Apr 22, 2009
Executives
Laura Gagnon - IR Jim Cracchiolo - Chairman and CEO Walter Berman - CFO
Analysts
John Nadel - Sterne, Agree & Leach Colin Devine - Citigroup Andrew Kligerman - UBS Suneet Kamath - Sanford Bernstein Thomas Gallagher - Credit Suisse Sam Hoffman - Lincoln Square Capital Management Eric Berg - Barclays Capital
Operator
Good afternoon, ladies and gentlemen, and welcome to the first quarter earnings call of Ameriprise Financial. (Operator Instructions) I will now turn the call over to Laura Gagnon.
Ms. Gagnon, you may begin.
Laura Gagnon
Thank you. Welcome to the Ameriprise Financial first quarter earnings call.
With me on the call today are Jim Cracchiolo, Chairman and CEO, and Walter Berman, our Chief Financial Officer. After their remarks, we'd be happy to take your questions.
During the call you may hear references to various non-GAAP financial measures which we believe provide insight into the underlying performance of the company's operations. Reconciliations of non-GAAP numbers to the respective GAAP numbers can be found in today's materials, available on our website.
Some of the statements that we make on this call may be forward-looking statements, reflecting management's expectations about future events and operating plans and performance. These forward-looking statements speak only as of today's date and involve a number of risks and uncertainties.
A sample list of factors and risks that could cause actual results to be materially different from forward-looking statements can be found in today's earnings release, our 2008 annual report to shareholders, and our 2008 10-K report. We undertake no obligation to update publicly or revise these forward-looking statements.
With that, I'd like to turn the call over to Jim.
Jim Cracchiolo
Good afternoon, everyone, and thanks for joining us for our first quarter earnings discussion. Even with the rally in the equity markets in March, the environment remained challenging and volatile during the first quarter.
The S&P 500 was down 40% from a year ago and 12% just for the quarter, and macroeconomic data remained weak. Considering this tough backdrop, we're pleased with how the company performed.
Our earnings of $129 million or $0.58 per share demonstrate the resilience of our franchise, the continued strength of our balance sheet, and the actions we've taken to prepare the company for the current environment. Of course, the weak conditions continue to affect our business.
Owned, managed and administered asset decreased by 21% compared with a year ago as a result of the sharply lower equity markets, which impacts our revenue. And at the same time short-term interest rates remain near zero and credit spreads in certain industries are very wide, which continues to impact our net investment income and balance sheet.
Overall, our revenues were down by 14% to $1.7 billion compared with the first quarter of last year. That said, our business fundamentals continue to be solid.
Client and adviser retention are very strong. We're driving significant gains in experienced adviser recruitment.
Our fixed annuities and certificate businesses are providing the safety clients are seeking. We've reduced expenses significantly, we've further strengthened our balance sheet, and we have increased our excess capital position and continue to maintain a large liquidity pool.
So my message for you today is this: While the environment continues to be very difficult, as we've seen in the quarter, we are riding out the storm. We've generated reasonable earnings and continue to strengthen our financial foundation.
I believe the company is well positioned both for the short-term challenges and to take advantage of a recovery. With that in mind, let me talk about how we're managing for the near term and then I'll provide some insight into how the businesses are performing.
Our foundation remains stable and strong. We continue to feel good about our own asset portfolio despite the ongoing dislocation in the credit markets.
In fact, we had only limited impacts to our investment portfolio and our net unrealized loss position strengthened during the quarter. We're also continuing to manage our capital conservatively.
Even after our three all-cash acquisitions in 2008, we finished the quarter with $1 billion plus in excess capital and we have a liquidity position of $5.8 billion in cash and cash equivalents. I should note here that all four of the rating agencies that cover us have changed their outlook for Ameriprise to negative, which is consistent with the industrywide actions.
At the same time, the agencies all reaffirmed our ratings while many others in the industry have been downgraded. Because we expect the soft conditions to persist through this year, we further increased our efforts to reduce our costs.
In fact, we now expect to achieve approximately $350 million in reengineering saves this year. We expect to deliver two-thirds of those saves to the bottom line and those bottom line savings will accelerate as we realize the benefits of the actions we've taken over the past several months.
For the quarter, general and administrative expenses were down 1% compared to last year, but keep in mind that the current quarter includes additional expenses associated with our acquisitions. Excluding those costs, general and administrative expenses would have been down by 15% compared to a year ago.
I want to be clear that we are being thoughtful about where we cut expenses. We've been very careful not to affect the level of service we provide our clients and advisors.
Now let me give you some insight into how our business is performing. The heart of our franchise, the close, personal relationships our advisers have with their clients, remains strong.
Clients are recognizing the importance of our planning and advice model now more than ever and we think this demand will continue to grow as consumers reflect on the market dislocation and the recession. In our adviser force we had three consecutive excellent quarters in experienced adviser recruitment.
Established advisers are increasingly drawn to our choice of platforms because of the strength of our culture, our corporate stability, and the extensive support we provide. In March alone we brought in 95 new experienced advisers and we brought in approximately 200 in the quarter, which is more than we recruited in all of 2008.
You'll notice that our overall adviser number continues to slightly decline. That's because we dramatically reduced our recruitment of novice advisers to focus on the compelling opportunity to bring in highly productive experienced advisers.
Now I'll move on to the product area. Owned, managed and administered assets declined by 21% compared with the first quarter of 2008, driven primarily by the market depreciation.
With regard to flows, we generated strong fixed annuity and certificate sales as well as return to net inflows in wrap products, and we remain in net inflows in variable annuities. The strength in fixed annuities and certificates reflect an important element of our business model and its resilience.
