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Executives

Naomi Kleinman – Head, IR

James Wehr – President and CEO

Peter Hofmann – Senior EVP and CFO

Christopher Wilkos – EVP and Chief Investment Officer

Philip Polkinghorn – Senior EVP and President, Life & Annuity

Analysts

Andrew Kligerman – UBS

Robert Glasspiegel – Langen McAlenney

Steven Schwartz – Raymond James

The Phoenix Companies, Inc. (PNX) Q3 2011 Earnings Call November 2, 2011 11:00 AM ET

Operator

Welcome to the Phoenix Third Quarter 2011 Earnings Conference Call. Thank you for standing by. (Operator Instructions) Today’s call is being recorded. If you have any objections, please disconnect at this time.

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

Naomi Kleinman

Good morning, and thank you for joining us. I’m going to start with the required disclosures; and then turn it over to Jim Wehr, our President and CEO, for an overview of the quarter. With us today are Peter Hofmann, Chief Financial Officer; Chris Wilkos, Chief Investment Officer; Phil Polkinghorn, Senior Executive VP 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 filing. Our actual results may differ materially from such forward-looking statements.

In addition to generally accepted accounting principles, we use non-GAAP financial measures to evaluate our financial results. Reconciliations of these non-GAAP financial measures to the applicable GAAP measures are included in our press release and financial supplement.

Now, I’ll turn the call over to Jim.

James Wehr

Thanks, Naomi, and thanks to everyone for joining the call. Hopefully everyone has had an opportunity to review our earnings release this morning, so I won’t repeat what you’ve already read. But I do want to use a few of the bullet points from the release as a jumping off point for my remarks. Peter Hofmann and Chris Wilkos will then provide a more detailed discussion of our results following my remarks. In addition, we will try to provide some enhanced transparency into the quality of our in-force business and balance sheet, as well as our plans for growth as we head into 2012.

Let’s start with our results. This past quarter was further tangible evidence of how we are building sustainable value here at Phoenix. We delivered significant improvement on both net and operating income. Statutory surplus grew and estimated risk based capital remains over 300%. Our investment portfolio held up despite the equity market and interest rate challenges with further growth in unrealized gains and impairments remaining relatively low.

Our aggressive expense management continues. And perhaps of greatest importance, our growth initiatives have traction, and are beginning to fulfill our profitable growth objective, one of the four strategic pillars I laid out more than two years ago. While we all know our efforts here at Phoenix must continue with energy and focus, we are proud of the fact that we’ve come a very long way. However, that progress is not reflected in our share price.

I know everyone on this call understands the battering financial services and insurance stocks have taken, and we’ve seen an even greater impact on our stock. I’ve always believed that valuation follows results, so I firmly believe it’s time for the market to recognize the very real and sustainable progress here at Phoenix and the transformation of our company into a viable and promising enterprise.

When I’m out visiting with shareholders and analysts, I hear concerns about balance sheet and capital issues, risk in our investment portfolio, expense levels, older-age and (inaudible) risk in our UL block, growth prospects, et cetera. Let me address these concerns. First, our balance sheet is very sound. We continue to generate capital at a healthy pace. As I said earlier, RBC continues above 300%; this quarter at 309%.

Statutory surplus continues to grow, now at $864 million, up 13% from year-end 2010 and up more than 50% from year-end 2009. Further evidence of the soundness of our balance sheet is the $1.4 million DAC unlocking charge we took this quarter. This relatively modest charge is a result of both active product management and increasingly refined assumptions as experience emerges.

As for our investment portfolio, despite the low interest rate environment, we are generating solid returns. Importantly, our portfolio is very well positioned with improved credit quality, very low impairments and market value that is more than $500 million in excess of book value. When it comes to our expense base, I encourage you to focus on the results in our news release and presentations. We continue to right size our infrastructure and carefully manage expenses. This quarter, our core operating expenses were 13% lower than the same period last year.

