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The Phoenix Companies, Inc. (NYSE:PNX)

Q4 2011 Earnings Call

February 16, 2012 11:00 am ET

Executives

Naomi Kleinman - Head IR

Jim Wehr - President and CEO

Peter Hofmann - CFO

Chris Wilkos - CIO

Phil Polkinghorn - SEVP Business Development

Mike Hanrahan - CAO

Analysts

Randy Binner - FBR

Bob Glasspiegel - Langen McAlenney

Steven Schwartz - Raymond James & Associates

Jimmy Bhullar - JPMorgan

Operator

Welcome to the Phoenix fourth quarter 2011 earnings conference call. (Operator Instructions) I would now like to turn the call over to the Head of Phoenix Investor Relations, Naomi Kleinman.

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 Vice President for Business Development; and Mike Hanrahan, Chief Accounting Officer.

Our fourth quarter earnings release, our quarterly financial supplement and the fourth quarter earnings review presentation are available on our website at phoenixwm.com.

Slide 2 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 fourth 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.

Jim Wehr

Thanks, Naomi, and thanks to everyone for joining our fourth quarter 2011 call. This morning I'll focus primarily on our full year results in my comments. Peter and Chris will amplify with quarterly perspectives as well. We are pleased to report strongest year we have had since 2007.

Particularly notable is operating income of about $42 million, but it goes far beyond earnings. We've developed a sustainable path to rebuild Phoenix into a successful enterprise. It is with confidence that we say we have returned Phoenix to stability and growth. Virtually all financial measures are improving. Our progress with the rating agencies validates that statement.

After several favorable changes over the past year-and-a-half, two outlooks turned out positive and one is stable. Collectively, the rating agencies acknowledge our improving financial profile and capital adequacy as well as emerging earnings momentum. They also take note of our reduced surrender activity, expense management and continued de-risking of the investment portfolio. And perhaps most importantly, they believe we can grow.

And I'm obviously pleased to see the rating agencies acknowledge our progress, I remain frustrated that this progress is not yet reflected in our share price. To me there is a clear disconnect between the fundamental value of this company and where our stock is trading. As we head into 2012, we are very focused on enhancing that fundamental value and believe improved valuation should follow.

Let me give you some highlights on where we stand at the end of 2011, which support my assertion that our stock is undervalued. First, our capital position is solid. When we established our four strategic pillars, I emphasize that regaining balance sheet strength was pillar number one.

Now, as we end 2011, our statutory surplus is up to $846 million and our risk based capital is estimated at 363%. That's up from 223% at the end of '09 and 282% at yearend 2010.

While our emphasis is on growth, we continue to take action to build a strong and flexible capital position. In the fourth quarter we entered into a close block reinsurance agreement to further enhance flexibility. At yearend we had over $100 million in cash and securities at the holding company.

Our investment portfolio continues to perform well, despite the challenges of the low interest rate environment. Impairments were half of what they were in 2010 and we further reduced a proportion of below investment grade holdings.

On the other side of the balance sheet, we've put significant focus on managing legacy exposures. Our discontinued reinsurance business has largely run-off and we are negotiating commutations of a significant portion of the remaining exposure. We have increased reserves in anticipation of finalizing these.

Similarly, we are monitoring the experience emerging in a block of UL business and as a high concentration of older-age insureds that represents about 8% of our gross life insurance in-force. We've taken action where appropriate including cost of insurance increases. My point here is though we are actively managing these exposures, so they do not distort the fundamental value of our franchise.

We addressed two other legacy issues in the fourth quarter that had a combined impact on operating earnings of about $15 million. The larger item was retirement benefit liability that predates our 2001 demutualization. The smaller item was the impact of unclaimed death benefits that we identified during our New York Section 308 review. Peter will provide more detail on both of these.

Moving on to our other strategic pillars. The policyholder service pillar is focused on both persistency and customer service. Here we returned a normal persistency level. The full year surrender rates for life at 6.5% and for annuities at 11.4%. This has take tremendous effort at all levels of the company and is a testament to the ability of our team to focused on an objective and the deliver.

Turning to our third pillar of operational efficiency, we've reduced core GAAP expenses to $197 million, down about one-third from our 2008 baseline. And we made progress on our profitable growth pillar with a focus on annuity product line and Saybrus. We grew our annuity business by expanding and deepening our relationships with IMOs serving the middle market. 2011 annuity deposits were $952 million compared with just $221 million in 2010.

Remember, we basically started at zero in this business in 2009 and we are now approaching the top 10 in market share in the fixed indexed annuity space. A significant growth, but I want to point out that we continue to balance this growth against profitability and capital management.

