Welcome to the third quarter 2011 earnings call. My name is Sandra, and I'll be your operator for today's call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Please note that this conference is being recorded. I will now turn the call over to Ms. Alicia Charity. Ms. Charity, you may begin.
Thank you, and welcome to the Ameriprise Financial third quarter earnings call. With me on the call today are Jim Cracchiolo, Chairman and CEO; and Walter Berman, Chief Financial Officer. Following their remarks, we'll be happy to take your questions. During the call, you will hear references to various non-GAAP financial measures, which we believe provide insight into the underlying performance of the company's operations. Reconciliations of the 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 2010 annual report to shareholders, or our 2010 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.
Good morning. Thanks for joining us for our third quarter earnings discussion. I'll begin with an overview of our performance, and then Walter will discuss our financial results in more detail. Overall, we generated another solid quarter despite very challenging market conditions, and we continue to demonstrate the strength of our diversified business model. In our advisory business, earnings were up nicely, and our advisors remained highly productive. In asset management, our net outflows increased primarily due to the equity market weakness and volatility. The business still produced solid earnings. At the same time, our insurance and annuity businesses generated solid underlying performance despite significant market impacts, the related DAC unlocking, and some catastrophic losses in auto and home. Our strong financial foundation continues to serve us well. We're maintaining more than $2 billion in excess capital.
We're continuing our investments for future growth. We've accelerated our share repurchases. During the quarter, we bought back nearly 10 million shares, returning $447 million to shareholders. In fact, so far this year, we returned $1.4 billion, or nearly 150% of our operating earnings, through buybacks and dividends. I'd like to briefly discuss the markets and their effect on our business. Then I'll provide some commentary on our underlying performance. Both the equity markets and the interest rate environment worked against us in the quarter. As you know, the S&P 500 was down 14%. The markets were quite volatile. The drop in equities affected our DAC mean reversion. The market conditions also drove an industry-wide pullback in equity investing, which affected our flows in asset management and wrap accounts. Our overall assets were down as well, which reduced our fees.
At the same time, long-term rates fell substantially because of the Fed's twist action. Shorter rates remained near zero. The interest rate movements impacted our DAC unlocking. Had a continuing effect on our spread revenue, which Walter will discuss in more detail. Even with the fairly severe headwinds we're facing, the business generated good results. I feel confident about our ability to navigate the markets. Our diversified mix of businesses, along with our strong capital position and flexibility, gives us the ability to manage through this near-term disruption and accelerate our growth when conditions improve. In fact, I believe we're in a stronger position today than ever before. To illustrate, I'll talk about each of our businesses and help you understand their performance apart from the market impacts. First, our advice and wealth management segments generated another strong quarter.
In fact, despite market conditions and despite the fact that our third quarter is typically slower for us, the segment delivered record pretax operating earnings of $116 million. Advisor productivity remained near all-time highs at $97,000 in operating net revenue per advisor for the quarter. We generated retail inflows. However, overall wrap inflows of $800 million were down from previous quarters as advisors held more cash in their clients' accounts. We're continuing our long-term investments in our advisor force. They are providing important benefits. Our experienced advisor recruiting effort delivered its best quarter since the financial crisis in 2009 with 88 recruits during the quarter and 37 in September alone. Advisors across the industry are seeing the benefits of our model. As a result, our pipeline of potential advisor recruits is quite full.
In addition, our new national advertising campaign featuring the Academy Award winner Tommy Lee Jones has been very well received both by advisors and consumers. You can expect to see more of our ads as we move into 2012. We're also continuing the rollout of our new brokerage technology platform, which combined with all our other advisor support, is enabling advisors to be more productive and grow their client bases. All these improvements have led to remarkably strong advisor retention and satisfaction rates. Retention of our most productive franchisee advisors is up to an all-time high of 97%. As we're completing the transformation of our employee channel, our employee advisory retention rose to 91%. That's an increase of 13 percentage points in just one year, and it's up 30 percentage points over three years ago. Now I'll move on to asset management, where the fundamentals also remain solid.
