Globe Life Inc. (GL) Q2 2012 Earnings Report, Transcript and Summary

Good day and welcome to Torchmark Corporation's Second Quarter 2012 Earnings Release Conference call. Today's call is being recorded. For opening remarks and introductions, I would like to turn the call over to Mike Majors, Vice President of Investor Relations of Torchmark Corporation. Please go ahead.

Thank you. Good morning, everyone. Joining me today are Gary Coleman, and Larry Hutchison, our Co-CEOs. Mark McAndrew, our Executive Chairman. Frank Svoboda, our Chief Financial Officer, and Brian Mitchell, our General Counsel. Some of our comments or answers to your questions may contain forward-looking statements that are provided for general guidance purposes only. Accordingly, please refer to our 2011 10-K and any subsequent Forms 10-Q on file with the SEC. I'll now turn the call over to Gary Coleman.

Thank you, Mike. Good morning, everyone. Net operating income for the second quarter was $127 million, or $1.30 per share, a per share increase of 19% from a year ago. Net income for the quarter was $129 million or $1.32 per share, a 4% increase on a per share basis. With fixed maturities at amortized costs, our return on equity was 15.8%, and our book value was $33.26, a 10% increase from a year ago. On a GAAP reported basis with fixed maturities at market value, book value per share grew 29% to $41.38. In our life insurance operations, premium revenue grew 4% to $451 million, and life underwriting margins increased 7% to $124 million. Net life sales increased 4% to $89 million. So far in July, our sales were ahead of expectations, and our guidance for 2012 remains unchanged. On the Health side, premium revenue, excluding Part D declined 5% to $177 million, and health underwriting margin declined 2% to $40 million. Health sales were $13 million, the same as the year ago quarter. I will now turn the call over to Larry Hutchison for his comments on the insurance operations.

Thank you, Gary. At American Income, life premiums were up 9% to $164 million, and life underwriting margin was also up 12% to $54 million. Net life sales increased 10% for the quarter to $40 million. The producing agent count at the end of the second quarter was 5,318, up 23% from a year ago and up 4% during the quarter. We are pleased with the continued progress at American Income, and we are excited about the company's future prospects. We are seeing growth in a number of newly hired agents who achieve our top bonus level, which is our best indicator of the agent retention. The first top bonus owners were up 60% in the second quarter. Our middle management ranks also increased by 21% in the second quarter. We expect sales growth for remainder of the year to range from 12% to 15%. Our Direct Response operation, Global Life, life premiums were up 5% to $58 million and life underwriting margin declined 1% to $35 million. The decline in margin was due to unusual claim fluctuations and we expect that the loss ratios will return to previous levels for the remainder of the year. Net life sales were up 4% to $38 million. We are also pleased with the results in Direct Response, despite a difficult economy, we have been able to grow our sales. We would also remind everyone of the change we initiated in our Direct Response underwriting in mid-2011. While improving our margins resulted in a reduction of our net sales due to more applications been rejected for health reasons, set sales growth through the remainder of the year to be around mid-single digit range. Liberty National segment declined 2% to $71 million. Our life underwriting was up 21% to $18 million. Net life sales declined 18% to $8 million, while net health sales declined 12% to $4 million. However, health sales increased 9% in the second quarter, compared to the first quarter. The producing agent count at Liberty National ended the quarter at 1,355, down 24% from a year ago, but up 6% for the quarter. We are very pleased with the progress we have made in turning around our declines and producing agents and sales. We are optimistic that agent growth will continue going forward, which will result in improved sales of Liberty National for the balance of the year. Premium revenue from Part D grew 60% to $78 million and the underwriting margin increased 47% to $8 million. Part D sales for the quarter jumped 915% to $22 million due to the increase in low income subsidized enrollees for 2012. I will now turn the call back over to Gary.