As clients have sought safety and fixed returns, we've been able to provide the range of products they need to shift their portfolios. It's important to note that the fixed annuity book will provide higher margins after the first year of the contracts, providing a base for future earnings growth.
Total asset management net outflows decreased to $0.3 billion or $300 million in the quarter compared to $8.7 billion in the fourth quarter of last year and $5.2 billion a year ago. In the domestic business, mutual fund net outflows improved sequentially and we drove solid net inflows in institutional asset management.
At Threadneedle, overall flows, including net inflows in both the retail and institutional higher margin businesses, were offset by outflows in the lower margin Zurich-related assets. Total Threadneedle net outflows decreased to $322 million compared to net outflows of $6.6 billion a quarter ago.
Investment performance at Threadneedle remained very strong, especially in equities, where 87% of the funds were above medium over the three years. In terms of domestic investment performance, most of our funds are positioned for an economic recovery so their performance has been strong since the markets began to rebound in March.
Our fixed income teams continue to generate solid performance, with 77% of funds above the median for one year, a 7% increase over December. Equity performance continues to be mixed.
We have pockets of strength, for example, in our value funds and at Seligman, but we also have areas of continued weakness. In the insurance business, cash sales continue to be impacted by clients' reluctance to invest cash in long-term products, a trend that we expect to improve as we experience the recovery.
Still, life insurance in force was up 2% over a year ago to $192 billion. The auto and home business continues to perform quite strongly, too.
Premiums increased 5% compared to a year ago, while total policies increased 6%. Our combined ratio in that business decreased by 2.2% compared with both the year ago and the sequential quarter.
To summarize, the environment remained very challenging in the first quarter, but we demonstrated the resilience of our business model and the strength of our foundation. We reduced expenses and further strengthened our balance sheet so that we could weather the economic and market storms.
At the same time, we have continued to execute our strategy and invest in the business so that we have leverage necessary to take advantage of improving conditions. Our diversified business model, centered on deep client adviser relationships, is intact and performing well given the environment, and it is underpinned by an increasingly strong financial foundation.
Now I'll turn it over to Walter for more detail on the quarter and then we'll take your questions.
Walter Berman
Thanks, Jim. We have posted slides on our website again this quarter and these slides will be updated with my talking points after the call.
If you will turn to Slide 2, my discussion today will focus on four topics - business metrics, earnings, balance sheet strength, and the accounting changes we adopted in the quarter. In the quarter, activity metrics continued to reflect the market dislocation and lower client activity, but flows and adviser metrics trends are encouraging.
The first quarter results reflected the volatile markets and headwinds created by those markets. We achieved a $0.58 reported per share profit and core operating EPS was $0.60 per share.
Finally, the balance sheet fundamentals remain strong and we adopted [FSP No. 157-4], Additional Guidance Relating To Fair Value In Recognition of Credit-Related Impairments.
Turning to Page 3, for the quarter all advice and wealth management metrics continued to be impacted by external markets. Clients continued to shift to defensive products, focusing on fixed annuities, universal life, brokerage cash, deposits, and certificate products.
Sales of mutual funds, variable annuities, variable universal life and other insurance products are being negatively impacted by this shift. Mutual fund redemptions are stable and consistent with historical trends and in the quarter we experienced both strong core adviser trends and positive retail flows.
Turning to Slide 4, this slide shows the details of the favorable adviser and client trends. Client retention remains at 94%, with an increasing portion of client acquisitions coming from newly appointed experienced advisers.
The adviser retention chart indicates the improved pattern. Franchisee retention is stable at 93% despite senior advisers managing their headcount through the market dislocation.
The retention of our most senior and productive advisers remains at all-time highs. Employee retention has increased from 61% in the year ago period to 72%.
This reflects the higher retention of the H&R Block financial advisers. Even excluding these advisers, our retention increased to 66%.
In the first quarter, branded experienced adviser additions were approximately 200, more than we recorded in the full year of 2008. The pipeline of potential recruits remains strong.
These advisers contribute to profitability much more quickly than novice advisers, who come to us with no existing books of business. On Slide 5 you can see the improvements in flows.
Variable annuity flows have accelerated over the prior year, driven by substantial fixed annuity net inflows. First quarter fixed annuity inflows were $1.5 billion.
As expected, variable annuity net flows declined to $300 million. Wrap net inflows of $1.3 billion were flat compared with first quarter 2008, but up substantially from the fourth quarter.
And asset management flows are improving Threadneedle flows, increasing net inflows from retail of $642 million and substantially lower net outflows from institutions. RiverSource flows include diminished retail and net outflows of $1.3 billion and inflows in institutional and trust.
Approximately $2.2 billion of institutional net inflows were related to the strong retail client flows in deposit products and fixed annuities. Slide 6 provides context for the external market dislocation in the quarter.
The S&P 500 Index declined 12% in the quarter and 40% compared to last year. The lower asset levels and fees resulting from this decline are estimated to have lowered core earnings by $94 million or $0.42 per share compared to last year.
Also, increased levels of liquidity, combined with a 190 basis point drop in short-term rates, reduced our core earnings for the quarter by $46 million or $0.20 per share compared to last year. Market conditions also exacerbated the dilution we anticipated from our acquisitions.
In addition to integration charges, the core operating losses attributed to the acquisitions was $12 million in the quarter. The same dislocation driving the negative impacts I've just referred to provided us an opportunity to generate a profit of $33 million by repurchasing our hybrid securities.
On Slide 7 I'll provide more detail on specific non-core items in the quarter. The net impact of non-core items was down substantially.
In the quarter we recorded $0.01 in net investment gains compared to $0.07 in realized losses last year. We recorded $0.05 of acquisition related to integration charges, which is on track with our plan.
