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Executives

Jim Sjoreen - Investor Relations Professional

Randal J. Freitag - Chief Financial Officer and Executive Vice President

Dennis R. Glass - Chief Executive Officer, President, Director, Member of Executive Committee, Member of Committee on Corporate Action and Head of Lincoln Financial Distributors

Analysts

Jay Gelb - Barclays Capital, Research Division

Thomas G. Gallagher - Crédit Suisse AG, Research Division

Suneet Kamath - Sanford C. Bernstein & Co., LLC., Research Division

Robert Glasspiegel - Langen McAlenney

Edward A. Spehar - BofA Merrill Lynch, Research Division

Christopher Giovanni - Goldman Sachs Group Inc., Research Division

John M. Nadel - Sterne Agee & Leach Inc., Research Division

Jamminder S. Bhullar - JP Morgan Chase & Co, Research Division

Lincoln National (LNC) Q3 2011 Earnings Call November 3, 2011 1:00 PM ET

Operator

Good afternoon, and thank you for joining Lincoln Financial Group's Third Quarter 2011 Earnings Conference Call. [Operator Instructions] At this time, I would like to turn the conference over to Senior Vice President of Investor Relations, Jim Sjoreen. Please go ahead, sir.

Jim Sjoreen

Thank you, Tyrone. And good afternoon and welcome to Lincoln Financial's Third Quarter Earnings Call. Before we begin, I have an important reminder. Any comments made during the call regarding future expectations, trends and market conditions, including comments about liquidity and capital resources, premiums, deposits, expenses and income from operations, are forward-looking statements under the Private Securities Litigation Reform Act of 1995. These forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from current expectations. These risks and uncertainties are described in the cautionary statement disclosures in our earnings release issued yesterday and our reports on Forms 8-K, 10-Q and 10-K filed with the SEC.

We appreciate your participation today and invite you to visit Lincoln's website www.lincolnfinancial.com, where you can find our press release and statistical supplement, which include a full reconciliation of the non-GAAP measures used in the call, including income from operations and return on equity, to their most comparable GAAP measures.

Presenting on today's call are Dennis Glass, President and Chief Executive Officer; and Randy Freitag, Chief Financial Officer. After their prepared remarks, we will move to the question-and-answer portion of the call. And with that, I would now like to call -- turn the call over to Dennis.

Dennis R. Glass

Thanks, Jim, and good afternoon to everyone. We produced another quarter of very strong operating results with increases in operating income, operating revenues, deposits and flows, particularly good momentum in our Group Protection and Defined Contribution businesses. Highlights in the quarter include sales increases and positive net flows in nearly every business, resulting in $5.5 billion of deposits and $2 billion of bonds net flows. A 6% increase in operating revenues and a 54% increase in income from operations. Also, we accelerated our capital management activities which, year-to-date, includes $375 million worth of shares repurchases. On a net basis, our results this quarter were affected by abnormally volatile [ph] markets and other atypical items. Randy will go into these in more detail in a moment. Low interest rates and capital market volatility continue to drive headlines for this industry. As we've shared previously, although sustained low interest rates would impact the rate of earnings growth for Lincoln over time, we do not expect low rates to materially affect the balance sheet. Importantly, given low rates, we have taken and continue to take decisive action across the organization to protect aggregate margins. For example, as discussed earlier this year, we entered into $1.3 billion of Treasury locks with an implied yield of 6.45% and extended the duration of the life portfolio. We are actively repricing products as needed to reflect market conditions. We are making strategic investments to grow revenues and earnings. We are taking risk out of the organization and actively managing expenses. We intend to cover several of these topics in more detail at our upcoming investor meeting.

