ve seen a lot of interest in Europe on different things that would help free up solvency to capital. So we’re starting to see the discussions happening that we thought might happen in that regard.

Andrew Kligerman – UBS Securities

And then when you said annuities, variable annuities, would that be included?

Greig Woodring

No, no, we’re not looking at any variable annuity blocks right now.

Andrew Kligerman – UBS Securities

Got it. And then last quarter, I think you had a negative – $8 million to $10 million negative variance on the long-term disability and you mentioned a little earlier that the claims were in line with expectations. Maybe a little color on the expectations. Are you kind of – has your expectations for long-term disability kind of gone up in terms of losses relative to where you would have thought a year or two ago, so that would be in line with expectations, and what’s your sense on that line going forward, has it stabilized?

Greig Woodring

That business – this is on the group side, and particularly in the US bend and to some extent in Australia. But in fact that business is historically quite a volatile it does go up and down. And a few large claims can swing in. The results this quarter were – okay, I don’t mean to say that everything is back to completely great for that business, but it was extremely good last year and a bit to more normalized too even a little bit high through parts of this year. This quarter was more in line with averages. So I don’t think we’ve changed our assessment, but we do recognize that this business does show characteristics of that volatility.

Andrew Kligerman – UBS Securities

Are you getting a sense that the primary companies have repriced a lot of it so far?

Greig Woodring

Don’t know that actually Andrew. I think that these tend to be one year at a time contracts. We look at – we look at the group’s – when we price the groups we look at the experience and set our own price on what we think is the appropriate risk we’re taking.

Andrew Kligerman – UBS Securities

Got it. Thanks a lot.

Operator

(Operator Instructions). And we’ll take a follow-up from Steven Schwartz.

Steven Schwartz – Raymond James and Associates

Hi. Okay, I’ve got some more now. First, I wanted – a couple of follow-ups if I may. On the lapsation, Greig, is the triple X business, is that maybe what is driving this that it’s coming off?

Greig Woodring

Yes. To some extent it is on the term business. But it’s across the board though.

Steven Schwartz – Raymond James and Associates

Okay. And then Jack this is follow-up to the question with regarding to interest rates and the lack of sensitivity is basically reflecting the fact that your business is primarily written on a YRT basis.

Jack Lay

Yes, that has a lot to do with it. That’s right.

Steven Schwartz – Raymond James and Associates

Okay. So then if I can go on to some of my own now; Canada, results in Canada looked weird to me particularly with regards to how you explained it. I did notice – well, my first question is, did the in-force in Canada in the Canadian Dollars go down from the second quarter? It looks like it to me, adjusted.

Jack Lay

Steven this is Jack. It may have. I’m just going from memory here. That would surprise me if it did, Steven.

Steven Schwartz – Raymond James and Associates

Okay. Maybe I’ll –

Jack Lay

That’s something we focus a lot on volume in-force.

Steven Schwartz – Raymond James and Associates

Okay. Maybe I’ll revisit with John. Just following up on in Canada, two things, you sighted good mortality. But if you take a look at the loss ratios that you put out between critical illness and traditional mortality, the traditional mortality that ratio looked actually high relative to the past eight quarters to me, towards the higher end of that. So I kind of wonder where we see the good mortality coming out. And then, how I see the good results is, you had a very, very large uptick in net investment income from the second quarter I think from the mid-40s – if I remember correctly $40 million to like $52 million or something like that, so I’m just – maybe you can explain that in the context of your mortality statements.

Jack Lay

Steven, on Canada, we have premiums that last for a long time, lapse rates that are extremely low. And you do buildup substantial amount of assets in Canada.

Steven Schwartz – Raymond James and Associates

Okay.

Jack Lay

That is one part of our operation that builds up assets. You would expect over time the loss ratio. So if you’re just calculating claims to premiums or claims and reserve increases to premium to drift higher and higher and higher as investment income becomes more of the funding of the claims that you pay and the profits that you bring to the bottom line. And so I would expect that is harder to look at our loss ratio and develop meaning out of it then the US’s by quite a bit. And I would expect to drift upward. What I can tell you is that, we understand what price in mortality was and we understand what we expect mortality to be given where it’s drifted over time. And this quarter, we were a couple of million dollars better than expect on that mortality side.