DAC [mean reversion] negatively impacted our results by $0.14 per share compared to a negative impact of $0.08 in the prior year period. Offsetting that loss was a $0.16 per share gain on variable annuities primarily from FAS 157 credit defaults spread widening.
Excluding the $0.02 per share negative impact of these non-core elements, core operating EPS was $0.60 per share compared to $0.99 last year. Turning to Page 9, in the quarter our G&A expenses fell 1%.
Excluding the impact of acquisitions, G&A was down 15% from the prior year. We anticipate that we will generate over $350 million in reengineering saves in 2009, with over two-thirds of that estimated to fall to the bottom line.
The savings represents the reengineering generated by our plans announced in the fourth quarter earning call plus additional actions in response to the market decline in the first quarter. In addition, we expect the full year impact in 2010 to be over $100 million higher than what we realize in 2009.
On Slide 9 you can see that we continued to maintain strong balance sheet fundamentals. First, our free cash liquidity pool remained over $4 billion even after redeploying over $3.2 million of cash into longer-term investments.
Our first debt maturity is November of 2010 and we have no reliance on short-term institutional funding. In addition, we have access to lines of credit at both the holding company and subsidiary levels.
We maintained a conservative capital position with more than $1 billion of excess capital and our ratios continue to remain strong. Our variable annuity hedging also continues to perform within our tolerance levels.
The net change in values of assets and liabilities was significantly impacted by FAS 157, Credit Default Spread Widening. However, the after-DAC, after-tax benefit from variable annuities were mostly offset by the impact of mean reversion on DAC.
Finally, we had good investment asset performance and, in fact, our net unrealized losses actually decreased in the quarter. I'll provide more detail on this shortly.
Our balance sheet numbers were impacted by our adoption of FAS 115-2 and FAS 124-4. These new guidelines provide for the credit-related portion of other than temporary impairments to be reported in earnings and the non-credit-related portion of valuation change to be reported as an unrealized loss in other comprehensive income.
At adoption retained earnings will be adjusted to eliminate the impact of the non-credit portion for items previously impaired. This amount did create an increase in the corresponding unrealized losses and other comprehensive income.
Expected principal losses are discounted using expected interest rates to determine the amounts of OTTI recognized through earnings. We also adopted FSP No.
157-4, which provides additional guidance for fair value determination when markets are less active. Our historic valuation practices were consistent with the FSP, so this adoption did not impact our numbers.
On the next slide you can see how the adoption of the new FSPs impacted our balance sheet. As the chart indicates, pre adoption our unrealized losses would have decreased by $224 million.
Post adoption, our unrealized losses were essentially flat. There is a corresponding increase in our retained earnings due to the reclassification of non-credit-related impairments.
Also in the quarter we recognized $47 million of pre-tax impairments. The adoption increased the impairments that will be recognized by $15 million.
If you turn to the next slide, No. 10, you will see a fair amount of detail on our net unrealized loss position, which is $1.82 billion in total or $1.96 billion excluding government-backed securities.
Unrealized losses after tax as a percent of equity excluding AOCI was 16%, one of the lowest in the industry. These unrealized losses continue to reflect high discount rate assumptions on valuations and the wide spreads in the corporate sector.
Even when you add unrealized losses, we compare very favorably to our peers. We believe these marks reflect the underlying strength of our investment portfolio.
Approximately half of the unrealized losses are in the corporate credits based upon continuing overall spread widening. On our website you'll find the underlying details relating to each of these categories.
I'll go over this to create transparency and allow you to form your opinion as to the quality of the remaining portfolio. On Slide 11 you'll see a few key facts about our investments.
I would encourage you to look at the complete disclosures on the web. This slide is basically unchanged since last quarter because the quality of the portfolio remains high, so I won't go through every line, but I'd like to highlight a couple of important areas.
CMBS is first. We are quite comfortable with our CMBS portfolio due to its vintage, its rating profile, which almost 30% is government backed and the remainder AAA.
One bond, $7 million in cost, is now rated AA. We have been investing in the market primarily in the 2005 vintages with AAA ratings.
Also, direct commercial mortgage holdings continue to maintain solid loan-to-value ratios, coverage and performance characteristics. LTVs have increased sequentially from 53% to 59% due to increases in cap rates.
Five mortgages with a book value of $20 million are classified as Level 4, the equivalent to our watch list. If you turn to Slide 7, to conclude let me cover where we focus from here.
In short, we will focus on what we can control. We will continue to evaluate trends.
The market remains volatile and challenging, but we are beginning to see some signs of underlying important in our client activity and flows. We will continue to focus on maintaining our balance sheet strength to help us weather the markets as well as position us to take advantage of emerging opportunities.
We will continue to rely on reengineering and prudent expense management to mitigate the market impacts on our margins. And we will focus on capitalizing on opportunities that present themselves, including recruiting experienced advisers in the midst of other firms' turmoil, increasing financial planning penetration as clients' needs grow, leveraging our existing spread products to meet client needs, redeploying excess liquidity and new cash flows in the attractive yield environment, and redesigning products to improve risk-return balance.
With that, I'd like to open it for questions, Operator.
Operator
(Operator Instructions) Your first question comes from John Nadel - Sterne, Agree & Leach.
John Nadel - Sterne, Agree & Leach
A couple quick questions, maybe one high level one, thinking about the FASB changes, and then maybe a couple of quick ones on the annuity line, if I could. On FASB, did you shift anything from Level 1 or 2 to Level 3 and market any differently as a result of the changes from FAS 157?
Walter Berman
No.
John Nadel - Sterne, Agree & Leach
A question on the annuity segment, maybe a little bit detailed here. I'm looking at the slide in your supplement that walks through all the disclosed items and I'm looking at the annuity line and the amortization of deferred acquisition costs.