Now, turning to the highlights from our underlying businesses. Sales in our life business were up 4%, driven by our comprehensive portfolio of products and multiple distribution channels strategy. We continue to advance our life offerings in the quarter by improving the competitiveness of our indexed UL product to take advantage of the growing market for these products. Our strategy of maintaining a broad product portfolio and investing in unrivaled distribution has made Lincoln the #1 or 2 life provider in our top distribution firms. In our Annuity business, DA sales were up 7%, while fixed sales were off given low interest rates. Our consistent approach to this business continues to resonate with advisors and consumers and recent product enhancements such as the guaranteed lifetime withdrawal benefit on our fixed product and a new fee-based variable annuity for the Registered Investment Advisor market are already gaining traction and should add results in coming quarters. We had a healthy production quarter in Defined Contribution with a 15% increase in deposits, positive net flows for the quarter and now, positive net flows for the year. We continue to gain momentum in this business as our investments in distribution, technology and marketing come online. Distribution expansion in both mid-large and small-case segments has propelled sales and pipeline development for this business.

Our Group Protection business experienced significant momentum, including a 7% increase in nonmedical net earned premium and a 9% increase in sales. We were pleased to see loss ratios stay inside our target range as actions we've taken including pricing changes on new and renewal business and claims management strategies have led to better results. We launched a critical illness product this quarter to round out our voluntary offerings and we continue to evolve the distribution force to align the organization, for increased productivity and position Lincoln to be a leader in the voluntary benefits market. We continued to successfully achieve our distribution goals by leveraging the combined strength and reach of our wholesale and retail distribution systems. At LFD, we boosted sales by 8% among our Top 20 strategic distribution partners year-to-date and we continue to see increases in the number of advisors recommending Lincoln products and in wholesaler productivity in most product lines. Wholesaler expansion efforts this year for MoneyGuard, small case 401(k), and mid-large retirement plans are mostly complete. Lincoln Financial Network continues to execute on its growth strategy by retaining top-level financial planners and attracting experienced recruits. LFN has increased net active producers to more than 8,000, which helped LFN to meaningfully contribute to Lincoln's sales results in the quarter. Our healthy capital and liquidity levels give us a surplus of strength that we are using to support our strong ratings and to cushion the company from possible event risk consequences, including the evolving situation in Europe. For the record, we have almost no direct exposure to European sovereign debt and limited exposure to European banks. Our high risk base capital levels are in part the result of general account management actions to de-risk the investment portfolio by rotating into higher quality assets. In terms of capital management, as I mentioned earlier, we have completed $375 million of share repurchases and we are not done for the year.

Overall, I am pleased with the underlying strength of the company, the actions we are taking to navigate the environment and our solid momentum in key earnings drivers. With that, I will now turn the call over to Randy for more details on earnings and the balance sheet. Randy?

Randal J. Freitag

Thank you, Dennis. Last night, we reported income from operations of $317 million or $1 per share for the third quarter. Earnings benefited from continued top line growth with operating revenues up 6%, disciplined expense management where the expense ratio declined to 9.3% and continued share repurchase $150 million during the quarter. Return on equity was up nicely to 10.2% while normalized earnings were in line with reported earnings. Book value per share, excluding AOCI grew 10% to $41.27 per share and their overall capital position continue to strengthen with statutory capital expanding to $7.6 billion, with a risk base capital ratio of approximately 500%, after payment $250 million dividend for the holding company. Cash of the holding company ended the quarter at $770 million. Of note, our net unrealized gain before DAC [ph] and tax grows to $6.2 billion, with $3.2 billion attributable to the life segment. I mention this because there tends to be a focus only on the liability side with the balance sheet, when thinking about the impact of low rates. The unrealized gain is the other side of that equation and is evidence of the strong ALM discipline, which our businesses operate with. We completed our annual review of assumptions in the quarter. In total, the impact of unlocking during the quarter was minimal. Looking at this by segment. Life results were negatively impacted by $8 million, the most significant item of note in the life unlocking was a resetting of new money rates to current levels, which negatively impacted results by $26 million. Annuity results were positively impacted by $8 million, including a $30 million benefit from a reduction in our ultimate last rate assumption. Some of the annuity assumption changes also impacted net income, which I will touch on in a moment. DC and Group Protection experienced little impact from unlocking. Net income was impacted by a number of items during the quarter, which fell primarily into 2 categories, investments and results in our annuity hedge program, both a reflection of extreme volatility in the quarter. Net realized losses and impairments totaled $28 million, driven largely by non-agency RMBS as the volatility in the housing market persists. Additionally, in the investment portfolio, we had a $69 million negative impact from mark-to-market assets, primarily in our credit linked note holdings. The underlying collateral experienced widening credit spreads. I view this as noneconomic, in fact we received an upgrade in the rating of 1 of our 2 credit linked note holdings during the quarter, and have seen some recovery in value during October. The hedge program results included a negative impact of $72 million, driven by the reduction in our ultimate lapse rate assumption. We also experienced $83 million of breakage in the hedge program primarily from 2 sources. Fund spaces risk was roughly half of the impact. I would expect to get this back over time has been our experience with this item. The balance of the breakage was due to extreme volatility in the capital markets. The variable annuity hedge liability increased $2.5 billion during the quarter, and the hedge program was very effective covering well over 90% of the increase, which is above the assumption we assume when pricing. Offsetting these 2 items, the MPR adjustment was $92 million. In the steps supplement this quarter you will find a revised Page 6 which clearly details all of the above items. Finally, we recorded a $14 million negative impact from the finalization of taxes on the sale of Delaware, and a one-time impact from calling a debt security.