To complete, insurance operations administrative expenses were $40 million for the quarter, 1% less than a year ago quarter and in line with our expectations. Now, I'd like to spend a few minutes discussing our investment operations. On our website are 3 schedules that provide summary information regarding our portfolio as of June 30, 2012. As indicated on the schedule, invested assets were $11.6 billion, including $11.1 billion of fixed maturities at amortized cost. There is no exposure to European sovereign debt and there are no commercial mortgage-backed securities or securities backed by subprime or Alt-A mortgages. Of the fixed maturities, $10.3 billion are investment grade with an average rating of A-. Below investment grade bonds are $764 million, compared to $721 million a year ago. The percentage of below investment grade bonds of fixed maturities of 6.9%, compared to 6.7% a year ago. With a portfolio of leverage of 3x, the percentage of big bonds to equity, excluding net unrealized gains on fixed maturities is 24%, which is less than most of our peers. Overall, the total portfolio is rated high BBB+, just slightly the under the A- of a year ago. We had net unrealized gains in the fixed maturity portfolio of $1.2 billion compared to $873 million in the first quarter, and $156 million a year ago. Now, regarding investment yield. In the second quarter, we invested $197 million in investment grade fixed maturities, primarily in the industrial sectors. We invested at an average annual effective yield of 4.49% , an average rating of BBB+ at an average life of 27 years. For the year, we have invested $430 million at an average rating of A-. The new money yield of 4.49% has declined from the 5.65% yield for all of 2011, and the 4.76% yield in the first quarter of this year. For the entire portfolio, the second quarter yield was 6.43%, compared to 6.47% in the previous quarter and 6.56% in the second quarter 2011. The decline in yield is due to the lower new money rates. As of June 30, the yield on the portfolio is 6.42%. On July 5, the notice of proposed rulemaking regarding the 2013 changes to the capital rules for banks, were issued. Subsequently we were notified that $301 million of our $708 million of bank hybrid trust preferred securities will be called in July and August. These securities have an average yield rate at 7.18%, and assuming the call proceeds are re-invested at 4.25%, the loss to annual income will be $9 million pre-tax, or $6 million after-tax. For 2012, the loss to income will be approximately $3 million after-tax and the portfolio yield will be reduced by about 8 basis points. This amount was accounted for in our guidance. The remaining bank hybrids, we anticipate that another $300 million could be called. We don't know whether any of them will be called in the last half of 2012, but I expect the most of them to be called by end of 2013. These bonds yield 7.35%, and assuming the same 4.25% investment rate, the lost annual income if all of those securities are called, will be a similar $6 million after-tax. On past analyst calls, we have discussed the current low interest rate environment and the impact of a lower for longer rate scenario. Our concern regarding an extended period of low interest rates continues to be the impact on earnings, not on the balance sheet. To maintain our underwriting margins, we raised the new business premium rates on the majority of American Income's life products and the Direct Response funeral products by 5% at January 1 of this year. These increases provided additional margin to help offset reductions to excess investment income on new policies and we did so without having a detrimental impact on sales. However, as long as we are in this low interest rate environment the portfolio yield will continue to decline and thus pressure excess investment income. However the decline will be slowed by the fact that on average only 2% to 3% of fixed maturities will run off each year over the next 5 years, and that assumes a call of the $600 million of hybrid preferreds. Last fall, we performed a stress test to determine the impact on the portfolio yield of investing all new money in at 4.75% over the next 5 years. Under that scenario, we determined that the portfolio yield at the end of 2016, would be between 5.95% and 6.10%. We have rerun the model this time using a new money rate of 4.25% and determined that the portfolio yield at the end of 2016 would be around 5.75% to 5.85%. At these rates, we would earn a small spread on the net policy liabilities while earning the full 575 to 585 basis points on our equity. Even though we don't believe our new money rate will be as low as 4.25% for the next 5 years, should that happen, we will still generate substantial excess investment income. As I mentioned, an extended lower interest rate environment impact to income statement, but not the balance sheet. Since we primarily sell non-interest sensitive protection products accounted for under FAS60, we don't see a reasonable scenario that will require us to write off DAC or put up additional GAAP reserves due to interest rate fluctuations. In addition, we do not foresee a negative impact on our statutory balance sheet. Now, I'll turn the call over to Frank to discuss share repurchases and capital.