And if I make the adjustments for the couple of items there and adjust that versus your reported number, it looks like DAC amortization in the quarter what you would have us think or what you would refer to us as a normal DAC number ex those items was $38 million and I can't remember a quarter where your DAC amortization was that low. Is there some way maybe you can give us a little bit more detail about how to think about that?
Is that a function of your shift to a reversion to the mean or is there something else there?
Walter Berman
No, it is lower but it relates to the [inaudible] profit and lower surrenders, so it corresponds to that.
John Nadel - Sterne, Agree & Leach
And then just thinking similarly around the benefits line in the annuities segment, again, if we look at the negative benefits number on a reported basis and then adjust for those one-time items, we get to a normalized level of benefits of about $65 million pre-tax. Similarly, that seems relative low.
Walter Berman
Well, the benefits, again, that you're getting the impact of the FAS 157 coming through.
John Nadel - Sterne, Agree & Leach
Walter, I’m adjusting for those one-time items from the disclosed items page, so if I take the reported number -
Laura Gagnon
I'm getting a slightly different - actually a higher - benefits number and a different DAC amortization numbers, so we can take it up after the call. I can reconcile it with you.
John Nadel - Sterne, Agree & Leach
The last item would be just to think about your definition of core earnings. I know you're guiding us to think about $0.60, but there's a benefit in there from the early retirement of the debt.
Is there some reason why we should think about that as ongoing? And then secondly on that, can you just talk to us about what your normal tax rate was in the quarter?
Even if I adjust for the 35% statutory rate on the one-timers, it looks like the tax rate in the quarter was extremely low.
Walter Berman
Yes, the tax rate has been low and it's been low for quite some time as we do effective tax planning.
John Nadel - Sterne, Agree & Leach
Maybe you can help us with how to think about that going forward, then?
Walter Berman
Well, I think we have given previous advice. Obviously, with the market situation as the PTI comes down you'll have a lower effective tax rate.
Our previous guidance has been in the lower 20s and I think now that gets adjusted down to the lowest PTI, again, depending where markets go. So it will drop into the teens.
Now as relates to the hybrid - I think you said retirement hybrid - I guess the way I look at it and obviously each person will have to form their own judgment, the conditions that created basically the drop in our core earnings, which we relate to equity markets and the spread, earning 20 basis points versus 200 basis points, and certainly the need to maintain a large liquidity pool, created the opportunity to generate and purchase our debt at $0.50 on $1. So is it going to be reoccurring?
I think it's the same dislocation that's causing both.
John Nadel - Sterne, Agree & Leach
Okay, I understand what you're saying. So equity markets return to a normal level, that sort of thing, we don't necessarily have a debt gain but we have the ability to earn better from just a core perspective.
Got it.
Operator
Your next question comes from Colin Devine - Citigroup.
Colin Devine - Citigroup
I'd like to come back to the annuity line because it seems to me, Walter, in trying to just work through the numbers - and obviously, for advice and wealth management and asset management, a tough quarter but certainly expected given the markets - but when you talk about FAS 157 adjustment, did you use a much higher discount rate this quarter to value the VA liability and that's why we've got this gain? Because I thought you did that in the third quarter, then you took that off in the fourth quarter.
And are we back to using a wider discount rate because if we just want to total up benefits and DAC, your run rate's $160 to $180 million a quarter. It's pretty steady between the two.
This looks to be a fairly significant swing off that, so if you can just help me through this.
Walter Berman
Yes, well I think if you take a look the spreads did widen and obviously we're guided by the correlation that it creates between the insurance and the holding companies as we use comps to do that, so there's really not too much leeway on that. And obviously there was a substantial widening.
I believe it went as high as 325 up from, I think, 225. That creates a fairly big gross factor when you adjust on the liabilities.
When you finish through the DACing of that, it actually gets down to an appreciably small number that's about $70 some odd million. Then when you take into consideration the normal mean reversion and the death benefits, it pretty much neutralizes through.
Colin Devine - Citigroup
But if we put this together, isn't the bottom line here the swing's about $80 million off any kind of run rate. I'm confused as to why you used the lower discount rate in the fourth quarter and now it's come back up again in the fore, which seems to have been what's driven this big swing in the expense line, unless I'm misinterpreting what you're saying.
Walter Berman
Are you doing the discount rate on the FAS 157?
Colin Devine - Citigroup
How you're valuing your living benefit liability. Is that what's driving the swing in this benefit line?
Walter Berman
The benefit line is being impacted, yes, by the 157, the [inaudible] yes.
Colin Devine - Citigroup
Then am I mistaken -
Laura Gagnon
It's also the DAC - the total net expense change in the annuity segment, it's down $13 million pre-tax.
Colin Devine - Citigroup
Hold on. Maybe you can walk me through, then, what happened in the third quarter versus the fourth versus the first here and why this extreme volatility because this is what's moving the whole earnings for the company up and down.
Walter Berman
You want me to go back and reconcile the third and the fourth on this call?
Colin Devine - Citigroup
Well, what I thought you'd done in the third was used a higher discount rate and you'd reversed that decision in the fourth, and now it looks like you've used a higher discount rate here in the first. Is that mistaken and if it is, then I got it wrong, but that's what I thought had happened in the fourth, which is why we saw the expense line come back up.
Laura Gagnon
What we reversed in the fourth quarter was actually the DAC. We said that the FAS 157 conceptually will reverse itself.
The spreads continue to widen so whatever the market does we have to carry into our valuation, but we don't have to assume they're going to stay there for our gross profits forecast. So that's one of the reasons why, when you look at this impact, the variable annuity benefit impact in the C pages, you're seeing a much higher percentage of DAC offset because we do not expect it to stay.