Turning to segment results and starting with annuities. Earnings during the quarter came in at $162 million or $132 million after normalizing for taxes and unlocking. Operating revenues were up 8% on an 11% increase in average account values over the prior year. Strong equity market performance in October should offset the headwind created by the fact that quarter and account balances were about $4 billion lower than the third quarter average. In our Defined Contribution business, we had a very good quarter, with earnings coming in at $41 million. Variable revenues and account values increased year-over-year in line with the markets, roughly 7%. While spreads held relatively steady at just under 230 basis points. And the pre-tax margin in the quarter came in at 22% comparable to last quarter. Turning to our Life Insurance segment, I told you on last quarter's call that there would some line item noise in Life this quarter and you can see that in our results, due both to the unlocking process and the continued conversion of our valuation platforms. At a high-level, the benefits and DAC amortization lines are where the majority of the noise occurred, with the impacts essentially offsetting each other. This line item noise should largely be behind us. We can provide more detail off line. Earnings drivers performed as expected with Life Insurance in force up 3% and account balances up 5% quarter-over-quarter. Normalized interest spreads remained strong in the 190 basis point range and were in line with a year ago quarter. Life earnings of $132 million were essentially flat with the prior year after giving effect for the notable items in both quarters. Growth in the Life segment has been mapped by the fact that we have completed a couple of reserve financing transactions over the last year. These transactions have freed up capital that we have allocated to other areas including share repurchase. Mortality did increase in the quarter attributable to a handful of large claims. Looking at the full year, our experience continues to be better than price for mortality. Turning to Group Protection. We had an excellent quarter with all key metrics showing strong results. Nonmedical net earned premium grew 7%, sales were up 9% and the nonmedical loss ratio for the quarter came in at 71.8%, continuing the trend of improvement this year. Strong growth metrics combined with actions that we've taken over the course of 2011 to build up claims management, and increased prices produced earnings of $28 million, very much improved from a weak 2010 quarter. Turning to expenses. Expense management was strong during the quarter, with expense ratios declining in both a sequential and a quarter-over-quarter basis. Even as we continued to invest in key growth initiatives, primarily in the Defined Contribution and Group Protection areas. Let me spend a few minutes addressing the issue of low interest rates and share with you the information we've provided to the market. In early September, we provided a forward-looking perspective on how a sustained at 2% of 10-year Treasury rate would affect both the income statement and the balance sheet. We said earnings would decrease by $50 million in 2012, with an incremental $50 million per year in 2013 and '14. We also said that the balance sheet, both statutory and GAAP, would not be affected over the next 5 years, outside of assumption changes. Based upon what I know about the dynamics of the business, I don't expect any meaningful changes and will provide more color at our investor conference. Before moving to Q&A, I have a couple more items. The expected impact of Regulation 09-G is detailed in the press release. By and large, the impacts appear consistent with estimates that I have seen in many of your reports.