In the U.S., Columbia Management was in net outflows in the quarter, which was consistent with a very tough quarter for the industry. We did make some progress. We drove net inflows in some categories that are in outflows for the industry as a whole, and our market share improved in key distribution channels. In the domestic institutional business, we reported net outflows of $2 billion, about half of which came from a single expected Bank of America Balboa insurance redemption. We have won several good institutional mandates recently, and our new mandates are generally producing higher fees than the business we're losing, so the revenue impact of the net outflows is relatively muted. Given the extremely volatile conditions in Europe, Threadneedle moved to net outflows of $1.2 billion in retail funds.
Institutional flows were quite strong and new wins more than offset continued Zurich outflows, resulting in net institutional inflows of $414 million. We're particularly pleased that Threadneedle won several new mandates, including several in the Middle East, which demonstrates the expanding global reach of our asset management distribution. While the flows picture was challenging in the quarter, both for us and for the rest of the industry, I feel good about our ability to improve flows over time for a number of reasons. First, investment performance remains strong both in the U.S. and at Threadneedle. Columbia Management increased its number of four and five-star funds from 52 to 54, which is among the most in the industry, and Threadneedle's performance remains excellent. Second, we're making good progress reestablishing wholesaling relationships now that our teams have been in place for several quarters.
Third, our institutional pipeline is quite strong and continues to grow. Fourth, we're dealing effectively with former parent-related outflows that we expected as part of the acquisition, and we're generating good revenue offsets for the outflows. Fifth, Threadneedle is making good inroads as it expands its distribution to Asia and the Middle East. Finally, Columbia integration is essentially complete with only final technology work remaining. Now I'll move on to annuities and insurance. The annuity business performed in line with our expectations despite the market-driven DAC impacts. Net inflows continue to be impacted by our decision to exit outside distribution of variable annuities and by the expected lack of fixed annuity sales given low rates. That said, we feel very good about our decision to exit outside distribution of variable annuities. It has given us a stronger risk profile while reducing the capital required by the business.
We've also been able to focus all of our wholesaling efforts on Ameriprise advisors, and sales remain quite strong. In the quarter, variable annuity net inflows in our advisor channel were about $400 million as advisors and clients continue to find our relatively new annuity product attractive. In the insurance business, life and health sales remain challenging. Clients continue to be reluctant to commit cash to long-term investments, especially in products like variable universal life, which has been one of our strongest products. We are seeing some pickup, in part because of the introduction of our new equity index universal life product. We also benefited from good claims experience in the quarter. In the auto and home business, catastrophic claims were higher than usual, primarily because of Hurricane Irene, but the catastrophic losses remain very manageable for a business of our size.
Sales in auto and home continue their steady upward trend, with policy counts increasing 8% over a year ago. In addition, we are in the process of raising auto insurance rates, which should help improve the earnings for that business. To summarize, we certainly are feeling the impacts of the market environment, but the conditions are very manageable for us, and I feel very good about our positioning. We're driving strong improvements in earnings and profitability in our advisory business. The asset management business is holding up well despite very tough conditions, and we have a strong foundation to build on in that business. Insurance and annuities remain solid contributors outside of the quarter's DAC expenses and catastrophic losses. Our foundation is as strong as ever. Our balance sheet is in excellent condition, and we are returning significant capital to shareholders while investing for growth.
I continue to believe we have the right strategy, the right market positions, and the right foundation to navigate this period in the markets and emerge stronger, just as we've done before. Now I'll turn it over to Walter.
Thank you, Jim. Our reported earnings in the third quarter clearly reflected the challenging environment we've been operating in. The S&P was down 14% sequentially point to point, and 7% on average. The 10-year Treasury declined 125 basis points to about 1.9%, and corporate spreads widened. We had some pretty severe weather, which impacted auto and home claims. The most pronounced impact on our earnings was in the annual and quarterly changes in DAC amortization, which resulted from negative market movements. With this as a backdrop, core business trends were solid with earnings growth in advice and wealth management. Underlying results in asset management, annuities, and protection were all within our expectations. Our balance sheet remained very strong, and we will continue to shift to low capital-intensive businesses. On slide four, you'll see a breakout of the different items that impacted results in the quarter.