We don't have a lot of options around the impact the spreads have on how we value our liabilities; we have to employ the guidelines under FAS 157. And the fact was that financial spreads widened in the quarter.
Colin Devine - Citigroup
So what you're saying is that if we see spreads come in, we're going to see this negative $129 million expense, there's a really good chance that whole thing is going to reverse out?
Walter Berman
Yes, it will reverse.
Colin Devine - Citigroup
I'm trying to get at what are the economics here as to what's exactly going on with this block because I don't think this represents the economics. I'm not debating the accounting with you.
Walter Berman
Well, I don’t make the rules on the 157.
Colin Devine - Citigroup
I'm trying to get the economics, Walter.
Walter Berman
Well, the economics are being reflected by the fact is, so to your point, as it will narrow, what you would then get is a reversal of the DAC going the other way and it will mitigate it coming back as it goes through. And that's what we're trying to manage through.
[Inaudible] given on it, the economics, candidly, as we talked about, Colin, to me 157's an interesting philosophy as it relates to setting up credit default swaps for your paper.
Colin Devine - Citigroup
But what you're saying here then is in terms of what helped earnings this quarter for the company was the wider spreads, debt spreads, here on the VA line and then also your ability to buy in the debt at a steep discount. So those two things helped and [inaudible] markets being down pushed it the other way.
Walter Berman
Colin, let me say what I think it is and then you can see if we're in agreement or not. There is no question we got a benefit, as I said, from the credit spreads widening, okay?
And that was reflected in the living benefits. Offsetting that was really the DAC reversion and the death benefits, which basically negate down.
So the benefit to the bottom line was really not significant when you take into consideration both elements. As it relates to the element, as I explained before, yes, there is a benefit on the hybrid, but we're also carrying $0.62 worth of deterioration, which is the same dislocation that is causing me the capability of buying my hybrid in is causing me to carry huge liquidity pools at very low rates and actually suffering the impacts of the market.
So yes, I am taking advantage of the other side of it.
Colin Devine - Citigroup
Okay, and I have just some final -
Walter Berman
[Inaudible] capital structure to do it.
Colin Devine - Citigroup
Okay. And then the final, a different topic, do you have any update, Jim, in terms of the federal government programs and Ameriprise's position on what might be available since we have a few new ones since the fourth quarter?
Jim Cracchiolo
Well, you know, regarding the TARP itself, we have heard nothing from the government. As you know, we applied when the government said that they wanted healthy companies to apply and we did that looking for continued ways to invest in our company potentially with the use of those funds.
As you know and we just stated again, our capital position remains strong, our investment portfolio's of high quality, and so if those programs present opportunities we'd be interested, otherwise we think that we're in good shape. Regarding some of the other particular programs we're looking at from an investment perspective depending on what are the sort of guidelines and the sort of attachments to those things, including for our own clients to invest in some of those activities that we've managed the money in those programs.
So those are the things we're exploring from an opportunity perspective, but again, we're trying to analyze what sort of stipulations the government has on those various programs as well because we feel that we're in good shape and we want to be able to control our destiny.
Colin Devine - Citigroup
Then you are still asking for TARP funds as we stand here today?
Jim Cracchiolo
We put in an application last year when the government said they wanted all good companies to apply. We have not heard anything, we have not done anything, and I'm not saying at this point in time it's still our viewpoint that we will take the funds.
Colin Devine - Citigroup
You've not withdrawn it, though? You've not withdrawn the application?
Jim Cracchiolo
No, not at this point in time because I think everything's sort of a wait and see on things, so we didn't have to make any decisions on it.
Operator
Your next question comes from Andrew Kligerman - UBS.
Andrew Kligerman - UBS
Let me start with some of the easier ones and then work to the DAC question and hopefully we can hit that real easily. One, on the excess capital, Jim and Walter, you state more than $1 billion.
Could you give a little clarity around one, what your RBC ratio was at the end of the quarter, and two, how you get to that $1 billion plus number?
Jim Cracchiolo
The RBC ratio at the end of the quarter was a bit over 500.
Walter Berman
Yes, [ex the 798] S&P.
Andrew Kligerman - UBS
Ex 798.
Jim Cracchiolo
And again, you know this is estimates, very rough. It's in that range.
Andrew Kligerman - UBS
When I calculate that now I get a lot more than just greater than $1 billion. I probably get more than $1.2 billion, maybe even more than $1.3 billion, just back of the envelope.
Am I out of the ballpark?
Walter Berman
We said $1 billion plus. It's a conservative number.
As you know from our past, we've always not given an actual number out. But I would say it's a conservative number.
Andrew Kligerman - UBS
Then shifting to the statistical supplement, Page 10 of 49, the management and financial advise fees just kind of keep dribbling down. They were $367 million in the first quarter of '08, they fell to $292 million in the fourth quarter of '08, and now you're at about $268 million.
Can you give a little color on where you think that kind of bottoming point is, what might drive it up, just a little more color around that one?
Jim Cracchiolo
Well, you know, I think, as we've said to you in the past, when you have very volatile markets, the client really holds back. They sort of sit on the sidelines a little bit.
We see money coming, as we said, some of the flows picked up in the first quarter a little bit. Some monies were redeployed back into equity markets, but a lot more was going into more fixed-type spread products.
And so I think what you're seeing is really slow client activity as well as the depreciating markets on the assets under management that they generate fee revenue from in their wrap accounts. So if we see the markets improve, those fees will come back very quickly because the assets are still there.