Saybrus was the other part of our growth story as it became profitable in the second half of the year. Saybrus' tripled revenues in 2011 to more than $18 million from just under $6 million in the 2010. Through deeper penetration within it's third-party distribution relationships and strong sales of Phoenix products.

We look at Saybrus as a separate profit center, but as the distributor of Phoenix products, Saybrus' success is a key part of our overall success. We are pleased with progress on both the Phoenix and third-party aspects of its business model.

Now, let me look ahead to 2012. In short, we will continue to focus on the four pillars that have guided us for the last several years; balance sheet, policyholder service, operational efficiency and growth. More specifically, on the balance sheet, we look to increase capital through profitable new business growth and effective in-force management and we also increase financial flexibility.

Relating to policyholder service, we expect to improve upon current persistency levels by reducing cost and allowing our service model to align with our growth strategy. In the area of operational efficiency, we are working to take an additional $10 million out of expenses in 2012 and another $10 million in 2013. These expense reductions will be achieved even while we invest in both operational efficiency improvements and growth initiatives.

This year we expect incremental growth in both our middle market annuity business and Saybrus. As we noted last quarter, we're estimating between $1 billion and $1.4 billion in annuity sales this year, mostly again, fixed indexed annuities.

We are also building new distribution for our Life business, for example, we recently announced an agreement with the National Agents Alliance to sell a redesigned indexed UL product. Life sales expectations for the year are modest but I'm pleased that we're taking additional steps to get that part of our business growing again.

For Saybrus, we expect growth from both Phoenix product sales and third-party business. In 2011, Saybrus had a two assisted sales and one new wholesaling relationship and our growth plan for this year includes expanding sales within these organizations as well as pursuing additional third-party agreements.

The main point I want to make about our growth plans is that all of them are drawn to appropriately balance capital, sales and earnings. In other ways, we will grow within our existing capital budget with a strong discipline to manage profitability of new business.

From an earnings perspective I want to point out a couple of factors to consider for 2012. First, we do not expect mortality to contribute to results to the same extend it did last year. Second, the 2012 expense reductions and investments in operational efficiency and growth will not translate into meaningful earnings improvement until 2013.

To sum up, we have well thought our plan for 2012 that will produce progress in critical areas such as capital generation, operational efficiencies, product development and distribution. And our plan positions the company for more robust earnings growth in 2013 and beyond.

With that I'll turn it over to Peter.

Peter Hofmann

Thanks, Jim. Please turn to Slide 3 of the presentation. While the results include some unusual items this quarter, the themes reinforce Jim's comment on the year overall.

GAAP pre-tax operating earnings excluding two legacy issues were at solid $17.7 million or $0.15 per share. Statutory results were also strong with surplus of $846 million at year end and a full year statutory net gain from operations at Phoenix Life of a $131 million.

We had another quarter of strong insurance results with improvements in life and annuity persistency and with mortality margins in lined with expectations. The investment portfolio while affected by the annual re-ratings of structured securities remains high quality. Impairments in the quarter were in line with our pricing expectations.

Our capital position improved further enhancing flexibility overall. We ended the year with surplus of 11% or RBC at an estimated 363%, and holding company cash and securities in excess of $100 million.

New business also continues to grow with annuity deposit of breakeven the third quarter, and more than doubled to prior years' quarter. We address several legacy exposures during the quarter. In aggregate these costs us about $35 million of statuary capital but they leave us with reduced exposure going forward.

The quarterly income statement that is shown in Slide 4, open block revenues decreased modestly from the third quarter, driven primarily by lower premium and fee income, partially offset by higher net investment income.

Benefits while in line with expectations reflected higher death claims versus the very favorable experience in the third quarter. DAC amortization swas significantly lower versus last quarter and a year ago as a result of the favorable equity markets. As we look ahead we estimate that our DAC amortization will decrease by $16 million to $24 million in 2012 as a result of the new DAC items effective January, 1.

Operating expenses include the $11.5 million legacy retirement benefit cost that Jim mentioned. I'll provide more details in just a moment. Excluding this charge expenses continued at the third quarter level.

The regulatory closed block contributed $12.5 million, consistent with the glide path of the block established at the time of the demutualization. As a reminder, based on this glide path, closed block pre-tax income will step down in 2012 to approximately $11.4 million per quarter.

Realized investment losses include $8.6 million of credit impairments, a $7.7 million loss in our surplus hedge and a $5.6 million loss from the non-performance risk factor that is used to discount the GAAP liability related to our living benefits. These losses were somewhat offset by transaction gains. On an economic basis, our variable annuity hedge program had a loss of $3.3 million.

A number of developments in the workers' comp carve-out arena put us in a position to potentially close out a significant piece of our remaining exposure.