Thanks, Gary. I want to spend a few minutes discussing our share repurchases and capital position. First, regarding share repurchases and parent company assets. In second quarter, we spent $184 million to buy 3.9 million Torchmark shares at an average price of $47.42. Going into the second quarter, we had anticipated spending price $90 million, which we did to acquire 1.9 million shares at an average cost of $48.54 per share. However due to favorable market conditions, we made the decision to acquire an additional 2 million shares during the quarter. These additional shares were acquired for total cost of $94 million, an average cost of $46.39 per share this was less than a $48.54 per share paid to purchase the initial 1.9 million. For the full year through June 30, we had spent $274 million of parent company cash to acquire 5.8 million shares at an average price of $47.53. The available liquid assets at the parent consist of assets on hand and the expected free cash flow from operations. Free cash flow results primarily from the dividends received by the parent from the subsidiaries less the interest paid on debt and the dividends paid to Torchmark shareholders. The parent began the year with liquid assets of $74 million. We expect to generate approximately $350 million of free cash for the entire year. Thus, the total liquid assets available for all of 2012 will be around $424 million. During the first 6 months of the year, we generated about $163 million of free cash flow but spent $274 million for Torchmark share repurchases, purchasing 5.8 million Torchmark shares. The repurchases were funded by $179 million from the cash on hand and $95 million from the issuance of additional commercial paper. As a result of this activity, the parent ended the second quarter with $58 million of available liquid assets comprised of $74 million of beginning liquid assets, plus $163 million of free cash flow, less $179 million used for share repurchases. Going forward, along with the $58 million on hand at the end of the second quarter, we should generate approximately $184 million of free cash flow in the next 2 quarters giving us $242 million of total cash available for the remainder of the year. $95 million of this cash will be used to reduce our commercial paper to its normal level, leaving us with approximately $147 million of liquid assets available between now and the end of the year. It should be noted that we have already reduced the commercial paper outstanding by approximately $90 million since June 30. As noted before, we will use our cash as efficiently as possible. If market conditions are favorable, we expect that share repurchases will continue to be a primary use of those funds. We also expect to retain a minimum of $50 million to $60 million of liquid assets at the parent company. Now regarding the capital levels at our insurance subsidiaries. We plan to maintain our capital at the level necessary to retain our current ratings. For the last 2 years that level has been around an NAIC RBC ratio of 325%. This ratio is lower than some peer companies, but it's sufficient for our companies in light of our consistent statutory earnings, the relative lower risk of our policy liabilities and our current ratings. At December 31, 2011, consolidated RBC was 336% and adjusted capital was approximately $46 million in excess of the amount required for the targeted 325% ratio. Those are my comments. I will now turn the call back to Larry.

Thank you, Frank. For 2012, we expect our net operating income per share to be in the range of $5.08 to $5.26 per share. Net investment income for the year will be lower than previously expected due to hybrids being called and the lower new money yields. Those were our comments for this morning. We will now open it up for questions.

[Operator Instructions] Our first question today comes from Vincent Lu [ph] with Morningstar.

Just a question about the investment portfolio. If I understand the credit rating has been dip one notch to a BBB+. How much was that, would you characterize natural credit migration, and how much was that, as a conscious effort to increase the allocation to below investment grade securities.

First of all we are not consciously increasing the below investment grade securities. The increase this quarter was due to downgrades, but we are not consciously moving towards lower credit rating either. The BBB+, rounded it's just under A-. So it's only a slight difference from where we were in the last several quarters. So it really hasn't changed that much.

Then, a separate question about the agency count at Liberty. Is that really a target agency count there to turn things around and start having the sale growth again?

I don't know what you mean by target agency count.

I mean it's been decreasing 6% from last year, but is there a target number that you are looking at or?

We are looking the investment to grow this quarter. I am confident that system and the processes have been changed at Liberty National. We will continue to see this sequential growth through the end of this year and into next year, and I expect growth to pick up to 6%. It's only single digit, but it's going to be 6%, 7%, 8% hopefully in the third and the fourth quarter of this year.

Our next question will come from Jeff Schuman with KBW.