If on the chance that the markets do settle, there's a direction to the markets that people feel a little more comfortable with, we think a lot more money will go back to work. So, you know, I would just say I think the fourth quarter/first quarter looks like some of the low point, look like activity improved a bit in March.
It really dropped off, as you would imagine, in January and February, as it did in December, so I think some of that started to come back a little bit but until there's a better direction to the market or at least when the client and the adviser feel there's some floor under it, I think that we'll have slow activity. Once that occurs I think that'll start to pick up.
More activity right now is going into the spread products. That has picked up and continues to come in that way.
Andrew Kligerman - UBS
Now I'm just going to take my shot at the DAC question and hopefully keep it really tight here. Before the quarter, my team and I, we were looking at Page 76 of the 10-K and it provided a hypothetical DAC impact if the equity markets declined roughly 10% which, you know, maybe we were in that ballpark in the quarter.
And the sense was that you would see a $160 million DAC and DSIC amortization hit as a result of that, and most of it would happen in the quarter when we discussed that with management. So then when we went to the reconciliation page, there was only a $46 million negative hit.
So part one of it is why the differential there from the guidance around DAC? I would think that would be fairly straightforward.
That's the part one. The part two is this variable annuity rider issue that I think Colin was getting into.
And in that same hypothetical, a 10% drop in the market, you would see a $58 million negative hit. Now you mentioned the effect of spreads widening.
That was written in the release; it's what you've just touched on. And the benefit was, I think, per this reconciliation page, $54 million.
So the question on the spread widening, where? Could you give a little color on exactly or isolate out where that widening is to be observed?
Walter Berman
The widening in the market is being observed?
Andrew Kligerman - UBS
Yes. I mean, I didn't see such a widening from point to point.
Walter Berman
Oh, okay. That one is easy because basically what we do is we use comps and basically we look at insurance comps that have basically holding companies and an insurance company and you look at the differentials.
And during those differentials on that basis they widen and they widen substantially. Yeah, you basically look at basically, you know, holding company and the insurance operating company, you look at the spread differentials and then we basically extrapolate on that basis.
We don't issue basically out of our insurance company. And that's the way we create the spread situation.
And that is done based on a series of comps that we look at and those comps widened in the quarter, as you would imagine, and that becomes the basis on which we do the calculation.
Andrew Kligerman - UBS
Maybe later on I could take a look -
Walter Berman
Yes, I think we could take you offline and take you through that.
Laura Gagnon
One thing I would like to point out, Andrew, is that the numbers you're referring to in this 10-K are annual numbers.
Andrew Kligerman - UBS
Yes, but when we discussed with management, the indication was that maybe 90% of the number would flow through to the quarter. That was the feedback, unless I misinterpreted it.
But I got the sense 90% of the numbers we see here should flow through into the quarter. I thought that was pretty clear, but we could follow up if you want.
Laura Gagnon
Yes, I think you were to the point, this is just the equity decline and not the other factors you were talking about.
Andrew Kligerman - UBS
So the DAC number as well involves other variables, including that credit spread widening? Is that right?
Walter Berman
No. The DAC is a straight on [inaudible] DAC.
Like I said, you know, in the quarter we basically evaluated what dropped in the marketplace, the drop that took place in the quarter, and then we basically are spreading the near-term rates and we're spreading that drop over the next five years, which we use for our mean reversion.
Andrew Kligerman - UBS
Right, okay, so there were a number of other factors aside of that basic 10% hypothetical then?
Walter Berman
And like I said, we can take offline, reconcile it and try and get you back to some good numbers.
Operator
Your next question comes from Suneet Kamath - Sanford Bernstein.
Suneet Kamath - Sanford Bernstein
Maybe we can focus on the operating business a little bit. A question about the 200 experienced advisers that you recruited in the quarter.
Can you give us a sense where they're coming from? Just describe maybe the companies that they left.
And then, in other words, were they the large warehouses or more regional firms? And then any sense of how their productivity would compare to the advisers that you have?
Are they employee adviser type or franchisee adviser? Just some general thoughts on that.
And then separately, I think you talked a little bit about this but I'm not so sure that I have a clean sense. Just you talked about activity picking up in March relative to February and January, but can you give us a sense of how things have trended so far?
I know it's still only a couple of weeks, but in April? Other companies that have reported first quarter results have talked a little bit about things maybe improving a little bit more in April.
Are you seeing that yet or are your clients still pretty much on the sidelines?
Jim Cracchiolo
Well, I think the first is on the recruiting end. It's coming from all the major houses - Merrill, UBS, Wachovia, Banc of America.
So I think the talent is coming in from a number of different places, and we see the pipeline continue to be there. The productivity really is consistent with our overall productivity that we have in the house.
It ranges in the type of advisers, from a few 100 to [break in audio] but mainly we're probably talking in the 300 to 500 range is where we're attracting people that sort of fit with the type of franchise and the type of offers we're making based on also the type of business they want to do, which is more planning and advice-based, fee-based business. And so we think that we're attracting a segment that really is appropriate for us.
Regarding activity, I think we're seeing it a bit consistent with what we saw in March and a bit of a pickup but, again, it's not where we were back to old levels by any stretch of the imagination because, as you know, a lot of our business is not transaction business, it's fee-based business and therefore a lot is based on the asset levels there. And so people deploy money more to it over time; we don't get big increases immediately.
Where we're seeing more transactions is, as I said, more in the fixed product right now. As we saw, variable annuities on the equity side have slowed down, but it's really growing in fixed.
We did move good inflows back into the wrap products in the first quarter but, again, those aren't the type of inflows compared to what we used to have in the past. So I think on one end it's a positive; on the other end, we're not saying that it's off to the races at this point in time.