We also continue to look for other ways to make Phoenix more efficient. And this past quarter, we entered into a multi-year agreement with Conning to manage our publically traded fixed income general account assets. This transaction provides capable resources to maintain quality investment performance while reducing cost. Since our significant expense reduction efforts began at 2009, we have continuingly reduced our expense base. Those actions, along with additional targeted reductions, should enable us to reduce expenses by $10 million in 2012, and an additional $10 million in 2013, while continuing to invest in growth initiatives and simplifying policy administration.

In terms of our more recent vintage UL blocks, we’ve managed these blocks through a combination of cost of insurance and legal remedies. As experience has emerged, mortality continues to be good in this block demonstrating a long-standing strength of Phoenix; our underwriting capability. In sum, when it comes to these UL blocks, we are confident we know what the risks are and can manage those risks.

Now, let’s look at growth. Back in 2009 when I became CEO, I said one of our strategic pillars was going to be profitable growth. Profitable, not just growth for top-line sake. Our continuing strong annuity sales demonstrate this approach. Annuity deposits increased again this quarter to $279 million. Although, we made some pricing changes at the end of the third quarter, we expect to continue to see significant annuity deposits going forward.

Looking ahead to 2012, we expect a $250 million to $350 million quarterly run rate. As you heard from Phil on last quarter’s call, this is profitable business. We are able to be interest rate sensitive with appropriate and timely adjustments, thus maintaining healthy margins.

Saybrus Partners, which continues to make progress in both third-party and Phoenix product sales, posted a profit at this quarter. While still modest from an overall revenue perspective, we believe achieving profitability here shows that the model works. We expect Saybrus to produce a growing level of profits, which will provide additional liquidity and flexibility to our holding company going forward.

Finally, I want to address this growth within the context of our capital position. As I said, we continue to generate capital. Having been where we’ve been, I can assure you we are extremely careful and thoughtful with our capital. As our annuity business and Saybrus demonstrate, we are committing capital where it generates shareholder value today and into the future.

To sum up, we are going to bring these messages to the marketplace. It is time Phoenix shares reflect what has been accomplished over the past couple of years, the results we are posting currently and our potential going forward. We are strong organization, well positioned to handle headwinds, as well as benefit from potential tailwinds.

Thanks, again, for confidence in Phoenix. And now, let me turn it over to Peter to amplify some of my comments. Peter?

Peter Hofmann

Thank you, Jim. I’m going to start with the review of the quarter, and then provide some of the facts around each of the items Jim mentioned: the quality of our balance sheet, our focus on expense management, the profitability of our new business and our approach to capital management.

I’ll start with the quarter for which highlights are shown on slide three. GAAP operating earnings, excluding tax benefits and a modest DAC unlocking, were $21.4 million, or $0.18 per share, and GAAP net income was $31.8 million.

The main driver of these results was favorable mortality, which more than offset the negative effects of the equity markets and low interest rates. Other fundamentals, specifically expenses and persistency, also contributed positively.

A more detailed earnings summary is shown on slide seven. Pre-tax income for the open block was $7.7 million, a significant increase from prior periods. Open block revenues decreased from the second quarter, driven primarily by lower fee and net investment income, modestly offset by higher premiums. Benefits largely reflect lower mortality versus the second quarter, offset by an unlocking impact and higher living benefit reserves.

Last quarter, we indicated that expenses were likely to increase as a result of the policy administration agreement with Infosys. And we did incur approximately $3 million of conversion related costs this quarter. And we expect to incur similar amounts in each of the next four quarters before we realize the full cost savings associated with this initiative.

However, we were able to more than offset this incremental cost through reductions in other outside services, including our legal, actuarial and IT expenditures. The regulatory closed block contributed $12.3 million consistent with the glide path of the block established at the time of the demutualization. Based on this glide path, closed block pre-tax income will step down in 2012 to approximately per quarter.