I wanted to follow-up a little bit on the arithmetic around the calls on the trust preferred. There are different ways to look at the arithmetic on the guidance change, but if we look at the movement in the mid-point, I guess, it would suggest the mid-point maybe has moved by $0.08. I think when you kind of walked us through the math on swapping out the coupons on the $300 million that has been called so far. You got to $3 million after-tax impact for the remainder of the calendar year which is about $0.03, so trying to bridge a little between that amount and what seems to be maybe by some interpretation of bigger move in the guidance. Is there another piece here, which is that you may suffer a period, where the funds are simply not deployed? We need to factor that in, or how should we think about it?

Yes, Jeff. That's definitely a point. We had $180 million of short-term investments at the end of the quarter and we are going to be adding another $300 million very shortly. It does take a while to get that money reinvested. To answer your question as far as the additional, I outlined the additional $0.03 comes from the fact that we are going to be slightly delayed in getting that money reinvested, but also all new money coming in besides the calls, will be invested at a lower rate than we had projected previously.

Okay, so the rest of it is just the general movement rates of further down. Okay. I'm sorry. You broke up a little bit when you gave the earlier. What is the total upsize of the bank trust preferred portfolio.

As of June 30, we have $708 million bank hybrids.

Bank hybrids, 708? Okay.

Of that $300 has already been called for July and August. The remaining $408 million, there's a $107 million that are either not callable or they there may call, calls and we're not expecting those to be called. That leaves another $301 million that could be called, and based on where their rates are, we feel they probably will be called. As we talked about this in previous analyst calls the reason these bonds are being called is there is a provision in those bonds that they can be called if there is a change in the capital rules, and they lose their capital status. Of course under Dodd-Frank those rules are going to be changed and those rules will be effective in 2013. So all along, we felt that the $600 million sort of the bond would probably be called and that they would be called in 2013. Early in the year, we read where some banks were looking at the fact, whenever the rules are published, which is expected to be in 2012, that, that would be the triggering event, not the actual implementation of the rules in 2013. That’s what has happened here, with these the $300 million, those banks are considering a triggering event happening when those rules are or at least the notice of the rule making was issued in July. So what we don't know is of the other $300 million that are potential calls. We don't know whether the banks will determine 2012 as a trigger year or whether later 2013. We'll just have to wait and see what they do.

Okay. That's helpful. Just one other area quickly if I may. Part D, looks like it's tracking below the 12% margin I think you had hoped to achieve. Is it too early to conclude they maybe are just not going to hit pricing assumptions, or how should we think about that?

I think it's a little too early to conclude what that pricing margin is going to be. If you look year to-date, where we are this year is where we were last year.

Okay, then you did see a strong uptick in the second half. Is there some normal seasonality or some reason that we can maybe think that that's likely to recur?

Yes, Jeff. There's some seasonality there and latter part of the year we got -- well we will probably this year too, rebates from the government. The rebates were greater than we expected last year in the second half of the year, and that helped to elevate that margin.

Our next question will come from Chris Giovanni with Goldman Sachs.

I think last quarter you guys talked a bit about if you made adjustments in the investment portfolio, down 100 basis points or so, you could offset that on the margin side by raising premiums just 2% to 3%, and you talked about the 5% rate increase, you did effective January 1. Are there any discussions around additional pricing changes you guys are looking to implement?

No, I wouldn't expect to increase the rates again, because of lower interest rates. We really only needed to raise the rates about 2%. We went ahead and raised them 5%, knowing that maybe rates might go down a little more. So I think, even rates have declined, I think the 5% that we implemented this year still covers that.

Okay, and then for Frank. You made the comment about being opportunistic on buybacks given the share price by using the CP. If shares did get back to that level, is that another lever you guys would be willing to pull again or was that just sort of a one-time opportunity?

Chris, we really look at that as being more of a one-time opportunity within the year to accelerate some of the purchases really from the third quarter back in the second quarter. We have really had a philosophy of not wanting to borrow to fund the buyback program and wanting to use our existing free cash flows for those buybacks, and I see that will continue to do that.

Chris, I would add it depends on the price. If the price got down to a very low level where we really we couldn’t pass up the buying, we could borrow again under a commercial paper and then pay it back with free cash flow from next year. The good thing about Torchmark is we got the $350 million of free cash this year. Well, it will be at least around $350 million again next year and year after that. So we could prefund using expected free cash flow from next year. However, I agree with Frank. I don't anticipate us doing that unless there is a significant reduction in the share price.