Suneet Kamath - Sanford Bernstein
In your answer to my question you mentioned 300 to 500 something and I don't know what that something is. Can you just expand that.
Jim Cracchiolo
In production, overall production, so looking at trailing 12-month production levels.
Operator
Your next question comes from Thomas Gallagher - Credit Suisse.
Thomas Gallagher - Credit Suisse
First, not to beat a dead horse here but back on the annuity segment, excluding the FAS 157 adjustment can you talk a little bit about how your hedge asset performed relative to the change in the variable annuity liability because obviously, based on the magnitude of 157, it's a little bit difficult to figure that out.
Walter Berman
Actually, considering the volatility that took place because obviously if you just look at the two end points it doesn't look like the liabilities moved as much as they did, within that element, actually the hedges performed within our tolerances, which are in the 95% range. But, again, you have to take all the points between the beginning point and the end point.
The hedges actually work reasonably effectively. Certainly, it's a big swing that took place, but we were comfortable with it.
Thomas Gallagher - Credit Suisse
So no big deviation, is that fair to say?
Walter Berman
That is fair to say.
Thomas Gallagher - Credit Suisse
Just a follow up question on that. You know, one thing we've been hearing from our derivatives desk is the supply of long-dated hedges is effectively done right now, so just curious, how do you think about managing the risk on what's effectively a long-term option you're giving to the client when the ability to hedge it on the other side appears to be, if not gone, very difficult right now?
Walter Berman
Well, you know, we've heard that also in working with our risk management people. We have not experienced that.
We are still getting the ability to cover our hedging. Remember, the volumes are down and things of that nature on the variable annuities, substantially down, so it's easier and at this time we've slowed down the hedging.
But we still continue to get hedges where we adjust our book and manage them.
Jim Cracchiolo
And we continue to be very focused. We also made sure, you know, with the lower volumes activity, the change in price, but we also will be changing our product set over the next few months as well.
So in the interim period we feel we could manage for the level of activity we have as well as the hedges that we already have on the books.
Thomas Gallagher - Credit Suisse
And then last question is just on your excess capital. I know you'd talked about having more than $1 billion.
I presume that does not include the $500 million of hold co cash and if that's true can you just talk about what are your annual cash flow needs at the holding company? Is it substantially less than $500 million?
Can you just remind us?
Walter Berman
It is substantially less than the $500 million. Obviously, we have good dividend flow coming in from all the subs and our debt service is in the 150 range.
So on that basis it is substantially below the 500 we have and we constantly replenish it though [dividend]. I didn't get the first portion of your question about the 500.
Can you repeat that, I'm sorry.
Thomas Gallagher - Credit Suisse
The only question is should we consider then some portion of the $500 million as excess?
Walter Berman
Yes, absolutely. When we go through our calculation, actually the majority of our excess capital is outside the insurance company, actually.
Thomas Gallagher - Credit Suisse
The majority is outside the insurance company?
Walter Berman
That's correct.
Thomas Gallagher - Credit Suisse
Then I guess I'm having trouble reconciling that because you're talking about a 500% risk-based capital in the insurance subsidiary, which would imply effectively all of your excess capital is there. So you're saying you have $1 billion in addition to that?
Walter Berman
No, I said majority. We use factor base on that and when we analyze on a factor-based situation there is excess in the insurance company, but not to the level that you would calculate using a cash flow tested basis.
So we strictly use a factor base, which creates a lower capital environment, a lower excess position at the insurance. And we have our excess capital positioned at the holding company and we also have it at the other subsidiaries.
Thomas Gallagher - Credit Suisse
So just to make sure I'm clear, so the 500 RBC plus suggests you need to maintain something close to 500 just because you're saying -
Walter Berman
No, no. Remember, you get into - that gets into cash flow test base.
We are looking at it on a factor base and on a factor base we have excess, but it is not at the level that, you know, when you do your calculation. We translate it through on factor base.
Jim Cracchiolo
I would just say this: We're not reconciling to $1 billion. There is more than $1 billion in capital.
There is excess in the life company, there's excess at the holding company, and we also have money in the other subs.
Laura Gagnon
I'd like to interrupt just with a response on the 10-K disclosures. I think this might help everybody in interpreting this number going forward.
In our 10-K disclosures we do not increase our near-term equity rate assumption. So you're looking at a 10% drop over the full five years and not only do we not assume a [break in audio] but also that the equity markets stay flat for the next 12 months.
Walter Berman
So it's extremely conservative.
Operator
Your next question comes from Sam Hoffman - Lincoln Square Capital Management.
Sam Hoffman - Lincoln Square Capital Management
Can you comment on your strategy to improve your investment performance in your equity mutual fund?
Jim Cracchiolo
Yes. First of all, we have seen some nice improvements.
As we said, first of all, Threadneedle is performing very well, very strong, and that's consistent. Our fixed income product have improved nicely and is actually performing quite well.
We have improvement in some of our value area. The tech area [inaudible] have been strong.
Some of their value and growth is still good. We are still weak in a few of our core products and we're focused on that right now and making adjustments to our portfolios and looking at also the positions for the longer term.
So people are working at it, but it's not where we want it to be right now and we'll continue to look at how we can improve that and continue to look at some opportunities to complement what we have in place.
Sam Hoffman - Lincoln Square Capital Management
The second question is: Can you give a bit more color on the recruitment of experienced advisers in terms of how their contracts are structured and whether they become profitable in their first year or how that all kind of plays out?
Jim Cracchiolo
Well, the experienced recruits, we only put a portion of their package upfront. Activity has to occur, they have to bring over assets, their productivity has to hit certain levels to get their greater amount of incentives.