Realized investment gains includes $8.4 million of credit impairments, offset by an $8.8 million gain on our surplus hedge. On an economic basis, our variable annuity hedge program had losses of $6.9 million. High equity market volatility coupled with very low interest rates caused the loss. We’ve stuck to our three Greek discipline and re-balanced our hedges. These adverse economics were overshadowed by a large gain due to the non-performance risk factor. In discontinued operations, we recognized a modest increase in reserves reported to us by certain seeding companies in our accident and health re-insurance blocks.

Slide five highlights the trends in operating income and spikes out discreet items that affect period-to-period comparisons. In addition to the unlocking, there was a $9 million tax benefit, which was driven primarily by NOL offsets to the alternative minimum tax payment made earlier in the year.

Looking ahead, as long as we maintain our valuation allowance and our statuary earnings remain strong, we expect to incur the alternative minimum tax. The AMT typically would not result in a GAAP tax expense. However, as long as we maintain a full valuation allowance on DTAs, it will translate into GAAP expense even though we will be accumulating AMT credits to offset future taxes.

Our best estimate is that this will translate into an effective GAAP tax rate of about 20% in 2012, very likely that actual expenses recorded in any given quarter will vary, but this is our current best estimate.

Turning to our insurance fundamentals, slide six shows mortality cost ratios for the open and closed blocks. The open block trend has been favorable to expectations in each of the past five quarters, which we believe at least partly reflects the quality of our underwriting. But you can see that it can also be quite volatile, so we will almost certainly experience unfavorable quarters from time-to-time.

Experience in the closed block was unfavorable in the quarter, even when you factor in the gradual aging of the block. As a reminder, however, because we have policy – positive policyholder dividend obligation, closed block mortality experience does not affect our GAAP earnings.

Turning to slide seven, surrenders generally remained at the improved levels we have seen so far this year. Annualized life surrenders were at 7%, an increase of 6.1% from last quarter. The increase was primarily the result of scheduled surrenders and a large corporate-owned life insurance case in the closed block.

Annuity surrender levels were at 11.3% for the quarter. This reflects the combination of our older variable annuity block, which have somewhat higher surrenders, and lower surrender levels in the recently sold fixed index annuity business.

Statutory results, as shown in the context of the RBC on slide eight. While surplus increased modestly, the September 30 estimated RBC of 309% decreased slightly from the second quarter estimate of 315%. This was mainly due to higher risk charges for equity market and interest rate risk.

Looking at the year-to-date components, the message continues to be the same as we have emphasize over the last several quarters: capital generation from the core business, coupled with risk reduction in the investment portfolio and supplemented by a positive impact from equity markets year-to-date. The headwind to these positives is also clearly visible on the slide: increased interest rate risk driven by the low interest rate environment. I should note that the interest rate component is an estimate, and is not fully calculated until year-end.

Let me turn from the quarterly details to the value drivers Jim highlighted in his opening comments. These are summarized, again, on slide nine, and I will discuss each in turn. Slide 10 includes quite a bit of detail, but it is important in the context of the significant discount-to-book value at which Phoenix is currently trading. We’ve taken the September 30, balance sheet and highlighted key categories, in essence dissecting the book value per share of $10.67 into its component parts.

First, I’ll only briefly touch on the investment portfolio because Chris is going to review this in more detail. The portfolio has swung dramatically into an unrealized gain position while the risk has been brought down and impairments have moderated to levels in line with long-term expectations.

Second, by industry standards, our DAC asset is large relative to shareholders’ equity. Nevertheless, we believe it is fully supportable based on reasonable assumptions. This is validated by our third quarter unlocking analysis, and the review of our deferral practices has part of the new DAC accounting rules. More on DAC in just moment.

Third, deferred taxes. As a reminder, we have a full valuation allowance against all deferred tax assets, except those that are created by and will also automatically reverse with unrealized investment losses. In other words, no value is reflected on the balance sheet for NOLs or capital loss carry forwards.

On the liability side of the balance sheet, first a reminder that the closed block accounts for more than 60% of policy liabilities, and this includes a cushion from the policyholder dividend obligation of $60 million against adverse experience in the block. The open block policy liabilities include basic account values, but also include SOP reserves that are subject to the same annual assumption unlocking process as our DAC asset.