Particularly given some of the large year-over-year changes. First, there were two different DAC impacts in the quarter. One from our regular mean reversion that captures equity market movements. The other is our annual DAC unlocking, which factors in our other assumptions like interest spreads and policy holder behavior. As you can see, the combined impact of the DAC items reduced year-over-year earnings by $0.42. The mean reversion in the quarter was a $-0.17 compared to a $+0.10 last year, reflecting a decline in the equity markets. The DAC unlocking was a $-0.10 compared with a $+0.05 last year. The annual DAC unlocking was primarily driven by lower interest spreads, offset partially by continued strong persistency. Excluding DAC impacts, there were a few unusual items in the quarter that were largely offset in aggregate to about $0.01 per share benefit.
Now let's look more deeply at the drivers for Ameriprise in each segment. We generate 8% revenue growth and are driving a higher contribution from our less capital-demanding businesses. Management and distribution fees had a double-digit growth. While we had a 1% growth in net investment income reflecting lower portfolio yields. Overall, we continue to shift our revenue base to our less capital-intensive businesses of advisor wealth management and asset management, which represented 58% of the revenues in the quarter. Turning to capital on the next slide. During the quarter, we repurchased 9.9 million shares for $447 million. Between both share repurchase and dividends, we have returned more than $2.1 billion to investors since we began our repurchase program in the second quarter of 2010. This represents about 110% of our operating earnings.
At our life companies, the estimated risk-based capital ratio is over 600%, well in excess of the required amount. We are planning to take a fourth quarter dividend of around $850 million and intend to manage RiverSource Life over the long term at an RBC ratio below 500%. Our hedge program is effective, and the quality of our balance sheet is strong. The investment portfolio is high quality and had $2 billion of net unrealized gains at the end of the quarter. We had no sovereign debt in Greece, Ireland, Italy, Portugal, and Spain, and only $50 million of holdings in the U.S. subsidiary of a financial institution in Spain. We are very comfortable with our holdings in Europe, and you can find additional details on these holdings in the appendix of this presentation.
Before I move into the segment results, I want to touch on two special topics, the adoption of EITF 09-G and the impact of a prolonged low interest rate environment. Let's start with the DAC accounting changes that will be effective in January. We will adopt EITF 09 on a retrospective basis. We estimate that this will result in a reduction to our DAC asset of between two to $2.2 billion, which represents about 45%-50% of the current DAC asset. On an after-tax basis, this is estimated to reduce book value between $1.3 billion-$1.4 billion. It is expected to have a slight favorable impact on earnings in 2012, and the reduction in book value will increase our return on equity going forward.
The amount of DAC that we are writing off is primarily a result of our distribution model and not due to having an aggressive deferral policy. We have sold the vast majority of our products through our advisor versus using a third-party distribution channel. Since this is an affiliated distribution model, there are sales-related expenses that we can no longer capitalize since they are not linked directly to a successful sale. Examples of these selling costs include certain compensation and benefits of employee advisors, field leadership, and wholesalers, as well as some branch office selling costs and support staff. This change has no impact on our statutory accounting and therefore will have no impact on our excess capital position. Importantly, the reduction in the size of the DAC asset should reduce equity market-related quarterly earnings volatility.
Let's move to the potential impact from low interest rates on the next slide. Clearly, the current rate environment is not the best for our business. The biggest impact is in the fixed annuity business. However, the pressure we would expect to see on earnings if the 10-year Treasury remain low is very manageable. We estimate that in 2011, low rates will reduce earnings by an estimated $30 million. If rates remained where they are now, it would impact us by an incremental $35 million in both 2012 and 2013. This evaluation is based upon a static view of the business currently on our books and does not project new business growth. We do not anticipate low rates to have an impact on reserves or our excess capital during this period. Like I said, we view this impact as very manageable.