Turning to capital management. As noted earlier, during the quarter, we continued our capital redeployment activities, the strength of our balance sheet and holding company free cash flow contributed to our ability to accelerate share repurchase activity in 2011. Current plans already use holding company cash to pay up a $250 million debt maturity in the fourth quarter. And as is our practice, we will be reviewing our shareholder dividend with the board during the fourth quarter. I look forward to discussing capital management further with you at the investor conference. With that, let me turn the call over to the operator for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question is from Suneet Kamath of Sanford Bernstein.

Suneet Kamath - Sanford C. Bernstein & Co., LLC., Research Division

My first question is for Dennis. I guess, in your prepared remarks, Dennis, you mentioned that in terms of share repurchases, you're not done for this year. Can you give us sort of what you're thinking in terms of fourth quarter, sort of, order of magnitude?

Dennis R. Glass

Yes, Suneet, we're trying to avoid specific guidance. I won't give you a specific number. I would say though that the guidance around annual free cash flow continues to be important to us. But we might back off of that this year a little bit if we continue to feel good about our conditions.

Suneet Kamath - Sanford C. Bernstein & Co., LLC., Research Division

Okay. Then maybe as a follow-up if you can just maybe, Randy, walk me through what happened with the RBC ratio this quarter, because I think last quarter you said you estimated around 500%, I think you're saying the same thing this quarter. But you took a dividend out and then obviously the equity markets were down. So if you can maybe help me reconcile how you stayed flat along with those other effects, that would be terrific.

Randal J. Freitag

Sure. During the quarter, as I mentioned, we took out the $250 million dividend. Offsetting that, we did do a reserve financing transaction during the quarter, which picked up a couple of hundred million dollars of capital. So that explains the movement in the total capital during the quarter. On the RBC side, we continue to see improvement in the general account, which continues to push down the overall C1 factor so despite the fact that the general account in the company continue to grow, you continue to see a less-than-normal growth in the denominator factor, which allowed the overall RBC rate to stay in that 500% range.

Jamminder S. Bhullar - JP Morgan Chase & Co, Research Division

Got it. And just quick clarification. Does that RBC reflect or include any of the captive subsidiaries that you have? And if not, what would be the impact if we threw those in there?

Randal J. Freitag

Yes, it does include, the majority of the captives that we have get rolled up into the overall results.

Operator

And next question is from Ed Spehar of Bank America Merrill Lynch.

Edward A. Spehar - BofA Merrill Lynch, Research Division

Randy, following up on some of the statutory questions. I think you've talked about stat earnings in the $600 million range, surplus note interest, I think, is another $100 million. When you look at reserve financings, how should we think about this as a potential source of additional capital generation looking forward? And then I have one follow up.

Randal J. Freitag

Sure, Ed. Historically, we've been able to do about $200 million in reserve financings a year, which really has represented the growth in both the term XXX and the UL AXXX reserves. This year, we actually have done a couple of transactions so if we've seen a little more capital generation this year from the reserve financing line, I would anticipate as we move forward that, a couple of hundred million dollars a year is a reasonable estimate given growth in Term and UL across the organization.

Edward A. Spehar - BofA Merrill Lynch, Research Division

Okay. So when we think about sort of statutory capital generation then, it's a number that's in addition to this $700 million by the reserve financings, correct?

Randal J. Freitag

Correct.

Edward A. Spehar - BofA Merrill Lynch, Research Division

And one last question. In terms of the overall strain from new business, can you give us a sense of what your view is of the sort of statutory earnings power of just your existing book excluding sort of strain that you are having from the new business writings?

Randal J. Freitag

Yes, Ed, I don't want to get into the details of splitting up the in force and new business. I don't have those numbers at hand. I would say, in general, if you look at overall required capital, that the required in a normal year inside the Life company, would grow roughly $250 million to $300 million. So of those statutory earnings you referenced earlier, I normally expect about $250 million to $300 million to be used up by growth in required capital.