Next is our debt, which is very long-dated and, thus, represents no near-term refinancing risk. Within other liabilities, we have both a qualified and a non-qualified pension plan. Both were frozen in 2010, and no further benefits are accruing. For the qualified plan, which is a funded ERISA plan, we are in the process of implementing a glide path management program, which will put the plan on a disciplined path to being fully funded.

We do expect to make ongoing contributions, but by implementing this program, which will include daily revaluations of both the assets and the liabilities, we expect to minimize the volatility of contributions needed to fund the deficit. The non-qualified plan is unfunded, and while the liability is significant, especially in the current low rate environment, both this plan and other post retirement benefits are funded on a pay-as-you-go basis, with very manageable annual benefit costs.

Slide 11 gives some detail on our DAC asset. This quarter, we conducted our annual comprehensive review of actuarial assumptions used to support DAC, as well as certain reserves. The overall net impact was a pre-tax reduction of $1.4 million. We reviewed all major assumptions embedded into DAC schedules, and updated them for current market conditions and experience.

I’ve highlighted some of the market assumptions on this slide. As I indicated, we believe these are appropriate, and the DAC asset is fully supportable. This slide also shows a year-over-year view of the DAC asset by product segment. The universal life balance is amortizing rapidly into equity. At the same time, we are adding new deferrals from fixed indexed annuity sales. But I would emphasize that other than commissions and sales inducements, we are deferring minimal expenses related to this product.

We’re in the process of implementing the new DAC accounting guidance. Our preliminary estimate is that approximately $140 million to $190 million of our DAC balance relates to costs that would not have been deferrable under the new guidance. And we will write those amounts off through equity.

This will have the effect of further improving the recoverability of the asset and reducing our ongoing amortization. At the same time, we don’t expect any reduction in amounts we are currently deferring, so we currently estimate an annual benefit to earnings of $16 million to $24 million, grading down over time.

Turning from the balance sheet to earnings, and in particular expenses, here, too, we have made significant progress and are focused on further improvement. As shown on slide 12, since 2008, we have reduced expenses by about a third, excluding GAAP items such as pension expense and deferrals, which have also come down dramatically.

The breakdown shown on the pie chart provides our estimate of cost per policy maintenance, new business activities, and infrastructure and overhead. We believe our per policy maintenance expense is above industry averages, and we’re taking steps to address this, including through the arrangement with Infosys.

We expect our expenses related to new business activities to be approximately $40 million, split roughly evenly between Saybrus and our fixed-index annuity product effort. As Jim mentioned, Saybrus did cross breakeven this quarter, and I’ll discuss the fixed-index business in a moment.

Finally, the largest ongoing cost is infrastructure and overhead. We continued to address this systematically but with urgency. Simplifying our policy administration and technology environment, improving financial and other operations and managing our legal and compliance costs are some of the key areas of focus.

Our near-term target, which is net of the roughly $12 million we expect to spend on the conversion to Infosys in 2012, is to realize expense savings of $10 million in 2012 and then $20 million by 2013, over the 2011 full year expenses.

Slide 13 summarizes our new business profitability. Annuity deposits were $279 million in the third quarter versus $39 million a year ago. And the new sales were primarily in fixed indexed annuities.

The declining interest rate environment has presented headwinds for this product. But the business we have written has been profitable. The overall estimated embedded value created by sales in the first nine months is a relatively modest $4 million.

Our overall achieved spread on the $633 million of fixed index annuity deposits included in the total amounts in the slide so far this year has been 235 basis points. We’ve actively managed the product. And as Phil pointed out in his presentation last quarter, have changed product features and pricing more frequently than other competitors.

Our most recent product changes went into effect at the beginning of October. These changes may slow sales somewhat in the second half of the fourth quarter, but they were appropriate for maintaining profitability and managing to our capital budget.