Let's take a closer look at our operating performance, starting with Advisor Wealth Management on the next slide. Earnings in Advisor Wealth Management increased 30% and margins increased to 12.4%, up from 10.7% last year. We continue to improve Ameriprise advisor productivity and grow client assets. Client wrap asset net flows were over $800 million, despite the weak equity markets during the quarter. We saw a 10% increase in the brokerage cash to $14.1 billion, and these balances currently earn only about 40 basis points. Turning to asset management. Asset management earnings include about $10 million of project-related expenses at Threadneedle relating to a change of transfer agents. While this resulted in additional expense now, it does reduce expense over time. Excluding these items, earnings in the segments increased 7%. Adjusted net operating margins were 32.7%. If you exclude the higher expense at Threadneedle, margins increased to 35.1%.
The Columbia integration is progressing well, with all the fund mergers completed and net synergies on track for our target of $130 million for 2011. The technological integration is taking a bit longer than we anticipated, and we are now targeting a complete separation early 2012. Turning to annuities. Operating pre-tax income was down year-over-year. As you can see, most of that was related to the $183 million swing we saw in DAC. In addition, earnings benefited from about $33 million in higher investment income. This was associated with an adjustment we made to the recognition of prepayment income on some structured securities. Adjusting for these impacts, earnings decreased by about 16%, primarily from lower fixed annuity earnings, reflecting spread compression and lower account values. The fixed annuity book continues to experience net outflows, reflecting low client demand in the current interest rate environment.
From a sales perspective, the Ameriprise channel continued to generate strong sales of our RAVA variable annuity product. As Jim said, net flows in this channel were about $400 million. Overall, variable annuity deposits are down 10% given our decision to exit outside distribution last year. During the quarter, we also announced plans to increase the fees on our living benefit riders and variable annuities to reflect current market realities. Let's move on to protection. Operating pre-tax income in the protection segment was also impacted by DAC, as well as $23 million of higher weather-related losses in the auto and home business. If you exclude these items, earnings increased 3% year-over-year as underlying results in both life and health and auto and home were good. Auto and home revenues increased 5% over last year, primarily driven by growth in the sales through our partnership with Progressive.
We have seen improving trends in the auto bodily injury claims. In the life and health businesses, earnings were consistent with our expectations given improvement in the overall claims levels. Turning to the trends in the firm's return on equity. Returns in the quarter declined to 13.4% from a high of 14.5% last quarter. Since we calculate the return on equity on a trailing four-quarter basis, this does reflect the year-over-year swing in DAC unlocking as well as higher catastrophic claims in the auto and home. Given the challenging market environment, returns are holding up well. In conclusion, our underlying business performance this quarter was solid. Earnings were affected by the markets, we continue to invest in our businesses, we are well positioned for growth when the equity markets come back. We are facing some headwind from low rates.
As we look ahead, the impact of prolonged low interest rates on earnings is quite manageable. Our risk management discipline is paying off under these conditions, we continue to prudently run our business. We have an effective hedging program against our variable annuities liabilities, our balance sheet is strong. The business mix continues to shift to lower capital businesses, which provide a strong source of excess capital. As we have demonstrated, we are prudent capital managers, will continue to return capital to shareholders as appropriate. We'll take your questions.
Thank you. We will now begin the question- and- answer session. If you have a question, please press star then one on your touch tone phone. If you wish to be removed from the queue, please press the pound sign or the hash key. If you're using a speakerphone, you may need to pick up the handset first before pressing the numbers. Once again, if you have a question, please press star then one on your touch tone phone. The first question is from Suneet Kamath from Sanford Bernstein. Please go ahead.
Thank you, good morning. I guess I have a couple questions. First, on the RBC ratio and the excess capital of $2 billion, and the RBC ratio of over 600%. My understanding is some of the improvement from last quarter came from the increase in value of the hedges that you have on the books for your variable annuity business. If that's the case, and markets rise obviously, in the fourth quarter, some of that benefit will unwind. I guess what I'm trying to get at is how much of this excess capital that you're talking about is really sort of redeployable or cash that you're comfortable taking out of life subs to support redeployment going forward? Thanks.
It's actually totally because the hedges actually just offset the basic liability that we had, they act in unison with it. It actually provided the protection we needed, it is totally available for distribution.