Slide 5 highlights the trends in operating income and spikes out discrete items that affect period-to-period comparisons. $11.5 million retirement benefit charge reflects a previously unrecorded liability for a number of individual retirement agreements the company entered into with former employees. These agreements date back to before our 2001 demutualization and as far back as the 1980s.

While the contractual payments under these individual agreements have been reflected in earnings, no balance sheet liability was established when these were entered into. This issue was identified as part of a comprehensive review of our balance sheet that we've been conducting during the latter part of 2011. This review in turn was begun till we converted to a new general ledger system at the beginning of the year.

The unclaimed death benefit charge is for death claims, including interest that date back as far as the 1960s. These were identified pursuant to a methodology prescribed by the New York Department of Financial Services, which was required for all New York domiciled companies. We completed the analysis for all our insurance subsidiaries. The total statutory impact was $11.4 million before taxes. But on a GAAP basis, the impact was $3.6 million after-tax and PDO offsets.

Finally, in this quarter, there was a modest tax expense of $1.5 million, bringing full year tax expense to $6.2 million. On the total GAAP basis, including realized gains and losses, this expense is largely offset by a tax benefit against realized losses. Our actual tax rate for the year was close to 0. We are subject to the alternative minimum tax this year, but ultimately the amount of the alternative minimum tax was only $0.6 million, which is less than we had projected earlier in the year.

Last quarter, we indicated that we expect again to be subject to the AMT in 2012 and we guided to an effective tax rate and operating income of 20%. After updating our projections, we think the actual AMT due will translate into a GAAP effective tax rate of closer to 30% for 2012. We currently do not expect to be subject to the AMT beyond 2012. As a result, we would be able to utilize tax credits to reduce taxes in 2013 that are not available under the AMT.

Turning to our insurance fundamentals, Slide 6 shows mortality cost ratios for the open and closed blocks. Full year experience was favorable compared with expectations, driven by excellent experience in the open block. Overall, favorable mortality was a meaningful contributor to 2011 earnings, adding approximately $30 million to the full year results.

Fourth quarter open block experience, although higher than the four-quarter average and last quarter, was in line with expectations. Note that this does not include the impact of the New York Section 308 claims. Experience in the closed block was in line with expectations for the quarter. As a reminder, because we have a positive policyholder dividend obligation, closed block mortality experience does not affect GAAP earnings.

Turning to Slide 7, both life and annuity surrenders improved significantly. Annualized life surrenders were at 6%, the lowest level since the third quarter of 2008. Annuity surrender levels were at 9.7% for the quarter. This reflects the combination of our older variable annuity block, which has somewhat higher surrenders and lower surrenders in the newer fixed indexed annuity business.

We continue to focus on controlling expenses. Slide 8 shows GAAP and consolidated statutory expenses adjusted for non-core items. Fourth quarter core GAAP expenses before deferrals were $48.8 million, down 21% from the prior year's quarter. This spills under longer trend shown on the slide. Before deferrals, GAAP expenses were down 15% versus 2010 and 34% since 2008 and core statutory expenses are down 30% versus 2008.

Slide 9 summarizes our new business volume and profitability. Annuity deposits were $276 million in the fourth quarter and $952 million for the full year which compares with $221 million for the full year 2010. New sales were primarily fixed indexed annuity. The declining interest rate environment has presented headwinds for this product, but the business we have written has been profitable.

The estimated embedded value created by sales in 2011 is $5.3 million. Our overall achieved spread on the $891 million of fixed indexed annuity deposits this year has been 2015 basis points, which is net of effect for defaults. We have actively managed the product and have regularly changed features in response to the market environment. We made pricing changes in October and again at the beginning of this month.

Turning to Slide 10, we continue to enhance our capital flexibility. In the quarter we announced the transaction with a subsidiary of Nomura Holdings in which we reinsured approximately one-third of the company's closed block of participating policies.

The transaction transfers risk to the reinsurer and thereby improves our RBC. We did not receive a seeding commission. The transaction does not affect closed block policyholders or decrease closed block earnings. It carries a cost of approximately $1 million per quarter, which is born entirely by the open block.

From a statutory surplus perspective between the discontinued reinsurance reserve, unclaimed death benefits and legacy retirement charge, we absorbed approximately $35 million of capital in the fourth quarter. This is obviously a real cost, but these do represent one-time items and leave us with reduced exposures going forward.

We also paid an additional dividend in the quarter, brining the total 2011 dividend to PNX to $64.8 million. Nevertheless, surplus grew 11% in the year. We ended the year with $101.3 million of cash and securities at the holding company, which meaningfully enhances our capital flexibility overall.