And on that note, let me end with some comments on capital management on slide 14. The headline here is that the management team is extremely focused on capital manage and how it relates to shareholder value. Our 2012 annuity sales target does not represent significant growth off of the fourth quarter run rate. It is limited by and explicit statutory capital budget, which itself is subject regular review and adjustments as results emerge.

Given Phoenix’s current ratings, we need to manage capital versus growth and profitability; all three are necessary for building upward momentum in ratings. And in that context, our current estimated RBC is adequate but not excessive. The primary near-term risks to capital continue to be the interest rate environment and equity markets with potential portfolio defaults and mortality losses factoring into the medium-term outlook. The principal opportunities for managing those risks include hedges and reinsurance of in-force blocks, as well as new business growth.

Finally, we are cautiously balancing holding company liquidity against capital constraints. Liquidity at the holding company provides superior financial flexibility. Until Saybrus begins to generate free cash, our primary source of liquidity for the holding company is the annual permitted dividend from Phoenix Life.

With that, let me turn it Chris for comments on the investment portfolio.

Christopher Wilkos

Thanks, Peter. As Jim described, our investment portfolio held up well despite the down equity market and interest rate challenges. Let me start with investment income, which is summarized on slide 15.

Net investment income declined quarter-over-quarter, primarily due to lower alternative asset returns. Some partnership investments were hurt by the market volatility and negative returns in the quarter, while private equity income declined due to weak performance in one partnership. On the positive side, long-term debt investment income was nearly flat quarter-over-quarter in spite of sharply lower treasury rates.

Let me turn to credit impairments on slide 16. Although credit impairments increased during the quarter to $8.4 million following a sharp drop in the second quarter, on a year-to-date basis they are less than half the level seen in 2010. These impairment levels remain below our long-term assumption for credit losses. Impairments in the quarter were driven by an additional mark-to-market impairment on a European bank trust preferred, which has deferred its coupon and small impairments on three CMBS, Re-REMIC and CDO transactions.

Impairments in the RMBS segment remained muted, and there were no impairments in our CLO holdings for the second consecutive quarter as that segment of the portfolio has performed well. And insignificantly, there were also no impairments in our $3 billion plus holdings on private placement bonds. We’ve spoken about the protective covenants and private bond holdings. And those covenants have benefited the portfolio in terms of reducing impairments, and often forcing the early redemption at par of potentially trouble credits.

As you can see on slide 17, portfolio quality improved in the quarter as the percentage of below investments declined from 8.5% to 7.6% on total bonds. The majority of the decline was driven by net upgrades in the portfolio, especially in the CLO segment. We also had a negotiated repayment of a CCC rated private placement bond where we received full repayment plus a prepayment fee. The remainder of the decline was due to lower prices for high yield bonds compared to the appreciation in the remainder of the portfolio.

Our investment policy range for high yield bonds is 6% to 10% of the portfolio, and we are comfortable with our current position. Overall portfolio quality is at the highest level since 2007. Given the market volatility in the past six months, we thought it would be illustrative to show the strength in our portfolio heading into any potential economic weakness or continued market volatility. The five metrics on slide 18 amply demonstrate the significant improvements in our portfolio and balance sheet over the past three years.

Portfolio market value now stands at 105% of book value, rebounding from a low of less than 86% of book value at the end of 2008. This improvement in market value over the past several years has allowed us to reduce our high yield holdings with minimal loss, reduce our highly liquid assets and better manage our asset liability profile. As described previously, we have reduced our below investment grade bond holdings from a peak level of nearly 11% of bonds, down to only 7.6% of bonds. This reduction was accomplished in a measured manner without incurring unnecessary capital losses.

Credit impairments have dropped substantially given the improvement in the economy and the strength of our portfolio. Our structured bond holdings are highly rated and concentrated in senior and super seniors rated securities, and the market value of those bonds has appreciated substantially since the end of 2008.

In September, Phoenix entered into a multi-year investment agreement with Conning, a leading provider of asset management services to the insurance industry. Although some of you may already be familiar with Conning, I want to give a brief overview of the firm and a summary of our transaction with them.