Operator

Our next question is from Jay Gelb of Barclays Capital.

Jay Gelb - Barclays Capital, Research Division

Can you give us an update on the potential for how the goodwill testing is coming along in 4Q?

Dennis R. Glass

Yes, sure, Jay. We're obviously -- we're in the middle of the analysis, so I don't have the answer on where we're going to end up. I'd like to focus really on what the primary driver of goodwill is, and that's sales. The most important thing that we can do to drive long-term value in this organization is to sell products that are in appropriate turns. That's what we have been doing. Dennis referenced a number of the pricing changes that we've made. And that's what we're going to continue to do in the face of the economic environment that exists today. So while the answer on goodwill is going to come out in the analysis, let me be clear that we are going make the changes we need to make during appropriate returns on any new business that we sell.

Jay Gelb - Barclays Capital, Research Division

To what extent would the stock trading below stated book have a meaningful influence on that outcome?

Randal J. Freitag

It's an item at the end that you need to take into account. I still think that the most important item driving goodwill is sales as I just referenced in my earlier comments.

Jay Gelb - Barclays Capital, Research Division

Okay. And then on a separate issue, there is some concern raised in the press about reserving for universal life, can you give us your perspective on that?

Dennis R. Glass

Yes. Jay, it's Dennis. Let me start by saying that I have absolutely full confidence that our reserves are more than adequate, and that we comply with this particular regulation. I further note many of you probably haven't seen it, but our main regulator at the State of Indiana came out with a statement this morning that essentially confirms what I've just said. And with respect to where we are in this process, this is at the ending I see that is, this not the first time we've gone through this process on AG 38. We went through it in 2005, and I believe we'll have the same result and that is that we'll come up with a solution that is satisfactory to all the parties. We have a lot of smart people inside the NAIC that are practical and want to the right thing, and we just need to work through this issue.

Jay Gelb - Barclays Capital, Research Division

When do you think we'll get resolution on that?

Dennis R. Glass

It's unclear.

Jay Gelb - Barclays Capital, Research Division

And just one last follow-up on that. What's the actual process that comes into play? I mean it's important that your primary regulator supports the reserving process, but what needs to happen for the rest of the NAIC to support that as well?

Dennis R. Glass

Well, what's occured so far is simply we have a group of state actuaries looking at the issue. They've come to some conclusions that aren't in fact entirely clear, but then it moves up through a committee process at the NAIC. Exactly how this will move through the committee process at NAIC is not clear at this moment.

Jay Gelb - Barclays Capital, Research Division

Okay. So hopefully, we can get an update on that at the Investor Day.

Operator

Our next question is from Jimmy Bhullar of JPMorgan.

Jamminder S. Bhullar - JP Morgan Chase & Co, Research Division

I had a question on -- just if you could give us an update on your DC business, you reported decent lows this quarter. Have you seen any disruption as you move to the new technology platform? And is that starting to abate? And then secondly, can you talk about incidence and the recovery rates in the Disability business. Your margins have stabilized the past couple of quarters but they were -- the losses are elevated in 2010. And if you can talk about the pricing environment of the business as well as any type of price actions that you are taking?

Dennis R. Glass

First, with respect to the D.C. business, the good news is that we're actually putting our first large case on this new system in the third quarter. And that is going well. We expect it to be executed very well. As we said in past quarters, some of the advisors that put us in the penalty box until they saw that we were, in fact, executing on this new administrative platform. So I guess to the extent that we have moved now into implementation of specific customers onto the platform, hopefully, that will take us out of the penalty box with those 1 or 2 consultants that had put us in the penalty box. So I would say that it's going very well and it should continue to improve optically in the marketplace with consultants. And it will continue to be a good result for the customers as they get on to that platform. The consumer or the employees themselves will have much better service, much better access and we're really quite excited about it.