Based on 2011 statutory results, we estimate that we have regulatory dividend capacity of approximately $72 million in 2012. Although, clearly we will continue to balance appropriate capitalization of the life companies with holding company liquidity.

The roll-forward of our RBC ratio for the full year is shown on Slide 11. The improvement in RBC came from both growth and surplus and reduced balance sheet risk. The largest contributor was the reduction in risk based capital due to the closed block reinsurance transaction. Also contributing positively and significantly were core life insurance results, which improved the ratio by 46 points.

On the flipside, dividends paid to the holding company lowered the ratio by 21 points and the legacy items that I have discussed lowered the ratio by 13 points. The negative impact of the low interest environment on interest rate risk was less than we had estimated during prior quarterly reports. Overall, the improvement in RBC clearly positions us well from a capital perspective as well look ahead.

I'm going to end here and turn it over to Chris.

Chris Wilkos

Thanks Peter. As Jim described, our investment portfolio continued to perform well in the fourth quarter, despite low interest rate environment. Let me start with investment income, which is summarized on Slide 12.

Net investment income was flat quarter-over-quarter, as a small improvement in alternative asset returns offset a slight decline in bond income. Income for the open block increased by $3.5 million due to higher alternative asset returns, specifically in mezzanine funds. Closed block income declined due to lower returns in private equity partnerships.

Given the large increase in the equity markets in the fourth quarter of 2011 and the one quarter lag in partnership accounting, we would expect the fourth quarter market increases to translate into improved alternative asset returns in the first quarter of 2012.

Let me turn to credit impairments on Slide 13. In the fourth quarter, credit impairments were flat compared to third quarter results. As Jim mentioned, for the full year impairments were half of what they were in 2010. These impairment levels remain below our long-term assumption for credit losses. Impairments in the quarter were driven by a number of small impairments on RMBS, CMBS and CLOs, and an incremental impairment on one corporate bond.

For the full year we saw a sharp decrease in CLO impairments as bank loan default rates plummeted. Impairments in the residential mortgage backed and CMBS segments were also lower. Corporate bond impairments were slightly higher. Our private placement bond portfolio, which totals over $3 billion, had an aggregate impairment of about $1 million during 2011. We've spoken about the protective covenants and private bond holdings and those covenants have benefited the portfolio in terms of reducing impairments.

As you can see on Slide 14, we had an increase in the percentage of below investment grade bonds in the quarter, but an overall decline in our below investment grade position during 2011. Our investment policy range for high yield bonds is 6% to 10% of the portfolio. And we are comfortable with our current position, which is at the midpoint of the range. Overall, yearend portfolio quality is at the highest level since 2007.

After a multiyear period of de-risking, we selectively added to our high yield position based on the attractive spreads available on the high yield market during the second half of the year. We also continued to experience upgrades and credit quality in the portfolio, although in the fourth quarter those upgrades were offset by downgrades in some of our non-agency RMBS securities, as a result of the annual PIMCO rating or residential mortgage-backed securities. Going forward, we will continue to actively manage our high yield bond position within our previously stated range.

Slide 15 shows our total exposure to Eurozone countries. We would not typically highlight our Eurozone exposure. However, given the recent industry focus on this subject, we thought we would briefly touch upon it today. As you can see, we have no sovereign exposure, limited financial institution exposure and minimal exposure to the most challenged countries in the region.

Jim mentioned that a strong balance sheet is pillar number one. The five metrics on Slide 16 clearly demonstrate the significant improvements in our portfolio and balance sheet, since the depths of the credit crisis at the end of 2008. Portfolio market value now stands at 105% of book value, having experienced steady improvement from a low of less than 86% of book in 2008.

This improvement in market value over the past several years gave us the flexibility to reduce our high yield holdings with minimal loss, reduce our highly liquid assets and better manage our asset liability profile. Our below investment grade bond holdings have been reduced from a peak level of nearly 11% of bonds down to only 8.1% of bonds, even with more active buying during the last quarter. This reduction was accomplished in a measured manner without incurring unnecessary capital losses.

Credit impairments have dropped substantially and consistently over the last three years, reflecting both the improvement in the credit markets and the strength of our portfolio. Our structured bond holdings, which were under tremendous pressure during credit crisis are very highly rated and concentrated into senior and super-senior securities. The market value of those securities is appreciated substantially since the end of 2008.

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

Jim Wehr

Thanks Chris. Over the last three years, this management team has demonstrated an ability to lay out a game plan, focus on it and get the anticipated results. Those same abilities are key to continued progress and managing our businesses and successfully dealing with the challenges we are sure to face and most important, enhancing shareholder value.

Thank you for you time and attention today. And with that, let's open up the lines for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Randy Binner with FBR.