Steven Schwartz – Raymond James and Associates

Okay. I understand, I understand where you’re going with that, this isn’t necessarily a YRT type of business. But I mean I am looking at a 15% a – somewhere around a 15% increase in investment income between these third quarter and the second quarter.

Jack Lay

Yes, Steven, I’m sorry. I mean it did go up to $52 million. And a lot of that relates to the amount of capital associated with that business and that’s how we allocate investment income so.

Steven Schwartz – Raymond James and Associates

Okay. So there was more capital allocated in the quarter.

Jack Lay

That’s right.

Steven Schwartz – Raymond James and Associates

Okay. That makes sense to me. And then, if I may, the collateral finance I guess repurchased for a lack of a better term, was that scheduled, was that something voluntarily that you saw an opportunity to do, is that used capital. How do we think about that and maybe what you do going forward?

Greig Woodring

Yes, that’s – I call it opportunistic. In that collateral finance those notes outstanding or structured notes that we saw an opportunity to take them and buy them back in one of our operating companies so that we still we can use them in terms of collateralization. But essentially we’ve removed them from the balance sheet. We saw an opportunity to buy those back at roughly $0.65, $0.66 on $1. So the longer-term economics were very attractive and we bought those back in. Now, I think to your latter point, would we expect to continue to do that? We’ve almost reached our limit in terms of the amount we would be comfortable buying back without going through it a full tender. So it’s – unless we dramatically change course, I wouldn’t expect to see us buyback any meaningful and additional amounts.

Steven Schwartz – Raymond James and Associates

And the accounting would suggest that that would have no affect on capital?

Greig Woodring

That’s right.

Steven Schwartz – Raymond James and Associates

Okay, all right. Thanks guys.

Operator

And we’ll go next to a follow-up from Jeffrey Schuman.

Jeffrey Schuman – KBW

Thank you. I want to come back first to the interest rate issue. In your scenario, you do talk about 50 basis points of ROE compression over five years, and I think that was probably a comforting result relative to what some people had feared. But I was wondering if you could talk a little bit what drives it – about what drives that. Is that driven more by compression in the legacy business, or is that more of a reflection of layering in lower new business returns?

Jack Lay

I guess it’s both if I understand – this is Jack – if I understand your question. Certainly we have an investment portfolio that’s rolling off over a duration of seven or eight somewhere in there, so that the modeling reflects that those funds being reinvested. There is new money coming in associated with a new business production, so we would contemplate – of course we would price for that, but we would contemplate lower new money rate on those funds coming in. So I’m – have I answered your question or –

Jeffrey Schuman – KBW

Well, I think part of what I’m getting at is, what new business returns looks like today. I mean we’ve established that YRT is not amongst the most investment income sensitive businesses. But I mean are you repricing and if you don’t reprice, what kind of returns are you getting on a lot of your new business today?

Jack Lay

Well, as we price new business, we certainly take – we certainly reflect our expectation of investment yields and we kind of anchor them at current new money rates. Though we would certainly consider the investment income environment, the investment yield environment as we price any new business [inaudible].

Jeffrey Schuman – KBW

Okay. So that is factored in, okay. And then the other thing I wanted to come back to you again was the Asset Intensive. To what extent were lower earnings this quarter was driven by variable annuities versus equity indexed? I guess, I’m used to thinking of equity indexed business often being pretty tightly hedged and not seeing – at least for the company seeing is a lot of pressure that comes through in a quarter like this. Was it more the VA and more the equity indexed?

Jack Lay

It was more the VA, but probably in terms of the shortfall versus expectation, I think two-thirds of it related to VA and a third related to EIAs or equity-indexed annuities.

Jeffrey Schuman – KBW

Okay. And then on the – to the extent that the VAs – just trying to understand kind of the basic factors here, I mean two – is the big piece which is just fee leverage or is it DAC unlocking or some reserve adjustments or what kind of hit?

Jack Lay

Yes, DAC unlocking certainly moved both the performance on the EIAs as well as the VAs.