Okay, then lastly your competitor this morning talked about the rating agencies forcing them to hold a higher level of capital RBC and they said that wasn't due to the liability structure or their product mix, but because of the long durations of their investment portfolio, and I guess given that your investment portfolio has a longer duration than some of your peers, have you been similar messages from the rating agency.

No, we haven't, and one reason maybe is, yes, our portfolio is long, but our liabilities are long too. We are matched. These other companies, there may be a mismatch in liability that could cause that reaction by the rating agencies, but we haven't heard anything like that.

Next, we'll take a question from Sarah DeWitt with Barclays.

I was wondering if you could elaborate on what drove the slowdown in sales growth in American Income and Direct, particularly given that the agent count of the American Income continues to grow at a pretty fast pace.

Well, it wasn’t running at [indiscernible] drove the slowdown, [indiscernible] and June. June sales were a little lighter than expected . When we look at July, we are back in excess of the 15% for sales in July, so I think it's just a one month aberration. Again, our guidance for the year, we think American Income will be in a 12% to 15% range.

Then on Liberty National, I think previously you had said you expect sales growth to be positive by year end there. Is that still the case?

That's still the case. We continue to see growth in the agents, but that's just sequential growth of the agents by the fourth quarter I think we'll see year-over-year growth.

Next is Randy Binner with FBR.

Just as a quick one on the preferred issues. Can you disclose if it was larger banks that were earlier to prepay these preferreds and if we could expect maybe the smaller ones to be slower to catch up?

Yes. Randy. I am just looking at our list here.

Or even better, specifically, who pre-paid and who didn't.

It was the bigger banks. Bank of America, JPMorgan, they were almost half of the call, and I am just looking at list of who is likely to be called and they are the smaller banks.

Okay, that's what we thought and will help us monitor. I guess the pick up on what Sarah was just asking on AIA. Larry, did you say 12% to 15% for AIA as the goal?

Yes

Okay. I guess just kind of looking for a little more color. Maybe this kind of is a question that spans both AIA and Liberty, but understand the agent counts, understand the sales manager count being higher, and obviously that's probably giving you some confidence in the forward look on sales, but there has been training initiatives. I think there has been new laptop presentations and other initiatives I would be curious kind of updates how those other initiatives might be playing into this and helping your thinking on the sales guidance.

Sure. There's not one initiative. There's a number of initiatives. One is the laptop presentation, and we are introducing that. And by year end that will be well underway at Liberty National life insurance company. It took some time at Liberty National to put the team in place, and as you introduce laptop it takes some time to spread that throughout the field. At American Income we still have a number of initiatives. We are seeing better training. We're producing better data to manage the training with and some of the data, again, comes from the laptop presentation at American Income. That’s fully introduced there. It's really the data that we can track them with the agents themselves, what their performance is in terms of number of presentations, the closing rates, all of it helps retain agents. That's reflected in those numbers, where we're seeing more of the first time agents hit bonus, we are seeing middle management grow. As some management grows, they will do better training, because there will be more middle managers that can train those new agents. So it's not one initiative and it’s a number of initiatives.

Yes. That's great color. Thank you.

Next we will turn to Paul Sarran, Evercore Partners.

I just wanted to follow-up first on American Income, where for the last year and a half or so agent count growth has exceeded sales growth, and especially large margin over the last few quarters. Is this is a trend that you think should reverse going forward? In other words, should we see productivity start to pick back up towards historical levels as new agents mature?

Yes, correct, and besides, new agents, the middle managers are more effective in terms of their training and closing rates of sales. So I think we are little bit level in terms of our productivity. We expect that to pick-up some more agents as they mature.

Okay. If you kind of adjust for the fact that you have more new agents now thanks to the growth. Is there anything else that's impacting productivity negatively?

Not negatively. It's just as you add have new agents there's a little bit of a catch-up period as you have surge of new agents. And I think it will be closer to the 15% growth at the end of the year than the 12%. It's a quarterly review. It's not month to month, but we're seeing improvements in those numbers.

Okay, turning to Direct Response. What is it that gives you confidence that the lower margins this quarter were a one-time claims fluctuation.