Randy Binner - FBR

I was hoping to pick up on some kind of newer comments around potential further commutations for the UL block. And Jim, I think I missed it, but you said that some of your life insurance in-force you're going to look to increase the cost of insurance charge. So particularly the commutations, I'm a bit curious if you can share any capital or earrings impact that you think that might bring?

Jim Wehr

Randy, I'm going to turn that to Peter to address the commutations on the discontinued reinsurance business.

Peter Hofmann

Yes, Randy, so there are two separate items, right. The commutations relate to our discontinued reinsurance business. This is not something that I can get into a lot of detail on, because we have ongoing conversations with some counter parties. But there have been a number of negotiations that have been ongoing in this space generally. We have knowledge of some of those. And we have received information on some of those and believe that we can bring some of our exposure to resolution over the next few quarters.

In anticipation of that we put up the charge, we reviewed all our reserves as of yearend, our net reserve at yearend related to this block are currently around $60 million. And that will come down as we successfully complete some of these negations. Now that's separate from the COI increase.

Randy Binner - FBR

Is there any ongoing income out of that discontinued reinsurance business?

Peter Hofmann

There is investment income under reserves, but other than that obviously to the degree that there are retro section there that we get recoveries from and we get that. But there is no income that we record typically.

Jim Wehr

And Randy, I think one other piece of context. This is business that dates back to the 90s. We started with 2,000 contracts or so, back 10-plus years ago and we're now approaching a 100 contracts remaining. So while we're not at the finish line, these commutations we're working on are getting us closer to that finish line and hence increase certainty that both Peter and I referenced.

Randy Binner - FBR

And then on the COI?

Peter Hofmann

Can you just reiterate?

Randy Binner - FBR

I was trying to clarify what the statement was there, if that was new that you were looking to increase your cost of insurance charges against a portion of the life block or if that was just business as usual?

Peter Hofmann

There was a change to COI rates and that affected certain single life Phoenix UL products, the policies, largely sold between 2007 and 2008. That was separate from an earlier COI rate increase that we had implemented on some other series of a similar product. And basically what drove the increase was that we had sufficient experience on these policies that led us to conclude that the adjustments we warranted.

Randy Binner - FBR

And then, one more if I could, and I'll drop back into the queue. I guess on the surrender stabilization and across the business your better persistency. I just wanted to understand if that's how good or bad that is? Meaning, it's good to keep business in-force as long as it's profitable. And this has been a debate, we thought about with Phoenix is. Can you give us color on is the business you're keeping the good profitability business and how we should think about better persistency from a profit perspective?

Jim Wehr

So, Randy, let me start there. I think the persistency that we are most focused on, and then I would suggest you folks should be most focused on, is the life persistency and in particular the close block life persistency. And those numbers have come down pretty consistently as you've seen over last few years from about 10% in the early '09, actually north of that in the early '09, '10 timeframe to closer to 6%.

Long-term experience for us has been 5% to 6%. I think that's fairly consistent with industry averages. So we're approaching that long-term or normal level. That business is quite profitable for us. It's consistently profitable. So as a result, getting persistency levels back to more normal levels is important. It's desirable from a financial perspective.

Randy Binner - FBR

In the close block, but in the other areas of the business, is that a little bit of a double-edged sword?

Peter Hofmann

I think it's important to recognize that our persistency measure does not include lapses of policies without value. So that's a separate decrement. So we generally view the lower persistency in both the life and annuity side as a positive.

In terms of the block that I think you're focused on which is the universal life block, the persistency of that block generally has been within our expectations which is basically consistent with the DAC unlocking that we took in the third quarter of last year. On the overall block, we've basically seen both surrenders and also lapses that are consistent with our assumptions.

And how does that affect our profitability, I think generally we have DAC that we need to amortize relative to these policies on the books, so an acceleration of lapses or surrenders would accelerate the DAC amortization. There is an offsetting benefit, if you will and that policies that come off the books, ultimately, represents fewer death claims in the future.

So it's not a black or white answer, it depends very much on which policies we're talking about. But I think globally we would say that improving surrender levels in the both the closed and the opened block and the life insurance spaces is a good thing.

Operator

Our next question comes from Bob Glasspiegel with Langen McAlenney.

Bob Glasspiegel - Langen McAlenney

And as you suspected my first question was going to be on the run-off reinsurance, did you say you're down to 100 claims death or was it another part of the company you were talking about on the commutation that you're pursuing?

Peter Hofmann

I said we're approaching 100 contracts.

Bob Glasspiegel - Langen McAlenney

And your reserve factors in the commutation on the 100 or there will be further charges if you did?