As you can see on slide 19, Conning has been managing insurance assets for nearly three decades. With $77 billion under management, they are one of the leading insurance asset managers with 115 life and property casualty clients.

Conning manages the full spectrum of fixed income asset classes. When it comes to service and performance, Conning ranks in the top decile in client satisfaction. The transaction consists of two parts. Phoenix will be selling Goodwin capital advisors to Conning, and simultaneously entering into a multi-year investment management agreement for public fixed income.

Goodwin is Phoenix’s wholly owned fixed income manager, managing both insurance assets and institutional assets for third-party clients. The overall management of the insurance assets will continue to be done by my corporate portfolio management staff and me. We are also retaining our private placement bond and alternative investment capabilities at Phoenix. Our private placement staff has generated consistently superior results.

I will continue to work directly with the current Goodwin general account portfolio manager who is moving to Conning along with 10 other Goodwin professionals. That continuity, along with access to a broader credit analysis team, makes us confident at the portfolio management process will continue to add value for Phoenix.

The transaction is on a schedule for a close in the second half of November. There is modest consideration at the time of closing with the potential earn-out on the existing third-party institutional and general account assets if certain parameters are met. The transaction will result in a modest annual cost savings on an ongoing basis.

Jim and I have worked with or known many of the key Conning principles who are based near us in Hartford for many years. Their philosophy in managing insurance assets and their culture are very similar to Phoenix’s. The combination of proximity, philosophy and culture make us highly confident that the partnership will be beneficial to the Phoenix portfolios.

With that. I’ll turn the call back over to Jim.

James Wehr

Thanks, Chris. Before we move to questions, I’d like to summarize some key takeaways from this morning’s call. First, we had a good quarter in what was a very challenging external environment. Earnings, statutory capital, portfolio market value and quality and mortality all improved sequentially.

Second, we are seeing continued progress from our growth initiatives with Saybrus reaching profitability and strong middle market annuity sales.

Finally, we, like most of our shareholders, are frustrated with our share price performance. While we believe that ultimately our progress will be recognized by the market, we felt it was our responsibility to directly address concerns and doubts in the marketplace with facts that demonstrate our progress and potential.

We appreciate your participation on this morning’s call, and we’ll take your questions now.

Question-and-Answer Session

Operator

Thank you, sir. (Operator Instructions) Our first question comes from Andrew Kligerman with UBS. Your line is open.

Andrew Kligerman – UBS

Hey, thanks a lot. Good morning. Couple of – a few questions. First, with regard to the equity index annuities. Could you clarify the change that you made in the pricing at 3Q end?

James Wehr

So, okay you want to start there? Andrew, I’m going to ask...

Andrew Kligerman – UBS

Yeah, and then I’ll follow-on with the follow-on questions.

James Wehr

Great I’m going to ask Peter to start there and – okay. You know, I’m going to turn it to Phil Polkinghorn. Phil?

Philip Polkinghorn

Great, Andrew. Sure. There were a number of changes that we made. We adjust the credited rates on a pretty regular basis. But in early October, we also made some targeted reductions in commission levels in certain spots, and we also reduced the guaranteed income available on a number of the guaranteed minimum withdrawal benefit riders that can be attached to those products.

Andrew Kligerman – UBS

Got it. And so, the sales were about $279 million. That was a big jump up in the volume. And it’s in a very, I understand to be a very competitive market. So, maybe you can talk to me about what the returns are on the products you’ve just changed the pricing on, and what you might expect to be your returns going forward. But if I -I just hear so many things about the competition in the EIA environment.

James Wehr

Yeah, so the – I think Peter had some data that gave you the return levels on the overall $633 million for the year. And one of the things that we talked about last quarter was the general price stickiness in that market, and how we’ve been changing the price a little bit more frequently. So, obviously, if you’re price is stable over a quarter and interest rates are changing daily or weekly, your margin is changing daily or weekly. And that’s why we’ve tended to change more frequently is to keep up with the general down draft in interest rates. And so, the numbers Peter gave you were sort of an amalgamation and sort of an average margin over the entire $633 million.