We have arranged this so that we have a very good return on investment here, but it doesn't necessarily give you a return in the first year because people are transitioning over, they're bringing their book, then they've got to get under way in activity. So we've clearly not set this up so that it is set that we have to earn money in the first year on it, but we've compared it to particularly novice recruitment, etc., and it gives us much better returns.
So by just shifting our resources and commitment to this area we'll actually improve our return tremendously from where we used to be with novice recruitment and development, particularly in a market like this. So we think it's a win-win for us and we did set this up so that it's not all upfront where we would put much at risk.
We think that what we put at risk versus what the transition and the adviser would need to do is very balanced.
Sam Hoffman - Lincoln Square Capital Management
And one final question, just to get back to the annuity segment. If equity markets remain flat for the foreseeable future, what impact would that have on earnings from variable annuities?
Walter Berman
Remain flat from this point on?
Sam Hoffman - Lincoln Square Capital Management
Yes, I mean for a few years let's say. What would be the impact on earnings from variable annuities?
Walter Berman
I can't give you the exact number. It would have a negative impact, obviously, because the assumptions are predicated on normal growth of the markets.
Jim Cracchiolo
It would hit us through the DAC being [reversed]. That would assume that markets do grow because you're tied to the equity markets, so if they didn't grow we would have to take another DAC reversion hit.
Walter Berman
Right. And so when you go through your initial period, obviously one thing, but you get to your long-term rate, which is assuming 9% growth on equity markets - actually it's less dividends.
So it would have a big impact, yes.
Sam Hoffman - Lincoln Square Capital Management
There's no way you can help us in terms of kind of tying it to what's happened in the last few quarters?
Walter Berman
Well, the impact that you saw in the fourth quarter was substantial and in this quarter it certainly was impacted. Again, we're amortizing the decrease that took place in the quarter over five years until we get to our long-term rate, which is the 9.
But again, as we indicated, we've got an offset as relates to the credit default swaps widening out, so the net impact was actually -
Jim Cracchiolo
I mean, if you're talking this year, we assumed that this year wouldn't be a strong market, it would become flat or relatively weak in that sense, but we didn't necessarily assume that for the next five years the markets would be flat.
Walter Berman
Yes, because what we assumed, it would be a slower recovery in this year and then as we moved away from the bottom [inaudible] you would have a spike, which we've seen in prior patterns, and that's what it was predicated on.
Sam Hoffman - Lincoln Square Capital Management
It's just hard for us to calculate, but we'll do our best.
Laura Gagnon
It's hard for us to calculate.
Walter Berman
The actuaries work on this all the time.
Jim Cracchiolo
I'm not trying to be cute. It would have a devastating impact because really, it depends on market increases and what we're doing, we're adjusting our models now to reflect - and that's when you get different aspects of the business performing, in those situations.
But in variable annuities it does depend on the markets appreciating and that's what estimated gross profits are based on.
Laura Gagnon
Operator, we have time for one more question.
Operator
Your last question comes from Eric Berg - Barclays Capital.
Eric Berg - Barclays Capital
I have a couple. I'll keep it to the two to give people a chance to get home in this evening hour here and I'll finish up with Laura separately.
So I see that the number of branded financial advisers has increased by roughly 5% year-over-year to 10,550 from 10,000, but how do we see - maybe it's because I don't have your slides in front of me, just your news release and statistical supplement - can we see in your financial supplement how the quality of your sales force has improved? Because this talks to me only the numbers of people.
The net sales actually went down, no surprise there, reflecting the market. Can we see in the supplement how the quality of these people has improved?
That's my first question.
Walter Berman
I'd say, Eric, I don't know how you would see that. First of all, you've got a number of variables being that you're in very weak markets compared to a year ago.
And as you know, the fourth quarter and first quarter are weak and I think you'll find that across the industry. Second of all, if people are just coming onboard now they're not even producing yet, they're just joining the firm.
So at the end of the day they're bringing over their assets, their [inaudible] and etc. You're not going to see productivity, particularly across a sales force of 10,000 from 200 people joining.
So I think you've got to factor that all in, but what I would say is the way to think about it is this: In the past we brought on novices and novices had no book. It would take them months and even years to book that matured to a level of assets and productivity.
And in this case we'll have people transfer in, those people clearly will be productive within weeks, they will bring their book over and that book over time will be up to more of an ongoing status of what our experienced people are doing. Therefore, as you look at that versus in the past and our numbers were a lot more novices not producing any, our averages will go up.
And particularly you'll see them go up in our employee network first, but then overall, as they add more, depending on how many we bring in. So I do believe that it's not so much in the number of advisers, because we're bringing down the number of novices, which will save us money and cost and expense, but the people we are bringing onboard, even though the numbers may not be higher in total, but the numbers of experienced people that really have books of business can be productive very quickly.
And so if you take that out a year or two and production comes back, meaning markets improve, it will give us a lot more leverage.
Eric Berg - Barclays Capital
My second question deals with the annuity business and its sufficiently detailed, but I'm going to work with Laura on it, so why don't I cede back to you. Thank you.
Jim Cracchiolo
Okay, that's as much time as we have tonight. I want to thank you for listening in and for your questions.
Laura will be able to take any more of your questions tonight and tomorrow so that you can update your models with information. As I said, I do feel that we had a good relative quarter based on the market conditions.
We think that we are managing the business prudently. We think we're managing it conservatively.
We think that our financial position remains strong and gives us some degree of freedom as we move forward to take advantage of the opportunities that may be there. And so I would just say after the first quarter, which none of us like the environment, I still feel quite good about our position to navigate it and to deal with the things at hand.
So I appreciate your time and thank you very much for listening.
Operator
Thank you, ladies and gentlemen. This concludes today's conference.
Thank you for participating. You may all disconnect.