Just to be clear, the increase in the RBC ratio from last quarter to this quarter was not driven by the change in value of the hedges because that change in value is offset by something else?
That's correct. They go in lockstep.
Okay. Got it. Moving on to the share repurchases, obviously more opportunistic in the third quarter. How are you thinking about the pace of buybacks going forward? Does this 09-G impact which obviously is not a statutory event, but it will change things like debt to capital, on a GAAP basis. Will that influence the pace of redeployment?
No, I do not believe it will. We have discussed this and reviewed this with the rating agencies and as again, it is a non-cash event, and on that basis, they viewed it, and they feel that we're in the ranges that could allow us to continue on the repurchasing.
Would you say the kind of current pace is about what you're thinking?
Suneet, we'll continue to review the opportunity for repurchase as well as other forms of redeployment. What we would say is that we're trading way below our intrinsic value, we saw it as a good opportunity in the third quarter, and we'll continue to review it appropriately as we move forward.
Okay, great. My last question is just on interest rates. I appreciate the earnings discussion in Walter's presentation, I was a little curious that the equity allocated to long-term care as one example, actually fell in the quarter by a fair amount. I was curious about some details in terms of that, especially given the low long-term rate environment. I guess the bigger question is how are you guys thinking about when the rate environment, if it persists, sort of moves from an earnings drag issue, which you sort of quantified to something that might be a little bit more serious in terms of either statutory reserves or DAC or anything like that. That would be helpful. Thanks.
On the long-term care, that was a reserve adjustment based upon actuaries evaluating it. They made a statutory reserve adjustment, and that was something that has been evaluated and was implemented in the third quarter. On the interest, we are continually evaluating that, and obviously, we do not see it having a significant impact as the schedules indicated. We will then have to evaluate it if it does continue beyond the two years that we discussed, 2012 and 2013. We certainly feel our capital and our earnings capacity will be able to deal with it in the near term, and then we'll have to evaluate what changes have to be post that.
Okay. Just quick follow-up on the long-term care statutory reserve release. Was there a GAAP earnings benefit from that in the quarter?
No, there was not. It was strictly statutory.
Okay. All right, terrific. Thank you.
Thank you, Suneet.
As a reminder, if you would like to ask a question, please press star, then one on your touch-tone phone. The next question is from John Nadel from Sterne Agee. Please go ahead.
Hey, good morning. Two questions for you, if I could. In asset management, can you help me with the distribution fees and distribution expenses? If I look at distribution fees, they fell 12% quarter-over-quarter. I'm looking at 3 Q versus 2 Q, and that's about what I was expecting. Distribution expenses remain flat. I thought there was supposed to be a relationship there where there was almost a direct function of distribution fees, but that clearly wasn't the case. Can you help me understand what happened there?
I think it is that while certain of the parts certainly fluctuate with it, there are elements that don't as it relates to, some are tied to account fees, some are tied to wholesaling and other factors. You get to timing differential, we anticipate that timing differential will adjust itself. As you saw, the net change was about $13 million. When you take the distribution revenue minus distribution expense, we had additional $13 million. We don't see an issue with that. It will adjust itself.
That will come back to you. How quickly does that happen, Walter?
It will come back in. It depends on what happens to the markets and other things of that nature. It's more of a timing. I don't have the exact elements, but certainly, it'll be driven by the market, and it will happen obviously, depending on how markets move. It's not a perfect correlation.
Okay. Maybe I'll just follow up offline on that one.
No problem.
Just thinking about, again, on asset management, just where you guys are on integration, gross and net saves. I think you made the comment about $130 million on target for that for this year. Can you just reset for us where you guys were coming out of this quarter, how much you have incrementally and what we should be expecting in 2012?
Yeah. As I indicated, the synergies will hit the $130 range, as we talked about for 2011. With the delay on the re-engineering, that will carry over into 2012 as we implement the one-time charge as activities, and we do complete the final integration. We are on track to be through 2012 in the $140 range on our synergies.
Are the one-time costs, I forget what that was originally expected to be, given the timing and the pushout on the system side, are you expecting that the one-time costs related to the integration process are going to be a bit higher?