If you looked at it weekly, it would bounce around a little bit. But it’s all averaging out to that 235 basis spread, which is – that’s a spread after a provision for a long-term default rate, which we’re not seeing it now, but we sort of quote it that way. So, as you approach the sort of the end of the third quarter with interest rates down and the old pre-October prices, the margins were getting thinner, and that’s why we made the changes.

Peter Hofmann

Overall, I would say, Andrew, that while we were generating positive embedded value, we were not hitting our target spreads. And so, that’s why we changed the price. And so, that goes to Phil’s comment.

Andrew Kligerman – UBS

Okay. And Peter, the targeted spread does not encompass the commission component, correct?

Peter Hofmann

It does – well, the spread is...

Andrew Kligerman – UBS

It excludes commission (inaudible)

Peter Hofmann

Targets and amortizes the commission and partially to cover overhead and profit.

Andrew Kligerman – UBS

Okay. And then, shifting over to the infrastructure. And as I looked at that pie chart on slide 12, it’s roughly north of a quarter of revenues today. And if you would take out $20 million of expense over the next two years, that might reduce it by maybe two, three percentage points. I think competitor ratios on those metrics are significantly lower. Could you give a sense of maybe longer-term how much further you can go? I mean, it would strike me that there might be another $30 million, $40 million, $50 million there. Is that possible?

James Wehr

Well, Andrew, we’ve committed, as you heard on today’s call, to $20 million by the end of 2013. So, $10 million in each of ‘12 – realize $10 million in each of ‘12 and ‘13 getting to a total of $20 million by the end of ‘13. Can we go further than that? There’s the potential. You know, I think you’ve seen in each of the last three years our expense base has been coming down. Can we get to the numbers that you’re referencing? I can’t say that definitively right now, but I wouldn’t rule it out. And expense management and expense reduction is something we’re very conscious of because we need to be competitive.

Andrew Kligerman – UBS

Got it. And then, lastly, Jim, you know, I wouldn’t – it wouldn’t be usual for me to not ask about M&A. And my question to you would be given your share price, which, you know, repeatedly on the call mentioned was at, you know, what I think and you think to be very much a sub-par level, have you gotten any material – have you received any material offers? And what are your thoughts if you have received those offers?

James Wehr

Well, Andrew, we don’t comment on rumors, but I guess I’d give kind of the standard response I have given to this question in the past, and that is that we believe we have a solid future. I’ve already addressed, I think, the disappoint in our share price. I will say, and I have said previously, that the Board will always consider what is the best interest of shareholders and policyholders. But beyond that, I can’t comment.

Andrew Kligerman – UBS

Okay. I mean, just putting it one other way, and I’ll take whatever response you give me on it; but assuming the stock stays at this inappropriately low level, you know, would there come a point where you really feel like you need to accept or more strongly consider an offer just given that shareholders don’t seem to understand the value in this company?

James Wehr

Well, I think, Andrew, that the answer to that is primarily embedded in the response I just gave you and lot of the information we provided today. We’re very frustrated that our share price doesn’t reflect what we’ve done, what we’re reporting currently and, I think, the potential going forward. We’re trying to articulate that story as effectively as possible. Regarding what might happen down the road and how the Board might do it is hard for me to respond to beyond what I’ve said previously and I’ll continue to say, which is that our Board is very interested in shareholder interest and shareholder value, and would have to consider very seriously anything put in front of them.

Andrew Kligerman – UBS

Thanks a lot, Jim.

Operator

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

Robert Glasspiegel – Langen McAlenney

Good morning, everyone. I’ve got a bunch of miscellaneous questions. Where are your – remind me where your index annuity sales are going in customers. What markets you selling them into?

Philip Polkinghorn

It’s largely middle market customers sourced through independent agents who do business with independent marketing organizations.

Robert Glasspiegel – Langen McAlenney

Okay, thanks. Phil.

James Wehr

Do you want to give a couple of examples.