Randal J. Freitag

Jimmy, on the group side, we're still seeing the incidence level a little bit elevated from the historical level even though it continues to move towards that level. I'll just say that in combination with the work with we've done in the claims management side, the price increases we pushed through have us in a place that we're very comfortable with, and we look for this experience to continue.

Jamminder S. Bhullar - JP Morgan Chase & Co, Research Division

And are you seeing competitor behavior change at all in terms of pricing in the market, in disabilities specifically?

Dennis R. Glass

Well, pricing in any of our products and all of our markets is a moving target. I think the best thing I can tell you is that what we are being able to achieve in the Group Protection at the moment, so year-to-date on our non-dental products we've been targeting around 3%, we're getting about 4%, a little bit more than 4% on our dental target. On our renewal pricing, we were targeting 8%, we're getting about 9%. So on a renewal pricing, we're doing better than we'd hope for, and so from our perspective, that's a good outcome.

Operator

Our next question is from Chris Giovanni of Goldman Sachs.

Christopher Giovanni - Goldman Sachs Group Inc., Research Division

Randy, a question on the interest rate commentary you had, sort of -- you mentioned the earnings impact, as well as the balance sheet impact and how that hasn't changed and don't expect really a material impact absent change in some of the assumptions. Can you comment to the extent that you changed some of, maybe, the long-term yield assumptions or others? What -- how we should be thinking about sizing that up?

Randal J. Freitag

Yes, Chris. Thanks for the question. The only assumption I can really think of that, as I look out over a 5-year period, that would realistically be changed as I can think of it would be the long-term run rate assumption. We've talked about a reduction in that assumption by 50 basis points is roughly $100 million. I'd note that during the unlocking this quarter, we did adjust our J curve. We brought the front end of the J curve down to be consisent with where we're investing money today, and that was about a $26 million hit to earnings during the quarter. So what we've done is we've lowered the Jay curve assumption to reflect what we know, and that's where we're investing money today. When you look at the longer term, where we have been investing over the -- if you look at the full spectrum of 2011, it's really right in line with what our J curve assumption is for the last couple of months, it's dipped below, but to change it now, based upon what we know today, just wasn't called for.

Christopher Giovanni - Goldman Sachs Group Inc., Research Division

Okay. And then maybe for Dennis just in terms of capital management. And obviously you guys are committed to share repurchases and make sense given where the stocks at. But can you talk some about how you're thinking about sort of the dividend policy? Obviously, you used to pay a higher dividend, kind of just -- at what point would you start to think about trying to bring that back?

Dennis R. Glass

We've been pretty clear all along, myself, as well as our board, my management team, believe in increasing the dividends at the appropriate time to a higher level certainly than it is at today. We will review that decision with the board, the decision to raise or not the dividend in a week or 2 at the board meeting.

Operator

Our next question is from Bob Glasspiegel of Langen McAlenney.

Robert Glasspiegel - Langen McAlenney

Just a follow-up on the NAIC task force, you're comfortable they're going to come to their senses. I appreciate that perspective. Your comment letter in the journal, they quoted you as saying that their position would needlessly constrain the capital position of companies. If they didn't come to their senses, how seriously would this constrain your capital position?

Dennis R. Glass

The whole process is unclear at the moment. All my letter did was repeat what their exposure draft said, which is that the exposure draft would increase reserves. But I want to come back to my comments that I made a few seconds ago. I'm confident that our reserves are more than adequate. I'm confident that we're in compliance with AG 38. The State has just reconfirmed that for us publicly, and the process is underway and it's unclear if what -- if anything will change.

Robert Glasspiegel - Langen McAlenney

Okay, that's clear. Would you, you would disagree with the journal's characterization that your accounting is more on the liberal side versus others in the industry?

Dennis R. Glass

I don't remember the Wall Street Journal attributing any conservatism or lack of conservatism in our accounting. I think they've mentioned us as one of the companies that had made comments, which we did. But I don't think there's any -- to my recollection, the article didn't say that.

Operator

Our next question is from Thomas Gallagher of Credit Suisse.