Peter Hofmann

It factors in some specific contracts that we are in conversation. And it does not factoring all 100 and the other important thing is that there is very much 90/10 rule around those 100 contracts. The bulk of them are pretty inactive and don't have much exposure associated with them. We are really talking about a handful of remaining exposures if we successfully bring the ones that we're working on to conclusion.

Bob Glasspiegel - Langen McAlenney

The cynic and me would say that last to 100 would be the hardest to deal with rather than the easiest but what you're trying to convey to me is that you're pretty relaxed about what's left versus what you've dealt with?

Peter Hofmann

We're down, we've brought the exposure down successfully by north of $0.5 billion of the year. So we're really sort of at the tail end and any one contract could break one way or another, but it's going to be small numbers. And we feel like we're really approaching the end here.

Bob Glasspiegel - Langen McAlenney

Hopefully, the 10-K has good disclosure and that that would be helpful. Pension, how much did that impact book value in the quarter and any sort of guidance and what that will be potentially and what leverage is in that prospectively?

Peter Hofmann

Couple of points on the pension, so the increase in the unfunded or the two plans, the ERISA funded plan and the non-qualified plan, roughly $55 million, that is entirely pretty much driven by interest rates. So it's important to remember that we froze both plans. As I discussed I think on an earlier call that for the ERISA plan, we have put in or in the process of putting in place a glide path management process with the help of an outside pension consultant to really systematically de-risk and rebalance that plan. So I think we're doing what we can do here. The increase is driven by the change in rates.

Bob Glasspiegel - Langen McAlenney

What's your current return assumption, Peter?

Peter Hofmann

We are lowering the return assumptions from the 8.5% that was last year to 8%. So we will have a modest pick up in pension expense on the order of $3 million in 2010 as a result of largely of that.

Bob Glasspiegel - Langen McAlenney

Jim, if I heard you right, you have given up on 2012 earnings gain, I think the tax increase and pension sort of is two pressures but it sounded like everything was going great and your opening remarks in progress, is there some other pressure that should be factoring in?

Jim Wehr

Well, I think what we're trying to inform, folks is that when you're turning a business around the trajectory is not always straight lined. There are going to be some up moves and then some sideways moves. And we had a big tailwind in 2011 that came from mortality. And it's not like investment performance. You can't beat the market every year in the mortality game. So we beat by $30 million or likelihood we're going to beat again by $30 million in 2012.

I think responsibly we have to say is low. So that's a big item. On the flip side, we're going to get some benefit from the DAC adjustment that we've mentioned. And we're really just trying to provide components for folks like yourself to calibrate our rate of progress and where we feel there is a year like this one where the pace is likely to slow to help you anticipate that.

Bob Glasspiegel - Langen McAlenney

I certainly appreciate the effort. I was just having trouble squaring all the facts together. I mean you also have that tailwind of Q4 partnership, Q4 market going into Q1. And with the market up 6% in Q1 which will help Q2 so we've got a couple of quarters of more favorable investments. You're not factoring that into your guidance or do you have the least?

Jim Wehr

We have not, although I think we certainly will agree with the fourth quarter which is in the bag and the first quarter which is off to a nice start. And so that should translate into a good first quarter from an alternative income standpoint. And assuming we stay on track this quarter, a good second quarter. So that's an important variable in our income for the year. But we have not factored that. So I'll agree with your assessment but we haven't factored it. And the other issue is we still have 10 months of market performance and who knows how that's going to play out.

Bob Glasspiegel - Langen McAlenney

And then the last question, RBC goal where do want to keep it?

Peter Hofmann

It's been moving up rather rapidly, the reinsurance transaction we did contributed to that. We're really trying to strike a balance between, making sure we have enough capital. And what does that mean? So enough capital to be able to support growth in the business, enough capital to be able to provide cushion against unforeseen events. So we kind of feel like we're in the right place, right at the moment.

Again, that's an area where I would expect the pace of increase to slow a bit. But we kind of feel like north of 300 is key for us. We'd like to stay there. And right now, we're trying to strike that right balance between capital adequacy, cushion against unforeseen events, being able to support new business.

Operator

Our next question comes from Steven Schwartz with Raymond James & Associates.

Steven Schwartz - Raymond James & Associates

First on the ASU 2010-2026 guidance, given that most of the sales are fixed annuities through NMOs, is there no offset on the deferral side?

Peter Hofmann

Peter, you got to clarify that a little bit more for me.

Steven Schwartz - Raymond James & Associates

Peter, you gave guidance on the amortization amount. I am assuming here that you're retrospectively adjusting. And then is there anything on the new sale side to offset part of that? That you historically deferred and can no longer defer the renewals?

Peter Hofmann

We are already deferring in accordance with the new guidance, and we actually are deferring very minimal expenses largely.