Paul, one thing, looking at margin, we were 22%, just a little over 22%, and 23.5% for the quarter to prior year. 24% from prior quarter, there's 23.5%. Still, we are not talking about big change, but what we did see is claims are little bit lower in the first quarter and I think we caught up in the second quarter and we think for the that they will be right around the 45% to 46% level they are now. We had little bit higher amortization in the quarter and that's kind of seasonal thing. We think that if you really look at the year to date percentages as opposed to this quarter. I think that's what you're going to see for the full year.

Okay. The lower claims in the first quarter and higher in the second? Do you think any of that was reporting timing or changes in IBNR, or you think it's random kind of fluctuation quarter-to-quarter.

No, I think it was a little bit of timing and it doesn't take much of the change on timing to affect the total for a quarter. For the 6 months though, they are about where we expected.

Okay. Then on Direct Response sales, I was a little surprised to see sales fall sequential and I know there is some seasonality to it, but you also expanded circulation pretty dramatically in the second half of last year. Are the responses not coming in as much as you would have expected or is this kind of in line?

That's kind of in line and we expect the responses for the year to be about what they were in last year. We just had a big surge in the third and fourth quarter that takes time for those sales to develop.

Mark Hughes with SunTrust has our next question.

On the Direct Response business, are there any campaigns coming up that might lead to any increase or tougher comps perhaps in sales activity?

There has always been campaigns at Global Life and Accident. That's what Global Life Accident does, constantly they are testing new methods of distribution or [indiscernible] growth in our electronic, media and we want the sales to go up.

Right, so we would expect just consistency.

I expect the same consistency and since the Global does they continue test and with single upward ticks over time I would expect that to continue.

Our next question will come from Jimmy Bhullar with JPMorgan.

Just had a question on the timing of share buybacks for the second half. The stock is obviously down, but should we expect the year to be buying back stock on an even basis in the third and fourth quarter, or if it declines more, would be you be opportunistic and do more of the buybacks in the third quarter. Then, secondly, I had a question on the agent count of Liberty National. Obviously, it's recovered nicely since February. Anything that would suggest that the recovery might short-lived, or do you expect the agent count to continue to improve?

I will take the second of that first. I don't think anything we do with Liberty National is going to be instantaneous, rather slow deliberate growth. You'll see sequential growth each quarter at Liberty National. As it takes some time to have those systems in place, but we're improving the training, the lead programs, the recruiting, well all those initiatives will start at the same time. Obviously with the sequential growth of agency, you are seeing those get some traction. You must see high single-digit growth in the fourth quarter, then I'll see the stronger growth next year as those mature and for the laptop [indiscernible] the first of the year through 2013.

Jimmy, as far as the share repurchases, as Frank mentioned came in here expecting to spend about $360 million on share purchases, and I think that as of today I kind of think that's where we'll end up. So that means for the second half of the year you are talking about $90 million of share repurchases. We haven't determined what, but we think the timing of that should be, but you are right. If there's an opportunistic chance to get a better yield on the purchase, we would accelerate it, but at this point we don't expect spending more than the $360 million.

Next is, John Nadel with Sterne Agee.

Gary, you mentioned 4.25% new money yield for the updated sensitivity analysis. I am just wondering is that around the level that might be consistent with where you are currently investing new money given the more recent drop in rates. I know you are just under 4.5% for the full quarter.

You are right. We're right about 4.5% and rates have dropped, and that's right around where we are investing now, maybe a little bit higher, but we assume 4.25% in our guidance and that's probably where we are going to be.

Yes, I understand. Second one is just how should we think about the outlook for Part D sales from here? Obviously, there has been some great momentum with the new product. I am just wondering how much longer you think that runway will last?

Well, long-term, John, it's hard to address. In the short-term, we submitted our pricing in June this year, and we expect CMS will publish the 2013 benchmark premiums in August. We hope to be able to maintain our existing regions, and possibly add a few more regions when that is published.

Okay, then just can you update us on the progress that you've been making on the premium retention program?