Thomas G. Gallagher - Crédit Suisse AG, Research Division

A couple of questions. First is, Randy, I just want to clarify if you changed your aggregate earned yield assumption -- ultimate earned yield assumption by 50 basis points which, at least, this was on the life insurance product I think it was 6.25% down to 5.75%. That would only be $100 million total impact to -- I assume that's just an all in sort of capture all balance sheet type impact. Is that right?

Randal J. Freitag

Yes, that's correct. We've lowered it 50 basis points last year and it had an impact of right in near of $100 million and we look at if we had lowered it -- were to lower it another 50 basis points, it's another $100 million impact. Of course, any impact to that, it runs through earnings and ultimately ends up on the balance sheet.

Thomas G. Gallagher - Crédit Suisse AG, Research Division

Got it. Okay. The next question I had, I just want to understand how to think about your RBC. So the 500 RBC, is that consolidated including the captive or is the captives stand-alone in the 500 just your lead life company?

Randal J. Freitag

Yes. We can get the complete details off line, but, yes, when you look at the captives, you have some that consolidate and some that don't. But remind everyone is that you don't calculate RBC as if calculated for the blue book on a quarterly basis. This is an estimate, and that's why I say approximately 500%. What we see is that capital continues to grow. Things like the general account continue to improve in quality. So very comfortable with the number as calculated.

Thomas G. Gallagher - Crédit Suisse AG, Research Division

Got it, okay. And just stepping back for a minute, can you get -- can you give us an idea of how -- if we looked underneath the covers within the captives, how the performance of your VA liabilities -- and I'm thinking about thiss just from a statutory standpoint, how the VA liabilities performed relative to the performance of the hedge assets? Were those a net loss, did those look something like GAAP? Or maybe just provide a little clarity there.

Randal J. Freitag

Yes, Tom, I'd point you to the -- my commentary where I talked about the breakage. So that breakage is essentially that, it's the difference in movement between the assets and the liabilities. So, we had the breakage and we had the unlocking impact during the quarter, both of which negatively impacted that result. If you looked at the end of the third quarter, we had assets that exceeded our liability by between $200 million and $300 million inside of the captive.

Thomas G. Gallagher - Crédit Suisse AG, Research Division

Okay. And so the breakage would look similar in terms of -- on a statutory basis in terms of the way this is disclosed?

Randal J. Freitag

Yes our -- statutory of course, is a different sort of calculation, but the statutory liability at the end of the quarter actually is below our hedge target so you would have more of an excess over your statutory liability.

Thomas G. Gallagher - Crédit Suisse AG, Research Division

Okay, got it. And then just last question is, as I think about the statutory cash flow and the ability to do some securitizations to free up capital, did -- let's just say you're able to do $200 million a year. Are you essentially just accelerating earnings there? Like I'm just trying to think about this conceptually. If what in a securitization, you're basically selling getting cash upfront in exchange for future cash flows. So aren't you just swapping future earnings for current -- for getting the cash in the door today? Doesn't that -- aren't you giving up future earnings in exchange for doing those transactions?

Randal J. Freitag

Yes, that's exactly right, Tom. You essentially are bringing some efficiency to your capital usage by bringing forward something that would happen over the next 30 to 40 years and recognize it today.

Operator

Our next question is from John Nadel of Sterne Agee.

John M. Nadel - Sterne Agee & Leach Inc., Research Division

Just 2 quick ones. One is more of a check the box, just to make sure my math is right. Randy, I think you mentioned $7.6 billion of stat capital at the end of the quarter and if you're -- is that equivalent to the numerator of what you would estimate at around a 500% RBC?

Randal J. Freitag

Yes.

John M. Nadel - Sterne Agee & Leach Inc., Research Division

Okay. And then just -- in the past you guys have talked about the UL book of business and what proportion of that is currently at minimum crediting rate versus what proportion is not. Can you just update us on where that stands?

Dennis R. Glass

Yes, I'll spend a little bit -- I'll talk about both Life and the D.C. business. We're getting close to our guarantees. Both of those businesses are in the area of 8 -- have about 8 basis points of room left to the guarantees in total. I would anticipate where rates are today that over the next 6 months, we would move pretty much all the way to our guarantee based on actions we have in place. And that's why you see when you move out past that, the $50 million impact that I talked about as part of our interest rate sensitivity.