Yes, they are. Obviously, take a look through the third quarter, about $182, they will be higher, we are assessing that right now.
Okay, thank you very much.
You're quite welcome.
Thank you. The next question is from John Hall from Wells Fargo. Please go ahead.
Good morning, everyone. I have a few different questions. The first one has to do with the dividend that you indicated you're going to pay out of the life companies in the fourth quarter, that $850 million. Is that encumbered in any fashion, or is that free and available?
Well, I think the majority of it is not encumbered. We will get permission from the Superintendent of Insurance, we are in the process of doing that. We do not see an issue with that.
Okay. On the DAC write-off, just wondering if you could comment because we've been seeing a number of other companies report similar types of things. At this juncture, the size of your write-off relative to your DAC balance is on the higher end of things. I was just wondering if you could comment on what it is about either your book of business or perhaps your DAC policies that would lead to that result.
Sure. First and foremost, it is totally appropriate, the level that we're doing a write-down from that standpoint. It primarily focuses on the nature of the business and written through the inside channel. Certainly, if you look at the components, if you look at the comp component and then the selling rate as it relates to the DAC that you would have in those two components, the impact relates to as an inside channel. Those elements under the new rules of being a successful sale are more subject to reversal from that standpoint of the policy that was in effect prior. Since we have the bulk of our activity through the inside channel, that's where the impact is coming on the reversal of that DAC.
Whereas if you sold in an outside channel, most of that is absorbed through the comp rate, which is again tied to a successful sale, therefore it does not get reversed. We've been through this. We've reviewed it, we've reviewed it by audits, certainly have been evaluating, we feel it's totally appropriate based upon the type of business and the focus in the channel that it evolved from.
Great. Just moving on to, I guess, fund flows. Jim, I was wondering if you'd just comment on the momentum that Threadneedle is showing in the Middle East. What's all of a sudden driving that, or is it not that sudden? Is there sustainability around it?
Yes. As you are aware, we had mentioned over the last few quarters that we've been expanding our distribution with Threadneedle to the other regions of the world, one of the ones that we started to really develop last year was the Middle East. Over the course of the year, we've been winning mandates coming from the Middle East. We've also expanded recently to Asia, we think that that will start to also bear some fruit as we move to the next number of quarters as well. We do believe that it is something sustainable. Threadneedle has excellent product. As you know, based on what we've experienced in Europe and the sovereign debt crisis, we experienced some lumpiness in redemptions, et c, because of what has occurred.
We're also seeing that come back quickly again, as we saw previously when that ticked up again as an issue in Europe earlier in the year. We do feel like the pipeline for Threadneedle is good, it's strong, we can continue to win good mandates. Their investment performance over the cycle has been quite good, they have really good products. We think that that will continue.
Great. Thank you very much.
At this time, we have no further questions. Mr. Cracchiolo, I will turn the call back over to you for closing remarks.
Thank you. We appreciate you listening in this morning. As I opened the call, even though we've experienced another impact from the market environment, stock market being down a lot in the quarter, we do feel like the fundamentals of our business remain quite solid. As we look across the businesses, we feel very comfortable with the position in the hand that we have. We feel good that if this environment continues, we can navigate even stronger than we did the first time out. In addition to that, we do believe that as markets continue to repair and stabilize, the foundation we have in place, the investments we continue to make, and the traction we're gaining, including with the asset management businesses as we have really integrated and stabilized them, will bear fruit as we move forward. We have de-risked the business.
We feel very good about our capital position. Volatility is lower. We really have an excellent book in our annuity business. Even though there are the normal exposures from market declines, et cetera, on a relative size and scale, it's very manageable for the size and scope of our business and the diversity of our business and the capital position. We will update you even further as we talk at our financial community meeting, which is November 16th at 8:00 A.M. at the New York Stock Exchange. We look forward to having a very good conversation with you and outlining how we'll continue to make progress as we move forward.
Also to discuss any of what you might think as issues or concerns in the environment so that we can actually quantify that for you and qualitatively give you how we think about it so that you can make informed decisions. We appreciate your time and thank you very much, look forward to speaking to you further.
Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.