Steven Schwartz - Raymond James & Associates

How much is the DAC write-down?

Peter Hofmann

We guided last quarter at $140 million to $190 million, and we're probably at the lower end of that range. But we haven't updated the range.

Steven Schwartz - Raymond James & Associates

On the DAC issue, you said there was an adjustment given the equity markets. Would you happen to know how much that was for the quarter?

Peter Hofmann

Overall, we quantified that favorable impact of the equity markets at around $9 million between annuities and VUL.

Steven Schwartz - Raymond James & Associates

I noticed in the presentation just for informational purposes that the expected mortality in the open block declines in the fourth quarter. Is that just a seasonal thing, or was there something else?

Peter Hofmann

We'll need to get back to you on exactly what's driving that, Steve.

Steven Schwartz - Raymond James & Associates

Interest rates are low. You're all still expecting I think very, very good FIA sales. I am wondering maybe you can give some commentary on maybe what your caps and maybe participation rates are currently, things like that. Why do you think these things could sell given wherever those are I guess?

Jim Wehr

Steven, I am going to ask Phil Polkinghorn who is managing that product for us to respond to that one.

Phil Polkinghorn

I'll answer it generally. The caps and the participation rates, as you know, we have lots of different crediting strategies, so to go over them one-by-one probably wouldn't be useful, but we can certainly get you that information. But I think your point is right now in this low trade environment, those crediting rates are generally at all time lows and how attractive is the product to the customer and do we see changes in demand.

They are low. But remember this product, particularly with the riders that are offered with it, offer kind of a hybrid. One is an accumulation deferred annuity-type product that has those credited rates that are under pressure. And the other is a product to provide a guaranteed level of income. So it cuts both ways. The credited rates are low historically, which would argue for less appeal. They're still okay relative to other options that the customer might have, because if they go into their bank to get a CD, that rate is low right now as well.

And conversely though, if you were a retiree who was depending upon investment income for retirement income, you're pressured right now and the guaranteed income aspect of that product where you're getting a little bit more income by taking sort of a longevity product continues to be quite attractive and perhaps even more attractive as interest rates go down, because the opportunities to create a livable level of income get fewer and fewer.

Steven Schwartz - Raymond James & Associates

So on the deferral bonus rates, what you're explaining I think is probably what's driving sales right now. Are those under pressure? I mean you're saying they're still good, but are those under pressure?

Phil Polkinghorn

They're under pressure, but remember on the guaranteed income side of things, it's a lifetime income. So the customer is getting levels of income that are higher than the investment rate of return, in part because they're drawing down their own principle and in part because we're pulling sort of a longevity risk there?

Operator

Our next question comes from Jimmy Bhullar with JPMorgan.

Jimmy Bhullar - JPMorgan

I had a question along the same lines on index, but I'll ask it a different way. Just was wondering what type of margins or returns you're achieving on new sales, and then any pricing or crediting rate actions you've taken as rates dropped through 2011?And then just as a clarification, I think Peter or Jim you mentioned that you're expecting close block earnings I think around $11 million at quarter end 2012? And is that right? Because you had about $49.8 million in 2011, but then I heard another comment on the call that mortality was about $30 million favorable. Not sure if you're implying that that entire $30 million is going to be gone or it's going to be less favorable in your view than it was in 2011?

Jim Wehr

So Jimmy, I'm going to let, Phil, follow-up, because it's just kind of a follow up to the prior question on the fixed indexed annuities. And I'll let Peter speak to the 2012 profit expectations on the close block.

Phil Polkinghorn

Although, the decline in interest rate environment has presented headwinds for the product. The business that we have written has had a rate of return in excess of 10% after tax. Not as much as we would have liked, because the trend in interest rates has been generally downward.

But we've manage to achieve that by actively managing the product and we've changed our product features and pricing probably more frequently then competitors. Our most recent product changes when new into effect at the beginning of February. And that's following changes that were back in October.

So we've tended to change the rates on the product more frequently to react to the change in economic environment. But the decline in interest rates do hurt our margins a bit, but as we see that happening we adjust price and have managed to get rates return better than 10% after tax on the business written thus far.

Peter Hofmann

Jimmy, those are the two separate things. The close block number that we guided to was $11.4 million a quarter. And that is the glide path number for the closed block and it will not change unless we deplete the policyholder dividend obligation, which currently stands at around plus $70 million. So that number you can think of pretty much locked in. It was $12.5 million this year, it's going down to $11.4.

The mortality benefit that we talked about related to all the open block mortality and the aggregate universal life, variable universal life and some of the bit the older businesses.

Jimmy Bhullar - JPMorgan

And was that $30 million?