Operator

We have a follow-up from Chris Giovanni of Goldman Sachs.

Christopher Giovanni - Goldman Sachs Group Inc., Research Division

I just want follow-up on, sort of, the management position that was created for Fred back in March of last year, just see if there's any update given the, I guess, the volatile macro environment, how you guys are thinking about long term whether it's changes in strategy or investment profile?

Dennis R. Glass

Well, we described in our remarks already the rotating of our investment selection process -- new money investments to a higher grade, and that's helping with the higher investment grades. We're doing quite a bit more work around stress testing. The asset portfolio, looking at different ways to get better results over the long term. We have Fred and his team doing that. There's excellent work being done, and we're going to share some of those stress tests with you at the upcoming IRB meeting. So I think you'll have an opportunity to see better, and more completely, what I'd see now which I think is pretty good work. And the answer has been pretty good as well, by the way.

Christopher Giovanni - Goldman Sachs Group Inc., Research Division

Okay. And then if we think about potential capital strain as we look out over the next couple of years, I mean, do you view capital strain more sensitive -- more sensitivity for you guys, for each, relative to equity markets or interest rates?

Dennis R. Glass

Capital strain? Capital strain -- in the Life Insurance industry actual economic hits the capital typically come from investment losses, and so that's why we focus a lot on talking about what we're doing in the portfolio. Interest rates can also, in some instances, create some reserving changes for your verbal annuity business, and we'll talk about all these things.

Randal J. Freitag

Yes, I would just expand on Dennis a little bit. It's credit that process capital strain, with the hedge program we run against the variable annuity business, you see the primary areas where you would have immediate stress from equity market movements or interest rates mitigated by the performance of that hedge program.

Operator

Our next question is from Edward Spehar of Bank of America Merrill Lynch.

Edward A. Spehar - BofA Merrill Lynch, Research Division

I just wanted to follow-up on the question about reserve fundings. Randy, isn't the issue though that it's the amount of capital that you have to commit upfront in the reserves, which are deemed to be redundant and that's the reason that there's a securitization market or fund market that exist, so that it's really helping with the strain of the business considering the reserving? Is that not correct?

Randal J. Freitag

Yes, absolutely. What you're doing is you're bringing some efficiency, your capital usage. You're putting capital behind reserves that you deem to be in excess of what you should use from an economic standpoint. You're not turning [ph] to reserve financing transaction so you can effectively release those reserves and use that capital in other areas. Like we've done today as I mentioned as part of the Life business, where these reserve financing transactions occur. We've been able to free up that capital and put it to other more productive uses such as the share repurchase activity that we've done over the first part of the year.

Edward A. Spehar - BofA Merrill Lynch, Research Division

Okay. I guess, the question that is it's not that -- if you have $600 million of stat earnings today that you're going to have $400 million of stat earnings next year because you've done a $200 million reserves securitization?

Randal J. Freitag

As I mentioned, the $200 million that -- of reserve financing -- you should remember that, that would come out over the next 30 or 40 years on these books of business. These are very long tail businesses. So the annual impact of running into that is very small and it's more than overcome by the new business that we put on the book.

Operator

Ladies and gentlemen, this ends the Q&A portion of today's conference. I'd like to turn the call over to Mr. Jim Sjoreen for any closing remarks.

Jim Sjoreen

Thank you. And again, as always, we appreciate your time on today's call. Just as a reminder, as we've referenced in our remarks, we will be hosting our annual conference for analysts, investors and bankers on Tuesday, November 15. And information will be available on our website on how to join the webcast for that. So as always, we will take your questions, any follow-up questions on our Investor Relations line at 1 (800) 237-2920 or via email at InvestorRelations@LFG.com. Again, thank you for your time today.

Operator

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may now disconnect and have a wonderful day. Speakers, please stay on the line.

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