Yes, or projections of this year that without the conservation program, we would be lapsing around $250 million worth of premiums, annual premiums, annualized. Our estimate now is that for this year, we will conserve around $31 million of that that, that would normally have lapsed, but of course so that's an annualized amount. The actual premium collected for year from that saving that $31 million will be around $15 million. It's a little bit higher than what we projected coming into the year.

How do you think about that for next year? I know whether it was a quarter or 2 ago, when you originally started talking about this program, you expected to broaden it to some of the additional channels. I am wondering what you are thinking about in terms of the savings you might be able to garner looking out to 2013.

Well, I don't have a projection for 2013, but you are right. We have extended it out. At first it was primarily the American Income. American Income is about 40% of it, but there's another 45% of it now that is in Direct Response and Liberty makes up the difference. Again, I don't have a projection for next year, but I am sure it's going to be higher, because we are improving as we go along.

[indiscernible] we need to hire within that section and train in order to expand those efforts and so it can grow next year we'll decide the percentage calculated just.

Okay. Then I am sorry I want just last one. Can you just walk us through why the discount rate on the policy liability has increased? I know it was 5.65% in the second quarter. That' s up from 5.60% last quarter and 5.55% a year ago. It also seems so counter intuitive with rates falling? Can you just remind us?

Yes, John, it's all related to the fact that our import block of business is made up of many years of issues, but really the last 2 years we have reduced the discount rate, but that's a discount rate on policies issued in the year. Going back several years ago, our discount rate was more into 6.5% to 7% range. Right now, a higher percentage of the block of business is at the 6% or 7% rates. As time goes by, though they'll decline end and the policies issues at the lower rates will become a bigger part of the in-force and we'll have a lower discount rate. What it looks like is, is that discount rate will continue to increase slightly over the next 2 to 3 years, and it’s really at a point versus around 5.75%, we think it will start declining from that point in interest rates are where they are today. So it will rise for a little bit and then it will start declining.

Next is Steven Schwartz, Raymond James & Associates

John just asked a question I wanted to ask on retention, so just a quick one. The $300 million of hybrids that have not been called that are callable. That's not in this year's guidance, right?

The impact if it's called -- let's say they have to give us at least 30 days notice on the call. And let's say they're called at -- the actual money goes out on September 30, and I kind of think that's the worst case. You are talking about $0.02. We did include the $0.02 in the low end, but it may be less that, and as I say we don’t really know how many of them will be called in 2012.

Okay, but it make sense if it's going to be called, it's going to be called by 12/31, because otherwise it's in the capital earned I guess not in the capital.

Well as the legal though is whether they can call them. All the provisions are a slightly different, and it is not clear cut. The banks that have called them they new position that's announcement it rules is a triggering event. Some of the other banks may think the GSA has implementation of the rules that won't be in 2013, before there is a triggering event. So it is a legal question that they are probably looking at, again we don't know how they'll look at it, so we don't whether they will call them in '12 or not.

[Operator Instructions] Next we'll hear from Ed Forun [ph], Nomura.

I was hoping you could quantify how much capital will be freed up as the $600 million of preferreds are called and what the use should be of that capital?

Yes, Ed. It looks like a portion of the known calls that we have, there's a portion of that that in fact would be NAIC category 3 and 4, so we will get some capital relief out of that. Out of the known, right now it would appear that it's maybe by $12 million of statutory capital that would be freed up. If in fact, the other $300 million of the bank hybrids are in fact called before the end of the year that an additional roughly $30 million statutory capital would be freed up as well. So remember that is sitting in the statutory in the insurance companies, so just depending upon what the other course of events over the remainder of the year as to whether now we can end up getting in that money out before the end of the year or 2013, or if we need to leave it in there to meet our RBC levels.

Ed, I might add that just looking at the debt quality portfolio the as the $300 million debt have been called $85 million are below investment grade. So our below investment grade bonds will decline $85 million. If the other $300 million are called below investment grade bonds will decline another $170 million. So that's the additional capital and the fact that we are doing some below investment grade bonds is a slight positive to these calls.

[Operator Instructions] Currently, there are no questions in the queue. I will turn the conference over to our host for any closing our additional remarks.

All right. Thank you for joining us this morning. Those are our comments and we'll talk to you again next quarter.

That does conclude today's conference call. Thank you for your participation.