Peter Hofmann

That was $30 million benefit. And that relative to our expectations and that one, we would certainly not plan on recurring. Now, we have had over a longer period of time generally favorable mortality results in any of our businesses, but we're not banking on that.

Jimmy Bhullar - JPMorgan

So part of that could continue, but you wouldn't expect to that. Although, given historical trends you've generally had the favorable mortality overtime, right?

Peter Hofmann

We generally had favorable mortality. But this is relative to expectations that we update pretty regularly basis for mortality studies.

Jimmy Bhullar - JPMorgan

And then, could I ask one more, and just on our life insurance sales other than maybe higher ratings, are there things that you could do that would stimulate sales of life insurance policies?

Jim Wehr

Jimmy, I'm going to ask Phil to respond to that one.

Phil Polkinghorn

Yes, there are. We have a number of opportunities in the life insurance space as we move to the middle market. And as we've examined those, we've been very careful to have that balance of profitability, good use of capital that Jim mentioned. And in this environment some of the opportunities that were available to us were things that perhaps weren't as profitable in a low interest environment and we didn't peruse them.

The recent launch of the indexed UL with NAA is an example of the really good intersection of them wanting to have something a bit more attractive in the permanent life insurance space for their agents. And our expertise in index as well marries pretty well in this (technical difficulty) environment, both from a customer standpoint and from a company profitability standpoint.

And we're actively exploring other life insurance opportunities. But are being very careful to make sure that we are not getting into a space that is unprofitable in today's low interest rate environment or so overly competitive that is not a good use of our capital.

Operator

Our next question comes from Randy Binner with FBR.

Randy Binner - FBR

But just wanted to clarify, it feels like a swing of the $30 million on the mortality. One clarification for modeling though, the relationship between benefits paid and then changes in reserves has moved around a little bit. It's really the net of those two items that would get around $30 million less favorable. Is that the right way to think of it from an income statement perspective?

Peter Hofmann

Yes.

Randy Binner - FBR

And then one other quick follow-up. The 30% GAAP tax rate is for 2012. Just wanted two clarifications, one, that there is no or very low cash taxes in '12? And then what would the GAAP tax rate expectation would be for '13?

Peter Hofmann

The 30% tax rate is predicated on the assumption that we will be paying AMT, which would be a cash tax. For 2013, currently our projections don't show us being subject to AMT. When we're not subject to AMT we can utilize credits that are not available under the AMT regime. And we would be able to substantially reduce probably down to zero effective tax rate in 2013. But obviously that's a ways out. But that's where we currently are in terms of our expectations.

Operator

Our next question comes from Steven Schwartz, Raymond James & Associates.

Steven Schwartz - Raymond James & Associates

Just on Saybrus, the original model was to help distributors kind of work third-party products and decide between third-party products and you guys to be unbiased referee. But now you've moved. I gather into Saybrus selling Phoenix products. So maybe you can discuss that, this latter move and what that means what that entails?

Peter Hofmann

Steven, it was also intended to be a hybrid with flexibility to really go at both aspects of the business. So the assisted sales piece that you referred to and then sales of Phoenix products, our view and our emphases and frankly the way we described it early on was that given where our ratings were that Saybrus was going to have much more success and much more focus on the assisted sales side of the business. And that overtime as we kind of rebuild the business and improved our financials and hopefully made some progress on the ratings front. Then we would have that capability to sell our own product.

The shift to Phoenix product has happened more rapidly that we anticipated and it's not because the first of the business isn't going well, it's really because the sales of Phoenix products have picked up more rapidly than we originally anticipated when we put that business model in place. But that flexibility and frankly the ability to support sales of our own products was the critical element of that business and frankly makes us feel very good that we effectively rented some of that capability to other folks but we're able to hand on to it such that now we can use it both to consult and assist with others and sell our own product. So that flexibility was always a key element. And I think we're really seeing that in reaping the benefits of that frankly today.

Steven Schwartz - Raymond James & Associates

So I assume this has mostly to do with the annuities. But is the Saybrus organization getting paid by PLIC to be a wholesaler to wholesalers? Is that the way you think about it.

Peter Hofmann

That's absolutely correct, Steve. So total revenues to Saybrus in 2011 was about $18 million, just under two-thirds of that was compensation for sale of Phoenix products, mostly under annuity side and the rest was the third-party revenues.

Operator

Thank you. I would now like to turn the call back over to Mr. Wehr.

Jim Wehr

Well, we used the full hour plus. I think that's great. Once again, I'll just thank everybody for their time and attention. And hope for the rest of your day is productive. Thanks, again.

Operator

Thank you. So that does conclude today's conference call. Thank you all for joining. You may disconnect at this time.

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