Philip Polkinghorn

Sure. I don’t know if the names of the firms would mean much but Amerilife, Dallas Financial, Gradient – some large and mid size independent marketing organizations who write multi-carrier. A lot of their business is focused on the fixed indexed annuity marketplace. Some will also have lead generation programs for the agents and do other products, but our focus has been fixed indexed annuities.

Robert Glasspiegel – Langen McAlenney

Okay. Peter, your DAC charge, is that after tax or pre-tax?

Peter Hofmann

It’s pre-tax.

Robert Glasspiegel – Langen McAlenney

So, any thoughts on how we...

Peter Hofmann

Are you talking about the accounting adoption or the...

Robert Glasspiegel – Langen McAlenney

Right. The $140 million to $190 million number that you threw out?

Peter Hofmann

That would be the reduction in the back balance of pre-tax. In our current valuation allowance regime, there would not – we wouldn’t expect a tax offset to that.

Robert Glasspiegel – Langen McAlenney

That’s the number that will hit book value?

Peter Hofmann

In our current regime, yes, unless something changes around the valuation allowance.

Robert Glasspiegel – Langen McAlenney

Okay. Color on the pension contribution, what order of magnitude might it be, just rough range?

Peter Hofmann

I think it’s on the slide, expect to divest about $17 million next year.

Robert Glasspiegel – Langen McAlenney

Okay.

Peter Hofmann

But that will be recalculated regularly, obviously.

Robert Glasspiegel – Langen McAlenney

Yeah. I think that does it. Thank you.

Peter Hofmann

All right.

James Wehr

Thanks, Bob.

Operator

(Operator Instructions) Our next question comes from Steven Schwartz with Raymond James.

Steven Schwartz – Raymond James

Hey, good morning, everybody. I’ve got some miscellaneous as well. Jim, I apologize. I got on late. I think you might have been making a comment about secondary guarantee universal life, but I’m not 100% sure of that.

James Wehr

I was not.

Steven Schwartz – Raymond James

You were not. Okay. That settles that question. Peter, I want to follow-up on Andrew’s question with – on returns on the FIA block of business. Unfortunately, I don’t speak European; and, therefore, I’m not quite sure what to make of the embedded value you put out there. Could we possibly hear a number more along the lines of return on capital?

Peter Hofmann

Well, let’s – so the embedded value is the present value of the future profits using marginal expense discounted at 10% in this case. So, that’s just the definition of that number. In terms of if you think about the GAAP results, we have that 235-basis point spread. We probably have about half of that spread that we utilize to amortize the DAC.

Steven Schwartz – Raymond James

Okay.

Peter Hofmann

So, that leaves the remainder for overhead and profits. And that’s sort of maybe a pre-tax ROA type of metric as opposed to ROE.

Steven Schwartz – Raymond James

Right. Right.

Peter Hofmann

So then, you put that number over the capital committed to it, and we use as a proxy the amount that was deferred.

Steven Schwartz – Raymond James

The commission, you mean?

Peter Hofmann

The commission.

Steven Schwartz – Raymond James

Okay, primarily. Okay.

Peter Hofmann

That would get you in sort of ROE, return on capital, kind of...

Steven Schwartz – Raymond James

Okay. I appreciate that. And then, just as a follow-up, something I didn’t quite understand with regards to your planning on cost cutting the $10 million going to $20 million and then Infosys. So, this ignores – you’ve got $12 million or so of expenses, I guess, over the next four quarters, but it ignores that and it ignores that in 2013. So, the savings would be even greater in 2013 because you’d be losing $12 million of expenses?

Peter Hofmann

That’s right.

Steven Schwartz – Raymond James

Okay. So, I got that right. All right. Thank you, guys, very much.

James Wehr

Thanks, Steven.

Operator

Thank you. At this time, sir, I’ll turn the call back over to Mr. Wehr.

James Wehr

Well, I’d like to thank everyone for their time and attention today. Looks like we’re finishing a few minutes early. That’s – I guess that’s always a good thing for everybody. So, have a good rest of your day. Thank you.

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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