Jeffrey Schuman – KBW

Okay. So that was a material factor. Okay, thanks Jack.

Operator

And we’ll take a follow-up question from Thomas Gallagher.

Thomas Gallagher – Credit Suisse

Hi. Just a follow-up on the YRT question. Can you give a sense for how much of your business can be repriced annually on the life insurance side versus something where you blocked in pricing for a longer period of time? Just a rough split of that would be helpful.

Jack Lay

Well, Tom, almost none of our business can be repriced. The group business can be, that’s a small piece of our business at this stage. The mortality business for the most part is locked in.

Greig Woodring

Yes. Tom, our comments related to pricing on new business not repricing existing business.

Thomas Gallagher – Credit Suisse

So in terms of the recurring premium that comes in, that can’t be repriced. Got it, okay. So you’re just looking at the margin potentially having a lot of room to go down over the next decade or so if interest rates remain low as opposed to being able to do anything on the pricing side.

Greig Woodring

On the existing –

Jack Lay

Correct. Clearly if interest rates go down, we make less money. But the fact that we get a new premium each year and that’s sufficient to pay claims, means that the investment component of our profit is quite a bit less than other businesses in that YRT business.

Thomas Gallagher – Credit Suisse

Thank you.

Operator

And we’ll go to Ryan Krueger with Dowling & Partners.

Ryan Krueger – Dowling & Partners

Thanks. I had a follow-up on the interest rate commentary. I just wanted to clarify one thing. In the release you talked about a 15 to 20 bp decline in 2012 and 50 bp decline in 2016. And I interpreted that to be the decline in your portfolio yield. Am I incorrect or does that relate to the ROE or to the portfolio yield?

Jack Lay

That relates to ROE.

Ryan Krueger – Dowling & Partners

Okay. I guess, I just wanted to follow-up on that, because it seems a little I guess inconsistent with some previous statements you’ve made where I think you said, last year that low rates might cause us $0.20 to $0.25 per share impact on EPS, which I think is around 3% or so of EPS. 15 bps to 20 bps of ROE would only translate into more like a 1% of EPS. I’m just trying to reconcile those two comments.

Jack Lay

No, your point is accurate in that. And a lot relates to how the portfolio is running off that we had a little more dramatic impact over the last – I think a last couple of years. And it’s starting to moderate somewhat as you reach as the new money rate goes down. But it should reach at some point some degree of equilibrium. So I would say at last year when we made that comment, we were coaching that in terms of if the interest rates stay where they are we would see our portfolio yield come down and affect us by that amount. What’s happened, of course, is that interest rates have come down further since then and quite dramatically even. So it’s more than $0.20 impact this year.

Ryan Krueger – Dowling & Partners

Okay. I just wanted to clarify that. So you’re saying the EPS impact would be more than $0.20 to $0.25 in –

Jack Lay

I’m saying it has been in the last year. It has been in the last year, but there is a point at which – and what we’re saying when we do this is, is – going forward is saying if interest rates stay low for a long time what does it do. But we’re not saying they go down to zero either. If it goes down to – if interest rates go down to zero, the affect would be less.

Ryan Krueger – Dowling & Partners

Okay, thanks.

Operator

And we’ll take a follow-up from John Nadel.

John Nadel – Sterne Agee

Hi, thanks for the follow-up. Just a couple of quick items. With the Canadian tax rate change here, what should we be thinking about in terms of your consolidated tax rate going forward?

Jack Lay

John, this is Jack. The effective rate going forward is only modestly affected, because we’re talking about solely interest rates changes or I’m sorry tax rate changes in Canada. So it probably carves – I try to look at it this way, but –

John Nadel – Sterne Agee

Well, maybe we can think about it in terms of what did the Canadian tax rate go from to.

Jack Lay

Well, it dropped about four points – 4 percentage points.

John Nadel – Sterne Agee

Okay. That’s helpful. And then what – so your portfolio yield in 3Q is 5.29%, where is the new money yields in the third quarter?

Greig Woodring

Yes, considerably lower than that.

John Nadel – Sterne Agee

Well, I guess I’m trying to understand like how far below that though, because we all focus on the 10 year, you’re probably investing further out on the curve, and my suspicion is you’re buying just about anything but treasuries right now. So can you give us a sense for where your new money yield was during the quarter?

Jack Lay

Yes. I’d say, on average, it’s around 4.25%.

John Nadel – Sterne Agee

Okay. So we’ve still got – to the extent that nothing changed forever, we’ve got a 100 basis points of downside to your portfolio yield? Okay.

Jack Lay

That’s right, that’s right.

John Nadel – Sterne Agee

Okay. And where is the offsets to that? I mean at what point – at what point do you say to yourself we need – we need to alter our expense load, we need to – we need to do some things differently to combat that, whether – obviously I would expect you to reflect that in pricing your new business. But your new business is a percentage of – your in-force is obviously small. What do we do with the operations?

Jack Lay

No, that’s a good point. I mean, obviously pricing is affected. But also we look at expense efficiencies and we do that now and we’ll – there will be even more pressure if we’re on a prolonged low investment yield environment, because just to make the economics of the business where you’d have to look long and hard at the efficiency of the operation. That’s what we would do.

John Nadel – Sterne Agee

Is there a particular business that you emphasize in a 4.25% new money rate environment or a particular business that you completely deemphasize in that type of an environment?

Greig Woodring

It happens by default a lot of times. Like I said, annuity blocks business are very tough to price right now, because we reflect for an interest rates. And YRT business on the other hand looks pretty good.

John Nadel – Sterne Agee

Okay. And then the last one for you is just a sizeable net unrealized gain on the investment portfolio, I don’t expect you’d necessarily be working to monetize any of those gains, but also a very sizeable foreign exchange gain, and I’m wondering if there any strategies you envision deploying to monetize some of that.

Jack Lay

John on the FX front, we don’t look at it as much of trying to monetize a gain as we do look at it. Just to ensure from an enterprise risk management standpoint, we’re comfortable with the currency exposures or the businesses in which we’re operating, so we continually look at that. Just to make sure that we don’t in our own view – internal view get over exposed to any particular currency and suffer a detriment down the road because of movement in that currency. But I think the philosophy is a little different than trying to – as you suggest monetize any existing gain on a particular currency.

John Nadel – Sterne Agee

Okay. And the last one is just a request for additional disclosure. Your segment disclosure’s income statement shows us policy acquisition costs and other expenses all in one line. Given all the moving parts with the DAC accounting change, really I would appreciate to the extent you could separate out capitalization from amortization.

Jack Lay

Okay John. Let us consider that.

John Nadel – Sterne Agee

Thank you.

Operator

And we have another follow-up from Steven Schwartz.

Steven Schwartz – Raymond James and Associates

Okay. Last comment, I promise. Two questions here. Just following up on Ryan’s question, the investment yield gradually drops 50 basis points over the five-year period, but the 15 basis points to 20 basis points in 2012 and the 50 basis points by the end of 2016 refers to return on equity?

Jack Lay

That’s right.

Steven Schwartz – Raymond James and Associates

Okay, good. Glad I got that. And then, just going back to YRT, just so I have got this straight, the point Greig isn’t that you can change your pricing, the point is that the pricing is such that it goes up every year to reflect the increased mortality charge on a book of business.

Greig Woodring

Well, that’s correct, Steve. But I think the bigger point in terms of interest is that we don’t hold the money for that long; it’s only one year at a time. So we’re not expecting a lot of investment income off of the funds we get.

Steven Schwartz – Raymond James and Associates

Right. That’s because you’re pricing for – you’re simply pricing for mortality each and every year.

Greig Woodring

Correct.

Steven Schwartz – Raymond James and Associates

Got you, okay. That’s – I just wanted to make sure that my understanding was correct about what was going on.

Jack Lay

This is Jack. I think we’re at the end of our allotted time, so we may need to end the call at this point.

Operator

And there are no further questions in the queue at this time, Mr. Lay.

Jack Lay

Well, that works well. Okay, thanks to everyone for joining us this morning. Any other questions, feel free to give us a call. And, with that, we’ll the end the third quarter conference call.

Operator

And, ladies and gentlemen, that does conclude today’s presentation. We thank you for your participation.

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